Western Asset Mortgage Capital Corp (WMC) 2015 Q1 法說會逐字稿

Welcome to the Western Asset Mortgage Capital Corporation's First Quarter 2015 Earnings Conference Call. Today's call is being recorded and will be available for replay beginning at 5PM Eastern Standard Time. (Operator Instructions). Now first I'd like to turn the call over to Mr. Larry Clark, Investor Relations for the company. Please go ahead, sir.

Thank you, operator. I want to thank everyone for joining us today to discuss Western Asset Mortgage Capital Corporation's financial results for the three months ended March 31, 2015. By now you should have received a copy of today's press release. If not, it's available on the company's website at westenassetmcc.com. In addition we are including an accompanying slide presentation that you can refer to during the call. You can access these slides in the Investor Relations section of the website. With us today from management are Gavin James, Chief Executive Officer, Steven Sherwyn, Chief Financial Officer, Anup Agarwal, 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 forecasts 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 factors 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 forward-looking statements unless required by law. With that, I will now turn the call over to Gavin James, Chief Executive Officer.

Thanks, Larry, and thanks everybody for joining us today for our first quarter conference call. I will begin the call by providing some opening comments, Steve Sherwyn, our CFO, will then discuss our financial results, and then Anup Agarwal, our Chief Investment Officer, will provide an overview of our investment portfolio and our future investment outlook after our prepared remarks we will conduct a brief question-and-answer session.

The first quarter of 2015 proved to be another challenging period for the U.S. mortgage markets, given the ongoing interest rate volatility that occurred during the quarter. Despite this continued volatility, we generated strong core earnings for the quarter, which more than supported our existing dividend. We delivered a positive economic return for the period, despite the impact of unrealized losses on our interest rate hedges on our book value.

During the first quarter we recorded net income of $0.34 per share while generating core earnings plus drop income of $0.82 per share. Our economic return on book value was 1.9% for the quarter, which included a $0.67 per share dividend, enabling us to remain the highest yielding mortgage REIT in the sector and that's based on yesterday's closing prices. Our results continue to reflect the ongoing implementation of our strategy to build a more diversified portfolio with a higher portion of credit sensitive investments as well as our ability to take advantage of relative value opportunities across the entire mortgage sector through our proactive approach to portfolio management.

Our performance in the first quarter was due to a number of factors. First, our core possess in agency RMBS, non-agency RMBS and CMBS performed well. We were also proactive during the quarter, continually adjusting our leverage and hedge positions in response to the significant swings in the U.S. Treasury market. In addition, we harvested some gains in our non-agency RMBS portfolio as we sold some high dollar price securities based on our belief that they have become fully valued.

Our view on interest rates remains consistent. We believe that the long end of the curve will remain range bound over the course of the year and short-term rates will remain near zero until at least late summer, and then only gradually increase from there. This view is based on our belief that the economic growth in the U.S. will remain modest over the next several quarters and that the Fed will continue to be patient and then proceed gradually with caution when it finally decides to increase short-term rates. Our portfolio has continued to perform well in the second quarter with a recent move up in rates, the value of our agency and non-agency holdings during the month of April had declined slightly, but this has been more than offset by the increase in the value of our hedge positions. As a result, our estimated book value has improved since the end of the first quarter. Anup Agarwal will go into more detail on our outlook going forward.

Our investment strategy remains the same. We plan to continue diversing our portfolio into credit sensitive investments and to continue to employ an active management strategy. Although we can't guarantee the performance of our portfolio investments, we believe we are well positioned to deliver on our long-term objective of generating strong core earnings to support an attractive dividend, while also maintaining a stable book value. At this time I'm going to turn the call over to Steve Sherwyn, our CFO, to discuss our financial results. Steve?

Thanks, Gavin. Good morning, everyone. I will discuss our financial results for the first quarter ended March 31, 2015. Except where specifically indicated, all metrics are as of that date. On a GAAP basis we recorded net income for the quarter of approximately $14.1 million or $0.34 per basic and diluted share. Included in the net income was approximately $28.4 million of net unrealized gains on MBS, other securities and hold ons, approximately $7.5 million of net realized gain on MBS and other securities, and approximately $48.3 million of net loss on derivative instruments.

For the quarter our core earnings plus drop income was approximately $34.4 million or $0.82 per basic and diluted share. This compares to core earnings plus drop income of approximately $36.4 million or $0.87 per basic and diluted share for the fourth quarter ended December 31, 2014. Our core earnings were approximately $29.5 million or $0.71 per basic and diluted share, which is a non-GAAP financial measure, which we define as net income or loss excluding net realized and unrealized gains and losses on investments, net unrealized gains and losses on derivative contracts, non-cash stock-based compensation expense, and other non-cash charges.

For the quarter we generated drop income of approximately $5 million or $0.11 per diluted share, which is within our expected quarterly range given our use of to be announced or TBA forward contracts on agency RMBS. Drop income represents a non-GAAP financial measure and is defined as the difference between the spot price and the forward settlement price for a comparable security on the trade date. For the quarter ended March 31, 2015, our average amortized cost of MBS, and other securities held including agency and non-agency interest only strips accounted for as derivatives, was approximately $4.32 billion as compared to approximately $4.45 billion for the fourth quarter ended December 31, 2014.

Our net interest income for the first quarter was approximately $34.4 million. This is a GAAP financial measure and does not include the interest we received from our IO securities that are treated as derivatives nor does it take into account the cost of our interest rate swaps. The latter two are included in the loss on derivative instruments line in our income statement. On a non-GAAP basis, our net opportunity income, including interest we received from IO securities treated as derivatives and the cost of our interest rate swaps, was also approximately $34.4 million. This compares to non-GAAP net interest income of approximately $31.8 million for the fourth quarter of 2014. The increase in our net interest income was primarily due to lower hedge adjusted volume costs resulting from our duration management during the quarter.

Our weighted average net interest spread for the first quarter of 2015, which takes into account the interest that we received from non-agency RMBS, CMBS and IO, home loans and other securities, as well as a fully hedged cost of our financing, was 3.16%, reflecting a 3.97% gross yield on our portfolio and a .81% effective cost of funds. This compares to a weighted average net interest spread of 2.71% for the fourth quarter of 2014, reflecting a 3.79% gross yield on our portfolio and a 1.08% effective cost of funds. Our net yield increase primarily due to lower effective interest costs, as I mentioned earlier.

During the first quarter our constant prepayment rate or CPR for our agency RMBS portfolio was 7.6% on an annualized basis. This compares to 6.8% for the fourth quarter of 2014. Despite the increase in refinancing activity that occurred during the first quarter, we were able to maintain a low CPR due to our focus on buying agency RMBS that we believe exhibit low prepayment characteristics.

Our operating expenses for the first quarter were approximately $5.6 million, which includes approximately $2.9 million for general and administrative expenses and approximately $2.7 million in management fees. Included in G&A expenses were non-cash stock-based compensation of approximately $679,000. Our G&A expense expressed as an annualized percentage of our average stockholders' equity were approximately 1.9% and were higher in the first quarter mainly due to higher professional costs and non-cash stock-based compensation.

Our book value per share as of March 31st, 2015, was $14.55, which takes into account the $0.67 regular cash dividend that we declared on March 26, 2015, and paid on April 28, 2015. As of March 31st, the estimated fair value of our portfolio was approximately $4.2 billion and we had borrowed a total of approximately $3.6 billion under our existing master repurchase agreements. Our leverage ratio is approximately 6 times at quarter end. Our adjusted leverage ratio was approximately 7.2 times at quarter end, adjusted for $737 million notional value of net long positions in TBA mortgage pass through certificates that we held at quarter end. We continue to be in the attractive position of having rebook capacity well in excess of our current needs. At March 31st we had master repurchase agreements with 25 counterparties and outstanding borrowings with 20 counterparties. We continue to have excellent relationships with our bank counterparties and we feel comfortable with our existing group. We have a highly diversified repo lender book and believe that we have more than ample liquidity to meet our present and expected funding requirements.

As of March 31st, we have entered into approximately $4.5 billion in notional value of pay fixed interest rate swaps, excluding forward starting swaps of $2.4 billion and approximately $3.1 billion of paid variable interest rate swaps, excluding forward starting swaps of $265 million, giving us a net pay fixed swap position of approximately $1.4 billion. Additionally we've entered into approximately $655 million notional amount of pay fixed interest rate swaptions with swap terms ranging from one to ten years and exercise expiration dates between June 2015 and June 2016. As a result of our hedge positions, our agency RMBS portfolio had a net duration of negative 1.7 months at quarter end. We are comfortable with our current leverage and adjust our implied leverage fairly quickly through the use of TBAs and we determine our leverage based on what we believe will enable us to optimize our core earnings on a risk adjusted basis and maintain a stable book value. With that, I will now turn the call over to Anup Agarwal. Anup?

Thanks, Steve. Good morning and thank you for joining us today. Let me spend a few minutes discussing our investment results for the quarter and update you on our portfolio strategy. As Gavin mentioned, the first quarter saw a continuation of extreme interest rate volatility with the ten year U.S. Treasury rate dropped by roughly 50 basis points in January and increased by approximately 60 basis points by early March, only to drift lower from there, ending the quarter down just over 20 basis points. Given our ability to add value through active management, we made a number of adjustments to our portfolio and our interest rate hedges as market conditions changed throughout the quarter.

As we entered 2015, we believed that prepayment risk will increase, putting pressure on TBAs draw to the specified pools and generally remove to a net negative position in TBAs thus lowing our implied or adjusted leverage. This technical shift worked well, as specified pools outperform TBAs in January however the flattening of the yield curve put pressure on the hedge positions during January. We subsequently improved during the remainder of the quarter, with partial retracement of ten year U.S. Treasury yield.

In early February, shortly after interest rates bottomed, we increased leverage again by returning to net positive TBA position and adjusted our hedges, moving closer to a net neutral duration on our agency RMBS portfolio. With respect to our agency portfolio, we also sold down some of our exposure to 30-year pools and increased our exposure to 20-year pool, as we believe that these pools offered a better hedge adjusted carry and increased prepayment protection. We have maintained our primary exposure to 3.5%, 4%, and 4.5% coupons in 30-year fixed rate pools and 3%, 3.5% and 4% coupons in 20-year pools, the majority of our agency investments continue to be in mortgage pools with loan on balance, with the remainder in high LTV or investor pools, which is consistent with our investment strategy of minimizing our prepayment risk.

Our activity in credit sensitive portion of portfolio during the quarter consisted primarily of shifting our holdings within the sector as we sold some of our high dollar price non-agency RMBS position and increased our holdings of residential home loans and GFC risk, credit risk transfer securities. In addition, we made our first investment in commercial real estate home loans, although the overall mix of assets between agency and non-agency securities was relatively unchanged in the quarter, we continue to target a steady increase in the mix of non-agency securities over a longer term horizon, and as we mentioned last quarter, our plan is to gradually replace a portion of our agency RMBS holdings with assets purchased through our whole loan programs. We continue to believe that our credit sensitive investments will continue to perform well in a gradually improving U.S. economy, while also exhibiting less interest rate sensitivity than agency securities.

We have entered the second quarter with interest rates increasing, closer to high end of our expected range, as Gavin mentioned, the value of our agency and non-agency holdings during the month of April have declined slightly, but the value of interest rate hedges have continued to recover. We have slightly reduced our adjusted leverage and maintained an approximate net neutral duration on our agency portfolio, given our belief that the number of cross currents in global macroeconomic environment, it is best to maintain such a duration positions. That being said, we expect to continue to manage our leverage and duration opportunistically based on our view of U.S. mortgage markets at any point in time.

We are making steady progress on our home loan strategy. We have increased our investment in non-TM residential mortgages and are also ramping up our commercial mortgage program with a focus on short-term conditional commercial first mortgages with maturities inside two years, loan amounts in the $5 to $20 million range and LTVs in 65% to 70% range. Our primary investment strategy remains unchanged, and that is to maximize total return for our shareholders. We plan on continuing to implement this strategy by holding a diversified portfolio of securities that offer what we believe are the best risk adjusted returns over our investment horizon, which is consistent with our long-term objective of generating sufficient core earnings to support an attractive dividend while also maintaining our stable book value. With that, we will now entertain your questions.

Thank you, sir, we will now begin the question-and-answer session. (Operator Instructions). At this time we will pause momentarily to assemble our roster. Our first question comes from Joe Houck from Wells Fargo.

Good morning and thanks for taking the question. Can you guys talk about the interquarter net duration band that you're comfortable with? Of all the mortgage rates you covered, I think you guys are probably one of the more active managers out there, and I guess it would be helpful from a, you know, kind of risk/reward tradeoff to understand what you're comfortable with, you know, interquarter. We obviously see the end of quarter net duration, but it can, as you know, change dramatically interquarter.

Yeah. Thanks, Joe. I think that, as we have discussed before, at any point in time I think you, the most you kind of see from us in terms of a duration GAAP has been plus/minus, plus one, to minus one in duration at any point in time on agency portfolios.

And how about the overall, you know, taking into account the credit book, which, you know, has some offsetting characteristics to the agency book?

Yes, I mean, I think, look, we, I always look at both just the combination of agency portfolio as well as just a broader credit book, but some of the, as you know, some of the credit instruments, even when they show that they have a duration, there is, they are more credit instruments than an interest rate sensitive instrument, if it's a legacy RMBS security, they have, they're all floaters, and they have zero duration, and you get some benefits off it but, ultimately, kind of where we see the bigger impact of duration is really on the agency book. But I think, I look at both combination of agency as well as the combination of agency and credit sensitive book. And overall you would not see from us going to, you know, within the band of plus one year to minus one year. Generally. You know, even when it's plus one to minus one, kind of on the wider end of those ranges, is more when we have a very, very strong conviction that it's going one way or the other. Generally it sticks within about plus/minus half a year, is where we would see our book.

Okay. Thank you very much.

And our next question comes from Lucy Webster from Compass Point.

Hey, good morning, guys, thanks for taking my question. I was hoping, you know, you could just generally talk about what you're seeing in the CRE market these days and maybe where you see that strategy ramping over the course of the year.

Sure. Now, I'm, look, I think, in CRE so there are effectively three segments in CRE where we see opportunity. The first one, which happens to be in the legacy CMBS market, where, kind of, we have been long, you know, Junior Triple A's, what are called AJs, we still see some value in some of those legacy books but that legacy AJ book is slowly starting to come down because the bet played out. Still have a strong carry, still have a very attractive leverage yield, but it's, the strategy played out and I think we are slowly starting to reduce that exposure. The place where we do see value right now is on the new issue CMBS, especially lower in the classes and the double B, single B classes because those yields look very attractive, as well as in U.S. and Europe CRE, especially buying kind of the [med] positions, anywhere from 55 to 75 kind of LTV kind of positions, ranging anywhere from 650 over to 800 over. And that's really the part of the, the third part of the bucket, which is the U.S. med and European med, as well as, the whole loan program and CRE, which is kind of the transition loans where borrowers used to go to a Community Bank. These are again low LTV loans which are 60, 65 loan-to-value loans, two-year maturity, one to two years maturity, have a strong coupon anywhere from 6% to 9%, that's really where we see, those are the two buckets where we see value and that's really what you will see us grow while the other buckets kind of come down.

Great. Very helpful. Thank you.

(Operator Instructions). We have no further questions, Mr. James.

Okay. With that, I'd like to thank everybody for joining the call today, and I look forward to meeting many of you in person over the course of the next couple of months. Thank you, operator.

Thank you again for joining us for the call. We look forward to seeing many of you in the months ahead. Thank you. You may now disconnect the line.