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Deutsche Bank Starts Western Asset Mortgage Capital (WMC) At 'Buy', $21.75 PT

 June 04, 2012 02:12 PM

(By Balaseshan) Deutsche Bank analyst Stephen Laws initiated coverage of Western Asset Mortgage Capital Corp. (NYSE:WMC) with a "Buy" rating and a price target of $21.75, which is based on a 10% premium to book value.

Laws expects WMC to generate net return on equities of 14% to 15% given current spreads available in agency mortgage-backed securities (MBS), as the portfolio benefits from the investments in less prepayment-sensitive securities and the low financing cost environment. He believes WMC deployed the new capital quickly and has benefited from rate changes since the offering.

Given the analyst's belief the offering proceeds were deployed rather quickly, the company has likely benefited from the recent move in rates. Because of declining long-term rates, he believes spreads on the initial portfolio are slightly wider than if the capital was deployed today, and the portfolio has likely benefited from a slight increase in asset values.

Laws said his target is based on applying a 10% premium to his book value estimate of $19.78 per share. Since 2000, agency MBS managers have traded in a range of 50%-250% of book value; however, the range post-2008 has narrowed to 75%-130%.

The analyst's targets for similar companies managing primarily agency MBS portfolios are based on premiums ranging from 10%-15% and he believes a premium at the low end of that range is appropriate given the opportunities in the sector while still taking into account WMC's lack of a track record and the execution risk associated with the deployment of IPO proceeds.

Laws said WMC has no operating history, and it may not be able to implement its investment strategy successfully. Slower-than-expected portfolio growth may result in his estimates proving aggressive. Investment illiquidity, rising interest rates, changing prepayment rates, and declining asset values may impact WMC's results.

WMC is trading up 1.40% at $18.78 on Monday.

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