Western Asset Mortgage Capital Corporation
Q4 2020 Earnings Call Transcript

Published: 4 Mar 2021

[Operator:]

Good day, everyone, and welcome to the Western Asset Mortgage Capital Corporation's Fourth Quarter and Year-End 2020 Earnings Conference Call. Today's call is being recorded and will be available for replay beginning at 5

[Larry Clark:]

Thank you Jamie. I want to thank everyone for joining us today to discuss Western Asset Mortgage Capital Corporation's financial results for the fourth quarter of 2020.

[Jennifer Murphy:]

Thanks, Larry, and thank you all for joining us today. WMC finished 2020 with positive momentum, delivering a fourth quarter economic return on book value of 4.7%, sequentially improved core earnings and a dividend increase to $0.06 per share. We continue to focus on strengthening our balance sheet, lowering recourse leverage, reducing our exposure to mark-to-market funding and improving the earnings power of our portfolio. We took important actions on these in the fourth quarter including extending some of our longer term financing at attractive levels and repurchasing $25 million of our outstanding convertible senior notes at an average discount of 13% to par value. We recorded GAAP net income of $10.8 million or $0.18 per share. Core earnings improved from $0.10 per share in the third quarter to $0.12 per share during the fourth quarter, reflecting lower operating expenses partially offset by slightly lower portfolio leverage and a lower net interest margin. Our GAAP book value per share increased 3.2% during the quarter to $4.20 per share and has increased by 33% since June 30, 2020, its lowest reported level after the onset of the pandemic. We believe we're well-positioned to benefit from what we anticipate will be the continued recovery of asset values and improved earning sustainability of our portfolio.

[Sean Johnson:]

Thank you, Jennifer. The equity and credit markets continued to rebound in the fourth quarter, driven by improved liquidity conditions across financial markets, optimism resulting from the rollout of vaccines and the potential for new government stimulus package. This translated into higher valuations on a number of our portfolio holdings and an improvement in our book value. The largest contributors to the book value increase were our residential credit risk transfer securities, Residential Whole Loan portfolio and our large loan Non-Agency CMBS holdings. Contributors to our net income were from across our portfolio holdings and generally in proportion to the relative size of each asset class. With respect to residential credit, the market has been improving rapidly. Overall delinquency and forbearance metrics for the universe of non-agency mortgages continues to improve and national home price indices have been rising at double-digit annual rates. Our Non-QM residential loan portfolio continues to perform well and again experienced a decline in the percentage of loans that were part of a forbearance plan, dropping to less than 6% at year-end from a high of 19% back in May of last year.

[Greg Handler:]

Thank you, Sean. Let me first say that I'm honored to become part of the senior management team of WMC and look forward to contributing to the company's future success. On the Non-Agency commercial mortgage-backed securities and commercial loans the positive developments with the COVID vaccines in the fourth quarter has benefited the overall outlook and valuations on the assets. Many of the underlying properties in both our commercial whole loan and Non-Agency CMBS portfolios have seen their cash flows adversely impacted during COVID, by lower occupancy and other operating metrics, particularly in our hotel and retail properties. We feel that these near-term challenges will eventually be overcome as COVID restrictions begin to lift and the economy moves towards a full reopening. These properties are generally high-quality assets, with strong equity sponsors. So we believe that the collateral values have not been materially or permanently impaired. Our commercial mortgage portfolio carries an approximate 65% original loan-to-value and all but one of these loans remains current. On the $30 million hotel loan, that is in default, the borrower has recently placed the property into bankruptcy. We expect to move forward with the foreclosure, subject to the bankruptcy process, working closely with a special servicer and legal counsel. To date, we have received meaningful interest in the asset and we feel there is strong value in the property with the added benefit of recourse to the borrower. Because of this, we believe that there is a reasonable likelihood that ultimately the majority of the principal and missed interest payments will be recovered, although there is no guarantee that will be the case.

[Lisa Meyer:]

Thank you, Greg. Before I review our fourth quarter results, I wanted to discuss the improvements we proactively made to our financing arrangements to improve our balance sheet in the fourth quarter. Since the onset of the pandemic, WMC has benefited from the broader Western Asset platform, which facilitated our ability to work with our strategic financing partners to improve liquidity and reduce our exposure to short-term daily mark-to-market financings.

[Operator:]

Ladies and gentlemen, at this time, we will begin the question-and-answer session. And our first question today comes from Trevor Cranston from JMP Securities. Please go ahead with your questions.

[Trevor Cranston:]

Great. Thanks. Good morning. You guys talked a lot about the credit performance of the CRE loan book and thank you for all that discussion in detail. I was curious if you could maybe talk a little bit more about the CMBS portfolio? What you've seen recently in terms of any changes in credit performance there? And also CMBS spreads continue to perform pretty well. Do you guys see any near-term opportunities to maybe sell parts of that portfolio that have appreciated a lot and deploy the capital elsewhere, or do you still feel like there's a significant amount of upside within that book?

[Greg Handler:]

Sure. Thanks for the question. I do think the trends have been positive across the majority of the commercial mortgage-backed securities especially post the vaccine news in November. And we have seen spreads recover although I think it's been very asset specific. In fact, we did have some sales as we had some portfolio positions that had recovered meaningfully in the fourth quarter. So, we did take advantage of that in select instances. I believe we're obviously looking at the total return potential versus other opportunities in the market as we examine the landscape going forward. But overall we feel that the securities still have meaningful upside from the reopening trade. So, we're constantly evaluating that but based on market conditions.

[Trevor Cranston:]

Okay, got it. And you also mentioned that non-QM loans could become a place where you're able to deploy some capital at some point over the next few quarters. Can you remind us if you still have flow agreements in place with lenders or if that would be something that you would need to reestablish before you start acquiring a significant volume of loans again?

[Sean Johnson:]

Hey, it's Sean. Yes all the agreements that we had in place before the COVID crisis remain in place. And in fact we've actually added a couple of agreements with originators purchase agreements. So, we're definitely staying on the offense with non-QM. We think that there's definitely an opportunity there.

[Trevor Cranston:]

Okay. Appreciate the comments. Thank you guys.

[Operator:]

And our next question comes from Jason Stewart from JonesTrading. Please go ahead with your question.

[Jason Stewart:]

Hey good morning. Thank you. A quick follow-up on Trevor's question. When you think about the balance sheet, is it in a spot where you're comfortable growing materially in non-QM? And if you could put a number around sort of what size you think that could be that would be helpful.

[Sean Johnson:]

Yes. Sure. As it is right now, it's difficult to find the quality of loans that we're targeting, but we do have room to grow. I don't think, we'll do a $1 billion-sized non-QM deal like we've done in the past. I think it will be more like the one we did in June, which is the $300 million to $400 million range. So that would be a very small increase in leverage in the portfolio. And then a securitization would bring that leverage back down again. So we definitely feel that, we're going to try and keep leverage at the lower end of the range, until we clear through all the potential COVID fallbacks.

[Jason Stewart:]

Okay. Got it. That makes sense. And then when we look at unrealized loss and sort of recapture of that part of the market, I think there was something like $46-odd million in CMBS that was unrealized. Is that the number investors should be focusing on, if we continue to see spread compression that we could potentially recapture, or is it a bigger more broad number there?

[Lisa Meyer:]

Honestly, yes. That's what we have on balance sheet as far as the unrealized losses related to that portfolio. So, that would be the potential upside in those positions.

[Jason Stewart:]

Okay. Got it. And then on the $90 million mezz loan, I was hoping you could provide a little bit more color. Is the – what percentage of debt service is the property generating in terms of cash? If the sponsors had to kick in any additional equity to date? Any additional color would be helpful.

[Greg Handler:]

Sure. I can take that one. The debt service coverage continues to be fairly weak and we are still awaiting updated financials for 2021 on the asset. But however, the reopening has been very positive, and we do expect that to improve dramatically throughout the year. We are working closely with senior lenders and with the sponsor, and we're in communication with all property – all parties. And everyone believes that, the sponsor is best positioned to return this landmark asset to profitability. So at this point, we have not seen any new equity coming to the deal, but we are optimistic, if that is the case.

[Jason Stewart:]

Okay. So is the end goal here sort of a restructuring of the debt capital structure here and the sponsor puts more equity in to get it into a right-sized scenario at the end of June?

[Greg Handler:]

Yeah. That is correct. That is the case.

[Jason Stewart:]

Okay. All right. Thanks for that. One more, and then I'll jump out. On the hotel loan, what is the timing for the bankruptcy process and the foreclosures sort of look like? Is it something that you can realistically see occurring in the first half of 2021?

[Greg Handler:]

We remain in negotiations with the borrower. But to the extent that, the courts decide the eventual outcome that could definitely take – I think the borrower has until June to provide the courts with a plan. So I think, there's a good scenario, a good chance that we can negotiate something outside of the courts. But to the extent that, it gets dragged to the courts, it could be more of a second – third quarter second half 2021 event.

[Jason Stewart:]

Okay. Thanks for the updates. Appreciate the questions.

[Operator:]

And ladies and gentlemen, at this time I'm showing that we've reached the end of today's question-and-answer session. I'd like to turn the conference call over to Jennifer Murphy for any closing remarks.

[Jennifer Murphy:]

Thanks for joining us today, and have a great rest of your week.

[Operator:]

Ladies and gentlemen, the conference has now concluded. We do thank you for attending today's presentation. You may now disconnect your lines.