Q4 2019 Earnings Call

[music].

For standing by and welcome to the dynamics capital to Q3 2019 earnings Conference call. At this time all participants are in listen only mode. After the speakers presentation. There will be a question and answer session to ask a question. During this session you will need to press star one on your telephone keypad, if you require.

Any further assistance. Please press star zero. Thank you I would now like to have the conference over your speaker today Alison Griffin. Please go ahead.

Thank you operator, good morning and.

Thank you for joining US everyone with me on the call today, I have Byron, Boston, President and CEO murky pumping.

He VP and CIO, and Steve Benedetti, BBP CFO and COO.

The press release associated with today's call was issued in filed with the FCC. This morning February six 2020, you may be the press release on the home page of the dynamics website at <unk>.

A little dot com as well as on the Fccs web site at SBC Dot Gov.

Before we began to be what's your money that this conference call may contain forward looking statements within the meaning of the private Securities Litigation Reform Act of 1995, the words believe expect forecast.

Hey estimate project plan and similar expressions identify forward looking statements that are inherently subject to risks and uncertainties some of which cannot be predicted for quantified.

The companys actual results and timing of certain events could differ considerably from those projected and or contemplated by those forward looking statement as a.

So unforeseen external factors are ready for.

For additional information on these factors are risks please refer to the annual report on form 10-K for the period ending December 31, 2018 as filed with the FCC document maybe found in the dynamics website under Investor Center as well as on the Fccs website.

This call is being broadcast live over the Internet with a streaming slide presentation, which can be found through a webcast link on the home page of our website. The slide presentation may be reference under quarterly reports on the Investor Center page.

I now have the pleasure turning the call ever to our CEO Byron Boston.

[noise].

Thank you Alison and thank you all for joining our call. This morning.

We finished 2019 on a strong though in the momentum is carried over into the first small 2020.

The year, we actively managed our portfolio based on our macro economic view that we expressed in our third quarter 2000.

Today's conference call.

If you recall at the time, we expressed our view that the fed would Paul's it's Rick hiking cycle and that our financing costs will began to decline.

We also expressed a view that interest rates would spend more time in a tighter historical range with a bias toward the lower end of the range.

[laughter].

Excuse me as such in 2019 actively manage both sides of our balance sheet to lock in lower financing cost take advantage of declining interest rates.

Adjusted our portfolio to increase the percentage of assets allocated to the agency CMBS sector and we.

Stone spot when our shares will suite mispriced.

Our collective actions in 2019 continue to create long term value for shareholders. Despite a global risk environment. There continues to intensify.

Oh, it's murky at speed go into more details blocked we solidly out earned our dividend in the fourth quarter.

Book value was down slightly at year end, what has rebounded solidly during the first small from 2020 as the spreads on our CMBS portfolio Titan.

Once again managed our portfolio to take advantage of declining rates.

Our margins have been increasing for the past few quarters and we are anticipating.

During our financing costs remained stable or decline.

Over the past several years, we've been consistent in our macro economic view of the global economy.

Global economy in capital markets are stuck in a cycle that depends on increasing levels of debt and continued flow of liquidity from the.

Mobile central banks as such we continue to emphasize higher credit quality assets with more liquidity. We're braced for continued global surprises such as we have witnessed so far in 2020 with the middle East conflicts in the outbreak of the Corona virus in China.

I will now turn the call over there.

Allison and she will walk you through a series of questions and answers so walks murky and Steve through a series of questions and answers to give you more detail about our results Allison.

Thanks Byron.

Let's start with Steve.

I'd like to.

If he could walk.

Through the the fourth quarter results.

Sure Allison.

Welcome everybody.

Our results for the quarter on a GAAP and non-GAAP basis are summarized on slide five reconciliations of non-GAAP results are included in the presentation on slide 27 329.

As Byron noted results for the fourth.

Quarter were strong headlined by an 18 cents increase in core EPS to 66 cents per common share from 48 cents per common share last quarter.

Driving the increase in core EPS was a sequential improvement in adjusted net interest income and adjusted net interest spread.

Adjusted net interest spread as a non-GAAP measure, which.

Fluid swap and dollar roll transactions on our GAAP net interest spread and it was 1.53% for the fourth quarter up from 1.14% and the third quarter and 1.24% for the year ago fourth quarter. Our historical net interest spread is included in the appendix on slide 26, and you can see.

The positive trend over the last several quarters.

The adjusted net interest spread continued to benefit this quarter from an declines declining financing and hedge costs repo financing costs declined 37 basis points to 2.1% this quarter from the decline in the federal funds rate coupled with the.

Subsequent injection of liquidity into the repo markets by the Federal Reserve.

Compared to fourth quarter last year repo borrowing costs have declined approximately 40 basis points, reflecting a little more than half of that 75 basis point reduction in the federal funds rate in the second half of the year.

She murthy will comment on repo costs.

And there as they have evolved in the first a few months in 2020.

As it relates to our hedge portfolio core EPS continued to benefit from the tactical decisions that we've made over the last several quarters as alluded to buy Byron overall, the net receive rate on our interest rate swap position was down five.

Basis points during the quarter, but the adjustments in our hedge position more than offset this decline net payments received on our interest rate swaps increased by $700000, which accounted for 77 basis points of the increase in the adjusted net interest spread compared to last quarter.

Overall, our hedge book added 39.

Basis points to our net interest spread during the quarter up from 32 basis points last quarter.

As it relates to leverage our leverage overall was modestly down as where our average interest earning asset balance from a book value per common share standpoint, we added we ended the year at 18, no one down from 18 or so.

Seven for both last quarter and the prior year end, it's Murphy will elaborate in more detail on book value later in the call.

Total economic return to common shareholders for the quarter was 2.2% and 10.8% for the full year for the quarter, we declared 45 cents in dividends and $2 in one sense for the full year.

That concludes my comments and I'll turn the call back Allison.

Thank you Steve.

Marty can you walk us through the performance for the year in 2019 as well as the fourth quarter.

Yes, hi, everyone and thank you Alison I will start with the market. Please turn to slide.

20 in the appendix. So you can follow along for this section.

Interest rates went through a series of shipped last year, ending the year down almost a 100 basis points across the younger more importantly, we had significant moves in the shape of deal car, specifically between financing costs and longer maturity bond issue.

You can see on the top two panels when you compare the one month LIBOR rate or three month LIBOR floor versus the respective 10, you're right. We started the year off with a flat to positively sloped yield curve, which converted in the second quarter.

This conversion, which we felt would be temporary in nature lasted about two quarters, peaking in.

In late September before the curve, we steepened in the fourth quarter.

No. The Federal Reserve is three times for a total of 75 basis points as Steve mentioned repo rates only declined 43 basis point mortgage rates dip over 100 basis points at their lowest since 2012 touching 3.5.

<unk> percent on the FHLB primary mortgage rate.

This trend toward a refinancing wave that was much more benign and markets expectations.

Right and ended the year wider an agency RMBS and tighter in agency CMBS.

Agency RMBS underperformed in the third quarter, but ended the year tighter.

In the fourth quarter relative to the third quarter White.

On the next page, we show pay ups versus TV aid for various specified pool types across the coupon stack.

Pay up for specified pools rose versus TV last year.

As the TB deliverable worsened and interest rates fell making the prepayment.

Protection more valuable.

Year to date and 2020, the trend has been for longer maturity leads to come down flattening yield curve agency RMBS, Oh, yes, and CMBS spreads are tighter higher coupon agency RMBS have outperformed lower coupon so far this year.

Please now turn back to slide.

Six and seven.

Against this market backdrop, we managed the portfolio to generate a 10.8% total economic return for the year paying $2.01 dividend keeping book value relatively flat.

We were active in managing the portfolio as you can see on slide seven eight and nine.

Our key decisions.

Made last year included on slide seven increasing capital allocation to agency CMBS shifting the percentage to 50 50 earlier in the year.

Slide eight.

A reduction in agency RMBS held in TB, a form with the purchase of prepayment protected specified pools.

And dynamic management about coupon exposure.

Slide nine rebalancing of our swap portfolio in the second and third quarters, resulting in locking in lower overall financing rates as the curve inverted and adjusting our hedge position in the fourth quarter.

And finally management of our financing portfolio to create value.

With no disruption during the spikes in the repo market rates.

As Steve mentioned, our rebalancing decisions in the second and third quarter had a significant impact on our fourth quarter results for Corey yes.

First the decision to add to pay fixed swaps as the curve inverted added a onetime benefit to fourth quarter earnings.

At the three month LIBOR receive rate was very favorable at 2.13%.

Well, we will continue to benefit from the low pay fixed rates in the future quarters. A three month LIBOR has come down that benefit is much lower current and future quarters.

Second we also benefited from a 37 basis point decline.

On an average repo cost during the quarter.

Some of this will continue to benefit us in early 2020, you can see that on slide 21 month LIBOR rates have declined to about 1.75% in January.

And finally as a result of the share buyback, we executed the lower average share count also boosted.

<unk> core earnings for the fourth quarter.

Late in the fourth quarter consistent with a macro view, we added protection for higher rates in the form of options, while lifted lifting existing pay fixed positions you can see on slide 11, the impact this had on our risk profile.

Quarter over quarter, our exposure to lower.

It was more positive.

The book value performance for the fourth quarter reflected our longer duration position in the back into the yield curve, causing book value to initially decline as rates in the long end increased during the month of January this positioning along with the tightening in agency CMBS and higher.

On RMBS outperforming has resulted in book value increasing to an estimated $19 in 30 cents to $19.50 per share is 7% to 8% right versus year end.

Our book value in earnings performance reflect the diversified construction of the portfolio.

And our consistent macro economic view.

2019, clearly demonstrated the value of diversification in the portfolio in several ways.

First the improved ability to keep book value stable, even one agency RMBS spreads widened was largely due to the positive convexity of the agencies.

Yes portfolio.

Second the ability to protect cash flows would be offset provided by prepayment compensation from the CMBS portfolio, while higher premium amortization arose from increasing prepayments on the RMBS portfolio.

This is a significant impact for the full year 2000.

19 prepayment compensation from CMBS offset 43% the negative impact from increased premium amortization on the agency RMBS portfolio.

Allison.

Thanks Murphy.

Hello, how the portfolio is positioned today.

How are you thinking about the investment strategy for 2020.

Our macro research and work continue to point to a range bound environment for interest rates with a higher probability for rates to be at the lower end of the range. We have always talked about the possibility of surprises impacting in already fragile.

Global economic framework that is burdened by debt.

We view the Corona virus is exactly the type of unexpected trigger that can shift fundamental economic trends in an unfavorable direction.

Our actions last year and continued active management have resulted in us out, earning the dividend significantly so in the fourth quarter.

As I mentioned earlier, the three month LIBOR set was a onetime benefit core EPS in the fourth quarter for 2020, we expect net interest margin to benefit from our rebalancing actions last year the decline in repo cost in the first quarter.

Eventually stabilizing at a level moderately above the dividend later in the year.

Our portfolio strategy for this type of environment remains focused on building durable cash flows for the lower end of the interest Street range with protection for a movement in rates. The upper end of the range as we have said before on many conference calls and environments. Like this we expect to manage the duration leverage and asset mix.

Dynamically intra quarter.

We continue to believe in the up in credit up in liquidity diversified portfolio that will perform in this environment.

We like the combination of agency CMBS and specified pools.

On page 22, we have laid out why we choose to buy some of our.

Protection in the form of an explicit lock out in the agency CMBS market.

One of the main reasons is that you actually receive compensation as an investor if your bonds pre pay.

This is a very important feature if we're going to spend a lot of time at lower interest rates. The same type of protection is nonexistent in.

<unk> agency RMBS market, that's not to say, we don't like that market or don't invest in it we absolutely do we recognize that the prepayment protection is implicit and it can disappear when we'd small low enough well the refinancing machine becomes a mission enough. So we have.

The prepayment compensation from the CMBS.

Offsets the increased premium amortization from the agency RMBS and that creates a more stable earnings profile and lower rate environment.

You are they can you comment on the retail market trend.

And the fed actions and what your expectations are.

Absolutely.

We build market is is a big deal and it continues to be a big deal at this point. The fed has clearly communicated that they're on hold on with a high BARDA raising interest rates and a low Barnett easing.

They remain extremely focused on a liquidity in the repo market and have continued to add their support.

Sure, Mike increasing their people exposure on their balance sheet and offering temporary we build facilities.

It is very clear to us that they do not want a repeat of September 2019, or December 2018, so the intervening offering support for the financing of the most liquid assets such as agency MBS.

Treasuries.

Over the long term they have solutions such as a standing repo facility. This remains something that the fed is reluctant to commit to but apparently exploring.

Our regulatory reform is also an option, but there again politically charged and not really leaves us with the fed stepping in right now.

At the lender of last resort.

As far as repo rates are concerned we'll just go back to page 20, we're finally seeing the benefit of the full 75 basis points of easing last year up just just now in the first quarter from this point on we expect financing costs to be stable and future declines are going.

To come from further easing by the fed and competition among our funding providers.

And then as well as a company that participate actively in the housing markets were also watching the developments at the federal home loan Bank system. The FHLB phase, we considering the ability for reads to be an active participant in that system and that would be another tailwind.

To our financing costs.

Where do you see marginal return today.

Interestingly Allison and we've said this for sometime now the most liquid assets continue to provide the best marginal return.

And then in an era, where central banks.

Stepped into flood the system with liquidity, it's really easy to overlook the value of liquid assets.

Right now we see the best hedge statically turns in the agency RMBS space.

11% to 14% returns in the agency RMBS based depending on the coupon type of specified pools purchased.

In the agency.

MBS base were a little bit tighter given how well they performed and those we turned to somewhere between 8% to 11% range.

[noise] things Murphy I'd like you now turn the call ever to fire and.

Thank you Allison Liberal in turn to slide.

<unk>.

As we anticipated business conditions have improved considerably for dynamics with the fed on hold.

And with a low bar for reducing interest rate and a high bar for raising interest rates.

Furthermore, spreads on agency mortgage backed securities are more attractive today.

Say that over the past several years, so we have opportunities to invest our capital.

We continue to believe global economic and political environment is subject to sudden surprises as we have seen so far in 2020, but we're positioned with a liquid portfolio. When we will continue to actively manage both sides of our.

She generate solid cash flow for shareholders.

Please turn to slide 14.

And I will remind you as I do so often that we're managing our business for the long term.

The cash dividends that we continue to pay to our shareholders are extremely attractive in a world where.

Long term U.S. government bonds will only pay you less than 2% kissinger's. Furthermore, we believe that above average dividends will be a major driver returns over the next five to 10 years given that today global asset price levels are highly a plate.

Dynamics's existed for 30 years.

Years, we haven't seasoned management team, we are internally managed we own our own stock and we continue to remain dedicated to a disciplined top down macroeconomic approach in our decision making process to create value for shareholders.

And with that operator, we're going to open the lines up.

<unk>.

Certainly.

If anybody would like to ask a question.

Please press star one on your telephone keypad.

To withdraw your question press, the pound or hash key.

Your first question comes from the line of stuck harder from credit Suisse.

Your line is open.

Hey, guys. This is actually Josh on for Doug [noise].

The commentary around the book value range provided.

Through the end of January.

I was wondering if you could walk us through some of the puts and takes around those numbers it seemed high to us when compared to anything we could see so just.

Curious if you could.

Estimate or quantify how much of that book value increase is coming from CMBS tightening versus maybe the higher coupon RMBS performance and any commentary around the performance of the lower coupon RMBS in the first quarter would be great. Thanks, I know that's all.

That's what I appreciate it no one below its merck to get some of the basic detail, but then from our perspective. It's modest surprising result, we purchase we increased our agency CMBS position throughout 2019 and spreads have tightened we stuck with a higher.

Coupon positions spreads have tightened they bought one in this first quarter.

And and then Oh, well given our macro economic view, we've always had a bias. We stated you're you're now we believe Warner in a range. We believe we're going to be in one or lower into the range and when you're at a.

Range with lower volatility for managing a book securitized part for the could become more favorable than bond.

And I'm than we would that backdrops, Martha you can get more specific a body, but it's worth what concerns not oh, an unusual result.

Thanks Byron.

So Josh if you could just turn to page 10 on this slide deck.

Yep.

Page 10 on the slide deck, where it says risk position interest rate.

We did execute a substantial shipped in the way our hedges worked and that's probably one of the biggest drivers of of book value in the first month.

So if you look at September Thirtyth versus December 31st the change in shareholders equity for a 50 basis point decline in interest rates is about 7% to the positive.

Relative to our position in September so that's one of the bigger drivers in terms of you know how we.

We were position coming into this year again, you know no one can predict Iran, or the corner wise or anything else, but our macro opinion was literally that you're going to be in a range. We're spending more time at the lower end to end the range, we had contingent protection for higher higher.

Interest rates and to be able to benefit if interest rates board a decline. Okay. I'm. So you can see that even in the up in the upgrade scenarios that contingent protection was sort of kicking in as as rates rose.

So that's a big driver the second thing I would say is our book is weighted.

Towards the higher coupon, so I think we own.

I'm good 70% of the book is sitting in for since Warner has and some into enhances well those coupons, even though the market rallied.

Really held in there and actually went up in.

Nice.

Even though even though the dollar price even though the.

Treasuries countries rally so that was the second piece and then the bigger piece I was just the this the 50% allocation to the CMBS portfolio. Some of those those bonds really outperformed in.

January there was a lot of demand for that product.

You know, we're showing you were par price bonds are trading in on slide 20, we own a variety of bonds. Some that are blow down. Some that are from 11 have so that spread tightening one it's an approximation you know there's other ways.

In which where there was demand from our for more lower duration Securities for example, which we own so that was another piece of the outperformance. So there's really three things.

Market rally, we had a position that benefited number to a higher coupon agency RMBS outperformed were overly there.

Yes agency CMBS also outperformed in bonds, we specifically own were happened to be you know very much in demand. So those are the three reasons.

Great really appreciate the color guys. Thank you.

Your next question comes from Eric Hagen from KBW. Your line is open.

<unk>.

Hi, good morning, Congrats on a a good year in January.

You guys.

Great.

Occurred so I'm, just confirming that expect slowdown in Prepays on agency RMBS should boost your net spread a little bit relative to the fourth quarter.

Correct in terms of the method, but I'll, let Steve.

Address that.

Yes, Eric that's that's correct were a prospective method. So the we reflect the actual paydowns that occurred during the quarter on the RMBS book, So any any any slowdown from seasonality or.

Work portfolio construction wouldn't be reflected in the result.

Great. Thank you. Thank you I just wanted to confirm that.

And then optimal level of leverage that you think the tearing of agency RMBS and CMBS.

Can get run that I imagine you are comfortable where you're out at around nine times.

Right now but.

What would be your comfort level and taking that a little.

Higher.

Here.

I think on given the positive convexity on the agency CMBS. It's it's we can run the leverage higher from this level I mean nine times is fine we're thinking about.

The risk adjusted return at this point, but the agency CMBS as a product does.

Sort of enable the ability to run the leverage higher.

Yeah, that's a real important one that gets murky at said here that the.

Structure of the agency CMBS pool.

Better structured wall.

It does give us the ability.

Carry a higher leverage level.

Is it simply about or better.

Oh structured product ramps on that smoke.

No.

Okay.

Okay, and I know that a lot of your comments around the repo market, probably pertain, mostly the agency RMBS, but.

On the agency CMBS side in a little bit on that.

A little bit of credit that you guys do.

Would you say that the commentary.

The.

Same or any different.

I would say, so obviously really regarding report right.

Right Theres really no difference Eric between the agency CMBS and the agency RMBS are those to really get funded right at the right at the same haircut and the same level the market doesn't distinguish that.

On the on the on the small amount to the islands that we own the credit product that we own.

We've seen very stable profile, they really did not suffer in the disruption.

Last year those things are primarily funded on bank balance sheets and as you guys know ours is we ever we.

Have a committed repo facility.

With one of our banks that.

That really you don't suffer disruption, we didn't suffer that disruption in any other people Morgan.

Right.

Great.

Yes.

That's helpful.

Your next question comes from Trevor Cranston from JMP.

Securities Your line is open.

Alright. Thanks.

You just talked about in your prepared remarks.

Dynamically managing your sort of repositioning as the market moves around.

Obviously, you guys benefited a lot from rates in January.

Can you comment on how you might have shifted the.

Right exposures of the portfolio as as rates came down a general thanks.

Yes. So again you know, we we are going to manage that portfolio dynamically we used a variety of a variety of of.

Instruments for the upgrade scenarios, where we're constantly in the options market either using options on treasury futures or Swaptions, if we get the opportunity to lock in attractive forward financing rates through the swap market we're doing that.

We had the opportunity to do that early in February those rates.

We basically came back to rate that weren't in existence in September.

So we are opportunistic in that manner, Trevor and what we're trying to say when we when we might manage things dynamically.

Is that.

From quarter to quarter, our our positions are actually changing intra quarter and what you see as the position at the end. That's reported you know in December 31st by the time, we get to March 31st we will probably have made some.

My judgment some adjustment, but yes, you know if if we.

These forward rates coming down in the man or that they have.

We're going to take advantage of them and lock them in.

Okay got it and I apologize if I missed this but given the improvement and and earnings this quarter.

You guys comment on how you're thinking about you know the dividend in light of or the earnings levels now. Thanks.

Hey traveled the what's really important.

A year or talk about disciplined process discipline.

Decision, making and actively.

Did you all our balance sheet and our capital dividends are part of that process on first and foremost understand that dividend levels or is the board to see.

And throughout the year, the board needs and decide or what.

<unk> Laborde throughout 2020, we will continue.

Your to do that but dividends are also part of the larger capital management.

Process, which we're very disciplined and you can think about 2019, one point, we raised capital one another point, we bought back capital until the point, we had a reduced our dividends or to reflect the overall risk environment.

We're very disciplined in talking to be very intelligent Bob way, we manage our overall balance sheet on both sides of the dividend.

Susan is part of that so what are the board decision. We are aldone nerve dividend, but you should always note that or would those earnings.

You can see what can happen when you deployed capital at the right spreads in the white product that can be extremely powerful so its a disciplined process and Oh the board as always we'll continue to meet you ought to year to make decisions on where that dividends it's worse.

As a competing uses of capital Oh, yes.

New moment in the marketplace.

Gotcha. Okay. Appreciate the comments thank you.

Your next question comes from Christopher Nolan from Ladenburg Thalmann. Your line is open.

Hey, guys.

The hedges that benefited the book value per share January 2020, I'm sure weeks correct.

Attribution to than that.

Spread.

You should increase.

First quarter.

Thanks.

I would say Chris so it's it's.

Again, it's a.

It's.

It's a bounce okay. So on page 10, if you look at what the way we were positioned at the end of the year.

Some of the hedges that we had on the balance sheet.

In September we took off.

And then we.

Ladies those with options.

So on a net basis I would say that's not going to be a major driver of of where where the earnings go but that's sort of more the dynamic aspect of when we feel like it's appropriate to lock in that financing costs in the future versus not.

On that I would say it's.

I'm going to be a major driver.

Contributing to that spread going forward at worst it's it's bringing its ethan.

Okay, Thanks, and so am I reading you correctly were.

Given that you had a really strong quarter, but you cut the dividend.

And the books.

Well you seem to be taken a nice job.

In January but.

That does not seem to be flowing through to earnings.

Book value.

Hi, good benefit in the first quarter.

It looks like the earnings run rate.

Likely be significantly different.

Orders.

<unk>.

Is that fair way to look at it.

<unk>.

So I'm going to try to repeat back I'm, a little confused on what you're asking you're trying to understand the earnings run rate or the earnings, but you're right was that what's your yep.

Yes exactly question that your did your.

Asking I'm going to let Steven smart begin in more detail why what is happening.

I do want to make sure that you and everyone else on this call understand how consistent we are in our process.

And what we say.

We are very good.

Our top down approach.

We gave you an opinion at the end of 2018, but third quarter October 2018.

We told you conditions were going to improve we told you our financing costs were going to come down. We told you also so we used to build that doesn't have the ability to raise racing and do what they were trying to do.

Now turning to move.

In that direction.

And we've been able to take advantage of that.

And you have seen the results of that in 2019 and easy that today in terms of where was it.

And I'll watch so again it all starts with our macro economic view will want to make sure that you understand how consistent we aren't.

Please go back and listen to our other topic spoke about multiple years.

And you're going to see and listen to what we say image should be able to see what took place here over the last year in one one mall and a it shouldn't be.

Two unusual and then when we talk about the future or would you view.

The the macro view that the fed is on home with a lower BARDA to reduce rates.

A higher bar to increase or rate will drive our financing costs. So smart smokers, Steve you want to chime in a little bit more.

Oh, Yeah, Chris understand.

Sure.

The outlook for 2014.

Right I mean, I would say early last year you know the primary reason if you look forward last year, you saw an inverted yield curve and really sort of NIM compression coming your way. Okay. So that's what drove.

The idea that maybe there are some there's there's NIM.

Compression coming your way and.

And we needed to we needed to reduce the level of the dividend at the time.

Once you started to see the markets move in the second and third quarters.

We got the opportunity to lock in some of that attractive forward financing rate.

Which offset.

The impact of that NIM compression from an inverted yield curve and so we were able to capture some of that margin.

One part of capturing that margin, we had a one time benefit in the fourth quarter, which was that three month LIBOR set up to 13.

That was great that helped us outperform the dividend in the fourth quarter.

That's not going to continue necessarily into the first in first quarter on into the rest of year, but what is is the fact that we locked in those lower financing costs in the second and third quarters. Okay. So a driver.

Core earnings improving from last year this year.

Yes.

Is that pay fixed position alright, and then the second thing that happened is that over all of last year repo rates only came down 43 basis points, there already down 25 basis point this month.

And last month, so that's giving you some tailwind going into 2020 now will that continue every quarter 25 basis points. You know that's going to depend on one of the fed eases or there's competition in the marketplace or whether we get into the home.

But let's just say that stays the same that's another thing.

And that sort of solidly puts the margin.

At levels, what it where it is larger than where it was at the beginning of last year. So those are the two things I would say you know contribute to that wider margin.

Coming into 2020, now certain other onetime things, which I mentioned will help us here.

Again in the first quarter and then we eventually expect that the margin will stabilize at a level above the dividend later in the year.

Right, Okay, but from a clarification.

Sure.

Your next question comes from Jason Stewart from Jones trading your line.

So fan.

Thank you good morning, I wanted us to RMBS market.

Given the reduction.

20, so far as you're talking to originators and Servicers what their oh.

Uh huh.

And your view of how that translates prepayments.

It's.

We're going to play out given lower rate environment.

Can you repeat that I missed a little bit about what you're asking about originators.

Are there just given that we're mortgage rates are to consumers and your discussion with a originators that I guess first the lesser degree.

Their assessment.

The terms of capacity, if they're increasing it.

Or.

More of a temporary.

Well, great BARDA, and maybe how that how that would translate to your view.

The RMBS.

Okay. That's a great question. So let me just start off with a general state.

The market in general both equity investors and some bond investors made a huge mistake last year.

They Miss twice what happened in prepayments the market was price for Armageddon, our stock was price for Armageddon and those are all those are either sold was.

So mortgage backed securities were wrong.

So I'm going to period, that's what took place it was mispriced now when you go quality origination universe.

It is not and it was not in is still not consistent today.

Some originators have better technology than others.

Some originators did increase capacity, but there were several originators that did not increase capacity because they were not willing to believe that that low rate environment was going to continue on that they should encourage the higher costs, we're trying to increase capacity through pushed.

Uhhuh faster prepayment speeds.

So we made a smart decision and I applaud our investment team, making that decision to maintain our positions and some of our higher coupon or mortgage backed securities.

And Oh and as such Smirky.

He said early she said so level or a large position and for the board hassles positions have done extremely well and they're generating a lot of cash flow. So the market made a huge mistake last year.

Repayments I've gone through every prepayment site since 1986, and I've, yet to see prepayment modelers get it right.

They are generally working with empirical data with the using historical data, which mean ever seen.

Oh, we payment cycle has been different and this little different than the others in the past.

So there was a great business opportunity.

CMBS agency CMBS spread widened out despite the fact that they don't have.

Oh.

All the cloud prepaid they have actually swaps will prepayment protection built into loans all board for perhaps another 30 or mortgage backed secure wears will price through an armageddon scenario. So there was a great business opportunity you see it in terms of ones where spreads are fine. We tightened back if you can see in terms of baby amount of Carey or.

Our net interest income were able to generate as the fed has reduced our off financing costs and and and the team has been able to active we manage our hedge book to take advantage of the environment. So I'm a little would start with that's Burton you can add to more specific detail around I think that's a great question because I think most of the marketplaces been confused in terms of.

And I think that season players really a with a lot of history. In this business have a huge advantage and managing through these type of cycles.

Yeah, I would agree with that Jason I think I think what you're seeing is a mortgage market that is getting more and.

And more efficient on the on the originator side. It it is patchy because certain originators have invested in so much technology that they get more and more efficient others are coming along.

But the trend is unmistakable in that the efficiency of that mortgage refinancing option is just getting better overtime.

And for US that's what makes us by the agency CMBS and the agency RMBS. So if you go back to that pricing matrix, where are we on page 21.

We're showing you what it what it costs you to buy prepayment protection in the agency RMBS market. So.

So if you wanted to buy a protection in the 4% coupon for example in January.

TB price was one of 4.46 and from 85 K Max pool, you paid five points above one of 4.46 getting you to a dollar price.

Almost 110.

All right. So just to give you any gave you a comparison in the in the dust market or in the agency CMBS market. There are pools that trade with a 4% coupon with a 10 point premium however, when that bond prepays.

You get compensated for that extra 10 points.

Because of the structure of the bond.

When the 4% 85, K Max Prepays you get par.

That's what you get to so there's value in these things and the value of them is going to get more as as the TB I guess more negatively convex, but also there is a diminishment of the value of this.

Specified pool itself over time intrinsically, we're not seeing does nothing happening tomorrow, but the more efficient the market gets the better originators get at building capacity and.

Taking that capacity down you know that the value of that $5.38 eventually starts to erode so.

Why we invest in both but that.

Hope that answers your question.

It's not in basin I call. It was a great question.

It is a big is this just understanding of prepayments was a big factor in 2019 and the market simply this price what took place.

One day highly probable we break through the lower end of the yield range somewhere somewhere out in future. We don't predict we don't have a qubec.

That's a day when all you should see a major readjustment because of prepayments speeds, but as we sit here.

We are in this range will low vol environment, Oh, what our book is showing that I'm sure others are showing the same thing that you can generate more cash flow all been the market price than last year.

Okay appreciate that.

Our.

[noise].

Okay, and if he would like to ask a question. Please press star one on your telephone Keypad. Your next question comes from Jay Weinstein from what the fire. Your line is open.

Hey, everybody how are Ya.

Hey, Jay Jay.

Nice to hear from you.

So Byron last a year on.

At the annual meeting.

Hey, I'm an interesting forecasted.

I ask you at the time rates were enough.

Range, but a higher range and I ask you, which direction. If you thought it was going to break it would go.

Got it for a second you said down.

Which proved to have.

Happen and about three months later form is later or whatever was.

Very accurate forecast I was wondering if I ask you. The same question today with a new range that we were sort of tracking and it seems like let's call. The 10 year between 150 into.

How would you answer that question today.

Oh.

It is a little more nuance if I put it like that all the we believe.

We use this phrase so want to be consistent we've said the globe is complex, we said risk of intensified with the most important thing. We've said is that surprises are highly probable.

And we views that phrase for multiple years.

When we go to our scenario analysis.

No surprises, we can come up with.

Average breaking to the lower side.

And one of the major problems is there's any ginormous and I love using the word.

Enormous amount of global debt.

It is continuing to increase.

Deficits do matter in the U.S. and it matters in every other country.

Jude growing the corporate level and at the individual level, so any movement up and reach in our opinion will be temporary.

Larry because it will put downward pressure on economic activity because.

We find baffling that we couldn't believe we could increase the amount of global debt and then increase the price of bad debt and believe that that will put downward pressure on economic growth and as a.

So interest rates so already this year, we think two events do surprises.

One was a middle east flare up and that situation is extremely chaotic.

We saw dropping rates when looked like things, we're not going to escalate rates move back up.

Now we have another situation, putting downward pressure on growth, which is another surprise factor.

That also has put downward pressure on growth and then on growth and ER on interest rates and we're in a range is a tighter range than we'd been but if you look back to 2011 is 12.

Same range, we were like between 150 into prison. If you look back to 2016 between 152% I would urge everyone to go back and study those periods because we only broke out of those periods on for our or something related to government policy with into the fed and thought they could tighten credit or was it would be.

For the a Republican sweep and or the U.S. government. So are still biases that or you can ultimately test the low in the rates of breakthrough we're not predicting when that will happen I think it's important that you understand there we're going to have a bias when we can to be longer.

Now the rates have already rally so much for this quarter of course, we have made some adjustments to our portfolio <unk> reflect that fact, but in general our bias in our mindset has been for multiple years, because we believe global risk have intensified that you have downward pressure all overall.

Interest rates.

Yes, it could you used the phrase I think that.

All that I think it's about 15 or 16 trillions of negative interest rate assets were sort of like a black hole fucking our rates in that direction and.

He's still sort of.

As you said use our surprises you just kind of you felt like any.

Right right downward.

Proves to be correct, so when somebody said.

Hey, look indicative of what's going on something what I'd say those scenarios that the worries only upside. So for example in Europe could Germany decide to deficit spin to.

Right to boost their economy, which could potentially have some impact boosting Europe, if nothing else, there's going to be if that took place there would be a psychological the moon and in bonds and then I think that would have an impact on global rage and.

Putting our rates in the U.S. and elsewhere and that would be a surprise, okay and you know in terms of when people when somebody said few other U.S. government as frame is huge deficit.

So therefore that should be upward pressure on rates, but that actually has proved to be the opposite.

What do you stated.

People savings like that.

Yes.

Well you know I'll point out I went back to look if.

You remember when I first said the word complex. It was like February of 2014, we basically made a statement that the fed would try to normalize but they really can't do it.

And is not a we're not being trying to be all pools or predict the future.

Oh, we're saying is from the the simple.

Or concept that we increased.

An enormous.

Amount of debt globally.

And would you try to increase the prices the debt. He brings we had the downward pressure on he.

Not much.

And that in itself creates a scenario, where we come back down.

So we seem to fit dual round trip conventionally they got to a point, where they realize that in fact, continuing to tighten financial condition, we're going to rig problem not only from a global growth perspective from a.

Stability perspective, and so then you end up with rates coming back down. So the dynamic process is not saying that we can't testers upper end of the range right now that 2%. So lets say everything comes down to Florida virus, let's say that we'll get to the point, where the world gets this under control still have.

Puts some downward pressure on world, but it's temporary pressure on ROE you could see again the rates start to drift back up toward 2% I don't think it was unusual but a lot of Super Bugs you can appears to 2% type level, but again, you try to push rates Bob on top of this enormously loans growing.

Level of global debt, which includes the United States.

We believe that the problem, but we believe it or create a scenario, where all our economic growth slow and rates will come back down and.

We're not into making political statements. Unfortunately, when you're talking economics today are people. Thank.

You're making a political statements about the fact that the matter its deficits do matter huge amounts of debt is detrimental and Oh, we believe it's a destabilizing factor beneath the surface.

Smirky won't happen.

I do hi, Jay.

I would say the.

One the one other thing to consider is central banks right. The U.S. government increased its deficit at a time when central banks were just massive buyers of debt.

So eventually the central banks proved to be bigger than the U.S. government increasing in the deficit until rates are down and it's.

Not just our central bank global Central banks, So that's where that that black hole comes and again. So you know it's kind of an incredible situation, where we're able to increase our deficit at lower and lower.

Interest costs.

Largely because of central bank activity.

No.

Imagine Jay the central banks don't buy this debt imagine if they weren't buying the debt.

Yeah that.

That would be about surprise I would imagine.

Yep.

Alright, Thank you I hope well see again in April.

Okay, great. Thank you so much plug in to.

Your next question comes from Glenn Peterson from corporate training LLC. Your line is open.

Hello Hello.

All.

How.

Hi minimal.

At the corner.

Yeah.

Currently warm, saying somewhere between.

I can tell you like <unk>.

Talk to me or <unk>.

Just exactly what simple that much.

So.

I'm, just having a little harder time.

So.

Thanks.

Oh.

There's some again I'm going to go back through what we've already said and the first point to understand is.

Agency CMBS spreads tighten.

As we bought an increase our board throw portfolio throughout 2019, and part of the spread tightening with agencies.

He CMBS spreads we did if there was some widening last year cool, which took place not only.

I suppose it.

As for the sector widening out but it was also a function of higher premium prices and that sector definitively repriced in January.

More than it did oh in the fourth quarter of all last year.

So that's the first point.

And spreads have been very solid in that sector second to that it's working pointed out that we still have positions at more than four and a half off with a market has realized a as.

Got it speeds have come down that they're very value when those products and generating very good cash flow Oh, we watch those products also.

Improve and and then thirdly as we've talked in you listen to this call you understand our macro economic view and out we.

Adjusted our hedges in such a wave that we anticipated that if rates rise up it would be temporary and that are most surprises that we are willing curves oh, well put downward pressure on rates. So that's the philosophy behind it.

We have a unique portfolio I don't think there's another mortgage riet that has a 50 50 split between agency CMBS and agency RMBS. So it is a unique portfolio and ER and that job prove valuable.

There are no further questions at this time.

Byron Boston I'll turn the call back over to you.

Thank you operator I appreciate all the questions I appreciate you all to me and into our all conference call and for those who want to.

In a better understanding of.

It's the gravel please feel free to go back and listen to other properties all going back multiple years are pretty consistent in terms of our macro economic view and were very consistent and are approaching the market. Thank you very much and we look forward to well you plug in and again with US all four Oh post quarter 2020 conference call in a couple of months. Thank you very much.

Ladies and gentlemen, this concludes today's fourth quarter 2019 conference call. Thank you for your participation you may now disconnect.

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