Q1 2022 Annaly Capital Management Inc Earnings Call
Good morning, and welcome to the first quarter 2022, and at <unk> Capital Management Earnings Conference call today, all participants will be in a listen only mode.
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Now I would like to turn the conference over to Sean Kensal Director of Investor Relations. Please go ahead Sir.
Good morning, and welcome to the first quarter 2022 earnings calls for antibody capital management.
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.
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.
As a reminder, we routinely post important information for investors on the company's website www Dot <unk> dot com.
Content referenced in today's call can be found in our first quarter 2022, investor presentation, and first quarter of 2022 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 an updated investor presentations and similar materials on a regular basis.
Please also note this event is being recorded.
Participants on this morning's call include David Finkelstein, President and Chief Executive Officer.
So we're gonna Wolfe Chief Financial Officer, Phil Kurtz, Chief Investment Officer, and Mike Daniel 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 on our first quarter earnings call today, I'll review, the macro backdrop and how it impacted our performance during the quarter and then I'd like to discuss the sale of our middle market lending portfolio and the transactions implications for our capital allocation and our broader strategic.
Ilkka will then provide more detailed commentary on our portfolio activity and then Serena will go over our financial results.
Although growth slowed in the first quarter relative to last year. The U S economy remains robust the strength in inflation in the labor market has demonstrated that the federal reserve needs to remove monetary policy accommodation much faster than previously anticipated.
This led to a sharp repricing in fixed income assets with the aggregate U S bond market index facing the worst quarterly performance since 1980.
Assisting with the broader market and lease portfolio was vulnerable to the exceptional volatility in this environment. Despite our efforts to defensively positioned our portfolio experiencing an economic return of negative 12% with a reduction in total portfolio size roughly 5 billion to end the quarter at $84 4 billion in total.
Assets.
Now returning to the macro landscape inflation continued to rise during the first quarter with headline CPI, reaching eight 5% in March driven by a sharp rise in commodity prices now even outside of commodities and food inflation pressures remain elevated and broad based as seen for example in the federal.
<unk> bank of Dallas as estimate that only 10% of P. C. E components are currently witnessing annualized inflation below 2%.
The labor market. However has arguably been the bigger driver of the Fed's Hawk is shift.
The employment picture has recovered significantly with the unemployment rate falling 1.1% over six months to three 6% March Consequently, the demand for labor remains extremely strong creating the risk the employers will have to pay even higher wages to attract workers, which could trigger a wage price spiral.
The combination of these two developments high inflation in tight labor markets have demonstrated the need for much more aggressive monetary policy tightening as fed officials have signaled expeditious rate hikes in coming months overnight index swaps suggest the fed will deliver a total of 250 basis points of hikes in 2022 <unk>.
<unk> to expectations of just 325 basis point increases back in January .
And 100 basis points of hikes are likely to come in the second quarter alone.
Now this repricing of fed expectations led to a meaningful sell off in treasury rates were two year yields rose 160 basis points during the quarter, marking the most severe quarterly selloff in nearly 40 years. The long end of the yield curve fared somewhat better with 10 year notes rising just over 80 basis points leading to a.
<unk> yield curve flattening during the quarter.
Given the rates fell off as well as concerning geopolitical developments that include the Russian invasion of Ukraine interest rate volatility, particularly in short and medium term tenors rose to the highest realized levels since the financial crisis and that's it.
Ilkka will discuss in further detail the volatile rate environment weighed heavily on mortgages with production coupon nominal spreads widening 40 basis points on the quarter agency MBS spreads are now attractive and we are comfortable maintaining our current agency portfolio at prevailing spread levels, but we remain considerate of heightened interest.
Rate volatility as well as the supply outlook in light of imminent fed portfolio run off.
Now specifically with respect to the fed's balance sheet. The March epilepsy meeting minutes provided the market with a general framework for the second iteration of quantitative tightening for one run off will be significantly faster with the fed planning to retire up to 95 billion in assets per month nearly twice the aggregate cap seen during the <unk>.
2017 to 19 period. In addition caps will be phased in more quickly than last time and we currently expect an announcement at the May F. O M. C meeting next week and fully ramp decline starting three months later runoff is likely to last for multiple years as current Federal Reserve Security Holdings had resulted in.
Excess liquidity within the financial system best seen in the one eight trillion and cash pledged to the fed's reverse repo facility using current run off parameters. The fed would have to shrink its balance sheet for roughly 18 months before reserves equivalent to these excess cash balances are extinguished and also.
Of note, although markets continue to discuss the potential for MBS sales fed official communication has indicated run off will be quote predictable and running in the background, suggesting the sales will be on the back burner for the next several quarters.
While accelerating Runoffs MBS sales from the Feds portfolio would further deteriorate and elevated supply outlook risk excessive tightening of financial conditions and could be difficult to implement effectively.
Now with that said, let's turn to our recent strategic activity. We are pleased to have announced the sale of our middle market lending portfolio to areas. This past Monday, the $2 $4 billion transaction inclusive of our on balance sheet portfolio as well as assets managed for third parties post the completion of a highly competitive <unk>.
<unk> that is expected to be accretive to book value and validates the quality of our differentiated corporate credit portfolio.
While the middle market lending portfolio has been a source of complementary returns. It was an opportunistic time to pursue a transaction given the relative valuation ascribed to middle market assets in the current environment is broader fixed income markets have come under pressure middle market lending was one of the few areas of the market that commanded a premium while attracting a cigar.
Difficult amount of new capital Accordingly, the sale, providing an efficient way to monetize a less liquid noncore business and an attractive valuation and redeploy over $1 billion in capital into cheaper assets in our core strategies, we expect to close the deal by the end of the second quarter following customary closing.
<unk> and we believe Ares is a clear strategic fit for the assets going forward.
Now finally, turning to our long term strategy the <unk> mill sale furthers, our natural progression towards becoming a dedicated housing finance REIT.
Combined with the sale of our commercial real estate business last year, the transaction moves and are we closer to the vision, we laid out when I stepped into the role of CEO two years ago.
As a relative value investor our permanent capital base allows us to increase our exposure to lower levered less liquid assets with a premium return which serves to enhance the durability and quality of our earnings Accordingly, we expect to expand our capital allocation to non agency mortgage finance over the long term and.
By our role as a market leader within the MSR and non agency residential credit sectors.
And leaves us well positioned to leverage operational synergies across these businesses, which we expect to provide a unique advantage in these high barriers to entry more operationally intensive businesses.
Regarding our MSR business, specifically, we expect it will grow to represent a greater steady state capital allocation in the approximately 10% guideline we have discussed in the past.
Following the removal of M M mills assets from our capital allocation framework, we will be able to devote more capital to MSR, while still maintaining our high liquidity and risk management standards. The increased emphasis on MSR has further informed by both the attractiveness of the asset class within our portfolio as well as the more.
Our rapid pace of establishment of our platform in the market, we've grown the asset base by more than five times over the past year and ended the quarter as a top 10 secondary market purchaser of MSR and as noted on previous calls the sector remains highly active due to consistent disposition of MSR by the.
<unk> community given reduced profitability a trend, we see likely to persist coupled with wider spreads we expect MSR to remain a vehicle for growth that should improve our overall returns and book value stability over the long term.
Additionally, we expect to build on momentum within our residential credit group, which recently surpassed over 1 billion in closed loans through our correspondent channel with the opportunity to further scale, both our securities and whole loan portfolio. We are poised to take advantage of substantial opportunity or cross residential credit where private capital is.
Prime to play an even greater role while the sector grows post global financial crisis highs annually continues to broaden its presence as demonstrated by Onslow Bay, becoming the second largest nonbank issuer of prime Jumbo and expanded credit MBS as we further increase our products partnerships and re.
Sources were well prepared to capitalize on organic as well as external growth opportunities throughout the marketplace.
Now ultimately following our M ml disposition Emily is positioned for its next phase of growth with a scaled and diversified portfolio backed by three distinct but complementary businesses power of an elite capital allocation framework lies in our ability to calibrate our investments based on where we are in the cycle as seen through the relative <unk>.
Growth of our agency and residential credit assets in recent years looking ahead I'm excited for analyst future as we continue to develop our housing finance capabilities fell by strong tail wins within MSR and residential credit while taking advantage of a more attractive reinvestment landscape for our core agency business and.
Now with that I'll hand, it over to Ilker to provide a more detailed overview of our portfolio activity for the quarter and outlook for each sector.
Thank you David.
As you discussed the first quarter was characterized by challenging macroeconomic outlook that led to extreme volatility in fixed income markets.
Mortgages underperformed significantly given the added headwinds of historically high levels of that supply.
Speculation about asset sales from the federal reserve.
Normal spreads widened roughly 40 basis points and a primary mortgage rates increased by over 150 basis points, marking one of the sharpest pickups into he stood up the mortgage market.
With respect to help me manage the portfolio in this environment, we began to hit her with our leverage at its lowest level since 2014 and maintain the stable notional exposure for MBS throughout the quarters.
We did the portfolio of Hollywood.
Actively managed out hedges rebel without a coupon exposure to better position ourselves considering three key market teams.
First Devon.
Just put it that foremost across mortgage thick.
Mortgages that are being produced under performed lower coupons, which were largely locked up inside the bank portfolios and therefore more insulated from the Pos system.
She is determined by elevated origination Williams Bu additional fortunate that the shift up in coupon southern roughly seven enough field in lower coupons.
The tools and moving into higher loss.
As mortgage rates sharpness sold off prepaid dynamics in the market changed rapidly.
With mortgage rates at roughly 5% this quarter and only a small fraction of what it was maintained on the incentive to refinance their mortgages at the same time Kiss show activity should remain somewhat elevated due to the recent strong housing market and some are seasonal.
Is it is all the comex the automobile portfolio improved meaningfully speed slowed to 22% quarter over quarter with the at risk portfolio are paying $16 seven CPR in Q1.
In addition, we believe our specified portfolios remain well position for a discount than what well do so at a 40 year, so seasonally roughly 60% of our pools being low loan balance and weighted average coupon on our portfolio being 50 basis points higher than the Turkey the mortgage universe.
Lastly.
As production has shifted into high coupon debt.
TBA deliverable in high coupon shifted from seasonal festive thing pool, two new production, resulting in collateral scarcity and meaningful roll specialness in these coupons well.
The specialist a lot left in perpetuity.
<unk> continued to ship up in coupon was their photos TBA pools, given the favorable Chilean split dynamics.
In terms of hedges.
Entered the quarter conservatively positioned with our portfolio of nearly fully hedged Hollywood as interest rates increase.
It just throughout the quarter across the Treasury futures and interest rate swaps at most a lot of activity concentrated in the intermediate part of the curve to help protect against expansion in our portfolio.
This contributed to an increase in our hedge ratio of it the notional balance of Bob Hey, just for the balance of our liabilities, increasing by 14 percentage points to 109%.
We ended the quarter with over 70% of what he just concentrated around seven to 10 year point, which has been beneficial as intermediate to longer term rates have continued to rise start the second quote looks.
Looking forward, we will remain disciplined managing our duration given the elevated volatility uncertainty in the macro environment and tied to financial conditions that state continues to normalize monetary policy.
Turning to MSR.
The market was extraordinarily weak.
It traded holdings newly reaching levels seen in the full years 2020 in the first quarter level.
There's opportunity to grow a lot of portfolios total net purchase of over 400 million in market value.
Combined with Mark to market gain we increased our MSR position by 19, 1% to over $1 2 billion.
Most of the children makers continue to be active sellers, there's operating profitability has come under pressure from rising mortgage rates. We continue to see in Minnesota that are complementary to our agency strategy do it as negative interest rates on mortgage spread duration and effects on liver tox, which domain in the high single digits.
And we expect to continue to grow out our location of devastating coming quarters should market conditions to remain favorable.
In this national grid at.
Our economy portfolio ended the quarter with $4 4 billion of us at the capital contribution close and get $2 1 billion. The modest decline in the portfolio was primarily driven by a robust securitization activity.
Although the total law school it'd be a securities.
So there's actually cause market was not immune to the volatility in the broader rates on credit market with key benchmark asset classes, establishing their widest levels since the onset of the pandemic two years ago.
Non QM spreads widened 75 basis points to 175 for the Cook well investment grade CRT P M to 160 basis points.
Ending the quarter at 325 basis points.
Credit spreads have subsequently tightened post quarter end with AAA non QM as CRT into its 40th between five basis points respectively.
Despite the challenging environment, our obs platform had its most active quarter to date to be put enough filling a hole law securitized across six transactions.
Let me put that discipline to being a programmatic issuer has allowed us to lock in financing on 87% of our whole loan portfolio at an average cost of funds of two.
2.3%.
Approximately 240 basis points below the current market cost of funds.
The recent sell off that incentivize the originators to expand product offering beyond agency mortgages into alternative credit products and we expect display as opposed to the impact on the development of the non QM market overtime.
We continue to dedicate resources to the growth of a correspondent channel, but also expanding our securitization partners also to note. This is volatility has led to increasing number of some old originators turning to our correspondent channel given the certain top execution, which we have ample liquidity to accommodate.
Housing fundamentals remain strong with healthy consumer balance sheets, it's a stomach shortage of single family housing literally available for sale inventory and a robust labor market well, there are increasing headwinds, namely it onto higher mortgage rates and affordability, we continue to expect to allocate incremental capital raise at Nashville.
Is it sectors.
Well, thus far 2022 has proved to be one of the most difficult periods for mortgage investors in recent memory at the Port Agency MBS has improved significantly.
As David alluded to spread sort of materially wider compared to recent historical leverages convinced as improved funding markets remain robust and there is more clarity on fit out because they have effectively laid out their plans for the balance sheet production.
And we believe these dynamics resulted in an effective investment there and violent for agency MBS.
Violaceous MBS is currently a placeholder for capital return through the middle market disposition looking further out the horizon and as market conditions warrant, we will continue to strategically grow out and masada and especially because it isn't this is as we further diversified across housing finance.
With that I will hand, it over to say, they're not to discuss the financials.
Thank you Guy and good morning, everyone. Today I'll provide brief financial highlights for the quarter ended March 31, 2022, and discuss select for the state in that case.
Consistent with Crackle is while our earnings release discloses GAAP and non-GAAP earnings metrics. My comments will focus on our non-GAAP AAD and related key performance metrics, which exclude T I E.
And David in the OCA has touched on Q1 was a challenging quarter for economic return given the extreme volatility in fixed income market.
Notwithstanding the challenging market environment, we continued to deliver solid earnings and ample coverage.
125% of that dividend.
To set the stage with some summary information our book value per share was $6.77 for Q1, and we generated earnings available for distribution per share of 28 cents.
Book value decreased by adult 20 for the quarter, primarily due to lower other comprehensive income of $3 4 billion or $2.34 per share on higher rates and spread widening and the related decline in valuations on our agency decisions as well as the common and preferred dividend declarations of 349 million or 24 cents a share.
Partially offset by GAAP net income of 2 billion or one dollar and 37 cents per share.
Consistent with the product without a multifaceted hedging strategy supported book value.
Adding a partial offset to the agency declines due to the basis widening mentioned about with swap futures in MSR valuation is contributing $1.98 per share to the book value during the quarter.
MSR valuations alive with 12 fish at higher in the quarter than in Q4 2021.
Combining our book value performance of our first quarter dividend of 22 cents a quarterly economic return was negative 12, 3%.
Diving deeper into the GAAP results as I noted above we generated GAAP net income for Q1 2 billion.
One dollar and 37 cents per common share and net of preferred dividends up from GAAP net income of $418 million or 27 cents per common share in the prior quarter.
The most significant driving that higher GAAP income for the quarter was the unrealized gains on derivatives of $1 6 billion in comparison to unrealized gains of $135 million in Q4.
GAAP net income also benefited from higher net interest income of 581 million compared to 361 nine in Q4 2021, primarily due to premium accretion of $25 million compared to premium amortization of $219 million. In Q4, 2021, do you feel about let's see yeah.
And higher net servicing income of 31 million compared to 27 million in Q4, 2021 and higher average balances of himself.
As I mentioned the early out of the portfolio generated strong income with D. A D plus share at 28, consistent with Q4 earnings.
We have in recent quarters communicated that we anticipate earnings to moderate which we still foresee.
So we continue to expect earnings to sufficiently covered the dividend for the near term all things equal.
Average yields ex PAA remained relatively consistent with prior quarter at 216% down one basis point in comparison to the pipeline. However, higher dollar roll income continues to contribute significantly to EIB, reaching another record level at $128 4 million.
<unk> also benefited from higher MSR net servicing income associated with the growth of the MSR portfolio. These increases were offset by higher interest expense of $75 million compared to $62 million in Q4, primarily as a result of higher average securitized debt and repay balances as well as higher rates high in swaps expense of $63 million compared to 59.
In Q4, 2021 on higher average notional balances and higher G&A in the first quarter due to timing of payroll taxes and other compensation items.
The portfolio generated 204 basis points of NIM S. P. A a one basis point from Q4, driven by the higher TBA dollar roll income Neil that's a path higher economic interest expense.
Net interest spread does not include dollar roll income and that's what was down 15 basis points at 1.73% compared to 12, 31 21 due to a higher cost of funds.
Now turning to our financing funding markets continue to function well with liquidity for agency MBS robust throughout the quarter as ample reserves and strong demand kept overnight levels trading on top of a site.
Following the fed's rate was stuck in March market continue to reprice, the increased pace of fed hikes and the possibility of balance sheet reduction.
Considering these factors we maintained a disciplined approach now overall liability portfolio.
Opportunistically extending funding on our agency and non agency securities as well as where the economics make sense.
This positioning increased our weighted average days to maturity factory by book ending the quarter at 68 days versus 52 days in the prior quarter.
And we will continue to evaluate 10 premiums in funding markets as we get more clarity from the fed dropping year and position our weighted average days to maturity accordingly.
The upward trend in interest rates, along with highest swap rate impacted our overall cost of funds for the quarter.
Rising by 14 basis points to 89 basis points in Q1, and our average repo rate for the quarter was 20 basis points compared to 16 basis points in the prior quarter.
Our activity in the securitization market also impacted funding costs, increasing the weighting of Securitizations on the composition of cost of funds, along with higher effective rates of 2.27% compared to 2.6%, resulting in an increase of seven basis points to cost of funds. They were all.
Finally, what had an impact of four basis points of interest expense due to a highest nationals, partially offset by lower average net rates during the quarter.
Additionally, just better and has defense overall liquidity profile, we continue to focus on securing financing facilities instructions found Brian ready learn and MSR businesses, including a new 250 million facility for our residential credit group subsequent to quarter end.
Moving now to operating expenses efficiency ratios wasn't during the quarter due to increased compensation expenses in Q1, one time items not consider run rate and the impact of a degradation in equity on the computation of the ratio.
The recently announced disposition of all MMO business should have an impact on expenses as we ought to drive cost savings from this transaction in a long time, and therefore expect to see an improvement in efficiency ratios in future periods.
The sale of MMO assets is also expected to be executed at a price above the current carrying value and as such a valuable benefit in the range of two to three cents per share upon the completion of this deal.
And in closing and we maintained an abundant liquidity profile with $7 2 billion of unencumbered assets down from the prior quarter at $9 3 billion, including cash and unencumbered agency MBS of approximately $4 billion.
Much of the reduction in unencumbered agency securities issued or pressure on valuations and increased leverage on credit assets, partially offset by increased unencumbered MSR.
Now that concludes our prepared remarks, and operator, we can now open it up to Q&A.
Okay.
We will now begin the question and answer session.
Mind you. If you ask a question you May Press Star then one on your telephone keypad. If you are using a speakerphone. Please pick up your handset before pressing the keys.
I would like to withdraw your question. Please press Star then two at this time, we will pause momentarily to assemble our roster.
Today's first question comes from Rick Shane with J P. Morgan. Please proceed.
Hey, guys. Thanks for taking my question. This morning, and now that you've sold the middle or selling the middle market business I'm not necessarily sure I have that much to ask but that seems to be my routine question.
I do want to delve a little into serena's comment related to dividend coverage in the near term.
That's helpful context.
Love to get your thoughts longer term about what the opportunity is and your competence around the dividend when.
When we look at things, obviously were looking at the margin expansion opportunity, but the trade off there potentially.
Potentially a less specialness on the roles and I'm just curious as you roll out further how you think about dividend coverage.
Sure Good morning, Rick.
So look as we've said in the past.
We set the dividend based on what we think is an appropriate level consistent with our historical yield.
And competitive in the in the market and we always looked at it with our board a quarter by quarter. We have we have out earned the dividend really since the second quarter of 2020 post Covid I think we've ranged between 27% and 30.
In terms of earnings available for distribution coming into this year, we did think that our E D would be a touch lower in the first quarter.
But with our dollar roll income increasing in a couple of other areas that benefited earnings we matched that of last quarter.
28.
Going forward, we continue to think that it's going to moderate towards the dividend.
This coming quarter, we're gonna well cover it although a 28 is certainly ambitious and how we think about it over the long run as we have to assess what the returns are across the businesses with the capital allocation is and determine what we think to be a level that we can consistently earn out the horizon right now we feel good about.
Our dividend.
The returns on agencies as both Hilger and I discussed are have increased a fair amount of we're in the low to mid teens in terms of Levered returns on agencies and so we feel good about that but the fed is raising rates.
You know at the horizon, it's a little bit difficult to to.
Predict exactly how earnings are going to evolve, but we feel good about it right now.
Great So and again just to sort of be clear about that theres no implication about some specific concern. It's just a reflection of the uncertainty you're willing to sort of make a near term call, but given what sort of an unprecedented environment less certain further out yeah yeah.
And Youre speaking with respect to the fact that were out earning the dividend right.
Right now and what our intention is why we're being conservative with the dividend is that your question.
That's exactly yeah, Yeah, and look I think as I've said, we do think that that earnings available for distribution will moderate towards the dividend, but we're comfortable that we're going to out earn it.
Q2 for example, but.
We do think that when we look at the forwards.
Moderate.
Great terrific. Thank you guys.
Rick.
The next question comes from Bose George with <unk>. Please proceed.
Just in terms of return so you mentioned low to mid teens on agencies can you just talk about how that compares to credit and also just in the returns on the MSR.
What's the return on the invested capital there.
Sure. So yes agencies are a little bit as we said close to the mid teens low to mid teens as David said and and in fact, if you look at the headline numbers it will be higher than that but look this is an environment that you need to be hedging a little bit more and then you have to pay more hedging costs, So let's call it.
This ultimate teams on the agencies and on the residential credit it will be very similar low to mid teens, because they also but it also widened.
And in terms of MSR and as you know, we always evaluate MSR and an unlevered basis and on their merger charges are mid to high singles right now.
Okay, great. Thanks, and then can you just give an update on your book value quarter to date.
Sure sure.
It's been a little bit of volatile volatile start to the quarter.
Rates were up 30 to 50 basis points across the curve and mortgages are about 10% to 12 wider I'm a little hesitant to put an exact pin in inches given that things are moving around but it's off roughly.
Mid to upper single digits on the quarter, thus far but things are mortgages have found their footing. It seems like this week and we got two months left to go in the quarter.
Okay, great. Thanks, a lot you bet Bose.
Yeah.
The next question comes from Eric Hagen with BP IAG. Please proceed.
Hey, Thanks, Good morning, maybe just one on the market to start you know how much connectivity do you guys see between higher fed funds and mortgage spreads.
In other words, we know that there's a tight connection between the fed securities portfolio and mortgage spreads, but do you see a strong linkage between fed funds and spreads or is there anything specific in this tightening cycle that could change that relationship.
Uh huh.
Excellent question so.
It is the latest deal because its not the level of fed funds, but how fast it's raising namely the velocity of the fed funds. So this shows the effects of the yield curve and overall months' entitlements in the system.
And we have these two channels it has indirect but very strong effect on MBS obligations and MBS spreads having said that when we look at the market today I'm told was inverted in the phone space and mortgage spreads are close to the historical Weiss with exceptional.
Like a funding problem days. So one would think that most of these things have been priced and then that's what we believe right now, but that's a very good observation. So this time at all it.
It's how fast it's ray zinc, but seems like market is already prepared for like for example, coming 50, and another 50 or so most of that velocity hasnt been price than you and Eric I'll just add one thing to know really since the onset of Covid and the intervention by the fed markets had been very fast at pricing in the eventual Paul.
Let's see in the markets and you saw that in the first quarter.
The yield curve is inverted one year forward between twos intangible like negative 15 basis points in mortgage spreads are obviously quite a bit wider so it does feel like the market has done a effective job of pricing in considerable amount of policy tightening.
That's really helpful guys. Thank you one on the portfolio just what kind of ratio I think you mentioned this in your prepared remarks, but maybe some more color just the ratio that you see yourselves being comfortable with between pass throughs.
Finance with repo and TBA is financed with the role and then when you reinvest the capital from the middle market portfolio, if nothing else changes, where do you see yourselves.
Kind of leaning with respect to that breakdown.
Yeah again as you know we have been eliminated on TBA levels anything in the short.
Well, Sean Kang you will still be able to deliver abundant TBA levels because the production coupon TBA is a very very special but you can see us going more into pools are down the road, but it will still be maintaining luck, let's call. It 200% TBA inside the thing that will be on getting into more long run it.
Average under it but in the short term you will be Elizabeth behavior on the T J, Yeah, and Eric we're not constrained.
Bi limits on TBA versus pools in light of the fact that there's ample liquidity in the market and financing while the fed is tightening policy still remains.
Quite ample and so really it's a pure relative value play between T. B as in pools in whatever offers the best value. There's always limits with respect to you know being a REIT in the life, but we have ample latitude within those two buckets and then on your question.
On overall capital allocation post M M L.
My prepared remarks, I did discuss the fact that we will expect to increase our MSR.
Position over time, and you know the way we look at it with the three buckets three vertical verticals between agency <unk> credit and MSR, we would like to get better balance over the long term into residential.
Residential credit and MSR and reduce our exposure to agency, but we're not in a hurry to do that by any stretch.
In fact, if you if you fast forward. This quarter, you will see the capital allocation to agency <unk>.
Modestly higher with the return of that capital agency serves as a good place holder and then Episodically, we'll reallocate into both the MSR and residential credit, but where we're not.
We're in no rush, we'll be patient.
We'll invest as we see it appropriate.
That's helpful. Thank you guys very much good talking to you Eric.
The next question comes from Kenneth Lee with RBC capital markets. Please proceed.
Hi, good morning, and thanks for taking my question I'm wondering if you could just share with us your thoughts about how funding costs to trend in the near term and consequently improve.
Implications for investment spreads.
Sure I'll start and.
<unk> can feel free to jump in here, but in spite of the volatility and short rates funding costs on a spread basis have actually been.
Rather stable. So if you if you look out the curve and you know in the front end of the curve out to three months versus OIS. You can you can term for two to four basis points or thereabouts on top of OIS and then it spreads out to about five to seven basis points on top of OIS out the curve. So there's still.
The considerable amount of liquidity and financing markets.
<unk> tile, but spreads have had been had been reasonably consistent and Ilker do you did you have anything to add there actually is even as you said you anticipated.
Funding is available if it spreads to the sofa and OSV, which they have to deliver on this was about a point as you and I've been discussing that's what MBS looks very very objective right. Now is kind of MBS delegations only happens lenders led to extreme.
Stretched into funding markets and lack of balance sheet funding markets are stable I have never seen M. B S dislodging nominal spreads.
Thanks for your question when we're looking forward with regards to cost of funds and agency repo rates. We our expectations are that agency repo rates will be about 20 basis points higher for the second what I say you should think about that when you think about our cost of funds as well.
Great very helpful. There and one follow up if I may just wondering if you could just talk a little bit more about some of the growth opportunities around the prime jumbo or expanded credit MBS assets.
Yeah.
Sure. Thanks, Thanks, Ken.
Prime Jumbo I'll say that we have a number of strategic partners that.
That we've utilized over the past year year, and a half we don't necessarily take balance sheet risk with prime jumbo a lot of that is that our cost of capital and our cost of funds is inferior to banks and we don't really feel as if we have any any real competitive advantage. However, you know, we're a very active and large buyer in the subordinate.
Securities and you know, we do have a fee structure in place that makes economic sense for us to issue those deals with our partners.
Now on the expanded credit non QM side, we feel very strongly that that market will continue to have solid origination activity I think if you look at the top four banks are down 30% origination volume in Q1, we do think non QM will be more stable in terms of origination volumes.
You know about 60% of that market is purchase money about 25% of the market is cash outflow, 85% of non QM originations in 2021, we're not you know with with rate rate and term refi. If you look at the agency market that's closer to 40% in terms of you know purchase and you know Dave and Okra. Both mentioned is in there.
So you have also seen a number of the you know the non bank community start to originate and start to rollout non QM platforms.
And underwriting guidelines and products and this has been very beneficial in terms of bringing supply. So this this you know year to date, we've locked over $800 million through our correspondent channel of non QM and I'll say in Q1, we lost $520 million was our highest quarter to date.
So you know theres fierce fierce fierce competition on the agency side origination volumes are down margins are down and you had seen originators come to the non QM market to fill that gap.
Got you very helpful. Thanks again.
Thanks, Ken.
The next question comes from Doug Harter with Credit Suisse. Please proceed.
Thanks.
Mike I was wondering if you see opportunities kind of on the bulk purchase side and in non QM, you know, especially in light of the middle market sale, you know what kind of having additional capital deployed.
Yeah sure Doug you know what I'll say, you know what I'll say in terms of transaction activity in January in the bulk market. We saw 2 billion of outflow and available you know for us to bid in March that number was $750 million and a lot of what's transpired as you know origination volumes.
<unk> are down but you're also seeing these smaller non bank originators in some of the larger non bank originators move away from the bulk market to delivering best efforts and wanting to deliver through our correspondent channel.
So we certainly have seen a number of opportunities I think the challenge that the market is going through and it's more on the originator side is non QM rates have increased so fast that originators have been caught off guard not necessarily having appropriate hedging strategies and they continue to sell discount loans. So.
Since the end of the year, we see non QM rates go from 425, you know, we think the one or two rate walking in here today is six and three quarters.
And unfortunately for a lot of these originators they've been trying to sell that bulk you know through the market, but it continues to be out of the money. So we've evaluated our preference is for you know at the money collateral and not necessarily continuing to buy discount pools on the way up but.
But I will say that you know the bulk market.
Have seen less supply and you are seeing more originators are willing to engage in lot best efforts, given the dynamics and given the hedging practices of those of those originators and Doug just to add to that you know the silver lining in the volatility we experienced a year to date is the fact that we have deep capital base and can provide a lot of.
And so when you look at bulk versus flow and originators want not wanting to warehouse loans, rather are opting for that certainty of execution.
You know we've been open for business and it's helped us build a micro correspondent channel, where we're very happy about that.
Great and David you talked about being willing to take MSR, you know kind of beyond the 10% you know any way to.
Dimension, you know kind of how how much beyond 10% you're willing to go on that sure. So looking at the less liquid bucket, obviously middle market lending off balance sheet that was roughly 10% of capital and I would think about it MSR over time could make up that balance and get to an upwards of 20% of <unk>.
Capital over time.
Great.
Thanks, Doug.
The next question comes from Kevin Barker with Piper Sandler. Please proceed.
Good morning. Thank you for taking my questions I just wanted to follow up on the proceeds from the middle market portfolio you touched on earlier could you did you talk to talk to us about how your way.
The differences between reallocating that capital between Msr's agency mortgage backs or maybe even look at.
Other you know.
Sources, whether it's M&A or other things that are out there as potential.
You know potential proceeds from from <unk>.
Sure Yeah, so with respect to the the actual billions in capital you know as I mentioned, the Placeholders agency MBS, but we will look to redeploy it episodically and rajiv or and or MSR over time and ultimately the longer term objective is to get those too.
Non agency and MSR buckets up to a higher percentage of capital, but we're perfectly comfortable with agency taking on that responsibility of redeployment over the over the near term.
In terms of other opportunities out the horizon, we're always looking at everything whether it's M&A or new sectors, we're consistently evaluating different opportunities in the market and we you know as Serena mentioned in terms of liquidity on the balance sheet cash and agency MBS 4 billion another $1 billion coming in.
Can we can engage in a lot of potential strategies should the opportunity materialize M&A has been tough over the past couple of years after some pretty high price points are in the sector.
We're not actively seeking to buy another company, but it's always something we look at.
So when you when you think about the opportunity set for other companies.
I mean do you have.
When you say you seem you indicate a pretty broad range.
Different things Youre looking at is there anything in particular or any sectors that you know screen is particularly attractive just giving your your raw strategy today.
Yeah. It's you know hopefully it fits within the three verticals that we're looking at with agency Youre looking largely at price with MSR potentially in the realm of other portfolio companies are in origination, which we do not need we've been very successful with respect to partnerships with them.
Large originators so we're not looking at the origination market right now and then in the resi credit space.
We have looked at smaller originators in the past, but the development of the correspondence corresponded channel and actually partnering with originators as opposed to competing with originators has worked out quite well and again, we're relied on for that certainty of execution. So.
To paint a broad picture if there is a need for liquidity in the in the mortgage REIT space and it's at the right price and it presents a stringent strategic fit we'll certainly evaluate it and we have the liquidity to execute on it but outside of that.
Portfolio management sector, we don't have aspirations to do anything at this time.
Okay. Thank you for taking my questions you bet Kevin.
As a reminder, if you do have a question. Please press Star then one on your telephone keypad.
Our next question comes from Mark Devries with Barclays. Please proceed.
Thank you David Analyst has been on quite a journey over the years you know building out its business is creating the most diversified mortgage REIT platform and then kind of under your leadership narrowing that focus back to residential mortgage. So can you just talk more about kind of the the.
Jake benefits you expect to realize from this more narrow focus you bet. So look I've always I've known Anthony really since the beginning well before.
I came to work here in Italy has always been residential housing financing has always been a market leader in it that I've known and and that's my background and as I laid out two years ago in terms of the strategic direction and then we are going it is refocusing on the roots of the company, but being broader within the housing finance.
And in creating a platform whereby we don't just invest in securities we invest across the loan whether it's you know the rate and convexity component of the loan and agency MBS the credit component in residential credit or the Io and MSR, we want to look at the <unk>.
Loan and allocate capital across the cheapest component of the loan and there's considerable synergies are.
Across these three functions.
As we've talked about in the past, whether it's MSR hedging our agency or residential credit having less correlated returns with both MSR and the agency and we think it's it leads to the best risk adjusted returns for our for this company now. The question is is those are the ingredients, but making sure you get the may.
<unk> appropriate so that your liquid and that you're generating the best risk adjusted return and so longer term agency is always going to be the anchor of the company and the mother ship, but increasing these other two ingredients, we think will create a better balance in the overall portfolio better.
Our risk adjusted returns lower.
Lower leverage and actually more liquidity because of these lower electric levered, our sectors and we think that's the optimal direction for the company.
Okay. Yeah. That's helpful and then with agencies kind of mirror their Wides you know, what's the greatest risk. That's keeping you from from levering up more is it is it just concerned that the fed might need the tightened conditions, even more than currently expected in and become a seller as opposed to just weathering.
Portfolio run off and do you see kind of a risk of that at least as great. As it was tightening here yeah, we don't see that risk in 2022, and I think look the fed's talked about the possibility of selling mortgages, although although they recently said until Q.
<unk> T is well underway they don't want to sell mortgages, they've never sold mortgages in the past other than test trades and it's not an optimal approach they would love to just let the portfolio run off naturally, but nonetheless, it could be eventually an eventuality out the horizon. We just don't think it's in 2022 and the other risk in the Mark.
And yogurt can expand on this is that there is still volatility in the rates markets and that gives us gives us a little bit of hesitation, we got pretty meaningful.
Risks in the system, whether it's geopolitical or.
Economic uncertainty and so and so we're waiting for.
A little bit more calmness to prevail, but.
The other the other point to note is that with agency spreads where they were at you don't need to add a lot of leverage to really good ample returns and we will certainly benefit from spread tightening but between the volatility in the market and the supply picture.
We're comfortable.
Got it. Thank you you bet. Thanks Mark.
At this time there are no further questioners in the queue and this concludes our question and answer session.
Wed now like to turn the conference back over to David Finkelstein, President and Chief Executive Officer for any closing remarks.
Well. Thank you everybody and we will talk to you in the in the summer.
The conference has now concluded. Thank you for attending today's presentation and you may now disconnect.
Okay.
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Okay.
Sure.