Q2 2024 Annaly Capital Management Inc Earnings Call

Good morning and welcome to the Annaly Capital Management second quarter 2024 earnings conference call.

Operator: Order 2024 Earnings Conference Call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions.

Speaker Change: All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions.

Speaker Change: To ask a question, you may press star, then 1 on your touch-tone phone.

To withdraw your question, please press star then 2.

Speaker Change: Please note this event is being recorded.

Sean Kensil: I would now like to turn the call over to Sean Kensil, Director Investor Relations. Please go ahead. Good morning, and welcome to the second quarter of 2024 earnings call for Annaly Capital Management.

Speaker Change: Any forward-looking statements made during today's call are subject to certain risks and uncertainties, which are outlined in the risk factors section in our most recent annual and quarterly SEC filings.

Unknown Executive: Actual events and results may differ materially from these forward-looking statements. We encourage you to read the disclaimer in our earnings release, in addition to our quarterly and annual filings. We do not undertake and specifically disclaim any obligation to update or revise this information. During this call, we may present both GAAP and non-GAAP financial measures. A reconciliation of gap to non-gap measures is included in our earnings release. Content referenced in today's call can be found in our second quarter 2024 investor presentation and second quarter 2024 supplemental information. Please also note this event is being recorded. VS Srinivasan, Head of Agency, and Ken Adler, Head of Mortgage Servicing Rights.

Actual events and results may differ materially from these forward-looking statements. We encourage you to read the disclaimer in our earnings release in addition to our quarterly and annual filings.

Additionally, the content of this conference call may contain time-sensitive information that is accurate only as of the date you're of. We do not undertake and specifically disclaim any obligation to update or revise this information.

During this call, we may present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in our earnings release.

Content referenced in today's call can be found in our second quarter 2024 investor presentation and second quarter 2024 supplemental information, both found under the presentation section of our website.

Please also note this event is being recorded.

Speaker Change: 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.

Speaker Change: VS Srinivasan, Head of Agency, and Ken Adler, Head of Mortgage Servicing Rights.

Ken Adler: Thank you, Sean. Good morning, and thank you all for joining us for our second quarter earnings call. I have four areas to discuss today before handing it off to Serena to discuss the financials. First, I'll briefly highlight our performance during the quarter, then review the macro and market environment, followed by an update on each of our three businesses. And I'll finish with our outlook for the second half of the year.

Speaker Change: And with that, I'll turn the call over to David.

David L. Finkelstein: Thank you, Sean. Good morning and thank you all for joining us for a second quarter earnings call. I have four areas to discuss today before handing it off to Serena to discuss the financials.

David L. Finkelstein: First, I'll briefly highlight our performance during the quarter, then review the macro and market environment, followed by an update on each of our three businesses, and I'll finish with our outlook for the second half of the year.

Ken Adler: Now, to begin with, we were pleased with our performance during a quarter that saw a fair amount of volatility. While interest rates rose modestly quarter over quarter, the 10-year Treasury yield traversed a 50-basis point range as economic data in April meaningfully reduced the magnitude of 2024 rate cuts priced into the market, whereas in June, employment and inflation data brought accommodative policies into near-term focus for the market and certainly the Fed. In this environment, we delivered a roughly 1% economic return for the second quarter and a 5.7% return for the first half of the year.

David L. Finkelstein: Now to begin with, we were pleased with our performance during a quarter that saw a fair amount of volatility.

David L. Finkelstein: While interest rates rose modestly quarter-over-quarter, the 10-year Treasury yield traversed a 50-basis-point range as economic data in April meaningfully reduced the magnitude of 2024 rate cuts priced into the market.

David L. Finkelstein: Whereas in June employment and inflation data brought accommodative policy in the near-term focus for the market and certainly the Fed.

Speaker Change: Now, in this environment, we delivered a roughly 1% economic return for the second quarter and a 5.7% return for the first half of the year.

Speaker Change: Earnings available for distribution exceeded our dividend by three cents, demonstrating our ability to consistently earn strong returns with prudent leverage, which stood at 5.8 turns at the end of the quarter.

Ken Adler: Now, to expand further on the macro landscape, activity continues to slow gradually as tight monetary policy weighs on most parts of the U.S. economy. While core service inflation has been more muted following its brisk pace in Q1, recent data suggest that shelter inflation, the most stubborn component of inflation, is finally beginning to meaningfully soften. These developments point to rising conviction that the Federal Reserve will begin to lower interest rates in the second half of the year, and this should be followed by additional cuts depending on the pace of further labor market softening as the Fed's employment mandate gains more prominence over the inflation mandate.

Speaker Change: Now to expand further on the macro landscape, activity continues to slow gradually as tight monetary policy weighs on most parts of the U.S. economy.

Speaker Change: While core service inflation has been more muted following their brisk pace in Q1, recent data suggests that shelter inflation, the most stubborn component of inflation, is finally beginning to meaningfully soften.

Speaker Change: Meanwhile, the employment picture has moved into better balance as demand for labor has slowed and the pace of hiring is more in line with historical averages.

Speaker Change: Now these developments point to rising conviction that the Federal Reserve will begin to lower interest rates in the second half of the year, and this should be followed by additional cuts depending on the pace of further labor market softening as the Fed's employment mandate gains more prominence over the inflation mandate.

Ken Adler: Now, moving to our portfolio and our investment strategies, and beginning with agency, we actively manage the portfolio during the quarter, as current coupon nominal spreads widen by roughly 10 basis points, driven predominantly by elevated rate volatility. We continue to rotate up in coupon to take advantage of wider spreads offered by production coupons, increasing our holdings of 5.5% and higher by $4 billion. And year-to-date, the average net coupon on our agency portfolio has increased by 30 basis points to 4.87%.

Speaker Change: Early in the quarter, as mentioned on our last call, we tactically reduced our agency holdings as we navigated higher rates and wider spreads.

Speaker Change: And year to date, the average net coupon on our agency portfolio has increased by 30 basis points to 4.87%.

Speaker Change: Now, as it relates to our hedges, the notional value increased relatively in line with agency asset growth, and we're likely to maintain the portfolio's conservative rate exposure as longer-term treasuries continue to face technical headwinds from elevated federal budget deficits.

Speaker Change: NBS spread volatility declined in the second quarter, with the technical pictures showing signs of improvement.

Speaker Change: And we expect demand for agency MBS to increase once the Fed initiates its cutting cycle. For example, a portion of the $6.1 trillion in money market assets should gravitate towards longer duration fixed income.

Ken Adler: In addition, agency MBS is highly attractive relative to other fixed income alternatives, particularly corporates, as MBS nominal spreads are well above historical averages while competing assets are trading at the tighter end of their historical averages. The modest decline in the Resi portfolio was driven by our sale of third-party securities to take advantage of relatively tight credit spreads while increasing our exposure to agency MBS. The fundamentals of the residential credit market remain constructive, although we are closely monitoring the increasing regional disparities in housing and the strength of the consumer given softening labor markets. Mortgage delinquencies, however, remain at near record low levels.

Speaker Change: In addition, agency MBS is highly attractive relative to other fixed income alternatives, particularly corporates, as MBS nominal spreads are well above historical averages, while competing assets are trading at the tighter end of their historical averages.

Speaker Change: Turning to residential credit, our portfolio ended the quarter at $5.9 billion in economic market value and $2.2 billion in equity, representing 20% of the firm's capital.

Speaker Change: The modest decline in the Resi portfolio was driven by our sale of third-party securities to take advantage of relatively tight credit spreads while increasing our exposure to agency MBS.

Speaker Change: Residential credit assets were largely range bound throughout the quarter with investment grade non-QM securities trading in a 10 basis point range and the CRT market tightening 10 to 20 basis points.

Speaker Change: The fundamentals of the residential credit market remain constructive, although we are closely monitoring the increasing regional disparities in housing and the strength of the consumer given softening labor markets. Mortgage delinquencies, however, remain in near record low levels.

Ken Adler: Our Onslow Bay Correspondent Channel experienced record growth in Q2, as we locked $4.1 billion of expanded prime loans and settled $2.8 billion, representing a 22% increase quarter over quarter. And year-to-date, we've already locked and settled more loans than the entirety of 2023. Our MSR holdings increased $135 million quarter over quarter, driven by purchase and settlements, as well as a modest increase in the value of the portfolio, given the 20 basis point increase in mortgage rates. Although our transactional activity slowed in Q2, the portfolio is nearly 30% higher year over year as Annaly remains firmly entrenched as a top 10 non-bank holder of servicing rights.

Speaker Change: Our Onslow Bay Correspondent Channel experienced record growth in Q2 as we locked $4.1 billion of expanded prime loans and settled $2.8 billion, representing a 22% increase quarter-over-quarter, and year-to-date we've already locked and settled more loans than the entirety of 2023.

Speaker Change: And our current pipeline continues to exhibit strong credit characteristics, including a 754 average FICO and a 68% CLTV.

Speaker Change: The OBX platform has remained a market-leading sponsor of securitizations, as we priced 5 non-QM transactions in the second quarter, and have now priced 13 securitizations, totaling $6.7 billion on the year.

Speaker Change: OBX represented 25% of the non-QM issuance in the market and approximately 10% of gross non-agency issuance for the first half of 2024. And also to note, we continue to see 12 to 15% prospective returns on the retention of OBX assets.

Speaker Change: Now, shifting to the MSR business, our portfolio ended the second quarter with $2.8 billion in market value and $2.5 billion of equity, representing 22% of the firm's capital.

Speaker Change: Our MSR holdings increased $135 million quarter-over-quarter, driven by purchase and settlements, as well as a modest increase in the value of the portfolio, given a 20 basis point increase in mortgage rates.

Speaker Change: Although our transactional activity slowed in Q2, the portfolio is nearly 30% higher year over year as Annaly remains firmly entrenched as a top 10 non-bank holder of servicing rights.

Speaker Change: The fundamental performance of the portfolio continues to outperform our expectations as prepayment speeds remain muted despite peak seasonals and serious delinquencies are inside of 40 basis points.

Speaker Change: An increased competitiveness surrounding deposits is driving elevated float income and all leading to prospective hedge returns remaining in the 12-14% range currently.

Speaker Change: And with respect to supply, the record amount of bulk offerings over the last two years appears to be normalizing as originators are better positioned with access to capital markets and their gain on sale margins improving.

Speaker Change: And while we will continue evaluating bulk MSR opportunities.

Speaker Change: As a result of the changing market dynamics, we have focused on enhancing our flow and recapture capabilities to acquire newly originated MSR from our network of partners.

Speaker Change: And we remain well positioned to grow our MSR business, given our structure and partnerships, and we believe we have constructed one of the most durable and high-quality portfolios within the MSR sector.

Speaker Change: Now, lastly, with respect to our outlook, we're encouraged by the return potential across each of our three investment strategies, and we're optimistic as the market prepares to enter a more accommodative phase in monetary policy.

Speaker Change: And this should steepen the yield curve, reduce volatility, and ultimately, in our view, lead the agency outperformance.

Speaker Change: And while we expect to continue to grow our residential credit and MSR businesses opportunistically, we feel our current capital allocation and portfolio construction is positioned to generate sustainable returns in an environment that should be favorable to fixed income investors.

Speaker Change: And now with that, I'll hand it over to Serena to discuss our financials.

Serena Wolfe: Thank you, David. Today I will provide brief financial highlights for the second quarter ended June 30, 2024.

Serena Wolfe: Consistent with prior quarters, while our earnings release discloses GAAP and non-GAAP earnings metrics, my comments will focus on our non-GAAP EAD and related key performance metrics, which exclude PAA.

Speaker Change: As of June 30, 2024, our book value per share decreased from the prior quarter to $19.25.

Serena Wolfe: Despite the asset spread widening and interest rate volatility during the quarter, we generated a 0.9% economic return, including our dividend of 65 cents per Q2.

Ken Adler: Looking back to the beginning of 2024, including $1.30 in dividends declared year-to-date, we have generated an economic return of 5.7%. Consequently, Average Asset Yields, XPAA, increased 27 basis points from the first quarter to 5.14% in Q2. Higher coupon income was partially offset by an increase of 12 basis points in our economic cost of funds. While repo rates remain stable, even declining two basis points in Q2, securitized debt expense increased in Q2 due to the high volume of securitizations we completed in the first six months of 2024. Our efficiency ratios worsened during Q2 due to the timing of certain expenses.

Serena Wolfe: Looking back to the beginning of 2024, including $1.30 in dividends declared year-to-date, we have generated an economic return of 5.7%.

Serena Wolfe: Earnings available for distribution increased in the second quarter by $0.04 per share to $0.68.

Serena Wolfe: Higher coupon income related to the continued rotation up in coupon on the agency portfolio and $2.8 billion in assets settled via the Onslaught Bay Correspondent Channel contributed to the increase in EAD.

Serena Wolfe: Higher coupon income was partially offset by an increase of 12 basis points in our economic cost of funds, taken together, and that interest spread, XPAA, increased by 15 basis points, reaching 1.24% in the second quarter.

Serena Wolfe: And net interest margin, XPAA, also rose 15 basis points, quarter over quarter, to 1.58%.

Serena Wolfe: While repo rates remain stable, even declining two basis points in Q2, securitized debt expense increased in Q2 due to the high volume of securitizations we completed in the first six months of 2024.

Serena Wolfe: Additionally our swap benefit declined modestly due to a large position maturing during the quarter representing our final scheduled swap maturity for this year.

Serena Wolfe: As we continued executing our repo strategy, our weighted average repo days declined seven days compared to Q1, at 36 days for the second quarter.

Serena Wolfe: During Q2, we furthered our strategy of providing financing optionality for our Envoy Bay platform, closing additional warehouse capacity of $250 million and expanding our non-marked market sublimits.

Serena Wolfe: As of June 30, 2024, we had $4.2 billion of MSR and Home Loan Warehouse Capacity at a 39% utilization rate, leaving substantial availability.

Annaly: Annaly's unencumbered assets increased to $5.4 billion in the second quarter, including cash and unencumbered agency MBS of $3.5 billion.

Annaly: We also had approximately $900 million in fair value of MSR pledged to committed warehouse facilities, which remain undrawn and can be quickly converted to cash subject to contractual advance rates.

Annaly: Together, we had approximately $6.3 billion in assets available for financing, up $45 million compared to last quarter, notwithstanding the slight increase in our leverage profile.

Annaly: Our efficiency ratios worsened during Q2 due to the timing of certain expenses. However, we expect expenses to normalize and full-year OPEX to equity ratios to align with historical levels.

Ken Adler: That concludes our prepared remarks. We will now open the line for questions. Thank you, operator. We will now begin the question.

Speaker Change: That concludes our prepared remarks. We will now open the line for questions. Thank you, operator.

Operator: We will now begin the question-and-answer session. 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 key. At this time, we will pause momentarily to assemble our roster. Our first question comes from Bose George with KBW.

Speaker Change: We will now begin the question-and-answer session. 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.

Annaly: To withdraw your question, please press star then 2.

Speaker Change: At this time, we will pause momentarily to assemble our roster.

Annaly: Our first question comes from Bose George with KBW.

Bose Thomas George: Please go ahead. Hey everyone, good morning. Actually, can I start just with getting an update on the quarter-end book value?

Speaker Change: Please go ahead.

Bose Thomas George: Right. Hey, everyone. Good morning. Actually, can I start just with getting an update on quarter date book value?

Ken Adler: Sure, Bose, good morning. As of Tuesday's close, we were up roughly 2% with dividend accrual and a little over 1% net of the dividend.

Speaker Change: Sure, Bose, good morning. As of Tuesday's close, we were up roughly 2% with dividend accrual and a little over 1% net of this dividend.

Bose Thomas George: Okay, great. Thank you. And then just in terms of the hedges, so you were replacing the maturing swaps with treasury futures this quarter. Can you just talk about the advantages of that?

Speaker Change: Yeah, sure, so there's multiple advantages. We were certainly concerned with rate volatility and particularly spread volatility. So reducing the exposure to swaps was somewhat warranted, particularly later in the quarter. And there is differences with respect to initial margin and liquidity associated with swaps. It's not a material change. One of the catalysts for the change was also putting on a little bit of a curve trade, a steepener, given what our view was with respect to the expectation for a little bit of yield curve steepening, which we saw this quarter. Certainly, as we're about 20 basis points steeper, twos, tens. And generally, just for liquidity and IM benefits.

Speaker Change: [inaudible]

Speaker Change: including this past quarter in Q1 and we're in a place where we do not have any more swap runoff of that low pay rate for the rest of this year and so we feel pretty good about our swap position here and when you look at the relative tightness of swap spreads you know I think 10-year swap spreads are around negative 45 it's a good hedge so we're going to be a little bit overweight swaps because the levered return relative to swaps versus other hedges is pretty attractive right now notwithstanding concerns over balance sheet as it relates to swap spreads.

Bose Thomas George: Okay, that makes sense. Thanks a lot.

Speaker Change: Okay, makes sense. Thanks a lot.

Speaker Change: Thank you, Boss.

Speaker Change: The next question is from Doug Harder with UBS. Please go ahead.

Douglas Michael Harter: Thanks. David, you talked about, you know, kind of having a slightly different strategy on acquiring new MSR. Can you just talk about the risk profile of new MSR and the relative attractiveness of adding those to what's, you know, a very attractive existing portfolio?

Bose Thomas George: Sure, Doug. I'm going to hand it over to Ken to help you with that. Yeah, sure. I mean, new MSR just has materially more prepayment exposure to it.

unknown: So it relies on a different hedging strategy than the legacy MSR with much

unknown: So it relies on a different hedging strategy than the legacy MSR

Speaker Change: lower note rate and more stable cash flow. However, the new MSR also provides opportunity for recapture that's not present in the legacy MSR, so that's an additional revenue opportunity as well.

Ken Adler: And can you just remind us, Ken, kind of where you are in terms of recapture, what agreements you have, and, you know, how confident you would be in your capabilities to execute?

Ken Adler: And can you just remind us, Ken, kind of where you are in terms of reCAPTCHA, what agreements you have and, you know, how confident you would be in your capabilities to execute? Absolutely. Look, we currently have four reCAPTCHA partners.

Ken Adler: We currently have four reCAPTCHA partners. Each of these partners has different strategies, approaches, and tools for customer outreach and creating reCAPTCHAs.

Ken Adler: Each of these partners has different strategies, approaches.

Speaker Change: and Tools for Customer Outreach and Creating ReCAPTCHA. And what we do is we compare the results between them and allocate our initiatives to the best performers and kind of refine these strategies over time. So we kind of have a portfolio approach to this.

Ken Adler: And what we do is we compare the results between them and allocate our initiatives to the best performers and kind of refine these strategies over time. So we kind of have a portfolio approach to this. And we have the ability to be dynamic given the use of multiple providers. We also have several strategic discussions with potential new partners that many are considered best in class. And they offer unique technology and differentiating strategies.

Ken Adler: And we have the ability to be dynamic, given the use of multiple providers. We also have several strategic discussions with potential new partners that many are considered best in class, and they offer unique technology and differentiating strategies.

Ken Adler: So, our approach and ability to partner with...

Ken Adler: Services and originators is what we're happy about.

Speaker Change: I guess just to be clear on that, so when there is recapture, do you share in the full origination economics or are you just getting the MSR back, you know, just want to make sure I understand how those economics work?

Ken Adler: We effectively share in the gain on sale in a material way by taking that MSR back at a below market price and those prices are negotiated and they're different depending on the provider, what the recapture rate is.

Ken Adler: So there's kind of an incentive fee structures with these providers and given how low origination margins are in the industry, the repurchase of the MSR back at a discount is effectively a premium. Thank you. Thank you.

unknown: You know, assuming that origination, you know, yeah, Doug, given how competitive origination and servicing is, we're able to extract the right value associated with our recapture relationships.

unknown: You know, assuming that origination, you know. Yeah, Doug, given how competitive origination and servicing is, we're able to extract the right value associated with our reCAPTCHA relationships.

Speaker Change: Very helpful. Thank you, guys.

Operator: The next question is from Rick Shane with J.P. Morgan. Please go ahead.

Richard Barry Shane: Thank you, Doug.

Speaker Change: The next question is from Rick Shane with J.P. Morgan. Please go ahead.

Richard Barry Shane: Hey guys, thanks for taking my question. I really needed to queue in before Doug because that was the topic I wanted to explore as well. I am curious, you know, one of one of the things that is driving MSR pricing is that recapture opportunity and I'm curious

Richard Barry Shane: And again, you've talked about some of the efficiency from an economic perspective for you, from a recapture perspective. But I am curious if you're seeing...

Richard Barry Shane: Peers out there whose economics are really focused on the origination side who are making pricing in that space less attractive for you. It's an interesting time to shift from bulk to flow.

Richard Barry Shane: has never been less than I've seen, so you are seeing increasing comfort with the ability to price in that recapture by the market overall.

Speaker Change: And there's always a couple of participants that stand out, but in general, yes.

Speaker Change: Comfort with using big data, call center technology has absolutely increased.

Operator: Yeah, and Rick, another point which you may be alluding to is that as it relates to our MSR portfolio, we're very protective of the borrower. And the last thing we want to do is use a subservicing relationship that is going to lead to, you know, over churning of our portfolio or anything that would damage our returns. And so it's a high bar to partner with us when it comes to recapture and subservicing.

Richard Barry Shane: Got it. That makes sense.

Richard Barry Shane: Hey, a request as you transition to more of a flow business and potentially the coupons start to shift a little bit, could you provide disclosure on the coupon in the way that you do for the

Speaker Change: NBS portfolio so we can see the distribution of coupons.

Richard Barry Shane: Sure, that's certainly a consideration, but it is important to note that in the current portfolio, the vast, vast majority is very, very low rate. So, it's a pretty homogenous bucket of what are

Doug: you know.

unknown: Absolutely. Yeah, it again, depending upon how fast that flow business grows, we could start to see the portfolio barbell a little bit and just move on.

Speaker Change: should be considered to be non-refinanceable mortgages.

Speaker Change: Absolutely, yeah. Again, depending upon how fast that flow of business grows, we could start to see the portfolio barbell a little bit and just move up to understand that better.

Rick: You bet, Rick.

Operator: The next question comes from Jason Stewart with Jenny Montgomery Scott. Please go ahead.

Speaker Change: Perfect. Thanks, guys.

Rick: Thank you, Rick.

Operator: The next question comes from Jason Stewart with Jenny Montgomery Scott. Please go ahead.

Jason Price Weaver: Good morning. Thanks for taking the question. One more on the MSR and servicing front. Do you have any thoughts? I know it's early and likely to change, but thoughts on the CFPB's proposed servicing rule regarding foreclosures, how that might impact the valuation, competitive environment, et cetera?

Ken Adler: Yeah, that's a good question, Jason. So we certainly recognize the CFPB's efforts to revise mortgage servicing rules to benefit borrowers. And many of the proposed changes would result in more complex loss mitigation processes with potentially longer timelines to reach resolution. And, you know, on the surface, if implemented as proposed, our subservicer oversight team would ensure that our subservicers are following all relevant laws and regulations. And we could expect subservicing costs to increase on the margin.

Ken Adler: Yeah, that's a good question, Jason. So, we certainly recognize the CFPB's efforts to revise mortgage servicing rules to benefit borrowers, and many of the proposed changes would result in more complex loss mitigation processes with potentially longer timelines to reach resolution, and, you know, on the surface, if implemented as proposed, our subservicer oversight team would ensure that our subservicers are following all relevant laws and regulations, we could expect.

Ken Adler: But our portfolio, both on the resi credit side, as well as on the MSR side, is composed of very high-quality borrowers with significant equity in their homes. And our portfolio is specifically Fannie and Freddie, made up with very low delinquencies, as I mentioned, less than 40 basis points. And we have no Ginnie borrowers to speak of. We have a very small sleeve of Ginnie Mae from the old Pingora days. So we don't expect the cost to us to increase in any meaningful way, but it could lead to a little bit higher servicing costs overall.

Ken Adler: subservicing costs to increase on the margin. But our portfolio, both on the RESI credit side, as well as the MSR side, is composed of very high-quality borrowers with significant equity in their homes. And our portfolio is specifically Fannie and Freddie, made up with very low delinquencies, as I mentioned, less than 40 basis points. And we have no Ginnie borrowers to speak of. We have a very small sleeve of Ginnie Mae from the legacy Pingora days. So we don't expect the cost to us to increase in any meaningful way, but it could lead to a little bit higher servicing costs overall.

Ken Adler: Yeah, thanks. Yeah, I think it's important to note that differentiation there. So thanks for that color. And then going back to the up and coupon trade, you know, when you look at specified pools with up and coupons, I think you know that you're looking at very, you know, I call them high premium or quality pools there. When you combine that with the competitive environment for, you know, marginal refi activity, where is the most value, and how are you looking at hedging those risks to protect that value?

Ken Adler: Yeah, thanks. Yeah, I think it's important to note that differentiation there. So thanks for that color. And then going back to the up-and-coupon trade, you know, when you look at specified pools up-and-coupon, I think you noted you're looking at very, you know, I call it high premium or quality pools there.

Ken Adler: When you combine that with the competitive environment for marginal refi activity, where is the most value and how are you looking at hedging those to protect that value?

Ken Adler: So, basically, our strategy has been that as we move up in coupon, we buy higher quality pools. So, on six and a half, we generally buy very high quality pools, and on six, it will be a little bit less, and on five and a half, it will be a little bit less. The way we think about hedging is that we think of a specified pool as a combination of the TBA duration plus a payout duration.

Ken Adler: So basically what our strategy has been that as we move up in coupon, we buy higher quality pools. So on six and a half, we generally buy very high quality pools.

Ken Adler: [inaudible]

Ken Adler: So, we kind of model how that payout duration is going to move during a rally and a sell-off, and we kind of measure that duration, and that's how we hedge the payout. Okay. Thank you. The biggest advantage is that the pools provide ample spread right now, and because they are less negatively convex, we are not really giving up that much carry in the near term. And in the long term, if and when rates do rally, they will provide very durable yields for an extended period of time.

Ken Adler: In a rally and a sell-off, and we kind of measure that duration, and that's how we hedge the payout.

Speaker Change: Okay, thank you for taking the time.

Ken Adler: The biggest advantage is the pools provide ample spread right now, and because they are less negatively convex, we are not really giving up that much carry in the near term. And in the long term, if and when rates do rally, they provide very durable yields for an extended period of time.

Jason Price Weaver: Yeah, I guess my takeaway there was that the carry is going to benefit you for several quarters, and you can potentially hedge away the negative convexity, but we might be getting too much into the weeds there, but that was just my thought. Yeah, that's the right assessment, Jason.

Jason Price Weaver: Yeah, I guess my takeaway there was that the carry is going to benefit you for several quarters and you can potentially hedge away the negative convexity, but we might be getting too much in the weeds there, but that was just my thought.

Jason Price Weaver: Yeah, that's the right assessment, Jason.

Jason Price Weaver: Thanks.

Jason: Thank you, Jason.

Jason Price Weaver: This concludes the question and answer session. I would like to turn the conference back over to David Finkelstein for any closing remarks.

Speaker Change: Actually, I do believe we have one more question in the queue. I do see him, yes. Let me announce him.

Operator: The next question is from Tim Chang with BTIG.

Operator: The next question is from Tim Chang with BTIG.

Tim Chang: Sorry for punching in late.

Tim Chang: [inaudible]

Tim Chang: Sorry for punching in late.

Tim Chang: I think the question here is just, you know, if it looks like the Fed is going to cut more aggressively, what's your perspective on how mortgage spreads will respond to that, even what we're seeing just in the market over the last, you know, call it 24 hours? Thank you, guys.

unknown: Yeah, under that scenario, Eric, we would be optimistic on mortgage spreads. You'll see, you know, further steepening in the yield curve than the 50 basis points that's priced in for the next year between twos and tens. You know, the $6.1 trillion in money market funds, as those yields start to decline, will gravitate toward longer-duration fixed income. As I mentioned, you'll potentially see bank demand come in, and it'll just be a better environment for agencies. We've experienced this cycle after cycle.

unknown: Yeah, under that scenario, Eric, we would be optimistic on mortgage spreads. You'll see, you know, further steepening in the yield curve than the 50 basis points that's priced in over the next year between twos and tens. You know, the 6.1 trillion in money market funds, as those yields start to decline, will gravitate toward longer-duration fixed income. As I mentioned, you'll potentially see bank demand come in and it'll just be a better environment for agencies. You know, we've experienced this cycle after cycle.

unknown: When the Fed cuts and the curve steepens, there is better demand for agency MBS, and you would expect the ball to come down. It should be a dampening environment, and we would expect strong performance from agency MBS, which is why we like the sector. We think that the appropriate amount of cuts is currently priced in. But, you know, when you look at the Fed's posture and the shift over the past number of months, it's gone from focus on the inflation mandate to more balance between the employment mandate and inflation.

unknown: When the Fed cuts and the curve steepens, there is better demand for agency MBS and you would expect vol to come down, it should be a dampening environment and we would expect strong performance from agency, which is why we like the sector. We think that the appropriate amount of cuts are currently priced in, but when you look at the Fed's posture and the shift over the past number of months, it's gone from focus on the inflation mandate to more balance between the employment mandate and inflation and there is a likelihood that given what's gone on in the labor market, is that the focus could shift to be more weighted towards the employment picture and you could see more aggressive cuts than what's been predicted.

unknown: And there is a likelihood that, given what's gone on in the labor market, the focus could shift to be more weighted towards the employment picture. And you could see more aggressive cuts than what's priced in, and that would be a perfectly good outcome for us.

unknown: Yep, that's a good perspective. I appreciate that. Hey, so how are we thinking about the tradeoff between maybe levering up with the MSR a little bit more and raising capital or even de-levering the agency MBS portfolio to maybe balance out or buffer any of that prepayment risk?

unknown: priced in and that would be a perfectly good outcome for us.

unknown: Yep, that's good perspective. I appreciate that. Hey, so how are we thinking about the tradeoff between maybe levering up with the MSR a little bit more and raising capital or even de-levering the agency MBS portfolio to maybe balance out or buffer any of that, you know, prepayment risk?

unknown: Yeah, so I would say that incremental purchases of MSR would likely be leveraged. We have very, very low leverage on that portfolio. We've been fortunate, given our abundant liquidity, to be able to use the agency portfolio as somewhat of a bank to finance it. And it's led to returns that are in excess of the 12 to 14% we show in the materials, which assumes warehouse financing. And so we have the ability to leverage.

unknown: Yeah, so I would say that incremental purchases of MSR would likely be levered. We have very, very low leverage on that portfolio. We've been fortunate given our abundant liquidity to be able to use the agency portfolio as somewhat of a bank to finance it. And it's led to returns that are in excess of the 12 to 14% we show in the materials, which assumes warehouse financing. And so we have the ability to leverage. Right now, we have the liquidity to not need to, but I would say to keep that capital allocation in the context of 20% or thereabouts, we probably would lever incremental purchases and maintain the liquidity of the overall portfolio. And look, as it relates to capital raise.

unknown: Right now, we have the liquidity to not need to, but I would say to keep that capital allocation in the context of 20% or thereabouts, we probably would lever incremental purchases and maintain the liquidity of the overall portfolio. And look, as it relates to capital raising, two conditions have to be met. It has to be accretive and benefit shareholders, and assets have to be available and at the right price.

unknown: Capital Raising, two conditions have to be met. It has to be accretive and benefit shareholders and assets have to be available and at the right price.

unknown: There's a lot to get through, and to the extent the market is compelling us to do so, we'll certainly look at it. But we feel like we're in a good place. And we'll see how things evolve.

unknown: You know, there's a lot to get through and to the extent it's, you know, the market is compelling us to do so, we'll certainly look at it, but we feel like we're in a good place and we'll see how things evolve over the near term.

unknown: I would just add that we have committed MSR lines so we can staff them anytime we want.

unknown: I would just add that we have committed MSR lines so we can tap them anytime we want.

Operator: http://TheBusinessProfessor.com Thank you, Eric. Have a good one.

Operator: Exactly.

Operator: Thank you, Eric. Have a good day.

Speaker Change: Yeah, that's helpful. Hey, we appreciate you guys. Thank you. Thanks for squeezing me in.

Operator: Thank you, Eric. Have a good day.

Operator: This concludes the question and answer session. I'd like to turn the conference over to David Finkelstein for any closing remarks. Thank you, everybody.

Operator: This concludes the question and answer session. I'd like to turn the conference over to David Finkelstein for any closing remarks.

David L. Finkelstein: Thanks, Debbie, and thank you everybody for joining us today. Enjoy the rest of the summer, and we'll talk to you in the fall.

David L. Finkelstein: Thanks Debbie and thank you everybody for joining us today. Enjoy the rest of the summer and we'll talk to you in the fall.

Operator: The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.

Operator: Great job, guys.

Operator: The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.