Good day, and welcome to the Annaly Capital Management Second Quarter 2021 Earnings Conference Call. Today, all participants will be in a listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note that today’s event is being recorded. At this time, I would like to turn the conference over to Sean Kensil, Vice President of Investor Relations. Please go ahead, sir.

Good morning, and welcome to the Second Quarter 2021 Earnings Call for Annaly Capital Management. Any forward-looking statements made during today's call are subject to certain risks and uncertainties, including with respect to COVID-19 impacts, which are outlined in the Risk Factors section in our most recent annual 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. As a reminder, Annaly routinely posts important information for investors on the company's website. www.annaly.com. Content referenced in today's call can be found in our first-quarter 2021 investor presentation and second quarter 2021 financial supplement, both found under the Presentations section of our website. Annaly intends to use our web page as a means of disclosing material non-public information for complying with the company's disclosure obligations under Regulation FD and to post and update investor presentations and similar materials on a regular basis. Annaly encourages investors, analysts, the media, and other interested parties to monitor the company's website in addition to following Annaly's press releases, SEC filings, public conference calls, presentations, webcasts, and other information it posts from time to time on its website. Please also note, this event is being recorded. Participants on this morning's call include David Finkelstein, Chief Executive Officer, and Chief Investment Officer; Serena Wolfe, Chief Financial Officer; Ilker Ertas, Head Of Securitized Products; Tim Coffey, Chief Credit Officer; Mike Fania, Head of Residential Credit. And with that, I'll turn the call over to David.

Thank you, Sean. Good morning, everyone, and thanks for joining us for our second quarter earnings call. Today, I'll provide an overview of the macro environment and current market dynamics, briefly discuss our performance and capital allocation trends during the quarter. And lastly, I'll highlight our progress on the various strategic initiatives that I outlined on last quarter's call. Ilker will provide a more detailed commentary on our agency and residential credit portfolio activity, and Serena will review our financial results. Finally, as Sean noted, we are joined by our other business leaders today, who can provide additional context during Q&A as needed.

Thank you, David. As you noted, MBS underperformed rate hedges into the bull flattening rally and a hawkish shift by the Fed that pulled forward rate hike and taper timelines. Over the quarter, MBS widened across the stack, with lower coupons impacted by heavy supply and accelerated taper outlook and higher coupons influenced by persistence of fast speeds, which further delays the eventual burnout expectations. In anticipation of market volatility by mid-May, we opportunistically reduced our agency portfolio by nearly $9 billion ahead of most of the spread widening across a mix of outright sales and portfolio runoff. As we manage the size of our portfolio, we maintained our barbell strategy of consisting of lower coupon TBAs and high-quality prepaid protected specified pools in our coupons.

Thank you, Ilker and good morning everyone. This morning I'll provide brief financial highlights for the quarter ended June 30, 2021. As noted in our earnings materials, in line with the evolving industry practices, the company has relabeled core earnings excluding PAA as earnings available for distribution or EAD. I want to be very clear that this is a name change only and that the composition of the non-GAAP metrics core earnings excluding PAA and EAD are precisely the same. Consistent with prior quarters, while earnings release discloses both GAAP and non-GAAP earnings metrics, my comments will focus on our non-GAAP EAD and related key performance metrics all excluding PAA. The general themes for this quarter's earnings are consistent with Q1. As we generated strong results from the portfolio benefiting from the continued low interest rates in the funding market, marking another quarter of record low cost of funds and sustained specialness in dollar roll financing. To set the stage with some summary information, our book value per share was $8.37 for Q2, a decrease of 6.5% from Q1. And we generated earnings available for distribution per share of $0.30, an increase of 3% or $0.01 per share from the prior quarter. As David and Ilker have both touched on, the second quarter was a challenging environment for Agency MBS. Book value decreased, primarily due to the common and preferred dividend declarations of $345 million or $0.24 per share, a GAAP net loss, and lower other comprehensive income of $222 million or $0.16 per share. Our book value reflects the challenges outlined by my colleagues, whereby the decline was driven by agency mortgage spread widening. As treasury rates rallied, reflected in reductions in our derivative market values, MBS yield changes were muted. As a result, our agency portfolio did not see book value gains to offset the derivative losses. Combining our book value performance with the $0.22 common dividend we declared during Q2, our quarterly economic and tangible economic return were both negative 4%. Economic return and tangible economic return for Q1 were 2.8% and 3.6% respectively. As we take a closer look at the GAAP results, the challenges in the interest rate environment are further illustrated here, as we generated a GAAP net loss of $295 million or $0.23 per share, down from GAAP net income of $1.8 billion or $1.23 per common share in the prior quarter. This quarter slipped many of the GAAP drivers I discussed in Q1. That is, in Q2, GAAP net income decreased, primarily on higher unrealized losses on our interest rate swaps and derivatives portfolio. Specifically, declining interest rates impacted GAAP net income, reflected in unrealized losses on interest rate swaps of $141 million, which was $772 million of unrealized gains in the prior quarter. Other derivatives led by futures of $578 million, which was $517 million of unrealized gains in the prior quarter, and swaptions of $233 million, which is $306 million of unrealized gains in the prior quarter. On a positive note, GAAP comp benefited from lower interest expense on lower average repo rates and slightly lower average repo balances at roughly $62 billion versus $65 billion in the preceding quarter. Now, for a further look at earnings available for distribution. The most significant factors that impacted EAD quarter over quarter included, first, consistent with my commentary around GAAP drivers, interest expense of $61 million was lower than $76 million in the prior quarter, due to lower average repo rates and balances. We had slightly increased expenses related to the net interest component of interest rate swaps of $83 million relative to $80 million in the prior quarter, as the swap portfolio notional balance increased by $2.2 billion. Higher TBA dollar roll income of $110 million versus $99 million in Q1, as the desk was able to extract marginally greater specialness in Q2 relative to Q1. And finally, we had lower interest income, primarily driven by lower average agency MBS balances. The continued stability of the funding market was a bright spot in the quarter, with Q2 marking eight consecutive quarters of reduced cost of funds for the company. We continue to opportunistically target extended term that six to 12 months for our repo book, with our weighted average days to maturity consistent with the prior quarter at 88 days. This strategy served us well during the quarter, as the Fed increase in RRP, IOER, has resulted in approximately three to four basis point rise in overnight rates, with a slight upward bias in term markets as well. Additionally, the funding markets are continuing to improve in credit, particularly regarding structured products, as we've seen tightening from both a spread and a haircut standpoint, up and down the stack. And while we expect funding markets out one year to remain relatively flat, uncertainty around the debt ceiling, infrastructure bill and possible Fed paper, could prove as headwinds in the funding markets over the second half of the year. Providing additional color regarding our reduced interest expense for the quarter. Our overall cost of funds decreased four basis points quarter-over-quarter from 87 basis points to 83 basis points. Our average repo rate for the quarter was 18 basis points compared to 26 basis points in the prior quarter and we ended June with a repo rate of 16 basis points down from 32 basis points at the end of December 2020. In my prepared remarks last quarter, I referenced our efforts to fund credit assets selectively. As I mentioned earlier, dealer appetite for credit assets is strong. However, given the conducive funding environment, we opted to optimize the use of our liquidity and hold a portion of our credit assets with equity thus further reducing the firm's interest expense. The portfolio generated 209 basis points of NIM, up from 191 basis points as of Q1, driven by the five basis point increase in average yields and the decrease mentioned earlier in cost of funds. Average yields increased due to an increase in agency yields of approximately nine basis points during the quarter, mostly because of declines in projected CPR and the impact on amortization for the quarter, and the change in portfolio mix to residential credit that has lower agency average balances and higher residential credit securities, average balances on CRT, and NPL/RPL purchases. Moving now to our operating expenses, our efficiency ratio for the quarter increased in comparison to Q1 ratio of 1.36% due to declines in equity during Q2 and timing differences in the true-up of certain accruals. Our OpEx to equity ratios were 1.55% and 1.46% for the quarter and year-to-date respectively, which is within a revised range of 1.45% to 1.6% provided in Q1. And to wrap things up, Annaly ended the quarter with an excellent liquidity profile with $9.6 billion of unencumbered assets, up from the prior quarter to $8.9 billion including cash and unencumbered Agency MBS of $4.7 billion. The increase in unencumbered assets is associated with the lower leverage and our approach to funding credit assets I mentioned earlier. That concludes our prepared remarks and operator, we can now open it up to Q&A.

We will now begin the question-and-answer session. Today's first question comes from Steve Delaney with JMP Securities. Please proceed.

Good morning everyone and thanks for taking my question. We noticed that you tapped your ATM plan in the quarter for about $400 million. Was that specifically related to the $200 million plus MSR growth, or what other things did you have in mind with that issuance? Thank you.

Good morning Steve and how are you? Thank you. With respect to the ATM, it actually had to do with a lot of factors. I think when you look back to last year, we used our buyback program to buy back stock in an accretive fashion. In December, we called a preferred issue or 7.5 which is about $460 million. And also to your point in terms of growth of MSR and expansion of residential credit, that influenced as well. So, the way I would look at it from one point, we improved our overall capital structure by somewhat lagging the call of the preferred to issuance of common, but also it's about growth of our alternative products and the build-out of that infrastructure.

Great. Well, certainly -- you certainly have indicated where you're going to be growing on the credit side and that certainly makes sense. One follow-up. We heard last night on the call that the non-agency RMBS the new issue market was getting a bit crowded. The comment was from an originator who would normally execute securitizations and it sounded like the economics of the securitization weren't as attractive because just the buyers were maybe just getting too much on their plate. So, with that in mind, can you talk about the ability of Annaly's balance sheet at your size? Can you pretty much acquire whole loans without an immediate securitization execution and just hold them with alternative short-term financing until the securitization market appears optimal? And if so, if you have the flexibility to do that, could you kind of size you would be comfortable with in terms of unsecuritized whole loans? Thank you.

That's a great question Steve. So, first off, I'll say that the securitization market has been quite robust and we've had a lot of successes recently last week issuing transactions. With respect to capacity and availability of our own balance sheet to warehouse loans, Mike can expand on this. But I will say that we did settle roughly a little over $1 billion in whole loans last quarter. We do have another $800 million in the pipeline and we have considerable warehouse line capacity. And we also have ample liquidity on the balance sheet as we discussed. And so we feel good about where we're at and Mike can talk a little bit about the securitization market and the dynamics associated with it. Thanks.

Sure, Steven, and thanks for the question. I think in terms of the originator that was claiming that the securitization market was 'full' a lot of that is the prime jumbo market and then also agency investor as because of the PSPA changes you've seen issuance there. So if you look at that market at the beginning of July, there was about $27 billion of issuance. If you look at last year in total, there was about $22 billion. So year-to-date you've already surpassed issuance last year. However, Steve, most if not the majority of our purchases are in the non-QM market. And when you look at the non-QM market, it's actually probably the most advantageous time to issue given where spreads are. So at the beginning of the year non-QM spreads on the AAA that makes up about 75% of what you sell was 85 to swaps. If you fast forward to today that's 60 to swaps. So I think that -- your point is valid in that there are certain components of the market that have widened given supply. However, the majority of our risk and our exposure is in a different market and different structure that is actually executing at what we would say the best economics we've seen. And the non-QM deal that we did over this quarter, we issued at a 90% advance rate 80 to swaps -- with a weighted average quality of swaps. And lastly, we did have two prime jumbo securitizations since the end of March and that is the market at which you have seen a lot of supply. However, those securitizations are a partnership where we don't actually have any economic risk until the deal closes. So hopefully that's able to answer your question.

Now that's extremely that little detail with respect to different products is extremely helpful to clarify my mind as to what I heard last night. Thank you everyone. Appreciate all the comments. Thank you.

You bet Steve. Thanks.

The next question comes from Doug Harter with Credit Suisse. Please go ahead, sir. Mr. Harter, your line is on mute.

Sorry. Is that better?

Yep.

Sorry. Sticking with residential credit, can you talk about what are the advantages that come from opening the conduit that you talked about?

Yes, largely price, but I'll let Mike expand on that.

Sure. Sure, Doug. I think that we've shown over the years since the inception of this business the ability to purchase residential loans in size without having exposure or a direct investment with an originator. We have a number of different pricing avenues and strategic relationships that allow us to be accretive outside of the bulk market. However, we have always participated in the bulk and many bulk markets. And I think the launch of the correspondent channel really what that does is that it allows you to face smaller originators and the ability to lock best efforts allows you to own the economics of the loan at a much more accretive price than it would if you would participate in the bulk or mini bulk market. And it's as easy as just the fact that you have to have infrastructure, personnel additions, sales, business, development, et cetera that -- those developments allow you to get entry into the market at a much more advantageous price. So that is the main reason. And we also have the ability to control our own credit, control pricing and control our partners. So it's a multitude of factors.

Yes. And it's providing certainty of execution to originators, which is a service that they value and we're consistent with it.

Got it. And then as you think about the equity allocation, capital allocation to credit ticked up in this quarter. Do you expect to see that trending over the next year? And what's kind of the longer-term range that you see it in?

So as Ilker discussed, our aspiration is to continue to grow our alternative products and we're certainly sensitive to relative value. Quarter-over-quarter the growth that we saw in residential credit we were very happy with. And as Serena noted that a lot of that capital allocation was -- because we didn't lever a lot of the assets. And one thing I'll note is that when we're not as optimistic on agency -- and this sounds counterintuitive, you will see leverage on our credit products actually go down. And that's because typically we're going to have ample liquidity because we're reducing agency and then we can look to use that liquidity to offset financing costs associated with credit products. But first and foremost it starts with our overall liquidity position and when we're in an abundant liquidity position that level of leverage is going to fluctuate. Does that help?

It does. Thank you.

You bet Doug.

The next question comes from Bose George with KBW. Please proceed.

Good morning. Actually just switching back to the agencies. In terms of spread widening, how much of the spread widening do you think is related to tapering that has already happened? And is there a way to think about the spread level at which you guys decide to get more aggressive in terms of capital deployment?

Sure. We think -- look let's basically look at the landscape of the mortgage universe. So roughly 50% of entire mortgages are held to maturity by the portfolios of banks and the Fed. So if you add available for sale securities for bank portfolios, you get that number to be around 66%, 67%. So given that this time around taper will be much less impactful in the mortgage market than before. In fact, I would argue that there are a lot of money managers and even like other relative value investors waiting on the sidelines for the taper to relocate the agency MBS. So I would think that a good chunk of the taper is being priced and agencies are in a healthier place right now compared to where they were at the end of Q1.

Okay, great. Thanks. Yeah, great. That's helpful. And actually just on the trends since quarter end, can you just give an update on book value quarter-to-date?

Sure, Bose. We're -- we've moved around a little bit but we're within $0.01 or $0.02 of flat on the quarter as of last night.

Okay. And then actually just one clarification on the capital allocation you mentioned for the MSR. Did you say about 10% of the capital is what you would be to allocate?

That's what we would like to get to over time, but we're very patient about that. We will certainly be responsible about the growth of that portfolio, and we're okay to take our time, but we do expect to grow it deliberately over the coming quarters and years.

Okay, great. Thanks.

You bet Bose.

Our next question comes from Rick Shane with JPMorgan. Please proceed.

Hey, good morning everybody, and thanks for taking my question. This actually, kind of, dovetails with the conversation you're having with Doug Harter. But when you look at your comments related to the MSR and the fact that you plan to own that on an unlevered basis. Can you talk about the return profile owning MSR unlevered? And should we really think of that as -- consider that in the context of the fungibility of your assets that you will increase and decrease the leverage on your other assets to fund MSRs based upon interest rate outlook and more efficient financing for those other assets?

Sure. So let me start with the last part of it. The funding decision will be based on the liquidity of the overall portfolio. So -- but when we analyze MSR, we analyze the returns unlevered. So right now you are getting high single-digit returns on MSRs with the hedge benefit that's coming from the TBA hedges unlevered returns of high single digits which is good enough. But we expect MSR availability will be higher down the road and we probably can find opportunities to add like double-digit returns unlevered with the help of the hedges.

Okay. And can you explore the second part of that, which is that, really you're looking at the fungibility of the funding to support the MSR and the efficiency of for example levering up the agency MBS a little bit more as opposed to some of the risks associated with MSR financing?

Yeah. Absolutely, like -- again David put that out very nicely. We never look at that way. So we never say that agency funding is here. So let me use the agency funding to fund other assets including MSR and other credit assets. We never look at that rate. That's a slippery slope. But what we are saying is that when we have excess liquidity in excess of what we will need down the road with the stress scenarios then, we may not fund some of our other assets. This includes MSR and then use the agency funding on that. So funding decision is based on our overall liquidity needs and then we try to optimize the funding portfolio. But we will never look at the agency funding and then use that funding leverage to get the returns on other asset classes. That will not be done. So then we are analyzing MSR for example or any other credit instrument, we will always look at the funding of debt instruments when you are doing the analytical work, when you are designing your hedges. But when it comes to funding, it depends on how much excess liquidity you have in the box. Does that help?

Okay. That's really helpful. Thank you, guys.

You bet. Rick, thanks.

The next question comes from Eric Hagen with BTIG. Please proceed.

Hi. Thanks. Good morning. I hope you guys are well. The first one on specified pools, I mean premiums still remain I think well above their historical levels although mortgage rates are of course lower right now. I'm mainly wondering if you feel like the structure of the market has changed, because of how much of the agency market the Fed owns at this point where maybe a new premium floor has been established for specified pools even if we do get some backup in rates and mortgage rates et cetera?

Yeah, that's a good one actually. You're right. A big chunk -- like the cheapest deliverable market has really been taken away both by banks and the Fed. And that makes specified pools a little bit in a unique place. But as you said, levels are a little bit elevated given the historical levels, but also speeds also suggest this, right? Specified pools especially on the lower coupons are prepaying much better for example than TBA pools. And TBAs are supporting that with the special roles. So if you ask me what I expect, I expect specified pay-ups will moderate a little bit because this roll specialness on the lower coupons will persist. When it comes to higher coupon specified pools payout really doesn't mean that much honestly because there's very little CDT float. So almost every pool is a specified pool when you are talking about forces.

So you look at it specifically on a cash flow basis irrespective of the TBA contract, Eric.

For high coupons, yeah.

Got it, I follow you. One on the hedging side a lot of swaps concentrated at the short end of the yield curve. I just want to get a sense for how much duration you feel like your assets have that short on the curve? And what you feel like the effectiveness of those hedges are in this environment?

Well, I'll just back up and note that, last year we actually did put a lot of those swaps on at close to negative rates or low single-digits. So they've been perfectly fine. In terms of curve positioning, we do have a modest steepener on. So a lot of our duration is still concentrated in the front end notwithstanding shorter-duration swaps. And generally our view is obviously rates are artificially low. We think they're a little bit too low here. And with respect to the curve we do feel it should be a bit steeper. The way we look at it at one metric, we uses five-year forward, five-year rates, which currently this morning are around 190. At the beginning of Q2, it was around 260 or thereabouts. So arguably, it was a bit cheap then. But to us, the forwards look rich which suggests higher rates and a slightly steeper curve. And so that's how we're positioned. And a lot of the steepening that did occur did come through contraction of the assets in the rally, but we're perfectly content with the position and we're not running a meaningful duration gap. We're slightly long or pretty close to flat.

Got it. Thanks for the comments.

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

Hi. Good morning. Sorry, if you covered this I had to bounce off the call for a minute, but what – the taper is kind of funny and that it's obviously destabilizing impact as it is destabilizing impact, I would assume on the market. But then again, it's probably the most widely anticipated thing that we've seen in years headed to the market as well. What would you need to see to either during that process or on the back of it or in front of it to take up leverage?

Yeah, I'll start and Ilker can add. To your point about the taper destabilizing, I wouldn't characterize it at all as such. We've been through this before. And I think the market well anticipates a reduction in the Fed's footprint and is prepared for it. And if you think about the technicals to Ilker's point about the stock effect with Fed and bank portfolios held to maturity and also the fact that money managers are underweight REITs, are less levered certainly. So we feel like, this time around, it's going to be a much smoother transaction. In terms of what type of widening we need to add leverage, it's not just about the headline spreads on Agency MBS. It's the quality of those spreads meaning what's it cost to hedge, what kind of volatility do we expect, and how manageable is adding Agency MBS? So I can't put an exact spread number on it for you. It's going to be state specific. But I will say that the agency market is reasonably comfortable. We're content with our leverage profile. And to the extent there was cheapening, and we felt like that was a manageable proposition from a hedging balance sheet standpoint, we would add. I just don't have an exact number because it does depend on what the rate landscape looks like in the overall market.

Okay.

You bet, Brock.

And just as a follow-up, David in your opening remarks you mentioned $0.30 is kind of a high watermark. As you sort of – could you just break down the major components of the lower numbers going forward what that would consist of?

Yeah. I would say that, we certainly expect to out-earn the dividend in Q3. And beyond that, I wouldn't comment. But our TBA position was a little bit smaller. So roll income should moderate a little bit. And there's other factors from an amortization standpoint, and runoff of higher book yielding assets that are in consideration, but we do expect a modest decline for Q3 but nonetheless well out earning the dividend.

Got it. Okay. Thank you.

You bet, Brock.

The next question comes from Kenneth Lee with RBC Capital Markets. Please proceed.

Hi. Good morning. Thanks for taking my question. Wondering if you could just further expand upon comments on what you could see in terms of funding costs for the second half of this year? Thanks.

Thanks, Ken. It's Serena. So as I mentioned in my prepared remarks, we think that we continue to have obviously reduced cost of funds. We think we've probably hit a bit of a trough with regards to agency repo though in saying that the average rate for the quarter was 18 basis points, and we ended the quarter with 16 basis points. So you are going to see some sort of natural benefit from that in the subsequent quarter. And so some sort of modest continued decline in that expense as well. We do see continue to see some level of tightening also in the credit side of things, but given the agency repo is the majority of our expense, I would say, a little bit of a timing or a reduction in the following quarters. But we do think we've probably hit a bit of a trough when it comes to those types of rates.

Great. That's very helpful. And one follow-up, if I may. It sounds like, there's a couple of opportunities between the MSRs and the residential whole loan channel. Wondering from a high level, where do you see investment leading towards for the marginal dollar, the incremental dollar? Just wanted to talk about the overall landscape there? Thanks.

Yes. I would say residential credit is the area where we still feel very good about that marginal dollar. Also, we haven't talked about Tim's business in middle market lending. There is a lot of activity on that front. And in MSR, a lot of the MSR we purchased was earlier in the quarter when valuations were cheaper. They're still okay right now, but they're not as cheap as where we added a lot of those assets early in the quarter. And so, I'd like to say we're content with the agency portfolio in the alternative sectors is where we want to put money to work, but we're not a forced deployer in any sector and we can let the market come to us. Does that help?

Very helpful. Thanks again.

You bet. Good talk with you, Ken.

The next question comes from Derek Hewett with Bank of America. Please proceed.

Good morning, everyone. And my question relates to what was discussed on the last question. But just given that increased capital allocation towards residential credit and expectations to grow the MSR in correspondent originations. What is the longer-term plan for middle-market lending? Are there additional opportunities to grow the portfolio, since it's been relatively flat for the last few years? Could you just expand on that?

Yes, sure Derek, and good to hear from you. And we talked a little bit on the last call about middle-market lending. That business remains a core part of the portfolio at nearly 10% of capital. The returns of the business are largely uncorrelated with agency, so it's incredibly complementary for us. And it's a scaled business with a very efficient cost structure and a solid franchise given the PE relationships. And so we feel good about it. But -- at the end of the day, we do certainly recognize that there are limits to growth given the fact that we're a REIT, but it's a steady-state scale business. And if there's incremental opportunities to grow it, from a return standpoint, we have certainly capacity to do so, and we feel good about that. And it's not nearly the conflict with the agency business, somewhat like CRE was in terms of competition for capital and the agency business making up some of the shortfall from lower CRE returns, the solid business.

Okay. And then, would you be willing to add a little bit of leverage to boost returns even higher, or is it still going to be funded basically with equity at this point?

Yes. And it depends on the composition between first lien and second lien. The portfolio is two-thirds first lien, a third second lien and less than a turn of leverage. And if it works from the standpoint of adding leverage to the portfolio and we do more first lien then we'll do so. And as Serena talked about, financing is improving in credit. If there is any potential upside to financing it's in our credit sectors. And so, it's going to be dependent on the composition of the portfolio and the cost of leverage.

Okay. Thank you.

You bet, Derek.

The next question comes from Ryan Carr with Jefferies. Please proceed.

Hi. Good morning, guys, and thanks for taking my question. Not to beat a dead horse here, but can you talk about the risk-adjusted return profile in the credit book relative to agencies given the prevailing environment? And how you're thinking about that going forward?

Sure. So, obviously it's specific to the type of transaction. Ilker talked high single digits on MSR without any leverage. Fannie, his securitization transactions are well into double-digits. And with Tim's business, it's probably right around that double-digit level with incredibly low leverage. So, those are attractive propositions. Now grant at the agency markets cheapened up. And if we apply specialness to TBAs, you do get into the double-digits. But it's dollar for dollar similar returns. The objective is to further diversify and we expect to have opportunities to do it, but it's product-specific and episodic.

Got it. Thank you. And then turning to the distribution. You noted that the $0.30 is kind of the high-end of core earnings at this point and going forward you're expecting that to drop a bit. But when would you consider a potential increase in the distribution? And what level would you -- where would you be comfortable in making that decision?

Yeah. So obviously, that's a conversation with our Board. What I'll say is we're not forced to adjust the dividend notwithstanding out earning it. And look at the end of the day, when we reset the dividend to $0.22 the considerations were, we wanted it to be a competitive yield and consistent with our historical average and we wanted to make sure it was consistent. Right now, our dividend yield on book is 10.5% in that proximity on the stock.

Thanks very much.

You bet. Thanks, Ryan.

The next question is a follow-up from Rick Shane with JPMorgan. Please proceed, sir.

Sorry about that. Thanks guys for letting me hop back in queue. I just wanted to ask one follow-up question on the MSR. When we think about the movement in book value this quarter. From a descriptive perspective, it was the underperformance of the hedge and that makes sense in light of what we saw for interest rates. I am curious if you had a greater hedge position associated with MSR, if that would have in fact dampened the book value pressure we saw this quarter?

Well to be clear, as we add MSR, we do adjust the hedge profile. And Ilker talked a little bit about receiver swaptions, which were done in conjunction with MSR purchases. So the answer to your question is, no. I think we effectively hedge the MSR and it contributed to overall book performance on the quarter from a hedge perspective.

Okay. But I understand the dynamic there, but what I'm asking is that would the -- in theory, should the MSR which was better correlated to the assets all other things being equal without moving the swap position, would it have been a more effective hedge this quarter in light of the environment we're in? Because I'm just thinking about the uncertainty that we're facing going forward as we sort of transition through the rate environment, if you think that will give you a more efficient hedge?

Absolutely. Ilker can expand on it. Yes, because MSR have tightened and it would have reduced your spread duration to agency and BSN agency and the other wide. For this quarter, your answer is definitely, yes. But also, let's not forget that when you are adding MSR, you are also adding the negative convexity that needs to be managed. But yes, we had our steady state; if we get to David's vision earlier, that would have definitely had a peak time on this quarter.

Got it. Okay. Thank you guys.

All right. Thanks, Rick. And I believe that's our last question. So thank you everybody for joining us and we look forward to talking to you again next quarter.

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