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spk04: Welcome to the Western Asset Mortgage Capital Corporation's fourth quarter and full year 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 a listen-only mode, and the floor will be open 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.
spk02: Thank you, Tom. I want to thank everyone for joining us today to discuss Western Asset Mortgage Capital Corporation's 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's included a slide presentation on the website that you can refer to during the call. With us today for management are Bonnie Wonterkuhl, 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'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 are included in the Risk Factor section of the company's reports filed with the SEC. We just claim any obligation to update our forward-looking statements unless required by law. With that, I'll now turn the call over to Bonnie Wontrakul. Bonnie?
spk00: 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 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 timeframe. During the fourth quarter, we continued 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 an attractive weighted average interest rate of 3.1%, which we believe was the right move given the market expectation 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 received $36 million in net proceeds and 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 $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 one cent per share, and a decrease in our gap 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 are 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?
spk07: 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 at 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 a 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 four 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 remain 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 continued to engage with existing and new non-QM originators and acquired $185 million of residential whole loans during the fourth quarter, bringing the year's total to $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 that meet our discipline criteria. Our approach to residential whole loans has always been to focus on high-quality borrowers with lower LTVs. We're 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 approved terms and extended maturity. Lisa will provide additional details of the new terms during her comments. And with that, I'll turn the call over to Greg Handler to discuss our commercial holdings. Greg? Thank you, Sean.
spk08: In regards to our commercial loan portfolio, in the fourth quarter, we sold approximately $28 million of non-agency commercial mortgage-backed securities And subsequent to year end, we sold the hotel that we acquired last year through 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 at 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 borrowers, 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 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 a judicial process and granting the project time and a path to recovery. Given the ongoing uncertainty regarding possible outcomes, our loan is currently marked at a value of $29.1 million. up slightly from the third quarter based on the ongoing developments. 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 are continuing to see positive operating momentum at a number of these properties. This portion of our portfolio had an approximate 65% original loan 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, but 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 restrictions 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 values. These sales consisted of two conduits and one single asset single borrower securitization. We believed 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 remain 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'll now turn the call over to Lisa Meyer, our President and CFO. Lisa?
spk01: 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 bears an interest rate of LIBOR plus 2%, with a LIBOR floor of 25 basis points. At December 31st, 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 our 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 28, 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 and our earnings presentation. So I am only going to focus on items that warrant additional discussion. We reported distributable earnings of $908,000 or one cent per share for the fourth quarter. Down from the third quarter's level of $3.8 million or six cents per share. Three primary factors drove the decline. First, we recorded $1.2 million lower net interest income from an accounting change to a distressed 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 recorded 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 prepayment fees decline and as we deploy the $36 million of capital we received from the hotel sale into both income-producing assets and repurchases of our 2022 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 25 cents per share from the third quarter. The majority of the decline, or 18 cents 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 4 cents per share, and non-recurring transaction costs of $1.3 million, or 2 cents 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. A 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.
spk04: Thank you. We will now begin the question and answer session. If you'd like to join the question queue, press star, then 1. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw yourself from the question queue, press star, then 2. We will pause momentarily to assemble our roster. The first question comes from Trevor Cranston with JMP Securities. Please go ahead.
spk03: Hey, thanks. Good morning. You guys referenced the spread widening and the residential loan portfolio, which I believe has continued into the first quarter. 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 kind of what the expected return would be on a new sort of loan purchase and securitization today relative to what it was in the last couple of quarters? Thanks.
spk07: 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, you know, where our target note rates were in right around 4%, very low 4% area, they're now just slightly above 5%. So primary rates have moved up, you know, 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 note rates that are pretty low. So we've seen, you know, dollar prices that, you know, call it we're in the, I don't know, mid to high 104s for the type of stuff that we like to buy. Now, you know, 101 and below dollar prices. So there's definitely been a move there. But the, you know, all-in business plan is still, you know, intact and the NIM is still you know, roughly around that kind of 100 basis point area.
spk03: Okay, got it. That's helpful. And you also talked about the impact of the fast prepayment speeds on the 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 sort of the go forward prepay speeds and amortization rate on the loan portfolio?
spk07: You know, we saw January speeds come in, and they were pretty consistent with the fourth quarter speeds, so not much relief there. But I think, as you said, note rates are up higher. A lot of the refi opportunities are sort of disappearing. for a lot of the borrowers, especially the ones that are in, you know, our target borrower area. So we do expect speeds to decline, you know, by how much we can't necessarily predict. But, you know, if we see over the next couple of, you know, the next couple of months rates stay where they are right now, we should see that, you know, 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 decreasing. over the next couple 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.
spk03: Okay, that makes sense. Can you comment on how book value has trended since the end of the year, given all the volatility we've seen in the markets?
spk01: Yeah. Hi, Trevor. Unfortunately, I can't give any guidance on book value. You know, we're still finalizing, you know, closing our books after the year-end audit. So, you know, we would expect to see book value slightly trend upward, but I can't give specifics on that. Okay.
spk03: Fair enough. Appreciate the comments. Thank you.
spk04: The next question comes from Jason Stewart with Jones Trading. Please go ahead. Hey, good morning.
spk06: Thanks. I want to start with a more global question. What's the appetite to keep WMC as a public vehicle versus taking it private? You know, when you think of it in context of waiving fees, et cetera, where's the mindset of the management team there?
spk00: Yeah, sure. I'll take that, Jason. Thanks for the question. You know, as you do know, and you noted, our manager did waive the management fee 25% for the calendar year 2022 and remains absolutely committed to WMC, which we do benefit from that relationship when we're looking to expand our financing, diversify, diversify our originator partners and such. And so none of that has changed. They remain supportive. In terms of our plans going forward. Our Neurotium 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.
spk06: Okay, 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 with the debt work out there?
spk00: Lisa, do you want to take that one?
spk01: Sure. So as far as buying back stock, You know, we did buy back stock in the fourth quarter, and we continue to look at buying stock because we're trading at significant discounts to book value. But I think, you know, 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, you know, 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 into 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 when determining what's the best use of the capital that we have. And that's how we will deploy it going forward.
spk06: Right. Thanks, Lisa. But 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 sounds like the answer is no.
spk01: Oh, no, no. There is no. We wouldn't be in a blackout unless something materially was going to be disclosed. So, no, we wouldn't be in a blackout from buying back stock. My apologies.
spk06: 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 non-performing loans going forward? Should we use the fourth quarter non-accrual as a benchmark, or was that sort of an anomaly on the high side?
spk01: 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. You know, I think that with the other asset that's non-performing, I don't think the intention is to foreclose on that asset, which would bring a lot of costs on balance sheet as did with the hotel asset.
spk06: Great. All right. Thanks for taking the question. Appreciate it.
spk04: The next question comes from Derek Hewitt with Bank of America. Please go ahead.
spk05: Good morning, everyone. So how should we think about financial leverage longer term, given there's more structural leverage with the securitization strategy?
spk00: Yeah, hi, Derek. I'll start, and others can add on if they want. Thanks for the question. Yes, so in terms of leverage, you know, we would expect just given where we are, depending on where we are in the securitization cycle, that we'd be, you know, somewhere between two, two and a half, and four times going up and down with the cycle. Does that answer your question?
spk05: Yes. Yes, it does. And then my next question is, it seems like there was at least two or three kind of unusual items during the fourth quarter. And I'm trying to just kind of get a sense of what Distributable earnings would have been kind of X those items. I thought you had mentioned that there was like $1.2 million was related to a non-accrual and another $400,000 was related to some other events. So kind of adding back another kind of $0.03 for the quarter. Were there other items that were kind of maybe just one time in nature that affected four quarter results?
spk01: So I think you've captured a number of them. I think it was also like a timing lag in the redeployment of capital because we had a significant amount of assets that paid off the end of the third quarter and assets that 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, you know, that hotel asset that we foreclosed 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.
spk05: Okay. And then my last question is just the dividend. I realize that it's kind of thought about kind of more of a longer-term basis, but the stock is trading at a level that would suggest that there would be at least a dividend cut at least in the short term. So I guess given this 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? It's just maybe on kind of a shorter term basis.
spk00: Yes.
spk01: So when we've... Go ahead, Bonnie, you can go.
spk00: I was just going to say, Lisa, that with respect to the dividend, You know, 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, you know, the steady state in our newer business model with post-transition. So that is a consideration, as well as she mentioned, taxable income considerations. So we're looking at that not from a quarter-to-quarter basis and not based on, you know, what might happen, you know, just event-driven, but rather longer-term So that is a decision that is made by the board. We make a recommendation based upon this modeling, and we'll be meeting with them in three weeks.
spk05: Okay, thank you.
spk04: This concludes our question and answer session. I'll turn the conference back over to Bonnie Wong-Trickell for any closing remarks.
spk00: 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.
spk04: The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.
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