Annaly Capital Management Inc

NYSE:NLY

Earnings Call Transcript 2021-Q3

[Operator]

Good day, and welcome to the Third Quarter 2021, Annaly Capital Management Earnings Conference Call. All participants will be in a listen-only mode. [Operator instructions]. After today's presentation, there will be an opportunity to ask questions. [Operator instructions]. Please note this event is being recorded. I would now like to turn the conference over to Mr. Sean Kensil. Please go ahead.

[Sean Kensil, Vice President, Investor Relations]

Good morning, and welcome to the Third Quarter 2021 earnings call for Annaly Capital Management. Any forward-looking statements made during today's call are subject to certain risks and uncertainties, including with respect to COVID-19 impacts, which are outlined in the Risk Factors section in our most recent annual 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 and 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. As a reminder, Annaly, routinely post important information for investors on the Company's website www. annaly.com.

Content referenced in today's call can be found in our third quarter 2021 investor presentation and third quarter of 2021 financial supplement, both found under the presentations section of our website, Annaly intends to use our web-page as a means of disclosing material, non-public information for complying with the Company's disclosure obligations under Regulation FD, and to post an update investor presentations and similar materials on a regular basis. Annaly encourages investors, analysts, the media, and other interested parties to monitor the Company's website. In addition to following annually press releases, SEC filings, public conference calls, presentations, webcasts and other information to post from time-to-time on this 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, Ilker Ertas, Head of Securitized Products. Tim Coffey, Chief Credit Officer and Mike Danielle, Head of Residential Credit. And with that, I'll turn the call over to David.

[David Finkelstein]

Thank you, Sean. Good morning, everyone and thanks for joining us for our third quarter earnings call. Today, I will provide an overview of the broader market environment, including our thoughts on the federal reserve's reduction in asset purchases, briefly touch on our performance during the quarter. And highlight some of our recent achievements in positioning across our businesses. Ilker will provide more detailed commentary on our agency and residential credit portfolios and Serena will discuss our financial results.

And as Sean noted, our other business heads are also here this morning to provide additional context during Q&A. Now, first with respect to the macro landscape, the COVID Delta wave and related factors have led to a moderation in the economic recovery. Labor market gains have slowed relative to the strong pace at the beginning of the summer. Production bottlenecks and global supply chain disruptions have caused delays, the raised prices on products in high demand. And while inflation has been boosted by higher goods in energy prices, record home price appreciation has started to filter into inflation shelter component, suggesting that price pressures may persist for longer than previously anticipated.

Meanwhile, interest rate experienced meaningful intra -quarter volatility given the shifting narrative on the economic recovery and inflation. Early in the quarter, rates rally this market sought direction on the magnitude of the impact of the Delta variant. And later in the quarter as a relative reduction in COVID case counts led to a return to economic optimism, rates sold off and the curve steepen in the quarter. Now the greater near-term focus in the macro landscape, however, is the imminent reduction in the [Indiscernible] of asset purchases. Following the September FOMC meeting, we now have a clear picture as to what the taper will likely look like.

That is expected to reduce treasury and Agency MBS purchases by roughly $10 billion $5 billion per month respectively, beginning as early as November. This pace would result in our Fed halting balance sheet expansion this summer of 2022 that we expect reinvestment of portfolio runoff to persist well beyond the end of the taper, consistent with the QE3 experience. Most notably, the Fed's transparent communications have helped to limit the market impact to both interest rates and agency MBS spreads ahead of the official taper announcement. While the Fed has attempted to decouple the taper and eventual rate hikes, elevated inflation readings and more hawkish Central Bank messaging globally have accelerated investors’ expectations of a rate hike.

With markets currently pricing as many as 2 hikes in 2022, we remain vigilant in managing Annaly's duration exposure, both in the front end and the long end as Ilker will expand later on. Now reflecting briefly on the agency MBS supply and demand outlook in light of the taper announcement. Private market participants will need to absorb an increased number of mortgages in 2022. Elevated net issuance remains an uncertainty in supply demand outlook, but we currently estimate supply to the private market next year will be similar to levels seen in recent years, pre -pandemic. And several factors are supportive of more limited widening and spread s before buyer’s merge. Banks are flushed with deposits and see little loan demand, suggesting strong appetite for securities is likely to continue. Particularly

At potential wider spread levels and money managers remain underweight mortgages, but will likely increase their relative allocation and mortgage spreads become more attractive. Ample liquidity best seen in the $1.6 trillion pledged to the Fed's reverse repo facility at quarter-end and readily available financing remain the main factors underlying the current accommodative financial conditions. The repo market remains highly liquid and has allowed us to decrease our cost of funds to another record low. In line with efforts earlier in the year, we continue to broaden our financing through an increased use of credit facilities by funding high-quality credit securities for longer terms.

These actions helped to enhance Annaly's liquidity profile at extremely attractive spread in haircut levels as Serena will discuss in more detail. Now, turning to Annaly's performance in the third quarter, our portfolio generated a positive economic return of 2.9% reflecting a $0.02 gain on book value, and earnings available for distribution of $0.28. We achieved these returns made continued conservative portfolio positioning, maintaining economic leverage at the low end of our historical range and unchanged quarter-over-quarter at 5.8 times. Our liquidity remains at our highest levels with total unencumbered assets of 9.8 billion at quarter end. We continue to see relatively tight spreads and as a result, are comfortable with our more cautious approach to managing the portfolio.

And that being said, should spreads become more attractive, our nimble positioning leaves us prepared to take a more offensive posture and increase leverage should it be justified. Now, over the quarter, mortgage performed in line with hedges in this environment as the sector benefited from clarity surrounding the upcoming taper and healthy demand from banks. We increased our agency portfolio by nearly $3 billion in Q3 as we invest a portion of the proceeds from our previously announced commercial real estate sale. Additions to our agency portfolio, which Ilker will cover in more detail, were primarily a placeholder as agency MBS remain fully valued, while credit sectors offer attractive pockets of opportunity, but deployment of capital is more episodic.

With respect to capital allocation then the third quarter, 30% of our capital was allocated credit of slightly from 29% in the prior quarter in line with our view on the relative value equation vis -a - vis agency. And our deliberate portfolio positioning ahead of the taper. Our residential credit business represents the majority of our credit allocation at 21% and had another strong quarter as the group continues to successfully execute on their strategy. With assets of 4.3 billion, the residential credit group is now larger than it was pre COVID and assets are up over 70% since year-end 2020. We maintain an optimistic outlook on the business given persistent robust housing market fundamentals and long-term tailwinds driving the need for private capital in the market.

Now onto our base securitization platform remains very active completing nearly 2 billion of securitization since the start of the third quarter, and nearly 3 billion of securitizations year-to-date. We expect to maintain our securitization footprint and we're continually adding to our partnerships to drive new sources of securitization collateral. Additionally, our correspondent network is adding new partners in Annaly's large capital base and market expertise, uniquely positioned onto a base as an aggregated within the industry. And also, as it relates to OBX, I wanted to briefly touch on the impact of the recent suspension of the FHFA's cap on second homes and investor properties,

While the decision will have an impact on the delivery of agency eligible loans to our platform, it does not tamper our bullish outlook for the sector. Annaly was an active issuer of agency eligible investor loans before the cap was put in place. And notably, we issued 3 securitizations in 2019 and 2020, backed by 1.15 billion of collateral prior to the PSP amendment limiting delivery of Investor loans, GSEs March of this year. As the FHFA has reversed, the introduction of the caps, we expect Annaly and private markets more broadly to be able to compete with GSC, LOPA adjusted pricing. Again, assuming securitization execution remains attractive. Now regarding progress on our MSR business, we grew our holdings by more than 40% on the quarter with the portfolio representing 575 million in market value and 4% of dedicated capital.

As we scale the business, we have solidified our position as a reliable partner in the MSR sector, supplementing our bulk transactions with acquisitions through flow relationships. We've increased our MSR holdings by $470 million in 2021 and we anticipate responsibly growing the portfolio through our unique position as a non-competitive partner to originators that need liquidity and capital. Turning to our middle-market lending business, we closed our Inaugural Private Closed-end Fund subsequent to quarter end, which has north of $370 million of capital to fund is approximately two times larger than the medium size of first-time direct lending and private debt funds. It includes a mix of both U.S. and European investors comprised of public and corporate pensions, insurance companies, and asset managers.

The fund has supported nearly $450 million in a middle market loan investments to date, with an attractive risk-adjusted return profile. Annaly is co-investing 50-50 alongside each fund investment, bringing a strong alignment of interests that we believe that fund services a test into the track record and expertise of our dedicated middle-market lending team, allows for enhanced capital allocation flexibility to further scale the strategy, and provides recurring fee revenue to the read. Including the fund. The middle market lending strategy managed 2.3 billion in funded assets at quarter end.

And lastly, as the largest mortgage REIT with the capability to invest across all aspects of the mortgage loan. Our strategic initiatives over the past year, including investing in MSR and Balance Sheet and expanding our residential credit business have prepared us to be a leading source of capital and residential housing finance. Ultimately, the strength of analysts diversified model is enabled by our size and scale and we remain confident in our ability to generate stable returns throughout various market environments and across economic cycles as we have done historically. And now with that, I'll turn it over to Ilker, to provide a more detailed lens into our agency and residential credit, portfolio activity and outlook.

[Ilker Ertas, Head of Securitized Products]

Thank you, David. Against the economic can interest rate [indiscernible] drop, David described, agency MBS performed broadly in line with [indiscernible] but performance was mixed across to coupons tech. Specifically, lower coupon MBS widened modestly due to continued record supply levels. Fetch taper moving closer, and elevated prepayment speeds. At the same time, higher coupons all per contagious into the retracement of higher interest rates that materialized later in the quarter and emerging signs of prepayment burnout.

Our portfolio performance showed the benefits of the barbell strategy. We have discussed in several of our recent earnings call. In third quarter, the out-performance of higher coupons more than offset the widening experienced in the local production coupons. We believe the approach is also efficient in protecting the portfolio from any potential taper induced whitening. As nearly 60% of our agency portfolio consists of non-fed supported coupons. That is 3% and [indiscernible] In addition, our specified pool portfolio is more than 45 months seasoned than average, which provides a strong source of durable earnings with minimal duration and convexity risk.

Turning to our portfolio activity, we tactically increased our agency portfolio by nearly $3 billion during the quarter, predominantly in lower coupon TBAs to opportunistic redeploy a portion of the proceeds from our previously announced commercial real estate sale. Our purchases consisted of primarily lower coupon TBAs, which exhibited spread-widening earlier in the quarters. We have favorite TBAs over posts in lower coupons due to attractive implied financing rates in the dollar roll market, which remain quite special in the context of negative 30 to 40 basis points financing, and enhanced leverage returns.

We expect these favorable conditions to purchase vol into 2022 as the Fed remains a net buyer of MBS throughout the tapers. In addition, the sector offer strongest liquidity should we choose to redeploy the capital into other opportunities. Regarding prepayment speeds, recent trends have meter divergent performance across to coupons tech, lower capacity being very reactive in what remains a historically low mortgage rate environment in which mortgage originated the ample capacity, while higher coupons that exhibited moderate burnouts since peak prepayment speeds in March.

At current mortgage rates, roughly 31% of mortgage inverse of greater than 50 basis points of refinancing incentive, which is down significantly from 72% at the beginning of the year. The restriking of the universe along with slower speeds and higher coupons has improved the prepayment outlook going forward. Additionally, the historically strong housing market has led to elevated cash-out refinancing activity, which should help mitigate extension risk for mortgage portfolios should interest rates continue to rise. Our portfolio prepaid 13% slower quarter-over-quarter, and our outlook is for further 10% to 15% reduction in the fourth quarter due to higher rates, less reactive borrowers, and slower housing seasonal.

In our hedge portfolio, the edit duration hedges at lower rates throughout the quarter, positioning the portfolio for modestly higher yields. The edit treasury future shorts across the curve, and increase our long-end swap position by exercising $3 billion in the minus swaptions. We also took advantage of relatively lower levels of implied volatility to replace our exercise swaptions with highest track swaptions at longer expiries. This proactive approach has already proven worked, filed given the rise in interest rates in September and October, the interest rate outlook remains cloudy due to uncertainties over inflation, the Fed's response and market positioning. We will continue to minimize our interest rate exposure in fourth-quarters.

It was an active quarter for our mortgage servicing rights business. We grew our portfolio through 200 million in bulk purchases and began transacting through [Indiscernible] arrangements, which we see as a good growth opportunity going forward. Additionally, in the fourth quarter, we expect to sell vast majority of our legacy MSR portfolio for roughly 85 million in estimated proceeds. The sale of higher-coupon seasoned MSR will provide additional capacity to grow our allocation to nibble production, low coupon MSR, which will serve as more effective hedge to the MBS basis. Additionally, the plant transaction is with an operational partners that describes a higher value to customer acquisition, which will drive strong execution for both parties.

We believe this transaction highlights Annaly's unique position in the MSR market as a capital partner for those [indiscernible] community that does not compete for their customers. Moving to our Residential Credit business. We continue to increase our allocation to the sector as measured by both assets under management and capital deployed. The residential portfolio ended the quarter at $4.3 billion of market value and $2.9 billion of dedicated capital, representing 21% of the firm's capital. The growth of the portfolio was predominantly through our acquisition of residential whole loans as we purchase $1.4 billion throughout the third quarter.

Our Q3 acquisitions were across both expanded prime non-QM markets and agency eligible investor loans. Our securities portfolio was up modestly, approximately under 25 million as we saw diminished opportunities in third-party securities relative to prior quarters. As David mentioned, our OBX securitization platform was active in Q3 with 1.1 billion of securitizations across 3 separate deals. Also to note, post-quarter-end, we priced 2 additional transactions representing another 800 million of issuance. Life-to-date level returns of our whole loan strategy remains in low to mid double-digits, utilizing minimal recourse leverage.

Our GAAP residential whole loan portfolio ended Q3 at 5.8 billion. 70% of which is currently termed financed with non-mark-to-market securitizations. In summary, MBS technical remain constructive as strength in prepays continue to improve. And recent price action highlights the amount of support for MBS into higher deals. August spreads have potential to the provider as the taper commences and supply remains elevated. We believe any widening is likely to be orderly, but we expect to maintain a conservative leverage profile and proactively manage our basis and interest rate exposures. With that, I will now turn the call over to Serena to discuss our financial results.

[Serena Wolfe, Chief Financial Officer]

Thank you Ilker and good morning everyone. This morning, I'll provide brief financial highlights for the Quarter ended September 30, 2021. 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. At the risk of repeating myself, I would say that the general themes for this quarter's earnings are consistent with recent quarters. That is, this quarter, we continued to generate strong results from the portfolio benefiting from the continued low interest rates in the funding market, marking another quarter of record low cost of funds and sustained specialists in dollar rolled financing. To set the stage with some summary information, our book value per share was $8.39 for Q3,

And we generated earnings available for distribution per share of $0.28. Book value increased primarily due to GAAP net income of 522 million or $0.34 per share, partially offset by the common dividend declaration of 320 million or $0.22 per share. And other comprehensive loss of a 142 million or $0.10 per share on higher rates. The negative impact to our book value from our agency MBS valuations was more than offset by the gains on our swaps, resulting from higher hedge rates and higher mark-to-market valuations on our MFO and ready credit portfolios, which together contributed approximately $0.06 per share to book value during the quarter.

Combining our book value performance of the $0.22 common dividend we declared during Q3, our quarterly economic intangible economic returns were both 2.9%. As we take a closer look at the GAAP results, the valuation drivers we mentioned above benefited GAAP results, as we generated GAAP net income for Q3 of $522 million or $0.34 per common share, up from GAAP net loss of $295 million or $0.23 per common share in the prior quarter. Expanding further on their summary comments, specifically GAAP net income increased due to net realized and unrealized gains on the fourth portfolio in the third quarter of $130 million compared to losses of $224 million in the second quarter, lower net losses on other derivatives and financial instruments in the third quarter of $45 million compared to $358 million in the second quarter, and net unrealized gains on instruments measured at fair value through earnings in the third quarter of $91 million compared to $4 million in Q2.

As David mentioned during our second quarter earnings call, we anticipated that EAD would moderate slightly. This is reflected in a $0.02 reduction in EAD compared to the Second Quarter. The most significant factors that impacted EAD quarter-over-quarter included lower interest income predominantly related to the run-off of higher yielding assets and the reduction in investment balances, which was offset by higher TBA dollar roll as a desk position, our TBA portfolio, based on the relative attractiveness competitive pools. EAB benefited from lower expenses on the net interest component on swaps from the termination of 28 billion gross notional swaps as the swap portfolio was repositioned to reduce exposure to libor.

And finally, lower interest expense of 50 million, in comparison with 61 million in the prior quarter due to lower average repo rates and balances. It should also be noted that the sale of our commercial real estate business, allowed us to shift capital allocation to a high percentage in resin credit. Where we saw higher levels of EAD on whole loan and NPL uphill purchases throughout the quarter. Now, turning to our financing, early in 2021, we communicated that we were forecasting lower repo rates for an extended period. As such, we have begun to opportunistically target extended term that is 6 to 12 months for our repo book. And this has resulted in higher weighted average base maturity for our work during 2021 in comparison to recent years.

And in doing this, we believe that we have appropriately managed the risk of our liabilities, while capturing the lows of the interest rate markets. Additionally, given our ample liquidity in the prior quarters, we elected to fund certain credit assets with equity, further contributing to a lower cost of funds. These strategies resulted in the third quarter marking 9 consecutive quarters of reduced cost of funds for the Company. Our weighted average days to maturity for Q3 was 75 days, slightly less than the prior quarter at 88 days. This reduction in days is due to the timing of rolling repo extended earlier in the year and not a function of a change in strategy by the Company. As David discussed, the market is pricing in rate hikes to begin in the latter half of 2022. Therefore, we have seen steepening in the repo curve as of late.

And so, while longer term repo does come at a higher cost today, our over $30 billion in shorter dated 0-to-3-year pace swap has been of considerable benefit to hedging this eventuality. And given the strong liquidity in the repo market that will likely persist beyond initial rate hikes. We have focused our effort on hedging short-term rates as opposed to repo spreads versus policy rates. Additionally, although our overall repo balances have been reduced since the beginning of 2021, we have tried to maintain steady balances within our broker-dealer. This has given us the opportunity to take advantage of attractive overnight funding conditions amid excess reserves and steady decline in TGA balances.

As in prior quarters, we continue to see strong demand to credit assets on the pattern repo lenders. And we have opportunistically began to lever credit assets at very competitive terms both rights and hiccup. Our average weighted days to credit assets are approximately a 100. And we continue to target longer duration funding to lock in those competitive spreads and hiccup at all time types, consistent with our prudent and conservative approach to maximize

liquidity. Given the growth in our ready credit businesses, we continue to add new warehouse facilities and amended existing facilities to meet the businesses needs with a further 300 million facility put in by during the quarter and increase capacity for our ready-credit partnership with a sovereign wealth funds. To provide additional color regarding our reduced interest expense for the quarter, our overall cost of funds decreased 17 basis points quarter-over-quarter from 83 basis points to 66 basis points. Our average repo rate for the quarter was 15 basis points compared to 18 basis points in the prior quarter. And we ended September with a repo rate of 15 basis points, down from 32 basis points at the end of December 2020.

With LIBOR reform looming, we took the opportunity during the third quarter to reposition our swap portfolio and reduce our exposures reliable, resulting in the aforementioned termination of 28 billion of swaps notional and reduced interest component of swaps for the quarter and future periods. The portfolio generated 204 basis points of NIM, down 5 basis points from the record NIM level of 209 basis points in Q2, driven by the lower interest income, partially offset by lower interest expense and improved TBA dollar roll income up three basis points.

Average yields decreased 13 basis points from 2.76% to 2.63% mainly because of the change in the composition of assets towards low yielding assets in the quarter, both agency and resi credit. Moving now to our operating expenses, efficiency ratios for the quarter decreased in comparison to Q2's ratio of 1.55%. As expected, we saw a reduction now OPEX to equity ratios during Q3 as we realize the benefits of the reduced compensation and other expenses from the disposition of our acreage business. And we saw a reduction due to the timing of certain fee payments and professional fees along with a true-up of prior period accruals in the second quarter.

Our OpEx to equity ratios were 1.2 to 8% and 1.4% for the Quarter and year-to-date respectively, with a full-year expenses expected to be at the low end, if not below the revised range of 1.45 to 1.60 provided in the first quarter. And to wrapping that annually ended the quarter with an excellent liquidity profile with 9.8 billion of unencumbered assets up from the prior quarter's 9.6 billion, including cash and unencumbered agency MBS of 5.9 billion.

The composition of our encumbered assets changed slightly this quarter with an increase in agency due to lower on Balance Sheet leverage and an increase in unencumbered assets due to MSR growth. Partially offset by reductions due to investments sold during the quarter and the levering of certain non-agency securities that I discussed earlier. That concludes our prepared remarks. Operator, we can now open it up to Q&A.

[Operator]

Thank you. We will now begin the question-and-answer session. [Operator Instructions] And at this time, we'll pause momentarily to a similar roster. And the first question will come from Steven DeLaney with JMP Securities. Please go ahead.

[Steven De Laney]

Thanks. Good morning, everyone. Given that you have 13 analysts following the Company, I'm just going to ask one question to lead off. David, curious, your quarterly dividend $0.22 has been stable for the past six quarters going back to Q20 after COVID. What does management and the board want to see that would give support to increasing that quarterly payout? Thanks.

[David Finkelstein]

Good morning, Steven. It's good to hear from you.

[Steven De Laney]

Yes, sir.

[David Finkelstein]

So first and foremost, just a backup in terms of how we set the dividend in -- Obviously, our board is -- provide strong guidance on that front. And in conjunction with the board, we look at the overall dividend yield with the earnings outlook looks like, and we want to achieve a competitive yield. And currently, our yield on book value is 10.5%, 10.25% on the actual stock price this morning. In terms of what we want to look for, to increase the yields or increase the dividend, we would need to see, obviously wider asset spreads and better investment opportunity, more durable earnings.

We feel good about where earnings are this quarter, and we feel good about covering the dividend into 2022, certainly. But we do recognize that we have out earned the dividend consistently since the second quarter of 2021. And we're comfortable with that. And we're very comparable with where the dividend yield is today. It's certainly competitive with the rest of the market and we're content right here.

[Steven De Laney]

Yeah. I would certainly agree that at 10% dividend yield is too high, and then their incomes to catch 22 of what comes first, but we certainly look at 10% and say, they're certainly up side and the stock is that dividend comes down. The credit-oriented names are more in the more in the 8 to 9% and you're certainly adding a good bit of that. Thank you for the comments

[David Finkelstein]

Thanks, Steve.

[Operator]

The next question will come from George Bose with KBW, please go ahead

[Bose George, KBW]

Hey guys, good morning. This is Bose. I just want to ask about the $1.5 billion resi portfolio. Can you just give us some color on that? What are the returns going to be and how much capital is that going to use in the end once that's securitized?

[David Finkelstein]

Hey, Bose. Good morning, and I'll start off and then hand it over to Mike. I would separate both loans from securities. We have had an emphasis on growing our loan portfolio and securitizing. The securitized portfolio has grown. But I will say from a return standpoint, the loan to securitization market is more attractive in terms of what we can generate relative to what our securities are currently pricing. Mike, you can jump in here.

[Michael Fania]

Sure, thanks. And I think we ended the quarter 3.2 billion in securities on an economic basis and then $1.1 billion in terms of whole loans. And I think when you think about the conversion of whole loans to securities on Balance Sheet, we're retaining anywhere, I'll say, between 7% to 8%. I will say between $75 million to $80 million to $85 million is what ultimately will be created from that $1.1 billion of whole loans. But to note, we've settled $2.8. billions of whole loans year-to-date, and we ended the quarter were $1.2 billion pipeline.

So we remain positioned to continue to go to the securitization markets to the extent that they're open. But I would think about it. Probably 7% to 8% of the whole loan portfolio is ultimately converted to security on Balance Sheet.

[Bose George, KBW]

Okay, great. And then, the target ROE on that, on a levered basis?

[David Finkelstein]

On securitization, we are in the low double-digits right now, Bose.

[Bose George, KBW]

Okay, great, thanks. And then, on the MSR investment, and how large could that get as a percentage of your capital? And in terms of the yields on the MSR that you are buying, can you just give us some color?

[David Finkelstein]

Sure. And as we've talked about both the last two quarters, we would like to get our MSR portfolio up to 10% in capital, but we've also stressed that we're going to be patient in doing so. We're not going to chase returns in the sector. We were happy with the growth that we achieved in the third quarter. But again, it may take time because the market is competitive, but we're finding opportunities, and Ilker can talk a little bit about the terms.

[Ilker Ertas, Head of Securitized Products]

Yes. The purchases that we were buying with the hedge benefit will be very low doubles. But at the current pricing, it will be high-singles. So that's why we reduce our purchases. We reduced our purchase pace recently.

[David Finkelstein]

Yeah. I know, we can also distinguish bulk purchases versus flow. Where with flow purchases you can get into the double-digits currently.

[Ilker Ertas, Head of Securitized Products]

Correct.

[Bose George, KBW]

Okay. Great. Thanks.

[David Finkelstein]

Thanks, Bose.

[Operator]

The next question will come from Rick Shane with JPMorgan. Please go ahead.

[Rick Shane, JPMorgan]

Thanks everybody for taking my questions this morning. I just wanted to talk a little bit the disparity between actual prepayment speeds in the long-term CPR assumptions fairly wide. I'm curious how we should think about the convergence of that over time and the implications in terms of your reported numbers.

[Ilker Ertas, Head of Securitized Products]

Sure. One of the main reason is the steepness of the curve. For long-term speeds are laid the forwards. And as the curve steepens, like mortgage rate goes up and forward to the speeds goes down. So that's one of the reason. And second reason is the burnout. As the portfolio burns out, speeds will slow down. But curve the bigger reason. If curve flattens, you will see those two numbers approach to each other.

[Rick Shane, JPMorgan]

How should -- it does. But at the same time, how should we think about -- ultimately they have to converge at some point. So how do we think about that from a reporting perspective, what we should anticipate and really what the time frame on that convergent should be. I mean, it's we're wider than ten points at this point and that just seems unsustainable. So trying to think about the timeline and the accounting implications.

[David Finkelstein]

Yeah. Rick, I'd say there is a consistent catch up that is adjusted on a quarterly basis, number 1. Number 2, let's just look back. I realized the disparity between actuals and long-term projection is quite widen out. But if you go back a few years, when rates were higher, you did have portfolio speeds that were in the low double-digits, very consistent with long term projection. So to the extent rates do normalize, then we're going to ultimately approach those longer-term CBRs if we follow the forward as Ilker suggested, and potentially even through those levels and will average out. But it's all dependent on where actual rates do go out the horizon. the horizon.

[Rick Shane, JPMorgan]

Okay. No, certain -- Look, I don't -- I'm not questioning the long-term prepayment speeds, particularly given the burnout that we're all anticipating. I'm just trying to think about what it means if you are persistently above the long-term assumptions because, obviously, what's left has a very low speed, but there's not much of it remaining. And as you replace or reinvest, you could have this situation where you have this persistent gap between the two.

[Ilker Ertas, Head of Securitized Products]

You can look at it this way, though. So as long as prepayment models were accurate, and if we were -- if forwards do not realize and [Indiscernible] see it, yes, short-term speeds will be higher than the long-term speeds. But through that, then you will get the roll-down benefit on your hedges. So if yield curve does not -- if the forward slope does not materialize, then your hedge costs will never increase as much as the forwards realize. So then, when you look at the spread of the mortgages to the hedges, you are taking the forward roll-down into account.

So one may think that okay forward realize then your hedge costs, goes higher, or other may think that forwards are not realized, then your hedge costs will be lower. So as long as what we are modeling or what market is modeling is consistent with where the mortgage rates and where the prepayments are, then those 2 offset -- those 2 effects will offset each other.

[Rick Shane, JPMorgan]

Okay. Got it. Thank you, and I've taken a lot of time. I apologize. Thank you guys.

[David Finkelstein]

Thanks, Rick.

[Operator]

The next question will come from Eric Hagen with BTIG. Please go ahead.

[Eric Hagen, BTIG]

Hey, good morning, guys. So we know that overnight repo is very plentiful in the treasury market, like you noted. But, can you share where on the term structure repo liquidity is currently most abundant for agency mortgages? And how you expect that could evolve as the Fed begins to taper and more collateral supply gets put onto the market?

[David Finkelstein]

Sure. Sure. Good morning. That's a good question. So I'll just give you a quick run of where bilateral repo is right now for a month, it's about 12 basis points, three months, 14, 17, roughly for six months and then in the mid-20s for a year. So obviously we have seen a steepening in the slope of that curve. Now let's look at repo and break it down for clarification. There are two components to repo costs. There's the short rate component or the Fed funds component, if you will.

[David Finkelstein]

And then there's the liquidity component, which is the spread of bilateral repo over that short rate. And the way we look at the current environment, what we're most concerned about is the rate component. And we've seen hikes get priced in, acceleration of hikes gets priced into the market as of late. And obviously. that's something we're very focused on. Now, however, when you look at our hedge profile, we're very well covered from that standpoint, $31 billion in 0-to-3-year swaps and 80% hedge ratio at quarter-end, actually a little bit higher than that. Now we're around 84%.

So the rate component and the risk associated with short rates going up, we're well covered from. Now the liquidity component, given our days, are about 75 roughly right now. We're not as concerned about that over the very near to intermediate term because of the liquidity in the system We set balance sheet about 8.5, 1.6 trillion in the reverse repo facility at Quarter-end, standing repo facility at the Fed in case there's any destabilization and repo market. So, we're more -- much more focused on hedging the rate component which we have. And we're confident that liquidity out the near term is going to be ample. And so we're not as inclined to pay as much of a premium for term repo, but we're actively looking to find good value in say 6 months to a year repo.

[Eric Hagen, BTIG]

Got it. That's helpful. And then it seems like one of the benefits of moving lower in coupon in the agency portfolio is that the premium risk, like a capital structure, gets reduced or tempered a little bit because you are buying lower price Securities. I mean, would you agree with that? And do you think that changes the way you think about your leverage and the way you guys manage risk and other areas of the portfolio sale?

[David Finkelstein]

Just to talk a little bit about premium risk, I'd say it's always a concern of ours, but if you back up to the beginning of the year, it's less of a concern now than it was then because, for example, we had $11 billion higher balance in fixed rate securities in the portfolio largely premiums, obviously. Rates were much lower at the time, so the risk of refi was greater. And then, lastly, and perhaps most importantly, we did experience a bit of a re-pricing of higher coupons in the second quarter. And so, as a consequence of that, premium coupons are priced to very fast speed. So we're always concerned about the premium in the portfolio.

Right now, I think it's 27% of our equity balance, which is lower than it's been over the past year certainly. Does it influence our leverage? We do take a holistic approach and what most influences our leverage is the attractiveness and the overall agency market. And also our capital allocation as we've talked about in the past. But generally speaking, we are shifting down in coupon into TBAs, because the carry is better. And TBAs did -- or lower coupons did cheap in a bit relative to higher coupons, both in the third quarter and on a relative basis to higher coupons and touch in the fourth quarter thus far. So again, we take a holistic look at leverage and a specific amount of premium. Obviously has is concerned about about refi risk, but it's generally a bigger picture than that.

[Eric Hagen, BTIG]

Thank you, David.

[David Finkelstein]

You bet, Eric.

[Operator]

[Operator instructions] Our next question will come from Kenneth Lee with RBC Capital Markets. Please go ahead.

[Kenneth Lee, RBC Capital Markets]

Hi, thanks for taking my question. Wondering on a broader level, could you talk about what are you looking specifically for before you start taking a more aggressive approach to leveraging portfolio positioning? Is it just a matter of spread widening in certain assets, or are there any macro considerations? Thanks.

[David Finkelstein]

Sure. Good morning, Ken. And look, this also goes back into the first question with respect to the dividend, you know, when we look at the market and landscape right now, we are approaching the Fed tapering and obviously rate hikes a little further out. The horizon is something that we're obviously very focused on. So is now the right time to raise leverage? We don't think so. Asset spreads are relatively tight. We're able to generate what we think to be strong earnings but we will need to see wider spreads, particularly in agency before we did raise leverage.

And I'll say that given our liquidity profile, as Serena discussed, and we are at the low-end of the range. We're at the lowest level of leverage that we've been in in over 5 years. So we do have ample opportunities should that eventuality materialized. But if I -- if the market ended the quarter where it is today, and the portfolio looks as it looks today, I'd say we're on that which will be here to slightly lower even. And should spread widened, we will have the capacity to do so, but we do need to see more abundant spreads to take leverage up. What that is, is dependent exactly on what the state of the world is at the time. But generally speaking, it's not a -- we're not inclined to leverage right at the moment.

[Kenneth Lee, RBC Capital Markets]

Got you. Very helpful. And one follow-up if I may, the Private closed and middle-market lending fund. Could you just talk a little bit more about what you see our opportunities in that area over time with the potential for perhaps additional funds. Thanks.

[David Finkelstein]

Sure, and look, I think when we look at the middle market business, we have said repeatedly that the returns in that sector are very complementary to the agency portfolio given the low correlation and the team has built a great franchise and has very extensive relationships with private equity that we think [Indiscernible] And as a consequence, they were able to successfully raise outside capital. And the catalyst was looking through the lens of the Annaly portfolio. We like the business and we very much like the assets, but given the fact that it's a corporate lending and there are limits to the potential growth.

And so outside capital certainly solves the issue of enabling that business in that portfolio to further scale. And also it reduces some of the concentration risk of individual position. So we're very happy with the accomplishment of raising the outside capital and to the extent there's more opportunities, we'll see but right now, we feel like we have capacity on the Annaly Balance Sheet to add to the portfolio. And we're happy with how it's performed and Tim, if you can add anything to it by all means.

[Michael Fania]

I think David summed it up beautifully.

[David Finkelstein]

Great.

[Kenneth Lee, RBC Capital Markets]

Great. Very helpful. Thanks again.

[David Finkelstein]

You bet. Thank you, Ken.

[Operator]

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. David Finkelstein for any closing remarks. Please go ahead.

[David Finkelstein]

Thanks, Jeff. And thank you guys for joining us today. Have a good holiday season, and we'll talk to you at the beginning of the year.

[Operator]

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