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spk10: Good morning and welcome to the Q2 2022 Annalee Capital Management Earnings Conference Call. Today, all participants will be in a listen-only mode. Should you need assistance during today's call, please signal for 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. If you would like to withdraw your question, please press star 10-2. At this time, I would like to turn the conference over to Sean Kensal, Investor Relations. Please go ahead, sir.
spk12: Good morning, and welcome to the second quarter 2022 earnings call for Annali Capital Management. Any forward-looking statements made during today's call are subject to certain risks and uncertainties, including with respect to COVID-19 effects. which are outlined in the risk factor 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 contents 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 second quarter 2022 investor presentation and second quarter 2022 financial supplement, both found under the presentation section of our website. annually 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. Please note this event is being recorded. Participants on this morning's call include David Finkelstein, President and Chief Executive Officer, Serena Wolf, Chief Financial Officer, Ilker Ertas, Chief Investment Officer, and Mike Fania, Head of Residential Credit. And with that, I'll turn the call over to David.
spk09: Thank you, Sean. Good morning, everyone, and thanks for joining us for a second quarter earnings call. Today, I'll review the macroeconomic and housing market backdrop, our performance during the quarter, and then provide an update on our broader strategic direction as we begin the second half of the year. Ilker will then discuss our portfolio activity in more detail, followed by Serena, who will go over our financial results for the quarter. Starting with the macro landscape, as all are aware, the first half of 2022 has been an exceptionally challenging investment environment. Very high inflation, geopolitical uncertainty, and the fastest pace of monetary policy tightening in recent history led to broad-based deterioration across asset classes. Despite forecasts for inflation to peak this spring, Headline CPI climbed through the quarter, reached 9.1% year-over-year in June. Meanwhile, tight labor markets supported healthy consumption, making it increasingly clear economic activity was too strong for inflation to slow meaningfully. In response, the Federal Reserve hiked 125 basis points in the second quarter and another 75 basis points just yesterday. The hawkish Fed markets pricing an additional 100 basis points of rate hikes for 2022 in June relative to March led to the largest quarterly tightening of financial conditions since the onset of the financial crisis. Economic activity now appears to be slowing, which can best be seen by the decline in activity in interest rate sensitive sectors such as housing. Given the importance of the housing market to our business, I want to spend a moment on the outlook for single-family housing. Home prices have continued to rise sharply, appreciating over 10% the first five months of the year, according to the Case-Shiller Index. Housing activity, however, has slowed recently, as the highest mortgage rate since 2008 and 40% cumulative home price appreciation since the start of the pandemic has weighed on both consumer and builder sentiments. Affordability for prospective homeowners has been significantly reduced with mortgage payments 50% higher year over year on a national average. This is curbing consumers' ability to purchase homes and in turn is reducing demand for mortgages. This correction will be welcome for the agency MBS market as it reduces elevated net supply, which has been the main headwind for the sector in the recent past. Our expectation is that housing will exhibit negative momentum in the second half of the year, with the deceleration of home prices and declining month-over-month HPA becoming a realistic possibility, particularly on a regional level. However, a systematic shortage of one to four single-family homes relative to future demand, low leverage as measured by outstanding mortgage debt to equity, lean builder inventories, Historically tight underwriting standards and the majority of mortgage borrowers locked into a low fixed rate mortgage suggest a moderation and slight decline in home prices is more likely than a protracted decline. Now shifting to the broader market outlook, risk to the rates market are more balanced now as concerns over an economic downturn are on the rise. The Fed has demonstrated its commitment to curb inflation, and markets are now anticipating elevated inflation to decline, particularly if we experience an economic slowdown. As a consequence, we expect investors to allocate more capital to fixed income in this environment, which should result in a welcome decline in volatility going forward. Combination of lower volatility and reduced supply would provide a positive backdrop for agency MBS where spreads remain historically high. While our MSR and residential credit businesses have benefited from rising HPA, we maintain a constructive outlook given the underlying composition of our portfolios and the support from the long-term supply demand imbalance in the housing market. Turning to our performance, we experienced a negative economic return of 9.6% in the second quarter in light of this difficult environment. Economic leverage increased slightly to end the quarter at 6.6 turns. And despite our decline in book value, we generated strong earnings available for distribution of 30 cents for the quarter. However, as we have signaled in prior quarters, we expect earnings to moderate going forward, as Serena will cover in more detail. Now I'd like to provide an update on our strategic initiatives. We completed the previously announced sale of our middle market lending portfolio during the quarter as planned. And to reiterate our rationale for the transaction, the sale provided an opportunity to monetize a less liquid non-core business at an attractive valuation and redeploy capital into our core businesses. As I discussed on last quarter's call, the sale of the MML portfolio culminates our natural evolution to becoming a dedicated housing finance REIT. With our sharpened focus, we have the capacity and flexibility to expand our operational capabilities and leadership across the residential credit and MSR landscape, and we have made significant strides over the past year, which I'll turn to now. Notwithstanding the broader market volatility and disruptions to the mortgage finance sector this year, our residential credit and MSR platforms have built upon their strategic capabilities and gained market share, all while maintaining an intentional focus on credit and risk management. Within residential credit, we remain a programmatic securitization issuer with Onslow Bay representing the largest non-bank issuer of prime jumbo and expanded credit MBS in the first half of 2022. We've securitized $4.8 billion across 12 transactions year to date, generating $525 million of credit investments. Our issuance has benefited from increased originator partnerships and continued momentum in our residential whole loan correspondent channel. Our 2022 non-QM lock commitments are approximately 50% above our 2021 total lock volume. In Annalise balance sheet, commitment to the market, permanent capital are differentiating factors that reinforce our position as an industry leader and a reliable source of capital to the originator community. Our mortgage servicing rights portfolio has grown significantly with Onslaught Bay establishing itself as the fourth largest purchaser of MSR year-to-date and a top 20 owner of GSE mortgage servicing rights. We've prudently built the infrastructure necessary to scale as we continue to enhance our operations through the addition of key hires and new partnerships. While the business has grown 15% of capital in the span of a year, we've been disciplined with respect to our purchasing activity in order to responsibly build our MSR assets vis-a-vis our broader portfolio. Also to note, we closed our first MSR credit facility subsequent to quarter end. However, consistent with our prior guidance, we plan to employ only modest leverage on MSR, and the facility serves primarily as a tool to manage liquidity. Over the long term, we expect our allocation of residential credit and MSR to approach 50% of our capital based on prevailing returns and where we are in the cycle. Accordingly, agency is at the higher end where we see its long run capital allocation, which we are very comfortable with given the current relative attractiveness of the agency sector. But ultimately, we are confident that increasing our exposure to lower levered, less liquid assets with a premium return will help improve the durability and quality of our economic returns. While this year has been difficult throughout financial markets, we are encouraged by the robust growth within these businesses and the long-term potential as we fully scale our housing finance capabilities. Now finally, before I turn it over to Ilker, I want to highlight that we published our third corporate responsibility report last month. The 2021 report demonstrates our continued focus on setting and measuring progress on our ESG goals, as well as our commitment to providing best-in-class disclosure and increased transparency. And we continuously strive to advance these efforts each year. In the latest report, for example, we included incremental disclosures that outline climate-related risks and opportunities across our business. We're proud of the progress we've made to further integrate ESG priorities throughout our company that has undoubtedly helped to create lasting value for all of our stakeholders. And now with that, I'll hand it over to Ilger to provide a more detailed overview of our portfolio activity for the quarter and outlook for each sector.
spk07: Thank you, David. As you discussed, volatility in the fixed income market persisted throughout the second quarter with a continued sell-off in rates and underperformance in risk assets. Agency MBS widened 20 to 30 basis points as supply remained elevated, while on the demand side, the Fed began reducing its balance sheet and banks were sellers on the quarter, leaving money managers as the primary buyer of MBS. the largest buyers of MBS have shifted from being price-agnostic and yield-based, the Fed and the banks respectively, to investors who are more focused on nominal and option-adjusted spreads. Mortgage underperformance has been closely tied to the rise in interest rate volatility, which, outside the short-lived spike in March 2020, is at the highest level since 2009. Within the agency universe, In a reversal of the trend in the first quarter, lower coupons underperformed as they were weighed down by fears of potential sales from the Fed, and investors gravitated towards wider spreads and increased carry offered in higher coupons. Specified pools outperformed TBAs attributable to improved convexity, which served as protection from the extreme levels of realized interest rate volatility. a worsening of the TBA deliverable due to higher average loan sizes, and TBA rose softening over the course of the quarter as new production replenished the float in higher coupons. During the quarter, we kept the size of our agency portfolio relatively stable while we continued to rotate up in coupon, reducing our holdings of 2s through 3s by nearly $16 billion in favor of 3.5s, 4s, and 5s. The tactical decision of rotating opt-in coupon reduced our spread duration and improved the earnings in the portfolio. In lower coupons, we maintain a significant portion in specified pools, notably lower loan balance, credit impaired, and faster servicer stories, which have historically prepaid more rapidly in discount environments. Turning to our hedge portfolio, we maintain a defensive posture given the volatile interest rate environment. We replaced the roll-down in front-end swaps with longer-dated hedges across swaps and treasury futures, which extended our hedges to match the expansion of our assets as rates continued to rise. Moving to our residential credit business, spreads widened materially across both non-agency and structured finance markets, notably underperforming corporate credit in light of the risk of environment and market volatility. AAA non-QM spreads were 35 basis points wider on the quarter, while benchmark investment-grade credit transfer was 100 basis points wider. Supply technicals and a deceleration in housing momentum have weighed on sentiment within the non-agency market, although consumer fundamentals have yet to show any deterioration. Mortgage delinquencies are at the lowest point over the last 20 years, and current delinquency roll rates remain stable. We took advantage of the spread dislocation and negative risk sentiment by increasing our allocation to short-duration MPL-RPL securities and GSE credit risk transfer, in addition to retaining our OBX securitizations as we term financed our whole loan portfolio. The economic value of the residential credit portfolio ended the Q2 at $4.8 billion, a $430 million increase quarter over quarter. And also to note, as Serena will elaborate on, we choose to tactically increase our leverage in the residential credit portfolio given attractive financing terms, with dedicated capital declining from 19% in Q1 to 14% at the end of Q2. In residential whole loans, we settled 1.1 billion of expanded credit whole loans in Q2, and we issued five securitizations, generating 275 million market value of OBX bonds. Our loan portfolio is well positioned for the volatility in the securitization market as we ended the quarter with less than 800 million of unsecuritized loans on balance sheet with significant warehouse capacity. In our MSR business, we continue to take advantage of the record origination volumes and the need for non-bank originators to monetize MSR, growing the portfolio by nearly 500 million in Q2, inclusive of the unsettled purchases. As of the quarter end, our MSR portfolio had sub 3% weighted average coupon, and we continue to favor low note rate, high credit quality collateral. With our MSR portfolio with 200 basis points out of the money, it is now fully extended and has minimal duration. However, the position provides strategic benefit to our overall portfolio. It generates high single digit, stable, unlevered returns with low correlation with the agency portfolio and provides a hedge to our lower coupons should the elevated discount speeds begin to subside. Our portfolio is now over $1.7 billion in market value and represents approximately 15% of the firm's capital. Now, expanding on David's comments regarding our outlook. The latter part of Q2 brought about a shift in the market narrative from struggling to price the impact of inflation to preparing for a possible recessionary environment, which has led bond deals to retrace from the highs and regain some of their typical negative correlation with other risk assets. This shift has important implications, which specifically benefit agency MBS from the perspective that market pricing in Fed cuts in early 2023 The potential for Fed sales of the MBS is now less likely, and a slowdown in housing activity will result in reduced MBS supply. Furthermore, given the favorable liquidity and risk profile of agency, we anticipate that fixed-income investors will prefer mortgages over corporate credit in a recessionary environment. Fundamentally, we believe that the outlook for agency MBS looks very attractive with the sector trading near historically widespread levels. Asset convexity is at record lows as cash flow certainty has improved, given over 90% of borrowers lack incentive to refinance their homes. Overall, investment opportunities across our three businesses are as compelling as we have seen in recent years. And we believe that we are well positioned to benefit in what we expect to be a less volatile environment with improved resentment across the fixed income landscape. With that, I will hand it over to Serena to discuss the financials.
spk06: Thank you, Ilka. Today, I'll provide brief financial highlights of the quarter ended June 30, 2022. Consistent with prior quarters, while earnings release discloses gap and non-gap earnings metrics, My comments will focus on our non-GAAP EAD and related key performance metrics, which exclude PAA. To set the stage with some summary information, our book value per share was $5.90 for Q2, and we generated earnings available for distribution per share of $0.30, ample coverage of our dividend. Book value decreased by $0.87 per share for the quarter, primarily due to a continuation of themes referenced in Q1. That is, higher rates and spread widening and the related declining valuations on our agency position. Agency and TBA valuations were down $2.18 per share on the prior quarter. Gap net income of $0.55 per share and our multifaceted hedging strategy continued to support book value, providing a partial offset to the agency declines mentioned above, with swaps, futures and MSR valuations contributing $1.25 per share to the book value during the quarter. MSR valuations moderated in comparison to Q1, but were valued six cents per share higher at the quarter end than in the prior quarter. After combining our book value performance with our first quarter dividend of 22 cents, our quarterly economic return was negative 9.6%. As noted earlier, the portfolio generated EAD per share of 30 cents. Earnings continued to be strong, resulting from high dollar roll income, increasing MSR net servicing income, reduced amortization due to lower CPRs, and a benefit from our swaps portfolio as it turned to a net receipt position during the quarter on higher short-term rates. However, EAD was meaningfully aided this quarter by an increase in specialness in dollar rolls, primarily driven by a scarcity of TBA-type collateral and newer, higher-rate production coupons. We don't expect this temporary phenomenon to persist in subsequent quarters as production is catching up with TBA demand, and rolls are trading close to carry thus far in Q3. We believe that the anticipated reduction in the specialness of dollar roll, combined with the expected rise in the cost of funds due to rising rates, should moderate future earnings. However, we expect to out-earn our 22 cent dividend in the third quarter, all things equal. Average yields, XPAA, were higher than the prior quarter at 2.87%, up 25 basis points compared to the preceding quarter. due to lower CPRs and to a lesser extent from the overall composition of the portfolio, shifting to higher-yielding assets during the quarter. Additionally, the portfolio generated 220 basis points of NIM X PAA, up 16 basis points from Q1, driven by the higher TBA dollar roll income that surpassed higher economic interest expense, which included the beneficial net interest component of swaps. Net interest spread does not have dollar roll income, and the increase was more muted. up three basis points at 1.76% compared to 3.3122, as lower amortization and reduced swap interest modestly outpaced higher repo rates during the quarter. Now turning to our financing. Funding markets continue to function well, with lender repo capacity for agency MBS remaining robust. However, uncertainty about the pace of future rate hikes has led to a shift in liquidity within the repo market towards the front end of the term curve, as providers have priced longer-dated repo contracts more conservatively in light of Fed uncertainty. Consequently, we have reduced our weighted average repo maturity to 47 days from 68 days in the prior quarter. We expect to maintain a shorter-dated book over the near term, which we are comfortable with, given ample reserves remaining in the system. Further to note, as Ilka discussed, early in the quarter, we increased the repo leverage on our resi credit assets, taking advantage of attractive prevailing haircuts and financing levels. Given the volatility experienced through the first half of 2022, this strategy added to the company's liquidity while taking advantage of beneficial economics and credit funding markets. In warehouse financing, after adding $500 million of credit facility capacity to our Resi credit business, our warehouse capacity for Resi is now approximately $2 billion. with significant unused capacity, and we continue to explore other financing alternatives for the business. Additionally, as David alluded to, to further enhance the firm's overall liquidity profile, we added a $500 million facility for our MSR business after quarter end. The upward trend in interest rates impacted our overall cost of funds for the quarter, rising by 22 basis points to 111 basis points in Q2. And our average repo rate for the quarter was 81 basis points compared to 20 basis points in the prior quarter. Our activity in the securitization market also impacted funding costs, increasing the weighting of securitization on the composition of cost of funds, along with higher effective rates of 2.73% compared to 2.30%, resulting in the increase of 11 basis points to cost of funds. Finally, SWAPs positively impacted cost of funds during the quarter, as previously mentioned, by 41 basis points. Moving now to our operating expenses, our efficiency ratios improved during the quarter from decreased compensation expenses in the second quarter related to the sale of our MML portfolio, offset by the impact of the degradation and equity on the computation of the ratio. And in closing, Annalie maintained an abundant liquidity profile with 6.3 billion of unencumbered assets down from the prior quarter at 7.2 billion, including cash and unencumbered agency MBS for approximately 4.5 billion. Much of the reduction in unencumbered assets was due to the sale of our MML assets and increased leverage on credit, which is partially offset by increased unencumbered MSR. That concludes our prepared remarks, and operator, we can now open it up for Q&A.
spk10: We will now begin the question and answer session. To ask a question, you may press star then one on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. If you would like to withdraw your question, please press star, then two. At this time, we will pause momentarily to assemble our roster. Today's first question comes from Bose George with KBW. Please proceed.
spk05: Hey, everyone. Good morning. Can I get your book value quarter date? I don't think you mentioned that in the prepared remarks.
spk09: Sure, Bose. Good morning. Book is up 4% as of yesterday. And this morning, post Fed follow through as well as GDP. It seems as though there's very positive momentum.
spk05: Okay, great. Thanks. And then, you know, in your hedges, your treasury future position continues to increase relative to swaps. Can you just discuss the benefits of futures versus swaps? And then just from an accounting standpoint, is there anything we should think about in terms of how they flow through the P&L?
spk09: Yeah, that's a good question, Bo. So with respect to an outsized position in futures relative to historical, it's about liquidity and better fit with the agency portfolio. And to your point, with respect to accounting considerations, and Serena mentioned that our swap position turned to a net receive where we generated income in Q2, and we expect that to grow given higher short rates. And as a consequence, the The futures position does not flow through EAD. There is an economic benefit, much like there is with swaps, but it doesn't flow through EAD. And so as a consequence, EAD may temporarily underestimate the economic earnings of the portfolio.
spk05: Okay, great. But I guess, is there any way to sort of quantify that or just for, yeah, just because I guess there's a period where, or I guess maybe to rephrase that, when you think about your total return and what drives the dividend, I guess there could be a period where your EAD is being depressed by the use of futures, but your economic return still is higher than that, right?
spk09: That's correct. And the way we think about the dividend is based on the economic earnings of the portfolio.
spk05: Okay, great. Thanks.
spk09: You bet, Bose.
spk10: The next question comes from Rick Shane with J.P. Morgan. Please proceed.
spk11: Thanks, guys, for taking my question, and I apologize. We've been bouncing around, so if some of this was covered, I apologize. So when we look at book value and we look at the ROE hurdle you need to sustain the dividend, which is about 15% right now, given... the opportunities that are in front of you, do you think that the market is presenting you with a 15 plus percent ROE opportunity that makes sense within your risk parameters?
spk09: Sure. So look, I would say when we look at levered returns on agency and residential credit, you know, we can get into the details within each of the sectors, but you can earn 15 percent in both sectors. MSR is, you know, on an unlevered basis is lower than that. But given the fit in the portfolio, we're perfectly comfortable with that. So to answer your question, the dividend yield on book value at quarter end, 15%. It's actually a little bit lower than that given higher book value. But current levered returns are reasonably consistent with the yield.
spk11: Got it. And then, Ilger, just curious, when you think about both – when you think about the trajectory of the forward curve, how does that impact your both tactics and strategy in terms of where you want to play in the coupon stack?
spk07: Yeah, forward curve, obviously, as everyone knows, curve is extremely – like, it's flat and inverted, some parts of the curve, big chunks of the curve. And forwards are also inverted. So that basically tells us that we can hedge down the stack like a lot better than what we used to. So basically, we are arranging that in our hedges, and then we are using coupon swaps to take advantage of that. But it doesn't provide that much challenges. If anything, it makes hedging relatively easier.
spk11: Got it. Okay. Thank you very much. Thanks, Rick.
spk10: Our next question comes from Doug Harder with Credit Suisse.
spk08: Thanks. You guys talked about the return opportunities kind of across your asset classes as being incredibly attractive. Can you talk about your appetite to continue to grow the portfolio, whether that's through increased leverage or additional capital? Sure.
spk09: Well, let me talk about leverage first, Doug. So leverage is a function of three factors. First, capital allocation, obviously higher allocation to agency, you're going to have more leverage. And then second, liquidity of the portfolio and asset valuation. Now, if you look at our portfolio over the past six months, for example, we actually have increased leverage. We feel good about it. The way we evaluate leverage is We have a baseline level of leverage, and if we think that there will be capital appreciation associated with the assets, then we'll increase leverage and vice versa. And we are above our baseline level of leverage, thus expecting capital appreciation, which to start the quarter, that's materialized. Now, another important point to note is where we are versus historicals. Our leverage currently is is the highest it's been since March of 2020, and we feel good about it. That being said, we have ample liquidity, and we can increase it more. One of the things we're waiting on, and you've heard a lot about this, is just a decline in macro volatility. We've taken steps in the direction of increasing leverage, but should we see a more definitive decline, we can increase it. Now, with respect to capital raises, we obviously did raise capital in the second quarter, A number of conditions have to be met. It needs to be accretive to book value. And assets have to be attractively priced such that there can be accretion of earnings. Another factor is governance-related issues. And the three of those considerations all have to line up, and they did in the second quarter. And as a consequence, we were able to raise capital. Great.
spk08: Appreciate that. Thank you. Thank you, Doug.
spk10: The next question comes from Trevor Cranston with JMP Securities.
spk04: Hi, thanks. Good morning. Can you talk a little bit about what you guys are seeing in the residential credit hold loan markets, particularly, I guess, on the non-QM side? There were some companies that seemed to have difficulty managing through all the rate volatility to start off this year. So I was curious what you guys are seeing in terms of origination volume in the non-agency loan space and kind of where you think returns would be on newly acquired loan securitizations as the market stands today? Thanks.
spk09: Sure, Trevor. I'll start and then hand it over to Mike. And I actually alluded to the turbulence in the origination channel in my prepared comments. And the fact of the matter is, yes, there has been disruption amongst firms, and I think it was primarily related to capital markets given the volatility in the market. And the way we look at it is we are a partner to originators. We're a liquidity provider. And as the market has evolved over the past six months, the world has turned from a scarcity of assets to a scarcity of capital. And that puts capital providers like us in a better position. And we're absolutely taking advantage of it, but responsibly. And with that, I'll hand it over to Mike to go into more details.
spk01: Yeah, thanks, David. Trevor, yeah, I think that when you look at the market, some of the originators that have entered bankruptcy or closed their doors, it's a misallocation of capital markets distribution, nothing to do with the actual loans being originated or the ability for the market to digest those loans. So we do think it's an isolated incident regarding unsophistication around hedging both rates, credit, and the ability to distribute that risk. In terms of the non-QM market, we still believe that volumes are healthy. I would say Q2, through our correspondent channel, we have $1.2 billion in locks, virtually all non-QM. In the month of June, it's been $440 million of locks. It's the highest lock volume that we've seen to date. And really what you're seeing is large non-bank originators are entering the space, given declining margins, declining volumes. And you're also seeing small, thinly capitalized originators that were bulking and selling it by the bulk market to come to the correspondent market. So with that being said, our volumes are at the healthiest level that we've seen. Right now, we see current coupon non-QM, call it a $102 price, $7.75 gross WAC. We think it's a low-mid 7% unlevered yield, mid-teens levered ROE on warehouse, and then through securitization without any recourse leverage, we'll call it the bottom 8%. we think is a low-mid double-digit return.
spk04: Got it. Okay, that's helpful. I think last quarter, you know, you mentioned that there weren't any specific company acquisitions that you were looking at at the time. You know, as market volatility has continued throughout the second quarter, could you maybe provide an update on whether or not there are any companies out there that might make sense for Annalie as a sort of add-on to the businesses you guys are growing in?
spk09: Sure, Trevor. And look, we're always looking at the market and evaluating opportunities in the M&A landscape. But the fact of the matter is, if you look at the evolution of the company over the past couple of years, our organic build strategy has been very effective in both residential credit through the correspondent channel, as well as the MSR build. So we feel very good about our ability to acquire assets. And really, a transaction in the mortgage origination space would be based on the ability to secure flow. And as I mentioned, the world has shifted from asset scarcity to capital scarcity, and we're not in a position to where we can't acquire the assets we want. So the organic build has been very effective. It's got a lot of momentum associated with it, but we're always looking at opportunities in the M&A landscape, whether it's a peripheral product or something that could enhance our own our own platform, but there's nothing to report right now.
spk04: Thank you.
spk09: You bet. Good talking to you, Trevor. Thanks.
spk10: Our next question comes from Kenneth Lee with RBC Capital Markets.
spk02: Hi, good morning. Thanks for taking my question. Just one on the credit portfolio. Specifically, what characteristics are driving you to increase the allocation versus agencies? And you talked about increasing the durability of earnings, but just wanted to see if we could just further expand upon that point and perhaps any other key points there. Thanks.
spk09: Sure. Sure, Ken, and good morning. Look, expanding residential credit and MSR, for that matter, is a longer-term objective. From a capital allocation standpoint, agency is always going to be the anchor of the company. The liquidity benefits are important. just so demonstrable that that's going to be the mothership for the company. That being said, we do know that adding incremental credit will be beneficial to the risk-adjusted returns of the portfolio over the long term. Now, when we look at where we're at now with respect to the cycle, as I talked about in my prepared comments, we do expect housing to soften, certainly, and so we're We're certainly a little bit more cautious, but to the extent that Mike has opportunities that are very healthy from a credit standpoint, we're going to add. But we feel good about the allocation now. It's just that over the longer term, we expect it to be higher.
spk02: Gotcha. Very helpful. And just one follow-up, if I may. Want to get your thoughts around any of the key potential risks for any further negative impact to book value when you look over the near term there. Thanks.
spk09: Sure. It's volatility. You know, that's plagued, I think, the market over the last number of months. And that's certainly something that we think about continuously. That being said, it appears to have declined when you look at implied volatility in the market. And so we feel good about the direction we're going. But we have a lot of data coming up, and we're always going to be cautious about an increase in volatility. But that's the main risk. Gotcha.
spk02: Very helpful there. Thanks again.
spk09: Good talking to you, Ken.
spk10: As a reminder, if you do have a question, please press star, then one. Our next question comes from Eric Hagan with BTIG. Please proceed.
spk03: Hey, thanks. Good morning. Going back to the liquidity for just a second. Right now, you have $4.5 billion of excess agency liquidity. How much liquidity do you think you'd use in levering up another turn? And in your answer, if you could talk about any differences in margin between pools and TVAs and maybe revisiting the hedging too. And maybe as just one follow-up to that, Is there a threshold for excess margin which you aim to run the portfolio regardless of how much debt to equity you're using?
spk09: Yeah. So, first of all, let me answer your second question first in terms of margin. You know, our business is liquidity management, and we're incredibly conservative with respect to liquidity. And, you know, for the past 25 years, we've always led with making sure that we maintain ample liquidity. And $4.5 billion is probably excess liquidity. But nonetheless, volatility is elevated. And so we're going to run in a conservative fashion. But there is capacity to utilize that liquidity. And to your question about, you know, a turn of leverage and what that would do to liquidity, you know, if you think about if you buy 10 billion mortgages with a 5% haircut, you're talking about half a billion in liquidity. So it'd be a 10%, a little over 10% reduction in liquidity.
spk03: Okay, I figured there might be some margin associated with hedges also included in there.
spk09: Yeah, there will be, but nevertheless, that's a rough estimate. And another point to note is that when you increase your overall portfolio, your value at risk increases, and that informs our model and our minimum liquidity that we carry as well. So it's an iterative process.
spk03: Right. That's helpful. So on the MSR... Oftentimes when MSRs get sold, as you guys know, there's recapture provisions or non-solicitation agreements for the seller or the subservicer to abide by. Can you talk about how you structure those provisions into the MSR that you're buying and how it drives who you buy from and where you subservice?
spk07: Sure, Eric. Actually, these non-solicited provisions in the old days used to be like seller used to give it to buyers. So basically, seller used to tell buyer that, look, I'm not going to solicit your borrowers, so you are buying an I.O., I'm not going to sell you the I.O. and then go solicit those guys. But last four or five years, due to the wholesale channel, a lot of non-bank originators making promises to brokers that they will not solicit their borrowers, and that's why now in this case, sometimes buyers end up giving sellers non-solicit provisions. Obviously, that reduces the value of the MSR that you are buying, especially for the operating entities. But the ones that we are buying, as you know, they are like a deep discount one, sub 3% gross rate existing portfolio. And for that, the value of recapture is much less. So that's why we tend to, from time to time, prefer those reverse solicit, reverse non-solicit deals because the value of the recapture is a lot less. And then another thing about that one is a lot of bank buyers are not involved in that reverse solicit MSRs, and that makes buyer base a lot lower, and that enables us to extract extra value from them. But that was a very good question.
spk03: Yeah, that's helpful. That's really interesting. Do you mind if I sneak in one more here? You mentioned some of the different types of buyers that could step in to buy MBS as the Fed rolls off its balance sheet. What do you think are some of the things that would drive more levered buyers to step in? What do you guys think is holding back that demand right now with spreads at 130, 140?
spk07: Eric, obviously levered buyers, the most important thing for the levered buyers, I'm assuming we mean hedge funds in this case, and obviously REITs, but mostly hedge funds, For them, it's the value at risk, and they will be looking at the volatility, implied volatility, as David has been alluding. As implied volatility has been subsiding, and then you are seeing, like, last couple days, even before the Fed, when implied volatility was declining, you see, like, levered money coming in. But most of the time, though, supply-demand imbalance cannot be met with the levered money buying. You need money managers. And we will expect more money managers buying in these instances because, like, as fixed income, as we said in our prepared remarks, as the negative correlation between rates and the risk assets finally starts appearing, fixed income money managers will be getting subscriptions, and that will be the marginal demand on the MBS until banks clear their RWA issues. Gotcha.
spk03: Thanks for the perspective this morning.
spk09: You bet. Thanks, Eric.
spk10: At this time, there are no further questioners in the queue, and I would like to turn the conference back over to David Finkelstein for any closing remarks.
spk09: Thank you, Chris. Everybody have a good rest of summer, and we'll talk to you in the fall. The conference is now concluded.
spk10: Thank you for attending today's presentation, and you may now disconnect.
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