Western Asset Mortgage Capital Corp (WMC) 2017 Q4 法說會逐字稿

Welcome to Western Asset Mortgage Capital Corporation's Fourth Quarter and Year-end 2017 Earnings Conference Call. Today's call is being recorded and will be available for replay beginning at 5:00 p.m. 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, Mr. Clark.

Thank you, operator. I want to thank everyone for joining us today to discuss Western Asset Mortgage Capital Corporation's financial results for the 3 months and year ended December 31, 2017.

We issued our earnings press release yesterday afternoon, and it's available on the company's website at www.westernassetmcc.com. In addition, we have included 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 Jennifer Murphy, Chief Executive Officer; Lisa Meyer, Chief Financial Officer; and Anup Agarwal, our 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 materially differ 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 Factors section of the company's reports filed with the Securities and Exchange Commission. Copies are available on the SEC's website at www.sec.gov. We disclaim any obligation to update our forward-looking statements unless required by law.

With that, I will now turn the call over to Jennifer Murphy. Jennifer?

Thanks, Larry. Welcome, everyone. In 2017, we delivered an exceptional fourth quarter and full year, generating an economic return on book value of 20.6% for the year, which is at the high end of our peer group. This return was driven by strong and consistent quarterly earnings, combined with an increase in our book value of 8.6% for the year.

As we discussed throughout 2017, our investment team undertook a significant repositioning of our portfolio beginning in the fourth quarter of 2016 and continuing into early 2017. The goal was to improve the risk-adjusted returns of the portfolio while also providing for more book value stability. This repositioning strategy, which Anup will talk about more in a few minutes, worked very well in 2017, as evidenced by our strong results for the year.

We also delivered a strong fourth quarter, generating core earnings plus drop income of $0.31 per share, which matches our declared dividend of $0.31. Our $0.31 dividend has been stable for the last seven quarters.

The company's book value increased by 2.5% during the fourth quarter, the fourth consecutive quarterly increase. That book value increase, together with our dividend, provided our shareholders with an economic return on book value of 5.3% for the quarter, also at the high end of our peer group.

An important goal for us is to improve the stability of the company's book value. In an effort to achieve that goal, throughout 2017, we took steps to improve the portfolio's interest rate risk profile by both lowering the duration and decreasing the convexity risk. These steps benefited the portfolio in 2017 and are continuing to benefit it in early 2018 as fixed income markets have experienced increased volatility. Our portfolio has fared well in this environment. We will provide an updated estimate of our book value when we announce our first quarter dividend in a few weeks.

You may recall, we recently renewed our share repurchase authorization. In the fourth quarter, we repurchased about 125,000 shares of our stock at about a 12% discount to book value. This is the first time the company has repurchased shares. These purchases were accretive to book value and a compelling investment opportunity in our view. We still have nearly 2 million shares left on our existing repurchase authorization.

Our strong financial results are a testament to the efforts of the entire investment team, which is led by Anup Agarwal. These results also speak to our entire management team's ability to draw on the breadth of Western Asset's global investment, risk and operational platform, which we view as a strategic advantage.

We continue to execute on our corporate goals, which include a focus on operational excellence and the highest standards of financial reporting and disclosure. We've strengthened our risk management program with additional resources and tools. We've reduced our total expenses by focusing on efficiencies, including, among other things, reducing outside professional fees as well as ongoing management fees as a result of the hedge book restructuring we implemented last spring. And we've improved our financial disclosure in our quarterly materials, making it easier for investors and analysts to analyze our portfolio and understand the drivers of our financial results.

We maintain our primary focus on our objective of generating consistent and sustainable core earnings that will support an attractive dividend while improving the stability of the company's book value.

Looking ahead, we'll continue to focus on our investment and operational execution, including maintaining our focus on risk management and use of best-in-class tools and practices.

With that, I'll turn the call over to our CFO, Lisa Meyer. Lisa?

Thank you, Jennifer. We are pleased with our continued strong performance for the fourth quarter and the full year. I'd like to start with financial highlights for the full year of 2017.

Book value per share increased during 2017, starting the year at $10.27 and ending the year at $11.15, resulting in an economic return on book value of 20.6% for the year.

We maintained a consistent $0.31 per share quarterly dividend for a total annual dividend of $1.24.

We generated net income of $85.1 million or $2.03 per share and core earnings plus drop income of $50.2 million or $1.20 per share.

The key contributors to our strong performance were: the portfolio repositioning, acquiring $1.8 billion in Agency CMBS and $403 million in credit-sensitive investments, while disposing of a net $622 million in Agency RMBS; the restructuring of our hedge portfolio, reducing swap-related interest expense by $13.1 million or 48%; and improved operational efficiencies, which reduced expenses by $3.5 million or 16.3%.

Moving on to our fourth quarter results. Book value per share increased from $10.88 at the end of the third quarter of 2017 to $11.15 at the end of the fourth quarter, for an economic return on book value of 5.3%.

We generated net income of $21.4 million or $0.51 per share and core earnings plus drop income of $13 million or $0.31 per share.

During the quarter, we acquired $58 million in Agency CMBS and $196 million of credit-sensitive assets, including approximately $123 million in Residential Whole-Loans and bridge loans and $73 million in Non-Agency RMBS and Non-Agency CMBS. In addition, as part of that ongoing rotation into Agency CMBS and credit-sensitive investments, we sold approximately $390 million of Agency RMBS during the fourth quarter.

Looking at our net interest income for the quarter of $16.7 million by source, approximately 45% of this is derived from our Agency CMBS and RMBS holdings and 65% of it from our credit-sensitive investments.

The portfolio had a net interest margin of 1.79%. This was comprised of an average yield on our assets of 3.82%, which was offset by an average effective cost of funds of 2.22%. The net interest margin decreased from the prior quarter as a result of an increasing LIBOR rate.

Our leverage ratio was 7.2x at year-end and 7.5x when adjusted for our net TBA position, which was relatively consistent with our leverage at the end of the third quarter. Over time, we expect our leverage ratio to decline as we transition our portfolio to a high proportion of credit-sensitive investments.

At December 31, 2017, we had master repurchase agreements with 28 counterparties and outstanding borrowings of 16. We continue to see financing interest in both our agency and credit-sensitive investments.

As we mentioned on last quarter's call in October, we completed $115 million offering of 6.75% convertible senior notes due in 2022. We believe this financing is an attractive source of longer-term capital, is more cost-efficient than using straight equity and has enabled us to increase our earnings power of our portfolio.

Before turning the call over to Anup, I would like to give you an update on the filing of our 10-K. As of December 31, 2017, WMC no longer qualified as an emerging growth company under the Jobs Act. As a result, our 10-K for 2017 is our first 10-K in which we are required to include our auditor's opinion of the effectiveness of our internal controls over financial reporting. Our auditors are currently conducting the audit, but if it is not completed by the March 16th filing date for our 10-K, we may need to file a 15-day extension.

With that, I will now turn the call over to Anup Agarwal. Anup?

Thanks, Lisa. The significant changes we made to our portfolio holdings during 2017, particularly rotating out of Agency RMBS and into both Agency CMBS and credit-sensitive mortgages, were the primary drivers of our solid performance for the fourth quarter and full year.

As we have discussed on previous calls, we believe that we were entering a period of time in which volatility would increase and rates would rise, and that most Agency residential mortgages did not adequately compensate for that risk. We believed Agency CMBS offered a more attractive risk-adjusted return. As a result, we increased Agency CMBS from 13% to 58% of our total portfolio during the year and reduced Agency RMBS from 53% down to 19%, a trend that continued after year-end.

Agency CMBS have better prepayment protection and convexity, are less expensive to hedge, and should be less exposed to the spread widening that may occur when the Fed significantly reduces its holdings of Agency RMBS. We expect that, at least under current market conditions, Agency CMBS will remain a major part of our total agency holdings relative to Agency RMBS.

Our dramatic shift in Agency holdings is an example of the benefit that WMC derives from being affiliated with Western Asset. Western's size and deep investment capabilities enable WMC to source investment opportunities and implement major shifts in the portfolio both quickly and seamlessly, which we believe is a competitive advantage.

One of our goals in the next 12 months is to reduce our leverage, as we continue to reduce our Agency holdings and increase our credit-sensitive investments. Within this sector, we are finding attractive opportunities in Residential Whole-Loans, commercial real estate loans and prime jumbo loans that are part of securitizations. Within Residential Whole-Loans, we have continued our efforts to purchase non-qualified mortgages, bridge loans and reperforming loans, having increased our exposure by more than $190 million in 2017.

We are exploring ways to improve the financing that we recieve for non-qualified mortgages through the potential use of loan securitizations. Going forward, we expect to continue to source loans that meet our target credit metrics and offer an attractive risk-adjusted return.

We also find new issue prime jumbo mortgage securitizations attractive, particularly where our investment team has participated in structuring the transactions. We are investing in the junior tranches of these securitizations as the convexity risk is more appropriately priced in.

Within the commercial real estate loan sector, we have continued to focus on adding mezzanine CMBS securities and junior tranches of Non-Agency CMBS. We continue to find co-investment opportunities with Western Asset in commercial real estate loans where Western is able to influence the transaction, covenants and deal structure. We have focused on short-term loans that are secured by properties with solid credit fundamentals and strong covenants.

Spreads in Non-Agency CMBS sector of the market have generally lagged the overall spread tightening in credit-sensitive assets, yet fundamentals are healthy and the outlook for commercial real estate remains favorable. We are being paid an attractive carry on these holdings, so any spread tightening that may occur in the future will be incremental to our total return expectations.

In conclusion, we are very pleased with the performance of our portfolio during the year, and we believe that it continues to be well positioned to deliver attractive long-term core earnings and a relatively stable book value.

With that, we will open up the call for questions.

(Operator Instructions) The first question comes from Trevor Cranston with JMP Securities.

First question, and you guys talked a bit about a few different investment categories where you're seeing attractive opportunities. Can you maybe elaborate a bit on, within those segments, which particular areas you're seeing the highest returns in and sort of how you would rank the attractiveness of adding those different categories to the portfolio?

Sure. I think within the attractiveness of the opportunities, commercial mezz loans still continue to be probably one of the most attractive opportunities, followed by bridge residential loans, followed by our non-qualified mortgages. And then, it is the prime jumbo, especially it has become pretty interesting, as well as reperforming loans, in that order.

Got it. Okay. And would you say the ROE levels are somewhat similar across those asset classes? Are there other characteristics that make them sort of have different rankings as you think of adding them to the portfolio?

Yes. ROE levels -- both from the quality of the credit as well as ROE levels are in that order, are similar. But on margin, I believe, that commercial mezz is more attractive on a relative basis, the commercial mezz and bridge residential, from an ROE perspective, are probably the most attractive opportunities, and then followed by the other segments.

Got it, okay. And on the residential loans, the bridge and the non-QM, can you give an update on your ability to source those loans and if you're seeing any potential to work with any new origination partners as we go into 2018 that might sort of increase the flow that's available of those assets?

Sure. If we take each category separately, for non-qualified mortgages, we are always looking out for newer partners to our program. But having said that, I think we have a pretty stable roster of originators who are providing us non-qualified mortgages. And at this point in time, between the quality and the rate we are able to get, I think, we are in a pretty good place. We haven't actively added more people for our non-qualified mortgages. On the bridge residential side, we continue to look for more. And I think we are always, on the margin, adding more people to our roster. But we have a pretty steady-state flow from some of the current relationships we have as well. But I think there you will see at least one or two more people added to the roster for bridge residential.

Got it. Okay, that's helpful. Last question, you guys have been stable at that $0.31 dividend level for several quarters now. Can you provide any color on how you're thinking about that heading into 2018 in light of the likely continued increases in short-term rates by the Fed?

Thanks, Trevor. It's Jennifer. The way we think about the dividend each quarter is we'd like it to reflect the long-term earnings power of the portfolio. So that's the way we'll continue to think about it in 2018. As you know better than most, I think, our dividend is set at a level that makes us one of the highest-yielding REITs in our peer group. So I think we're already providing a very attractive dividend, and that's a goal for us. But we also want to be aware of the earnings power of the portfolio. So as that changes, the long-term characteristics change, we'll change the dividend to reflect that. Does that answer your question?

Yes, that helps.

(Operator Instructions) I'm showing no further questions. This concludes our question-and-answer session. I would like to turn the conference back over to Jennifer Murphy for any closing remarks.

Thank you for joining us. Have a great day.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.