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spk07: 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 p.m. Eastern Standard Time. At this time, all participants have been placed in a listen-only mode. The floor will be open for questions following today's presentation. Now, first, I'd like to turn the conference call over to Mr. Larry Clark, Investor Relations. Please go ahead, Mr. Clark.
spk02: 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. 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 for management are Jennifer Murphy, Chief Executive Officer, Lisa Meyer, Chief Financial Officer, and Greg Handler and Sean Johnson, both Interim Co-Chief Investment Officers. Before I 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 to the impact of many factors beyond the control of the company. All forelooking 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 contained in the forelooking statements are included in the risk factor section of the company's reports filed with the SEC. Copies are available on the SEC's website. We disclaim any obligation to update our forelooking statements unless required by law. With that, I'll now turn the call over to Jennifer Murphy. Jennifer?
spk01: 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 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 gap net income of 10.8 million or 18 cents per share. Core earnings improved from 10 cents per share in the third quarter just 12 cents per share during the fourth quarter, reflecting lower operating expenses, partially offset by slightly lower portfolio leverage and a lower net interest margin. Our gap value per share increased 3.2% during the quarter to $4.20 per share, and has increased by 33% since June 30th, 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 earnings sustainability of our portfolio. In December, we announced that our board of directors has appointed Sean Johnson and Greg Tambler to serve as interim co-chief investment officers. You all know Sean, as he's been an integral part of the company's investment team and strategy since our initial public offering in 2012, and most recently served as deputy chief investment officer Sean has 31 years of investment experience and has a critical role at WMC and at Western Asset. Greg is the interim head of the mortgage and consumer credit team at Western. He's been investing in the mortgage sector for more than 18 years and is also a member of Western Asset's U.S. Broad Strategy Committee. We're pleased to welcome Greg and Sean to their expanded roles at the company. In addition, we've launched a comprehensive search for an experienced commercial real estate debt professional to fill out the leadership team. We'll continue to pursue our investment strategy to position the company in the most attractive sectors of the mortgage market by drawing on the breadth and depth of Western Assets Mortgage and Consumer Credit Team. We remain focused on protecting and growing the value of the portfolio, which will position us to deliver on our long-term objectives of generating sustainable core earnings that support an attractive dividend and enhancing value for our shareholders. I'll now turn the call over to Sean and Greg to discuss the portfolio and investment outlook. Sean?
spk05: Thank you, Jennifer. The equity and credit markets continue 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. Nearly all the loans and forbearance are now in their repayment period. And those that aren't represent less than one half of 1% of the total residential portfolio. We see this as a confirmation of the effectiveness of our credit underwriting, where we focus on 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. The non-QM origination market was fairly soft for most of 2020 as mortgage originators focused on making conforming loans given the high level of refinance and purchase demand driven by the extremely low mortgage rates we saw. However, with recent modest rise in rates and a corresponding decline in refinance applications, originators once again are beginning to focus on non-QM production. We expect to have the opportunity to add to our non-QM portfolio in the coming quarters with the goal of financing these investments through another securitization. I'll now turn the call over to Greg to discuss our commercial portfolio. Greg?
spk06: 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 toward 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. Within this portfolio, we also hold a junior mezzanine loan with a face value of $90 million. The underlying property is a high quality retail and entertainment complex located in New Jersey and owned by a prominent equity sponsor. The pandemic has adversely impacted the operating performance of this asset, with the entertainment portion of the property only able to operate at approximately 25% capacity in the fourth quarter, which has already been increased to 35% here in the first quarter. The retail portion of the asset has also been impacted and is about a year behind its projected lease-up schedule. We have continued to receive interest payments from an interest reserve fund that we expect to be depleted by the end of June unless the borrower is able to raise additional capital before that. As a result, we have marked down the value of this loan to just over $80 million. While we still believe there is significant equity value in the asset, we recognize that the borrower still needs time to stabilize the property before bringing the loan current and being able to refinance the capital stack. Our large loan non-agency commercial mortgage backed portfolio has an original loan to value of 60%, and despite exposures to some retail and hotel assets, Delinquency trends continue to improve as some loans have been brought back to current by a mix of improved cash flows and equity infusions. We continue to be actively involved with many of our commercial real estate borrowers, working with them to help preserve the value of their properties in order to protect our collateral and increase the probability of an eventual recovery in asset values. We continue to believe that our focus on high-quality properties with well-capitalized sponsors should enable our commercial real estate portfolio to recover from the pandemic, although there remain significant challenges and losses could occur should the reopening stall and financial conditions deteriorate. In the meantime, we remain focused on maintaining sufficient liquidity and positioning our portfolio for future appreciation, which we believe will occur as the economy continues to reopen. Additionally, we believe our focus on real hard assets and low interest rate exposure will benefit the portfolio in the current rising rate and reflationary environment. With that, I'll turn the call over to our CFO, Lisa Meyer.
spk00: Thank you, Greg. Before I review our fourth quarter results, I wanted to discuss the improvements we've 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 financing. From its highest level at 9.5 times at the end of March 2020, our recourse leverage has declined to 2.1 times at the end of this year, also significantly lower than the 5.4 times at December 31, 2019. In October, we amended our residential whole loan facility, converting it to a limited mark-to-market margin facility that bears an interest rate of LIBOR plus 2.75% with a LIBOR floor of 0.25% and eliminated the premium recapture fee. At December 31st, 2020, we had outstanding borrowings on this facility of $30.2 million, which was secured by $67.1 million in non-QM loans. We further reduced our recourse debt by repurchasing an additional $25 million in principal amounts of our convertible senior notes at an average 13% discount to par value. At December 31st, 2020, The outstanding principal balance on our convertible notes was $175 million, down from $205 million at December 31st, 2019. Moving to earnings. We have provided great detail regarding our portfolio and our fourth quarter and full year results in both our press release and our earnings presentation. So I'm only going to focus on items that warrant some additional explanation. We reported core earnings of $7.2 million or 12 cents per share for the quarter. Our core earnings came in higher than the $6.4 million generated in the third quarter. Our improved core earnings enabled us to increase our dividend 20% to 6 cents per share. Future core earnings, of course, will be dependent on the earnings performance of our portfolio. We evaluate the level of our dividend every quarter based on a number of factors, including our outlook for the near-term sustainability of our core earnings. Economic book values for the quarter increased 1.9% to $4.19 per share. As we have discussed in the past, we believe that this non-GAAP financial metric provides investors with a useful supplemental measure to evaluate our financial position. It reflects our actual financial interest in all of our investments and eliminates the accounting mismatch that may arise from our royal securitization, where we fair value the loans and not the debt. In summary, we continue to focus on actions that will solidify our capital structure, increase our liquidity, and enable us to participate meaningfully in the reopening of the economy post-COVID. Our net interest margin remains healthy, and with a significant portion of our investment now financed by attractive long-term financing, we believe that we are well positioned for improved financial results in the year ahead. With that, we will open up the call to your questions. Operator, please go ahead.
spk07: Ladies and gentlemen, at this time, we will begin the question and answer session. To ask a question, you may press star and then 1. If you are using a speaker phone, we do ask you please pick up your handset before pressing the keys to ensure the best sound quality. To withdraw your questions, you may press star and two. Once again, that is star and then one to join the question queue. We'll pause momentarily to assemble the roster. And our first question today comes from Trevor Cranston from JMP Securities. Please go ahead with your question.
spk03: Hey, thanks. Good morning. You guys talked a lot about the credit performance of the CRE loan book, and thank you for all that discussion and 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, you know, 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 deployed capital elsewhere, or do you still feel like there's a significant amount of upside within that book? Thanks.
spk06: Sure. 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.
spk03: 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'd need to... you know, reestablish before you start acquiring a significant volume of loans again.
spk05: Hey, it's Sean. Yeah, all the agreements that we had in place before, you know, 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, you know, staying on the offense with non-QM. We think that there's definitely an opportunity there.
spk03: Great. Appreciate the comments.
spk07: Thank you, guys. Once again, if you would like to ask a question, please press star and 1. And our next question comes from Jason Stewart from Jones Trading. Please go ahead with your question.
spk04: Hey, good morning. Thank you. 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.
spk05: Yeah, 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... you know, billion-dollar-sized non-QM deal like we've done in the past. I think it'll be more like the one we did in June, which is, you know, in the $300 to $400 million range. So that would be, you know, a very small increase in leverage in the portfolio, you know, and then a securitization would bring that leverage back down again. So, you know, we definitely feel that, you know, we're going to try and keep leverage at the lower end of the range until, you know, we clear through, you know, all the potential COVID, you know, fallbacks.
spk04: Okay. Yeah, 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?
spk00: Yes, that's what we have on the balance sheet as far as the unrealized losses related to that portfolio. So that would be the potential upside in those conditions.
spk04: Okay, got it. And then on the $90 million MES loan, I was hoping you could provide a little bit more color. What percentage of debt service is the property generating in terms of cash? Have the sponsors had to kick in any additional equity? to date, any additional color would be helpful.
spk06: Sure, I can take that one. The debt service coverage continues to be fairly weak, and we're still awaiting updated financials for 2021 on the asset. 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 parties. And everyone believes that the sponsor is in the best position to return this landmark asset to profitability. So at this point, we have not seen any new equity come into the deal, but we are optimistic that is the case.
spk04: Okay. So is the end goal here sort of a restructuring of the the debt capital structure here and the sponsor puts more equity in to get it into a right size scenario at the end of June?
spk06: Yeah, that is the case.
spk04: 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?
spk06: 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 through the courts, it could be more of a, you know, second, third quarter, you know, second half 2021 event. Okay.
spk04: Thanks for the updates. Appreciate the questions.
spk07: And ladies and gentlemen, at this time in showing interest, 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.
spk01: Thanks for joining us today, and have a great rest of your week.
spk07: Ladies and gentlemen, the conference has now concluded. We do thank you for attending today's presentation. You may now disconnect your lines.
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