Q2 2019 Earnings Call

Welcome to the Western asset mortgage mortgage capital Corporation's second quarter 2019 earnings Conference call.

Today's call is being recorded and will be available for replay beginning at five PM Eastern standard time.

At this time, all participants have been placed in the listen only mode and the floor will be opened for your questions. Following the presentation.

Now first I'd like to turn the call over to Mr., Larry Clark Investor Relations. Please go ahead Mr. Clark.

They could yet.

Well. Thank you everyone for joining us today to discuss western asset mortgage capital Corporation's financial results for the three months ended June Thirtyth 2019.

The company issued its earnings press release yesterday afternoon, that's available on the company's website at Www dot western asset M.C.C. Dot com.

In addition, the company has included an accompanying slide presentation that you can refer to during the call.

You can access these slides in the Investor Relations section of the website.

With us today from management or Jennifer Murphy, Chief Executive Officer, Lisa Meyer, Chief Financial Officer, Nurture Baun, Chief investment Officer.

Before we begin I'd like to review the Safe Harbor statement.

This conference call will contain statements that constitute forward looking statements within the meaning of the private Securities Litigation Reform Act of 1995.

All such forward looking statements are intended to be subject to the safe Harbor protection provided by the Reform Act.

Actual outcomes and results could differ materially from those forecasts due the impact of many factors beyond the control of the company.

All forward looking statements included in this presentation are made only as of the date of this presentation and are subject to change without notice.

Certain factors that could cause actual results to differ materially from those contain forward. Looking statements are included in the risk factor section of the Companys reports filed with the Securities and Exchange Commission.

Copies are available on the Fccs website at Www Dot FCC Dot Gov.

We disclaim any obligation to update our forward looking statements unless required by law.

With that I'll now turn the call over to Jennifer Murphy Jennifer.

Thank you Mary welcome everyone.

Our strategy to position western asset mortgage capital in sectors of the mortgage market, where we see attractive risk adjusted returns like drawing on the power of our global manager Western asset continued to show in our second quarter results.

The weapons robust origination and banking relationship we added 1.2 billion in target assets, including both residential and commercial idea for our agency portfolio and non agency MBS commercial loans and GFT risk transfer securities for our credit sensitive portfolio.

Our investment team was very active this quarter as the significant interest rate volatility in the fixed income market created what we believe to be compelling investment opportunity in the mortgage sector.

Despite the backdrop of a market characterized by heightened rate volatility we've continued to deliver solid financial performance generating 21 cents in earnings per share on a GAAP basis for the second quarter.

Core earnings of 31 cents per share for the quarter and 63 cents per share for the first six months.

And posting an economic return on book value of 1.1% for the quarter and 6.5% year to date, an annualized rate of 13%.

We continue to demonstrate our commitment to paying an attractive dividend that sustain <unk> strong core earnings.

Our second quarter dividend of 31 cents per share represents an annualized yield on average book value of 11.7% and remained consistent for 13 consecutive quarters.

Over that same time period, our core earnings have exceeded our total dividends paid by just over 8%.

We believe this is a direct result of our differentiated investment strategy, which has enabled us to assemble a diversified portfolio of mortgage related assets, which itself is a direct result of our ability to draw on the breadth and depth of western asset global investment risk and operating platform.

As we stated before we view our association with Western asset that's an important strategic advantage for W.M.C. and its shareholders.

We're also pleased to have completed two significant capital markets transactions during the quarter.

In May we completed a $49 million equity offering which allows us to take advantage of what we thought at compelling investment opportunities afforded by the powder rate environment.

The threeg enabled us to further invest in our target asset.

We believe this offering enhances the overall earnings power of our portfolio well also supporting our long term goal of growing the company to achieve better scale and increasing liquidity.

Well, we already enjoy many of the benefits of the global scale of Western asset. We continue to see specific benefits of increased scale for doesn't know see including allowing us to spread our fixed cost over a larger equity base, increasing our ability to sustain origination relationship on favorable terms and enhancing the liquidity of our shares Oh, which should accrue to the benefit of our shareholders.

In June we completed the securitization of a portion of our residential whole loans, resulting in the issuance of $919 million in mortgage backed note.

This transaction represents the Companys first securitization and enables us to finance our assets with longer term fixed rate financing at attractive levels.

Our successful execution of this financing also reflects the company's ability to leverage the platform of western asset as western has established relationships in this sector the financing market, having completed prior securitization on similar pools of mortgage loan.

We're pleased with our solid financial results in the second quarter and year to date, we remain focused on our primary objective of generating consistent and sustainable core earnings that will support an attractive dividend, while maintaining a relatively stable book value for our shareholders.

With that I'll turn the call over to our CFO Lisa Meyer Lisa. Thank you Jennifer the second quarter was another strong quarter for WMC.

Driven by our ninth consecutive quarter solid core earnings.

During the quarter, we generated net income of $10.6 million or 21 cents per share.

Core earnings of $15.8 million or 31 cents per share.

Oh portfolio continues to consistently generate income that covers of 31 cents seven which has remained confident 13th consecutive quarter.

A key contributor to our ongoing strong performance without diversified investment portfolio.

As Jennifer mentioned Harris who'll provide more detail, we continued to assemble a portfolio about harvest assets, including both credit sensitive investments in agency MBS.

We look at particularly active during the second quarter, putting to work the capital that we raised some equity offering we increased the size of our total portfolio by over $900 million.

Net of pay off an exit.

Primarily by acquiring approximately $1.1 billion of agency MBS.

And $137 million in credit sensitive investments.

In the quarter, our portfolio generated net interest income of $20.4 million inclusive of hedging costs.

Our credit sensitive investments contributed $14.5 million or 72% of the total compared to 62% in the second quarter of 2000 and <unk>.

Our annualized net interest margin in the second quarter was 2.14% down from 2.6% in the first quarter. The decline was the result of lower weighted average yield on our portfolio due to higher proportion of agency securities.

<unk>, partially which was partially offset by a decrease in the effective cost of funds.

Turning to expenses total expenses for the quarter were $5.1 million down $200000 from the first quarter of 2018.

The decline was mainly due to lower professional fees and lower loan servicing fees on a residential bridge loan as a result of $67 million of pay off and no new reinvestment in this asset class.

These reductions were partially offset by increased compensation expense and other general expenses.

Our leverage ratio was 5.6 times at the end of the quarter, which excludes the $1.6 billion of non recourse securitized debt down from 5.9 times at the end of the first quarter.

As Jennifer mentioned, we completed our first securitization during the quarter backed by a portfolio of residential whole loans.

This long term non recourse financing was beneficial to us for a number of reasons.

Including the eight being able to lock in an attractive long term interest rate as well as being able to provide less collateral then would have on the alternative sources of financing.

Over time, we expect our adjusted leverage ratio will vary depending upon the mix of our agency and credit sensitive assets in the portfolio.

At June Thirtyth, we had $2.9 billion of repo borrowing and eating about 33 master repurchase agreement.

And $69 million outstanding under our longer term financing facility.

We continue to operate with a significant degree of interest rate protection on our own purchase agreement financing from an interest rate swap position.

At quarter end, we held interest rate swaps, the net notional amount of $2.4 billion, excluding forward starting swaps.

Covering over 80% of our outstanding repo exposure.

The net duration gap went up what sort of HFI portfolio, but 0.09 years.

With that I will now turn the call over to parse the fun huh.

Thanks Lisa.

My first quarter as CIO WMC certainly proved to be an eventful one to quickly recap we saw significant rally in the rates market and nearly a 10% decline in the equity market only to see the sell off completely retreat by the ended the quarter. We also completed an equity raise.

Shoot our first securitization and added a sizable exposure to the agency RMBS market for the first time in eight quarters.

Our view of the macro environment has not changed materially nor do we anticipate any near term changes to our broad market view.

Interest rates have remained low with sporadic episodes of increased rate volatility inflation remains well below target levels. The U.S. economy continues to grow at a subdued get steady state and has modestly outperform the slower global economy.

Central banks around the world continue to be accommodative in light of the slower global growth outlook.

Domestic real estate market, both residential and commercial remain relatively healthy against the backdrop of ongoing job growth positive household formation and limited new supply.

Looking ahead, we believe that the credit spreads that they will continue to perform well in this environment and we continue to find compelling investment opportunity.

In residential and commercial whole loans.

We also believe that our agency MBS holdings, both commercial and residential provide an important balance to our credit sensitive assets and will remain a core component of our portfolio.

Now turning to our activity during the quarter, where we added over $1.2 billion of investments in the portfolio consisting of both credit sensitive assets and agency MBS.

For the first time in several quarters reinvested back into agency RMBS, taking it from essentially no exposure to just under $600 million or nearly 12% of our total portfolio at quarter end.

For quite some time, we have been cautious about agency RMBS due to its high sensitivity to interest rate volatility and its convexity profile previously become more attractive investment opportunities in other areas of the mortgage market. However, in the second quarter. The agency mortgage market provided a better entry point.

With the more attractive opportunities to invest in agency RMBS and in combination with our equity raise we were able to leverage off the larger western asset platform and quickly we established a meaningful position in this sector of the market.

We also added $500 million of agency CMBS to the portfolio as we continue to see attractive risk adjusted returns in that sector.

We invested $137 million on the credit side of our portfolio, primarily in the structured market through investments in both agency.

Non agency CMBS and GFC risk transfer securities on the residential side.

And while we invested any 50 million dollar commercial whole loans, we continue to be active in the residential whole loan market, mainly non QM mortgages originated by our growing base of partners.

Although we did not close any residential whole loan transactions in the second quarter, we do expect to close some transactions in Q3.

It should be noted that our ability to invest in such a large amount of capital in a very short period of time is reflective of our access to western assets global platform.

Providing WMC the scale not only identify attractive opportunity, but also to source structure underwrite and manage these investments.

This is something that we could not do as a standalone mortgage rate.

In summary, we are very pleased with the performance of our portfolio during the quarter and we continue to focus on our goal of delivering solid core earnings and preserving book value. Our differentiated investment strategy is based on holding a diversified portfolio of loan and securities that offer what we view to be the best risk adjusted returns over our investment horizon.

We believe this approach is the best way to pursue our objective while continuing to enhance shareholder value.

With that we will open the call up to your questions. Operator. Please go ahead.

Thank you.

We will now begin the question and answer session to ask a question you May Press Star then one on your Touchtone phone. If you are using a speakerphone. Please pick up your handset before pressing the keys to withdraw your question. Please press Star then too.

At this time, we will pause momentarily to assemble our roster.

First question comes from Trevor Cranston with JMP Securities. Please go ahead.

All right. Thanks, good morning, congratulations on a nice quarter.

Its first question on the on the capital deployment during the quarter.

You know I guess looking back over the last few you guys had been pretty consistently able to acquire you know good volumes of river as the whole loans.

I was curious if you could elaborate on.

So why that didn't happen this quarter or if it if it was primarily due to your views on relative value or if there were other factors within the market you know such as lack of supply or increased competition.

So just generally interested in your comments around to why that fell off this quarter.

Sure. Thanks, Thanks for the question Trevor.

And the reason for the drop off and it's a combination of a few different factors one was.

We were actively working on completing our inaugural securitization, which we talked about during the comment that was an enormous endeavor that.

And not just efforts on the investment team, but also Lisa team as well.

Which took a lot of time and effort. The second thing was to your point, we have observed over the last couple of months and enormous amount of competition and new capital coming into that sector, which has compressed margins and therefore made the relative value proposition a little less attractive on the margin.

Does that help answer your question.

Yeah that does.

And I guess related to that I guess when you guys are looking at your opportunity set today I mean, how can you talk about how that how that opportunity stacks up versus.

Like the agency market in particular or or the CMBS market as well.

Sure.

Sure Brad as you recall throughout many of the conference call then and follow up conversations you know we have a an active relative value approach to how we manage the portfolio of Dublin City, and you know nonqm, while we're constructive on the sector and we think it has enormous benefits to our portfolio and we continue to be actively engaged and involved in the stack. There clearly over the last couple of weeks and months markets had been extraordinarily fluid and dynamic and the relative value proposition in all of the sectors, whether its agency CMBS or agency RMBS or traditional structured products or the whole loans that were looking at in the non QM space on the residential side and some of the commercial real estate related opportunities. It changes day by day, particularly in environments like this.

So as we discussed during the call we've been a little bit we favored a little bit more heavily the agency side.

Of our portfolio over the last couple of months, but we continue to find very interesting investment on on the credit sensitive side of the ledger, we executed on a number of those in the second quarter and continue to find pretty interesting opportunities.

This quarter as well.

Got it okay.

And you know markets have obviously been pretty volatile recently I was curious if you guys could share any color you have with what you're seeing particularly within the credit market, if you've witnessed any any spread widening within either the resi or the or the CMBS sectors.

And if you could also maybe comment on how that might have impacted book value.

Trickery, so far in August .

Sure.

We've seen a very limited amount of spread widening.

For CMBS and RMBS sectors over the last couple of months. Obviously, the last few days have been pretty extraordinary in terms of the magnitude of the market movements that we've seen both in treasuries as well as as well as the equity market. So we have seen a very modest amount of spread widening however that spread widening has been very well contained and actually has been much less than what we've seen in the corporate credit markets for example.

So.

We continue to think that Theres, some interesting opportunities on the credit side, both in securities form as well.

And whole loan form both on the commercial and residential side, we don't anticipate at this time to see a very meaningful amount of spread widening in the traditional structure product market.

We've been encouraged by some of the new deals that have priced over the last week or so both in CMBS as well as the RMBS and just the overall wellbeing amount of demand for securities, particularly the more subordinate securities and those capital structures. So we continue to be broadly constructive on the markets, while recognizing that we're in a period of heightened volatility.

And we're managing the portfolio accordingly.

And Kevin I, just wanted to add on our book value our book value.

Quarter end has been relatively flat to slightly down.

And you know in September when we do our dividend I believe we will.

We will announce our August .

Right.

Okay. That's helpful.

And then last question for me.

Related to the securitization that you guys were able to complete where there any.

Deal expenses associated with that and the income statements.

And can you also say if those were.

Part of that part of the core EPS calculation this quarter as well.

Yes, there were expenses related to that.

Passionately about $5.6 million in expenses and those expenses are actually capitalize and they're amortized.

Financing costs over a five year period.

Okay perfect.

Thank you.

Our next question will be from Eric Hagen with KBW. Please go ahead.

Hey, Thanks, Good morning, guys and congrats on getting that securitization completed that was really nice to see.

On that securitization is there a turn of leverage on the retained tranches of the deal and.

So just a little hard to tease apart if that if that might be levered or if theres repo that's just supporting.

New assets that have been acquired since you did that deal.

There is no sign of leverage on the retained portion the way that structure is set up its benefited the most traction not a remic. So based upon that structure. We are not we cannot encumber those positions.

Interesting okay.

But I would just add to that to the amount of structural leverage that are embedded in those securities that only there to the restriction that Lisa just mentioned from the investment teams perspective. It is not our view that it is appropriate to put additional leverage on those securities.

Got it okay and since you're not levering the retained traunch, whereas I think some other.

Mortgage rates that are active in the market are what is the what is the levered return that you expect on.

On a on that deal.

We expect the mid teens, our arm on the package of securities that we retained on that deal.

Got it.

And then.

Sticking with the deal you guys are obviously holding a fairly concentrated piece of credit risk.

And to the Mark to market at least appears somewhat high but if you guys intend to hold that bond.

For the life of the security.

Then the Mark to market is really just effectively noise.

And your total return.

We'll be the book yield that you you know that kind of mid teens return you just talked about I just want to make sure I'm thinking about that correctly and if.

And if I'm thinking about it in correctly can you just guide us to.

You know what the biggest inputs are that are going to drive the mark to market.

On that.

I believe you are thinking about that correctly.

Cool.

Thank you very much for the answers.

You're welcome.

Once again, if you have a question. Please press Star then one.

This concludes our question and answer session I would like to turn the conference back over to Jennifer Murphy for any closing remarks.

Thanks, everyone for joining us and have a great day.

The conference has now concluded. Thank you for attending today's presentation you may now disconnect.

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