Q3 2020 Annaly Capital Management Inc Earnings Call

[music].

Good morning, and welcome to the Annaly Capital Management third quarter 2020 earnings Conference call.

All participants will be in listen only mode should you need assistance. Please signal a conference specialist by pressing the star key publicized zero.

After todays presentation, there will be an opportunity to ask questions.

Please note this event is being recorded.

I'd now like to turn the conference over to poor become Dar head of Investor Relations. Please go ahead.

Good morning, and welcome to <unk> third quarter 2020 earnings call for Annaly capital management.

Any forward looking statements made during todays call are subject to certain risks and uncertainties, including with respect to COVID-19 impacts which are outlined in the biggest factor section in our most recent annual and caught up in the I think the phone.

Actual events and results may differ materially from these forward looking statements we.

We encourage you to read the disclaimer to earnings release in addition to our quarterly and annual filings.

Additionally, the content of this conference call may contain time sensitive information that is accurate only as of the date 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.

A reconciliation of GAAP to non-GAAP measures is included in our earnings release.

As a reminder, handily routinely post important information for investors on the company's website at www dot handling dotcom.

Content weapons in today's call can be found in a third quarter 2020, investor presentation, and third quarter 2020 financial supplement both signed under the presentation section of our website.

And we intend to use the web page as a means of disclosing material non public information the complying with the company's disclosure obligations under regulation FD and to post an updated investor presentations and cinema materials on a regular basis.

And only encourages investors analysts and media and other interested parties to monitor the company's website. In addition to falling and as press releases SEC filings public conference call presentation webcast and other information it pulls from time to time on its website.

Please also note this event is being recorded.

Participants on this morning's call include David Finkelstein, Chief Executive Officer, and Chief Investment Officer the.

Renal Wulff, Chief Financial Officer, Tim.

Tim Coffey, Chief Credit Officer, Ilker attack head of securitized products like Fannie <unk> head of residential credit and Michael Quinn head of commercial investment and with that I'll turn the call over to David.

Thank you Barbara good morning, everyone and thanks for joining us for our third quarter earnings call I'll briefly provide an update on the broader market and how we manage our portfolios during the quarter before srini reviews. The financials I'll discuss the factors that underscore our business principles risk posture and have contributed to our performance.

The U.S. economy rebounded at a faster pace than many had anticipated in the third quarter best exemplified by the decline in the unemployment rate, 7.9% September household spending rose sharply in certain sectors of the economy arguably led by housing had made a substantial improvement with current activity.

Well above pre koby levels. However momentum is slowing as the service sector is unable to fully recover while the virus persist the extended unemployment benefits supported under the Cures Act, which meaningfully boosted incomes expired in July although only half of all jobs lost during the pandemic have been restored.

Monetary policy accommodation continues to be critical, especially given challenges on the fiscal front, which is further complicated by the uncertainty around the course of the virus as well as the outcome of next week's presidential election.

Similar to the second quarter. The Federal reserve continues to use all available tools to smoothed markets functioning well signaling they stand ready to provide more support if needed suppressed interest rate volatility remains a positive backdrop for agency MBS and credit businesses contributing to our ability to generate a 6.3% economic return.

Turn during the quarter and core earnings exceeding our dividend by 10 cents. Additionally, we achieved these results while reducing our leverage to 6.2 times. It is important to note that historic volatility we faced in March and a pending risk event in the election, our reasons for maintaining a cautious approach and why we would.

Characterized the third quarter core earnings as a near term peak, we do expect out around the current dividend again in the fourth quarter all else equal.

Now shifting to portfolio activity and beginning with our agency business large scale fed purchases now totaling over 700 billion net of pay downs since March and strong nominal carry have offset high levels of supply and elevated prepayment speeds, while our agency portfolio was largely unchanged in notional terms.

Further shifted out of higher coupon pools in favor of lower coupon TV A's. The current attractiveness of TB A's is driven by an improved deliverable, resulting from the fed taking out the most negatively convex pools and implied financing rates that are well below repo rates and while roll Specialness will not last in perpetuity. He can.

Tributes to excess returns and serves to mitigate episodes of spread widening such that we anticipate maintaining our overweight and TV A's, while the fed sustains a heavy presence in the market.

Our specified pool holdings do continue to provide considerable value as they offer meaningful call protection have more accurate model durations in exhibit better supply and demand dynamics. The generic pools prepayments are currently at their cycle highs and we expect speeds will remain elevated given historically low mortgage rates a strong.

Housing market and improved uptake in technology, facilitating refinancing efficiencies the.

The investments we have made specified pools over the last number of years are paying off in this environment our portfolio prepaid at just under 23 CPR in the quarter more than 10, CPR slower than the GRC universe of 30 year fixed rate MBS. Despite a weighted average loan rate on our portfolio that is 17 basis points higher than the unit.

Verse and with 96% of our pool holdings characterized by some form of prepayment protection, we are well positioned to withstand the current environment and we anticipate our speeds will continue to outperform the broader market.

Our outlook for the agency sick sector remains constructive as recent spread compression is supported by continued fed support attractive financing strong nominal Carrie and subdued volatility.

Our hedging activity was focused on protecting the portfolio from tail whisk as we opportunistically added out of the money swaptions at attractive pricing and also added modestly to our swaps and futures positions funding.

Funding markets are healthy and liquid as capacity remains ample with abundant reserves in the system also.

Also financing spreads for credit products, which were elevated through much of the summer have recently contracted and we expect further improvement to call.

Notwithstanding this liquidity and financing markets. We are cognizant of risks out the horizon and are therefore operating with conservative leverage and nearly $9 billion of unencumbered assets the strongest liquidity position for the firm in years.

Shifting to residential credit we maintain our positive outlook on the sector, considering strong fundamentals and technicals such as stabilizing delinquencies in favorable housing supply dynamics less than 6% of the overall housing market is now and for Barents, which is down from 9% in late may the pace of improvement in housing has held pretty.

Certain markets to a more normal state and led to firmer asset spreads and a rebound in securitization volume.

We completed two securitizations in the third quarter totaling over $1 billion, which did reduce our overall capital allocation to the sector. However, this decline was partially offset by retained bonds on our new securitizations as well as opportunistic investments in NPL and RPL Securities.

The non QM loan market also exhibited meaningful spread contraction since the end of the first quarter, Consequently credit and convexity valuation or is critical is ever in this environment given less cushion in underlying yields we believe the limited layer risk and delinquencies and convexity profiles of our loan to demonstrate.

Our proactive asset selection and focus on borrowers with significant equity.

Our belief in this strategy as evidenced by our sizable retained interest in our securitizations well beyond the mandated 5% risk retention in all securitizations at the time of issuance now, although non QM loan originations have been more limited since the first quarter. We are working to rebuild pipelines in source additional supply is non QM or.

Originators reopened operations.

In commercial real estate, while our portfolio was roughly flat quarter over quarter, we have seen a notable uptick in activity with loan and new issue security channels and our selectively evaluating new opportunities. In addition, underlying property sales and leasing activity is beginning to pick up as well we remain focused on ensuring the health of our.

Current portfolio through an active dialogue with sponsors to closely monitor underlying performance trends and we're comfortable with our current portfolio positioning it.

It is likely that part's, the commercial real estate landscape will be systemically changed by the pandemic, but is still too early to judge the full extent, despite declining rents and lower net operating margins broadly characterizing the near term CRT environment cap rates should continue near current levels given record low interest rates ample liquidity.

Entity in the commercial real estate sector in the significant amount of capital raised in the sector pre cobot, all of which could prove to be longer term tailwinds.

Turning to our middle market lending business as we have spoken about extensively we have taken a countercyclical approach over the past few years and the economic downturn. We are experiencing validates. This investment strategy. Our view is that our portfolio is in a sound position given our financing of Nondiscretionary companies, the vast majority of which.

Been deemed essential operators.

Over diversification has been the downfall of many in late cycles, and we have opted instead for concentration among our top sponsors in certain niche industries as evidenced by the fact that over 50% of our portfolio is predicated on government spending with the majority of individual assets in excess of $60 million. We go.

Writing portfolio fundamentals underlying cash flow trends have been encouraging year over year as weve seen EBITDA and revenue growth that has consistently delivered the portfolio companies also to note last quarter, we highlighted our conservative approach to reserves and seasonal adjustments to illustrate our middle market lending reserves of 33.

William this quarter down from 51 million, which is roughly 1.5% of our $2.1 billion portfolio as Rina will discuss in further detail.

Now with respect to our outlook for capital allocation I noted on our last earnings call that our allocation to agency would increase this quarter. However, with tighter agency spreads in our credit exposure at the lower end of the range. We are focused on responsibly, increasing our credit portfolios, but as we are still early into this recovery.

Attractive opportunities are episodic now a further note on use of capital decisions about when to raise or buy back common stock are evaluated as part of our capital capital allocation framework and similar to how we analyze investment opportunities across our businesses. It is a dynamic process considered of liquidity time horizon.

And relative returns, we've repurchased over $200 million in stock throughout the past six months at times when our evaluation deemed at the most attractive use of capital and we will consider using the buyback as a tool to generate shareholder return when appropriate to do so.

No one additional topic I want to cover today is related to how we manage our overall business and risk profile and specifically the three different forms of leverage we have available to enhance returns first.

First at the corporate level as capital structure leverage, which includes preferred equity and unsecured corporate debt.

Second is structural leverage at the asset level, including subordinate securities retained through securitization in third traditional balance sheet leverage primarily in the form of repurchase agreements will.

Beginning with capital structure leverage as of the ended the quarter. Our preferred equity represents just under 15% of our long term capital, which is in line with our average over the past few years, we have been very intentional with the construct of our capital structure by analyzing the relative attractiveness of the complimentary financing and capital options.

While capital structure leverage can enhance returns during periods of benign volatility that benefit can quickly evaporate when not prudently managed as the REIT sector witnessed earlier this year capital structures, because it can become overburdened, which is exceedingly difficult to manage when access to common equity.

Constrained by depressed valuations.

Now at the asset level, when we consider structural leverage relative to balance sheet leverage we focus on synchronizing our financing with the liquidity of our investments. An example of this is our securitization platform, which matches term financing with less liquid residential whole loans, we have been very conservative with respect to repo leverage.

On top of structural leverage as evidenced by the relatively low balance sheet leverage applied to our credit businesses and importantly, certain assets within those businesses select.

Selection to leverage is a relative value analysis, and we have been very careful about not over layering multiple forms of leverage which is not always apparent reported figures and we believe this discipline was very evident in our relative performance this year as markets experienced unprecedented volatility.

And finally, I want to touch on transparency and governance has more mortgage related companies have publicly announced or completed transactions. We welcome a renewed focus on the sector since it will come with it and expanded investor base increase capital in greater disclosure mortgage investing is the core of our business and we have a differential.

It platform that has proven across all market environments, importantly, where a long term model with an ownership mentality and accountability embedded in how we operate the business earlier. This month on the 20 Threerd anniversary of our IPO, we published our inaugural corporate responsibility report, which details our significant.

In corporate governance enhancements responsible investments corporate philanthropy initiatives and human capital diversity and inclusion commitments. It is available on our website and I encourage everyone to read it we published their report during a time of considerable global challenges the COVID-19 pandemic, resulting.

Economic and market upheaval and systemic social justice issues continue to have far reaching impacts.

Especially in times like these we are guided by strong corporate values that enable us to successfully manage risks and take advantage of new business opportunities like others around us we are using this unparalleled moment in history to lead with increased purpose, an impact both societal and economic and we hope others will do the same.

And with that I'll hand, it over to Sienna.

Thank you David and good morning, everyone.

I will provide a brief financial highlights for the quarter ended September 30, Twentytwenty and while our earnings release discloses, both GAAP and non-GAAP core result, I will be focusing this morning, primarily on our core results and related metrics all excluding pay.

As David mentioned earlier, the suppressed interest rate environment continued fed support and our active portfolio management has enabled us to do more with less.

Less leverage that is as weve generated the best core attempt to share with had in five years with 6.2 times leverage.

Our book value per share was 8070 cents for the third quarter, a 4% increase from the second quarter and we generated core earnings per share excluding Cta of 32 cents a.

A 19% increase from the prior quarter.

Book value increased on GAAP net income of approximately $1 billion or 70 cents per share, which includes a two cents benefit related to reversals of Stifel and specific reserves that will be addressed in more detail later in my comments here.

Partially offset by common and preferred dividends and lower other comprehensive income of 253 million or 18 cents per share.

GAAP net income increased in comparison to the second quarter due to gains on the swap portfolio of 107 million as well as higher GAAP net interest income of 447 million up from 399 million in the prior quarter.

Primarily due to lower interest expense from lower average repo rate and balances.

Partially offset by lower net unrealized gains on instruments measured at fair value to any of $121 million down from 255 million in the profit.

The disruption in March we have recovered a large portion of the decline in the fair value about calia.

We have included a slide in our Investor presentation that provides additional color and detail on the assumptions utilized in the evaluation about diesel is that.

In the kind of caught up.

We have seen a general improvement in market sentiment and the economic models. We use in this process. The key macro economic assumptions used in determining our is that being GDP unemployment and commercial real estate value.

Still projecting unfavorable assumptions compared it to prior years. However, they have improved in comparison to Q2 assumptions used.

We recorded a modest reversal of reserves associated with our credit businesses of $22 million unfunded commitments during the third quarter drew.

Driven by portfolio activity, primarily loan payoff and the aforementioned improvement in macro assumptions and now total reserves net of charge offs comprise 4.56% about eight Craig and ml portfolios as of September 32020. This is 5.32% as of the pro.

At quarter end.

As always we do not simply book, what the model tells US we should reserve and therefore in conjunction with our investment teams. We spent time analyzing the results of the reserve calculation and ensuring our expectations are aligned with the quality of the portfolio and the performance of the borrowers which supports the release of reserves.

Consistent with prior quarters.

We continue to think it critical in the current environment.

On the side of conservatism given the significant uncertainty in the economic and market value scenario.

We remain comfortable with our existing credit portfolio and the associated see sort of that and we'll continue to monitor specific asset performance and economic projections as we determine future results.

Turning to ending the lot effective quarter or the quarter to core earnings a low interest expense of $115 million compared to $186 million in the prior quarter, primarily due to lower average repo rates lower compensation and Gionee expenses as a result of cost savings from the company's internalization as well as record.

Hi, TV, a dollar roll income of 113 million.

In comparison to $96 million in the prior quarter due to higher average balances as we took advantage, especially in the TV AD markets and increased concentration and dollar rolls compared to pool.

These increases are partially offset by lower coupon income on agency MBS due to lower average balances.

Core did benefit from a reduction in financing costs with lower average repo rates down to 44 basis points from 79 basis points in the prior quarter combined with lower average.

That's a 67.4 billion from 68.5 billion impact quota and weighted average days to maturity relatively consistent with the prior quarter at 72 days versus 74.

Our all in average cost of funds is quota was 93 basis points versus 1.29% in the pack what.

Well, we continue to benefit from the zero interest rate policy. Our Treasury Department has a keen eye on the market and had renegotiated all debt agreements possible to take advantage of the optimal financing environment.

We have opportunistically time that repo, where it had made sense, however, with ample reserves in the system and deliberate forward guidance on the part of the fed were of the opinion that repo rate will be lower so long that therefore, a striking the appropriate balance between short attempt funding and modestly more expensive longer term repo agreements.

We reduced our leverage with our economic leverage declined to 6.2 times from 6.4 times quarter over quarter, primarily due to lower repo balances of 2.5 billion higher equity balances of 397 million due to favorable mark to Mark Mark to market changes the swaps in instruments measured at fair value through earnings as well as realized gains on investments underway.

Got it.

And lower net payable for investment touches of 254 million, partially offset by higher TV added 1.9 billion.

In addition, we reduced the balances on our FHLB facility in preparation for the Securitizations, we closed during the quarter and the upcoming Sunset about FHLB membership.

As David has mentioned before you cannot see what we went through in March and April we are proud of the strong results for the quarter achieved with a prudent management of our leverage given the lower risk tolerance levels.

The portfolio generated 205 basis points of NIM from second quarter of 188 basis points, driven primarily by the decrease in cost of funds that I mentioned a moment ago.

<unk> core return on average equity excluding pay was 13.79% for the quarter in comparison to 12.82% for the second quarter.

Our core return on average equity excluding PAA per unit of leverage improved to 2.22% in Q3 versus 2% in the second quarter again, illustrating the notion of doing more with less.

We have started to see the benefits of our internalization with improvements to our efficiency metrics and instead quota being 1.32% of equity for the third quarter in comparison to 2.1% in the second quarter of 2020.

And 1.73% year to date, which is within the range of expected cost savings disclosed in Q1 with our generalization transaction announcements, even with the reduced equity base as a result of a much disruption and our share buyback program.

And we ended the quarter with an excellent liquidity profile with $8.8 billion of unencumbered assets, an increase of almost 1 billion from the prior quarter, including cash and unencumbered agency MBS at 6.9 billion.

And after Labor day, we began a hybrid what working arrangement with employees voluntarily working from our Manhattan office periodically.

While we recognize the benefit to communication and collaboration from being physically together a few days a week, we continue to work seamlessly outside the office and we'll continue to monitor state and city data and determining future retirement plan.

And that concludes our prepared remarks, and I'll turn it over to the operator for questions.

Thank you we will now begin the question and answer session to ask a question you May Press Star then one on your Touchtone phone if.

If you are using a speakerphone please pick up your handset before pressing the keys.

To withdraw your question. Please press Star then too.

At this time, we will pause momentarily to assemble the roster.

The first question today comes from Steve Delaney of JMP Securities. Please go ahead.

Thanks, Good morning, everyone a lot of good numbers in this report, but I'd like to just comment that I think from my view, possibly the best number is the 70 basis point drop in expenses to average equity. So we know where that came from and congratulations on the internalization.

Your dividend coverage, obviously was excellent strong quarter and 145%.

David We heard your comments you know that this threeq <unk> Q, maybe a little PQI in terms of the near term cycle, but screen I'm wondering if you have available the information to comment on any undistributed retaxable income that Annaly may have had EPS up September 30.

So we are there's obviously a lot of differences.

Steve with regard to core of this is that more income yeah, and one of the largest one of those being the amortization all swap losses.

Which we do over the term of the original.

Hedging instrument. This is the gap we take it.

Well it wasn't the coal we exclude and so as of the third quarter. We don't have any concerns with not meeting our redistribution requirements for the for the full year I would say.

Understood. So it sounds like there is no.

It won't be any tax driven need to either increase the dividend or pay a special dividend that you make that decision based on other factors as to where the dividend goes but not taxed a mandated.

That's that's a correct assumption Steve.

Thank you and David just on the RMBS activity I'm can you comment on you do several loan products can you comment on the specific loan products that work in those third quarter transactions and maybe give us some color on what your actual risk.

Risk retention is and those deals above the 5% mandated level. Thank you.

Sure, Steve and it's good to hear from you. So in terms of the loans into Securitizations. Those were from our expanded prime program and largely geico loans and I think if you look at that in totality. The securitizations that weve done, which over 5 billion I believe we retained roughly 18% of.

Our overall securitization.

Excellent.

And there was a nice bonds and I think you know has the possibility to see ratings upgrades right as those as those who are in season.

Yes, and you really okay.

Okay, Great and again, we thank you look to my earlier point, Steve about balance sheet leverage we do apply very minimal leverage to these assets and.

The return on our last deal was about 12.5% on the balance sheet solid non recourse.

Thank you both for your comments thanks. Thank you.

The next question comes from Rick Shane of JP Morgan.

Good morning, everybody look it in a normal environment, you guys space binary risk in terms of rate direction, but.

But were in a period now where the distribution of outcomes is more skewed than it's probably ever been on the other risks you normally space is determining the timing of those rate.

And that said is a pretty eating in environment through their communications that deliberately diminishes data uncertainty I think that this creates a set up where there's.

More or less uncertainty on a theoretical basis. Then you guys have ever faced I'm curious, how you balance being able to maximize profitability in that environment with also managing risk and there was an interesting comment from stringer related shooting one place where you're in.

Hansen profitability by staying on maintaining or exposure to the shorter end of the repo financing curve can you talk about how you look at this going forward.

Sure so to your point the rate risk is skewed its asymmetric we don't expect the fed to go to negative rates and we're at the zero lower bound for the next number of years and they've been very deliberate with their forward guidance, which has been encouraging but that being said as I mentioned in my prepared remarks, there is.

As always that risk that we could.

See rates out the curve.

Increase in there's a lot of uncertainty around that so our hedge profile is set up.

As it has been for the last number of quarters with a modest steepening profile, because there could be events that do lead to higher rates help curb we're very comfortable at the front end of what what the fed has conveyed to us but.

You could see volatility at some point out out the curve and so thats why weve physician hedge profile to reflect that and that also is why we've added more swaptions to the to the hedge portfolio to help us mitigate against that tail risk now with respect to.

Financing and our average days, which I believe was 72 days at the end of the quarter.

We do look at our financing profile relative to the cost of hedging short rates.

With other instruments and we are very comfortable with the level of financing rates out the near term horizon. The curve is relatively flat from one month to a year we understand that.

But there is an incremental cost of terming everything out to two a year. When we don't think it's necessary to do so and we can manage those risks in hedge those risks more cheaply with other interest rate instruments, and we do have a fair amount of short dated swaps that.

Due to protect for that.

Got it so that strategy.

Makes sense because the swaps.

The cost of swaps are low in a mobile environment and so that allows you to take the risk on a little more risk on the financing and again I don't want to overemphasize the risk because it makes sense, but is that the way you sort of look at it.

Sure there.

There were even periods last quarter, where we.

Pay fixed at negative rates and so it's it's attractive to do so as opposed to terming out repo from that standpoint.

That's a pure relative value.

Okay and I do have one last question I apologize to my peers, who are waiting in queue just given the.

The volatility we've seen in the equity markets headed into election can you comment on the volatility that you've seen on during.

During that same period in your core asset classes as well.

Sure sure and look we do have this risk event next week I think heading into the latter part of last week and this week there were expectations of stimulus and the potential for.

Democratic sweep so we saw an increase in rates predicated on on the possibility for stimulus that seems to have subsided given the lack of progress on the stimulus front, but.

You know I will say there are brought a variety of outcomes that could occur with respect to the election and fiscal policy that does have us relatively cautious thats why were hedged well and Thats why our leverage is at the low end of the range over the last number of years.

So we think this conservative approach is appropriate and it also does happening more than covered the dividend and so we're pretty comfortable with our operating environment, we have a lot of latitude.

Particularly with low leverage right now.

Great. Thank you and thank you for letting me get that last question of course Rick.

Our next question comes from Kenneth Lee <unk> of RBC capital markets.

Hi, Good morning, Thanks for taking my question appreciate the discussion of all the different types of leverage wondering if you could just further expand upon it perhaps share your appetite for potentially increasing leverage within each of the buckets just given the current attractive environment for investing thanks sure.

So I'll just go through the individual asset classes in what's attractive what type of leverage is attractive for example, instead just starting with.

At the corporate level I talked about.

Capital structure leverage right now, it's not advantageous to add capital structure leverage given the pricing associated with Pref and that's not something we're looking at certainly now with respect to balance sheet leverage versus structural leverage starting with balance sheet leverage there is obviously an ample.

Amount of reserves in the system given that policy. So as a consequence balance sheet leverage is relatively cheap and that most informs our agency business and so as a result, that's the focus in agency.

Is on balance sheet leverage now on the credit side structural.

Structural leverage is relatively attractive and you see that through our securitization returns.

You know, we use more structural leverage on in our credit portfolios, but our balance sheet leverage on those portfolios is roughly one and a half turns and so we think weve stricken the appropriate balance and not layered.

Structural leverage with balance sheet leverage and and we feel good about it now in terms of increasing leverage.

Look assets have to be cheaper for us to increase leverage we're very comfortable with where we're at right. Now 6.2 turns of leverage gives us a lot of flexibility to see how markets evolve to the extent assets cheapened.

You would see some increase in leverage just through equity degradation, but we would still have dry powder to add asset to cheaper levels. If we think the cheapening is transitory that's not our expectation that assets will cheapen, given the fed backdrop, but to the extent that didnt materialize.

We could we could have the opportunity to add assets now Conversely, if theres continued spread tightening which brings our leverage down from book value appreciation. Its not the case that we would add assets to maintain leverage we may even be of the mindset that assets too rich and even further reduced leverage and sell asset.

So so.

So generally speaking we just have a lot of latitude to do exactly what we think is appropriate given the market given asset pricing and given our current liquidity and leverage profile.

Got you that was very helpful color I'm, just one follow up if I may.

Just on the equity capital allocation sounds like some of the increase towards agencies was due to the securitization transaction, but just wanted to.

Get your any any kind of updated thoughts on where that that <unk> equity capital allocation to trend in the near term. Thanks, Yeah sure and as I said in the prepared comments, we would like to to tick up our allocation to credit, but there's still a lot of uncertainty. We you know we don't know the exact course the virus. We don't know how policy is going to shape.

Now on the fiscal front, we are still learning about how this economy is evolving so we have to be very methodical about how we could add credit assets. Our pipelines are filling up we're seeing very good opportunities.

But again it is episodic and so we'll see how it plays out and we'd like to get a lot more certainty with how the economy shapes out before we make a stronger commitment but at the margin I would say, we would like to get our allocation of credit marginally higher.

Got you very helpful. Thanks, again, you bet good to hear from you can.

I for reminder, if you have a question. Please press Star then one the next question comes from Doug Harter of Credit Suisse.

Good.

Thanks.

Talk about I'm kind of how how book value has performed.

In October so.

Sure sure and we're up a few pennies a quarter to date nothing to write home about and we have a long way to go left in the quarter.

Understood understood can you yeah, obviously next week, it's kind of a volatility.

Actual volatility event.

Okay. I guess can you just talk about kind of how the passage of next week turnaround.

[laughter], that's kind of my influence you know kind of your actions versus kind of the the remaining you know.

Some unknowns that are out there in the market.

Yeah, well Unfortunately, it's likely the case that the passage of next week may not lead to a resolution in the outcome of the election and so that's something we're certainly concerned about but theres different states of the world based on how things evolve if you get to if you get a blue wave. For example, then you could see a continuation of that so.

Right sell off we saw last week.

And before.

With the optimism around stimulus if you get a split Congress if the president retains the White House and you have a democratic Congress that could lead to a moderate stimulus and if it goes the other way.

You you potentially into something that concerns us could see a repeat of what we saw in to 2010, where you had austerity coming from from Congress from the Senate.

And the White house in need of stimulus. So there's a variety of circumstances that could prevail and again it does come back to taking a cautious approach as we do figure they'll allow.

Understood I appreciate that it comes you.

You bet.

The next question comes from Bose George of KBW.

Hello. Good morning can you talk about the level of specialists Tobar you versus the last quarter and then just how do you think about the level of your net <unk> position as a percentage of your total.

Exposure could we see that increase if.

You know returns remain elevated just curious how you're thinking about sizing that.

Sure No that's a very good question Bob So.

Specialists in October is still is still quite prevalent it has moved down in coupon into one and ask them to use but generally speaking.

The financing rates implied financing rates on those coupons or negative 60 to negative 80 basis points, depending on underlying assumptions and that compares.

Almost on par to what we experienced in the third quarter, we generally on average ruled that rolled our.

Portfolio in south of negative 50 basis points on the quarter.

As the market does re populate with new new collateral are you you should see special Miss dissipate somewhat as as as time passes and the fed doesn't take all of the lower coupons out of the market, but it should be here for a little while now.

In terms of how we think about it.

This is a carry driven market you know in the third quarter, we had about 4.8 billion in portfolio run off in the agency portfolio about half of that was allocated to TV is to grow the TV a position with the other half more early on allocated to pools now we're at a point where specified pools have gotten to a point, where they're they're pretty.

Fully valued and so the way we're thinking about it currently is run off in the fourth quarter will you know more.

More than on average go into Tvs, but we are certainly considerate of.

What the portfolio looks like and we have to manage the portfolio not just for near term carry but we have to think about a variety of scenarios is how mark as to how markets can evolve and our specified pool portfolio is the core of our business and those cash flows.

Long term cash flows that we put on the balance sheet are going to remain the core so to make a long story short will probably grow the TV a portfolio modestly in the fourth quarter.

We do remain focused on our full portfolio and we think it's performed quite well as I talked about in the prepared comments with respect to portfolio speeds.

Okay, Great. That's helpful. Thanks, and then just in terms of the difference incrementals as differences the TB returns versus like schools can you just size that smell.

Sure I would say pools are in the high single digits in the very low low double digits in Tvs.

Okay, great. Thanks, and actually just one clarification seat or the cost of funds that you guys report the 93 basis points does that include the implied funding. The TPS is it's just about no no. That's a subjective assessment because you'd have to incorporate a prepayment assumption. So when we give you our cost of funds it's entirely objective.

Okay. Okay.

Okay, great. Thanks.

You bet.

The next question comes from Brock Vandervliet of you'd be us.

Hey, good morning, everyone.

Hey, Brian.

Hey, David.

David on the CPR speeds.

Hi.

In March we are kind of in a.

Unusual environment here with low rates for looking like a very long time, but seasonally.

Should be a bit of a de sell in activity.

Help us kind of get our head around a forward look on.

CPR and also with respect to the available pool of mortgages.

Pencil for for refinancing and where that is now versus a.

A couple of months ago.

Sure So let's start with the available pool of refinancing the mortgages as of today.

Roughly 80% of the universe is 50 basis points in the money or more so it's dropped a little bit and that's largely because the market has been re populated with heavy issuance in lower loan rate loans, but nonetheless, the vast majority of the market is in the money. So how how we think speeds will.

The ball over the over the near term speeds.

These will be faster in the fourth quarter, but not by too much we think roughly 5% to 7% faster so to your point about seasonality one thing to note is that.

Originators are operating at full capacity and they're adding a lot of capacity and so when you're at full capacity and.

Supposing, we do have lower housing turnover in the winter, which drives that seasonality you're going to see a shift the resources over to the refinancing.

Side of the spectrum and originators and so we don't think that seasonality will will be a significant lead to a significant decline.

In prepayments in Q1, which is typically when you see a most if anything it will be flat to up.

Okay got it you bet.

And on with respect to funding costs, a big drop this quarter.

Much more.

Since you may have there or is this ah that's kind of it.

Well look I think when we look at repo rates on the agency side from overnight out to a year, we're talking 13 basis points or there about out to you know in upwards of 30, and so as the portfolio does roll we will be resetting the agency portfolio at the end.

At lower rates as of today, our average rate is 36 basis points, or where where where where our current repo rates are today. So that's a that's a day.

Klein to some extent and we'll see as more repo rules.

Got it Okay got you all.

All right. Thank you you.

You bet Brock.

Your next question comes from Mark the rise of Barclays.

Yeah. Thanks.

You mentioned looking to start to reallocate back towards towards credit investments, but.

Opportunities, you're seeing or episodic care can you just talk about where you're seeing the most attractive relative value and what we should expect you to kind of reallocate capital.

Sure. So we can we can go around the room here, we do have the full room of all our business heads and again opportunities are episodic we have started to rebuild our residential whole loan pipeline and we're seeing.

Our other businesses a pickup in activity in terms of at least looking at a lot of opportunities, but again, we do have to take backdrop.

But the uncertainty entails with respect to the economy and how credit could evolve so were certainly cautious, but let's just start with Mike Fannie on the resi side [noise].

[noise] sure. Thanks, David I would say within you know residential credit we do think non QM securitizations have levered I ours in the low to mid double digits to mid double digits and I think to your point a lot of it is just there's a certain element of scarcity of supply and supply has been relatively nascent.

Agency pipelines are full high gross margins and you also had a reduction.

Programs I went to in April so we like the sector continued to build back up our originator network and our strategic alliances and I think you know another area of the market that we find attractive is the unrated MPL RPL security.

Sector, we see.

A one senior securities three enemy to three in a quarter unlevered yield and we see the senior support securities five in a quarter to 550, unlevered yields and we think.

Levered IR ours within that space or high single digits on the senior securities and low mid double digits to mid double digits on the senior senior supply.

Hey, Mark this is Mike Glenn so on the commercial side I would say the most attractive things that we're seeing today are in the transitional whole loan space.

I think thats for a couple of reasons, one obviously, we're being cautious.

Just given the uncertainty going forward.

Assets have have repriced and I think we're seeing opportunities, where we're able to land.

Two borrowers at lower levels today than we saw no call it 12 months ago and.

In addition spreads are quite a bit wider today than they were I think all in.

Coupons are probably pretty similar maybe a little bit higher but.

But the credit quality of those loans is quite a bit better. So we are seeing opportunities to make make new investments on the whole on time.

[noise] markets, Tim coffee I think on the middle market side, we will just continue the pattern of what we've been able to accomplish to date the portfolio remains very clean. So we expect to see continued tack on acquisition activity on our existing book, you'll see it in the numbers.

Issuers that we've been able to maintain it continues to be at 50 on the head and so.

Take the benefit of having a clean portfolio is that those names have the ability to go out and execute with tack on acquisition activity, thus, resulting in financing needs.

To which we can obviously leverage our past success. So the bulk will be coming from what we've done today.

And continuing to increase our exposure is on our existing stable of names.

And Mark you also have hilger to us here on the agency side, but it looks as though I've already stolen all his thunder in prior comments.

Where we stand on that front.

Okay great helpful.

Could you just provide us an update on.

Efforts to manage whether you know retroactively on existing portfolio perspective, and then new underwriting kind of covered exposure in the commercial and middle market lending.

Sure.

[noise] might can start yeah, So hey, Mark this is Mike Glenn again.

I think the cobot exposure in the commercial portfolio I think hits US most in two places one is the hotel space and two is in retail. So first on the hotel side, we've really got five positions in the hotel space and in every one of those positions sponsors are contributing capital.

To those deals to support those assets and four out of our five hotel positions.

Our currently paying.

In the retail side I think we've we've we've been hit as well I think similar themes in that space in that the positions we have.

Sponsors are supporting those deals and infusing capital I think in some instances those loans will need to be extended.

In order to get through this kind of low liquidity period, but we like our basis in those assets and we feel comfortable.

With the outcomes going forward.

Market on the MLP side, I think it's it's pretty clear to us that we've been.

Ironically, a pretty big beneficiary in our portfolio of what's gone on with Covidien and certainly we don't like to.

To say that too loudly, but the portfolio has certainly been able to take advantage of the last six or seven months. So I.

I think counter critical to a lot of things that have been going on with our peers. Our portfolio has actually been able to witness a fundamental improvement.

Across the portfolio name by name.

And I would also tell you to the extent that we have seen a select narrow group of names see softness over the past six or seven months.

I can also tell you that just in the last couple of months those names that did see softness in the initial phases of Cove. It has seen substantial.

The progression in the last few months.

As they may have been the first they may have witness the first order effects of covered but they certainly have seen that the second second order return.

So again, we feel pretty good about.

How the portfolio stands up to them.

After the latest stuff.

Sure.

In general markets.

Okay very helpful. Thanks.

You bet. Thanks Mark.

This concludes our question and answer session I would like to turn the conference back over to David Finkelstein for any closing remarks.

Thank you Melissa and thanks, everybody for joining us we hope everybody stay healthy in these times and in line with my earlier commentary around purposely impact in this environment.

Respect of your political affiliation just want to conclude by reminding everyone to get out and vote next week. If you haven't already and we'll talk to you soon thanks.

The conference is now concluded. Thank you for attending today's presentation you may now disconnect.