While Western Asset Mortgage Capital Corp (NYSE:WMC) is trading in line with its peers as far as its relative valuations are concerned, it is still an attractive investment for investors looking to enhance their regular income. The investment thesis aims to explore reasons for its attractiveness and review its recent operating performance.
Company Business
Western Asset operates as a mortgage REIT in the United States with a market cap of $530 million. The company has investments in mortgage backed securities backed by residential loans for which the principal and interest payments are guaranteed by any of the government Agencies. To further diversify its portfolio, the company also invests in non-Agency RMBS, commercial mortgage backed securities and other asset backed securities.
Investment Portfolio
The following chart displays each specific security’s proportion within the entire MBS portfolio.
A large concentration in Agency RMBS is visible in figure 1. Around 94% of the recent quarter’s portfolio is composed up of Agency RMBS, while the rest is non-Agency RMBS with a negligible proportion of collateralized mortgage obligations. Figure 2 illustrates the proportion of each security within the Agency holdings. It is visible that WMC has large chunks of 30-year fixed rate securities. Over half of these 30-year fixed rate RMBS have a coupon rate of over 3.5%. The 15-year fixed rate RMSB form 7% of the entire Agency holdings.
Recent Quarter Performance
Western Asset Mortgage Capital Corp (NYSE:WMC)’s fourth quarter earnings came in better than expected. The company reported EPS of $1.05, $0.18 per share ahead of the consensus mean expectation. WMC reported interest income of $35.9 million during the fourth quarter, up 144% from the linked quarter. During the quarter, WMC earned 2.86% in asset yields compared to 2.79% during the third quarter. Also, during the quarter, interest earning assets increased 11%. The sequential surge in interest earning assets and the asset yield is cited as the reason for the surge in interest income during the fourth quarter.
Interest expense during the quarter for Western Asset Mortgage Capital Corp (NYSE:WMC) came in at $5.4 million, compared to $1.93 million during the third quarter of 2012. This is partially the result of the 2 bps increase in the effective cost of funds to 0.81%. Borrowings under repurchase agreements increased 150% to $4.79 billion. This was another reason for the surge in the fourth quarter’s cost of funds.
As a result, the fourth quarter net interest rate spread came in at 2.05%, up from the prior quarter’s 2.0%. Also, during the quarter, WMC incurred $2.5 million in other losses, largely on higher unrealized loss on RMBS, partially offset by realized gain on sale of RMBS. Operating expenses of $3.2 million also remained higher from a quarter ago, causing the net income to decline 12% to $24.8 million.
In conclusion, despite higher asset yields during the fourth quarter, Western Asset Mortgage Capital Corp (NYSE:WMC)’s results were negatively impacted by higher interest expense, unrealized loss on RMBS and operating expenses.
In comparison, American Capital Agency Corp. (NASDAQ:AGNC) and American Capital Mortgage Investment Crp (NASDAQ:MTGE) reported 27 bps and 11 bps expansions in their respective asset yields during the fourth quarter. While American Capital Agency Corp. (NASDAQ:AGNC) is exclusively invested in Agency MBS, MTGE is classified as a hybrid mREIT. The cost of funds for MTGE increased 13 bps, while American Capital Agency Corp. (NASDAQ:AGNC) reported a 6 bps sequential increase. MTGE reported a two-fold increase in its fourth quarter bottom line, while American Capital Agency Corp. (NASDAQ:AGNC)’s net income climbed from $86 million to $810 million.
Western Asset Mortgage Capital Corp (NYSE:WMC) reported prepayment speed of 3.6%, down 50 bps sequentially. This is even below the CPR of 10% for American Capital Agency. American Capital Mortgage reported a CPR of 6.5% at the end of the same quarter.
Dividends
The company pays a quarterly dividend of $0.9 per share and offers an attractive dividend yield of 16.4%. It also increased its regular dividend 6% from the previous quarter.
Valuations
Western Asset Mortgage Capital Corp (NYSE:WMC) is currently trading at a moderate 1% premium to its book value. Compared to this, American Capital Agency Corp. (NASDAQ:AGNC) is trading at a 3% premium, and American Capital Mortgage is trading at a 1% premium.
Conclusion
Western Asset Mortgage has a diverse investment portfolio, which also includes non-Agency RMBS. Going forward, non-Agency RMBS will continue to enhance the company’s asset yield. However, I believe the company needs to concentrate on taming its operating expenses.
The article Get to Know This 16% Dividend Yielder originally appeared on Fool.com and is written by Adnan Khan.
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