Annaly Capital Management - Q3 2024

Transcript

Operator (participant)

Good morning, and welcome to the Third Quarter 2024 Earnings Call for Annaly Capital Management. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press Star, then one on your telephone keypad. To withdraw your question, please press star, then two. 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 (Director of Investor Relations)

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 Presentation 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. With that, I'll turn the call over to David.

David Finkelstein (CEO and CIO)

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 lowered by fifty basis points in September, in turn, ending sixteen months of 5%+ short-term interest rates.

The 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 and Agency MBS in particular. In addition, interest rate volatility declined over the quarter to the lowest levels seen since the onset of the March 2023 regional banking crisis, though it remains meaningfully above pre-COVID average levels.

Now, 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 on 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 in 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 was 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 a quarter 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 a 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 as the largest non-bank 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%-15%. Our correspondent channel produced record volumes again in Q3 across both locks and fundings, at $4.4 billion and $2.9 billion, respectively. 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 Bay's non-QM securitizations having the lowest delinquencies across the top ten 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 points 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 3-month CPR of 3.9%, and serious delinquencies are a mere 45 basis points.

Deposit income remains elevated given the shape of the curve, and increased competition in the sub-servicing 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 sub-servicing 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 sub-servicing agreements, our Rocket agreement allows Annaly to participate in the gain on sale of a 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 and 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 whole 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 WAC 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 (CFO)

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 discloses 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 yield ex PAA increased eleven basis points to 5.25% in Q3. Increased coupon income was partly offset by a marginal increase of three basis points in our economic cost of funds for the quarter. Average repo rates declined three 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 eight basis points to 1.32%. Our net interest margin, ex PAA, declined by six basis points to 1.52%, primarily due to nuances in the calculation of NIM that are not apparent in NIS. For example, the 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 non-security portfolios. Our repo strategy is consistent with prior quarters, with the book position around Fed meeting dates as we look to take advantage of any future rate cuts. As a result, our Q3 reported weighted average repo days were 34 days, down 2 days compared to Q2.

To date, 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 pledged to committed warehouse facilities that remain undrawn and can be quickly converted to cash, subject to market advance rates.

We have approximately $7.4 billion in 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 (participant)

Thank you. We will now begin our Q&A session. To ask a question, you may press star, then one on your telephone keypad. If you're using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star, then two. At this time, we will pause momentarily to assemble our roster. The first question will be from Richard Shane from JP Morgan. Please go ahead.

Richard Shane (Analyst)

Thanks, everybody, for taking my question this morning. You know, look, the history of mortgage rates 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 experience 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, you know, political uncertainty over the next two and a half weeks?

David Finkelstein (CEO and CIO)

Hi, Rick, and 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 shocks, 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 vol 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 it today approximately a 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, you know, here, we're sitting here today with ten-year real yields approaching 2%, nominal yields, you know, on the ten-year 4.20%, which is a hundred and 35 basis points or thereabouts above the rest of the G7, which looks reasonable. OAS at three seventy as a proxy for future short rates looks perfectly reasonable to us. The five-year note of 4% or just above 4% here looks fair. Now, at in the three forties, 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. You know, given that we sold mortgages, our leverage position has maintained—we've maintained the leverage position, and we feel good about it. And as we go through the next couple of weeks, we're gonna be very disciplined about managing our rate and basis risk here because this is a big unknown.

You know, 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 how that plays out. But for now, we're keeping things close to home. We like our basis exposure, and we're gonna manage our rate risk here. Does that help?

Richard Shane (Analyst)

That's very helpful. Thank you, guys, and thank you for squeezing me in this morning. I appreciate it.

David Finkelstein (CEO and CIO)

You bet, Rick. Have a good morning.

Operator (participant)

The next question will be from Bose George, from KBW. Please go ahead.

Bose George (Managing Director)

Hey, everyone. Good morning. Can I start just with asking for an update on book value?

David Finkelstein (CEO and CIO)

Sure, Bose. Good morning. 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 (Managing Director)

Okay, great. Thanks. And then, I mean, in terms of dividend, I guess you've commented that you're comfortable, you know, through 2024. Are you ready to sort of discuss the outlook into 2025, how you feel about the dividend?

David Finkelstein (CEO and CIO)

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. You know, 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, you know, not so low levels, and some others that were essentially approaching or contextual with our dividend currently. But it...

You know, 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, you know, the market and policy plays out, heading into 2025, we do certainly recognize that, you know, the Fed's posture provides a tailwind to a lot of aspects of our business and certainly EAD, and we're hopeful that, you know, we do get the cuts that are priced in, and we'll see how it goes.

Bose George (Managing Director)

Okay, great. Thank you.

David Finkelstein (CEO and CIO)

Thank you, Bose.

Operator (participant)

The next question is from Doug Harter from UBS. Please go ahead.

Doug Harter (Managing Director)

Thanks. Can you talk about how you're thinking about equity allocation, capital allocation to the three businesses and, you know, kind of how different rate scenarios might change your appetite for that capital allocation?

David Finkelstein (CEO and CIO)

Sure, and look, as I noted in my pre-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, and 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 raised 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. But 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, you know, the extent to which packages do come to market. And we'll be, you know, 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 (Managing Director)

I guess just on your comment that all three businesses kind of warrant, you know, an investment. You know, with that comment, you know, how do you think about continued capital raising in this environment?

David Finkelstein (CEO and CIO)

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 those stars line up, you know, we'll consider it. But we have ample liquidity. You know, if you look at where our liquid book is, as Serena mentioned, $4.7 billion in Agency MBS cash. We don't need to raise capital. You know, 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.

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, you know, I'd characterize it as offensive scale. We're clearly fully scaled across our businesses, and we are among 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.

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, you know, telling us to do so, we'll consider it.

Doug Harter (Managing Director)

Great. Thank you, David.

David Finkelstein (CEO and CIO)

Thank you, Doug.

Operator (participant)

The next question is from Jason Weaver from Jones Trading. Please go ahead.

Jason Weaver (Managing Director)

Good morning. Thanks for taking my question. David, and maybe Mike can provide some input, too. 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 (Deputy Chief Investment Officer and Head of Residential Credit)

Yeah, Jason, this is Mike. Thanks for the question. I think in terms of 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 fifteen, the latest transaction that we priced, you know, that average loan size is $495,000 on a 68 LTV. That's, you know, $730,000 property value. Our average borrower makes about $250,000 per year. So when you think about the type of, you know, 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, you know, like, 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, you know, the D60+ of our entire portfolio, it's a 137 basis points. And when we look at just the non-QM, 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 (Managing Director)

Thank you. That's helpful. I'm 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 sub-servicing expense or any change in the economics that are more favorable to Annaly? When that product comes online, partnership.

David Finkelstein (CEO and CIO)

Sure, Jason. Jason, we'll have Ken get on that one.

Ken Adler (Head of Mortgage Servicing Rights)

Hey, Jason. Thanks for the question. In short, absolutely. You know, as the MSR, 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, you know, lower pricing and better economics.

Jason Weaver (Managing Director)

All right. That's helpful. Thank you for the color.

Ken Adler (Head of Mortgage Servicing Rights)

Thank you, Jason.

Operator (participant)

The next question is from Eric Hagen from BTIG. Please go ahead.

Eric Hagen (Managing Director)

Thanks. Good morning. So when we look historically at the portfolio, you know, the book value has been consumed by, you know, a higher bond premium. I think at one point, the premium in the Agency portfolio was, like, a third of book value. Versus now the premium risk is, you know, a lot more dialed down, and so the prepayment exposure might be, you know, 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 (CEO and CIO)

Well, certainly, the convexity profile of the Agency portfolio is going to inform how we think about leverage. You know, right now, the Agency average coupon, I think, is about 495, 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 sell-off, but nevertheless, it is a consideration. And Srini, feel free to elaborate on how we think about it from an overall managing the portfolio standpoint, the Agency portfolio standpoint.

V.S. Srinivasan (Head of Agency)

Yeah. 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, if you are in generic pools. So given that the dollar prices are generally higher for the quarter as rates rally and the durations are lower, so which means your hedging costs or your the amount of hedges you need against them is lower, it creates more liquidity.

Eric Hagen (Managing Director)

Okay, that's helpful. Yeah, that was, that was a helpful explanation. Thank you, guys. You know, returning to the non-QM a little bit, you guys have been, you know, 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 (CEO and CIO)

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'll spur more housing activity and certainly should benefit non-QM. Oftentimes, you know, the originators are in a lower rate environment, more focused on the Agency market, but it feels like the market's in a healthy place and could grow as rates do come down.

Eric Hagen (Managing Director)

Again, regarding, yeah, 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 (Deputy Chief Investment Officer and Head of Residential Credit)

Yeah, about Eric, this is Mike. About 85% of the portfolio is fixed rate, but we do look at that portfolio on a hedged basis. You know, 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 down to the 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, you know, there's a realization of these Fed cuts, I think it does put origination volumes up. Hopefully, it puts non-QM securitization volumes higher.

You know, from a spread perspective, we do think once we get past some of these vol events, you know, specifically the election, that spreads could continue to tighten. So I think it's a conducive environment for us to the extent the Fed, you know, does ease as kind of the market predicts, and, you know, you do see a little bit rally from here in rates.

Eric Hagen (Managing Director)

Gotcha. Thank you, guys, very much.

V.S. Srinivasan (Head of Agency)

Thank you, Eric.

Operator (participant)

The next question will be from Harsh Hemnani from Green Street. Please go ahead.

Harsh Hemnani (Senior Analyst)

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 (CEO and CIO)

Yeah, absolutely. Well, recapture is absolutely a component of valuation, and you know, with the Rocket partnership, that's just another addition to our portfolio of recapture and sub-servicing partners. You know, we're excited about the opportunity given their, you know, leading customer retention rates and customer satisfaction. It's also been great to work with the Rocket team. You know, each of our partners has differing strategies and approaches to sub-servicing and recapture, so they are part of our portfolio and, you know, we're prepared to opportunistically bid on the higher note rate or the lower note rate, and building out our infrastructure just adds to this capacity.

Harsh Hemnani (Senior Analyst)

Okay. Thank you. I'll leave it there.

David Finkelstein (CEO and CIO)

Thank you, Harsh.

Operator (participant)

The next question is from Jason Stewart, from Janney Montgomery Scott. Please go ahead.

Jason Stewart (Analyst)

Hey, thanks for taking the question. 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 (CEO and CIO)

Yeah. So as it relates to raising capital, you know, that's a better alternative than 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 vol 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, you know, calms down, we could certainly take leverage up because mortgages have cheapened about 4 to 5 basis points thus far on the quarter. They look perfectly reasonable, but vol is high, and, we have to be respectful of it.

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.

Mike Fania (Deputy Chief Investment Officer and Head of Residential Credit)

... Okay, that's helpful. Thanks for taking the question.

David Finkelstein (CEO and CIO)

Thank you, Jason.

Operator (participant)

The next question is from Don Fandetti from Wells Fargo. Please go ahead.

Donald Fandetti (Managing Director)

Hi, good morning. 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, you know, 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?

V.S. Srinivasan (Head of Agency)

So, just stepping back, the big picture is that monetary policy that has been restrictive for a while is now normalizing along with labor markets and inflation. 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 since 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 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 technicals also look pretty good for the Agency MBS market. So we've been trading. I 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 if, as we get past the election and volatility subsides, we could see that spread tighten to a 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 banks and the Fed were actively involved. I think we will remain wide of those levels, but we could definitely tighten another.

The range can move down by 10 to 15 basis points from where we are today.

Donald Fandetti (Managing Director)

Okay, thank you.

David Finkelstein (CEO and CIO)

Thank you, Don.

Operator (participant)

And again, if you would like to ask a question, please press star then one. The next question is from Trevor Cranston, from Citizens JMP. Please go ahead.

Trevor Cranston (Equity Research Analyst)

Hey, thanks. There was some news recently about a large asset manager making a move to get involved in the non-QM space. Can you guys maybe talk a little bit about generally what you guys are seeing in terms of, you know, new participants coming into the market and what that might mean for the competitive landscape and overall economics in the non-QM space? Thanks.

Mike Fania (Deputy Chief Investment Officer and Head of Residential Credit)

Sure. Thanks, Trevor. You know, I would say that we actually think it's a little bit of the opposite, where entities that have fully scaled platforms with, you know, dedication of significant resources are in a really good spot right now. You know, with where we're at, if you include October, you know, 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. You know, the market share that we're experiencing continues to increase. A lot of that is signing up new correspondents. 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, you know, we're putting a lot of those, you know, 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 as if we continue to gain market share, and the margins that we're putting out on a daily basis for our rate sheet are increasing.

So while you'll certainly always have participants and asset managers that want to participate in this product, without the extensive architecture that we've put in place, without the infrastructure, the ability to face 240+ correspondents, it's hard to buy those assets, you know, at the same pricing that we have. So I think, you know, we've been ahead of the game. You know, we launched this correspondent 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 (CEO and CIO)

Yeah, Mike, I'll just add, Trevor, there are huge barriers to entry in this space. You know, 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, you know, as volatility hit and capital markets efforts amongst originators were in a precarious position, we were there for them. And as a consequence, we've 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 gets better pricing and more durable commitments from us. So, we feel like we're in a good place.

Trevor Cranston (Equity Research Analyst)

Got it. Very helpful. Thank you.

David Finkelstein (CEO and CIO)

Thank you, Trevor.

Operator (participant)

Ladies and gentlemen, this concludes our Q&A session. I would like to turn the conference back over to David Finkelstein for any closing remarks.

David Finkelstein (CEO and CIO)

Thank you, Chad, and, thanks for joining us, everybody. We'll talk to you soon.

Operator (participant)

Thank you, sir. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.