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spk01: Hello, and welcome to the Western Asset Mortgage Capital Corporation's first quarter of 2021 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 listen-only mode, and the floor will be open for your questions following the presentation. Now I'd like to turn the call over to Mr. Larry Clark, Investor Relations. Please go ahead, Mr. Clark.
spk00: Thank you, Keith. I want to thank everyone for joining us today to discuss Western Asset Mortgage Capital Corporation's financial results for the first quarter of 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's included a slide presentation on the website that you can refer to during the call. With us today from our management team are Jennifer Murphy, Chief Executive Officer, Lisa Meyer, Chief Financial Officer, and Greg Handler and Sean Johnson, Interim Co-Chief Investment Officers. 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 forecast 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 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 forward-looking statements are included in the risk factor 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 Jennifer Murphy. Jennifer?
spk05: Thanks, Larry, and thank you all for joining us today. We've had a good start to 2021 as our positive momentum continued in the first quarter. The actions we've taken to strengthen the balance sheet and protect our portfolio have enabled our shareholders to further benefit from the ongoing mortgage market recovery. WMC delivered an economic return on book value of 3.1%, mainly driven by higher valuations of our residential mortgages and securitized commercial loans. We recorded gap net income of $8 million, or 13 cents per share, and core earnings of 10 cents. Our gap of value increased 1.7% during the quarter to $4.27 per share and has increased by 36% since June 30, 2020, which reflects a partial recovery in the value we see in our portfolio. In March, we declared a cash dividend of $0.06 per share for the first quarter, in line with the previous quarter. We remain committed to paying a sustainable and attractive dividend. We assess the dividend each quarter, taking into consideration our view of the long-term core earnings power of the portfolio, the company's liquidity needs, and other factors. We continue to focus on strengthening our balance sheet, maintaining relatively low leverage, increasing liquidity, and positioning the company for growth. During the quarter, we again repurchased some of our outstanding senior convertible notes at a discount to CARV, which reduces our leverage and increases shareholders' equity. We continue to improve the funding terms for our assets as we have renewed and extended some of our financing arrangements at more attractive rates and terms while reducing our exposure to short-term repo. Lise is going to talk more about this later. One of Western Asset's core strengths is its team-based investment approach and its deep bench of seasoned investors. As a result of their efforts led by Greg Handler and Shawn Johnson, we continue to make good progress on protecting and growing the value of the portfolio and positioning it to benefit from the full reopening of the economy. While many of our assets have seen near-full recoveries in value, particularly our residential whole loans, a number have yet to experience a similar rebound, most notably our commercial real estate holdings. However, the outlook for commercial real estate has improved, especially as more states have announced their full reopening plan. Therefore, we're cautiously optimistic that the value of our commercial investments will benefit as economic activity moves closer to pre-COVID levels. We're encouraged by all the progress we see in the economy and at WMC. We continue to focus on delivering on our long-term objectives of generating sustainable core earnings that support an attractive dividend while enhancing shareholder value. Sean's going to go into more detail about our residential holdings, and then Greg will provide some color on our commercial real estate portfolio. Sean?
spk03: Thank you, Jennifer. In the first quarter of 2021, the U.S. economic recovery continued as more people were vaccinated and businesses worked to fully reopen. Equity and credit markets continued to improve, albeit at a slower pace than in the second half of 2020. This translated into higher valuations in a number of our portfolio holdings and improvement in our book value. Our residential home loan portfolio continued to experience appreciation, benefiting from a strong housing market fueled by historically low mortgage rates and very tight supply and favorable consumer sentiment. First quarter national home price indices again rose at double-digit annual rates. The residential credit market continues to improve as a result of lower delinquency and forbearance metrics for non-agency mortgages. Our residential loans continue to perform well, and the percentage of loans that were part of a forbearance plan declined, dropping to 3.4% at quarter end, from 6% at year end, and a high of 19% in May of last year. Nearly all the loans and forbearance are now in their repayment period, and those that aren't represent about one half of 1% of the total residential portfolio. We see this as a confirmation of the effectiveness of our credit underwriting when we focus on borrowers that have meaningful equity in their homes, as we believe it creates a strong incentive to remain current on their mortgage payment. The non-QM origination market was fairly slow for most of last year and into the early part of this year as mortgage originators focused on making agency-deliverable loans as low mortgage rates drove high refinance volumes. With the recent modest rise in rates and a corresponding decline in refinance applications, originators are once again beginning to refocus on non-QM production. During the quarter, we have actively engaged with both new and existing non-QM originators to grow this portion of our portfolio in the near term, 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?
spk02: Thank you, Sean. While our residential loans have recovered in value, a number of our commercial real estate holdings have yet to experience a similar recovery. In general, commercial real estate continues to lag the residential market as many property types are still impacted by the pandemic and performing at suboptimal levels due to ongoing restrictions and reduced demand. While the outlook has improved, there still is uncertainty around the timing and extent of a recovery in the performance of these properties. Within non-agency commercial mortgage-backed securities, our holdings continue to be weighed down by concerns regarding the future performance of the underlying property. The large loan credit portfolio consists mainly of Class A retail, hotel, and office buildings. A number of these properties have seen their cash flows adversely impacted during COVID by lower occupancy and other operating metrics, and their recoveries have yet to materialize. This portion of our portfolio had an approximate 66% original loan-to-value, and all but one of these loans remains current. representing less than 2% of our holdings in this bucket. These properties are generally high-quality assets with strong equity sponsors, so we believe that their collateral values have not been materially or permanently impaired. In our commercial mortgage-backed conduit exposure, the liquidity trends are improving as some loans have become current through a mix of improved cash flows and equity infusions. We continue to believe that these near-term challenges will eventually be overcome as COVID restrictions are lifted and the economy moves towards a full reopening. Our commercial mortgage portfolio, which carries an approximate 65% original loan-to-value, is generally performing according to our expectations, and all but one of these loans remains current. The $30 million hotel loan that we have previously discussed continues to be in default. The property is in the midst of bankruptcy proceedings and we are actively monitoring the process. Additionally, the hotel is currently listed for sale, and there appears to be significant interest in the assets. We feel there is strong value in the property, and we have the added benefit of recourse to the borrower. We continue to reinforce our rights on the personal guarantee, and we believe that there is a reasonable likelihood that ultimately the majority of the principal and this payment will be recovered, although there is no guarantee that will be the case. As we also discussed on our last call, we hold a junior mezzanine loan with a face value of $90 million in this portfolio. 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. However, the property is now operating at 50% capacity versus approximately 25% capacity in the fourth quarter of last year. We are encouraged that New Jersey is planning for a full reopening of their economy on July 1st and eliminating capacity constraints on May 19th for all retail, restaurants, and amusement parks. We believe that as this happens, it will accelerate what are already improving operating trends at this premier property. This loan remains marked down to a value of just over $80 million and 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. As a rule, we work closely with our impacted commercial real estate borrowers to achieve customized solutions designed to help them weather the near-term disruption caused by the pandemic. When necessary, our team becomes actively involved in assisting them and working through property stabilization plans. We believe that these measures allow us to protect our collateral and increase the probability of an eventual recovery in our investments. However, there remain significant challenges and losses could occur to 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 expect to occur as the economy continues to reopen. With that, I'll turn the call over to our CFO, Lisa Meyer.
spk06: Lisa? Thank you, Greg. Before I review our first quarter results, I want to discuss further improvements we have proactively made on our financing arrangements to improve our balance sheet. Since the onset of the pandemic, WMC has benefited from the broader Western asset platform, which has 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 high level at 9.5 times at the end of March 2020, our recourse leverage has declined to two times at the end of the quarter, also significantly lower than 5.4 times at December 31st, 2019. Just this week, we amended our primary securities repurchase facility, which finances most of our non-agency CMBS and RMES assets. The term of the facility was extended by one year. We obtained improved advance rates and secured more attractive pricing, significantly lowering our borrowing costs from LIBOR plus 500 to LIBOR plus 200. At March 31st, we had outstanding borrowings on this facility of $93.9 million, secured by assets with a fair value of $199.4 million. Additionally, we recently amended our commercial whole loan facility, converting it from a facility that automatically rolls every 30 days to now having a one-year maturity. At March 31st, we had outstanding borrowings on this facility, of $119.2 million, secured by commercial loans with a fair value of $243.5 million. During the first quarter, we further reduced our recourse debt by repurchasing an additional $6.7 million in principal amount of our convertible senior notes at an average 6.3% discount to par value. At March 31st, the outstanding balance of our convertible notes was $168.3 million, down from $205 million at December 31st, 2019. Moving to earnings, we have provided great detail regarding our portfolio and our first quarter results in both our press release and our investor presentation. So I'm only going to focus on items that warrant some additional explanation. We reported core earnings of $6.1 million or 10 cents per share for the first quarter. Our core earnings more than covered our first quarter dividend of 6 cents per share. We evaluate the level of the dividend every quarter based on a number of factors, including our outlook for the sustainable earnings power of the portfolio. Gap book value for the quarter increased by 1.7%. mainly driven by the overall improved valuation of our residential mortgages, which fully offset the significantly lower valuations on two non-agency CMBS bonds. Economic book value, which reflects the value of our retained interest in the consolidated securitization trust rather than the gross assets and liabilities. decreased by 4.1% for the quarter to $4.02 per share. The decrease was mainly driven by lower valuations on our non-agency CMBS, which was not partially offset by the improved valuations of those retained interests. As we have discussed in the past, this non-GAAP financial metric reflects our actual financial interest in all of our investments, and eliminate the accounting mismatch that may arise from our ROIA 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. A net interest margin remains healthy. and with a significant portion of our assets now financed by attractive longer-term financing, we believe that we are well positioned to selectively grow our portfolio with the objective of improved financial results in the quarters ahead. With that, we will open up the call to your questions. Operator, please go ahead.
spk01: Yes, thank you. We will now begin the question-and-answer session. To ask a question, you may press the star then 1 on your touch-tone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. To answer your question, please press star then two. At this time, we will pause momentarily to assemble the roster. And the first question comes from Trevor Cranston with JMP Securities.
spk04: Trevor Cranston Hey, thanks. Good morning. And thank you for the update on the status of the properties in the CRE loan portfolio. That was very helpful. I guess when I look at the portfolio, I was kind of focused on slide nine, where you showed the CMBS investments, which obviously still have a fair value, which is a pretty big discount in it. So I was wondering if you could maybe talk a little bit more about that. And as you guys run credit analysis on that portfolio, is there like a projected loss level you see embedded within that? basically trying to sort of size how much of that discount you think is ultimately likely to be recoverable within the CMBS investments. Thanks.
spk02: Thanks, Trevor. Yeah, in terms of the unrealized loss, you know, we would assume that that is on the upper end of what is recoverable. I would say, you know, in the first quarter, some of the challenges that we face in the commercial mortgage tax security portfolio, we're related to near-term maturities, which the market is still very negative on the outlook. However, we typically do have the control rights in these securities, so we have the ability to effectuate loan workouts, and we are actively pursuing those opportunities to maximize the value of these properties. So while I can't give you an exact number. I would say we are actively working to maximize the recovery on these securities towards the upper end of that range.
spk04: Okay. Got it. That's helpful. And then in terms of financing, it sounds like you guys made some nice improvements to the financing agreements you have in place after the end of the first quarter. I was curious, as you look at your financing profile today, do you see any areas where there's room for further improvements, either in the rate or the structure of the financing that you guys have in place today, or with the improvements you're able to get in the two facilities in the second quarter? Do you think the financing side is pretty well squared away at this point?
spk03: Trevor, it's Sean. Yeah, I think We do have the opportunity to improve some things on the margin. Those two facilities were the source of a lot of interest expense for us, so making changes there was extremely important, in addition to making them more longer-term and reducing our margin call vulnerability. There are a couple other financing facilities that we think we can improve, and we're going to continue to work on that. That's always been a focus, especially this first quarter. We spent a lot of time trying to improve that side of the book. So there is some marginal opportunity to improve things from here.
spk04: Okay, got it. Appreciate the comments. Thank you, guys.
spk01: Thank you. And once again, please press star then 1 if you would like to ask a question. Just once more, pressing star then 1 will allow you to speak. All right. And as there is nothing at the present time, this concludes our question and answer session. I would like to return the conference back to Jennifer Murphy for any closing comments.
spk05: Great. Thank you all for joining us today. And please follow up with us if you have any additional questions. And have a great day.
spk01: Thank you. The conference is now concluded. Thank you for attending today's presentation.
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