Q1 2020 Earnings Call
Dead dead dead dead dead.
Dead dead dead dead.
Dead dead dead dead dead.
Good day and welcome to the analy first quarter 2020 conference call with all participants will be in a listen-only that should you need assistance, please signal conference specialist by pressing the star key followed by zero after today's presentation through will be an opportunity to ask questions to ask you a question. You may I started and one on your touchtone phone which are your question, please press * then two, please note this event is being recorded. I'll now like to turn the conference over or become dark head of investor relations. Go ahead.
Good morning, and welcome to the 2020 earnings per month including with respect to covid-19 impacts, which are outlined in the risk factors section and our most recent annual and quarterly SEC filings actual events and results May differ materially from these statements. We encourage you to read the disclaimer in our earnings release in addition to our quarterly and annual filings.
Additionally the
This conference call may contain time-sensitive information that is accurate only as of the date hereof. We do not Undertake and specifically disclaim any obligation to update or revise this information.
During this call. We may present both gaap and non-gaap financial measures a Reconciliation of gaap to non-gaap measures is included in our earnings release as a reminder Annalee routinely post important information for investors on the company's website at ww.w.
Content referencing today's call can be found in our first quarter 2020 investor presentation and first quarter 2020 Financial supplement both found under the presentation section of our website month only intends to use our webpage as a means of disclosing material non-public information for complying with the company's disclosure obligations and regulation ft and to post an update investor presentation materials on a regular basis and only encourages investors analysts the media and others
To monitor the company's website in addition to following Emily's press releases SEC filings public conference calls presentations webcast and other information and post from time to time on his website. Please note. This event is being recorded participants on this morning's call include David Finkelstein chief executive officer and chief investment officer, Serena wolf Chief Financial Officer named like Sonia had a residential credit Tim Gallagher had a commercial real estate Tim Coffey Chief credit officer and head of securitized products and off. I'll turn the call over to David.
Thank you and good morning everyone since we last spoke on our market update call on March 16th. We've seen the covid-19 pandemic spread rapidly. We would like to again extend our deepest sympathies to those directly impacted by the virus and we hope everyone joining us for the call today continues to stay healthy keep ourselves our families and communities safe and Ali continues to work remotely until it is appropriate for us to return to the office. We are grateful to have had well established business continuity planning in place prior to this crisis just to ensure the well-being of our staff without disruption to our operations.
Now on today's call I'll briefly provide an update on the market and how we manage our portfolio during the extreme volatility in March and leaders of each credit business will go through their respective or folios. Serena will discuss the financials and I will follow up with our positioning and Outlook going forward.
That was the covid-19 outbreak wreak havoc on financial markets and the economy. We witnessed the fed and Congress intervene in unprecedented ways. The FED is enacted policy stimulus at a record Pace announcing larger and broader based measures than during the 08 financial crisis. They reduce the policy rate to the zero lower bound provided ample liquidity and repo and $5 swap markets conducted record asset purchases and treasuries and MBS and established lending facilities to support a broad array of markets contextualize. The the magnitude of the fed's actions. Its balance sheet has grown by more than 50% in the past six weeks. These measures have helped support financial markets and should prove beneficial for the economic recovery. Once we find ourselves on the other side of the virus. And in addition to the FED Congress has now passed four rounds of fiscal stimulus measures with more than 10% view data u.s. GDP
We believe that the extraordinary.
Steps that policymakers have taken to address the problems have been and will continue to be effective in normalizing markets and the economy, but this will require patience given the magnitude of the loss impact.
No turning to markets in our portfolio specifically I'll begin with the agency market liquidity vacuum. We experienced in March was akin to the financial crisis, but it was the velocity of the risk-off move that was most notable normal trading relationships among asset classes almost instantly decoupled volatility spiked and spreads gaps substantial wider specify pools were particularly impacted as pay up-to went from all-time highs as the market approached and impending refi wave the local Lowe's as investors wage rushed to the sidelines to raise the quiddity adding to this turbulence dealer struggled to intermediate as the balance sheets were constrained by elevated Holdings heading into quarter-end off our portfolio management efforts have consisted of strategic asset selection unique hedging strategies and a particular focus on the quiddity in fact throughout January and phone number.
Weary in addition to a modest outright reduction in and see assets. We were shifting out of generic pools in the lower coupon tva's since that one third of our reduction in our pool purposefully. Okay prior to the volatility we experienced in March. We reduced our leverage over the quarter from 7.2 times to 6.8 x in order to preserve capital and it's the same price action the decline in our portfolio by over $28 billion over the course of two one was largely driven by sales of generic non-story collateral and the composition of our portfolio portfolio improved as a result of these decisions percentage of what we Define as quality specified pools now represents 85% of our portfolio moved up from 69% in the prior quarter with the remainder made up of season collateral the shift in portfolio makeup has proven prudent thus far as specified pools have had a strong.
Rebound in the second quarter with the average pay up on our portfolio improving by nearly a point since quarter end now looking forward in an environment with uncertainty around housing and pre-owned as we are confident that our portfolio is better positioned to perform throughout a range of different outcomes of additional note vigorous fed actions have dramatically improved the technical Landscaping MBS Nets apply to private investors was forecasted to be roughly $500 billion at the start of the year, but with the fed pivoting from runoff mode to becoming the largest fire in the market off the net Supply outlook for 2020 has turned sharply negative. The impact of fed purchases is tight and spreads and reduce volatility meaningfully while settlements will continue to clean up clean up the TV 8 float benefiting roll markets in addition repo financing remains ample for the product as it was even during the height of the volatility in March.
Tailwind for the
Tire sector both on the asset and financing side and thus we are very constructive on agency going forward now regarding our hedging activity in light of the significant rally. In fact, we took proactive steps throughout the quarter to manage the contraction in the duration of our portfolio first. We had exited our treasury Futures positions prior to the widening and swap spreads that occurred at the end of the quarter second. We added receiver swaptions at the beginning of the quarter which proved effective in managing the sharp decrease in duration in our agency assets and March be able to exercise or exit many of these options to the notable gain and continue to deploy more option based hedge has given the cheapening and volatility that has occurred thus far this quarter adding a options is beneficial way to manage the risk of longer-term rates, moving higher further out the Horizon. And finally we extended the hedges further out the curve as front-end Hedges off your little value age.
That's fed is anchored short-term rates the zero lower bound as a consequence the decline in our swap portfolio is primarily attributable to the reduction in short-term swaps in turn off the average maturity and lowering the notional amount of our Hedges our decision over the past few quarters to keep most of our swaps in libor-based hedge has benefited the portfolio is life meaningfully above overnight rates throughout the latter part of the quarter. However, we expect to spread to normalize as we have seen in similar widening episodes and feel comfortable heading into the second quarter with the majority of our swaps now, you know is Shifting to the credit sides while no portfolio is immune to the impacts of the pandemic we feel we are positioned to withstand current volatility given the composition of our portfolios and the relatively low leverage across our businesses are cautious view on the economic cycle and credit pricing over the past number.
Orders is somewhat mitigated or exposure to high beta products. We are pleased with conservative stance our residential and Commercial teams have taken with respect to credit quality as well as the Strategic approach that our middle-market lending business is taken that their focus has been on financing non-discretionary non-cyclical companies where the vast majority of the portfolio is invested in this Central business with our origination and underwriting teams across all three credit teams have been focused on actively monitoring our existing loans and maintaining close contact with our borrowers and sponsors off the impact of the virus continues to play out. And now with that I will hand it over to Mike to begin with the Residential Credit sector.
Thank you David the Residential Credit Market similar to the broader fixed income and Equity markets experienced significant disruption in late to 1 as the downstream impact to the economy due to the covid-19 became increasingly apparent Residential Credit spread started to widen in the second week of March with significant asset price decline and liquidity temporarily evaporating from the market wage at markets were extremely turbulent over the following two weeks. Even a vicious cycle of deleveraging margin calls or liquidations and Redemption concerns as technicals laid on asset prices similar to the broader credit markets the resi market began to stabilize with spreads moving Tighter and early April has forced be leveraging subsided and Market participants turned to evaluate assets upon Faith value most sectors within the resi market while tightening significantly from mid to late March still remain wider than previous levels for context AAA Prime jumbo spread.
trading in the loan to $100
To swap three virus touch 600 to 650 to swap satellites before tightening into the low mid 200s currently new origination crtm twos trading at par hath phir Iris hit mid High fifties at the Lowe's and are currently trading in the low 70s dollar prices and non-agency Legacy Market generally a source of stability trading in the low-mid 100,000 to swap pre virus hit 10% yields before stabilizing in the four-and-a-half to five percent yield areas the new origination not agency Holo Market also experienced significant disruption securitization was no longer a creative or viable and Market participants repriced assets. Give an industry-wide forbearance policies and economic disruption this in turn forced a number of non-agency Gators and Originators to close their operations. Stop accepting new locks and being forced to liquidate Holdings on Warehouse facilities.
Moving to our portfolio. We price to securitizations in January and February 2020. I envied one and O B X 2020 GXP one with total deal sizes of that $75 million and 468 million respectively those transactions priced at a weighted average cost of funds of $133 and $100 swaps with Annalee retaining approximately 810 million market value of Securities across those two deals and only has now secured ties ten residential whole loan transactions since 2018, representing our discipline and commitment and obtain a term non mark-to-market financing.
The economic risk of our Residential Credit portfolio ended the quarter at approximately 2.6 billion gallons from three point nine billion at the end of two for giving the after mentioned whole loan securitizations paid off and targeted security sales consistent with the deleveraging of the agency portfolio turning to the residential home portfolio. We ended q1 with approximately 1.3 billion of economic risk, a loan portfolio is conservatively positioned as a consists of a hundred percent first name new origination collateral which strong credit characteristics including a weighted average seven sixty-two voir psycho 67% Original El TV and a 37% DTI layered risk within traditional credit metrics is also minimal within the portfolio as less than 1% off loans have an original flight go less than seven hundred and original LTV greater than 80% at quarter-end our residential Securities portfolios that at approximately 1.3 billion with 5 off.
30 million of those Holdings representing positions in our OBX securitizations similar to our hold on portfolio. We believe our Securities portfolio is conservatively positioned with 55% of our assets, excluding Legacy rmbs rated investment-grade at quarter-end our aggregate CRT positions. It's slightly over two hundred million market value comprising only 8% of Residential Credit exposure month in addition to the strength and conservatism of our portfolio and all these presents as a programmatic securitization issuer the ability to transact in either Securities or whole loans and the current lack of a legacy operating platform put Santa in a new position among our peers as we evaluate the new landscape within Residential Credit with that. I'll hand it over to Tim Gallagher head of commercial real estate.
Thanks.
Like the commercial real estate property and credit markets continue the momentum of 2019 and got off to a solid start in 2020, but that progress abruptly stopped with the onset of the coronavirus real life crisis as the sector became one of the first to experience the impacts of curtailed travel and shelter in place orders hospitality and Retail saw an immediate impact on operating performance initial data from multi-family office and Industrial are better, but even these more stable asset classes are not immune to near full economic shut down Commercial Club had started to widen in the second week of March in line with other credit markets and certain Theory Market participants such as money managers treats and hedge funds were forced to raise cash due to find out flows down agent calls and redemptions by the third week of March several mortgage rates and other funds could not satisfy margin calls prompting them to seek forbearance with lenders while some Vehicles were liquidated altogether.
For adding to pressure on spreads through these Force liquidations similar to the broader credit markets the liquid Commercial Credit markets began to stabilize and spreads moving tighter in early April as forced to be leveraging subsided while Triple A paper has significantly tightened from its March wides credit continues to languish without a clear buyer base or financing option in addition servicers ability to wrap up Staffing their liquidity to provide advances and their assessment of special servicing and workout fees continue to be top-of-mind and Industry discussions.
According to research reports more than 2,600 borrowers totaling nearly $50 billion in loans have requested forbearance, as of the end of March. This backlog will be an ongoing effort into existing credit bombs in the cmbs market.
Your imagination Market remains largely Frozen as Market participants await further Clarity on the macroeconomic impact of the disruptions and the resulting direct impact on the commercial property sector wage certainly has shut down debt fund lending as their existing financing execution remains unknown and the new issue series. Clo market is closed Warehouse counterparties are either on home or I've had to adjust pricing and haircuts. So materially the new direct lending is largely absent balance sheet lenders such as Banks and insurance companies are focusing on their existing portfolios. As for bandwidth requests have swamped institutions that have significant cieri exposure.
Turning to our portfolio prior to the dislocation. We had originated three whole loans in the corridor for a total of 172 million to bring the overall Siri portfolio to approximately 3 billion in assets with a billion economic risk.
We continue to maintain more than one point two billion of unused capacity on our term Warehouse facilities. And the majority of our loan portfolio is financed through a term non-recourse non-market c o e clo we issued in February 2019 as a payment dates in April across both our loan and securities portfolios. We received 47 out of 15 agents. See MBS portfolio is mostly comprised of industrial multi-family and office assets as we chose to invest primarily in the single asset single borrower Market where we can underwrite each ass moreover underlying loans and single asset single borrower transactions are the larger sponsors and are secured by higher-quality stabilized real estate. Finally. Our Equity portfolio is comprised of need-based real estate including grocery-anchored shopping centers health care and not leased assets financed with long-term fixed-rate loans.
our portfolio is
Positioned with a focus on strong sponsorship a premium on cash flow and executable business plans and best-in-class operating Partners. We have a dedicated in-house asset management and legal team leadership of the seriousness have been through multiple Cycles dating back to the 90s prior to the dislocation. The portfolio was performing according to our business plan and we expect the vast majority of our assets to weather the storm and rebound when the economy reopens and with that I'll hand it off to Tim coffee ahead of credit.
Next to him as a reminder the Middle Market effort was the first of the firm's three credit strategies to reside on an elite balance sheet commensurate with the arrival of the group's current leader of the 2010 at the time the firm's Founders Mike Farrell and Wellington denihan sought Professionals in the Middle Market space with the solid track record. Not just through the 2007 to 2009. But over multiple Cycles today handling Middle Market is a two point three billion dollar business comprised of $51 that are 100% back by Tom to your private Equity sponsors despite recent volatility and heightened uncertainty. We believe the Annalee little market portfolio is uniquely positioned given our tightly-wound approach to an Aero industries that dedication to private Equity firms with well-established track records a line to our industry set and deep first order due diligence. I cannot emphasize enough. We do not compromise on utility job.
The composition of the Middle Market portfolio is 70% first name 30% second lane the number of hours in the portfolio and our percentage mix between first and second lead has not changing really over the past two years. The group's asset expansion has been driven by growth from within our portfolio across multiple vintage investment years as opposed to the rapid addition to remove hours much like how we handled past periods of intense convergence in the local Marketplace and I can assure you the past three or four years where as intense is any. We have seen we tackle this convergence by pruning. We prune the number of Industries to which we are willing to lend from 16 to 8 over the past four years and corresponding with the number of private Equity sponsors. With whom we partner to better align with the sectors We Believe are counter-cyclical non-discretionary and defensive.
Consequently reduce the number of our tier one private-equity Relationships by almost two-thirds since 2010 is careful concentrated approach has resulted in the office mentioned our account remaining virtually static for two years.
We readily admit our pruning was quite early. However, the Middle Market loan space is illiquid in the best of times consequently pruning must come early in our view in addition. The minimum wage has always been a pure-play direct lending business every. One of our two point three billion dollar book is a direct loan with no exposure to Securities a securitizations. We use very often third-party non-recourse Leverage is our past disclosures indicate. It did not change in the first quarter of 2020 and each of our three primary financing counterparties have been consistent with their approach off since the relationships were initiated on average each of our term facilities maintain a maturity that least four point six years out from today. We have not experienced to change and valve adjustment on the portfolio forequarter read nor in the days subsequent to quarter-end as a relates to the specifics of the portfolio and the weighted average unlevered return of the first name book is
approximately 7.6% full before
The weighted-average unlevered return to the second dream book is approximately 11.2% fully floating yielding an Amalgamated unlevered return for the portfolio of approximately 8.8% fully floating in addition to the modest third-party leverage of 0.7 times. I referenced previously. We are also differentiated in the underlying leverage profiles of our investments the weighted-average Detachment Point through our first lead exposure is approximately 4.6 times even top and the weighted-average Detachment point across the book is approximately 5.1 times. Even while this weighted average Detachment point is comparatively low. It reflects the substantial free cash flow generation inside our second lien exposure specifically, whereby are secondly leverage today reflects in many instances where firstly was originally executed at those deals inceptions consequently wage.
Comfort it again spread duration risk. This point is further Amplified by a portfolio aggregated across past integers with short effective durations, 21 months on the first lead and counter-intuitive Lee twenty months on the second week the earlier mentioned of a static portfolio power account further illustrates. This point has acid growth from existing values is accompanied by required lender consistent and support mitigating against Federation risk. Lastly 85% of our portfolio is comprised of new cash Equity transactions to clarify with our new cash Equity comes in to buy a business with median Equity contributions, representing 44% of the capital structure underneath this moving to portfolio fundamentals off the fundamentals of the portfolio we have in many respects that aided through the month of March due the mission critical nature of our underlying Powers 90% nine hundred ninety percent of analyzing log.
Market group exposure resides within Industries and bars categorized as essential under federal guidelines enabling these hours to continue operations further an additional 9% of our aggregate exposure not deemed essential has operated unimpeded and grounds of the month of March. We proactively has been in contact with all $51 and our portfolio off and received one interest forbearance request on a $14 first-lien exposure interestingly $153 million of the $222 million. We have categorized under a quarter and watch list witnessed considerable benefit in March given the nature of these Powers operations and we suspect that should continue in the coming months as you will hear from Serena the middle mortgage loans are classified as held to maturity level three and subject to recently imposed Cecil reserves reserves taken in this quarter alone are multiples of what the Middle Market wage.
cube root of actual losses have been
Overnight and a half years at an elite. We are certainly concerned with the prospects of deteriorating fundamentals and its potential impact on the Middle Market space generally not surprisingly a variety of influences in a stifled new issue activity with the exception of a few select industries that have been sources of opportunities for Annalee in the past.
You select Industries are currently well represented in our middle-market portfolio unlikely to expand going forward Trends within the clo market for 10 difficulty on the larger end of the middle market off of new issue and secondary the volume of amendments forbearance request and workout activity and a condensed. Generates a supply to personnel and balance without precedent in a market wage is now operating with a non-bank majority in charge this signifies a prolonged reduction in new issue for the traditional middle-market. We are very cautious about secondary Market participation all them very narrow opportunities that do exist given handling middle markets biases, which mandate intensive due diligence as I mentioned earlier. We expect our involvement will be wage board primaries.
Both new issue and Tack on acquisition activity and like wider pricing will certainly accompany these lower lever transactions in wrapping up. It can be said unequivocally the middle of a group will be as measured as we have banned in our nine and half years and handling and for many of us individually that caution has been a staple of our behavior in our prior fifteen twenty twenty-five years before joining. I know that our experienced team will continue to access to you to Define strategy shared by a group with an entrenched credit culture and no turnovers since formation with that. I will turn it over to Cerritos.
Thank you, Tim and good morning everyone. I'm sure you will agree with me after that overview that we have the best team in the business. I'm pleased to join you today for this earnings call and provide you with color on our financial results and the success of our remote close.
I will provide brief financial highlights for the quarter ended March 31st, 2020. And while our earnings release discloses both gaap and non-gaap call results. I will be focusing this morning primarily on our call result of related metrics all excluding, PA.
David mentioned earlier given the great shut down the latter part of two one was challenging. However, we are proud of the results given the enormous headwinds that management and the company faced as we close out the quarter of a book value per share with seven dollars fifty for the first quarter a 22.4% decrease from 2019 year end and we generated earnings per share excluding PA a month of $0.21 for the quarter on a gaap net loss of $2 57 as compared to $0.26 and $0.82 for the fourth quarter of 2019.
The decrease in Book value is attributable to the increase in unrealized losses on the swaps portfolio of approximately 3.2 billion do to lower Ford rates compared to a gain of $778 million in the project as well as higher unrealized losses on instruments measured at fair value through earnings of 730 million down from losses of six million in the prior quarter, which is offset by an offer of $997 million from our agency portfolio.
It is.
To know that the vast majority of our assets and liabilities are up here values and our book value reduction illustrates a significant Market disruption that occurred prior to quarter-end and the impact on Fair Value measures Black Book value decline was not a function of forced asset sales, but rather and realized mark-to-market losses with potential for recruitment.
Tim Gallagher and Tim coffee provided an update to our and FML businesses earlier and the impact of covid-19 on their portfolios given the market turmoil and uncertainty around the long-term economic picture of it was certainly an interesting quarter to adopt the Cecil standards.
We recorded reserves associated with our private businesses of 139.6 million during q1 consisting of 39.6 million of opening balance Cecil reserves and 100 million of faith during the quarter primarily resulting from the impacts of covid-19 on our borrowers of that that being sixty-two million or more General reserves related to forecast for a deterioration economic conditions of thirty-eight million in totality these results comprise 3.7% of our acreage. Ml portfolios portfolios loans as of March 31st, 2028.
We've discussed on previous owned and calls. We have implemented an extensive process to determine appropriate Reserve to the a Craig and FML businesses, which includes developing policies systems and controls including the use of to suck any models. We have found that the key inputs into the season model that have material impact on the reserve our the credit attributes of the loans life of the loan driven by prepayments and the economics involved with a lot of representing a considerable challenge given variability and data this quarter. We spent additional time with the businesses analyzing the results of the reserve calculations and ensuring it's consistent with our expectations given the quality of the portfolio and the performance of the boroughs
The full impact of the shutdown to the economy is yet to be seen and we will continue to monitor specific asset performance and economic projections as we determine future Cecil reserves. We view it to be critical in that environment to consider the adverse economic scenarios available in this process and we remain comfortable with our existing credit portfolios, even given the thoughtful approach outlined by the a Craig and MLK latest. It should also be noted that are Residential Credit businesses have elected fair value accounting and that's the entirety of that portfolio is recorded in market value, including our whole loan call loan holding inconsistent with the vast majority of our assets.
Turning to earnings the largest factors quarter of a quarter-to-quarter earnings, excluding PA or higher premium amortization on agency investment Securities on 41.9 billion of Aging security sales as well as lower average balances on our credit portfolio. However, call did benefit from a reduction and financing costs with lower average repo rates down to 1.77% from 2.1% combined with lower average repo balances down tonight 6.8 billion from 102.8 billion. We expect continued reduction in financing costs with a repo rate of 1.23% at quarter-end.
The portfolio generated 118 basis points of nym down from two four of 141 basis points driven primarily by decreasing coupon from lower average interest-earning assets balances off an increase in premium amortization that I mentioned a moment ago analyze core return on average Equity excluding PA was 9.5% for the quarter in comparison to 10.56% off a 2019.
It'll be many factors that play over the next quarter with respect to expectations for unemployment forbearance and other issues being experienced by the mortgage Market that will likely mute prepayments relative to what we would otherwise expect given a low-rate environment.
The change in our efficiency metrics relatives to Q4 2019 being 1.98% of equity for the first quarter was primarily driven by our reduction in equity rather than any natural increase in operating expenses.
Also to note our internalization transaction is on track and we expect to close by the end of the second quarter.
I'm only was able to weather the storm from this dislocation and and the quarter with an excellent liquidity profile due to our high-quality asset composition across the businesses.
A strong repo counterparty relationships and reputation broad diversity of financing arrangements and the ability to tactically utilize our broker-dealer a color for incremental liquidity.
Well numerous firms experienced difficulties meeting margin calls, and now the funding disruptions the stability and resiliency of our funding sources was on display as our repos finding operations were uninterrupted. We continue to have good access to reflect financing and I direct lending businesses did not experience any meaningful funding pressures with term facilities.
To protect the health and well-being of our employees their families and communities remote work requirements began in phases in early March, dating with a company-wide exercise on March 13th, 2018 to test connectivity and functionality. All employees were able to successfully perform their duties in this testing and we have operated remotely since that time as a result. We completed our quarterback is remotely without any interruption or significant changes to our normal processes or controls resigning from remote work requirements. This is a testament to the quality of our Personnel processes and it systems.
Finally, I would like to acknowledge David to stepping into the role seamlessly and I'm try to Waters despite the fact drop he has demonstrated incredible Poise and character throughout his time and we're all thankful of his leadership month challenging times can bring people together. And and we as a management team have cemented strong relationships in a short time and we look forward to brighter Horizons and continuing to bring value to our stakeholders month and so in conclusion with that, I'll turn over to David who will provide commentary on our Outlook and positioning.
Thank you, Serena. And we hope the relatively deeper dive into the credit businesses. This quarter proves informative in light of current market conditions. Now as with any. The Thursday Market volatility, there are three conceptual stages of stabilization and Recovery as it relates to how we manage our portfolio phase one involves preserving capital and showing up a quiddity which we have successfully completed this through the measures. I have already discussed in phase two which is how I would characterize where we are currently there are opportunities to deploy Capital the agency sector why we obtain more information on the long-term outlook on the economy. We are looking forward to transitioning from a defensive posture to a more offensive one, but this locations and constrained liquidity do persist and as a leopard participant we must remain focused on the stability of financing available for our investments and agency MBS currently provides the dog.
30 and even as the Fed
Ships to a more measured QE Pace aimed at lowering mortgage rates and economic stability. The agency sector will continue to benefit we view the outlook for volatility to be lower and easier regulations to facilitate dealer enter mediation in the treasury market markets functioning should continue to stabilize while a great deal of uncertainty Remains the environment for our interest rate and convex the risk is much more favorable heading into the second quarter now phase three which we believe is near involves strategically allocating Capital to invest position the company in a new environment as we look ahead we will benefit from having numerous ways to capitalize on this locations across markets and those with ample Capital will have many opportunities to choose from and we sit and healthier liquidity position today. Then we have over the past few quarters. There will be abundant prospects across our businesses which again highlights the Dead
Instead of our model as we are able to most optimally balanced the best risk-adjusted returns available episodes of extreme volatility has witnessed in March are pivotal moments for the growth of family in our team. We have reaffirmed the principal ways in which we've always managed our business liquidity is Paramount scale is critical and relationships matter and monthly particularly on the financing side. And lastly we have been at the view that historical leverage levels for our sector or elevated and we expect them to decline in the coming quarters, which is not specific just the agency market. And lastly I wanted to thank our team had the honor of stepping into this role as the world as we had all known. It turned upside down. Our team is truly worked tirelessly and collaboratively to successfully managed the unprecedented markets. We have experienced. The analy culture has been a bright light of this the turmoil wage.
And I'm excited for what is ahead for our firm and now with that we can open up the call for questions operator.
We will now begin the question-and-answer session. You ask a question. You may press * then 1 and your telephone keypad to withdraw your question, please press * then two. If you're using the speaker phone, please pick up your handset before pressing them at this time. We will pause momentarily to assemble The Rock.
Canterbury question today comes from seed Delaney with JMP Securities, please. Go ahead. Good morning. Everyone. Thanks for taking the question. It was great to hear from the individual credit heads given the environment we're in right now and I would say you all came across as sounding very comfortable with what you own today. I guess the question that that raises is your posture towards credit generally as a team a lot of people seem to be running from the hills to the hills because they I think more because of financing with this is but do you see this is more over the next six to nine months more an issue of managing which you have in in in minimizing losses, or do you actually see potential opportunities from the dislocations that have occurred? Thanks.
Hi Steve, this is David.
And things like David is a good to hear from you speak and thank you for your comments on on the credit businesses in terms of the more informative approach. We did want to make sure that everybody understands exactly how these businesses are operating in the portfolios or performing and to your question, you know, there obviously is a lot of uncertainty still remaining with respect to how the economy and credit revolves. Um, as I said in my prepared comments agency is is the core of the portfolio, um, that does represent the best shelter in the storm here. I'm sure the factors obviously quite attractive now with respect to credit going forward. Each of our three credit business is very likely will have opportunities, you know, there's three components of off of the repricing of credit that we've experienced in are experiencing. There's a technical cheapening which we saw in March when there was overhang and Ready Credit some commercial assets. There's the fundamental dog.
Calling the price which is still yet to be determined and then there's a risk premium, you know, given the uncertainty to what extent of you just getting compensated for bearing more variables be returned. So we we kind of think we're beyond the technical component now, we're figuring out the fundamental price and credit and whether it's warranted I've given current pricing and what kind of risk premiums we should expect to achieve for for making these Investments. And so there is still work to be done and we have to have more information but the way I would characterize it is, you know, starting with the Residential Credit business when we started the year, we felt that that would be a growth area given the fundamentals of the residential landscape off. We still think it will be a growth area. You know, there's obviously been a dislocation and and you know loan origination is confined to Prime jumbo Christine loans and the gses and there's birth
A little bit of a uh, uh lack of sponsorship for the loans that we have historically acquired but we think it'll come back. We think securitization will come back and that being said I'm not going to trade cheaper financing is a little is going to be a little bit more expensive but uh, but we think the returns are going to be commensurate with the risk. So we do still think that's a growth area our middle-market landing page. This is Tim discussed that we believe will perform admirably through this and will be differentiated from other businesses in in the Mid-Atlantic space. And so we do anticipate more opportunity and we have the liquidity of the Reit uh to to potentially add assets if it's warranted. But again, we still need to figure it out with respect commercial sector. I will say that that you know, the focus over the near-term is going to be a little bit more on the asset management side, but it is the it is from an economic interest standpoint. It is small wage.
the business or has been the smallest business in our in our credit, um allocation, and we've been very conservative both with respect to uh,
Allocating Capital as well as the the assets that we've acquired. So, um, I think we're kind of waiting in the wings here. We will see shortly how pricing really shapes out and if we think it's cheap relative the fundamentals in the risk premium. We don't have a problem allocating Capital but in the meantime agencies is is the shelter in the storm understood and super helpful. And just one question on that is the your favorable early 2020 outlook for residential based on the strength of the housing market, etcetera. Obviously, we don't have a secure job market today. We'll see if the FED ads AAA or two towels, but do you are you do you believe that once we see, uh, a securitization Market awaken that the problems we've had with Warehouse lending will will evade and the banks will come back and be supportive of of securitization investment Club.
Yeah, so I think seeing that execution will give more comfort that there is in quiddity two Banks, but I will also say that we're starting to see some aspects Securities of Warehouse lines actually open up, you know, it's addict higher-cost. Um, but nonetheless, we're at a point now, you know a month out of the back of the real volatility where banks are starting to look at the sector. Um, you know, it's it's dependent upon the assets as well as the counterparty, but there there is some Silver Linings with respect to Warehouse lines, and the two will likely occur coincident both securitization, and warehouse is opening up. Thanks for the comments and everyone stay safe. Thanks. Thanks, Steve Jobs.
And our next question comes from Kenneth Lee with RBC Capital markets, please go ahead.
Hi, good morning. And thanks for taking my question. Wondering if you could just share with us any updates thoughts on your current dividend coverage. Thanks. Sure. So thanks for joining us today. Can you know we will have more formal guidance in a point in the future with respect to the dividend? What I what I will say God is, you know, we recognize there certainly have been Cuts in the sector and we're aware of the guidance that analysts have come out with so all I can tell you is that we do expect to maintain a competitive dividend yield relative to peers which has been in the low double-digits over the past number of years on Book value. So we're comfortable with with conveying our competitiveness of our dividend yield and we really want to spend the time over the very near-term and not just look at the second quarter, but look at multiple.
Orders out and determine what what we think the appropriate dividend yield yield is obviously our core was was a little bit lower in q1. And as Serena mentioned that there was some catch-up amortization associated with with asset sales that dragged that down a bit. We do expect our core to be a touch higher in the second quarter and we'll have more formal guidance or respect to the dividend later in the quarter.
Okay.
Helpful, and just one follow-up. If I met this one just on the the middle markets lending business. Is there any potential benefit or do you see any potential benefit from any of the vests Federal Reserve lending programs for the portfolio companies within that business? I'll turn it over to Tim to cancel it.
Yeah, I think you know as a relates to the variety of the programs that are out there. I think given where we play we're less influenced by what goes on with a lot of those programs as they have been contemplated today. Certainly. The one area that has not been a part of of a lot of these programs has been leveraged loans. You certainly have seen it on the AAA clo side where they have announced some action, but I think but long story short we are certainly not banking on it. I don't think we need to bank on it.
And I think as a relates to the AAA clo portion of it. I think the the benefit there is probably ultimately going to be outweighed by the fact that the Cecil I think is going to have a more profound effect ultimately on how things get get priced off of the cheapest cheapest package of the capital stack and and the cheapest form of prime brokerage activity that feeds the entire ecosystem in leveraged Lending.
Okay, very helpful. Appreciate it. That's it for me, and hope everyone stays safe. Thank you. Thanks Ken.
And our next question comes from Rick Shane with JPMorgan, please go ahead.
Hey guys. Thanks for taking my questions and I hope everybody's well a couple of things and I don't know if I missed it. Did you provide a quarter to date update on Book value at this point?
I haven't rigged but I will tell you as of yesterday or book was up roughly 7% right around $8 or leverage has declined modestly primarily as a consequence of higher Equity value. We we are right now at about six point six times maybe six and half times and our liquidity is 5 billion in in terms of cash and bought agency MBS.
Great. Thank you for that update. And we really appreciate the the deeper dives into the credit businesses and wanted to follow up a little bit on the ml business page. Look your competition in that space to some extent has some very different constraints. They're subject to fair value accounting versus your Cecil reserves. They typically have hard leverage limits related to their forty acts status. I am curious if you are seeing any sort of Arbitrage created by those differences, and also wanted to talk a little bit about the 3.7% Cecil Reserve in the context of potentially of some of the spread wide mean that we've seen in the space that will impact fair value accounting companies.
Well, this is David. I'll start and then hand it over to Tim with respect to the Cecil accounting on the Middle Market book. I think you know when Tim went through the metrics and the portfolio operate sealed with a Detachment point at 5.1 times ebitda. We feel like that is a very comfortable level, you know from a marketing standpoint even with potentially pricing. So from the standpoint of fair value on the ml book, I think we feel pretty good about it and they'll hand it off to Tim to yeah, I think just as it pertains switch is the first part of your question there walk through where we were with our watch list categorization names, which is approximately two hundred twenty million bucks, you know, a hundred and fifty million off that number the bar is actually experienced some substantial growth in the month of March so clearly an outlier for the names that wage
Would consider to be the the most sensitive to its everything that's been going on but a March was a very productive month for a large portion of those watch list names. So I think what we try to marry up our the the fundamental aspects of the portfolio a coupled with what you're ultimately describing the the spread duration issue that that certainly goes into any feo calculation. I will tell you I think the Middle Market space generally speaking has been largely dead most of them diplomatically, you know, not particularly concerned with spread duration risk, cuz it's something that had reared his head for basically seven or eight years until Q4 June 2018 when it first hit.
And then obviously with this most recent bout beginning in q1 and sixteen Rick we became very very focused on that and I think Dave David spelled out the numbers and the attachment points, but I think the real telling one is as a relates to our effective durations, you know, we carry a second lien book that's got a shorter effective duration of our first lien book which is a clear anomaly but it's also a function of the types of credits that we play in and so we've been very very conscious of spread duration risk wage. Fortunately. I think ninety-nine percent of the space is not particularly concerned with it and the only really find out until you have. Like today.
So certainly I think how people are going to have to assess that is going to be a big part of the the FBO calculations and then respectively potentially the hit. Um, I would also I would also tell you that where you play is very very important in terms of how you imagine effective duration risk. And so when you take a look at our book, I think one of the things that does stand out is the fact that we have shifted our Focus off the last two or three years to morally deranged opportunities that are sub-50 sub-60 of Eva. And they tend to be platform Investments where sponsors are rolling down a specific space and they have to come back to us.
This is obviously.
Complete any perspective acquisition opportunities and that allows us the optionality to either the binary optionality to either stay in the deal or or ultimately exit stage left. It commensurate with any perspective acquisition opportunity. And so that particular segment has really been the most powerful thing that we've strategically done to mitigate spread duration risk.
Tim that's very helpful and it really does come through. I apologize to my colleagues listening but I am and asked one last question. Can you just talk about Libor floors on that portfolio? When is The Benchmark rate for those Investments 3 month Libor?
Powers having an option Rick in a basically 136 cetera. There's since the crisis the 12-month authors and has been less relevant and a lot of the underlying credit agreements. Uh, we do have live more floors on our portfolio with approx 80% of our book has a library fewer how we are financed our counterparties with us on the third party leverage as I do not have live more floors with us. So there is a bit of an armed there. I think as a relates to the one free month option what I can tell you is recently the trend has been to the overwhelming majority being at the one month end.
Thank you guys very much. You bet. Thanks Rick.
Internet question comes from Eric Hagen with KBW. Go ahead.
Hey, hey, thanks gud morning guys, and hope you're well. And hey David. I enjoyed the interview on the website. Thanks for following up on the the adjustments in the Hedge book, you know all and are you guys running a positive duration Gap right now unless you know, what's the message you think for investors with respect to the you know, spread and duration exposure. They can expect to receive right now and Annalee going for sure. Yeah sure. It's good question. So to the first question, the the duration we are running right now is is a half a year as of this morning point five four years and the message. I think we would say is that it's not the quantity of pages into the quality, you know with the FED clearly, um in play for the foreseeable future in terms of policy Foundation. We don't expect short rates increase for the foreseeable future and so having Hedges at the front end of the curb is is is not advisable in our view when we look at the possible risk.
The portfolio the agency portfolio. It's it's very asymmetric and so far as there's very little call risk. The duration of the index is sub to well well below two years as is our portfolio that's really about extension risk. And so how we wanted to create the or or reposition the Hedge portfolio late last quarter is to make sure that we had we had protection out the curb to the extent that the market, you know became somewhat complacent and we did see a bit of a cell up in the longer end just given the fact that there is going to be a lot of Treasury issuance and often times. You know, we think the feds is is you know, providing a a put option on the market. They're not always doing that. So we wanted to make sure that our Hedges were out the curb because you know, like in the summer of 2013 which we all remember in those types of episodes where the market gets tripped up. You can't see a meaningful sell-off of steep a new birth.
So that's where we felt the most risk.
Was I think the average lives a little over nine years on the edge book and you know, our assets are are much shorter and that brings our duration down to about a half a year. And if anything we would we would shorten the time duration a little bit more potentially and we're also a little bit more inclined to use these options here. Um, just given that volatility is says, uh-huh come off the way back to the levels of January and we think that's a worthwhile investment and the tales get cheap you want to buy them and so so we have added a number of pairs options out of the money page option to the portfolio as well in the second quarter.
Thanks for that market call. It was great and and just one on prepays, you know, some people think we're effectively just you know, kicking the can down the road so to speak because of the operational liquidity challenges that have obviously in a mortgage president and race very wide right now. Does your prepay assumption assume some normalization in mortgage spreads and and mortgage rates and just help us contextualize the phone to prepay assumption I think would be really useful. Thanks. Yeah. Are you talking about the longer-term prepay assumption in the yeah, we published. Yeah, so that's that's the average wage. I believe it's five dealers in their average prepays long-term prepaid on our portfolio. You know, we we look at that relative to what you know our model for example, and it's more the reason why we use it is it's arm's length and so far as we're not influencing that we think that all models have real issues right now giving birth.
We have not been at these rate levels before number one. You can't really model the uncertainty with respect to this virus and the ability for life for loans to close at cetera. The primary secondary spread should should contract over times more capacity is added we do anticipate that to be the case. And so it's a little it's a little uncertain with respect to what the what the model impact will be on or whether or not models are are completely accurate but we you know, 17. C p r s a reasonably good long-term estimate give a great environment and you know, if anything over the long term, perhaps a little bit conservative given the quality of the collateral be home, which is now the vast majority of it. I think ninety-nine percent now he's either is either medium or high quality specified pools or season Bond. So we're comfortable with it.
Got it. So since it's a long-term estimate, it does take into account some normalization of spreads over time. Yes. Got it. Got it. Thank you. And then just one on housekeeping. How much are you guys spending over right now through our Cola?
Yeah, I'd say right now. It's 25% of our overall repo book right around there maybe a touch inside of there a bar overall financing. We you know with respect Arcola. It was a very valuable tool during the month of March that's where the the considerable amount of liquidity um was with respect to you know, the FED providing liquidity in repo markets a lot of it ended up in ficc and so we we appreciate having that we have more capacity if we wanted to increase or Arcola balances, but we also you know heavily appreciate the the bank counterparty relationships and and you know, we have to balance that trade-off between overnight financing it ten basis points and going out a little a little further whether it's one month three months and paying just a little bit of term premium on that.
Got it. Thank you so much.
The stay well, thanks. Thanks, Eric.
And our next question comes from Doug harder with Credit Suisse, please go ahead. Thanks David. If you just talked about kind of your outlook for leverage, you know kind of money to do these three about that. You described in your prepared remarks. Sure. Are you speaking with respect to us or broadly? Yeah. Yeah. Oh, okay. So, you know, obviously our Leverage is a touch lower on the quarter and even lower now and we do think that it is a an environment where young leverage will be lower. There is more spread in the agency market and and the economics are are more favorable than they have been given the fact that you know, we're at the zero lower Bound by the FED is is is obviously in play and buying assets and we're certainly comfortable with the agency market, but you can take two approaches you can say, okay, let's add leverage because wage
Glad you're going to tighten which we do on the agency market that just tends to be the case. When you have this type of uh of environment as we saw in the earlier cue he's or you can take the approach that off to you know, we can earn a competitive yield with a little bit lower risk and I think we're more on the side of lower leverage and a slightly lower risk folio. And a lot of that is informed by what we just experienced in March, you know liquidity was obviously highly constrained for agency investors. It wasn't just the the read sector. I mean, if you look at you know, the amount of assets the FED purchase which is so in excess of $500 billion, uh, the uh, fund Redemption be leveraged deleveraging and other sales of agency MBS obviously provided a lot of Supply in the market and we learned we learned a lesson from that from that experience and I think it doesn't fall off.
You look at leverage on a go-forward basis in generally speaking. You think it's a little bit lower.
And then just sticking to leverage. How are you thinking about the the borrowings currently against fhlb and kind of what the Outlook, you know, there is you know has kind of approach the the sort of the end of that of your ability to access that sure sure. So as you suggest our line does in currently in February of next year, we did reduce our our borrowings from the fhlb last quarter given the fact that it was we do we were financing a fair amount of agency MBS in addition to our phones on the line and it actually became more economical to use to use our bank counterparties to finance the agency. And yes, so we reduced the the line by about two-thirds. We still maintain our our whole loans on our fhlb line, but we are preparing for the eventual. Um end of that line. Should that be the case and Thursday?
The as I was talking about earlier.
Received we're looking at warehouse lines Bank Warehouse lines. It's more expensive obviously, but again, you know the economics of of home runs right now are are more favorable. So when you look at the balance, we do think that converting over to bank Warehouse lines, assuming a securitization Market read develops, and we anticipated do so, we think the economics will will not be quite as good as fhlb but you know, they'll be competitive in the fact that we've already built in brand in the securitization space. Thanks to the fhlb line and add that helping us incubate our home own business. I think we're in good shape going forward not relying on she'll be if it's not there.
great thank you that Doug
internet question control Matthew with namora let's go ahead thanks everyone good morning first on the margin you know you really color on what happened there in the corner and wage low is at the end of the quarter one of your peers I think guy that over a hundred fifty basis point that interest spread second quarter can you is there a sort of a Cadence on or any type of forward guidance you can give us or what to expect on the on that mortgage interest rate next several quarters yeah and you know obviously it's fluid both financing what we do on the asset side and how we reposition Hedges I will say that the net worth net interest margin is higher our our repo expense is going to be inside of a hundred basis points certainly we can you know and have repositioned are swaps to reduce the net interest spread all I can tell you right now because it's obviously fluid man is is you know from a name standpoint um I would view Q one as a
Relative too cute for and cute too. And now that being said it is on a lower overall asset base. So you do have to take that into consideration, right? Absolutely. So the the biggest variable is clearly is it just speeds I mean is that the equipment we've sort of clarity on where repo is and when swap rates are is that the biggest variable we think about modeling this the next several quarters? Yeah, and it's you know repo I think is relatively stable and predictable and they're what we do on the asset side and speeds obviously can includes that. But um and what we do on the swap side and there's a lot of small variables that I think can make up the overall didn't but you know, I'm comfortable telling you that Q one is a trough of
Okay, great. And then then David you're on the on the on the roll company is internalizing here in the second quarter. I want to ask you about BuyBacks, you know wage board. Can you maybe just spend a second to address your vision of annaly, maybe give us an update on the internalization of what changes and cost things are going to happen. It just overall anything you'd like to say in terms of where you guys are going to take this company next several years and congrats again. Okay, let's let's talk a little bit about that. And thanks for the question Matt. So in terms of the vision and Annalee, what I'll say is, you know, I've obviously been with the firm for nearly seven years and I've overseen the the businesses for the past number of years. So there is a level of continuity is that obviously had an influence on how these businesses have have been directed. Now what I'll say is first and foremost an elitist and agency oriented read dead.
And I'm not just saying that because it has been a port in the storm over the volatility. That's the DNA the company, you know, it was founded by two.
Mon Traders and nurtured by those individuals and that happens to be the DNA that that does exist today both on the asset and liability side. So with agency oriented, but that being said we do have three very solid credit businesses and they all performed admirably through this volatility, you know on a go-forward basis in terms of how may see the world as I was as I was discussing earlier looking at these three credit businesses. We came into the year thinking that the resi sector probably had the most promise given fundamentals and that's what we've been able to do in that business. We still do think that you know, Tim in his in the Middle Market lending business will differentiate that business I think through this volatility relative to his peers as I said, and so, um, you know, that is something we're we're certainly happy about and the commercial business has a capital markets Focus. It's been it's been conservative dead.
Both with respect to Capital allocation. And and what we think the sectors that they've invested in but the commercial business I think the sector is a whole, you know is is probably dead characterized over the very near-term is more precarious given the uncertainty with respect to the commercial real estate. So my view is that we're an agency firm. We have all of these options we have incredibly talented people and we have brands in each of those businesses some level of continuity. We will make incremental changes as we get more information in terms of how this how this episode gets plays out. I wouldn't characterize anything. We we anticipate as transformational but you can expect that when we go through an environment like this with disruption that we have the capital and number eighty-two to take advantage of opportunities and we're absolutely looking uh-uh to to execute on that but it's a little early to really predict how that plays out.
Now in terms of bigger picture and we will be very relevant in real estate Finance both in markets as well as in policy circles. We built a strong brand in DC. We're looked upon as a part down there and we anticipate continuing that because there's a lot of policy work that we think needs to needs to happen over the number of next number of years to make sure that real estate markets are well functioning and and liquidity goes to borrowers Etc. So we will be relevant on that front, um, in terms of managing the company, we will look a little bit more organic life. I think relative to the recent past. This means more focus on portfolio management looking within to create opportunities and generate growth and ultimately my view and our view is that we will attract Capital through performance. That's what's going to be the key ingredient here. You know, we won't need them.
Hi growth, we anticipate performing and capital coming our way. And so that's the general philosophy how we're going to run this company a little bit more portfolio focused organic growth to say we wouldn't be acquisitive. But uh, we think we have all the ingredients within the company to be able to do what we want to do. And now over the near-term we obviously have the Tailwinds off the agency market. And so and so we are, you know, a little bit Centric toward that business, but we'll see how everything plays out. Um, so and continuing on your questions again that and appreciate that the BuyBacks. I know I know maybe premature but just wanted to throw it in there.
yeah, so
With respect to buying back stock obviously in in in March and even into April the quiddity was was Paramount how we look at buying back stock is it's a it's a capital allocation equation, you know on one hand you have the very near-term immediate accretion when your price when your stock price is at a discount you and you trade that off with liquidity and what we might think to be a longer-term investment opportunities to use that Capital. So what I'll tell you is we have the authorization it is it is a capital allocation consideration and and we'll evaluate it relative to both liquidity and other options that we have.
Thanks a lot. I really appreciate it. You bet. Thanks, Matt.
Hey, ladies, and gentlemen, this will conclude our question-and-answer session. I'd like to turn the conference back over to David Finkelstein for any closing remarks. Well, thank you everybody. We hope everybody stays healthy and safe throughout this episode, and we look forward to talking to everybody shorten. Thanks.
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect your system.