Annaly Capital Management Inc

NYSE:NLY

Earnings Call Analysis

Firm Thrives Amidst Market Turbulence

In a year rife with unpredictability and risk events, the firm showcased the robustness of its diversified housing finance model with a 6% economic return, bolstered by a strategic approach that resulted in a 10.1% return for the last quarter alone. This was achieved amidst a decrease in economic leverage to 5.7 turns. The company adeptly capitalized on shifts in yields and moderation of inflation, optimally reconfiguring its portfolio by favoring residential credit and mortgage servicing rights (MSR) over agency investments, which contracted to 62% of dedicated equity. The increased value of its portfolio, specifically its agency and residential credit investments, and an active mortgage servicing rights market led to a robust financial position with substantial liquidity, allowing the firm to remain poised for future opportunities.

Overview of Annaly Capital Management's Fourth Quarter 2023 Earnings Call

Annaly Capital Management's earnings call provided insights into the final quarter of 2023, touching on broader market conditions, the performance and strategy of their portfolio, and a look towards the upcoming year. The narrative began with optimism tied to the Federal Reserve's signals of a conservative approach to its balance sheet, which may influence liquidity in the financial system. Reflecting on a strong economy and a housing sector that overcame expectations despite high mortgage rates, the company is hopeful for the year ahead, particularly citing a resilient labor market and consumer base as key pillars of their positive outlook.

Portfolio Adjustments and Performance

Annaly's portfolio saw significant activity throughout the quarter. They reallocated investments from agency securities to residential credit and mortgage servicing rights (MSR), with the latter growing nearly 50% in value across 2023. Their disciplined approach to agency portfolio management enabled them to weather spread widening and market volatility effectively, leading to a year-end composition where 62% of equity was dedicated to the agency strategy, reduced from 64% in the previous quarter. Moreover, the residential credit market presented opportunities for growth through securitization strategies and direct sourcing of high-quality loans, contributing to a 14% year-over-year increase in the residential portfolio.

Market Trends and Predictive Adjustments

The call indicated that Annaly is very hopeful for fixed income and mortgage-backed securities (MBS) in 2024, anticipating tighter spread ranges compared to previous years, especially as the Fed leans towards easing monetary policy. Despite economic shifts over the past year and banks reinvesting over $200 billion in MBS paydowns in the fourth quarter, confidence remains in the sector's potential, especially if the investment trend continues throughout 2024. The context of banks' activities and the capacity for additional investments in MBS create a constructive perspective on agency spreads for the coming year.

Dividend Sustainment and Financial Outlook

The company resolved to maintain its current dividend level, having modestly outearned it in the fourth quarter, and expects earnings available for distribution (EAD) to align with dividend commitments. Return estimates have been moderated in light of recent market tightening, yet the sentiment remains positive with an outlook that foresees no immediate adjustments to the dividend. The assessment of core earnings power and returns will continue to shape the approach but remains optimistic for the into 2024.

Leverage Approach and Market Adaptability

Annaly maintains a conservative stance on leverage, influenced by recent market volatility and the strategic weight given to different asset classes within their portfolio. Commitment to nurturing a balance between agency, residential securities, and MSRs guides their leverage strategy, granting flexibility to benefit from market improvements or protect against downside risks. Annaly is poised to harness rate cuts, liquidity strength, and global market stability as triggers to adjust leverage, with a focus on capitalizing on spreads and asset attractiveness in a dynamic environment.

Earnings Call Transcript 2023-Q4

[Operator]

Good day, and welcome to the Fourth Quarter 2023 Annaly Capital Management Earnings Conference. Please note that today's event is being recorded. I would now like to turn the conference over to Mr. Sean Kensil, Director and Investor Relations. Please go ahead, sir.

[Sean Kensil, executive]

Good morning, and welcome to the Fourth Quarter 2023 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 fourth quarter 2023 investor presentation and fourth quarter 2023 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, and thanks for joining us today. I'll begin with a brief review of the fourth quarter market environment and our portfolio performance then discuss the current macro landscape, followed by an update on our businesses and our outlook for 2024. Serena will then discuss our financials before opening up the call for Q&A.

Now as all are aware, fixed income markets exhibited considerable volatility in the fourth quarter, as evidenced by the 10-year treasury trading in a 120 basis point range, peaking at 5% in mid-October before rallying throughout November and December. The second half of the quarter prove beneficial to mortgage assets as implied volatility declined.

The yield curve modestly steepened and agency spreads tightened meaningfully. We were well positioned to take advantage of this environment, delivering a 10.1% economic return for the quarter, and we outearned our dividend with earnings available for distribution of $0.68 per share. And we achieved these results with lower economic leverage, which declined to 5.7 turns at the end of the quarter.

And as we reflect on 2023, we are pleased to have generated a 6% economic return in a year characterized by numerous unforeseen risk events. We believe that our performance on the year demonstrates the value of our diversified housing finance model and our disciplined portfolio and risk management.

Now turning to the macro environment. The primary driver of the strong demand for fixed income since November can largely be attributed to a shift in the Federal Reserve's communications, moving away from the higher for longer narrative, beneficial began to express comfort around the decline in inflation, suggesting that risks around the monetary policy outlook are more balanced.

Normalization of policy is likely to begin in 2024, as long as inflation continues to moderate. And while not declaring victory just yet, as evidenced by Chair Powell's recent statements, policymakers are keen to ensure that a soft landing can actually occur. Powell also highlighted that future balance sheet discussions will occur in the upcoming March meeting, noting policy rates and the potential tapering in the balance sheet as independent tools.

And while existing financing conditions remain ample, we're encouraged that the Fed appears to be signaling a conservative approach with regard to its balance sheet and liquidity in the financial system. Now a second factor leading to the decline in yields in the fourth quarter is the change in debt issuance dynamics as the treasury chose to issue incremental supply in the front end of the yield curve, taking advantage of the record amount of cash in money market funds, while exerting less pressure on longer-term yields. Now the broader domestic economy remains strong with Q4 GDP at 3.3%, the unemployment rate at 3.7% and consumers still exhibiting spending strength.

Inflation, meanwhile, has moderated meaningfully and absent a shock core PCE should benefit from base effects to bring year-over-year measures towards 2.5% in the coming months. Now looking at the housing sector, home prices outperformed the market's expectations over the last couple of years despite mortgage rates reaching 20-year highs. HPA has continued to benefit from existing homeowners experiencing lock-in effect, resulting in low available-for-sale inventory as borrowers, who struck below current market mortgage rates are unwilling to move or trade up.

Housing activity remains subdued, although we have seen modest signs of an uptick in demand following the recent decline in mortgage rates. And all told, we're constructive on the housing sector should the labor market and the consumer remain resilient and in line with the soft landing scenario. Now shifting to our portfolio and beginning with the agency sector. Much of our agency reduction occurred at the very outset of the quarter, which left us well prepared for the spread widening and volatility the market experienced as October progressed. And as volatility subsided and spreads normalized, we rotated out of lower coupons in TBAs and in the higher coupon specified pools.

We remain disciplined in our selection of specified pool stories favoring high-quality prepaid protected securities, which represented the vast majority of our higher coupon purchases. In addition, we opportunistically grew our Agency CMBS holdings by $1.2 billion as the sector did lag the move tighter in Agency MBS locking in attractive spreads and increasing the portfolio size to $3.2 billion in market value. Fixed rate Agency CMBS is a complementary asset to our agency portfolio as it provides a high-yielding, stable cash flow with minimal convexity exposure.

Our agency strategy overall represented 62% of our dedicated equity at quarter end, down from 64% the quarter prior as we further reallocated out of agency in favor of resi credit and MSR late in the quarter. As it relates to our hedges, our balanced liability position helped protect us from the elevated rate volatility experienced during the first half of the quarter. One adjustment we did make tactically, however, was we rotated from treasury futures into SOFR swaps at the very front end of the yield curve given the particularly tight level of swap spreads experienced in the year-end.

And overall, we remain conservatively positioned as it relates to our rate exposure as seen through our 106% hedge ratio and rate shock tables. However, given the changing policy landscape, we may reach a point, where we'll begin to feel more comfortable adding duration of the portfolio in the near future. And as we begin 2024 with the Fed's pivot to a more neutral monetary policy, the distribution of future rate path has narrowed which has resulted in a decline in implied volatility.

We'll likely see rate cuts materialize as we approach midyear, which historically have been a catalyst for inflows in fixed income funds. And furthermore, an earlier end to QT should help stabilize deposits, which, along with incremental regulatory clarity, should support bank demand. In coincident with these improving technical factors, MBS are at historically attractive spreads, particularly relative to fixed income alternatives, while convexity and prepayment risk in the market remains relatively low.

Now turning to the residential credit market. The non-Agency sector participated in the broader fixed income risk on sentiment to end the year with AAA non-QM spreads, 20 basis points tighter and below investment-grade CRT, 60 basis points tighter quarter-over-quarter.

Our resi portfolio ended the year at $5.7 billion in market value, up 14% year-over-year and currently comprises 20% of the firm's capital. The growth in the portfolio can be attributed to our organic whole loan acquisition and Onslow based securitization strategy. And the OBX retained portfolio and whole loan position now account for roughly half of the total resi portfolio assets. Residential whole loan acquisitions continue to be strong in Q4 as we settled $1.8 billion in loans of which $1.6 billion was sourced directly through our correspondent channel.

Lock volume was robust in the fourth quarter at $2.7 billion, a 13% increase quarter-over-quarter despite winter seasonals. In our quarter end correspondent pipeline was $1.6 billion with strong credit characteristics as demonstrated by a 748 FICO and 70% CLTV. And since the beginning of the fourth quarter, we securitized 7 OBX transactions for $2.8 billion, inclusive of 3 transactions priced subsequent to quarter end, and these securitizations generated $290 million of assets that projected mid-teens returns, utilizing modest recourse leverage.

Onslow Bay continues to be a leader in the residential credit market as we remain the largest non-bank securitizer and second largest overall over the past 2 years. In addition, we have the lowest delinquency rates across the 10 largest non-QM issuers. And also to note, we were just able to sell the tightest new issue AAA bond executed in 2024 year-to-date. And our correspondent channel remains our preferred investment option within residential credit, allowing us to organically manufacture assets while maintaining control over pricing, our partners, diligence, credit and volume.

Now shifting to MSR. Our portfolio increased by 18% or $400 million in market value in the fourth quarter through the purchase of 3 bulk packages in addition to modest flow acquisitions. And our MSR portfolio, inclusive of forward settling trades increased nearly 50% throughout 2023 to end December at $2.7 billion in market value making Onslow Bay a top 10 nonbank owner of servicing rights.

The MSR market had an active Q4 with bulk transactions up modestly quarter-over-quarter, capping a record 2023 that saw over $800 billion in principal balance trade. Annaly was able to capitalize on this significant supply, and we were the fifth largest buyer in the market, onboarding $42 billion in principal balance throughout the year. And consistent with our previous commentary, we continue to favor low note rate, high credit quality collateral and given the lack of refinance incentive, the portfolio is exhibiting highly stable cash flows and historically low prepayment speeds.

The MSR portfolio had a 3-month CPR of 2.9% as of December approximately 40% lower than the MBS universe. And with our unique positioning in the MSR market as a preferred partner to originators in light of our scale and certainty of capital, we've been able to establish new relationships and expand our footprint. In particular, we've started to add flow sourcing partnerships, which we have begun selectively purchasing through this past quarter. And while low no rate collateral still our preferred segment of the MSR market. We expect these flow relationships to add a source of more predictable supply.

Now looking ahead, we anticipate the MSR market to be active this year, those sales may moderate from 2023's elevated levels. And we continue to be well positioned to add MSR with ample warehouse capacity, minimal leverage and a desire to continue to allocate capital to this strategy. Now to wrap up before handing off to Serena, I wanted to note that as always, we're cognizant of the risks on the horizon, and we remain prepared for additional market turbulence and vigilant as the operating environment evolves.

That said, we're optimistic with respect to our outlook for each of our 3 businesses, and we believe that our 3 complementary fully skilled strategies should continue to provide Annaly's shareholders superior risk-adjusted returns a strong earnings profile and stability across different interest rate and macro environments. And with substantial liquidity, improving leverage, we remain ready to take advantage of opportunities, where we believe capital will be most accretive.

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 fourth quarter and select year-to-date metrics for the year ended December 31, 2023. Consistent with prior quarters, while our earnings release discloses GAAP and non-GAAP earnings metrics, my comments will focus on our non-GAAP EAD and related key performance metrics, which exclude PAA.

As David mentioned earlier, 2023 was a year filled with substantial volatility, and our team managed the markets admirably, finishing the year strong, as demonstrated by our results for the quarter and full year. Our book value per share at year-end increased from the prior quarter to $19.44. And with our fourth quarter dividend of $0.65, we generated an economic return for the quarter of 10.1% and 6% for the year ended December 31, 2023.

In November and December, we experienced the investor of the prior quarter with a sharp rally in rates and strong performance of mortgage-related assets, which led to a net book value contribution of $6.74 per share from our Agency residential credit and MSR portfolios.

These investment gains outpaced the losses on our hedging portfolio of roughly $5.56 per share. Earnings available for distribution increased compared to the third quarter by $0.02 per share to $0.68 for the fourth quarter. EAD benefited from a higher coupon on investments and lower repo expense due to lower average balances despite higher average repo rates, partially offset by a lower net interest income on swaps and certain positions rolled off with favorable net receive rates.

David referenced our continued rotation up in coupon in Agency MBS. We also saw an increase in weighted average coupon for our residential credit investments. Altogether, this portfolio positioning continues to provide increased yields as average yield ex-PAA rose again quarter-over-quarter, 18 basis points higher than the prior quarter at 4.64%. Similarly, NIM followed the same trajectory as EAD for the quarter with the portfolio generating 158 basis points of NIM ex PAA, a 10 basis point increase from Q3.

Net interest spread increased 4 basis points quarter-over-quarter at 122 basis points compared to 118 basis points in Q3 as agency yields increased at a higher rate than repo rates, net of swap interest. The total cost of funds continue to increase quarter-over-quarter, albeit at a reduced pace in comparison to prior periods, rising 14 basis points to 3.42% for the quarter. Meanwhile, our average repo rate for the quarter was 556 basis points compared to 544 basis points for the previous quarter. Despite this increase, our total economic interest expense was only up marginally at $665 million compared to $652 million in the prior quarter, primarily due to the decrease in average repo balances from $66 billion to $62 billion.

As noted above, our swap impact on the cost of funds further normalized due to the maturity of specific contracts, resulting in the net interest component of interest rate swaps declining by $15 million, which negatively impacted our cost of funds by approximately 4 basis points.

Turning to details on financing. Notwithstanding modest pressure we have noted in funding markets around quarter end. Funding markets remain ample and liquid. We continue to see strong demand for funding for our Agency and non-Agency security portfolios. And while we keep an eye on RRP volumes and treasury supply, we acknowledge that the Fed is very focused on liquidity and funding markets. Our repo strategy is consistent with prior quarters, and our Q4 reported weighted average repo days were 44 days, down from 52 days in Q3. Due to the roll down of longer-term trades completed in prior quarters.

Our treasury team continued to source additional funding options for our credit businesses and had another busy quarter, focusing on expanding warehouse capacity and achieving competitive financing terms for existing and new warehouse lenders. During the quarter, we upsized our committed MSR financing by $500 million and renewed a $400 million residential whole loan facility, incorporating a non-mark-to-market supplement. As of December 31, 2023, we have $3.6 billion of warehouse at a 38% utilization rate, leaving substantial capacity.

Market fundamentals for the quarter aided our liquidity profile with unencumbered assets of $5.2 billion compared to $4.7 billion in Q3 including cash and unencumbered agency assets of $3.8 billion, an increase of $1 billion compared to the prior quarter. In addition, we have approximately $1 billion in fair value of MSR that has been pledged to committed warehouse facilities that remain undrawn. Together, we have roughly $6.2 billion in assets available for financing. Our disciplined approach to financing our credit businesses and prudent risk and cash management strategies have resulted in a very comfortable liquidity position to end the year.

And lastly, despite continued growth in our operating businesses during 2023, we efficiently managed our expenses, resulting in an OpEx-to-equity ratio of 1.42% for the year compared to 1.4% for the year ended December 31, 2022. That concludes our prepared remarks, and we will now open the line for questions. Thank you, operator.

[Operator]

[Operator Instructions] And the first question will come from Bose George with KBW.

[Bose George, analyst]

Just wanted to start with the question just about the sort of the best place for allocating new capital. You seem to lean into credit a little more. Just curious if you could see that continue in 2024.

[David Finkelstein, executive]

Sure. Yes, we could see that continuing. I think one of the points we noted is just the acceleration in activity in the conduit channel and ultimate financing through securitization. So we do feel good about growing the credit portfolio, primarily through the Onslow Bay channel, and we'll look for more opportunities to do so.

I think the market share that Mike has captured as it relates to the non-QM market, I think it's been impressive. We had our highest lock volume and purchase volume last quarter in a quarter where origination declined. So we feel really good about it, and we would expect to increase capital towards that effort.

[Bose George, analyst]

Okay. But just in terms of incremental ROEs, are they still a bit better in the agency versus that channel? Or how does it compare?

[David Finkelstein, executive]

Well, agency has a better headline ROE, but you got to consider volatility and the overall capital allocation and still makes sense on a risk-adjusted basis to continue to rotate further into both resi and MSR on a risk-adjusted basis.

[Bose George, analyst]

Okay. Great. And, can I get an update on book value quarter-to-date?

[David Finkelstein, executive]

Sure. We actually just closed the books for January yesterday. So had a good month end number for you, which was up 2%. Rates have drifted a little bit higher over the last couple of days. So we've softened a bit since then, but nothing to write home about.

[Operator]

The next question will come from Crispin Love with Piper Sandler.

[Crispin Love, analyst]

First, can you just update us on your outlook for agency spread just given the significant tightening we've seen since -- over the last several months, so curious on your view there on potential spread ranges with rate cuts likely coming in mid-'24 and hopefully, a less volatile rate environment here?

[David Finkelstein, executive]

Sure, Kristen. -- we'll let Srini fill that one.

[V.S. Srinivasan, executive]

[indiscernible] spread that 150 basis points over the branded treasury curve was materially tighter than the ones we saw in 2023. But the economic environment is also very different. David had mentioned that the Fed is most likely going to ease monetary policy in 2024. They are also going to pay sub duty. And through the first 3 quarters of 2023, bank shed about over $200 billion in MBS. And in the fourth quarter of 2023, they reinvested all of their paydowns.

Our base case here is that they will continue to reinvest paydowns in 2024. And there's potentially some upside that's been like add MBS in the second half of the year. So overall, they are pretty constructive on Agency spreads. Absent the [ no-analytic ] scenario where the Fed is forced to hike rates again, we do not expect MBS spreads to get back to the rise that we saw in 2023. Overall in 2024, I think MBS spreads would trade the tighter range than they did in the last couple of years. And MBS has underperformed other fixed income asset classes for 2 years in a row, and we are very hopeful that in 2024, they will outperform.

[Crispin Love, analyst]

And second question for me. Just can you speak to how you're thinking about the dividend level right now and sustainability in the current environment. You lowered your return assumptions across your strategies in the presentation. So curious how that plays into how you think about the dividend level and core earnings power and returns relative to the $0.65 quarterly dividend?

[David Finkelstein, executive]

Sure. We did moderate those return estimates given the tightening that did occur later in the quarter. But look, Chris, we outearned the dividend modestly in the fourth quarter as it relates to the first quarter here. We do expect EAD to be contextual with the dividend, which we feel good about. And at this time, our view is that it's not our recommendation to the Board to make an adjustment to the dividend. We'll see how things progress throughout the rest of the year, but we feel good about this quarter.

[Operator]

The next question will come from Doug Harter with UBS.

[Douglas Harter, analyst]

Can you talk about kind of what the target leverage level would -- can be going forward kind of given your current mix of assets?

[David Finkelstein, executive]

Sure. Look, obviously, our overall leverage is going to be a function of capital allocation and the decline in leverage is attributable to some extent, a lower weighting to agency, but also the fact that, look, we're -- when we look at the market, and what we've recently experienced, volatility is something that could persist for a little bit longer. We're still kind of living underneath the lion's bar as it relates to risk events in the market. And so we're playing it very conservatively. But the good news is we're able to earn a good return with the current level of leverage.

So to sum it up, we're comfortable with where we're at here. Our overall leverage is going to be a function of reallocation into either RESI or MSR, and we feel good about where we're at. We're not of the mindset immediately to increase leverage nor really take it down.

[Douglas Harter, analyst]

I guess just a follow-up on that, David, kind of what are the types of events or markers you're looking for that would kind of cause you to feel comfortable taking leverage up. And I guess, how do you balance that with by the time you get those all clears, maybe spreads aren't as attractive and then you're leveraging less attractive assets. So I guess, how do you balance that? And what are the signposts you're looking for?

[David Finkelstein, executive]

Sure. give us rate cuts, give us the end Q2, give us stability around the world, and we'll certainly raise leverage. But look, at the end of the day here, if you look at our spread shocks, we do experience spread tightening, we're still going to get very good returns as we saw in the latter half of last quarter. Just in terms of the overall model, we are generating a more stable return with less leverage than what a monoline agency firm would deliver. And we feel very good about it.

Now to the extent there are some real green shoots out there as it relates to volatility in the market, yes, we could increase leverage, if spreads are attractive. And to the extent that we get a widening in spreads, we have ample liquidity and the balance sheet to allow leverage to organically increase without having to worry about selling to manage our leverage.

So it's a really good position to be in right here, Doug. But to the extent things do change for the better, and the market is priced to that soft landing scenario. It's priced to perfection across all assets, possible exception of some mortgage-related assets. So we're a little bit cautious here, but that could change.

[Operator]

The next question will come from Jason Weaver with Jones Trading.

[Unknown Analyst]

I'm just going to dovetail off Bose's question with a bit of refinement. I was wondering, can you ballpark the incremental ROE range for new deployment across both agency and residential credit today?

[David Finkelstein, executive]

Yes. I think we'll go around the room here, but in agency, we do get mid-teens returns, upper teens returns on specified pools, for example, moderate loan balance production coupon pools to the extent we can find them, there are some scarcity, but you can get upper -- upper teens in those assets. And then, Mike, do you want to give a little rundown on the resi front?

[Michael Fania, executive]

Sure. Jason, this is Mike. In terms of securitization, the organic whole loan strategy, we'll say that's, call it, mid-teens using a modest amount of recourse leverage. Within the security part of our portfolio called CRT, that's probably high single digits on, call it, 2 turns of leverage for below IG [indiscernible]. And then in terms of NPL, RPL, what we'll say it's low teens on, call it, 3 turns of leverage. So the majority of our capital deployment within resi has been in the whole loan and OBX strategy given those returns.

[David Finkelstein, executive]

And actually Ken, would you give a little color on MSR as well?

[Ken Adler, executive]

Yes. I mean the MSR market is providing like -- and we put it in the book around 10% to 12% return. Now those returns are a little bit lower because we do not employ material amounts of leverage on that strategy at this moment. Now we have the liquidity line, the ability to lever that asset and drive those returns higher, but managing it with the context of the entire portfolio, that return is additive to the above target.

[David Finkelstein, executive]

Yes. And Jason, just to add to that on MSR, we're running our portfolio at 0.4 of a turn of leverage. And given the low note rate nature of it and how benign the cash flows are, it could be levered to a greater extent. But if you think about it, the agency portfolio is doing some of that levering for it. And so if you consider the benefit of that, then that gets those returns up into the teens.

[Unknown Analyst]

All right. That's actually very helpful. I know, David, you said in your prepared remarks about the shifting from treasury-based hedges over to SOFR swaps. Obviously, we've seen what's happened in swap spreads for the last, call it, 2.5 months or so since the end of November. Can you just elaborate on that shift in strategy a little bit and that's what's behind it?

[David Finkelstein, executive]

Yes, sure. So both November and December month ends, we did have a little bit of pressure in financing markets, which suggest that balance sheet assets might be a little bit heavy, and that's what led to a lot of the swap spread tightening that we experienced. And for example, in the very front end of the yield curve at the 2-year level, 2-year rate, we got to negative 21 basis points on swap spreads versus treasury, so versus SOFR.

So the way we viewed it is that will gravitate to 0 through the passage of time over the 2 years, and it made perfect sense to us to transition some of our 2-year futures over to paying on swap. And just since the end of the year, those swap spreads are down from negative 20 or thereabout to negative 14 this morning. So -- it's been a good trade. We do still think that swap spreads are on the tight side, particularly even out the curve with 10-year swaps at negative 36 basis points, that to us, looks a little bit tight. The Fed has obviously begun discussing the tapering of QT.

And as the Chair noted last week, that would be an active conversation at the March meeting. To the extent they do move on that this spring then we will get a little bit of relief as it relates to balance sheet and that should help swap spreads widen back out.

[Unknown Analyst]

That's helpful. And maybe some of that is due to the last 2 months, $200 billion of issuance. But that's what you hear there.

[David Finkelstein, executive]

Yes.

[Operator]

The next question will come from Rick Shane with JPMorgan.

[Richard Shane, analyst]

I have 2 questions, one on each side of the balance sheet. When we look at the growth in the fourth quarter in terms of the agency book. You guys were -- most of what was added appears to be up in coupon 6s and 6.5. I'm curious at this point in the cycle, how you feel about adding premium securities given that as we sort of reached that inflection point, we could see pretty significant bifurcation in the book and speeds could pick up in those coupons fairly quickly.

[David Finkelstein, executive]

Yes. Let me pass it to Srini to talk about what we're exactly doing in higher coupons.

[V.S. Srinivasan, executive]

Sure. I think we have highlighted this over the last few quarters. Our core strategy is to move up in coupon and specified pool of SOFR production. And what we've done over the last 2 quarters is execute that strategy. Basically, the coupon stack, given the sharp movement, whereas the coupon stock traded with a lot of volatility in the first quarter. So this gave us an opportunity to move up in coupon at relatively attractive levels. And the pace at which we move up in coupon is somewhat dictated by our ability to source high-quality specified pools at reasonable valuations.

So that's why the pace has been somewhat moderated at which we move up in coupon, but we continue to like specified [indiscernible] up in coupon. I think if you look at CBA, it's pricing in the -- the loan size that new production is -- the new production loan size has gone up almost $75,000 over the last year or so and is now running at around $450,000. So these tools are likely to have a very steep S curve and very poor convexity profile. And so the pay-outs for specified -- compensates one of the reasons we see in the TBA collateral.

[Derek Hewett, analyst]

Yes. One more point.

[David Finkelstein, executive]

I was just going to say that if you look at the overall portfolio, the average dollar price is still [ 98 ], notwithstanding the rally we experienced in the fourth quarter. And you do get the most spread in higher coupon. So you take more convexity risk, but we try and mitigate that, as Srini said, through Specified pool selection.

But at the end of the day, we get paid to manage convexity risk. And if you're way down the coupon stack, in low dollar-price securities, you're not going to get the spread you needed. So that informs the strategy.

[Unknown Analyst]

Got it. And it is -- as you make the point, I realized that one of the things that shifted not only it is where you are in coupon, but the percentage of generics, to your point, also went down. So that's consistent.

Turning to the right side for a second. If we look at the repo funding from the third to the fourth quarter, the duration went down or the funding time went down slightly. I'm assuming in the third quarter, you extended funding with the idea that you didn't want to take risk into year-end balance sheet contraction and that some of that was just runoff of the 120s, over 120s in the longer-duration borrowings rolling down. But I'm also wondering if what we're seeing here is a little bit more bullish positioning on rates with you shortening the funding also.

[David Finkelstein, executive]

Yes. So to your first point about adding term in the third quarter, you are correct and that does reflect the roll down. And I'll tell you, another point to note about the repo market today, Rick, relative to a number of years ago, is that the vast majority of the liquidity is in the very front end of the curve there. And to really extract the value in the repo market. It's -- we do need to stay somewhat short.

We did have some very good opportunities to put on some long-term trades last year that we benefit from. But generally speaking, the term of the repo is going to remain relatively short because that's where the liquidity is. And to the extent that the Fed does ease certainly, then you benefit from that by being able to capture those lower rates. So to a certain extent, that's the case as well to your second point.

[Unknown Analyst]

Perfect. Okay. And term was the phrase I was struggling to find at 6:30 in the morning, I apologize.

[David Finkelstein, executive]

We understand our vest there.

[Operator]

Our next question will come from Trevor Cranston with JMP Securities.

[Trevor Cranston, analyst]

David, I think you mentioned in your prepared remarks that you may consider adding duration to the portfolio in the near future. So I was wondering if you could maybe just talk a little bit about what kind of catalysts you'd be looking for, for that? And maybe just generally your outlook on rates, particularly at the longer end of the curve.

[David Finkelstein, executive]

Yes, sure. So we have -- duration has been added organically a little bit, since the end of the quarter just through higher rates. But look, what we're looking for is more persistent signs that inflation has moderated to a point, where the Fed feels good about cutting rates, and we think we'll get there. If you -- if you think inflation prints for the next 3 months are going to be consistent with what they were for the last 3 months, we do think the Fed will release beginning in May, irrespective of how the economy plays out.

And once we see those signs, we'll be more comfortable with duration because real rates still do look attractive. And ultimately, we think where the long end of the yield curve should settle as we get through this, it's probably inside of 4%, and we'll look for those signs that volatility dissipates and that might be beneficial to the portfolio.

[Unknown Analyst]

Got it. Okay. That's helpful. the last several days, there's been a lot of headlines coming out about NYCB in particular. Can you guys talk about kind of how you think about CRE market? And if you see any sort of incremental risks coming out this year from banks or others potentially sitting on unrecognized CRE losses and sort of how you think that would impact markets overall.

[David Finkelstein, executive]

Yes, certainly. One point to notice is we're certainly thankful to a little over 2 years ago, we did sell our commercial platform. So we're glad not to be in that sector. We also -- last year, for example, we took -- we sold all of our CMBX positions to reduce that securitized exposure. And currently, what we own is roughly $220 million of AAA CLOs, which are almost exclusively multifamily. So very little exposure there.

Now as it relates to the broader CRE market, yes, there's certainly some isolated risks out there. We do think that this particular episode will be contained. There are other banks out there that will have to work off some of those CRE loans. The big banks are in good shape, but it's something that's going to impact a lot of the regional banks over the near term, but we don't see it as being systemic to any extent, notwithstanding some of the volatility we're experiencing in markets as a consequence of New York Community Bank.

So long story short, we don't have exposure, and we're thankful of that. And we think this will be a relatively muted event in the market, but it is some factors that need to be worked through at the bank level.

[Operator]

The next question will come from Eric Hagen with BTIG.

[Eric Hagen, analyst]

Just continuing on that topic of the regional banks. I mean, how do you feel like mortgage spreads and liquidity have responded to the pressure there over the last week? And do you see that creating an opportunity to buy MSRs potentially? And then even tacking on to that, I mean what's your outlook more generally for the supply of MSRs this year and how aggressive you expect to be and maybe bidding for bulk MSRs at different levels of interest rates?

[David Finkelstein, executive]

Sure. So I'll start off with just the overall mortgage market, and then Ken can talk about MSR specifically. There has been a little bit of volatility in spreads the past week, and it certainly is -- does create opportunities, but it's not the type of event where we're looking to dive into the market. We've reinvested runoff at better levels and things like that. And we're watching, but it's not a catalyst to necessarily jump into the market. And on MSR.

[Ken Adler, executive]

Yes. I mean, over the last year, I mean, regional banks have been buyers of MSR and there's been some regional banks that have been sellers of MSR. And the actual names are available in the transfer data. On the margin, I mean, we definitely think this will take some of those buyers out. The allocation of MSR to the regional banking sector.

I mean, might it -- it doesn't seem like the holders of large portfolio they are in, which are the stressed institutions. So on margin, we believe to be a positive event for our strategy, specifically because we are an opportunistic participant at times so that more to come.

[David Finkelstein, executive]

Yes. And we will also see how banking regulation plays out and what impact that may have. But generally speaking, we're reasonably optimistic on our ability to source MSR in a less competitive fashion.

[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, sir.

[David Finkelstein, executive]

Thanks, Chuck, and thank you, everybody. Good luck, and we'll talk to you in the spring.

[Operator]

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