Q4 2021 Dynex Capital Inc Earnings Call

Good morning, My name is Rob and I will be your conference operator today.

At this time I would like to welcome everyone to the <unk> Capital, Inc. Fourth quarter 2021 earnings results and conference call.

All lines have been placed on mute to prevent any background noise.

After the Speakers' remarks, there will be a question and answer session. If you'd like to ask a question. During this time simply press star followed by the number one on your telephone keypad, if you'd like to withdraw your question again press the star one.

Alison Griffin Vice President of Investor Relations you May begin your conference.

Thank you operator.

And thank you all for joining us today, the direct capital fourth quarter and full year 2021 earnings conference call. The press release associated with todays call was issued and filed with the ITC. This morning February 3rd 2022, you May view the press release on the homepage of the Dynegy website.

At <unk> capital Dotcom as well as on the SEC's website at S E C Dot com.

Before we began we wish to remind you that this conference call may contain forward looking statements within the meaning of the private Securities Litigation Reform Act of 1995. The words believe expect forecast assume anticipate estimate project plan continue will and similar expressions identify forward looking statements.

These statements reflect our current beliefs assumptions and expectations based on information currently available to us and are applicable only as of the date of this presentation.

These statements are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified.

The company's actual results and timing of certain events could differ considerably from those projected and are contemplated by those forward looking statements as a result of unforeseen external factors or risks for additional information on these factors or risks. Please refer to our disclosures filed with the SEC, which may be found in the <unk> website under.

Or in the Investor Center as well as on the SEC's website.

This conference call is being broadcast live over the Internet with a streaming slide presentation, which can be found through a webcast link on the homepage of our website. The slide presentation may also be referenced under quarterly reports on the Investor Center page.

Joining me on the call is Byron, Boston, Chief Executive Officer, and co Chief Investment Officer, Murphy, Pappano, President and co Chief Investment Officer, and Steve Benedetti Executive Vice President Chief Financial Officer, and Chief operating Officer.

And with that it is my pleasure to turn the call over to Byron Boston.

Thank you Allison.

You everyone for joining our fourth quarter earnings call.

Sitting here at the beginning of 2022 I am incredibly excited about the opportunities we see before us generate strong future long term returns over.

Over the past three years the world has seen some of the most unique market events in history.

From the beginning we have always structured our portfolio to expand and anticipate unforeseen market events.

Over the past three years, we have done just that maintaining our year end book values.

Around $18 per share through periods of spread volatility. We also generated solid returns over the same period with a three year total economic return of 28%.

We entered 2021 with the same disciplined portfolio strategy and mindset.

The market environment was highly uncertain and experienced fits and starts throughout the year, primarily driven by the pandemic.

In that environment, we were able to grow our common equity capital base by over $200 million protect book value and maintained $1.56 dividend.

For the past year, we have believed that better opportunities to invest our capital would evolve.

So we've been patient and disciplined in preparing for bowls opportunities, especially by keeping our leverage low and holding onto dry powder.

Now we are seeing the beginning of a more favorable environment as the largest non economic buyer of fixed income assets U S. Federal Reserve bank is about to exit the market.

Our strategy has continued to enable us to protect book value, while maintaining our low leverage profile during the month of January .

We're confident in our ability to navigate the complex environment before us and to continue to deliver an attractive dividend and long term returns even if the fed raises short term interest rates four to five times this year.

At <unk>, we have the unique and enviable combination of a highly experienced management team with a flexible mindset and a very liquid balance sheet.

These factors position us extremely well to take advantage of the opportunities. We see ahead in this market.

As I stated at the beginning we managed for the long term and as such we're making the necessary investments in our people processes and technology to scale and grow our business and to ensure we have the ability to generate solid returns for our shareholders well into the future.

It is our belief that technology will significantly impact the world of asset management, and we are growing our relationships with the right technology partners to keep the competitive edge as the world continues to change and evolve.

And with that I will now turn the call over to Steve to give you more specifics regarding our performance.

Thank you Byron.

The fourth quarter was marked by periods of volatility is mortgage spreads widened and the yield curve flattened all short term interest rates and funding costs costs continue to remain low.

Given the environment, we held leverage at the lower end of our target range of five to 10 times, our equity capital to minimize the impact of this volatility on our results.

With this backdrop on a per common share basis, both comprehensive income and total economic return for minus four cents per share.

Minus two.

Percent for the quarter for.

For the year on a per common share basis comprehensive income was 53.

Total economic return was 47 cents.

Two 5%.

Earnings available for distribution was $1 97 per common share and we paid a dividend of $1 56 to six cents difference between comprehensive income and economic return for the year is largely attributable to net capital raising activities.

From a full year perspective, the company raised $237 million in new common equity capital growing common equity by over 50% at an average net price of $18 27.

Substantially improving the liquidity of our common stock and unlocking operating leverage in the platform.

Earnings available for distribution per common share sequentially declined from 54 last quarter to 45 this quarter.

Klein was principally due to lower leverage on our capital during the quarter, resulting in a smaller average balance of interest earning assets coupled with a modest decline in asset yields.

Net interest spread and adjusted net interest spread of six to seven basis points, respectively was due largely to increases in prepayment speeds on agency <unk>.

Partially offset by income received from early prepayments on call protected <unk>.

Overall agency MBS prepayment speeds were 11, 2% CPR.

As a reminder, the company utilizes the prospective method for amortizing investment premiums on our MBS and as such our results fully reflect the actual realized prepayments during the period and do not include cumulative catch up amortization adjustments that are based on long term assumptions and could potentially distort near term results.

Finally, the funding cost benefit on dollar rolls versus repo on our MBS was an estimated 77 basis points during the third quarter versus an estimated 64 basis points last quarter.

As it relates to book value the driver of the 43 per common share declined during the fourth quarter was spread widening on agency MBS, we estimate that book value per common share at the end of January is unchanged since the end of the year from.

From a portfolio perspective investments inclusive of TBA securities declined by 133 million, mainly due to pay downs. Our investment portfolio is approximately $4 7 billion as of December 31, with 90% invested in agency MBS and 10% invested in <unk> from.

From a hedging perspective, we maintained our notional coverage of $4 3 billion with a minor increase in short U S Treasury futures during the quarter.

Regarding the tax character of dividends for 2021 to $1 56 dividend declared on common stock will be substantially return of capital. The reason for the return of capital is largely due to timing differences between GAAP and tax income.

<unk> deferral of net gains on derivative instruments designated as tax hedges and the higher use of TBA securities, which impact current year tax results versus on balance sheet or MBS.

That concludes my prepared remarks, I will turn the call over to Smriti.

Thank you, Steve and good morning, everyone.

I'll start with a comment on our 2021 performance.

We believe that it was critical to remain patient and disciplined in our portfolio construction maintaining liquidity in the position and flexibility in both the position and our mindset.

That discipline is paying off here in 2022 as book value has remained flat through January .

I'm going to focus my comments today on how we view the current investment environment and the <unk> strategy for navigating it as well as our outlook.

First off we believe changes in government policy will continue to have major implications for returns.

We are entering a very favorable period for investing.

We heard from the Federal Reserve last week. They are clearly focused on managing inflation without damaging growth in the economy. They have indicated a willingness to raise rates in March and to continue to raise based on evolving data and that they will begin shrinking their balance sheets sometime in may or June .

This near simultaneous removal of monetary stimulus and liquidity support is unprecedented and it creates the unusual dynamic of asset yield correcting higher even as financing costs rise, making the return environment quite attractive. This is a key positive factor for <unk>.

<unk>, giving us the opportunity to expand our balance sheet and locking in long term accretive returns.

Transition to this favorable investing environment has begun option adjusted spreads on agency RMB or 45 basis points wider since the tights in April of 2021, and 20 basis points wider since the end of December .

Through January we have already which stood at 20 basis point wider OAS adjustment and an adjustment to higher yields keeping book value flat and our capital intact into today's wider spread environment.

Going forward returns for <unk> will be driven by the performance of our existing portfolio.

Less incremental returns on capital that we invest let's.

Let's start with the existing portfolio. The main factors determining returns will be rising repo rates that will impact earnings wider spreads and greater interest rate volatility those will impact book value. So.

So first rising repo rates, we believe we can adjust the size of the balance sheet to generate the earnings needed to meet the current dividend in the face of rising repo rates.

As of now with the market pricing 45 rate hikes in 2022, we estimate that adding one incremental turn of leverage will fully cover our existing dividend, we expect to add that over the coming quarters as we see spreads widen further from today's levels.

Second the exposure to further spread widening.

<unk> risk to spread widening is mitigated by three factors, our low levels of leverage.

Coupon positioning and our hedge construction.

Our year end leverage of five eight times limited the book value decline from spread widening thus far in 2022 simply because we own fewer assets.

Second the assets that we owned was sheltered from wider spreads.

We own low coupons, choosing two and a half that have been and will continue to be protected against the worst of the spread widening. This is because as mortgage rates rise and exceed three 5% new supply gets pushed into the three and the three 5% coupons. These.

These higher coupons will continue to bear the brunt of future widening from quantitative tightening because there won't be a fed backstop.

In the lower coupons twos in two and a half the stock effect of the fed and bank balance sheets come into play.

They own 75% of the float.

That plus the lack of new supply and the seasoning and those bonds will all contribute to limiting spread widening.

And also provides support for dollar rolls.

Finally, we've insulate the portfolio from big moves in specified pool pay ups by focusing on low pay up stories and limiting the amount of capital at risk that collapses and pay ups such as that experienced in March 2020, and thus far in January 2022.

So while we do expect spreads to widen and we expect that <unk> existing portfolio of assets will experience less volatility and lower return degradation than the rest of the mortgage universe as the fed begins to exit.

We also believe that we can adjust our position to mitigate the impact of spread widening.

Our hedge ratios for the lower coupons that we own or designed for the extension in a rates up spread widening environment, which is what we're experiencing and it's actually the biggest reason for our book value preservation to date.

At these rate levels, the 2% coupon is fully extended and convexity in the two 5% coupon is much lower than before.

Our hedge construction was designed to match this extension risk and has functioned as expected and the move up to one 8% and 10 year yield.

We also expect interest rate volatility to be something that all asset managers will contend with in 2022 at.

At <unk>, we addressed this with our scenario planning preparation and process all of last year, we had plenty of chances to make tactical decisions at the wrong time. The tenure was down at 112.

You're back at 177, but working within the framework of a short medium and long term view kept us grounded.

Coupon positioning and hedge selection are a big part of how we manage rate volatility selecting coupons that will be more stable designing effective hedges using option strategies. It's all part of our active management process and this will be a focus for us in 2022.

So all in all we feel very solidly positioned heading into this environment.

By holding a flexible liquid high credit quality position, even as spreads widen we believe we'll be able to manage the balance sheet to position the portfolio for solid long term return generation.

So that covers our existing portfolio and now lets talk about incremental returns.

As we've seen in January with the market's realization that the fed will soon begin to exit the mortgage and treasury market.

Rice's have begun to adjust across risk assets, we have already seen this as crypto currencies back certain tech stocks high yield municipal bonds corporate bonds and mortgage spreads have all reacted to the mere mention of quantitative tightening.

Most market participants anticipate the quantitative tightening process to begin sometime between May and July of this year.

Mortgage desks are calling for 15 to 25 basis points wider spreads and current coupons.

We think lower coupons will widen less and that at that 15% to 25 basis points wider level. This would bring spreads to near what we would term fare levels for the long term we.

We believe this is an attractive entry point at.

At returns in the low to mid teens Roe.

We also believe that we could see even wider spreads during bouts of volatility.

<unk> is well positioned for these anticipated widening events and we view them as opportunities for us to add assets and contribute significant incremental return to our portfolio.

So how should investors think about this in the context of our balance sheet on.

On the existing book, we have cushion the move wider thus far and the real power is in the headroom for expansion of the balance sheet. We think we have the room to add two to four turns of incremental leverage which one invested in the low to mid teens Roe.

Provides a strong foundation for returns well in excess of the current level of the dividend.

As always we're approaching this market with discipline.

You should see us take up leverage over the coming quarters to take advantage of wider spreads are.

Our investing in hedging will likely be in the higher coupons as they cheapen and offer additional returns. We're also open to explore diversification and to see MBS as those spreads have already adjusted wider and we'll continue to do so.

We've spoken about CRT that market is about to have more supply in 2022, then in many years and it remains an alternative that will continue to evaluate.

<unk> is natural portfolio position is to be diversified and we believe that transitioning environment will allow for these types of strategies to be implemented in the portfolio again.

I will add that all else being equal our preference will be to generate returns with more liquid and flexible investment.

I'll leave you with the following thoughts.

We have successfully managed through the significant widening in spreads thus far.

We are experienced at this and we believe we've positioned the book to be cushioned against the worst of the widening.

We stand ready to deploy capital as we move into this more favorable return environment and were looking forward to building a very solid stream of cash flow that will position us to deliver strong performance and the long term.

I'll now turn it over to Byron.

Thank you.

Pointing out a couple of things here at the end, we're entering into a unique transitional period.

And it is.

More important now than ever to be able to rely on a team that has a clear strategy and deep experience in navigating complex environments.

<unk> capital, we have a plan to manage through this evolving environment where patient.

Disciplined and focused on our execution and on driving long term shareholder returns. We believe the Dynegy capital represents a compelling investment opportunity and income oriented investors should consider diversifying their portfolio with both our common and preferred stock.

Come join us on our long term and continue journey of delivering attractive risk adjusted returns.

Thank you and we will open up the call for questions.

At this time I would like to remind everyone in order to ask a question Press Star then the number one on your telephone keypad, we'll pause for just a moment to compile the Q&A roster.

And your first question comes from the line of Eric Hagen from <unk>. Your line is open.

Thanks, Good morning, great job last months managing risk on your balance sheet.

A couple from me I think you guys are much heavier in the 2% coupon that you are in the two and a half can you guys just maybe walk through and expand on our liquidity you expect for that coupon as the fed begins tightening.

And just the reinvestment risks that are more generally with prepays being slow.

And then I'm looking at slide 13.

Thank you guys mentioned there is an opportunity to increase leverage is 2% to four turns I assume for tern represents doesn't represent really a cap on your leverage.

But maybe just reminding us what that cap kind of as in any detail.

On whether that two to four turns as a short term vision for the balance sheet or just kind of how that fits into the overall outlook. Thanks.

Sure Good morning, Eric Thank you for your questions.

So I'll take the second question first if you don't mind, just discussing the leverage in <unk>.

And then we'll address the more detailed question around the Fannie twos.

So on the leverage yes, I think we believe there's room to increase 2% to four turns it does not represent a cap.

I think the environment as we see it right now.

With returns in the low to mid teens.

That is a very reasonable.

Evel for us to go up to.

And I will say that in <unk>.

Our comments, we talked about the potential during bouts of volatility for spreads to go considerably wider and you could make an argument in in those types of environments to really take it up.

You know more than that two to four turns in general you've seen us operate somewhere between five and 10 times.

We rarely dipped below five it's usually when there is really significant risk in the environment.

Rarely go above 10, it's usually when there's significant return in the environment.

I would say five to 10 is is is generally where we operate.

Yeah.

Two.

Two to four times is a reasonable expectation, but and it's obviously not a captain and great and great return environments, we we should be.

Taking advantage of those with a with more assets.

So and then I will turn to your question of two so.

Tuesday, very interesting coupon.

We were in that coupon before the fed started buying that coupon. We believed that it is going to be a strong foundation for our portfolio.

We've we've owned that coupon from the very beginning and I think it'll be a core part of our long term position here in the portfolio.

So with respect to the the reinvestment risk in that coupon, so again and they're not really producing that many twos at this point.

Most of the tools that are out there are sitting on bank balance sheets and the fed.

In fact, 75% of the float into the sitting in those two places.

Theres very little float.

In that in that coupon that makes it a scarcity.

Did that will support the price of it.

The seasoning and the coupon.

In General also allows you to take advantage of <unk>.

Reinvestments from prepay so as these bonds season.

We have embedded home price appreciation and turnover that can can give you a pretty nice return on capital.

In terms of Reinvestments.

And look over the long term, there's going to be very little supply in this coupon. So it's a very technically sound.

A place for us to to keep our portfolio.

Did that address both of your questions.

That was really helpful. Thank you so much.

Sure.

Your next question comes from the line of Doug Harter from Credit Suisse. Your line is open.

Hey, good morning, everyone. This is Josh Bolton on for Doug.

[laughter] pleasantly surprised to see book value flat through January , especially given the spread widening and some other updates from peers.

We're down throughout that I was wondering if you could walk through some of the factors that you think led to that book value outperformance in <unk> again, and the seemingly tough environment for Levered mortgage investors. Thanks sure. Thank you Josh.

Yeah, I mean, I would point to this the three things number one is we came into this with with much lower leverage.

I think you know you guys see.

Leverage our total leverages a function of.

Levels of common and preferred are leveraged to common equity is also lower that's something I would I would look.

I would point investors to as something to to also take a look at in terms of metrics when you're evaluating.

Different different companies. So our leverage overall was lower coming into this that really helped a lot. The second piece is you know our allocation to these lower coupons.

They've really been absolutely rock solid we've been completely aligned with the fed in.

In terms of the strategy for to buy what they buy into one what they own.

And the way to be clever and and and smart about that that strategy is as the fed exits, they're not selling the two two and a half coupon they're going to own those for forever right and they're going to run off slowly. So that's been what's contributing to the outperformance of those two coupons and the.

Underperformance has been coming in the higher coupons threes and three fives because those are the coupons that are now being produced and they're not being purchased by the fed.

So I think we were just positioned in these technically very sound our positions.

And I think of it as sort of the safest place to hide in the in the mortgage market at this point and then lastly, it's just our hedge positioning.

These assets are longer duration assets, we hedge them to a longer duration hedge ratio.

That is how we think about duration in general.

Our strategy and you guys have probably heard this from US a long long time.

We don't we think about duration is not just a single point estimate, but we're looking at durations across a different different environments and quite frankly.

<unk>.

Long duration asset hedged with a long duration.

Hedge.

It worked out and and and and it was the right strategy for this for this scenario so.

Those are the three things and and look I can't emphasize enough.

Liquidity flexibility.

Our process. These are all things that contribute.

How we how we position and and and how we got here.

Yes, Josh let me add one other thing that this is we've been consistent.

I think a year ago, you could have listened to our conference call and we've been very consistent in terms of how we've approached them. So you know in reality, we've talked about this opportunity to talk about these potential adjustments when we've had the portfolio structured this way and we've been very patient.

And waiting for this environment to evolve.

Great. Thanks for that and then just following up on the leverage comments you made earlier.

You mentioned could take leverage up 2% to four times I'm wondering if we don't see any meaningful widening from here should we still expect leverage to creep higher just given you.

Mentioned, adding one turn of leverage will cover the dividend this year or any thoughts around timing.

The leverage increase would be helpful. Thank you.

Yeah, I mean, that's the $64 question right like when are you going to do it and how much and it's it's really interesting because this environment is.

Is a is really unique so let me let me just walk through just.

So we've had a significant amount of widening here.

And the incredible thing about this market is that returns are in the low to mid teens or between 10 and 12% right now as we as we measure it and that includes the impact of.

Essentially a 200 basis point rate hike.

And in.

That's being priced in the market. So returns are accretive here. They they they have said they are very strong. So we were we're not you know we're cognizant that that is this is in an environment, where we could actually put capital to work today, but what we think from here going ahead is that more widening is yet to come.

Right and so so far we've had you know.

2025 basis points of widening in January we think Theres, an additional 15 to 20 to go.

And we're going to be patient about when we step into that.

So you know again.

If you think about when is the the tapering going to and probably in March the impact of that really doesn't flow through into the fed and the mortgage markets until.

June or July .

Because the fed will continue to receive settlements of securities than they may begin quantitative tightening that stuff starts to impact in early.

Early second quarter, maybe late third quarter, all of those things will contribute to decision, making on our part in terms of timing.

So you know again, all else being equal, we actually think spreads will be wider from here. So.

So we're not in any great rush to run in and buy bonds.

You know at the moment, although I will say returns are accretive here, we expect them to get more accretive and will will be there to to put money to work then.

Hey, Kurt let me add one other thing in there which is.

J, Paul doesn't know yet how they're going to manage that portfolio, how theyre going to reduce your portfolio, how many great guidance youre going to have.

All of those things are bankers wanted to say, we're flexible we're nimble with Janney.

Capital has to be the same government policy will drive returns and if the government policy makers are feeling their way through this this is an evolving environment where discipline.

We're not going to try to predict the future, but we're ready to respond disciplined scenario planning preparation preparation preparation.

Great I appreciate the comments guys.

Thanks, Josh.

Your next question comes from the line of Trevor Cranston from JMP Securities. Your line is open.

Hey, Thanks, good morning.

Looking at the interest rate exposures on.

Slide 11.

And some shifts in the numbers from the end of the year through January 31, I was wondering if you could just take us through what drove that if it's any changes to the portfolio or if that's more so just the result of.

Incremental extension of some of the assets.

Hi, Trevor.

That is that is actually some very minor changes in the portfolio and again, the two 5% coupon up here at 180 on tens has more convexity to it relative to what you know.

What it had down.

Below that in the 160 170 area. So so you're just seeing some of that in here, we've not made any meaningful changes to the book.

Okay got it.

In terms of prepay speeds.

The portfolios.

Fairly slowly already in the fourth quarter.

And you mentioned that <unk> are already fully extended I was wondering if you could kind of talk about how much room, you think there is or your portfolio speeds too.

Decline further this year.

Larry.

And mortgage rates that we've seen in <unk>.

January .

Right I mean, so this is really the interesting part right so rates have moved higher.

And I think one of the one of the biggest factors going forward in terms of impacting prepay speeds is going to be the home price appreciation that we've seen.

And in the market, so that 18% to 25% home price appreciation puts a lot of bonds in play for cash out refinancing.

Cash out refinancing will be an issue.

The other thing I think that will be an issue and again this will probably affect the two and a half coupon more than than the 2% coupon.

Is just the structure of the mortgage market right now.

You know you've seen a lot of competition.

With a non bank mortgage originators that will tighten the primary and secondary mortgage spreads. So those we expect to prepay speeds environment to not slow down as much as people think especially in the higher coupons right staffing at these originators has been actually also initiative kept capacity.

City.

And even as rates have risen. So you know that the landscape is going to be really competitive. So we feel like the call protection and in and having those look low coupons is important.

And relative to the rest of.

The coupon stack, well will probably be sheltered.

And then in terms of room for for prepay speeds to slow.

I you know I can't sit here and say that to you that theyre going to slow or not I can't say that where were positioned.

For this environment and the lower coupon specifically because you know we've had this fundamental opinion of the option costs.

<unk> in general being.

Much much higher than the models are telling us because of the fundamental structure in the mortgage market as being.

Very much geared.

Geared towards these assets being very callable.

I hope that answers your question and.

And good morning.

The bottom line is the book isn't that sensitive to it to be honest, that's that's what I would say.

Okay. Yeah, that's very helpful. I appreciate the color. Thank you sure.

Again, if you would like to ask a question Press Star then the number one on your telephone keypad.

Next question comes from the line of Bose George from K B W. Your line is open.

Hi, everyone. This is actually Mike Smith on for Bose.

Congrats on a really strong start to the year.

A couple from me on the on the balance sheet I'm. Just wondering if you have a base case estimate for run off or kind of how youre thinking about the pace of reduction compared to the prior taper and then just as a follow up to that where do you think the incremental demand for agency MBS will come from.

Sure Hello, Mike.

Yeah I mean, it's it is it is actually anybody's guess at this point in terms of the pace of the balance sheet, but I would say one general comment you know first office.

I think the fed has more tools in their toolkit. This time around relative to the last time, we went through this.

I think they've realized that the balance sheet is a significant tool and the reaction.

The reaction of risk assets to quantitative tightening talk from central banks around the globe is something that every investor should be paying attention to at this point.

So we generally expect risk assets across the spectrum to respond to a global decline in liquidity, that's coming and it's being very well telegraphed by you know Madame Lugard today, you know Jay Powell last week.

So this is a major factor.

The timing and the pace of this this balance sheet reduction.

Really the the timing is at least as important as the pace for us and and essentially the adjustment that won't that will need to a company that is the pricing at which private capitals is able to come in and start to take these assets from the fed right. So relative to the last time, you know I think theres a real.

Desire at the fed to shrink the balance sheet sooner.

So you know we're thinking about it in those terms.

Give you an exact forecast I think the market is is really.

Got a wide range of things here and defend themselves have not really telegraph that much I wouldnt be surprised to see a.

A relatively steep decline in and in the way. These you know the balance sheet gets runoff and then your second question.

Can you repeat your second question again, I'm, sorry, you talked about the fed balance sheet and what was your second question.

No I'm sorry, the second part of the question was just where do you think the incremental demand comes for us the fed kind of first of all the demand.

Right Yeah. So that's again a great question because.

Look you have.

You have a situation right now where the fed is reducing its footprint and private capital needs to come in who is the private capital. It's a money managers its banks its mortgage REIT such as ourselves it's other hedge fund investors.

That come in and the gap is really pretty massive.

Some of the some of the street analysts have estimated about a $400 billion gap between you know what the fed is going to effectively.

Implicitly sell versus what needs to be bought.

And then the number one plug for that as money managers.

And I think.

That is going to single Handedly drive.

The different you know, where we end up in terms of how much wider things get so.

Our belief and and the our operating assumption is that there's going to be a gap between the supply that comes in as a result of the fed's balance sheet running off and the demand and that's why we think spreads are going to go wider I mean money managers have sold over $500 billion worth of mortgages in the last two years.

And they need to get back to neutral but.

You know they they so if they come in I think that will govern.

Part of how this and that supply gets absorbed but at these at these prices I think youre still are you still not there yet.

With respect to.

You know how these were these spreads will eventually end up.

Great. That's really helpful color and then just one more you mentioned, where you think spreads could settle out but just wondering how you're thinking about TBA specialness in the back half of the year in the context of the balance sheet reduction.

Yeah. So it's gonna be a tale of two halves I would say the first half of the year I think we're going to we continue to expect specialness in the roles.

There's some really kind of neat.

Neat nuanced dynamics and into lower coupon rolls because the fed still buying those coupons and until the settlement cycle goes through in June and July I, you know, we expect to see the specialness relative to repo to stick in there until then.

It should it should kind of normalize itself in the second half of the year. So the second half of the year is where we see you know some of that specialized start to fade off.

And and that's how we're you know we're thinking through our positioning with with that kind of mindset.

Great. Thanks, a lot for taking the questions.

Sure and I'll, just say on the specialists right now we've been rolling R. R. R advantage that we say that we see in the roll market right. Now is about 30 to 40 basis points still special relative to repo and that's kind of holding through.

The levels that we see for April settlement.

Great. Thanks again.

Sure.

And your next question comes from the line of Christopher Nolan from Ladenburg Thalmann. Your line is open.

Hey, guys are smart you earlier mentioned mortgage spreads widening 15 to 20 basis points further or is that just for the quarter or is that your longer term vision.

So let me clarify that I think I think 15 to 25 wider is what most wall Street analysts are saying they could go to okay and.

In bouts of volatility I think they'd go even wider than that.

But in general to get back to levels, where long term.

Your your sort of sitting fair relative to swaps or treasuries.

15 to 25 is sort of where we think we we see them settling out long term.

And the timing of that is it look it's tough I think I think from here.

I'd say, we've widened a fair amount with pricing some of this tapering and the quantitative tightening and then from here to go wider we're going to need to see a net seller come in like some some selling either origination or we're going to have to start to see the the quantitative tightening actually happened. So it could take some time to get that next one.

25 basis points, but on the other hand look I mean, we could trade with risk assets and be wider than in in in the next month. So it's really hard to predict that and we try not to do that what we tried to do is just is kind of watch watch the markets with with some discipline, obviously, because we've got to have that and.

And and then.

You know cause risk.

Respond as we see the chance has come in so.

The toughest thing on this right now is predicting the timing of spread widening.

And and I think I think we're not going to try to do that we're actually going to try to be very responsive.

To that when we see it.

And my follow up question your comments earlier were in terms of.

When you start to leverage up the balance sheet.

<unk> focus on the higher coupon MBS and see them.

What sort of coupons on our MBS are what percentage of the portfolio, you think could be and see MBS.

Yeah, I mean, I have eight I I I dream of a time when we could go back to our 50 50 allocation to see MBS. It would it would be fantastic.

We've seen spread widening in the in the agency desk market here, thus far Freddie K twos are wider.

Nowhere close to where we're where we're trying to be interested in.

And on those types of assets I think we're just seeing the very beginning of a price adjustment.

As as deferred starts to exit so.

You know, we we expect to see wider spreads and all of those sectors.

And ultimately you know I think they will be there for us.

Right now I think in in the agency pass through market.

The 3% coupon sticks out to be a very cheap coupon and it's going to get cheaper. So I think that will be that will have a role in our future. Some some some some time so that that would be probably a place where you'd see us put capital and.

And look I think I think again.

The biggest the biggest thing about this environment is you have global central banks basically telling you that they are ready to exit these markets and that means the price of risk is going to change it's going to change not only for agency mortgages, It's gonna change for non agency mortgages CRT.

Paper up in credit down in credit, it's all going to change.

And you know the only way to navigate this is is to have a lot of liquidity and be super flexible.

And and jump on opportunities when they come.

And that's that's I think what we're trying to do so.

I would say the.

For us our natural position is to be diversified and and you know we think we're going to get that shot.

Great. Thank you.

Sure.

Yeah.

And there are no further questions at this time I turn the call back over to the management team for some closing remarks.

Thank you all for joining US today, let me just leave you with just one quick thought we believe government policy will drive returns.

Currently the government officials don't want the mortgage assets on their balance sheet and we're very much aligned with the fed we've reduced our balance sheet in preparation to take some of the assets that they don't want at much more attractive level. So thank you so much for joining us and we look forward to chatting with you again next quarter.

Sure.

This concludes today's conference call. Thank you for your participation you may now disconnect.

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