Wunderlich downgrades to Sell

Western Asset Mortgage Capital Corp WMC reported a nearly 11 percent sequential contraction in BVPS, and its core EPS significantly missed expectations. Wunderlich’s Merrill Ross downgraded the rating for the company from Hold to Sell, while reducing the price target from $10 to $8. The analyst expects value erosion to continue to accelerate.

Western Asset Mortgage Capital’s BVPS contracted by $2.73 in 2015, and declined by another $1.30 in 1Q16. Even with the dividend of $0.45 per share, there was 7 percent value erosion in the quarter, analyst Merrill Ross said.

“We understand that the rally in credit-sensitive assets reversed as much as 50% of the decline in BVPS subsequent to quarter end; we have limited appetite for this amount of BVPS volatility in a levered entity,” Ross wrote.

Dividend May Continue Declining

The company reported its net interest spread had shrunk by 65bps to 1.53 percent, mostly due to increased costs of funding and hedging.

“Despite the FOMC's policy of lower interest rates for a longer period of time, WMC is operating at a zero duration gap, which led to a relatively high 2.73% cost of funds among peer companies,” the analyst noted. Moreover, management fees and G&A increased by nearly $1mm on a sequential quarter basis

Ross expects core plus drop income to continue to be under pressure, although there could be some sequential quarter improvement. He added that dividends would likely decline from $0.45 paid for 1Q16 to $0.30-$0.35 per quarter.