Annaly Capital Management, Inc. (NLY) Q4 2016 Earnings Report, Transcript and Summary

Good morning and welcome to the Q4 2016 Annaly Capital Management Earnings Conference Call. All participants will be in 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 Jessica LaScala of Investor Relations. Please go ahead.

Good morning and welcome to the fourth quarter 2016 earnings call for Annaly Capital Management Inc. Any forward-looking statements made during today’s call are subject to risks and uncertainties which are outlined in the Risk Factors section in our most recent Annual and Quarterly SEC filings. Actual events and results may differ materially from these forward-looking statements. We encourage you to read the forward-looking statements disclaimer in our earnings release, in addition to our quarterly and annual filings. Additionally, the content of this conference call may contain time-sensitive information that is accurate only as of the date of this earnings call. We do not undertake and specifically disclaim any obligation to update or revise this information. During this call we may present both, GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in our earnings release. Please also note that this event is being recorded. Participants on this morning’s call include Kevin Keyes, Chief Executive Officer and President; David Finkelstein, Chief Investment Officer; Michael Quinn, Head of Annaly Commercial Real Estate Group; Glenn Votek, Chief Financial Officer; and Tim Coffey, Chief Credit Officer. I’ll now turn the conference over to Kevin Keyes.

Good morning, everyone. In the fourth quarter of 2016 Annaly distributed to its shareholders another $0.30 dividend, the same, exact quarterly dividend we’ve now offered for over three years. On recent earnings calls across every industry sector, more than enough attention has been paid to the metrics measuring today’s market uncertainty. On this call I prefer to remind and further explain how Annaly has continued to provide such a consistent return overtime amidst this historic volatility and as importantly, why we remain confident in our diversified platforms, ability to continue to produce quality and stable earnings, while protecting book value in various market environments in the future. 2017 marks the third anniversary of arrival of most of our current investment in financing teams who may have collectively transformed, grown and diversified the entire portfolio. It is important to note and it’s no coincidence that over the same time period Annaly has continued to pay its approximate $300 million dividend for the past 13 quarters in a row, while utilizing one-third less leverage than the average mortgage REIT that is roughly 10% of our size. In comparison, over the last three years, 75% of the companies in this sector have cut dividends at least once. In fact there have been 44 dividend cuts in total. Our portfolio transformation has contributed to how we have been able to outperform and provide industry-leading dividend stability over the same timeframe. Annaly’s total return of 44% since 2014 has outperformed all yield-oriented equity strategies and specifically, has beaten the returns of the S&P 500 in the mortgage REIT industries by over 30%. In our agency interest rate strategies, which David will expand upon, we have proactively improved the quality of the assets by increasing the prepaid protection of the portfolio, rebalancing our hedge profile providing insulation when rates turn upward and broadening our sources of financing through our broker dealer, FHLB membership and direct repo relationships unique to us. And as importantly, less understood by the market, in 2017 we are now finally becoming unburdened by certain longer-term, higher cost repo financing transactions which have put in place prior to 2014. In addition, each of our credit platforms commercial real estate, residential credit and middle market lending now have seasoned performance grown to self finance scale and meaningfully contribute to the durability of our book value without a single credit loss since their inceptions. As we enter 2017, Annaly is positioned now more than ever in the company’s 20-year history to continue to deliver predictable, and protected value to our shareholders. It’s quite simple as to why we’ve made the various large investments overtime in our businesses in our people. To prepare for this volatility the unexpected for periods when the fundamentals are trumped by rhetoric and brews, regardless of ones economic our market forecast for raising and falling rates, for accelerating our slowing growth, Annaly has now established as a cyclical and countercyclical yield investment alternative. Our focus in 2017 is maintaining our stability protecting our downside and growing opportunistically in any market scenario. We are confident in our platform’s position and believe our performance will be enhanced further by our unique capital allocation advantage and what we call the substitution effect. The substitution effect is simply ment to describe our optionality, and search for optimal capital efficiency and relative value across and within each of our four businesses. As I’ve mentioned all four of our businesses now have established sizable platforms that allow us to substitute our capital from agencies to credit and back again if we desire. We are not a monoline for support capital to work in a specific, overvalued asset class at all times. Our model is one of a kind shared capital with dedicated sources of diversified financing with incremental capacity available for each strategy. We have constructed our overall portfolio to have complimentary profiles to the core Agency strategies in terms of cyclicality. We have multiple bowels to turn in our capital allocation process on a daily basis, as our views on the business cycle and market environment evolve. We don’t have to grow or plan to raise equity in order to enhance our franchise value or continue to sustain our divided. By illustration, over the past year we have chosen not to reinvest the prepayments from our $2.3 billion commercial real estate business because of our view on the valuation and risk return profile of these casuals relative to our residential credit and middle market lending businesses which in 2016 grew 81% and 58% to $2.5 billion and $800 million in assets respectively. Importantly, we have not approached our risk or liquidity thresholds with the asset substitution while at the same time we have maintained our dividend by augmenting our agency earnings with predominantly floating rate, lower level cash flows. We actively measure not only the relative valuations across the four businesses we calibrate the cyclicality of the underlying cash flows within each of the businesses. For instance, the residential credit and commercial real estate businesses are both inherently pro-cyclical, pro-growth assumption based returns. However, today, currently, we view the valuations in the U.S. housing industry to be relatively more attractive than the U.S. commercial real estate fundamentals in most comparable cases, not all but most. A view manifested in the relative growth of the residential credit portfolio just mentioned. We are also capable of other types of substitution, by rotating our exposures within certain sub sectors of each asset class altering our positioning in the capital stack, or using leverage as a risk adjustment factor to mitigate the impact of market or economic cyclicality. In addition to focusing on our capital efficiency and asset substitution in 2017, we believe the market will more keenly focus on the benefits of further consolidation in our industry. I believe consolidation among the mortgage REIT sector has to happen. There has been a demonstrable increase in value for almost all mortgage REIT shareholders since we announced our acquisition of Hatteras Financial, April of last year. The total valuation of the Bloomberg Mortgage REIT Index has increased 15% by over $6 billion in total market capitalization while the number of – the total number of companies in the index has actually decreased by over 20% from 42 to 33 members, primarily due to the onset of industry consolidation. Just like other industry sectors that have over expanded at the wrong time, mortgage REIT valuations have suffered for similar reasons, including a supply demand imbalance in the sector was too many inefficient ill liquidity one-dimensional companies. By comparison, we currently operate our multi strategy model with large business at an operating expense to asset level, 68% lower than the average mortgage REIT. In addition, amid this persistent market volatility the performance from most of the single assets, single financed mortgage REITs will continue to be challenged as evidenced by the 44 dividend cut I mentioned earlier and the sizable book value seen as recently as this past quarter. Operational efficiencies combined with strategies with limited illiquid options and pronounced under-performance, serve as additional catalyst for management teams and their board members to actively consider strategic alternatives. Bottom line investors in this sector will benefit from continued consolidation of our overly fragmented industry. Finally, amidst this conflicting daily debates on the market outlook for 2017 and beyond Annaly is positioned as a unique liquid investment alternative with unmatched optionality, earnings sustainability and book value durability. Annaly’s yield manufacturing strategy is now made up of complimentary cash flows built with cyclical neutrality position to outperform in today’s uncertain markets. Our diversified platforms provide us with capital efficient substitution options and the potential for numerous external growth opportunities across the four complimentary industry sectors in which we operate. Now will turn the call over to David Finkelstein who will further expand upon these themes as it relates to our asset portfolios and our outlook.

Thank you Kevin. The fourth quarter brought about the second largest selloff in the treasury market of any calendar quarter of this century. The majority of which occurred in the immediate aftermath of the presidential election. The election was a pending risk event that we discussed specifically on our last earnings call and cited it as justification for maintaining a cautious approach over the near term. While we did experience a decline in book value, our portfolio was cushioned by proactive portfolio decisions made in prior quarters including our diversification in the quality of our hedges. Now I’d like to follow-up with additional detail regarding Kevin’s comments on our portfolio management approach across our core businesses. With respect to the agency portfolio we were deliberate in ensuring that the duration extension of the portfolio was appropriately managed in light of the sell off. We entered the quarter with a steepening bias in our hedges which helped minimize our book value decline and also enabled us to stay somewhat ahead of the extension risk as the yield curve steepening in corresponding lengthening of our agency portfolio actually led to a better equilibrium between the curve exposure of our assets relative to our liabilities. Consequently while we did add incremental hedges over the quarter, we were by no means forced to engage in any extensive rebalancing exercises with respect to our hedges. Regarding the composition of our agency portfolio, we did substitute a portion of our TBA’s prespecified rules as we felt that the subsequent re-pricing of pools and the sell off led to more attractive pricing relative to TBA’s which exhibit a decline in role special later in the fourth quarter. Agency valuations are slightly more favorable today and levered our OEs in the low-double-digits, albeit not in the mid-teens as some suggest, keep us comfortable with the agency market, but we do not anticipate adding meaningful capital or leverage to this sector over the near term given the risk of further rate volatility. Of additional note regarding the agency portfolio, our MSR position prove to be a valuable duration and curve hedge as the vast majority of the increase in MSR value quarter-over-quarter was attributable to one $150 million in price appreciation of the asset given lower projected prepayments to the IO stream. So our additional capital committed to this sector was relatively minimal and we expect this to be the case going forward. Given that our investment in this sector has achieved scale and in our view of the appropriate capital allocation we strategically launched a new fund in the fourth quarter with a sizable and highly reputable partner who will purchase approximately 90% of Pingora Loan Servicing’s flow-based MSR acquisitions for the foreseeable future with Annaly purchasing the remaining 10%. Shifting to residential credit, spreads obviously tightened over the fourth quarter and into 2017 consistent with other risk assets. As a consequence we slowed the pace of growth of the portfolio and we also substituted a portion of our longer spread duration more credit sensitive assets with shorter duration conservatively structured resecuritizations. Although much of the non-agency sector is now priced to perfection, particularly credit risk transfer securities we believe that opportunities remain in certain parts of the legacy sector as well as residential whole loans. We have been able to expand our whole loan acquisition effort with new partnerships with the originators and aggregators while not being burdened by the high infrastructure costs associated with an in-house conduit. As our footprint in residential credit has increased counter parties are looking to Annaly as a liquidity provider on larger pools of assets knowing that we have the capabilities and financing advantages to success – facilitate such transactions. Anecdotally, we are currently evaluating multiple larger block size opportunities which offer double digit returns with modest leverage through our FHLB relationship. As much of the non-agency sector remains relatively rich these types of packages should enable us to continue to grow the portfolio without chasing ever tighter spreads in the space. As Kevin mentioned the necessity of a more exhaustive evaluation of risk and return also extends to our commercial real estate effort, as well as our middle market lending business. Our commercial business trade [ph] modestly this past quarter given our view that pricing is not quite reflective of risk characteristics, nonetheless we are seeing pockets of opportunities in the market, but we will remain highly disciplined in the sector. We were able to add to our middle market lending portfolio in the fourth quarter, contributing to the growth of roughly $300 million in assets for that portfolio for the year, given the strong activity thus far in the quarter. In the first quarter we expect that trend to continue into 2017. The further build out of our middle market platform over the past three years has positioned that business to be a leading partner with top tier private equity sponsors and we feel that the investment opportunities we’re seeing in that sector both organic, as well as portfolio trades will enable the business to continue to grow with accretive returns over the coming quarters. With respect to our outlook going forward, we expect volatility to remain somewhat elevated as monetary policy makers attempt to calibrate their reaction function to a set of ambitious fiscal policy proposals. We are realistic with respect to current returns and accompanying risks that each of our businesses have to offer and we are not overreaching for returns in anyone sector. And touching back on Kevin’s comments regarding the substitution effect, with fundamentals suggest they shifting capital from one business to another or between sectors within one of our core businesses, we can officially mobilize resources to take advantage of these opportunities. And lastly, when larger dislocations in the market arise, we have the liquidity in reach to capitalize on such circumstances, much like we have in the past. Now with that I’ll hand it over to Glenn to discuss the financials.

Thanks David, good morning. Beginning with our GAAP results, we reported net income of $1.8 billion, or $1.79 a share versus Q3 net income of $731 million or $0.70 a share, the prior quarter. Both quarters benefited from unrealized gains on our investment rate swaps hedge portfolio, the quarter-over-quarter improvement was largely attributable to both a favorable movement in the hedge portfolio marks, as well as lower premium amortization. Turning to core results, during the middle of last year the SEC publicly released interpretive guidance that relates to rules and regulations on the use of non-GAAP financial measures. In order to comply with this guidance this will be the final quarter that we will report core earnings excluding the premium amortization adjustment or PAA, which in this quarter’s disclosures we’ve labeled as unrevised core earnings. Going forward, core earnings will include the PAA which has been labeled in this quarter’s disclosures as revised core earnings. However, given its usefulness in analyzing the Company’s financial performance we’ll continue to separately disclose the PAA and this will allow you to calculate unrevised core earnings metrics, as well as permit you to compare the prior historical measures. And of course non-GAAP measures should not be viewed in isolation, and are not a substitute for financial measures computed in accordance with GAAP. Our revised core earnings which again, excludes the PAA was $327 million or $0.30 a share, which compares to $0.29 a share in the prior quarter. Premium amortization adjustment was a benefit of $239 million or $0.23 a share driven by decline in long-term CPRs to 10.1% from last quarter’s 14.4%. This resulted in revised core earnings of $0.53 a share. Our core ROE on an unrevised basis was flat quarter-over-quarter at 10.1%, while the core ROE on the revised basis was 17.5%. Some of the key factors contributing to the quarterly results for higher coupon income on higher investment balances, as well as higher drop income that combined represented an increase of approximately $0.02. Our average repo rate was up about four basis points on swaps expense decline and lower net rates that together represented lower economic interest cost of about a penny. MSR amortization and other expenses were up modestly at about representing about $0.02 on a core basis. In terms of the balance sheet, the Residential Investment Securities portfolio was up approximately $2.1 billion with a slight increase coming from the residential credit assets. MSRs increased $160 million on both improved marks as well as new acquisitions and the commercial portfolio, as was previously mentioned, declined modestly and included the sale of about $30 million held for sale loan. Our book value declined to $11.16 a share. Leverage as traditionally reported increased about a half turn to 5.8 times and economic leverage which captures the effect of the TVA contract increased modestly to 6.4 times So with that Daniel we’d like to open it up to questions.

Thank you. We will now have a question-and-answer session. [Operator Instructions] And our first question comes from Bose George with KBW. Please go ahead.

Thanks, good morning. It’s Eric on for Bose. I want to expand on the potential growth in the sort of non-core segments of the business right now. Specifically looking at the middle market lending portfolio which seems to be generating an ROE that’s above the return – at or above the return across the portfolio, so I can’t help but wonder if you wanted to grow that segment, would you be more compelled to do it organically with your existing capital or use your currency to acquire an outside portfolio that you view is attractive?

Hi Eric it’s Kevin.

Hi Kevin.

I think – look there’s an easy answer to that one and I’m going to keep it there. It’s similar to – the returns are very attractive cash-on-cash. It speaks for the origination platform we built since 2010 and the relationships we developed. And we haven’t had a credit loss we have good pretty good reputation in the market. But similar to our other businesses the returns quarter-over- quarter might shuffle back and forth, this quarter or the last couple quarters low market lending had on a relative value basis, it’s been very attractive. May not last, that’s why we have these other businesses. But as it is today we can grow that business as we have been organically. We don’t need to raise money. We only need to get outside financing. We’ve been building that portfolio Tim Coffey and his team patiently over the past seven and a half years. So we can continue to grow at this pace with these incremental returns, without doing anything else. In terms of external opportunities, I would just say that the BDC sector is not the similar from the mortgage REIT sector and I’m on record in saying that publicly. The BDC sector, I would argue is even more fragmented with 40 or so companies that are essentially smaller. And I would argue probably even more strapped for liquidity or lack of financing. So look, that’s how we compete. We’ve chosen these industries because they’re highly fragmented. And when you have our capital and our track record we think we can compete pretty well within these fragmented industries, we’re not banging our head against the wall. Very often when it comes to winning these transactions and gaining on these returns.

This is Time Coffey, I would just add to that. But I think as it relates to acquiring BDC or something of that ilk, right now my view is that you’re just buying other people’s problems. Bad decisions have been made but other portfolios and right now organically we feel very confident about the origination platform and portfolio list outs. What we can sled [ph] assets and use our credit selection skills that have an impact is probably the more likely of all the from there.

Thanks Tim. Go ahead I’m sorry.

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

Right. Well thanks for that thoughtful response guys.

Thanks Eric.

Our next question comes from Brock Vandervliet with Nomura Securities. Please go ahead.

Good morning. Thanks for taking the question. Kevin I wanted to touch on a comment you made in passing on long-term repo financing it’s always struck us how some of your financing is particularly long duration. Is there an ability to shorten that up and generate some saves?

Hi Brock. To the commentary I made I’ll just summarize it by saying we’re financing our businesses a lot differently today than we were a couple years ago, including the agency portfolio, we’re hedging a lot differently, we’re using different technologies, we have different expertise. So the repo is kind of like the headline obviously tool or financing tool for this space. It’s obviously a big part of our balance sheet, but certainly not the only financing access we have by any means. But long story short, there were some transactions or some financing put on before 2014 and before we’ve really, I would say, heightened the level of scrutiny and competitive nature among other alternatives including term, and counterparty and pricing. So this year you’ll see as come out of the life at the end of the tunnel finally and there’s been some friction cost that will no longer be affecting us due to some of those positions of the past.

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

Well Brock this is David. I think it has come off. Over the past year, if you look at our financing cost relative to our peers, it’s narrowed quite a bit. In fact this past quarter our financing cost, our repo cost were only up four basis points in spite of fed hike. And our swap expense actually was down 17 basis points, so that relationship improved dramatically relative to our peers. And it will continue to improve over the year. The vast majority of it is out of the way, but there’s still a very, very small amount left that will come to pass.

Well beyond it will be kind of a legacy friction cost it will be over in the third quarter.

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

.:

Great thank you.

You bet Brock.

[Operator Instructions] Our next question comes from Joel Houck with Wells Fargo. Please go ahead.

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

Yes Joel that’s a good point. And you’re exactly right. I mean credit is obviously tightened over the last number of months and agencies lagged. And the reason why it’s lag, we believe, is for the reasons you cite. There are some risks out the horizon with respect to agency NBS potential for higher rates and even little further out the horizon the potential for the Fed to stop reinvesting their runoff. And that’s exactly how we consider the value proposition. Agency does look relatively more attractive than credit, but at the end of the day we’re considerate of those risks out the horizon. And what we think, in terms of looking at the portfolio, what we think is, we have the appropriate balance. We haven’t – we’re not on these calls talking about how agencies are mid – mid-teens returns. They’re really not. It’s you get double digits, as we do with all of our business, but they’re not screaming cheap considering all the risks, they’re offering a fair return particularly relative to credit. But we’re conservative with respect to our leverage. And when we compare agency versus credit it looks like we have the right balance in the portfolio right now.

Joel I would just – the takeaway is we try to develop it in our comprehensive scripts David and I and the team. And look having options in this market where everything is – lot of things are priced to perfection is what we feel is the most durable strategy. When we run our scenarios out for this year to David’s point whether you assume bull flattener or bear steepener or go with the forwards, or think about different forms of leverage or constitution of the agency diversification within the agency business. And any way you slice what we see is a heck of a lot more visibility and durability of our earnings and our book value, certainly than most other companies in this sector. So I’ll call relative and relative value is what we do every day. Your point is well taken. It’s the reason we haven’t Mike Quinn doesn’t get paid to grow his assets under management commercial real estate he gets paid on return on invested capital. So we’ve shrunk that portfolio because we see relative value in the other credit businesses. That may not be the case this time next quarter. It’s the case now.

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

Yes that’s a good question Joel. I wouldn’t say we’re nervous we do think the sector is particularly tight I think this is as tight as we got in the spring of 2015. It was tighter prior to that. But it is certainly tight and lot of the reason is there is more sponsorship for the sector, there’s a little bit more liquidity now as time has passed. Spreads in residential credit have obviously performed well and some of that does have to do with the fact that there are positive technicals for the sector. The legacy market is paying down relatively rapidly and this happens to be a product that some investors may find suitable as a replacement. And so there’s a little bit more sponsorship for it. In terms of being nervous, no, the market always finds a way of clearing and if there is a dislocation that was to occur in that market, we see it as an opportunity to add to it. But at these spreads were actually marginally better sellers of it trying to provide liquidity to the market.

All right. Thank you very much.

Joel, I’d like to simplify for the average investor here analogy we use for the CRT market is in my mind like an IPO of an emerging sector of any industry, right. Today is relatively small albeit growing, it’s relatively illiquid because it’s new. So each deal is almost like – to David’s point on relative value there’s entry points on each deal. And there is valuation metrics that we monitor. So when you buy into one of these deals I view it you’re almost buying a quasi-IPO you better be darn sure that your entry-level and evaluation is something you are comfortable with because you got to expect to hold it longer because of the relative illiquidity around it. That being said, we think we’re pretty good IPO buyers and I think we built this portfolio with the three other products in resi credit, three other asset types in resi credit pretty deliberately over the last couple of years.

All right, great thanks Kevin.

Thanks Joel.

Our next question comes from Douglas Harter with Credit Suisse. Please go ahead.

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

Hi Doug this is David. So as we’ve said in the past we don’t believe that while we like the asset very much we don’t believe that the capital allocation to the sector should be as large as some others. And we’ve said in the past 4% to 7% of capital it is a already levered asset and it does have somewhat volatile performance. And so we’ve considered finding other investors to invest in the MSR business because Pingora produces MSRs on an ongoing basis to rather purchases them from their many, many originator partners. And this is a way to where we stay in the market. We have critical mass in terms of the asset we are at above 5% of capital. And we stay in the market and we have another investor actually taking most of the flow and we have the optionality if the sector does cheap in we can go out into the secondary MSR market and buy both packages if we like. I mean we see those packages multiple times a week. And so essentially we’re at where we want to be but we have optionality to add if we so choose to.

What does the economic look like to Pingora you guys on those MSRs you’re selling?

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

Got it. Is there an opportunity as you said you see bulk opportunities. Is there opportunity to kind of grow that fund management business within Pingora? And then also in their opportunities to leverage kind of the platform you have throughout Annaly for other fund opportunities?

It’s a good question. There’s always opportunities and we always explore everything that we think has potential. Right now we’re still in the evaluation stage and we’ll see how things develop. But we’re very comfortable with the business, and how they operate it and the investors that participate in the trade.

Doug well I would say just the bigger picture as an institution here we’re all about capital efficiency and operating efficiently. And then in terms of growth making sure we do that as efficiently as possible. So there’s a number of things that we don’t necessarily beat our chests about here. But this one MSR relationship is one of other things that we’re doing is joint ventures here where we’re plugging into origination platforms, where we have access to the flow without having to pay for the infrastructure. That’s how we’ve been able to manage our efficient returns with all – with these four large businesses. So you’ll see us over time we’ll be plugging into different platforms, that’s our model. We’re not going to be in the business of having big overhead and operating businesses. We can plug into other platforms more efficiently and utilize our capital and our expertise and generate just incremental return really off of others backs.

Great thanks for that. That’s helpful.

Thanks Doug.

[Operator Instructions] Our next question comes from Jessica Levi-Ribner with FBR. Please go ahead.

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

Yes Jessica, this is Mike Quinn. Look I think Kevin and David mentioned that we’ve reduced our closure over the past 12 months or so and I think that was really a relative value decision. To me the markets remain, I think, pretty solid and fairly priced. Fundamentals are still pretty strong in the commercial real estate markets across the U.S. And the debt markets are fairly rational. I think there may be some underpricing of risk out there, but LTVs remain pretty reasonable. I think the issue for me right now is sponsors. And opportunistic sponsors and value added players have largely stepped away from the market in the U.S. So you’ve got a situation where there’s not a lot of new capital coming into the space for new investments. I think a lot of what we’re seeing today is in refinancing and from my perspective that is marginally worse for a transitional lender. So I do think we will see pockets of opportunity deals where we can invest our capital and make leverage returns in the 9% to 11% range. But on average I think we still see better opportunities elsewhere.

Okay. Fair enough. And then just moving to elaborate on the overall portfolio you mentioned for the agencies in particular that you’re being conservative with respect to leverage because of the volatility. How do we think about your leverage on a go-forward? Is this 58 [ph] times appropriate, are you thinking about taking it down? How do we think about that?

Jessica I think the simplest answer is what’s past is prelude [ph]. I mean we’ve been conservatively operating at a leverage third or 25% less than the average company out there, while we’re still able to produce these very attractive, stable dividends like nobody else. So there will be episodic upturns like for instance when we bought Hatteras the leverage went up half a turn to take on those assets, generate our targeted return and then the next month or so, or two months it was back down to six times roughly. So put it this way. We have other opportunities to generate return in Alpha. I think a lot of other companies that only rely upon the leverage lever or the leverage dial and that feeling they can talk about. So we’ll talk about our complimentary cash flows and less levered returns in these credit businesses. In commercial Mike just gave you kind of his summary, look we like that business –and we’ve really liked the credit in our portfolio. And we have great relationships with our clients. But we want to be the industry leader and the reasonable man in the room. And some of the deals we’re getting done, and the way there being described to the market, we don’t feel – I don’t feel personally that that’s entirely transparent. I think there is incremental risk being taken to generate returns that are similar to ours, primarily because most of those companies have nothing else to do with their capital. And that to me is a the definition of heightened risk. So we like the sector. We like others little bit more right. And in terms of leverage, kind of like the same thing, we know how to utilize it, but we don’t have to go crazy with it.

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

Thanks.

Our next question comes from Steve DeLaney with JMP Securities. Please go ahead.

Thanks for taking the question. Just a couple things to follow-up on your stated current preference for residential credit as opposed to CRE lending that we’ve been discussing. Just curious looking at on Page 4 of the deck as you breakout your buckets within the resi credit. With respect to Jumbo 2.0 can you talk about exactly where in the securitization structure you are currently investing, whether it’s senior subordinate and I see you have some IO as well which suggest maybe you’re in the subordinate part of stack?

Yes, hi Steve.

Hi Tim.

I would give any subordinate, but first of all let me say we are not buying Jumbo 2.0 securitizations right now when we were adding those securities, the AAAs we’re trading back north of three points from TBAs or agencies. Now they’re back one in 20.

Yes.

From TBAs. So they performed quite well. And they happen to be, when you look at them, even though with the headline yield is higher, given the lower dollar price, the option adjusted spread on Jumbo 2.0 is actually the same as agency. And so given that when you have the liquidity of the agency market and even OAS you would always prefer to buy agency. So to simply answer your question, we’re not participating in that market, we do have some positions and we have sold a reasonable amount.

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

That’s a good question Steve. I’d say right now we view ourselves as a portfolio company.

Yes.

And as Kevin talked about the ability to plug in to operators and efficiently extract the product we’re looking for, we’re willing to pay a small amount to be able to do that because it keeps us nimble, and keeps us liquid, and enables us to mobilize resources when they need to into various businesses. So the way we view it right now is we’re a portfolio company and we’re not so much an operating company. And that could change out the horizon if there’s some synergy out there that we can really capitalize on. But for the time being we’ll keep working with our partners.

We see I think we can…

Yes got it.

We hear you on friction costs right when you don’t have the manufacturer in your basement.

Right.

But look I think you’re going to see us grow this portfolio all things being equal with our current setup, current partnerships that we have. And we’ll talk about it more when we get there. But I think to David’s point, the only reason I’m putting a cherry on top of this is that we’d never put anything out of the question, but as long as we can manufacture these returns with this amount of flow, it really doesn’t make any sense for us to take on the incremental risk of an operating entity [ph] to do that.

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

Thanks Steve.

Thanks Steve.

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

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