Q1 2024 Annaly Capital Management Inc Earnings Call
Good morning, and welcome to the first quarter of 2020 for Italy Capital Management Earnings Conference call. Today, all participants will be in a listen only mode should you need any assistance during todays call. Please signal for a conference specialist by pressing star key followed by zero on your telephone keypad.
Operator: Good morning, and welcome to the first quarter 2024 Annaly Capital Management Earnings Conference Call. Today, all participants will be in a listen-only mode. Should you need any assistance during today's call, please signal for a conference specialist by pressing the star key, followed by zero on your telephone keypad. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then one on your telephone keypad. To withdraw your question, you may press star, then two. Please note that today's event is being recorded. I would now like to turn the conference over to Sean Kensil, Director of Investor Relations. Please go ahead, Sean.
After todays presentation, there will be an opportunity to ask questions to ask a question you May Press Star then one on your telephone keypad.
To withdraw your question you May Press Star then two.
Please note that today's event is being recorded I would now like to turn the conference over to Sean Kensal Director Investor Relations. Please go ahead Sir.
Sean Kensil: Good morning, and welcome to the first quarter 2024 earnings call for an elite capital management.
Sean Kensil: Good morning, and welcome to the first quarter 2024 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 factor section in our most recent annual and quarterly SEC filings. Actual events and results may differ materially from this forward-looking statement. We encourage you to read the disclaimer in our earnings release in addition to our quarterly and annual budget.
Sean Kensil: 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.
Sean Kensil: Actual events and results may differ materially from these forward looking statements.
Sean Kensil: We encourage you to read the disclaimer in our earnings release in addition to our quarterly and annual filings.
Sean Kensil: Additionally, the content of this conference call may contain time sensitive information that is accurate only as of the date hereof we.
Sean Kensil: We do not undertake and specifically disclaim any obligation to update or revise as appropriate.
Sean Kensil: During this call we may present, both GAAP and non-GAAP financial measures.
Sean Kensil: A reconciliation of GAAP to non-GAAP measures is included in our earnings release.
Sean Kensil: Content referenced in today's call can be found in our first quarter of 2024 investor presentation, and first quarter of 2020 for supplemental information.
Sean Kensil: Found under the presentations section of our website.
Sean Kensil: Additionally, the content of this conference call may contain
Sean Kensil: Please also note this event is being recorded.
Sean Kensil: Participants on this morning's call include David Finkelstein, Chief Executive Officer, and Chief Investment Officer.
Sean Kensil: may contain time-sensitive information that is accurate only as of the date you're on. We do not undertake and specifically disclaim any obligation to update or revise this information.
Speaker Change: Serena Wolfe Chief Financial Officer, Mike Damia, Deputy Chief Investment Officer head of residential credit yesterday, He Boston had of agency and kind of as our head of mortgage servicing rights.
David L. Finkelstein: With that I'll turn the call over to David.
Sean Kensil: During this call, we may present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in our earnings release. Content referenced in today's call can be found in our first quarter 2024 investor presentation and first quarter 2024 supplemental information, both found under the presentation section of our website.
David L. Finkelstein: Sean Good morning, and thank you all for joining us on our first quarter earnings call. Today, I will briefly review the macro and market environment, along with our first quarter performance and then I'll provide an update on each of our three businesses and conclude with our outlook. Serena will then discuss our financials after which we'll open the call up to Q&A.
David L. Finkelstein: Now beginning with the macro landscape first quarter of 2024 was characterized by surprisingly resilient economic data healthy labor market and an uptick in inflation. Consequently interest rates sold off modestly in the quarter as the market priced out roughly half the rate cuts that were expected at the beginning.
David L. Finkelstein: Yes.
David L. Finkelstein: Slightly rising rates risk assets performed well over the quarter volatility declined the money flowed into both equity and fixed income markets.
Operator: Please also note that this event is being recorded.
David L. Finkelstein: It's also re emerge just modest buyers of treasuries and agency MBS in the first quarter a welcome development given the absence over the past couple of years.
Sean Kensil: Participants on this morning's call include David Finkelstein, Chief Executive Officer and Chief Investment Officer, Serena Wolfe, Chief Financial Officer, Mike Fania, Deputy Chief Investment Officer and Head of Residential Credit, VS Sweeney-Bossom, Head of Agency, and Ken Adler, Head of Mortgage Servicing Rights. And with that, I'll turn the call over to David. Thank you, Sean.
David L. Finkelstein: So in addition to federal reserve made it clear that it considers policy rates and balance sheet management be separate tools as they've begun discussing slowing pace the feds Treasury securities runoff.
David L. Finkelstein: We're encouraged by this development as this approach allows for a more gradual decline in bank reserves, thereby stabilizing liquidity substantially reducing treasury supply to the private sector and strengthening bank's deposit growth.
David L. Finkelstein: All positive fixed income and agency MBS.
David L. Finkelstein: Against this supportive backdrop ultimately about housing finance strategies performed well in the quarter with production coupon agency MBS spreads roughly five basis points tighter credit spreads 25 to 100 basis points tighter in the MSR market experiencing modest multiple expansion.
David L. Finkelstein: Good morning, and thank you all for joining us on our first quarter earnings call. Today, I'll briefly review the macro and market environment, along with our first quarter performance. Then I'll provide an update on each of our three businesses and conclude with our outlook. Serena will then discuss her financials, after which we'll open the call up to Q&A.
David L. Finkelstein: So we delivered a four 8% economic return for the quarter.
David L. Finkelstein: 64 cents and leverage at quarter end five six turns.
David L. Finkelstein: No. It was the second quarter was unfolding continued strong economic data coupled with stalled progress. Some disinflation has driven a further repricing forward rate expectations as well as an increase in volatility.
David L. Finkelstein: Mr. Scott tone has led the marginal spread widening across agency credit and justifies our leverage profile, which is at its lowest level of the cycle.
David L. Finkelstein: Now, beginning with the macro landscape, the first quarter of 2024 was characterized by surprisingly resilient economic data, a healthy labor market, and an uptick in inflation. Consequently, interest rates sold off modestly in the quarter as the market priced out roughly half of the rate cuts that were expected at the beginning of the year. Now, despite rising rates, risk assets performed well over the quarter as volatility declined, and money flowed into both equity and fixed income markets.
David L. Finkelstein: Now notwithstanding lower leverage for daily return environment gives us confidence in the durability of the portfolio earnings profile and we believe that our current dividend is appropriately set for 2024, given our expectations for earnings this year.
David L. Finkelstein: Shifting to the businesses and beginning with agency portfolio ended the quarter modestly lower to accommodate growth in our residential credit and MSR business. We continued to gravitate up in coupon with a weighted average coupon increasing 20 basis points to 476%, reducing our holdings Inc.
David L. Finkelstein: 4% coupons are lower.
David L. Finkelstein: 5 billion in favor of predominantly five and a half some higher.
David L. Finkelstein: We continue to see that production coupons as they provide the widest nominal spreads and as evidenced by their performance. This past quarter. The best returns in a range bound rate environment.
David L. Finkelstein: They also stand to benefit from potential spread tightening should option costs declined due to a steeper yield curve lower implied volatility.
David L. Finkelstein: Our agency MBS portfolio was largely unchanged over the quarter spreads in this sector tightening 10 to 15 basis points on continued broad based demand outperforming agency, MBS and providing incremental excess returns while improving our overall convexity profile.
David L. Finkelstein: Banks also reemerged as modest buyers of treasuries and agency MBS in the first quarter, a welcome development given their absence over the past couple of years. Now, in addition, the Federal Reserve made it clear that it considers policy rates and balance sheet management to be separate tools as it has begun discussing slowing the pace of the Fed's treasury securities runoff.
David L. Finkelstein: Now as it relates to interest rate management, the notional value of our hedge portfolio declined slightly as we moved hedges out the curve leading to a modest decline in our hedge ratio.
David L. Finkelstein: As our existing plant in swap position has been rolling off we replace that risk with hedges in the intermediate and long and part of the yield curve closely aligning our hedges with the interest rate risk or assets. In addition, our increased allocation of swaps relative to treasuries that we discussed last quarter benefited our overall return given.
David L. Finkelstein: We're encouraged by this development as this approach allows for a more gradual decline in bank reserves, thereby stabilizing liquidity, potentially reducing treasury supply to the private sector, and strengthening banks' deposit growth, all positive for fixed income and agency MBS. Against this supportive backdrop, all three of our housing finance strategies performed well in the quarter, with production coupon agency MBS spreads roughly five basis points tighter, credit spreads 25 to 100 basis points tighter, and the MSR market experiencing modest multiple expansion. As a result, we delivered a 4.8 percent economic return for the quarter, with an AD of 64 cents and leverage a quarter end of 5.6 turns.
David L. Finkelstein: The widening in swap spreads during the quarter.
David L. Finkelstein: In the short term outlook for agency MBS has become somewhat more challenging recent inflation reports and delayed the start cutting cycle, maybe a pickup in volatility.
David L. Finkelstein: But we remain constructive on the sector given the potential of Steve Bank demand and the expected upcoming reduction in fed treasury runoff factors that should be supportive of agency MBS and were absent in the prior widening episodes and Meanwhile, hedge carry remains attractive with historically wide mouth spreads.
David L. Finkelstein: <unk>.
David L. Finkelstein: Now turning to residential credit portfolio ended the quarter at $6 2 billion in market value of $2 4 billion of equity.
David L. Finkelstein: It's 21% of the firm's capital quarter end.
David L. Finkelstein: We actually credit spreads tightened meaningfully to start the year given the supportive fundamental backdrop with AAA non QM spreads 35 basis points tighter than below <unk> 70 basis points tighter.
David L. Finkelstein: The credit curve continued to flatten as the issuance in supply of subordinate assets remain limited.
David L. Finkelstein: Growth in our portfolio was driven by our organic Townsville based strategy to increase whole loan purchases and retention of <unk> securities given the tightening spreads we opportunistically reduced our CRT portfolio and the other segments of our third party Securities Holdings and the strong demand.
David L. Finkelstein: Now, as the second quarter has unfolded, continuing strong economic data coupled with stalled progress on disinflation has driven a further repricing of forward rate expectations, as well as an increase in volatility. This current risk-off tone has led to marginal spread widening across agency and credit and justifies our leverage profile, which is at its lowest level of the cycle. Now, notwithstanding lower leverage, the prevailing return environment gives us confidence in the durability of the portfolio earnings profile, and we believe that our current dividend is appropriately set for 2024, given our expectations for earnings this year. We're shifting to the businesses, and beginning with agency, the portfolio ended the quarter modestly lower to accommodate growth in the residential credit and MSR businesses.
David L. Finkelstein: We also paid a correspondent channel had another record quarter as we registered $2 7 billion of expanded credit watch in Q1 up 40% quarter over quarter.
David L. Finkelstein: We set a $2 4 billion of loans, the vast majority of which was sourced directly via our correspondent channel and our pipeline remains robust with $2 billion of blocks at quarter end and continued momentum into the spring selling season.
David L. Finkelstein: Most importantly, our credit discipline remains strong as our current pipeline is characterized by a 68 LTV and a 753 FICO with only 3% of our locks greater than 80 LTV.
David L. Finkelstein: We were able to take advantage of a supportive capital markets by pricing seven securitizations totaling $3 3 billion in Q1 generating 328 million in assets by the end of its balance sheet and low to mid double digit returns and subsequent to quarter end, we price in additional non QM transaction with retained assets.
David L. Finkelstein: Exhibiting similar expected returns.
David L. Finkelstein: We continue to gravitate up in coupon, with our weighted average coupon increasing 20 basis points to 4.76%, reducing our holdings of 4% coupons and lower by over $5 billion, in favor of predominantly 5.5% and higher. We continue to favor production coupons as they provide the widest nominal spreads and, as evidenced by their performance this past quarter, the best returns in a range-bound rate environment. They also stand to benefit from potential spread tightening should option costs decline due to a steeper yield curve or lower implied volatility.
David L. Finkelstein: I'm looking forward to the further expansion beyond slip paid channel disposition and leaves a market leader in the residential credit margin, allowing us to manufacture our own credit risk, while retaining control of all aspects of the process.
David L. Finkelstein: Shifting to our MSR business, our portfolio ended the first quarter and $2 7 billion in market value, representing $2 3 billion of the firms capital.
David L. Finkelstein: MSR transaction volumes continue to be elevated in the first quarter, given challenging originated profitability, while demand and pricing remains firm.
David L. Finkelstein: Spite elevated supply we were disciplined spending better opportunity in relative value post quarter end and in early April we committed to purchase just over $100 million of market value of a bold package, which we expect to close in the second quarter.
David L. Finkelstein: We're confident we've constructed one of the highest quality conventional MSR portfolios in the market characterized by our industry low 3.07 said no ratings and exceptional credit quality front.
David L. Finkelstein: Fundamental performance of our MSR portfolio has continued to outpace our initial expectations with our holdings. Realizing a three month CPR of 3% rising float income given increased escrow balances and minimal borrower delinquencies and all of these factors contributed to our MSR portfolio exhibiting heightened.
David L. Finkelstein: Our agency CMBS portfolio was largely unchanged over the quarter; spreads in the sector tightened 10 to 15 basis points on continued broad-based demand, outperforming agency MBS and providing incremental excess returns while improving our overall convexity profile. Now, as it relates to interest rate management, the notional value of our hedge portfolio declined slightly as we moved hedges out the curve, leading to a modest decline in our hedge ratio.
David L. Finkelstein: With cash flows of double digit returns.
David L. Finkelstein: Given the analyst diversified strategy and ample liquidity position currently do not utilize the significant amount of recourse leverage on the MSR portfolio as it is advantageous to supplement leverage with lower cost agency repo. However, with 125 billion of committed warehouse facilities would be.
David L. Finkelstein: <unk> sort of additional MSR growth should pricing favorable.
David L. Finkelstein: Now looking ahead, we're optimistic about the outlook for our two businesses and we continue to see attractive risk adjusted returns across each of our investment strategies.
David L. Finkelstein: However, bouts of volatility remain a key risk as we had been reminded in recent weeks and we remain vigilant.
David L. Finkelstein: As our existing front-end swap position has been rolling off, we've replaced that risk with hedges in the intermediate and long-end part of the yield curve, closely aligning our hedges with the interest rate risk of our assets. In addition, our increased allocation of swaps relative to treasuries that we discussed last quarter benefited our overall return given the widening in swap spreads during the quarter. The short-term outlook for Agency MBS has become somewhat more challenging as recent inflation reports have delayed the start of the cutting cycle and led to a pickup in volatility.
David L. Finkelstein: And we continue to be well prepared given our conservative leverage position and capital structure, our ample liquidity and a diversified capital allocation strategy that can outperform across different interest rate macro landscape and while we continue to make progress in allocating incremental capital towards our residential credit.
David L. Finkelstein: MSR strategy, we like our current capital allocation disciplined in pricing and selective in the sourcing of assets. Overall, we're proud of the unique platform. We built three established and fully scaled businesses on our balance sheet and we believe this model can continue to deliver superior returns relative to the sector.
David L. Finkelstein: Just as we have over the past couple of years.
David L. Finkelstein: And now with that I'll hand, it over to Selina to discuss our financials.
Selina: Thank you, David and I will provide brief financial highlights for the third quarter and then my statement.
Selina: <unk> 20th Paul.
Selina: Consistent with prior quarters, while our earnings.
Selina: Really it's quite a GAAP and non-GAAP earnings and I think my comments will focus on our non-GAAP.
David L. Finkelstein: However, we remain constructive on the sector given the potential of sustained bank demand and the expected upcoming reduction in Fed Treasury runoff, factors that should be supportive of Agency MBS and were absent in the prior widening episodes. Meanwhile, hedge carry remains attractive with a historically wide nominal spread. Now turning to residential credit, the portfolio ended the quarter at $6.2 billion in market value and $2.4 billion in equity, with a rise of 21% of the firm's capital at quarter end.
Selina: Related to key performance metrics.
Selina: Hey.
Selina: Our book value per share as of March 31st 2020 fold increase from the prior quarter to $19 or seven 8%.
Selina: Yeah.
Selina: Depreciation with minimal interest rate exposure and was our first quarterly dividend of 50%.
Selina: Nick mentioned earlier, we generated an economic return.
Selina: Yeah.
Selina: Rising rates by tightening the credit asset was also the nice thing that had been put holiday $2 19.
Selina: And that isn't already MSR investments.
Selina: I'm, taking losses on our agency investment portfolio of $2 four that I can find voluntary declined.
Speaker Change: Got it.
Speaker Change: And he's available for distributions decreased five 4%.
Selina: Well that compared to Q4 2023.
Selina: <unk> declined on lower acquisitions mature.
David L. Finkelstein: Resume credit spreads tightened immediately to start the year, given the support of the fundamental backdrop, with AAA non-QM spreads 35 basis points tighter, and below IG CRTM 2, 70 basis points tighter. The credit curve continued to flatten as the issuance and supply of subordinate assets remained limited.
Selina: Interest expense increased rig count.
Speaker Change: That sounds great.
Speaker Change: Approximately $3 6 billion.
Speaker Change: The net financing impact was mitigated by continued improvement in asset.
Speaker Change: And I read that right.
Speaker Change: 22 basis points higher than in the fourth quarter.
Speaker Change: Okay.
Speaker Change: I think you benefited from the agency MBS portfolio, continuing like happened people strategy and the corresponding channel experiencing record Bryan.
Speaker Change: He said that the attractive deal.
Speaker Change: Net interest margin reflected maintained at two P M.
David L. Finkelstein: The growth in our portfolio was driven by our organic onslow-based strategy through increased whole loan purchases and retention of OBX securities. Given tightening spreads, we opportunistically reduced our CRT portfolio and other segments of our third-party securities holdings into strong demand. The Anzalo Bay Correspondent Channel had another record quarter as we registered $3.7 billion of expanded credit locks in Q1, up 40% quarter over quarter. We settled $2.4 billion of loans, the vast majority of which were sourced directly via our Correspondent Channel.
Speaker Change: The portfolio generating 143 basis points of NIM.
Speaker Change: And 15 basis point decrease from Q4.
Speaker Change: Net interest spread decreased quarter over quarter to 109 right.
Speaker Change: Total cost of funds increase quarter over quarter rising 35%.
Speaker Change: The $2.
Speaker Change: As I previously highlighted.
Speaker Change: He hates to normalized conditions.
Speaker Change: The net interest on part by $49 million, an increase in cost of funds by anything.
Speaker Change: Accounting for much of the quarter and accordingly.
Speaker Change: On the other hand average repo rates with bandwidth for the quarter.
Speaker Change: Declining nominally by one right.
Speaker Change: Turning to pick up on financing, we continue to see strong demand for finding back ABB non agency securities portfolio.
Speaker Change: A replay of challenging time.
Speaker Change: What is the book condition around fed meeting date.
Speaker Change: We hope to take advantage of any future rate cuts.
Speaker Change: As a result of Q1 reporting.
Speaker Change: Well I'm going to go down.
Speaker Change: <unk> thousand one day compared to Q4.
Speaker Change: During Q1, we continued to obtain additional funding capacity for our credit business.
Speaker Change: Two increased financing optionality.
Speaker Change: I.
Speaker Change: It's quite a debate on warehouse facilities.
Speaker Change: We can put an expanded product offering and non mark to market to actually attack.
Speaker Change: As of March 31, 24, we had $3 9 billion of MSR homeland warehouse.
Speaker Change: Anesthetic because that would imply that you're right.
David L. Finkelstein: And our pipeline remains robust, with $2 billion of locks at quarter end and continued momentum into the spring selling season. Most importantly, our credit discipline remains strong as our current pipeline is characterized by a 68 LTV and a 753 FICO, with only 3% of our locks greater than 80 LTV. We were able to take advantage of the support of capital markets by pricing seven securitizations, totaling $3.3 billion in Q1, generating $328 million in assets for Annaly's balance sheet and low-to-mid double-digit returns. And subsequent to quarter end, we priced an additional non-QM transaction with retained assets exhibiting similar expected returns. I'm looking forward to the further development of the Onslaught Bay Channel.
Speaker Change: That was already.
Speaker Change: I believe the unencumbered assets increased to $5 3 billion in first quarter compared to $5 nine in the fourth quarter, including cash and unencumbered agency MBS and three 5 billion.
Speaker Change: In addition, we have approximately $900 million and value of the MSR, that's been placed committed warehouse facilities.
Speaker Change: Remain undrawn and can be quickly converted cash subject to market is that right.
Speaker Change: There was approximately $6 2 billion and I think if I look at financing unchanged compared to last quarter.
Speaker Change: We believe that our disciplined approach to liquidity and credit leverage.
Speaker Change: Alcatel.
Speaker Change: Got it.
Speaker Change: Actually the volatility of the predictive.
Speaker Change: Lastly, we have continued to efficiently manage our expenses.
Speaker Change: The decline in the equity you might try to one from three 5% for the first quarter compared to one 1%.
Speaker Change: A 2023.
Speaker Change: I'll conclude our prepared remarks, and we'll now open the line for questions.
Speaker Change: Yeah.
Speaker Change: Thank you we will now begin the question and answer session. As a reminder to ask a question you May Press Star then one on your telephone keypad, if youre using a speakerphone. Please pick up your handset before pressing the keys if at any time. Your question has been addressed and you would like to withdraw it.
Speaker Change: Please press Star then two at this time, we will pause momentarily to assemble our roster.
Speaker Change: Today's first question comes from Bose, George with K B W. Please proceed.
Bose Thomas George: Hey, everyone. Good morning.
George: I get an update or book value quarter to date.
George: Sure Bose good morning, so as of our last flash, which was tuesday's close net of bar dividend accrual. We were off just inside of 3% inclusive of that dividend just inside of 2% off.
David L. Finkelstein: In this position, Annaly is a market leader in the residential credit market, allowing us to manufacture our own credit risk while retaining control over all aspects of the process. Shifting to our MSR business, our portfolio ended the first quarter at $2.7 billion in market value, representing $2.3 billion in the firm's capital. MSR transaction volumes continued to be elevated in the first quarter, given challenging originator profitability, while demand and pricing remain firm. Despite elevated supply, we were disciplined, finding better opportunities in relative value post-quarter end, and in early April, we committed to purchase just over $100 million in market value of the bulk package, which we expect to close in the second quarter.
Bose: Oh, Okay perfect. Thank you and then the I noticed the targeted return on your MSR increased to 12 to 14 from 10 to 12.
Speaker Change: Is that sort of just better yields in the market or is there like a different leverage assumption or just kind of curious what drove that.
Speaker Change: It's predominantly the increase in float income associated with higher short rates projected, but Ken you want to elaborate yes.
Ken: As you May know ownership of the MSR asset involves.
Ken: The MSR owner I mean, the bulk of it.
Ken: Floating.
Ken: Maintaining those escrow accounts adopt higher for longer change in rates.
Ken: Just translates to a much higher yield.
Ken: Actual multiple so it's rather just the math.
Ken: Matt.
Matt: Okay, great. Thank you.
Speaker Change: Thanks Bose.
Speaker Change: Okay.
Speaker Change: Your next question comes from Doug Harter with UBS. Please proceed.
Douglas Michael Harter: Oh thanks.
Douglas Michael Harter: You talk about how msr's are performing kind of in this oh as rates continue to increase.
Douglas Michael Harter: And the effectiveness of hedging knee the MBS portfolio.
Douglas Michael Harter: Yeah, absolutely. This is Jeff thanks for the question.
Douglas Michael Harter: And in terms of spot performance with speeds you can see in our presentation are extremely stable delinquency is extremely stable.
David L. Finkelstein: We're confident we've constructed one of the highest-quality conventional MSR portfolios in the market, characterized by our industry-low 3.07% note rate and exceptional credit quality. Fundamental performance of our MSR portfolio has continued to outpace our initial expectations, with our holdings realizing a three-month CBR of 3%, rising float income given increased escrow balances, and minimal borrower delinquencies. And all of these factors have contributed to our MSR portfolio exhibiting highly stable cash flows with double-digit returns.
Speaker Change: Five question alluded to we have an increase in cash flow and expected cash flow over time as the earnings.
Speaker Change: Or are not expected to decline given given.
Speaker Change: It's coming out of the market in terms of expected Tyson.
Speaker Change: In terms of hedging the MBS portfolio.
Speaker Change: Slower speeds.
Speaker Change: Good for the Amazon.
Speaker Change: The mortgage universe trading in Wisconsin slower speeds are or are not a good outcome for all mortgage backed securities. So we do have that headroom.
Speaker Change: Yes.
Speaker Change: Doug I'll just add too.
Speaker Change: Add to Ken's point.
Speaker Change: When we buy MSR.
Speaker Change: Standard standard speaking, it's often a hedge for the duration of the portfolio when its deep out of the money Theres two other hedge benefits, we get as good Ken.
David L. Finkelstein: Now, given Annaly's diversified strategy and ample liquidity position, we currently do not utilize a significant amount of recourse leverage on the MSR portfolio as it is advantageous to supplement leverage with lower-cost agency repo. However, with 1.25 billion of committed warehouse facilities, we're positioned for additional MSR growth should pricing be favorable. Now, looking ahead, we're optimistic about the outlook for our three businesses, and we continue to see attractive risk-adjusted returns across each of our investment strategies.
Speaker Change: Discuss first is the higher float income hedges are the higher for longer and short rates and financing associated with the agency MBS and secondly, the turnover.
Speaker Change: Which is lower in a in a higher rate environment, it's better for them is SAR. So those two factors have led to the shift in the benefits associated with MSR for our portfolio.
Speaker Change: Thanks, and then the increase in the envelope Bay a correspondent activity is.
Speaker Change: How much is that kind of adding new customers is that getting deeper with existing customers kind of if you could give a little more color behind the increased activity there.
Speaker Change: Hey, Thank you. This is that this is Mike. Thanks for the question I think a lot of it is the corresponding channel is not yet mature we still believe that there is over 100 of correspondents that are originating non QM and the SCR loans that are not currently our captive customers.
David L. Finkelstein: However, bouts of volatility remain a key risk, as we have been reminded in recent weeks, and we remain vigilant. Annaly continues to be well-prepared, given our conservative leverage position and capital structure, our ample liquidity, and a diversified capital allocation strategy that can outperform across different interest rate and macro landscapes. And while we continue to make progress in allocating incremental capital towards our residential credit and MSR strategies, we like our current capital allocation and are disciplined in pricing and selective in the sourcing of assets.
Speaker Change: We've been very aggressive in trying to build at the correspondence.
Speaker Change: Some of that volume is just through the maturation of the of the corresponding channel.
Speaker Change: Some of it is a spring seasonal right. So we've certainly benefited from that in Q1 relative to Q4 and I think a lot of it is also the growth in the actual market itself.
Speaker Change: Like non banks have rolled out these programs and they have been very active participants and now potentially taking market share from some of the smaller niche specialty finance players, but they are building market share as well and the borrower you know within the non QM Dfc. Our market is also a little bit less sensitive than agency or jumbo market.
Speaker Change: Two rates.
Speaker Change: At quarter end of the volume that we're doing right now is cash outs that number is 7% to 8% within the agency market. So I think there's a number of factors that are leading to the increase in volumes, but I will say one of the largest drivers is just the actual bill of the correspondent, adding new originators to the platform.
Speaker Change: Great. Thank you.
Speaker Change: Thank you Doug.
Speaker Change: Our next question comes from Rick Shane with J P. Morgan. Please proceed.
David L. Finkelstein: And overall, we're proud of the unique platform we've built with three established and fully scaled businesses on our balance sheet, and we believe this model can continue to deliver superior returns relative to the sector, just as we have over the past couple of years. And now, with that, I'll hand it over to Serena to discuss our financials.
Richard Barry Shane: Thanks, everybody and good morning.
Richard Barry Shane: Look I'm looking at slide six and I know closed and ask the question here is well there's convergence between the returns on the three strategies and I'd love to explore in the current environment sort of the base case higher for longer what you think the right tactical.
Serena Wolfe: Thank you, David. Today I will provide brief financial highlights for the first quarter ending March 31st, 2024. Consistent with prior quarters, while our earnings release discloses GAAP and non-GAAP earnings metrics, my comments will focus on our non-GAAP EAB and related key performance metrics, which exclude the PAA. Our book value per share as of March 31, 2024, increased from the prior quarter to $19.73, based largely on asset spread appreciation with minimal interest rate exposure. And with our first quarter dividend of $0.65, as David mentioned earlier, we generated an economic return of 4.8%.
Speaker Change: <unk> and then if you could let it.
Speaker Change: You sort of lay out if we saw the tail scenarios, one tail scenario being additional hikes. The other being caught sooner than we thought how you would position yourself in the context of these three choices basically I want to understand how you're thinking about things now and what the risks are or what the opportunities are.
Richard Barry Shane: If you make a strategic call.
Speaker Change: Sure. Thanks, <unk>. So just in terms of overall capital allocation as I mentioned in our prepared remarks. So we do very much like where we are where we are at today.
Speaker Change: Take the three sectors are all fully scaled obviously in the portfolio is in a good balance right now and I think it shows up in our economic returns over the over the past many quarters. So so we're happy with where we're at in terms of relative value.
Richard Barry Shane: Agency looks perfectly fair here.
Richard Barry Shane: Certainly sensitive to higher volatility that could could materialize, albeit we don't expect to see anything like we saw last fall.
Richard Barry Shane: But nevertheless, some were sensitive too so we're a little bit under Levered on the agency side, but our allocation as you know.
Serena Wolfe: Rising rates and spread tightening for credit assets resulted in gains on our hedging portfolios of $2.19 and gains on our leading MSR investments of $0.17, outpacing losses on our agency investment portfolios of $2.04 as implied volatility declined in asset price time. Earnings available for distribution decreased by $0.04 per share to $0.64 in the first quarter compared to Q4 2023. EAU declined on lower thought benefits as some of our positions
Richard Barry Shane: Nearly 60% and that's the core of the portfolio and that's where our liquidity is so so we like it there.
Richard Barry Shane: In terms of the other two sectors, both are adding accretive returns both in terms of book value in their spend and their supporting the dividend.
Richard Barry Shane: So we like where we're at and then when we look at from a relative value and a capital allocation percentage in terms of expected returns under various scenarios. This allocation here today gives us the best Bang for a buck when we stress the portfolio with shock rates up or down.
Richard Barry Shane: Now in terms of how we would position it.
Richard Barry Shane: The scenario, you mentioned, whether it's higher for longer versus businesses or even higher potentially.
Richard Barry Shane: Versus the potential for cuts.
Richard Barry Shane: The way we look at it is we are carrying a very small amount of interest rate risk, but you don't you're not getting paid for it.
Serena Wolfe: Gross interest expense increased as average repo and securitized debt balances increased by approximately $3.6 billion. However, the net financing impact on the AB was mitigated by continued improvement in asset yields as average asset yields at PAA further rose quarter over quarter, 22 basis points higher than in the fourth quarter at 4.87%. Asset yields benefited from the agency NBS portfolio continuing its up-and-coupon strategy and the Onslaught Bay Corresponding Channel experiencing record growth in hold-on purchases due to their attractive yield.
Richard Barry Shane: The rates market as we've been to be relatively fairly priced.
Richard Barry Shane: Sold off over 80 basis points on the long end of this year and it's been warranted given the much stronger data that we've seen in the surprise uptick in inflation.
Richard Barry Shane: When you look at the horizon and think about longer term rates you know five year five year rates five years forward and treasuries is at 465, which we did which perfectly reasonable 10 year real rates are roughly 2.25% and then globally rates are quite competitive with the.
Richard Barry Shane: Nominal 10 years 150 basis points over the rest of the G. Seven so the rates market mix didn't have priced in.
Richard Barry Shane: The stronger growth in the high inflation that we've recently seen in another point to note.
Richard Barry Shane: With respect to rates markets relative to the fed for example, which is the market has priced in at a much higher.
Richard Barry Shane: Neutral rate than the Feds long run average over 4% now when we look at the curve on very short rates and stuff. So the mortgage.
Serena Wolfe: Net interest margin reflected the changes to EAB for the first quarter, with the portfolio generating 143 basis points of NIMXPAA, a 15 basis points decrease from Q4. Similarly, net interest spread decreased 13 basis points quarter over quarter to 109 basis points. Total cost of funds increased quarter-over-quarter, rising 36 basis points to 3.78%. As I previously highlighted, swap benefit continues to normalize as positions expire, reducing net interest on swaps by $49 million and increasing cost of funds by 33 basis points, accounting for much of the quarter-over-quarter impact. On the other hand, average repo rates were stable through the quarter, declining nominally by one basis point.
Richard Barry Shane: Is reasonably well priced for uncertainty associated with the potential for higher for longer or even heights.
Richard Barry Shane: And the way we would position ourselves if we did anticipate heights is.
Richard Barry Shane: We maintain a conservative approach with respect to interest rate risk, we're already at the lowest leverage we'd been at since 2014, and so we feel good about that and we're prepared for it and the positive aspect of it as I mentioned in our prepared remarks is that.
Richard Barry Shane: We're able to earn returns that support <unk>.
Richard Barry Shane: 2% yield on book and so we feel really good about it and we're prepared for that type of uncertainty now on the other hand, if all of a sudden new higher rates in there.
Richard Barry Shane: The trajectory is.
Richard Barry Shane: The policy does create unintended consequences and interest rate sensitive sectors. For example, whether it's mutual banks of CRE and housing the fed does have to do.
Richard Barry Shane: We act in a way that's much more accommodative much quicker.
Richard Barry Shane: Plenty of opportunity to position the portfolio in a more aggressive fashion as that materializes. So so we're not worried about missing anything.
Richard Barry Shane: Right now our leverage is at where it's at because candidly.
Richard Barry Shane: The range of outcomes has increased to the intent of your question.
Serena Wolfe: Turning to details on financing, we continue to see strong demand for funding for our agency and non-agency security portfolios. Our repo strategy is consistent with prior quarters, with a book position around Fed meeting dates, as we look to take advantage of any future rate cuts. As a result, our Q1 reported weighted average repo days were 43 days, down just one day compared to Q4.
Richard Barry Shane: We need to get through this volatility.
Richard Barry Shane: And so we're going to remain relatively conservative, but we're well prepared for the downside and we can easily.
Richard Barry Shane: Hum react if.
Richard Barry Shane: Policy becomes much more accommodative.
Richard Barry Shane: And all of a sudden they observe improved quite a bit.
Richard Barry Shane: Does that help.
Speaker Change: It does and I apologize for asking such an open ended question, but I really I have to say enjoy the answer its very helpful and thank you.
Speaker Change: Anytime rig.
Speaker Change: Yeah.
Speaker Change: The next question is from Jason Weaver with Jones trading. Please proceed.
Jason Price Weaver: Good morning, I was wondering can you give us a ballpark on the incremental NIM youre targeting for the whole loans going into the Onslow Bay Securitizations and what you think your capacity is there and what might be a weaker origination environment.
Jason Price Weaver: Hey, Jason this is Matt.
Serena Wolfe: During Q1, we continued to open additional funding capacity for our credit businesses. To increase financing optionality for our on-going bank platform, we closed additional warehouse facilities approaching $1 billion in size, which included expanded card offerings and non-marked market features at two-year terms. As of March 31, 2024, we have $3.9 billion of MSR and home loan warehouse capacity at a 34% utilization rate, leaving substantial availability. Annaly's unencumbered assets increased to $5.3 billion in the first quarter compared to $5.2 billion in the fourth quarter, including cash and unencumbered agency MDS of $3.5 billion.
Matt: When when you say NIM, you're talking about some form of projected gain on sale and in terms of if you had any.
Matt: Any internal market yes.
Matt: Yeah.
Matt: Not a metric that we'd given out historically.
Matt: Historically, but I will say in terms of when we're actually pricing our loans you know when we're putting out a rate sheet, we are targeting close to mid teens Roe.
Jason Price Weaver: Based upon retaining call it 10% market value and then maybe a small nominal amount of recourse language. So youre looking at 6% to 7% dedicated deploy capital on those whole loans at.
Jason Price Weaver: Mid teens are a lease in terms of where we're where we're setting setting the risk and the rate sheet and Jason just to add you know as I talked about my prepared comments as we added all be ex securities to the balance sheet, we reduced our third party securities.
Jason Price Weaver: The way, Mike is able to organically create assets, it's much cheaper to be phased in third party securities and credit has done quite well as im sure Youre aware. So we've reduced that component the third party component of the balance sheet to make room for it.
Jason Price Weaver: What is candidly much more attractively priced Dolby ex securities.
Serena Wolfe: In addition, we have approximately $900 million in fair value of MSR that has been pledged to committed warehouse facilities that remain unborn and can be quickly converted to cash, subject to market advance rates. We have approximately $6.2 billion in assets available for financing, unchanged compared to last quarter. We believe that our disciplined approach to liquidity and credit leverage leaves us well prepared to confront market risk, such as the volatility of the previous few weeks.
Speaker Change: We can do that.
Speaker Change: Alright. Thank you that's helpful and then David maybe expanding on your earlier prepared remarks, a little bit what do you think about the impact of Q T. Krill curtailment on your agency portfolio strategy doesn't change the approach at all.
David L. Finkelstein: You know it.
David L. Finkelstein: It gives us more confidence in in the near term horizon and you know it is.
Speaker Change: Very incremental what the what the fed will do it.
David L. Finkelstein: Everybody's aware, they're likely to begin to taper either may or June and will reduce the run off of their treasury portfolio by roughly 50% and what that would do is it will help.
David L. Finkelstein: Provide comfort to private market participants that theres less treasury supply coming to the market it'll help Bob banks.
David L. Finkelstein: And so far as deposit growth will be able to be deployed into fixed income in terms of in terms of their liquidity and ultimately that'll help agency MBS banks, where did reemerge as buyers both treasuries and agency MBS in the first quarter and we're hopeful that that will.
Serena Wolfe: Lastly, we have continued to efficiently manage our expenses, resulting in a decline in our optics-to-equity ratio to 1.35% for the first quarter, compared to 1.41% for the fourth quarter of 2023. That concludes our prepared remarks, and we will now open the line for questions. Thank you, operator.
David L. Finkelstein: <unk> and reduced treasury supply from from from the Fed will will help fixed income markets overall and indirectly the agency MBS market, but we don't expect them to.
David L. Finkelstein: Reduce their run off in agency MBS.
David L. Finkelstein: We don't expect them to buy agency MBS in any event other than a crisis type agreements.
Operator: Thank you. We will now begin the question and answer session. As a reminder, to ask a question, you may press star then 1 on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been answered and you would like to withdraw it, please press star then 2.
David L. Finkelstein: Foreseeable future, but the reduced treasury supply will be helpful for all fixed income markets.
Speaker Change: Alright, Thanks again for taking my question.
Speaker Change: You bet Jason.
Speaker Change: Okay.
Speaker Change: Our next question is from Trevor Cranston with JMP Securities. Please proceed.
Trevor John Cranston: Alright. Thanks.
Operator: At this time, we will pause momentarily to assemble our roster. Today's first questioning comes from Bose George with KBW. Please proceed.
Trevor John Cranston: On the MSR business.
Trevor John Cranston: As that continues to grow and gain scale can you talk about how you would think about potentially bringing the servicing function in house.
Bose Thomas George: Hey, everyone. Good morning. Can I get an update on book value quarter to date? Sure, Bose. Good morning. So as of our last
Trevor John Cranston: Kind of generally how you think about the tradeoffs between using sub servicers.
Trevor John Cranston: I know there were some function right.
Speaker Change: Yeah sure. So we've looked at Servicers in the past and have seen a number of them come to market and what we've learned is that it's much more efficient for us to outsource servicing in.
Unknown Executive: Sure, Bose, good morning. So as of our last flash, which was Tuesday's close, net of bar dividend accrual, we were off just inside of 3% inclusive of that dividend. Okay, perfect. Thank you.
Speaker Change: In the absence of significant scale.
Speaker Change: It's very low margin business and we have considerable amount of flexibility by using multiple high quality sub servicers is very competitively priced and we have good recapture relationships and we also have better access to assets.
Unknown Executive: And then I noticed the targeted return on your MSR increased to 12 to 14 from 10 to 12. You know, was that sort of just better yields in the market? Or is there like a different leverage assumption? Or just curious what it is. It's predominantly the increase in float income associated with higher short rates projected, but Ken, you want to elaborate? Yeah, I get it.
Speaker Change: As a consequence, we're not a competitive threat to the mortgage origination community.
Speaker Change: So.
Speaker Change: By outsourcing servicing.
Speaker Change: It's better for our overall business now that could change at some point, but right now we really like the relationships. We have on the sub servicing side and we're going to maintain that posture for the time being.
Speaker Change: Got it okay that makes sense.
Speaker Change: And then in light of the significant move in rates here in April.
Speaker Change: Could you comment on any changes you've made within the portfolio, particularly.
Speaker Change: And agency MBS or with the hedges.
Ken Adler: As you know, ownership of the MSR asset involves the MSR owner earning the benefit of the float income, maintaining those escrow accounts about higher for longer, changing rates.
Speaker Change: Sure. So we did actually sell early in the quarter a couple of billion agency MBS.
Speaker Change: Some of that was outright so part of it part of that was anticipatory.
Speaker Change: We were certainly glad we did.
Speaker Change: We will manage our rate exposure here as the market evolves. We're currently running at about a half year duration, which we're comfortable with but we're certainly cautious agency MBS.
Ken Adler: are no longer changing rates, which translates to a much higher yield at the exact same multiple. So it's really just the math on that.
Speaker Change: Taken this sell off they've been better behaved certainly in the fall primarily because <unk> has been it's been a little bit better.
Speaker Change: This time around and theirs.
Speaker Change: There's more fundamentally positive factors in the market today than they were last year.
Operator: The next question comes from Doug Harder with UBS. Please proceed.
Speaker Change:
Speaker Change: The bar for the fed to hike is higher today than it was last year as we just talked about the Q T tape there is likely to be underway.
Douglas Michael Harter: Thanks. Can you talk about how MSRs are performing as rates continue to increase and their effectiveness in hedging the MBS portfolio?
Speaker Change: Composition of Treasury issuance is in a better place than it was last fall and money is actually flowing into fixed income. So so we feel a little bit better about the market in this rate sell off and we did.
Ken Adler: Yeah, absolutely. This is Ken. Thanks for the question. In terms of spot performance, I mean, the speed you can see in the
Speaker Change:
Speaker Change: Last year in October and we sort of unknown and insight mentality and that doesn't exist today and that should be supportive of the agency market, but we're going to stay conservative.
Speaker Change: To the extent Theres cheapening more cheapening and the basis, we're going to cover those mortgages that we bought and we anticipate doing selling it.
Ken Adler: We are extremely stable. And as the prior question alluded to, we have an increase in cash flow, expected cash flow, over time as earnings on the float.
Speaker Change: And has that been changes to sell early and traded around so.
Speaker Change: That's pretty much the story in trouble.
Speaker Change: Okay I appreciate the comments thank you.
Speaker Change: You bet.
Speaker Change: The next question is from Eric Hagen with B P. I G. Please proceed.
Ken Adler: are not expected to decline given federal cuts coming out of the market in terms of expected pricing.
Eric J. Hagen: Hey, good morning, how are you guys done hey, it looks like the preferred stock is going to go fully floating rate by the end of June right now the press or you know around 15% of the equity capital structure.
Eric J. Hagen: So how does your outlook for leverage in our positioning of the portfolio, maybe respond to the cost of that preferred.
Eric J. Hagen: And maybe even at your current valuation and when you look at the environment.
David L. Finkelstein: In terms of hedging the MDX portfolio, you know, slower speeds are good for the MSR and the mortgages.
Eric J. Hagen: Do you think it actually makes sense to maybe scale up with more preferred right now yeah. So in terms of the capital structure, you're right. It's roughly 13, 5% of our capitalism preferred and C series is do go slowly.
David L. Finkelstein: Transcribed by https://otter.ai Yeah, Doug, I'll just add to Ken's point. Look, when we buy MSR, you know, standard speaking, it's often a hedge for the duration of the portfolio. When it's deep out of the money, there are two other hedge benefits we get, as Ken discussed. First is the higher float income, hedges, the higher for longer and short rates, and financing associated with the agency MBS. And secondly, the turnover, which is lower in a higher rate environment, is better for MSR. So those two factors have led to a shift in the benefits associated with MSR for our portfolio.
Eric J. Hagen: Here in June and how we looked at it as our cost of preferred capital will be.
Eric J. Hagen: A little over 10% at that time.
Eric J. Hagen: Which is relatively high but it's also important to note that we're at the highs of the rate cycle and so when we look at our cost of prep, we look at it over.
Eric J. Hagen: A longer horizon compared to the forwards and it does come down.
Eric J. Hagen: With the ultimate spread cut so so.
Eric J. Hagen: Two around 9% or thereabouts, and then we compare that level to be.
Eric J. Hagen: The asset yield on the portfolio and when you look at the relationship even at the at the spreads today versus at your asset yields.
Eric J. Hagen: That spread is actually higher today than the long run average so we're comfortable with the elevated cost of preferred capital in this floating rate environment, even with the ice going floating which as you know we will have a relatively immaterial call cost burden of less than a penny a quarter inlet.
David L. Finkelstein: Thanks. And then the increase in the Anzalo Bay correspondent activity, how much is that kind of adding new customers? Is that getting deeper with existing customers? Can you give a little more color behind the increased activity there? Hey, Doug. Thank you. This is Mike.
Eric J. Hagen: Two our prep costs. So so not that material and then with respect to potentially issue and more press and we like our capital structure, where it's at the prep market Hasnt really opened up there's been a couple of very recent bank transactions, but generally speaking, it's still it's still relatively quiet, but to the extent it does.
Eric J. Hagen: And we get some firmness in pricing in the mid to upper upper single digits call. It.
Michael Fania: Hey Doug, thank you. This is Mike.
Michael Fania: Thanks for the question. I think a lot of it is that the correspondent channel is not yet mature. We still believe that there are over 100 correspondents that are originating non-QM and DSCR loans that are not currently our captive customers. So we've been very aggressive in trying to build relationships with the correspondents. So, you know, some of that volume is just through the maturation of the correspondent channel. Some of it is spring seasonals.
Eric J. Hagen: To be able to issue and potentially even refi, we would certainly look at it but.
Eric J. Hagen: We liked the low leverage in our capital structure as it stands.
Eric J. Hagen: And we will keep an eye on that market.
Speaker Change: I mean, along the same lines I mean, as you guys scale up with the MSR is there room for unsecured debt.
Eric J. Hagen: Just as a kind of more effective duration match maybe versus using secured.
Eric J. Hagen: Well look we have $3 5 billion of essentially cash and agency MBS on the on the balance sheets. So we don't need the debt right now as I mentioned in my prepared remarks, a lot of that capital to fund the MSR is coming from excess liquidity.
Eric J. Hagen: And we do have.
Eric J. Hagen: The ample warehouse capacity and we compare that warehouse capacity and the cost of warehouse financing to debt markets and the fact of the matter is that issuing unsecured debt would be funding that MSR at a cost that's much higher than.
Michael Fania: So we've certainly benefited from that one relative to Q4. And I think a lot of it is also due to growth in the actual market itself. You know, large non-banks have rolled out these programs, and they have been very active participants, not only potentially taking market share from some of the smaller niche specialty finance players, but they're building market share as well. And the borrower, you know, within a non-QM DSCR market is also a little bit less sensitive than an agency or jumbo market, you know, two rates.
Eric J. Hagen: Term committed warehouse financing and so it wouldn't make sense for us and particularly given the fact that we don't need the liquidity to go to the debt markets certainly it's not something we're actively considering.
Speaker Change: Yep. Thank you guys I appreciate it.
Speaker Change: Thanks, Eric.
Speaker Change: Again, if you do have a question. Please press Star then one on your telephone keypad.
Speaker Change: The next question comes from Kenneth Lee with RBC capital markets. Please proceed.
Kenneth S. Lee: Hey, Thanks for taking my question. Good morning, just one for me.
Kenneth S. Lee: You mentioned in the prepared remarks.
Kenneth S. Lee: Dividends are set appropriately for 2024 wondering if you could just further flesh this out.
Kenneth S. Lee: Pendant upon rate volatility to potentially decline or does it depend on a on a certain agency MBS spread range. Thanks.
Kenneth S. Lee: You don't get sick, it's a function of where the asset yields on the portfolio are in looking at the forward to trying to give some guidance a little bit further out the horizon given the fact that with lower leverage just just in attempt to provide a little comfort that we can operate at lower leverage instead.
Michael Fania: You know, about a quarter of the volume that we're doing right now is cash outs. That number is, you know, 7 to 8 percent within the agency market. So I think there are a number of factors that are leading to the increase in volume. But I'll say one of the largest drivers is just the actual build of the correspondent, adding new originators to the platform.
Kenneth S. Lee: Generate a yield that is certainly competitive.
Kenneth S. Lee: It's the durability of the earnings power of the portfolio that I just wanted to highlight there.
Kenneth S. Lee: Now look quarter over quarter, EAP is going to ebb and flow.
Kenneth S. Lee: But when it comes to the economic earnings of the portfolio, we do feel quite good about covering it.
Kenneth S. Lee: The second quarter, our NIM will go up very modestly we anticipate.
Kenneth S. Lee: And in the absence of a shock to the market we feel reasonably good about where were the earnings picture is for 2024.
Speaker Change: Great very helpful. There.
Operator: Our next question comes from Rick Shane with JP Morgan. Please proceed.
Speaker Change: Thanks, Jeff.
Speaker Change: The next question comes from Merrill Ross with Compass point. Please proceed.
Richard Barry Shane: Thanks, everybody, and good morning. Look, I'm looking at slide six, and I know Bose had asked a question here as well. There's convergence between the returns on the three strategies, and I'd love to explore in the current environment, sort of the base case, hire for longer, what you think the right tactical approach is, and then if you could sort of lay out if we saw the tail scenarios, one tail scenario being additional hikes, the other being cuts sooner than we thought, how you would position yourself in the context of these three choices. Basically, I want to understand how you're thinking about things now and what the risks are or what the opportunities are if you make a strategic call.
Speaker Change: Yeah.
Merrill Hadady Ross: Thank you I wanted to ask about the lower swap benefits.
Merrill Hadady Ross: And I expect that will continue well hopefully you should talk to 97%.
Merrill Hadady Ross: You called him give us a ballpark for what would be Oh, well also positions expire throughout the year Oh.
Merrill Hadady Ross: Okay.
Speaker Change: Merrill I was a little difficult to hear you on that but what I think you asked is about the roll down on the on the hedge portfolio and where the hedge ratio would go. So just real quickly when you look at our swap book currently we.
Speaker Change: We did have roughly 5 billion roll off in the first quarter second quarter. Its very light section just the 1 billion in the quarter and witnessed when we look at that solo and swap position zero to three years is roughly $18 billion.
Speaker Change: Emotional and it has an average life.
Speaker Change: Oh average maturity at one point for six years. So so if you think about it over the next three years, we're going to always have that on average in <unk>.
Merrill Hadady Ross: In a year and a half and so it's pretty evenly distributed now the way to think about it is is as that those swaps run off also whats happening is agency MBS are running off and when you look at the asset yield on our portfolio, which is in the $4 <unk> on a book yield basis, and you look at reinvesting.
David L. Finkelstein: prepared remarks, we do very much like where we are at today. We think the three sectors are all fully scaled, obviously, and the portfolio is in a good balance right now.
Merrill Hadady Ross: Those that run off into new agency MBS in production coupon MBS yield somewhere in the 6% quarter range right screening thereabouts thereabouts, so what youll see over the next number of years is is a pretty orderly run off of the of the hedge portfolio, which will replace out the curve.
David L. Finkelstein: And I think it shows up in our economic returns over the past many quarters. So, we're happy with where we are. In terms of relative value, agency looks perfectly fair here. We're certainly sensitive to higher volatility that could materialize, albeit we don't expect to see anything like we saw last fall. But nevertheless, it's something we're sensitive to.
Merrill Hadady Ross: And make sure that we are.
Merrill Hadady Ross: Hedged for the environment, but also youre going to replenish yield bye bye reinvest in agency, but often an increase in the asset yield overtime. So we like the hedge portfolio, where Jack will manage for the environment and we're gonna stay reasonably well hedged now.
Speaker Change: Thank you.
Speaker Change: Thank you.
Speaker Change: At this time there are no further questioners in the queue and this does conclude our question and answer session I would now like to turn the conference back over to David Finkelstein for any closing remarks.
David L. Finkelstein: So, we're a little bit underleveraged on the agency side, but our allocation is nearly 60%, and that's the core of the portfolio, and that's where our liquidity is. So, we like it there. In terms of the other two sectors, both are adding accretive returns, both in terms of book value, and they're supporting the dividend. So, we like where we're at. And then when we look at, you know, the relative value and the capital allocation percentage in terms of expected returns under various scenarios, this allocation here today gives us the best bang for the buck when we stress the portfolio shock rates up or down.
David L. Finkelstein: Thank you and thanks, everybody for joining us today have a good rest of the spring and we'll talk to you next quarter.
Speaker Change: The conference has now concluded. Thank you for attending today's presentation and you may now disconnect.
Speaker Change: [music].
David L. Finkelstein: Now, in terms of how we would position in the scenario you mentioned, whether it's higher for longer versus or even higher potential versus, you know, the potential for cuts, look, the way we look at it is we are carrying a very small amount of interest rate risk, but you're not getting paid for it. The interest rate market is, we think, relatively fairly priced. We have sold off over 80 basis points on the long end this year, and it's been warranted given the much stronger data that we've seen and the surprise uptick in inflation.
David L. Finkelstein: But when you look out the horizon and think about longer-term rates, you know, five-year rates, five years forward in Treasuries are at 465, which we think looks perfectly reasonable. Ten-year real rates are, you know, roughly two and a quarter percent. And then globally, rates are quite competitive with nominal ten years, 150 basis points over the rest of the G7. So, the rates market looks to have priced in, you know, the stronger growth and higher inflation that we've recently seen.
Speaker Change: Yeah.
Speaker Change: [music].
David L. Finkelstein: And another point to note with respect to rates markets relative to the Fed, for example, is that the market is priced in a much higher neutral rate than the Fed's long-run average. We're over 4% now when we look out the curve on very short rates.
Speaker Change: Yeah.
Speaker Change: Yes.
Speaker Change: Yeah.
Speaker Change: Yeah.
Speaker Change: [music].
David L. Finkelstein: And so, the market is reasonably well priced for uncertainty associated with, you know, the potential for longer or even hikes. And the way we would position ourselves if we did anticipate hikes is that we maintain a conservative approach with respect to interest rate risk. We're already at the lowest leverage we've been at since 2014. And so, we feel good about that, and we're prepared for it. And the positive aspect of it, as I mentioned in our prepared remarks, is that we're able to earn returns that support, you know, a 13% year-long book.
David L. Finkelstein: And so, we feel really good about it, and we're prepared for that type of uncertainty. Now, on the other hand, if all of a sudden, you know, higher rates and, you know, the trajectory of policy does create unintended consequences in interest rate sensitive sectors, for example, whether it's regional banks or CRE and housing, the Fed does have to react in a way that's much more accommodative much quicker. We're going to have plenty of opportunity to position the portfolio in a more aggressive fashion as that materializes.
Speaker Change: Okay.
Speaker Change: [music].
Speaker Change: Yeah.
Speaker Change: [music].
Speaker Change: Yeah.
Speaker Change: [music].
David L. Finkelstein: So, we're not worried about missing anything. You know, right now, our leverage is where it is because, you know, candidly, the range of outcomes has increased to the intent of your question. And we need to get through this thought of volatility. And so, we're going to remain relatively conservative, but we're prepared for the downside, and we can easily react if policy becomes much more accommodative, and all of a sudden, rates improve quite a bit.
Richard Barry Shane: Does that help? It does, and I
David L. Finkelstein: It does, and I apologize for asking such an open-ended question, but I really, I have to say, enjoyed the answer. It's very helpful, and thank you. Any time. Great.
Operator: The next question is from Jason Weaver with Jones Trading. Please proceed.
Speaker Change: Okay.
Speaker Change: [music].
Jason Price Weaver: Hey, Jason, this is Mike. When you say you're talking about, you know, some form of projected gain on sale, in terms of if you had any, any internal target. Yeah. Yeah, that's not a metric that we've given out historically, but I will say in terms of when we're actually pricing our loans, you know, when we're putting out a rate sheet, we are targeting close to, you know, mid-team ROEs based upon retaining, call it, you know, 10% market value, and then maybe a small nominal amount of recourse leverage.
Jason Price Weaver: So you're looking at six to 7%, you know, dedicated deploy capital on those whole loans at mid-team ROEs, in terms of where we are, where we're setting the risk and the rate sheet. Yeah, Jason, just to add, you know, as I talked about in my prepared comments, you know, as we added OBX security to the balance sheet, we reduced our third-party securities. You know, the way Mike is able to organically create assets, it's much cheaper than third-party securities, and credit has done quite well, as I'm sure you're aware. And so we've reduced that component, the third-party component of the balance sheet, to make room for what is, candidly, much more attractively priced OBX securities, and we'll continue to do that.
David L. Finkelstein: You know, it gives us more confidence in the near term horizon and
Unknown Executive: [inaudible] Transcripts provided by Transcription Outsourcing, LLC.
Operator: Our next question is from Trevor Cranston with JMP Securities. Please proceed.
Trevor John Cranston: On the MSR business, you know, as that continues to grow and gain scale, can you talk about, you know, how you would think about potentially bringing the servicing function in house? And kind of generally what you think about the trade-offs between using sub servicers and having an in-house servicing function?
David L. Finkelstein: Yeah, sure. We've looked at servicers in the past and seen a number of them come into the market, and what we've learned is that it's much more efficient for us to outsource servicing. In the absence of significant scale, it's a very low-margin business, and we have a considerable amount of flexibility by using multiple high-quality subservicers. It's also very competitively priced. We have good recapture relationships, and we also have better access to assets as a consequence.
Speaker Change: Okay.
Speaker Change: Uh huh.
Speaker Change: [music].
David L. Finkelstein: We're not a competitive threat to the mortgage origination community, and so, you know, by outsourcing servicing, it's better for our overall business. Now, that could change at some point, but right now, we really like the relationships we have on the subservicing side, and we're going to maintain that posture for the time being.
David L. Finkelstein: Got it. Okay, that makes sense. And then, you know, in light of the significant move we've had in rates here in April, can you comment on any changes you made within the portfolio, particularly in agency MBS or with the hedges?
Speaker Change: Yeah.
Speaker Change: [music].
David L. Finkelstein: Sure, so we did actually sell early in the quarter a couple billion agency MDS, and some of that was outright. So part of that was anticipation, and we were certainly glad we did.
David L. Finkelstein: We will manage our rate exposure here as the market evolves. We're currently running at about a half-year duration, which we're comfortable with, but we're certainly cautious. You know, agency MDS, we think in this sell-off, they've been better behaved, certainly in the fall, primarily because the fall has been a little bit better this time around. And, you know, there are more fundamentally positive factors in the market today than there were last year.
David L. Finkelstein: You know, the bar for the Fed to hike is higher today than it was last year, as we just talked about. The QT taper is likely to be underway. The composition of Treasury issuance is in a better place than it was last fall, and money is actually flowing into fixed income. So we feel a little bit better about the market in this rate sell-off than we did last year.
David L. Finkelstein: And, you know, when we were in October, it was sort of a no end in sight mentality, and that doesn't exist today, and that should be supportive of the agency market, but we're going to stay conservative, you know, to the extent that there's cheapening, more cheapening in the basis. We're going to cover those mortgages that we bought, and we anticipate doing so, and it is advantageous to sell early, and we'll trade it around. So that's pretty much the story, Trevor. Okay, I appreciate it.
Trevor John Cranston: Okay, I appreciate the comments. Thank you.
Operator: The next question is from Eric Hagen with BTIG. Please proceed.
Eric J. Hagen: Hey, good morning. How are you guys doing?
Eric J. Hagen: Hey, it looks like the preferred stock is going to go fully floating rate by the end of June. Right now, the press is around 15% of the equity capital structure. How does your outlook for leverage and positioning of the portfolio maybe respond to the cost of that preferred? And even at your current valuation when you look at the environment? Do you think it actually makes sense to maybe scale up with more preferred customers right now?
David L. Finkelstein: Yeah, so in terms of our capital structure, you're right, roughly 13.5% of our capital is in preferred, and our Series I's do go floating here in June. And how we look at it is that our cost of preferred capital will be, you know, a little over 10% at that time, which is relatively high, but it's also important to note that we're at the highs of the rate cycle. And so when we look at our cost of preparation, we look at it over a longer horizon compared to the forwards, and it does come down with the ultimate Fed cuts to around 9% or thereabouts.
David L. Finkelstein: And then we compare that level to the asset yield on the portfolio. And when you look at the relationship, even at the spreads today versus asset yields, that spread is actually higher today than the long-run average. So we're comfortable with the elevated cost of preferred capital in this floating rate environment, even with the I's going floating, which is, you know, we'll have a relatively immaterial cost burden, less than a penny a quarter it'll add to our prep costs. So not that material.
Speaker Change: Okay.
Speaker Change: [noise].
David L. Finkelstein: And then with respect to, you know, potentially issuing more prep, we like our capital structure where it's at because the prep market hasn't really opened up. There's been a couple of very recent bank transactions, but generally speaking, it's still relatively quiet to the extent that we get some firmness in pricing in the upper single digits, call it, to be able to issue and potentially even refi. We would certainly look at it, but we like the low leverage in our capital structure as it stands, and we'll keep an eye on that market.
Speaker Change:
Speaker Change: Yeah.
Speaker Change: [noise].
Eric J. Hagen: Yeah, I mean, along the same lines, I mean, as you guys scale up with the MSR, is there room for unsecured debt, just as a, you know, kind of more effective duration match maybe versus using secured?
Speaker Change: Right.
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David L. Finkelstein: Well, look, we have $3.5 billion of essentially cash and agency MBS on the balance sheet, so we don't need the debt. And right now, as I mentioned in my prepared remarks, a lot of that capital to fund the MSR is coming from excess liquidity. And we do have ample warehouse capacity, and we compare that warehouse capacity and the cost of warehouse financing to debt markets. And the fact of the matter is that issuing unsecured debt would be funding that MSR at a cost that's much higher than, you know, term committed warehouse financing, and so it wouldn't make sense for us. And particularly given the fact that we don't need the liquidity to go to the debt markets, certainly it's not something we're actively considering.
Speaker Change: Yeah.
Speaker Change: Okay.
Speaker Change: [music].
Eric J. Hagen: Yep.
Eric J. Hagen: Yep. Thank you guys. I appreciate it. Thanks, Eric.
Operator: Again, if you do have a question, please press star than one on your telephone keypad. The next question comes from Kenneth Lee with RBC Capital Markets. Please proceed.
Kenneth S. Lee: It's, you know, it's a function of where the asset yields on the portfolio are and looking at
Speaker Change: Yeah.
Unknown Executive: Unknown Speaker The function of where the asset yields on the portfolio are and looking at the forwards and trying to get some guidance for a little bit further out the horizon, given the fact that we're lower leverage, just in attempt to provide a little comfort that we can operate at lower leverage and still generate a yield that is certainly competitive. And it's the durability and the earnings power of the portfolio that I just wanted to highlight.
Speaker Change: [noise].
Unknown Executive: And now, quarter over quarter, EAD is going to ebb and flow. But when it comes to the economic earnings of the portfolio, we do feel quite good about covering it. You know, in the second quarter, our NIM will go up very modestly, we anticipate. And in the absence of a shock to the market, we feel reasonably good about where the earnings picture is for 2024. Great, very helpful there. Thanks, Ken. The next question comes from Merrill Ross.
Operator: The next question comes from Merrill Ross with Compass Point. Please proceed. Thank you.
Merrill Hadady Ross: Yeah, Merrill, it was a little difficult to hear you on that, but what I think you asked was about the roll down on the hedge portfolio and where the hedge ratio would go. So, just real quickly, when you look at our swap currently, we did have roughly $5 billion roll off in the first quarter. The second quarter, it's very light.
David L. Finkelstein: It's actually just a billion and a quarter. And when we look at that front end swap position, zero to three years, it's roughly $18 billion notional, and it has an average life of average maturity of 1.46 years. So, if you think about it, over the next three years, we're going to tap that on average in a year and a half. And so, it's pretty evenly distributed.
David L. Finkelstein: Now, the way to think about it is as those swaps run off, also, what's happening is agency MBS are running off. And when you look at the asset yield on our portfolio, which is in the 480s on a book yield basis, and you look at reinvesting that runoff into new agency MBS and production coupon MBS, yield somewhere in the six and a quarter range, right, Srini? So, what you'll see over the next number of years is a pretty orderly runoff of the hedge portfolio, which will replace the curve and make sure that we're hedged for the environment.
Speaker Change: [music].
David L. Finkelstein: But also, you're going to replenish yield by reinvesting agency runoff and increasing asset yield over time. So, we like the hedge portfolio where it's at. We'll manage for the environment, and we're going to stay reasonably well hedged now.
Operator: At this time, there are no further questioners in the queue, and this does conclude our question and answer session. I would now like to turn the conference back over to David Finkelstein for any closing remarks.
David L. Finkelstein: Thank you and thanks to everybody for joining us today. Have a good rest of the spring, and we'll talk to you next quarter.
David L. Finkelstein: and we'll talk to you next quarter.
Operator: The conference is now concluded. Thank you for attending today's presentation, and you may now disconnect.
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