Image source: The Motley Fool.
Western Asset Mortgage Capital Corp (WMC)
Q1Â 2020 Earnings Call
May 7, 2020, 12:00 p.m. ET
Contents:
- Prepared Remarks
- Questions and Answers
- Call Participants
Prepared Remarks:
Operator
Welcome to the Western Asset Mortgage Capital Corporation's First Quarter 2020 Earnings Conference Call. Today's call is being recorded and will be available for replay beginning at 5:00 p.m. Eastern Standard time. At this time, all participants have been placed in 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 Relations
Thank you, Debbie. I want to thank you everyone for joining us today to discuss Western Asset Mortgage Capital Corporation's financial results for the first quarter of 2020. The Company issued its earnings press release yesterday, and it's available on the Investor Relations section of the Company's website at www.westernassetmcc.com. In addition, the Company has included a slide presentation that you can refer to during the call and you can also access these slides on the website. With us today from management are Jennifer Murphy, Chief Executive Officer; Lisa Meyer, Chief Financial Officer; and Harris Trifon, 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'll now turn the call over to Jennifer Murphy. Jennifer?
Jennifer Williams Murphy -- President and Chief Executive Officer
Thank you, Larry. Welcome, everyone.
The March quarter was an extremely challenging and difficult environment for global markets as the economic impact of the pandemic created unprecedented market conditions, severe illiquidity, volatility, and uncertainty. In the beginning of 2020, we were anticipating continued moderate economic expansion in the United States. At that time, our investment strategy combined primarily agency CMBS interest rate investments with residential and commercial credit holdings. Our residential credit investments focus on home loans to non-QM borrowers with strong credit profile and lower loan to value. Our commercial credit investments focus on higher quality, single asset, single borrower loans where we can play a significant role in shaping covenants and structure.
By mid to late March, virtually all asset classes, agency and non-agency, residential and commercial, suffered an acute lack of liquidity and forced selling in the marketplace, leading to swift and dramatic price declines. Agency CMBS DUS spreads widened from 50 basis points to 60 basis points in January and February to 225 basis points at one point during the week of March 16, closing the week at 135 basis points spread, a sudden standard deviation change.
Spreads widened even more dramatically in non-agency CMBS, with AAA CMBS widening from approximately 60 basis point spreads to over 300 basis points and BBB CMBS widening from 300 basis points to 1,200 basis points, both over 50 standard deviation moves. These dramatic price declines reflected the uncertainty surrounding the economic impact of unprecedented actions taken by governments, business and individuals to enforce social distancing, including widespread business closures and other lockdown restrictions. The price declines also reflect the anticipated cost of some of the actions taken by federal, state and local authorities to mitigate the impact on individuals and business owners, such as prohibitions on eviction and the ability to obtain deferrals of mortgage and rent payments for those affected by the pandemic. The Fed acted quickly and decisively to stabilize agency mortgage markets and this seem to be largely successful as spreads in Agency CMBS DUS bonds, for example, are almost back to pre-crisis levels of about 60 basis points.
In non-agency markets, however, spreads have recovered only somewhat in senior AAA CMBS, while non-agency RMBS and BBB CMBS spreads have not recovered much at all. You can find this data on Page 5 of our earnings presentation.
As a result of these unprecedented economic and market disruptions. the extreme uncertainty around how long and how negatively mortgage assets would be affected, combined with our portfolio positioning as a hybrid REIT and our exposure to margin calls related to our repo borrowing, we experienced significant declines in the fair value of our assets during the quarter.
Book value declined 68% and we recorded a GAAP net loss of $382 million. As the management team focused on book value stability, we are very disappointed with this result. However, as the environment normalizes and the real impact on mortgage assets in general and our portfolio in particular become more clear, we are keenly focused on preserving the opportunity for our shareholders to benefit from price recovery in our portfolio.
While we generated core earnings plus drop income of $0.29 per share during the first quarter, relatively consistent with the previous quarter, we made the decision to retain those earnings and suspend the first quarter dividend to maintain additional liquidity to help protect the value of shareholder assets in these distressed and disrupted markets.
We've taken a number of other actions designed to help protect the portfolio during the crisis, including sold assets and repaid the associated repo borrowings to significantly reduce market exposures, entered into an 18-month term facility for a non-QM loan portfolio, removing its exposure to mark-to-market margin calls, entered into a 12-month term facility for non-agency CMBS and RMBS securities significantly mitigating their exposure to mark-to-market margin calls, reduced short-term repo financing to 10% of overall financing and consolidated our financing relationships with collaborative, well-financed counterparty who we believe take a long term view of our relationship and mortgage REITs generally.
We believe the assets we retained in the portfolio are supported by the underlying value of the properties that serve as collateral for these investments, as well as the terms and covenants designed to protect their value. While it will likely take time to assess the actual impact of the pandemic on our assets, we believe current prices of non-agency residential and commercial assets reflect an overly pessimistic view with little differentiation among security. And while the trajectory of the economic downturn and recovery is still very uncertain, we believe that asset prices place too much weight on the most bearish scenario. As we get more clarity, we expect the underlying values to be more fully reflected in prices. Therefore, we see the potential for significant recovery in our book value as a result.
2020 has been a huge challenge for WMC and the entire mortgage REIT industry. We are committed to taking the necessary steps to protect the portfolio and preserve the opportunity for our shareholders to benefit meaningfully as asset values recover. We believe our focus on high-quality borrowers and assets, as well as our diversified approach will provide the opportunity for our assets to recover significantly as the economy recovers.
As fellow shareholders, we are extraordinarily focused on acting to protect shareholder interests. We appreciate your patience, as we seek to protect book value, enable shareholders to benefit from recovery and reposition the Company to resume delivering on our long term objectives.
With that, I'll turn the call over to our CFO, Lisa Meyer.
Lisa Meyer -- Chief Financial Officer and Treasurer
Thank you, Jennifer.
As Jennifer mentioned, March was a challenging month for many mortgage REITs. The unprecedented market conditions, in terms of both magnitude and speed, resulted in a significant decline in our asset value. We were severely impacted by this market volatility, resulting in a GAAP net loss of $381.9 million or $7.15 per share.
Our core earnings, plus drop income was $15.8 million or $0.29 per share. We have taken certain measures to preserve the long-term value of our equity, including selected asset sales, unwinding interest rate swap positions that were deemed no longer effective and seeking financing arrangements that reduce our exposure to short-term repurchase agreement borrowings with daily margin requirements.
More specifically, we took the following actions to achieve these objectives. During the quarter, primarily in March, we sold just over $1.7 billion in security. The vast majority consisted of agency CMBS and RMBS, reducing our purchase agreement borrowing by $1.6 billion.
We terminated our entire interest rate swap positions, consisting of $3.1 billion in notional value of fixed-pay swaps and $1.9 billion of variable pay swaps. The interest rate swaps were no longer effective due to the deep decline in short-term interest rates and were a source of margin call. We suspended our first quarter dividend to preserve liquidity and subsequent to quarter end, we entered into two term facilities with counterparties that share our long-term strategic view, which significantly reduced our exposure to margin calls. The combined facilities have an aggregate balance of $485 million and further reduced our repurchase agreement borrowings.
At March 31, our leverage was 9.5 times. The higher leverage was the result of unsettled trades over quarter end and a significant decrease in stockholders equity, which in part was the result of the $296 million of unrealized losses recognized during the quarter. Since quarter end, we continue to selectively sell assets to reduce leverage, selling approximately $454 million in securities, mainly Agency MBS and $149 million in home loans. We expect that by the end of the second quarter, our leverage will be in line with pre-crisis level.
The current composition of our financing arrangements of approximately $1.5 billion is as follows: approximately 48% in non-recourse securitized debt from our Arroyo securitization; approximately 32% in the new term facility; approximately 10% in warehouse lines; and approximately 10% in the purchase agreement financing.
We have met our margin requirements to date and given our significantly reduced exposure to daily mark-to-market financing and a more stable market environment for mortgage credit-related assets, we anticipate continuing to do so. At March 31, while we were not in compliance with certain covenants with some of our lenders, we have obtained a waiver or modification of those covenants or have paid off the outstanding borrowings with those lenders. As Jennifer mentioned, we believe the remaining assets we hold in the portfolio have fundamental value in excess of their current prices.
While it may take some time for to get -- [Indecipherable], we estimate that there is a potential for significant upside to be realized, which would lead to a partial recovery of book value per share.
With that, I will now turn the call over to Harris Trifon. Harris?
Harris Trifon -- Chief Investment Officer
Thanks, Lisa.
While the broader market volatility resulting from the COVID-19 pandemic led to extreme price declines on our assets in March, we have experienced some recovery in their prices through the end of April. We believe that current prices in the credit sector of the US residential and commercial real estate mortgage markets, envisage severe economic scenarios that were last seen during the global financial crisis.
While assessing the longer-term economic damage of this crisis remains challenging, given its unique nature and unprecedented scale, our view is the extraordinary amount of fiscal and monetary support that the US government is providing our financial system and the broader economy, will dampen the economic impact of the quarantine period and support liquidity conditions in fixed income markets.
We believe valuations in mortgage credit assets are particularly favorable relative to fundamentals, even given the increased uncertainty in the near-term. We also believe that the current recession will eventually pass and give way to an economic recovery, although the timing and strength of the recovery will be dependent on the spread of the virus and the availability of therapeutics and a potential vaccine. The magnitude of the price and liquidity dislocation in mortgage markets over the last two months, resulted in the most challenging environment in my career. In response to the paradigm shift, we significantly reduced the size of our portfolio in order to lower debt and increase liquidity.
In March, we primarily sold Agency MBS Holdings, with most of the sales coming after the Federal Reserve announced buy programs for first the RMBS market and then the CMBS market. During the current quarter, we have also sold some of our residential and commercial credit investments, as these markets began to stabilize and prices rose modestly from the late March lows.
Our current portfolio holdings remain diversified across a number of sub-sectors of the mortgage market, but the majority of our holdings are now in residential whole loans, commercial whole loans and both non-government guaranteed residential and commercial mortgage-backed securities.
Our residential whole loan portfolio consists of mortgages made to high-quality borrowers who have substantial equity in their homes. The average LTV at origination of this pool of loans was 62%. These loans are being serviced by our loan origination partners, mainly community banks and while we expect that some of the borrowers may require some form of loan payment deferral, we don't believe that there will be any long-term material credit losses from the portfolio, nor do we expect a meaningful amount of payment disruption due to forbearance requests.
Our long-term view on residential real estate remains favorable. Right before the crisis, the US housing market was healthy, driven by improved affordability, rising incomes and historically low consumer debt levels. This was overlaid against the backdrop of limited supply and tight credit standards. The shutdown and economic uncertainty will slow down housing activity significantly in the near term. We are expecting lower prepayments as origination volumes slow, and extension of mortgage timelines and home prices to decline by up to 5% in our base case. But we don't believe that there will be significant and permanent declines in residential real estate values in this country.
Our commercial whole loan portfolio, primarily consists of a number of single asset and single borrower mortgages, where we have focused on short term loans secured by properties with solid credit fundamentals and strong covenants that protect our interest as lenders. Our $320 million portfolio at quarter end had a weighted average loan to value at origination of 65%. However, we are mindful that some areas of the market will be more exposed to COVID-19 risks, most notably hotel and retail properties. That being said, we believe that our focus on high quality properties, with well capitalized sponsors, capable of withstanding short-term disruptions, should enable our assets to emerge from the crisis without significant impairment.
Looking ahead, we believe mortgages secured by real estate assets with meaningful equity in the properties and higher quality credit, will continue to perform well over the long term. While many sectors of the mortgage market currently offer historically attractive valuations, our primary focus is on maintaining sufficient liquidity and reducing our overall debt, while consolidating our financing relationships in order to protect against further book value erosion and position the portfolio for potential future appreciation.
The entire WMC team, as well as the broader Western Asset team has worked tirelessly during what has been an extremely difficult environment and was confronted with a variety of challenges over the last two months and I am proud of our team's effort navigating these unprecedented market conditions. While the decline in book value was large and unexpected, we feel that our current stance is the best way to put us back on course toward our long-term objectives of generating sustainable core earnings that can support an attractive dividend with the overall goal of enhancing stockholder value.
With that, we will open the call up to your questions. Operator, please go ahead.
Questions and Answers:
Operator
[Operator Instructions] The first question comes from Eric Hagen with KBW. Please go ahead.
Eric Hagen -- KBW -- Analyst
Hey, thanks. Good morning and I hope you guys are doing well. A couple of questions on the new funding arrangements, what's the funding costs on those facilities and are you able to reinvest any pay-downs or does all the P&I effectively go toward paying down the facilities? And then, what's the pay-down seniority on the cash flow from the portfolio? It is the convert rank ahead of the repo in terms of the priority of payments or it is the collateralized funding rank first?
Jennifer Williams Murphy -- President and Chief Executive Officer
Okay. I think, I'll ask Lisa to comment on that, Eric. Thanks for your questions. There is two different facilities. So, maybe we should start by commenting on the non-QM loan facility first?
Lisa Meyer -- Chief Financial Officer and Treasurer
Sure. The non-QM facility, the way it works is that the cash flows from the underlying loan value goes to pay a coupon which is based upon the WACC, and then any additional proceeds of P&I then actually pay down the facility.
Jennifer Williams Murphy -- President and Chief Executive Officer
And then the second facility, maybe comment on that...
Lisa Meyer -- Chief Financial Officer and Treasurer
Sure. The second facility, it works a little differently. What happens is the cash flows go directly to the counterparty. The interest is taken out and then the net proceeds come back to the Company, that is based upon a LIBOR plus 500 basis points. And in addition to that P&I payments -- I mean, principal payments, sorry, go to reduce the facility 50% and 50% comes to us when it reaches a certain level.
Eric Hagen -- KBW -- Analyst
How about the -- that was helpful. Thank you. And the seniority of payments? The conversion [Speech Overlap].
Lisa Meyer -- Chief Financial Officer and Treasurer
It's a secured financing. So, it would be for those assets that are financing it, then you have first claim on it.
Eric Hagen -- KBW -- Analyst
Understood. Great, thanks. And then, what's your book value and leverage after having completed the sales of the portfolio in April. And then, what percentage of your CRE and non-QM portfolio have asked for forbearance so far? Thanks.
Lisa Meyer -- Chief Financial Officer and Treasurer
It's a little difficult right now to provide a book value update for April, only because a significant portion of our portfolio now is in our whole loan products and those loan products don't get marked, they get marked on a monthly basis. So we're in the process of just getting in valued for those loans. So, it's kind of difficult for me to say exactly at this point in time with any clarity what book value is.
Jennifer Williams Murphy -- President and Chief Executive Officer
Having said that, it's improved and with the parts of the portfolio that are mark-to-market every day there's improvement. And just to be clear, those -- the loans that Lisa mentioned that are marked monthly are marked by a third-party provider, an independent provider.
Eric Hagen -- KBW -- Analyst
Got it. Okay, great. And then, can you just maybe guide us a little bit toward the kind of core earnings that we should expect you know, just over the -- I guess kind of near term. Thanks.
Jennifer Williams Murphy -- President and Chief Executive Officer
Yeah, I don't -- I think, our core earnings -- my expectation given the change in the portfolio is they'll be lower. So, maybe, Lisa, you might want to comment if there is a range we can offer or some sense of that.
Lisa Meyer -- Chief Financial Officer and Treasurer
Yeah. We're estimating the range to be around in between $0.06 to $0.07 a month.
Eric Hagen -- KBW -- Analyst
Got it. Got it. Thank you guys very much. Stay well.
Lisa Meyer -- Chief Financial Officer and Treasurer
Thank you. You too.
Jennifer Williams Murphy -- President and Chief Executive Officer
Thanks, Eric.
Operator
The next question comes from Trevor Cranston with JMP Securities. Please go ahead.
Trevor Cranston -- JMP Securities -- Analyst
Hey, thanks. A couple of follow up questions. I guess, first, with the portfolio sales you guys have made in April, as you look at what remains in the book, are you continuing to opportunistically look to sell assets or with what remains is that sort of things you're comfortable with that you'd like to try and capture upside on as markets recover or how should we think about the balance of the portfolio going forward from here?
Harris Trifon -- Chief Investment Officer
Sure. Trevor, it's Harris. I can take that one. I think generally speaking, we always try to be as opportunistic as possible, particularly in this environment with our program of derisking and delivering the portfolio. The market conditions while improved relative to where they were in March, continue to be very fluid. So, the opportunity set in terms of selling assets in the portfolio remains fluid as well. I would say also that the execution of the longer-term facilities for the majority of our securities portfolio as well as our residential loan portfolio, certainly goes a long way in giving us more time and flexibility and taking advantage of the liquidity conditions on a day-to-day basis. But our entire team is always focused on evaluating where we think we can move every single line item in the portfolio and we're constantly weighing the attractiveness of selling versus keeping, given the overall goal of trying to preserve as much optionality in the portfolio to recover as much book value as possible.
Trevor Cranston -- JMP Securities -- Analyst
Okay. Got you. And then, a couple of detailed questions on the portfolio. First, on the non-agency CMBS, can you give a breakdown of the ratings you own in the remaining portfolio there?
Harris Trifon -- Chief Investment Officer
I don't I don't have that in front of me, Trevor, but I would say that most of the ratings are below investment-grade. However, I would also note that it's our long-standing view that ratings, particularly, for mortgage credit assets have been overly conservative over the course of the last number of years and we don't think necessarily reflects the inherent credit quality of the various classes.
Trevor Cranston -- JMP Securities -- Analyst
Okay. Got you. And then, on the commercial loan portfolio, I think, you briefly mentioned potential issues with hotel and retail loans in the prepared remarks. Can you provide any additional color on whether or not any of those borrowers have asked for payment deferrals or what the statuses of those loans and how you're thinking about the risk there?
Harris Trifon -- Chief Investment Officer
Sure. Those conversations are still ongoing. There's one exposure that we have in the portfolio where -- and for the April payment, the borrower asked for forbearance. That was ultimately not granted in full and most of the exposures that we have, most of the loan exposures we have, are structured with various reserve and in many cases with debt service and interest reserves as well. So, those reserves are being drawn down, particularly for assets which are not operational at the current point in time.
Trevor Cranston -- JMP Securities -- Analyst
Okay. Got you. And then -- so, looking at the details you guys provided on the new financing facilities, it looks like there's a provision for your counterparties to potentially share in some upside price improvement in the assets. When we think about your book value going forward to the extent prices do recover and spreads tighten, will there be some sort of offset to the improvement in asset values to account for that potential sharing or how should we think about how those facilities are going to work in that perspective?
Harris Trifon -- Chief Investment Officer
Well, just to be clear, Trevor, only the residential loan facility has that provision in it. The securities facility there is no sharing of potential upside. And on the resi loan facility, there is that participation. You should think about it largely in terms of a monetization event of the underlying assets. In other words, if -- when and if we sell the loans in a portfolio basis or we securitize the loans and achieve financing that way, the delta between the adjusted basis of the lending now and the facility at that point in time relative to the proceeds that are generated as a result of one of those two events would be shared. The share is heavily in the Company's favor, but that was the concession that that we needed to make to achieve some of the structural features that were very important to us, primarily non-mark-to-market, as well as the term of the facility itself.
Trevor Cranston -- JMP Securities -- Analyst
Perfect, OK. Got it.
Jennifer Williams Murphy -- President and Chief Executive Officer
And Trevor, could I just add to that, that opportunity for sharing with that partner is a very small -- would represent a very small part of the potential for a recovery in the portfolio.
Trevor Cranston -- JMP Securities -- Analyst
Right, OK. Got it. And then, the last question for me, looking at Slide 12 in the deck, I guess, you showed some positions in TBAs and credit default swaps. Just wondering if you could provide some color on what those positions are and if those are things you continue to own in the portfolio? Thanks.
Harris Trifon -- Chief Investment Officer
The TBA is no longer in the portfolio. The credit default swaps were part of a credit hedge that we had in place in the portfolio and that's what's reflected on the table you're referencing.
Trevor Cranston -- JMP Securities -- Analyst
Okay. And do you still have that hedge in place or has that been taken off?
Harris Trifon -- Chief Investment Officer
We've been -- we still have -- we still have part of it, we've been adjusting it as market conditions allow, but we still do have a position there yes.
Trevor Cranston -- JMP Securities -- Analyst
Okay. Got it. Thank you, guys.
Jennifer Williams Murphy -- President and Chief Executive Officer
Thanks, Trevor.
Operator
[Operator Instructions] The next question comes from Derek Hewett with Bank of America. Please go ahead.
Derek Hewett -- Bank of America -- Analyst
Good morning. And I hope everyone is well. Most of my questions were already asked and answered, but in terms of the fee waivers, will that continue until the dividend is turned back on?
Jennifer Williams Murphy -- President and Chief Executive Officer
Hi, Derek. It's Jennifer. We've been making that determination on a month-by-month basis. So, it's in part to assist the Company -- WMC, in keeping liquidity and helping to manage our expenses as well. So, we'll make that determination again later this month, but we haven't set any particular rule like you just suggested. It's more of a month-to-month determination.
Derek Hewett -- Bank of America -- Analyst
Okay. That's it for me. Thank you.
Jennifer Williams Murphy -- President and Chief Executive Officer
Thank you.
Operator
This concludes our question-and-answer session. I would like to turn the conference back over to Jennifer Murphy for any closing remarks.
Jennifer Williams Murphy -- President and Chief Executive Officer
Thank you. Thanks everyone for joining us today. We appreciate your interest in your questions and hope everyone remains safe and healthy during this challenging time and we look forward to speaking with you again soon. Thank you.
Operator
[Operator Closing Remarks]
Duration: 33 minutes
Call participants:
Larry Clark -- Investor Relations
Jennifer Williams Murphy -- President and Chief Executive Officer
Lisa Meyer -- Chief Financial Officer and Treasurer
Harris Trifon -- Chief Investment Officer
Eric Hagen -- KBW -- Analyst
Trevor Cranston -- JMP Securities -- Analyst
Derek Hewett -- Bank of America -- Analyst
