Q2 2022 Dynex Capital Inc Earnings Call
Yes.
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 di next capital second quarter 2022 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 <unk>.
Sure 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. Thank you Alison Griffin Vice President of Investor Relations you May begin your conference.
Good morning, and thank you for joining us today for the <unk> capital second quarter 2022 earnings Conference call. The press release associated with todays call was issued and filed with the SEC. This morning July 26, 2022, you May view the press release on the homepage of the dynamic web site at <unk> capital Dock.
Com as well as on the SEC's website at SEC Gov.
Before we begin 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.
Forward looking statements reflect our current beliefs assumptions and expectations based on information currently available to us and are applicable only as of the date of this presentation. These 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 ICC, which may be found on <unk> website under Investor Center.
Her 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 dynamics website. The slide presentation may also be referenced under quarterly reports on the Investor Center page.
Joining me on the call I have Byron, Boston, Chief Executive Officer, and co Chief Investment Officer.
Murphy popping out President and co Chief Investment Officer, Steve Benedetti, outgoing Executive Vice President Chief Financial Officer, and Chief operating Officer, and Rob collagen incoming executive Vice President Chief Financial Officer.
And with that it is my pleasure now to turn the call over to Byron Boston CEO .
Thank you Allison and thank you everyone for joining our second quarter earnings call.
Before I move into broader market discussion I want to address a recent news that we'd been a day will be stepping down as CFO . After 28 years with IDEXX and Rob Colligan has joined the firm concerns Vichy entered the CFO position alright. Thank you.
End of next week.
Steve has been a key business partner for me and instrumental in building a world Class Finance Department at di and his generosity humor and leadership have contributed.
Through our unique team oriented culture.
He will be greatly missed by all of us and we wish him the best.
The dynamics you often hear me discuss our long term strategy there Walt succession planning is not something that we just got publicly often.
Some will be a key component of our strategy as it should be for any strong and successful companies.
That in mind I have known Rob for many years and believes he would be an excellent fit for Nymex.
No we value experience and dynamics of Rob's background, and bear Stearns Star would mirror will provide valuable insights to our team as we continue to navigate this current challenging environment and position the company for long term growth and success.
We are excited that he has joined our team and we look forward to you getting to know him.
Now moving onto the second quarter.
The first half of 2022 I witness some of the most volatile moments in the fixed income markets in my career, especially during the month of June .
Over the last two years with Dianetics team has protected book value is 10 year Treasury yields moved from 60 basis points to over 3%.
Our second quarter performance look like spread widening in June and we've used this as an opportunity to grow our balance sheet.
Our year to date basis, we reported a negative total economic return of two 3% and we continue to outperform the broad fixed income sector as shown on slide five of our investor presentation. We.
We achieved this while maintaining a priority on preservation of capital and our book value while down this quarter as we remain within this decades range as shown on slide six.
Our performance in capital Preservation focus is put di makes it an extremely strong position entering the second half of the year.
We believe will enable us to take advantage of the attractive opportunities. We are currently seen in the mortgage market.
We have begun to allocate incremental capital to these opportunities.
We will discuss in more detail, but we remain thoughtful and judicious.
The pace and size of our investing.
The second quarter with a strong reminder of the importance of not only having a strategy built on top down macroeconomic analysis, but having the experience and discipline to stick with that strategy in a turbulent market environment.
When there were plenty of opportunities to waiver to make mistakes.
So that strategy is developed by a management team with decades of experience and is built with the flexibility is a core principle continues to guide us through these volatile times and we believe into a period of tremendous opportunity.
Throughout this year, we have approached the markets with our hallmark patience and discipline.
You hear US say these words, often patients disciplined flexibility, but I want to emphasize that these aren't just words to us. These are actions and key components of our long term strategy.
Active patient and disciplined when it first half of 2022 resulted in meaningful capital preservation for our shareholders and our decision to maintain a high level of liquidity means that our upside potential going into the next stage of the market cycle is significant as we are poised to benefit from a wider mortgage spreads as we deploy it.
Capital.
Believing that we were in a prolonged period of greater return opportunities, we raised equity capital throughout the quarter.
During the quarter and as of July we've been putting that capital to work and the incremental risk adjusted returns improve.
However, we have maintained significant dry powder as the market evolves and accretive opportunities arise.
Cannot emphasize enough that we are at the crossroads of some significant historical events as the market grapples with issues such as Q T increasing global conflict the lingering impact of the pandemic and a potential energy crisis just to name a few.
While many of these issues are new this root provides a roadmap to help us successfully navigate times like these is.
As an example mortgage spreads have essentially widened back to where they were in March 2020.
We're seeing many of the same potential investment opportunity now that we did that.
Our business model and strategy are designed to drive and find opportunities in any economic environment, not just heres a quantitative easing.
We believe that this sets us apart from other opportunities in the mortgage space.
We're seeing evidence of that differentiation in our results.
During these challenging environment, there will be risks there will be opportunities.
First half of this year as we have throughout multiple market cycles, we effectively and skillfully navigated. The risks we are prepared to capitalize on the opportunities.
We have a great liquidity position.
Our book value has been well protected and long term return opportunities are compelling.
Proud of the results our team has produced our commitment to providing attractive long term returns for our shareholders is unwavering and I'm excited about the opportunities ahead of us with that.
I'll turn the call over to Steve Benedetti more specifics regarding our second quarter performance.
Thank you Byron and good morning all.
For the quarter the company reported a comprehensive loss of 85 cents per common share.
And then negative total economic return of $1 six per common share or five 8% of beginning book value.
Negative total economic return of $1 six consisted of dividends declared of <unk> 39 per share and a decrease in book value of $1 45.
Comprehensive loss for the quarter consisted of 40 cents in earnings available for distribution or <unk>.
And a $1 25, and negative fair value adjustments and realized losses on our investment portfolio position net of hedges.
AAD per common share declined <unk> <unk> this quarter versus last.
On balance the higher cost of repo funding outweighed benefits from an increase in both average interest earning assets and asset yields.
Furthermore, while leverage ticked up from quarter to quarter. It was virtually unchanged throughout the quarter as we were methodical investing that capital that we raise into spread widening toward the end of the quarter.
Net interest income was down $1 6 million sequentially, while adjusted net interest income a non-GAAP measure, which includes TBA drop income was down approximately $300000.
Adjusted net interest spread likewise declined to 184% in the second quarter from 2.6% last quarter.
As previously noted higher repo funding costs as the fed continues to raise short term rates were the main driver of the decline in all three measures.
Repo cost averaged 68 basis points this quarter versus 25 basis points last quarter.
And TBA implied financing rates were only slightly better than repo rates during the quarter.
As it relates to book value the driver of the dollar 45 per common share decrease was principally spread widening on agency MBS.
Interest rates were up substantially during the quarter, but the companys hedge position mitigated declines in fair value of the investment portfolio.
Book value was also impacted approximately 21 cents per common share or one 1% from the company's capital raising activities during the quarter.
From a portfolio perspective, we added higher coupon agency MBS exposure, principally through TBA and adjusted our hedge position accordingly for the shift in portfolio construction and consistent with our macroeconomic view.
Almost all additional active investment activity has been in agency MBS and TBS.
It is important to note that our on balance sheet asset prices hedges and book value as of June 30th reflect the rate and spread volatility as well as a substantial re pricing of mortgages that occurred during the quarter.
As a result, they reflect market yields for our investments based on spot and forward rates on June 30th.
For example, the amortized cost basis or book price that we own our agency MBS excluding ppas.
102, and three quarters, while the fair value price is 89 and a half.
Estimated market yield on the investment portfolio based on fair value is 4%.
Versus a yield of two 4% based on book price and.
In general amortized cost basis yields drive AAD.
The excess of market yields over amortized cost basis.
We'll benefit book value and total economic return performance.
Therefore from a total economic return outlook perspective, all else equal in future periods. The company won't show a total economic return as if it had sold its portfolio assets and bought them back at market yields on June 30.
And finally this will be my last quarterly call as CFO of <unk>.
Immensely enjoyed my time here interacting with our investors analyst and business partners.
Of course working side by side with my many talented colleagues at <unk>.
I have the utmost confidence in Rob who has significant experience that will serve <unk> well in the future and who I believe is the right choice at this point in the history of the company.
I also want to express my sincere, thanks to Byron and smoothie it.
It's been a privilege to work with them and I look forward to watching <unk> continue to grow and succeed under their leadership.
I'll now turn the call over to Smriti for comments on the quarter.
Thank you, Steve and good morning, everyone.
I'd like to start by recognizing Steve for his 28 years of service at <unk> capital and to thank him for facilitating a smooth transition at the executive leadership level.
Steve has been instrumental in maintaining <unk> sterling reputation with our lenders and Counterparties and providing us a solid foundation with his leadership of the finance and accounting team.
We will Miss his daily banter and his unique sense of humor.
Steve and best wishes to you and your future endeavors.
I am very excited to have Rob collagen join us on the executive team welcome Rob Robert experience skill set and mindset are an excellent fit for the performance and stewardship culture of our company and I look forward to building the future dialogues with him as my team mate.
Turning now to the market this quarter, if interest rates were much more volatile than the beginning and closing numbers would suggest.
10 year yields rose 113 basis points from $2 34 to $3 47 in mid June before falling 47 basis points to close the quarter at about 3% on June 30. The same was true for two three and five year part of the treasury yield curve, each rising about 110 basis points.
For falling 50 basis points to close the quarter.
30 year mortgage rates rose 93 basis points on the quarter to 583%.
Market gyrations across the curve have continued into the third quarter.
Realized volatility that is how much prices actually move in a given day is the highest it has been since the early 19 eighties and this is true across prices for many asset classes, including mortgages treasuries equities credit sensitive assets currencies in crypto currencies.
During the quarter, we also saw spread widening across many fixed income sectors, including investment grade and high yield corporate bonds, CLO see MBS and agency MBS.
Agency MBS had been leading the way on widening because they are linked directly to the reduction of defense balance sheet, but this quarter. Many other sectors Carter as you can see on page 21 of the Investor presentation 30 year agency MBS moved wider overall, but more so in the lower coupons and this was primarily due.
Driven by fear that the fed would sell lower coupons to combat inflation.
<unk> that the market has since discounted.
Against this backdrop the <unk> team delivered a total economic return for the quarter of negative five 6%, bringing our six month total economically turned to negative two 3% book value ended the quarter at $16 79 per share and includes approximately 21 incentive dilution associated with capital raising activities.
During the quarter.
Book value as of July 20th is estimated to be between $17 30.
$17 40 per share up about 3% from quarter end. This reflects the spread tightening on lower coupons post quarter end and the modestly tighter spreads on incremental additions to the portfolio and higher coupons.
We were active in raising capital, adding $105 million in equity capital at a margin on that cost of capital of nine 7%.
We are raising capital in an environment, where we have significant investment opportunity with a short earn back period for any book value dilution, which is offset by higher high marginal returns on capital.
We believe that we are in the middle of a persistent and historic investment opportunity for the following reasons.
We are still in the early months of quantitative tightening and in our view the markets are yet to price the full impact of the actual liquidity drain from.
From the Feds exit of the mortgage and treasury market for the first time since the 19 seventies, there will be no secondary market presence from the gse's or the fed starting in September we expect to be at zero net purchases from the fed. This is a major technical factor in our focus.
The demand that was previously provided by the fed must be replaced by private capital and current conditions do not favor bank or money manager flows to absorb this net supply beginning in September .
As of last week, MBS spreads greater than two standard deviations wide when looking back all the way to the 19 nineties. We are now at peak spreads versus March of 2020 and versus our funding rates as high as 375% Agency RMB.
Offer attractive returns in the mid teens Roe.
We see no clear impetus for a significant drive tighter and spread.
We do see several factors in play that can keep spreads here or wider particularly in lower rate scenarios and this is why we see this as a persistent opportunity.
Let me review the specific actions. We took in addition to capital raising last quarter. Please turn to page 10.
You can see the progression on this page during and after the quarter at the end of the first quarter, our leverage to total capital was six one times over 60% of our agency portfolio was in the two and a half coupons and we initiated new positions in threes and three and a half throughout.
Throughout the second quarter, we rebalanced the asset portfolio to diversify the coupon exposure, adding fours and four and a half and TBA form to the mix and increasing leverage to six six times all in the last two weeks of June .
We also adjusted our hedge ratios at this time to have a longer duration profile to benefit the portfolio in lower rate scenarios.
Post quarter end as mortgage spreads have widened further we increased our asset balance and replaced our entire 3% position.
With an allocation to <unk>, four and a half leverage to total capital as of July 20th reflects this increase in earning assets, which was offset by approximately 3% higher book value quarter to date.
Turning now to our macroeconomic view going forward.
As Byron mentioned, the global economies and evolving post pandemic situation with increasing complexity across many factors, including energy human conflict geopolitics inflation climate change and the global supply chain.
Central banks are facing conflicting mandates between supporting employment and generating growth versus combating the worst global inflation since $19 70.
As a result markets have been somewhat range bound in a level seeking mode as we get data and.
And we appear to be in a tug of war between inflation and growth with intermittent shocks from a variety of exogamous factors.
The U S treasury yield curve is moving to invert between the two year the tenure and the 30 points of the yield curve, reflecting market pricing of the possibility of a recession and then eventual fed easing cycle.
This means based on what the forward curve is pricing today that our short term financing costs will likely face a temporary increase through year end of 2022 and decline thereafter in 2023.
To put the moves in the yield curve in context, historically flattening or inverted yield curves are often associated with faster prepayment speeds and wider mortgage spreads in the agency MBS market.
We believe that in this environment.
Continued inversion that result in lower 10 year yields and lower mortgage rates, especially mortgage rates below 5% in combination with the expected quantitative tightening from the fed in September could set the stage for wider MBS spreads and very solid returns in the second half of 2022 and beyond this is.
A scenario that we have moved to prepare for in the positioning of the portfolio.
We also remain prepared for the possibility of continuing inflation pressures and coordinated hawkish behavior across global Central banks, we expect that these factors will define the range and interest rates and keep market volatility elevated.
What does all this mean for <unk> shareholders.
Protecting capital and generating total economic return to meet or exceed our dividend through this transitional period remains our core focus.
A component of total economic return is earnings available for distribution as Steve has previously mentioned our hedge strategy of using futures contracts instead of interest rate swaps means that our hedge costs and benefits are reflected in book value not earnings available for distribution, so as financing costs rise adjusted net.
Net interest spread will appeal to decline because the offsetting benefit is recognized in book value, which will reflect the benefit of our hedges we.
We believe we can continue to generate solid E. D. Over this quarter next quarter's levels will be a function of portfolio size coupon selection in the fed's actions post the July meeting.
We are in an attractive total economic return environment, and we encourage investors and analysts to focus on total economic return, which we believe is the appropriate long term metrics that drive shareholder value and shareholder returns.
On book value, we are in an environment, where book value may be volatile and barring extraordinary circumstances, we expect to take it as an opportunity to make long term accretive investments for our shareholders.
Having minimized large downside hits to book value to date and holding significant liquidity. We can now play offense to deploy capital and benefit from potential spread tightening in the future.
This has been the foundation of our investment strategy and this is exactly what we executed in the first quarter and repeated in the second quarter.
The timing of our investment activity, we were very patient and disciplined in changing the composition and size of the balance sheet on although we had previously viewed returns are attractive we waited to add assets until this last round of widening in late June and July .
We have been accurate, thus far and focusing on the quantitative tightening calendar and we believe that that will continue to offer chances to deploy capital at excellent returns.
I'd like to leave you with the following thoughts.
The <unk> team is prepared and ready to execute on our investment strategy and we are putting capital to work at highly accretive returns.
We will continue to be disciplined in our management of capital on both sides of the balance sheet.
We expect this historic opportunity to persist for some time in the midst of a highly volatile market and a rapidly changing environment and we are adjusting our investment actions and mindset accordingly.
I'll now turn it over to Byron.
Thank you Sue Murphy.
Let me close by reiterating that <unk> capital, we are guided by our core values and our long term vision for the company.
All aspects of our decision making has developed from this perspective.
For example, our dividend policy is not based on short term quarterly EAC.
We set our dividend based on our assessment of long term return.
<unk> may fluctuate from quarter to quarter.
But our goal is to give our shareholders a solid stream of cash flow, while creating an attractive total return experience over the long term.
Please know all my favorite chart on slide 15.
Abstention portion of our returns over the past 15 years have come in the form of cash dividends.
Furthermore, we are making meaningful changes in dynamics and multiple operational areas better positioned for this complex global environment that is evolving as we speak.
We're excited about the future because returns are attractive.
We have a plan we have a solid base of core values to guide our decision making.
The management team and the board continue to remain personally invested in dynamics as there is no better place to invest and with ourselves.
Please join US on this journey as we look to the future.
With that operator, we will open the call for questions.
Thank you to ask a question. Please press star one on your telephone keypad.
First question is from Bose George of <unk>. Please go ahead. Your line is open.
Hey, everyone. Good morning.
Actually first can you just discuss your thoughts on just the outlook for leverage and just given some of these commentary that spreads could widen further in September .
What does that suggest for the outlook for leverage.
Hi Bose.
So I think it's really consistent with the with the comments made during the call which is.
A disciplined stepping forward.
We think that the real spreads are wide here and theyre going to move in a range.
Not too much tighter from here and could get back to the wide or even wider.
I think that sort of happened in sync with them.
The further reduction in the fed's balance sheet in September .
And we see that as a as a real window.
We would meaningfully take.
Leverage up at that time.
So you know in the second half of this year is where we expect to see more opportunities like that to happen.
And once again I think you know we.
I've said many times on this call that.
Every time, we invest it's a function of the risk environment and if the risk environment warranted and we feel really good about the long term returns will be putting that capital to work.
Okay, Great makes sense. Thanks, and then just switching to the earnings available for distribution.
You guys don't want it but I'd like multiple metrics, but I mean is there any way to sort of think about how the treasury futures gains kind of translates into a spread benefit.
Just because the market obviously focuses on that number and that number's going down it doesn't reflect the returns youre generating right. Yeah, I would say, there's actually two ways to kind of think about that.
One way is to simply Mark the.
The Treasury futures using.
Warner and market yield.
Or even an instantaneous market yield.
And see what that differences quarter to quarter, and an easier way might be simply to do what Steve mentioned during his comments, which is.
Take a look at the market yield of our assets versus the market yield on the financing and that should give you an idea of the economic return.
That's just embedded in the portfolio.
That's.
There's two ways to do it and the funny thing about <unk> is that it has a non mark to market yield on the assets.
Compared to a mark to market yield on the financing so you've just got to.
Just one or the other.
Yes.
Makes sense great. Thanks sure.
Sure.
Your next question is from Trevor Cranston of JMP Securities. Please go ahead. Your line is open.
Alright. Thanks.
And congratulations Steve on the retirement.
Thanks, Dara couple questions a.
Couple of questions about.
Your comments around MBS spreads and the technical backdrop.
I guess as you guys look at the market and what the fed is communicated.
How much risk do you see at this point that there could potentially be.
And from what Theyre currently stated of the copper quantitative tightening.
Do you see any possibility that they could potentially and you to accelerate at some point.
Hey.
Jim I'm going to start this and then turn it over this mercury morbid thoughts, but I.
I think we are in a global macro environment.
Absolutely.
This profitability.
All the central banks could deviate at some point in time.
We call it a fat tail environment here Theres. So many global factors that could surprise the market the world.
Human on the planet every asset manager Alright, absolutely brewery.
This is.
As viable to shift their policy at some point in time, so thats, just a bigger higher level macro view that is what we believe the dynamics, we've talked a gazillion times with you guys about being a big moment in history and surprises are highly probable and that's the way we think about.
The larger picture.
End of the day central bankers are human beings and they will respond like human beings and with large events in history. That's taken place human beings have to respond. So that's just a.
A higher level view I'll, let mark chime in with anything more specific.
I mean, one thing that's really interesting right now is that the fed seems to be using interest rate hikes as the main tool with which to address inflation.
Think it's psychologically impacts the market in a way that they want they want it to.
And they've really indicated that the balance sheet is a tool that's going to sit in the background and Jana.
Janet Yellen used to say watching paint dry.
And I believe that that's what they're trying to achieve with that.
At <unk>, our scenario planning when we go through that we basically feel like the.
The way that the fed accelerates any kind of sales from their balance sheet is going to be an environment. When there is really out of control inflation much more so than what we have today.
One of the most interesting things that the fed focuses on obviously is inflation expectations and those expectations of inflation have all come down over the past six weeks. So the likelihood that they're going to need to use that big stick of the balance sheet has actually declined.
So not could they deviate from that path yes.
The way that that happens is as an example, the surprise where they're forced to either stop running off the balance sheet or they're forced to accelerate what's already in place.
Got it okay that makes sense.
And then the second question was.
When you guys were talking about spreads today.
Historical context versus where they've been over the last 20 or 30 years.
Do you guys look more.
Oh, yes, or nominal spreads when you make historical comparisons and I was curious what your goods.
Meaningful metric to look at given the level of volatility in the market.
Right, yes, so it's a very good question and you know we have we track probably you know all all in maybe 10 or 15 different things.
That help US go back in time, and see you know normalized for coupons in production and things one of the neatest.
Metrics that someone can use is to take the price of whatever the $102 price coupon was.
Impute OAS as or nominal spreads based on that and that's actually in my experience has been one of the best ways to do comparisons across time, when the coupon stacks changing so much.
So that's really the metric that we're using to go back and say look if you just look at the par plus two points of dollar price coupons over time.
You can see that we're really sitting at at the wide since the nineties.
That's why we're saying this is a historic opportunity in a great environment for us in which to raise capital and deploy that capital.
Okay.
And then the last question I mean again, given how high volatility is today.
Does that impact kind of how you guys are thinking about the use of options within the hedging strategy.
Does it potentially makes sense too.
Yes.
What options in there David.
The potential for volatility and maybe come down over the next few months.
Another great question, Trevor I think I think one of the most interesting things about this market environment is the.
The inability of a as an investor to go back in time and look at the period between 2008, and 2022 and believe that that you can normalize for the impact of the fed. So the fed clearly has had a huge impact on market volatility dampening that volatility as long as they've been doing QE.
No.
Are being challenged right now to look at.
B.
The markets and say look this in a historic context going forward right Youre volatility environment is going to be very different than what it was with the fed actively involved in the market. So you have to take the pricing of options peanuts.
And in that context, so having said that options are expensive and we're actually finding that the cheaper place to buy optionality in in the market right now is actually in the MBS market relative to say just a straight up two options our treasury options until but we're looking at the triangulation between those through.
Three things all the time.
And what I would say to our investors as you know, it's the forward volatility that matters and if you're expecting forward volatility can be high you have to make your options purchases in the context of of that mindset.
Sure. Okay. That's interesting I appreciate the color. Thank you guys sure. Thanks.
Thanks Trevor.
Your next question is from Eric Hagen of <unk>. Please go ahead. Your line is open.
Hey, Thanks, Good morning, Dennis Kim and thank you to Steve for all the Great work and leadership welcome back Rob just one on the hedging.
What was what would you say the range was but I wish you adjusted the hedge position in the quarter like it started at around four 9 billion. It ended a little closer to $5 billion you.
You guys raised some capital in there too, but intra quarter, what would you say the range was the kinds of variables, what's driving you to maybe fine tune that hedge piece a little bit more.
Right I think so we adjusted we adjusted our 10 year futures position down over the quarter.
We added to our five year futures position, but Eric if you go to page 11 on.
On the deck.
What we show kind of our our portfolio equity sensitivity to rates and spreads.
And we actually decided to include.
The portfolio sensitivity as of June July 20th, which is a post quarter and update on that.
So really between the end of June and early July or even the third week of July we we've got longer duration, you can see that our sensitivity to down rates increased in a positive way our sensitivity to upgrades increased in a negative way so we have gotten longer.
Duration of the portfolio more.
Beneficial from rates flattening rates curve inverted.
Rates down type of situations, so our hedges.
Migrated.
From the back end of the yield curve to the front end of the yield curve and over all our duration position is a little bit longer than where we were and we really kind of executed a lot of visits as yields order.
Have just gone through their most recent peak.
Right Yeah, that's really helpful. Thanks for pointing that out on slide 11.
I'm also glad that you mentioned the difference between your cost basis in the market value of Securities I guess the question is.
How do you think about managing that unrealized loss position. If we stay in this elevated rate environment and more specifically how much of a driver.
Long duration position is slow speeds and such.
It is for the amount of leverage you're willing to tolerate more holistically if you will.
Yeah. The one thing about those positions you also want to remember is there their way out of the money with zero convexity. So the hedging costs on those are really basically zero related to convexity right.
All of the risk in those positions are sitting on the prepayment side.
<unk> portfolio in particular is over.
Somewhere between 15 and 20 months seasoned.
Even in an elevated rate environment youre going to see some level of turnover from.
From just people moving houses and things like that.
So that's gonna be a key factor in in our in our thought process with respect to the relative value on that position.
And we're always.
Someone asked the question earlier about the price of options.
And those those coupons at this point are very cheap call options that we can own it in the portfolio. So.
The uses of capital for investment purposes, there's uses of capital for risk management purposes, and we're always thinking through where and how best to allocate that.
So for now from a risk reward perspective, those coupons looked like a great.
Alternative to buying call options in the market. There there is still a positive yield relative to financing.
When we talk about market yields and then the interesting thing is each month, we've seen these prepayments come in and you know in the book value is where youll see the pop from the prepayments.
The market value of these securities is in the mid to high $80 price, you're getting prepayments back at par that accrete directly to book value.
And so that has actually been a tailwind as well for us.
Yeah. That's really helpful. Can you remind us if you have a loss carryforward that you are still utilizing and where you guys sit from a taxable earnings standpoint.
Sure Eric.
By the way. Thank you for the nice very nice comments.
Sure.
Estimated tax characterization right now about 80% ordinary income 20% return on capital, we really do not have a meaningful operating loss carryforward at this point.
We do have and we will have disclosure in the Q on this we do have capital loss carryforwards, and we do have deferred hedging gains.
As well.
Got you that's very helpful. Thank you and thanks again, Steve.
Thanks, Eric.
Your next question is from Christopher Nolan of Vandenberg Thalmann. Please go ahead. Your line is open.
Hi, everyone congratulations to both Steve and Rob.
Could you give us a little guidance in terms of where your average repo.
Funding costs are quarter to date.
Yes.
So right now I would say.
We're seeing levels in the twenties.
For the one and three months period, and that's going to reflect the 75 basis point hike that people expect the fed to make.
This month.
Actually a couple of days from now.
And then given that and given the.
So longer duration investments.
Do you expect your investment spreads too.
Widen a little bit in the third quarter or is too early to say.
I think it's too early to say Chris.
You know what they do this this month plus.
Plus the composition of the book and any rebalancing that we continue to do.
Yeah, we feel really good as I mentioned about this quarter's the a D. A.
And then it's really the fourth quarter.
And how well it depends on exactly what the fed does this quarter next quarter.
Our portfolio composition, and then you know as I as I was also saying on the call.
If you look at forward rates, which is out into 2023, youre actually seeing funding cost decline.
Over time, so we think of it as a temporary pickup in rates and then and.
And then if the forward curve realizes obviously stuff coming back down next year.
And did I hear correctly, Byron mentioned were booked value per share was 3% higher.
To date yeah.
I said that but we will give borrowing credit as we always [laughter] final question are you guys continuing to raise equity in July .
Look we've got a long term view in terms of growing our company and I am pretty pretty we have been very.
Strong about this opinion about how we look to the future over the long term.
We are building our company we are growing our company, we have no desire to be the largest company in this industry by any stretch of imagination, but we are in a phenomenal time.
To deploy capital with returns this this attractive.
We fully intend to be very strategic about continuing to try to to go.
Through our company and this type of environment, we didn't grow as much when spreads were really really tight.
Spreads are really really wide and returns are is the right time to try to grow our company, but we wanted to do it in a manner that really favors our shareholders and as again, we have a long term, we're going to create a solid long term shareholder experience. So we're very thoughtful in the process, but this is a great return environment too.
Grow our company, we don't grow for guests growth's sake.
Great. Thanks, guys.
Thanks, Chris Thanks, Chris.
Your next question is from Jason Stewart of Jan Strident. Please go ahead. Your line is open.
Thank you Steve Congrats on a great career.
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Thanks, I wanted to ask and welcome back.
I mean, Rob.
I wanted to ask where you guys think terminal fed funds get too and the duration.
The inversion of the yield curve.
Wow that's like.
You're making me predict Jason.
Well I was just like a base case, okay yeah.
I'm kidding.
Well, if the fed said to us that they think neutral is two 5%.
They also said that they think that they need to hike beyond neutral in order to control the inflation that they see.
And so if you hold them to their word.
You would say peak fed funds is 3.5% to 375%, which is another 100 to 125 basis points higher assuming they go 75 this time around right.
But you can see that you you asked about the inversion in the yield curve.
Sure.
Once again I think this is you know this is one of these things with them.
Beatings will continue until morale improves and that that's literally what's happening at this point.
And the yield curve is the fed is being challenged.
To go.
Go ahead and raise rates at $3 75, because the market believes that those rates will have to come right back down because they're going to push the U S into a recession.
So how long that lasts and how long the curve remains inverted I think is it's directly related to this idea that we could already be in a recession.
That the recession, the slowdown will be you know not insubstantial, obviously cause theyre, killing off demand.
And that the fed will be easing here in the first or second quarter of 2023.
So the inversion can laugh out you know and we saw this in 2018.
Where the fed was very stubborn about continuing to raise and look don't forget not only are they raising as much as anything. They also are doing Q T. At the same time.
And they've done more acuity this time around or the amount of Qt Theyre doing is is much much higher than.
And then last time around so there is a significant tightening of financial conditions already underway.
And for that reason you know, we're respecting that inverted yield curve scenario, we have to we have to think about that very seriously when we look at our risk positions.
And then.
One thing I just wanted to take you think to jump on it so box here about this because I laugh I Chuckle every time I look at Bloomberg and they say, what's your prediction what do you think you know what this is.
Unbelievable moment in history, no one can predict to be Frank with you.
And what I am proud of at Nymex is preparation greatest athletes prepare they prepare to prepare to prepare over and over again and this team is preparing for multiple scenarios and we're preparing to respond to multiple scenarios and as great. As we all talk about what's going to happen in the U S and what the best.
Kind of do Europe has enormous amounts of problems.
From a war to energy self sufficiency to a union that may not hold with this type of situation. So we're preparing for multiple scenarios as opposed to trying to rely on our ability to predict the future and this unbelief.
Verbal moment in history, and if I want to say anything to our shareholders.
I understand that we are preparing in preparation is extremely important.
Our daily workouts.
Yes, and you guys have done a great job with that I guess, what I'm trying to get to is it.
In the environment, where we have an inverted yield curve and where does the basis fans and why not go down and coupons.
Well, we are down in coupon.
I mean, I'm I'm I'm joking, a little bit, but you know we've had that down in coupon position.
You know already.
So we've we've actually felt like getting longer duration has been.
A move to make which we have done and as I pointed out in our risk risks that you'll actually see that.
You know as as yields peaked in June and then beyond that we've been we've been actually taking some of our long term hedges off.
But yeah I mean, those are all strategies under consideration and we've hung onto our low coupons because we felt like they were again they were good call options for us to have in the book.
We're adjusting our hedge ratios.
And yes, I mean, I think we've we've looked at the inversion and again, we don't we're not saying this is the only way that curve could be shaped because if I go back to being steeper and in a moment.
We believe for now right like this is this is what the market's pricing.
Where we're planning around that.
Scenarios at this point with the with the positioning in the portfolio.
Okay. Thanks for taking the questions and congrats again Steve.
Thanks, Jason.
Your next question is from Doug Harter of Credit Suisse. Please go ahead. Your line is open.
Hoping you could walk me through your thought process.
As you look to grow assets between increasing leverage.
On top of all of that at least in the short term is his daughter.
Sure.
So one one thing we we look at.
First off I I did say in my comments that our.
Our net cost of capital after after issuance costs. It is nine 7% that's kind of what it was for our last block here.
And when we look at that and we lay that up against the.
The investment environment, where we're really you know.
We're seeing returns in the low to mid to high teens, depending on the coupon those are massively accretive returns relative to a nine 7% cost of capital.
In terms of you know when when should management you know raise capital when you have accretive investments to make them and we feel like this is a great time to do that.
But it's not costless as you pointed out right. So, but what we think about there is just there is an earn back period that you have for for spending that dilution.
And that earn back period right now is as short as we've seen it.
And in decades going back to the first.
QE period, I think you'd have to go back that far to find returns like this.
And we're not by any stretch of the mentioned imagination back at those levels, but but still these are really good levels at which we feel that that earn back period is very very low.
So the main decision, though is you know, what's my cost of capital versus where I can put the money to work.
And we think that this is this is a very accretive environment for that.
Okay.
Then just thinking about the growth.
Constructor.
It was kind of economic return and the potential of the portfolio I guess, how would you compare.
The in place return of the portfolio.
Mark to market basis versus a low to high or low to mid to high teens that you just talked about for.
No new investments you see today.
Right. So yeah. The entire book is mark to that.
To that we turn environment. If you will each time, obviously, we mark the book.
As our coupon profile changes Youll also see more of a quote reset to what at what our current market yields. So if you look at the.
The sheet, where we're talking about what our coupon distribution is where we've gone up in coupon a fair amount.
And I would say in general right over the very very long term, we've said generating an 8% to 10% total economic return is it is a good is a good total return and there are times in which we're going to exceed that.
On a weighted average basis rate, where those returns look more like you know.
12% and Theres going to be times, when we we don't we don't even make the 8% we're in an environment, where going forward, we believe with the mix of existing and new capital that we're raising that we're going to be on the upper end of that range. I mean, that's why we're saying, it's a historic opportunity and we have the ability.
To put this capital to work and so right now we're sitting with.
Six eight times leverage to total capital.
As of July 20th.
You know we've said we can take that that leverage up another two to four turns.
Which would be again, a two third size larger than where we are today on the balance sheet.
And those are the types of returns that we're getting on that incremental deployment.
Deployment of capital.
And then I guess can you just remind me when you talk about the.
Mid <unk>.
Teens returns on incremental capital what leverage are you assuming on that is that kind of consistent with the current 600 or are you assuming kind of a normalized leverage we think about it always in normalized leverage terms does because our leverage is always a function of our risk posture.
And so in order to compare apples to apples, where we look at it and you know it.
Terms of normalized leverage so for agencies its nine to 10 times.
Common this is kind of how we think about it.
Great I appreciate the answers.
Yeah.
Thanks, Doug.
There are no further questions at this time I will turn the call over to Byron Boston for closing remarks.
Thank you very much for joining us today, and we look forward to you joining us for our third quarter conference call sometime in late October .
This concludes today's conference call. Thank you for your participation you may now disconnect.
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