Image source: The Motley Fool.
Western Asset Mortgage Capital Corp (WMC)
Q1Â 2019 Earnings Call
May. 8, 2019, 11:00 a.m. ET
Contents:
- Prepared Remarks
- Questions and Answers
- Call Participants
Prepared Remarks:
Operator
Welcome to Western Asset Mortgage Capital Corporation's First Quarter 2019 Conference Call. Today's call is being recorded and will available for replay beginning at 5:00 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.
Larry Clark -- Investor Relation Officer
Thank you, Kate. 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, 2019. The company issued its earnings press release yesterday afternoon, and it's available on the company's website at www.westernassetmcc.com.
In addition, the company has included and 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; Harris Trifon, 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 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 Jennifer Murphy. Jennifer?
Jennifer Murphy -- President and Chief Executive Officer
Thank you, Larry. Welcome everyone. I'm pleased to report we delivered another quarter of strong performance, generating GAAP net income of $0.58 per share and core earnings of $0.32 per share. Our quarterly core earnings have been very consistent over the last few years and have on average exceeded our $0.31 per share dividend -- quarterly dividend, which has remained stable for 12 consecutive quarters.
We also delivered an increase in book value of 2.4% during the quarter as our differentiated investment strategy benefited from tighter credit spreads and the effects of hedging of our interest rate exposure. The book value increase together with our dividend, provided our shareholders with an economic return on book value of 5.4% for the quarter or more than 21% on an annualized basis, a very good start to 2019.
Our solid first quarter performance is a result of the strength of our diversified portfolio and differentiated investment strategy as we continue to benefit from the significant asset repositioning we began in the fourth quarter of 2016. On a broader level, our results continue to reflect our ability to draw on the breadth and depth of Western Asset, our manager's global investment, risk and operating platform, which we view as a strategic advantage for WMC and its shareholders. Essentially, WMC is able to leverage the Western Asset platform to gain access to proprietary opportunities that we simply would not have as a stand-alone mortgage REIT.
Our investment team was again quite active during the quarter, as Sean Johnson will talk about later in the call. Our finance team was busy as well as we opened two new financing facilities with a longtime financing partner, one each for residential and commercial loans. These lines offer the security of longer-term, committed financing and are consistent with our goal of increasing the duration of our liabilities.
On Monday, we announced very positive news regarding our search for permanent Chief Investment Officer. I'm pleased to report that our Board of Directors has appointed Harris Trifon as WMC's new Chief Investment Officer and Sean Johnson as its Deputy Chief Investment Officer. Harris has been part of the investment team at WMC for five years and is deeply involved in the strategy and management of the company's portfolio.
Harry currently serves as the Co-Head of Mortgage and Consumer Credit of Western Asset Management and has been a valuable contributor at Western since he joined the firm in 2014. We look forward to expertise in leading our investment team. His extensive experience in managing credit-sensitive assets will be particularly valuable as that asset class will remain a core part of our investment strategy. You all know Sean as he's been an integral part of the company's investment team and strategy since our initial public offering in 2012 and most recently served alongside Dennis McNamara as Interim co-CIO since last September. Sean has more than 30 years of investment experience and has played a critical role in the restructuring of our portfolio and the development and execution of our differentiated strategy.
Western Asset's hallmark is its team-based investment approach, and we have a deep bench of talent to draw on for the leadership and implementation of WMC's investment strategy. We're very excited to welcome Harris and Sean to their expanded roles at the company and look forward to their working together to continue to deliver the consistent financial performance that we've achieved over the last few years.
Before turning the call over to Lisa Meyer, our CFO, and Sean, who will both discuss our results in more detail, I'd like to ask Harris to share his thoughts regarding WMC's investment approach and outlook. Harris?
Harris Trifon -- Chief Investment Officer
Thank you, Jennifer. It is an honor to be appointed Chief Investment Officer of WMC, and I am looking forward to working closely with Sean and the rest of the investment team to continue building upon the successful track record that has been established over the last seven years since going public in 2012. I'm looking forward to meeting with you, our analysts and shareholders in the months ahead as we share our progress toward achieving our long-term goals and objectives. As you have heard many times, WMC's primary goal is to generate consistent and sustainable core earnings that support an attractive dividend while maintaining a relatively stable book value. We seek to achieve this goal by employing a differentiated investment strategy that is based on our ability to identify and access relative value opportunities across the entire mortgage sector and assemble a portfolio of assets that offer what we believe to be the best risk-adjusted returns.
We are able to do this because of our access to the global investment, risk and operational platform provided by our manager, Western Asset. Western's best-in-class portfolio and risk-management capabilities come with scale and provide WMC with investment opportunities and financing relationships that it would likely not have a stand-alone mortgage REIT. As you know, in the fourth quarter of 2016, we began implementing a significant portfolio repositioning with a goal to improve the portfolio of risk-adjusted returns while also providing for greater book value stability.
More specifically, we changed the asset composition of our portfolio to reduce our exposure to Agency RMBS and increased our exposure to Agency CMBS and other assets that we believe will offer better risk-adjusted returns, including Residential and Commercial Whole-Loans and other credit-sensitive investments. This repositioning strategy has contributed to our strong and consistent performance over the last two years.
Looking ahead, we believe that credit spread sectors will continue to perform well again in 2019, and we continue to find compelling investment opportunities in Residential and Commercial Whole-Loans. We also believe that our Agency CMBS holdings provide an important balance to our credit-sensitive assets and compare favorably to Agency RMBS. This investment outlook is governed by our view that the US and global economic expansions will continue albeit at a slow pace allowing for an ongoing low-inflation environment. We believe that the continuing primary focus of monetary policymakers around the world will be to continue to support their respective economies through accommodative measures.
Our view of residential real estate remains favorable as the US housing market is entering a more normalized phase, and we expect home price appreciation to moderate. Underlying demand continues to be healthy and is supported by historic lows in unemployment and strong consumer confidence levels. However, the outside price appreciation the market has experienced over the last few years has led to affordability concerns in some areas and is acting as a moderator to higher prices.
We also expect commercial real estate fundamentals to remain favorable, given the ongoing economic expansion, the strong job market and limited new supply. That being said, our approach to commercial real estate lending is very transaction-specific. We continue to target short-term loans to establish institutional investors, focusing on properties with strong credit fundamentals and long-term that include covenants that enhance and protect our interests as lenders.
In summary, our differentiated investment strategy is based on holding a diversified portfolio of loans and securities that offer what we to be -- what we view to be the best risk-adjusted returns over our investment horizon. We believe this approach is the best way to pursue our objective of strong core earnings and an attractive dividend while maintaining a relatively stable book value per share with the overall goal of enhancing shareholder value.
With that, I will now turn the call over to our CFO, Lisa Meyer. Lisa?
Lisa Meyer -- Chief Financial Officer and Treasurer
Thank you, Harris. We delivered another strong performance in the first quarter of 2019 driven by our eighth consecutive quarter of solid core earnings.
During the first quarter, our core earnings were $15.5 million or $0.32 per share. As Jennifer mentioned, our portfolio continues to generate income in excess of our $0.31 dividend. Our dividend has remained constant for 12 consecutive quarters and our core earnings plus drop income has exceeded the dividend by approximately 9% in the aggregate over that time period.
A key contributor to our ongoing strong performance is our diversified investment portfolio. As Harris mentioned and Sean will provide more detail, we continue to assemble a portfolio of Residential Whole and Commercial Loans complemented by our holdings in Agency CMBS and other securities.
During the first quarter, we increased the size of our credit-sensitive investments by 6% primarily -- by acquiring $249 million in Residential Loans, $121 million in Commercial Loans and $65 million in Non-Agency CMBS.
In the quarter, our portfolio generated net interest income of $20.3 million, inclusive of hedging costs. Our credit-sensitive investments contributed $15 million or 74% compared to 55% in the first quarter of 2018. Our annualized net interest margin for the quarter increased by 11 basis points to 2.36% from 2.25% in the fourth quarter of 2018. The increase was a result of higher yielding credit-sensitive investments, which was partially offset by an increase in the effective cost of funds.
Turning to expenses. Our total expenses for the quarter were $5.3 million, down $600,000 from the fourth quarter of 2018. The decrease is mainly due to lower loan servicing fees paid on our residential bridge loan portfolio, as a result of $68 million of payoff and no new reinvestment in this asset class.
Our objective is to maintain a relatively stable book value while generating core earnings positioned to support our dividend. We will manage our leverage to balance these objectives. As of March 31st, our recourse leverage was 5.9 times.
At the end of the quarter, we had $2.9 billion of repurchase agreement borrowings on 17 of our 32 master repurchase agreements. We continue to evaluate other attractive sources of financing, and during the quarter, we secured two financing facilities, a $150 million facility for commercial loans and a $700 million facility for residential loans. As Jennifer mentioned, these facilities offer attractive mortgage and financing, extending our weighted average maturity from approximately three months to approximately two years.
We continue to operate with interest rate protection from our interest rate swap position. At the end of the quarter, we held interest rate swaps with a net notional amount of $2.2 billion and nearly no duration gap on our Agency portfolio.
With that, I will now turn the call over to Sean Johnson. Sean?
Sean Johnson -- Deputy Chief Investment Officer
Thanks, Lisa. The repositioning of our portfolio out of Agency CMBS and into high-quality, credit-sensitive investments was a primary driver of our solid performance for the first quarter. We continue to realize benefits of our differentiated investment strategy and diversified portfolio.
As of March 31st, credit-sensitive assets represented 61% of our total adjusted portfolio, up from 29% one year ago. Our focus on the credit-sensitive portion of our portfolio has been to invest across several sectors of the market, but primarily in Whole-Loans.
In the quarter, we continued to build on our positions in these loans. We acquired $460 million in target assets, including $370 million in Residential and Commercial Whole-Loans through Western's robust relationships with high quality originators. This quarter's Whole-Loan purchase pace was nearly double that of the first quarter of 2018. Our Residential Whole-Loans now make up 60% of our credit-sensitive holdings, and our commercial loans represent another 19% on an unconsolidated basis.
As we've discussed in the past, we have developed strategic relationships with residential and commercial loan originators, originators who understand us and what we're looking for and we are able to provide us with attractive opportunities that meet our discipline criteria. Our approach to the Residential Whole-Loans has always been to focus on high-quality borrowers with lower LTVs who are able to demonstrate a strong desire and ability to repay.
On the commercial side, we target short-term loans that are secured by properties with solid credit fundamentals and strong covenants that protect us as lenders. We like these loans because we're able to get involved in the deals early and often collaborate on key aspects of the structure.
In addition to our commercial loan purchases, we bought nearly $90 million of Agency and Non-Agency securitized commercial mortgage bonds. These were purchases that in our view offered attractive, relative value opportunities and fit well with our differentiated investment strategy.
In conclusion, we are very pleased with the performance of our portfolio during the quarter, and we continue to focus on our goal of delivering solid core earnings and preserving book value.
With that, we will open up the call to questions. Operator, please go ahead.
Questions and Answers:
Operator
(Operator Instructions) The first question is from Eric Hagen of KBW. Please go ahead.
Eric Hagen -- Keefe, Bruyette & Woods -- Analyst
Hi, good morning. Harris, congrats on the new job, and I look forward to meeting you. An accounting question, I guess. Just the yield was up quarter-over-quarter. The size of the portfolio was stable and even up, but interest income was down by a few million dollars on an adjusted basis. Just want to get a -- is there a timing -- was there a timing issue with securities (multiple speaker).
Lisa Meyer -- Chief Financial Officer and Treasurer
Yes. it was timing issue. Yeah. The repo (ph) which is a securitization that we consolidate on balance sheet, which is been $1 billion (ph) securitized commercial loans. What happens is, is it's paid off and refinanced during the quarter. So what happened is that paid off actually on March 15. And then the new deal that came out includes until the end of the last day of -- business day at the end of the quarter on March 29. So we lost about two weeks of interest income related to that, which is a little over $3.5 million.
Eric Hagen -- Keefe, Bruyette & Woods -- Analyst
Got it. So the yields that you're showing us is the period ending yield, correct? Okay. Got it. Great. Super. And then the non-QM portfolio was up very nicely in the quarter. How should we think about the growth in that portfolio going forward?
Harris Trifon -- Chief Investment Officer
Thanks, Eric. This is Harris. Appreciate the kind words earlier and looking forward to meeting you as well. As far as the non-QM portfolio, you're right. We did grow our position in that part of the market pretty aggressively over the first quarter. And we continue to find a tremendous amount of value in that sector, leveraging the relationship that we've built with originators over the last number of years. More generally, I think you would expect to see continued growth in that part of the market in terms of WMC's participation, obviously, subject to market conditions changing. But we continue to find a lot of value in that segment of the market.
Eric Hagen -- Keefe, Bruyette & Woods -- Analyst
Okay. Can you kind of guide me to a run rate? I mean, is there a gross level of acquisitions you guys are kind of targeting on a quarterly or even monthly basis?
Harris Trifon -- Chief Investment Officer
We don't have a firm target per se. But as the entirety of the portfolio is concerned, we do think about, particularly in the repositioning that we've gone through over the last couple of quarters as we've increased our exposure to credit-sensitive investments, particularly on the private side residential and commercial loans. We have been thinking very carefully about how much we want to spend in terms of what percentage of our balance sheet. I wanted to say there's a hard number or a target per se. All of this is contingent on market conditions and the relative value opportunities that are presenting themselves.
That all being said, the conversations we've had with our partners in that space as well as the commercial loans space, we're very optimistic about our potential to continue to grow our activity level in that space and have a stabilized run rate in terms of our purchases going forward.
Eric Hagen -- Keefe, Bruyette & Woods -- Analyst
Great. And the new financing facility for the non-QM, is there any chance that you could kind of transition the entire portfolio to be financed with that longer-dated funding?
Lisa Meyer -- Chief Financial Officer and Treasurer
I'm sorry. This is Lisa. The bulk of the non-QM portfolio is already on that facility.
Eric Hagen -- Keefe, Bruyette & Woods -- Analyst
Right. I think there were some that was left on with the shorter-term repo. My question is whether we can eventually see all of kind of the repo financing be longer-term backed by that, supporting that portfolio.
Harris Trifon -- Chief Investment Officer
We're looking very carefully at getting longer-term financing for the entirety of our Whole-Loan portfolio, inclusive of not just non-QM, but also the commercial loans as well.
Eric Hagen -- Keefe, Bruyette & Woods -- Analyst
Got it. And if I'm doing the math correctly, it looks like about 8 times leverage in the Whole-Loan, the Residential Whole-Loan portfolio. Is that -- I just want to make sure I'm kind of doing that right.
Harris Trifon -- Chief Investment Officer
Yeah, that's pretty close. Yeah.
Eric Hagen -- Keefe, Bruyette & Woods -- Analyst
Okay. Great. Thank you guys. Thank you for the colors.
Harris Trifon -- Chief Investment Officer
Thank you.
Lisa Meyer -- Chief Financial Officer and Treasurer
Thank you.
Operator
The next question is from Trevor Cranston of JMP Securities. Please go ahead.
Trevor Cranston -- JMP Securities -- Analyst
Hi. Thanks. Good morning. A couple of follow-up questions on the resi-loan portfolio. First, I was wondering if you could disclose what the weighted average coupon was on the new loans you acquired during the first quarter. And maybe more generally, if you could provide some color on kind of where you think returns are on that opportunity today versus where they've been over the last year or so, if there's been any meaningful sort of trend one way or the other. Thanks.
Harris Trifon -- Chief Investment Officer
Trevor, this is Harris. I'll start off, Sean will jump in a moment. Just in terms of your last question specifically. You're right in terms of -- there has been more capital flowing into that during and we have observed some spread compression in terms of our new purchases. However, I think as the team has discussed in the past, the segment of the non-QM market that we're particularly focused on are lower leverage loans, higher-quality borrowers. And as such, most of the newer capital that has come into that sector has been focused on the other end of the market. So we have not observed as much spread compression or coupon compression -- purchases. But at a broader level, yes, there has been some mild degradation in terms of the levered yields and unlevered yields.
Sean Johnson -- Deputy Chief Investment Officer
And just to follow up a little bit. Our -- the rates that we're getting right now on new non-QM in our sort of lower-risk bucket focus is in the mid-5%. And the yields are approximately in that same area as well. What we are seeing now is that the originators that we're -- we've been dealing with have been growing their market share and their production volumes had a pretty good clip. So it feels like even with new market participants, the supply is going to fill the demand.
Trevor Cranston -- JMP Securities -- Analyst
Got it. Okay. That's helpful. And then a question on the hedge portfolio. We've seen three-month LIBOR decline somewhat significantly over the last few months. Curious if you guys could provide any of your thoughts around sort of how that impacts your thinking on the earnings level and dividend going forward, and if there's some potential offsets we should think about in terms of higher leverage or better financing terms that might offset some of the decline from the compression between three-month LIBOR and repo. Thanks.
Sean Johnson -- Deputy Chief Investment Officer
Right. Yeah. We have seen some of that. I think a lot of that is just the market got a little ahead of itself in thinking that the Fed might cut. Obviously, the Fed is more worried about the recent weakness as being transitory as opposed to something significant. So generally, we are seeing -- we have a hedge strategy that we try to minimize our exposure to the shorter-term rates. So you'll see that our swap book is pretty well balanced against a more interest rate-sensitive asset. And we found that over time, including the new facilities that we have, we've been able to reduce our -- the margin on our financing relative to LIBOR. So even though general repo might be widening versus LIBOR, or the margins we're paying versus LIBOR have been generally shrinking. So in that sense, we've been able to manage that cost. And I think we're always looking at longer-term financing and fixed-rate financing to help mitigate some of that risk.
Trevor Cranston -- JMP Securities -- Analyst
Okay. Got you. Appreciate the comments. Thank you.
Operator
(Operator Instructions) There are no additional questions at this time. This concludes our question-and-answer session. I would like to turn the conference back over to Jennifer Murphy for closing remarks.
Jennifer Murphy -- President and Chief Executive Officer
Okay. Thank you. And thanks everyone for joining us today. Have a nice day.
Operator
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
Duration: 26 minutes
Call participants:
Larry Clark -- Investor Relation Officer
Jennifer Murphy -- President and Chief Executive Officer
Harris Trifon -- Chief Investment Officer
Lisa Meyer -- Chief Financial Officer and Treasurer
Sean Johnson -- Deputy Chief Investment Officer
Eric Hagen -- Keefe, Bruyette & Woods -- Analyst
Trevor Cranston -- JMP Securities -- Analyst
