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spk02: Good morning and welcome to the Anna Lee Capital Management Second Quarter 2024 Earnings Conference Call. All participants will be in 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 1 on your touchtone phone. To withdraw your question, please press star, then 2. Please note this event is being recorded. I would now like to turn the call over to Sean Kensel, Director, Investor Relations. Please go ahead.
spk01: Good morning, and welcome to the second quarter 2024 Earnings Call for Annali Capital Management. Any forward-looking statements made during today's call are subject to certain risks and uncertainties, 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 you're of. 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. Content referenced in today's call can be found in our second quarter 2024 investor presentation and second quarter 2024 supplemental information, both found under the presentation section of our 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, Mike Fania, Deputy Chief Investment Officer and Head of Residential Credit, V.S. Sreenivasan, Head of Agency, and Ken Adler, Head of Mortgage Servicing Rights. And with that, I'll turn the call over to David. Thank you, David.
spk09: Thank you, Sean. Good morning, and thank you all for joining us for our second quarter earnings call. I have four areas to discuss today before handing it off to Serena to discuss the financials. First, I'll briefly highlight our performance during the quarter, then review the macro and market environment, followed by an update on each of our three businesses, and I'll finish with our outlook for the second half of the year. Now, to begin with, we were pleased with our performance during a quarter that saw a fair amount of volatility. While interest rates rose modestly quarter over quarter, the 10-year Treasury yield traversed a 50 basis point range as economic data in April meaningfully reduced the magnitude of 2024 rate cuts priced into the market, whereas in June, employment and inflation data brought accommodative policy into near-term focus for the market and certainly the Fed. In this environment, we delivered a roughly 1% economic return for the second quarter, and a 5.7% return for the first half of the year. Earnings available for distribution exceeded our dividend by 3 cents, demonstrating our ability to consistently earn strong returns with prudent leverage, which stood at 5.8 turns at the end of the quarter. Now, to expand further on the macro landscape, activity continues to slow gradually as tight monetary policy weighs on most parts of the U.S. economy. While core service inflation has been more muted following their brisk pace in Q1, recent data suggests that shelter inflation, the most stubborn component of inflation, is finally beginning to meaningfully soften. Meanwhile, the employment picture has moved into better balance as demand for labor has slowed and the pace of hiring is more in line with historical averages. These developments point to rising conviction that the Federal Reserve will begin to lower interest rates in the second half of the year. This should be followed by additional cuts depending on the pace of further labor market softening as the Fed's employment mandate gains more prominence over the inflation mandate. Now, moving to our portfolio and our investment strategies, and beginning with agency, we actively managed the portfolio during the quarter. This current coupon nominal spreads widened by roughly 10 basis points, driven predominantly by elevated rate volatility. Early in the quarter, as mentioned on our last call, we tactically reduced our agency holdings as we navigated higher rates and wider spreads. We gradually added that exposure back over the remainder of the quarter as our outlook and relative value considerations improved, growing our agency portfolio by approximately $1.6 billion notional on the quarter. We continue to rotate up in coupon to take advantage of wider spreads offered by production coupons, increasing our holdings of $5.5 and higher by $4 billion. And year-to-date, the average net coupon on our agency portfolio has increased by 30 basis points to 4.87%. And consistent with prior quarters, we favored high-quality, prepayment-protected collateral with durable cash flows. And in an environment where the TBA deliverable is expected to further deteriorate, premium-specified pools best position us for strong performance in the coming quarters. Now, as it relates to our hedges, the notional value increased relatively in line with agency asset growth, and we're likely to maintain the portfolio's conservative rate exposure as longer-term treasuries continue to face technical headwinds from elevated federal budget deficits, not to mention potential volatility surrounding the upcoming November elections. MBS spread volatility declined in the second quarter, with the technical picture showing signs of improvement. The market has experienced strong inflows into fixed income funds and modest bank buying, while net issuance has run slightly below expectations. And we expect demand for agency MBS to increase once the Fed initiates its cutting cycle. For example, a portion of the $6.1 trillion in money market assets should gravitate towards longer-duration fixed incomes. In addition, agency MBS is highly attractive relative to other fixed income alternatives, particularly corporates, as MBS nominal spreads are well above historical averages while competing assets are trading at the tighter end of their historical averages. Turning to residential credit, our portfolio ended the quarter at $5.9 billion in economic market value and $2.2 billion in equity, representing 20% of the firm's capital. The modest decline in the resi portfolio was driven by our sale of third-party securities to take advantage of relatively tight credit spreads while increasing our exposure to agency MBS. Residential credit assets were largely range-bound throughout the quarter, with investment-grade non-QM securities trading in a 10-basis point range and the CRT market tightening 10 to 20 basis points. The fundamentals of the residential credit market remain constructive, although we are closely monitoring the increasing regional disparities in housing and the strength of the consumer given softening labor markets. Mortgage delinquencies, however, remain in near record low levels. Our Onslow Bay Correspondent Channel experienced record growth in Q2 as we locked $4.1 billion of expanded prime loans and settled $2.8 billion, representing a 22% increase quarter over quarter. And year-to-date, we've already locked and settled more loans than the entirety of 2023. And our current pipeline continues to exhibit strong credit characteristics, including a 754 average FICO and a 68% CLTV. The OBX platform has remained a market-leading sponsor of securitizations since we priced five non-QM transactions in the second quarter and have now priced 13 securitizations, totaling $6.7 billion on the year. OBX represented 25% of the non-QM issuance in the market and approximately 10% of gross non-agency issuance for the first half of 2024. And also to note, we continue to see 12% to 15% prospective returns on the retention of OBX assets. Now, shifting to the MSR business, our portfolio ended the second quarter with $2.8 billion in market value and $2.5 billion of equity, representing 22% of the firm's capital. Our MSR holdings increased $135 million quarter over quarter, driven by purchase and settlements, as well as a modest increase in the value of the portfolio, given the 20 basis point increase in mortgage rates. Although our transactional activity slowed in Q2, the portfolio is nearly 30% higher year over year, as Annalie remains firmly entrenched as a top 10 non-bank holder of servicing rights. The fundamental performance of the portfolio continues to outperform our expectations as prepayment speeds remain muted despite peak seasonals and serious delinquencies are inside of 40 basis points. An increased competitiveness surrounding deposits is driving elevated float income and all leading to prospective hedge returns remaining in the 12% to 14% range currently. And with respect to supply, the record amount of bulk offerings over the last two years appears to be normalizing as originators are better positioned with access to capital markets and their gain on sale margins improving. And while we will continue evaluating bulk MSR opportunities as a result of the changing market dynamics, we have focused on enhancing our flow and recapture capabilities to acquire newly originated MSR from our network of partners. and we remain well-positioned to grow our MSR business given our structure and partnerships, and we believe we have constructed one of the most durable and high-quality portfolios within the MSR sector. Now, lastly, with respect to our outlook, we're encouraged by the return potential across each of our three investment strategies, and we're optimistic as the market prepares to enter a more accommodative phase in monetary policy. And this should steepen the yield curve, reduce volatility, and ultimately, in our view, lead to agency outperformance. And while we expect to continue to grow our residential credit and MSR businesses opportunistically, we feel our current capital allocation and portfolio construction is positioned to generate sustainable returns in an environment that should be favorable to fixed income investors. And now with that, I'll hand it over to Serena to discuss our financials.
spk05: Thank you, David. Today I will provide brief financial highlights for the second quarter ended June 30, 2024. Consistent with prior quarters, while our earnings release discloses GAAP and non-GAAP earnings metrics, my comments will focus on our non-GAAP EAD and related key performance metrics, which exclude PAA. As of June 30, 2024, our book value per share decreased from the prior quarter to $19.25. Despite the asset spread widening and interest rate volatility during the quarter, we generated a 0.9% economic return, including our dividend of $0.65 per Q2. Looking back to the beginning of 2024, including $1.30 in dividends declared year-to-date, we have generated an economic return of 5.7%. Rate volatility and mostly higher treasury rates resulted in a decrease of $0.96 per share on our agency MBS portfolio. with positive contributions of $0.16 and $0.31 per share, coming from our RISI MSR portfolios and hedges, respectively. Earnings available for distribution increased in the second quarter by $0.04 per share to $0.68. Higher coupon income related to the continued rotation up in coupon on the agency portfolio, and $2.8 billion in assets settled via the Onslaught Bay Correspondent Channel contributed to the increase in EADs. Consequently, average asset yields, XPAA, increased 27 basis points from the first quarter to 5.14% in Q2. Higher coupon income was partially offset by an increase of 12 basis points in our economic cost of funds. Taken together, our net interest spread, XPAA, increased by 15 basis points, reaching 1.24% in the second quarter. And net interest margin, XPAA, also rose 15 basis points quarter over quarter to 1.58%. While repo rates remain stable, even declining two basis points in Q2, securitized debt expense increased in Q2 due to the high volume of securitizations we completed in the first six months of 2024. Additionally, our swap benefit declined modestly due to a large position maturing during the quarter, representing our final scheduled swap maturity for this year. As we continued executing our repo strategy, our weighted average repo days declined seven days compared to Q1. at 36 days for the second quarter. During Q2, we furthered our strategy of providing financing optionality for our Envoy-based platform, closing additional warehouse capacity of 250 million and expanding our non-marked market supplements. As of June 30, 2024, we had 4.2 billion of MSR and whole-loan warehouse capacity at a 39% utilization rate, leaving substantial availability. Analyze unencumbered assets increased to $5.4 billion in the second quarter, including cash and unencumbered agency MBS of $3.5 billion. We also had approximately $900 million in fair value of MSR pledged to committed warehouse facilities, which remain undrawn and can be quickly converted to cash, subject to contractual advance rates. Together, we had approximately $6.3 billion in assets available for financing, up $45 million compared to last quarter, notwithstanding the slight increase in our leverage profile. Our efficiency ratios worsened during Q2 due to the timing of certain expenses. However, we expect expenses to normalize and full-year OPEX to equity ratios to align with historical levels. That concludes our prepared remarks. We will now open the line for questions. Thank you, operator.
spk02: 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. To withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. Our first question comes from Bose George with KBW. Please go ahead.
spk07: Hey, everyone. Good morning. Actually, can I start just with getting an update on quarter date book value?
spk09: Sure, Bose. Good morning. As of Tuesday's close, we were up roughly 2% with dividend accrual and a little over 1% net of the dividend.
spk07: Okay, great. Thank you. And then just in terms of the hedges, so you were replacing the maturing swaps with treasury futures this quarter. Can you just talk about the advantages of that?
spk09: Yeah, sure. So there's multiple advantages. We were certainly concerned with rate volatility and particularly spread volatility. So reducing the exposure to swaps was somewhat warranted, particularly later in the quarter. And there is differences with respect to initial margin and liquidity associated with swaps. It's not a material change. One of the catalysts for the change was also putting on a little bit of a curve trade, a steepener, given what our view was with respect to the expectation for a little bit of yield curve steepening, which we saw this quarter. Certainly, as we're about 20 basis points steeper, twos, tens. And generally, just for liquidity and IM benefit, as well as creating the right balance. Another point to note as it relates to our swaps, Bose, is that our swap position is in a very good place. We have had a lot of runoff over the past couple of years. including this past quarter and Q1. And we're in a place where we do not have any more swap runoff of that low pay rate for the rest of this year. And so we feel pretty good about our swap position here. And when you look at the relative tightness of swap spreads, you know, I think 10-year swap spreads are around negative 45. It's a good edge. So we're going to be a little bit overweight swaps because the levered return relative to swaps versus the other hedges is pretty attractive right now, notwithstanding concerns over balance sheet as it relates to swap spreads.
spk07: Okay, makes sense. Thanks a lot.
spk09: Thank you, boss.
spk02: The next question is from Doug Harder with UBS. Please go ahead.
spk06: Thanks. David, you talked about, you know, kind of having a slightly different strategy on acquiring new MSRs. Can you just talk about the risk profile of new MSR and the relative attractiveness of adding those to what's a very attractive existing portfolio?
spk09: Sure, Doug. I'm going to hand it over to Ken to help you with that.
spk08: Yeah, sure. I mean, new MSR just has materially more prepayment exposure to it. So it relies on a different hedging strategy than the legacy MSR with the much lower note rate and more stable cash flow. However, the new MSR also provides opportunity for recapture that's not present in the legacy MSR. So that's an additional revenue opportunity as well.
spk06: And can you just remind us, Ken, kind of where you are in terms of recapture, what agreements you have and how confident you would be in your capabilities to execute? Absolutely.
spk08: We currently have four recapture partners. Each of these partners has different strategies, approaches, and tools for customer outreach and creating recapture. And what we do is we compare the results between them and allocate our initiatives to the best performers and kind of refine these strategies over time. So we kind of have a portfolio approach to this. And we have the ability to be dynamic given the use of multiple providers. We also have several strategic discussions with potential new partners that many are considered best in class, and they offer unique technology and differentiating strategies. So our approach and ability to partner with servicers and originators is what we're happy about.
spk06: I guess just to be clear on that, so when there is recapture, do you share in the full origination economics or are you just getting the MSR back? You know, just want to make sure I understand how those economics work.
spk08: We effectively share in the gain on sale in a material way by taking that MSR back at a below market price. And those prices are negotiated and they're different depending on the provider, what the recapture rate is. So there's kind of an incentive fee structures with these providers. And given how low origination margins are in the industry, the repurchase of the MSR back at a discount is effectively, you know, assuming that origination, you know.
spk09: Yeah, Doug, given how competitive origination and servicing is, we're able to extract the right value associated with our recapture relationships.
spk06: Very helpful. Thank you, guys. Thank you, Doug.
spk02: The next question is from Rick Shane with JP Morgan. Please go ahead.
spk10: Hey, guys. Thanks for taking my question. I really needed to cue in before Doug because that was the topic I wanted to explore as well. I am curious, you know, one of the things that is driving MSR pricing is that recapture opportunity. And I'm curious, and again, you've talked about some of the efficiency from an economic perspective for you from a recapture perspective, but I am curious if you're seeing peers out there whose economics are really focused on the origination side who are making pricing in that space less attractive for you. It's an interesting time to shift from bulk to flow.
spk08: Yeah, well, we are observing just you know, as everybody is, when you observe the prices, the price spread between low note rate MSR and newly created higher note rate MSR has never been less than I've seen. So you are seeing increasing comfort with the ability to price in that recapture by the market overall. And there's always a couple of participants that stand out. But in general, yes, you know, the Comfort with using big data, call center technology has absolutely increased.
spk09: Yeah, and Rick, another point which you may be alluding to is that as it relates to our MSR portfolio, we're very protective of the borrower. And the last thing we want to do is use a subservicing relationship that is going to lead to, you know, over churning of our portfolio or anything that would damage our returns. And so it's a high bar to partner with us when it comes to recapture and subservicing.
spk10: Got it. That makes sense. Hey, a request. As you transition to more of a flow business and potentially the coupons start to shift a little bit, could you provide disclosure on the coupon in the way that you do for the MBS portfolio so we can see the distribution of coupons?
spk09: Sure, that's certainly a consideration, but it is important to note that in the current portfolio, the vast, vast majority is very, very low rate. So it's a pretty homogenous bucket of what should be considered to be non-refinanceable mortgages.
spk10: Absolutely, yeah. Again, depending upon how fast that flow of business grows, we could start to see the portfolio barbell a little bit and just would love to understand that better.
spk09: You bet, Rick. Perfect.
spk02: Thanks, guys.
spk09: Thank you, Rick.
spk02: The next question comes from Jason Stewart with Jenny Montgomery Scott. Please go ahead.
spk03: Good morning. Thanks for taking the question. One more on the MSR and servicing front. Do you have any thoughts? I know it's early and likely to change, but thoughts on the CFPB's proposed servicing rule regarding foreclosures, how that might impact the valuation, competitive environment, etc.? ?
spk09: Yeah, that's a good question, Jason. So we certainly recognize the CFPB's efforts to revise mortgage servicing rules to benefit borrowers. And many of the proposed changes would result in more complex loss mitigation processes with potentially longer timelines to reach resolution. And on the surface, if implemented as proposed, our subservicer oversight team would ensure that our subservicers are following all relevant laws and regulations. And we could expect subservicing costs to increase on the margin. But our portfolio, both on the resi credit side as well as the MSR side, is composed of very high-quality borrowers with significant equity in their homes. And our portfolio is specifically Fannie and Freddie, made up with very low delinquencies, as I mentioned, less than 40 basis points. And we have no GINI borrowers to speak of. We have a very small sleeve of GINI from the legacy Pingora days. So we don't expect the cost to us to increase in any meaningful way, but it could lead to a little bit higher servicing costs overall.
spk03: Yeah, thanks. Yeah, I think it's important to note that differentiation there. So thanks for that color. And then going back to the up and coupon trade, you know, when you look at specified pools up and coupon, I think you noted you're looking at very, you know, I call it high premium or quality pools there. When you combine that with the competitive environment for, you know, marginal refi activity, where is the most value and how are you looking at hedging those to protect that value? Yeah.
spk04: So basically what our strategy has been that as we move up in Groupon, we buy higher quality pools. So on 6.5s, we generally buy very high quality pools. And on 6s, it will be a little bit less. And on 5.5s, it will be a little bit less. The way we think about hedging is we think of a specified pool as a combination of TBA duration plus a pay-up duration. So we kind of model how that pay-up duration is going to move in Groupon. in a rally and a sell-off, and we kind of measure that duration, and that's how we hedge the bear. The biggest advantage is these pools provide ample spread right now, and because they are less negatively convex, we are not really giving up that much carry in the near term. And in the long term, if and when rates do rally, they provide very durable yields for an extended period of time.
spk03: Yeah, I guess my takeaway there was that the carry is going to benefit you for several quarters, and you can potentially hedge away the negative convexity. But, you know, we might be getting too much in the weeds there. But that was just my thought.
spk09: Yeah, that's the right assessment, Jason. Thanks. Thank you, Jason.
spk02: This concludes the question and answer session. I would like to turn the conference back over to David Finkelstein for any closing remarks.
spk09: Actually, I do believe we have one more question in the queue.
spk02: I do see him, yes. Let me announce him. The next question is from Tim Chang with BTIG.
spk00: Sorry for punching in late. I think the question here is just, you know, if it looks like the Fed is going to cut more aggressively, what's your perspective on how mortgage spreads will respond to that, even what we're seeing just in the market over the last, you know, call it 24 hours? Thank you, guys.
spk09: Yeah, under that scenario, Eric, we would be optimistic on mortgage spreads. You'll see, you know, further steepening in the yield curve than the 50 basis points that's priced in over the next year between twos and tens. You know, the $6.1 trillion in money market funds, as those yields start to decline, will gravitate toward longer duration fixed income. As I mentioned, you'll potentially see bank demand come in, and it'll just be a better environment for agencies. You know, we've experienced this cycle after cycle. When the Fed cuts and the curve steepens, there is better demand for agency MBS, and you would expect ball to come down. It should be a dampening environment, and we would expect strong performance from the agency, which is why we like the sector. We think that the appropriate amount of cuts are currently priced in, but when you look at the Fed's posture and the shift over the past number of months, it's gone from focus on the inflation mandate to more balance between the employment mandates. and inflation, and there is a likelihood that given what's gone on in the labor market is that the focus could shift to be more weighted towards the employment picture, and you could see more aggressive cuts than what's priced in, and that would be a perfectly good outcome for us.
spk00: Yep, that's good perspective. I appreciate that. Hey, so how are we thinking about the tradeoff between maybe levering up with the MSR a little bit more and raising capital or even de-levering the agency MBS portfolio to maybe balance out or buffer any of that prepayment risk?
spk09: Yeah, so I would say that incremental purchases of MSR would likely be levered. We have very, very low leverage on that portfolio. We've been fortunate, given our abundant liquidity, to be able to use the agency portfolio as somewhat of a bank to finance it, and it's led to returns that are in excess of the 12% to 14% we show in the materials. which assumes warehouse financing. And so we have the ability to leverage. Right now, we have the liquidity to not need to, but I would say to keep that capital allocation in the context of 20% or thereabouts, we probably would lever incremental purchases and maintain the liquidity of the overall portfolio. And look, as it relates to capital raising, capital raising, Two conditions have to be met. It has to be accretive and benefit shareholders, and assets have to be available and at the right price. You know, there's a lot to get through, and to the extent it's, you know, the market is compelling us to do so, we'll certainly look at it, but we feel like we're in a good place, and we'll see how things evolve over the near term.
spk04: Yep. We have to.
spk09: One more sec, Eric. Go ahead.
spk04: I just have that we have a committed MSI line, so we can tap them anytime we want.
spk09: Exactly.
spk00: Yep, that's helpful. Hey, we appreciate you guys. Thank you. Thanks for squeezing me in.
spk09: Thank you, Eric. Have a good day.
spk02: This concludes the question and answer session. I'd like to turn the conference over to David Finkelstein for any closing remarks.
spk09: Thanks, Debbie, and thank you, everybody, for joining us today. Enjoy the rest of the summer, and we'll talk to you in the fall.
spk05: Great job, guys.
spk02: The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
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