Western Asset Mortgage Capital Corporation (WMC) is a real estate investment trust (REIT) that invests in, finances, and manages a portfolio of real estate-related securities, whole loans, and other financial assets. The company has faced significant headwinds in recent years, reporting an annual net loss of $85,466,000 and annual revenue of $63,338,000 in its latest fiscal year. However, the company's focus on residential investments and efforts to strengthen its balance sheet provide a glimmer of hope for the future.
Business Overview
WMC's investment strategy is based on the perspective of its external manager, Western Asset Management Company, LLC, which seeks to identify assets across the broad mortgage universe with attractive risk-adjusted returns. The company's current portfolio is primarily composed of non-qualified residential whole loans, non-Agency residential mortgage-backed securities (RMBS), commercial loans, non-Agency commercial mortgage-backed securities (CMBS), and to a lesser extent, Agency RMBS, GSE risk transfer securities, residential bridge loans, and asset-backed securities secured by private student loans.
In December 2021, the company announced that its investment strategy would focus on residential real estate-related investments, including non-qualified mortgage loans and non-Agency RMBS, as it continues to transition out of its commercial loan investments. This shift aligns with the manager's core competencies and allows the company to address attractive market opportunities while maintaining its REIT qualification and exemption from registration under the Investment Company Act of 1940.
Financials
For the third quarter of 2023, WMC reported a net loss of $8,707,000, compared to a net loss of $40,008,000 in the same period of the prior year. The company's net interest income decreased from $5,699,000 in the third quarter of 2022 to $3,162,000 in the third quarter of 2023, primarily due to higher interest expense on its repurchase agreements and securitized debt. The company's unrealized losses on its investments and securitized debt amounted to $7,362,000 in the third quarter of 2023, compared to $43,582,000 in the same period of the prior year, reflecting the continued volatility in the mortgage markets.
During the first nine months of 2023, WMC reported a net loss of $10,769,000, compared to a net loss of $84,632,000 in the same period of the prior year. The company's net interest income decreased from $16,217,000 in the first nine months of 2022 to $11,527,000 in the first nine months of 2023, primarily due to higher interest expense. The company's unrealized gains on its investments and securitized debt amounted to $76,100,000 in the first nine months of 2023, compared to unrealized losses of $66,300,000 in the same period of the prior year.
Liquidity
As of September 30, 2023, WMC had $24,608,000 in cash and cash equivalents, providing the company with ample liquidity to fund its operations and investment activities. The company's total debt, excluding the non-recourse securitized debt, was $254,660,000, resulting in a debt-to-equity ratio of 3.3x.
WMC has worked to diversify its financing sources, seeking longer-term and less onerous financing arrangements, including repurchase agreements, term financing, securitizations, and convertible senior unsecured notes. As of September 30, 2023, the company had outstanding borrowings under four of its master repurchase agreements totaling $170,818,000, with a weighted average interest rate of 9.10% and a weighted average remaining maturity of 327 days.
Residential Whole Loans and Bridge Loans
As of September 30, 2023, WMC's residential whole loan portfolio had a fair value of $986,978,000, comprising 2,761 adjustable-rate and fixed-rate non-qualified and investor mortgages. The company's residential bridge loan portfolio had a fair value of $2,782,000, consisting of four non-performing loans.
The company's residential whole loan portfolio had a weighted average current coupon rate of 4.9%, a weighted average original loan-to-value (LTV) ratio of 65.7%, and a weighted average original FICO score of 749. The company's residential bridge loan portfolio had a weighted average current coupon rate of 9.4% and a weighted average original LTV ratio of 74.2%.
Non-Agency RMBS and CMBS
WMC's non-Agency RMBS portfolio had a fair value of $31,872,000 as of September 30, 2023, with a weighted average purchase price of $77.23 and a weighted average life of 11.8 years. The portfolio's weighted average original LTV ratio was 73.3%, and the weighted average original FICO score was 708.
The company's non-Agency CMBS portfolio had a fair value of $54,206,000 as of September 30, 2023, with a weighted average life of 2.9 years and a weighted average original LTV ratio of 65.4%.
Commercial Loans
WMC is continuing to transition out of its commercial loan investments, with a fair value of $78,701,000 as of September 30, 2023. The company's commercial loan portfolio consists of four interest-only first mortgage loans secured by retail, hotel, and nursing facility properties, with a weighted average original LTV ratio of 59.5% and a weighted average interest rate of 4.0%.
Recent Developments
On June 28, 2023, WMC announced that it had entered into a definitive merger agreement with Terra Property Trust, Inc. (TPT), an externally managed REIT that originates, invests in, and manages loans and assets secured by commercial real estate. However, on August 8, 2023, the company terminated the TPT merger agreement and concurrently entered into a new merger agreement with AG Mortgage Investment Trust, Inc. (MITT).
Under the terms of the MITT merger agreement, each outstanding share of WMC common stock would be converted into the right to receive (i) 1.498 shares of MITT common stock and (ii) the per share portion of a cash payment from the MITT Manager equal to the lesser of $7 million or approximately 9.9% of the aggregate per share merger consideration. Additionally, the MITT Manager would waive $2.4 million of management fees in the first year post-closing.
The transaction has been approved by WMC's Board of Directors and is subject to customary closing conditions, including the approval of WMC's stockholders. The transaction is expected to close during the fourth quarter of 2023.
Risks and Challenges
WMC faces several risks and challenges that have contributed to its recent financial performance. These include:
1. Interest rate risk: The company's assets and liabilities are sensitive to changes in interest rates, which can impact its net interest income and the fair value of its investments.
2. Credit risk: WMC is exposed to the risk of potential credit losses from general credit spread widening related to its non-Agency RMBS, non-Agency CMBS, residential whole loans, residential bridge loans, and commercial loans.
3. Prepayment risk: The value of the company's Agency and non-Agency RMBS and residential whole loans may be affected by prepayment rates on the underlying residential mortgages.
4. Liquidity risk: WMC relies on short-term repurchase agreements to finance a significant portion of its portfolio, which exposes the company to the risk of margin calls and the potential inability to renew or replace these financing arrangements.
5. Regulatory and market environment: Changes in the regulatory environment, as well as weakness in the financial markets, the residential mortgage markets, the commercial mortgage markets, and the economy, could adversely affect the company's lenders and its ability to obtain financing.
Outlook
Despite the challenges faced by WMC, the company's focus on residential investments and efforts to strengthen its balance sheet provide a glimmer of hope for the future. The pending merger with MITT, if completed, could potentially offer the company a path forward, with the combined entity benefiting from MITT's expertise and resources.
Conclusion
However, the company's success will ultimately depend on its ability to navigate the volatile market conditions, manage its risks effectively, and execute its residential investment strategy. Investors should closely monitor WMC's progress in the coming quarters and years, as the company works to return to profitability and create value for its shareholders.