Q2 2022 Annaly Capital Management Inc Earnings Call
Good morning, and welcome to the Q2 2022 annually capital Management earnings Conference call today, all participants will be in a listen only mode should you need assistance during todays call. Please signal for a conference specialist by pressing the star key followed by zero.
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At this time I would like to turn the conference over to Sean Kensal Investor Relations. Please go ahead Sir.
Good morning, and welcome to the second quarter of 2022 earnings call for <unk> capital management.
Any forward looking statements made during today's call are subject to certain risks and uncertainties, including with respect to COVID-19 effects, which are outlined in the risk factors section in our most recent annual and quarterly SEC filings.
Actual results may differ materially from these forward looking statements. We encourage you to read the disclaimer in our earnings release in addition to our quarterly and annual filings.
Additionally, the content of this conference call may contain time sensitive information that is.
When we have them today.
In Europe 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 are included in our earnings release.
As a reminder annually routinely post important information for investors on the company's website www dot dot com.
I am Jeff referenced in today's call can be found in our second quarter 2022, investor presentation, and second quarter of 2022 financial supplement.
Both found under the presentation 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 presentation and similar materials on a regular basis.
Please note this event is being recorded.
Participants on this morning's call include David Finkelstein, President and Chief Executive Officer, Serena Wolfe Chief Financial Officer.
Okay, Chief investment officer.
Mike <unk> head of residential credit.
And with that I'll turn the call over to David.
Thank you Sean good morning, everyone and thanks for joining us for our second quarter earnings call today, I'll review, the macro economic and housing market backdrop, our performance during the quarter and then provide an update on our broader strategic direction as we begin the second half of the year.
Ilkka will then discuss our portfolio activity in more detail followed by Serena who will go over financial results for the quarter.
Starting with the macro landscape as all are aware the first half of 2022 has been an exceptionally challenging investment environment.
Very high inflation geopolitical uncertainty and the fastest pace of monetary policy tightening in recent history led to broad based deterioration across asset classes.
Despite forecast for inflation to peak this spring headline CPI declined through the quarter reached nine 1% year over year in June means.
Meanwhile, tight labor markets supported healthy consumption, making it increasingly clear economic activity was too strong for inflation of slow meaningfully in response, the federal reserve height to 125 basis points in the second quarter and another 75 basis points just yesterday.
The hawkish fed markets pricing, an additional 100 basis points of rate hikes for 2022 in June relative to March led to the largest accordingly tightening of financial conditions since the onset of the financial crisis.
Economic activity now appears to be slowing which can best be seen by the decline in activity and interest rate sensitive sectors such as housing.
So given the importance of the housing market to our business I want to spend a moment on the outlook for single family housing.
Home prices have continued to rise sharply appreciating over 10%. The first five months of the year. According to the case Shiller index housing activity. However has slowed recently is the highest mortgage rates since 2008, and 40% cumulative home price appreciation since the start of the pandemic has weighed on both.
<unk> and builder sentiment.
Affordability for prospective homeowners has been significantly reduced with mortgage payments, 50% higher year over year on a national average. This is curbing consumers' ability to purchase homes and in turn is reducing demand for mortgages is.
Correction will be welcomed to the agency MBS market as it reduces elevated net supply which has been the main headwind for this sector in the recent past.
Our expectation is that housing will exhibit negative momentum in the second half of the year with the deceleration of home prices and declining month over month, each VA, becoming a realistic possibility, particularly on a regional level. However.
However, our systematic shortage of 1% for single family homes relative to future demand low leverage as measured by outstanding mortgage debt to equity lead builder inventories historically tight underwriting standards and the majority of mortgage borrowers locked into a low fixed rate mortgage suggest a.
Moderation in slight decline in home prices is more likely than a protracted decline.
Now shifting to the broader market outlook risk to the rates market are more balanced now as concerns over an economic downturn are on the rise.
The fed has demonstrated its commitment to curb inflation and markets are now anticipating elevated inflation that decline, particularly if we experience an economic slowdown.
As a consequence, we expect investors to allocate more capital to fixed income in this environment, which should result in a welcomed decline in volatility going forward.
The combination of lower volatility and reduced supply would provide a positive backdrop for agency MBS spreads remained historically high while our MSR residential credit businesses have benefited from rising HPA, we maintain a constructive outlook given the underlying composition of our portfolios.
And the support from the long term supply demand imbalance in the housing market.
Turning to our performance, we experienced a negative economic return of nine 6% in the second quarter in light of this difficult environment.
Economic leverage increased slightly to end the quarter at $6 six turns and despite our decline in book value. We generated strong earnings available for distribution of <unk> 30 cents for the quarter. However, as we have signaled in prior quarters, we expect earnings to moderate going forward as Serena will cover in more detail.
Now I'd like to provide an update on our strategic initiatives. We completed the previously announced sale of our middle market lending portfolio during the quarter as planned and to reiterate our rationale for the transaction the sale provided an opportunity to monetize the less liquid noncore business at an attractive valuation.
Redeploy capital into our core businesses as.
As I discussed on last quarter's call the sale of the MMO portfolio culminates our natural evolution to becoming a dedicated housing finance REIT with our sharpened focus we have the capacity and flexibility to expand our operational capabilities and leadership across the residential credit MSR landscape, we have made significant.
Difficult strides over the past year, which altered to know now.
Withstanding the broader market volatility and disruptions to the mortgage finance sector. This year, our residential credit and MSR platforms are built upon their strategic capabilities and gained market share all while maintaining an intentional focus our credit and risk management.
Within residential credit we remain a programmatic securitization issuer with Onslow Bay, representing the largest nonbank issuer prime jumbo and expanded credit MBS in the first half of 2022, we've securitized $4 8 billion across 12 transactions year to date generating 525 million of credit investments.
Yes.
Our issuance has benefited from increased originator partnerships and continued momentum in our residential whole loan correspondent channel or.
Our 2022 non QM lock commitments are approximately 50% above our 2021 total lock volume and an <unk> balance sheet commitment to the market permanent capital are differentiating factors that reinforce our position as an industry leader and a reliable source of capital to the originator community.
Our mortgage servicing rights portfolio has grown significantly with Onslow Bay, establishing itself as the fourth largest purchaser of MSR year to date and the top 20 owners GSE mortgage servicing rights, we prudently build the infrastructure necessary to scale as we continue to enhance our operations through the addition of key.
Hires and new partnerships, while the business has grown 15% of capital in the span of a year. We've been disciplined with respect we're purchasing activity in order to responsibly build our MSR asset vis vis our broader portfolio.
Also to note we closed our first MSR credit facility subsequent to quarter end, however, consistent with our prior guidance, we plan to employ only modest leverage on MSR. The facility serves primarily as a tool to manage.
Yeah.
Over the long term, we expect our allocation of residential credit and MSR to approach, 50% of our capital based on prevailing returns and where we are in the cycle accordingly agencies at the higher end, where we see its long run capital allocation, which we are very comfortable with given the current relative.
<unk>. This the agency sector, but ultimately we are confident that increasing our exposure to lower levered less liquid assets with a premium return will help improve the durability and quality of our economic returns. While this year has been difficult throughout financial markets. We are encouraged by the robust growth within these businesses.
In the long term potential as we fully scale, our housing finance capabilities.
Now finally before I turn it over to Ilker I want to highlight that we published our third corporate responsibility report last month, the <unk> 'twenty 'twenty. One report demonstrates our continued focus on setting in measuring progress on our ESG goals as well as our commitment to providing best in class disclosure and increased transparency.
And we continuously strive to advance these efforts each year in the latest report for example, we included incremental disclosures that outline climate related risks and opportunities across our business. We're proud of the progress we've made to further integrate ESG priorities throughout our company that is undoubtedly helped to create lasting.
Value for all of our stakeholders 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 will tilt in the fixed income market persisted throughout the second quarter with a continued selloff in rates and under performance in risk assets Agency MBS widened 20 to 30 basis points as supply to remain elevated while on the demand side the fed began reduced.
Its balance sheet and banks, who are sellers on the quarters, leaving money managers as the prime made a biotope MBS.
The largest buyers of MBS have shifted from being price agnostic and yield base, the fed and the banks respectively to investors who are more focused on nominal an option adjusted spreads mortgage underperformance has been closely tied to the ryzen anticipates volatility which outside the shortlist.
Spike in March 2020 is at the highest level since 2009.
We Didnt agency universe in a reversal of the trend in the first quarter lower coupons underperformed as they were weighed down by fears of potential sales from the fed and enlist this gravitated towards wider spreads and increased Kidded, all 14 high coupons Smith.
Specified pools outperformed TBA is attributable to improved convexity meet surface protection from the extreme level of stope realized interest rate volatility.
The worst singles the TBA deliverable due to higher average loan sizes.
N T b, a little softening over the course of the quarter is named production replenish the flawed in coupons.
During the quarter, we kept the size of our agency portfolio relatively stable, while we continued to rotate upping coupon reducing at holding so push through trees by nearly $16 billion in favor of three NFS fours and fives.
The technical the seasonal flu, taking up in coupon reduced our spread duration and improved earnings in the portfolio.
In lower coupons, we maintain a significant portion is specified pools, notably lower loan balance credit impaired in Festus services studies, which have historically prepaid more rapidly in discount them once.
So let me Todd hedged portfolio, we maintain a defensive posture given the volatile interest rate environment.
Replace the roll down in the front end swaps with <unk>.
Longer dated hedges equal swap centralizing, the futures, which extended thought hey, just the mistakes nationale Borg offsets as rates continue to rise.
Moving to our residential credit business splits widen materially close both non agency and structured finance markets north of the underperforming corporate credit in light of the risk off environment and market volatility to.
Does it play non QM splitsville coat five basis points wider on the quarters, well benchmark investment grade credit risk transfer 100 basis points wider.
Supply technicals and a deceleration housing momentum have weighed on sentiment within the non agency market, although called similar fundamentals have yet to show any deterioration.
Mortgage delinquencies are at the lowest point over the last 20 years and current delinquency roll rates remain stable.
We took advantage of the spread dislocation of negatively sentiment by increasing our relocation to short duration NPL of U S Securities and GSE credit risk transfer in addition to retaining our <unk> securitization is the tough financed out of whole loan portfolio.
The economic building off the residential credit portfolio ended the Q2 at $4 8 billion, a 430 million increase quarter over quarter.
And also to note is Sarah and I will elaborate on we choose protectively increase our leverage in the residential credit portfolio given the attractive financing terms with dedicated kept those declining from 19% in Q1, 2014% at the end of Q2.
And there's actually a whole loss, we settled the $1 1 billion of expanded credit hold loss in Q2, and we issued five securitizations generating 275 million market will develop will be X months.
Our loan portfolio is well positioned for the volatility in the securitization market is we ended the quarter with less than 800 million of honest securitize loans on balance sheet with significant bad I'll skip esoteric.
You know what MSR business.
Continued to take Edmunds drove record origination volumes and the need for nonbank originators to monetize them. It's us growing the portfolio by nearly $500 million in Q2 inclusive of all settled purchases.
After cortlandt, our MSR portfolio had sub 3% weighted average coupon and we continue to favor low note rate high credit quality collateral.
Vitol and Lasalle portfolio over 200 basis points out of the money. It is now fully expanded and has minimal duration how would the position provides strategic benefit to our overall portfolio.
It generates high single digit stable Unlevered returns with low correlation with the agency portfolio and provides a hedge to.
Lower coupons should the elevated discount speeds begin to subside.
Our portfolio is now over $1 7 billion in market value and it represents approximately 15% of the firms capital.
Now expanding on David's comments regarding out outlook. The lesser part of Q2 brought about the shift in the market negative from struggling to price the impact of inflation.
Preparing for a possible decision that environment.
Let bond deals to replace from the highs and regain some of the typical negative correlation with other risk assets.
This shift has important implications with specifically benefit agency MBS from the perspective that market pricing and fed cuts in early 2023, the potential for FID sales of the MBS is now less likely and a slowdown in housing activity will result in reduced MBS supply.
Furthermore.
Given the favorable liquidity and risk profile of the agency, we anticipate that fixed income you missed this with throughput mortgages over corporate credit in a recessionary environment.
Fundamentally we believe that the outlook for agency MBS looks very attractive, but the sector trading near historically widespread levels offset convicts. These at record lows as the cash flow certainty has improved given over 90% of borrowers select incentive to refinance their homes.
Overall investment opportunities across our three businesses are as compelling as we have seen in recent years and we believe that we are well positioned to benefit and what we expect to be a less volatile environment with <unk>.
Improved sentiment across the fixed income landscape.
I will hand, it over to sit enough to discuss the financials.
Thank you Bill Com today I'll provide brief financial highlights for the quarter ended June 32022.
Consistent with prior quarters, well earnings release, discloses GAAP and non-GAAP earnings metrics. My comments will focus on our non-GAAP , a D and related key performance metrics, which exclude P. I E.
Is that the state with some summary information our book value per share was $5.90 for Q2, and we generated earnings available for distribution per share of 30 cents ample coverage of that dividend.
Book value decreased by 87 cents per share for the quarter, primarily due to a continuation of themes referenced in Q1.
That is higher rates and spread widening and the related decline in valuations on our agency position.
Agency and TBA valuations were down $2.18 per share in the prior quarter.
GAAP net income of 55 cents per share and a multifaceted hedging strategy continue to support book value, providing a partial offset to the agency declines mentioned about with swap futures and MSR valuations contributing a dollar and 25 cents per share to the book value during the quarter.
MSR valuation has moderated in comparison to Q1.
Well valued six cents per share higher at quarter end than in the prior quarter.
After combining our book value performance in our first quarter dividend of <unk> 22 cents, a quarterly economic return was negative nine 6%.
As noted earlier the portfolio generated <unk> per share of 30 cents earnings continued to be strong, resulting from high dollar roll income increasing MSR net servicing income reduced amortization due to lowest EPS and a benefit from our swaps portfolio as it turned to a net receipt position during the quarter on higher short term rates.
However.
He was meaningfully aided this quarter by an increase in Specialness in dollar rolls, primarily driven by a scarcity of TBA type collateral and newer higher rate production coupons we.
We don't expect this temporary phenomenon to persist in subsequent quarters as production is catching up with TBA demand and rolls are trading close to carry the fight in Q3.
We believe that the anticipated reduction of specialists of dollar roll combined with the expected rise in the cost of funds due to rising rates should moderate future earnings.
However, we expect to out earn enough money to send dividends in the third quarter all things equal.
Average yield X P. A a lot higher than the prior quarter at 2.87% up 25 basis points compared to the preceding quarter due to lower C. P S and to a lesser extent from the overall composition of the portfolio shifting to higher yielding assets during the quarter.
Additionally, the portfolio generated 220 basis points of NIM ex PAA up 16 basis points from Q1.
Driven by the higher TBA dollar roll income that's the past higher economic interest expense, which included the beneficial net interest component of swaps.
Net interest spread does not have dollar roll income and the increase was more muted up three basis points at 1.76% compared to 331 22.
As lower amortization number did you swap interest modestly outpaced higher repo rates during the quarter.
Now turning to our financing.
Funding markets continue to function well with lender repo capacity for agency MBS remaining robust however, uncertainty about the pace of future rate hikes has led to a shift in liquidity within the repay market towards the front end of the 10-K, that's provided us a price longer dated repo contracts more conservatively in light of fed uncertainty.
Consequently, we have reduced our weighted average repo maturity to 47 days from 68 days in the prior quarter.
We expect to maintain a shorter dated book up in the near term, which we are comfortable with given ample reserves remaining in the system.
Further Tonight as Ilkka discussed early in the quarter, we increased the repo leverage on a ready credit assets, taking advantage of attractive prevailing had cut some financing levels given.
Given the volatility experienced through the first half of 2022. This strategy added to the company's liquidity, while taking advantage of beneficial economics and credit funding markets.
And warehouse financing after adding 500 million of credit facility capacity to our resi credit business.
Warehouse capacity for ready is now approximately $2 billion with significant unused capacity and we continue to explore other financing alternatives for the business.
Additionally, as David alluded to.
Further enhance defense overall liquidity profile, we added a 500 million facility for our MSR business after quarter end.
The upward trend in interest rates impacted our overall cost of funds for the quarter rising.
Rising by 22 basis points to 111 basis points in Q2, and our average repo rate for the quarter was 81 basis points compared to 20 basis points in the prior quarter.
Our activity in the securitization market also impacted funding costs, increasing the weighting of securitization on the composition of cost of funds along with higher effective rates up to seven 3% compared to 2.3%, resulting in an increase of 11 basis points to cost of funds.
Finally swaps positively impacted cost of funds during the quarter as previously mentioned by 41 basis points.
Moving now to operating expenses, our efficiency ratio has improved during the quarter from decreased compensation expenses in the second quarter related to the sale of our M. M L portfolio.
Offset by the impact of the degradation in equity on the computation of the ratio.
And in closing I only maintained an abundant liquidity profile with $6 3 billion of unencumbered assets down from the prior quarter at $7 2 billion, including cash and unencumbered agency MBS of approximately $4 5 billion Mark.
Much of the reduction in unencumbered assets is due to the sale of valley mill assets and increase leverage on credit which.
Which is partially offset by increased unencumbered M S out.
That concludes our prepared remarks, and operator, we can now open it up for Q&A.
We will now begin the question and answer session.
I 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. If you 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 Bose, George with K B W. Please proceed.
Hey, everyone. Good morning can.
Can I get your book value quarter to date I don't think you mentioned that in the prepared remarks sure Bose. Good morning book is up 4% as of yesterday and this morning post fed follow through as well as GDP. It seems as though there's very positive momentum.
Okay, great. Thanks, and then in your hedges you had treasury future position continues to increase relative to swaps can you just discuss the benefits of our futures versus swaps and then just from an accounting standpoint is there anything we should think about in terms of how they flowed through the P&L, yes. That's a good question Bose so with respect.
An outsized position.
Position in futures relative to historical it's about liquidity and better fit with the agency portfolio and to your point with respect to accounting considerations and Serena mentioned that our swap position turned to a net receive where we generated income in Q2, and we expect that to grow given higher short rates.
And as a consequence.
The the futures position does not flow through E. D. There is an economic benefit.
Much like there is with swaps, but but it doesn't flow through AAD and so as a consequence, he may temporarily underestimate the economic earnings of the.
Portfolio.
Okay, great and but I guess is there any way to sort of quantify that or just for.
Yeah, just because I guess, there's a period, where or I guess, maybe to rephrase that when we think about when you think about your total return and what drives the dividend.
You know I guess, there could be a period, where E. D is being depressed by the use of futures, but your economic returns still is is higher than that right. That's correct in the way we think about the dividend is based on the economic earnings of the portfolio.
Okay, great. Thanks.
You bet Bose.
The next question comes from Rick Shane with J P. Morgan. Please proceed.
Thanks, guys for taking my question and I apologize we've been bouncing around so if some of this was covered I apologize.
So when we look at book value and we look at the ROE.
Hurdle you need to sustain the dividend, which is about 15% right now.
Given the opportunities there in front of you do you think that the market is presenting you with a 15 plus percent ROE V opportunity that makes sense within your risk.
Parameters.
Sure sure.
Look I would say when we look at Levered returns on agency and residential credit we can get into the details within each of the sectors, but you can earn 15% in both sectors.
MSR is on an unlevered basis is lower than that but given the fit in the portfolio, where we're perfectly comfortable with that so to answer your question the dividend yield.
On book value at quarter end, 15%, it's actually a little bit lower than that given higher higher book value, but current levered returns are reasonably consistent with.
With the yield.
Got it and then.
I'm just curious when you think about bold when.
When you think about the trajectory of the forward curve, how does that impact you.
Sure.
Both tactics and strategy in terms of where you want to play in.
And the coupon stack.
Oh, Yeah forward for August as you know.
As everyone knows covers extremely.
Excellent and inverted some part of North Dakota in terms of the go forward set also inverted so that basically tells us that we can hedge down the stake look a lot better.
They look they used to so basically we are arranging debt in our hedges and then the other using coupon swaps to take advantage of that but it doesn't provide that law challenges if anything it makes hedging relatively easier.
Got it okay. Thank you very much thanks, Rick.
Yeah.
Our next question comes from Doug Harter with credit Suisse.
Thanks, you guys talked about you know.
The the return opportunities kind of across your.
Across your asset classes as is being incredibly attractive can you talk about your appetite to to continue to grow the portfolio, whether that's through increased library or or additional capital.
Sure well, let me talk about leverage first Doug So leverages a function of three factors first capital allocation, obviously higher allocation to agency, you're going to have more leverage and then second liquidity of the portfolio and asset valuation now if you look at our portfolio over the past six months for.
Well, we actually have increased leverage we feel good about it.
The way, we evaluate leverage is we have a baseline level of leverage and if we think that there will be capital appreciation associated with the asset then we will increase leverage and vice versa.
We are above our baseline level of leverage.
Expecting capital appreciate appreciation, which to start the quarter that that's materialized.
Now another important point to note as you know where we are versus historically our leverage currently is the highest it's been since March of 2020, and we feel good about it that being said, we have ample liquidity and we can increase even more.
One of the things, we're waiting on and you've heard a lot about this is just a decline in macro volatility we've taken steps in the direction of increasing leverage but should we see a more definitive decline. We can we can increase it now with respect to capital.
Capital raises.
Obviously, you did raise capital in the second quarter, a number of conditions have to be met it needs to be accretive to book value and assets have to be attractively priced such that there can be accretion to earnings and another factor is governance related issues and the three of those considerations all have to line up and they did in the second quarter.
As a consequence, we were able to raise capital.
Great I appreciate that thank you.
Thank you Doug.
The next question it comes from Trevor Cranston with JMP Securities.
Alright, thanks, good morning.
Can you talk a little bit about what you guys are seeing in the residential credit whole loan markets, particularly.
I guess on the non QM side, there were some companies that seem to have no difficulty managing through all the all the rate volatility started off this year.
So I was curious what you guys are seeing in terms of.
Origination volume in the non agency loan space and kind of where where do you think returns would be on.
Acquired loan securitization market stands today. Thanks.
Sure Trevor I'll start and then hand, it over to Mike and I actually alluded to the turbulence in the origination channel in my prepared comments and the fact of the matter is yes. There has been disruption amongst our firms and I think it was primarily related to capital markets given the volatility in the market and the way we look at it is we.
We are a partner to origination originators, where liquidity provider and <unk>.
As the market has evolved over the past six months.
The World has turned from a scarcity of assets to a scarcity of capital and that puts capital providers like us.
In a better position and we are absolutely taking advantage of it both responsibly and with that I'll hand, it over to Mike to go into more details.
Yeah, Thanks, Dave or Trevor, Yes, I think that when you look at the market you know some of the originators that have entered bankruptcy or.
Closed their doors, it's a it's a misallocation of capital markets distribution nothing to do with the actual loans being originated or the ability for the market to digest those loans. So we do think it's an isolated incident.
Regarding you know on sophistication around hedging both rates credit.
And the ability to distribute that risk in terms of the non QM market. We still believe that volumes are healthy I would say Q2 through our correspondent channel. We have $1 2 billion in locks virtually all non QM in the month of June it's been $440 million a block is the highest lock volume that we've seen to date.
And really what Youre seeing is large non bank originators are entering the space given declining margins.
Mining volumes and you're also seeing small thinly capitalized originators that were bulky and selling it by the bulk market to come to the correspondent market. So with that being said our volumes are at the healthiest levels that we've seen right now we see current coupon non QM quarter, one or $2 price you know seven and three quarters gross.
We think it's a you know a low to mid 7% Unlevered yield you know mid teens Levered ROE on warehouse and then through securitization without any recourse leverage we'll call. It the bottom 8%. We think is a low mid double digit return.
Got it okay. That's helpful.
Hum.
I think last quarter you.
You mentioned that there weren't any specific company acquisitions that you were looking out at the time.
The market volatility has continued throughout the second quarter could you maybe provide an update on on whether or not there are any companies out there that might make sense for annually.
Is that sort of add on to the businesses. So you guys are you growing it thanks sure.
Sure Trevor and look we're always looking at the market and evaluating opportunities in the M&A landscape, but the fact of the matter is if you look at the evolution of the company over the past couple of years, our organic build strategy has been very effective in both residential credit through the correspondent channel as well as the MSR build so we feel very.
Good about our ability to acquire assets and really.
In a transaction in the mortgage origination space would be based on.
The ability to see her secure flow and as I mentioned the world has shifted from asset scarcity to capital scarcity and we're not in a position to where we can acquire the assets. We want so the organic build has been very effective it's got a lot of momentum associated with it but we're always looking.
At opportunities in the M&A landscape, whether it's a peripheral product or something that could enhance our own.
Our own platform, but theres nothing to report right now.
Thank you.
You bet good talking to each other.
Yeah.
Yeah.
Our next question comes from Kenneth Lee with RBC capital markets.
Hi, Good morning, Thanks for taking my question just one on the credit portfolio.
Specifically what characteristics are driving you to increase the allocation versus agencies and you talked about increasing the durability of earnings but just wanted to see if you could just further expand upon that point and perhaps any other key points. There. Thanks sure sure Ken and good morning look expanding residential credit and MSR that matters a lot.
<unk> term objective.
From a capital allocation standpoint agency is always going to be the anchor of the company the liquidity benefits or are just show demonstrable.
That's going to be the <unk>.
Another ship for.
The company that being said, we do know that that adding incremental credit.
Will be beneficial to the risk adjusted returns of the portfolio over the long term now when we look at where we're at now with respect to the cycle as I talked about in my prepared comments, we do expect housing to soften certainly so we're we're certainly a little bit more cautious but to the extent that Mike.
Has opportunities that are very healthy from a credit standpoint, we're going to add but we feel good about the allocation now it's just that over the longer term, we expect it to be higher.
Got you very helpful and just one one fall off but if I may.
Wanted to get your thoughts around any of the key potential risks for any further negative impact to book value. When you look over the near term there. Thanks sure its volatility.
That's plagued our I think the market over the last number of months and Thats certainly.
Something that we think about continuously that being said it appears to have declined.
When you look at implied volatility in the market.
So we feel good about the direction we're going.
But we have a lot of data coming up and we're always going to be cautious about an increase in volatility, but thats. The main risks.
Gotcha very helpful. There. Thanks again, good talking to you Ken.
As a reminder, if you do have a question. Please press Star then one.
Our next question comes from Eric Hagen with B P. I G. Please proceed.
Hey, Thanks, good morning, I'm going back to the liquidity for just a second.
Now you have $4 $5 billion of excess agency liquidity, how much liquidity do you think you'd use and levering up another turn and in your answer if you could talk about any differences in margin between pools and TBA as well, maybe revisiting the hedge the hedging too.
And maybe just one follow up to that is there a threshold for excess margin would you aim to run the portfolio, regardless of how much debt to equity or using.
Yeah. So first of all let me answer your second question first in terms of margin.
Our business is liquidity management, and we're incredibly conservative with respect to liquidity and.
For the past 25 years, we've always led with making sure that we maintain ample liquidity and $4 5 billion is probably excess liquidity.
Nonetheless volatility is elevated and so and so we're going to run in a conservative fashion, but there is capacity to utilize that liquidity into your question about.
Turn of leverage and what that would do to liquidity. If you think about if you buy 10 billion mortgages with a 5% haircut you were talking about half a billion in liquidity. So it would be a 10% a little over 10% reduction in liquidity.
Okay, I figured there might be some margin associated with hedges also included in there yeah, yeah, there will be but nevertheless.
That's a rough estimate and another point to note is that when you increase your overall portfolio your value at risk increases and that informs our model and our minimum liquidity that we that we carry as well so it's an iterative process.
Right that's.
That's helpful.
On the MSR.
Oftentimes what MSR is good solid as you guys know, there's recapture provisions or non solicitation agreements for the seller or the sub servicer to abide by.
Can you talk about how you structure those provisions into the MSR that you're buying.
How it drives.
You know, who you buy from and where your sub service.
Sure.
Uh huh.
All sorts of provisions in the old days used to be a luck.
<unk> forgive into buyers, so basically sell them used to tell via dental, but I'm not going to solicit your borrowers so you're buying in all your I'm not going to sell you do all your knuckles so to those guys.
The last four or five years due to the.
The wholesale channel Alto nonbank originators, making broken promises the brokers that they will not solicit their borrowers and that's why in this case, sometimes buyers end up giving sellers mussels it.
Provisions. Obviously this is that reduces the value of the MSR that your volume, especially on the board for the operating entities.
But the vast that's gotta button as you know, but theyre like a deep discount one sub 3% close rate existing portfolio.
And Paul that the recapture of value to capture is much less so that's why I left tend to from time to time.
And for those.
Reverse Polish divorced muscles at deals because like the newly opened and captures a lot less and then the other thing about that one is a lot of like bank buyers or.
Oh not involved in that universe. So it's M. S us and that makes like body interface, a lot lower and that enables us to expedite class external building from them.
But that was a very good question.
Yeah. That's helpful. That's really interesting do you mind, if I sneak in one more here you know you mentioned some of the different types of buyers that could step in to buy MBS as the fed rolls off its balance sheet. What do you think are some of the things that would drive more levered buyers to step in like what do you guys think is holding back that demand right now with spreads that one.
31 40.
And obviously the Levered buyers.
The most important thing for the Levered buyer. So I'm, assuming you mean hedge funds in this case and obviously the rates, but most of the hedge funds.
For them, so building interest and they will be looking at the volatility implied volatility as David said, it's been eluding is implied volatility has been subsiding and then you are seeing like less.
A couple of days, even before the fed funding blood voltage bus decline, you'll see like live with money coming yet but.
Most of the time door.
Supply demand imbalance cannot be met we can deliver.
With money buying you need money managers, and we ought to be able to expect more money manager buying this thing is does it because I guess fixed income as we said in our prepared remarks is a negative correlation between rates under discussed that's fine. This stuff, they're dealing fixed income money managers will be getting subscription and that will be the module.
On the Mds until banks clear there are other issues.
Gotcha. Thanks for the perspective. This morning, you bet. Thanks, Eric.
At this time there are no further questioners in the queue and I would like to turn the conference back over to David Finkelstein for any closing remarks.
Thank you Krish everybody have a good rest of summer and we'll talk to you in the fall.
The conference has now concluded. Thank you for attending today's presentation and you may now disconnect.
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