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spk02: Good day and welcome to the Western Asset Mortgage Capital Corporation third quarter 2022 earnings conference call. Today's call is being recorded and will be available for replay beginning at 5 p.m. Eastern Standard Time. Now I'd like to turn the call over to Mr. Larry Clark of Investor Relations. Please go ahead, Mr. Clark.
spk00: Thank you, Chuck. I want to thank everyone for joining us today to discuss Western Asset Mortgage Capital Corporation's financial results for the third quarter of 2022. 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 this call. With us today from our management team are Bonnie Wong-Terkul, Chief Executive Officer, Robert Lehman, Chief Financial Officer, Greg Handler, Chief Investment Officer, and Shawn Johnson, Deputy Chief Investment Officer. Before we begin, I'd like to remind you that in August, the company announced its board of directors authorized a review of strategic alternatives aimed at enhancing shareholder value, which may include a sale or merger of the company. No assurance can be given that the review being undertaken will result in a sale, merger, or other transaction involving the company. and the company has not set a timetable for completion of the review process. The company intends to refrain from making comments related to the strategic review process until a definitive agreement has been reached or until the process of exploring strategic alternatives has ended. Therefore, as a result of the ongoing status of this process, we will limit this call to our prepared remarks and will not be conducting a question and answer session during the call. I'll now 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 including 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 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 Wantrickle. Bonnie?
spk01: Thanks, Larry, and welcome, everyone. Before I discuss our third quarter financial results, I would like to say a few words about our ongoing review of strategic alternatives for the company. As I discussed on last quarter's call, the COVID-19 pandemic negatively impacted a number of our investments, primarily within our commercial holdings. As you are well aware, we have experienced a significant decline both in the value of our portfolio and in our stock price. Therefore, over the past two years, our overarching goal has been to improve and stabilize our future earnings power. Over this period, we have made significant progress by taking actions to improve our liquidity and balance sheet and by shifting our investment focus towards residential real estate. Nonetheless, we have not seen these positive actions reflected in our stock price, and therefore, we decided to embark on a strategic review of our alternatives with the goal of unlocking shareholder values. We continue to move forward in this process and to analyze alternatives that may involve a sale, merger, or other transaction involving the company. We are focused on concluding the strategic review process as quickly as possible and will provide updates as appropriate. In the meantime, we will continue to run the company in a manner that is consistent with our goal of optimizing the value of our assets and maintaining stable earnings, which will in turn support our ability to pay an attractive dividend. We truly appreciate our shareholders who have remained with us through this challenging period. With that, I will now turn to our quarterly results. Our third quarter results continue to reflect the ongoing challenges of interest rate volatility and fluctuating asset values, which again translated into credit spread widening across our holdings. This market volatility, combined with an additional write-down of our non-performing commercial loans, put pressure on our gap book value per share, which declined 30.2% from the prior quarter, while economic book value per share declined 21.7%. We generated stable net interest income during the quarter, after adjusting for income from our interest rate hedges, due to lower prepayments from our residential portfolio. However, this was offset by moderately higher operating expenses. Consequently, our distributable earnings of $2.3 million, or $0.37 per share, in the third quarter were down approximately $400,000 from the second quarter. While our distributable earnings were less than our $0.40 per share dividend for the quarter, our philosophy remains to pay dividends that are supported by the long-term earnings power of the portfolio. During the third quarter, we did not acquire any target assets and instead focused primarily on strengthening our balance sheet and increasing our liquidity. We received approximately $75 million from the sale, repayment, or paydowns of investments and used these proceeds to build our cash balances and to further reduce debt, including the full retirement of our 2022 notes, which occurred on October 3rd. We remain confident that we have sufficient liquidity to retire additional recourse debt and execute our investment strategy as we continue to monetize our non-core commercial assets in an orderly manner. We also remain confident in the overall credit quality of our portfolios. The residential loans that we own have been diligently underwritten and are supported by significant homeowner equity, and our residential portfolio is performing as expected. In summary, we continue to take steps to further strengthen our balance sheet and stabilize the earnings power of the portfolio. As always, we remain committed to building value for our shareholders. Now, I'll hand it over to Sean and Greg to go into more detail about the investment portfolio. Sean?
spk04: Thanks, Bonnie. During the third quarter, rates rose dramatically and spreads widened marginally across our residential home loan portfolio. This put pressure on our book value. Because the vast majority of our residential whole loans are held within our securitization, the yields on our two most recent transactions also rose, which partially mitigated the impact on our book value. However, our first two securitizations did not have this gap offset due to the accounting method used. We did not acquire any non-QM loans during the quarter as our focus was on maintaining sufficient liquidity to address the maturity of our 2022 notes. During the quarter, origination rates on non-QM loans rose alongside conventional mortgage rates, and as expected, the higher rate environment caused prepayment rates to meaningfully slow. Third quarter non-QM prepayments for the portfolio were 12.4 CPR compared to 15.6 CPR in the second quarter and 30 CPR in the first quarter. As a result, premium amortization from loan prepayments in the quarter was $945,000 down from an average of 2.2 million for the first two quarters of the year. We anticipate that higher mortgage rates will continue to cause refinancing activity in our portfolio to remain relatively low. Our non-QM portfolio continues to perform well with approximately 0.23% of our total loans more than 60 days delinquent at quarter end. This underscores the effectiveness of our credit underwriting standards which focus on high-quality borrowers that have meaningful equity in their homes. At origination, our weighted average loan-to-value ratio was 66%, and the average FICO score for our borrowers was 748. Now a word on our view of the overall housing market. After booming during the pandemic, home prices have begun to stall and even decline in certain markets under the pressure of higher mortgage rates and a lack of affordability. The housing market surge during the pandemic was primarily due to inadequate supply relative to increased demand. Supply chain issues continue to delay new home construction, but as supply comes online over the next six to 12 months in the face of waning demand, we anticipate that there will be continued downward pressure on home prices. The speed and magnitude of the path will likely be determined by the broader economic growth levels and the absolute level of mortgage rates. While housing is expected to cool, we do not see the significant risk of defaults or home price correction that current market pricing implies, mainly due to our approach of targeting high-quality credit non-QM borrowers, as well as disciplined lender underwriting standards that have been a hallmark of the sector since the great financial crisis 14 years ago. Additionally, we expect volatility in interest rates and spreads to decline as we get more clarity on the pace and timing of the Fed's tightening cycle. Therefore, we believe that spread normalization combined with high carry will provide upside value to our residential holdings. With that, I'll turn the call over to Greg Handler to discuss our commercial holdings. Greg?
spk05: Thanks, John. Now, turning to our commercial portfolio, during the third quarter, spreads continued to widen across the commercial mortgage credit sector but our commercial holdings were only modestly impacted with the exception of the non-performing commercial loans that I will address later. At quarter end, we held six commercial whole loans at a fair value of $90.1 million. All but one of these loans have performed in line with expectations. During the quarter, we received a full repayment from one loan and a partial pay down from another for a total of just over $20 million. The five remaining performing loans represent $82 million of principal balance and are currently being marked at just over $81 million, a negligible discount to cost. We expect these loans to pay off over the next several quarters as properties are either sold or refinanced. However, the ultimate timing and realization of loan payoffs depends on the specific factors pertaining to each property, and there can be no assurance as to whether or when these payoffs will occur. With respect to the junior mezzanine loan backed by a retail and entertainment complex located in the U.S. Northeast, we reduced the fair value of this loan as, in late October, the senior mezzanine lender consummated a foreclosure of its equity interest in the property, which also served as the primary collateral for our loan. As a result, our loan remains outstanding but without the benefit of the primary collateral supporting the loan. We are currently exploring all available measures to maximize our recovery on the loan, but there are no assurances that any of those measures will be successful, in which case we could experience a total loss of our investment. At September 30, the loan was marked down to a value of $8.8 million, compared with approximately $27 million at the end of the second quarter. Within non-agency commercial mortgage-backed securities, Our single-asset, single-borrower credit portfolio is valued at $78.3 million, down from $82.3 million in the prior quarter. This portfolio consists mainly of a 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 approximately 65% original loan-to-value, and all but one of these loans representing less than $1 million. of the $78 million portfolio remain current. 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. Our commercial mortgage-backed conduit exposure is valued at $10.5 million, down slightly from the second quarter. We remain focused on optimizing the recovery values in our commercial portfolio and intend to use those proceeds to pay down our recourse debt level and to opportunistically reinvest into new target assets that continue to offer attractive risk-adjusted returns. I'll now turn the call over to Bob Lehman, our CFO. Bob?
spk03: Thank you, Greg. We provided great detail regarding our portfolio in our third quarter press release and in our earnings presentation, so I'm going to focus here only on items that warrant additional attention. And as we've noted in the earnings release, all per share amounts have been adjusted to reflect the 1 for 10 reverse stock split that we implemented on July 11th. We reported distributable earnings of $2.3 million, or 37 cents per share for the third quarter, down from the second quarter's level of $2.7 million, or 44 cents per share. We received $41.3 million from the sale and repayment of residential whole loans during the quarter, down from $68.4 million in the second quarter. This resulted in $945,000 of premium amortization, which was down from $1.8 million in the second quarter. Our higher core operating expenses in the quarter were primarily a result of increases in compensation costs related to our new CFO and controller that began in June 2022 and increases in professional fees that were offset by a slightly lower management fee. We remain focused on discipline expense management while recognizing that we will continue to support the strategic review process and will likely incur some associated transaction expenses as a result. While our distributable earnings in the quarter fell short of our dividend of 40 cents per share, we will continue to evaluate the level of the dividend every quarter based on several factors including our outlook for the long-term sustainable earnings power of the portfolio and our taxable income. GAAP book value for the quarter was $16.22 per share, a decrease of $7.01 or 30.2 percent from the second quarter. The decline was driven by two factors. First, the further increase to the unrealized loss of the junior mezzanine loan that Greg noted, negatively input-packed at book value by $3.01 per share, and second, spread widening across our holdings, but mainly our residential whole loans due to their relative size in the overall portfolio. 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 21.7 percent for the quarter to $19.25 per share. Turning to leverage, our recourse leverage ratio at quarter end was 3.3 times up from the 2.4 times in early July after the completion of our fourth securitization at that time. Our leverage ratio was further reduced to 3.1 times after the retirement of our 2022 notes that occurred on October 3rd. Turning to liquidity, We ended the quarter with unrestricted cash of $55.4 million. After retiring the remaining $26 million of our 2022 notes, our unrestricted cash was $28.6 million. Subsequent to quarter end, we extended the maturity date of our commercial home loan facility to November 3rd, 2023, as was scheduled to mature on November 4th of this year. In addition, we extended the maturity date of our residential whole loan facility to October 25th, 2023. In summary, we remain focused on actions that will solidify our capital structure and maintain our liquidity. With a significant portion of our assets now financed by attractive longer-term financing, we feel that we are well positioned to generate consistent distributable earnings with the objective of supporting our dividend in the quarters ahead. With that, I'll turn the call back to Bonnie for closing remarks. Bonnie?
spk01: Thank you, Bob, and thank all of you again for joining us for today's call. We appreciate your continued interest in WMC. Have a good day, and we look forward to keeping you apprised of our progress in the months ahead.
spk02: The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.
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