Q3 2023 Two Harbors Investment Corp Earnings Call
Greetings and welcome to the two harbors investment Corp, third quarter 2023 financial results Conference call. At this time all participants are in a listen only mode. A brief question and answer session will follow the formal presentation.
Anyone should require operator assistance during the conference. Please press star zero on your telephone keypad.
Minder. This conference is being recorded it is now my pleasure to introduce your host Maggie Karr head of Investor Relations. Thank you Maggie you may begin.
Good morning, everyone and welcome to our call to discuss two harbors third quarter 2023 financial results with me on the call. This morning are Bill Greenberg, our President and Chief Executive Officer, Nick <unk>, Our Chief investment Officer, and Mary Rescue, our Chief Financial Officer.
The press release and presentation associated with today's call have been filed with the SEC and are available on the Sec's website as well as the Investor Relations page of our website at two harbors investment dotcom.
In our earnings release and presentation, we have provided reconciliations of GAAP to non-GAAP financial measures and we urge you to review this information in conjunction with today's call.
As a reminder, our comments today will include forward looking statements, which are subject to risks and uncertainties that may cause our results to differ materially from expectations. These are described on page two of the presentation and in our Form 10-K, and subsequent reports filed with the SEC, except as may be required by law two harbors.
Does not update forward looking statements and disclaims any obligation to do so I will now turn the call over to Bill.
Thank you Maggie and good morning, everyone and welcome to our third quarter earnings call.
Today I'll provide an overview of our quarterly performance in the markets.
He will cover our financial results in detail.
Let's begin with slide three.
Our book value at September 30 was $15 36 per share representing a negative three 5% total economic return.
Income excluding market driven value changes or eye exam was 51 per share representing a 12.6% annualized return.
This backward looking metric a realized return is analogous to the forward looking metrics on slide 14.
Includes the actual cash flows actual prepayments and actual costs incurred in the quarter.
Please turn to slide four.
Undoubtedly the highlight of our third quarter was the closing of the acquisition of round point mortgage servicing which reinforces our commitment to MSR as a core and central part of our strategy.
When we first envisioned acquiring a servicer our goal was to achieve economies of scale improve MSR economics and be able to leverage a more expansive set of opportunities in the mortgage finance space.
Everything we have seen it Ron pointed to last year from the announcement through the closing has given us confidence that our visions were not misplaced.
Let me expand a little more on this topic.
The sub servicing model works well when you have a small portfolio because the cost of service is a fixed number of dollars per loan.
However, when the portfolio gets to a certain size it becomes more expensive since the marginal cost of service is lower than the average costs.
For instance, it costs less to service the one millionth alone than it does the 100000 flown or the very first slope.
Conventional wisdom says that portfolio was worth approximately 500000 loans are about breakeven and this conforms with our own observations and estimates.
As a reminder, we are owners of MSR related to more than 850000 lots.
By bringing our servicing in house, we can enjoy all cash flows related to the assets, whereas previously we only participated in a fraction.
Although we were already receiving 100% of the float income associated with holding the principal and interest and taxes and insurance. We only received about 15% of the late fees and other ancillary income and we did not receive any incentive payments from the gse's for helping delinquent borrowers.
In addition to the immediate economics I just described we intend to grow round points third party sub servicing business.
Ron point currently services approximately 80000 loans from a total of six true third party clients.
We believe that we can grow this significantly.
Furthermore, we will be as they say eating our own cooking, which means that we can provide the same experience to clients as they tag along with what we will be doing for our own portfolio.
To date, we have transferred approximately two thirds of our MSR portfolio from our sub servicers to romp weights.
We have three final transfers remaining and expect the last one should take place in June 2024.
At the end of that process, we estimate that Ron point will have approximately 930000 loans on the platform, which will make it the eighth largest servicer of conventional loans in the country.
The team at round point has done an excellent job of facilitating these loan transfers.
October one 2023 marks one year since our initial servicing transfer.
Ron point has been able to keep up with the expanding portfolio through successful recruiting technology refinements and a commitment to delivering exceptional service to every customer.
Since last October Ron point has completed eight real reallocation transfers totaling approximately 600000 loans.
As one measure of the capabilities of the <unk>. The average 30, plus day delinquency rates 90 days post transfer is 16 basis points lower than it was before the transfer.
Additionally, with an operating entity. We can also participate more fully in the structured finance housing market.
This includes areas like new loan products reverse mortgages, Helocs second liens and other ancillary products, we have an incredible opportunity to grow round points and two harbors businesses together.
Most importantly, this acquisition resulted in the bottom line benefit to stockholders.
We anticipate that the operation of round point will be accretive to our 2024 pretax earnings by $25 million to $30 million.
Mary will detail this and the purchase price more fully in her remarks.
Turning to slide five I'd like to engage with a brief discussion on the markets.
The fixed income markets fluctuated during the quarter as participants try to understand potential future fed action or inaction.
The June reading of headline CPI of 3.0% showed good progress coming down from a high of nine 1% a year prior.
However, CPI readings in August and September increased back to three 7%.
There are of course more factors that go into determining the market's reaction, but it all led to interest rates generally rising over the quarter.
With greater acceptance of fed funds rates close to their peak and likely higher for longer along with concerns about greater treasury supply and spillover effects from overseas Central Bank tightening the sofa interest rates swap market curve repeat materially better steepens as the quarter progressed.
The 10 year swap rate rose 68 basis points from 3.6% to four 3% while the to your <unk>.
Swap rate rose 15 basis points from four 8% to 5.0% as you can see in figure one.
The rates on current coupon MBS increased 60 basis points from $6 seven to seven 3%.
Note that these rates are current coupon rates and not primary mortgage rates, which are often 75 to 100 basis points higher.
At quarter end the market projections for short term rates was that they should come down moderately through 2024.
Landing around four 7% at the end of next year as seen in figure two on the right hand side of this slide.
Compared to the shape of the front end of the curve in previous periods.
Current expectations have changed calling for fewer cuts in total and extended out in time.
The fed has been clear that interest rate cuts are not imminent and it seems that the market has finally taken the fed at face value.
Elevated rate and spread volatility can pose near term challenges to the sector.
But if rate volatility moderates spreads at this level are very attractive for investing our agency portfolio.
Additionally, with our MSR weighted average coupon at three 4%. It is so far out of the money that we have a very low convexity low duration assets with stable cash flows.
As you will see on our return potential slide.
We believe that our combined strategy can generate low to mid teens returns in this environment.
October has seen continued difficulties in the M P S and interest rate markets.
While rates have continued their upward trajectory geopolitical volatility and its attendant flight to quality have not tempered the upward rise and caused large movements intraday levels of rates as well as in mortgage spreads.
This is why we believe it remains prudent to maintain a neutral leverage position and low risk exposures.
Despite the continued market volatility. This is an exciting time for two harbors.
<unk> uniquely positioned to capitalize on opportunities in agency RBS and MSR and our size allows us to be nimble enough to do so.
The addition of round point improves our outlook as we expect to realize further operational and cost efficiencies as it becomes fully integrated into two harbors.
Finally, we posted the first of our conversation series of videos last night, you can find them on our website under investors and insights.
Each quarter, we plan to release videos on special topics in the REIT industry or specific to two harbors.
We hope that you find these helpful and interesting.
That I'd like to hand, the call over to Mary to discuss our financial results.
Thank you Bill and good morning, Please turn to slide six the company incurred a comprehensive loss of $56 $8 million or 61 cents per weighted average share in the third quarter.
Book value was $15.36 per share at September 30th compared to $16.39 at June 30th.
And the 45 cent common dividend resulted in a quarterly economic return of negative three 5%.
Let's take a moment to review the von <unk> acquisition purchase price and anticipated post closing adjustments.
As a reminder, we paid our preliminary purchase price of $23 $6 million, which was equal to around plants tangible net book value plus a premium of $10 $5 million less certain purchase price adjustments.
Additionally, we agreed to pay certain post closing adjustments, which reflect the earnings of round point from October one 2022 through September 30th 2023.
These adjustments will be finalized in the next 30 days or so and are subject to change. The currently estimate that this adjustment will add approximately $21 1 million to the aggregate purchase price.
Estimated final purchase price of $44.7 million is reflected in our financial statements at September 30th 2023, and resulted in goodwill and other intangibles of $28 $5 million.
In addition, we expect to pay a total of $16 million in the boarding fees to move our loans from our sub servicers turnaround point.
It's worth noting that $10 million of Easter boarding fees have already been realized in paid and are reflected in our current book value.
In combination with the expected incremental earnings of $25 million to $30 million that Bill highlighted we expect a return of approximately 60% on the invested capital.
Please turn to slide seven.
I ask him for the third quarter was $49 $3 million or 51 cents per share representing an annualized return of 12, 6%.
Within the range of our estimated return potential of 45 to 61 cents at the end of last quarter.
Moving to slide eight let's look at some detail of the quarter over quarter variances and I accept.
Ask Sam is lower quarter over quarter by eight point to $9.
Although it appears that axon is primarily impacted by increased funding costs.
These individual components shouldn't be viewed in isolation in fact, the primary driver of the overall decrease in eye exam was the reduction in asset balances and a large move higher in rates, which pushed the portfolio further out of the money.
As you will see on slide 10, there is a steep slope to static spreads which shows that MBS spreads are tighter for securities that are further out of the money.
This had the effect of lowering the aggregate spread of the assets and eye exam over the quarter as a whole.
As a reminder, eye exam reflects our daily adjusted holdings over the quarter as opposed to a return potential which reflects a snapshot of our holdings as they existed at quarter end.
There can be quarterly distortions and eye exam.
And repo or the timing of MSR cash flows.
But we believe it is the most helpful way for our investors and analysts to understand the current quarter return contributions.
X M is complementary to the return potential on outlook slide later in the presentation, which reflects our view on prospective returns.
Please turn to slide nine.
Spreads on repurchase agreements remained stable and liquid with financing for our MBS between sulfur plus 19% to 23 basis points.
At quarter end, our weighted average days to maturity for our agency repo with 99 days, which helps us maintain stability in our financing.
The finance or MSR class four lenders with $1 7 billion of outstanding borrowings under bilateral facilities and 296 million of outstanding five year term note.
We ended the quarter with a total of 504 million unused MSR financing capacity and 166 nine unused capacity for servicing advances.
I will now turn the call over to Nick.
Thank you Mary please turn to slide 10.
Over the third quarter, the correlation of higher rates higher volatility and wider mortgage spreads remained in place. Nevertheless, the active management of our agency coupon positioning and our our exposure to MSR, coupled with disciplined rehashing of our interest rate risk as yields rose protected the portfolio and resulted in less of an impact too.
Our book value.
Let's look at figure one.
Mortgage spreads performed well in July as rates and volatility remained stable only to weaken during the months of August and September as the yield of the 10 year Treasury notched its highest level in over a decade.
So the current coupon the nominal spread to treasuries widened by 11 basis points over the quarter to 151 basis points, while the OAS increased to 48 basis points only water by four basis points, given the concurrent increase in volatility.
At these levels spreads remained very wide historically with a nominal current coupon spread well above the 19th percentile of long term history.
In a nearer term contexts spreads finished the quarter much closer to their averages since the beginning of June a period that is mostly pass the distortions of the banking crisis and raising the debt ceiling in the second quarter.
Focusing solely on the current coupon does not reveal the underperformance of lower coupons for the quarter most of which took place during the later half of September as longer and rates shot higher what made US, particularly interesting is that the FDIC successfully completed their sales of lower coupon MBS like two and a half by early August at which point the.
Bonds had recovered almost all of the widening that occurred since the banking crisis was touched off in March.
Call It guilt by association, but given the rise in rates and Steepening of the yield curve. There was clearly no love for longer duration bonds and lower coupons, the longest duration arm B S.
Figure two shows quarter over quarter spread curves in nominal and option adjusted terms.
It's evident how much the lower coupons underperformed by seeing the curve flattening from one quarter to the next particularly when focusing on option adjusted spreads.
As is expected when coupons go up so do spreads compensating the investor for a greater degree of prepayment risk.
As you can see the nominal curve in blue is still downward sloping, but less so than last quarter with the higher coupons close to unchanged and lowers moving higher.
The option adjusted curve at quarter end was remarkably flat, especially considering the dramatic range of Morgan coupons available in the market and they are inherently different risks.
Now, let's turn to slide 11, and discuss our portfolio positioning and activity in the third quarter.
At September 30th our portfolio was $14 1 billion, including 12 billion of subtle positions on the top right of the slide you can see a few bullets about our risk positioning and leverage our quarter end economic debt to equity was six three times.
Against the backdrop of continued elevated rate and spread volatility. We think it is prudent to maintain a neutral leverage position importantly, we don't need to add more leverage to generate strong returns as you will see in a few slides when we detail our return outlook.
We kept our book value exposure to changes in rates low the maintained a short duration bias given the propensity for MBS to widen as rates increase, particularly to long end rates, making new highs.
You can see more detail on our risk positioning by looking at slide 16, and 17 28 and 29 in the appendix.
On the bottom right of this slide we've highlighted our portfolio activity in the quarter for both agencies and MSR, which we will address in detail in the following slides.
Please turn to slide 12 to review our agency portfolio.
One shows the composition of our specified pool holdings by coupon and story and then figure two you can see the performance of TBA as in the specified pools, we own throughout the quarter.
So the entire stack underperformed on a relative basis, we benefited from having a concentrated exposure to the upper belly coupons like four in a housing fives.
These coupons outperformed primarily due to two factors demand for money managers that had previously been focused on lower coupons from F. T. I C cells and diminish supply as mortgage rates moved higher pushing them fully out of the production of window.
Specified pools also outperformed TBA rolls generally traded below carry making specified pools, a better choice, particularly with semi season pools that prepaid, particularly well during the summer months.
We actively managed our positioning in the quarter strategically moving our exposure within the coupon stack as well as rotating some TBA exposure to specified pools.
Most notably we moved close to $2 billion of our TBA five position predominantly up in coupon to sixes and six in the house.
The rotation was driven by several factors, including strong performance in the quarter by the upper belly coupons as we already discussed the natural need to reset our current coupon hedge against our MSR as rates sold off and our belief that into a higher for longer environment higher coupons should outperform.
Figure three on the bottom right shows our specified pool prepayment speeds, which were 6.7% CPR in the third quarter, increasing modestly from the second quarter.
Given that our pool position is concentrated in discount bonds faster speeds are beneficial to our performance as you can see from the chart on aggregate speeds on these pools were materially faster than T V as hence providing more return.
Please turn to slide 13.
Our MSR portfolio was $3 2 billion in market value at September 30th This was down slightly from June 30, because of the conversion of approximately 1.2 basis points of MSR to Io securities, reducing the net servicing theater MSR to twenty-five 0.2 basis points.
We did not buy any MSR through bulk purchases in the quarter, but did at 472 million through flow purchases and recapture.
<unk> on our MSR holdings paid 4.9% CPR declining 9.3% from the prior quarter over.
Over 60% of our MSR have a weighted average loan age of 20 to 40 months and those had a CPR of only four 3% we.
We expect prepayment rates to fall again in the fourth quarter, reflecting weaker seasonal factors and the rise in primary rates.
With a weighted average mortgage rate of our MSR of close to 400 basis points lower than today's rates prepayment speeds should remain historically slow.
Finally, please turn to slide 14, our return potential outlook slide the top half of this table is meant to show what returns. We believe are available in the market. We estimate that about 62% of our capital is allocated a hedged MSR with a market static return projection of 12% to 14%.
The remaining capital is allocated or hedged our MBS with a static return estimate of 15% to 16%.
The lower section of this slide is specific to our portfolio with a focus on common equity and estimated returns per common share.
Note that with the closing of the round point acquisition. We have added an after tax benefit of 80 to 100 basis points of return to this section of the outlook.
With our portfolio allocation shown in the top off the table and after expenses. The static return estimate for our portfolio is between 10.4% to 12.9% before applying any capital structure leverage to the portfolio.
After giving effect to our outstanding convertible notes and preferred stock we believe that the potential static return on common equity falls in the range of 12.3 to 16, 3% or a prospective quarterly static return per share of 47 to 62 sons.
Circling back to my earlier comments, there is no need to employ more leverage with our return potential in this range.
Our active management of our agency coupon positioning our exposure to MSR and our disciplined risk management benefit of returns this quarter and protected the portfolio from additional downside.
While rate and spread volatility can pose near term challenges to the RMB S sector.
With our capital allocation and current spreads for M. P. S and MSR. We believe this is a very attractive time to invest in our assets.
Thank you very much for joining us today and now we'd be happy to take any questions you may have.
Thank you we will now be conducting a question and answer session. If you'd like to ask a question. Please press star one on your telephone keypad, a confirmation tone will indicate your line is in the question queue. You May press star two if you'd like to remove your question from the queue for participants using speaker equipment. It may be necessary to pick up your handset before pressing the star keys, one moment, please while we.
Paul for questions.
Thank you. Our first question is from Bose George with K B W. Please proceed with your question.
Hey, everyone. Good morning.
You bet Bose good morning.
Been pretty volatile in the markets with the with <unk>.
In terms of both rates and spreads, but given all that we estimate that as of last friday's close that our book value or that are T. R was down around 6%.
Okay, great. Thanks, and then with the acquisition of round point.
DSO, it's about how much capital you.
<unk> invested in the MSR change you know as you can get a benefit from synergies of being a largest servicer just yet how does that kind of play into your capital allocation.
Sure well one thing I wanted to clarify is of course is that the acquisition of round point in itself doesn't really attract more capital to the business right. It's it's a servicing operational entity.
Out of servicing that we own.
As owners is you know, we're we're pretty close to the ideal amount of what we want to own here, yes, we can add a little bit.
If there's if there's good opportunities in that space, but we're pretty close to to the capital allocation that we prefer we.
We do intend to grow the amount of loans on the <unk> platform through sub servicing relationships as we said but that won't.
Change the the capital allocation mix per se. It will if you look on slide 14 that will just change Hum.
Returns in that round point line and the bottom half of the chart.
Okay, Great and then if you just one more on the sub servicing.
How meaningful do you think that opportunity could be.
Well I think there's there's there's a lot of opportunity there. There's lots of servicing that is for sale. There's lots of servicing that is moving around from sub servicers are from one to another and I think that that you know our position in the market and what what we are which is a large owner of server.
Thing and the subsurface theres not that many of those guys in the market.
There were people can put.
They're loans next just someone who who is as I wrote it as I said in my prepared remarks is eating their own cooking right and I think we were able to provide.
Servicing clients a lot of what they're looking for that is is underserved in the marketplace. So I think we're really excited about that.
Great. Thanks, and good job protecting your book value with all this volatility.
Thanks Bose.
Thank you. Our next question is from Trevor Cranston with JMP Securities. Please proceed with your question.
Okay. Thanks.
Another question on the round point acquisition.
You made the point about.
Potentially having the ability to explore participating in other segments of the structured finance market I was curious if you.
To elaborate on that a little bit and sort of what you would envision that to be.
In terms of.
Investments for two harbors would that include things like taking credit risk on these types of loans are these.
Secondly, how do you see that.
Okay.
Sure well you know with with a large servicing portfolio with you know a large operating platform. You know some amount of of you know portfolio defense and recapture is certainly going to be an important part of what we do but the but the main point is that once we have such an entity and we're involved in those activities. It opens up.
The opportunities to be able to do other things as I said in my prepared remarks, whether it's whether it's offering helocs are second liens or other products.
You know that's something that that we can certainly do with an operating platform rather than just being exposed to MBS spreads and MSR spreads.
Terms of taking credit risk, that's not something that we're particularly looking at we like.
Where we are in the in the in the in the conventional MSR and MBS space and if we do.
Participating some of those other products you know, we would figure out ways to to to provide an outlet for those sort of things and so forth.
Unclear about what form that will take yet because we haven't done it yet.
These are still in the formative stages, but I think the the number of different things and opportunities that we have.
Plentiful.
Okay got it.
And this is a question that I think has come up on a number of calls before but.
Given how.
Much mortgage rates have increased over the last.
A couple of months can you talk about how much rate sensitivity you, you'll see the MSR asset having at this point.
Yeah. So you know it's it's one of those things that I think is tempting, sometimes and sometimes there's a shorthand will even say oh with mortgage rates 400, or 450 basis points out of the money that the MSR has no duration or it's a very low duration low convexity, that's it and that's true, but it doesn't have no duration right. It has low.
Duration and so what I always like to think is that does that and at the money pool servicing will have a duration of say minus 30 that means that for an at the money pool of mortgages, if interest rates rise by 100 basis points servicing asset will change by 30% in value right, our servicing 450 basis points out of the money.
Probably has a duration of I dunno minus three minus.
<unk> III minus four somewhere in that zone, but we have a lot of servicing right and so all of that adds up to a a non negligible amount of duration right and you might ask why does the servicing portfolio. That's 450 basis points out of the money even have any duration why isn't it zero right and this is something that we tried to.
You talk about I.
In the first quarter, when we talked about what the duration sensitivity of the float components of MSR is relative to the whole thing remember as the owner of servicing we not only receive the the service fee cash flows, but we also enjoy the benefit of the float earnings on the <unk>.
Principal and interest and on the taxes and.
In insurance and I always like to call that the the float components of servicing acts like what in the in the CMO market days of old we used to call a super floater Io, which means that it's an interest only cash flows, but it's no principal attached to it but when interest rates rise.
Right, especially the front end part of the curve the coupons. The earnings that you get also rises so so the cash you know its typical servicing portfolio. The cash flows will extend because prepayments slow.
And the rate that you earn on those cash flows for longer also increases now it's true that with a pool, that's 450 basis points out of the money. The cashless arent really extending anymore prepayment speeds have bottomed out but the other effect is still presence right that the earnings rate that you earn on the cash.
I was just going up as rates rise and in fact.
Well it might be true that the the interest rate duration of the pure service fee strip of the of the servicing asset.
<unk> has switched from having negative duration to positive duration.
Meaning that part will go down as rates rise the floating rate components are still negative duration and in fact.
Our larger in magnitude than the positive duration of the strips. So that the overall duration is still slightly negative which gives you the overall minus three <unk>.
<unk> rather than the minus three.
Does that answer the question.
Okay got it very good answer thank you.
<unk>.
Thank you our final question will be from Aaron <unk> with Citi. Please proceed with your question.
Thanks, I was wondering if you could talk a little bit about.
The outlook for REIT volatility and maybe spread volatility I know, it's kind of a crystal ball question, but in this kind of higher for longer and the fed.
Getting hopefully close to this tightening cycle.
Yeah.
With it with a natural expectation be for that volatility to subside a bit.
Hey, Eric This is Nick Thank you for the question, it's really the question.
They are of the day and it's really been a question frankly for the last year. We I think we've talked about this almost.
Every call that we've been on and the markets are giving us signals that things are that we're close to an end of this hiking cycle and that maybe.
Maybe the fed really is going to hold now we see that if you look at the shape of the yield curve for example, we've seen the.
The two tenths curve for example go from.
Something like wider than minus 100 basis points not long ago to only minus 20 now it's that curve has has.
It has become less inverted or has become steeper by about 80 basis points.
That's the signal the market is giving you that we're getting closer to the end of the cycle.
But the reality is it's it's these things are famously difficult to predict and to tell and that's the reason why in our comments as we've said we are being very respectful of the risk in the market and we are we are we believe that our.
Physician is balanced and is as we described our leverage position as being neutral. It gives us enough return potential enough upside to us to a spread tightening event that we feel that we will capture that but yet at the same time.
Don't have an excessive amount of downside exposure should things continue to happiness with spreads widening and we we have talked about is it.
Spreads being why historically, which they are the problem is they keep getting a little bit wider every quarter.
And we are we are respectful of that so we've kind of built into the portfolio the level of leverage and risk and composition between our MSR and our securities holdings that generates we think a very very attractive return potential and should spreads tightened and we get a cycle change.
We will definitely participate in that upside as well.
Thanks, and then second question I had was you had mentioned you know shifting a little bit higher in coupon I guess I think you said in the TBA side.
How do you how are you hedging that and you know what's the risk to the extent that I don't know if the economy falters and Theres a flight to quality and we start to see the 10 year fall again.
Yeah.
Oh, there there has been I mean, good question and there certainly has been a correlation between the performance of the lower and higher coupons with right directionality now we hedge it the same way we hedge everything else.
We.
We.
We we use our models in.
We have.
We think.
Accurate representation of the risk of those securities versus the lower coupons.
And we hedge it with a combination of futures and swaps.
And of course with our again with our MSR, we have as an adult Bill's talked about it on the prior question about the sensitivity of our MSR to mortgage rates. There is still some some sensitivity that impacts where how our hedging ultimately resides where our exposure is ultimately reside on the coupon stack.
And one of the reasons that we did go up in coupon was the fact that the current coupon went higher I mean that was part of it.
Part of it was also as I said the rotation out of.
Coupons, we thought did really well and also just the fact that if you are in a higher for for a longer environment. You hired the current coupon should provide a lot of good return.
Got it alright, thank you.
Yeah, I I I might just add that that you know we do actively manage the portfolio not just in the interest rate rebalancing and so forth, but also but also in coupon selection and where we are on the coupon stack and some of that.
It relates also to how we think.
Does does it relate also into how we hedge the portfolio and what risks we want to take in different environments and so as rates move sometimes in addition to hedging what Alex but I'll call. It a theoretical interest rate exposures.
We will often sometimes modify our coupon positioning which has an impact as well and so you know as we see lower coupons underperforming we may choose to increase exposure there from time to time or or as rates fall, we might be moving down in coupon or or up in coupon as well and so it's a dynamic portfolio Hum.
But the hedging.
Our strategy is the same in any environment.
Got it thank you.
Yep.
Thank you. Our next question is from Eric Hagen with BTG. Please proceed with your question.
Hey, Thanks, Good morning, guys have where oh well.
How do you see the bulk market for for MSR, developing if interest rates move even higher from here.
How much overall capital do you feel like you can.
Maybe you devote to the MSR.
That scenario where there.
Theres bulk MSR is to buy in and rates are higher at the same time.
Sure. Thanks for the question, Eric look Theres ample supply of MSR in in the bulk markets right and as we've said in quarters past and it continues to be true that the market is trading our rationally and professionally and orderly.
And the sellers, especially of large portfolios seem to be strong hands that understand how the market works and it isn't going to flood the market and in no way shape or form is the MSR market trading as a distressed market it's happening in a very very orderly way.
Yeah, as I said I'm, a little bit earlier, you know, we like our capital allocation right here.
We're trying to balance the relative attractiveness of MSR with the relative attractiveness of MBS, along with making sure that we have ample liquidity in the portfolio and so forth all of which the MBS portfolio provides more so than the MSR. So if there are if there are opportunities to acquire more MSR.
We can certainly participate in that to some degree we obviously can't double the amount of MSR portfolio that we have have them currently, but we could grow a little bit, but we're happy with our capital allocation and the relative mix given the opportunities in the market right now.
Okay.
A follow up on the hedging I mean is there a way to hedge the float and the float income component of the MSR or is that not really a cash flow that's really worth hedging with with with repo also being present in the portfolio or just how to think about that thank you guys.
Yeah. Thanks for that question not only is is there a way to hedge the the flow components, but we do hedge the flow of components right that is to say that that when rates rose we did not.
<unk> achieve a windfall from rates rising and the increased earnings benefit that we had because we hedged it and should rates fall from here, we will not realize a degradation in our book value.
Due to that because we will be hedging that as well. So you know when we talk about hedging our portfolio as we've discussed many times and actually I think one of our conversation series that we just posted is about partial durations and hedging along the yield curve right and so the floating rate components have their own exposure along the yield curve.
It's different than the pure interest only strip out we put it all together when we manage the portfolio and we hedge the individual interest rate buckets interest rate maturity buckets separately so that we're.
We're able to hedge the floating rate components as well.
Great. Thanks for the explanation I appreciate it guys. Thanks.
Okay.
Thank you there are no further questions at this time I would like to hand, the floor back over to Bill Greenberg for any closing comments.
I just want to thank everyone again for joining us today and thanks as always for your interest in two harbors.
This concludes today's conference you may disconnect your lines at this time. Thank you for your participation.
Okay.