Annaly Capital Management Inc.

Q3 2021 Earnings Conference Call

10/28/2021

spk07: Good day, and welcome to the third quarter 2021 Annalee Capital Management Earnings Conference Call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your touchtone phone. And to withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Mr. Sean Kinsel. Please go ahead.
spk09: Good morning and welcome to the third quarter 2021 earnings call for Annaleigh Capital Management. Any forward-looking statements made during today's call are subject to certain risks and uncertainties, including with respect to COVID-19 impacts, which are outlined in the risk factors section in our most recent annual and quarterly SEC filings. Actual events and results may differ materially from these forward-looking statements. We encourage you to read the disclaimer in our earnings release in addition to our quarterly and annual filings. Additionally, the content of this conference call may contain time-sensitive information that is accurate only as of the date hereof. We do not undertake and specifically disclaim any obligation to update or revise this information. During this call, we may present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in our earnings release. As a reminder, Annalie routinely posts important information for investors on the company's website, www.annalie.com. Content referenced in today's call can be found in our third quarter 2021 investor presentation and third quarter 2021 financial supplement, both found under the presentation section of our website. Annaleigh intends to use our webpage as a means of disclosing material, non-public information, for complying with the company's disclosure obligations under Regulation FD, and to post and update investor presentations and similar materials on a regular basis. Annalie encourages investors, analysts, the media, and other interested parties to monitor the company's website. In addition to following Annalie's press releases, SEC filings, public conference calls, presentations, webcasts, and other information it posts from time to time on its website. Please also note this event is being recorded. Participants on this morning's call include David Finkelstein, Chief Executive Officer and Chief Investment Officer, Serena Wolf, Chief Financial Officer, Ilker Ertas, Head of Securitized Products, Tim Coffey, Chief Credit Officer, and Mike Fagna, Head of Residential Credit. And with that, I'll turn the call over to David.
spk05: Thank you, Sean. Good morning, everyone, and thanks for joining us for our third quarter earnings call. Today, I'll provide an overview of the broader market environment, including our thoughts on the Federal Reserve's reduction in asset purchases, briefly touch on our performance during the quarter, and highlight some of our recent achievements in positioning across our businesses. Ilker will provide more detailed commentary on our agency and residential credit portfolios, and Serena will discuss our financial results. And as Sean noted, our other business heads are also here this morning to provide additional context during Q&A. Now, first, with respect to the macro landscape, the COVID Delta wave and related factors have led to a moderation in the economic recovery. Labor market gains have slowed relative to the strong pace at the beginning of the summer. Production bottlenecks and global supply chain disruptions have caused delays that raise prices on products in high demand. And while inflation has been boosted by higher goods and energy prices, record home price appreciation has started to filter into inflation's shelter component, suggesting that price pressures may persist for longer than previously anticipated. Meanwhile, interest rates experienced meaningful intra-quarter volatility given the shifting narrative on the economic recovery and inflation. Early in the quarter, rates rallied as markets sought direction on the magnitude of the impact of the Delta variant. And later in the quarter, as a relative reduction in COVID case counts led to a return to economic optimism, rates sold off and the curve steepened to end the quarter. Now, the greater near-term focus in the macro landscape, however, is the imminent reduction in the Fed's pace of asset purchases. Following the September FOMC meeting, we now have a clearer picture as to what the taper will likely look like. The Fed is expected to reduce Treasury and agency MBS purchases by roughly $10 billion and $5 billion per month, respectively, beginning as early as November. This pace would result in the Fed halting balance sheet expansion in the summer of 2022, though we expect reinvestment and portfolio runoff to persist well beyond the end of the taper, consistent with the QE3 experience. Most notably, the Fed's transparent communications have helped to limit the market impact to both interest rates and agency MBS spreads ahead of the official taper announcement. While the Fed has attempted to decouple the taper and eventual rate hikes, elevated inflation readings and more hawkish central bank messaging globally have accelerated investors' expectations of a rate hike. With markets currently pricing as many as two hikes in 2022, we remain vigilant in managing analyst duration exposure, both in the front end and the long end, as Ilker will expand later on. Now reflecting briefly on the agency MBS supply and demand outlook in light of the taper announcement, private market participants will need to absorb an increased amount of mortgages in 2022. Elevated net issuance remains an uncertainty in the supply-demand outlook, but we currently estimate supply to the private market next year will be similar to levels seen in recent years pre-pandemic. And several factors are supportive of more limited widening in spreads before buyers emerge. Banks are flush with deposits and see little loan demand, suggesting a strong appetite for securities is likely to continue, particularly at potential wider spread levels. and money managers remain underweight mortgages but will likely increase their relative allocation if mortgage spreads become more attractive. Ample liquidity, best seen in the $1.6 trillion pledged to the Fed's reverse repo facility at quarter end, and readily available financing remain the main factors underlying the current accommodative financial conditions. The repo market remains highly liquid and has allowed us to decrease our cost of funds to another record low. In line with efforts earlier in the year, we continue to broaden our financing through increased use of credit facilities by funding high-quality credit securities for longer terms. These actions help to enhance Analeigh's liquidity profile at extremely attractive spread and haircut levels, as Serena will discuss in more detail. Now, turning to Annalise performance in the third quarter, our portfolio generated a positive economic return of 2.9%, reflecting a two-cent gain on book value and earnings available for distribution of 28 cents. We achieved these returns and made continued conservative portfolio positioning, maintaining economic leverage at the low end of our historical range, and unchanged quarter over quarter at 5.8 times. Our liquidity remains at our highest levels with total unencumbered assets of $9.8 billion at quarter end. We continue to see relatively tight spreads and as a result are comfortable with our more cautious approach to managing the portfolio. Now that being said, should spreads become more attractive, our nimble positioning leaves us prepared to take a more offensive posture and increase leverage should it be justified. Now, over the quarter, mortgages performed in line with hedges in this environment as the sector benefited from clarity surrounding the upcoming taper and healthy demand from banks. We increased our agency portfolio by nearly $3 billion in Q3 as we invested a portion of the proceeds from our previously announced commercial real estate sale. Additions to our agency portfolio, which Ilker will cover in more detail, were primarily a placeholder as agency MBS remained fully valued, while credit sectors offer attractive pockets of opportunity, but deployment of capital is more episodic. With respect to capital allocation to end the third quarter, 30% of our capital was allocated to credit, up slightly from 29% in the prior quarter. in line with our view on the relative value equation vis-a-vis agency and our deliberate portfolio positioning ahead of the taper. Our residential credit business represents the majority of our credit allocation at 21% and had another strong quarter as the group continues to successfully execute on their strategy. With assets of $4.3 billion, the residential credit group is now larger than it was pre-COVID, and assets are up over 70% since year-end 2020. We maintain an optimistic outlook on the business, giving persistent, robust housing market fundamentals and long-term tailwinds, driving the need for private capital in the market. The Onslow-based securitization platform remains very active, completing nearly $2 billion of securitizations since the start of the third quarter and nearly $3 billion of securitizations year-to-date. We expect to maintain our securitization footprint, and we are continually adding to our partnerships to drive new sources of securitization collateral. Additionally, our correspondent network is adding new partners and analyzing large capital base and market expertise uniquely positioned Ansel Bay as an aggregator within the industry. And also as it relates to OBX, I wanted to briefly touch on the impact of the recent suspension of FHFA's cap on second homes and investor properties. While the decision will have an impact on the delivery of agency-eligible loans to our platform, it does not temper our bullish outlook for the sector. Annaleigh was an active issuer of agency-eligible investor loans before the cap was put in place, And notably, we issued three securitizations in 2019 and 2020, backed by $1.15 billion of collateral prior to the PSP amendment limiting delivery of investor loans to the GSEs in March of this year. As the FHFA has reversed the introduction of the caps, we expect Analeigh and private markets more broadly to be able to compete with GSE LLPA adjusted pricing again, assuming securitization execution remains attractive. Now regarding progress on our MSR business, we grew our holdings by more than 40% on the quarter with the portfolio representing $575 million in market value and 4% of dedicated capital. As we scale the business, we have solidified our position as a reliable partner in the MSR sector supplementing our bulk transactions with acquisitions through flow relationships. We've increased our MSR holdings by $470 million in 2021, and we anticipate responsibly growing the portfolio through our unique position as a non-competitive partner to originators that need liquidity and capital. Turning to our middle market lending business, we closed our inaugural private closed-end fund subsequent to quarter-end, with just north of $370 million of capital. The fund is approximately two times larger than the median size of first-time direct lending and private debt funds. It includes a mix of both U.S. and European investors comprised of public and corporate pensions, insurance companies, and asset managers. The fund has supported nearly $450 million of middle market loan investments to date with an attractive risk-adjusted return profile. Italy is co-investing 50-50 alongside each fund investment, bringing a strong alignment of interests. We believe the fund serves as a testament to the track record and expertise of our dedicated middle market lending team. allows for enhanced capital allocation flexibility to further scale the strategy and provides recurring fee revenue to the REIT. including the fund, the middle market lending strategy, managed $2.3 billion in funded assets at quarter end. Lastly, as the largest mortgage REIT with the capability to invest across all aspects of a mortgage loan, our strategic initiatives over the past year, including investing in MSR and balance sheet and expanding our residential credit business, have prepared us to be a leading source of capital in residential housing finance. Ultimately, the strength of Annalie's diversified model is enabled by our size and scale, and we remain confident in our ability to generate stable returns throughout various market environments and across economic cycles as we have done historically. And now with that, I'll turn it over to Ilker to provide a more detailed lens into our agency and residential credit portfolio activity and outlook.
spk03: Thank you, David. Against the economic and interest rate backdrop David described, agency MBS performed broadly in line with hedges, but performance was mixed across the coupon stack. Specifically, lower coupon MBS widened modestly due to continued record supply levels, Fed's taper moving closer, and elevated prepayment speeds. At the same time, higher coupons outperformed hedges into the retracement of higher interest rates that materialize later in the quarter and emerging signs of repayment burnout. Our portfolio performance showed the benefits of the barbell strategy we have discussed in several of our recent earnings calls. In third quarter, the outperformance of higher coupons more than offset the widening experience in the lower production coupons. We believe the approach is also efficient in protecting the portfolio from any potential taper-induced widening, as nearly 60 percent of our agency portfolio consists of non-FED-supported coupons. That is 3 percent and higher. In addition, our specified pool portfolio is more than 45 months seasoned on average, which provides a strong source of durable earnings with minimal duration and convexity risk. Turning to our portfolio activity, we tactically increased our agency portfolio by nearly $3 billion during the quarter, predominantly in lower coupon TVAs to opportunistically redeploy a portion of the proceeds from our previously announced commercial real estate sale. Our purchases consisted of primarily lower coupon TBAs, which exhibited spread widening earlier in the quarter. We have favored TBAs over pulls and lower coupons due to attractive implied financing rates in the dollar role market, which remain quite special in the context of negative 30 to 40 basis points financing and enhanced levered returns. We expect these favorable conditions to persist well into 2022, as the Fed remains a net buyer of MBS throughout the taper. In addition, the sector offers strongest liquidity should we choose to redeploy the capital into other opportunities. Regarding prepayment speeds, recent prints have mirrored the divergent performance across the coupon stack. Lower coupons have been very reactive in what remains a historically low mortgage rate environment in which mortgage originators have ample capacity while higher coupons have exhibited moderate burnouts since peak prepayment speeds in March. At current mortgage rates, roughly 31% of mortgage universe have greater than 50 basis points of refinancing incentive, which is down significantly from the 72% at the beginning of the year. The restriking of the universe, along with slower speeds in higher coupons, has improved the prepayment outlook going forward. Additionally, the historically strong housing market has led to elevated cash-out refinancing activity, which should help mitigate expansion risk for mortgage portfolios should interest rates continue to rise. Our portfolio prepaid 13 percent slower quarter-over-quarter, and our outlook is for a further 10 to 15 percent reduction in the fourth quarter due to higher rates, less reactive borrowers, and slower housing seasonals. In our hedge portfolio, we added duration hedges at lower rates throughout the quarter, positioning the portfolio for modestly higher yields. We added Treasury futures shorts across the curve and increased our long-end swap position by exercising $3 billion in the money swap options. We also took advantage of relatively lower levels of implied volatility to replace our exercised swaptions with higher strike swaptions at longer expiries. This proactive approach has already proven worthwhile given the rise in interest rates in September and October. The interest rate outlook remains cloudy due to uncertainties over inflation, the Fed's response, and market positioning. We will continue to minimize our interest rate exposure in fourth quarter. It was an active quarter for our mortgage servicing rights business. We grew our portfolio through $200 million in bulk purchases and began transacting through flow arrangements, which we see as a good growth opportunity going forward. Additionally, in the fourth quarter, we expect to sell the vast majority of our legacy MSR portfolio for roughly $85 million in estimated proceeds. The sale of higher-coupon seasoned MSR will provide additional capacity to grow our allocation to newer production low-coupon MSR, which will serve as a more effective hedge to the MBS basis. Additionally, the planned transaction is with an operational partner that ascribes a higher value to customer acquisition, which will drive strong execution for both parties. We believe this transaction highlights NLE's unique position in the MSR market as a capital partner for the originator community that does not compete for their customers. Moving to our residential credit business. We continue to increase our allocation to the sector as measured by both assets under management and capital deployed. The residential portfolio ended the quarter at $4.3 billion of market value and $2.9 billion of dedicated capital, representing 21% of the firm's capital. The growth of the portfolio was predominantly through our acquisition of residential whole loans as we purchased $1.4 billion throughout the third quarter. Our Q3 acquisitions were across both expanded prime non-QM markets and agency-eligible investor loans. Our securities portfolio was up modestly, approximately $125 million, as we saw diminished opportunities in third-party securities relative to prior quarters. As David mentioned, our OBX securitization platform was active in Q3 with 1.1 billion of securitizations across three separate deals. Also to note, post quarter end we priced two additional transactions representing another 800 million of issuance. Life to date levered returns of our whole loan strategy remains in low to mid double digits utilizing minimal recourse leverage. Our GAAP residential whole loan portfolio ended Q3 at $5.8 billion, 70% of which is currently term-financed with non-mark-to-market securitizations. In summary, MBS technicals remain constructive as trends in prepays continue to improve, and recent price action highlights the amount of support for MBS into higher yields. Our spreads have potential to drift wider as the taper commences and supply remains elevated. We believe any widening is likely to be orderly, but we expect to maintain a conservative leverage profile and proactively manage our basis and interest rate exposures. With that, I will now turn the call over to Serena to discuss our financial results.
spk00: Thank you, Oka, and good morning, everyone. This morning I'll provide brief financial highlights for the quarter ended September 30, 2021. Consistent with prior quarters, while earnings release discloses GAAP and non-GAAP earning metrics, my comments will focus on our non-GAAP EAD and related key performance metrics, which exclude PAA. At the risk of repeating myself, I would say that the general themes for this quarter's earnings are consistent with recent quarters. That is, this quarter, we continued to generate strong results from the portfolio, benefiting from the continued low interest rates in the funding market, marking another quarter of record low cost of funds, and sustained specialness in dollar roll financing. To set the stage with some summary information, our book value per share was $8.39 for Q3, and we generated earnings available for distribution per share of $0.28. Book value increased primarily due to gap net income of $522 million or $0.34 per share, partially offset by the common dividend declaration of $320 million or $0.22 per share, and other comprehensive loss of $142 million or $0.10 per share on higher rates. The negative impact to our book value from our agency MBS valuations was more than offset by the gains on our swaps, resulting from higher hedge rates and higher mark-to-market valuations on our MSR, and resi credit portfolios, which together contributed approximately six cents per share to book value during the quarter. Combining our book value performance for the 22 cent common dividend we declared during Q3, our quarterly economic and tangible economic returns were both 2.9%. As we take a closer look at the GAAP results, the valuation drivers we mentioned above benefited GAAP results as we generated GAAP net income for Q3 of $522 million or $0.34 per common share up from GAAP net loss of $295 million or $0.23 per common share in the prior quarter. Expanding further on those summary comments, specifically gap net income increase due to net realized and unrealized gains on the SWAPS portfolio in the third quarter of $130 million compared to losses of $224 million in the second quarter, lower net losses on other derivatives and financial instruments in the third quarter of $45 million compared to $358 million in the second quarter, and net unrealized gains on instruments measured at fair value through earnings in the third quarter of $91 million compared to $4 million in Q2. As David mentioned during our second quarter earnings call, we anticipated that EAD would moderate slightly. This is reflected in a two cent reduction in EAD compared to the second quarter. The most significant factors that impacted EAD quarter over quarter included. Lower interest income predominantly related to the runoff of higher yielding assets and the reduction in investment balances, which was offset by higher TBA dollar roll as the desk positioned our TBA portfolio based on the relative attractiveness compared to pools. EAD benefited from lower expenses on the net interest component on swaps from the termination of $28 billion gross notional swaps as the swaps portfolio was repositioned to reduce exposure to libel. And finally, lower interest expense of $50 million in comparison to $61 million in the prior quarter, due to lower average repo rates and balances. It should also be noted that the sale of our commercial real estate business allowed us to shift capital allocation to a higher percentage in resi credit, where we saw higher levels of EAD on whole loan and RPL purchases throughout the quarter. Now turning to our financing, early in 2021, we communicated that we were forecasting lower repo rates for an extended period. As such, we had begun to opportunistically target extended term, that is six to 12 months, for our repo book. And this has resulted in higher weighted average days to maturity for our book during 2021 in comparison to recent years. And in doing this, we believe that we have appropriately managed the risk of our liabilities while capturing the lows of the interest rate market. Additionally, given our ample liquidity in the prior quarters, we elected to fund certain credit assets with equity, further contributing to a lower cost of funds. These strategies resulted in the third quarter marking nine consecutive quarters of reduced cost of funds for the company. Our weighted average days to maturity for Q3 was 75 days, slightly less than the prior quarter at 88 days. This reduction in days is due to the timing of rolling repo extended earlier in the year and not a function of a change in strategy by the company. As David discussed, the market is pricing and rate hikes to begin in the latter half of 2022. Therefore, we have seen steepening in the repo curve as of late. And so, while longer term repo does come at a higher cost today, our over $30 billion in shorter dated zero to three year pay swaps has been of considerable benefit to hedging this eventuality. and given the strong liquidity in the repo market that will likely persist beyond initial rate hikes, we have focused our effort on hedging short-term rates as opposed to repo spreads versus policy rates. Additionally, although our overall repo balances have been reduced since the beginning of 2021, we have tried to maintain steady balances within our broker dealer. This has given us the opportunity to take advantage of attractive overnight funding conditions amid excess reserves and steady decline in TGA balances. As in prior quarters, we continue to see strong demands for credit assets on the part of repo lenders, and we have opportunistically begun to lever credit assets at very competitive terms, both rates and haircuts. Our average weighted days for credit assets are approximately 100, and we continue to target longer duration funding to lock in those competitive spreads and haircuts at all time types, consistent with our prudent and conservative approach to maximize liquidity. Given the growth in our resi credit businesses, we continue to add new warehouse facilities and amend existing facilities to meet the businesses' needs, with a further $300 million facility put in place during the quarter and increased capacity for our resi credit partnership with the Sovereign Wealth Fund. To provide additional color regarding our reduced interest expense for the quarter, our overall cost of funds decreased 17 basis points quarter over quarter from 83 basis points to 66 basis points. Our average repo rate for the quarter was 15 basis points compared to 18 basis points in the prior quarter, and we ended September with a repo rate of 15 basis points down from 32 basis points at the end of December 2020. With LIBOR reform looming, we took the opportunity during the third quarter to reposition our swap portfolio and reduce our exposure to LIBOR, resulting in the aforementioned termination of $28 billion of swap notional and reduced interest component of swaps for the quarter and future periods. The portfolio generated 204 basis points of NIM, down five basis points from the record NIM level of 209 basis points in Q2, driven by the lower interest income, partially offset by lower interest expense and improved TBA dollar roll income, up three basis points. Average yields decreased 13 basis points from 2.76% to 2.63%, mainly because of the change in the composition of assets towards lower yielding assets in the quarter, both agency and resi credit. Moving now to our operating expenses, efficiency ratios for the quarter decreased in comparison to Q2's ratio of 1.55%. As expected, we saw a reduction in our OPEX to equity ratios during Q3, as we realized the benefits of the reduced compensation and other expenses from the disposition of our Acreg business, and we saw a reduction due to the timing of certain fee payments and professional fees, along with the true-up of prior period accruals in the second quarter. Our OPEX to equity ratios were 1.28% and 1.4% for the quarter and year to date, respectively, with the full year expenses expected to be at the lower end, if not below the revised range of 1.45 to 1.60 provided in the first quarter. And to wrap things up, Annalie ended the quarter with an excellent liquidity profile with $9.8 billion of unencumbered assets, up from the prior quarter's $9.6 billion, including cash and unencumbered agency MBS of $5.9 billion. The composition of our unencumbered assets changed slightly this quarter, with an increase in agency due to lower on-balance sheet leverage and an increase in unencumbered assets due to MSR growth. partially offset by reductions due to investments sold during the quarter and the levering of certain non-agency securities that I discussed earlier. That concludes our prepared remarks. Operator, we can now open it up to Q&A.
spk07: Thank you. We will now begin the question and answer session. To ask a question, you may press star then 1 on your touchtone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed, and you would like to withdraw your question, please press star then two. And at this time, we'll pause momentarily to assemble our roster. And the first question will come from Steve Delaney with JMP Securities.
spk01: Please go ahead. Thanks. Good morning, everyone. Given that you have 13 analysts following the company, I'm just going to ask one question to lead off. David, curious, you know, your quarterly dividend, 22 cent, has been stable for the past six quarters, going back to Q20 after COVID. What does management and the board want to see that would give support to increasing that quarterly payout? Thanks.
spk05: Good morning, Steve, and it's good to hear from you. Yes, sir. So first and foremost, just to back up in terms of how we set the dividend, and obviously our board provides strong guidance on that front. And in conjunction with the board, we look at the overall dividend yield, what the earnings outlook looks like, and we want to achieve a competitive yield. And currently, Our yield on book value is 10.5%, 10.25% on the actual stock price this morning. In terms of what we want to look for to increase the yield or increase the dividend, we would need to see... Obviously, wider asset spreads, a better investment opportunity, more durable earnings. We feel good about where earnings are this quarter, and we feel good about covering the dividend into 2022, certainly. But we do recognize that we have out-earned the dividend consistently since the second quarter of 2021. And we're comfortable with that, and we're very comfortable with where the dividend yield is today. It's certainly competitive with the rest of the market, and we're content right here.
spk01: Yeah, well, I would certainly agree that a 10% dividend yield is too high, and then therein comes the catch-22 of what comes first. But, you know, we certainly look at 10% and say there's certainly, you know, upside in the stock as that dividend comes down. You know, the credit-oriented names are more in the 8% to 9%, and you're certainly adding a good bit of that. Thank you for the comments.
spk05: Thanks, Steve.
spk01: Okay.
spk07: The next question will come from George Bose with KBW. Please go ahead.
spk04: Hey, guys. Good morning. This is Bose. Actually, I wanted to ask about the $1.5 billion Resi portfolio. Can you just give us some color on that? What are the returns going to be, and how much capital is that going to use in the end once that's securitized?
spk05: Good morning and I'll start off and then hand it over to Mike. You know, I would separate both loans from securities. You know, we have had an emphasis on growing our loan portfolio and securitizing. The securitized portfolio has grown, you know, but I will say from a return standpoint. The loan to securitization market is more attractive in terms of what we can generate relative to where securities are currently priced. Mike, you can jump in here.
spk06: Sure. Thanks, Buzz. And I think we ended the quarter, you know, $3.2 billion in securities on an economic basis and then $1.1 billion in terms of whole loans. And I think when you think about the conversion of whole loans to securities on balance sheet, we're rotating anywhere, you know, I'll say between 7 to 8%. So we'll say, you know, between 75 to 80 to, you know, 85 million is what ultimately will be created from that 1.1 billion of whole loans. But to note, we settled $2.8 billion of hold loans year-to-date, and we ended the quarter with a $1.2 billion pipeline. So we remain positioned to continue to go to the securitization markets to the extent that they're open. But I would think about it probably 7% to 8% of the hold loan portfolios ultimately converted to securities on balance sheet.
spk04: Okay, great. And then the target, are we on that on a levered basis? Yes.
spk05: On securitization, we're in the low double digits right now.
spk04: Okay, great. Thanks. And then on the MSR investment, how large could that get as a percentage of your capital? And in terms of the yields on the MSR that you're buying, can you just give us some color? Sure.
spk05: Sure. And as we've talked about both the last two quarters, we would like to get our MSR portfolio up to 10% of capital. But we've also stressed that we're going to be patient in doing so. We're not going to chase returns in the sector. We are happy with the growth that we achieved in the third quarter. But again, it may take time because the market is competitive, but we're finding opportunities. And Ilkka can talk a little bit about returns.
spk03: Yeah, the purchases that we were buying with the hedge benefit will be very low doubles, but at the current pricing, it will be high singles. So that's why we reduced our purchases. We reduced our purchase pace recently.
spk05: Yeah, and we can also distinguish bulk purchases versus flow, where with flow purchases, you can get into the double digits kind of product.
spk04: Okay, great. Thanks.
spk07: Thanks, Boz. The next question will come from Rich Shane with JP Morgan. Please go ahead.
spk08: Thanks, everybody, for taking my questions this morning. I just wanted to talk a little bit the disparity between actual prepayment speeds and the long-term CPR assumptions fairly wide. I'm curious how we should think about the convergence of that over time and the implications in terms of your reported numbers.
spk03: Sure. One of the main reasons is the steepness of the curve. Long-term speeds are at the forwards, and as the curve steepens, the mortgage rate goes up and forward speed goes down. So that's one of the reasons. The second reason is the burnout. As the portfolio burns out, speed will slow down. But the curve is the bigger reason. If the curve flattens, you will see those two numbers approach each other.
spk08: And how should it does? But at the same time, how should we think about the ultimately they have to converge at some point. So how do we think about that from a reporting perspective, what we should anticipate and really what the time frame on that convergence should be? I mean, it's we're wider than 10 points at this point. And that just seems unsustainable. So trying to think about the timeline and the accounting implications.
spk05: Yeah. So, Rick, I'd say there is a consistent catch-up that is adjusted on a quarterly basis, number one. Number two, you know, let's just look back. I realize the disparity between actuals and long-term projection is quite wide now, but if you go back a few years when rates were higher, you did have portfolio speeds that were, you know, in the low double digits very consistent with long-term projections. So, you know, to the extent rates do normalize, then we're going to ultimately approach those longer-term CPRs if we follow the forwards, as Ilker suggested, and potentially even through those levels and we'll average out. But it's all dependent on, you know, where actual rates do go out the horizon.
spk08: Okay. No, look, I'm not questioning the long-term prepayment speeds, particularly given the burnout that we're all anticipating. I'm just trying to think about what it means if you are persistently above the long-term assumption, because obviously what's left has a very low speed, but there's not much of it. remaining, and as you replace or reinvest, you could have this situation where you sort of have this persistent gap between the two.
spk03: Yeah, you can look at it this way, though. So as long as prepayment models were accurate, and if we were, If forward does not realize and curve stays here, yes, short-term speeds will be higher than the long-term speeds. But through that, then you will get the roll-down benefit on your hedges. So if yield curve does not, if the forward does not materialize, then your hedge cost will never increase as much as the forward realize. So when you look at the spread, to the spread of the mortgages to the hedges, you are taking the forward roll down into account. So one way is saying that, okay, forward's realized, then your hedge cost goes higher. Or other way is saying that forwards are not realized, then your hedge cost will be lower. So as long as what we are modeling or what market is modeling is consistent with where the mortgage rate and where the prepayments are, those two effects will offset each other.
spk08: Okay, got it. Thank you, and I've taken a lot of time. I apologize.
spk07: Thank you, guys. Thanks, Rick. The next question will come from Eric Hagan with BTIG. Please go ahead. Hey, good morning, guys.
spk10: So we know that overnight repo is very plentiful in the Treasury market, like you noted, but can you share where on the term structure repo liquidity is currently most abundant for agency mortgages? and how you expect that could evolve as the Fed begins to taper and more collateral supply gets put onto the market?
spk05: Sure, sure. Good morning. That's a good question. So I'll just give you a quick run of where bilateral repo is right now. For a month, it's about 12 basis points. Three months, 14, 17 roughly for six months, and then in the mid-20s for a year. So obviously we have seen a steepening in the slope of that curve. Now, Now, let's look at repo and break it down for clarification. There are two components to repo costs. There's the short rate component or the Fed funds component, if you will, and then there's the liquidity component, which is the spread component. of bilateral repo over that short rate. And the way we look at the current environment, what we're most concerned about is the rate component. And we've seen, you know, hikes get priced in, acceleration of hikes get priced into the market as of late, and obviously that's something we're very focused on. Now, however, when you look at our hedge profile, were very well covered from that standpoint. You know, $31 billion in zero to three-year swaps and 80% hedge ratio at quarter end, actually a little bit higher than that now, around 84%. So the rate component and the risk associated with short rates going up were well covered from. Now, the liquidity component, given our days are about 75% roughly right now, We are not as concerned about that over the very near to intermediate term because of the liquidity in the system. You know, a Fed balance sheet of about $8.5 trillion, $1.6 trillion in the reverse repo facility at quarter end, a standing repo facility at the Fed in case there's any issues. destabilization in repo markets. So we're much more focused on hedging the rate component, which we have, and we're confident that liquidity out the near term is going to be ample. And so we're not as inclined to pay as much of a premium for term repo, but we're actively looking to find good value in, say, six-month to a year repo.
spk10: Got it. That's helpful. And then it seems like It seems like one of the benefits of moving lower in coupon in the agency portfolio is that the premium risk on your capital structure gets reduced or tempered a little bit because you're buying lower-priced securities. I mean, would you agree with that? And do you think that changes the way you think about your leverage and the way you guys manage risk in other areas of the portfolio too?
spk05: Yeah, so just to talk a little bit about premium risk, I'd say it's always a concern of ours, but if you back up to the beginning of the year, it's less of a concern now than it was then because, for example, you know, we had $11 billion higher balance in fixed-rate securities in the portfolio, largely premiums, obviously. Rates were much lower at the time, so the risk of refi was greater. And then lastly, and perhaps most importantly, we did experience a bit of a repricing of higher coupons in the second quarter. And so as a consequence of that, premium coupons are priced to very fast speed. So we're always concerned about the premium in the portfolio. Right now, I think it's 27% of our equity balance, which is lower than it's been over the past year, certainly. Does it influence our leverage? You know, we do take a holistic approach, and what most influences our leverage is the attractiveness of the overall agency market and also our capital allocation, as we've talked about in the past. But generally speaking, you know, we are shifting down in coupon into TBAs because the carry is better, and TBAs or lower coupons did cheapen a bit relative to higher coupons, both in the third quarter and later. and on a relative basis to higher coupons and touch in the fourth quarter thus far. So, again, we take a holistic look at leverage, and a specific amount of premium obviously has us concerned about refi risk, but it's generally a bigger picture than that.
spk07: Got it. Thank you, David. You bet, Eric. Again, if you have a question, please press star, then 1. Our next question will come from Kenneth Lee with RVC Capital Markets. Please go ahead.
spk02: Hi, thanks for taking my question. I'm wondering on a broader level, could you talk about what are you looking specifically for before you start taking a more aggressive approach to leverage and portfolio positioning? Is it just a matter of spread widening in certain assets or are there any macro considerations? Thanks.
spk05: Sure. Good morning, Ken. And look, this also goes back into the first question with respect to the dividend. You know, when we look at the market and the landscape right now, we are approaching Fed tapering, and obviously rate hikes a little further out the horizon is something that we're, you know, obviously very focused on. So is now the right time to raise leverage? We don't think so. Asset spreads are relatively tight. We're able to generate, you know, what we think to be strong earnings, but we would need to see, you know, wider spreads, particularly in agency before we did raise leverage. And I'll say that given our liquidity profile, as Serena discussed, and we are at the low end of the range, we're at the lowest level of leverage that we've been in in over five years. So we do have ample opportunity should that eventuality materialize. But if the market... End of the quarter where it is today and the portfolio looks as it looks today, I'd say we're here to slightly lower even. And should spreads widen, we will have the capacity to do so. But we do need to see more abundant spreads to take leverage. What that is is dependent exactly on what the state of the world is at the time. But generally speaking, we're not inclined to use leverage right at the moment.
spk02: Gotcha. Very helpful. And one follow-up, if I may. The private, closed, and middle markets lending fund, could you talk a little bit more about what you see are opportunities in that area over time with the potential for perhaps additional funds? Thanks.
spk05: Sure. And look, I think when we look at the middle market business, we have said repeatedly that the returns in that sector are very complementary to the agency portfolio, given the low correlation. And the team has built a great franchise and has very extensive relationships with private equity that we think need a lot of barriers to entry. And as a consequence, they were able to successfully raise outside capital. And the catalyst was looking through the lens of the Annalie portfolio. We liked the business and we very much liked the assets, but given the fact that it's corporate lending and we're a REIT, there are limits to the potential growth. And so outside capital certainly solves the issue of enabling that business and that portfolio to further scale. and also it reduces some of the concentration risk of individual positions. So we're very happy with the accomplishment of raising the outside capital, and to the extent there's more opportunities, you know, we'll see. But right now we feel like we have capacity on the annually balance sheet to add to the portfolio, and we're happy with how it's performed. And, Tim, if you want to add anything to it, by all means.
spk02: I think David summed it up beautifully. Great. Great. Very helpful. Thanks again.
spk05: You bet. Thank you, Ken.
spk07: This concludes our question and answer session. I would like to turn the conference back over to Mr. David Finkelstein for any closing remarks. Please go ahead.
spk05: Thanks, Chuck, and thank you guys for joining us today. Have a good holiday season, and we'll talk to you at the beginning of the year.
spk07: The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.
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