Two Harbors Investment Corp. (TWO) Q2 2016 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and welcome to the Second Quarter 2016 Financial Results. At this time, all participants are in a listen only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] as a reminder, this conference is being recorded. I'd like to introduce your host for today's conference Tim Perrott, Senior Director of Investor Relations. Sir, you may begin.

Thank you, Timmy [ph] and good morning to everyone. Thank you for joining our call to discuss Two Harbors' second quarter 2016 financial results. With me this morning are Tom Siering, our President and CEO; Brad Farrell, our CFO and Bill Roth, CIO. After my introductory comments Tom will provide a recap of our quarterly results, Brad will highlight key items from our financials and Bill will review our portfolio performance. The press release and financial tables associated with today's call were filed yesterday with the SEC. If you do not have a copy you may find them on our website or on the SEC's website at sec.gov. Also in our earnings release and slides which are now posted in the Investor Relations section of our website. We have provided a reconciliation of GAAP to non-GAAP financial measures. We urge you to review this information in conjunction with today's call. I would also like to mention that this call is being webcast and will be and maybe access on our website in the same location. Before I turn the call over to Tom, I would like to remind you, that remarks made by management during this conference call and the supporting slides may include forward-looking statements. Forward-looking statements reflect our views regarding future events and are typically associated with the words such as anticipate, target, expect, estimate, believe, assume, project or should or other similar words. They imply risks and uncertainties and actual results may differ materially from expectations. So we caution investors not to rely on duly on forward-looking statements. We urge you to carefully consider the risks described in our filings with the SEC, which may be obtained on our SEC's website at sec.gov. We do not undertake any obligation to update or correct any forward-looking statements if later events prove them to be inaccurate. With that now, I will now turn the call over to Tom.

Thank you, Tim and good morning everyone. I'd like to take a moment to welcome Tim Perrott, our Senior Director of Investor Relations to the team. Tim has an extensive background in Investor Relations and we're excited to have him on board. We hope you've had a chance to review our earnings press release that we issued last night. As you can see on our results, we delivered a solid quarter in a volatile interest rate environment, highlighted by healthy increases in book value and comprehensive income. Our rates credit and commercial strategies all contribute to the success as our team took advantage of attractive market opportunities to drive strong performance and return for shareholders. As reflected on Slide 3, in the quarter we had total return on book value of 3.7% and comprehensive income of $122 million, or $0.35 per share. We incurred a GAAP net loss of $0.05 per weighted average share in core earnings of $0.22 per weighted average share. We accomplished these results despite a volatile market following the BREXIT's vote - during the quarter the tenure drop by 30 basis points to 147, with all signs point to rates being lower for longer. Turning to Slide 4, let's review some highlights from the rates credit and commercial strategies in the second quarter. Within the rate strategy, we added to our agency RMBS Holdings and thusly [ph] increase overall leverage. We started taking locks from three new MSR float sale arrangement and remained focus on adding more of these relationships. MSR represents an excellent fit within our portfolio and compliments our agency RMBS holdings providing positive fields negative [ph] duration and hedging mortgage basis [ph] risk. In our credit strategy, our legacy non-agency RMBS continued to perform well due to strong underlying fundamentals. On the commercial real estate side, we continue to add assets to our portfolio, our investment approach allows to be selective and crafting a diversified portfolio. We believe that the environment continues to be favorable for non-bank lenders. Rents and occupancies are improving, new constructions remains muted and our loans benefit from the healthy cushion provided by borrowed equity. Before I turn the call over to Brad, I would like to discuss our mission to discontinue the mortgage loan conduit and securitization business as we announced last week. Over the past few months, we have spent a significant amount of time analyzing the fundamentals of our entire business reviewing the performance and growth potential of each area. The current environment in the prime jumbo market has made it difficult for us to grow our conduit business to a level where we can achieve economies with scale. We do not expect these market conditions to change anytime soon. Therefore despite the best efforts of our team, we made the decision to discontinue the conduit business. While this was a difficult decision it was made in the best interest of our shareholders. Will allow us to reduce our operating complexity and cost and position us to redeploy our capital to areas in the business that will generate stronger risk adjusted return for stockholders over the long-term. The wind down process is expected to be substantially complete by the end of 2016. I will now turn the call over to Brad to discuss our financial results.

Thank you, Tom. Let's turn to Slide 5, our book value at June 30, was $9.83 per share which represents an increase from March 31 book value of $9.70 per share. Comprehensive income of $122.3 million this quarter was primarily driven by fair value gains on both agency and non-agency RMBS as well as a meaningful increase in net interest income due to growth in our agency RMBS and commercial real estate portfolios. This was offset by fair value losses on our hedges both derivatives and mortgage servicing rates [ph]. Please turn to Slide 6, core earnings were $0.22 per share in the second quarter representing a $0.01 per share increase over the prior quarter. Core earnings principally benefited from purchases of agency securities and overall higher debt-to-equity which increased to four times from three times at March 31. This was offset by increased overall financing cost due to the associated borrowings on agency RMBS and a sale of previously retained Agate Bay Senior AAA bonds which resulted in higher collateralized borrowing cost. In addition, we realized a lower yield on MSR investments. The decrease in the MSR yield is consistent with our expectations of increased prepayment speeds due to lower interest rate environment. Our other operating expenses were $17.6 million compared to $14.9 million in the first quarter of this year. The primary driver of the increase was higher amortization of previously issued restricted stock orders [ph] due to the strong performance of our shares, up nearly 8% during the quarter. We continue to focus on expense efficiency across our business and evaluate our expenses based on the additional returns that they support. For example, while there are expenses associated with our MSR and CRE businesses, we believe that they drive higher returns in our portfolio. That said, it is important to note that we expect that the discontinuation of the conduit business will ultimately allow us to reduce ongoing operating expenses by over $10 million on an annual basis. When combined with restrictive stock amortization void of valuation adjustments, we believe that our other operating expense ratio this quarter were decreased by more than 40 basis points in 2017. Please turn to Slide 7 for an overview of our financing profile. We had $9.7 billion of outstanding repurchase agreements at June 30, up from $6.2 billion at March 31 due to purchases of agency RMBS. The repo markets continue to function efficiently and importantly we've observed improved advance rates in spreads on financing of non-agencies. As we announced on our first quarter earnings call, we introduced direct lending with one counter party. We had about $418 million outstanding at quarter end, this relationship for the further diversification of our financing profile and lowers our overall repo cost. Our FHLB advances totaled $4 billion at June 30 with a weighted average borrowing rate of 63 basis points. At quarter end, our advances were collateralized by $3.4 billion of agency RMBS, $0.6 billion of prime jumbo loans and retained interest and $0.4 billion of senior commercial real estate loans. Additionally, we have two facilities in place where financing commercial real estate assets and we've expanded the usage of these in the second quarter. As a reminder from time-to-time, we cash fund certain of these senior commercial loans prior to being financed by the FHLB and therefore fully levered. We've provided some additional details on our borrowings on appendix Slide 25. I will now turn the call over to Bill for portfolio update.

Thank you, Brad. Let's turn to Slide 8. In the second quarter, we had strong performance across the board in our rates, credit and commercial strategy. As of June 30, our portfolio was $16.1 billion with 56% of capital allocated to our rate strategy, 31% to credit and 13% to commercial. Our allocation was relatively stable quarter-over-quarter with commercial increasing from 11% to 13% as we continue to commit capital to this strategy. Moving to Slide 9, let's cover a few of the drivers of our portfolio performance in yields. Our strong return for the quarter was positively impacted by higher leverage on our agency holdings offset by lower net interest margin of 2.59%. As expected, the addition of approximately $4 billion of agency pools at lower yields than our existing agency holdings contributed to this lower margin. Additionally, faster realized prepay s drove a lower MSR yield of 3.3%. As Brad mentioned, our debt-to-equity increase quarter-over-quarter. We had solid performance across our residential mortgage credit assets as well as our growing commercial real estate portfolio. Both of these strategies had realized yields largely consistent with the first quarter. Please turn to Slide 10 to discuss our rates strategy in the second quarter. As you can see on the bottom left of this slide. Our total agency holdings including TBAs increased about $2 billion. Agency pools however increased by about $4 billion as we converted our long TBA positions into generic pools during the quarter. Late in the quarter, we also begin converting some generic pools into specified pools thus seeking better prepayment protection in the lower rate environment. As of July 31, approximately 60% of our agency pools had some form of prepayment protection. We also have roughly $4 billion of generic Fannie Mae 3 pools, which we expect to exhibit slow prepayment characteristics. With respect to MSR, we added about $5.7 billion UPB from flow sale arrangements during the quarter. As of June 30, we had 13 total flow sale partners and we anticipate average MSR flow sales acquisitions of around $2 billion per month in the near term. As we've noted in the past, we look at MSR paired with fixed rate agency RMBS pools, not in isolation as they have offsetting risk profile. When combined we believe that agency and MSR generate better returns with less book value volatility then a strategy of hedging with interest rate swap only. We have continued to maintain low interest rate and duration exposure this quarter, that said given the uncertainty from low and negative global interest and the potential fallout from BREXIT along with economic growth in the US, we increased our use of optional hedge protection, increasing our swaptions and mortgage options positions by $3.5 billion on a net notional basis. This provides protection against higher rates, but also allows us to benefit should rates fall further. Let's move to our credit strategy highlighted on Slide 11. US economic growth housing price improvement and low interest rates provide favorable tailwinds for our legacy non-agency RMBS portfolio. When we began purchasing non-agency bonds in 2009, we expected that we could benefit from upside resulting from faster than expected prepayments improving housing price appreciation better borrower performance and potentially positive legal proceedings. We have benefited from all of these over the past several years and most recently this quarter, we benefitted substantially from the Countrywide settlement. Both credit performance and prepayments have been better than our initial expectations contributing to the continued attractive yields on our legacy holdings. As a result of this strong performance we have again this quarter released credit reserves against this portfolio. Consistent with the discontinuation of the conduit business, we recently ceased taking locks, although we do have approximately $1.2 billion of loans either closed or in the pipeline as of July 31. We anticipate disposing of these loans by completing one or more securitizations or by selling them through whole loan sales. Roughly half of the capital allocated to the conduit is invested in subordinate and IO bonds, which we view as attractive assets and intend to keep [ph]. The other half of the capital is dedicated to the mortgage loans that we aggregate for securitization and our loan pipeline. As we dispose of these loans over the remainder of the year, we intend to redeploy that capital into our other target assets. In addition to the cost savings of $10 million that Brad mentioned we also expect the incremental investment income on that redeployed capital to be about $10 million in 2017. Turning to Slide 12, our commercial real estate portfolio grew as we added four assets bringing the total carrying value of our portfolio to $926 million at June 30. These assets had an average stabilize LTV of 65.5% and an average spread of LIBOR plus 486 basis points. At June 30, we had deployed about $430 million of equity capital to the commercial strategy. As we have previously stated due to the attractiveness of this opportunity, we intend to continue deploying capital to this strategy past our initial $500 million equity commitment. The second quarter was strong across the board, we're excited about the opportunities ahead and believe that we can deploy capital to drive strong returns for our shareholders. I will now turn the call back over to Timmy [ph].

[Operator Instructions] and our first question comes from Douglas Harter from Credit Suisse. Your line is open.

Bill, I was hoping you could just clarify that last comment you made about that freed up capital from the locks generating $10 million. Does that capital generate any income today and so is that incremental $10 million?

Doug, good morning. Thanks for joining us. Yes so the capital that I referred to there that supports loans that we've aggregated for securitization or loans that we need to have capital for that are in pipeline. Typically that's a relatively low return because you're basically hedging these out until you sell AAA's into the market. So we're really in this for the returns on the credit and the IO. And so the capital that's currently going against that is generally earning a fairly low return. So as we free that up the $10 million is, what we expect to be incremental income once that gets deployed to much higher returning, the other asset classes we're targeting.

Great and then sort of on the conduit, one of the other benefit you talked about was relationships and adding flow agreements and possibly adding non-agency or non-clean or expanded credit products, are those things that are impacted by the decision as well?

Doug, it's Tom, good morning. How are you?

Well, Tom. Yourself?

Good. So with respect to our discontinuation of the business. Firstly I want to say that, we're very proud of the team and platform the securitization brand that the business built, but as we evaluate the business the economics of this decision were fairly clear, it was difficult decision in respect of, it effected some folks jobs around here, so it's definitely difficult in that regard. But as we look forward the environment just was not one that was conducive to the continuation of the business, the market hasn't materialized in the way that we expect when we started in 2011. We couldn't conceive a way that we could achieve the scale necessary to be truly economic and frankly competing ROEs and things like MSR and commercial were certainly a consideration. So with regard to your question, with respect in the non-prime business that has been very, very slow to rebuild itself in the last couple years. In respect of these relationships that is an important thing because there is commonality between people that were doing originally aviation [ph] business for us and MSR sellers and obviously what we got into consideration when we made this decision. But we expect to be great counter parties in respect of purchasing MSR and we think we can advantage through that process.

And then other ways to use the Agate Bay shelf other mortgage REITs have bought sort of pools of existing legacy loans and been able to securitize those, do you see those as opportunities for you guys as well since you have the Agate Bay shelf?

Yes, I would say probably we would not do that. I mean Agate Bay is one thing that it's got a great reputation in the market for being a pristine sort of focused on pristine collateral. All the deals we've done people, they know what they're getting. To the extent that we were going to look at doing sort of re-securitizations you can easily use a dealer shelf or you can come up with another shelf that would be whatever different name or different brands. I mean we're certainly aware that some others have done that, we haven't gone down that path. We've basically bought and held the securities and used street leverage and supposed to doing re-securitizations though.

Doug, Tom again. I really wouldn't expect that out of us, we want to be laser focused on our other businesses.

Okay, thank you.

And our next question comes from the Trevor Cranston from JMP Securities. Your line is open.

Follow-up on the closing of the conduit. Can you remind us what the FHLB financing that you guys are using for the loans and I guess some of the investment grade securities, if you have the ability to transfer other types of collateral onto those lines and maybe just comment generally how you intend to use the FHLB financing going forward? Thanks.

Hey, Trevor thanks for joining us and thanks for getting up so early on the West coast.

Sure.

And the home loan question over to Brad.

Yes, so the many appealing things about the FHLB advance is, but one of them is that you can replace collateral onto support the advances. So with that, the loans that we have in our balance sheet as well as any of the senior AAA retain interest, which we don't really hold much anymore, when those wind down, we would just really replace it with either agency RMBS, which we find appealing with their advance rates and cost as well as senior commercial real estate assets. Those would be, what would be replaced and are eligible for the FHLB. So no impact to the collateral support for those advances and multitude of things we can do with those advances that aligned our portfolio.

Got it, okay. And one more on the financing side. I guess, we've seen a decent increase in three month LIBOR in the last few weeks, I guess. Have you guys seen any change in repo financing connected with that?

Trevor, its Bill. I'll take that one. It's interesting what we have seen, as the full LIBOR thing is related to the some of the new loans that are coming in October, so LIBOR has gone up. Agency repo levels have basically stayed the same, so on a spread to LIBOR agency repo is actually improved. So I get the shorter answer is that the rate pay on agencies is really unchanged despite the fact that LIBOR has gone up.

Got it. Okay and then last question. It looks like you guys added like a $1 billion of bulk MSR acquisitions in the quarter. Can you talk about where you're seeing evaluations on bulk MSRs and if you think there is opportunity to add more of those over the next couple of quarters?

I think basically our additions were all in flow, but to answer your question about opportunities in bulk. I think as we said before, we're really focused on new issue GSC prepay oriented servicing. So to the extent that bulk comes out of that we could obviously look at it. Yields on the sort of flow or bulk of that type are sort of in the 8% area, that's sort of the market yield for that. In terms of other bulk transactions that might have taken place. If they were away from that type, in other words either you know distress servicing or delinquent servicing or other, that's not an area that we're playing in. So I would say that we're not probably the best guys to ask on that.

Okay, appreciated the comments. Thank you.

And our next question comes from Bose George from KBW. Your line is open.

Going back to the conduit, now that you guys won't be investing in newly created credit risk through the conduit, are you going to look more meaningfully at doing it another ways like maybe through CRT or through like the securitizations on budget J.P. Morgan [ph] potentially by others in the future?

Bose, good morning. It's Bill. Look, we obviously have a big credit book, we have a great expertise there, our credit. The performance our credit strategy has delivered over the year is just been tremendous. You know there should be no misunderstanding about our commitment to that. The only difference is, when we got into this we thought that geez, we'll be able to make our own credit and make it in good size. So while we did make credit, we weren't be able to make it in any real size to justify it, that does not mean thought that we won't be looking at other ways to invest so it's absolutely the case that. I mean we looked at CRT, we've been involved not in any big way but as that looks attractive, we can take part in and we can take part in any of these transactions, whether it's the banks doing it or the GSE's or what have you.

[Indiscernible] note about CRT, while we have anticipated in that market in the past, it's not a good REIT asset as it's constituted to that. So we don't expect anytime soon for that to be a substantial part of our portfolio.

Okay, great. That makes sense and then, just switching to the comment you made earlier about direct repo. How big a piece do you think that could be of your funding overtime and then can you also just talk a little bit about the mechanics of that, who values the securities, who issues margin calls, things like that?

Great question. So first the market, I think over the long-term, I think that is a could be a large opportunity, but I think that time period is going to be fairly lengthy. I think right now the participants who are starting to have the most interest. One, are largely focused on rated players and second they're establishing their mechanics and the processes that they haven't really had historically. So it's going to be relatively slow going, we've been fortunate to find a counter party and then finding a handful of others that are starting to work with us. So the mechanics themselves, I mean they're going to be with your standard, they're going to clearing margins and that's why it's going to take some time for them to build those mechanics, but it could be quite large on the road, but I think that's going to take quite a bit of time and for us in the near term, it's not going to be that meaningful to our portfolio. Standard clearing repo, anytime in the near future is where most of our financing will be from.

Okay, great. That's helpful. Thanks and actually just one more on the prepayments. I mean your prepays actually went down this quarter. Can you just comment on sort of what's going on with that, is it just the prepayment protected collateral performing very well? And then just where you're seeing prepayments over the next few quarters.

The prepayments dropping is largely a function of, well first our prepay protected pools performing well, but additionally we added a substantial amount of pools and generally those were either new or prepay protected, so those we're going to pay extremely slow, that's more of a function of their newness. So I wouldn't read a huge amount into just one quarter's numbers. In terms of going forward, I mean it's going to be driven by rates. I would expect and if you look at the projections that most mortgage research groups have, for generic collateral given the level of rates, speeds will be in the 20s or 30s for a good part of the rest of the year. Prepay protected collateral typically is much slower and that's been our experience and so we would be expect our speed to be relatively tame compared to that, but then as you might expect it will depend what rates do, in terms of what happens from there.

So, okay. Great that's helpful. Thanks.

And our next question comes from Joel Houck from Wells Fargo. Your line is open.

The second quarter in order you increased the agency exposure this quarter or I should say second quarter it looks like it actually accelerated. Can you talk about the relative attractiveness of agency RMBS versus what you currently own or other opportunities with non-agency and then the second part of the question, is how does the kind of cheap optional protection weigh into that decision. Obviously you noted that you had a 3.5 being a net notional in option protection.

Yes, sure good morning, Joel. I mean the agency, so just to be I sort of remind this is a little bit of follow from last quarter. When we saw the dislocation that occurred in the market in toward that late first quarter and into the second quarter. We saw agency spread as really being very attractive. We always saw there are sectors that were attractive, it was just very easy to add agency pools in good size. So we added pools and TBAs and then this quarter, we largely if you look at the numbers we generally converted a lot of those TBAs in the pools and then we saw some other opportunities to do. So I would say that spread since then have tightened up somewhat and so, we're pretty happy with what we have, they're sort of in the hold zone. Given current spreads, I don't think you should expect to see agencies move in any large size one way or the other. So we're pretty happy with what we have, in terms of other opportunities vis-à-vis agencies. Today I think you've probably have gotten this from our comments. MSR continues to be attractive when paired with pools, MSR and pools is sort of 12% to 13% ROE area and so, we're going to be putting based on about $2 billion a month that's $20 million or more per month into MSR. And then commercial is sort of in the low-to-mid teens and those are floating rate, so we don't have any rate risk there and that run rate is more into $30 million to $40 million a month. So I would say those are the areas that you're most likely to see growth in vis-à-vis others. And then to your second part of your question the cheap optional protection. I mean, basically after we sort of saw all this volatility, the cost of buying protection came down quite a bit partly as I think as a result of all the fed and another central banks comments or action. And if you look at it, there's always uncertainty in the market, but given where rates are you could see a 50 basis point move one way or the other and have a good explanation for either outcome, and so we've just saw that the chance to improve our convexity by basically buying a bunch of put options. So if the market rallies, we do benefit because those are sort of more for protection against the big increase in rates, so we would benefit from a rally, but be protected somewhat in the sell-off.

So that's necessarily driving the agencies just more of a side benefit of owning the larger agency portfolios, you can get in your view cheaper protection for an outsized rate move in either direction.

Yes, I think that's fair. They go together really. I mean if we had no agencies obviously we wouldn't need the hedges that we have given our agency position, we use a combination of the MSR some swap and we just converted bunch of the swaps into swaptions and puts which is a similar form. This improves our convexity.

Yes, okay. Great thanks Bill.

And our next question comes from Jessica Levi-Ribner from FBR

[Indiscernible] just one question today. How are you guys thinking about the MSR investments given the historically low rates?

Good morning, this is Bill. So actually if you think about it, right the best time to be adding MSRs when rates are low. I mean, I'm not saying or projecting they won't go lower but if you think about it, people who were taking mortgages today that have fade 3 and 3.25 coupons, the odds are extremely high that those are going to be around for a long time. So we're actually really quite excited that we've got our float seller is in place, the volumes that we're expecting to see. If you figure $20 million a month that's $240 million over the course of the year going forward, that's pretty exciting given where rates are and given what we expect the yields to be on those new acquisitions.

Yes, I was going to add kind of circling back to Trevor's question earlier and making sure we're clear that, nearly $60 million of fair value MSR we added this quarter, was flow that represents roughly about nearly $6 billion of UPB and that kind of correlates to what Bose [ph] commented on, that we're flow network. We're up in the low teens now with relationships and able to really generate this new production at rates that are very appealing given prepayment behaviour is going forward and replacing some of the valuation of our MSR currently on the hedge and earlier, while we terminated our prime jumbo and expanded credit programs, this was an opportunity for us kind of reaffirm and even strengthen our commitment to our relationships there to continue to buy that product on an ongoing basis. So we're very happy with that flow program that fits really with the benefits of the assets in a low rate environment.

I just want to add one more comment to emphasize that. We continue to work to add other flow sellers and we expect that we would be in the 15 to 20 flow sellers as we get to the end of the year, which would drive those monthly volumes up somewhat, as we move into 2017. So it's definitely an area of high focus for us, especially given the low level of rate.

Okay, sounds good. Thanks guys.

And our next question comes from Brock Vandervliet from Nomura. Your line is open.

I think everything has been asked and answered with the exception of the commercial real estate initiative, was just I see the slide of Page 12 in terms of the breakdown. As you think about the portfolio by property type what are you most focused, are you trying to keep the relative weightings the same at this point and how are you sourcing these credits?

Brock, this is Bill. Good morning. So looking at Slide 12 as the portfolio grows the percentages will move less than they have when you start with a small portfolio. Our whole intent is to have a diversity not just in property type but also in geography also in sponsor. In other words you might really like a sponsor, you don't want to make every loan to the some borrower. So as result you see, hotel is currently very low as you can see, we don't have a problem with that number being higher but you shouldn't expect that to be substantially higher. Multi family is a great asset class. It's typically it's gone very well, there's huge cash flows there but we like the diversity that we have and you know we'll keep you posted if we think that there will be any significant changes. The thing that we are finding is that, given that there is been relatively low levels of construction in building relative to the growth in the economy and you've seen huge amount, you could see our borrower equity is substantial. We're focused mostly on properties that have cash flow that can cover the debt service today and so that as the borrowers move forward, if their plans don't quite workout the way they anticipate we're still in a very good shape, not only on a cash flow coverage but also on an equity basis. So we're just very excited about the opportunities we're seeing, there's huge amount of refinancing is taking place, there's lots of transaction volume, so it's perfect opportunity for balance sheet lender like ourselves.

Yes, it's Tom. If I could add something to that and the commercial business is much more idiosyncratic on our other businesses. So what's really our focus is to make sure that we have good deals, good cash flow, good LTV and good sponsors and that's our primary obsession rather than targeting and saying, we want X% of hotels, X% of commercial etc., so that's our true focus.

The second part of your question is about, how do we get these things. So the group that we on board is been doing this for decades, they have very deep relationships not only directly with borrows but with also in the broker community. Commercial real estate lending is a highly brokered business. So our pipeline of deals that we actually see either directly or through the brokers is extremely large. It just doesn't, doesn't always fair it down to if you see 20 deals, you might only do one or two of them. So it's a direct lending relationship, so we're originating the loans directly underwriting them and closing them.

Great, thank you very much.

And our next question comes from Rick Shane from J.P. Morgan. Your line is open.

Last quarter when you talked about the portfolio growth on the agency side, you attributed to wider spreads. Obviously this quarter we saw the timing would matter a great deal because we saw rates decline throughout the quarter and we saw spreads tighten up a little bit. Love to get a sense of when during the quarter you added the agency assets and also get a sense with rates now as low as they are, what the duration on that portfolio and I apologize, if I missed that? We’ve got a lot of companies on the take today.

Yes, it's early morning for you as well, Rick. So good morning. The first part of your question about timing, the timing was early in the quarter. I mean as we said, I think on our last call, late first quarter, early second quarter was really a great time for adding which we did. The difference is, in this particular case. We had close to $2 billion of TBAs which is the same risk profile, it's just not in pool form. So lot of the growth, half of the growth roughly was pools that we took on early in the quarter and the other half roughly was converting TBAs to pools, during the quarter. So I hope that answers your timing question.

It does and presumably the reason is, you left the TBAs converted as spread tighten there's value being created there.

Yes, I mean look, as you know I think the second part was about low rates and the bulk of what we added was in 3s and 3.5. New 3s were not particularly worried about. I mean because either people who literally just took out a loan at the market rate. 3.5s you'll see that we have a lot of prepay protection there just because if you have a 4 and a quarter coupon say and the rates are 3 and 3.25, we feel more comfortable with protection on that, either in today's rate environment potentially lower rate. And then in terms of your question on duration. I think probably the best thing to point you to is the little table that we and others produce about changes in book value for changes in rate and once again you'll see the Q will be out later today, are up 100 is once again a very a low number and are up 50 is obviously even much less. So without necessarily and unless you were, without necessarily gaining the duration of any particular asset, we look at the whole portfolio with its hedges on a combined basis.

Got it. So one other question and one other comment. The question is, basically that interest rates have sensitivity despite the significant adds because of swap and swaptions that you added to show material change.

It's a combination of the MSR, which has negative duration, the swaps and the swaption. So you take the duration impact of all of the assets and the duration impact of all of the hedges. You know that's where you're going to get the overall sensitivity.

And then the comment is, would you've ever imagine discussing needing prepayment protection on 3.5s?

Well, I started in 1981 on the long treasury bond yielded at almost 15%, so I think it's fair to say, no I would not have ever imagined that.

And guys thank you very much.

Thanks for getting up, Rick. Have a good day.

And our next question comes from Jim Young from West Family Investments. Your line is open.

You mentioned on the commercial real estate area that you had a $500 million equity commitment but that's going to be expanded. Can you give us a sense to how large you expect that to grow to and over kind of what timeframe?

Hey, Jim. It's Bill. Good morning, thanks for joining us. Yes, well as I mentioned a few minutes ago our capital commitment run rates in the $30 million to $40 million a month. So if you think about the back half of the year that's going to be call it, roughly $200 million. So we can certainly see that being adding to what we have now getting up and close to that 20% of capital around the end of the year plus or minus. Certainly it's going to depend on the opportunity, but based on what we're seeing today. We're going to continue at that pace and then, we'll see how things unfold as we get late in the year and into next year. As Tom mentioned and some of the comments I had, with high sponsor equity and good cash flow coverage and the kind of ROEs we're seeing and also the fact that it doesn't have rate exposure fully underwritten commercial loans is definitely something that we intend to keep adding through the remainder of the year.

Jim, again you've been in the market a long time and you know that market conditions are temporal but right now the run rate for commercial looks quite good for us. Obviously we can't make any super strong comment with respect to allocation because market conditions could change but that's our expectation for the remainder of the year.

Okay, so if I'm hearing it will be effectively about 20% of capital by during 2016 as you move into 2017, with a target range be 25% or would you be either willing to take your equity commitment to the commercial real estate business even higher.

It just going to depend upon market conditions and other opportunities that exist within our universe. So we're reluctantly, as I said to get pin down on precise allocation metrics, but that is as Bill said that is our expectation for the remainder of 2016. It will be just to pick face upon market conditions and commercial and other market conditions for our competing assets.

Okay, thank you.

And at this time, I'm showing no further question. I would like to turn the call back to Tom Siering for any closing remarks.

Thank you, [indiscernible]. Thank you for joining our second quarter conference call today. We will be participating in the Barclays and JMP Conference in September in New York. Well we hope to see you there. Thanks again for joining us, have a wonderful day.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect. Everyone have a great day.