Annaly Capital Management Inc (NLY) 2016 Q4 法說會逐字稿

Good morning, and welcome to the Q4 2016 Annaly Capital Management earnings conference call. 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 Jessica LaScala of Investor Relations. Please go ahead.

Good morning, and welcome to the fourth-quarter 2016 earnings call for Annaly Capital Management Inc.

Any forward-looking statements made during today's call are subject to 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 forward-looking statements disclaimer in our earnings release in addition to our quarterly and annual filings. Additionally, the contents of this conference call may contain time-sensitive information that is accurate only as of the date of the earnings call. 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. Please also note this event is being recorded.

Participants on this morning's call include Kevin Keyes, Chief Executive Officer and President; David Finkelstein, Chief Investment Officer; Michael Quinn, Head of Annaly Commercial Real Estate Group; Glenn Votek, Chief Financial Officer; and Tim Coffey, Chief Credit Officer.

I'll now turn the conference over to Kevin Keyes

Good morning, everyone.

In the fourth quarter of 2016, Annaly distributed to its shareholders another $0.30 dividend, the same exact quarterly dividend we've now offered for over three years. On recent earnings calls across every industry sector, more than enough attention has been paid to the metrics measuring today's market uncertainty. On this call, I prefer to remind and further explain how Annaly has continued to provide such a consistent return over time amidst this historic volatility; and, as importantly, why we remain confident in our diversified platform's ability to continue to produce quality and stable earnings while protecting book value in various market environments in the future.

2017 marks the third anniversary of the arrival of most of our current investment and financing teams, whom have collectively transformed, grown, and diversified the entire portfolio. It is important to note, and it's no coincidence, that over the same time period, Annaly has continued to pay its approximate $300 million dividend for the past 13 quarters in a row while utilizing one-third less leverage than the average mortgage REIT that is roughly 10% of our size. In comparison, over the last three years, 75% of the companies in the sector have cut dividends at least once. In fact, there have been 44 dividend cuts in total. Our portfolio transformation has contributed to how we have been able to outperform and provide industry-leading dividend stability over this same timeframe. Annaly's total return of 44% since 2014 has outperformed all yield-oriented equity strategies and specifically has beaten the returns of the S&P 500 and the mortgage REIT indices by over 30%.

In our agency interest-rate strategies, which David will expand upon, we have proactively improved the quality of the assets by increasing the prepaid protection of the portfolio, rebalancing our hedge profile, providing insulation when rates turn upward, and broadening our sources of financing through our broker dealer, FHLB membership, and direct repo rate relationships unique to us. And as importantly, less understood by the market, in 2017 we are now finally becoming unburdened by certain longer-term, higher-cost repo financing transactions which had been put in place prior to 2014. In addition, each of our credit platforms, commercial real estate, residential credit, and middle market lending, now have a seasoned performance grown to self-finance scale and meaningfully contributed to the durability of our book value, without a single credit loss since their inception.

As we enter 2017 Annaly is positioned, now more than ever in the Company's 20-year history, to continue to deliver predictable and protected value to our shareholders. It is quite simple as to why we have made the various large investments over time in our businesses and our people: to prepare for this volatility, the unexpected, for periods when the fundamentals are trumped by rhetoric and ruse. Regardless of one's economic or market forecast, for rising or falling rates, for accelerating or slowing growth, Annaly is now established as a cyclical and countercyclical yield investment alternative. Our focus in 2017 is maintaining our stability, protecting our downside, and growing opportunistically in any market scenario. We are confident in our platform's positioning and believe our performance will be enhanced further by our unique capital allocation advantage in what we call the substitution effect.

The substitution effect is simply meant to describe our optionality and search for optimal capital efficiency and relative value across and within each of our four businesses. As I've mentioned, all four of our businesses now have established sizable platforms that allow us to substitute our capital from agency into credit and back again if we desire. We are not a monoline, forced to put capital to work in a specific overvalued asset class at all times. Our model is one-of-a-kind, shared capital, with dedicated sources of diversified financing with incremental capacity available for each strategy. We have constructed our overall portfolio to have complementary profiles to the core agency strategies in terms of cyclicality. We have multiple dials to turn in our capital allocation process on a daily basis, as our views on the business cycle and market environment evolve. We don't have to grow or plan to raise equity in order to enhance our franchise value or continue to sustain our dividend.

By illustration, over the past year we have chosen not to reinvest the prepayments from our $2.3 billion commercial real estate business because of our view on the valuation and risk return profile of these cash flows relative to our residential credit and middle-market lending businesses, which in 2016 grew 81% and 58% to $2.5 billion and $800 million in assets respectively. Importantly, we have not approached our risk or liquidity thresholds with this asset substitution, while at the same time we have maintained our dividend by augmenting our agency earnings with predominantly floating-rate lower-leveled cash flows. We actively measure not only the relative valuations across the four businesses, we calibrate the cyclicality of the underlying cash flows within each of the businesses.

For instance, the residential credit and commercial real estate businesses are both inherently procyclical, pro-growth assumption-based returns. However, today, currently, we view the valuations on the US housing industry to be relatively more attractive than the US commercial real estate fundamentals in most comparable cases, not all but most; a view manifested in the relative growth of the residential credit portfolio just mentioned. We are also capable of other type of substitutions by rotating our exposures within certain subsectors of each asset class, altering our positioning in the capital stack, or using leverage as a risk adjustment factor to mitigate the impact of market or economic cyclicality.

In addition to focusing on our capital efficiency and asset substitution in 2017, we believe the market will more keenly focus on the benefits of further consolidation in our industry. I believe consolidation among the mortgage REIT sector has to happen. There has been a demonstrable increase in value for almost all mortgage REIT shareholders since we announced our acquisition of Hatteras Financial in April of last year. The total valuation of the Bloomberg Mortgage REIT Index has increased 15% by over $6 billion in total market capitalization, while the total number of companies in the index has actually decreased by over 20%, from 42 to 33 members primarily due to the onset of industry consolidation.

Just like other industry sectors that have over-expanded at the wrong time, mortgage REIT valuations have suffered for similar reasons, including a supply-demand imbalance in the sector with too many inefficient, illiquid, and one-dimensional companies. By comparison, we currently operate our multi-strategy model with large businesses at an operating-expense-to-asset level 68% lower than the average mortgage REIT. In addition, amidst this persistent market volatility, the performance for most of the single-asset, single-financed mortgage REITs will continue to be challenged, as evidenced by the 44 dividend cuts I mentioned earlier, and the sizable book value hits seen as recently as this past quarter. Operational efficiencies, combined with strategies with limited illiquid options, and pronounced underperformance, serve as additional catalyst for management teams and their board members to actively consider strategic alternatives. Bottom line, investors in this sector will benefit from continued consolidation of our overly fragmented industry.

Finally, amidst this conflicting daily debate on the market outlook for 2017 and beyond, Annaly is positioned as a unique liquid investment alternative with unmatched optionality, earnings sustainability, and book value durability. Annaly's yield manufacturing strategy is now made up of complementary cash flows built with cyclical neutrality, positioned to outperform in today's uncertain markets. Our diversified platforms provide us with capital-efficient substitution options and the potential for numerous external growth opportunities across the four complementary industry sectors in which we operate.

Now I will turn the call over to David Finkelstein, who will further expand upon these themes as it relates to our asset portfolios and our outlook.

Thank you, Kevin.

The fourth quarter brought about the second largest selloff in the treasury market of any calendar quarter this century, the majority of which occurred in the immediate aftermath of the presidential election. The election was a pending risk event that we discussed specifically on our last earnings call and cited it as justification for maintaining a cautious approach over the near term. While we did experience a decline in book value, our portfolio was cushioned by proactive portfolio decisions made in prior quarters, including our diversification and the quality of our hedges.

Now, I'd like to follow-up with additional detail regarding Kevin's comments on our portfolio management approach across our four businesses. With respect to the agency portfolio, we were deliberate in ensuring that the duration extension of the portfolio was appropriately managed in light of the selloff. We entered the quarter with a steepening bias in our hedges which helped minimize our book value decline and also enabled us to stay somewhat ahead of extension risk as the yield curve steepening and corresponding lengthening of our agency portfolio actually led to a better equilibrium between the curve exposure of our assets relative to our liability. Consequently, while we did add incremental hedges over the quarter, we were by no means forced to engage in any extensive rebalancing exercises with respect to our hedges.

Regarding the composition of our agency portfolio, we did substitute a portion of our TBAs for specified pools as we felt that the subsequent repricing of pools in the selloff led to more attractive pricing relative to TBAs, which exhibited a decline in roll specialness later in the fourth quarter. Agency valuations are slightly more favorable today and levered our OEs in the low double digits, albeit not in the mid-teens as some suggest, to keep us comfortable with the agency market. But we do not anticipate adding meaningful capital or leverage this sector over the near term, given the risk of further rate volatility. Of additional note regarding the agency portfolio, our MSR position proved to be a valuable duration in curve hedge, as the vast majority of the increase in MSR value quarter over quarter was attributable to $150 million in price appreciation of the asset, given lower projected prepayments of the I/O stream.

So our additional capital committed to this sector was relatively minimal and we expect this to be the case going forward. Given that our investment in the sector has achieved scale, and in our view the appropriate capital allocation, we strategically launched a new fund in the fourth quarter with a sizable and highly reputable partner who will purchase approximately 90% of Pingora loan servicing flow-based MSR acquisitions for the foreseeable future, with Annaly purchasing the remaining 10%.

Shifting to residential credit, spreads obviously tightened over the fourth quarter and into 2017, consistent with other risk assets. As a consequence, we slowed the pace of growth of the portfolio and we also substituted a portion of our longer spread duration more credit-sensitive assets with shorter-duration, conservatively structured re-securitization Although much of the non-agency sector is now priced to perfection, particularly credit risk transfer securities, we believe that opportunities remain in certain parts of the legacy sector as well as residential home loans. We have been able to expand our home loan acquisition effort with new partnerships with originators and aggregators, while not being burdened by the high infrastructure costs associated with an in-house conduit.

As our footprint in residential credit has increased, counterparties are looking to Annaly as a liquidity provider on larger pools of assets, knowing that we have the capabilities and financing advantages to successfully facilitate such transactions. Anecdotally, we are currently evaluating multiple larger block-size opportunities, which offer double-digit returns with modest leverage through our FHLB relationship. As much of the non-agency sector remains relatively rich, these types of packages should enable us to continue to grow the portfolio without chasing ever-tighter spreads in the space.

As Kevin mentioned, the necessity of a more exhaustive evaluation of risk and return also extends to our commercial real estate effort, as well as our middle market lending business. Our commercial business shrank modestly this past quarter, given our view that pricing is not quite reflective of risk characteristics. Nonetheless, we are seeing pockets of opportunities in the market, but we will remain highly disciplined in the sector. We were able to add to our middle market lending portfolio in the fourth quarter, contributing to the growth of roughly $300 million in assets for that portfolio for the year. Given the strong activity thus far in the quarter, in the first quarter, we expect that trend to continue into 2017.

The further build-out of our middle market platform over the past three years has positioned that business to be a leading partner with top-tier private equity sponsors, and we feel that the investment opportunities we are seeing in that sector, both organic as well as portfolio trades, will enable the business to continue to grow with accretive returns over the coming quarters.

With respect to our outlook going forward, we expect volatility to remain somewhat elevated as monetary policymakers attempt to calibrate their reaction function to a set of ambitious fiscal policy proposals. We're realistic with respect to current returns and accompanying risks that each of our businesses have to offer, and we're not overreaching for returns in any one sector. And touching back on Kevin's comments regarding the substitution effect, when fundamentals suggest a shift in capital from one business to another, or between sectors within one of our four businesses, we can officially mobilize resources to take advantage of these opportunities. And lastly, when larger dislocations in the market arise, we have the liquidity and the reach to capitalize on such circumstances, much like we have in the past.

Now with that, I will hand it over to Glenn to discuss the financials.

Thanks, David, and good morning.

Beginning with our GAAP results, we reported net income of $1.8 billion or $1.79 per share versus Q3 net income of $731 million or $0.70 per share of the prior quarter. Both quarters benefited from unrealized gains and our investment rate swaps hedge portfolio. The quarter over quarter improvement was largely attributable to both a favorable movement in the hedge portfolio marks as well as lower premium amortization.

Turning to core results, during the middle of last year the SEC publicly released interpretive guidance that relates to rules and regulations on the use of non-GAAP financial measures. In order to comply with this guidance, this will be the final quarter that we will report core earnings excluding the premium amortization adjustment or PAA, which in this quarter's disclosure we've labeled as unrevised core earnings. Going forward, core earnings will include the PAA, which has been labeled in this quarter's disclosures as revised core earnings. However, given its usefulness in analyzing the Company's financial performance, we'll continue to separately disclose the PAA, and this will allow you to calculate unrevised core earnings metrics as well as permit you to compare to prior historical measures. And of course, non-GAAP measures should not be viewed in isolation and are not a substitute for financial measures computed in accordance with GAAP.

Our revised core earnings, which again excludes the PAA, was $327 million or $0.30 a share, which compares to $0.29 a share in the prior quarter. Premium amortization adjustment was a benefit of $239 million or $0.23 per share, driven by a decline in long-term CPRs to 10.1% from last quarter's 14.4%. This resulted in revised core earnings of $0.53 a share. Our core ROE on an unrevised basis was flat quarter over quarter at 10.1%, while the core ROE on the revised basis was 17.5%.

Some of the key factors contributing to the quarterly results for higher coupon income on higher investment balances, as well as higher drop income that combined, represented an increase of approximately $0.02. Our average repo rate was up about four basis points, while swaps expense declined and lower net rates that together represented lower economic interest costs of about $0.01. MSR amortization and other expenses were up modestly at about, representing about $0.02 on a core basis.

In terms of the balance sheet, the residential investment securities portfolio was up approximately $2.1 billion, with a slight increase coming from the residential credit asset. MSRs increased $160 million on both improved marks as well as new acquisitions. And the commercial portfolio, as was previously mentioned, declined modestly and included the sale of about $30 million in held-for-sale loans. Our book value declined to $11.16 a share. Leverage, as traditionally reported, increased about a half turn of 5.8 times, and economic leverage, which captures the effect of the TBA contracts, increased modestly to 6.4 times.

So with that, Daniel, we'd like to open it up to questions.

Thank you. We will now have a question-and-answer session.

(Operator Instructions)

Bose George, KBW. Please go ahead.

Thanks, good morning. It's Eric on for Bose. I want to expand on the potential growth in the sort of non-core segments of the business right now. Specifically looking at the no market lending portfolio which seems to be generating an ROE that's above the return -- at or above the return across the portfolio.

So I can't help but wonder if you wanted to grow that segment, would you be more compelled to do it organically with your existing capital or use your currency to acquire an outside portfolio that you view as attractive?

Hi Eric, this is Kevin.

I think there's easy the answer to that one, and I'm going to keep it there. You know, it's similar to -- the returns are very attractive, cash on cash. It speaks for the origination platform we've built since 2010 and the relationships we've developed. And we haven't had a credit losses, and we have a pretty good reputation in the market.

But similar to our other businesses the returns quarter over quarter might shuffle back and forth, this quarter, the last couple of quarters. Middle market lending had a -- on a relative value basis it's been very attractive.

It may not last. That's why we have these other businesses. But as it is today we can grow that business as we have been organically. We don't need to raise money. We don't need to get outside financing. We've been building that portfolio, Tim Coffey and his team, patiently over the past 7 1/2 years.

So we can continue to grow at this pace with these incremental returns without it, without doing anything else. In terms of external opportunities, I would just say that the BDC sector is not dissimilar from the mortgage REIT sector And I'm on record as saying that publicly. The BDC sector, I would argue is even more fragmented with 40 or so companies that are essentially smaller, and I would argue probably even more strapped for liquidity or lack of financing.

So, look, it's how we compete. We've chosen these industries because they're highly fragmented and when you have our capital and our track record, we think we can compete pretty well within these fragmented industries. We're not banging our head against the wall, you know, very often when it comes to winning these transactions and gaining on these returns.

This is Tim Coffey.

I would just add to that as it relates to acquiring a BDC or something of that ilk, you know, right now my view is that you're just buying other people's problems. Bad decisions have been made by other portfolios and right now organically we feel very confident about the origination platform and portfolio liftouts [what we can slate that] and use our credit selection skills to have an impact possibly the more likely of all the scenarios.

Go ahead. I'm sorry.

We're not in the business of buying other people's problems.

Right. Well, thanks for that thoughtful response, guys.

Thanks, Eric.

Brock Vandervliet, Nomura Securities. Please go ahead.

Good morning. Thanks for taking the question.

Kevin, I wanted to touch on a comment you made in passing on long-term repo financing. It's always struck us how some of your financing is particularly long-duration. Is there an ability to shorten that up and generate some saves?

Hi, Brock.

So the commentary I made -- I'll just summarize that by saying we are financing our businesses a lot differently today than we were a couple years ago, including the agency portfolio. We're hedging a lot differently. We're using different technologies. We have different expertise.

So the repo is kind of like the headline, obviously, tool or financing tool for the space. It's obviously a big part of our balance sheet but certainly not the only financing access we have by any means. But long story short, there was some transactions or some financing put on before 2014, and before we really, I would say, heightened the level of scrutiny and competitive nature among other alternatives, including term and counterparty and pricing.

So this year you'll see us come out of the lights at the end of the tunnel finally and there's been some friction cost that will no longer be affecting us due to some of those positions of the past.

And will that come out gradually over the year or is there a period of time we should be particularly watchful?

Brock, this is David.

I think it has come out over the past year if you look at our financing costs relative to our peers. It's narrowed quite a bit. In fact, this past quarter, our financing costs, our repo costs, were only up 4 basis points in spite of the Fed hike and our swap expense actually was down 17 basis points so that relationship improved dramatically relative to our peers and it will continue to improve over the year.

The vast majority of it is out of the way, but there's still a very, very small amount left that will come to pass.

It'll be kind of a legacy friction cost that will be over in the third quarter.

Got it. Got it. And just as a follow-up, David, on the resi whole loan initiative. Is any of that going to be or potentially new issue, so-called non-QM paper or not?

Yes, we expected to be so, Brock. You know, it's not -- there's been about seven non-QM deals and those are typically for the most part deep, deep credit loans. Where we're at in the space is really, typically there's only one mitigating factor that makes it a non-QM loan so the gross WAC on the loan is 5 to 5 1/4. It's about 100 basis point pickup over pristine jumbo loans so the credit is not what you would think when you hear the term non-QM. These are typically above 750 FICO, mid-60s LTV type loans. We can finance those through the FHLB and so as a result the levered returns on that product are very attractive.

Great. Thank you.

You bet, Brock.

(Operator Instructions)

Joel Houck, Wells Fargo. Please go ahead.

Thanks and good morning, guys. So could you just go back to slide 13, and I think this is very relevant data, but I'm wondering how do you adjudicate the issue that obviously spreads in a lot of the credit-oriented businesses are very tight. Yet while agency's attractive you still have this potential overhang of Fed hikes, potential spread widening, and what we're now seeing which we haven't had in the previous years, is perhaps a reflation trade. So how do you guys think about that trade-off between higher returns in agency relative with what's available on the credit side versus the risk you would be taking care if you allocated more capital toward agency?

So that's a good point. And you're exactly right. Credit has obviously tightened over the last number of months, and agency has lagged. And the reason why it's lagged, we believe, is for the reasons you cite. There are some risks out the horizon with respect to agency MBS potential for higher rates, and even a little further out the horizon the potential for the Fed to stop reinvesting their runoff and that's exactly how we consider the value proposition.

Agency does look relatively more attractive in credit but at the end of the day we're considerate of those risks out the horizon. And what we think, in terms of looking at the portfolio, what we think is we have the appropriate balance.

We haven't -- we're not on these calls talking about how agencies are mid-teens returns. They're really not. You get double digits as we do with all of our businesses. But they're not screaming cheap, considering all the risks. They're offering a fair return, particularly relative to credit, but we're conservative with respect to our leverage. And you know when we compare agency versus credit, it looks like we have the right balance in the portfolio right now.

Joel, the takeaway is we try to develop within our comprehensive scripts, David and I and the team. And look, having options in this market where everything is -- a lot of things are priced to perfection -- is what we feel is the most durable strategy.

When we run our scenarios out for this year, to David's point, whether you assumed a Bull Flattener or Bear Steepener our go with the forwards, or think about different forms of leverage or constitution of the agency diversification within the agency business, kind of anyway you slice, what we see is a heck of a lot more visibility and durability of our earnings and our book value, certainly than most other companies in this sector. So it's all relative, and relative value is that we do every day. Your point is well taken.

It's the reason we haven't -- Mike Quinn doesn't get paid to grow his assets under management and commercial real estate. He gets paid on Return on Invested Capital so we've shrunk that portfolio because we see relative value in the other credit businesses. That may not be the case this time next quarter. It's the case now.

Right, and if I can just add on one. I appreciate the comments. They are helpful. The credit risk transfer security, that's obviously a relatively new asset class versus some of the other credit-oriented spreads, and as you pointed out, it's tight. Is that an area that makes you nervous just because it is so new and we have seen, although not recently, we have seen tremendous volatility since that program initiated?

Yes, that's a good question, Joel.

I wouldn't say were nervous. We do think the sector is particularly tight. I think this is as tight as we got in the spring of 2015.

It was tighter prior to that. But it is certainly tight and a lot of the reason is there is more sponsorship for the sector. There's little bit more liquidity now as time has passed.

Spreads in residential credit have obviously performed well and some of that does have to do with the fact that there are positive technicals for this sector. The legacy market is paying down relatively rapidly in this happens to be a product that some investors may find suitable as a replacement, and so there's a little bit more sponsorship for it.

In terms of being nervous, no. The market always finds a way of clearing and if there is a dislocation that was to occur in that market, we'd see it as an opportunity to add to it. But at these spreads we're actually marginally better sellers of it and trying to provide liquidity to the market.

All right. Great.

I'd like to simplify for the average investor here the analogy we use for the [CRT] market is -- in my mind it's like an IPO market of an emerging sector of any industry. Today is relatively small albeit growing. Is relatively illiquid because it's new. So each deal is almost like, to David's point on relative value, there is entry points on each deal, and there's valuation metrics that we monitor.

So when you buy into that one of these deals, I view it as you're almost buying a quasi-IPO. You better be darn sure that your entry-level and you valuation is something you are comfortable with, because you're going to be -- you got to expect to hold it longer because of the relative illiquidity around it. That being said, we think were pretty good IPO buyers and I think we've built this portfolio with the three other products in resi credit -- three other asset types in resi credit, pretty deliberately over the last couple of years.

All right. Great. Thanks, Kevin.

Thanks, Joel.

Douglas Harter, Credit Suisse. Please go ahead.

Thanks. I was just hoping you could expand a little bit more on the MSR comment and the decision to sell 90% of the production as opposed to sort of keeping that as a hedge.

Hi Doug. This is David. So, as we've said in the past, we don't believe that -- while we like the asset very much, we don't believe that the capital allocation to the sector should be as large as some others and we've said in the past 47% of capital it is an already levered asset and it does have somewhat volatile performance.

And so we've considered finding other investors to invest in the MSR business because Pingora produces MSRs on an ongoing basis, or rather purchases them from their many, many originator partners, and this is a way to where we stay in the market.

We have critical mass in terms of the asset. We are at about 5% of capital and we stay in the market and we have another investor actually taking most of the flow and then we have the optionality. If the sector does cheapen, we can go out to the secondary MSR market and buy both packages if we like them. And we see those packages multiple times a week. So essentially we are where we want to be but we have optionality to add if we so choose to.

What is the economics look like to Pingora, you guys, on those MSRs you're selling?

So there's a management fee associated with the business and that all flows up through to the REIT. And to note this isn't the first fund that Pingora has launched-- there is an existing fund of legacy MSRs where there's a management [that's] associated with that as well.

Is there an opportunity -- you know, as you said, you see bulk opportunities. Is there opportunity to kind of grow that fund management business within Pingora? And then also is there opportunities to leverage kind of the platform you have throughout Annaly to further fund opportunities?

That's a good question. You know, there's always opportunities and we always explore everything that we think has potential. You know, right now we're still in the evaluation stage and we'll see how things develop, but we're very comfortable with the business and how they operate it and the investors that participate in the trade.

Doug, what I would just say bigger picture is, as an institution here, you know, we're all about capital efficiency and operating efficiency, and then in terms of growth making sure we do that as efficiently as possible. So there is a number of things that we don't necessarily beat our chests about here but this one MSR relationship is one of other things that were doing.

There's joint ventures here where we're plugging into origination platforms where we have access to the flow without having to pay for the infrastructure. That's how we've been able to manage our efficient returns with all -- with these four large businesses.

So you'll see us over time, we'll be plugging into different platforms. That's our model. We're not going to be in the business of having big overhead and operating businesses. We can plug into other platforms more efficiently and utilize our capital and our expertise and generate just incremental return, really, off of other's backs.

Great. Thanks for that. That's helpful.

Thanks, Doug.

(Operator Instructions)

Jessica Levi-Ribner, FBR. Please go ahead.

Good morning. Thanks so much for taking my question. Can you talk just a little bit more about your view on the CRE market and what kind of -- you mentioned that you do see some pockets of opportunity. Can you elaborate on that?

Yes, Jessica, this is Mike Quinn.

Look, I think Kevin and David mentioned that we reduced our exposure over the past 12 months or so, and I think that was really a relative value decision. To me the markets remain, I think, pretty solid and fairly priced. You know, fundamentals are still pretty strong in the commercial real estate markets across the US and the debt markets are fairly rational. I think there may be some underpricing of risk out there that LTVs remain pretty reasonable.

I think the issue for me right now is sponsors and opportunistic sponsors and value-added players have largely stepped away from the market in the US. So you've got a situation where there's not a lot of new capital coming into the space for new investments. I think a lot of what we're seeing today is in refinancings and from my perspective that is marginally worse for a transitional lender.

So I do think we will see pockets of opportunity deals were we can invest our capital and make levered returns in the 9% to 11% range. But on average, I think we still see better opportunities elsewhere.

Okay. Fair enough. And just moving to leverage on the overall portfolio, you mentioned for the agencies in particular that you are being conservative with respect to leverage because of the volatility.

How do we think about your leverage on a go-forward? Is this [5.8] times appropriate? Are you thinking about taking it down? How do we think about that?

Jessica I think the simplest answer is what's past is prelude. I mean, we've been conservatively operating at a leverage level 33% or 25% less than the average company out there while we're still able to produce these very attractive stable dividends like nobody else.

So there will be episodic upturns. For instance when we bought Hatteras the leverage went up 1/2 turn to take on those assets, generate our targeted return, and then the next month or so or two months, it was back down to 6 times roughly.

Put it this way. We have other opportunities to generate return and alpha. I think a lot of the companies that only rely upon the leverage lever or the leverage dial and that's the only thing they can talk about. So we'll talk about are complementary cash flows and less leverage returns in these credit businesses.

In commercial, Mike just gave you his summary. Look, we like that business and we really like the credit in our portfolio and we have great relationships with our clients. But we want to be the industry leader and the reasonable man in the room and some of the deals getting done in the way they're being described to the market, we don't feel, I don't feel personally that's entirely transparent.

I think there's incremental risk of being taken to generate returns that are similar to ours, primarily because most of these companies have nothing else to do with their capital. And that to me is the definition of heightened risk.

So we like the sector. We like others little bit more right now. And in terms of leverage, it's kind of like the same thing. We know how to utilize it, but we don't have to go crazy with it.

Okay. Fair enough. Thanks so much for taking my questions.

Thanks.

Steve DeLaney, JMP Securities. Please go ahead.

Thanks for taking the question. Just a couple things to follow-up on your stated current preference for residential credit as opposed to CRE lending that we have been discussing. Just curious, looking at on page four of the deck as you breakout your buckets within the resi credit. With respect to jumbo 2.0 can you talk about exactly where in the securitization structure you are currently investing, whether it's senior subordinate? I see you have some I/O as well would suggest maybe you are in the subordinate part of the stack.

Yes, hi Steve, I wouldn't consider the I/O fairly subordinate. The first of all, let me say we're not buying jumbo 2.0 securitizations right now. When we were adding the securities, the AAAs were trading back north of 3 points from TBAs or agencies. Now they are back 1 in 20 from [PPA], so they performed quite well.

And they happen to be, when you look at them, even though with the headline yield is higher, given the lower dollar price, the option-adjusted spread on jumbo 2.0 is actually the same as agency. And so given that, when you have the liquidity of the agency market and even OAS, you would always prefer to buy agency.

So to simply answer your question, we are not participating in that market. We do have some positions and we have sold a reasonable amount.

Appreciate that and that's a great segue into the second part of my question on resi credit. Given that buying somebody else's paper that they have originated or sourced is going to leave you with some kind of a diminished return, and given Kevin's comments about a very big-picture approach to M&A, can you guys ever see yourself either establishing our acquiring an operating platform for to do your own origination and servicing, with the ultimate goal simply being able to create your own resi credit pieces? Thanks.

That's a good question, Steve.

I'd say right now we view ourselves as a portfolio company. And as Kevin talked about, the ability to plug-in to operators and efficiently extract the product we're looking for -- we're willing to pay a small amount to do that because it keeps us nimble and keeps us liquid and enables us to mobilize resources when they need to in the various businesses.

So the way we've view it right now is we're a portfolio company and we're not so much an operating company. And that could change out the horizon, you know, if there's some synergy out there that we can really capitalize on. But for the time being, we'll keep working with our partners.

We hear you on friction costs, right, when you don't have the manufacturer in your basement. But look, I think you're going to see us grow this portfolio all things being equal with our current setup, current partnerships that we have and we'll talk about it more when we get there.

But I think to David's point, the only reason I'm putting a cherry on top of this is that we've never put anything out of the question. But as long as we can manufacturer these returns with this amount of flow, it really doesn't make any sense for us to take on the incremental risk of an operating entity to do that.

I hear you. You can leave the regulatory risk with your partners with the current approach as well. Thank you so much for the comments.

Thanks, Steve.

Thank you. This concludes our question-and-answer session. I would like to now turn the conference back over to Kevin Keyes for any closing remarks.

Thanks, everyone, for participating and we look forward to talking to you before next quarter. Thanks.

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