Q3 2024 Two Harbors Investment Corp Earnings Call
Speaker Change: [inaudible]
Good morning, My name is Cynthia and I will be your conference facilitator at this time I would like to welcome everyone to choose third quarter 'twenty 'twenty four financial results conference call.
Speaker Change: Please stand by.
Speaker Change: All participants will be in a listen only mode.
Speaker Change: After the Speakers' remarks, there will be a question and answer period.
Speaker Change: I would now like to turn the call over to Maggie Karr.
Maggie Karr: Good morning, everyone and welcome to our call to discuss <unk> third quarter 2024 financial result.
Speaker Change: With me on the call. This morning are Bill Greenberg, President and Chief Executive Officer, Nick <unk>, Our Chief Investment Officer, and William go all our interim Chief Financial Officer.
Speaker Change: Of interest rate and prepayment risks this new branding marks and a very visible way our commitment to MSR as a core part of our investment strategy.
Speaker Change: Although we intend to grow our origination and operational capabilities within our round point subsidiary overtime. We are intently focused on providing high quality investment returns and our combined strategy is designed to extract the most value that we can from our MSR asset for the benefit of our shareholders.
Speaker Change: I will tell you about some of those things in a few moments.
Speaker Change: Please turn to slide three.
Speaker Change: Our book value at September 30th was $14 93 per common share and which including the third quarter common stock dividend of <unk> 45 per share represented a one 3% quarterly economic return on book value.
Speaker Change: For the first nine months of 2024, we generated a 7.0% total economic return on book value, which demonstrates that our strategy is designed to produce strong returns across market environments.
Speaker Change: Please turn to slide four.
Speaker Change: Figure one shows market expectations over the past year for the fed funds rates.
Speaker Change: As you can see by looking at the Green line at the end of the second quarter market expectations were for a total of 50 basis points and cuts in 2024.
Speaker Change: However, forecasts rapidly changed for the short end of the yield curve. Following the Feds 50 basis point cut in September.
Speaker Change: By the end of the quarter the market was pricing in almost 200 basis points of cuts over the next 15 months.
Speaker Change: Editing out at around 3% referenced by the Blue line.
Speaker Change: Recent data, including inflation jobs in retail sales have all come in hotter than expected and ambiguous statements from several fed governors have resulted in the market tempering. Its enthusiasm so that as of October 21st two cuts have been taken out of the market and the terminal rates is projected to be around three four.
Speaker Change: Percent.
Speaker Change: But you can see in the Purple line on this chart.
Speaker Change: Moving to figure to ultimately the 10 year Treasury yield finished the quarter 62 basis points lower at $3 seven 8%, while the two year treasury yields fell by 111 basis points to 364%, which you can see in the Blue line.
Speaker Change: The curve Steepens by 50 basis points, resulting in the first positively sloped yield curve between two and 10 year Treasury notes since 2022.
Speaker Change: However, the change in fed expectations took their toll on the long end of the curve and rates increased in the month of October.
Speaker Change: As of October 21st which is the Purple line. In this chart 10 year rates had given back approximately two thirds of the third quarter's rate declines rising 42 basis points to 420%, while the two year rate rose 39 basis points to 4.03% during the same period.
Speaker Change: Deepening the curve by three basis points.
Speaker Change: Please turn to slide five.
Speaker Change: The acquisition of round point was almost exactly one year ago, and we are on track to achieve the cost savings that we initially set out and improving the economics for our investments in the MSR asset.
Speaker Change: Additionally, the direct to consumer loan origination channel that we started from scratch in December is starting to bear fruit.
Speaker Change: Once that scale, we imagine this effort to provide significant hedge benefits to our MSR portfolio and to protect our asset from significantly faster than expected prepayment speeds should interest rates dropped precipitously.
Speaker Change: I hand, the call over to William to discuss our financial results.
Speaker Change: Thank you Bill.
Speaker Change: Please turn to slide six our book value was $14 93 per share at September 30th compared to $15 and 19 on June 30th.
Crude into the 45 common stock dividend. This resulted in a 1.3% quarterly economic return as Bill has already mentioned.
Speaker Change: Please turn to slide seven.
Speaker Change: The company generated comprehensive income of.
Speaker Change: $19 $3 million or <unk> 18 per weighted average common share in the third quarter.
Speaker Change: Net interest expense of $42 million was higher than the third quarter on higher average borrowing balances, which were partially offset by higher R. M. B S interest income.
Speaker Change: Net servicing income was $172 million.
Speaker Change: Minus $4 million of third party sub servicing fees and other MSR related servicing costs.
Speaker Change: That servicing income was unfavorable to the second quarter by $4 million due to lower servicing fee collections offset by higher float income and lower third party servicing costs from servicing our MSR on the Ram point platform.
Investment Securities gain and change in OCI was favorable to the third quarter by about $337 million due to a rally in rates and spread tightening.
Speaker Change: Versus a selloff in rates and slight spread widening in the second quarter.
Speaker Change: Servicing asset losses were $133 million in the quarter.
Speaker Change: Unfavorable to the second quarter due to declining rates drove a larger decrease in the servicing asset.
Speaker Change: Net swap and other derivative gains were lower in the third quarter by $225 million.
Speaker Change: Hedging losses from the rally in rates.
Speaker Change: Please turn to slide eight.
Speaker Change: R M B S funding markets remain stable and liquid throughout the quarter with ample balance sheet available.
Speaker Change: At quarter end, our weighted average days to maturity for our agency MBS repo was 78.
Spreads for repurchase agreements widened with financing for our M. B S between sofa, plus 24 to 28 basis points.
Speaker Change: The widening was primarily due to uncertainty of the fed's actions in September.
Speaker Change: At quarter end bank balance sheets were temporarily tight.
Speaker Change: Linked to a number of factors that included settlements of auction Treasury securities as well as banks managing quarter and reporting metrics.
Speaker Change: Post quarter end liquidity and balance sheet room quickly returned to easing financial conditions.
Speaker Change: Similar effects may occur at year end and this has been the case in past years, we will seek to minimize our exposure to year end funding pressures.
Speaker Change: We finance our MSR activities across four lenders was $1 $6 billion of outstanding borrowings under bilateral facilities.
Speaker Change: We ended the quarter with a total of 610 million in unused MSR assets fantastic capacity and $91 million of unused capacity for servicing advances I will now turn the call over to Nick.
Thank you William please turn to slide nine our portfolio at September 30th was $16 4 billion, including $11 4 billion in subtle positions and $4 9 billion in T. B S.
Nick: Overall, our portfolio benefited from the net performance of mortgages over the quarter, but performance across coupons was uneven.
Nick: Lower coupons outperformed as investors added duration in the bond rally, while production and higher coupons lagged as negative convexity kicked in and prepayment concerns emerged.
Nick: We entered the quarter with an up in coupon bias, but as interest rates declined we shifted our TBA exposure lower mainly tracking the change in current coupon exposure coming from our MSR and also selling some higher coupon TBA is to mitigate prepayment risk.
Nick: I'll review spread performance shortly but given the performance of spreads over the quarter, we steered the portfolio to a less spread exposure by quarter and even as the economic debt to equity rose slightly to seven times.
Nick: The increase in leverage naturally results from MSR, requiring more current coupon hedging as rates rally.
The amount of spread duration is a function of how many and which TBA pools, where along after taking into account the effect of the MSR.
Nick: We continue to manage our exposure to rates across the curve very closely as you can see in figure two and can be seen in more detail on appendix slide 17.
Nick: Please turn to slide 10 to discuss the market for investing in agency MBS.
Nick: Over the third quarter against the backdrop of the fed continuing to have success in guiding the economy to a soft landing risk assets performed well.
Nick: S&P 500 was higher by about five 5%.
Nick: And with interest rates falling in a yield curve steepening demand remained high for fixed income assets.
Nick: Bigger one, which we have shown over the past several quarters show spreads versus volatility from 2019 through presence.
Nick: Our preferred implied volatility gauge to your options on 10 year rates decreased from 104 hundred 94 basis points on an annualized basis close to its lowest level for 2024.
Nick: Nominal spread on current coupon RMB S finished 20 basis points tighter than 107 over the treasury curve, while option adjusted spreads finished six basis points tighter at 18 basis points.
Nick: While nominal spreads remain wider than longer term averages by quarter end option adjusted spreads moved tighter than our long term non kiwi average of 29 basis points.
Nick: With OAS as at these tight levels future spread tightening will likely need to be driven by an increased demand from depository institutions and or further declines in volatility.
Nick: The nominal spread curve flattened a little but remain steep with peak spreads around the five and a half coupon at quarter end as you can see in figure two.
Nick: On an OAS basis, the belly coupons of four and a half some fives, where the richest part of the coupon stack with the higher and lower coupons somewhat cheaper.
Nick: The move in rates focused a lot of demand on these coupons from convexity hedgers, such as originators and Servicers.
Speaker Change: Please turn to slide 11 to review our agency MBS portfolio.
Speaker Change: Figure one shows the performance of TBA as compared to the specified pools, we own throughout this quarter.
Speaker Change: As I mentioned earlier hedged mortgage performance varied across the coupon stack, which is evident in this chart.
Speaker Change: Overall specified pools outperformed TBA is with better performance from higher coupons as prepayment risks increased.
Speaker Change: We shifted about $3 8 billion in TBA exposure from five and a half through six and a half into four and a housing fives predominantly to rehash the MSR exposure as rates rallied.
Speaker Change: Overall, we continue to like the relative value of specified pools. The TBA is particularly some of the seasoned pools, we own and we added about $300 million in loan balance six and a half pools in the third quarter.
Speaker Change: Bigger too on the bottom right shows our specified pool prepayments speeds by coupons on aggregate speeds increased to seven 6% from seven 2% CPR in the quarter.
Speaker Change: Mary mortgage rates dropped about 75 basis points to just above 6%, which triggered some mild media effect for high coupon originations from the past two years and led to material increases in print prepayment speeds for six and a half coupons and above.
Speaker Change: Overall prepayment rates for 30 year agency, MBS increased 8% quarter over quarter to six 5% CPR in the October report, which reflected September activity.
Speaker Change: Please turn to slide 12, as we discuss the market for investing in MSR.
Speaker Change: MSR performed well in the third quarter with strong demand for bulk packages. The volume of MSR sales continued to normalize from the record levels of the past few years.
This quarter brought approximately $40 billion U P. P of supply, bringing the year to date total to 305 billion about 70% of the pace of 2023.
Speaker Change: Traded prices have held steady with the supply being easily absorbed by a deep pool of buyers, including both banks and Nonbanks.
Speaker Change: The number of banks offering MSR financing has brought in and the increased competition has led to a compression in financing spreads.
Speaker Change: Additionally, we saw the first securitization of MSR financing over the past two years as spreads for the securities returned to sub 300 basis points the sofa.
Speaker Change: Let's look at figure one as mortgage rates have dropped prepayments have begun to display a bifurcated pattern. They are speeding up for newer higher coupon mortgages, but they continue to be very slow for the locked in low coupon Covid Arab borrowers.
Speaker Change: This chart compares actual one month speeds for 30, or six and a half versus our MSR population for the past 12 months and then shows projections the dotted lines for the next several months.
Speaker Change: As is evident while the six and a half that picked up in speed. Our MSR portfolio has not noticeably responded to the rally in mortgage rates.
Speaker Change: The quarterly prepayment speed was unchanged at five 3% CPR.
Speaker Change: Figure two shows the composition of our MSR and where mortgage rates were at quarter end.
Speaker Change: Assuming a 6.25% mortgage rate on a U P V basis, only 1% of our MSR as a rate refinance incentive of 50 basis points or more.
Speaker Change: Even if 30 year mortgage rates were to drop to 5% the number increases to only 7%.
Speaker Change: Suffice it to say that we have a substantial buffer to further declines in rates before triggering a large scale refi wave for our MSR.
Speaker Change: Please turn to slide 13, where we will discuss our MSR portfolio.
Speaker Change: With mortgage rates declining the price multiple of our MSR decreased slightly to five six times from five eight times and 60 plus day delinquencies remained low at under 1%.
Speaker Change: The portfolio was $203 billion <unk> at September 30th.
Speaker Change: Afflicting the net effect of the settlement of the sale of $6 2 billion of higher coupon MSR that we announced last quarter.
Speaker Change: All set by subtle purchases of $3 3 billion U P D from bulk and flow channels both.
Speaker Change: At quarter end, we committed to purchase $2 1 billion U P b through another bulk acquisition.
Speaker Change: Finally, please turn to slide 14, our return potential and outlook slide.
Speaker Change: Top half of this table is meant to show what returns we believe are available on the assets in our portfolio.
Speaker Change: We estimate that about 65% of our capital is allocated to servicing with a static return projection of 12% to 16%.
Speaker Change: The remaining capital is allocated to the securities with a static return estimate of 12% to 14%.
Speaker Change: With our portfolio allocation shown in the top half of the table and after expenses. The static return estimate for our portfolio is between nine and a half to 12, 7% before applying any capital structure leverage to the portfolio.
Speaker Change: After giving effect to our outstanding convertible notes and preferred stock we believe that the potential static return on common equity falls in the range of 10, and a half to 15, 6% or a prospective quarterly static return per share of 39% to 58.
Speaker Change: As Bill discussed earlier since quarter end, we have witnessed a large reversal in rates that had been reminded once again, how quickly market sentiment can shift.
Speaker Change: Bouts of high interest rate volatility are not over.
Mortgage spreads have widened racing much of the spread performance in the third quarter.
Speaker Change: In response, we have moved some of our TBA exposure higher and concurrently increased our spread exposure.
Speaker Change: As noted earlier, we also added $2 1 billion <unk> of MSR through a bulk purchase.
Speaker Change: While periods of high market volatility remain a challenge we are confident in our strategy as evidenced by the attractiveness of our return potential.
Speaker Change: We continue to favor the long run return and stability of having a majority of our capital invested in low mortgage rate MSR, while still preserving some upside to tighter mortgage spreads and a decline in volatility.
Speaker Change: Mortgage spread volatility has declined as the fed has moved to an accommodative stance and the market feels generally balanced with regard to supply and demand.
Speaker Change: So demand is strong in the MSR market, we have nevertheless continue to find good opportunities to add at attractive levels, leveraging our deep expertise coupled with the benefits of our own in house servicing in recapture operations.
Speaker Change: Thank you very much for joining us today and now we will be happy to take any questions you might have.
Speaker Change: If you would like to ask a question. Please signal by pressing star one on your telephone keypad. If you are using a speaker phone. Please make sure. Your mute function is turned off to allow the signal to reach our equipment again press star one to ask a question, we'll pause for a moment to assemble the queue.
Speaker Change: The first question comes from Doug Harter with UBS.
Speaker Change: Thanks.
Doug Harter: Hoping you could talk about the move lower in the static return for the securities.
Doug Harter: Portfolio, how much of that was a result of kind of the move lower in coupon that you talked about.
Hey, Doug This is Nick Thank you for the question.
Speaker Change: It was mostly really related to the fact that spreads just Scott.
Speaker Change: Tighter over the quarter and also you have to remember that on our return estimate that fully reflects the composition of our portfolio and as you can see the amount of.
Speaker Change: Servicing we have from as a percentage of capital has gone up a little bit.
Speaker Change: It's leverages as a total of the portfolio has gone up and on the other side. These are security side leverage goes down a little bit so that impacts the return potential as well.
Speaker Change: Got it and and.
Speaker Change: And obviously this number.
Speaker Change: Moves around but then you know I guess, how how would you think about you know how the one kind of how quarter to date you know spread.
Speaker Change: Spreads have impacted book value in two kind of how that translates to kind of incremental returns today.
Speaker Change: Yeah. Good morning, Doug. Thanks for the question I can take the book value parts.
Speaker Change: As we said in our prepared remarks, and as Doug as a as Nick mentioned, a moment ago. The market in October has been pretty volatile that expectations have changed.
Speaker Change: Rates have risen curve steepens them all of that and so through October 18th we think.
Speaker Change: That our that our book value was down between one and a half and 3% and Oh over the week last week mortgages, continuing to widen a little bit more so we're down a couple more on top of that.
And I can address the question I mean, we've had as everyone knows we had a major reversal since.
Speaker Change: The lows in rates that was just prior to the fed meeting in September and in fact since quarter end.
Speaker Change: We're up about.
Speaker Change: 50 basis points or so in mortgage spreads really widened out so.
Speaker Change: All of the things many of the things that happened throughout the third quarter have now been reversed in the short period of time in the fourth quarter and.
Speaker Change: If you would look at our return potential now would surely be shifting.
Speaker Change: Back to somewhat of a higher leverage.
Speaker Change: We have since quarter end.
Speaker Change: As I mentioned in my comments, we have split our coupon our TBA exposure up back up a little bit and our spread exposure up a little bit. So you would definitely see an uptick in the return potential on the security side compared to what you saw at quarter end.
Speaker Change: Great. Thank you both.
Speaker Change: Yeah.
Speaker Change: Thank you Doug.
Speaker Change: The next question comes from Bose, George with K B W.
Bose George: Hey, guys. Good morning, just a follow up to Doug's question in terms of the new target range I'm just curious what drove the just a much wider range this quarter.
Bose George: On the return potential both.
Speaker Change: Yeah, Yeah exactly on the return potential.
Speaker Change: We have quite a wide range and maybe just discuss factors that would take you to the high end versus alone.
Speaker Change: Yeah, well I know you've asked this question before and it's a good question what really drives those the variance in those returns are prepay expectations as well as funding rates and based on based on the assumptions that we use for the for the highs and lows and how they affect those numbers that is what really drives it so.
Speaker Change: The extent that we use a wider like funding rate spread on on the security side for for repo that will affect what those ranges are and as we mentioned there has been a little bit more volatility.
Speaker Change: On the funding rates on the repo side.
Speaker Change: On the on the on for pools are funding for MSR is as you know is pre determined Reno, that's all longer term kind of locked in sort of spreads.
Speaker Change: But.
It's really just the variations in prepays as well as as funding rates.
Speaker Change: Okay, great. Thanks, and then just based on your earlier comments it sounds like the return profile just since quarter end with the move in rates should be somewhat closer to what it was.
Speaker Change: Last quarter is that kind of a good way to think about that.
Speaker Change: Yeah, that's correct I mean, I think it would even be wider than that because mortgage spreads where they sit right now they are they really have widened out.
Speaker Change: To the to the highest levels of the year, depending there are lots of ways to look at spreads as everybody knows but almost to a one they are they are at the highest levels of the year in fact, where we are where we sit today.
Speaker Change: Our mortgage spreads are now starting to look very attractive.
Speaker Change: Okay, great. Thanks, a lot.
Speaker Change: The next question comes from Jason Stewart with Janney.
Speaker Change: Yeah.
Jason Stewart: Hey, good morning, Thanks could you talk a little bit about your outlook intermediate term, maybe near term and intermediate term for Prepays, how servicing capacity looks for the industry, given where current mortgage rates that.
Jason Stewart: Sure.
Prepays.
Jason Stewart: Have seen.
Thus far for this month, we have seen an uptick in prepaid some some of it has to do with day count some of it has to do with lags of.
Jason Stewart: Of where mortgage rates went up in the third quarter. Those lags are a little bit hard to gauge these days for various reasons and without getting too deep into that topic, but.
Jason Stewart: We do expect Prepays to pick up in this this and this this next report and then I think you really get into.
Then it will start reflecting the fact that you know rates it really have reversed and we have done.
Jason Stewart: We did we we estimated that mortgage rates were down about 75 basis points in the third quarter and were up at least that much now in the fourth quarter. So.
Jason Stewart: And then we'll also be entering the winter months as we get here. So overall I think we'll see prepay is really starting to come back down across the board, reflecting slower turnover rates for the lower coupons and then just much less.
Jason Stewart: Sensitivity for the hires that we saw that a little bit of as people were saying we had like a two week refi.
Jason Stewart: <unk> for the higher coupons, which is now kind of turned around.
Speaker Change: I'll, let bill talk about the MSR side.
Speaker Change: Yeah in terms of MSR supply you know I think we've said in.
Speaker Change: Other people have commented that MSR supply is really reverted back to more historical norms.
Speaker Change: The amount of MSR, which has changed hands and in in 2021 and 'twenty 'twenty. Two we're really 'twenty three were record levels.
Speaker Change: And now the amount is really back to historical levels, which is in that two.
Speaker Change: 200 billion kind of a range for it for a year. So we're continuing to see certain.
Speaker Change: Certain amounts of pools trade and we're participating in those markets as Nick said, we we participated in that market we bought some.
Speaker Change: Attractive levels.
Speaker Change: You know we're finding.
Speaker Change: Our opportunities to be situational right and.
Speaker Change: We sold a little bit a in the previous quarter, we bought some here. So I'd say the market is is is returning.
Speaker Change: To historical norms, but remains healthy and well supported.
Speaker Change: Got it okay. Thank you and then and just in terms of transaction activity on the MSR valuation do you think that has an impact on multiples maybe if you could just parse out the delta in the.
Speaker Change: Moving to multiple maybe three key to where it's going and <unk> in terms of.
Speaker Change: Earnings on float income versus Prepays and how those two factors are driving MSR transaction multiples.
Speaker Change: Sure well you know I mean, the transaction multiples of the prices of MSR is depends on on all of those factors.
Speaker Change: Forward short term rates right to extent that the fed has cut rates will decrease slowed earning some which should.
Speaker Change: Hum.
Speaker Change: Drive multiples lower all else being equal as Nick said prepayments long term prepayments I, probably back to where they were a quarter ago right. So that's going to be sort of a wash where people are pricing recapture is is of course.
Speaker Change: Become a very hot topic of interest for for MSR participants.
Speaker Change: And generally we have seen a what I will call. The MSR bulk curve that is the prices the bulks of MSR packages ranging from very low WAC like we have of three 5% up to higher WAC packages, five five and a half six to be as flat as it's been in in the history.
Speaker Change: Right and that's really attributable to two the value that people are putting on.
Speaker Change: Recapture that said, putting all that together I think I think the the movements in in in in the short rates are small compared by comparatively to where we are.
Speaker Change: Forward curve has steepened out so that means forward projections.
Speaker Change: Projections of float income is higher than it was when the curve is flat. So I think these will translate to two pretty small changes in MSR moments.
Speaker Change: Yeah.
Speaker Change: I'll just add onto that so your question about float income versus pre pay as we've talked in previous calls about the fact that a lot of our a lot of our price sensitivity on our MSR is really related to float income given how far out of the money. Our MSR has given its low gross WAC and although there is always some prepay response as we've.
Gone to some lengths to kind of demonstrate its still pretty small right. So our most of most of the price sensitivity there.
Speaker Change: Net debt.
Speaker Change: That our MSR displays is about float rather than Prepays I don't think that's changed dramatically in this this move.
Speaker Change: Of course, if you had higher gross WAC MSR alone than Prepays in current coupon exposure would.
Speaker Change: We have a much bigger impact on the pricing, but most of it is really just just interest rate movement related.
Speaker Change: Alright, so net neutral on market multiples and biased higher on the on twos.
Speaker Change: And then sorry, multiple and then just a quick question.
Speaker Change: It is it is the MSR and your estimate of book value quarter to date is there any change to the MSR valuation embedded in that.
Speaker Change: Yeah, well when we said we were down between between one and a half and 3% as of as of October 18th adding that incorporates the entire portfolio.
Speaker Change: Okay. Thanks, So it's a it's a hedge portfolio that make both sides is like all positive duration of negative duration assets are moving around in that and that's the estimate that we think.
Speaker Change: Great. Thank you.
Speaker Change: Thank you.
Speaker Change: The next question comes from Rick Shane with J P. Morgan.
Rick Shane: Thanks, everybody for taking my question I'd like to follow up on Jason's question related to the MSR.
Rick Shane: You know when we look at the sales and bulk purchases.
Rick Shane: Almost net out when.
Rick Shane: When we look at the growth coupon rate it ticked down slightly can you help us understand a little bit about the characteristics of the purchases you're making.
I'm assuming that some of this is or a lot of this is season gannett's or youre not buying a new production.
Rick Shane: But help us.
Rick Shane: If you could help us understand what's going on here.
Rick Shane: What the strategy is.
Rick Shane: Hey, Rick this is Nick Thank you for that question.
Nick: As you know MSR is a nuanced asset there is all kinds of things that go into its valuation and you know that old adage in the bond market Theres no bad bonds, just bad prices, we really look across the the wax the whack range of Msr's and.
Nick: Each package is unique and.
Nick: It's hard to generalize so we have.
Nick: We have as you know we've sold some high gross WAC stuff because we've we've we've been engaged in buying some from time to time.
Nick: We bought sort of intermediate whack kind of things that are in the 4% to 5% gross WAC range through time, it really varies and it depends on where the value is but we know we are a participant we have bought some high gross waxed up too.
It doesn't just because its high gross WAC doesn't mean that it doesn't have a good value and.
Nick: As I said, it's a nuanced asset world.
Nick: Deep variables really really do matter and we also have some flow in the flow the flow MSR is by definition pretty much current coupon and we have that coming into our portfolio too. So it's a mix of things.
Speaker Change: Okay, and again, you know when I I think.
Speaker Change: A lot it's interesting I'm looking at your slide looking at the new logo looking at the new branding.
And realizing that.
Speaker Change: This is indicative of.
Speaker Change: The strategic shift that you guys are pointing to.
Speaker Change: And when we think about how you're approaching the MSR market at this point, we've historically thought of it as a pure hedge against the agency book, but I think what you're.
Speaker Change: Really happening here is that you are trying to play both sides of the coin that you really want to be in the recapture business or you are competing there as much as you are sort of creating the traditional I'll call. It two harbors book versus the two book.
Speaker Change: Yeah, I think I think that's that's that's mostly right you know what we saw in the last couple of years as rates Rose was was that the the traditional you know what I like to call hedge capacity of the MSR asset declined and the portfolios. The MBS part of the portfolio and the MSR portfolio bifurcation.
Speaker Change: Kate because they didn't really hedge one another necessarily but.
Speaker Change: But we like the attributes.
Speaker Change: And return opportunities of both.
Speaker Change: And then in our portfolio, our MSR portfolio today, its three and a half gross WAC.
Speaker Change: As we showed on on some of the earlier slides as prepaying slowly it's cash flowing well, which is very far out of the money Hum.
Speaker Change: And so forth and so the MBS part and the MSR part don't hedge one another exactly but they complement one another.
Speaker Change: When we think about.
Speaker Change: The ways too to add or augments potentially.
Speaker Change: Potential returns to our MSR asset.
And to and to improve returns for the company and for shareholders. There's things we can do on the MSR side that we can't do it on the security side and one of the things that we can do as well we can buy a servicer right and because we did that we you know we we as I said in my prepared remarks, we're on track to achieve the cost savings that we said.
Speaker Change: Through economies of scale, and and and controlling our own destiny in and being able to be more efficient than we were rather than owning sub servicing the recapture effort as a part of that also you know I think I've talked publicly about being able to hedge faster than expected prepayment speeds right when <unk>.
<unk> moved when rates fall or rise we.
Speaker Change: We have expectations of what we think prepayments will do and therefore, we have expectations for what MSR prices will do and we can hedge those with financial instruments, but what we can't do we can't hedge speed.
Speaker Change: Speeds that are faster than we expect the origination channel the direct to consumer channel will help us do that right and so that's really the genesis of wanting to to embark on that and then once we're here.
Speaker Change: Alright, we can do some of these other things like I mentioned in my prepared remarks in terms of originating or brokering second liens to other people and other such things so.
Speaker Change: It is a recognition that that were creating this ecosystem around the MSR asset, but it's designed to to supports right and augment the investment portfolio.
Speaker Change: Got it.
Speaker Change: Phil Thanks, Thank you very much and bill that's a very helpful. It it's good to get strategic insight and we appreciate it. Thank you.
Rick Shane: Yeah. Thanks, Rick.
Speaker Change: The next question comes from Trevor Cranston with citizens JMP.
Trevor Cranston: Hey, thanks.
Speaker Change:
Trevor Cranston: Can you talk a little bit about your thoughts on swap spreads relative to treasuries.
Trevor Cranston: Limit to how low you think those can go and how all that plays into your choice.
Trevor Cranston: Choice.
Trevor Cranston: <unk> instruments for the portfolio.
Speaker Change: Hey, Trevor Thanks for that question.
Speaker Change: Great question and.
Speaker Change: I will hesitate to state a limit on where I think swap spreads can go.
Speaker Change: Alright, I will say that we use a combination of swaps and treasury futures to hedge our book overall.
Speaker Change: And.
Speaker Change: It does it does appear to us as though a lot of the supply concerns about the market are priced into swap spreads right now we are.
Speaker Change: At extremely tight levels on swaps relative to treasuries, but as.
Speaker Change: As we've seen this quarter there continues to be.
Speaker Change: Sure.
Speaker Change: That gap continues to grow and a lot of a lot of it has to do with market directionality a lot of it has to do with.
Speaker Change: The expectation for budget responsibility of of the next and future administrations.
Speaker Change: But overall, we do think that swap spreads here presented good hedging opportunity.
Speaker Change: And have <unk>.
Speaker Change: Shifting a little bit.
Speaker Change: We remain.
Reasonably.
Speaker Change: Heavily hedge with swaps.
Speaker Change: Just thinking that they that they do offer.
Speaker Change: Better carry from a hedge perspective and that there are there reasons to also believe that swap spreads could widen and one of them really would be.
Speaker Change: The February.
Speaker Change: Really stop.
Speaker Change: With the Q T side and that there is there is debates about that in the market.
Speaker Change: Their arguments on both sides, but there's a reasonable chance that that happens as well, which would which would change the dynamics of that market greatly.
Speaker Change: But.
Speaker Change: It's.
Speaker Change: It's a very good question.
Speaker Change: And.
Speaker Change: It's one in which.
Speaker Change: A lot of it will just depend on.
Speaker Change: What happens from a.
Speaker Change: From a budgetary perspective for the U S and what supply it looks like but as I said on balance we think that.
Speaker Change: There is a lot of.
Speaker Change: A lot of the bad news about the budget is in treasury supply as pricing two spreads right now.
Speaker Change: Yeah. Okay. That's helpful. Thank you.
Speaker Change: The next question comes from Eric Hagen with B P. I G.
Eric Hagen: Hey, Thanks, good morning.
Eric Hagen: When you say that you raised your spread exposure into October or is that a function of taking your financial leverage higher or is this spread exposure also a function of how much TBA you have relative to pools in session.
Speaker Change: Hey, Eric.
Speaker Change: It's a function of a few things so it's not it's not leverage that's one thing that we pointed out on the prepared remarks, leverages, but one measure of risk that we look at and it has to do with it.
Speaker Change: Some of our spread exposure has to do with how we allow our spread exposure to change with regard to the MSR when MF when rates go down.
Speaker Change: The MSR.
Speaker Change: It becomes it.
Speaker Change: Acquired as I mentioned more in mortgages to hedge when rates go back up.
Speaker Change: Less so if you hold essentially the same amount of mortgages are going to have more mortgage spread exposure.
Speaker Change: As rates go up unless as rates go down so some of it just has to do with letting that exposure grow.
Speaker Change: As spreads have widened so.
Speaker Change: It's really more of a function of that than than than a leverage then leverage we are really not taking our leverage up.
Speaker Change: Okay got you.
Speaker Change:
Speaker Change: I think there is a follow up question here on leverage, though I mean, what is the right way to benchmark your leverage relative to the spread environment like this your leverage account for the fact that the fed is expected to cut rates versus last year when spreads were even wider than they are right now, but the benefit from the borrowing costs wasn't really reflected in the spread environment. How do you benchmark your leverage.
Speaker Change: <unk>.
Speaker Change: Against that.
Speaker Change: Honestly I'm not sure I really understand your question.
Speaker Change: We look at our portfolio composition.
Speaker Change: Look at the spreads in the market and what kind of returns we think we could generate in <unk>.
We've said on prior calls we don't.
Speaker Change: We've kind of given a range of what our overall economic Leverages I think thats. The holds but it has to do really with where we see spreads are now and.
Speaker Change: We are.
Speaker Change: Essentially I think youre asking us to I think youre asking like do we are we are predicting mortgage performance based on the way. The fed is going to act, but I'm not quite sure what you're asking me to be perfectly honest.
Speaker Change: Okay, and you guys have the convertible debt coming up on a current liability in a couple of months do you have a sense for how youre thinking about.
Speaker Change: Potentially refinancing not just your capital structure.
Speaker Change: Uh huh.
Speaker Change: Well the convertible debts coming due in early 'twenty six and so that's on our radar and Glenn will be addressing it before that.
Speaker Change: Hum.
Speaker Change: One other point, if I could just make about your question about leverage and so forth and Nick's answer I might just just elaborate a little bit that leverages is one measure.
Speaker Change: <unk> of our risk that we look at of course, but we are.
Speaker Change: Other measures in terms of now that we've put it put in the in the in the deck also about our mortgage spread exposure and the amount of liquidity, we have and so forth.
Speaker Change: Because the MSR as out of the money as it is it does still contribute to offsetting some mortgage spread exposure.
Speaker Change:
Speaker Change: We think that's important to include in our overall risks as well and so you know we don't just look at Leverages, one measure, although we obviously pay attention to it and in respect it but it's a whole suite of metrics that we look at when we're managing the portfolio exposures.
Speaker Change: Gotcha, Alright, Thats really helpful. Thank you guys.
Speaker Change: Thank you.
Speaker Change: The next question comes from harsh.
Speaker Change: <unk> with Green Street.
Speaker Change: Hey, Thanks for taking my question.
Speaker Change: Hey.
So no it <unk>.
Speaker Change: <unk> is scaled up and operating I guess could you remind us the recapture rate on a long term basis that you are projecting on the MSR stuff.
Speaker Change: Yeah.
Speaker Change: Yeah, you know I mean as I said, we just finished our first quarter of DTC operations, and we know as I mentioned, we only had.
Speaker Change: A number of loan officers that can be counted on one hand, and so you know what.
Speaker Change: We're not up to scale, yet as I said I think what we've done here is a proof of concept and we're bringing the thing to scale and so I think it's too soon to talk about what what they are.
Speaker Change: With recapture rates are in our portfolio, but we do expect that there will be able to achieve an industry level recapture rate on the agency portfolio. Once we're fully at scale.
Speaker Change: Or in this in this weird environment, where 1% or less than 1%, especially with the recent move in rates of our portfolio. Our at the money and so these are very small numbers of our portfolio that are actually in the money. So it's not a great.
Speaker Change: Moment to talk about what the recapture rate is but we'll have more to say about that in future quarters.
Speaker Change: Okay, that's fair.
Speaker Change: And then you've.
Speaker Change: That's on the left.
Speaker Change: In the prepared remarks, I don't know if you crack question perhaps.
Speaker Change: Perhaps in the near term call. It next couple of quarters how are you.
Looking at the relative value across the two strategies today.
Speaker Change: <unk> seen the opportunity to invest to be better in the securities portfolio.
Speaker Change: Yeah.
Speaker Change: Hey, harsh thank you for that question it is.
Speaker Change: Mortgage spreads having done what they have done thus far this quarter the mortgage side at the moment looks quite attractive how long that lasts it's hard to say there is.
I believe there are a lot of market participants that are holding on for the election to be over because as we know there can be a significant amount of volatility and we have a lot of lot of events coming up in the next few weeks, we have nonfarm payroll.
Speaker Change: The election, and then we have the fed right. After that there's a lot of reasons to do nothing and I think that there are a lot of investors right now that are happy to just sit and watch right now and I think that I believe that explains a lot of the reasons why we've seen mortgage spreads move out as they have so at the moment. If you asked me right today, if I had if I had more.
Speaker Change: To invest I would put it into the mortgage side, because I think mortgage spreads or are very attractive.
Speaker Change: My sense is that that won't last for a longer period of time, unless we really have a different.
Speaker Change: The environment for one reason or another unless we're again moving back to higher rates or some questioning about where the feds really cutting or not.
Hi.
Speaker Change: I think the base case should be that mortgage spreads probably do better.
Speaker Change: Once we got through these these market events that were that are coming up.
Speaker Change: But longer term, we still we love our MSR asset.
Speaker Change: We say it's.
Speaker Change: It's a great risk reward asset.
Speaker Change: All easy to hedge and provides a lot of great cash flows and prepays are very stable. So from a longer term perspective, we really do like the MSR.
Speaker Change: Got it great. Thank you.
Thank you.
Speaker Change: There are no further questions at this time, Mr. Greenberg I will turn the conference back to you for any additional or closing remarks.
Speaker Change: I'd like to thank everyone for joining us today. Thank you as always for your interest you harbors go too.
Speaker Change: Yeah.
Speaker Change: This concludes today's call. Thank you for your participation you may now disconnect.
Speaker Change: Yeah.
Speaker Change: [music].