Annaly Capital Management Inc

NYSE:NLY

Earnings Call Analysis

Annaly Capital demonstrates strong economic returns and navigates market changes.

In Q3 2024, Annaly Capital achieved a 4.9% economic return, bringing the year-to-date total to 10.5%. Their book value per share rose from $19.25 to $19.54, driven by solid performance across business lines. Agency MBS gains contributed $4.30 per share despite market volatility. Earnings available for distribution outpaced the dividend of $0.65. The company raised $1.2 billion in common equity and anticipates continued growth in a favorable interest rate environment. Management projects economic leverage to stabilize near 5.7 turns, with expectations for modest NIM and increased dividends ahead as they adapt to Fed policies.

Contextual Background: A Favorable Market Environment

As the third quarter of 2024 unfolded, a notable shift occurred in the financial markets, characterized by the Federal Reserve's initiation of a cutting cycle. In September, policymakers reduced rates by 50 basis points, ending a period of over 16 months in which rates exceeded 5%. This change, driven by a more balanced labor market and normalizing inflation, fostered a welcoming atmosphere for diversified housing finance models, building optimism for Annaly Capital Management's (Annaly) growth trajectory.

Performance Overview: Solid Economic Returns

Annaly showcased strong performance, achieving a 4.9% economic return for Q3 and a year-to-date return of 10.5%. Earnings available for distribution (EAD) once again surpassed the dividend, underlining effective management and positive market conditions. Notably, the book value per share rose from $19.25 to $19.54, attributed largely to the $1.2 billion common equity raised during the quarter. This capital raise, executed through Annaly's ATM program, was markedly supported by institutional demand, as around 40% of proceeds stemmed from negotiated sales amidst investor inquiries.

Investment Strategy: Agency Mortgage-Backed Securities

A significant focus of Annaly's investment strategy remained on Agency Mortgage-Backed Securities (MBS). The Agency portfolio expanded by over $4 billion in notional value, primarily due to price appreciation and strategic repositioning toward high-quality specified pools. By the quarter's end, approximately 70% of these pools were deemed to possess high-quality prepayment protection, mitigating the risks associated with fluctuating mortgage rates. The company also carefully managed its interest rate exposure, maintaining a conservative posture while capitalizing on favorable market conditions.

Growth in Residential Credit: Pursuing New Opportunities

Annaly's residential credit sector demonstrated robust activity, with a market value increase of $535 million to $6.5 billion. A highlight was the record-breaking performance of the correspondent platform, which generated impressive funding volumes. This growth was punctuated by six securitizations amounting to $3.3 billion in total, with projections indicating an annual total of $9.4 billion for 2024. The returns on deployed capital within this segment were forecasted to range between 12% and 15%, reflecting Annaly's effective credit underwriting and asset management capabilities.

Mortgage Servicing Rights: Strategic Developments

As of the end of Q3, Annaly's Mortgage Servicing Rights (MSR) portfolio was valued at $2.8 billion, utilizing 21% of the firm’s capital. Despite an 80 basis point decline in mortgage rates, the valuation for MSRs minimally decreased to a 5.6 multiple, showcasing resilience. Significantly, a partnership with Rocket Mortgage was announced, poised to enhance operational efficiency and market competitiveness by leveraging Rocket’s superior recapture capabilities, aiming to optimize servicing margins.

Outlook: Navigating a Volatile Regulatory Landscape

Looking ahead, Annaly's leadership articulated a cautiously optimistic outlook, projecting continued favorable conditions should the Fed maintain its easing trajectory. However, the company's management emphasized a disciplined approach toward balancing leverage and liquidity, particularly in light of political uncertainties tied to upcoming elections. The expectation is to sustain current economic returns while observing market conditions closely to inform future capital allocation decisions.

Concluding Insights: A Path Towards Sustainable Growth

In summary, Annaly maintains a favorable position in a shifting economic landscape, driven by proactive capital management and strategic investments. With strong operational metrics and a commitment to innovative partnerships, the firm is well-equipped to navigate upcoming challenges while striving for sustainable growth and shareholder value. Investors may view the prospects for dividends as stable, with management expressing confidence in maintaining current payouts amidst favorable economic conditions and strengthened capital bases.

Earnings Call Transcript 2024-Q3

[Operator]

Good morning, and welcome to the Third Quarter 2024 Earnings Call for Annaly Capital Management. [Operator Instructions] Please note, this event is being recorded.

I would now like to turn the conference over to Sean Kensil, Investor Relations. Please go ahead.

[Sean Kensil, executive]

Good morning, and welcome to the Third Quarter 2024 Earnings Call for Annaly Capital Management. Any forward-looking statements made during today's call are subject to certain risks and uncertainties, which are outlined in the Risk Factors section in our most recent annual and quarterly SEC filings. Actual events and results may differ materially from these forward-looking statements. We encourage you to read the disclaimer in our earnings release in addition to our quarterly and annual filings.

Additionally, the content of this conference call may contain time-sensitive information that is accurate only as of the date hereof. We do not undertake and specifically disclaim any obligation to update or revise this information. During this call, we may present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in our earnings release. Content referenced in today's call can be found in our third quarter 2024 investor presentation and third quarter 2024 supplemental information, both found under the Presentations section of our website.

Please also note this event is being recorded. Participants on this morning's call include David Finkelstein, Chief Executive Officer and Chief Investment Officer; Serena Wolfe, Chief Financial Officer; Mike Fania, Deputy Chief Investment Officer and Head of Residential Credit; V.S. Srinivasan, Head of Agency; and Ken Adler, Head of Mortgage Servicing Rights.

And with that, I'll turn the call over to David.

[David Finkelstein, executive]

Thank you, Sean. Good morning, everyone. Thank you all for joining us for our Third Quarter Earnings Call. Today, I'll briefly review the macro and market environment along with our performance during the quarter. Then I'll provide an update on each of our 3 businesses and end with our outlook. Serena will then discuss our financials, after which we'll open the call up to Q&A.

Now starting with the macro landscape. Financial markets benefited from both the Federal Reserve beginning the long anticipated cutting cycle as well as the continued robust pace of growth exhibited by the U.S. economy. With respect to the Fed, as all are aware, policy rates were lowered by 50 basis points in September in turn, ending 16 months of 5% plus short-term interest rates and policymakers signaled that they will continue to ease over time as current rates remain restrictive. With the pace and extent of easing dependent on economic data. Now the change in monetary policy was driven both by the labor market moving into better balance as hiring slowed over the summer as well as the continued normalization of inflation, with core PCE likely to run only slightly above 2% annualized for the third quarter.

The market's pricing of additional rate cuts has led to a steeper yield curve, increasing the attractiveness of fixed income assets. In Agency MBS in particular. In addition, interest rate volatility declined over the quarter to the lowest level seen since the onset of the March '23 regional banking crisis, though it remains meaningfully above pre-COVID average levels. Meanwhile, economic growth has been resilient with estimates for Q3 GDP roughly in line with the 3% annualized expansion in the second quarter.

Now these developments have been supportive of our diversified housing model as seen in the performance we delivered on the quarter. We generated an economic return of 4.9% for Q3 and 10.5% year-to-date and our earnings available for distribution again exceeded our dividend. Economic leverage ticked down slightly to 5.7 turns, which we anticipate maintaining over the near term. And also to note, our performance and the constructive backdrop for Annaly's investment strategies allowed us to raise $1.2 billion of accretive common equity since the beginning of the third quarter through our ATM program. The environment to deploy capital remains attractive, and the market value of all 3 of our business lines increased quarter-over-quarter. Notably, roughly 40% of the proceeds raised were from negotiated sales following investor reverse inquiries, underscoring the value proposition and associated institutional demand.

Now turning to our portfolios and beginning with Agency MBS. In light of the capital raise, our Agency portfolio grew by just over $4 billion notional with the remaining increase in market value attributable to price appreciation. As mortgage rates declined over the quarter, prepayment concerns weighed on generic higher coupons, while lower coupons and specified pools with prepayment protection outperformed. Now this was less of a concern for us as the focus of our methodical migration up in coupon over the past 2 years has been on high-quality specified pools. For example, our 6s and higher represent roughly 1/4 of our portfolio. And within these coupons, only a small fraction of our pools are backed by generic collateral and approximately 70% have what we would characterize as high-quality prepayment protection and the benefits of our collateral selection were best seen in the latest prepayment report.

Now as the third quarter unfolded and higher coupons lagged into the rally, particularly in September. We did rotate an additional 5% of the portfolio from intermediate coupons to higher coupon collateral on a relative value basis. Now as it relates to our hedge portfolio, we maintained conservative interest rate exposure throughout the quarter, while benefiting from a steepening bias. As rates rallied, we proactively managed our rate exposure as mortgage durations contracted but ended the quarter with minimal duration thus helping prepare us for the recent sell-off as the fourth quarter has unfolded.

Now shifting to residential credit. The portfolio ended Q3 at $6.5 billion in economic market value with $2.3 billion of dedicated capital representing 18% of the firm's equity. The market value of the portfolio increased by $535 million quarter-over-quarter, driven by the continued growth of our correspondent platform with our whole loan and retained OBX securitization portfolio increasing by $640 million. Residential credit spreads were range bound during the quarter with new issue AAA non-QM securities trading in the 10 basis point range providing a supportive backdrop for our OBX securitization platform.

Now capitalizing on the firmness in credit spreads, we priced 6 securitizations totaling $3.3 billion in UPB since the beginning of the third quarter and have now priced 18 securitizations totaling $9.4 billion in 2024, maintaining Onslow Bay, the largest nonbank sponsor in the residential credit market and second largest overall. Year-to-date, these transactions have led to the organic creation of over $1.3 billion in market value of retained OBX securities across Annaly and our joint venture with projected ROEs on deployed capital of 12% to 15%. Our correspondent channel produced record volumes again in Q3 across both locks and fundings at $4.4 billion and $2.9 billion, respectively. And we have now achieved 11 consecutive months of expanded credit lock volume in excess of $1 billion per month.

And the momentum of the channel continued into Q4 as we have a current lock pipeline of $2.2 billion with strong credit characteristics and limited layer risk representing a 754 weighted average FICO and a 68 LTV. Our disciplined focus on underwriting sound credit risk and our proactive asset management has led to Onslow Bay's non-QM securitizations having the lowest delinquencies across the top 10 issuers in the market. And while the overall serious delinquency rate on the entire GAAP portfolio remains nominal at under 1.4%. And our resi business is very well positioned given the optionality of our ever-growing correspondent channel and our ability to manufacture high-yielding assets across all spread environments.

Now moving to the MSR business. Our portfolio ended the third quarter at $2.8 billion in market value, utilizing $2.5 billion in equity representing 21% of the firm's capital. Our MSR holdings, including unsettled acquisitions, were up modestly as we committed to purchase one bulk transaction comprising $125 million in market value, which we expect to close before year-end. And notwithstanding the 80 basis point decline in mortgage rates on the quarter, the valuation on our MSR portfolio decreased minimally to a 5.6 multiple, highlighting the durability of a portfolio that is 300 basis points out of the money.

Fundamental performance of the portfolio continues to be strong with a 3-month CPR of 3.9% and serious delinquencies are mere 45 basis points. Deposit income remains elevated given the shape of the curve and increased competition in the subservicing market should benefit financial participants like Annaly. And on the strategic front related to MSR, Annaly's long history of formulating value-add partnerships was again on display this quarter. As we announced a subservicing partnership with Rocket Mortgage in early October. Annaly's size and the stability of our capital helped develop this relationship, and we're pleased to be Rocket's first agency MSR sub-servicing partner.

Rocket is expected to begin servicing loans for us as early as December, and this collaboration should allow Annaly to benefit from Rocket's best-in-class recapture capabilities and we expect it to increase our competitiveness in purchasing new MSR. And similar to our existing subservicing agreements, our Rocket agreement allows Annaly to participate in the gain on sale of the loan refinanced helping to preserve and protect our portfolio. This new partnership in conjunction with our existing recapture agreements should allow Annaly to leverage best-in-class industry partners without taking on the operational leverage and earnings cyclicality of an originator.

Now lastly, as it relates to our outlook, we remain optimistic that our business model is well positioned with the Fed's cutting cycle now officially underway and the potential realization of a soft landing. We do, however, remain disciplined in our management of the portfolio concerning leverage, liquidity and duration exposure given the Fed's meeting-to-meeting dependence in the upcoming presidential election. We remain in a very attractive environment for Agency MBS given elevated investor inflows, a steeper yield curve and an improving technical backdrop.

Our Onslow Bay home loan correspondent channel has continued to bring in record volume and allows us to create proprietary assets not available to the broader market. Our ability to create industry-leading partnerships within MSR and our low gross WACC portfolio have created differentiated advantages. And collectively, we have all the pieces in place across our residential housing finance businesses to deliver stable returns as demonstrated by our 25% economic return realized over the past 2 years.

And now with that, I'll hand it over to Serena to discuss the financials.

[Serena Wolfe, executive]

Thank you, David. Today, I will provide brief financial highlights for the third quarter ended September 30, 2024. Consistent with prior quarters, while our earnings release disclosures GAAP and non-GAAP earnings metrics, my comments will focus on our non-GAAP EAD and related key performance metrics, which exclude PAA. As of September 30, 2024, our book value per share increased from $19.25 in the prior quarter to $19.54. Strong performance across all our businesses contributed to the realization of a 4.9% economic return, including our dividend of $0.65 for Q3. When added to our first half performance, we have generated an economic return of 10.5% year-to-date for 2024.

Lower interest rate volatility during the quarter combined with modestly lower treasury rates, resulted in gains on our Agency MBS portfolio of $4.30 per share. Our resi portfolio continued to add to book value, contributing $0.24 per share and lower rates adversely impacted MSR values for the quarter by $0.06. Together with the agency returns, these portfolio gains outpaced the losses on our hedging portfolio of $4.23 per share. Earnings available for distribution per share exceeded our dividend though decreased modestly in the third quarter compared to Q2, 2024, mainly due to an increase in share count and slightly higher preferred dividend expense. Due to our Series I preferred changing from fixed to floating as of June 30, 2024. That said, earnings available for distribution on an absolute basis increased on higher coupon income related to continued rotation up in coupon on the agency portfolio and additional yield provided by the securitization of the assets sourced through the Onslow Bay correspondent channel.

Consequently, average asset yields ex-PAA increased 11 basis points to 5.25% in Q3. Increased coupon income was partly offset by a marginal increase of 3 basis points in our economic cost of funds for the quarter. Average repo rates declined 3 basis points during the quarter, but were offset by higher securitized debt expense from the 6 securitizations that closed during the quarter. Our swap interest component benefited EAD as we actively managed the hedge book throughout the quarter during the rates market rally. Based on the earlier factors, our net interest spread ex-PAA, improved by 8 basis points to 1.32%. Our net interest margin ex-PAA declined by 6 basis points to 1.52%, primarily due to nuances in the calculation of NIM that are not apparent in NIM. For example, the impact of the higher denominator of average interest-earning assets in TBA notional and not an indicator of a decline in income from interest-earning assets.

Turning to details on financing. We continue to see strong demand for funding for our agency and nonagency security portfolios. Our repo strategy is considered with prior quarters with the book position around Fed meeting dates we look to take advantage of any future rate cuts. As a result, our Q3 reported weighted average repo days were 34 days, down 2 days compared to Q2. Today, we have maintained our disciplined approach to diversifying our funding options in our credit businesses.

We added $560 million of warehouse capacity for residential credit, which brings our total warehouse capacity across both credit businesses to $4.7 billion with a utilization rate of 40% as of September 30. Post quarter end, we implemented an additional MSR warehouse facility for $300 million, adding to our substantial availability. Annaly's unencumbered assets increased to $6.5 billion in the third quarter compared to $5.4 billion in the second quarter, including cash and unencumbered Agency MBS of $4.7 billion. In addition, we have approximately $900 million in fair value of MSR that has been placed to committed warehouse facilities, that remain undrawn and can be quickly converted to cash, subject to market advanced rates. We have approximately $7.4 billion of assets available for financing, up $1.1 billion compared to last quarter.

Finally, turning to expenses. Our efficiency ratios improved during the quarter due to lower other G&A costs and higher average equity balances. This resulted in our OpEx to equity ratio decreasing 10 basis points to 1.48% for the quarter. On a year-to-date basis, our OpEx to equity ratio remains in line with historical amounts at 1.46%.

That concludes our prepared remarks. We will now open the line for questions. Thank you, operator.

[Operator]

[Operator Instructions] And the first question will be from Richard Shane from JPMorgan.

[Richard Shane, analyst]

Look, the history of mortgage REITs suggests that the known risks are pretty manageable. It's the unexpected risks. It's when you think rates are going up and they go down. It's when you think rates are going down, that they go up that you get, you experienced the greatest turmoil. Fourth quarter has started with base rates going up, spreads widening, higher volatility. Can you tell us a little bit about how you're managing that and particularly in light of political uncertainty over the next 2.5 weeks?

[David Finkelstein, executive]

Rick, thank you. That's actually a good question to kick off the call here. So we came into the quarter with virtually no rate risk, as I mentioned in our prepared remarks. And if you look at our rate shots, that reinforces that notion. And our leverage was down a touch heading into the quarter. Now at the onset of the quarter, we got payrolls, which was certainly stronger than expected, and we proactively managed the portfolio selling roughly $2 billion in Agency MBS, given the pickup in ball and higher rates. And we've actively managed the rate risk as the market has sold off. We probably sold a little over $3 billion 10-year equivalents over the course of the month of October. But nevertheless, the portfolio has extended. We're operating at today, approximately half a year in duration, which we're perfectly comfortable with here, notwithstanding the election uncertainty.

When we take a step back and look at the rates market, here, we're sitting here today with 10-year real yields approaching 2% nominal yields on the 10-year 420, which is 135 basis points or thereabouts above the rest of the G7, which looks reasonable. OIS at 370 as a proxy for future short rates looks perfectly reasonable to us. And the 5-year note of 4% or just above 4% here, it looks fair. Now in the 340s, as we sat in mid-September, it looked certainly rich, and that's why we didn't carry any rate risk. Market is pricing, a terminal funds rate 50 basis points higher than where the Fed is at, which is a big reversal from where we were at before, and that's encouraging. We're respectful of the data, which has been quite strong. And so we understand the volatility that's materialized. And obviously, as you point out, the election is front and center. And it warrants maintaining a very conservative position.

Given that we sold mortgages, our leverage position has maintained -- we've maintained the leverage position. We feel good about it. And as we go through the next couple of weeks, we're going to be very disciplined about managing our rate and basis risk here because this is a big unknown. If we do get a red wave, then the points I made about market pricing, may look a little too optimistic, and we'll see where that -- how that plays out. But for now, we're keeping things close to home. We like our basis exposure and we're going to manage our rate risk here. Does that help?

[Operator]

The next question will be from Bose George from KBW.

[Bose George, analyst]

Can I start just with asking for an update on book value?

[David Finkelstein, executive]

Sure, Bose. Through Friday, we were off just a little over 1% in book value. That's pre-dividend accrual. If you consider the dividend accrual, it's roughly 0.5% off.

[Bose George, analyst]

Okay. Great. And then, I mean, in terms of dividend, I guess you've commented that you're comfortable through '24. Any -- are you ready to sort of discuss the outlook into '25, how you feel about the dividend?

[David Finkelstein, executive]

Well, as we sit here today, we feel good about the dividend. We're in a safe place here. We do expect to modestly earn a little bit more this quarter, the fourth quarter than in Q3. We expect our NIM to increase modestly. But look, we have to see how things play out. We need to understand the Fed's direction, the market's direction before we can really understand where the dividend is going. Obviously, there's been dividend increases over the course of the last number of months in the sector, but a lot of that was coming from very low levels to get to not so low levels and some others that were essentially approaching or contextual with our dividend currently.

But 13.5% roughly a dividend yield on book, I think, 13.3%. It's a solid return and we're much more focused on economic return and making sure that we can deliver the dividend. And as the market and policy plays out heading into 2025, we do certainly recognize that the Fed's posture provides a tailwind to a lot of aspects of our business and certainly EAD, and we're hopeful that we do get the cuts that are priced in, and we'll see how it goes.

[Operator]

And the next question is from Doug Harter from UBS.

[Douglas Harter, analyst]

Can you talk about how you're thinking about equity allocation, capital allocation to the 3 businesses and kind of how different rate scenarios might change your appetite for that capital allocation?

[David Finkelstein, executive]

Sure. And look, as I noted in my prepared remarks, all 3 of our businesses weren't growing. We can generate good returns across the 3 businesses. But right here, given where we're at in the cycle at the beginning of sequence of rate cuts, agency does look the best. Now we understand volatility is high, but spreads are considerate of that and the technicals in the agency market have become much more supportive. So at the margin, agency looks a little bit better. And you can see that in our capital allocation at quarter end as we raise capital, the vast majority did go into the agency sector.

Now we do want to get the resi credit business higher, certainly. We'll have to see how originations materialize. But when you look at the returns in that business, through securitization from loans acquired through our correspondent channel, we want to keep growing that, and we expect to do so, but we got to be responsible at credit or with respect to credit here at this point in the cycle. So we feel like we can keep that engine going. And then in MSR, that does tend to be episodic. We, again, would like to grow it, and we'll see the extent to which packages do come to market, and we'll be certainly aggressive as that materializes. But at the margin, agency is where the marginal dollar is going, and we'll keep it balanced overall, though.

[Douglas Harter, analyst]

I guess just on your comment that all 3 businesses kind of warrant an investment, with that comment, how do you think about continued capital raising in this environment?

[David Finkelstein, executive]

Sure. Look, as we've always said, we'll only raise capital if it's accretive and if assets are priced appropriately. So to the extent that, that -- those stars line up, we'll consider it. But we are -- we have ample liquidity. If you look at where our liquid box is, as Serena mentioned, $4.7 billion in Agency MBS cash. We don't need to raise capital. A lot of the justification in our minds for the capital raise was obviously accretive in assets, but also the ability to generate more scale for these businesses without impacting our operating expense ratio. And we feel like we have greater resources now to be able to make investments in things like technology as well as broadening the correspondent channel and the resi efforts and other things to where we feel good about capital raising because I'd characterize it as offensive scale.

We're clearly fully skilled across our businesses, and we are among -- we are the most efficient for anybody who has this broad of a business mix in the market running these 3 businesses is about 150 basis points of OpEx to equity. But it does help to raise equity so that we can make the appropriate investments to generate more initiatives that will ultimately benefit the shareholder over the long term. So that's just a little thought -- a little of our thought process around raising capital. We don't need to. But if the market is telling us to do so, we'll consider it.

[Operator]

And the next question is from Jason Weaver from JonesTrading.

[Jason Weaver, analyst]

David, and maybe Mike can provide some input to. I was wondering if you're seeing anything in the securitization data out there just given your visibility that might indicate any kind of early stress like first-time delinquencies, slow pays, grace period maximization?

[Michael Fania, executive]

Yes. Jason, this is Mike. Thanks for the question. I think in terms of the -- a lot of the commentary around the consumer, it's more focused on the lower end consumer, the low to medium income borrower. That's not consistent with the type of borrower that we're lending to. So if you look at non-QM 15, the latest transaction that we priced that average loan size is $495,000 on 68 LTV, that's $730,000 property value. Our average borrower makes about $250,000 per year.

So when you think about the type of borrowers we're lending to, it's very sophisticated self-employed borrowers, it's professional real estate investors. We are not necessarily seeing that stress that other products are seeing like credit cards, like that lower-end consumer like subprime auto. You're not seeing within the portfolio. David mentioned it earlier in the call, but the D60+ of our entire portfolio, it's 137 basis points. And when we look at just the non-QM, the DSCR part of the portfolio, it's around 2%. So I think we feel very good with the type of credit that we're originating and the borrowers, specifically that we're targeting.

[Jason Weaver, analyst]

That's helpful. And I'm wondering more in a macro sense, just seeing if there's any persistence into that higher level credit quality. But it sounds like not. And then going back to your remarks on the Rocket partnership, I think you had mentioned seeing some greater competition among subservicers. Should we take that to expect any better pricing on subservicing expense or any change in the economics that are more favorable to Annaly when that product comes online partnership?

[David Finkelstein, executive]

Yes, sure. Jason, we'll have Ken on that one.

[Ken Adler, executive]

Jason, thanks for the question. In short, absolutely, as MSR, as there's been substantial MSR trading in the last few years, the amount leaving sub-servicers and going to owners who service their own loans has been material. So there's been a contraction in the share of overall mortgage servicing rights handled by subservicers and that's created a lot of competition in the market. So we are seeing lower pricing and better economic.

[Operator]

And the next question is from Eric Hagen from BTIG.

[Eric Hagen, analyst]

So when we look historically at the portfolio, the book value has been consumed by a higher bond premium. I think at 1 point, the premium in the agency portfolio was like 1/3 of book value versus now the premium risk is a lot more dialed down, and so the prepayment exposure might be characterized a lot differently on the balance sheet. Do you feel like that, in any way, drives your philosophy around leverage and capital allocation versus how you've managed in the past and how we should expect you guys to manage going forward?

[David Finkelstein, executive]

Well, certainly, the convexity profile of the agency portfolio is going to inform how we think about leverage. Right now, the agency average coupon, I think, is about 495. So we're below par. We have methodically gone up in coupon, as I talked about. And the convexity obviously has -- convexity exposure has increased, and it's now off a little bit or it's now a little bit better with the selloff, but nevertheless, it is a consideration. And Srini feel free to elaborate on how we think about it from the overall managing the portfolio -- the agency portfolio standpoint.

[V.S. Srinivasan, executive]

Yes. I mean, to a large extent, we have gone up in coupon, but we have stayed in fairly high-quality specified pools as David alluded to in his opening remarks about 70% of our portfolio is in high-quality pools. So we don't have the same amount of duration drift that you would have if you are in lower quality -- if you're in generic pools. So given that the dollar price are generally higher for the quarter as rates rally, and the durations are lower, which means your hedging costs or your -- the amount of hedges you need against them is lower, it creates more liquidity.

[Eric Hagen, analyst]

Okay. That's helpful. Yes, that was a helpful explanation. Returning to the non-QM a little bit. You guys have been really active there. I mean how do you think that portfolio maybe benefits from the Fed cutting rates? And do you think lower rates will catalyze originators to create more non-QM?

[David Finkelstein, executive]

We certainly hope so. We've been pretty happy with the growth of the correspondent channel as obviously, we discussed in the prepared remarks. Presumably, if you do get lower rates, it will spur more housing activity and certainly should benefit to non-QM. Oftentimes, the originators are in a lower rate environment, more focused on the agency market, but it feels like the market is in a healthy place and could grow as rates do come down.

[Eric Hagen, analyst]

Yes. And with respect to the back book, I mean, how do you feel like the back book of non-QM might benefit from the Fed cutting rates since it's a fixed rate portfolio?

[Michael Fania, executive]

Yes. About -- Eric, this is Mike. About 85% of the portfolio is fixed rate, but we do look at that portfolio on a hedge basis. We're hedging that on a macro level with the MSR portfolio and with the agency portfolio as well. I do think that the majority of investors look at non-QM in terms of the AAA investors down to the BBB. They're looking at it on a spread basis and not necessarily a yield basis.

So I think to the extent that rates do rally and there's a realization of these Fed cuts, I think it does put origination volumes up. Hopefully, it puts non-QM securitization volumes higher. And from a spread perspective, we do think once we get past some of these fall events, specifically the election that spreads could continue to tighten. So I think it's a conducive environment for us to the extent the Fed does ease as kind of the market predicts and you do see a little bit rally from here in rates.

[Operator]

The next question will be from Harsh Hemnani from Green Street.

[Harsh Hemnani, analyst]

Maybe in light of the Rocket Mortgage partnership and also perhaps the desire to grow the MSR book into the end of the year. Could you comment on how you're viewing relative value between sort of the higher coupon MSRs but with recaptured opportunities versus the lower coupon MSRs that are currently in the portfolio?

[David Finkelstein, executive]

Yes, absolutely. Look, recapture, it's absolutely a component of valuation. And with the Rocket partnership, that's just another addition to our portfolio of recapture and subservicing partners. We're excited about the opportunity, given their leading customer retention rates and customer satisfaction. It's also been great to work with the Rocket team. Each of our partners has differing strategies and approaches to subservicing and recapture. So they are part of our portfolio, and we're prepared to opportunistically bid on the higher note rate or the lower note rate and building on our infrastructure just adds to this capacity.

[Operator]

The next question is from Jason Stewart from Janney Montgomery Scott.

[Jason Stewart, analyst]

I wanted to pull together the concept of offensive capital raising leverage in the election. And maybe if you could, David, put a pin in whether that's a signpost that would lead you to take leverage up? Or there other issues that you're looking at? And if you could just pull those 3 together for us and then maybe another signpost to take leverage up and how you're thinking about those?

[David Finkelstein, executive]

Yes. So as it relates to raising capital, that's a better alternative been taking leverage up in our mind right now. The way we look at it is if you really like Agency MBS you don't need to raise capital, you raise leverage. We do like Agency MBS, but it was more advantageous to raise capital than to lever up because of all these all events on the horizon. Now if we fast forward a couple of weeks and we get an outcome on the election imminently after Tuesday, 2 weeks from now and the market calms down, we could certainly take leverage up because mortgages have cheapened about 4 to 5 basis points thus far in the quarter.

They look perfectly reasonable, but wall is high, and we have to be respectful of it. And we don't need to take leverage up. We're certainly earning an adequate return. But if we feel like there's a tactical opportunity or even more intermediate-term opportunity to do so, we certainly have the capacity to do so, but we've got to see how things play out.

[Operator]

The next question is from Don Fandetti from Wells Fargo.

[Donald Fandetti, analyst]

Can you talk a little bit about your sort of view on Agency MBS spreads. I mean I think they're still a little wide versus historical and the bull case is that maybe the banks come in and you could see some tightening. Do you subscribe to that? Or are you sort of more thinking we're range bound for a while?

[Sean Kensil, executive]

So just stepping back, the big picture is that monetary policy that has been restrictive for a while has -- is now normalizing along with labor markets and inflation. So from a fundamental perspective, I think you're likely to see the yield curve steepen up and interest rate volatility decline, all of which are positive for Agency MBS. And what you alluded to, the supply-demand technicals are better today than any time since 2022. Banks, which shed about $200 billion in 2023 have modestly added to MBS this year.

So looking forward, I think if the Fed cutting cycle continues as we expect or as the Fed expects we should see an increase in bank demand, and we should also see foreign buyers coming into the Agency MBS market. So the technical also looks pretty good for the Agency MBS market. So we've been trading -- put some numbers on it. We've been trading in the 115 to 145 range -- basis point range current coupon spread to blended treasury curve for the last 4, 5 months.

And I think as we get past the election and volatility subsides, we could see that spread tighten to 110 to 130 basis point range. What we don't expect is that we'll go back to spreads, we saw pre-COVID which was closer to, say, 65 to 85 basis points when both the price with the Fed were actively involved. I think we will remain wide of those levels, but we could definitely tighten another -- the range has moved down by 10 to 15 basis points from where we are today.

[Operator]

[Operator Instructions] The next question is from Trevor Cranston from Citizens JMP.

[Trevor Cranston, analyst]

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

[Michael Fania, executive]

Sure. Thanks, Trevor. I would say that we actually think it's a little bit of the opposite where entities that have fully scaled platforms with dedication of significant resources are in a really good spot right now. With where we're at, if you include October, we've already funded $9 billion of loans year-to-date. Now when you look at the market, it is hard to put a pin in what the actual origination volume is within non-QM and DSCR. But we think we're anywhere at a 10% to 15% market share. The market share that we're experiencing continues to increase. A lot of that is signing up new correspondents. We're signing up about 15 correspondents per each quarter. We've started to roll out additional originator tools, the ability to underwrite bank statement income. A lot of the capital raise that David talked about, we're putting a lot of those resources towards helping improve the velocity of funding loans.

So I would say, it's actually a little bit of the opposite, Trevor. Like we actually feel is that we continue to gain market share and the margins that we're putting out on a daily basis where our rate sheet are increasing. So while you'll certainly always have participants and asset managers that want to participate in this product, without the extensive architecture that we put in place, without the infrastructure, the ability to phase 240-plus correspondents, it's hard to buy those assets at the same pricing that we have. So I think we've been ahead of the game. We launched this correspondent in 2021. We've been buying non-QM loans since 2016, 2017. So I think we've identified the opportunity a lot earlier than others, and I think we feel really good with kind of where we're at.

[David Finkelstein, executive]

Yes. And then I'll just add, Trevor, there are huge barriers to entry in this space. We've -- Mike said, we started the correspondent channel in 2021. We've been in non-QM since around 2016. And we've been consistent, and we've been a durable partner to a lot of the originator community through COVID. We funded everything we committed to in 2022, as volatility hit in capital markets efforts amongst originators, we're in a precarious position. We were there for them. And as a consequence we have established very deep relationships in the originator community. Our infrastructure is as good as anybody's. We provide white glove service to our partners, and we have the distribution through our securitization brand that leads to very competitive spreads. And as a consequence, the originator community gets better pricing and more durable commitments from us. So we feel like we're in a good place.

[Operator]

And ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the conference back over to David Finkelstein for any closing remarks.

[David Finkelstein, executive]

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

[Operator]

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