Q1 2022 Dynex Capital Inc Earnings Call
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Okay.
Thank you for standing by my name is Cheryl and I will be your conference operator today at this time I would like to welcome everyone to the Dinette capital first quarter earnings 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 would like to ask a question. During this time simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question again press Star one.
Alison Gretchen you may begin your conference.
Okay.
Thank you operator, good morning, and thank you all for joining us today for the <unk> capital first quarter 2022 earnings Conference call. The press release associated with todays call was issued and filed with the FCC. This morning April 27th 2022, you May view the press release on the homepage of the <unk> Webster.
I would die next capital dotcom as well as on the SEC's website at SEC Gov.
Before we began you 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 forward looking statements reflect our current beliefs assumptions and expectations based on information currently available to us and are applicable only as of the.
The date of this presentation.
These forward looking 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 <unk> 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 on the <unk> website under 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 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, Pompano, President and co Chief investment Officer, and Steve Benedetti, Executive Vice President Chief Financial Officer, and Chief operating Officer.
And with that it's my pleasure to now turn the call over to Byron Boston.
Alison and thank you everyone for joining our first quarter earnings call.
I am incredibly proud of the dynamics seen in the first quarter results.
We skillfully navigated a historically volatile macro environment. It was all major bond indices produced negative returns as you can see on slide five.
This is the second such rapid market disruption in the fixed income market. We have seen in the last few years during which we generated double digit returns.
In the first quarter, we generated a total economic return of three 5%.
And our total economic return for common shareholders since January one 2020.
21, 3%.
All while maintaining an average book value of around $18 per share. During this period as you can see on slide six.
There's a reason for these exceptional results.
It's because of the skills of our experienced team our risk management.
We'll mindset.
Our disciplined and patient approach to investing and our differentiated top down macro approach to capital management.
As I said many times, we invest your capital with a long term view.
Our team has navigated many complex and volatile market environment.
The 1987 stock market crash, the 1998 long term capital crisis 2008, great financial crisis of 2013 taper Tantrum and most recently the pandemic turmoil in 2020 and now the first quarter of 2022.
All of the lessons learned from these historic events help us maintain perspective, when navigating todays complex and volatile market environment.
Our focus on our global top down macro approach is fundamental to our strategy and our success.
We've been consistent and transparent in sharing our macro views with the market and how these deals have translated into our disciplined investment process.
We have been positioned with increased liquidity and flexibility for some time.
We continue to expect turbulence and uncertainty in global markets, our Russian invasion of Ukraine has intensified the unpredictability of geopolitical risks and we expect this conflict have both short and long term market consequences.
There also continues to be uncertainty around federal reserve actions to combat inflation.
Corresponding impact that has on interest rates credit spreads in the U S economy.
But with volatility and uncertainty also comes opportunity.
We're beginning to see opportunities to generate attractive long term returns through increased leverage.
We remain very well positioned to take advantage of market opportunities, which we believe will persist for an extended period of time.
We're being measured with our approach, while our balance sheet and our mindset remain flexible.
We have adjusted our portfolio and we expect to navigate this environment with patient and disciplined as market conditions evolve looking for opportunities to generate accretive returns.
I want all of you our shareholders to have confidence confidence in our team and our unique and disciplined approach.
What makes us unique.
Our unwavering commitment to ethical principles.
For me it starts with risk management and disciplined capital allocation, our sound investment strategies that are based on top down macroeconomic analysis.
Most importantly, our skilled and experienced people, who work day in and day out to protect capital and generate attractive risk adjusted returns for you our shareholders.
And with that I will turn the call over to Steve Smith to give you more specifics regarding our first quarter performance.
Thank you Byron and good morning.
For the quarter the company reported a total economic return of 64 cents per common share and comprehensive income of <unk> 65 cents.
The total economic return of 64 cents includes a dividend of 39 and.
And an increase in book value per common share of <unk> 25 cents.
Comprehensive income of 65 consists of 44 cents in earnings available for distribution in 'twenty, one and positive fair value adjustments on our investment portfolio position net of hedges for the quarter.
Earnings available for distribution per common share a non-GAAP measure was <unk> 44, this quarter versus 45 less.
Average interest, earning assets and leverage were largely unchanged, while adjusted net interest spread increased five basis points during the quarter.
Agency MBS yields increased 11 basis points, while TBA drop income yields improved by 21 basis points.
Does he RMB as yields benefited from slower overall prepayment speeds during the quarter, which were nine CPR versus 11 CPR last quarter.
The increase in yields on TBA was primarily due to the reallocation into higher coupons during the quarter.
Offsetting these items was an increase in repo financing rates of five basis points.
As a reminder, the company predominantly used as treasury futures and swaps to hedge its exposure to interest rate risk.
Unlike interest rate swaps.
These instruments do not have a calculable periodic costs that can be allocated to current period hedge expense and therefore are not included in earnings available for distribution.
Rather the benefit or cost of these instruments is included and changes in fair value total economic return and comprehensive income and book value per share.
As it relates to book value the driver of the 25 per common share increase resulted primarily from the company maintaining its hedge position throughout the quarter, which mitigated declines in the fair value of the investment portfolio as interest rates increase and as our MBS spreads widened.
The company's book value also benefited from its lower coupon agency, MBS allocation, which experienced less spread widening relative to higher coupon assets.
It is important to note that our on balance sheet asset prices and our book value as of March 31 reflects rate and spread volatility that occurred during the quarter.
It also reflects the substantial repricing of mortgages and as such reflects market yields for our investments based on spot and forward rates on that date.
All else equal assuming projected prepayment speeds in forward interest rate curves are realized as they existed on March 31.
Yield on our agency MBS assets from a GAAP fair value basis is approximately 3%.
Which drives forward total economic return and.
That is substantially higher than the 182 basis points effective yield for the first quarter based on an amortized cost basis.
From a portfolio perspective investments inclusive of TBA securities increased on a quarter over quarter basis by $235 million, mainly due to TBA investments and our $4 9 billion as of the end of the quarter with 91% invested in agency MBS and 9% invested in <unk>.
<unk>.
From a hedging perspective, we maintain our notional coverage of approximately $4 4 billion throughout the quarter principally in U S Treasury short positions.
That concludes my prepared remarks, and I will turn the call a reduced merithew for her comments on the quarter.
Thank you, Steve and good morning, everyone. Let me start by saying we have witnessed historic moves in the first quarter the fastest drive in yields and the largest percentage change in yields in 42 years.
The trend continues into the second quarter with yields up an additional 30 to 40 basis points across a steeper curve.
We also saw the fastest increase in mortgage rates since 1985 to over 5% levels not seen in 12 years.
These moves were accompanied by a rapid widening of nominal and option adjusted agency RMB at spreads that have repriced in a sustained manner to levels that we haven't seen since the last quantitative tightening cycle in 2018.
Yes.
We believe we're on the brink of a historic opportunity to invest in agency MBS.
Which I will discuss in more detail in my remarks.
Yeah.
We have maintained our book value in this environment ending at $18 24 on March 31, and holding between $17 50, and 18 10, thus far in April .
We entered the first quarter with our portfolio focused in two coupons 30 year MBS twos and 200 years. We felt these were the right place to be in a rapidly rising interest rate environment.
As spreads and higher coupons have widened we've responded by moving our entire TBA position from lower coupons into U M. B S reasons, we enhance this adjustment substantially mitigated the adverse impact of spread widening that we've seen this quarter across all coupons, but particularly in lower coupons now.
Now turning to our macroeconomic outlook. The consistent overall theme remains which is that government policy will be the main driver of returns.
We believe that the global economy is in transition from the emergency phase when aggressive government policies will use to buffer the direct impacts of the pandemic to the post pandemic phase, where we faced the consequence of massive liquidity infusions and fiscal stimulus.
The <unk> team has been prepared for elevated volatility.
Also the increased probability of surprise factors and a bumpy ride in the market.
We continue to be alert for changes in the economic whether focusing on future inflation labor market dynamic global and domestic growth the psychology messaging and actions of central banks War and pandemic related disruptions as well as domestic and global geopolitics.
We are maintaining an up in credit up in liquidity position holding significant amounts of dry powder for investment joined bouts of volatility.
Most importantly, our flexible portfolio and mindset to respond to evolving conditions.
I wanted to take a few minutes to talk about our approach to managing this environment.
I use terms like prepared ready and respond to highlight our approach rather than trying to predict the future. We focus on scenario planning, which allows us to respond rather than react to market events.
This is an important distinction and one of the keys to <unk> success in navigating volatile market environment.
We continuously evaluate our decisions for accuracy, rather than whether we were right or wrong.
This allows our teams to have a performance improvement mindset with clear thinking that reduces the emotional component of decision making.
How do we put this into practice during transitional environment such as the one we're in our focus is on capital preservation.
We measure ourselves and we encourage you to measure us on the total economic return that we generate we believe our shareholders are best served by the preservation of capital in our business model, which is focused on generating returns over the long term.
At <unk>, we aim to generate earnings that meet or exceed the level of the dividend, while ending up with the same or higher book value per share at the end of a period by.
By doing this repeatedly we work towards a strong capital base that is available to deploy for future investment opportunities.
No it isn't always possible to keep book value intact, and there are situations like the one we're in where book value may decline and yet we might still be in a position to make long term accretive investments for our shareholders as we did in 2020.
And this kind of environment, we aim to minimize the damage to book value from controllable losses by focusing on our hedge ratios positioning across the yield curve and managing our overall leverage to protect capital by minimizing the downside hits to book value, we reduced the amount of time it takes to recover the cash.
Capital in earnings.
We can then deploy the capital at the right time and position ourselves to benefit from potential spread tightening in the future.
These are the foundational elements of our investment strategy for the environment and it is exactly what we executed in the first quarter now.
Now, let me turn to why we believe this is a historic opportunity.
The largest non economic buyer the U S. Federal reserve is stepping back from the MBS market and unlike the short bursts of spread widening that we saw in 2019 and 2020.
We believe the conditions are ripe for a sustained investment opportunity.
Fed has also consistently messaged, a desire to own fewer MBS on their balance sheet.
Providing a structural opportunity for private capital to step in.
The MBS market has been the leader in pricing the impact of quantitative tightening.
Turns are higher now than in 2018 with a significant amount of widening already behind us, possibly the majority of it.
From this point on we anticipate going through a cycle of spreads.
Yes, they're wide now we think they could go wider because the amount and pace of quantitative tightening being contemplated by the fed is higher than it was in 2018. It's also the first time that we will not have the GSE portfolios in the secondary market.
We ultimately expect support at the wider spread levels as agency guaranteed MBS will be viewed as an attractive cash flow alternative first as risky credit oriented investments.
We see this as a very positive investment environment for dynamics.
We've done a good job of preserving our shareholders' capital to date and it is important to understand that at current levels of returns. We believe we can quickly earn back any incremental book value declines.
This is supported by the significant dry powder that we have to invest we are positioned with over $500 million in available liquidity.
Our decision to deploy capital will be driven by two factors.
First our view of the overall macroeconomic environment, which we still believe to be vulnerable to unexpected shocks. This necessitates prudent decisions on leverage and second the overall level of mortgage spreads, which while already attractive today may provide better opportunities at the wider spread levels that we.
Expect.
Let me add that at today's level of the balance sheet, we are in position to earn or exceed the level of the dividend and earnings available for distribution for the second quarter and.
And we expect to be able to maintain that with an additional two to three turns of leverage even as financing costs rise to the three 5% implied by the forward curve in 2023.
From a hedge ratio standpoint, given the complexity of the global environment and the rapid move higher in interest rates that we've already experienced and we see the chance for rates to go either higher or lower from here and that call for a different portfolio strategy. We therefore diversified our coupon holdings to be more balanced with about 40% of the <unk>.
<unk>, our MBS portfolio now in threes and three in halves.
While our hedges remain in the 10 year part of the curve, we expect to be more active in managing our hedge ratio in the coming quarters.
We have successfully managed through the significant widening in spreads and a historic rising rates. We're experienced at this and 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 we're 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 Martin.
I've also said on these calls that when choosing how to invest your money.
Or SaaS relative performance in our sector. The key factors for consideration should be management team quality and total economic return performance I believe the best thing we have done for shareholders over the past two years is the preservation of our capital.
Because of our focus on preserving capital dynamics is now extremely well positioned to capitalize on these big moment in history.
We believe dining scaffolds should be in the portfolios of many types of investors.
Our performance demonstrates that we have the ability to hedge our portfolio risk, while we generate an above average cash dividend yield for our investors.
You are running a traditional 60 40 investment portfolio strategy and consider diversifying your fixed income portfolio with either <unk> common or preferred stock.
Dominant that needs an annual draw on your portfolio.
Our above average dividend yield can help meet your needs.
You are in retirement or approaching retirement, you need an asset management team that you can trust over the long term.
You can simply enjoy life.
<unk> capital offers a unique investment opportunity.
We are an experienced an ethical management team with strong core values and a long term mindset.
Our record of preserving capital and very importantly, a game plan for navigating the current and anticipated market environment.
To our existing shareholders I encourage you to stay with US on this journey and to those who are not yet dynegy shareholders I invite you to join US operator, please open the lines for Q&A.
To ask a question. Please press star one on your telephone keypad.
First question is from Doug Harter of Credit Suisse. Please go ahead. Your line is open.
Okay.
Thanks.
First off congratulations on a good book value performance for the quarter.
I guess just wanted to follow up if I look at the available returns that you show in your presentation.
Despite the spread widening you saw kind of only showing the widening of 100 basis points of the potential Levered return.
Can you just talk.
Through kind of sort of comparing.
That spread widening and wider spreads only returns only increased 100 bps.
Sure.
So I think it depends on the coupon that you pick.
Two to identify what the returns are right one of the most interesting things that's happened over the quarter is the change in the coupon.
Distribution with respect to what is the current coupon.
And as the current coupon has migrated.
Higher and higher so right now if you think about it the current coupon is actually four 5%.
That is a big driver in terms of what that marginal return looks like so from our from our perspective I wouldn't take that as a only a 100 basis point change in the overall return it's simply a function of what is the $102 price coupon and how has that changed over.
The last quarter.
If you really look at the the coupon distribution in total.
You'll actually see that the returns are higher by by the appropriate amounts of probably close to two to two 5% quarter over quarter.
Got it okay.
That is helpful and I know you talked a little bit it was somewhat coupon distribution, but.
Just any more color that you can give us.
Kind of how are you.
Navigated the widening of well, it's kind of all spreads and still kind of produce the positives.
Positive book value return.
In the quarter.
Hey, Hey, Doug I'm going to start and I don't know what smriti.
Follow up with any micro details.
So we are very disciplined about our top down approach.
And I.
I think you could probably go back during the tenure was about 65 to 70 basis points.
We gave you a view or thought process about the yield curve.
About anticipated spreads.
And we started to position the portfolio at that time.
And literally the best thing that we've done for shareholders is remaining calm.
Patient.
Glen.
It's been a gyrating ride from 65 basis points over the way appeared to 202.
$82 90 on the tenure.
We literally.
Still with our opinion about the yield curve about rates about spreads.
You'll recall also back I don't know year or so ago, we did a couple of capital raises.
Very open and we said we're not deploying all this capital.
Because we don't believe that this is the perfect time to do so we believe there's going to be a better opportunity.
Dissipating steeper curve higher yield wider spreads.
We've been on this we've been very disciplined and the best thing I can tell you that we've delivered for shareholders as being column.
Asia.
Disciplined and having a short medium and long term deals.
Literally you can go back and install those calls are going to hear us talk.
And one of my goals is to make our management of this portfolio look to you and other shareholders like a symphony.
The move from one movement to the next.
You enjoy the music the entire time.
Alright, thank you.
Mark do you want to add some more specific.
Details then we'll go back and listen we literally.
<unk> been very disciplined very patient very calm with the same overall.
Thanks.
I would say just from a more detailed perspective, Doug it's really three things.
You know when we talk about hedge ratios, it's really making sure that you understand what the duration of our mortgage security is it's very hard to predict the duration of our mortgage securities. So one of the things that we do is we.
I think Wayne Gretzky said, you don't skate to where the puck is what you skate to where the puck is going to be.
And we think about durations and those terms so and it takes some amount of scale and some amount of art and understanding how mortgages work.
So part of it is hedge ratios, how do you hedge and what he used to hedge.
So thats positioning across the yield curve.
I think it's all of the above with respect to saying.
Our asset allocation was in lower coupons lower coupons that grades are hedged election was in the 10 year part of the curve that part has really sold off.
In line with the assets and then look we've been talking about low leverage all along through this period, it's not a popular thing one when theres. So much carry to be had in the yield curve, but I think it's served us really well.
And obviously as Byron mentioned this is all driven by.
Macro view, so those four things together.
Get us here.
Great I appreciate that answer.
Sure.
Okay.
Your next question is from Trevor Cranston of JMP Securities. Please go ahead. Your line is open.
Yes.
Hey, Thanks, good morning.
You guys talked some about the.
Movement up in coupon during the quarter.
I was curious if you could maybe talk some more about how you're thinking about positioning within the coupon stack is.
Rates have continued to move higher.
In the second quarter, it looks like most of the portfolios.
Discount bonds now.
I guess I was particularly curious in the context of.
When you look at the.
The book yield on your assets.
It's substantially below market rates and it seems like there would be a large amount of.
Yields you could pick up by continuing to put the portfolio coupons. So just curious how you guys are thinking about that thanks.
Sure, Yes, the one of the most interesting things. That's happened is is almost the entire coupon stack is at par or below par right. So when you're moving up in coupon typically you'd think about them going from a discount to a premium but really are not.
So let me let me take this a couple a couple of different ways. One is we shifted our entire TBA position last quarter up in coupon as spreads widened in the higher coupons.
I think we are respecting.
Just the idea from here on.
That there is a more balanced view of how rates could go from here and that's what leads us to have a more diversified coupon distribution okay.
The second thing I would say is that you know.
You don't want to think about that book yields per say every quarter, we're really marking our balance sheet to market those bonds that now sit at 880 $889 price discount there are three ish percent market yield.
And because we preserve book value with really essentially preserve the forward NIM on those assets.
A movement out of those assets at this point, it's really going to depend on two things. One is what are the prepayment speeds in these lower coupons going to be okay, that's driven by cash out refinancing and turnover.
So we're watching those to say is this something.
These are the gauges that that we feel like we need to watch to get out of those positions.
Relative to the higher coupons.
And right now just just so you guys know our portfolio of <unk>.
And two and a half the pools that we own paid about 8% to nine CPR last month, and that's worth a lot and one dollar prices are 11 points below par.
We're watching that and and by no means do we feel married to those positions and.
And I think there will be an opportunity for us to go up in coupon as the fed starts to step away from the higher coupons, but.
But that's something that we're watching the other way to think about the low coupons is you know we think about them as like an on balance sheet call option.
Yeah.
Swaption Mall and option vol is really elevated on both the cost side on the put side. So these are right now they're a positive carry.
Call option that we have on the portfolio and.
So at this point.
I'd say all of these positions are temporary we're obviously watching every every single day.
In terms of when it's appropriate to get out of them, but we feel very comfortable at the at the prices where things are we've had these hedged.
The forward NIM looks good.
So really now at this point, it's going to be about the relative value going forward.
Got it okay that makes sense.
And in terms of as you guys are looking to.
Invest paydowns or potentially increase leverage can.
Can you talk about how you're thinking about spec pools.
How much payouts would come down.
<unk> versus TBA is at this point.
Yeah.
The interesting thing about specified pools I'll just give you some some color on it's kind of bifurcated between the lower coupons versus the higher coupons. So <unk> two through threes you are seeing just massive.
Reduction in the pay ups versus TBA.
For those coupons and thats appropriate because the dollar prices on those coupons are so much lower.
Three and a half and above that.
Pay ups have come down.
And they've come down.
As dollar prices have come down but in that instance on the premium side, I say premium, but the higher coupon side.
The percentage of theoretical.
That youre getting is is still actually about the same so those look a little expensive relative to TBA, so and the higher in the higher coupons I think the TBA theres still going to be.
Where are we where we go the low coupons, they've gotten really beat up.
And you guys noted already we kind of stayed in the in the low pay up.
World for that reason.
Those might start to look a little bit more attractive.
The other thing Thats happening in the lower coupons is that.
Because you have bonds that are 80 $889 price now.
Seasoning starts to matter until you have a really nice.
<unk> to.
Pay ups, because the seasoning will start to count. So at this point I would say three and have been above <unk>.
TBA still look better cheaper from <unk> versus <unk>.
<unk> and below we're a little bit indifferent.
And we'll look to pick up.
Call protection that we think it's really cheap but.
We're happy with with the spec pool positions, we have in the lower coupons right now.
Got it okay.
Last thing you guys have an estimate as to.
How book value has moved since you ended the quarter.
Yes, I mentioned on my comments that we've been sort of sitting between <unk> 50, and 18 10, thus far in April .
Okay perfect. Thank you.
Your next question is from Eric Hagen of <unk>. Please go ahead. Your line is open.
Thanks, Good morning, and congrats on a great quarter.
Just a follow up on the TBA.
Just a follow up on the TVA I just wanted to get your perspective on the dollar roll.
How that responds in the three and the three and a half as the fed starts to draw down the portfolio.
Hi, Eric Thank you for that question.
So I would say, it's less a function of the feds drawdown well, it's partially related so as the fed stops buying those coupons.
You would expect to see the roles in those coupons start to come off alright. That's that's definitely the case the bigger driver is going to be.
The level of rates. So you can actually see just in the last week or so.
Role in Fannie fours has come down for ticks, it's really directional.
So it's and it's a very difficult thing to sort of lock in.
And play that game, so it's less sustainable I would say than it was when the fed was buying so the volatility in those roles is going to increase the.
The carriers there for if you if you can if you can hit the right level on these dollar rolls, but at this point I would say.
It's less sustainable.
So as the fed steps away you have more production without a bid for that production.
Specialness in these roles is not going to be sustainable without a very deep bid from a goal going away buyer.
And so it's just less sustainable at this point.
Right. That's helpful color and then on the hedging side I just wanted to get your sense for what kind of market conditions I suppose.
What would they need to look like in order to change the approach to hedging.
Instead of with the futures, but across the curve.
And how do you also think about maybe replacing the swaption swift volatility potentially staying relatively high.
Yes, I think I think the.
The way to think about the hedges at this point.
Because we have.
Pretty flat yield curve, that's that's a factor the second factor is just the overall direction of rates right. So.
So at this point I think our inclination would be.
To be I would say more neutral relative to relative to the level of rates.
We've said in the comments that we think that we need to have a more balanced approach.
And we'll be more thoughtful about where.
The individual points on the curve.
With respect to the swaption, it's really tough here.
And when you when you think about the level of ball.
So.
With everything at a discount at this point theres less of a need to use swaption. So we're not as we're not as married to kind of continuing to have some options at the moment.
And we do think about other ways to buy vault right.
And spec pools or something else. So that's another piece of of how we're thinking about it.
<unk>.
From here we.
We are going to be much more active in managing the hedge hedge piece I think we noted that in my comments.
So youre right in terms of picking picking that up.
For me to tell you, it's going to be in the 235 year part of the curve at this point.
We don't yet have the level of uncertainty to be safe to say, how it's going to be.
I do know that we're going to be positioning our book and have positioned our book to have a more balanced view of rates.
From here on out.
That's really helpful color. Thank you very much.
Sure.
Your next question is from Bose George of <unk>. Please go ahead. Your line is open.
Hey, good morning.
Just wanted to go back to the discussion on sort of incremental returns and I think smoothie you suggested that <unk> are up to two 5%. So just can you just talk about where levered Roes are just given your current leverage.
Yeah.
<unk>.
So I am not going to tie it necessarily to our current leverage I will say that on the margin.
We're seeing returns somewhere between 12 and 14%.
Depending on the coupon depending on the day, depending on depending on the hedges that you pick alright, so and the interesting thing about that is that the hedged returned already include.
They already include the financing costs going up to three 5% as implied by the forward curve. So that's why we say this is historic and the other reason.
1% to 15 might not sound like like <unk>.
Great shakes here.
But the reason it is historic.
Is the sustainability right the largest non economic buyer has stepped away and it's telling you that they're stepping away and they don't want to own more of these.
So the ability for these returns to be there for some time is really the other piece that you want to be thinking about.
So these levels of mortgage spreads we have not seen since 2018 2019.
And that's that's the other piece here I think thats important to understand so I would I would say to you that that the.
Current returns in the 12% to 14% I mean, we see mid mid teens definitely possible within about the volatility.
And when we when we've created when these returns are calculated of diagnostics.
True risk adjusted returns like it's murky.
It's got built in there a solid rise in rates and financing costs.
And I think that's very important because when you when you at different companies.
Their returns and one of the challenges you have is well what are they assuming in.
And their calculations and we're not very liberal when we are making these calculations if anything we're going to be on.
Very disciplined and very conservative in the process.
And what's exciting about that is if in fact, you add assets at these wide levels.
And then you're looking to hold them over the long term.
And then in fact, some of those risk factors turn out to be better than anticipated.
That actually gives you the opportunity to make higher returns.
I just want you to understand the philosophy behind the return numbers.
Okay great.
Thanks, and then just back to the book value discussion and again, great job with that this quarter, what was the duration gap going into the quarter.
Yeah, We don't we don't look we don't disclose that Bose.
And I think the way to really think about it is what what what assets did we own relative to the hedges that we had on.
And the way I would I would say that we were positioned was we were hedging for the extension risk that we thought was present in the twos and two in the year, we were hedging for the extension risk.
And so I do want to make this point. This is this is really important because.
We talk about controllable risks like in say hedge ratio durations et cetera.
One of the most interesting things about being in MBS portfolio manager is really dissecting how.
How much of your return came from duration drift versus what I call, a true spread widening and spread the spread widening actually happens when on days, where treasuries are you hedge it goes up in price and value of your asset goes down right. That's a difficult thing.
The hedge book.
When treasuries when you hedge and your asset are going in the same direction, you want to be as accurate as possible.
Those things are moving together.
So our assessment on the twos in two and a half for extension risk or the way. The duration was going to move was we felt like they were going to move actually quite correlated with with treasury. So our hedge ratio was appropriately adjusted for that so that's how I would think about it.
We don't we don't really think about duration gap because it's a real it's a spot metric. It tells you what your duration is today. It doesn't tell you. How your duration is going to move 25, or 50 basis points from now and so it might give you a false sense of security in that sense.
And then Bert tied back to your comment earlier about Gretzky comment about scale.
We'll be that's very important in Miami or mortgage backed securities portfolio.
65 basis points Entertainment, which is where we are we believe in all probability. The tenure he is going to be closer to 2% you need to think about your mortgage backed securities durations as to where they would be if the tenure is actually up another 100 basis points.
Okay. That's helpful. Thanks, a lot.
Okay.
Your next question is from Christopher Nolan of Ladenburg Thalmann. Please go ahead. Your line is open.
Hi back to the ROE question, given that you are covering the dividend and Youre seeing book value appreciation and Youre Levered Roes are in your target what motivation could you have to increase your leverage it seems like.
Youre hitting all your targets without much leverage.
I think it would be.
The opportunity to put assets on.
A.
An accretive level, Chris relative to the cost of capital.
When we think about the risk adjusted returns given the macro environment. If we have that opportunity you would step into that.
And I think this is that kind of environment.
So as you can see increasing your leverage sometime assuming.
The volatility in the market remains sometime in 2022.
Yeah, I think I would think about it as the next few quarters are going to be really important with respect to how risk assets reprice and you've heard us say probably in June or March of last year.
As quantitative tightening comes in risky assets are going to adjust the price of crypto equities bitcoin credit everything is going to adjust to the liquidity drain that's coming.
Mortgages have led the way.
So it's and we expect this bumpy ride in that bumpy ride could there be and will there be some chances to put.
Some capital to work at really good levels yet.
It has to be done in the context of this global macro environment that.
Deserves a lot of respect quite frankly, so will.
Will we take leverage up Opportunistically, yes, do we think the next two to three quarters as is critically important with respect to how these prices evolve yes.
And I think what.
What people can expect us to do is do what we've always done we're doing it thoughtfully.
Not rushing in.
These returns are good returns relative to the cost of our capital.
And we're being we're being judicious about when we when we put the money in.
And assuming the returns do go up what's the thoughts on the dividend would it be a increase.
The increase in the base dividend or dividend supplement any thoughts on that.
The one thing that I'll say Chris.
<unk> said it many times before.
We start with our macroeconomic view.
And we have a very strong view about global risk dividend levels at this point as a matter of risk management we.
But we need to be very cautious about moving to direct a dividend in any direction.
And so we think of the long term, we think of the total return.
<unk> for our shareholders, we think of first.
Book value preservation.
And one thing I will say is that.
We're not your stock where if you are looking for someone to give you 15, 16% dividend yield.
We're not that person, we're offering a different product you're diagnosed capital. We're trying to give you a good long term total return experience and the dividend is just one input into that process.
And I really want to emphasize this macro view because this is an unbelievable moment in history.
It is really there is yes, there is risk with prepared for we started preparing for years ago.
When we first started talking about complex about six or eight years ago, we've leaned into it more and more and the dividend is just one input, but I will tell you. Let me just as a product manager now we're.
We're not.
We were looking to generate cash income from our shareholders and then we're looking to protect the value of our balance sheet, while we're generating that cash income, but we are not the product where we're looking to just say, let me just lay out.
15, 16, 17% dividend yield and.
And then give you a bad total return experience.
We're offering a different product.
Thanks, Peter I hope that gives you some extra color.
Thanks.
Your next question is from Jason Stewart of Jones trading. Please go ahead. Your line is open.
Alright, thanks for taking the question and congratulations on navigating a really difficult environment. Just following up on the dividend question. Steve is there any REIT requirement.
Get that we're still very early in the year.
Or any limitation as we think about REIT income and the payout.
Okay.
Hey, Jason Good morning at this point, we feel like at the current dividend level.
Okay.
Navigate any of the REIT requirements, but as you point out it's pretty early in the year still but as we see it right now where we should be okay. There.
Okay.
And then pulling way up what gets Barnett Smriti gets you guys constructive on on the credit side of the story is it more about spread level or is it more about your thoughts on it.
Perhaps positioning for a recession I mean, just where do those two toggle in your in your minds.
And again.
Jason I'm going to start like a disciplined man I'm going to start at the top it's a global macro view.
I call this a fat tail environment.
For those.
I'm asking if you want to think about a normal distribution.
An enormous amount of factors in the tails and the expected outcomes do not have.
Hi.
I expected probability attached to them that you would normally think with that type of backdrop. When you think about credit and credit assets. When you look at the sheet we haven't.
Our presentation, you'll realize that youre, taking on more and more liquidity risk. When you are playing in the most credit assets.
We're emphasizing liquidity and we have been for multiple years now we've been up in credit up in liquidity, but we've been in that position because of our macroeconomic view.
Nothing here on the landscape this change in our view at this point.
Always like to use or is this a fat tail environment and the reason I tried to say that my team is to remind them. How many factors are in the channels that could surprise us.
So far this decade, then one surprise after another surprise after another surprise, but we're prepared for it.
We feel very strong about our liquidity position so when we talk about credit.
You are starting to talk about taking more liquidity risk as you move down in credit we're not ready to do that at this point.
Yeah.
And what I would say also Jason there is.
We don't think it's a good risk reward.
As before Qt has begun.
I would want to see the price of risk assets adjust to a level of liquidity, where the fed isn't supporting large parts of the market.
As I've mentioned, all the way from crypto currency down to like high yield credit and so on so.
I think theres a price element to that.
And there is also a fundamental and okay, we're coming out of a pandemic we've got inflation.
There is an increase in in general levels of borrowings.
We don't know how the fundamentals are going to play out here.
So I think thats.
Wait and see approach is correct.
Would take you back to 2007.
In 2007 as spreads widened going into the financial crisis things look really attractive.
From a historical perspective, and if you had stepped into credit at that time, you would have made a colossal mistake. So we are very very cognizant of.
That type of situation here as the fed is starting to step away.
And not that we're saying that's going to be repeated but there is a lesson to be learned.
When there is.
Artificial levels of liquidity.
And cash propping up these assets to wait for a bit before you can really see the true colors. The fundamentals that that underlie some of the some of the instruments that are out there.
Okay. That's very helpful color. Thank you last question from me when we think about share repurchases can you just remind me I know the stock looks like today, it's probably getting close to book.
I think reflective of a great quarter, but as it trades down to 85% to 90% of book is that something that you would still entertain.
I think I think the way to think about it Jason is we're telling we're telling you and the market that we believe we're on the breakup of historic investment opportunity and in that environment.
Cutting the dividend or buying back shares is in sort of the number one thing on our list.
We want the capital we've preserved the capital we think the capital can be deployed we think we can make.
Good money much higher than the level of our cost of capital and so that capital needs to be here for us to be able to invest it.
So I would very strongly say.
That's our mindset here.
And I don't know Byron if you wanted to add anything with regards to the strategy or anything else.
No that is a great job.
Got it thank you.
Great.
Alright, Thanks for taking my question.
I'll, just say wider spreads.
More capital to be able to deploy it.
With that.
Okay.
Thanks, Jason.
We have completed the allotted time for questions I will now turn the call over to the presenters for closing remarks.
To our shareholders. Thank you very very much for giving us the opportunity to manage your money.
We appreciate you being here today and for those who are not here, who lets call at some other point.
And that concludes our call and we look forward to speaking with you again next quarter. Thank you again.
This concludes today's conference call. Thank you for your participation you may now disconnect.
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