Q4 2020 Annaly Capital Management Inc Earnings Call
[music].
Good morning, and welcome to the Italy Capital Management fourth quarter 2020 earnings Conference call.
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I would now like to turn the conference over to Sean Kensal, Vice President Investor Relations. Please go ahead.
Good morning, and welcome to the fourth quarter 2020 earnings call for <unk> capital management.
Any forward looking statements made during today's call are subject to certain risks and uncertainties, including with respect to COVID-19 impacts which are outlined in the risk factors section in our most recent annual and quarterly SEC filings.
Actual events and results may differ materially from these forward looking statements.
We encourage you to read the disclaimer in our 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 reconciliation of GAAP to non-GAAP measures is included in our earnings release.
As a reminder, <unk> routinely post important information for investors on the company's website www dot dot com.
Content referenced in today's call can be found in our fourth quarter 2020, investor presentation, and fourth quarter 2020 financial supplement both found under the presentations section of our website.
And on the intent to use our webpage as the means of disclosing material nonpublic information for complying with the company's disclosure obligations under regulation, FD and to post and update investor presentations and similar materials on a regular basis.
And we encourage investors analysts the media and other interested parties to monitor the company's website. In addition to following <unk> press releases SEC filings public conference call presentation webcast and other information it posts 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.
Serena Wolfe Chief Financial Officer for OCA.
For our top head of securitized products Tim.
Tim Coffey, Chief Credit Officer, Mike Scania head of residential.
<unk> of credit and Tim Gallagher head of commercial real estate.
And with that I'll turn the call over to David.
Thank you Sean good morning, everyone and thanks for joining us for our fourth quarter earnings call.
Today, I'll provide an update on the broader market or capital allocation trends, including credit activity and our outlook.
The OCA or to us our head of securitized products will follow up with specific commentary on our agency and hedging activity and Serena will review, our financial results and as Sean noted our other business heads are also present to provide additional context during Q&A.
The primary themes the dominated markets in the fourth quarter are largely consistent with our third quarter narrative. The fed's monetary policy of combination provided considerable support for risk assets and contained interest rate volatility. This backdrop, coupled with active portfolio management drove our strong performer.
To close out the year as we delivered an economic return of five 1% for the quarter, ensuring a positive return for our shareholders for 2020, which is particularly notable given the historic disruption we all faced in March.
Turning to the macro environment, the yield curve bear steepened in the fourth quarter in light of optimism about the post COVID-19 economic recovery, which outweighed the negative developments of record virus cases, and the resulting lackluster economic growth to end the year, we have seen a continuation of this rate move into 2021.
<unk> largely due to the results of the January runoff election, and Democratic control of each branch of government, leading to greater prospects for other stimulus for.
Furthermore of the Federal reserve remains committed to monetary accommodation until the U S witnesses of meaningful recovery in labor markets and higher inflation readings that's the.
Fed is expected to continue purchasing assets at their current pace through 2021, while forward guidance will keep the front end anchored we do think the shift of higher longer term rates will be gradual nonetheless, it remains prudent to hedged the tail risk of the spike in rates as we will discuss shortly.
Now to address how this landscape influences our positioning the capital allocation monetary policy tailwind maintain agency is the primary vehicle for reinvestment of the portfolio run off and we remain comfortable with the agency market for reasons Zilkha will discuss but the continued spread tightening does leave us cautious on higher.
Levels of leverage.
Fiscal stimulus should ensure healthy consumer spending once the economy reopens more broadly and service of consumption can resume which should be of constructive backdrop for credit our allocation of credit marginally increased to 22% as we began the fourth quarter at the lower end of our range and targeted opportune.
Of these largely in residential credit and middle market lending modestly tilted the relative value equation back towards certain pockets of credit. It should be noted however, the risk assets continued to see strong sponsorship and associated spread contraction given the liquidity in the system and optimism for cyclical.
Coverage, which necessitates a very disciplined approach to asset selection as our investment teams consistently employed.
With respect to our residential credit business, specifically, we found the unrated NPL and RPM security sector attractive as we discussed last quarter, which drove much of the $400 million growth in our residential securities portfolio during the quarter within the CRT universe, we have rotated our investments up the capital structure.
<unk> with a focus on very short spread duration assets that have strong deleveraging profiles in light of elevated prepayment speeds spread.
Spreads on our non agency securities purchased in the fourth quarter of rallied over 100 basis points given the strength of the market to date. This year, although securities remain an important part of our portfolio as they provide opportunistic relative value. We were encouraged to see volumes. Once again gained traction within the non QM loan market.
Our expanded prime home loan effort continues to be of priority and we are focused on new strategic relationships to grow our sourcing capabilities, which builds further optionality for us within residential finance.
Turning to middle market lending activity picked up in the fourth quarter as liquidity reentered the sector and we were able to grow our portfolio of nearly 10% to $2 2 billion.
Of the nearly $400 million of gross activity in the quarter, 80% was first lien and included both new and existing borrowers.
As discussed on recent earnings calls our targeted investment strategy continues to differentiate our portfolio relative to our peers and our middle market lending groups disciplined credit focus has proven itself out through strong fundamentals with underlying borrower LTM EBITDA, increasing by 14% on average since initial.
Close we continue to maintain an active dialogue with our borrowers and sponsors and our watch list performance improved by 43% this quarter underscoring the health of our portfolio.
Our commercial real estate portfolio decreased somewhat quarter over quarter, while we were able to resume origination activity. This past fall volume did not offset the $108 million in paydowns as well as an opportunistic sale and our health care portfolio, the $150 million sale price for a portion of our <unk>.
Skilled nursing facilities, which closed in the fourth quarter resulted in an IRR of 35% for the portfolio and net nearly two times equity multiple.
Now shifting to the financing of our portfolio with Serena will discuss in greater detail I would just like to note the borrowing conditions that exist today of the best we've seen during the company's two plus decades of history. The.
The liquidity in the system has shifted the market advantage to the borrower much more so than in past periods of monetary of combination its not just the absolute low level of rates, but also the flat term structure of the repo curves, which signals of the persistence of the ample borrowing capacity and also affords us the ability to fund <unk>.
<unk> out of year inside of a mere 20 basis points. Additionally, on the financing front securitization markets have rebounded substantially resulting in execution inside of pre pandemic levels. This continued momentum provides attractive non recourse term financing to bolster our asset generation.
<unk> strategy and diversified funding for our whole loan business.
The prevailing financing and securitization dynamics have made both balance sheet and structural leverage more attractive than capital structure leverage in the current environment as evidenced by our recent preferred stock redemption, which was prudent from both the capital management and efficiency standpoint, and follows a series of transactions since 2000.
17 to reduce our cost of capital and preferred equity.
We have differentiated ourselves from others in the REIT sector by growing capital structure leverage more slowly and maintaining a relatively stable amount of total leverage of common equity, which is important as we've seen a higher portion of capital structure leverage lead to higher volatility in returns if not well managed.
And Lee is unique in that our size expense ratio and liquidity afford us the flexibility to manage our capital exclusively in an accretive fashion.
Proactive capital management remains a priority and we renewed our common stock repurchase program authorization following $209 million and repurchases in 2020.
Lastly, despite the attractiveness of balance sheet leverage and funding we remain disciplined with respect to our overall leverage profile, we've reduced leverage in each quarter. Since the end of 2019 through last year and maintain leverage of six two times quarter over quarter. The lowest we've had since the <unk>.
First quarter of 2017, we strive to deliver the highest risk adjusted return for our shareholders and I am confident of our current risk construct as appropriate to yield book value and earnings stability going forward.
Now with that I'll hand, it over to Ocurred of dive deeper into our agency portfolio activities.
Thank you David.
As David mentioned the agency portfolio had a strong quarter supported by healthy investor demand, both low implied and realized interest rate volatility and steepening yield curve.
The lower coupon TBA smoothed the strongest performing part of the agency market as they benefited greatly from fed purchases.
Hollywood in contrast of probably the sorts of QE specified pools of also demonstrated solid performance.
Given the current elevated prepayment environment.
The desire for more cash flow certainty and the strong bid for longer duration mortgage assets, we are seeing the level of payoffs, which the entire rates and steeper curve experience over the quarters and into 2002 anymore.
Apart from fit.
Agency MBS demand remains robust led by north of a lift died from commercial bank community.
In the current environment banks are seeing strong deposit growth, while C&I loan growth remains muted in fact, the loan to deposit ratio for the sector is the lowest we have seen in the past 50 years.
The deposits continuing to rise banks have chosen to grow day of securities portfolios, which directly benefits MBS valuations and strength as the specified pool market looking at 2000 trended data.
<unk> said net both over one trillion of MBS in aggregate, which was more than twice the available net agents of supply last year.
Turning to composition of our MBS portfolio of.
The lower coupon holdings remain largely in Tba's volume.
All of the height of coupons are predominantly Inc pools.
This multiple approach <unk> liquidity and benefits from high levels of nominal carrying the dollar roll market volume.
Providing cash flow stability across diverse interest rate environments from our force.
Approximately 8% to 6% of our full portfolio consists of higher coupon quality specified pools, which provides us with improved convexity and prepayment protection. While the remainder of is mainly concentrated in season pools, which are beginning to experience prepayments burnout.
The value of our asset selection as evidenced by the prepayment speeds on our portfolio of just under 25 CPR.
Roughly a third of CPR slower than the MBS universe over the quarters.
In terms of thoughtful the activity.
Portfolio runoff, but the missed it in lower coupon Ppas and the also rotated out of some of our the higher coupon TBA into specified pools.
On the hedging side the.
Added to our treasurer of the future swaption positions, mostly in the 10 year part of the yield curve, which benefited from the steepening in the fourth quarter.
Hedging costs to remain relatively in expensive in this low rate and low volatility environment.
The also wants to be positioned for further rise in yields under the scenario that optimism on the economic recovery at least of higher long end interest rates in the medium term.
Given how the other risk assets have performed since the second half of 2020 of.
For the agency of reimbursement landscape is somewhat less attractive than earlier in the year.
Hollywood all of the outlook for the agency MBS remains constructive due to a number of factors first.
The availability of attractive funding in the repo and dollar roll the markets, David addressed the repo market and as for the rules.
It is the focused it on the last call gross specialist has moderated somewhat.
The market being repo for related new collateral beyond that which has been delivered the fit.
We still achieved a net negative financing close for our TBA over the quarters.
And the expect current production coupon roles for the remained modest the special over the near term.
Secondly.
We expect the technical backdrop of strong demand for agency MBS to persist over the course of this year given nominal Kitty and continued bank demand and finally.
There is the data potential for improved per payer profile, resulting from steeper yield curve and video early signs of flow not in prepayments to the extent on this point the observed from recent data of debt.
The Prime Minister secondary the split is narrowing despite more than 75 per cent of the universe, having greater down 50 basis points of refinancing incentive.
In addition.
Average time to refinance loans has steadily increased from for today's this bus strength to almost 60 days as of late.
This suggests that universal easily refinance targets is decreasing for originators the acquiring.
Quite an incremental efforts to find the eligible borrowers so for the first time since last spring the prepayment environment may not be as big of a headwind for higher coupon MBS.
As a final point the.
Note that the cannot look at the agency MBS in isolation.
During previous Qe's other risk assets linked MBS tightening and gave private they missed there is still opportunity to rotate into these asset classes.
In contrast during the current QE nearly all spread products tightened in line.
If not more than agency MBS as the result, the remain constructive on the outlook for agency MBS.
Now I will turn the call over to Serena to review our financial results for the quota share.
Thank you Erica and good morning, everyone.
Before I get started with the numbers I just wanted to comment at December 2020 marks My first day with the company and CFO.
Over the year the company performed exceptionally well given the challenges we faced.
Our results in performance during 2020 reinforced the reasons I was compelled to join the analyst team we.
Which include our human capital differentiated risk culture, and robust infrastructure built around the businesses in terms of finance legal technology and other support functions.
During 2020, and we demonstrated a 23 year old company steadfast nature.
Exhibiting and of that industry leaders agility.
So with that as a backdrop today I will provide brief financial highlights for the quarter ended December 31st 2020.
And discussed for.
Select year to date metrics.
While our earnings release discloses, both GAAP and non-GAAP core results.
Focus this morning on our core results and related metrics all excluding P. Eight.
As David mentioned earlier, the primary drivers of a couple of minutes for an extension of the games from last quarter.
We took advantage of the interest rate and financing environment to generate strong results, while prudently managing leverage.
This is the state for some summary information.
Value per share was $8.92 for.
Q4 of two 5% increase from Q3.
Book value increased from GAAP net income, partially offset by the aggregate common and preferred dividends of $344 million or 25 cents per share.
And other comprehensive loss of 215 land for 16 cents per share.
We generated core earnings per share excluding PAA of studies.
A decrease of 6% or <unk> <unk> per share from the prior quarter.
Our core earnings also represent.
Third 40% of our dividend and we saw back to back quarters of 13% plus of core Roe.
Combining our book value performance for the 22% common dividend we declared during Q4, our quarterly economic return was five 1%.
We generated a full year of economic return of $1, 76% and of total shareholder return of $2 four 3%.
While down compared to prior years, we are proud of our positive 2020, we're 10, given the unprecedented market conditions, we faced earlier this year.
Delving deeper into the GAAP results, we generated GAAP net income of 879 million of 60 cents per common share for Q4 down for 1 billion of 70 cents per common share in the prior quarter.
GAAP net income decreased primarily due to lower realized gains for the investments, resulting from fewer agency MBS sales in Q4 as of Q3.
However, the GAAP net income benefited from higher unrealized gains on the interest rate swaps driven by higher rates.
Additionally, we recorded higher gains on other derivatives largely futures.
All set by lower gains and fair value option lines of securities and lower interest expense and lower average repo rates down at 35 basis points from 44 basis points and low average repo balances down of $65 5 billion kind of $67 5 billion.
Moving on now to see sort of reserve in the current quarter, we continue to see a general improvement in market sentiment and the economic models, we use in the process.
Total <unk> for specific reserve were relatively consistent with kind of quoted.
As we continue to provide transparent disclosure we've included a slide in our investor presentation that provides additional color and detail on the assumptions utilized in evaluating our piece of where is that.
We recorded an immaterial increase in reserve primarily associated with our commercial real estate business of $1 5 million of unfunded commitments during Q4.
Driven by an increase of specific reserves, partially offset by a decrease in the general piece of was that.
Federal reserve net of kind of.
Now comprise of $4 four 8% about a cricket name of Nelnet in portfolios as of December 31, 2020.
This is for five 6% as of the prior quarter end.
We remain comfortable with our existing credit portfolios and the associated piece of where is that and will continue to monitor the specific asset performance and economic projections as we determine future of is that.
Turning back the earnings I wanted to provide more detail surrounding the most significant factors and impact of core earnings quarter of a quarter.
Consistent with my commentary around GAAP drivers.
Interest expense of $94 million was Lola that 115 million in the prior quarter due to low average repo rates and balances.
TBA dollar roll in of the Mdx coupon income of $99 million was lower than $114 million for the third quarter due to slightly more modest specialness in the fourth quarter.
We had increased expenses related to the net interest component of interest rate swaps of 67 million relative to $63 million in the prior quarter as the swap portfolio of reset to low end market receive rate and two high strike received the swaps expired.
Finally, we experienced the continued improvement in G&A expenses.
On the financing front, our all in average cost of funds. This quarter was 87 basis points versus 93 basis points in the preceding quarter.
The fourth quarter for the <unk>.
Full year average cost of partners to 134%. This is 2.25% in the prior year.
Our weighted average days to maturity of down compared with the prior quarter at 64 days versus 72.
Q4 weighted average day slight reduction compared to Q3 results from the natural roll down from a longer duration of repo trades, we executed in prior quarters.
And the Treasury Grant have you in the latter part of last year was that 10-K will continue to flatten.
What I can tell you is that we said the SKU based upon the fed forward guidance on the remaining at the zero lower bound into 2023 as well as a meaningful increase in already of partner was that in the system in 2021.
And by the continued QE and the drawdown in Treasury General account balances as of.
We've entered the new year. This view of conjecture ocean as one of the bilateral term repo for agency MBS can be locked in at the.
The high teens currently.
Sequentially, we are beginning to add duration to our repo book this quarter.
Concerning credit financing, we see further improvement in repo terms for our credit securities with increasingly low hiccups and tighter spreads. We have also renegotiated our warehouse facilities to support out of direct lending businesses proactively and of realized cost savings accordingly.
The portfolio generated 198 basis points of the NIM down from 205 basis points as of Q3, driven primarily by the decrease in average asset yields and reduce dollar roll income offset by the decline in the cost of funds that I mentioned a moment of guy.
And as the management team, we focus on providing value to our shareholders, including a keen eye on the company's expenses.
Having said that we continue to see improvements in our efficiency ratios being 127% of equity for the fourth quarter in comparison to 132% in Q3 of 2020.
And 162% for the full year compared to $1 eight 4% for the prior year.
The 2020 annual Opex results within the range of expected cost savings disclosed in Q1 without internalization transaction announcements and I would reiterate the one six to $1 seven 5% Opex target, we disclosed last year at an appropriate benchmark.
And to wrap things up and we ended the quarter with an excellent liquidity profile with $8 7 billion of unencumbered assets consistent with prior quarters of $8 8 billion, including cash and unencumbered the agency MBS of $6 3 billion.
I'll now turn it back to David for some closing remarks before opening it up for Q&A.
Thanks, Serena lastly, before we move on to Q&A I thought I'd provide broader perspective in two areas.
First there is an abundance of metrics of that underscore of growing disconnect between valuations and fundamentals broadly market indices of reaching historical records and consensus calls for them to continue to rise. The S&P 540 times earnings high yield credit and the proximity of all time tight spreads and the 81 Bill.
<unk> of specs raise last year as liquidity has flowed further out the portfolio of balanced channel.
Annually. However continues to be a source of responsible yield in a market, where it's increasingly challenging to deploy capital as I mentioned at the outset. The fundamentals are positive brand all the investors with a low cost stable financing environment and upward sloping yield curve low interest rate volatility and a.
<unk> supply and demand backdrop for assets.
Our book value continue to strengthen into 2021 and of out earned our dividend for the past few quarters, we are delivering of dividend yield of over 10% in line with our historical average while the S&P 500 earnings yield of two 5% is the lowest it's been in the past decade.
<unk> represents one of few counter cyclical or a cyclical yield strategies that are less at risk to the pace of economic recovery.
Additionally, we provide equity portfolio diversification without sacrificing returns, while money market funds or zero and real treasury yields are at near record lows as unproved foreseen events were once again shift investors' focus to fundamentals balance sheet strength in the earnings stability will be coveted.
Secondly, we have talked about leading with purpose of this year in response to the trying societal and economic climate. The March 2020.
At <unk>, our mission is to utilize our capital to generate attractive returns and support the American homeowner to that end, we have kept our focus on the individual needs of our borrowers and supported government policies to extend forbearance periods. We have also used our human capital to meaningfully contribute to the communities, where we live and work.
Through our corporate philanthropy initiatives, we are focused on partnerships with high impact programs that seek to combat homelessness provide food security and advanced women and underrepresented groups in the workforce and only employees have volunteered their time and energy to serve boom of both new Yorkers in their hour of need and our.
Culture of responsible investment with respect to where we invest both of our dollars and time is something we're very proud of and it is undoubtedly yield the considerable impact for our overall stakeholders and with that operator, we can open it up to Q&A.
Thank you.
We will now begin the question and answer session to ask a question you May Press Star then one on your telephone keypad, if youre using a speakerphone. Please pick up your handset before pressing the keyes.
To withdraw your question. Please press Star then two.
We will pause momentarily to assemble our roster.
And the first question will come from Steve Delaney with JMP Securities. Please go ahead.
Good morning, everyone and thanks for taking my question David based on your comments any oelkers.
I would certainly conclude that in the first quarter.
For the word tightening several times.
Yields compressing so it would indicate to me that unless something.
On the derivative side.
Came into play you bet your book value.
For annually should have moved higher in the first six weeks of the year and wondered if you could offer any observation on that.
Sure Hi, Steve.
Good morning.
Our book value has moved up as of Tuesday, we were up roughly three 5% on the quarter, partially attributable to your point on spread tightening, but also portfolio positioning in terms of the bias towards the steeper curve as well as up in coupon, which has outperformed lower coupons thus far.
This year, so there's still have half the quarter left to go but we feel pretty good about where we're at now.
I appreciate you sharing that will we will adjust the comp table immediately.
And then just looking over here on page three of the deck and looking at the credit book, a little bit you know it.
It seems like.
There was growth in virtually every credit bucket that I could determine especially as you highlighted in the residential.
In the residential loan areas, but CRE yet of CRE debt did decline of about $80 million and is that a trend that we should expect to continue.
If so what would change.
You in Tim's outlook for for win to win the step back into that market.
Sure I'll start off and then pass it off the Tim look it's still early in terms of the CRE recovery.
Stress that on past calls given the dynamics with respect of the virus and how we're using commercial real estate of society.
The notable decrease in the portfolio is attributable to a sale of part of our healthcare.
The facilities as I mentioned, which we basically took advantage of a very good opportunity to generate the profit on that we did.
We did again.
<unk> returned to the origination front and the fall in the did get a couple of deals done, but we also had a little over $100 million in run off so yes.
The decrease largely it was opportunistic and with respect to the outlook on CRE.
Yes, I think Thats right I think this is of one quarter look as to sort of what happened in the fourth quarter with respect for that sale.
We're being cautious about where we deploy capital like a lot of people in our space were focused on industrial and multifamily and.
And to the degree that we can find good opportunities there and we're doing that and so.
I wouldn't read a whole lot into the decrease in one particular quarter.
As the market continues to heal we'll continue to look at opportunities.
That's helpful. Thank you both for the comments.
You bet Steve.
Yes.
And the next question will come from Rick Shane with J P. Morgan. Please go ahead.
Hey, guys. Good morning, and thanks for taking my question.
Look I think that there are lots and lots of silver linings here, but David.
You said something that was kind of interesting.
In terms of reducing are staying at the lower end of leverage we're in an environment now where.
Rates are exceedingly low yields are exceedingly low and that has the historical precedent of not necessarily ending particularly well because it sucks so much liquidity into the system.
I'm curious to sort of hear your touch of gray theory of lower leverage and how youll be defensive through this period.
Yes, it's a good.
Question Rick.
Yes, we are at the lower end of our leverage we do feel like we still have in 2021 of fair amount of runway for Cary and agency MBS to dominate the day, but again asset spreads across sectors are tight and we have to be very mindful of yields and spreads in two.
For the extent that there is some local shake up in terms of the spreads or any market volatility we want to be prepared for that eventuality now that's not to say, we would keep leverage at the at these low levels, but we are a ways away from <unk>.
Spread widening that would suggest we the increase it and we just think it's the right approach to maintain we're still generating a double digit yield.
It is providing the income for the shareholder and we're able to do more with less and were perfectly content to maintain that posture for the time being.
Got it and it is interesting because of the last couple of quarters you've talked about.
Very clearly a path to out earning the dividend at this point.
You didn't make that comment this quarter, how do you feel in context of running with the lower leverage and some of the spreads tightening.
Sure.
So for the first quarter, we do expect to out earn the dividend, but not to the extent we have in the.
The last quarter, but we still feel very good about.
Core earnings are coming in at.
For the near term.
Terrific, Thanks, and I apologize for the puppy on even in the background.
We expected now.
Thanks you.
You bet Rick.
The next question is from Eric Hagen with BTG. Please go ahead.
Hey, good morning, guys hope, you're well couple of questions here lots of numbers getting offered out there, suggesting I think you said in your opening remarks 75 per cent of the market I've heard of upwards of 90 per cent of the overall market and the money to refi that feels aggressive.
Considering how much turnover there already was last year can you weigh in on that and maybe just rationalize how strong you think the incentive is.
Including for various cohorts of the of specified pools.
And then on the portfolio can you talk about where in the coupon stack you see the Caribbean strongest right now on which cohorts of specified pools, you think off of the strongest value.
Thanks.
Okay for sure in terms of luck of refi incentive what People's use of newer for use of similar thing is look we just look at the gross coupon of the pools.
As long as it's like 75 basis points in the mind of equaled it lots of debate as well as long as 50 basis points in the money of equaled 50 basis points in the money. For example, if you take the priming of the rate is 275, clearly that's the best part of it where sort of getting right. Now you can say that <unk> 77 per cent of the universe is in the mind of a viewpoint.
Perfect the debt not all the guys get this to 75 for an out of these guys said look the problem with the refinancing you take like we said.
The prepared remarks that we are seeing some signs of burn up because everybody is not getting this.
In terms of luck of specified pools, we are still finding opportunities in the.
Uh huh.
Higher coupon higher coupon, meaning to NFS in threes in this case.
The loan balance pools with some other characteristics for example, non owner occupied and all of that kind of stuff.
So yes, there are still pockets of opportunities, but unlike the previous two ease of that own the fee.
That was buying in specified pools of a reasonably attractive this time around the banks totals for buying and that will make specified pools price on the in line, but there are sort of opportunities as I said loan business with like some other characteristics.
Does that help Eric.
Yes, Thank you guys very much.
Thanks, Eric.
The next question will be for Bose, George with K BW. Please go ahead.
Hey, guys good morning.
So just wanted to follow up a little bit there on just on the returns incremental returns in terms of Specialness I think youll.
We expect modest specialness.
Quantify that a little bit.
And then just incremental.
What youre seeing out of the specified pools and then if you just add it all up and you get a double digit return now in the market on incremental capital.
Hi, Bose this is David.
So yes to <unk> earlier comments getting of double digit yield is difficult.
Certainly achievable and TBA is in the latter half of 2020, but the Specialness has dissipated somewhat we do expect it to remain prevalent certainly one of the fed's in but I'd say, we're talking very high single digits on TBA is and in that context on pools for buying.
Okay, Great. That's helpful and then actually just switching over to the.
The returns you're seeing in Npls in our Pls the cause.
If you look at the the recent deals they're selling a car. So can you just help us walk through the returns that youre seeing for those assets.
I'll start and then hand, it over to Mike and this is this is something <unk> talked about in the last year for this call in terms of that being a part of the resi sector that we've taken advantage of and throughout the fourth quarter I think Mike was very active in acquiring.
PLE twos and.
At spreads that were meaningfully wider than where they are today. So the.
Of the trade is not quite as attractive now, but we certainly took advantage of it in Q4 and into Q1.
Sure. Thanks, Kevin.
I would say in terms of economy unrated NPR appeal of space, We still think net youre able to achieve high single digit Levered Roe vs.
And that's on a prudent amount of recourse leverage I would say the assets that we added throughout Q4, we think we're probably closer to low mid double digits.
The low teens.
And maybe kind of frame that market right now <unk> ones are probably at $2 25 yields so thats a 190 195.
And then <unk>, which has been more of a focus not so much on the NPL of <unk>.
All of that $3 75 for 400 to the curve and again, the commonly right now very high single digits lever of blended Roe vs.
In terms of CRT D has been answers has mostly been seasoned pre COVID-19 and twos. So these assets are unlevered spreads of the 180 to 200.
The number of redeeming.
What characteristics of one or two of your weighted average life of assets very high gross WAC and Youre seeing significant deleveraging of those assets and I would say for both of these products.
There has been the ample liquidity and balance sheet in terms of the compelling we've continued to see terms tightened in given given the landscape so non attractive not as attractive as what we saw last quarter, but we still think that the more pockets of opportunity.
Okay. That's helpful. Thanks, you bet Bose.
Yes.
The next question comes from Doug Harter with Credit Suisse. Please go ahead.
Thanks.
Acknowledging that we haven't even hit the kind of of the one year anniversary of of the volatility.
But I guess, how do you think about your liquidity position today and kind of over the long term as markets continue to heal you know kind of what what the right level for.
For for for liquidity Holdings.
And of more norm, you know in a normalized environment.
Yes, it's a great question, Doug and we have talked about this a fair amount over the past look we cant as I've said, we can't Unsee, what we saw in March and all of these episodes of volatility does have to inform you.
Your business model on a go forward basis. So so in light of this we do think that the steady state level of leverage is lower than it was.
Of the fed's not always going to be there.
And liquidity is Paramount, we put ourselves in a very good position coming out of March and we've maintained that and it's not just about having reserves on the balance sheet to manage through volatility. Its also about having opportunities to do things that others without the capital base of entity.
That we have.
That others can't can't quite do and when it comes to investing for example, in Mike's residential effort and being able to provide certainty of execution for originators with one of the liquidity.
That's the confidence inspiring to our partners and they look at our balance sheet and they know it.
We're in a place of strength and so there's a lot of other benefits beyond just simply being able to manage through volatility of the same is the case on middle market lending, where Tim has got a very unique business, where he he does have the liquidity of the REIT.
That conveys to our sponsors that we can do things that other lenders arent in a position to two of the consequence, you can accomplish some pretty significant things in that.
So so there is both a conservative aspects coming out of March but Theres also an opportunistic aspect as we look forward in terms of just being able to do things with our liquidity and having that strong foundation that we feel good about.
We think it will remain the case for the foreseeable future.
Thanks, and then also just on the capital structure.
How are you thinking about that going forward any other kind of changes.
But you would envision kind of in the.
In the coming years sure.
Sure and I talked about the call of our preferred.
Which we certainly feel very good about our overall capital structure were 11% of of our capital is in is in preferred with the rest entirely in common and.
It's important to know with our existing preferred.
Where we issued that the.
Post reset spreads that will prevail or between 417 basis points and 490 basis points and when you look at the forwards when those preferreds do reset we're talking about preferred cost of capital.
In the context of 5%. So so the existing preferreds that we currently own we feel good about particularly with respect to that low cost of capital, but not how we look at our overall capital structure is as we said last quarter. You know there are three forms of leverage there is first and foremost balance sheet leverage than their structural leverage within.
In the portfolio and then there's capital structure leverage currently right now the best form of leverage as balance sheet leverage and that's a function of just the incredible amount of reserves in the system.
And as a consequence, that's what we're taking advantage of it that's what we feel good about now.
With respect of structural leverage it's important to note that the just the ample amount of of balance sheet available in the system and it Hasnt just affected agency MBS, but it's also had an impact on on other products that also use leverage mainly very high credit quality assets like Triple A's.
And as a consequence for example, AAA spreads across our businesses are very tight.
So the way we look at that is for example in our resi business and securitization. We can take advantage of the availability of balance sheet by selling triple A's and the.
Then retaining that structural leverage and we'd get a benefit from that but it all starts with the balance sheet leverage that's available in the system and with respect the preferreds in the capital structure leverage.
We're not at a point in terms of where.
Yields are on preferred.
Where we would issue we need a much greater spread between where we can invest for example agency MBS versus the cost of prep in the market and so.
At these current spreads we don't have an intention of increasing our structural leverage right now.
Or I'm, sorry, our capital structure leverage.
Great. Thank you.
You bet.
The next question is from Kevin Barker with Piper Sandler. Please go ahead.
Thank you good morning could you.
<unk> just give us the view on the act.
Your appetite for acquisitions and what the market currently looks like.
Just given.
A lot of activity that's going on in the capital markets.
And with a bunch of disruption and various other lending categories. You just love to hear your view on what's happening within M&A sure Kevin.
Look we have been acquisitive in the past.
The way I look at it is theres three catalysts for acquisition number one as assets.
For two as price and number three is the strategic fit now there has been a couple of combinations that we've seen in the recent past.
And candidly they've traded of prices that.
Acquire a company provide liquidity, we got to get paid.
For our time operational risk of Onboarding of portfolio and we've got to make sure that the assets fit what we want to do.
Going forward and so.
I will say, it's not as attractive today, just given given the pricing.
But to the extent, where there is a disconnect between where we're trading versus where somebody else may be trading and there is a need for our liquidity.
And we can do so profitably we will absolutely consider the opportunity now the third point is strategic fit of the third catalyst.
There is something out there that can accommodate our businesses.
We would certainly look at it but right now we feel we're well equipped across all of our businesses to do what we need to do organically.
And.
To the extent that changes and there is something out there, we'll certainly look at it but we feel very good about how our businesses are.
Are performing right now and we're in a good place.
I mean would you categorize the M&A opportunities or the amount of flow that youre seeing.
To be equal or better than what you were seeing pre pandemic levels.
Given the state of the market today.
It's episodic that's a hard question to answer candidly.
We do expect there to be.
The more M&A activity in this sector and a lot of it does have to do with what occurred early last year in terms of depletion of capital across firms. So you get to a point where.
Firms can can really be inefficient because operating expenses relative to what what type of returns can be generated are just they're just not of scale and so so I would expect there to be more activity in 2021, and again to the extent of it would work for for annually, we would certainly look at it but.
We're not out there chasing companies to buy but yes, you should expect more activity going forward. Okay. Thank you very much you Becca.
The next question will be from the Villa Abraham with UBS. Please go ahead.
Hey, guys how are you.
The commentary on the commercial bank bid for the agency MBS.
Curious how material do you think that is to where spreads are now and just how does that play out over the course of the year.
Yes, maybe off the tying that into what you guys are thinking about the.
The fed taper and then on the back of those kinds of events.
Where it can leverage go you know could it go higher.
Most of events transpire.
The village.
So look with respect to commercial banks. It has been a very strong bid in the market.
In 2020 commercial banks.
We're flushed with deposits and.
There weren't a lot of lending activity or there wasn't a lot of lending activity to take advantage of and so banks have had really the.
The.
The direction. They took was to buy securities and between Treasuries and agency MBS the added over 750 billion.
In those sectors in 2020, now you compare that to prior episodes of QE and net securities growth for banks. For example, in Q3 was roughly flat, even I think slightly negative of.
The memory serves me correctly and so the point being is that banks have been a very strong bid for the agency sector of the fourth quarter alone of about 200 billion Janney.
January we just got data another 75 billion in agency MBS and so they've been a strong contributor.
Two the spread tightening and we do expect that to continue.
Now with respect to of taper and Thats, obviously gained a lot of the conversation in the market over the over the not too over the recent past now I'll say.
This is a very different environment in 2021 than what we experienced in 2013 with the taper tantrum of the fed's in a very different place in the market is in a very different place now the fed learned a lot from the taper tantrum and as a consequence, you see much greater transparency better forward guidance.
And the.
Fully intend to prepare the market for cessation of drop off in purchases.
Securities. So so we feel good about how the fed's going to message to the market and the signaling. We've got is that the QE will exist in the current form through 2021.
And we May get a reason to think they'll change of that guidance, depending on how the economy plays out, but we do think we're a ways off from that from that eventuality now another point to note is the market is in a much different place in 2021 than it was in 2013 and 2013.
It was almost as if the market felt like it had a put option because of.
The fed's position and obviously that turned out not to be the case.
Here in 2021, I think the market is much more conservative and defensively positioned and you see it in a lot of the data for example.
If you look at some of the statistics about short positions on the CFT see the market appears appears hedged.
Also JP Morgan puts out a survey about.
Long versus short in the market appears short from that standpoint at least hedged and then when you look at option pricing the.
The price of Puds for the price of portfolio insurance and fixed income is.
Meaningfully higher than the price of calls and so it does feel like the market's a little bit positioned for higher rates.
And another point to note is the convexity profile of the convexity in the market is better today.
And it's not just about.
Just the actual convexity in the instruments, but also who holds the agency MBS in the market and that did contribute to a lot of the sell off in spread widening in 2013 at the time.
The fed in banks owned roughly 50% of agency MBS in 2013 with the rest of the market owning the rest in a lot of the rest was.
Was hedged Reits were more levered and so there had to be more activity with the sell off at that point today banks and the <unk>.
Fed 163% of the universe at year end now if we fast forward to how this year should play out of bank demand is consistent with what it was last year and the fed maintained its pace then that number will grow to 70% of the agency MBS in the market.
And again, the fed doesn't hedge convexity in banks hedge very little of it. So we feel like the market's better prepared the feds doing a much better job of messaging.
And.
We're in a much better place, but we're always going to be watchful.
We have our portfolio of pretty.
Pretty much fully hedged from a duration standpoint, we have optionality, where roughly 40% of the convexity profile of.
The agency portfolio is hedged with swaps and so we feel good about that but we're going to be vigilant and we're going to make sure. We stay on top of any rate moves.
That help.
It's very helpful. Thank you.
Just quickly on the prepay.
Prepay speeds. It sounds like you guys are getting incrementally more positive there.
Just talk about what you see the the <unk>.
Instead of in the CPR is being like do we get to a normalized level there anytime soon or is it.
Still going to be pretty elevated for a while just maybe a little bit of less elevated than you previously may have thought.
Thanks.
Sure Okay.
Yes, it is very low and in the near term it may stay elevated in the.
The reason for that one is obviously because of the COVID-19.
They made it so easy to refinance for example, electronic form of a flood of signing some documents and all of that kind of stuff and recent ipos. All of these non bank originated just becoming extremely efficient. These are all well known but also look what's happened is the Israeli it very sharply. So there were lots of really good call that sort of 2018.
<unk> for for example out of luck prime borrowers at the point because it was the current coupon rate and <unk> of 2019, Likewise 2002, and the two announced so brand new issued the collateral at that point become in the minus so quickly and these guys have recently refinanced guys. They know how to do finance and they are getting closer on brokers.
And also the refined that surplus locking two channels, but it would of course to refinance or landed of brokered reaches the about the work to define us. So we do not expect the burn out on the second channel that I mentioned, Inc. And the reason is that recent ipos and the the high profitability of the refinancing, but we are seeing Bernard and we will.
Expect to see more burn out on the first channels.
Which means that bottle, where it makes the outgoing calls because if you havent caused by now than you have been in the money more than the 100 basis points in the money for over a year. It's a good bet that you will not be calling soon so in the first channel that I mentioned, we will be seeing some burnout and discipline.
The show itself in the more seasoned collateral and lots of more loan balance of collateral is for the overall burn out that we were accustomed to it will take a little bit longer time, probably the end of the year that you will see on the brand new collateral of getting the burnout.
Sure.
Does it help thank you.
Thank you guys.
You bet.
<unk>.
Once again, if you have a question. Please press Star then one.
The next question is from Kenneth Lee with RBC capital markets. Please go ahead.
Hi, Thanks for taking my question wondering if you could further expand upon your prepared remarks about potentially seeing some benefit from a steepening yield curve.
One of you can share some thoughts on the impact to returns or net investment spreads going forward. Thanks.
Sure there is.
A couple of components, Ken I will say from a positioning standpoint as I said, we do have a modest steepening or on we added roughly $10 billion hedges.
Hedges in the fourth quarter at the longer end of the yield curve. We also actually added a little bit very early in the.
The first quarter of this year. So we feel good about the positioning we're right around five years.
The average duration of our hedge profile and our mortgage portfolio is roughly half of that and so and so from that standpoint, just appears steepening of the yield curve with spreads unchanged.
We would benefit modestly.
From that we think.
Now it is somewhat of a double edged sword because of the steep of the yield curve. The more expensive. It is the hedge your pay rate.
The new hedges goes up while you received rate stays very low as the front end is anchored another point to note is that is that your hedges.
Do roll down the curve and they rolled down at a much quicker pace than.
The agency assets do so as that rolled down occurs there is some mark to market deterioration as a consequence of that but nonetheless, a steeper curve would probably would modestly benefits and I'll give the ilker.
The <unk> those are the very good points David Auld.
So look steeple Cook hubs the option cost of luck on these mortgages and we were talking about burnout.
Deep water pumps, the prepayments of a lot of and also market segmentation can be really beneficial.
Curve Steepens.
So it will be more opportunities on the coupon swaps.
Because of the option close and that will be also opportunities on the data with the execution. So steeply as most of mortgaging missed this month and we're looking forward to it but the.
You shouldn't be vehicles missile for the.
Hedging consequences that David mentioned, so as long as we can manage those default code was look really nice of outcome for the mortgage investors.
Great. That's very helpful and just one follow up if I may I, just think of in the prepared remarks, you mentioned that cash.
We're adding a little bit of duration to the repo book.
Wondering if that's primarily an opportunistic just taking advantage of the current costs or is there any kind of longer term view towards either extending out the finance maturities or more.
Okay sure Thanks sure Ken so.
We have added duration of the repo book, we are now just over three months and a lot of that is attributable to taking advantage of as I've talked about in the prepared comments of one.
One year rates for example inside of the 20 basis points, we don't expect to see of negative rate environment.
As a consequence to the extent you can lock in funding costs for a year.
That close to the zero lower bound.
Shame on us if we don't take advantage of it and so thats just simply a function of of the fact that.
The rates out of the term or.
Our incredibly low in <unk>.
Serena talked about we did let the let the repo book run run down in terms of average days in the fourth quarter and that was just simply a function of of the desks view that with more and more liquidity entering the system and the actual need to lock up cash.
With collab.
Collateral.
We've seen a willingness for participants to term it out just the lockup that collateral at rates above overnight, even though were 10 basis points or less.
Between overnight in term and Theres just demand for collateral in the market that we've taken advantage of.
Great. That's very helpful. Thanks, again, Thanks, you bet Ken.
Ladies and gentlemen, 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 and thank you everybody for joining us today as we move into the future.
Jason will talk in the queue.
Thank you Sir.
<unk> has now concluded. Thank you for attending today's presentation you may now disconnect.
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