Q3 2023 Annaly Capital Management Inc Earnings Call
Good morning, and welcome to the third quarter 2023 conference call for MLT Capital management, all participants will be in a listen only mode should you need assistance. Please signal conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions to ask a question you May Press Star then one on your touch.
Telephone and to withdraw your question. Please press Star then two please note. This event is being recorded I would now like to turn the conference over to Mr. Sean Kensal Director and Investor Relations. Please go ahead Sir.
Good morning, and welcome to the third 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.
A reconciliation of GAAP to non-GAAP measures is included in our earnings release.
Concept referenced in today's call can be found in our third quarter 2023, investor presentation, and third quarter 2023 supplemental information 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, Danielle Deputy Chief investment Officer, and head of residential credit.
We have three new Boston kind 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 thanks for joining us today.
I'll begin with a discussion of the macro and interest rate landscape and then I'll review the current operating environment, including our portfolio activity in positioning now as all are aware the third quarter was characterized by a sharp rise in interest rates as the 10 year Treasury yield rose nearly 75 basis points the.
The move was in part driven by strong economic data the fed's messaging is higher for longer rising commodity prices and the selloff in global yields.
The main driver for higher yields however, there's been a shift in perception around U S government debt that began with the August treasury funding announcement.
It's after increasing issuance following the debt ceiling deal in early June Treasury began to term out debt above market expectations in August all while signaling further increases in coming quarters.
This higher supply it's been met with limited demand as the bank continues to run down its balance sheet. Thanks remained sidelined given the sizeable unrealized losses on their bond portfolios and foreign Central Bank buying has been lukewarm at best.
Consequently money managers pensions and ultimately households for the main source of demand for treasuries and by extension Agency MBS.
However, thus far households are saving less than historical averages savings are largely being allocated to short term fixed income instruments as seen through the record six trillion in money market Mutual fund holdings contributing to the sharp selloff curve steepening in rates markets in recent weeks.
Now as it relates to the broader U S economy growth has been supported by strong consumption. It sound investment activity, while the labor market remains very healthy.
Felicia has continued to moderate looking forward. It appears that a number of headwinds are building for the economy, including household shrinking excess savings geopolitical risks and the tightening of financial conditions as of late however.
However, hard economic data has shown little evidence of a meaningful slowdown thus far.
Now all told higher term premium and the continued elevated volatility contributed to significant underperformance in agency MBS during the quarter, which was exacerbated by a pullback in demand from the money manager community, who remain the primary buyers of MBS.
As a result spreads widen roughly 15 to 20 basis points on the quarter higher coupons outperforming lower coupons as investors sought to optimize carrion duration profiles.
These factors weighed on our performance, resulting in a negative 8.8% economic return for the quarter and our leverage ended Q3 at six four turns.
With respect to portfolio activity the notional value of our agency holdings was relatively unchanged given the flexibility from our reduction in leverage heading into the third quarter. We continued to migrate up in coupon and we favored specified pools over T. B as in order to improve the convexity profile, while benefiting from lower banana.
Zinc costs.
We also grew our agency MBS portfolio by roughly 500 million from a relative value perspective agency C. M. B S provide attractive and stable cash flows without the negative convexity of M. B S not to mention a more favorable technical backdrop.
As it relates to hedging as the hiking cycle comes to an end we anticipated this shift from protecting the front end to protecting long end and therefore over 75% of our hedge duration remain in the 7% to 20 year part of the curve matching our asset duration profile.
We were active in adding longer and treasury futures early in the quarter and also to note is front end swaps matured. We replaced a portion of those hedges further out the curve, we anticipate will reach a point in the near future, where it will be advantageous to add interest rate exposure, but for the time being we remain conservatively positioned.
L M. B S valuations look very attractive relative to other high quality fixed income alternatives as well as on a standalone basis, which we expect will improve investor sentiment and help to normalized spreads over the medium term. However, our intention is to remain disciplined in terms of managing leverage is M. B S find their equilibrium in the current environment.
Turning to residential credit spreads across the sector were resilient during the quarter driven by limited issuance supportive housing fundamentals and is still generally healthy borrower.
Benchmark CRT below investment grade spreads tightened 50 to 70 basis points on the quarter and AAA non QM spreads were flat to 10 basis points tighter with non QM securitization cost of bonds relatively stable.
Resi portfolio ended the quarter at $5 3 billion in market value of approximately 315 million predominantly attributable to an increase in our whole loan portfolio. As we settled one 5 billion of expanded credit loans in the third quarter of which 80% was sourced directly from our correspondent channel.
The continued expansion and beyond so bay corresponded channel allowed us to more than double our Q2 old loan production, while maintaining our conservative lending standards Q3 settlements are characterized by a 752 average FICO, 69% LTV and limited layered risk our securitization platform issue too.
Non QM transactions totaling $812 million during the quarter, which generated 98 million of retained assets and post quarter end, we closed another non QM deal continuing our programmatic issuance, while locking in term financing and generating a mid teens Roe.
Now I'll be X remains the largest nonbank securitizers of new origination collateral with 2023 year to date issuance of nearly $4 billion and with over $3 5 billion of dedicated facilities across Italy, and our joint venture we can efficiently finance, our whole loan position be a securitization or warehouse financing, which Serena will expand.
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Now lastly, within mortgage servicing rights, our portfolio grew by $90 million in the third quarter and 480 million year to date ending September at $2 3 billion in market value and 153 billion in principal balance and Onslow Bay is now a top 10 nonbank servicer servicing roughly two.
Sent at the agency market, while both trading levels declined on the quarter. The MSR market remains active and we expect supply to be elevated over the next few quarters given broad activity in the sector and continued pressure on non bank originator profitability.
We've discussed in the past <unk> uniquely positioned to acquire MSR from originators, given our certainty of capital as well as our noncompetitive business strategy now.
Our holdings continue to benefit from our low low rate high credit quality asset profile, which drove the expansion of our valuation multiple on the year. Our MSR cash flows remain highly stable as evidenced by below four CPR prepayment speeds and minimal delinquencies, both consistent with the prior quarter.
Capital allocation MSR as of quarter end was 19%, which brings us close to our long term target allocation, though we maintain capacity did increase our holdings further given minimal leverage currently and our additional warehouse capacity.
We've also expanded our MSR acquisition capabilities and we can now participate in GSE flow programs to supplement our bulk ex execution strategy when attractively priced.
Now before handing it off to Serena I wanted to provide one final note as it relates to where we sit today yields and notably real yields are at their most attractive levels in more than 15 years and agency MBS spreads are historically wide, our residential credit and MSR strategies are fully scaled and established leaders in their respective.
Sectors and provides strong complementary returns to our core agency business as has been exhibited over the recent past now given the interest rate and spread backdrop in similar periods throughout this company's history and Lee has generated very strong returns and we have the size scale and liquidity to successfully navigate this environment.
Ironman and capitalize on opportunities as they arise and now with that I'll hand, it over to Serena to discuss the financials.
Thank you David can I will provide brief financial highlights for the quarter and nine months period that ended September 32023.
Consistent with past what is Wow earnings release, discloses GAAP and non-GAAP earnings metrics. My comments will focus on our non-GAAP E. A D and related key performance metrics, which exclude P. I E.
Cheetah factor as David mentioned earlier, our book value per share for Q2, a decrease from the prior quarter to eight.
$18.25 and without a third quarter dividend of 65 cents.
We generated an economic return for the quarter, a negative 8.8% and negative 2.8%. So that first nine months of the year.
The increase in rates in the quarter I drive gains now hedging portfolio of roughly $3.76.
MSR book at 16 cents.
While spread widening and increased volatility significantly impacted our agency portfolio, resulting in losses of approximately $6.16 for the quarter.
Additionally, I already kind of assets were down 24 cents for the quarter, primarily related to mark to market changes on the portfolio.
We generated earnings available for distribution of <unk> 66 cents per share for the third quarter.
Even with the prior quarter E. D was adversely impacted by the continued rising repo expense.
Our portfolio positioning and have now average yield ex PAA, which rose again quarter over quarter 24 basis points higher than the prior quarter at $4 four 6%.
Yields also improved by nine basis points due to lower amortization with long term C. P as decreasing from $8 six in Q2, two 7.1 in the third quarter.
Impacted by the same factors as E. D. NIM declined 18 basis points from Q2 to a 148 basis points of NIM ex PAA in the third quarter.
Net interest spread declined 27 basis points quarter over quarter to 1.18% versus 1.45% in Q2 as the rate increases on our financing agreements modestly exceeded the increase in asset yields.
The aforementioned rising repo rates impacted at a total cost of funds for the quarter rising by 51 basis points to 328 basis points in Q3, and now average repo rates in the quarter was 544 basis points compared to 515 basis points in the prior quarter.
The beneficial impact of swaps on the cost of funds was tempted in Q3 due to the maturity of certain contracts, resulting in the net interest component of the interest rate swaps declined by 7% to approximately $395 million for the quarter compared to 425 million in Q2.
Now turning to details on financing funding market remain ample and liquidity, we continue to see strong demand for funding for our agency and non agency securities portfolios.
Our financing strategy is consistent with prior quarters, and our Q3 reported weighted average repo days were 52 days.
From 44 days in Q2.
As we look to find the opportunistic longer term trade in the market, adding $2 5 billion of floating rate repo with turns exceeding 12 months during the quarter.
We continued our disciplined approach to adding and extending existing warehouse capacity for our credit businesses during the quarter.
As I previously mentioned the appetite for credit by Linda has also been robust and we renewed two facilities for approximately 700 million upsizing, one facility by $100 million since the beginning of Q3 tightest spreads decipher and improved advance rates.
We continue to expand our suite of financing options available to us and have various additional funding initiatives underway to keep or and beyond to both already in MSR businesses.
As at the end of Q3, the $1 8 billion of unused warehouse capacity of course that ready credit and MSR financing facilities, providing us with a very comfortable liquidity position for these businesses.
Impacted by the volatility experienced during the third quarter, our liquidity profile decline compared to prior quarters.
However remained healthy with unencumbered assets of $4 7 billion compared to $6000 in Q2, including cash and unencumbered agency assets of $2 8 billion for the quarter.
The decrease in unencumbered assets, primarily came from higher on balance sheet leverage for agency MBS securities offset by 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 Touchtone phone if youre using a speakerphone. Please pick up your handset before pressing the keys if at any time. Your question has been addressing you would like to withdraw. Your question. Please press Star then two and at this time I'll pause momentarily to assemble our roster.
And the first question will come from Bose, George with a B W. Please go ahead.
Everyone. Good morning machine can I get an update for our book value quarter to date.
Sure Bose good morning, So I have as of Tuesday evening, which was up 11% for the quarter. So we're still trading well below book value.
Okay, great. Thanks, and then just switching to your MSR, so that 19% of capital can you just talk about the lever.
Unlevered yield and I get the Levered yield now that you had some asset level leverage and how large do you think you have it.
As far as could get just given the opportunity up looks pretty attractive over the next year.
Sure I'll start with the capital allocation and Kim can talk about returns. So as we show we have a third or about a third of a turn of leverage on the MSR and what we've talked about in the past is that with the current composition of our MSR, which is deep deep out of the money and relatively benign cash flows you can apply lever.
<unk> to that and so the way we think about it is you could incorporate a turn of leverage into that and if we did it today. If we did that today you'd have roughly 1.15 billion in capital.
115 billion of debt, so that would be much lower capital allocation and so as a consequence thinking about it through that lens, we do have capacity to increase the MSR portfolio should the opportunity arise and we have ample warehouse capacity to do so with that Jim can talk about returns yes sure.
Sure Rick.
Turns on the sort of MSR, we've been participating in our unlevered basis are in.
In the nine 5% to 10% range.
Eddy, adding leverage to that and we get to the uptick.
<unk> 2014 sort of sort of level.
More generic MSR as higher stated returns because there's more negatively convex.
Okay.
Okay, great. Thanks very much.
Thanks Bose.
The next question will come from Crispin Love with Piper Sandler. Please go ahead.
Thanks, Good morning, everyone. I appreciate you taking my questions.
First off can you speak to how you and the board or thinking about the dividend right. Now we have earnings coverage right now on the dividend the dividend yield and yield on book value has increased as well.
It's been under pressure.
That's all the same reasons that warranted your last decrease in the dividend earlier. This year. So I'm curious on how are you and the board of balancing earnings coverage plus a higher dividend yield on book value and then what all those mean for the sustainability of the dividend.
Sure Kristen so as we've talked about in the past the board evaluates our dividend every quarter and we have three criteria by which we said it we want it to be a competitive dividend yield with peer set.
Should be consistent with our historical payout.
It should be sustainable to the extent, we have line of sight into earnings.
In the future now.
You mentioned, we did modestly out earn our dividend in the third quarter in terms of Q4, we expect <unk> to.
B contextual with the dividend.
And that a lot depends on for example, how the fed behaves.
Other factors and we don't have.
<unk> beyond 2023, but rest assured it's always a conversation or a.
For our board.
We feel good about this quarter.
Thanks, David I appreciate the comments there and David you you made some comments earlier in the call about our agency MBS valuations looking attractive and how our investor sentiment should improve here and we could see some tightening over the medium term I'm curious if you could just expand on that a little bit what type of Titan.
And do you think would make sense or said differently. How far do you think we are from fair value and kind of.
What do you mean by medium term and how long that could be just given the rate volatility we're seeing currently.
Yes, that's a great question Kristen so.
As I mentioned in the prepared remarks, we are reliant on the money manager community to be the support for agency MBS, obviously that said its running off the portfolio and bank Sir on the sidelines. So a lot will depend on flows in the money.
The money managers and one of the considerations that I think will be with <unk>.
Wired for consistent durable flows is a decrease in volatility and hopefully an end to the fed hiking cycle, but with levels of current volatility in the market. We do think there should be some tightening just given where it historically wide levels and we think thats fair value would be roughly 20 basis points tighter than the current led.
And shouldn't volatility decline than you would expect to see even more incremental tightening from there but look good.
It's an uncertain time there.
There is still a lot of volatility in the technicals are somewhat daunting in so far as.
Banks and the fed obviously net sellers, so we're being patient we're managing leverage judiciously.
We're optimistic on mortgages, but we've got to be disciplined here.
Thanks, David appreciate you taking my questions.
We've got Christian.
The next question will come from Trevor Cranston with JMP Securities. Please go ahead.
Hey, Thanks, good morning.
Follow up to the comments you made about the book value movements, so far in October.
Can you comment on any changes you've made alongside that to the to the portfolio.
Unknown Executive: Good morning and welcome to the third quarter 2023 conference call for Annaly Capital Management. All participants will be in a listen only mode. Should you need assistance, please signal conference specialists by pressing the star key followed by zero.
Yeah.
Our asset composition or the size of the agency book.
And also maybe comment on where your leverage demonstrate thanks.
Unknown Executive: After today's presentation, there will be an opportunity to ask questions. To ask a question you may press star than one on your touch tone phone. And to withdraw your question, please press star than two. Please note this event is being recorded.
Sure. So look we are very disciplined when it comes to managing liquidity and leverage and so as a consequence, we have reduced the portfolio to maintain leverage consistent actually even maybe a tiny bit.
Sean Kensil: I would now like to turn the conference over to Mr. Sean Kensil, director and investor relations. Please go ahead, sir.
Lower than we ended the fourth quarter.
David Finkelstein: Good morning and welcome to the third quarter 2023 earnings call for Annaly 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 made different 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.
No.
Oh, sorry per quarter.
Yep Yep Yep.
So we manage leverage we sold assets but.
We feel good about where the portfolio sits particularly from a liquidity standpoint now.
Okay great.
And then obviously you guys have been pretty successful growing the non agency conduit.
Can you talk generally about how you think the movement higher in rates.
David Finkelstein: Additionally, the content of this conference call may contain time sensitive information that is accurate only as of the date here of. We do not undertake and specifically display any obligation to update or revise this information. During this call, we may present both gap and non-gap financial measures. A reconciliation of gap to non-gap measures is included in our earnings release. Content reference in today's call can be found in our third quarter 2023 investor presentation and third quarter 2023 supplemental information, both found under the presentation section of our website. Please also note this event is being recorded.
What will impact that business sort of over the coming couple of quarters.
Yeah. So I'll start and then Mike handed off but we've been very pleasantly surprised with the growth in the correspondent channel, particularly as mortgage rates have increased.
<unk> and.
Originations have slowed quite a bit but the.
The fact of the matter is we have taken a lot of market share we've expanded our partnerships across the originator community and it's been it's been a welcome.
Development for the <unk>.
Rescue business and Mike you want to add to that sure. Thanks for the question Trevor I think in terms of kind of where we're at with the corresponding build.
David Finkelstein: Participants on this morning's call include David Finkelstein, Chief Executive Officer and Chief Investment Officer, Serena Wolfe, Chief Financial Officer, Mike Sania, Deputy Chief Investment Officer and Head of Residential Credit. V. S.
Probably 65% to 70% there we have a 180 approved correspondence we have 30 to 40 of correspondents that are in our pipeline that want to be Oswald they approved sellers.
David Finkelstein: Renevathan, Head of Agency and Ken Adler, Head of Mortgage Femrething Rights.
So I think the stability of our capital the stability of our operations.
David Finkelstein: And with that, I'll turn the call over to David. Thank you Sean.
Operations with our counterparts I think over the last number of years have led our reputation that.
David Finkelstein: Good morning everyone and thanks for joining us today. I'll begin with the discussion of the macro and interest rate landscape and then I'll review the current operating environment, including our portfolio activity and positioning. It was all over where the third quarter was characterized by a sharp rise in interest rates as the 10-year Treasury yield rose nearly 75 basis points. The move was in part driven by strong economic data, the Fed's messaging of higher for longer, rising commodity prices and the sell off in global yields.
Net debt to be involved in this market being involved console day, it's something that makes sense in terms of momentum.
We had over $900 million blocks in August we had over $800 million of locks in September and I think in October, we'll probably have close to $750 million to $800 million blocks.
Lot of that volume.
Ultimately as coming from gaining market share, but a lot of it also too is we have a number of exclusive relationships with very large non bank originators that don't partner with you now.
David Finkelstein: The main driver for higher yield, however, has been a shift in perception around US government debt that began with the August Treasury Refunding Announcement. As after increasing issuance following the debt ceiling deal in early June, Treasury began to term out debt above market expectations in August, all while signaling further increases in coming quarters. This higher supply has been met with limited demand as the Fed continues to run down its balance sheet.
That broaden the universe itself I'd say synergies with the MSR portfolio, our MSR business buying MSR from a number of these counterparties also helps on that.
On the relationship on the correspondent side and.
And lastly, I'll say that the borrower is a little bit different borrower than the conforming market I think on the conforming side about 90% of the volume right. Now is purchase what we are seeing through our correspondent channel about 20% is cash out at 10% is still a rate and term refi them sell it it is less dependent on the purchase market which is at.
David Finkelstein: Thanks for made sideline given the sizable unrealized losses on their bond portfolios, the foreign central bank buying has been lukewarm at best. Consequently, money managers, pensions and ultimately households are the main source of demand for treasuries and by extension agency MBS. However, thus far, households are saving less than historical averages and savings are largely being allocated to short-term fixed income instruments, best seen through the record $6 trillion in money market mutual fund holdings, contributing to the sharp sell-off, incurred steepening in rates markets in recent weeks.
You know close to close to 30 year lows.
Okay very helpful. I appreciate the color. Thank you.
Thank you Trevor.
Next question will come from Rick Shane with J P. M. Please go ahead.
Good morning, everybody.
There were some comments about our incremental investments.
Agency MBS business.
And when we look at slide six.
It's actually the economic returns art mentioned, there I'm curious if you could help us understand that a little bit better I'm, assuming the attractiveness is the lack of prepayment optionality and.
David Finkelstein: Now, as it relates, the broader U.S, economy growth has been supported by strong consumption and sound investment activity while the labor market remains very healthy. Inflation is continued to moderate and looking forward, it appears that a number of headwinds are building for the economy, including household shrinking excess savings, geopolitical risks, and the tightening and financial conditions as of late. However, hard economic data has shown little evidence of a meaningful slowdown thus far.
The lack of negative convexity that.
E C. On the agency book at this point can you just sort of walk through how you approach that business a little in more detail.
Hi, This is Jamie thanks for the question.
Basically agency MBS, it's almost like a bullet cash flow and it spreads north of 110 basis points.
David Finkelstein: Now, all told, higher-term premium and the continued elevated volatility to contribute to significant underperformance and agency MBS during the quarter, which was exacerbated by a pullback in demand from the money-manager community who remained the primary buyers of MBS. As a result, spreads widen roughly 15 to 20 basis points on the quarter, with higher coupons outperforming lower coupons as investors sought to optimize carry-in duration profiles. These factors weighed on our performance resulting in a negative 8.8% economic return for the quarter, and our leverage ended Q3 at 6.4 turns.
All of that it's like Oh, yes.
So hello, and 10 basis points of our strategy is there like a seven times leverage it.
It gets you to about a plus 10%.
Mid to high teens.
But the advantage of that or what MBS is just that you don't have slipped as you generally tend to arm the entire amount.
If you could just go back to your spreads were at 15 basis points. So this is a pretty attractive level.
While our cash flow that is a very embedded optionality or very little risk yeah, and also as I mentioned rig the technical landscape for agency MBS better than agency MBS.
David Finkelstein: With respect to portfolio activity, the notional value of our agency holdings was relatively unchanged, given the flexibility from our reduction in leverage heading into the third quarter. We continued to migrate up in coupon, and we favored specified pools over TBAs in order to improve convexity profile while benefiting from lower financing costs. We also grew our agency's CNBS portfolio by roughly 500 million from a relative value perspective. The agency's CNBS provided tract and unstable cash flows without the negative convexity of MBS, not to mention a more favorable technical backdrop.
Got it.
Is that consistent with your strategy of hedging further out on the curve or is it coincide I guess tied to because of the longer more predictable duration of the agency M. C. MBS.
I think we all buy it if you see I guess, we think of it as buying it on a swap basis. So.
Hedge the duration gap lately on the dollar swap basis.
Okay.
Okay, and what what are the what are the durations that you're assuming associated with them. Just so we understand how to think about how that's going to impact the hedge book.
David Finkelstein: As it relates to hedging, as the hiking cycle comes to an end, we anticipated the shift from protecting the front end to protecting the long end, and therefore over 75% of our hedge duration remained in the 7 to 20-year part of the curve, matching our asset duration profile. We were active in adding longer and treasury futures early in the quarter, and also to note, as front end swaps matured, we replaced a portion of those hedges further out the curve.
Uh huh.
The rationale of this will be right around eight years, they embraced epileptic tenure treasury and cash flows.
Terrific.
Go ahead.
Thank you Rick.
Thanks, guys.
The next question will come from Eric Hagen with B T. I D. Please go ahead.
David Finkelstein: We anticipate we'll reach a point in the near future where it will be advantageous to add interest rate exposure, but for the time being, we remain conservatively positioned. Now, MBS valuations look very attractive relative to other high-quality fixed-income alternatives, as well as on a standalone basis, which we expect will improve investor sentiment and help to normalize spreads over the medium term. However, our intention is to remain disciplined in terms of managing leverage, as MBS find their equilibrium in the current environment.
Hey, good morning, how are you doing.
So first question here I mean, how are you guys feeling about the shape of the capital structure.
Just the mix of common and preferred.
How much leverage the common stock you're willing to tolerate this spread levels.
Yeah.
Look we entered this period with very little capital structure leverage we averaged around 12%, 13% of our capital and preferreds with common deterioration, we're up to 15%.
David Finkelstein: Atturning to residential credit, spreads across the sector will resume entering the quarter, driven by limited issuance, supportive housing fundamentals, and is still generally healthy borrower. Benchmark CRT, below investment grade spreads, tighten 50 to 70 basis points on the quarter, and AAA 9QM spreads were flat to 10 basis points tighter, with 9QM securitization cost of funds relatively stable. A REZI portfolio ended the quarter at 5.3 billion in market value, up approximately 315 million, predominantly attributable to an increase in our whole loan portfolio, as we settled 1.5 billion of expanding credit loans in the third quarter, but which 80% was sourced directly from our correspondent channel.
Which is still quite low certainly relative to to the sector and particularly when you consider.
The alternative.
Businesses that are less levered from a balance sheet standpoint, and the way we look at it is we do have a floating rate preferreds, obviously now and the fact that the curve steepened as much as it is is it did the cost of the preferreds on a forward basis Didnt increase much at all while.
The asset side of the equation actually became a lot more ample and so from a cost of capital standpoint preferred actually looks more reasonable today than it did say at the end of the second quarter, we do have capacity to increase it but that market has been closed really theres been a couple of bank deals.
David Finkelstein: The continued expansion of the Onzel Bay Corp, channel allowed us to more than double our Q2 whole loan production while maintaining our conservative lending standards. Q3 settlements are characterized by a 752 average fight go, a 69% LTV and limited layered risk. Our securitization platform issued two non-QM transactions, totaling 812 million during the quarter, which generated 98 million of retained assets. In post-quarter M, we closed another non-QM deal continuing our programmatic issuance while locking in term financing and generating a mid-teens ROE.
Not much else to.
To the extent, we can reap by at some point, we would look at it but it's.
It's not there now.
And we'll see how that market develops.
Right no. That's helpful. Thanks, and so how are we also thinking about hedging your cost of funds at the short end of the yield curve.
If it looks like the fed.
Could really cut rates next year.
To get embedded into the forward curve, even more thank you guys very much.
Yeah, you bet, Eric So we're keeping our repo profile relatively short we do think although there is a third of a probability of another hike. We think it's somewhat unlikely and so we're kind of pivoting to a point, where the next move to your point.
David Finkelstein: Now, OBX remains the largest non-banked securitizer of new origination collateral with 2023 year-to-date issuance of nearly 4 billion. And with over 3.5 billion of dedicated facilities across Annaly and our joint venture, we can efficiently finance our whole loan position via securitization or warehouse financing, which Serena will expand on. Now, lastly, within mortgage servicing rights, our portfolio grew by 90 million in the third quarter, and 480 million year-to-date ending September at 2.3 billion in market value, and 153 billion in principal balance.
B cuts and so we're managing it very nimbly in most of our focus is on hedging out the curve because we do think that's that's really where the risk is given just the amount of supply coming to the market, particularly from from the Treasury market next year I think there is projected to be $1 seven trillion in net charge.
Re issuance and then you also have fed run off to the tune of $900 billion between treasuries and agency MBS. So a lot of the focus is out the curve as you see in the changing composition of our hedge profile quarter over quarter.
David Finkelstein: And Onzel Bay is now a top 10 non-banked servicer servicing roughly 2% of the agency market. While bolt trading levels declined on the quarter, the MSR market remains active, and we expect supply to be elevated over the next few quarters, given broad activity in the sector, and continued pressure on non-banked originator profitability. As we've discussed in the past, Annaly is uniquely positioned to acquire MSR from originators, given our certainty of capital, as well as our non-competitive business strategy.
Alright, Thank you guys very much.
You bet Eric.
Again, if you have a question. Please press Star then one our next question will come from Matthew <unk> with Jones trading. Please go ahead hey, good.
Good morning, guys. Thanks for taking my question. David You just mentioned the composition of the hedge portfolio could you talk a little more about the added Houston of futures and kind of if you are still sitting in that 7% to 20 year part of the curve there.
David Finkelstein: Now, our holdings continue to benefit from our low-no rate, high-credit quality asset profile, which drove the expansion of our valuation multiple on the year. Our MSR cash flows remain highly stable, as evidenced by below-four CPR prepayment speeds and minimal delinquencies, both consistent with the prior quarter. Our capital allocation MSR as of quarter-end was 19%, which brings us close to our long-term target allocation, though we maintain capacity to increase our holdings further, given minimal leverage currently, and our additional warehouse capacity. We've also expanded our MSR acquisition capabilities, and we can now participate in GSE flow programs to supplement our bulk execution strategy when attractively priced.
Yes, we are so in terms of the additions.
Futures.
Look at the end of the day the way we looked at it was we wanted the liquidity of the futures market.
We wanted to add hedges, we did a lot of that early in the quarter.
Our composition of hedges was underway futures relative to where we have historically been.
So now we're up to 24% of the hedges in futures, which we're comfortable with and now one point to note is that.
Swaps have generated.
Really the vast majority of income just given the shape of the curve and you don't get that benefit from futures and so it does it does.
David Finkelstein: Now, before handing it off to Serena, I wanted to provide one final note as it relates to where we sit today. Yields and notably real yields are at the most attractive levels in more than 15 years, and agency MBS spreads are historically wide. Our residential credit and MSR strategies are fully scaled and established leaders in the respective sectors and provide strong complimentary returns to our core agency business, as has been exhibited over the recent past.
And to some extent, but we're okay with that.
Gotcha, and then do you expect the kind of increased or decreased futures are you guys kind of comfortable at the level that you're at right now.
So we will see how the market evolves, but we're comfortable with where we're at.
Thank you.
Thank you Matt.
This concludes our question and answer session I would like to turn the conference back over to Mr. David David Finkelstein for any closing remarks. Please go ahead Sir.
David Finkelstein: Given the interest rate and spread backdrop in similar periods throughout this company's history, and we has generated very strong returns, and we have the size, scale, and liquidity to successfully navigate this environment and capitalize on opportunities as they rise.
Thank you Chuck and thanks for joining us today and good luck everyone.
The conference has now concluded. Thank you for attending today's presentation you may now disconnect.
Serena Wolfe: And now with that, I'll hand it over to Serena and discuss the financials. Thank you, David. Today, I will provide brief financial highlights for the quarter and nine months period that ended September 30, 2023.
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Serena Wolfe: Consistent with prior quarters, while I'll only truly disclose this gap and non-gap earnings metrics, my comments will focus on our non-gap EAD and related key performance metrics which exclude PAA. Due to factors David mentioned earlier, our book value per share for Q3 decreased from the prior quarter to $18.25. And with our third quarter dividend of 65 cents, we generated an economic return for the quarter of negative 8.8% and negative 2.8% for the first nine months of the year.
Okay.
Yeah.
Okay.
Yeah.
Serena Wolfe: A further increase in rates for the quarter drove gains now hitting portfolio of roughly $3.76. And our MSR book of 16 cents. While spread widening and increased volatility significantly impacted our agency portfolio, resulting in losses of approximately $6.16 for the quarter. Additionally, our credit assets were down 24 cents for the quarter, primarily related to market market changes on the portfolio. We generated earnings available for distribution of 66 cents per share for the third quarter.
Serena Wolfe: Consistent with the prior quarter, EAD was adversely impacted by the continued rising repo expense. Our portfolio positioning enhanced our average yield expAA, which rose again quarter of a quarter, 24 basis points higher than the prior quarter at 4.46%. Yields also improved by nine basis points due to lower amortization, with long-term CPRs decreasing from 8.6 in Q2 to 7.1 in the third quarter. Impacted by the same factors as EAD, NIM declined 18 basis points from Q2 to 148 basis points of NIM expAA in the third quarter.
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Serena Wolfe: Net interest spread declined 27 basis points quarter over quarter, to 1.18% versus 1.45% in Q2, as the rate increases on our financing agreements modestly exceeded the increase in asset yields. The asset mentioned rise in repo rates, impacted our total cost of funds for the quarter. Rising by 51 basis points to 328 basis points in Q3, and our average repo rate to the quarter was 544 basis points compared to 515 basis points in the prior quarter.
Serena Wolfe: The beneficial impact of swaps on the cost of funds was tempted in Q3 due to the maturity of certain contracts, resulting in the net interest component of interest rate swaps declining by 7% to approximately 395 million for the quarter compared to 425 million in Q2.
Serena Wolfe: Now turning to details on financing, funding markets remain ample and liquid. We continue to see strong demands for funding for our agency and non-agency security portfolios. Our financing strategy is consistent with prior quarters, and our Q3 reported weighted average repo days were 52 days, up from 44 days in Q2. As we look to find opportunistic longer term trades in the market, adding 2.5 billion of floating rate repo with terms exceeding 12 months during the quarter.
Serena Wolfe: We continue to our discipline approach to adding and extending existing warehouse capacity for our credit businesses during the quarter. As we previously mentioned, the appetite for credit by Lenders has also been robust, and we renewed two facilities for approximately 700 million, upsizing one facility by 100 million, since the beginning of Q3 at tie-dispreads to sofa and improved advanced rates. We continue to expand our suite of financing options available to us and have very traditional funding initiatives underway to keep all and beyond for both our REZI and MSR businesses.
Serena Wolfe: As of the end of Q3, the 1.8 billion of unused warehouse capacity across our REZI credit and MSR financing facilities provided us with a very comfortable liquidity position for these businesses. Impacted by the volatility experience during the third quarter, our liquidity profile decline compared to prior quarters. However, it remained healthy with unencumbered assets of 4.7 billion compared to 6 billion in Q2, including cash and unencumbered agency assets of 2.8 billion for the quarter. The decrease in unencumbered assets primarily came from higher on-dology leverage for agency MBS securities, offset by MSR purchases during the quarter.
Unknown Executive: That concludes our prepared remarks, and we will now open the lines of questions. Thank you operator. Thank you.
Unknown Executive: We will now begin the question and answer session. To ask a question, you may press addressing the keys. If at any time your question has been addressing, you will like to withdraw your question. Please press star then two.
Unknown Executive: And at this time, we'll pause momentarily to assemble our roster.
Bose George: And the first question will come from both George with ABW. Please go ahead. Hi everyone, good morning.
David Finkelstein: Actually, can I get an update for book value quarters today? Here goes, good morning. So I have as of Tuesday evening, which was off 11% for the quarter, so we're still trading well below book value. Okay, great. Thanks.
David Finkelstein: And then just switching to your MSR. So it's not 19% of capital. Can you just talk about the unlevered yield? And I get the levered yield now that you have some asset level leverage and how large do you think the MSR could get just given the opportunity it looks pretty attractive over the next year? You're all start with the capital allocation and can can talk about returns. So as we show, we have a third of a third of a turn of leverage on the MSR.
David Finkelstein: What we talked about in the past is that with the current composition of our MSR, which is deep, deep out of the money and relatively benign cash flows, you can apply leverage to that. And so the way we think about it is you could incorporate eternal leverage into that. And if we did today, if we did that today, you'd have roughly 1.15 billion in capital and 1.15 billion in debt. So that would be a much lower capital allocation. And so as a consequence, thinking about it through that lens, we do have capacity to increase the MSR portfolio should be up to your rise. And we have ample warehouse capacity to do so.
David Finkelstein: And with that, we can't can talk about returns. Yeah, sure. Returns on the sort of MSR we've been participating in our unlevered basis are in the 9.5 to 10% range and adding leverage to them. We get to the up to 12 to 13 sort of level. More generic MSR has higher stated returns because there's more that we can back. Thank you very much.
Crispin Love: The next question will come from Crispin Love with Piper Sandler. Please go ahead. Thanks, good morning everyone, I appreciate you taking my questions.
David Finkelstein: First off, can you speak to how you and the board are thinking about the dividend right now? We have earnings coverage right now on the dividend, but the dividend yield and yield on both value as increased as both I has been under pressure. And those are the same reasons that warranted your last decrease in the dividend earlier this year. So curious on how you and the board are balancing earnings coverage plus a higher dividend yield on book value and then what all those mean for the sustainability of the dividend.
David Finkelstein: As we talked about the past board evaluates our dividend every quarter and we have three criteria by which we set it. We wanted to be a competitive dividend yield with peer set. It should be consistent with our historical payout and it should be sustainable to the extent we have line of sight into earnings in the future. Now, as you mentioned, we did modestly out earn our dividend in the third quarter. In terms of Q4, we expect EAD to be contextual with the dividend beyond that.
David Finkelstein: A lot depends on, for example, how the Fed behaves and other factors. And we don't have guidance beyond 2023, but rest assured it's always a conversation for a board. And we feel good about this quarter. Thanks, David. I appreciate the comments there.
David Finkelstein: And David, you made some comments earlier in the call about agency MBS valuations looking attractive and how investor sentiment should improve here and we could see some tightening over the medium term. I'm curious if you could just expand on that a little bit. What type of tightening do you think would make sense or said differently? How far do you think we are from fair value and what do you mean by medium term and how long that could be just given the rate volatility we're seeing currently?
David Finkelstein: Yeah, that's a great question, Chris. So as I mentioned in the prepared remarks, we are relying on the money manager community to be the support for agency MBS, obviously the Fed's running off their portfolio and banks are on the sideline. And so a lot will depend on flows in the money managers and one of the considerations that I think will be required for consistent durable flows is a decrease in volatility and hopefully an end to the Fed hiking cycle.
David Finkelstein: But with levels of current volatility in the market, we do think there should be some tightings just given where it's historically wide levels and we think a fair value would be roughly 20 basis points tighter than the current level and should volatility decline than you would expect to see even more incremental tightening from there. But look, it's an uncertain time. There is still a lot of volatility and the technicals are somewhat daunting so far as banks in the Fed obviously net sellers.
David Finkelstein: So we're being patient, we're managing leverage judiciously and we're optimistic on mortgages, but we got to be disciplined here.
Unknown Executive: Thank you for taking my questions. You're that Christian.
Trevor Cranston: The next question will come from Trevor Cranston with JMP Securities. Please go ahead. Hey, thanks. Good morning. Follow up to the comments you made about the book value movement so far in October. Can you comment on any, you know, changes you made alongside that to the portfolio in terms of, you know, asset composition. I'm sure I know the size of the agency book and and also maybe comment on on where your leverage stands today. Thanks.
David Finkelstein: Sure. So, look, we are very disciplined when it comes to managing liquidity and leverage. And so as a consequence, we have reduced the portfolio to maintain leverage, consistent, actually, even maybe a tiny bit lower than we ended the fourth quarter. So I help. So we manage leverage. We sold assets, but we still good about where the portfolio sits, particularly from liquidity standpoint now.
Mike Sania: Okay, great. And then obviously, you know, you guys have been pretty successful growing the non agency conduit. Can you talk generally about how you think the movement higher rates will impact that business sort of over the common couple of quarters. Yes, all starting and Mike and handed off. We've been very pleasantly surprised with the growth in the corresponded channel, particularly as mortgage rates have increased and and. The originations have slowed quite a bit, but the fact of the matter is we have taken a lot of market share.
Mike Sania: We've expanded partnerships across the originator community and it's been, it's been a welcome development for the resident business and might want to add to that. Sure. Thanks for the question, Trevor. I think in terms of kind of where we're at with the correspondence bill, you know, we're probably 65 to 70% there. We have 180 approved correspondence. You know, we have 30 to 40 correspondence that are in our pipeline that want to be on the approved sellers.
Mike Sania: So I think the stability of our capital, the stability of our operations with, you know, our counterparts. I think over the last number of years have led our reputation that, you know, that to be involved in this market, being involved on both days, something that makes sense. In terms of momentum, you know, we had over 900 million of locks in August. We had over 800 million of locks in September and I think in October will probably have close to 750 to 800 million of locks.
Mike Sania: A lot of that volume ultimately is coming from gaining market share, but a lot of it also too is we have a number of exclusive relationships with very large non bank originators that don't partner with, you know, that that brought to the universe. So I think synergies with the MSR portfolio or MSR business, buying MSR from a number of these counterparties also help on the, on the relationship on the correspondence side.
Mike Sania: And lastly, I'll say that the borrower is a little bit different borrower than the conforming market. I think on a conforming side, about 90% of the volume right now is purchased. What we are seeing through our correspondent channel, about 20% is cash out, at 10% is still rate in term refi. So it is less dependent on the purchase market, which is at, you know, close to close to 30 year lows.
Mike Sania: Okay, very helpful. Appreciate the color. Thank you.
Unknown Executive: Thank you, Trevor.
Ken Adler: The next question will come from Rick as Shane with JPM. Please go ahead. Good morning, everybody. There were comments about incremental investments in the agency, agency, CNBS business. And when we look at slide six, it's actually the economic returns aren't mentioned there. I'm curious if you could help us understand that a little bit better. I'm assuming the attractiveness is the lack of prepayment optionality and the lack of negative convexity that you see in the agency book at this point. Can you sort of walk through how you approach that business a little in more detail?
Ken Adler: Hi, this is Shrinie. Thanks for the question. Basically, agency CNBS is almost like a bullet cash flow and it spreads north of 110 basis points. You will earn all of that. It's like OAS for MBS. So at 110 basis points of strategy, as you like, a seven times leverage, it gets you to about so for plus 10%. That's in the high, mid to high teams. But the advantage of that over MBS is just that you don't have slippage.
Ken Adler: You've generally tend to earn the entire amount. And if you just go back two years, it spreads well at 15 basis points. So this is at a pretty attractive level for a cash flow that is very little optionality or very little risk. And also, as I mentioned, the technical landscape group agency CNBS is better than agency MBS. Got it. And is that consistent with your strategy of hedging further out on the curve?
Ken Adler: Or is it coinc- I guess tied to because of the longer, more predictable duration of the agency CNBS? I think we buy agency CNBS. We think of it as buying it on a swap basis. So we would hedge the duration completely and own it on a swap basis. Okay. And what are the durations that you're assuming associated with them just so we understand how to think about how that's going to impact the hedge book? I mean, the duration on these would be right around eight years. They're very similar to penny up treasury cash flows. Correct. Let's go ahead.
Unknown Executive: Thank you.
Unknown Executive: Thanks, guys.
Eric Hagen: The next question will come from Eric Hagen with BTIG. Please go ahead. Hey, good morning. How are we doing? So, you know, first question here. I mean, how are you guys feeling about the shape of the capital structure? Does the mix of common and preferred? How much leverage the common stock will in the tolerate these spread levels? Yeah.
David Finkelstein: So, we entered this period with very little capital structure leverage. You know, we average around 12 to 13% of our capital and prefers with common deterioration. We're up to 15%, which is still quite low, certainly relative to the sector, and particularly when you consider, you know, the alternative businesses that are less levered from a balance sheet standpoint. And the way we look at it is, you know, we do have floating rate perverts, obviously now.
David Finkelstein: And the fact that the curve steepens as much as it did is it did. The cost of it prefers on a forward basis didn't increase much at all, while the asset side of the equation actually became a lot more ample. And so, from a cost to capital standpoint, preferred actually looks more reasonable today than it did, say, at the end of the second quarter. We do have capacity to increase it, but that market's been closed, really. There's been a couple of bank deals and not much else. Today, Stan, we can refide some point. We would look at it, but it's not there now, and we'll see how that market develops.
David Finkelstein: Right, now that's helpful, thanks. And so, how are we also thinking about, you know, hedging your cost of funds at the short end of the yield curve? You know, especially if it looks like the Fed could really cut rates next year and that, you know, begins to get embedded into the forward curve even more. Thank you guys very much. Yeah, you better, so we're keeping our repo profile relatively short. We do think although there's a third of a probability of another hike, we think it's somewhat unlikely.
David Finkelstein: And so we're kind of pivoting to a point where the next move to your point would be cuts. And so we're managing it very nimbly and most of our focus is on hedging out the curve because we do think that's, that's really where the risk is given just the amount of supply coming to the market, particularly from the Treasury market. Next year, I think there's projected to be 1.7 trillion in net treasury issuance.
David Finkelstein: And then you also have Fed run off to the tune of 900 billion between Treasury's and agency and V.S. So a lot of the focus is out the curve as you see in the changing composition in our edge, both by quarter to quarter.
Unknown Executive: All right. Thank you guys very much. You better. Again, if you have a question, please press star then one.
Matthew Ertner: Our next question will come from Matthew Ertner with Jones Trading. Please go ahead. Thank you.
David Finkelstein: Good morning, guys. Thanks for taking the question. David, you just mentioned the composition of the hedge portfolio. Could you talk a little more about the added use of futures and kind of if you're still sitting in that seven to 20 year part of the curve there? Thanks. Yes, we are. So in terms of the additions in futures, look at the end of the day, the way we looked at it was we wanted the liquidity of the futures market.
David Finkelstein: You know, we wanted to add hedges. We did a lot of that early in the quarter and our composition of hedges was underway futures relative to where we have historically been. So now we're up to 24% of the hedges in futures, which we're comfortable with. And now one point to know is that swaps have generated really the vast majority of income just given the shape of the curve and you don't get that benefit from futures.
David Finkelstein: And so it does it does stamp an EAD to some extent, but we're okay with that. Gotcha. And then do you expect to kind of increase or decrease futures, or are you guys kind of comfortable with the level that you're at right now? We'll see how the market evolves, but we're comfortable with where we're at. Thank you. Thank you, ma'am.
David Finkelstein: This concludes our question and answer session. I would like to turn the conference back over to Mr. David Finkelstein for any closing remarks. Please go ahead, sir. Thank you, Chuck. And thanks for joining us today. Good luck, everyone.
Unknown Executive: The conference is now concluded. Thank you for attending today's presentation. You may now disconnect. Thanks for joining us today.
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