Q1 2023 Annaly Capital Management Inc. Earnings Call
Good morning, and welcome to the Q1 2023, and then the capital Management earnings Conference call.
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I would now like to turn the conference Sean Kensal director of Investor Relations. Please.
Please go ahead.
Good morning, and welcome to the first quarter 2023 earnings call for <unk> capital management and.
Any forward looking statements made during today's call are subject to certain risks and uncertainties, which are outlined in the risk factors section in our most recent annual and quarterly SEC filings.
Actual events and results may differ materially from these forward looking statements.
We encourage you to read the disclaimer in our earnings release in addition to our quarterly and annual filings.
Additionally, the content of this conference call may contain time sensitive information that is accurate only as of the date hereof.
We do not undertake and specifically disclaim any obligation to update or revise this information.
During this call we may present, both GAAP and non-GAAP financial measures.
A reconciliation of GAAP to non-GAAP measures is included in our earnings release.
Content referenced in today's call can be found in our first quarter 2023, investor presentation, and first quarter of 2023 financial supplement both found under the presentations section of our website.
Please also note this event is being recorded.
Participants on this morning's call include David Finkelstein, Chief Executive Officer, and Chief Investment Officer.
Serena Wolfe Chief Financial Officer.
Mike Fannia, Deputy Chief investment Officer, and head of residential credit yesterday in Boston head of agency.
Ken Adler head of mortgage servicing right now.
And with that I'll turn the call over to David.
Thank you Sean good morning, and thank you all for joining us on our first quarter earnings call today I'll review our performance during the quarter provide an update on the macro landscape and then discuss our portfolio activity and positioning within each business. Serena will then provide further detail on our <unk>.
Actual performance and we are also joined by our other business leaders, who can provide additional perspective during Q&A.
Now beginning with our performance as we noted on our last call our outlook was optimistic but cautious given the potential for further volatility over the near term. Our conservative approach was validated as we generated an economic return of 3% during what proved to be a very challenging quarter.
We're deliberate with respect to our asset selection and hedging strategy, which I'll discuss in more detail and we continued to maintain our defensive posture with economic leverage roughly unchanged on the quarter at six four turns well out, earning our right sized dividend by 16 cents now.
Now on the macro environment do you anticipated the bank liquidity management would be among the first victims of the fed's rapid hiking cycle.
The SBB induce turbulence led to questions about the outlook for the banking system, the economy and monetary policy. Moreover, they compromise the notion of calmer markets, resulting in some of the highest levels realized an implied fixed income volatility since the financial crisis the.
The situation remains fluid given events this week and we'd be the main implication of the banking turmoil is creating an overhang of assets that need to be open absorbed by private market participants the SBB and signature portfolios are currently being sold adding the MBS supply and even if other banks do not sell securities.
Most market participants had penciled in about 100 billion in MBS demand coming from banks at the start of the year. However, instead of this demand we will more likely see bank holdings of MBS decline and with the fed and continued runoff mode. In addition, and net issuance the market will be further reliant on money managers to absorb.
Roughly 500 billion in aggregate supply.
Now spreads are sufficiently attractive for this to occur so the potential for spread tightening is more limited going forward.
Now a second implication of this episode is that it illustrates the banks will likely opt to preserve capital in turn curbing lending activity credit availability was already reduced in lending standards were tight for March but the events over the past few weeks suggest further contraction as possible in turn slowing economic.
Gross.
Now the U S economy remains on solid ground with the labor market is still recording nearly 350000 jobs per month, this quarter and U S inflation readings staying above the federal reserve's target measure, although the banking situation increases risks of a meaningful slowdown that will likely height 25 basis points next week.
Aimed to keep interest rates unchanged for the rest of the year in line with their forecasts.
Now shifting to our portfolio activity during the quarter within agency mortgage performance diverge meaningfully each month, given interest rate and spread volatility in January MBS spreads tightened significantly driven by the decline in implied ball strong inflows into fixed income bonds.
Form has softened however in February this yields rose despite manageable levels of MBS supply and this ultimately gave way to a more meaningful cheapening in March on the news of SBB and signature bank entering FDIC receivership and total mortgage option adjusted spreads widened approximately five to 15 basis.
Points across coupons on the quarter.
And we modestly grew our agency portfolio commensurate with the accretive common equity raised early in the quarter, while maintaining prudent leverage we continued our gravitation higher up the coupon stack in a quarter and only 5% of our portfolio was in tutors in two and a half down from 34% a year ago.
And thus we were better protected from the widening that occurred lower coupons as a result of the FDIC portfolio in Bray.
Also to note over 50% of our portfolio is in what we define as intermediate coupons, three and a half two four and hams, which remain more insulated from potential bank sales, while avoiding the supply pressure higher up the coupon stack. This dynamic drove investors to shift into these coupons leading to March.
Italy positive hedge performance within this portion of our portfolio. Despite headline M. B S spreads widening over the quarter looking.
Looking forward, we continue to favor these intermediate coupons and we will also opportunistically invest up the stack in the fives and higher as these assets provide a historically attractive nominal spreads.
In addition to our balanced positioning across the agency market, our duration management and hedging decisions were critical in helping us navigate the volatility in March over seven consecutive trading sessions beginning on March 9th two year no moved in excess of 20 basis points per day throughout disappear varied.
Portfolio was well positioned and we were able to take advantage of the outside moves by adding shortly in hedges at attractive levels, which replace swap runoff experienced over the quarter.
The more we continued to rotate hedges out of Treasury futures in the sopra swaps, which we see as a more efficient hedge and more closely tracks. Our repo funding costs shifting to residential credit performance was mixed across products, both benchmark credit risk transfer securities and expanded credit whole loans worked.
10 to 15 basis points tighter on the quarter, while AAA non QM securities with 30 to 40 basis points wider from year end.
Ah Reggie portfolio ended Q1 at $5 2 billion in market value of approximately 200 million quarter over quarter.
Currently representing 18% of capital.
This increase in market value was driven by retention of obs assets generated through securitization and opportunistic purchases predominantly investment grade C. R. A T.
We remained active in expanded credit whole loans purchasing $645 million in loans on the quarter of which 80% was sourced directly through our correspondent channel our loan quality remains high as Q1 settlements had a 743 weighted average FICO 70, LTV with an aggregate mortgage rate.
Of 8.79% and despite challenging market conditions, we ended the quarter with a robust loan pipeline of $555 million.
Our excess warehouse capacity and liquidity management allowed us to be selective in accessing the capital markets via our <unk> securitization platform. We conducted three transactions in the first quarter totaling $1 1 billion, including two non QM transactions and a jumbo partnership deal all complete.
<unk> in the first two months of the quarter prior to the onset of spread volatility in March.
Also to note is volatility subsided to begin in the second quarter, we priced our third non QM securitization of the year just last week.
Now lastly, within our MSR portfolio consistent with recent quarters, we were disciplined adding just one bolt package and our portfolio is currently comprised of $1 8 billion in market value and 130 billion U P. B very low no rate high credit quality MSR with an attractive risk profile.
Stable cash flows and this is evidenced by recent portfolio prepayment speeds trending below three C. P. R.
Serious delinquencies remained less than 50 basis points now in terms of the sector more broadly despite widely publicized supply introduced into the market and interest rates declining roughly 40 basis points during the quarter. The strong performance of low WAC MSR drove an increase in valuations which is reflected in.
A modest expansion of our portfolio of multiple.
Now to briefly touch on our outlook, we feel good about our positioning across our three businesses and believe we are appropriately levered for the current environment and our careful approach to leverage and liquidity has been beneficial where fundamentals have improved but technical headwinds persist, but that being said as outlined in our investor presentation.
Do see attractive new money returns for each of our businesses with agency remaining our preferred avenue per incremental capital deployment over the near term.
Residential credit and MSR do offer appealing low to mid double digit returns and provide a diversification benefit to enhance the stability of our risk adjusted returns and out the horizon. We will look to grow these strategies to represent roughly 50% of our dedicated capital collectively, though we continue to be patient.
Measured with respect to further diversification.
Now finally before I hand, it off to Serena I wanted to welcome back D. S. Srinivasan, who were very pleased to have with us on the call. This morning screening has returned to lead our agency effort and having worked with him extensively over the years I'm fully confident in his ability to navigate the agency market and we're very happy to have him back on the.
Now with that I will hand, it over to Serena to discuss the financials.
Thank you David today, I will provide brief financial highlights for the quarter that ended March 31st 2020 train.
System with prior quarters, well earnings release describes as GAAP and non-GAAP earnings matrix. My comments will focus on our non-GAAP EIB and related key performance metrics, which exclude P. I E.
Despite the challenging market, David referred to earlier and book value per share for Q1 was relatively unchanged from the prior quarter at $20 77.
It's kind of across the board with increases in valuation on our agency <unk> and MSR portfolio is contributing $2 54 to book value for the quarter.
These gains were offset by losses on our derivative positions of roughly $2.75 predominantly related to our swap portfolio, which comprised 82% of the losses on our hedging book.
After combining our book value performance with our first quarter dividend at <unk> 65 cents.
Quarterly economic return was 3%.
We generated earnings available for distribution of <unk> 81 per share for the first quarter.
The 8% or 10% reduction in <unk> compared to last quarter is primarily attributable to the continued rise in repo expense and interest expense up 20% or approximately 125 million compared to the prior quarter.
Largely mitigating the increase in repo expense is a higher net interest component of swaps and the average receive rate climbed 66 basis points, resulting in a 35% or 19 9 million increase in swap income quarter on quarter.
TBA dollar roll continued to decline offsetting the benefit of higher yields on the spec pools experienced during the quarter.
In previous earnings calls, we communicated our expectation that earnings would moderate as demonstrated this quarter.
And the driving factors that we had referenced previously still hold that is the continued increase in financing cost swap runoff the decline and especially once it rolls and the mismatch between the economics in earnings related to features.
Therefore, we expect some further moderation of the idea in the near term that continue to be comfortable without current dividend level, given the economic earnings of the portfolio.
Equal.
Average yields ex PAA were 14 basis points higher than the prior quarter at 396% as we continued to Rite aid I think coupon this quarter with 56% of the agency portfolio now in four 5% coupons.
The fact that the impacted E idea also illustrated the NIM for the quarter with a portfolio generating 176 basis points of NIM ex PAA and 14 basis point decrease from Q4.
Net interest spread does not include dollar all income therefore, the decline in NAV with less nine basis points down quarter over quarter at 162%, that's just 1.71% in Q4.
The continued rise in repo rates and higher average balances impacted our total cost of funds for the quarter rising by 23 basis points to 234 basis points in Q1, and our average repo rate for the quarter was 462 basis points compared to 372 basis points in the prior quarter.
However, as previously mentioned.
All of them people impacted cost of funds during the quarter by approximately 58 basis points.
Now turning to details on financing funding markets remain a bright spot amongst all the volatility in the financial markets with funding power Agency and non agency securities portfolio is remaining resilient and Paul.
Consistent with most of 2022 liquidity is concentrated in shorter term market after fed meeting date skin.
In saying that a core tenant of our planning philosophy is diversification that counter party and Tim and as such we have sought to extend approximately 10% of our agency repo book.
And then finally during Q1, we opportunistically entered into six and 12 month floating rate trade at attractive rates as a result of this positioning our Q1 reported weighted average repo guys were 59 days up from 27 days in Q4.
Since the beginning of the year, we increased our dedicated financing for our credit businesses upsizing of existing ready credit facility by $200 million, and adding $500 million of new warehouse facilities already credit and unpack combined.
<unk> approach to diversifying financing for our credit businesses has resulted in a combined 3 billion of capacity with leverage levels substantially unchanged from Q4 and substantial unused capacity is about ready credit and <unk> 2 billion.
I'll securitization platform continues to be a core part of that ready credit strategy.
As of the end of Q1, 86% of our GAAP consolidated whole land portfolio with funded through securitization at a weighted average cost of funds of $3 seven 8% approximately 215 basis points below the non QM balance sheet cost of funds for the quarter.
In addition to the below market financing right about securitized debt, 96% of the debt is locked in at a fixed rate.
Our opex to equity ratio for the quarter was unchanged from full year 2022 at one 4% as we've realized most of the cost savings from our internalization and divestiture and the melon and <unk> businesses.
Operating expenses May rise modestly as we continue to invest in resources for growth and are ready credit and MSR platforms.
Our liquidity profile remains robust with unencumbered assets of $5 7 billion, including cash and unencumbered agency, a $3 8 billion for the quarter.
The approximately $600 million decrease in unencumbered assets, primarily came from the pledging of assets to a new MSR hit already in Q1, which remained undrawn and slightly higher leverage of agencies and homeland conditions at quarter end.
Now that concludes our prepared remarks, and we will now open the lines for questions. Thank you operator.
Okay.
We will now begin the question answer session.
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Okay.
Our first question will come from Bose, George with K B W.
You May now go ahead.
Everyone. Good morning.
Can I get an update on book value quarter to date.
Sure Bose good morning, so as of weeks and we were off roughly 1%. The last couple of days has been a little bit choppy nothing to write home about and there's still long ways left in the quarter.
Great. Thanks, and then just in terms of that in your outperformance versus the market and agencies in the first quarter as well is it.
Largely attributable to the positioning where the lower coupons or not.
But there's a bunch of part of your portfolio.
Look Bose Theres a lot of factors.
<unk> very steady in the first quarter and most importantly, I think we have the right capital allocation to keep us nimble each of the three businesses generated a positive economic return, but the fact of the matter is that diversification enabled us to navigate the market much better.
We gravitated up in coupon, which helped we didn't get whipsawed in January rally as Deb sell off because of the fact that agency is two thirds of the portfolio.
It's much easier to manage rate risk when it's a smaller portion of your capital allocation.
And then into March we had the right positioning when the bank crisis.
<unk>, we had a steep but are on and we were along the market and we ultimately reduce debt with.
The front end got.
Very low well inside of 4% on a two year note and so we ended the quarter.
And what we think to be very conservative position with leverage roughly unchanged, a very moderate amount of duration and responsible level of leverage and capital allocation and thats effectively what helped us navigate the quarter.
Okay, absolutely a good job on the book value. Thanks for that and then actually just on spreads you noted that you thought that.
Spread tightening is not.
Not that likely so just curious what your thoughts are and just longer term spreads like where do you think where you think things could settle out.
Sure. The agency market is priced appropriately for the current environment Bose. The fact of the matter is it is difficult for agency to tightened considerably when banks arent involved. So we are relying on money managers.
We anticipate that spreads will remain range bound, but the fact of the matter is they are on a longer term basis to your point very inexpensive and we do like them, but over the short term, we could see localized dislocations given the volatility in the market and that that may occur and we're perfectly prepared for it.
Generally speaking, we like agency, we're cautious on volatility.
Over the long term, we think they're great assets.
Great. Thanks very much.
Thank you both.
Our next question will come from Trevor Cranston with JMP Securities You May now go ahead.
Hi, Thanks, good morning.
<unk>.
You guys talked about.
The failed bank portfolio sales coming in the changing outlook or for bank demand in the agency market.
I was curious if you've seen or if you can say if you've seen any.
A material amount of sales of <unk>.
Other assets non agency assets or whole loans out of banks or if you expect to see that.
And bumps and how do you think.
That could impact the non agency market.
Sure sure well, obviously this week the market is talking about first Republic bank, which does hold roughly a 100 billion in residential loans.
And that potentially could hang in the balance as well as well as other residential credit assets when we looked at.
That particular portfolio those are very high quality performing loans.
And there is value to the relationship. So we do think that there will be ultimately a home for those loans should should they be sold.
You know Mike can expand on this but but over the intermediate term. We do think we're a very good fit for this type of asset, particularly that portfolio given.
Over 50% of it is Io and should it go through the securitization channel.
Our brand and our shelf is obviously quite strong, but we have the ability to take the risk retention on the aisle and we do have an appetite for subordinate securities of high quality collateral and so we will see how things play out but ultimately.
This will be handled responsibly, we believe it might feel free to expand on that yes. I think we would just added the gse's have set precedent in terms of having large loan sales you know in the context of two to 5 billion per each auction and we think that to the extent that that portfolio came out in that size it could be digested.
Pretty easily through the market in terms of just the banks stepping away from blending and tightening underwriting standards, we have not really seen that on in terms of leading to supply on prime jumbo.
We still see bank rates on prime jumbo in a five 5% five and three quarters, where we think that the cost to securitize new.
New origination loan probably need to be in that 7% area north of 7%. So volume at this point from new origination Prime Jumbo is not going to the to the secondary market into two securitizers.
Got it okay. That's helpful.
You mentioned that you had a curve steepen or on which helped with your book value performance in March.
Can you talk in general kind of your thoughts around.
The rate outlook.
How do you think the shape of the curve kind of plays out over the near term. Thanks.
Yes, so first of all with respect to the rate outlook.
You know our view is very conservative with respect to rate exposure I think if you. If you look at the first quarter. We saw three very different markets. You know in January we saw a rally driven by disinflationary sentiment ultimately leading to Cubs, which was very good for risk assets and particularly.
What also happened over the last 10 years, there's a lot of private money kind of been a floor into the agency MBS sector are left affect that and we fully expect that these attractive spread levels. Some of that private money will come back to the effect of that takes time to organic growth. It takes some time.
So overtime, we see between that private money coming in which will help.
And on the credit side, we would say that it's probably a continuation of last quarter, we've allocated to credit risk transfer. We think that there is supportive both positive short term and long term technicals CRT and <unk>, which is the triple B bond Theyre low mid three hundreds there are 250 basis points of NIM, given our cost of.
Financing.
Teens ROE on one turn of leverage we've seen the gse's be reactive to market conditions potentially pulling deals just given where spreads are so we do think.
We feel pretty good in terms of our portfolio, there and continuing to allocate and then also a continuation of the correspondent channel in buying loans through through through Ob acts. So whole loans right now non QM whole loans, the one or two rates probably eight to eight in the quarter, we'll call. It a 725 to 750 unlevered yield and we think.
In securitization Youre, achieving mid mid mid teens Roe.
On the MSR side.
You know the characteristics of the cash flows are unprecedented for the.
For the mortgage servicing rights industry to be able to buy <unk>.
What do you think the the best capital opportunity is on the investment side is it on the long side, our Q So Todd.
On the MSR multiples I mean, it really is a discounted cash flow approach. So it is certainly dependent on interest rates.
As prepayment speeds slowed down that they've improved and quantity.
The reason, it's been such a great opportunity is because the the required selling by the mortgage industry has not allowed those multiples to Raj.
Theoretical values that would ordinarily.
Sure.
So right.
Happy to see those multiple not go higher because we're continuing to allocate capital.
Sure.
And we don't expect they will go much higher.
And we're certainly happy about that given our capital allocation and our long term approach to the asset class.
And Jason in terms of credit whether loans versus securities. We have the ability to flex into both I would say our preferred approach remains purchasing loans.
We control the product we control the strategy our partners, we control pricing, where you know on third party Securitizations, you've obviously don't have that level of controls so going into a little bit of a more uncertain economic environment, we certainly want to have that control.
Dictate all aspects of the strategy.
Yeah, Jason that makes sense.
Thank you alright, Thank you Jason.
This concludes our question and answer session I would like to turn the conference back over to David Finkelstein for any closing remarks.
Thanks, Anthony and thank you everybody for joining US today, good luck and we'll talk to you next quarter.
The conference has now concluded. Thank you for attending today's presentation you may now disconnect.