Q2 2019 Earnings Call
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Good morning, My name is get a road and I will be your conference facilitator at this time I would like to welcome everyone to two harbors second quarter 2019 financial results Conference call.
All participants will be in a listen only mode. After the speakers remarks, there will be a question and answer session.
I would now like to turn the conference over to Maggie field with Investor Relations for two harbors.
Thank you and good morning, everyone. Thank you for joining our call to discuss two harbors first quarter 2019 financial results with me on the call. This morning are Tom Siering, our president and CEO Mary risky, our CFO and Bill Roth Our CIO. After my introductory comments, Tom will provide an overview of our quarterly results and long term strategy Mary will highlight key items from our financials and Bill will review, our portfolio and investment opportunity.
The press release and financial tables associated with todays call were filed yesterday with the FCC. If you do not have a copy you may find them on our website or on the Fccs website at <unk> Dot Gov.
In our earnings release, and slides, which are now posted in the Investor Relations section of our website. We have provided a reconciliation of GAAP to non-GAAP financial measures.
We urge you to review this information in conjunction with today's call.
I would also like to mention that this call is being webcast and maybe accessed on our website in the same location.
Before I turn the call over to Tom I would like to remind you that remarks made by management. During this conference call and the supporting slides may include forward looking statements.
Forward looking statements are based on the current beliefs and expectations of management and actual results may be materially different because of a variety of risks and other factors.
Such statements are typically associated with the words, such as anticipate expect estimate and believe or other such words, we caution investors not to rely unduly on forward looking statements.
Two harbors described these risks and uncertainties in its annual report on Form 10-K for the fiscal year ended December 31, 2018 and in other filings it makes or may make with the FCC from time to time, which are available in the Investor Relations section of two harbors web site or on the Fccs website at SCC Dot Gov.
Except as maybe required by law two harbors does not update forward looking statements and expressly disclaims any obligation to do so I will now turn the call over to Tom.
Thank you Maggie and good morning, everyone. We hope that you had a chance to review our earnings press release and presentation that we issued last night.
Please turn to slide three to review our results.
We had a very strong quarter or book value grew to $13.83 per share representing a total return of 9.1% for the period.
We reported core earnings of 49 cents per common share and would generate a comprehensive income of $1.23 per common share.
We also completed an underwritten common stock offering and utilized our at the market stock issuance program for net proceeds to the company of approximately $335 million, we deploy this capital into agency and mortgage servicing rights.
Please turn to slide four.
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Ladies and gentlemen, apologies for the technical.
Difficulties. Good morning, My name is get roads and I will be your conference facilitator at this time I would like to welcome everyone to two harbors second quarter 2019 financial results Conference call.
All participants will be in a listen only mode. After the speakers remarks, there will be a question and answers period I would now like to turn the conference over to Maggie field with Investor Relations for two harbors.
Please go ahead.
Thank you and good morning, everyone.
Thank you for joining our call to discuss two harbors second quarter 2019 financial result.
With me on the call. This morning are time, Siering, our president and CEO , Mary risky, our CFO and they'll Roth our CIO.
After my introductory comments, Tom will provide an overview of our quarterly results and long term strategy Mary will highlight key items from our financials and Bill will review, our portfolio and investment opportunity.
The press release and financial tables associated with todays call were filed yesterday with the FCC. If you do not have a copy you may find them on our website or on the FCC is website at SCC Dot Gov.
In our earnings release, and slides, which are posted in the Investor Relations section of our website Weve provided a reconciliation of GAAP to non-GAAP financial measures.
We urge you to review this information in conjunction with today's call.
I would also like to mention that this call is being webcast and maybe accessed on our website in the same location.
Before I turn the call over to Tom I would like to remind you that remarks made by management. During this conference call and the supporting slides may include forward looking statements.
Forward looking statements are based on the current beliefs and expectations of management and actual results may be materially different because of a variety of risks and other factors.
Such statements are typically associated with the words, such as anticipate expect estimate and believe or other such work.
We caution investors not to rely on duly on forward looking statements.
Two harbors described these risks and uncertainties in its annual report on Form 10-K for the fiscal year ended December 31, 2018, and in other filings that makes or May make with the FCC from time to time, which are available in the Investor Relations section of two harbors web site and on the Fccs Web site FTC Dot Gov.
Except as may be required by law two harbors does not update forward looking statements expressly disclaims any obligation to do so I will now turn the call over to Tom.
Thank you Maggie and good morning, everyone. We hope that you have a chance to review our earnings press release and presentation that we issued last month.
Please turn to slide three to review our results.
This quarter was highlighted by our strong book value growth, we delivered a 5.4% quarterly return on book value.
And a 14.7.
Additive terms compared to our bilateral facilities and it gives us more financing flexibility for MSR.
Please turn to slide four.
In the second quarter, our sector traded under stock price pressure.
Which we believe was driven by dividend cut concerns lower interest rates and a flatter yield curve as well as an emergence of faster money buyers and sellers.
Which created more inter day volume and volatility.
As you know our goal is to deliver book value stability through a variety of market environments.
We construct our portfolio with this long term focus and mine, while endeavoring to minimize the impact of short term changes in rates.
In particular, we believe our strategy apparent MSR with agency RMBS generates a more stable risk adjusted returns through market cycles compared to hedging agencies with swaps only.
Additionally, our unique portfolio of legacy non agency Securities is one that can be easily replicated and we believe this strategy will continue to generate.
Attractive returns given the strong tailwinds in housing.
On this slide you can see how these differentiating factors have resulted in total stockholder outperformance of 45%.
Since our inception.
Recently, we have received some questions on possible GLC reform, we think it is unlikely that anything of substance happens prior to the 2020 election.
Obviously that outcome could greatly influence any reform efforts.
Finally, I would like to congratulate bill on behalf of two harbors on his retirement at the end of the year.
Under his leadership, we have built a strong team of investment professionals I would also like to congratulate bill Greenberg and Nadcap and <unk>.
On their appointment as co chief investment officers beginning in 2020.
We have a great team at two harbors and we're very excited about the opportunities ahead.
I will now turn the call over to marry to review our financial results.
Thank you Ken turning to slide five let's review our financial results for the second quarter.
We generated comprehensive income of $201 million or 74 cents per share.
And our book value was $14.17 per share compared to 13, guys and 83 cents at March 31st.
Increase in book value was primarily driven by the outperformance of higher coupon agencies and specified pool.
With MSR performing as expected and offsetting current coupon spread widening.
Credit spreads also improved and contributed to positive book value.
Finally, I'd note that through the end of July 3rd quarter book value is that between 2% to 3% after accruing for dividends.
Moving to slide six lets review our core earnings result.
Core earnings, including dollar roll income or 39 cents per share in the second quarter.
Representing a return on average common equity of 11.1%.
Core earnings was impacted primarily by the higher prepayment environment.
However, we also realized a minor impact on the compression of the LIBOR repo spreads.
Yes, but not to the effects of the spread widening that occurred in the first half of this year by maintaining longer repo maturities.
We do expect to see a small impact from this in the third quarter.
However, we are actively managing our repo laddering to minimize both cost and exposures.
I'd like to take a brief moment to discuss the change we made this quarter to core earnings.
The change involves a modification to the approach we use to calculate MSR amortization.
Specifically, an adjustment for any gain or loss on the capital used to purchase the MSR.
We recognize that core earnings is an important metric to the investment community.
We believe that our new approach allows core earnings to better reflect how the carry earned on MSR varies as a function of prepayment rate.
As such we believe it is a much improved and more accurate reflection of the economic returns our portfolio can generate.
Further details are provided in the appendix slide 19.
Finally, I would note that our other operating expense ratio.
Excluding non cash L tip amortization was 1% down slightly from 1.2% in the first quarter.
As a reminder, we anticipate that our expenses will remain stable in a low ones in 2019.
Turning to slide seven our portfolio yield declined in the quarter to 3.93%.
This was primarily driven by lower agency yield reflective of the lower rate and higher prepayment environment.
They also purchased this kind of legacy non agencies at lower base yield.
However, as we have discussed in the past, we anticipate that overtime. It's just kinda bonds will generate double digit total returns through a combination of both strong yield and price appreciation.
Now, let's review our financing profile as shown on slide eight.
Our economic debt to equity ratio, which includes the implied that enter TB positions.
With 7.8 times at June Thirtyth.
Our average economic debt to equity was up slightly quarter over quarter at 7.2 times from seven times.
Our diverse financing profile includes a mix of traditional repo variable that revolving credit facilities and MSR secured term note.
We have 25 active agency repo counterparties and the market continues to function efficiently for us.
As I mentioned earlier, we're focused on managing the laddering of our repo maturities to minimize cost and exposure to repo LIBOR spread changes.
The improvement in financing for both MSR and non agencies presents an ongoing opportunity for our business.
On the MSR front, we closed our first financing securitization this quarter.
It's 400 million securitization of five year secured term note.
As 12 months prepayment protection and a spread of LIBOR plus 280.
The benefits of this structure includes scalability competitive advance rates and pricing.
And the length of the term is greater than bilateral facilities.
Across all of our bilateral MSR facilities, we had 300 million outstanding with a total capacity of 790 million as of June Thirtyth.
With respect to non agencies haircuts in spreads have continued to be favorable.
And were consistent quarter over quarter.
With that I will now turn the call over to bill for our portfolio update.
Thank you Mary and good morning, everyone.
Please turn to slide nine.
In the second quarter.
Global growth concerns, especially trade issues with China in Mexico fueled the rally in interest rates and impact that economic growth expectation.
This resulted in a flatter yield curve and three month LIBOR above most longer term rate.
This curve shape reflects the market's expectation that the fed will lower rage, which ended up occurring in July and the anticipation is that there will be further rate cuts in the latter half of 2019.
In the mortgage market the agency basis widened with current coupons widening by about a point higher coupon mortgages outperform widening only by about three eighth of a point.
Specified pools performed quite well in the rally offsetting much of the basis widening.
MSR performed as expected declining in value in line with its duration and current coupon spreads.
Residential credit assets continued to perform well.
Discounted legacy non agencies benefited from lower expected forward, LIBOR, which would have the effect of increasing the excess spread available to cover future losses. As a result prices were modestly higher by about one point.
Let's move to slide 10 to review our portfolio, which at June Thirtyth was comprised of 32 billion of assets at about 9 billion of net long TB.
From a capital allocation perspective, 76% of capital was allocated to our rate strategy and 24% to credit.
In terms of portfolio activity as the market rallied in the quarter. We added the agency RMBS in part to manage our duration exposure, but also to take advantage of the wider spreads available in the market.
Specifically, we added approximately 5.7 billion.
Of three and a half and 4% coupon lower pay up of specified pools.
We think that these bonds have excellent prepayment protection and convexity characteristics at reasonable prices.
We also reduced our four and a half and 5% coupon higher pay up a specified pool position by approximately 950 million.
As we felt these pools were priced at levels that have more risk and reward.
Despite the higher agency balances however.
Our exposure to mortgage spread was slightly lower since our mortgage spread risk declines as interest rates fall.
One question, we've been getting recently is our outlook for leverage as it has been drifting higher of the past few quarters.
We think about leveraging our portfolio from a risk exposure standpoint, similar to the way, we think about interest rate exposure.
In short our focus is more on the sensitivity of book value relative to movements in mortgage spreads than it is on just the nominal leverage number.
Although this quarter, we added agencies, which increased our leverage our mortgage spread risk actually decline.
As we've discussed in the past and as you will see on the next slide we continue to believe that pairing agencies with MSR allows us to have higher agency leverage, but with lower overall risk.
We are comfortable with our current level of leverage and do not expect that to change materially from here.
On the MSR front, we did not purchase any bulk servicing in the quarter as we didn't see any packages that met our criteria either collateral wise or pricewise.
We do expect to see a pickup in transaction volume in the second half of 2019 as there will likely be an increase in supply driven by higher refinance volume.
Finally in our credit strategy, we added approximately 370 million in market value of discounted legacy non agency, which at an average price of $58. We believe have the potential for upside price appreciation.
Turning to slide 11, let's discuss our risk positioning.
As seen on the top of the slide our exposure to changes in rates remain small.
Consistent with our typical practice in the second quarter, we utilized an extensive amount of swaptions and mortgage options to protect our portfolio against big rate moves either higher or lower.
This hedging practice contributed to our strong performance.
The bottom table of this slide shows our spread exposure to rates up and down 25, and 50 basis points.
As we've discussed in the past MSR has negative duration and hedges, both interest rate and mortgage spread risk, which you can see in this table.
Please turn to slide 12.
The second quarter presented an interesting rate environment with a flat yield curve LIBOR or elevated relative to longer term rates and the potential for increased refinance activity.
Nonetheless, we delivered strong returns because of our portfolio positioning principally holding higher coupons.
Specified pools, and MSR and also because of our dynamic use of options in hedging.
Given the current market backdrop, we believe that we position both our rates and credit strategies to deliver strong long term risk adjusted returns.
You know our rate strategy, we view Levered returns on agencies as currently in the low double digit range.
We continue to believe our holdings of specified pools, and higher coupons will generate attractive long term returns.
Returns on agency paired with MSR are also in the low double digits, but as we discussed on the last slide this comes with a lower risk profile.
I'd like to spend a moment highlighting the total return opportunity that exists in our credit strategy.
We believe that our portfolio of legacy non agencies will continue to benefit from the strengthening housing market.
Additionally, the lower rate environment is beneficial to our discounted portfolio.
Residential credit Tailwinds have been strong and as you can see in the charts on this slide.
Subprime non agency prepayments have increased while loss metrics have come down.
Continued re equivocation overtime has resulted in and can continue to result in increased prepayments.
And lower delinquencies defaults and severities.
We believe these favorable dynamics will persist.
Driving bond prices higher in generating strong total returns going forward.
Despite the fact that the legacy non agency sector is shrinking we have a substantial and unique portfolio of deeply discounted bonds.
And we continue to find pockets of value and opportunities to add to our holding.
In conclusion, we believe that we have positioned our portfolio through both security selection and active hedging to drive strong returns over the long term.
We're very excited about the opportunities in both our rates and credit strategies in the latter half of 2019 and beyond.
I will now turn the call back to the operator for queuing <unk>.
Thank you.
If you would like to ask a question at this time you signaled by pressing star and then one on your telephone keypad.
If you are using a speaker phone. Please make sure. Your mute function is turned off to an out of your signal to reach your equipment again. Please press star and then one to ask a question.
We will take our first question from.
Hector. Please go ahead your line is open.
Saying, obviously the kind of the start to August has a husband been quite volatile I'm. Just if you could just talk about kind of how you're repositioning is for for kind of this kind of magnitude of rate declines we've seen.
And you know kind of how you see the prepaid outlook a changing with with this move.
Sure. Good morning, Doug how are you from wells I'd like to apologize for the Uh Huh.
Goal a glitch we have this morning.
With that I'll turn your question to Bill.
Hey, Doug Thanks for joining us.
Yeah [noise]. So there were a couple of questions in there you know I think.
Slide 11 is sort of a relatively good depiction of where we were at the end of June you know, we continue to maintain a light lead long bias in duration, but we have a substantial amount I you know I talked on the call and one of the things that benefited the second quarter the extensive use of option.
Certainly as markets become more volatile and whip around you know protecting the mortgage you know the the portfolio by use of options. It is very important and effective you know in terms of you know what we seen in August .
You know, it's a little hard to make sense of what's going on but you know we continue to stay close to home, yes. The primary rate come down and it's been pretty sticky so far but I guess it depends on what rate level. We said a lot. If the primary rate comes down then I think you'll see.
You know a reasonable pickup in generic pre pay or per case on generic collateral you know one of the reasons that we have been acted a continued to be active in adding specified pool, especially off of 'em lower lower coupons as I discussed on the call is because you know.
That creates more stability in the portfolio, it's easier to hedge and there's less pre pay volatility there. So so we continue to see move in that direction.
Yeah. The team has done a really good job managing this dog and use them to August as well.
Great I'm, just I guess on that you know the relative where do you see relative attractiveness of you know of kind of specified pools. Today, obviously, given you know given the commentary that you know generic speeds going to likely continued increase but but obviously pay ups of have increased substantially.
Yeah, Great question, Yeah, I think you know the positioning that we talked about on the call. This is representative of where we think value. It you know we've been trying to buy lower pay up.
Oh, let's say three and have you know we haven't seen as much off of threes, yet, but we sold.
Who had performed very well in pay ups went up quite a bit off the higher coupon and so by recycling into lower pay ups off a lower coupon to.
We come up with better convexity with less premium at risk.
And you know, we think Oh, we think those represent good value and and we continue to pursue that.
Great. Thank you both.
And.
Thank you.
We will now take our next question from Matt device.
Yeah. Thanks.
Let me be the first to congratulate you Bill on an annual retirement and then we may have you seen other sort of it's been a pleasure working with you over the years.
First question.
Okay. As you noted in the prepared remarks.
Yeah, the leverage went up almost more than a half turn in the quarter, although it sounds like part of that was.
Efforts to manage both spread duration risk.
Are there any implications, we should think about though from a higher leverage in terms of higher earnings power.
At the end of the quarter versus the average for the quarter.
Hey, Mark Yeah, well, thanks to the good wishes I I appreciate it George working with you as well.
Yeah, the average economic leverage for the quarter went from seven to seven to and keep in mind that we think.
Leverage in terms of including net TV, a because that is economic leverage and I think you know as we discussed on the call you know, we frankly think about.
Really more risk metrics, which you know we talked about on slide 11, which is you know.
You know because we have MSR, you know MSR help dramatically hedge mortgage spread risk. So even though we have more agencies, we actually we actually have less risk to spread moves that being said you know we do not expect to see a leverage change materially from from the levels that we've been running recently.
Yes leverage and I blame them as sort of a whole metric mark.
Really we think good.
Terms of risk.
Headline.
Leverage metrics, obviously, that's an important number but in isolation that doesn't mean all that much.
Okay fair enough so.
Thank you.
He also noted that you through through you know some of the.
Levering or.
Sorry, Laddering of of your maturities on repo you've at least mitigated some of the impact of the.
The bit of a dislocation we've seen in a kind of.
Report repo LIBOR spread.
But how much of a drag is that on earnings and if that normalizes, how much of a lift might we see from kind of core earnings.
Yeah. That's a great question I'm Mary is going to answer that one.
Good morning, Mark.
Oh, Yes, you realize it's a small impact you to about one cents.
Per share due to our I'm, making the long or longer repo maturity.
I see a real cost obviously haven't come down like the rest of that short term rates.
HM.
And you know, it's not really the availability, but that's really the pricing.
We are keeping our eyes on it.
Not a line that I'm happy.
Okay got it thank you.
Thank you.
Thank you.
We'll now take our next question from.
George Please go ahead your line is open.
Hey, good morning, I'm just in terms of incremental returns you you gave us some numbers on that but I'm. Just curious how does the incremental kind of spreads that you are getting compares to the level you were in the quarter.
Could you rephrase that.
Both I mean sure right.
Sure just see in spreads on new investments and how that compares to the I guess 138 basis points spread you guys had at quarter end.
Yeah, well I'd say a couple of things.
The first thing is we talked on the call about you know the are expected.
You know total returns that we think we can realize.
Generally being in the low double digits and then on the non agency clearly the.
We've talked about this in the past sort of the baseline is lower than what we think the total return will be.
You know the.
If you think about it right.
We talked about the NIM you know the Prepays the repo spreads and then obviously you know some purchases at lower yields of assets, but.
You know as you know, we don't really manage our portfolio based on the NIM. You know, we really are thinking about it in terms of where we can generate the best total return, while keeping book value stable.
So I think.
It's kind of hard to talk about the.
Spread.
These would be you know.
Today versus a historical accounting spread rather we think about the returns that we discussed on the call low double digits and then potentially.
You know strong total returns on non agency being better than that.
The and so then maybe just in terms of the low double digit returns from an early standpoint.
Yeah, I mean, just give us a bit of a range that is that is that similar to what you have in the portfolio is it a little bit lower or just how would you characterize it versus the ROI you generated this quarter.
Well I think it's probably pretty similar.
To you know what you saw this quarter I mean, obviously one of the things we've been physician Dan has been higher coupons in the specified switch.
You know did well last quarter. They continue to do well this quarter as Mary talked about our performance through July and into you know.
So far this this quarter and.
So I think thats relatively consistent with what we saw.
Yes, you know both.
What kind of people that want to move listing we have our have firmly in our Ham for instance in the fourth quarter.
You know we were we're very honest about our disappointment in our performance, but this was a great quarter for us we generated a lot of alpha and the opportunities for us going forward.
Our abundant so we're excited.
Okay, great. Thanks, and then actually just on the MSR securitization that you guys did.
Should we think of that more as a just a better structure because of the term funding or is there any any funding benefit as well from that.
Good morning.
So I think we think of that a number of benefits from it that a term.
Definitely beneficial.
As the scalability and the ability to to add additional terminal for the future.
And it's not an in car.
Okay.
Great.
Thanks, and then actually one just on the regulatory side you've seen a note you noted that GNC reform.
It's unlikely, but just curious what your take is on how the QM patch issue gets resolved.
Oh, Yeah, that's a good one.
I think what we saw was sort of an initial shot across the valley. If you will.
You know I think the the it sounds like death HFSA.
You know.
They would like to get a number of things accomplished and yet at the same time it seems like Mr. Calabria has.
No.
Also aware that you know there's a lot of if it might need legislation.
And so I think by.
Putting something out there on on the QM patch expiring.
The idea is not necessarily to have it expire, but maybe have a discussion and dialogue as to you know what should it look like.
And you know how can how can the TSC continued support housing, but with a modified footprint.
So I think that I think this is just the beginning of the discussion of how that patch and how that the QM how that was going to play out and I think it'll probably take a decent amount of time so.
Okay that helps thanks, and let me add my congratulations to you Bill on your retirement and to build Greenberg and Matt on their promotions as well.
Thanks, guys. Thank you.
Thank you.
We will now take our next question from Trevor Cranston.
Hey, Thanks, good morning, and ill add my congratulations on your retirement Bill.
Question on the.
You updated methodology, you're using for your core earnings calculation I'm on the MSR amortization.
I guess I wanted to make sure I understand the change better.
It is the new method that you're using I guess similar to what we would think of it in the agency MBS market was using like a like a lifetime assumed yield on on the MSR that you're multiplying by the m. sites cost or.
Maybe you can just expand a little bit on exactly what the what the change was there and how we should think about modeling that going forward.
Hey, Travis theory are so high that its at Merrimack, we did not buy amortization to it.
The gain or loss on the Caplease purchase MSR. So this is consistent with the rest of our portfolio, where you know the hedging or the gains and losses on our RMBS portfolio are not included in core earnings on Appendix Slide 19 provides more details, but you can think about MSR for income.
The amortized cost at the beginning of the period time original pricing yield.
NB Yeah, we really believe that this is a more accurate reflection of economic return and the carry on.
Okay. So I guess, so when we think about for example, this like third quarter to date, where rates have dropped significantly.
Does the new methodology imply that there wouldn't be a significant uptick in amortization because the original personal doesnt changed or I'm not thinking about there correctly.
Yeah.
That's correct.
Okay, great. Thank you.
And then the second question I guess more on the <unk>.
Macro side.
You know with the volatility we've seen this quarter and expectations for the fed to to likely continue dropping rates pretty significantly.
I'm just curious if you guys had any thoughts on the likelihood you know if we do continue to see things move lower in the rates market.
You know if you think the fed would be likely to potentially reinstitute balance sheet growth or the acuity programs and whether or not do you think that might be focused on the MBS market.
Yeah, Great question, Matt happens Harry is going to answer that one for you.
Hi, there.
That's an interesting question, maybe some other people in the room went away and its a.
We're definitely in the midst of a transitioning market here.
Back to you know back to the World, where where we are in a low rate environment and that is is cutting.
We definitely.
Your I think you would you expect to see at a higher volatility environment, you know mortgages continuing to be under pressure.
I think in terms of I'm looking forward to two Q E again.
I don't think anybody is really I'm talking about that are discussing that that seems that's probably a ways down the road.
But we are continuing to.
Like we said earlier, we are continuing to.
Managed the portfolio consistent with how we have in the past.
We're we're certainly glad an environment like this too.
Be maintaining low risk exposures.
Low duration and low spread risk.
This is the environment that we we talk about and prepare for lots of times. So.
We feel like we're holding up fairly well.
Okay, Great I appreciate the comments thank you.
Thank you.
We will now take our next question from Rick Shane. Please go ahead. Your line is open.
Hey, guys. Thanks for taking my question in a build those those looks that everybody is giving you a table or jealousy congratulations.
[laughter]. Thank you all right I appreciate that that's a good one right [laughter].
I I have my moments, Hey, Tom you talked about the al. So that you guys created in the quarter and in in its given the challenging quarter. It really stands out and I think we understand a lot of it.
I think to the.
Coal the coal protected or the prepayment protected.
Agency MBS did very well, obviously some challenges on the NSR side, but when we walk through the details there are some significant gains needs or realize gains on swaps that really makes sense to us there's 97 million of realized gains on other derivatives, what is that and I am just help us understand when you think about the alpha Neil outperformance this quarter, what the puts and takes work.
Yeah. Thanks for that question America, though greenberg going to take that one.
Yeah.
Hi Records is good to talk to you.
You mentioned some some causes for for our outperformance this quarter and I would say there are really three one it was I thought if I could one is the asset selection that we have our focus on being exposed and her coupons is one.
Uses of MSR portfolio, which reduces overall mortgage spread risk is another.
And then lastly, as was alluded to on the call are active hedging strategy and and experience.
I think all three of those things really contributed a lot I think without going.
That does not having too much into detail through exactly talking without I would expect that those of realized gains on those derivatives result from.
Realizing gains on options that we had typically when we buy say out of the money options.
No. It's a hedge for short tail risk in the market rallies those options become in the money or at the mine and rather than keeping them there with reduced convexity benefit we will roll those options into ones that are further out of the money.
And I expect that those gains result from that.
Got it and is that why the notionals on the swaps in the Swaptions didn't seem to change much. It was that you took the swaptions and roll them.
Yeah, that's right.
Great. Thank you guys, but so so so things.
But for your buy Swaptions at some again forget about the portfolio effect that some price market rallies. They go up in value.
Our convexity.
Increases for a little while and then it starts to decrease and then in order to maintain the convexity benefit the protection that we want for continued rate rallies, we basically will we'll sell those and by other ones oftentimes that people notionals and will reset the value of the convexity and and the portfolio protection characteristics.
Got it okay perfect. Thank you very much.
Thank you.
We will now take our next question from Matt you how this.
Please go ahead Matthew your line is open.
Hi, guys. Thanks, a lot bill Congrats just two questions first.
On the MSR is bill did I hear you correctly that you said that you PB sort of would start to pick up the portfolio on or you'd be bases would start to grow again third quarter with the flow arrangements and then what would it take.
You said you're out of the bulk market what would it take to get more active is that more just where prices come down too or is it just more of an outlook of where you think speeds are going to ultimately end up.
Hey, Matt. Thank you appreciate the good wife it yeah. So a couple of things.
First we have seen flow volumes pick up which is which is not surprising given that we started seeing higher refinancings come in.
Hi, just to be clear, we are not out of the bulk market. Okay. We bought a number of packages.
I'll first quarter.
As you know and.
We did not buy any close any in the second quarter, but that was more a function of what was available and the prices and the collateral. So it was more.
You know sort of like saying, while we didn't see any bonds. We liked at the prices that they were trading at we do expect to see to see an increase in our bulk volumes through the remainder of the year.
Obviously, there's a lot of volatility lately. So you know there might be a little bit of a pause from potential sellers until the market settles down a bit but you know given that rifai volumes.
Our clearly picking up a we would expect the second half of the year.
Eventually to see pick up in both volumes and we anticipate participating you know if the prices make sense to us.
Got it Okay, and then what display in sort of the.
It was a lack of.
Price due to the lack of packages coming out in the second quarter was there just.
Just the sellers didn't like the prices are getting a little more use of improved they don't need to sell him as ours.
Well, we don't originate loans and look at whether we should keep the sort of thing or not but I could tell you first you know volumes earlier in the year were quite substantial.
You know one thing that we did see as the market rally was we did see you know people who wanted to get a certain price hold off because they thought well you know.
They want to yesterday's price effectively and you know so there are a lot of packages that didnt trade.
That might have traded but you know if somebody makes them and maybe they don't hedge and keep the duration inline with what the market's doing they might just say well I'll wait.
So I think there is a combination of factors.
You know as you know once the mark rates get to a certain point and stabilize and there is more visibility and clarity what I'll call. The bid offer if you will will tighten up and you'll see a lot more transaction volume.
Got it.
Okay.
Just one question the FHLB advances I know you took that down just curious on what.
Why you decided to take that down.
I'm sure Uh Huh.
So.
We have that dances that were rolling off we still maintained a 50 million dollar position with a a much longer term.
We value that relationship that we.
What the agency book that as the advances and rates are not better than what we can get and everything like that.
Yeah, we're always going to most economically.
The short answer.
[noise] break the Red Hills Submarkets It did better find this a little bit better. Okay. Then the last thing just on the.
I know you guys said low still sort of low double digit on the on the agency.
Just the agency this is putting aside the MSRP for a second is there should we look at the spread it was it was sort of the realized prices.
1.1% when you look at sort of Threeq do you have this dynamic where in the fed cod in swap rates go down yet.
Prepays were looked like they were up over 30% in July and the yields are lower misery that can we expect that spread to be stable sort of.
All else sort everything taking together is it going to get any sort of color on where that spread could heads in threeq you.
Sure.
Yeah I mean.
See you know some of the things you're saying about you know, obviously prepays were off et cetera, and you know there is a question of you know.
One of the yield on the on the cheapest to deliver if you will.
When we look at deploying capital.
Whether it's in a credit side on the agency side, you know, we're basically surveying across all coupon.
All collateral types, all specified pool types et cetera, and accessing what we think is the most attractive you know that's sort of what we view our jobs out to do to drive long term returns so as a result.
You know when we when we sign those kind of returns we're really looking at you know what we think is the best of what we can purchase which is definitely not necessarily.
Now the cheapest to deliver the TV, a which is.
Arguably not going to be nearly as attractive as certain specified pool.
Right got it Thats very just really asset selected is less than originally.
What it all really comes down to as I look at breakfast at.
That's exactly correct. That's the name of the game.
Okay, great well congrats on a really solid quarter, thanks, again and congrats bill.
Thanks, Thanks, Thank you very much.
Thank you as there are no further questions I will turn the call back to Ms. field for concluding comments.
Thank you and think refrigerant have conference compromise the PRASM I paid and the Barclays Global Financial Services Conference on September time on our presentation will be webcast live on our website under the events and presentations link we look forward to speaking with you then have a wonderful guy.
Ladies and gentlemen, this concludes today's conference call.
Thank you for your participation you may now disconnect.