Annaly Capital Management Inc (NLY) 2013 Q4 法說會逐字稿

Good day and welcome to the Annaly Capital Management's fourth-quarter 2013 earnings call and webcast. All participants will be in listen only mode.

(Operator Instructions)

Please note this event is being recorded. At this time I would like to turn the conference over to Willa Sheridan. Please go ahead.

Good morning and welcome to the fourth quarter 2013 earnings call for Annaly Capital Management. Any forward-looking statements made during today's call are subject to risks and uncertainties which are outlined in the risk factors 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 forward-looking statements 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 of this earnings call. We do not undertake, and specifically disclaim, any obligation to update or revise this information.

Participants on this mornings call include Wellington Denahan, Chairman and Chief Executive Officer; Kevin Keyes, President; Glenn Votek, Chief Financial Officer; Dave Finklestein, Head of Agency Trading; and Bob Restrick, CIO of Commercial Investments.

I will now turn the conference over to Wellington Denahan, Chairman and Chief Executive Officer.

Thank you, Willa, and welcome to the Annaly Capital Management 2013 fourth-quarter earnings call. 2013 was not a good year for the mREITs. A cloud of uncertainty surrounding the timing and magnitude of the Fed pullbacks from the markets and the potential impacts it would have on book values plagued the sector for most of the year.

Now with two tapers under our belts and a much more sober reaction to diminishing demand, coupled with potentially diminishing supply, both the treasury and MBS markets have settled down. With tapering underway, monetary policy will now center on the forward guidance of the Fed funds target rate. The focus will remain on the timing and magnitude of the potential change in the cost of carry.

The question now is how much was economic strength dependent on QE policies? The recent softening in both the housing and employment numbers may provide some clues. We do not think that the economic backdrop is going to afford the Fed a hasty exit from its low rate policy.

Housing finance reform seems to be giving way to campaign season, while the quicksands of regulatory change are hardening, encouraging us to become more optimistic on the investment environment for our strategy. Even though mortgage spreads are not at historic wides, the steepness of the yield curve continues to provide attractive investment options in the agency market. Around this time last year, the [2-10] spread was around 160 basis points compared to 240 basis points today.

At year-end we held leverage at 5 to 1 leaving us with tremendous buying power to augment forward earnings. To put it into perspective, we could purchase an additional $24 billion in assets, bringing balance sheet leverage to 7 to 1 and still come in lower levered than most others in the sector. With new money spreads approaching 200 basis points, and the improvement in the landscape, unless things change over the next several months, we intend to opportunistically add to our position over the next few quarters.

With our hedges at 92% of our repo balances, we do not expect to add meaningfully to the hedge position when adding assets. Looking ahead, I expected the market to be more concerned with contraction risk than extension risk. So we are likely to allow for greater market moves in the long end, given we expect they will be short-lived based on our outlook for tepid economic growth in 2014.

As we allocate capital across the agency and commercial investment spectrum, we also consider share buybacks, buying other REITs, investing in MSRs, among many other things. When evaluating anything for investment, we tend to focus on the simple economics as well as the liquidity of these investments.

With new money spreads at current levels, it is more economic to lever up than by assets than to buy our stock back. However, buybacks at the right valuation and market environment will remain an option for us going forward. Even though mREITs stocks are trading below stated book and theoretically allow for discounted purchases of the underlying mortgages, there are other ways to accomplish this similar dynamic.

I think of the mREITs sector broadly as a type of inverse floater. When short rates rise, generally earnings go down. With an inverse floater, when LIBOR rises, the coupon goes down.

Secondary market inverse IO are cheap to the repo levered MBS implied fair value by about 18%, which is comparable to the discount in the mREIT stocks. With an inverse, you do not have to rely on good management. You get the plain facts from the numbers.

During the 1998, 1999 period, mREITs were also trading at substantial discounts to book value for longer than they have been most recently. During that period there were agency REITs that turned out to own Russian debt when Russia defaulted. We feel that capital is better spent buying inverse IOs cheap to lever MBS versus buying MBS 2 to 2.5 points cheap to the purchase of mREIT stocks.

We also consider better ways to hedge our position and MSRs have been a popular topic of discussion. When we evaluate MSRs, we compare them to owning IO, which we have used for many years to hedge higher rates. As I have mentioned many times, no hedge works perfectly, but when looking at the economics of the choices available to us, we consider quantitative as well as qualitative metrics.

The IO market is fairly liquid. With our IO position yielding roughly 9% compared to some of the more aggressive and less liquid MSR yields of 6% to 9%, we are happy with our choice. If and when the economics suggest a better risk/reward profile, we will act on it.

We are creating a more durable yet flexible business model to better handle the changing investment landscape. Our agency position continues to provide the core of our earnings and allows us the flexibility to better offset deteriorating economic conditions.

Our commercial investments allow us to more easily endure periods of economic strength that are usually accompanied by rising interest rates and provide a more steady income over time. The combination of the agency MBS liquidity and the commercial investment stability afford us a more durable income profile for our shareholders.

We ended the year with approximately $2 billion in commercial real estate assets and successfully priced our first CMBS securitization earlier this year. We are currently in talks with a very large holder and originator of real estate that will give us exclusive access to certain of its originations.

Our commercial investment portfolio yields 9.2% and now accounts for roughly 14% of our capital. We expect to continue to prudently grow the commercial position within our 25% equity allocation to assets other than agency MBS.

After a very tough year for the mREIT sector, we remain optimistic about our ability to be the capital provider to the housing market for years to come. As I have said in the past, the investment disciplines placed on REIT management teams, who have to distribute 90% of our earnings annually, who don't have the benefit of retained earnings and rely on capital markets for growth, are unparalleled in most of corporate America.

I will now turn the call over to Glenn to discuss some of the financial highlights and afterwards we will open it up for questions.

Thank you, Wellington, and good morning, everyone. I will take you through just a few of the key financial highlights for the quarter. To begin, we reported net income of $1 billion, or $1.07 per share. The sequential increase was primarily driven by higher unrealized mark-to-market gains on swaps and, to a lesser extent, trading assets and agencies IOs.

Our economic net interest income was up on lower premium amortization as prepayment speeds declined to 7% from 13% in the prior quarter as well as the benefit of higher commercial portfolio investment balances. As Welly had mentioned, we continue to have good success in growing the commercial portfolio.

Overall asset yields were 3.5%, which was up from just under 2.9% the prior quarter. Interest expense increased by about $6 million on higher swap expense partially offset by lower repo expenses. This translated to a higher cost of funds in period of about 25 basis points.

As swaps represented a greater proportion of our funding, Wellington had mentioned 92% of repo is now hedged versus 85% in the prior quarter. When you add that all up, our net interest spread expanded further to 143 basis points, which was up from 107 basis points the prior quarter.

Our core earnings, which excludes both realized and unrealized gains and losses on asset sales and derivatives, was $350 million, or $0.35 a share. That is up from $0.28 a share in the prior quarter and our annualized core ROE was just over 11% in contrast to that 8.6%, again, in the prior quarter.

Turning to the balance sheet, our agency portfolio declined about $9.6 billion to $73.4 billion while the commercial portfolio was up about 30%. Repo balances consistent with the decline in our assets as well as lower leverage was down about $7.4 billion. And our capital position remains strong at $12.4 billion.

Wellington had mentioned our leverage being down to 5 times. That's in contrast to the prior quarter of 5.4 times. And our net capital ratio, which is another important metric that we look at in measuring the adequacy of our capital position, grew to just under 16%, which was up from just under 15% the prior quarter. Book value was down a bit at $12.13 versus $12.70 the prior quarter.

So on balance feel good about the quarter. Our core earnings have been stable throughout the year and our diversification strategy continues to advance with the commercial portfolio generating an increase in contribution to our results.

So with that, Lara, we're ready to open it up for questions.

(Operator Instructions)

Joel Houck of Wells Fargo.

I think the theme from Annaly and others last year was you want to see the taper happen before you get more aggressive. And it sounds like you are -- you have a little more confidence. But I am interested in -- if you look at how the year plays out, the supply is not very great right now so the small taper really hasn't changed much and certainly spreads have been well behaved and [files] come down.

But if the Fed actually goes to zero by the end of the year -- stays on this trajectory -- are you still concerned about basis widening and perhaps you're still kind of cautious going into the second half of the year, given the notion that it is not over yet, I guess?

I certainly would not describe our outlook as all clear. I would say that we will continue to monitor every aspect of the market that helps form our decision about how we proceed from a leverage perspective. What I will say is this economy has never gone through a period where you have had this level of stimulus injected and then slowly removed.

So I do think that there is no precedent for what aspect of the economy has been supported by this tremendous amount of liquidity that has gone in. We see it directly in the mortgage market but it has trickled through to a lot of other sectors of the economy and helped out. So it will be interesting how it unfolds as they start to move away.

I will have Dave Finkelstein talk a little bit more about the basis and how it will impact the market from a supply perspective.

Sure. Thanks, Wellington. Hi, Joel. Let's separate the near-term from beyond the taper. I think over the near-term when we look at the supply projections, both gross and net supply, we obviously are going to be in a year where supply is relatively low. This morning we saw the cycle lows on the refi index as well as the purchase index. So from that standpoint, supply will be low.

The Fed is still involved in the MBS market on an outright basis. I think when we look at actual net supply or growth of the Agency MBS market will be this year, most estimates have it ranging from about $100 billion to $150 billion in net supply. The Fed, even with the taper, will absorb that much supply in the first four to five months of this year. So the technicals for the year are certainly on the positive side.

Beyond that, one thing to note is that the fact that the Federal Reserve does hold this large portfolio of Agency MBS, and it will be one-third of the market, it does change the structural landscape for Agency MBS over the long-term. They have removed a lot of negative convexity for the market -- or from the market. And when we look beyond even 2014, the costs associated with hedging MBS for MBS holders will be relatively lower, even beyond the exit of the Federal Reserve.

So there is some fundamental factors that are favorable in spite of the fact that we do -- we will not have this noneconomic buyer in the market beyond 2015. But when we look at the fundamentals in terms of lower relative implied volatility, cheaper hedging cost and the fact that the Fed has removed a lot of MBS from the hands of private investors over the last couple of years and they may be back in the market to ultimately reinvest. So we're certainly constructive on the basis near-term as well as even beyond.

Joel, did that -- did we answer your question?

Yes. That was extremely helpful. Thank you very much, both of you.

Thank you.

Mike Widner of KBW.

Let me start with one real simple question. I was very surprised at the extremely low premium amortization in the quarter and just wondering if there was some a one-time catch-up benefit in there?

Yes. We would not expect to see a repeat of that level of amortization. I refer to it as catch-down.

Catch-down -- either way. Could you guys maybe quantify or at least put a ballpark range on it?

It is difficult to put an exact number on it but I would say that it's definitely not going to be a run rate on the amortization level.

Okay so I was -- as I calculate it, and what realistic run rate is based on a 7% CPR, it looks like there was probably somewhere in the vicinity of $0.08, $0.09 benefit this quarter. Is that -- does that sound ballpark?

That is ballpark-ish right. Yes.

Okay. Thanks. I guess my other question -- thank you for the clarity on your thinking on MSRs relative to IOs and that makes a lot of sense although I think you are the first to talk about it that way. But let me just see if you have any update on thoughts of activities elsewhere in the residential mortgage space.

Obviously you are doing a good job on putting more assets into the commercial front but there is also a lot on the residential front as well. We see others doing things like Fannie series -- sorry, Freddie Series K Multifamily and obviously Jumbo is more and more of an interest to folks these days. Any thoughts on doing more in the residential side?

We look at -- I always like to boil things down to the economics of does it -- first of all does it compete with what we are doing? And then what are the other frictional intangible drags on making the decision? Whether it is legal or accounting implications for making the choice and then layer on top of that, liquidity. So the way the Company is positioned, I think that we have a tremendously flexible, yet durable, position with the Agency and the commercial barbell.

Now the Agency market was not the most advantageous market over the last couple of years with the Fed being the large participant that it was. But with that waning, I think it is competing handsomely to -- with other things that you can do in the market. So I would say there is nothing that is glaringly cheap, relative to what we are doing. Does that answer your question?

I think it does. And as always, I appreciate the comments and the clarity.

Thank you.

Rick Shane of JPMorgan.

Just really one quick one. When we look at the 3.5% yield on the portfolio for the quarter, I am wondering if there is any true up on the amortization that went through there that is one-time in nature?

Yes, there is. Actually, the gentleman before you asked at the same question but, yes, there is. We would not expect the yield pickup from the amortization decreased to be an ongoing part of our earnings profile.

Got it. Okay. Great. Thank you. Sorry for that, I've got two calls going on at the same time.

No problem. I understand.

Dan Furtado from Jefferies.

In a follow-up to two questions ago with the attractiveness -- or relative attractiveness of the Agency space. Is it safe to say that the 25% cap on the equity side in terms of nonAgency investments is something that is probably going to be with you for a while? Or is that something you would look to potentially change over the near to intermediate term if conditions dictate?

I wouldn't characterize it as hard and fast and inflexible, so it would be up for discussion as the investment landscape changes and the relative attractiveness among the choices changes. We have been in discussions with our Board over the years about altering the size of that.

Again, we always want -- we understand the complexity of combining strategies within one balance sheet and always want to make sure that we are -- we don't get over our skis first of all, and we don't lose sight of the interconnectedness of the assets on balance sheet. Making sure that they continue to complement each other in both their liquidity and economic profiles.

Understood. Thank you for that. And then I don't know if this is the proper forum for this question but over the last 1.5 years or so, I think there has been a DNA change in Annaly in terms of spreading out past the Agency space. Can you give a glimpse to outside investors and analysts in terms of what are the things you are doing behind the scenes to further enable that strategy?

I get it -- maybe difficult to answer right here but I'm just wondering if there's anything specific that comes to your mind that really personifies or highlights the changes that you have been making internally at the firm.

Yes. We've -- one area that has had tremendous growth from an investment standpoint is the commercial area. Over the last year I think we have probably added about 20-odd people to the investment team. And also, with that comes added infrastructure in our accounting and legal and all of the background that supports those investments. With the Agency position, we have continued to add and augment the way in which we manage that portfolio.

As you noticed over the last year, we have incorporated other hedging vehicles and things like that into the position. And so I would say generally we have added a lot of talent. And as with any business as it changes and matures, you always have management changes and things like that, that will occur. So we are no different from that normal process.

Understood. Thank you for the time this morning.

Sure. Thank you, Dan.

Dan Altscher of FBR.

I was interested, one, in the comment about buying other REITs because we saw one of your peers do something similar. I'm just looking if you can clarify. Did you mean purchasing equity stakes in other REITs or purchasing entire companies?

Well I meant stocks, equity stakes in companies. But we have looked at companies over the years as we have been on and off on buying whole companies. We actually did buy a whole company -- another REIT, which was CreXus.

But we -- as I mentioned in the 1998, 1999 period, there was an Agency mortgage REIT out there that no longer exists, that was the darling of the day. And had you been lured into owning their stock -- I think there is a lot of great managers out there and I think everybody should do what they think is the right thing to do. I'm just trying to clarify for our investors the way that we look at things. And the way that we analyze it.

I don't want to get pulled into the trade du jour without really taking an honest economic look at all of the aspects of being in that trade.

Sure. That make sense and I appreciate that. And just taking that question a different direction, actually, and maybe the reverse sense. In an effort to create value for shareholders, we've seen other companies do spinoffs or separations.

And obviously Annaly has had a great franchise value with FIDAC and the related entities there. Would there ever be a potential to separate FIDAC into its own publicly traded REIT or publicly traded asset management style company?

We will always consider what is in the best interest of the shareholders from a value perspective. I think FIDAC gains a tremendous amount of advantage by being and internally owned vehicle. But of course we look at, as we grow these businesses, do we get more value out of separating them from the parent?

Thanks so much. I appreciate the time.

(Operator Instructions)

Kenneth Bruce of Bank of America Merrill Lynch.

I guess I am a little shocked -- maybe is the right word to use -- about the change in tone around QE that were -- the taper. Over the past couple of quarters in our discussions you have characterized the market as wait till the taper actually occurs and we haven't seen anything yet. Could you juxtapose how you feel today? What changed the view in terms of your willingness to possibly step back into the market and lever backup? It just seems like the change around the thinking around the taper is quite significant.

Well with the Fed actually engaging in reducing its position has put the market in -- I think the market has sobered up a little bit about the implications for that lack of demand. And I think the mortgage market shouldn't be considered an island on the investment spectrum.

So there is been a tremendous amount of beneficiaries from this policy that, whether you look at the stock market or you look at the housing market or you look at the economy in general, that will have to deal with the reduction in that stimulus. And none of us have ever dealt with that. Our economy has never dealt with the type of stimulus withdrawal that we have just been through.

Now with that said, the forward guidance and the low rate policy out of the Fed is much more meaningful to a position that carries assets via short-term interest rate. So as much as they -- I think they will continue to taper come hell or high water. But with respect to the Fed funds target, I think that is another story altogether. And that they have already backed down a little bit on some of the more firmness around their unemployment thresholds and things like that.

So for us, I just want to let people know that we are going to be opportunistic when we are evaluating a market that -- [210s] this time last year was around 160 versus 240 [basis points] today. Yes, do I think the long end is going to bear some volatility as the reality of this tapering sets in? Absolutely. But do I think we are going to have a straight shot to 4% on 10-[years] -- no looking back -- and this economy is going to be just fine with it? Absolutely not.

Right. I guess you look at how the rates market has played out in the last couple of months and it feels like the market is being seduced back into thinking everything is maybe not as strong as we thought it was just a couple months back. So I guess when I see the Annaly deleverage into rising rates and then basically discuss releveraging into when rates are -- have fallen and it feels like we are getting set up for the yo-yo of when or if rates due back up again.

I wouldn't characterize us as 270 today on 10-years we are going to load the boat. That is absolutely not what I'm trying to get across. Is that we will be opportunistic in these moves around the volatility associated with this exit. And the uncertainty associated with the change in -- the potential change in forward guidance and then the actual change in the forward rate.

So the period of time where the Fed was in the market, continuing to buy, dollar prices were much different than they are today. The idea of participants that the Fed was always going to be a buyer and was always going to have to be a buyer is changed by them committing to taper. Now I was -- I find it ironic that the first female that is at the Head of the Central Bank finally has the cojones to actually start tapering.

So we will see, as the market unfolds, where opportunities are. I just don't want to say we are just going to sit back and watch it without trying to capture some of the volatility and that the returns that go with that for the shareholders. We are a good 2 turns below the rest of the sector.

Right. You have been running a much more conservative position for a while. And that is certainly, I think, one of the hallmarks of your strategy. And that's why I guess I'm reacting a little bit to just the about-face and trying to understand what may be driving that.

I wouldn't consider it an about-face, I would just let people know that we will be opportunistic with the buying power that we have.

Right. That is fair. We want you to do that.

Maybe lastly, and this -- others have touched on it. But you had a little bit of a pause there in your prepared remarks when you discussed potentially investing in equities. I don't know if that was deliberate or just a coincidence on the pause. But is there any -- aside from the lack of interest in buying other managers given that you don't know what they may or may do over time -- is there particular areas of interest that you would like to introduce into the Annaly portfolio that, that might be a way to pursue it?

I will say that we -- and this is something we have done for years -- is just look across the spectrum of opportunities that would be complementary to our business. Whether they are encapsulated in a BDC or REIT or whatever the vehicle may be, we constantly look at areas for investment that would make sense for us.

So other REIT stocks -- and I meant to say REIT stocks at the time -- yes, theoretically they look cheap to where they have been. Like I mentioned earlier, they are not as cheap as they were in the past for as long as they were in the past. And anybody who purchased at that time did very, very well had they held for the long-term and you have similar opportunities today.

Now the reason those companies did well is because they were opportunistic at the time in looking at the relative options for reinvestment of their capital. And like I say, looking at the markets today, the returns in perpetuity from investing in assets are greater than the returns from -- or the temporary returns from buying back your own stock. But looking at the investment spectrum, which is inclusive of REIT stocks, other REITs completely as we did in the case of CreXus, we continue to do and have always done.

And, Ken, what I just would add to this specific question is buying a position in a relatively illiquid equity REIT stock -- whatever that position is make an assumption 5%, up to 10%, there is a discount on the front end. There is friction with the fees, obviously, that you are paying as a fund-to-fund essentially. But what hasn't been talked about is when you want to monetize.

And the relative illiquidity of these vehicles, of these companies that you take a couple months to get out of the position of $100 million or $200 million versus the liquidity options that we have, that Wellington's mentioned just in the IO market. So it's -- to me it is really not that important for us to focus on that type of option given the end liquidity in and out relative to what we can do in a day versus a couple months. There's a lot of risk, to your point, on the outlook that I think we factor into the net present value of any sort of purchase.

Right. Okay well thank you very much. I appreciate your comments, your candor and the enhanced disclosure that you have provided over the last few quarters. Thank you.

I appreciate your candor as well. Thanks, Ken.

Steve DeLaney of JMP Securities.

I guess this is -- I'll direct this to Bob. We haven't given him a chance to speak yet this morning, I don't think.

Thanks, Steve. (laughter)

What I want to see if you guys would do is could you just generally comment on the scale and breadth of what you are trying to do with the commercial real estate platform? Welly, you mentioned 20 new hires. I would be curious how many people totally do have now? And what I'm getting at is, is the goal here with Annaly Commercial to be a full-service platform for borrowers or brokers? Are you looking at this as just taking more of a rifle shot approach at specific types of loans and investments? Thanks.

Hi. So I would say we are -- we are really a full-service platform. We are set up to have everything from originations, to underwriting, to closing, to securitization, to asset management. And we said, we are really executing the plan that we developed in fall of 2012 and probably hit the -- got ourselves altogether as Annaly Commercial Real Estate Group in the latter half of last year. And during that time, we put out over $1 billion in over 20 individual assets.

Part of that effort too can be seen in the -- our first securitization, which we closed at the end of January, which we got really great execution on. We were able to tighten it after we issued it and kept over 25 investors in that deal. And that is the plan going forward. So what we are able to do is look at all the opportunities in front of us whether they are first mortgages or Mez or B-Note opportunities and find the ones that we think are the best risk-adjusted returns for us that fit within the portfolio that we have been building.

And, Bob, as those relationships build, would you even consider quoting on conduit loans just as an additional revenue source?

We -- myself and our team have a lot of experience in the conduit space and I would say I'm very happy that we are not involved in the conduit space. It's a very, very competitive markets that it is a great one-way trade, is the way I look at it. It's really a trade and we're really investors.

We have made use of the CMBS, the conduit market. I would describe what we do in the floating rate CMBS space as really just match term nonrecourse financing. The way was meant to be. And the conduit space is really just a big game of hot potato and make a couple points and move onto the next one.

So we do it opportunistically where we can get to -- we control a whole deal on have it at high leverage and have an opportunity to work with one of our investment bank partners and layoff that first mortgage directly into a conduit we would do it but it is not -- I don't see it as a real sustainable business plan.

Maybe more is just part of a B-Note or Mez acquisition strategy but not a quick trade.

Yes. On the other side of that, we frequently do Mez behind the conduit lenders where we think it makes sense, where there is still good credit and structure on their first mortgage.

That is very hopeful. Thank you. And, Wellington, I guess just one final thing. I want to ask you about resi credit opportunities earlier. And just what I understood your relative value comments. But just for clarity, in the past your position has been that within Annaly per se that you would not look to invest in resi credit as that asset class was viewed as being the domain of Chimera. I am just curious if that is still your general position.

That is correct.

Okay. Thanks. Have a great day and a great quarter. Thank you.

Thanks, Steve.

Arren Cyganovich of Evercore.

I just have a question -- it is related to the comments that you have made about potentially levering up the balance sheet. Obviously we've talked about this a lot. But I just want to help understand what kind of earnings expectations we can have going forward because obviously it would be meaningful if you went to 7 times leverage.

I certainly did not want to imply that we are going 7 times. I just wanted to put it into perspective for people to understand what it means for us to go to 7 to 1 and still be lower leverage than most everyone else in the sector. But the earnings potential I would put it at each turn of leverage approximately 30% to 40% pickup in earnings power.

That definitely makes sense. That's why I was little sensitive to the topic. Have you added leverage at all quarter-to-date? Obviously the book value has probably picked up some.

We are not materially different from year-end.

Okay. And then your comments about not likely picking up your swap position, does that essentially mean that you're going to be increasing duration risk as you go forward? Or are there other ways to manage that?

That is essentially what it means. And I will say that with -- in light of where we are in the market today and what we see today. Yes, we are fairly well hedged and so as we add incremental assets, we don't necessarily expect the same pace on the hedging position.

You expect to let your swap options just runoff or do you will think you will continue to use those going forward?

No. We will continue to use what makes the most sense for us and what we are trying to hedge. Absolutely.

Okay. Great. Thanks for the clarification.

Sure. Thank you.

Douglas Harter with Credit Suisse.

Thanks. I wanted to talk about -- you mentioned you expect the environment to be volatile going forward. And how do you guys think about your tolerance for book value volatility in that type of environment?

I think if you get overly concerned with trying to hedge out every little movement in book, you can sacrifice a lot of earnings along the way. And with the economic backdrop -- and I think the economy has relied heavily on the stimulus that has come through six years of very easy monetary policy.

So we -- I think the economy is at risk of the retraction that is taking place in the asset purchases that will ultimately rest -- the weight of policy will rest in the forward rate guidance. So I don't think you are going to have an economy runway. There is a number of things you can point to. One of the things that we look at is debt to GDP. And just to get debt levels back relative to where they were during the 2000 period, you would have to have a reduction in the outstanding credit of about $14 trillion, which is about the size of our economy.

So I think the Fed has -- their policies have been designed to make that debt burden easier to handle over the last several years. But ultimately, whether you have the forward growth to support and to sustain that kind of weight, we have engaged in years of pulling demand forward and pulling profits forward. So as you try and remove that kind of crutch from the market, I think there is going to be volatility associated.

But ultimately, I think that things will settle down and you are not going to have a runaway interest-rate environment where you can't hedge or you can't handle the fluctuations in book value associated with this. We did see the 10-year at 3.02 at year-end and we are at 30 basis points inside of that now. Will we go back to 3.5%? Potentially. But I think the Company is well insulated for that. But I will say we're not going to try and insulate ourselves from every little movement out there as the economy attempts to adjust to this unprecedented retreat of policy.

Great. Thanks for that. And your thoughts on the spread duration and the potential volatility or book value risk from that side?

I will let Dave answer that question.

Sure. Again, our spread volatility quarter-over-quarter, or our spread risk, increased modestly and the reason being is primarily attributable to lower dollar prices from Q3 year-end to the year end. And so as a result, when mortgage dollar prices are lower, the duration extends and there is sensitivity to spreads -- to spread changes increases little bit. Going forward, we are certainly cautious on the basis. But, again, we are constructive and we feel like it is going to be a low vol -- relatively low vol environment and the technicals are favorable. And so we're comfortable adding spread duration.

Great. Thanks for the color.

Thank you, Doug.

And this concludes our question-and-answer session. I would like to turn the conference back over to Wellington Denahan for any closing remarks.

Yes. I just want to thank everybody for participating in our call for the fourth quarter. We look forward to speaking to you on the first quarter and I want to thank my team for a job very well done. Thank you.

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