Q3 2019 Earnings Call
Good morning, and welcome to the Annaly Capital Management quarterly conference call.
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Please note. This event is being recorded I would now like turn the conference over to poor E Com Dar head of Investor Relations. Please go ahead.
Thank you.
Okay and welcome to the third quarter 2019 earnings call every capital management.
Any forward looking statements made during todays call are subject to certain risks and uncertainty which are outlined in the Bakken production at our most recent annual importantly, I think.
Actual events or results may differ materially.
Thank you.
We encourage you to read the forward looking statements disclaimer in our earnings release in addition to our quarterly and annual filings.
Additionally, the content at this time only contain time sensitive information that is accurate only as of today.
We do not undertake and specifically disclaim any obligation to update or revise its been fairly.
During this call we may present, both GAAP and non-GAAP financial measure a reconciliation of GAAP non-GAAP measures is included in <unk> or anything.
As a reminder.
Only routinely post information for investors on the company's website at Www Dot Dot com.
I referenced in today's call can be found in our third quarter 2019, investor presentation, and third quarter 2019 national.
Both time after the presentation section or what.
Italy intends to use or what you as a means of disposing material nonpublic information I'm fine with the company disclosure obligations under regulation, FD, I, suppose and updated investor presentation, and some of the materials on a regular basis.
I really encourages investors analysts the media and other interested parties to monitor the company's website. In addition to falling Ellie press releases as we see filing other conference call relocation webcast and other information about sometimes it's I like that.
Please note this event is being recorded.
Participants on this morning's call include cabin key Chairman, Chief Executive Officer and President.
David Finkelstein, Chief Investment Officer, Glenn Votek, Chief Financial Officer, and other members of management.
With that I'll turn the call over to Kevin.
Thank you for me.
Good morning, everyone and welcome to our call [noise].
As we enter the final two months of this decade and approached 20 twenties I want to reiterate update and provide commentary on some of the critical themes. We highlighted at the start of this year.
To recap on our fourth quarter 2018 earnings call in February we stated that there was closed in the hobbyist combination of economic fiscal political and macro pressures that will contribute to a shift toward more comedy <unk> monetary policy and we've been able to project for a long time.
On our call in May I, then remark.
There has been return on flashing red lights across markets with the flattening yield curve and compressed credit spreads, resulting in little differentiation of risk.
While this summer follow and our second quarter call in July I commented quote deteriorate deteriorating economic data, we can place in ratings and the unresolved global treat all treat outlook signaling a growing plausibility of in a parent earnings recession in corporate America and call. This promote.
I had to embark on its first rate cut.
Later that day fast forward to today.
Following a challenging third quarter for which my prior commentary served to preview. We can now say that the market environment has certainly improved for annaly for numerous reasons.
I'll give you the top five first lower funding costs going lower still number to better outlook for asset yields number three the New York Feds recent commitment and actions to stabilize the repo market number for the expected slowing prepayments by quarter end number five.
Improving repo lag or spread as an additional tailwind because of this increased visibility we reaffirmed the fourth quarter dividend of 25 cents.
Against this backdrop of more favorable market conditions and enhanced visibility into policy. There are five significant and expanding market industry in corporate themes, which annaly is uniquely positioned to capitalize on as we finish this year and enter the next decade.
The first theme is GST shrinkage and the need for private capital in the U.S. housing market.
We discussed this theme over time, but this past quarter, we gained additional clarity about the administration's view of the GRC evolution, which clearly necessitates a further shift to the private market.
Fannie and Freddie well, Fannie and Freddie will remain a critical component of housing finance. The treasuries 2019 housing Finance reform plan published in September highlights, how integral private capital will be to the future system in whatever form it may take.
To date private capital has absorbed 67% of risk transfer on three trillion of unpaid principal balance in the Gses residential credit exposure.
Artsy market issuance is now in excess of 75 billion since the program's infancy in 2013 and Annaly has been an active participant in the market purchasing roughly 2.5 billion since that time period.
The CRT market is a good prototype for the EPS HFSA, which is now leading efforts to align regulatory treatment to level, the playing field for private capital and assess which products are consistent with the GRC statutory mission.
In order to ensure the U.S. housing market continues to evolve and remains robust we anticipate private level market volumes to increase overtime in several asset asset classes, we finance.
Our residential credit credit business has doubled over the last three years and we expect to match that great growth rate over the next year by taking advantage of upcoming supply and potential new structures and a growing market.
What has also become more clear recently are the secondary effects that further GST shrinkage could have on the market as Fannie and Freddie reduce their collective footprint, while home ownership is already unaffordable for many Americans.
35% of homeowners have had to move into affordable housing this year, an increase of 35% since last year.
And surprisingly in this country, 82% runners now view renting is more affordable than homeownership. This is an all time high and a 22% increase since just last year.
The government needs to enable private capital help fill the GRC is void and to avoid further worsening affordability, especially given that housing is a proven powerful driver of our economy.
Annalys focused on expanding our role here our business is now built to finance housing across the country, while supporting several related pillars of the economy.
We have extended over 200000 loans totaling over 16 billion, so bars with lower loan band lower loan balance mortgages in the country financing homes that are typically less than half the nation's average price. We have also financed over 4200 loans totaling over 2.8 billion to credit worthy.
Borrowers, who may not have access to try to traditional bank channels, including self employed bars. Lastly, we have invested nearly 2 billion in two areas of economic opportunity such as affordable housing education, healthcare retail groceries, and other sectors and low income and low access areas.
Through our portfolio investments and our Jvs with capital impact partners.
We are without legislative reform the footprint of the Gecs is undoubtedly shrinking in the next decade and Annaly is poised to continue its growth as a significant contributed to private capital to maintain the affordability and liquidity of the U.S. housing finance system.
The second long term opportunity for annually is the product of banks shrinking their mortgage businesses parallel trends to the gses hold true in the banking sector, which is also experienced significant transformation due to regulatory reform.
Leverage and liquidity constraints have altered banks business models and shifted various residential and commercial lending activity to other players as an example banks of decrease their GFC footprint and now originally only one of every three GFC eligible loans compared to twice that share just.
Six years ago.
Anecdotally certain large us banks today once dominant in the mortgage markets characterize the business now under other income in their financial statements.
As banks mortgage related exposure trends lower non banks and other originators have stepped in to fill the void since 2014 nonbank share of total agency mortgage origination is up from 29% to 53% of the market. These non bank originated originators are growing need of strategic.
Capital partners such as annually.
Our third theme for the 22 warnings private equity needs New partners.
The growth of private equity has played a huge role and balancing out the redistribution of corporate leverage out of the banks and with the amount of leverage drawing in the market structural terms depreciating and approved assistant lack of differentiation risk I wanted to provide some real time examples of how we're partnering with sponsors to invest in line.
On safely in credit in this environment.
Within our diversified strategies, we're simply focused on selecting the right credit right sponsor right place in the capital structure and sourcing larger less competitive deals given our strong established relationships scale and liquidity.
Within our commercial real estate grew Annaly has participated in financings over of several large portfolios from major private equity firms, including approximately 300 million for Blackstone. Just this month contributing to deal volume for the group of nearly $800 million year to date.
Our middle market lending team has originated approximately $700 million of assets. This year of which 90% was repeat business with existing top tier sponsors, notably our average deal size and that business is up nearly two times in the past two years.
And lastly, our residential credit team as efficiently competing true proprietary partnerships with these strategic partners, we have access to asset flow from a network of over 100 originators and we're on pace to produce 1.7 billion of whole loans in 2019, a two times increase over the past 12 months fine.
We are producing very competitive returns using conservative leverage across all three of our credit businesses.
For the third quarter.
Over one are over our $1 billion of credit investments generated a weighted average levered return of 12.6% using only 2.3 turn 2.3 times leverage.
The four theme as a combination of our focus on operating efficiency financing expertise and capital optimization.
For the next decade and beyond Annalys already built with operational efficiency, we have paid it forward the investment in the company's infrastructure to efficiently invests in the redistribution of assets in the future as I just outlined out of the fed the geo season, the banks, while investing alongside the growth of private equity.
Now that our four businesses have successfully reached scale, we've reduced our management fee to 75 basis points for additional capital raise and have added a total of 25 institutional partnerships in looming in lieu of paying for additional infrastructure.
We have in comparable operating leverage in our four businesses, our operating expense as a percent of equity is only 2% compared to 25% on average for the nearly 300 mortgage Reits banks insurance companies and asset management companies that have an aggregate market cap of 3.8 trillion.
These ratios we are over 12 times more efficient on average across all our asset classes and these other investment models, we compete against.
Regarding financing and capital optimization, we refined our capital structure through capital markets activities additional financing alternatives and Securitizations. We have repeatedly demonstrated diligent allocation of capital beginning in late August and into the fourth quarter, we repurchased over $220 million of shares.
Taking advantage of evaluation Harbin our stop.
These repurchases resulted in immediate book value accretion and created real economic return for shareholders.
Our repurchase program emphasizes our differentiated approach to the capital markets. We are buying back stock at similar valuation levels that others are issuing stock below book value believe it or not 60% of the equity offerings completed in the mortgage REIT sector in the third quarter were dilutive to shareholders.
Yes.
Finally, I want to highlight another significant theme in today's market and for the next decade. We're annaly continues to be a market leader corporate responsibility as GE.
Specifically, our focus on diversity and inclusion has foster the culture, which is opened a healthy debate enriched by broad experiences and made up of talent from all over the world.
So vs Subramanian, a leading boys in ESG research from Merrill Lynch, who we've invited who we invited to present to our board just this year validates that through an extensive study businesses with at least 30% women and leadership positions have higher returns on equity at lower future price and earnings volatility.
Yeah.
With 50% of our additions to leadership represented by women since I became CEO and more than half of our from identifying as female racially diverse we've illustrated our commitment to diversity across our organization in an effort to outperform over the long term.
While we are always striving to improve a few additional data points illustrate annalys employee diversity.
33% of our operating committee are women, 45% of our border Board of directors are women and finally, 69% of the 26, new hires we've made in 2019 identify as female or racially diverse.
Shareholders of validate our validated our efforts in these areas of corporate responsibility as demonstrated by the 79 SG oriented oriented funds and now on Annaly, which is an increase of almost 70% since 2015.
Finally, we are encouraged by the direction in the market is heading which helps make our opportunities more visible and tangible today.
As a private capital solution for the US housing market, the commercial real estate industry and business owners across the country. We look forward to the opportunities that will be provided in this next phase a monetary policy and asset redistribution in the next decade and beyond.
Now I'll turn the call over to David Finkelstein.
Thank you Kevin.
While the market environment at the onset of the third quarter was relatively calm and increase in trade tensions in the prospect of further slowdown in the global economy resulted in volatility picking up meaningfully in August longer term interest rates rallied sharply to levels close to their all time lows, which led to a considerable flattening of the yield curve.
And agency MBS exhibited one of their worst month relative performance in the post crisis period on a rising concerns over prepayments and hedging costs.
Although September brought some relief as rates retraced, partially in spreads for modestly we did in the quarter with materially lower rates and wider agency spreads amidst this challenging environment, we were able to generate a positive economic return of 1.4% and we ended the quarter at 7.7 turns of leverage.
Turning to portfolio activity and beginning with the agency sector performance was highly directional with interest rates prepayments increase driven by a combination of lower mortgage rates in summer Seasonals and while our portfolio has considerable protection, we were not immune to higher speed as portfolio prepayments increase to just over 40.
And CPR the did remain somewhat contain relative to the prepayment increase in the broader MBS universe.
We took a relatively conservative trading approach during the quarter as we opted to protect book value by reducing assets in the volatility in managing leverage coincident with our stock fiber buyback program that we commenced in August also on the asset side, we modestly gravitated down in coupon specifically in TV A's.
Our activity was more focused on the hedging side as we shifted roughly 10% of our swap position to the front end of the yield curve, which we began prior to the curve flattening and the adjustment also helped to reduce our weighted average pay rate by 24 basis points on the quarter.
Some of these brought in swaps were subsequently rotated into overnight index swaps linked to fed funds when the spread between LIBOR in Hawaii has reached a year to date whites in a declining rate environment like that third quarter. Those swaps provided an immediate benefit to our cost of hedging, particularly because they reset daily versus our LIBOR base.
Apps that recent quarterly these conventions do balance out over the longer horizon. So looking at one single quarter doesn't give a complete picture and we will never manage the near term.
As the market ultimately transitions away from LIBOR, we will look to continue to opportunistically gravitate toward OAS or silverlink swaps at prudent market levels and considering that the liquidity of those products.
While who I asked is a good short term repo hedged it doesnt provide the same credit and liquidity hedge as LIBOR.
No. The vast majority of our swaps remain LIBOR based and we anticipate the wider LIBOR Elias spread that prevailed at the end of the quarter to be a benefit relative to peers in the fourth quarter as over half of our LIBOR swaps reset September .
Additionally, on the hedging side, we added out of the money payer in receiver Swaptions to help manage tail risk and we were also compelled to add duration of the portfolio primarily in form of covering futures hedges as the decline in interest rates shortened MBS durations.
Agency repo rates remained elevated throughout the quarter, which culminated in the sharp increase in overnight rates in mid September .
Just like in financing rates necessitated the fed not only to intervene in the repo margin for the first time in more than a decade, but also restarting their balance sheet growth beginning this month and in that and to ensure sufficient liquidity in the banking system.
Following the feds measures overnight and shorter term repo markets at largely normalized however liquidity in longer term contracts remain somewhat impaired through September and as a result, we opted to maintain a shorter repo duration profile through quarter in which we have since begun to extend.
While we do certainly utilize our broker dealer balances were limited to under 20% of our overall financing during the funding dislocation with just under half of those balances reliant on overnight by Cc financing, which was the epicenter of the episode.
The remainder being either termed out were financed through our direct repo counterparties, which did not experience Monday volatility to the same extent.
Shifting to our residential credit business as Kevin preview, we increased the pace of our whole loan program as we acquired over 700 million of expanded Prime in agency eligible investor loans, we completed our seventh securitization in July with an additional transaction into our October both of which consisted of.
Branded prime loans.
Organic creation of residential credit securities such as through these two transactions remains a more efficient mechanism in the secondary market to add exposure within residential credit given resulting low to mid double digit yields with modest leverage and we're also encouraged by the growth of the expanded prime channel in the period.
Aggression in the securitization market to these borrowers were deals completed on non QM loans. Thus far this year as eclipsed 18 billion, which is already double that of the market in 2018.
So the note the prospect of some form of administrative GST reform as Kevin touched on would likely lead to further growth in both alternative channels for mortgage borrowers.
Now with respect to our outlook, while the agency market is experiencing elevated prepayments and higher convexity costs valuations are reflective of these dynamics and we are more constructive on the agency sector today, given historically wide spreads.
Moreover, in a fundamental shift from a year ago East agency assets will benefit as the fed adds rather than reduces liquidity within the broader system and financing should be more stable going forward.
However, despite the attractiveness of the agency sector as we've said consistently we do remain committed to our diversification strategy given its inherent benefits of predicting book value and contributing to greater earnings stability. While we do expect to remain at the lower end of our allocation at credit with benchmark spreads close to close.
Crisis tight levels, we will continue to underwrite high quality credit assets to ensuring appropriate balance between agency credit in our proprietary platforms will hope to ensure we can accomplish this without meaningfully sacrificing returns.
Maintaining our capital allocation in the proximity the current distribution should hope to keep portfolio leverage in the recent range over the near term and with the tailwind of accommodative monetary policy and persistently wider agency spreads we do expect an improved carry environment in the fourth quarter and beyond.
Now with that I will hand, it over to Glenn to discuss the financials. Thank David beginning with the GAAP results, we reported a GAAP loss of 54 cents per share driven by hedge portfolio losses, which improved sequentially.
And offsetting mark to market gains in our agency portfolio, which one through equity resulted in comprehensive income of 11 cents per share.
Book value declined modestly to $9.21 a share and we generated core earnings expiate.
The $342 million or 21 cents a share.
A number of factors that contributed to our results this quarter beginning with interest income while coupon income increased four cents on have on higher average, earning assets higher prepayments speeds resulted in approximately six cents of additional PPA adjusted premium amortization.
Higher amortization expenses due to projected shipyards, increasing quarter over quarter as David just noted a moment ago.
Additionally, drop income declined one cents sequentially and higher average repo balances added another penny to interest expense, our operating efficiency metrics improved on declines in both management fees and other GNS.
The dislocation between repo funding costs in LIBOR that we've discussed in prior calls remained the fact that once again this quarter, while our average repo funding cost declined 13 basis points LIBOR based reset on the receive leg of our swaps declined on an average base by about 25 basis points.
This dynamic also impacted NIM and net interest spread is lower rates, coupled with the higher premium amortization and I just mentioned.
Drove asset yields lower to a greater extent than the decline in our funding costs, which have lagged feds reduction in rates.
Looking forward, we expect CPR to peak in early Q4, and anticipate lower funding costs in line or agency spreads to more than offset disinfect contributing to NIM and net interest spread net interest spread improvements at 10 15 basis points.
Turning to the balance sheet assets declined roughly $3 billion, primarily driven by a reduction of agency MBS holdings and our loan portfolio has experienced net growth of $400 million on originations and purchases of $1.3 billion, partially offset by Securitizations and paydowns.
During the quarter, we further lowered our preferred cost of capital by completing the previously announced redemption of 175 million seven in five eight series C preferred.
As well as the underwriters partial allotment exercise of the six in three quarters series I preferred that we had previously issued at the end of the second quarter.
As a result in the past roughly two years with these additional actions weve cumulatively reduce the cost of our of our preferred capital by approximately 70 basis points were 9% in terms of our common dividend. We've reaffirmed our prior guidance for 25 cents for the fourth quarter dividends subject of course to our Board's review and approval so to wrap up.
As we alluded to in our prior call the third quarter proved to be a challenging one driven by compressed asset yields and resistant financing costs. We expect Q3 will have been an earnings trough in under the current conditions would anticipate core earnings trending higher into the fourth quarter.
I believe our business model is well positioned and offers of capital deployment choices to drive shareholder value whether that be in the form of asset allocation options or further share repurchases.
Operator, we'll open it up for questions.
We will now begin the question answer session.
Ask your question you May Press Star then one on your Touchtone phone.
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At this time, we will pause momentarily to assemble our roster.
Our first question comes from Rick Shane with JP Morgan.
Hey, guys. Thanks for taking my questions. This morning.
Look as you head into Q4 and into 2020.
You make a compelling case that margins are going to improve that this is a trough in earnings.
And.
We definitely see that in the in the trends as well I am curious when you think about this not on a pure return basis, but on a risk adjusted return basis, and I know that that's more.
Qualitative in terms of thinking about risk, but when you think about things on a risk adjusted basis, how do you feel about the operating environments.
Hey, Rick.
I think.
Our comments are meant to be constructive and positive but measured.
First of all I think the way I would answer that and on Reader's Digest version on a risk adjusted basis and it's a very good ways as to how we look at our capital allocation models cross for businesses.
I think it's fair to say, we anticipated what was going to happen and happened and.
I think going forward pursuant to our commentary.
The risks are lower.
And returns can be higher.
Predominantly in agency business.
I think in the credit businesses, what we've demonstrated as we've done about $4 billion of credit the last couple of years across the businesses.
No risk adjusted basis that I think is been demonstrably better than the market, albeit it's not necessarily reflected in the numbers yet because there hasn't been it can be a credit contraction or credit.
The credit sorry, the credit hiccup.
For sell off so.
All that being said we were a bit different because we have these four businesses that are that are complimentary and combined so credit I think to David's point still is quite tight but we're finding out 12, 13% returns at the two times leverage which is very attractive even versus the agency business, which has become a lot more a lot.
More favorable so.
I think going into the fourth quarter. The reason, we're maintaining the dividend. The reason why were constructive on the outlook is that we see the portfolios long term earnings potential.
Not just stabilizing but returning really to the levels that we anticipated.
Earlier, this year and I think the bogey for us the attractive kind of call option for us is.
It is what happens in credit.
Because I think we basically been firing on two of our four cylinders here.
And if theres any if theres a corruption or if there's a disconnect in any of the credit businesses, we're capable of capitalizing like nobody else, so and Thats on top of again the agency business that we think is is.
A lot more attractive today, certainly that it was over the summer.
Got it.
In that spirit look if you look at the leverage the economic leverage on a on a headline basis, it's Charlie it's ticked up at telling year over year, but if you in any idea of sort of risk adjusted if you look at the allocation to equity too.
Credit.
Going down I would argue that theres actually less.
Risk.
In terms of the increased leverage than the number would suggest headed into this sort of environment in Q4 and into 2020 are you comfortable taking leverage up given the current.
Allocation to credit.
Hi, Rick This is David so to your point about leverage ticking up as a consequence of shift further towards agency that is correct agencies, obviously more levered.
So as we make that ship, you'll see more leverage in the portfolio as you have another point to note over the past year is to my comments in my script.
The fed has shifted to a more culminated approach not just in terms of.
Short rates, but also very recently as we've seen their intervention in the repo market and agency being a balance sheet intensive product does give us more comfort with respect to having a higher levered portfolio now going forward. We think we can generate returns that.
We feel is practical imprudent with the current level of leverage which should things change or should we shipped our capital allocation back towards credit if things Chief and then they may go down or or if theres an opportunity that we really think agency leverage could go up or leverage could go up by.
Increasing our agency exposure, we would do so but we're not there right now.
Rick what I would just you know I'm also offer permanent ties to your first question risk adjusted returns. When we also what we really look at his core our core Aro lead per unit on leverage.
And if you look at our if you just take a look at our numbers. If you analyze our core earnings year to date per unit of leverage we have a higher return then the sector by far.
By using less leverage so thats the output of the this model is designed to produce better or higher returns with lower leverage and to me that part of your risk adjusted equation.
And over time really the last five years, even if you looked at that measure historically, our core ROI for you to leverage is about 30, 35% higher return with 30 or 35% lower leverage. So there is there thats a big part of how we balance out.
Where we put our capital.
Got it Hey, Kevin and David Thank you very much.
Thanks, Rick.
Our next question comes from Kenneth Lee with RBC capital markets.
Hi, Thanks for taking my question.
Just a follow up on on the equity capital allocation.
You mentioned the prepared remarks that allocation towards credit asset is closer to the lower end of the range right now.
And agencies is closer to the higher end, but just wondering looking forward in the near term given the current investment opportunities and the macro environment.
How do you see that evolving could we see material shifts more allocated towards credit if pricing changes I just want to get a little bit more more thought about that.
Yep.
Yes, it's really it's it's pretty basic.
Right now on a relative value basis basis risk adjusted basis agency is is cheaper than credit full stop so that's where you see our portfolio, reflecting that turns on our capital allocation being.
Higher towards agency than it has been in the past few years.
It will shift when credit gets cancelled relatively.
Cheaper relative to agency so thats the the other part of our model, which is you know.
Share capital and by definition no risk management is that we don't we don't put we don't have to put our money to work.
In every and everything or in any one thing. So we measured everyday every week when credit is weaker weekends are we find the deal in credit that is on a risk adjusted basis more attractive than agency. Then we will we will see our steer our money that way.
The way I always answer. The question also is what does it take for if Theres a correction on a reset in credit what's so what what our mix look like and now the efficient frontier for this company given our effective given the efficiency of our operations that we could be 50 50 credit agency in terms of capital allocation.
Without really having to invest in Ana and the infrastructure here when I said in my comments, we paid it forward. We've set this company up to grow in many different ways, especially in credit when we do see that retraction or that retraction in the spreads.
I'll be very helpful. Yes, I would you say to the point about being at the lower end of the credit spectrum and capital allocation and efficient frontier, we do have to strike the balance between smoothing book.
Volatility in earnings and we are late cycle in credit spreads are relatively tight we do have a no organic origination through our three businesses to certainly maintain our credit exposure in quality assets, but we're not we're not price takers in credit by any means we'll do what we what we do into.
The extent theres an opportunity to add.
Through cheaper spreads, we will but we're not chasing anything.
Got it very helpful and just one follow up if I may.
Wondering I wanted to get some of your thoughts around around your capital position and specifically.
Available capacity for making investments going forward. Thanks.
You are saying with respect to increasing leverage or making larger capital investments.
With our liquidity.
Yes, I guess either potential to.
Got you increased leverage or.
Utilized.
There are like for example, the unencumbered assets just wondering to see the interplay between them and how do you view.
How much you could actually used to deploy capital and potential investment opportunities.
Can I ask that the headline answer to that is yes, yes, and yes, I mean, we have.
I would argue to this model not just more.
There's three things more options to invest in the core businesses number two more financing.
Availability in options for the four businesses and number three our liquidity and capacity dwarfs. Most in the sector. So the reason, we're not kind of fully amped up.
Across the businesses in terms of leverage is that it's been so.
So the point on the other question about risk adjusted returns there's has been a high risk market.
Across the board now what we see going forward is lower risk in agency on relative basis.
And we're we're picking our spots and credit bought our liquidity really is our most it's our advantage.
And frankly, the sources of that liquidity.
We have 10 different ways, we finance our businesses non recourse, which nobody else has and Thats. The reason we built this platform the way we did so.
Going forward, you're going to see the lag effect.
Catch up for us, meaning our weighted average cost of funds will continue to go down in the fourth quarter and beyond.
So the cost of financing is going up and yet we still haven't drawn down on a lot of our capacity.
And any one of the businesses. So we're we're we think we're paying you are pretty good cash on cash return to wait for.
You know a capital appreciation event or the next bigger event in terms of an acquisition or portfolio lift or or some other strategic direction that we are that's why we are.
That's why we maintain of liquidity good liquidity position that we do.
Great very helpful. Thank you very much thanks, guys.
Our next question comes from Matthew Holiday with Nomura.
Everyone. Thanks for taking my question just.
To reiterate did you say 10 to 15 basis point improvement in Fourq you in the margin.
Yes, we did.
Okay.
I know Im does that when you look at for that is that something that's sustainable them and when you look at sort of new purchase yield and we can finance and Matt how should we think about the stability did a good job really outlining what the headwinds were in the third quarter. It needs are going to normalize in fourth quarter is that.
You think things will stabilize on that rather they get better can they get worse Anil.
Perfect Devil, but just want to hear your thoughts.
Yes, I mean, obviously, we don't have a crystal ball as far as what's going to happen over overtime, but we are very confident in what we're seeing in terms of trends with respect to our funding costs in the benefit will have on both in as well as net interest spread.
Great. Okay, and then can I just wanted to follow up on.
Your positioning and lot of you've probably seen a lot of rates move it moved into this operating model now you said, you're not price takers here in this market.
When you look at buying originator or becoming more of an original how do you see things playing out as anyone mainly looking at everything here.
It's a good question I mean, we.
Yes, annaly looks at everything and we have I think.
Thankfully, we see a lot in the market just because of the ecosystem of these businesses right.
In terms of origination we do we see everybody we have great relationships right now we've chosen to.
Maintain our joint venture in partnerships that I described in my prepared comments and look we do the math.
And the math is is is a definitive for us that we can produce.
No X billion.
Of assets from an origination partnership that at 20% to 25% of the costs, meaning 75% cheaper.
Because we're not we don't have the people of the systems infrastructure needed to run a conduit originator and have all the bricks and mortar around it. So the math says that we are accessing.
This add these assets 70, 580% more cheaply than those that are producing it on their own.
So that's beneficial for.
Incremental returns here and as we see that business grow and it's been one of our higher growth businesses and we will continue to be to my comments.
The point here is I want to grow not necessarily just in size, but in have seeing return on invested capital so incremental business that will push through our residential platform should be higher higher margin business for us the more we do so we're getting to that scale, we're at that threshold malware those returns.
Albeit all all things being equal in the.
In the market those returns those returns should even get better.
Now that being said if theres a partnership or a platform that we would like to lock off in terms of proprietary relationships and have an investment.
To do that.
By all means we're open to that because we know that's another way to just to trigger lock all flow.
And secure secure.
You know more tangible definitive flow on top of what we have mobile we have is producing some really good growth as you've seen.
Well I'll, certainly states I see you're buying back stock and recognizing the value in the platform.
Long term does it make sense I mean, given those businesses combined I know you like to sort of reference to shared capital model or do they need at some point to be issued or segregated given the high returns and some of the premiums that are apply to other peers.
Yes, so to some other parts, we think are undervalued today, but long term I think especially in these in these in these markets where.
I don't think you get paid to take excessive risk or get paid to do quarterly trades or you know things can go sideways on you quite quickly. So we think there's some other parts here the value for our shareholders is really safety and these businesses together churning out the complimentary cash flows that they churn out it's more states for them all.
All to be collectively together.
Now and it's easier grown its more efficient and living liquidity.
And everything else every everywhere every every business benefits from each other.
Well if there comes a time and I mentioned that I think couple of quarters ago.
So some of the parts becomes more abra, obviously theres an arbitrage.
Ability for us take advantage of some are whether we sell assets or spin off of business or carve out a company. We're prepared to do that all these businesses are running at accounted for independently under one under one very tight umbrella. So it's a call another call option.
And only our owning our shares is that potential, but I don't see anything.
Coming down the road because we are we are frankly focused on efficient growth with returns on invested capital, which are higher as one company versus if one of these companies those on a standalone basis.
Good day should the comments Kevin.
Thank you.
Our next question comes from Eric Hagen with KBW.
Hey, guys. Thanks, Good morning, I had a question on the originator as well and I think you answered that really well I'll just add that it's been exciting to watch you guys issue, some securitizations and get those deals done so congrats.
Just a couple of housekeeping couple of housekeeping items I guess I think this is for you but is there a sensitivity that you can give us.
The level of premium amortization that corresponds to a changing your CPR assumption in either direction.
Yes, it's a really complicated set of calculations.
In terms of how the whole PPA adjustment works I think the simple way of looking at it is to look at what the prior quarters projection was and how that compares against a featured in other words were trying to reset it back to that prior period I can tell you that based on where we see a prepayment trends currently.
We would expect on a PPA adjusted basis amortization expense to be roughly equivalent next quarter as far as what we see.
Or what we had experienced in Q3.
Okay.
Okay. That's a that's helpful.
And then where in the coupon stack are you guys reinvesting runoff in agency portfolio.
On the dollar roll side I see that you guys have a net long position in TV A's run 11 billion, but are you short any roles.
That's that's the question thanks.
Eric with respect to where on the coupon stack, we do have a tilt towards higher coupons.
But that being said I'd say, the we still do think that in spite of elevated pay ups.
Loan balance of paper is still very attractive.
The way, we look at TV A's versus.
Pools is.
PBS or a benchmark in there there are relatively cheap benchmark and pay ups have obviously increased quite a bit.
But there rich to achieve benchmark. So when you look at pools on a cash flow basis in the spread relative to financing in hedging costs.
Reasonably well protected pools are still certainly attractive to us and we are we are certainly maintaining our exposure in in higher quality pools, but we're also sensitive too.
To the value associated with lower pay approvals. For example, you could distinguish between servicer and how much third party origination in gross WACC and you actually can get real value relative to that very cheap benchmark, where the payoffs are are somewhat low.
So your question about PVA is in and rules.
In the third quarter, we did not have short positions as has been discussed higher coupon rolls did trade negative.
Our view was that higher coupons were also relatively cheap and their performance TV performance in the third quarter on a curve adjusted basis was relatively strong. So we think that was a good decision not to be short TV is in the third quarter. However, since.
Since higher coupons have have.
Performed reasonably well since August we have.
Entered into some short TBA positions in higher coupons, given the fact that rules to persist at a negative.
Drop so we do have a small amount of short positions in Tvs.
Got it that's helpful. And then just to kind of pin you down on the coupon question just runoff is going into.
Threes in three and a hubs are mostly threes and just give us a sandals per agent three that's some threes and three that's I'd say.
But we have no 70% of coupon exposures in force board have so we're not reallocating there.
Got it thank you very much.
You bet.
Again, if you have a question. Please press Star then one.
Our next question comes from Douglas Harter with Credit Suisse.
Oh, Thanks, I was hoping you could help me understand kind of the.
A big drivers of kind of the earnings volatility the last two quarters.
Almost four years of let's kind of stable earnings and.
Kind of what the kind of what changed so yeah. So much over the past few quarters to.
Introduce more volatility into earnings.
Sure.
David I'd say, there's a couple of factors heading into the spring and summer. We did have some some swap run off of some lower fixed rate.
Payers that did run off in the second quarter, which.
Caused earnings to to.
Go down somewhat in the second quarter and in the third quarter was predominantly attributable to higher.
Associated with prepayments.
But that being said when you consider the third quarter versus the fourth quarter I think it's notable that we got essentially 80% of one fed cut in the third quarter. If we look at the fourth quarter. We've now had three cuts from July September and October .
Over to where the weighted average is two and two thirds rate cuts for the fourth quarter and so we do think that will be to predominant tailwind that that will.
Equate that third quarter, two a trough.
Great and then thanks.
Looking forward kind of no as we get through the fourth.
Quarter, and you get those those rate cut benefits I guess, just how do you view your earnings stability going forward, we're likely to go back to kind of the prior four years of stable earnings or.
Do we think we're in a period that that there's volatility in earnings is going to continue.
Look our outlook right now is on more constructive.
Doug and.
When you look at our stability right.
The last four years.
Our core earnings variability is been 24% versus the sector, then read sectors core earnings or variability was 111%.
So were notes, which is five times or at all.
Well the yield sector that always quote in terms of the broader.
Market for companies and other industries that produce income.
Thereby their variability is about 60% under three times more volatile than us. So we have proven over time that were more stable and there's no reason to believe with our outlook that we can maintain that stability with this model to David's point in declines points protecting book value, sometimes you sacrifice earnings.
In order to maintain the portfolio in the earnings potential going forward and Thats, what weve done.
And the outlook I think.
Risk adjusted basis to start the queuing may.
I think we feel a lot better.
Albeit we never feel good about anything because we're a defensive yield stock. So look this this model more than I was more than any other is built for stability and not again for our quarterly trader a short term outlook.
That's why I talked about the next decade, we talk about the big macro influences and GST reform banks retreating PE PE needing Switzerland in terms of our lending to them. So you know I think we've we've not only made it through the trough of one quarter of earnings I think we're looking forward to.
Frankly more volatility in different parts of the market that we're prepared to take advantage of that others are and then that's what we've been start firing on all cylinders and Thats what were looking forward.
Thank you.
Thanks, Doug.
This concludes our question and answer session I would like to turn the conference back over to Kevin Keyes for any closing remarks.
I'd like to thank everyone for their interest Natalie and for joining the call and we will speak to next quarter. Thanks, everyone.
The conference has now concluded. Thank you for attending today's presentation can you may now disconnect.