Q2 2023 Annaly Capital Management Inc Earnings Call
Okay.
Good morning, and welcome to <unk> second quarter 2023 earnings call clean Nowy Emily.
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Yeah.
Good morning, and welcome to the second quarter 2023 earnings call for <unk> capital management.
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.
Conciliation of GAAP to non-GAAP measures is included in our earnings release.
Content referenced in today's call can be found in our second quarter 2023, investor presentation, and second quarter 2020 financial supplement both found under the presentations section of our website.
Please note this event is being recorded.
Participants on this morning's call include David Finkelstein, Chief Executive Officer, and Chief Investment Officer.
So we're gonna Wolfe Chief Financial Officer, Mike Fannia, Deputy Chief Investment Officer head of residential credit.
Three new Boston head of agency and.
Ken Adler head of mortgage servicing rights and with that I'll turn the call over to David.
Thank you Sean good morning, everyone and thank you for joining us for our second quarter earnings call today I'll begin with our performance during the quarter review the macro landscape in housing market, followed by an overview of our portfolio activity in positioning Serena will then go over our financial results for the quarter.
And we're also joined by our other business leaders, who can provide additional context during Q&A.
Starting with our performance we are pleased with the 3% economic return generated for the quarter, despite elevated rate and spread volatility and to know we've achieved a 6% return year to date and kept book value largely unchanged notwithstanding heightened uncertainty caused by the changing path a bit.
Heights, the regional banking turbulence and debt ceiling negotiations.
Our ability to manage through this volatility is attributable to our diversified capital allocation prudent hedge portfolio and responsible leverage position.
Even with the reduction in leverage from six four times to five eight times, we again out earned our dividend this past quarter.
Now shifting to the macro environment. Despite the banking stress at the onset of the quarter. The U S. Economy has remained on solid footing with healthy gains in the labor market and economic growth consistent with recent quarters.
Inflation was elevated through most of the quarter. However data began to signal a more pronounced slowdown in June lower used car prices and improvement shelter inflation in a seemingly more price sensitive consumers have begun to put downward pressure on prices and this should slow inflation more than recent year end.
<unk> forecast of three 9% and core P. C E.
Well beyond inflation data during the quarter suggest the likelihood of a soft landing is increased and that the fed will hold interest rates higher for longer, particularly at the labor market continues to demonstrate resilience. It is likely that the fed has reached peak interest rate levels from cycle after yesterday's height, but upside.
Rises in inflation readings may lead to an additional <unk> this year.
With respect to the housing market home prices continued to outperform expectations as we have now experienced five consecutive months of national home price increases. According to Zillow recent momentum has turned positive even though the previously hard hit areas is the top 50 metro areas all experienced pause.
Is it a month over month HPA in June with the year to date National home prices now up four 7%.
Market participants were projecting meaningful price declines given elevated mortgage rates and low affordability with the expectation of those factors translating to reduced housing demand. Although transactional activity has declined the market has been supported by historically low available for sale inventory as existing borrower.
With low mortgage rates are unwilling to trade up or move given the potential increased payment.
Total active inventory was down 10% from last year and currently sits at a very notable 45% below June 2019 levels.
Now before turning to the portfolio I want to make one point on the banking sector. During last quarter's call. We stated that the main implication of the regional bank stress was that it created an overhang of assets that need to be absorbed by private market participants the supply came to the forefront during the second quarter as the F D. A.
C began selling assets from the SBB and signature bank receiver ships the sales weighed on the market for parts of the quarter, but money manager demand and transparency on the disposition process and help the market Digest a substantial portion of the 114 billion in assets already.
Now shifting to our portfolio and starting with agency when you look at the overall performance of the portfolio.
Once again looks more benign on the surface them now which actually occur.
As previously discussed the confluence of market events, and the resulting uncertainty led us to believe mortgage spreads widened.
Lee, we proactively reduced our agency exposure early in the quarter with our portfolio declining by roughly $5 billion in notional. This tactical shift proved beneficial as spreads reached their quarterly peak in late may and it afforded us flexibility to opportunistically deploy capital across our businesses Mitch.
The volatility in June it's the debt ceiling resolved in the banking sector recovered risk on sentiment reemerged in MBS experienced broad based outperformance ultimately driving spreads modestly tighter quarter.
With respect to portfolio positioning we continue to rotate into higher coupons, which provide the most attractive nominal spreads. We also reduced our holdings of seasoned intermediate coupons 15 year MBS and as a result, the average coupon on our portfolio shifted modestly hired a four 3%.
But we remain disciplined in managing our convexity profile through collateral selection.
We also took advantage of softer pay ups to replace over 8 billion TBA as with specified pools during the quarter and in addition to their favorable prepayment profile specs provide incremental carry relative to TBA as in the current environment.
On the hedging side, the notional value of our hedges declined in line with our assets, though we remain fully hedged we maintained a slight flattening bias throughout the quarter as twos tens and treasuries exceeded negative 100 basis points, but it shifted to a balanced curve position given the extreme end version in the yield curve.
The diversity of our assets allows us to be opportunistic in our rates exposure as the market stays highly sensitive to income data.
Now moving to residential credit spreads tightened in the credit curve flattened in the quarter driven by a supportive backdrop of limited net issuance resiliency in the housing market and a strong consumer.
Benchmark CRT below investment grade spreads tightened 95 basis points in the quarter, while production coupon non QM loan spreads were 75 basis points tighter, reflecting a declining cost of funds in the securitization market.
Our residential credit portfolio ended the quarter at $4 9 billion in market value down approximately 300 million quarter over quarter, given our increased pace of securitization activity.
Whole loan purchases remained healthy increasing 16% relative to Q1 with approximately $750 million of loan settled.
We securitized $1 5 billion in loans in the second quarter through our obs platform generating $162 million of retained assets and post quarter end, we priced our latest non QM deal taking advantage of the recent market rally to achieve AAA levels 20 basis points tighter than at the end of June .
This brings our aggregate year to date securitization volume to eight transactions totaling over 3 billion and notably Italy has been the largest nonbank securitizers since the beginning of 2022 and second largest overall, including bank issuers.
Our securitization activity has been supported by our correspondent channel, which continues to gain momentum. Despite a challenging landscape for mortgage origination our Q2 loan lock volume of $1 5 billion was our largest since inception and the channel accounted for 85% of our total loan settlements and we've maintained the discipline.
<unk> credit focus as demonstrated by the current pipeline exhibiting a weighted average FICO of 748 and.
And then L P b, 68% as well as limited layered risk.
Now finally within MSR, we grew our portfolio by $350 million or 19% during the quarter through the purchase of poor bulk packages. Our holdings now stand at just over $2 billion in market value and 150 billion in unpaid principal balance the portfolio exhibited another quarter is slow.
Prepayment speeds paying below sports C. P R and delinquencies were unchanged and remained minimal.
All told our strategy of acquiring low no rate high credit quality MSR continued to deliver predictable cash flows with attractive risk adjusted returns.
MSR trading volumes were strong in the second quarter as market participants sufficiently absorbed high levels of bulk supply a dynamic that we expect to persist for the foreseeable future and despite elevated supply pricing has held firm and low WAC MSR valuations improved driven by the rise in rates muted.
Prepayment speeds and modest spread tightening.
Now shifting to our outlook, we expect the second half of 2023 should provide a more accommodative environment for agency MBS.
While supply and demand challenges will persist with money manager is likely to be the primary buyers of mortgages net supply from banks is likely to decline as FDIC sales are completed and the fed nearing the end of his hiking cycle should lead to lower volatility and a potentially steeper curve, making MBS more.
<unk> to investors on an option adjusted spread basis, but I would note that we do expect spreads will stay wider relative to historical averages given technical considerations, though there is still room for tightening from here and there.
That said the benefit of agency spreads settling at wider levels is that we expect to earn a healthy yield without employing excessive leverage as.
As it relates to residential credit and MSR, we're optimistic about the opportunity set within these businesses and we'll look to grow these strategies responsibly in Ramsey, we anticipate further expansion of our corresponded channel as we now have approximately 160, Counterparties onboarding and we expect to benefit from our scale.
As we further penetrate the market.
<unk> quarter end lock volume has been strong with a current expanded credit pipeline of 900 million.
MSR, we're well positioned for opportunistic growth as an established top 20, servicer and we continue to add partnerships, including new sub servicing as well as bulk and flow relationships and have ample capacity to further leverage our platform.
And now with that I'll hand, it over to screen and to discuss the financials.
Thank you David today, I will provide brief financial highlights the quarter and six months period ended June 32023.
Consistent with prior four days, while earnings release discloses GAAP and non-GAAP earnings pretax my comments will focus on our non-GAAP E unrelated key performance metrics, which excluding P. I.
Many of the themes, we discussed in the first quarter continued to play out in Q2, and we are proud of our strong earnings and economic return considering the challenging market.
Our book value per share for Q2 was relatively unchanged from the prior quarter at $20 73.
And as David mentioned earlier with our second quarter dividend at 65 cents, we generated a positive economic return for the quarter at two 9% and approximately 6% for the first.
Six months of the year.
Highlights in the quarter drove gains in our hedging portfolio, a roughly $2 26 and.
And our MSR bulk of 19.
We're having a modest drag on our agency portfolio, resulting in loss of approximately $2 49.
Yeah.
We generated earnings available for distribution of 72 cents per share for the second quarter.
System with the product what I E. L. D was adversely impacted by the rise in retail expense, albeit a slot portfolio continues to mitigate the increase in rate.
Okay.
Average U S. P. A a were 26 basis points higher than the prior quarter at $4 <unk>.
As we continue to ratchet up in coupon this quarter with 57% of the agency portfolio and four 5% coupons in hernia.
The factors that impacted the EIB I'll also illustrated our NIM for the quarter.
Hollywood generating 166 basis points of meter X P I.
10 basis point decrease from Q1.
Net interest spread declined 17 basis points.
At 1.45.
Just 1.6 chip.
Okay.
The continued rise in repo rates impacted our total cost of funds for the quarter right.
Rising by 43 basis points to 277 basis points in Q2, and our average repo rate for the quarter was 515 basis points compared to 462 basis points in the past.
Yeah.
As previously mentioned to ask what impact on the cost of funds improved by four basis points to show an increase in average lifestyle.
On the sports portfolio ended the quarter with a net receipt right at 255 basis points compared to a net receive rate it's running at 74 basis points in Q1.
Now turning to details on financing funding markets remains ample and liquid we continue to see strong demand for funding for our agency and non agency securities portfolio.
Our strategy is consistent with prior quarters, and our teacher reported weighted average repo guys with 44 down from 59 days in Q1, mainly due to the roll down as longer term trying to reference during our Q1 earnings call.
The advertising credit mainland as has also been robust on the warehouse side and we continue to engage with new and existing Counterparties as we look to enhance our dedicated warehouse facility crack credit businesses and very competitive times.
Given the characteristics and growth of our MSR portfolio, and we have significant unpledged assets available that we can utilize to unlock liquidity.
That being said as at the end of Q2, we had $1 7 billion of unused warehouse capacity quite that Randy credit and MSR financing facility, which leaves us in a very comfortable liquidity position 40.
Our liquidity profile improved compared to the prior quarter with unencumbered assets of 6 billion compared to $5 7 billion in Q1, including cash and unencumbered assets of $4 4 billion for the quarter.
There are approximately $328 million increase in unencumbered assets, primarily came from lower unbalanced sheet leverage for agency MBS securities and the MSR purchases during the quarter.
That concludes our prepared remarks, and we will now open the line for questions. Thank you operator.
We will now begin the question and answer session to ask a question you May Press Star then one on your telephone keypad.
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Our first question comes from.
Oh George.
Please go ahead.
Hey, everyone. Good morning.
I just wanted to ask about returns, but you know for the different groups I mean last quarter you had that slide that just shows the blended ROE I didn't see that is the return kind of the same level as it was last quarter that 11, 5% to 13 and a half range.
Sure. Good morning, Bose, So I'll just run through it real quickly. It's similar agency you can call mid to upper teens.
Residential credit securitization through Ob ex retaining the triple B zone down with a turn of leverage gets you to low to mid teens and then the MSR unlevered around 10%, 11% with a turn of leverage gets you to 15% so still it still healthy.
Okay, great. Thanks, and then just on the book value can you just give us an update quarter to date.
Sure we were up 1% as of last night.
Okay, great. Thank you.
Thanks Bose.
Our next question comes from <unk>.
Ben Lowe. Please go ahead.
Thanks, Good morning.
Let's talk about leverage and just how you're positioned in the third quarter you brought down leverage in the second quarter to levels I don't think we've seen since 2021, but based on your comments you're optimistic on the environment. So I'm curious if you've begun to bring leverage higher and AD agency MBS after decreasing agency early in the.
Second quarter.
Sure sure and yeah, we didn't we trough the leverage levels I think at the beginning of 2022 I'm going to say five seven we ended at five eight.
A fair amount of that is capital allocation, we did add MSR as I mentioned $350 million, we committed this quarter to a little bit more so so given the leverage profile of MSR that does account for about a quarter of a turn of the decrease and then we have an active pipeline in resi, which is also less levered as.
As we sit today, we did we did add a little bit of mortgages to begin the quarter. So we're right at around six turns of leverage and we really like where we're at we we have ample liquidity.
There is an opportunity to add mortgages, if they widened our leverage will organically go up but we do have capacity to add but we're able to generate the returns we need with current leverage with ample liquidity and then if you look at our spread shocks or improvement in booked value isn't.
Seriously different with lower leverage I think we for 25 basis point spread tightening we're around 2010, 4% appreciation versus 10, 9% last quarter. So we're able to do a lot more given longer spread duration with with less and we really like where we sit right here.
Thanks, David that's helpful. And then just one other question from me just money managers have been vocal in fixed income flows had been positive I'm kind of in in the last quarter or so about the attractiveness of agency MBS, but how are you thinking about banks potentially entering the agency market again is there a scenario where.
You would expect them to become buyers.
Of agency later in the year or early next or too soon to tell and then do you think banks need to reenter for spreads to a tightened meaningfully.
So to answer the question will banks be involved this year are our guests is not we don't expect to see our active selling but we do think there'll still be runoffs from bank portfolios. We estimate about another $50 billion in decline in bank <unk>.
B S holdings by the end of the year and beginning in 2024, and we will see what the outlook looks like and defense posture, but you could see them re emerging at that point. It's just too early to tell in terms of do we need banks for mortgages to really tighten look it really depends on how our money managers.
Our posture.
We are at or near the end of the fed hiking cycle that does bring about optimism with respect to fixed income yields are elevated and real rates are certainly attractive and so our expectation is that you will see more money coming into money managers, which will provide support and agency MBS or more.
The cheapest assets in fixed income so even in addition to new money coming in.
We hope to see over weights and agency on the part of money managers, which will we will certainly support the basis and another point to note is that <unk>.
<unk> is still relatively elevated.
The end of the fed hiking cycle the passage of <unk>.
Significant risk events should lead to a decline in ball and that'll be very beneficial for the agency basis.
Thanks, David I appreciate the comments.
Our pleasure Kristen.
Our next question comes from Eric Hagen from <unk>. Please go ahead.
Hey, Thanks, Good morning, maybe a follow up on the spread environment I mean at this point do you feel like spreads are more likely to widen or tightened into an interest rate rally and then maybe somewhat separately I mean, how much sensitivity do you see between MBS spreads and bank deposit rates right now. Thank you guys. Yes. So in terms of the in terms of the symmetry widen.
Bruce is tight and we do think spreads should tighten not materially, but we definitely feel like given where we're at in the cycle.
Spreadsheet should should come in we're above fair value, we do look at today's market compared to past.
Past cycles, and if you look pre Covid, where agency spreads were roughly around 75 C V were materially wider than that but a lot of that is explained factors like volatility is likely to remain more elevated.
Option cost is higher given loan balances are higher mortgage refinancing is more efficient and factors like that and then lastly, the supply picture is a little bit more negatives for mortgages.
This environment relative to the last time, even the fed was engaged in Q T. Just given banks and other factors. So spreads should tighten we think there's about 15 basis points in a spread tightening.
Get them to fair value and what will be the determining factors I've mentioned Crispin is where volatility goes if we get a decline in ball thats going to be very good.
Been beneficial should there be some unforeseen event on the horizon and ball spikes, then we would expect some widening but our views that they should tightened somewhat and in terms of bank deposits versus versus mortgages.
Look here's the way I'd characterize it a lot of focus has been on.
Money market funds and just the elevated balances in money market funds that money is potentially dry powder for fixing investment fixed income investments or other investments and so so we're looking for money to come out of money market funds and more into longer term fixed income vehicles.
Ultimately support mortgages and in terms of bank deposits, you're going to see bank deposits and reserves go down as the fed withdraws liquidity right now reserves are sitting around three and a quarter trillion. We expect that to decline is currently 12% of GDP by the end of the year it will probably be around 10, 11% and thats.
That's what's going to drive our bank deposits and again as I mentioned.
Previously, we don't expect banks to be buyers of mortgages.
Right.
That's helpful commentary I appreciate that.
Maybe on the MSR I mean, how big do you think you can get there in light of the MSR supply hitting the market, what's the tolerance for leverage in the MSR portfolio. I mean would you ever look to encumber the agency portfolio to basically support leverage for the MSR or is the idea to borrow against the MSR unencumbered that directly.
Well, we have a lot of optionality, given our liquidity and our and our capital allocation.
Currently the MSR portfolios hedged at about <unk> Levered at about <unk> three turns the way we looked at it as a steady state for low WAC MSR with benign cash flow variability as it should be about a turn levered turn levered. So theoretically then the agency is doing some of the agency portfolio is doing some of the <unk>.
Heavy lifting and funding that portfolio, but we have ample capacity for warehouse financing and we continue to grow that and in terms of the trajectory of supply and how the year might play out let me turn it over to Ken.
Supply has been very steady at roughly 200 billion of GSE MSR each quarter.
With the exception of.
The fourth quarter of each year when.
The transaction volume slows down to due to the GSE constraints at that time of year.
When we look at the balance sheets of the sellers, we don't see that supply stopping for the next few quarters.
Our relationships.
Our our very encouraging that there'll be more coming dejac sorts of assets, we'd like to buy.
Yes Hello.
Thank you guys for the commentary I appreciate it.
Thanks, Eric.
Our next question comes from Trevor Cranston from JMP Securities. Please go ahead.
Alright, thanks, good morning.
David I think I heard you say you maintained.
A curve flattening bias sort of throughout the quarter and it had moved now to a more balanced curve positioning can you elaborate a little bit on how you guys are thinking about the evolving shape of the yield curve going forward given that we may be sort of at the end of the fed rate hike cycle at this point it seems like we could also have oh.
Offline with the economy.
Sure Trevor and good morning, So that is correct. We did have a flattened our own for much of the quarter and we balanced without towards the end of the quarter here when when the curve got extremely inverted in terms of our expectations. We do expect some steepening in the curve, but it's really important to note.
The way the market is priced right now has the is the two year note rallying over the next year by roughly 80 basis points. So theres a lot priced into the curve and if you put a steepening or on in rates for example, and it doesn't meet those those lower rates than then it's not an advantageous trade, but given the fact that.
We do like a steepening bias the best way to play a steepening or normalizing some volatility is long mortgages.
Historically in the absence of a risk on spike in ball type event agency MBS do very well when the curve steepens. So we feel like we have.
That trade on through Levered agency.
And in terms of our outlook for rates.
Given the likelihood of a soft landing and we feel reasonably good about where the rates market is priced.
If you look two years out for example at the forwards the entire curve is priced between three 5%, 4% in treasury. So so rates will come down according to market and we think that's that's.
The likely scenario.
We do expect it to be driven more by normalization of rates from a disinflationary standpoint.
<unk>.
The way, we look at the market right now the range of outcomes has narrowed considerably given where we're at in the cycle runaway inflation is just far less likely now given the data we've seen there are fewer known risks out the horizon.
And yields are still quite attractive, particularly real yields of one 5% on 10 years. So so the market feels pretty good.
But also yields should stay elevated.
We did just experienced this inflation bell.
And we're not just going to go back to where we were 2018 19 or the post crisis period.
Monetary policy is not going to be as active a benefit.
For rates in real rates should stay positive.
We think they're fairly priced right here.
Got it okay very helpful. Thank you.
You bet.
Our next question comes from Doug Harter from Credit Suisse. Please go ahead.
Thanks.
Can you talk about how you're viewing the residential credit.
Credit market and you mentioned that that spreads in Securitizations have improved now.
Spreads still remain volatile and kind of how you're viewing tomorrow.
The market and willingness to kind of balance sheet loans are all waiting for securitizations.
Sure Doug.
As I mentioned in my prepared comments <unk> has had a very good.
Set of performance quarters here.
And it stands to reason housing has done reasonably well.
Better than our expectations and Theres also a scarcity of supply in residential credit. Unlike the agency market. So so we understand why spreads have tightened and to elaborate Mike can jump in here yeah. Thanks, Doug I think in terms of securitization, we we expect to continue to be programmatic.
We just priced a deal that's actually closing today the economics on that deal is at 91% advance to our market value at a blended cost of funds at 178 over to Curt and I'll call. It a 650 cost of funds to an IRR. When we look at that relative to warehouse our warehouse financing is call. It mid high one hundreds high one.
Hundreds so the ability to term out that debt inside of warehouse is certainly something that we think makes sense. So.
<unk> seen issuance this year as lag, we'll say 36 37 billion of total gross issuance within the non agency market. So we do think that the positive technical there should be a tailwind for issuers like ourselves in the second half in terms of spreads continuing to tighten absent any any sort of macro weakness or a risk off so.
We were 20 basis points tighter quarter over quarter, and I think if we came out with a deal today, we would be inside the levels that we just transacted about a week ago.
Great, Thanks, Mike and Ken.
Were looking at Counterparties to kind of by MSR from.
You know in the past you know refinance ability and in the you know the.
Counterparties.
Refinance ability to kind of greatly impacted performance you know I guess, how are you thinking about that in terms of you know who.
Who you're buying from today.
Well thanks for the question.
Counterparties are really important to us from a few perspective on the prepayment speeds.
Being not a competitor with our Counterparties. We can also engage in very specific relationships, where we share in recapture performance with with Counterparties.
And.
We're able to kind of price in the value we capture in a way other participants are not as willing to because of our positioning in the market. So we're an extremely unique participant for the mortgage industry and that again, we're not competing with them, we're partnering with them. So we either place in the value of the recapture.
For sure and the recapture so.
It gets very different from from our peers, yes, one more point credit is also a big consideration on that front, we limit the set of Counterparties that we transact with one durable counter.
Counterparties just in the event that <unk>.
And there is buybacks and things like that.
Makes sense. Thank you.
Thanks, Doug.
Our next question comes from Rick Shane from J P. M. Please go ahead.
Thanks, guys for taking my question.
First of all this is sort of a more big picture question.
You make the observation about spreads eventually tightening but at this point do you really care.
I mean, it's priced into the book value and ultimately is this a secular change that allows you to generate higher returns.
With less leverage or manage risk in different ways.
Yeah, you're exactly right right Rick it is not our preference for spreads to tighten we think they will because of the attractiveness of the asset but to the extent they don't that's perfectly fine for us.
One the assets will continue to generate yields and when we have run off will be reinvested and wider yield so it's not necessarily our preference for spreads to tighten.
Perfect World, we do sit at wider spreads.
<unk> continued to generate the return.
We are generating with low leverage so that's how we look at it.
Got it and then.
The other question says she Serena had made the comment about moving up in coupon.
And we're seeing right now sixes with slight premiums five and a half with slight discounts given.
<unk>.
Ultimate asymmetry to interest rates are you how sensitive to.
Premium or are you and does it make sense to play a little bit lower in the stack. Just so you don't take that risk.
If rates start to move more quickly than expected.
It will upstream jump in here on that one.
You are absolutely right, Brad we like premium coupons, particularly six six and a half since when we can find high quality specs.
A lot of production so.
We have a building that portfolio out slowly.
It's mostly high quality specs rapidly like the basis embedded we like PVH backed by the slightly below that in four and a half and fives.
That's where I think can add or take.
Takeoff basis, very quickly and that's where I think if you look along the forward four announcement fires are closer to par.
Fire lots of pictures that I bought part allowed them to follow us given that the fall with the pricing and the rally and rate.
The lower coupons, we have generally shied away from we think they will still.
Look I try it they will still have very good demand because money managers when they see slower than site.
Try to match the index on the index is the amount of local bonds on the technicals for them are pretty strong.
The cash flow themselves don't look, particularly attractive on those back so the belly coupons has grabbed me by PVH pay found out higher coupon spread we can revise specified pools high quality specified pools.
Great. That's very helpful. Thank you everybody.
Thanks, Rick.
Our next question comes from Matthew Earner from Jones trading. Please go ahead.
Hey, good morning, guys. Thanks for taking the question you mentioned mortgage spreads tightened pretty significantly during the quarter. After the debt ceiling resolution could you provide a explanation and kind of expand what book value is down quarter over quarter. The dividend is reflective of the core earnings.
Yeah.
Sure mortgages did tightened pretty considerably after the debt ceiling episode, but they did widen very materially for the first two months of the quarter. So on balance we were marginally higher I think on a nominal basis five to seven basis points tighter may be and then OAS not quite as tight and there's a little bit.
Hedging costs.
Go along with it.
And also we do carry a positive duration gap.
So the market.
We sold off somewhat in duration.
As is often the case can cost money so.
The fact that I will say given the volatility we experienced.
Fed funds futures went from four <unk> at year end at the beginning of the quarter to five and three eighths. That's a significant move the yield curve flattened 50 basis points on the quarter two's to 10. So there was a lot more volatility there.
Actually occurred I think then.
You see from.
Quarter end.
One two quarter end to end.
I think we I think we manage it quite well and I'll make another observation about the sector as a whole.
Where much of the way through the reporting cycle here, particularly with agency reads.
In light of the volatility that I just mentioned on the quarter. The sector did very well I think the fact of the matter is leverage has been quite responsible and folks have managed interest rate risk reasonably well and now we're actually.
Most likely at the very end of the fed hiking cycle and so the outlook looks a lot more positive and so I think the investor and analyst community should be should be quite optimistic about where the sector sits right now.
The ability to generate strong returns for shareholders.
Awesome. That's helpful color, there and then kind of shifting gears previously you guys had mentioned capital allocation I want to get to 50% on the agency side MSR to 'twenty and then Brad.
Credit to 30.
Is that still the expectation and what is the timing surrounding that.
So that is still the expectation over the longer term and the timing is dependent on on the valuation of assets right now agency certainly looks attractive and we expect this sector to do well. So we're going to remain overweight, but over the next number of years that's the objective.
When things are fairly valued we will continue to gravitate further into both <unk> as well as MSR and this past quarter in MSR.
You'll see an increase in capital allocation given the amount of commitments. We've made that are better forward settling and so youll see that go up and again.
Residential pipeline is.
<unk> healthy and so we're hopeful that we'll grow that.
Responsibly and deliberately.
Awesome. Thank you guys.
You bet Matt.
Our next question comes from violence Abraham from UBS. Please go ahead.
Hey, everybody. Thanks for the question.
On the hedging on the hedge ratio flat quarter over quarter or just how do you think that trends.
Over the over the coming quarters, and do you see yourself being particularly active in implementing anything anything new there.
Yeah. Good question <unk>, so so theres the active component in the passive components.
Start with passive component first actually if you just look at the runoff of the portfolio.
By year end, 15% of our swaps will run off.
Only 6% or thereabouts over the next four months, so theres going to be some passive runoff and the determination will make is that given where we're sitting with respect to.
Monetary policy do we want to let those hedges run off and be a little bit longer in the front end of the yield curve and that is quite likely.
Also if there is if there is.
Meaningful change in either the rates market or the yield curve.
We will absolutely intervene and reflect our views and whether it be steeper flatten or adding duration or taken off duration, we'll absolutely do it but right now we're sitting right at a half a year of duration with a hedge ratio a little bit above 100% all else equal that hedge ratio would go down.
And we think we're fairly balanced as it relates to interest rate risk both in actual duration exposure as well as our curve exposure.
Okay.
Okay got it thats helpful.
And just maybe a bigger picture question on you know on fed policy at the press conference yesterday.
Sure Paul suggested that there could be a scenario, where you see rate cut but.
You know run off on the balance sheet still still occurring just kind of what are your thoughts around that.
That you know how would the market react to that is that priced in to to spreads or any other parts of the market right now.
To hear your thoughts there.
Sure so the scenario where that would occur they're cutting rates well the balance sheet is still running off is likely a disinflationary scenario as opposed to something like a hard landing.
They can actually achieve that objective I know, it's counterintuitive, but they're normalizing both both.
Policy tools getting rates back to what they consider to be neutral.
Inflation does come down below their expectations that we'll likely start next year and they still need to get the balance sheet down to levels that they want to operate right now.
The balance sheet is still quite elevated.
Five trillion treasuries to naturally mortgages made if you look at what we think to be their timing of runoff for when they think that they need to stop stop runoff and start growing again it could be the middle of next year or later and they may need to ease or may it may be warranted. The ease in advance of that so you can do both things at once so long is it.
Not driven by recessionary cuts in which case you'd want to.
Stopped the balance sheet runoff to help the economy and add liquidity to the system now in terms of the share making that statement yesterday.
Relatively good for MBS and the reason being is that we did not expect agency MBS to stop running off when the in Q T. Much like the last iteration of Qt.
We expect to agency MBS to run off and then be reinvested into treasuries. After the end of Q T. If they are cutting rates and still letting the balance sheet runoff theyre also letting treasuries runoff as well beyond the beyond the time that they stopped.
Or are they start reducing rates and so and so that basis trade that could have occurred.
When disinflate disinflationary cuts occur is postponed effectively some generally it's at the margin better for the basis.
Does that help.
Yep.
Thanks, David.
You bet.
Again, if you have a question. Please press Star then one our next question comes from Bose George. Please go ahead.
Hey, guys.
Quick question, just about the hibbett small see MBS portfolio can you just remind me what the exposure is there and is that just an opportunistic portfolio.
Hey, Bose, Yes, I think thats the correct characterization of it we did have a <unk> position that was closed on the quarter. So we no longer have any exposure to <unk>. We don't actually think it's a core asset on a go forward in terms of.
Where we're at now we own AAA CRE CLO.
$340 million.
And we expect that to be opportunistic dependent upon spreads it's an asset.
Re lever, yes, like 96% multifamily at least.
Okay.
Okay, great. Thanks, a lot.
Sure Bose.
This concludes our question and answer session I would like to turn the conference back over to David Finkelstein for closing remarks.
Thank you Scott and thank you everybody for joining US today, we appreciate your participation and I hope everybody has a very good into summer.
The conference has now concluded. Thank you for attending today's presentation you may now disconnect.