Western Asset Mortgage Capital Corporation
Q4 2021 Earnings Call Transcript

Published: 3 Mar 2022

[Operator:]

Welcome to the Western Asset Mortgage Capital Corporations Fourth Quarter and full year 2021 Earnings Conference Call. Today's call is being recorded and will be available for replay, beginning at 5

[Larry Clark:]

Thank you, John. I want to thank everyone for joining us today to discuss Western Asset Mortgage Capital Corporation financial results for the Fourth Quarter and full-year 2021. The company issued its earnings press release yesterday afternoon and it's available in the Investor Relations section of the company's website at www.westernassetmcc.com. In addition, the company has included a slide presentation on the website that you can refer to during the call. With us today from management, are Bonnie Wongtrakool, Chief Executive Officer. Lisa Meyer, President and Chief Financial Officer. Greg Handler, Chief Investment Officer, and Sean Johnson, Deputy Chief Investment Officer. Before we begin I 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 to the impact of many factors beyond the control of the company. All forward-looking statements included in this presentation are made only as of this date of this presentation and are subject to change without notice. Certain factors that could cause actual results to differ materially from those contained in the forward-looking statements are included in the Risk Factors section of the company's reports filed with the SEC. We disclaim any obligation to update our forward-looking statements unless required by law. With that, I'll now turn the call over to Bonnie Wongtrakool. Bonnie.

[Bonnie Wongtrakool:]

Thank you, Larry, and welcome everyone. As you know, we announced last December that going forward, we plan to focus on residential real estate related investments and to transition out of the commercial investments in our portfolio. We expect this transition to occur over the next 12 to 18 months. We believe this focus will allow us to address the attractive market opportunities, while maintaining alignment with Western Asset's core competencies. Investing in residential non-QM whole loans is an area where we have deep experience and a solid track record. Western has been investing in this sector since 2014 and WMC has not experienced any cumulative losses over this time frame. During the fourth quarter, we continue to implement our strategic shift by acquiring approximately $185 million of residential whole loans, extending the maturity of our residential whole loan facility and exiting $27.5 million of our non-Agency CMBS investments. In addition, we repurchased an additional $8 million of our 2022 convertible notes and bought back approximately 480,000 shares of our common stock at a significant discount to book value. In February, we completed our third securitization of approximately $400 million backed by $432 million of residential whole loans. This securitization enabled us to lock in long-term fixed rate financing and at attractive weighted average interest rate of 3.1%, which we believe was the right move, given the market expectations for short-term interest rates to rise in 2022. In addition, in February, we reached a successful resolution on one of our challenged investments. Specifically, we sold the unencumbered hotel property, we foreclosed on in 2021. We've received $36 million in net proceeds an estimate we will record a $6.7 million gain on sale of the property. We are in the process of redeploying the proceeds, which we anticipate will be a combination of investing in our target assets, retiring a portion of the remaining outstanding principal amount of our 2022 convertible notes and repurchasing our common stock. We anticipated that as we transitioned and repositioned our portfolio, there could be timing issues that would impact the near-term earnings power of our portfolio. This was the case in the fourth quarter as our earnings were negatively impacted by several factors. First, relating to the transition, we had lower net interest income for the quarter as we exited a $157 million of commercial real estate investments in the third quarter. We incurred incremental expenses associated with the ownership and sale of the hotel property, and we placed one investment in our non-Agency CMBS portfolio on non-accrual status. Second, we experienced elevated prepayment activity on a residential whole loan portfolio. And third, market conditions in the fourth quarter were challenging due to higher interest rate volatility and fluctuating asset values. The combination of these factors resulted in a GAAP net loss of $12.1 million or $0.20 per share. Distributable earnings of $908,000 or $0.01 per share, and a decrease in our GAAP book value per share of 7.2% from the third quarter. While this was clearly a challenging quarter, we remain committed to growing our portfolio and protecting shareholder value. We are confident that we're taking the necessary steps to resolve our challenged investments, strengthen our balance sheet, and improve the earnings power of the portfolio, in order to generate sustainable earnings that support an attractive dividend. Now, I'll hand it over to Sean and Greg to go into more detail about the investment portfolio. Sean?

[Sean Johnson:]

Thanks, Bonnie. Our residential investments continue to perform well in the fourth quarter, benefiting from the strong housing market supported by historically low mortgage rates, tight supply, healthy consumer balance sheets, and rising incomes. Fourth-quarter national home price indices again rose a double-digit annual rates. While we expect home price appreciation to moderate, we believe the housing market will remain well supported given the favorable supply and demand dynamics and disciplined lender underwriting standards. Mortgage underwriting today is performed much more responsibly than it was in prior periods. And when combined with the fundamental strength in today's housing market, consumers are generally less burdened with mortgage payments, and have more equity in their homes. This provides a cushion to withstand home price fluctuations and swings in economic conditions when they occur. With respect to our portfolio, loans in forbearance plan declined, dropping to just four loans at year-end, from 149 loans at the beginning of the year. And at year-end, these forward loans were in their repayment period. We see this as a confirmation of the effectiveness of our credit underwriting, where we focus on high-quality borrowers that have meaningful equity in their homes as we believe it creates a strong incentive for them to prioritize their mortgage payment and remain current on that obligation. Mortgage rates remained low during the fourth quarter, but prepayments in our non-QM portfolio declined to 28.2 CPR from the third quarter's level of 34 CPR. Non-QM origination volumes continue to grow as originators refocus on non-QM production. We continue to engage with existing and new non-QM originators and acquired a $185 million of residential whole loans during the fourth quarter, bringing the year's total to two, sorry, $428 million. As we have discussed in the past, we have developed strategic relationships with residential mortgage loan originators who understand our specifications well and are able to provide us with attractive opportunities to meet our disciplined criteria. Our approach to residential whole loans has always been to focus on high-quality borrowers with lower LCVs were able to demonstrate a strong desire and ability to repay. We plan to continue to grow this portion of our portfolio in the near-term with the goal of financing these investments through securitization. As Bonnie mentioned, in February we successfully executed our third Residential Whole Loan securitization, continuing our strategy of securing permanent financing on our holdings. In addition, during the fourth quarter, we amended our Residential Whole Loan facility, obtaining improved terms and extended maturity. Lisa will provide additional details of the new terms during her comment. And with that, I'll turn the call over to Greg Handler to discuss our commercial holdings. Greg.

[Greg Handler:]

Thank you, Sean, in regards to our commercial loan portfolio, in the fourth quarter, we sold approximately $28 million of non-agency commercial mortgage-backed security. And subsequent to year-end, we sold the hotel that we acquired last year to be foreclosure. As Bonnie mentioned, we plan on exiting the majority of our commercial holdings over the next 12 to 18 months, through organic paydowns and opportunistic dispositions. At year-end, we held $130 million of commercial whole loans and fair value, representing seven loans with all but one performing in line with expectations. These six loans are expected to pay off over the next 18 months as we believe the refinance market will remain a viable alternative for the borrower's, particularly for those properties with post - COVID stabilized cash flows. However, the ultimate timing of loan payoffs remains uncertain as it depends on the specific factors pertaining to each property. With respect to the junior mezzanine loan backed by a retail and entertainment complex located in the new Northeast U.S., we continue to engage in discussions with the borrower and certain other lenders regarding potential alternatives to address the situation. We believe the lenders and borrower are looking to strike a balance by avoiding as judicial process and granting the project time in the path to recovery. Given the ongoing uncertainty regarding possible outcomes, our loan is currently marked at a value of 29 spot 1 million up slightly from the fifth to third quarter based on the ongoing development. As we have noted previously, there remains a risk of further impairment under certain scenarios. Within non-agency commercial mortgage-backed securities, our large loan credit portfolio, which is valued at $84 million, consists mainly of class a retail and hotel properties that cater to leisure travelers and we're continuing to see positive operating momentum at a number of these properties. This portion of our portfolio had an approximate 65% original loan-to-value and all but one of these loans representing $2 million of the $84 million portfolio remains current. These properties are generally high-quality assets with strong equity sponsors that we believe that their collateral values have not been materially, or permanently impaired. Our CMBS conduit exposure is valued at $21 million. And while credit trends are improving on some loans, others remain challenged. We continue to believe that many of these near-term challenges will eventually recede as COVID restriction continue to be lifted and the economy moves towards a full reopening. As I mentioned, during the quarter, we exited three CMBS credit positions, totaling approximately $28 million at their value. These sales consisted of two conduit and one single asset, single borrower, securitization. We believe that the upside relative to the downside for these investments was skewed and that there were better alternatives for the capital in our target assets. We will continue to evaluate future potential sales of our investments in this space, as we seek to optimize our recovery values. In summary, we remained focused on positioning our existing commercial portfolio for potential future appreciation and growing our residential portfolio in a disciplined manner with new investments that offer attractive risk adjusted returns. I will now turn the call over to Lisa Meyer, our President and CFO. Lisa?

[Lisa Meyer:]

Thank you, Greg. Before reviewing our Fourth quarter results, I want to highlight some of the measures we have recently taken to further improve our balance sheet. WMC continues to benefit from the broader Western Asset platform, facilitating our ability to work with our strategic partners to improve liquidity and secure attractive longer term financing. In November, we amended our Residential Whole Loan facility. The amended facility has a 12-month term, a stated capacity of $500 million and there is an interest rate of LIBOR plus 2%, with a LIBOR floor of 25 basis points. At December 31, we had approximately $396 million outstanding on this facility. In February of 2022, we completed our third securitization of non-QM loans, which provided long-term financing for $432 million of loans, which were previously financed under our Residential Whole Loan facility. Upon completing the securitization, the outstanding balance on the Residential Whole Loan facility was reduced to approximately $30 million, leaving $470 million of borrowing capacity under the facility, which will be utilized to continue growing on Residential Whole Loan portfolio. In the fourth quarter, we repurchased an additional $8 million, aggregate principal amount of our existing 6.75 convertible senior notes due on October 1st, 2022, at a weighted average premium to par of approximately 1%. At year-end, we had a remaining outstanding balance of $37.7 million on the 2022 notes. Our goal is to continue repurchasing and retiring the 2022 notes prior to their maturity. Provided accretive repurchase opportunities exist over the next seven months. We believe that we have ample liquidity to address the maturity of our 2022 notes and execute on our investment strategy. With the February Securitization and the sale of the hotel asset, as of February 28th, 2022, we had approximately $70 million of cash and cash equivalents, as well as unused borrowing capacity under both our residential and securities financing facilities. Now, turning to our financial results. We have provided great detail regarding our portfolio and our fourth quarter results in our press release in our earnings presentation. So, I am only going to focus on items that weren't additional discussion. We reported distributable earnings of $908,000, or $0.01 per share, for the fourth quarter, down from the third quarter's level of $3.8 million, or $0.06 per share. Three primary factors drove the decline. First, we recorded $1.2 million lower net interest income from an accounting change to a distress conduit, non-agency CMBS security to the cost recovery method. Second, we experienced an elevated level of prepayments in our residential whole loan portfolio that led to an increase of $400,000 in premium amortization in the fourth quarter. For the fourth quarter, we reported a total of $2.5 million of premium amortization. Third, we experienced lower net interest income for the quarter from payoffs of $157 million of commercial real estate assets, and $90 million of residential whole loans. While the capital was redeployed into new residential investments, we did not get the full quarter benefit of either the additional income or the improved cost of funds under the amended residential whole loan facility. Also, the residential investments are generally lower yielding than the commercial investments that paid-off. The aggregate decline in net interest income was approximately $1.1 million. We believe our earnings will improve as prepayments seats decline and as we deploy the $36 million of capital, we received from the hotel sale into, both income producing assets and repurchases about 2,022 notes. In addition, our earnings will benefit from the 25% reduction in the management fee for 2022 paid to our manager. While our distributable earnings for the fourth quarter were lower than our dividend of $0.06 per share, it is important to note that we evaluate the level of our dividend every quarter based on several factors. These factors include our outlook for the long-term, sustainable earnings power of the portfolio, and our taxable income. GAAP book value for the quarter was $3.20 per share, a decrease of $0.25 per share from the third quarter. The majority of the decline or $0.18 per share was mainly driven by modest spread widening in our residential whole loan portfolio. Lower net interest margin on the portfolio of $2.2 million or $0.04 per share, and nonrecurring transaction costs of $1.3 million or $0.02 per share associated with the hotel asset that was sold in February of 2022. Economic book value, which reflects the value of our retained interest in the consolidated securitization trust rather than the associated gross assets and liabilities, decreased by 6.2% for the quarter to $3.03 per share. Now turning to our leverage. our recourse leverage ratio at year-end was 3.8 times, up from 2.9 times at September 30th of 2021. This was primarily due to financing new investments of residential whole loans under our Residential Whole Loan Facility. As we completed the securitization in February, which is non-recourse, our recourse leverage ratio has declined as expected. Our recourse leverage ratio will fluctuate as we continue to grow the portfolio with the goal of executing additional securitizations. In summary, we continue to focus on actions that will solidify our capital structure and maintain our liquidity. While positioning WMC to benefit from the improving economic conditions and the ongoing recovery of certain commercial real estate sectors that were most impacted by the pandemic. With a significant portion of our assets now financed by attractive longer term financing, we feel that we are well-positioned to continue to grow our portfolio through select investment opportunities with the objective of improved financial results in the quarters ahead. With that, we will now open up the call to your questions. Operator, please go ahead.

[Operator:]

Thank you. We will now begin the question-and-answer session. We pause momentarily to assemble our roster. The first question comes from Trevor Cranston with JMP Securities. Please, go ahead.

[Trevor Cranston:]

Thanks. Good morning. You guys referenced the spread widening in the residential loan portfolio, which I believe has continued into the first quarter. Is in light of that, can you talk about what you've seen in terms of the loan origination market in terms of changes in pricing on newly acquired loans so far this year? And can you also talk about what the expected return would be on a new loan purchase and securitization today relative towards what it was in the last couple of quarters? Thanks.

[Sean Johnson:]

Sure, Trevor. It's Sean, I'll take that one. We have seen prices come down. We've seen primary rates, so rates to borrowers move up. And I would say that where our target note rates were in, I'll call it right around 4%, very low 4% area. They are now just slightly above 5%. So primary rates have moved up roughly 100 basis points. I think the yields on that stuff are in the mid-fours and I think the securitization execution is in the low-to-mid 3%, so the NIM is still there, it's still roughly unchanged after the sort of adjustment in rates. There's certainly a large number of loans out there right now that are sitting on originator and bank balance sheets with loan rates that are pretty low. So we've seen dollar prices that call it, we're in the, I don't know, mid to high 104s for the type of stuff that we'd like to buy. Now, one-on-one and below dollar prices, so there's definitely been a move there. But the all-in business plan is still intact and the NIM is still roughly around that 100 basis point area.

[Trevor Cranston:]

Got it. That's helpful. And you also talked about the impact of the fast prepayment speeds on fourth quarter results. I guess in light of the increase in rates and increase in mortgage rates in the first quarter, can you talk about how much you expect that to impact the go forward prepaid speeds and amortization rates on the loan portfolio?

[Sean Johnson:]

We saw January speeds come in and they were pretty consistent with the fourth quarter speeds. So not much really there, but I think as you said, note rates are up higher. A lot of the refi opportunities are disappearing for a lot of the borrower's, especially the ones that are in our target borrower area, so we do expect speeds to decline. By how much? We can't necessarily predict. But if we see over the next couple of months rates stay where they are right now, we should see that amortization costs, I think was last quarter $2.5 million, roughly close to $10 million on the year. Those numbers should potentially come down a little bit. That said we are trying to buy more loans. So that dollar amount may increase, but so will the income as well. I think we see speeds over the next couple of months declining. I don't know, 10% to 15%, maybe 20% even from where they are right now in agency space. And I don't think the non-QM space is going to be immune to those declines as well.

[Trevor Cranston:]

Okay, that makes sense. Can you comment on how book value is trended since the end of the year, given all the volatility we've seen in the markets? Thanks.

[Lisa Meyer:]

Yeah. Hi, Trevor. Unfortunately, I can't give any guidance on book value. We're still finalizing closing our books after the year-end audit. So we would expect to see book value slightly trend upwards, but I can't give out specifics on that.

[Trevor Cranston:]

Okay. Fair enough. Appreciate the comment. Thank you.

[Operator:]

The next question comes from Jason Stewart with JonesTrading. Please go ahead.

[Jason Stewart:]

Good morning. Thanks. Want to start with a more global question. What the appetite to keep WMC as a public vehicle versus taking a private? When you think of it in context of waiving fees, etc. where is the mindset of the management team there?

[Lisa Meyer:]

Sure. I'll take that, Jason. Thanks for the question. As you do know, and you noted, our manager did wave the management fee 25% for the calendar 2022 and remains absolutely committed to WMC at which we do benefit from that relationship when we're looking to expand our financing diversifier originator, partners and such. And so none of that has changed. They remain supportive. In terms of our plans going forward, our near-term focus is really to execute on this transition and to grow organically. We're always open to other ways to increase shareholder value. But for now, our focus does remain on the portfolio, and making a successful transition.

[Jason Stewart:]

Thanks. And I appreciate the color on the New Jersey Mall. Is there any preclusion to buying stock back as it relates to the negotiation strategy that work out there?

[Bonnie Wongtrakool:]

Lisa, do you want to take that one?

[Lisa Meyer:]

Sure. So as far as buying back stock, we did buy back stock in the fourth quarter, and we continue to look at buying a stock because we are. Trading at significant discounts to book value. But I think, as Bonnie mentioned, our priority is to continue to organically grow the company. So we have to look at capital, and determine what's the best use of that capital. Is that capital better used to put into income producing assets in which we continue to grow the earnings power of the portfolio? We also have to keep in to consideration our 2022 notes, the $37.7 million that we have outstanding, and trying to buy those back to also improve the earnings power of the portfolio. So I think the company weighs all those things on when determining what's the best use of the capital that we have. And that's how we will deploy it going forward.

[Jason Stewart:]

Right. Thanks, Lisa. I guess my question was more legal-oriented. Is there any preclusion that prohibits you as you negotiate the work out from buying stock back? It sound like the answer is no.

[Lisa Meyer:]

No, no. There is -- No. We wouldn't be in a blackout at almost something materially going to be disclosed. So no, we wouldn't be in a blackout from buying back stock. My apologies.

[Jason Stewart:]

Got it. Okay. I appreciate that. And then, last one for me, when you look at some of the other workouts, how should we, from a modeling perspective, take forward the workout costs from nonperforming loans going forward? Should we use the fourth-quarter non-accrual as a benchmark? Or was that an anomaly on the high side?

[Lisa Meyer:]

I don't think you should use that for a benchmark. I think that was specific to that particular asset, so I think that was probably a little on the high side. I think that with the other asset that's nonperforming, I don't think the intention needs to foreclose on that asset, which would bring a lot of costs on balance sheet as it did with the hotel assets.

[Jason Stewart:]

Right. All right. Thanks for taking the question, appreciate it.

[Operator:]

The next question comes from Derik Hewitt with Bank of America. Please, go ahead.

[Derik Hewitt:]

Good morning, everyone. So how should we think about financial leverage longer term, given there is more structural leverage with the securitization strategy?

[Bonnie Wongtrakool:]

Hi, Derik. I'll start and there's thanks for the question. Yes. So in terms of leverage, we would expect, just given where we are in -- depending on where we are in this securitization cycle that we'd be somewhere between two and half and four times going up and down at the cycle. Does that answer your question?

[Derik Hewitt:]

Yes, it does. And then my next question is it seems like there was at least two or three unusual items during the fourth quarter. And I'm trying to just get a sense of what distributable earnings would have been, explore those items. I thought you had mentioned that there was 1.2 million was related to a non-accrual and another 400,000 was related to some other events adding back another $0.03 for the quarter. Were there other items that were maybe just onetime in nature that affected fourth quarter results?

[Lisa Meyer:]

No. I think you've captured a number of them. I think it was also like a timing lag in redeployment of capital because we had a significant amount of assets that paid off the end of the third quarter and assets are paid off in the fourth quarter. And it was just timing in redeploying that capital into income-producing assets. I do think it's important to note that hotel asset that we felt closed on has not been income producing for several months. And now with that $36 million of capital that the company received, we can deploy that asset now into income producing asset, which will definitely help distributable earnings going forward.

[Derik Hewitt:]

Okay. And then my last question is just the dividend. I realized that it's kind of thought about more of a longer-term basis, but the stock is trading at a level that would suggest that there would be a -- we saw a dividend cut in, at least in the short-term. I guess, given the transition period over the next 12 to 18 months, is there any additional color that you can provide in terms of how you're thinking about the dividends just maybe on kind of a shorter-term basis?

[Bonnie Wongtrakool:]

Yes.

[Lisa Meyer:]

Some when we've -- got ahead, Bonnie, you can go.

[Bonnie Wongtrakool:]

I was just going to say, Lisa, that with respect to the dividend, we are looking at this from a long-term perspective, as Lisa described in her comments. So we're looking at the long-term earnings power. And for us today, that is the steady-state in our newer business model with at post-transition. So that is a consideration, as well as she mentioned, taxable income consideration. So we are looking at that, not from a quarter-to-quarter basis and not based on what might happen, just event-driven, but rather longer-term. So that is the decision that is made by the Board. We make a recommendation based upon this modeling, and will be meeting with them in three weeks.

[Derik Hewitt:]

Okay. Thank you.

[Operator:]

This concludes our question-and-answer session. I'll turn the conference back over to Bonnie Wongtrakool for any closing remarks.

[Bonnie Wongtrakool:]

Thank you, Operator. And thank all of you again for joining us for today's call. We appreciate your continued interest in WMC and hope everyone remains healthy and safe. Have a good day and I look forward to personally connecting with you in the weeks ahead.

[Operator:]

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