Western Asset Mortgage Capital Corporation (NYSE:WMC) announced their fourth-quarter earnings on the 7th of March. The company made significant changes to their portfolio due to rising rates and the fear of rates continuing to rise:
- Agency MBS allocation shrank from $2.984 Billion on Sept 30th to $2.197 Billion on Dec 31st, which included a $570 million reduction of 3.5% coupon 30-year fixed MBS
- Non-agency MBS allocation rose from $265 million on Sept 30th to $430 million on Dec 31st , this took the allocation to non-agency MBS from 8% to 15% of the portfolio
- Swap hedges only shrank by $46 million despite the $570 million reduction in agency MBS allocation
- Spread decreased from 2.28% to 2.15%, which took into account the cost of financing through repurchase agreements rising from .48% to .54%, the yield on agency and non-agency MBS increasing from 3.42% to 3.61%, and the cost of financing including swaps rising from 1.14% to 1.46%.
- Core earnings dropped from .83 per share to .70 per share
- Leverage decreased from 9.0x to 6.9x
- Duration gap decreased from 1.12 to -.98
On paper the book value went from $16.81 on Sept 30th to $15.27 on Dec 31st, a reduction of $1.54. However WMC paid a $2.35 dividend in Q4, consisting of $.9159 in cash and .0970 shares of newly issued common stock. The company reported in the earnings call that if they adjusted the Q3 book value to account for the new shares distributed in the Q4 dividend, the book value would have been $15.21 on Sept 30th. The book value essentially grew by $.06 during Q4. The tactics management took to preserve book value in the rising interest rate environment of Q4 included increasing hedges, selling lower coupon agency MBS, and increasing holdings of non-agency MBS.
The company made a statement in their conference call about what has happened to book value so far in Q1 2014 -
"In the first two months of 2014, the fixed income markets including the mortgage markets have rallied based on more clarity about Fed policy and economic data, that points to continued slow growth and a gradual recovery in the job market. As a result, we have experienced increases in the value of our agency and non-agency holdings, partially offset by a decline in the value of our hedge positions."
I take that to mean the book value is higher so far in Q1 despite this restructuring of the portfolio.
I think the company has increased leverage in Q1, likely while either maintaining their swap hedges or lowering them somewhat. This would increase their duration gap, which would be good in a lowering rate environment. Again from the conference call -
"We are comfortable with our current leverage, but as we progress through the year, we may tactically increase leverage in response to market conditions particularly if we believe that an environment of lower interest rate volatility will persist."
The interest rate on the ten-year treasury has gone from 3.03% to 2.74% in Q1 so far and I think management will respond by increasing leverage as the fear of rapidly rising rates has not materialized after the taper announcement. While Q4 was a time of preparing for rapidly rising rates, Q1 has been a time of range-bound rates that may slowly rise in the future. WMC thinks those rates will range from 2.5% to 3.25% on the ten-year treasury.
WMC may have also increased their non-agency MBS and CMBS holdings. The earnings call stated,
"We expect to diversify our sources of return by increasing our exposure to non-agency securities and CMBS, though our allocations to these asset classes will vary based on market conditions".
Buying these securities would lower their leverage. I think overall the leverage has increased in Q1, but it's possible WMC bought enough non-agency MBS and CMBS to keep the leverage increase muted.
I estimate a 15.75 book value as of this writing. The quick allocation changes that can happen in the portfolio inter-quarter (as we saw in Q4) preclude the accuracy of a detailed analysis of price shifts of the underlying assets relying on holdings as of Dec 31st. I do know the FNMA 3.5% coupon 30-year fixed MBS have risen in value from 99.34 on Jan 1st to 100.69 on Mar 12th (data from mortgage news daily). The 10-year swap rate has dropped from 3.095% to 2.863% in the same time frame (data from WSJ). Those two values reflect WMC's largest holdings and were the only data used to estimate the current book value.
The next big announcement from WMC will likely be the dividend. They had .70 in core earnings in Q4 and they now have more shares to pay the dividend on due to the new share distribution in Q4. The number of shares increased by 10.5%, meaning they have to make that much more to pay the same dividend. I think their core earnings will increase from increased leverage, but the increased share count will bite into the dividend. I estimate a 75 cents dividend for Q1.
If you take into account the added shares you got if you were long at ex dividend time in Q4, a 75 cent dividend would come to 82 cents, which is less than the 90 cents WMC was paying in Q2 and Q3 in 2013, but still the highest dividend yield in the mREIT world.
|mREIT Stock||Price to Book Value||Annual Dividend Yield|
* using .75 estimated dividend
WMC did a good job managing the portfolio in Q4 because, taking into account the share distribution, the book value increased in Q4. The largest mREITs, AGNC and NLY, both had book values that went down in Q4 (AGNC BV -$1.34, NLY BV -$.57). WMC once again proved itself worthy of a higher price to book value than most of its peers and I believe it will continue to maintain the highest dividend in the mREIT space save perhaps if MORL catches up. MORL is a 2x leveraged index fund of mREITs, and due to recent dividend cuts in the underlying holdings, is behind WMC in dividend yield at the moment. MORL doesn't hold WMC in its index. (If it did MORL wouldn't be third best in yield.)
If you are thinking of going long WMC, it's a tough call on if you should get in before or after the dividend announcement (last year's Q1 dividend was announced on April 4th). I think the announcement of a dividend cut would likely send the stock lower. They also report an estimated book value at the same time, which could offset the dividend cut in the eyes of investors.
Disclosure: I am long WMC, MORL, NYMT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.