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Western Asset Mortgage Capital Corp (NYSE:WMC)
Q2 2020 Earnings Call
Aug 6, 2020, 11:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Welcome to Western Asset Mortgage Capital Corporation's Second Quarter 2020 Earnings Conference Call. Today's call is being recorded and will be available for replay beginning at 5:00 PM Eastern Standard Time. [Operator Instructions]

Now 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, Kate. I want to thank everyone for joining us today to discuss Western Asset Mortgage Capital Corporation's financial results for the second quarter of 2020. The company issued its press -- earnings press release yesterday afternoon, and it's available in the Investor Relations section of the company's website at www.westernassetmcc.com.

In addition, the company has included a slide presentation that you can refer to during the call. 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 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. Our main focus in the still challenging environment for credit oriented mortgage assets is to protect the portfolio to ensure the opportunity for our shareholders to meaningfully benefit, if asset values recover as we expect they will, and to sustain the future earnings power of the portfolio that underlies our dividend.

In the second quarter, we significantly strengthen the company's balance sheet, and improved the earnings power of the portfolio. We did this by significantly reducing our leverage from 9.5 times to 3 times, securing longer term fixed rate financing at attractive levels, reducing our reliance on short-term repurchase agreements by over 75%, increasing our liquidity, and bolstering our common equity by selling new shares at a premium to GAAP book value. We recorded a GAAP net loss of $15.6 million or $0.29 per share. These results include an expense accrual of $20.5 million or $0.35 per share, related to a profit participation fee incurred on our June securitization of $356 million of non-QM residential whole loans.

This fee was fully expensed in the second quarter, and represents more than 100% of the quarter's law. But the benefits of the securitization are expected to be realized by the company for years to come. Through the securitization we finance the significant portion of our non-QM whole loans for 35 years at an attractive weighted average rate of 2%. This was an important milestone that strengthened the company's capital structure and positioned us for improved cash flows from these assets for a long period of time.

Our core earnings were $0.11 per share during the second quarter, reflecting lower portfolio leverage as I mentioned, and a smaller asset base. We decided to retain earnings in the second quarter to build additional liquidity and equity, which we believe will help preserve shareholder value in this environment. It's a high priority for us to put the company in a position to resume paying an attractive dividend, supported by sustainable core earnings.

The key factors we'll evaluate when considering future dividends, are the sustainable earnings power of the portfolio, and the liquidity needs of the company in the current environment. We believe there continues to be the potential for meaningful improvement in the prices of our assets, if as we expect the pandemic subsides, and economic activity resumes. For the past several years, our investment strategy has focused on high quality borrowers, and asset as well as the diversified investment approach.

As we get more clarity about the path of the economic recovery, we expect the underlying fundamental values to be more fully reflected in prices. This creates the potential for significant recovery in our book value. To assist investors in assessing one aspect of this potential this quarter, they're including WMC's economic book value, a non-GAAP calculations. Economic book value removes the consolidated assets and liabilities of three securitizations from the balance sheet, and adds back with fair market value of our retained, and acquired interest in these securitizations.

From our perspective, this provides a view of what the company directly owns and what it owes. This calculation resulted in an economic book value of $4.04 as of June 30, and $4.25 as of March 31. Lisa will talk about this in more detail. We made significant strides in the second quarter to strengthen our balance sheet, and improve the sustainable earnings of the company.

As fellow shareholders we remain committed to protect and grow the value of the portfolio, and preserve the opportunity for our shareholders to benefit meaningfully in the event asset values recover. We're highly focused on putting the company in a position to resume delivering on our long-term objective of generating sustainable core earnings that support an attractive dividend with relative stability in our book value.

With that, I'll turn the call over to Harris Trifon, our Chief Investment Officer. Harris?

Harris Trifon -- Chief Investment Officer

Thank you, Jennifer. The second quarter of 2020 proved to be another volatile period dominated by headlines regarding the COVID-19 virus. Also like the first-three months of the year, it was a quarter that started and ended with very different tones. The first few weeks mortgage credit markets exhibited more stability compared to the end of March, but prices remained at very depressed levels.

The unprecedented size and speed of the monetary and fiscal support measures did begin to improve sentiment, and we subsequently saw market improvement and liquidity conditions, and to a lesser extent prices by the end of June. As markets began to heal, we continued to deleverage and de-risk WMC, and by quarter's end had sold nearly $600 million of agency bonds and very high quality residential loans.

Our ability to reduce risk, and do so in an improving market helped prevent additional realized losses from our portfolio and for our shareholders. We also spent a significant amount of time and effort to improve the terms of our financing arrangements and the company's risk. To that end, we completed three meaningful transactions that we believe accomplished all of our goals.

The first transaction resulted in consolidating the financing of our residential whole loan portfolio with one lender, and a facility that provided no mark-to-market features and provided 18 months of term. The transaction not only allowed us to remove margining requirements of the assets during a very volatile time period, and avoid potentially problematic liquidity issues. It also provided a meaningful amount of stability to the overall portfolio that we were able to build on.

Shortly, after the close of the residential loan facility. We reached an agreement to move the majority of financing related to our securities portfolio to one provider and one structure. This transaction also provided a streamlined counter party relationship, limited margin call risk, extended term and most of all more stability. Lastly, we were able to take advantage of the improvement in the securitization markets in the second half of the quarter, and issued a $356 million transaction of our non-QM loans under the Royal Shelf. This was WMC's second securitization and first of the year.

Our ability to issue securitizations is a critical part to our success, and we were able to benefit from the improving market, find the investor support, and strong credit quality, the securitization further solidified our funding sources, and dramatically lowered the cost of financing. In all, through these transactions and asset sales, we reduced our repo exposure by over 76% in the quarter.

In terms of our mortgage credit portfolio performance the non-QM residential portfolio is performing well, given the severe economic background, 84% of the loans remain current, we see this is a strong indication that borrowers with meaningful equity in their homes will prioritize their mortgage payments in order to remain current on that obligation.

The commercial loan and non-Agency CMBS portfolios are performing in line with expectations under the current pandemic conditions. The large loan CMBS portfolio has an approximate LTV of 63%. And despite being concentrated in retail and hotel assets over 70% of the loans by principal balance remains current. All the borrowers of the delinquent loans in the non-agency CMBS portfolio are in negotiations for forbearance and modifications.

The company believes there is a reasonable likelihood that the majority of the delinquent loans will return to performing status in the coming months. Although, there is no assurance that this will be the case. The commercial loan portfolio carries a 65% original LTV, and all but one of the loans remains currents. We expect the outlook will remain challenging, and dependent on the path of COVID-19. The availability of improved therapeutics and vaccines and continued fiscal and monetary support.

In recent weeks, there has been both good news and bad, which we expect will continue for the foreseeable future. Given the uncertainty we expect central banks will remain extraordinarily accommodative, and supportive of economic growth. This is one of the reasons we have repositioned the portfolio to be concentrated in residential and commercial credit assets, which we believe will be primary beneficiaries of an economic recovery and offer shareholders, the best chance for the recovery in our book value.

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

Lisa Meyer -- Chief Financial Officer and Treasurer

Thank you, Harris. We've provided a great amount of detail regarding our portfolio and our second quarter results in both our press release, and our earnings presentation. So, I'm only going to focus on items that warrants' some additional explanation. During the second quarter, we focused on reducing our exposure to short-term, recourse borrowings, increasing liquidity, and improving shareholder's equity. As both Jennifer and Harris discussed, we completed a number of financing transactions that created a more stable capital structure, and help lay the foundation for improved earnings going forward.

In addition to these financing transactions, we also undertook measures that strengthened our balance sheet and improved shareholders' equity. In June, we sold 6 million shares in our at-the-market equity program at an average price of $3.70 per share for a total net proceeds of $22 million. This transaction was done at a premium to GAAP book value per share.

In July, we opportunistically retired $5 million in principal amount of our 6.75% convertible senior notes due in 2022 at a 25% discount to par value in exchange for 1.35 million shares of our common stock. Both of these transactions were accretive to book value, and more importantly, strengthened our equity base. As of June 30, our recourse finance funded with short-term repurchase agreements of less than a year with $87 million or 23% of the outstanding recourse borrowings. We also reduced the leverage levels against all of those borrowings. So the risk of future margin calls remain low. Finally, our manager Western Asset weighed its management fees for April and May.

Now, turning to a discussion about our core earnings. We reported core earnings of $5.8 million or $0.11 per share for the second quarter. Our lower core earnings was primarily driven by its smaller portfolio, and reduced leverage due to our asset sales, partially offset by higher net interest margin. As we discussed, an important step taking to improve the sustainable core earnings of the portfolio was the new Arroyo 2020-1 securitization, which allowed us to reduce an income drag experienced under the interim residential whole loan facility.

Since, the securitization closed on June 29, any benefit of this financing was not reflected in the second quarter core earnings. With this new lower cost, and longer-term financing now in place, we believe that it will have a positive impact on our core earnings going forward. Additionally, as Jennifer mentioned, we have disclosed a new non-GAAP financial metric economic book value, which we feel provide investors with a useful supplemental measure to evaluate our financial position. It reflects our actual financial interest in all of our investments, and eliminates the accounting mismatch that arises from our Arroyo securitizations, where we fair value the loans, but not the debt.

Economic book value was $4.04 per share, which is significantly higher than our GAAP book value per share of $3.17. The higher economic book value was primarily due to fair value of the retained or acquired interest in the three consolidated securitizations, which were priced independently by third-party pricing service being greater than the GAAP equity, resulting in a $0.87 mismatch.

In summary, we are encouraged by the steps we took to solidify our capital structure. We have lowered our recourse leverage to 3 times a significant improvement from 9.5 times at the end of March and from 5.4 times at the beginning of the year. Our net interest margin remains healthy, and with a significant portion of our assets finance by attractive long-term financing, we believe we are well-positioned for improved earnings in the third quarter.

With that, we will open up the call to your questions. Operator. Please go ahead.

Questions and Answers:

Operator

We will now begin the question-and-answer session. [Operator Instruction] Our first question is from Trevor Cranston of JMP Securities. Please go ahead.

Trevor Cranston -- JMP Securities -- Analyst

All right. Thanks. Yeah. First question, you guys mentioned that in the opening about believing that there is still significant recovery potential, and a lot of your assets. In light of the new disclosure you have around economic book value. I was wondering, if you could provide some context around, where the assets that you've retained from the securitizations are mark today kind of versus where they were remarks pre-March, and how much recovery potential there specifically is in those assets? Thanks.

Jennifer Williams Murphy -- President and Chief Executive Officer

Lisa, do you want to comment on where they were March before is that, I think that's, I think I understand your question, Trevor. Thank you for the question by the way.

Lisa Meyer -- Chief Financial Officer and Treasurer

Sure. So, before March the non-QM loans were marked at 103, I think 103.5. Most recently, I think the market, we've got on those loans are probably around 96.5 to the 97.5 range. So, we do feel that there is a significant upside, even if the loans actually just go back up to par. There is significant value that we will recognize. And in addition, we think that and Harris can chime in, and that we think there is probably more value beyond probably par. As you know, as the, as the economy starts to recover.

Trevor Cranston -- JMP Securities -- Analyst

Okay. Got it. Thank you.

Jennifer Williams Murphy -- President and Chief Executive Officer

Maybe Trevor. I'm sorry if I could just add on to that briefly. That speaks to the non-QM whole loan part, portion of our portfolio and the economic book value measure really provides insight into those assets. We do think there is recovery potential in our commercial assets as well.

Trevor Cranston -- JMP Securities -- Analyst

Right, sure. Okay. Thank you for that. And with the securitization you guys were able to do at the end of June, looked like there were $70 million some of loans, still on the financing line outside of securitization. Can you comment on, why those weren't included in the June securitization, and sort of what the plan is for that remaining loan balance differ for, [Phonetic] if you're going to sort of hold it on the financing line, and definitely are or if that could be securitized at some point as well?

Harris Trifon -- Chief Investment Officer

Sure, Trevor. I'll take that one. The reason that the majority of those loans were not included in the securitization as many of those loans are in the borrower's are in forbearance periods. And we made the decision to intentionally hold them out of the securitization in order to secure more favorable treatment both from rating agencies, as well as reception from investors in the transaction.

I think if you look at the execution that we were able to obtain on the deal. It certainly validated that decision. So looking-forward, our plan is to, of course, monitor the performance of those loans, and either include them in a future securitization, as they return to current performing status and-or the forbearance period burns-off or potentially sell them or potentially transfer them to another facility.

Trevor Cranston -- JMP Securities -- Analyst

Okay. Got it. That makes sense. And then, I wasn't, I wanted to clarify something I wasn't sure I caught it all in the prepared comments on the non-agency CMBS portfolio. I guess first, did you disclose what the property types or specifically for the, the single asset part of the CMBS portfolio. And then, I also wanted to clarify, just to make sure I heard correctly, was it 80% of the loans within that portfolio, you said was still correct?

Harris Trifon -- Chief Investment Officer

So on that portfolio we did not disclose. I don't believe the exact property type concentration in our, in the investor reporting package. The LTV that I referenced was 63% for that portfolio, and the current pay is 70% in that portfolio.

Trevor Cranston -- JMP Securities -- Analyst

Okay. And can you comment on what the property types are or is that something we should, would be able to find in the 10-Q? Thank you.

Harris Trifon -- Chief Investment Officer

I'll comment generically, a lot of assets are either hospitality or retail related, when we sold a lot of the assets that we did on the non-agency side, at the end of Q1, in the beginning of second quarter, just given the dislocation in the market. We did sell sort of non-hotel and non-retail securities. So it did push up the concentration in those asset classes. But, I would note that within each one of those property types, there is a fair amount of dispersion.

In other words, not all of the retail assets are secured by regional mall portfolios. There is a number of power centers, and shopping centers that are doing quite well. Similarly on the hotel side, there is a fair amount of concentration in limited service hospitality, which has actually held up relatively well throughout the last few months and certainly our expectations going forward is, is that sub-sector within hospitality will continue to outperform for the foreseeable future.

Trevor Cranston -- JMP Securities -- Analyst

Okay. Thanks for that color. And then last question, you were able to retire some of the convertible notes in July. Can you say anything about whether or not there was a unique opportunity or if you think you might be able to pursue, potentially retiring some more of the convertible notes going forward?

Larry Clark -- Investor Relations

Hi, Trevor. Its Lisa. I'm sorry.

Jennifer Williams Murphy -- President and Chief Executive Officer

No, go ahead. Lisa.

Lisa Meyer -- Chief Financial Officer and Treasurer

I think that we will continue to look for opportunities in, which we can do similar transaction as the one that we did at quarter end. I think that it just, it makes sense for us to do transactions like that, because it strengthens our equity base, and reduces our liability. Jennifer, would you like to add anything?

Jennifer Williams Murphy -- President and Chief Executive Officer

Just as, we've Trevor. We've, those are, we've had both inbound inquiries from our convertible note holders as well as we've had, we've made initiated discussions in one or two cases ourselves. So, we're hopeful that we could continue those transactions.

Trevor Cranston -- JMP Securities -- Analyst

Okay. Great. Appreciate the color. Thank you.

Operator

The next question is from Bose George of KBW. Please go ahead.

Eric Hagen -- KBW -- Analyst

Hey. This is Eric Hagen. A follow-up on the resi-whole loans and the yields that you show on Page 23 of the deck. What's the yield on the retain tranches in this in those structures and is the plan going forward. And those with any additional debt or essentially just hold them with equity? Thanks.

Jennifer Williams Murphy -- President and Chief Executive Officer

Harris, do you want to comment on that or?

Harris Trifon -- Chief Investment Officer

Yeah. I don't know we break out the yields on the retain securities for the securitization. I would say that they're quite accretive, particularly in light of the favorable execution that we were able to get on the securitization that I referenced a few minutes ago. As far as what our plans are that package of securities, along with everything else we have in the portfolio. We're constantly trying to think about what makes the most sense to where we should be taking leverage the cost of that leverage the terms of that leverage.

I think 2020 that's more true now than it's ever been. So, those securities on an un-levered basis certainly are accretive to our income and to the overall portfolio, and where and when we can take opportunistic leverage on that, on that sub-sector within the portfolio is something that we're monitoring on a daily basis. And when we think it makes sense, in order to further our strategic objectives we will.

Eric Hagen -- KBW -- Analyst

Okay. And then, where you guys reinvesting run-off and what was your economic book value when you raise the $22 million of capital during the quarter, and what did you do with the capital that you raised?

Jennifer Williams Murphy -- President and Chief Executive Officer

Eric, it's Jennifer. First, I would comment that some of the run-off as you termed in, is helped us to build liquidity that's been. So our priorities have been to remain current on all of our bills, make sure the in a healthy financial position also build our liquidity, which is part of our overall plan for ensuring the stability of the company. So we really focus that run-off in the second quarter on those priorities.

So as we said, given all the progress we made in this quarter. I think in the third quarter, we can start to think more forwardly about, how to potentially use those earnings, but our focus in this quarter is really to strengthen the balance sheet and put ourselves in a position to improve sustainable core earnings, I think, you had another question that I didn't address.

Eric Hagen -- KBW -- Analyst

The economic book value when you raised the $22 million of capital and what you did with the capital during the quarter.

Jennifer Williams Murphy -- President and Chief Executive Officer

Yeah. Sure. I don't know the economic book value at the time of the rates, so I'm guessing it's in between the two numbers we disclosed. Lisa, would that be correct?

Lisa Meyer -- Chief Financial Officer and Treasurer

Yes.

Jennifer Williams Murphy -- President and Chief Executive Officer

Yes, exactly. And again Eric, our priority with that capital was to improve our liquidity position, obviously it was a very helpful to improve our -- the strength of our balance sheet, our equity position. And so, we use those proceeds to help us build liquidity. In some cases as Lisa mentioned, we've lowered our loan amounts for in virtually every relationship we have. So, in part proceeds went to priorities like that.

Lisa Meyer -- Chief Financial Officer and Treasurer

And Eric, just to add to what as Jennifer said. I mean the overall equity raised through the at the market program, it was pretty much about 2% accretive to book value.

Eric Hagen -- KBW -- Analyst

Okay. Hey, going back to the my previous question on the retain tranches from the recent non-QM deals. Are those is the collateral from those bonds or tranches pledged on any repo lines right now?

Lisa Meyer -- Chief Financial Officer and Treasurer

No.

Harris Trifon -- Chief Investment Officer

They are not pledged.

Eric Hagen -- KBW -- Analyst

Okay. Thank you. Thanks for the comments, guys.

Operator

[Operator Instructions] This concludes our question-and-answer session. I would like to turn the conference back over to Jennifer Murphy for closing remarks.

Jennifer Williams Murphy -- President and Chief Executive Officer

Thanks everyone for joining us and we look forward to updating you again soon. Bye.

Operator

[Operator Closing Remarks]

Duration: 30 minutes

Call participants:

Larry Clark -- Investor Relations

Jennifer Williams Murphy -- President and Chief Executive Officer

Harris Trifon -- Chief Investment Officer

Lisa Meyer -- Chief Financial Officer and Treasurer

Trevor Cranston -- JMP Securities -- Analyst

Eric Hagen -- KBW -- Analyst

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