Q3 2021 Annaly Capital Management Inc Earnings Call
[music].
Good day and welcome to the third quarter 2021, and <unk> Capital Management earnings Conference call. All participants will be in a listen only mode should you need assistance. Please signal conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions to ask a question you may.
Press Star then one on your Touchtone phone and towards draw. Your question. Please press Star then two please note. This event is being recorded I would now like to turn the conference over to Mr. Sean Kensal. Please go ahead.
Good morning, and welcome to the third quarter 2021 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, antibody routinely post important information for investors on the company's website www.
<unk> Dot dot com.
Content referenced in today's call can be found in our third quarter 2021, industrial presentation and third quarter of 2021 financial supplement.
Both found under the presentations section of our website.
And we intend to use our webpage as a 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 all he encourages 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 calls presentations webcast and other information to post 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.
Our tough head of securitized products, Tim Coffey, Chief Credit Officer, and Mike Daniel <unk> head of residential credit.
And with that I'll turn the call over to David.
Thank you Sean good morning, everyone and thanks for joining us for our third quarter earnings call. Today, I will provide an overview of the broader market environment, including our thoughts on the federal reserve's reduction in asset purchases briefly touch on our performance during the quarter and highlight some of our recent achievements and positioning across our businesses.
Ilker will provide more detailed commentary on our agency and residential credit portfolios and Serena will discuss our financial results and as Sean noted our other business heads are also here. This morning to provide additional context during Q&A.
First with respect to the macro landscape.
<unk> Delta wave and related factors have led to a moderation in the economic recovery labor market gains have slowed relative to the strong pace at the beginning of the summer production bottlenecks and global supply chain disruptions have caused delays that raised prices on products in high demand and while inflation has been boosted by higher <unk>.
<unk> and energy prices record home price appreciation has started to filter into inflation shelter component, suggesting that price pressures may persist for longer than previously anticipated.
Meanwhile, interest rates experienced meaningful intra quarter volatility given the shifting narrative on the economic recovery and inflation early in the quarter rates rallied this market saw direction on the magnitude of the impact of the Delta variant.
And later in the quarter as a relative reduction in Covid case, count led to a return to economic optimism rates sold off in the curve steepened in the quarter.
Now the greater near term focus and the macro landscape. However, as the immediate reduction in the fed's pace of asset purchases. Following the September <unk> meeting, we now have a clearer picture as to what the taper will likely look like that is expected to reduce treasury and agency MBS purchases by roughly $10 5 billion per month risk.
<unk> beginning as early as November this pace would result in a fed halting balance sheet expansion in the summer of 2022. So we expect reinvestment of portfolio run off to persist well beyond the end of the taper consistent with the Q3 experience.
Notably the Fed's transparent communications have helped to limit the market impact both interest rates and agency MBS spreads ahead of the official taper announcement.
While the fed has attempted to decouple, the taper and eventual rate hikes elevated inflation readings and more hawkish central bank messaging globally have accelerated investors' expectations of a rate hike with market is currently pricing as many as two hikes in 2022, we remain vigilant in managing in lease duration exposure.
Both in the front end and the long end as hilker will expand later on.
Now, reflecting briefly on the agency MBS supply and demand outlook in light of the taper announcement.
Pivot market participants will need to absorb an increased amount of mortgages in 2022 elevated net issuance remains an uncertainty in the supply demand outlook, but we currently estimate supply to the private market next year will be similar to levels seen in recent years pre pandemic and.
Several factors are supportive of more limited widening in spreads before buyers emerge.
So flushed with deposits and see little loan demand, suggesting strong appetite for securities is likely to continue particularly at potential wider spread levels and money managers remain underweight mortgages, but will likely increase the relative allocation mortgage spreads become more attractive.
Ample liquidity best seen in the one six trillion dollars pledge to the fed's reverse repo facility at quarter end and readily available financing remain the main factors underlying the current accommodative financial conditions. The repo market remains highly liquid and has allowed us to decrease our cost of funds to another.
Record low in line with efforts earlier in the year, we continue to broaden our financing through increased use of credit facilities by funding high quality credit securities for longer terms. These actions help to enhance <unk> liquidity profile at extremely attractive spread and haircut levels as Serena will discuss in more detail.
Now turning to <unk> performance in the third quarter, our portfolio generated a positive economic return of two 9%, reflecting a <unk> <unk> gain on book value and earnings available for distribution of 28.
We achieved these returns to make continued conservative portfolio positioning maintaining economic leverage at the low end of our historical range and unchanged quarter over quarter at five eight times, our liquidity remains at our highest levels with total unencumbered assets of $9 8 billion at quarter end, we continue to see.
<unk> tight spreads and as a result, we're comfortable with our more cautious approach to managing the portfolio now that being said should spreads become more attractive or nimble positioning leaves is prepared to take a more offensive posture and increase leverage should it be justified.
Over the quarter mortgages performed in line with hedges in this environment is the sector benefited from clarity surrounding the up coming taper and healthy demand from banks, we increased our agency portfolio by nearly $3 billion in Q3, as we invested a portion of the proceeds from our previously announced commercial real estate sale.
Additions to our agency portfolio, which Ilker will cover in more detail, we're primarily a placeholder as agency MBS remain fully value, while credit sectors offer attractive pockets of opportunity, but deployment of capital is more episodic.
With respect to capital allocation in the third quarter, 30% of our capital was allocated credit up slightly from 29% in the prior quarter in line with our view on the relative value equation vis vis the agency and our deliberate portfolio positioning ahead of the taper.
Our residential credit business represents the majority of our credit allocation at 21% and had another strong quarter as the group continues to successfully execute on this strategy with assets of $4 3 billion residential credit group is now larger than it was pre COVID-19 and assets are up over 70% since year end 2000.
'twenty.
We maintain an optimistic outlook on the business given persistent robust housing market fundamentals and long term tailwind is driving the need for private capital in the market.
Envelope based securitization platform remains very active completing nearly $2 billion of securitizations since the start of the third quarter and nearly $3 billion of Securitizations year to date, we expect to maintain our securitization footprint and we're continually adding to our partnerships to drive new sources of securitization collateral.
Additionally, our correspondent network is adding new partners and annual these large capital base and market expertise uniquely position Onslow Bay as an aggregator within the industry and also as it relates to <unk> I wanted to briefly touch on the impact of the recent suspension of FHFA is cap on second homes and investor properties.
The decision will have an impact on the delivery of agency eligible loans to our platform. It does not temper our bullish outlook for the sector annually was an active issuer of agency eligible investor loans before the cap was put in place and notably we issued three securitizations in 2019, and 2020 backed by one 1%.
5 billion of collateral prior to the PSP amendment limiting delivery of Investor loans Gse's in March of this year as the FHFA has reversed the introduction of the caps, we expect annually in private markets more broadly to be able to compete with GSE LLP adjusted pricing again, assuming securitization X.
Houston remains attractive.
Now regarding progress on our MSR business, we grew our holdings by more than 40% on the quarter with the portfolio representing $575 million in market value and 4% of dedicated capital as we scale. The business, we have solidified our position as a reliable partner in the MSR sector supplementing our bulk trans.
Actions with acquisitions through flow relationships, we've increased our MSR holdings by $470 million in 2021, and we anticipate responsibly growing the portfolio through our unique position as a noncompetitive partner to originators that need liquidity and capital.
Turning to our middle market lending business, we closed our inaugural private closed in fund subsequent to quarter end with just north of $370 million of capital to fund is approximately two times larger than the medium size of first time direct lending and private debt funds. It includes a mix of both U S and European investors comprised.
Public and corporate pensions insurance companies and asset managers. The fund has supported nearly $450 million of middle market loan investments to date with an attractive risk adjusted return profile, Italy is co investing 50 50, alongside each fund investment, bringing a strong alignment of interests that we.
Believe the fund serves as a testament to the track record and expertise of our dedicated middle market lending team allows for enhanced capital allocation flexibility to further scale. The strategy and provides recurring fee revenue to the REIT, including the fund the middle market lending strategy managed $2 3 billion in funded asked.
At quarter end.
Lastly is the largest mortgage REIT with the capability to invest across all aspects of our mortgage loan our strategic initiatives over the past year, including investing in MSR and balance sheet and expanding our residential credit business have prepared us to be a leading source of capital and residential housing finance ultimately the strength.
<unk> diversified model is enabled by our size and scale and we remain confident in our ability to generate stable returns throughout various market environments and across economic cycles. As we have done historically and now with that I'll turn it over to Ilker to provide a more detailed lens into our agency and residential credit portfolio activity and outlook.
Yeah.
Thank you David against the economy can anticipate picked it up David described.
<unk> performed broadly in line with pages, but performance was mixed across the coupon stack.
Specific to lower coupon MBS widened modestly due to continued record supply levels.
Pets taper moving closer and elevated prepayments speeds at the same time higher coupons outperformed hedges into the retracement of Hyatt anticipates that materialized later in the quarter and emerging signs of prepayments burnout.
Our portfolio performance showed the benefits of the barbell strategy, we have discussed in several of our recent earnings calls.
In third quarter, the outperformance of higher coupons more than offset the widening expanding us into lower production coupons. We believe the approach is also efficient in protecting the portfolio from any potential tapering induced widening is nearly 60% of our agency portfolio consists of <unk> <unk>.
<unk> supported coupons that is 3% and <unk>.
In addition, our specified pool portfolio has more than 45 months seasoned on average which provides a strong source of durable earnings with minimal duration and convexity risk.
Turning to our portfolio activity, we tactically increased our agency portfolio by nearly $3 billion during the quarter predominantly lower coupon TBA store Opportunistically redeploy a portion of the proceeds from our previously announced commercial real estate sales.
All purchases cautious to talk primarily lower coupon TBA, which exhibited spread widening earlier in the quarter.
Favorite TBA portion lower coupons due to attractive implied financing rates in the.
The overall market, which remained quite special in the context of negative 30 to 40 basis points financing and enhanced.
There were times.
We expect these favorable conditions to persist well into 2022.
If the fed remains a net wide of MBS throughout the tapers. In addition, the sector offer strongest liquidity should we choose to redeploy capital into other opportunities.
Regarding prepayment speeds.
Prints have mirrored the divergent performance across the coupon stack lower coupons have been very active in.
What remains to historically low mortgage rate environment in which mortgage originators have ample capacity, while higher coupons have exhibited modest burn offs since peak prepayments speeds in March.
Its current mortgage rates, roughly 31% of mortgage universe of greater than 50 basis points of refinancing incentive which is down significantly from the 7% to 2% at the beginning of the year.
The recycling of the universe, along with slower speeds and higher coupons has improved.
Repayment outlook going forward.
Additionally, the strong housing market has led to eliminated cash out refinancing activity, which should help mitigate extension risk or mortgage portfolios should interest rates continue to rise.
Our portfolio prepaid, 13% slower quarter over quarter and our outlook is for a further 10% to 15% reduction in the fourth quarter due to higher rates less reactive borrowers and slower housing season those.
In our hedge portfolio the added duration hedges at lower rates throughout the quarter positioning the portfolio for modestly higher yields.
And it tells you the future shorts across the curve and increase our longest long end swap position by exercising Neely.
Helium in demand disruptions.
We also took advantage of relatively lower levels of implied volatility to replace our exercise of options with highest strike swaption said longer expiries.
This proactive approach has already proven worthwhile given the rise in interest rates in September and October.
The interest rate outlook remains cloudy due to uncertainties all inflation. The fed's response and market positioning we will continue to minimize our interest rate exposure in fourth quarters.
It was an active quarter for our mortgage servicing rights business. We grew our portfolio through 200 millennium bulk purchases and began transacting through flow arrangements, which we see as a good growth opportunity going forward.
Additionally, in the fourth quarter, we expect to sell the vast majority of our legacy MSR portfolio for roughly 8% to 5 million in estimated proceeds.
The sale of higher coupon seasoned MSR will provide additional capacity to grow auto location to knievel production low coupon MSR, which will serve as more effective hedge to the MBS basis.
Additionally, the planned transaction as we then operational partners that ascribes, a higher value to customer acquisition, which will drive strong execution for both parties. We believe this transaction highlights and <unk> unique position in the MSR market as a capital partner for the origination community that does not compete for their customer.
Yes.
Moving to our residential credit business.
We continued to increase our allocation to the sector as measured by both assets under management and capital deployed.
The residential portfolio ended the quarter at $4 3 billion of market value and $2 9 billion of dedicated capital.
Resenting, 21% of the firms capital.
The growth of the portfolio was predominantly through our acquisition of residential whole loans as we purchased $1 4 billion throughout the third quarter.
Our Q3 acquisitions were across both expanded prime non QM markets.
Agency eligibility Mr laws.
Our securities portfolio was up modestly approximately $125 million as we saw diminished opportunities and third party securities relative to prior quarters.
As David mentioned.
<unk> securitization platform was active in Q3 with $1 $1 billion of Securitizations across three separate deals.
Also to note.
First quarter rent, we priced two additional transactions, representing another $800 million of issuance.
Life to date Levered returns of our whole loan strategy remains in low to mid double digits neutralizing minimal recourse leverage.
Our GAAP residential whole loan portfolio ended Q3 at five 8 billion, 70% of which is currently financed with non mark to market Securitizations.
In summary.
MBS technicals remain constructive as trends in group pace continue to improve and recent price section highlights the amount of support for MBS into higher yields.
<unk> spreads have potential to divide us as the taper commences and supply remains elevated we believe any widening is likely to be orderly, but we expect to maintain a conservative leverage profile and proactively manage our basis and interest rate exposure with that I will now turn the call over to set it up to <unk>.
Our financial results.
Thank you Luca and good morning, everyone.
This morning, I'll provide brief financial highlights for the quarter ended September 32021.
And with prior quarters, while earnings release discusses GAAP and non-GAAP, earning metrics my comments will focus on our non-GAAP AAD and related key performance metrics, which exclude PAA.
At the risk of repeating myself I would say that the general themes for this quarter's earnings are consistent with recent quarters.
That and this quarter, we continued to generate strong results from the portfolio benefiting from the continued low interest rates in the funding market, marking another quarter of record low cost of funds and sustained specialness and dollar roll financing.
To set the stage with some summary information our book value per share was $8 and 39 for Q3, and we generated earnings available for distribution per share of <unk> 28.
Book value increased primarily due to GAAP net income of $522 million.
<unk> 34 per share, partially offset by the common dividend declaration of $320 million or 22 cents per share.
And other comprehensive loss of $142 million or <unk> 10 per share on higher rates.
The negative impact to our book value from our agency MBS valuations was more than offset by the gains on our swap, resulting from higher hedge rates and higher mark to market valuations on our MSR and ready credit portfolios, which together contributed approximately <unk> <unk> per share to book value during the quarter.
Combining our book value performance of the 22% common dividend, we declared during Q3, our quarterly economic and tangible economic returns with by two 9%.
As we take a closer look at the GAAP results. The valuation drivers, we mentioned above benefited GAAP results as we generated GAAP net income for Q3 of $522 million or 34 cents per common share up from GAAP net loss of 295 million or <unk> 23 per common share in the prior quarter.
Expanding further on my summary comments, specifically GAAP net income increased due to net realized and unrealized gains on our swap portfolio in the third quarter of $180 million compared to losses of $224 million in the second quarter.
Lower net losses on other derivatives and financial instruments in the third quarter of $45 million compared to $358 million in the second quarter.
And net unrealized gains on instruments measured at fair value through earnings in the third quarter of $91 million compared to $4 million in Q2.
As David mentioned during our second quarter earnings call, we anticipated that <unk>.
Would moderate slightly.
This is reflected in a two cent reduction in AAV compared to the second quarter.
Most significant factors that impacted quarter over quarter included.
Lower interest income predominantly related to the runoff of higher yielding assets and a reduction in investment balances, which was offset by higher TBA dollar roll as a desk position at TBA portfolio based on the relative attractiveness compared to pool.
<unk> benefited from lower expenses on the net interest component on swaps from the termination of 28 billion gross national flopped as this.
Portfolio was repositioned to reduce exposure to LIBOR.
And finally, lower interest expense at $50 million in comparison to $61 million in the prior quarter due to lower average repo rates and balances.
It should also be noted that the sale of our commercial real estate business.
Allowed us to shift capital allocation to a higher percentage of resi credit.
We saw higher levels of AAV on whole loan and NPL IPL purchases throughout the quarter.
Now turning to our financing early in 2021, we communicated that we were forecasting lower repo rates for an extended period.
As such we have begun to Opportunistically target extended 10 that is six to 12 months for our repo book and this has resulted in higher weighted average days to maturity for Apple during 2021 in comparison to recent years.
And in doing this we believe that we have appropriately manage the risk of our liabilities, while catching a lot of the interest rate market.
Additionally, given our ample liquidity and the prior quarters, we elected to fund certain credit assets with equity further contributing to our lower cost of funds.
These strategies resulted in the third quarter, marking nine consecutive quarters of reduced cost of funds for the company.
Our weighted average days to maturity for Q3 was 75 days slightly less than the prior quarter at 88 days. This reduction in days is due to the timing of rolling repo extended earlier in the year and not a function of a change in strategy by the company.
As David discussed the market is pricing in rate hikes to begin in the latter half of 2022.
Therefore, we have seen steepening in the repo curves as of late.
So while longer term repo does come at a higher cost today, our over $30 billion in shorter dated zero to three year pay swaps has been a considerable benefit to hedging this eventuality.
And given the strong liquidity in the repo market that will likely persist beyond initial rate hikes, we have focused our effort on hedging short term rates as opposed to repo spreads versus policy rates.
Additionally, although our overall repo balances have been reduced since the beginning of 2021, we have tried to maintain steady balances within our broker dealer.
This has given us the opportunity to take advantage of attractive overnight funding conditions in mid excess reserve and steady decline in Pgi Jonathan.
As in prior quarters, we continue to see strong demand for credit assets on the part of repo lenders and we have opportunistically began to level credit asset a very competitive tests, both rice and hiccup.
Average weighted data credit assets are approximately 100, and we continue to target longer duration funding to lock in those competitive spreads and hiccup at all time tights, consistent with our prudent and conservative approach to maximize liquidity.
Given the growth in our ready credit businesses, we continue to add new warehouse facilities and amend existing facilities to meet the business needs with a further $300 million facility put in place during the quarter and increased capacity for already credit partnership with a sovereign wealth fund.
To provide additional color regarding our reduced interest expense for the quarter.
Overall cost of funds decreased 17 basis points quarter over quarter from 83 basis points to 66 basis points.
<unk> repo rate for the quarter was 15 basis points compared to 18 basis points in the prior quarter and we ended September with a repo rate of 15 basis points down from 32 basis points at the end of December 2020.
With LIBOR reform looming, we took the opportunity during the third quarter to reposition our portfolio and reduce our exposure to LIBOR, resulting in the aforementioned termination of $28 billion of swap notional and reduced interest component of <unk> for the quarter and future periods.
The portfolio generated 204 basis points of NIM down five basis points from the record NIM level of 299 basis points in Q2, driven by the lower interest income, partially offset by lower interest expense and improved TBA dollar roll income up three basis points.
Average yields decreased 13 basis points from 276% to $2 six 3%, mainly because of the change in the composition of assets towards lower yielding assets in the quarter, both agency MBS and credit.
Moving now to operating expenses efficiency ratios for the quarter decreased in comparison to Q2's ratio of 155%.
As expected we saw a reduction in our opex to equity ratios during Q3, as we realize the benefits of the reduced compensation and other expenses from the disposition of our acreage business and we saw a reduction due to the timing of certain fee payments and professional fees along with the true up of prior period accruals in the second quarter.
Our opex to equity ratios were 128% and one 4% for the quarter and year to date, respectively with the full year expense is expected to be at the lower end if not below the revised range of $1 45 to $1 six <unk> provided in the first quarter.
And to wrap things up and we ended the quarter with an excellent liquidity profile with $9 8 billion of unencumbered assets up from the prior quarter's $9 6 billion, including cash and unencumbered agency MBS of $5 9 billion.
The composition of our unencumbered assets changed slightly this quarter with an increase in agency due to lower on balance sheet leverage and an increase in unencumbered assets due to MSR Bryce.
Partially offset by reductions due to investments sold during the quarter and the lever levering of certain non agency securities that I discussed earlier.
That concludes our prepared remarks, operator, we can now open it up to Q&A.
Thank you we will now begin the question and answer session.
Just a question you May press Star then one on your Touchtone phone.
If youre using a speakerphone please pick up your handset before pressing the keys.
Anytime your question has been addressed and you would like to withdraw your question. Please press Star then two and at this time, we'll pause momentarily to assemble our roster.
And the first question will come from Steve Delaney with JMP Securities. Please go ahead, thanks, and good morning, everyone.
Given that you have 13 analysts following the company I'm just going to ask one question to lead off.
David curious.
Your quarterly dividend.
<unk> has been stable for the past six quarters going back to.
<unk> 'twenty after COVID-19.
What does management and the board want to see that would give support to increasing that quarterly payout.
<unk>.
Good morning, Steve and it's good to hear from you.
So first and foremost just a back up in terms of how we set the dividend and obviously our board is is.
<unk> provides strong guidance on that front and in conjunction with the board. We look at the overall dividend yield with the earnings outlook looks like and we want to achieve a competitive yield and currently our yield on book value is 10, 5%, 10.25% on the actual stock price. This morning in terms of what we want to look for.
To increase the yields or increase the dividend.
We would need to see.
Obviously wider asset spreads are better investment opportunity more durable earnings. So we feel good about where earnings are this quarter and we feel good about covering the dividend.
Into 2022, certainly, but we do recognize that we have out earned the dividend consistently since the second quarter of 2021 and.
And we're comfortable with that and we're very comfortable with where the dividend yield is today.
Certainly competitive with the rest of the market.
We're content right here.
Well I would certainly agree that a 10% dividend.
Is too high and then their incomes to catch 22.
What comes first but.
We certainly look at 10% and say there is certainly upside in the stock is that is that dividend comes down the credit oriented names are more R&D and more in the 8% to 9% and you are certainly adding a good bit of that thank you for the comments that thanks, Steve.
Okay.
The next question will come from George Bose with <unk>. Please go ahead.
Hey, guys. Good morning, this is bose.
I wanted to ask about the <unk>.
$1 5 billion dollar resin portfolio can you just give us some color on that what is the return is going to be and how much capital is good is that going to using the and once that's securitized.
Sure Bose, good morning, and I'll start off and then hand it over to Mike.
I would separate both loans from securities. We have had an emphasis on growing our loan portfolio and securitizing the securitized portfolio has grown.
But I will say from a return standpoint, the loan to securitization market is more attractive in terms of what we can generate relative to where securities are currently pricing might kick in.
Jumping in here sure. Thanks, Ron and I think we ended the quarter $3 2 billion.
Securities on an economic basis, and $1 $1 billion in terms of whole loans and I think when you think about the conversion on whole loans to securities on balance sheet, we're retaining anywhere 15, I'll say between 7% to 8%. So we will say between 75% to 80 to 85 million is what ultimately will be created from that.
$1 $1 billion of whole loans, but to note. We settled $2 8 billion of whole loans year to date, and we ended the quarter with $1 $2 billion pipeline. So we remain positioned to continue to go to the securitization markets to the extent that they are open but I would think about it probably 7% to 8% of the whole loan portfolios ultimately.
Converted.
Two securities on balance sheet.
Okay, Great and then the target ROE on that on a levered basis.
Yes on securitization were in the low double digits right now.
Okay, great. Thanks, and then on the MSR.
<unk>, how large could that get as a percentage of your calculus of your capital and in terms of the yields on the MSR that you're buying can you just give us some color.
Sure and as we've talked about both the last two quarters, we would like to get our MSR portfolio up to 10% of capital, but we've also stress that we're going to be patient in doing so we're not going to chase returns in this sector. We were happy with the growth that we achieved in the third quarter, but again it may take time because of the market.
The market is competitive, but we're finding opportunities can talk a little bit about returns.
Yes.
<unk> is that we were buying with the hedge benefit will be very low doubles.
At current pricing it will be high singles, So thats, while we reduced our purchases we reduced our purchase pace recently, yes. Now we can also distinguish bulk purchases versus flow wherewith flow purchases you can get into the double digits kind of equipment.
Okay, great. Thanks.
Thanks Bose.
The next question will come from rich Shane with J J P. Morgan. Please go ahead.
Thanks, everybody for taking my questions. This morning.
I just wanted to talk a little bit that the disparity between actual prepayment speeds in the long term CPR assumptions fairly wide.
I'm curious, how we should think about the convergence of that overtime and the implications in terms of.
Your reported numbers.
Should one of the main reason is the steep steepness of the curve long term speeds, the forwards and as the curve steepens like mortgage rates goes up and forward speed scores zone. So thats one of the reason and second reason is the burnout is the portfolio of Burns out.
Speech will slowdown so but.
With a bigger reason if Kirk let us youll see those two numbers they approached each other.
And how should it does but at the same time, how should we think about ultimately they have to converge at some point. So how do we think about that from a.
A reporting perspective, what we should anticipate and really what the timeframe on that convergence should be I mean, it's.
Wider than 10 points at this point.
And that just seems unsustainable so trying to think about the timeline.
The accounting implications.
Yes.
Yes, so Rick I would say there is a consistent catch up that is adjusted on a quarterly basis number one number two let's just look back I realize the disparity between actuals and long term projection is quite widen out but if you go back a few years when rates were higher you did have portfolio speeds.
We're in the low double digits very consistent with long term <unk>.
Long term projections, so to the extent rates do normalize them, we're going to ultimately approach those longer term CPR. If we follow the forward Zucker suggested and potentially even through those levels and will average out, but it's all dependent on where.
Actual rates do go out the horizon.
Got it okay.
Certainly look I don't I'm not questioning the long term.
Prepayment speeds, particularly given the burn out.
That we're all anticipating I'm.
I'm just trying to think about what it means if you are persistently above the long term assumption.
Because obviously, what's left has a very low speed, but theres not much of it.
Remaining in Asia to replace.
Or reinvest it you could have the situation, where you sort of have this persistent gap between the two.
Yes, you can you can look at it this way.
As long as prepayment models were accurate and if you would.
Forward did not does not realized on coach Stacy It yes short term speeds will be higher than the long term speeds, but through that then you will get the roll down benefit on your hedges. So if yieldco does is two.
<unk> does not materialize then your pitch costs will enable increased as much as the forwards realized. So then when you look at the spread to the spread of mortgages to the hedges you are taking the forward rolled on into account. So one way of saying that okay forward to realize than your hedge cost close hires or other ways to bring that forward or not.
Realized than your hedge costs will be lower so as long desk.
What we are modeling or what market is modeling is consistent with where the mortgage rate and where the prepayments us that those tools those two effects will offset each other.
Okay got it thank you and I have taken a lot of time I apologize. Thank you guys. Thanks Rick.
The next question will come from Eric Hagen with BTG. Please go ahead.
Hey, good morning, guys.
So we know that overnight repo is very plentiful in the treasury market like you noted.
Can you share where that were on the term structure repo liquidity is currently most abundant for agency mortgages.
And how you expect that could evolve as the fed begins to taper and more collateral supply gets put onto the market.
Sure sure. Good morning, that's a good question. So I'll just give you a quick run aware bilateral repo is.
Right now for a month, it's about 12 basis points three months 14 seven.
<unk> roughly for six months and then in the mid twenties for a year. So obviously, we have seen a steepening in the slope of that curve now.
Let's look at repo and break it down for.
For clarification, there are two components to repo costs, there's the short rate component or the fed funds component. If you will and then theres the liquidity component, which is the spread of bilateral repo over that short rates and the way we look at the current environment. What we're most concerned about is the rate.
And we've seen.
Hikes get priced in acceleration of hikes get priced in the market as of late and obviously thats.
Something we're very focused on now.
However, when you look at our hedge profile.
We're very well covered from that standpoint $31 billion in zero to three year swaps.
80% hedge ratio at quarter end actually a little bit higher than that now around 84%. So the rate component and the risk associated with short rates going up we're well covered from now the liquidity component given our days are about 75 roughly right now.
We are not as concerned about that over the very near to intermediate term.
Because of the liquidity in the system of fed balance sheet of about $8 five trillion.
One six trillion in reverse repo facility at quarter end, a standing repo facility at the fed in case there is any.
Destabilization in repo markets. So were more much more focused on hedging the rate component, which we have and we are confident that liquidity out of the near term is going to be ample and so we're not as inclined to pay as much of a premium.
Short term repo, but.
We're actively looking to find good value in.
Six month two year repo.
Got it that's helpful.
And then it seems like it seems like one of the benefits of moving lower in coupon in the agency portfolio is that the premium risk on your capital structure, I guess reduce are tempered a little bit because youre buying lower priced securities.
Would you agree with that do you think that changes the way you think about your leverage and the way you guys manage risk in other areas of the portfolio too.
Yes, so just to talk a little bit about premium risk I'd say, it's always a concern of ours, but if you back up to the beginning of the year. It's less of a concern now than it was then because for example, we had 11 billion higher balance in fixed rate securities in the portfolio largely premier.
<unk> obviously.
Rates were much lower at the time, so the risk of refi.
Was greater and then and then lastly, and perhaps most importantly, we did experience a bit of a repricing of higher coupons in the second quarter and so as a consequence of that premium coupons are priced to very fast speed. So we're always concerned about the premium in the portfolio.
Right now I think it's 27% of our equity balance, which is lower than it's been over the past year certainly does it influence our leverage we do take a holistic approach and what most influences our leverage is the attractiveness of the overall agency market.
And also our capital allocation as we've talked about in the past, but generally speaking we are shifting down in coupon in the TBA is because the carries better and TBA as did or lower coupons did cheapen a bit relative to higher coupons. Both in the third quarter end and on a relative basis to higher coupons.
Touch in the fourth quarter, thus far.
So again, we take a holistic look at leverage and in a specific amount of premium obviously has us concerned about about refi risk but.
It's generally a bigger picture than that.
Got it. Thank you David you bet Eric.
Again, if you have a question. Please press Star then one our next question will come from Kenneth Lee with RBC capital markets. Please go ahead.
Hi, Thanks for taking my question.
I'm wondering on a broader level could you talk about what are you looking at specifically for before you start taking a more aggressive approach to leverage and portfolio positioning.
It just a matter of spread widening in certain assets or are there any macro considerations.
Sure Good morning, Ken and look this also goes back into the first question with respect to the dividend when we look at when we look at the market and the landscape right. Now we are approaching the fed tapering and obviously rate hikes, a little further out the horizon is something that.
We're obviously very focused on so it was now the right time to raise leverage we don't think so.
Asset spreads are relatively tight we're able to generate what we think to be strong earnings but.
We would need to see wider spreads, particularly in agency before we did raise leverage and I'll say that given our liquidity profile as Serena discussed and we are at the low end of the range. We're at the lowest levels of leverage that we have.
Been in over five years, so we do have ample opportunity should that eventuality materialized, but.
If the market ended the quarter, where it is today in the portfolio.
It looks as it looks today I would say.
We'd be here to slightly lower even and should spreads widen.
We will have the capacity to do so, but we do need to see more abundant.
Spreads.
To take leverage up what that is is dependent exactly on what the state of the world is at the time, but generally speaking.
It's not we're not inclined to leverage right at the moment.
Got you very helpful and one one follow up if I may.
The private closed and middle market lending fund can you just talk a little bit more about what you see are opportunities in that area over time with a potential for perhaps additional funds.
Sure.
Look I think when we look at the middle market business, we have said.
Repeatedly that the returns in that sector are very complementary to the to the agency portfolio given the low correlation and the team has built a great franchise and.
<unk> has very extensive relationships with private equity that we think there's a lot there.
Barriers to entry.
And as a consequence, they were they were able to successfully raise outside capital in the catalyst was looking through the lens of the <unk> portfolio, we like the business.
We very much like the assets, but given the fact that as corporate lending where REIT there are limits to its potential growth and so.
Outside capital certainly solves the issue of enabling that business in that portfolio to further scale.
And also it reduces some of the concentration risk of individual position. So we're very happy with the accomplishment of raising the outside capital and to the extent theres more opportunities.
We'll see but right now we feel like we have capacity on the annually balance sheet to add to the portfolio.
We're happy with.
With how it performed and Tim if you want add anything to it by Amit I think David summed it up beautifully.
Great very helpful. Thanks again.
You bet. Thank you Ken.
This concludes our question and answer session I would like to turn the conference back over to Mr. David Finkelstein for any closing remarks. Please go ahead.
Thanks, Chuck and thank you guys for joining us today have a good holiday season, and we'll talk to you at the beginning of the year.
Yes.
The conference has now concluded. Thank you for attending today's presentation you may now disconnect.
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Yes.
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