Annaly Capital (NYSE:NLY) Management, Inc. (NYSE: NLY), a leading real estate investment trust, reported strong third-quarter results for the period ending September 30, 2024, during its earnings call on October 30. CEO David Finkelstein and CFO Serena Wolfe outlined the company's performance, noting a favorable macroeconomic backdrop marked by a recent 50 basis point reduction in Federal Reserve policy rates. The company's economic return stood at 4.9% for Q3 and 10.5% year-to-date, surpassing its dividend payouts. Annaly's disciplined portfolio management and strategic growth in sectors such as Mortgage Servicing Rights (MSR) and residential credit contributed to its robust financial position.
Key Takeaways
- Annaly Capital Management reported a Q3 economic return of 4.9% and 10.5% year-to-date, outperforming its dividend.
- The company raised $1.2 billion in common equity and grew its agency portfolio by over $4 billion.
- Residential credit segment market value increased to $6.5 billion, with $3.3 billion in successful securitizations since Q3.
- Annaly's MSR portfolio reached a market value of $2.8 billion, with a new partnership with Rocket Mortgage to commence in December.
- Book value per share rose to $19.54, with a net interest spread improvement to 1.32%.
Company Outlook
- Management is confident in sustaining the dividend through 2024 and cautiously optimistic for 2025, depending on market conditions and Federal Reserve policies.
- Annaly plans to maintain a conservative approach to capital allocation, focusing on agency securities and remaining open to market opportunities.
Bearish Highlights
- Lower interest rates have negatively impacted MSR values by $0.06 per share.
- Earnings available for distribution per share exceeded the dividend but decreased slightly compared to Q2 due to an increased share count and higher preferred dividend expenses.
Bullish Highlights
- Annaly has increased warehouse capacity for residential credit to $4.7 billion and grown unencumbered assets to $6.5 billion.
- The company enjoys strong demand for funding across portfolios and has improved its efficiency ratios, with the OpEx to equity ratio decreasing to 1.48%.
Misses
- The company experienced a slight decrease in earnings available for distribution per share compared to the previous quarter.
Q&A Highlights
- CEO David Finkelstein emphasized Annaly's readiness to aggressively pursue growth opportunities, particularly in the MSR sector.
- Mike Fania addressed the stability of the consumer credit market, noting that Annaly primarily serves high-income borrowers and has not seen significant stress in its portfolio.
- Management discussed the potential impact of a Fed rate cut on non-QM securitization volumes and origination activity.
- The company reported funding $9 billion in non-QM loans year-to-date, capturing a 10% to 15% market share.
Annaly Capital Management has demonstrated resilience and strategic growth amidst a changing economic landscape. With a disciplined approach to portfolio management and a focus on sectors with strong performance potential, the company is well-positioned to continue delivering value to shareholders. As the markets evolve, Annaly's conservative yet opportunistic stance may serve it well in sustaining its financial health and market position.
InvestingPro Insights
Annaly Capital Management's (NYSE: NLY) recent performance and strategic positioning are further illuminated by key metrics and insights from InvestingPro. The company's market capitalization stands at $10.59 billion, reflecting its significant presence in the real estate investment trust sector.
One of the most striking InvestingPro data points is Annaly's impressive dividend yield of 13.3%, which aligns with the company's commitment to shareholder returns mentioned in the earnings call. This high yield is supported by an InvestingPro Tip highlighting that Annaly "pays a significant dividend to shareholders" and has "maintained dividend payments for 28 consecutive years." This long-standing dividend history underscores the company's ability to generate consistent returns for investors, even in varying market conditions.
Despite the current challenges, including the reported negative revenue of $366.07 million over the last twelve months, InvestingPro Tips suggest a positive outlook. Analysts anticipate sales growth in the current year and expect the company to return to profitability. This optimism is consistent with management's confidence in sustaining the dividend through 2024 and their cautious optimism for 2025.
The Price to Book ratio of 1.1 indicates that the stock is trading close to its book value, which could be attractive for value investors considering the company's strong market position and potential for growth in sectors like Mortgage Servicing Rights and residential credit.
For readers interested in a deeper dive into Annaly's financial health and prospects, InvestingPro offers additional tips and metrics that could provide valuable insights for investment decisions. With 8 more InvestingPro Tips available, investors can gain a more comprehensive understanding of Annaly's financial position and future potential.
Full transcript - Annaly Capital Management Inc (NLY) Q3 2024:
Operator: Good morning, and welcome to the Third Quarter 2024 Earnings Call for Annaly Capital Management. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Sean Kensil, Investor Relations. Please go ahead.
Sean Kensil: Good morning, and welcome to the third quarter 2024 earnings call for Annaly Capital Management. Any forward-looking statements made during today's call are subject to certain risks and uncertainties, which are outlined in the Risk Factors section in our most recent annual and quarterly SEC filings. 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 hereof. 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 third quarter 2024 investor presentation and third quarter 2024 supplemental information, both found under the Presentations section of our website. Please also note this event is being recorded. 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; V.S. Srinivasan, Head of Agency and Ken Adler, Head of Mortgage Servicing Rights. And with that, I'll turn the call over to David.
David Finkelstein: Thank you, Sean. Good morning, everyone. Thank you all for joining us for our third quarter earnings call. Today, I'll briefly review the macro and market environment along with our performance during the quarter. Then I'll provide an update on each of our three businesses. And end with our outlook. Serena will then discuss our financials, after which we'll open the call up to Q&A. Now starting with the macro landscape. Financial markets benefited from both the Federal Reserve beginning the long anticipated cutting cycle as well as the continued robust pace of growth exhibited by the U.S. economy. With respect to the Fed, as all are aware, policy rates were lower by 50 basis points in September in turn, ending 16 months of 5% plus short-term interest rates and policymakers signaled that they will continue to ease over time as current rates remain restrictive, with the pace and extent of easing dependent on economic data. Now the change in monetary policy was driven both by the labor market moving into better balance as hiring slowed over the summer as well as the continued normalization of inflation, with core PCE likely to run only slightly above 2% annualized for the third quarter. The market's pricing of additional rate cuts has led to a steeper yield curve, increasing the attractiveness of fixed income assets in agency MBS in particular. In addition, interest rate volatility declined over the quarter to the lowest level seen since the onset of the March '23 regional banking crisis though it remains meaningfully above pre-COVID average levels. Meanwhile, economic growth has been resilient with estimates for Q3 GDP roughly in line with the 3% annualized expansion in the second quarter. Now these developments have been supportive of our diversified housing model as seen in the performance we delivered in the quarter. We generated an economic return of 4.9% for Q3 and 10.5% year-to-date and our earnings available for distribution again exceeded our dividend. Economic leverage ticked down slightly to 5.7 turns, which we anticipate maintaining over the near term. And also, to note, our performance and the constructive backdrop for Annaly's investment strategies allowed us to raise $1.2 billion of accretive common equity since the beginning of the third quarter through our ATM program. The environment to deploy capital remains attractive, and the market value of all three of our business lines increased quarter-over-quarter. Notably, roughly 40% of the proceeds raised were from negotiated sales following investor reverse inquiries, underscoring the value proposition and associated institutional demand. Now turning to our portfolios and beginning with Agency MBS. In light of the capital raise, our agency portfolio grew by just over $4 billion notional with the remaining increase in market value attributable to price appreciation. As mortgage rates declined over the quarter, prepayment concerns weighed on generic higher coupons, while lower coupons and specified pools with prepayment protection outperformed. This is less of a concern for us as the focus of our methodical migration up in coupon over the past two years has been on high-quality specified pools. For example, our sixes and higher represent roughly 1/4 of our portfolio. And within these coupons, only a small fraction of our pools are backed by generic collateral and approximately 70% have what we would characterize as high-quality prepayment protection and the benefits of our collateral selection were best seen in the latest prepayment report. Now as the third quarter unfolded and higher coupons lagged into the rally, particularly in September, we did rotate an additional 5% of the portfolio from intermediate coupons to higher coupon collateral on a relative value basis. Now as it relates to our hedge portfolio, we maintained conservative interest rate exposure throughout the quarter, while benefiting from a steepening bias. As rates rallied, we proactively managed our rate exposure as mortgage durations contracted, but ended the quarter with minimal duration thus helping prepare us for the recent sell-off as the fourth quarter has unfolded. Now shifting to residential credit, the portfolio ended Q3 at $6.5 billion in economic market value with $2.3 billion of dedicated capital representing 18% of the firm's equity. The market value of the portfolio increased by $535 million quarter-over-quarter. Driven by the continued growth of our correspondent platform with our whole loan and retained OBX securitization portfolio increasing by $640 million. Residential credit spreads were range-bound during the quarter with new issue AAA non-QM securities trading in the 10 basis point range providing a supportive backdrop for our OBX securitization platform. Now capitalizing on the firmness in credit spreads, we priced six securitizations totaling $3.3 billion in UPB since the beginning of the third quarter and have now priced 18 securitizations totaling $9.4 billion in 2024, maintaining Onslow Bay, the largest nonbank sponsor in the residential credit market and second largest overall. Year-to-date, these transactions have led to the organic creation of over $1.3 billion in market value of retained OBX securities across Annaly and our joint venture with projected ROEs on deployed capital of 12% to 15%. Our correspondent channel produced record volumes again in Q3 across both locks and fundings at $4.4 billion and $2.9 billion, respectively. And we have now achieved 11 consecutive months of expanded credit lock volume in excess of $1 billion per month. And the momentum of the channel continued into Q4 as we have a current lock pipeline of $2.2 billion with strong credit characteristics and limited layer risk representing a 754 weighted average FICO and a 68% LTV. Our disciplined focus on underwriting sound credit risk and our proactive asset management has led to Onslow Bays non-QM securitizations having the lowest delinquencies across the top 10 issuers in the market. And while the overall serious delinquency rate on the entire GAAP portfolio remains nominal at under 1.4%. And our resi business is very well positioned given the optionality of our ever-growing correspondent channel and our ability to manufacture high-yielding assets across all spread environments. Now moving to the MSR business, our portfolio ended the third quarter at $2.8 billion in market value, utilizing $2.5 billion in equity representing 21% of the firm's capital. Our MSR holdings, including unsettled acquisitions, were up modestly as we committed to purchase one bulk transaction comprising $125 million in market value which we expect to close before year-end. And notwithstanding the 80 basis point decline in mortgage rates on the quarter, the valuation on our MSR portfolio decreased minimally to a 5.6% multiple, highlighting the durability of a portfolio that is 300 basis points out of the money. Fundamental performance of the portfolio continues to be strong with a three-month CPR of 3.9% and serious delinquencies are mere 45 basis points. Deposit income remains elevated given the shape of the curve and increased competition in the subservicing market should benefit financial participants like Annaly. And on the strategic front related to MSR, Annaly's long history of formulating value-add partnerships was again on display this quarter, as we announced a subservicing partnership with Rocket Mortgage in early October. Annaly's size and the stability of our capital helped develop this relationship, and we're pleased to be Rocket's first agency MSR sub-servicing partner. Rocket is expected to begin servicing loans for us as early as December. And this collaboration should allow Annaly to benefit from Rocket's best-in-class recapture capabilities and we expect it to increase our competitiveness in purchasing new MSR. And similar to our existing subservicing agreements, a Rocket agreement allows Annaly to participate in the gain on sale of the loan refinanced helping to preserve and protect our portfolio. This new partnership in conjunction with our existing recapture agreements should allow Annaly to leverage best-in-class industry partners without taking on the operational leverage and earnings cyclicality of an originator. Now lastly, as it relates to our outlook, we remain optimistic that our business model is well positioned with the Fed's cutting cycle now officially underway and the potential realization of a soft landing. We do, however, remain disciplined in our management of the portfolio concerning leverage, liquidity and duration exposure given the Fed's meeting-to-meeting dependence in the upcoming presidential election. We remain in a very attractive environment for Agency MBS given elevated investor inflows, a steeper yield curve and an improving technical backdrop. Our Onslow Bay home loan correspondent channel has continued to bring in record volume and allows us to create proprietary assets not available to the broader market. Our ability to create industry-leading partnerships within MSR and our low gross WACC portfolio have created differentiated advantages. And collectively, we have all the pieces in place across our residential housing finance businesses to deliver stable returns as demonstrated by our 25% economic return realized over the past two years. And now with that, I'll hand it over to Serena to discuss the financials.
Serena Wolfe: Thank you, David. Today, I will provide brief financial highlights for the third quarter ended September 30, 2024. Consistent with prior quarters, while our earnings release disclosures GAAP and non-GAAP earnings metrics, my comments will focus on our non-GAAP EAD and related key performance metrics, which exclude PAA. As of September 30, 2024, our book value per share increased from $19.25 in the prior quarter to $19.54. Strong performance across all our businesses contributed to the realization of a 4.9% economic return, including our dividend of $0.65 for Q3. When added to our first half performance, we have generated an economic return of 10.5% year-to-date for 2024. Lower interest rate volatility during the quarter combined with modestly lower treasury rates, resulted in gains on our agency MBS portfolio of $4.30 per share. Our resi portfolio continued to add to book value, contributing $0.24 per share and lower rates adversely impacted MSR values for the quarter by $0.06. Together with the agency returns, these portfolio gains outpaced the losses on our hedging portfolio of $4.23 per share. Earnings available for distribution per share exceeded our dividend though decreased modestly in the third quarter compared to Q2, 2024, mainly due to an increase in share count and slightly higher preferred dividend expense due to our Series I preferred changing from fixed to floating as of June 30, 2024. That said, earnings available for distribution on an absolute basis increased on higher coupon income related to continued rotation up in coupon on the agency portfolio and additional yield provided by the securitization of the assets sourced through the Onslow Bay correspondent channel. Consequently, average asset yields ex-PAA increased 11 basis points to 5.25% in Q3. Increased coupon income was partly offset by a marginal increase of 3 basis points in our economic cost of funds for the quarter. Average repo rates declined 3 basis points during the quarter, but were offset by higher securitized debt expense from the six securitizations that closed during the quarter. Our swap interest component benefited EAD as we actively managed the hedge book throughout the quarter during the rates market rally. Based on the earlier factors, our net interest spread ex-PAA, improved by 8 basis points to 1.32%. Our net interest margin ex-PAA declined by 6 basis points to 1.52% primarily due to nuances in the calculation of NIM that are not apparent in NIM. For example, impact of the higher denominator of average interest-earning assets in TBA notional and not an indicator of a decline in income from interest-earning assets. Turning to details on financing. We continue to see strong demand for funding for our agency and nonagency security portfolios. Our repo strategy is considered with prior quarters with the book position around Fed meeting dates we look to take advantage of any future rate cuts. As a result, our Q3 reported weighted average repo days were 34 days, down two days compared to Q2. Today, we have maintained our disciplined approach to diversifying our funding options in our credit businesses. We added $560 million of warehouse capacity for residential credit, which brings our total warehouse capacity across both credit businesses to $4.7 billion with a utilization rate of 40% as of September 30. Post quarter end, we implemented an additional MSR warehouse facility for $300 million, adding to our substantial availability. Annaly's unencumbered assets increased to $6.5 billion in the third quarter compared to $5.4 billion in the second quarter, including cash and unencumbered Agency MBS of $4.7 billion. In addition, we have approximately $900 million in fair value of MSR that has been placed to committed warehouse facilities, that remain unwon and can be quickly converted to cash, subject to market advanced rates. We have approximately $7.4 billion of assets available for financing, up $1.1 billion compared to last quarter. Finally, turning to expenses. Our efficiency ratios improved during the quarter due to lower other G&A costs and higher average equity balances. This resulted in our OpEx to equity ratio decreasing 10 basis points to 1.48% for the quarter. On a year-to-date basis, our OpEx to equity ratio remains in line with historical amounts at 1.46%. 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. [Operator Instructions] And the first question will be from Richard Shane from JPMorgan (NYSE:JPM). Please go ahead.
Richard Shane: Thanks, everybody, for taking my question this morning. Look, the history of mortgage REIT suggests that the known risks are pretty manageable. It's the unexpected risks. It's when you think rates are going up and they go down. It's when you think rates are going down, that they go up that you get, you experienced the greatest turmoil. Fourth quarter has started with base rates going up, spreads widening, higher volatility. Can you tell us a little bit about how you're managing that and particularly in light of political uncertainty over the next 2.5 weeks?
David Finkelstein: Rick, thank you. That's actually a good question to kick off the call here. So, we came into the quarter with virtually no rate risk, as I mentioned in our prepared remarks. And if you look at our rate shots, that reinforces that notion. And our leverage was down a touch heading into the quarter. Now at the onset of the quarter, we got payrolls, which was certainly stronger than expected, and we proactively managed the portfolio selling roughly $2 billion in Agency MBS, given the pickup in ball and higher rates. And we've actively managed the rate risk as the market has sold off. We probably sold a little over $3 billion, 10-year equivalents over the course of the month of October. But nevertheless, the portfolio has extended. We're operating at today, approximately half a year in duration, which we're perfectly comfortable with here, notwithstanding the election uncertainty. When we take a step back and look at the rates market, here, we're sitting here today with 10-year real yields approaching 2%, nominal yields on the 10-year 420, which is 135 basis points or thereabouts above the rest of the G7, which looks reasonable. OIS at 370 as a proxy for future short rates looks perfectly reasonable to us. And the 5-year note of 4% or just above 4% here, it looks fair. Now in the 340s, as we sat in mid-September, it looked certainly rich, and that's why we didn't carry any rate risk. Market is pricing, a terminal funds rate 50 basis points higher than where the Fed is at, which is a big reversal from where we were at before, and that's encouraging. We're respectful of the data, which has been quite strong. And so, we understand the volatility that's materialized. And obviously, as you point out, the election is front and center. And it warrants maintaining a very conservative position. Given that we sold mortgages, our leverage position has maintained -- we've maintained the leverage position when we feel good about it. And as we go through the next couple of weeks, we're going to be very disciplined about managing our rate and basis risk here because this is a big unknown. If we do get a red wave, then the points I made about market pricing, may look a little too optimistic, and we'll see where that -- how that plays out. But for now, we're keeping things close to home. We like our basis exposure and we're going to manage our rate risk here. Does that help?
Operator: The next question will be from Bose George from KBW. Please go ahead.
Bose George: Can I start just with asking for an update on book value?
David Finkelstein: Sure, Bose. Through Friday, we were off just a little over 1% in book value. That's pre-dividend accrual. If you consider the dividend accrual, it's roughly 0.5% off.
Bose George: Okay. Great. And then, I mean, in terms of dividend, I guess you've commented that you're comfortable through '24. Any -- are you ready to sort of discuss the outlook into '25, how you feel about the dividend?
David Finkelstein: Well, as we sit here today, we feel good about the dividend. We're in a safe place here. We do expect to modestly earn a little bit more this quarter, the fourth quarter than in Q3. We expect our NIM to increase modestly. But look, we have to see how things play out. We need to understand the Fed's direction the market's direction before we can really understand where the dividend is going. Obviously, there's been dividend increases over the course of the last number of months in the sector, but a lot of that was coming from very low levels to get to not so low levels and some others that were essentially approaching or contextual with our dividend currently. But 13.5% roughly a dividend yield on book, I think, 13.3%. It's a solid return. And we're much more focused on economic return and making sure that we can deliver the dividend. And as the market and policy plays out heading into 2025, we do certainly recognize that the Fed's posture provides a tailwind to a lot of aspects of our business and certainly EAD, and we're hopeful that we do get the cuts that are priced in, and we'll see how it goes.
Operator: And the next question is from Doug Harter from UBS. Please go ahead.
Doug Harter: Can you talk about how you're thinking about equity allocation, capital allocation to the three businesses, and kind of how different rate scenarios might change your appetite for that capital allocation?
David Finkelstein: Sure. And look, as I noted in my prepared remarks, all three of our businesses weren't growing. We can generate good returns across the three businesses. But right here, given where we're at in the cycle at the beginning of a sequence of rate cuts, agency does look the best. Now we understand volatility is high, but spreads are considerate of that. The technicals in the agency market have become much more supportive. So, at the margin, agency looks a little bit better. And you can see that in our capital allocation at quarter end as we raise capital, the vast majority did go into the agency sector. Now we do want to get the resi credit business higher, certainly. We'll have to see how originations materialize. But when you look at the returns in that business, through securitization from loans acquired through our correspondent channel, we want to keep growing that. And we expect to do so, but we got to be responsible at credit or with respect to credit here at this point in the cycle. So, we feel like we can keep that engine going. And then in MSR, that does tend to be episodic. We, again, would like to grow it. and we'll see the extent to which packages do come to market. And we'll be certainly aggressive as that materializes. But at the margin, agency is where the marginal dollar is going, and we'll keep it balanced overall, though.
Doug Harter: And I guess just on your comment that all three businesses kind of warrant investment. With that comment, how do you think about continued capital raising in this environment?
David Finkelstein: Sure. Look, as we've always said, we'll only raise capital if it's accretive and if assets are priced appropriately. So, to the extent that, that -- those stars line up, we'll consider it. But we are we have ample liquidity. If you look at where our liquid box is, as Serena mentioned, $4.7 billion in Agency MBS cash. We don't need to raise capital. A lot of the justification in our minds for the capital raise was obviously accretive in assets, but also the ability to generate more scale for these businesses without impacting our operating expense ratio. And we feel like we have greater resources now to be able to make investments in things like technology as well as broadening the correspondent channel and the resi efforts and other things to where -- we feel good about capital raising because I'd characterize it as offensive scale. We're clearly fully skilled across our businesses, and we are among -- we are the most efficient for anybody who has this broad of a business mix in the market running these three businesses is about 150 basis points of OpEx to equity. But it does help to raise equity so that we can make the appropriate investments to generate more initiatives that will ultimately benefit the shareholder over the long term. So, that's just a little thought -- a little of our thought process around raising capital. We don't need to. But if the market is telling us to do so, we'll consider it.
Operator: And the next question is from Jason Weaver from Jones Trading. Please go ahead.
Jason Weaver: David, and maybe Mike can provide some input to. I was wondering, if you're seeing anything in the securitization data out there just given your visibility that might indicate any kind of early stress like first-time delinquencies, slow pays, grace period maximization?
Mike Fania: Yes, Jason, this is Mike. Thanks for the question. I think in terms of the -- a lot of the commentary around the consumer, it's more focused on the lower end consumer, the low to medium income borrower. That's not consistent with the type of borrower that we're lending to. So, if you look at non-QM 15, the latest transaction that we priced that average loan size is $495,000 on 68 LTV, that's $730,000 property value. Our average borrower makes about $250,000 per year. So, when you think about the type of borrowers we're lending to, it's very sophisticated self-employed borrowers, it's professional real estate investors. We are not necessarily seeing that stress that other products are seeing like credit cards, like that lower-end consumer like subprime auto. You're not seeing within the portfolio. David mentioned it earlier in the call, but the [D-60 plus] of our entire portfolio is 137 basis points. And when we look at just the non-end the DSCR part of the portfolio, it's around 2%. So, I think we feel very good with the type of credit that we're originating and the borrowers, specifically that we're targeting.
Jason Weaver: That's helpful. Wondering more in a macro sense, just seeing if there's any persistence into that higher level credit quality, but it sounds like not. And then going back to your remarks on the Rocket partnership, I think you had mentioned seeing some greater competition among sub-servicers. Should we take that to expect any better pricing on subservicing expense or any change in the economics that are more favorable to Annaly? When that product comes online partnership?
David Finkelstein: Jason, we'll have Ken that one.
Ken Adler: Hey Jason, thanks for the question. In short, absolutely, as MSR, as there's been substantial MSR trading in the last few years, the amount leaving sub-servicers and going to owners who service their own loans has been material. So, there's been a contraction in the share of overall mortgage servicing rights handled by sub-servicers and that's created a lot of competition in the market. So, we are seeing lower pricing and better economic.
Operator: And the next question is from Eric Hagen from BTIG. Please go ahead.
Eric Hagen: So, when we look historically at the portfolio, the book value has been consumed by a higher bond premium. I think at one point, the premium in the agency portfolio was like 1/3 of book value. versus now the premium risk is a lot more dialed down, and so the prepayment exposure might be characterized a lot differently on the balance sheet. Do you feel like that, in any way, drives your philosophy around leverage and capital allocation versus how you've managed in the past and how we should expect you guys to manage going forward?
David Finkelstein: Well certainly, the convexity profile of the agency portfolio is going to inform how we think about leverage. Right now, the agency average coupon, I think, is about 4.95%. So, we're below par. We have methodically gone up in coupon, as I talked about. And the convexity obviously has -- convexity exposure has increased, and it's now off a little bit or it's now a little bit better with the selloff, but nevertheless, it is a consideration. And Serena, feel free to elaborate on how we think about it from the overall managing the portfolio -- the agency portfolio standpoint.
Serena Wolfe: Yes. I mean, to a large extent, we have gone up in coupon, but we have stayed in fairly high-quality specified pools as David alluded to in his opening remarks about 70% of our portfolio is in high-quality pools. So, we don't have the same amount of duration drift that you would have, if you are in lower quality generic pools. So given that the dollar price dollar prices are generally higher for the quarter as rates rally, and the durations are no ore, which means your hedging costs or the amount of hedges you need against them is lower, it creates more liquidity.
Eric Hagen: Okay. That's helpful. Yes, that was a helpful explanation. Returning to the non-QM a little bit. You guys have been really active there. I mean how do you think that portfolio maybe benefits from the Fed cutting rates? And do you think lower rates will catalyze originators to create more non-QM?
David Finkelstein: We certainly hope so. We've been pretty happy with the growth of the correspondent channel as obviously, we discussed in the prepared remarks. Presumably, if you do get lower rates, it will spur more housing activity and certainly should benefit to non-QM. Oftentimes, the originators are in a lower rate environment, more focused on the agency market, but it feels like the market is in a healthy place and could grow as rates do come down.
Eric Hagen: Yes, with respect to the back book, I mean, how do you feel like the back book of non-QM might benefit from the Fed cutting rates since it's a fixed rate portfolio?
Mike Fania: Yes. Eric, this is Mike. About 85% of the portfolio is fixed rate. But we do look at that portfolio on a hedge basis. We're hedging that on a macro level with the MSR portfolio and with the agency portfolio as well. I do think that the majority of investors look at non-QM in terms of the AAA investors is down to BBB. They’re looking at it on a spread basis and not necessarily a yield basis. So, I think to the extent that rates do rally and there's a realization of these Fed cuts, I think it does put origination volumes up. Hopefully, it puts non-QM securitization volumes higher. And from a spread perspective, we do think once we get past some of these all events, specifically the election that spreads could continue to tighten. So, I think it's a conducive environment for us to the extent the Fed does ease as kind of the market predicts and you do see a little bit rally from here in rates.
Operator: The next question will be from Harsh Hemnani from Green Street. Please go ahead.
Harsh Hemnani: Thank you. Maybe in light of the Rocket mortgage partnership and also perhaps the desire to grow the MSR book into the end of the year. Could you comment on how you're viewing relative value between sort of the higher coupon MSRs but with recaptured opportunities versus the lower coupon MSRs that are currently in the portfolio?
David Finkelstein: Yes, absolutely. Look, we capture, it's absolutely a component of valuation. And with the Rocket partnership, that's just another addition to our portfolio of recapture and subservicing partners. We're excited about the opportunity, given their leading customer retention rates and customer satisfaction. It's also been great to work with the Rocket team. Each of our partners has differing strategies and approaches to subservicing and recapture. So, they are part of our portfolio, and we're prepared to opportunistically bid on the higher note rate or the lower note rate and building on our infrastructure just adds to this capacity.
Operator: The next question is from Jason Stewart from Janney Montgomery Scott. Please go ahead.
Jason Stewart: I wanted to pull together the concept of offensive capital raising leverage in the election. And maybe if you could, David, put a pin in whether that's a signpost that would lead you to take leverage up? Or are there other issues that you're looking at -- and if you could just pull those three together for us and then maybe another signpost to take leverage up and how you're thinking about those?
David Finkelstein: Yes. So, as it relates to raising capital, that's a better alternative been taking leverage up in our mind right now. The way we look at it is if you really like Agency MBS you don't need to raise capital, you raise leverage. We do like Agency MBS, but it was more advantageous to raise capital than to lever up because of all these all events on the horizon. Now if we fast forward a couple of weeks and we get an outcome on the election imminently after Tuesday, two weeks from now. And the market calms down, we could certainly take leverage up because mortgages have cheapened about 4 to 5 basis points thus far in the quarter. They look perfectly reasonable. But ball is high, and we have to be respectful of it. And we don't need to take leverage up. We're certainly earning an adequate return. But if we feel like there's a tactical opportunity or even more intermediate-term opportunity to do so. We certainly have the capacity to do so, but we've got to see how things play out.
Operator: The next question is from Don Fandetti from Wells Fargo (NYSE:WFC). Please go ahead.
Don Fandetti: Can you talk a little bit about your sort of view on agency MBS spreads? I mean I think they're still a little wide versus historical and the bull case is that maybe the banks come in and you could see some tightening. Do you subscribe to that? Or are you sort of more thinking we're range bound for a while?
Sean Kensil: So just stepping back, the big picture is that monetary policy that has been restrictive for a while has -- is now normalizing along with labor markets and inflation. So, from a fundamental perspective, I think you're likely to see the yield curve steepen up and interest rate volatility decline, all of which are positive for Agency MBS. And what you alluded to, the supply-demand technicals are better today than any time it's 2022. Banks, which shed about $200 billion in 2023 have modestly added to MBS this year. So, looking forward, I think if the Fed cutting cycle continues as we expect or as the Fed expects, we should see an increase in bank demand, and we should also see foreign buyers coming into the Agency MBS market. So, the technical also looks pretty good for the Agency MBS market. So, we've been trading -- put some numbers on it. We've been trading in the 115 to 145 range -- basis point range, current coupon spread to blended treasury curve for the last four, five months. And I think as we get past the election and [indiscernible] subsides, we could see that spread tighten to 110 to 130 basis point range. What we don't expect is that we'll go back to spreads, we saw pre-COVID which was closer to, say, 65 to 85 basis points when both the [indiscernible] the Fed were actively involved. I think we will remain wide of those levels, but we could definitely tighten another. The range has moved down by 10 to 15 basis points from where we are today.
Operator: [Operator Instructions] The next question is from Trevor Cranston from Citizens JMP. Please go ahead.
Trevor Cranston: All right. Thanks. There was some news recently about a large asset manager making a move to get involved in the non-QM space. Could you guys maybe talk a little bit about generally what you guys are seeing in terms of new participants coming into the market and what that might mean for the competitive landscape and overall economics in non-QM space?
Mike Fania: Sure. Thanks, Trevor. I would say that we actually think it's a little bit of the opposite where entities that have fully scaled platforms with dedication of significant resources are in a really good spot right now. With where we're at, if you include October, we've already funded $9 billion of loans year-to-date. Now when you look at the market, it is hard to put a pin in what the actual origination volume is within non-QM and DSCR. But we think we're anywhere at a 10% to 15% market share. The market share that we're experiencing continues to increase. A lot of that is signing up new correspondence. We're signing up about 15 correspondents per each quarter. We've started to roll out additional originator tools, the ability to underwrite bank statement income. A lot of the capital raise, that David talked about, we're putting a lot of those resources towards helping improve the velocity of funding loans. So, I would say, it's actually a little bit of the opposite, Trevor. Like we actually feel is that we continue to gain market share and the margins that we're putting out on a daily basis where our rates are increasing. So, while you'll certainly always have participants and asset managers that want to participate in this product, the extensive architecture that we put in place without the infrastructure, the ability to phase 240-plus correspondents, it's hard to buy those assets at the same pricing that we have. So, I think we've been ahead of the game. We launched this corresponding in 2021. We've been buying non-QM loans since 2016, 2017. So, I think we've identified the opportunity a lot earlier than others. And I think we feel really good with kind of where we're at.
David Finkelstein: Yes. And then I'll just add, Trevor, there are barriers to entry in this space. Mike said, we started the correspondent channel in 2021. We've been in non-QM since around 2016. And we've been consistent, and we've been a durable partner to a lot of the originator community through COVID. We funded everything we committed to in 2022. As volatility hit in capital markets efforts amongst originators, we're in a precarious position. We were there for them. And as a consequence, we have established very deep relationships in the originator community. Our infrastructure is as good as anybody's. We provide white glove service to our partners, and we have the distribution through our securitization brand that leads to very competitive spreads. And as a consequence, the originator community. It's better pricing and more durable commitments from us. So, we feel like we're in a good place.
Operator: And ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the conference back over to David Finkelstein for any closing remarks.
David Finkelstein: Thank you, Chad, and thanks for joining us, everybody. We'll talk to you soon.
Operator: And thank you, sir. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
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