Q1 2020 Earnings Call

Thursday

Dead dead dead.

Good day and welcome to the cab said mortgage first quarter 2020 earnings conference call and webcast. All participants will be in listen-only mode. Should I be of assistance, please signal carpet Specialist or pressing the star key followed by zero after today's presentation. There will be an opportunity to ask questions to ask a question. You may press * then 1 and a touch-tone phone. So we'll try your question, please press * then two, please note this event is being recorded our now like to turn the conference over to is going to be crab factor of eye on the floor address ma'am.

Good morning. Thank you for attending Captain first quarter earnings. The first quarter earnings release was issued yesterday and posted on our website, under the investor relations tab the link to this webcast is also in the investor relations section of our website in our private this webcast in a retail call will be available through June 29th, 2020 details of the repair included in yesterday's release on the call. Today are still runs for president and chief executive officer Roberts. Executive Vice President and chief investment officer. And Lance Phillips Senior vice president and Chief Financial Officer to support the health and well-being of our employees and community and address the risks associated with the global covid-19. We have implemented our business continuity plan that enables our employees to work remotely. Please be patient with us as we answer questions says not all presenters are together before we get started. I want to remind me that some of today's Thursday.

Could be considered forward-looking statements pursuant to the safe harbor provisions of the private Securities litigation Reform Act of 1995 and they're based on certain assumptions and expectations of management page detailed list of all the risk factors associated with our business. Please refer to our filings with the SEC which are available on our website the information contained in this call and current only as of this type of the day of this call April 2020. The company assumes no obligation to update any statements including any forward-looking statements made during this home with that. I'll turn it over to Phil.

Thank you, Lindsay.

After my remarks Lance will give a recap of the quarter and then we'll open the call to questions and unprecedented near total shutdown in the US economy beginning in March due to the covid-19. And then I didn't fears are extremely high credit default levels and recession leading to be risking occurring all levels of the fixed-income markets.

Credit asset pricing came under severe pressure destabilizing 16th and Market all Financial firms regardless of sometimes our business model were adversely affected leather package investors across the Spectrum began a process of be risking and in many instances selling their most liquid positions to raise cash to meet margin calls and Redemption Song in the mortgage rates sector firms are already experimenting with pretty drained due to declining treasury rates, which led to losses on derivatives held for education purposes and valuation block marketing calls.

Is the crisis deepened this drain on liquidity became more pronounced and included increased based Market requirements for swaps due to heightened Market volatility selling of age the MBS intensified as credit sensitive mortgage rates try to avoid realizing greater losses and selling less liquid non-agency positions eventually disrupting trading in the agency MBS markets you to the sheer volume of Sellers and a lack of buyers. The end result was sharply following MBS prices even as Market interest rates declined losses underneath it is we're not offset by portfolio valuation gains mortgage rates book values for crust over three equities traded at discounts rarely seen,

Can't find fixed-rate agency MBS and artists on Monday, March 23rd, but that was too late for a number of credit or more of your three. So the amount that could not make marginal that's sad the massive size of the FED intervention together with the near exhaustion of selling a fixed-rate agency MBS on the part of leopard firms as allowed for a more stable operating environment going forward the firm such as half said that are focused on agency MBS and we're not severely damaged in March regarding cap said specifically off early in the court. We were executing on science increase portfolio leverage modestly in anticipation of Raven, Nefertiti Acquisitions, exceeded run off in January and February and thirteen million in, Mexican effort. He was issued in February using our at-the-market continuance offering program.

In early March it became apparent that the markets were deteriorating in our Focus shifted to generating liquidity run off from March was not replaced swaps were paired out of and not replace refold is rolled in the April and Beyond on pricing held up fairly. Well through the middle of Parts. Lee speaking even as the more liquid in traffic home page agency market was breaking down with the Market's continuing to deteriorate culminating and non-agency business actually trading on Sunday, March 22nd. We conclude was proven to sell a portion of our portfolio to prepare for future projected liquidity. I want to emphasize that throughout this time. We met all marketing calls on forward. We have recovered a portion of the lag in Orem pricing relevant to fix rate MBS that was evident at quarter in which book value estimated the up. 45% is this month

With this Improvement in bookbag.

And having not replaced April for fully over and off. Our leverage currently is a comfortable 7.8 the one compared to 8.5 to 1 and quarter round.

As we begin replacing my portfolio runoff reinvestment return some very attractive and perhaps most importantly are borrowing costs are down dramatically with unhedged repo rep typically between twenty and thirty five basis points. Thanks largely to the FED having reduced the FED funds rate a hundred fifty basis points in March and near-zero wrapping up. I believe the worst of the recent Market turbulence is behind us in our portfolio is well positioned to generate attractive Returns on investment Capital at lower lower levels levels, and we have employed recent bass looking for we are increasingly confident that for the rest of the year. We can produce core earnings that will meet or exceed our current $0.15 a quarter of common dividend run, right?

With that. I'll turn the call over to fill a gap net loss of two hundred four point seven million this quarter or $2.21 per diluted share. Our core earnings were 19.8 million or 16 cents per diluted common share core earnings exclude realized and unrealized losses on our portfolio still related interest rate swap agreements along with a realized loss on the sale of two point five billion of Securities. We include a Reconciliation of Gap and quarter earnings on page nine thousand press release.

Book value decreased $2.55 per share during the first quarter ending at $6.07 per common share primarily due to $1.84 and losses in our interest rate swap agreements of which a dollar 04 were realized losses. Additionally. We incurred a realized loss of $0.70 on the sale of home.

With the realized losses from hedging activities and Sunday nights, and and this quarter. It is expected that all twenty20 common and preferred dividend distributions will be characterized as a non tax returns of capital portfolio yields average 2.49% during the quarter a decrease of 18 basis points from the 2.67% We reported in the prior quarter yields decline primarily due to lower cash yields as a portion of our armed portfolios reset to lower prevailing interest rate and to a lesser extent as a result of an increase in our lifetime prepayment estimate.

Our portfolio related borrowing costs after adjusting for hedging activities average 1.72% during the first quarter twenty five basis points lower than in the prior cord leading to a 7 basis-point improvement in our net interest rates during the quarter. We paired out of 5.2 billion and swap agreements replacing them with 2.5 billion in new swap agreements at lower rates the benefits of lower on his repo rates and lower fixed rates on our swap book or partially offset by The Vines and receive like if these derivatives based on Lower 3 month Libor Scandal is rates at March 31st, the fix pay rate on our swap vocalist, 1.54% a decline of 33 basis points from rates in effect on December 31st. These lower fixed rates together with lower notional amount bounces. Should yep.

Is it future earnings was that?

We will open the call up to questions.

Thank you, sir. We will now begin the question-and-answer session to ask a question. You may press * then 1 on a touch-tone phone. If you're using the speaker phone pick up your handset before pressing the keys for the time. The question has an adjuster lights will try the question, please press * then two at this time. We'll just pause momentarily to a semi roster.

And the first question we have will come from Steve Delaney of JMP Securities, please go ahead.

Morning everyone. I was wondering a lot of moving pieces, and I think you guys sound like you're I know you were an eye of the storm there in March, but glad to hear that things have kind of settled to to where they are today given the backdrop that we're all living in. Just curious looking forward to fill you commented on the stability the expected stability of the dividend. I'm just curious if you know how you guys see the range of leopard Returns on Equity, you know, whether you were to go, you know, drop down to maybe seven times or move up to nine times wage. What do we kind of looking like there and and part of that is obviously entails something. We don't know exactly and that would be your your hedging strategy. Thanks.

Yeah, so so, you know as I mentioned, you know, we around 7.8 the one now after replacing April runoff and we're replacing may run off so you can kind of figure eight times is is what we view as a reasonable, right and and returns are going to be strong. We're for exceeding well exceeding the platform all in is as well as feeding the returns the cloth cover missing in our common actually leverages from that, right and and with and frankly there's there's a heavier racial mezzanine too, and it was one quarter ago with the trip. So so future returns look great now at the margin we're reinvesting we're looking at Birth

Plus percent far away's on on on new acquisition and but the but the base portfolio is kicking out some really nice insurance right now. I'm on your press is anything that I could dig it out of the cube, but is there anything coming up that you might have a rate benefit on that? You know, what are their five-year fixed. Fix the floating and there's a period in which you can call those right if anything is is above Market.

You talking about prefers? Oh, yeah, your preferred stock on a hundred million of unsecured borrowings or truck, right? Yeah, very long, you know floating-rate over Libor that would be so this the series he might be an opportunity depending upon how the the mortgage Reit Equity markets Channel down here over the next couple of quarters. Okay? Well, thanks for the comments folks and and you all be safe as Texas comes out of quarantine here in the weeks ahead. Thank you.

And next we have Eric Hagen of KBW.

Hey, thanks. Good morning guys, and my best wishes to you as well.

Yeah, one of your peers was just talking about some of the benefits of being able to fund off-balance-sheet with tva's just any thoughts on whether the moves, you know from last quarter off the funding pressure that we saw just across the space like you guys talk about your opening remarks just you know, really just accelerates remove potentially into the fixed-rate market just in order to access that that whole balance sheet funding which can be very valuable at certain points in the cycle. Thanks. That's that's interesting. When we view the retail Market is behaving very nicely in here. We don't see availability of repo as a problem. The little town of parties have had their book of business has received significantly because of all the you everything that occurred in March and our

I might characterize them as having a being hungry for balances. So they're not they're not pushing back with any kind of, you know, higher haircuts or anything of that and plenty of plenty of reason for them not to push hard on raise. You know that said you also gotta look at financing package. If you sell to consider your caring and all the great risks associated with that kind of a position so you really are Levering up with that so long

I don't see any reason for us to to be playing in the market. One thing would be taking 30 year fixed kind of exposure that we're not dead. It's not really part of our strategy is this point?

Okay, and and and then what prompted the sale and current reset artist vs. Longer recite. Can you just you know, I feel like I asked if maybe once a year, can you just give us a snapshot for the same price and spread that you expect in in a current reset bucket versus longer reset bucket today.

Yeah.

Yeah, sure part of part of the decision. The reason was told to reset Security. It was as simple as the larger fires if if you would like to do size this quarter the larger buyers we're looking for shorter reset paper. We saw the combination of pre reset, uh recently reset faiths arms, Jenny May arms, etcetera. Uh, mainly because that there was a there was a decent demand for that at that point in time having said that off remaining portfolio. It's it's still 41% shorter reset and 59% longer reset and we we expect that mix to it's nice outside of of where we've been it's kind of been 6041 Waverly versus another

Yeah, that was kind of kind of.

In a nutshell guys guys were specifically looking for shorter reset papers.

Okay, and what are the prices look like in in in each of those buckets right now? Can you just give us a snapshot there? And then and then one on the head inside while now just the longer duration Gap is that was the reason for that, you know on it's on it's the Gap is going in a certain direction or something or quarter balancing. I mean, what kind of what kind of duration do you guys feel comfortable running in this environment? Where is your direct variation concentrated on the yield curve? Thank you.

Sure. I mean if you look at performance over the quarter children reset Security has underperformed. It's under Yuri. They were down in a quarter to a point that happened probably took it reset Security for us Point price is still a link to earlier Post Corner end. You're seeing spreads recovered nicely in in both segments about book off the duration Gap. We took our Gap out to 6 months which in this environment where the FED is very comfortable with that and if you look at our remaining opposition of 4.4 people did it essentially covers the bulk of our longer reset position and and we're more or less unhedged on our shorter reset. So our exposure given the coupon of our longer resets right now it really we're still kind of looking in the Tube app.

Right in the area where we see risk on our longer reset book probably inside of two years actually probably closer to a year and half and so we're mindful of that and also offer to take in mind keep in mind that arms underperformed, uh fixed rate, you know, cuz basically the FED came in on the 23rd and they bought agency fixed rates and if you look at the public agency market that they did not buy directly. It was basically arms and CMOS. And so now as you get over quarter in fixed rates have Rich and so much that there's a lot of really nice bed or arms predominately.

From Banks and so because of that we feel like even if rates go up the first fifty or so basis points spread thin arms have widened so much that there's probably not a lot of room for prices to slip but so we're comfortable running a little longer right now because spreads are wider and we thinking in a upgrade environment those spreads with tighten back in. We don't have I mean if you just look at where I mean you got Thirty or two and half trade with a 10104 handle right now and you know, we've got our entire Arm book marked off with the 103 handle. And so if you just kind of interpolate where those prices would go great sell-off, we think it makes sense to not hedge as much right now given where spreads are Anja were not of the mindset that the FED is going to tighten anytime soon. So we're probably going to run from the longer side and the next few months and wage.

Right now we have closer to 50.

Set of our liabilities hitched, and I think that's probably where we'll be for the next few months as opposed to prior to this. We had 70% of our liabilities hatched. Right right. Thank you very much, sir. That market color guys and stay well. Thank you very much. Thank you.

The next question we have will come from a Bank of America. Good morning everyone and and hopefully everyone is is doing well. I I hopped on the call a little later. So I might have missed it. But could you remind us kind of what your near-term outlook is for for a prepayment speeds at this point given the low-rate environment?

I'm sure I'll put that if you if you look at armed security right now last month generically ticked off about 18% from the prior month and fixed rates kicked up about 40% And so I think you know generically fixed rates wage out of in the mid twenties and arms were in the in the high twenties given so you have conflicting stories right now right rates are down and so I'm very refinances should be up and at the same time between all the forbearance and the disarray and the primary mortgage Market. We think speeds are going to be well contained in our book and and along with that our current reset book those those loans will continue to reset down such that are shorter reset the gross whack is going to Rome.

Down to around 3% which with 30-year no-cost refinance rate closer to 3 and 1/2. We think that's a very compelling speed story going. Most of the the speed pressure in our book will be on our longer resets that are more newly originated in the last couple of years and will have a slightly higher gross. So having said all that putting the pieces together and we think speeds are going to be very well contained in the next few months and probably they're obviously going to be slower than what just generic interest rate forecast would have if you didn't take into account the virus and everything else and so we we really feel good about our speeds going through over the next five or six months.

Okay, great. Thank you.

Oh, sir. No further questions at this time Google and conclude today's question answer session. I will now like to turn the conference call back over to Liz Lindsay crap when it comes to remarks ma'am.

Thanks again for joining us today. If you have further questions, please give us a call. We look forward to speaking with you next week.

And we said

Thank you, ma'am it to the rest of the management team for your time. Also today the conference calls now concluded at this time. You may disconnect your last. Thank you again everyone. Take care and have a great day.

Are you guys still up?

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