Earnings Call Transcript - NLY Q1 2023

Sean Kensil, Director of Investor Relations

Good morning, and welcome to the First Quarter 2023 Earnings Call for Annaly Capital Management. Any forward-looking statements made during today's call are subject to certain risks and uncertainties, which are outlined in the Risk Factors section in our most recent annual and quarterly SEC filings. Actual events and results may differ materially from these forward-looking statements. We encourage you to read the disclaimer in our earnings release in addition to our quarterly and annual filings. Additionally, the content of this conference call may contain time-sensitive information that is accurate only as of the date hereof. We do not undertake and specifically disclaim any obligation to update or revise this information. During this call, we may present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in our earnings release. Content referenced in today's call can be found in our first quarter 2023 Investor Presentation and First Quarter 2023 financial supplement, both found under the Presentations section of our website. Please also note, this event is being recorded. Participants on this morning's call include David Finkelstein, Chief Executive Officer and Chief Investment Officer; Serena Wolfe, Chief Financial Officer; Mike Fania, Deputy Chief Investment Officer and Head of Residential Credit; V S Srinivasan, Head of Agency; and Ken Adler, Head of Mortgage Servicing Rights. And with that, I'll turn the call over to David.

David Finkelstein, CEO and Chief Investment Officer

Thank you, Sean. Good morning, and thank you all for joining us on our first quarter earnings call. Today, I will review our performance during the quarter, update you on the macro landscape, and discuss our portfolio activity and positioning within each business. Serena will provide further details on our financial performance, and we are also joined by other business leaders who can offer additional insights during the Q&A. Starting with our performance, as mentioned on our last call, our outlook was optimistic but cautious due to potential volatility in the near term. This conservative approach was validated as we generated an economic return of 3% during what turned out to be a very challenging quarter. We were deliberate with our asset selection and hedging strategy, which I will elaborate on, and we maintained a defensive posture with our economic leverage remaining relatively unchanged at 6.4 turns, while surpassing our rightsized dividend by $0.16. Regarding the macro environment, few expected that bank liquidity management would be among the first casualties of the Fed's rapid hiking cycle. The turbulence caused by SVB led to concerns about the banking system, the economy, and monetary policy, compromising the notion of stable markets and resulting in some of the highest levels of realized and implied fixed income volatility since the financial crisis. The situation remains fluid based on recent events, and we believe the main implication of the banking turmoil is the surplus of assets that need to be absorbed by private market participants. The portfolios of SVB and Signature are currently being sold, adding to MBS supply. Even if other banks do not sell securities, most market participants expected around $100 million in MBS demand from banks at the start of the year. However, instead of this demand, we are more likely to see a decline in bank holdings of MBS. With the Fed continuing its runoff mode, alongside net issuance, the market will be more dependent on money managers to absorb approximately $500 billion in total supply. Spreads are attractive enough for this to happen, although the potential for spread tightening is limited moving forward. Another implication of this situation is that banks are likely to focus on preserving capital and reducing lending activity. Credit availability was already constrained and lending standards were tight before March, but the events of the last few weeks indicate that further contraction is possible, which could slow economic growth. The U.S. economy remains strong, with the labor market adding nearly 350,000 jobs per month this quarter, and U.S. inflation readings staying above the Federal Reserve's target. Although the banking issues heighten the risks of a significant slowdown, the Fed will likely raise rates by 25 basis points next week and aim to keep interest rates steady for the remainder of the year, consistent with their forecasts. Now, moving to our portfolio activity during the quarter. In the agency sector, mortgage performance varied significantly each month due to interest rate and spread volatility. In January, MBS spreads tightened sharply due to decreased implied volatility and strong inflows into fixed income funds. However, performance weakened in February as yields rose despite manageable MBS supply, leading to a more significant cheapening in March in response to the news of SVB and Signature Bank entering FDIC receivership. Overall, mortgage option-adjusted spreads widened by about 5 to 15 basis points across coupons in the quarter. We modestly enlarged our agency portfolio in line with the accretive common equity raised early in the quarter while maintaining prudent leverage. We continued to shift up the coupon stack, with only 5% of our portfolio in 2s and 2.5s, down from 34% a year prior, which better shielded us from the widening in lower coupons that happened due to the FDIC portfolio situation. Moreover, over 50% of our portfolio is in what we define as intermediate coupons, 3.5s to 4.5s, which remain more insulated from potential bank sales while avoiding the supply pressure in higher coupons. This trend encouraged investors to shift toward these coupons, resulting in slightly positive hedge performance in this part of our portfolio despite overall MBS spreads widening during the quarter. Looking ahead, we continue to favor these intermediate coupons and will also opportunistically invest in 5s and higher, as these assets offer historically attractive nominal spreads. In addition to our balanced positioning in the agency market, our duration management and hedging strategies played a crucial role in helping us navigate the volatility in March. Over several trading sessions starting on March 9, the 2-year note moved more than 20 basis points daily. During this period, our portfolio was well-positioned, allowing us to capitalize on the market movements by adding short-end hedges at favorable levels, replacing swap runoff experienced during the quarter. Furthermore, we continue to adjust hedges from treasury futures to SOFR swaps, which we find to be a more effective hedge that aligns closely with our repo funding costs. Regarding residential credit, performance varied across products. Both benchmark credit risk transfer securities and expanded credit whole loans tightened by 10 to 15 basis points in the quarter, while AAA non-QM securities widened by 30 to 40 basis points since the year's end. Our residential portfolio stood at $5.2 billion in market value at the end of Q1, increasing by approximately $200 million quarter-over-quarter, now representing 18% of our capital. This market value increase was driven by the retention of OpEx assets via securitization and strategic purchases, primarily in inspection-grade CRT. We remained active in expanded credit whole loans, acquiring $645 million in loans during the quarter, with 80% sourced directly through our correspondent channel. Our loan quality remains strong, with Q1 settlements showing a 743 weighted average FICO, 70 LTV, and an aggregate mortgage rate of 8.79%. Despite challenging market conditions, we finished the quarter with a solid loan pipeline of $555 million. Our ample warehouse capacity and liquidity management enabled selective access to the capital markets via our OBX securitization platform. We executed three transactions in the first quarter, totaling $1.1 billion, including two non-QM transactions and a jumbo partnership deal, all completed in the first two months of the quarter before the onset of spread volatility in March. As volatility eased at the beginning of the second quarter, we priced our third non-QM securitization of the year just last week. Lastly, regarding our MSR portfolio, in line with previous quarters, we were disciplined in adding just one whole package, resulting in a current portfolio valued at $1.8 billion and $130 billion UPB, characterized by low note rates and high credit quality with an appealing risk profile and stable cash flows. This is evidenced by recent prepayment speeds trending below 3 CPR, while serious delinquencies remain under 50 basis points. In terms of the broader sector, despite the well-publicized supply hitting the market and interest rates dropping by roughly 40 basis points during the quarter, the strong performance of low WAC MSR led to an increase in valuations, which is reflected in a modest growth of our portfolio multiple. Briefly touching on our outlook, we are confident in our positioning across our three businesses and believe we are well-suited for the current environment. Our cautious approach to leverage and liquidity has benefited us in areas where fundamentals have improved, despite ongoing technical headwinds. As outlined in our investor presentation, we foresee attractive new money returns for each of our businesses, with Agency being our preferred avenue for additional capital deployment in the near term. Residential credit and MSR present appealing low to mid-double-digit returns and offer diversification benefits that enhance the stability of our risk-adjusted returns. Looking forward, we aim to develop these strategies to collectively represent around 50% of our dedicated capital while continuing to be patient and measured regarding further diversification. Finally, before I pass it to Serena, I would like to welcome back V.S. Srinivasan, who we are very pleased to have with us on the call this morning. Srini has returned to lead our agency efforts, and having collaborated with him extensively over the years, I am fully confident in his ability to navigate the agency market. We are thrilled to have him back on the team. Now, I will hand it over to Serena to discuss the financials.

Serena Wolfe, Chief Financial Officer

Thank you, David. Today, I will provide brief financial highlights for the quarter that ended March 31, 2023. Consistent with prior quarters, while earnings release disclosures GAAP and non-GAAP earnings metrics, my comments will focus on our non-GAAP EAD and related key performance metrics, which exclude PAA. Despite the challenging market David referred to earlier, our book value per share for Q1 was relatively unchanged from the prior quarter at $20.77. Our investments gained across the board with increases in valuation on our agency resi and MSR portfolios contributing $2.54 to book value for the quarter. These gains were offset by losses on our derivative positions of roughly $2.75, predominantly related to our swap portfolio, which comprised 82% of the losses on our hedging book. After combining our book value performance with our first quarter dividend of $0.65, our quarterly economic return was 3%. We generated earnings available for distribution of $0.81 per share for the first quarter. The $0.08 or 10% reduction in EAD compared to last quarter is primarily attributable to the continued rise in repo expense with interest expense up 20% or approximately $135 million compared to the prior quarter. Largely mitigating the increase in repo expense is a higher net interest component of swaps as the average receive rate climbed 66 basis points, resulting in a 35% or $99 million increase in swap income quarter-over-quarter. TBA dollar roll continued to decline, offsetting the benefit to EAD of higher yields on the spec pools experienced during the quarter. In previous earnings calls, we communicated our expectation that earnings would moderate, as demonstrated this quarter. And the driving factors that we had referenced previously still hold. That is the continued increase in financing costs, swap runoff, the decline in the specialness of rolls and the mismatch between economics and earnings related to futures. Therefore, we expect some further moderation of EAD in the near term, but continue to be comfortable with our current dividend level, given the economic earnings of the portfolio, all things equal. Average yields excluding PAA were 14 basis points higher than the prior quarter at 3.96% as we continue to rotate up in coupon this quarter, with 56% of our agency portfolio now in 4.5% coupons and higher. The factors that impacted EAD are also illustrated in NIM for the quarter, with the portfolio generating 176 basis points of NIM excluding PAA, a 14 basis point decrease from Q4. Net interest spread does not include dollar roll income. Therefore, the decline in NIS was less than NIM, 9 basis points down quarter-over-quarter at 1.62% versus 1.71% in Q4. The continued rise in repo rates and higher average balances impacted our total cost of funds for the quarter, rising by 23 basis points to 234 basis points in Q1, and our average repo rate for the quarter was 462 basis points compared to 372 basis points in the prior quarter. However, as previously mentioned, swaps positively impacted cost of funds during the quarter by approximately 58 basis points. Now turning to details on financing. Funding markets remain a bright spot amidst all the volatility in the financial markets with funding for our agency and non-agency security portfolios remaining resilient and ample. Consistent with most of 2022, liquidity is concentrated in shorter-term markets after Fed meeting dates. In saying that, a core tenet of our funding philosophy is diversification, both counterparty and term. And as such, we have sought to extend approximately 10% of our agency repo books. In this vein, during Q1, we opportunistically entered into 6- and 12-month floating-rate trades at attractive rates. As a result of this positioning, our Q1 reported weighted average repo days were 59 days, up from 27 days in Q4. Since the beginning of the year, we increased our dedicated financing for our credit businesses, upsizing an existing resi credit facility by $200 million and adding $500 million in new warehouse facilities for resi credit and MSR combined. Our deliberate approach to diversifying financing for our credit businesses has resulted in a combined $3 billion of capacity with leverage levels substantially unchanged from Q4 and substantial unused capacity for both resi credit and MSR of over $2 billion. Our securitization platform continues to be a core part of our resi credit strategy. As of the end of Q1, 86% of our GAAP consolidated whole loan portfolio was funded through securitization at a weighted average cost of funds of 3.78%, approximately 215 basis points below the non-QM balance sheet cost of funds for the quarter. In addition to the below-market financing rate of our securitized debt, 96% of the debt is locked in at a fixed rate. Our OpEx to equity ratio for the quarter was unchanged from full year 2022 at 1.4% as we've realized most of the cost savings from our internalization and divestiture of MML and ACREG businesses. Operating expenses may rise modestly as we continue to invest in resources for growth in our resi credit and MSR platforms. Our liquidity profile remains robust with unencumbered assets of $5.7 billion, including cash and unencumbered agencies of $3.8 billion for the quarter. The approximately $600 million decrease in unencumbered assets primarily came from the pledging of assets to our new MSR facility in Q1, which remains undrawn, and slightly higher leverage of agencies and whole loan positions at quarter end. Now that concludes our prepared remarks, and we will now open the line for questions. Thank you, operator.

Operator, Operator

Our first question will come from Bose George with KBW.

Bose George, Analyst

Actually, can I get an update on book value quarter-to-date?

David Finkelstein, CEO and Chief Investment Officer

Sure, Bose. So as of weeks in, we are off roughly 1%. The last couple of days have been a little bit choppy, nothing to write home about, and there's still a long way left in the quarter.

Bose George, Analyst

Great. And then just in terms of that and your outperformance versus the market and agencies in the first quarter as well, is it largely attributable to the positioning where the lower coupons are not as much a part of your portfolio?

David Finkelstein, CEO and Chief Investment Officer

Look, Bose, there's a lot of factors. We kept things very steady in the first quarter. Most importantly, I think we have the right capital allocation to keep us nimble. Each of the 3 businesses generated a positive economic return, but the fact of the matter is that diversification enabled us to navigate the market much better. We gravitated up in coupon, which helped. We didn't get whipsawed in the January rally and February sell-off because of the fact that agency is 2/3 of the portfolio, and it's much easier to manage rate risk when it's a smaller portion of your capital allocation. And then into March, we had the right positioning. When the bank crisis evolved, we had a steepener on and we were along the market, and we ultimately reduced that when the front end got very low, well inside of 4% on a 2-year note. And so we ended the quarter in what we think to be a very conservative position with leverage roughly unchanged, a very moderate amount of duration and responsible level of leverage and capital allocation. And that's effectively what helped us navigate the quarter.

Bose George, Analyst

Okay. Great job on the book value. Regarding spreads, you mentioned that you believe spread tightening is unlikely. I'm curious about your thoughts on longer-term spreads and where you think they might settle.

David Finkelstein, CEO and Chief Investment Officer

Sure. The agency market is priced appropriately for the current environment, Bose. The fact of the matter is it is difficult for agency to tighten considerably when banks aren't involved. So we are relying on money managers. And we anticipate that spreads will remain range bound. But the fact of the matter is they are, on a longer-term basis, to your point, very inexpensive. And we do like them. But over the short term, we could see localized dislocations given the volatility in the market, and that may occur, and we're perfectly prepared for it. But generally speaking, we like agency, we're cautious on volatility. And over the long term, we think they're great assets.

Operator, Operator

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

Trevor Cranston, Analyst

You guys talked about the failed bank portfolio sales coming and the changing outlook for bank demand in the agency market. I was curious if you've seen or if you can say if you've seen any material amount of sales of other assets, non-agency assets or whole loans out of banks or if you expect to see that over the coming months and how do you think that could impact the non-agency market?

David Finkelstein, CEO and Chief Investment Officer

Sure, Trevor. Well, obviously, this week, the market is talking about First Republic Bank, which does hold roughly $100 billion in residential loans. And that potentially could hang in the balance as well as other residential credit assets. When we look at that particular portfolio, those are very high-quality performing loans. And there is value to the relationship. So we do think that there will be ultimately a home for those loans should they be sold. Mike can expand on this, but over the intermediate term, we do think we're a very good fit for this type of asset, particularly that portfolio given over 50% of it is interest-only and should go through the securitization channel. Our brand and our shelf is obviously quite strong. We have the ability to take the risk retention on the interest-only. And we do have an appetite for subordinate securities of high-quality collateral. And so we'll see how things play out. But ultimately, this will be handled responsibly, we believe. And Mike, feel free to expand on that.

Michael Fania, Deputy Chief Investment Officer and Head of Residential Credit

Yes, I think we would just add that the GSEs have set precedence in terms of having large loan sales in the context of $2 billion to $5 billion per each auction. And we think that to the extent that, that portfolio came out in that size, it could be digested pretty easily through the market. In terms of just the banks stepping away from lending and tightening underwriting standards, we have not really seen that in terms of leading to supply on prime jumbo. We still see bank rates on prime jumbo, 5.5%, 5.75%, where we think that the cost to securitize new origination loans probably needs to be in that 7% area, north of 7%. So volume at this point from new origination prime jumbo is not going to the secondary market and to securitizers.

Trevor Cranston, Analyst

Got it. Okay. That's helpful. And you mentioned that you had a curve steepener on, which helped with your book value performance in March. Can you talk in general kind of your thoughts around the rate outlook and how you think the shape of the curve kind of plays out over the near term?

David Finkelstein, CEO and Chief Investment Officer

Yes. So first of all, with respect to the rate outlook, our view is very conservative with respect to rate exposure. I think if you look at the first quarter, we saw 3 very different markets. In January, we saw a rally driven by disinflationary sentiment ultimately leading to cuts, which was very good for risk assets and particularly Agency MBS. Then all of a sudden, in February, you get a pickup in economic data, stronger inflation data and a meaningful sell-off and a flattening bias on the curve, which obviously was not good for agency. And then in March, you end up in a crisis scenario where it was completely flight to quality and a meaningful steepener, which, to your point, we were prepared for. And we ultimately flattened out our curve exposure. And currently, right now, we're running at about half a year, inside of a half a year of duration and we're relatively agnostic on the curve, and I'll tell you why momentarily. But the fact of the matter is, in terms of the outlook, we don't think any of those 3 scenarios are going to repeat themselves. We'd love to see January occur again, but we don't think that's the case. We think that ultimately, you will have a steady progression of weaker economic data and a slowdown in inflation, and that will leave the Fed ultimately to be more accommodative. We do expect the Fed to hike next week, and we think that will be bad. We're not as optimistic on cuts, three cuts this year as the market is pricing in. And so as a consequence, we don't have the bet of the steepener on any longer. And the fact of the matter is it's a very expensive trade to have on. The curve is already priced to steepen roughly 85 basis points over the next year. And so if you do have that bet on and it doesn't steepen by that amount, you lose money. And so we're respectful of where the market is pricing in terms of cuts, but it's not something we're willing to go all in on, and we're staying relatively agnostic with respect to the curve and very conservative on the duration front because the fact of the matter is we get enough spread in our assets to where we don't need to make meaningful bets right here on rates. We want to keep enough duration. Should there be a flight to quality, we have some protection. But again, if the inflation data doesn't calm down, and we do get a sell-off like we're seeing a little bit of this morning, we want to be protected from that standpoint as well. Does that help?

Trevor Cranston, Analyst

Yes, very helpful.

Operator, Operator

Our next question will come from Doug Harter with Credit Suisse.

Douglas Harter, Analyst

Can you talk about how you're balancing kind of the longer-term goal of 50-ish percent equity allocation to credit and MSR versus higher relative returns you see in Agency today?

David Finkelstein, CEO and Chief Investment Officer

Yes, that's correct. The relative value equation does slightly favor agency right now. The reality is, Doug, if we wanted to increase both our MSR and residential holdings, we could adjust our pricing in a modest way, and we do that. However, we prefer to take a conservative approach regarding credit, considering the potential risk of an economic downturn and the expected performance of agencies in such an environment. We're committed to maintaining strict lending standards in our residential channel and acquiring quality assets as we've discussed. Regarding MSR, we anticipate that the supply of MSR in the secondary market will continue throughout 2023, and we do plan to gradually expand that portfolio. However, we will proceed cautiously due to the significant competition in the market for these packages, and we will be selective. Ultimately, our goal is to allocate 50% of our capital to both residential and MSR, and we will reach that target, but we intend to be patient. At the moment, the relative value equation favors agency, which is why we have a higher allocation there.

Douglas Harter, Analyst

And then can you just talk about to the extent that it's either on loans or MSR, if there's kind of larger attractive opportunities that come about the ability to kind of add leverage to the portfolio to take advantage of that versus kind of raising capital, kind of how you would weigh those sources of liquidity to fund any large acquisitions if they come along?

David Finkelstein, CEO and Chief Investment Officer

We have significant unused warehouse capacity. For instance, in MSR, our portfolio has very little leverage. When we examine our MSR holdings compared to what's available on the market and how far out of the money those loans are, they appear to be relatively stable compared to current coupon MSRs. If we were to leverage our 297 gross WAC MSR, it would likely show less price volatility in response to rate changes than unlevered current coupon MSRs. We believe we are well-positioned to leverage our capacity, and if larger trading opportunities arise, we are prepared, as our warehouse lines are open. On the residential side, we have discussed our warehouse capacity and the potential for its use. The securitization market for residential loans is very liquid, allowing us to buy loans, maintain a substantial portfolio, and securitize when advantageous, as we have done four times this year. We can also warehouse a significant amount of loans should the opportunity present itself. Additionally, we are relatively under-levered in residential, with our overall leverage just above 6 turns. Essentially, there's very little leverage in MSR and minimal in residential, indicating we have capacity available.

Operator, Operator

Our next question will come from Vilas Abraham with UBS.

Vilas Abraham, Analyst

Can you expand a little bit on your hedging strategy? Specifically, how are you thinking about your swap position versus your treasury futures position evolving from here? I mean, it sounded like you may be trying to wind down those treasury hedges.

David Finkelstein, CEO and Chief Investment Officer

Sure. We aren't completely winding down our positions. In the first quarter, we converted a number of our hedges from treasuries to futures, as we saw very tight spreads along the curve. For instance, with 10-year swaps in the negative mid-30s, this proved to be a favorable trade until the banking situation caused some fluctuations. However, it's still beneficial. The conversion aligns better with our financing, given SOFR, and we believe the spreads on swaps are tighter compared to treasury futures. We still maintain about 16% to 17% of our hedges in futures. When we trade TBAs and engage in basis trades, it often involves futures. Therefore, we will always keep a futures position, but for our longer-term cash flows and pools, swaps generally suit our needs better.

Vilas Abraham, Analyst

Okay. That makes sense. And then just maybe shifting gears, I was curious, could you talk about the behavior of your funding counterparties through the quarter? I mean, it sounds like it was business as usual. But was there any anxiety at any point given some of the volatility.

Serena Wolfe, Chief Financial Officer

Vilas, it's Serena. We would say no. Like I said in my script, the funding markets have been and have continued to be a port in the storm, for want of a better word, they are robust and fulsome and we've had no issues with being able to roll repo. We've actually, like I said, also I have been able to opportunistically get term on some trades where it makes sense for us. And I would say also, even with haircuts and things like that, we have not seen any meaningful increase at all in haircuts even through the volatility. We did see repo spreads modestly widen through the end of the first quarter. But post quarter end, those spreads have actually tightened and I would say that repo spreads are consistent with historical spreads at this point in time.

David Finkelstein, CEO and Chief Investment Officer

One thing I'll just add, Vilas, is that even in credit, we didn't see a disruption in March. Securitization markets kind of went on hold, but the financing through short-term warehouse or otherwise was in repo for securities was perfectly liquid and ample as well.

Serena Wolfe, Chief Financial Officer

Also, as illustrated right there by the fact that we've added capacity during the quarter and post-quarter end for our credit portfolio. So I think that is also illustrative of the access and the banks' appetite for warehouse and repo.

Operator, Operator

Our next question will come from Richard Shane with JPMorgan.

Richard Shane, Analyst

Thank you everyone for taking my question this morning. I apologize if some of this has already been discussed, as we are transitioning between calls. I would like to inquire about supply and demand in the industry, specifically regarding how the production capacity being released throughout the year affects pricing and supply from other sellers.

David Finkelstein, CEO and Chief Investment Officer

So you're talking about production at the origination level coming out?

Richard Shane, Analyst

Yes, exactly. Does that actually have any impact for you guys in terms of pricing? Because presumably, what will happen is you will start to see wider origination spreads, better margins there. I'm wondering how that impacts your securities?

David Finkelstein, CEO and Chief Investment Officer

On the agency side, correct?

Richard Shane, Analyst

Yes, exactly. Yes...

David Finkelstein, CEO and Chief Investment Officer

Yes. The primary and secondary spread is quite wide given the current interest rates, sitting at around 125 to 130 basis points, which is on the higher side. With limited origination, you might expect the spread to be tighter due to increased competition, but market volatility and various other factors have kept it wide. There is significant capacity within the origination industry, with employment levels surpassing those of 2018 and 2019, approximately 350,000 people still working in the market. If rates improve, we are likely to see those employees become active again, which will affect newly issued higher coupon mortgage-backed securities. That's why we are cautious with the 5.5s and 6s; a small rally could prompt refinancing for those borrowers. We are paying for protection in current production coupon bonds, and we believe it is warranted. Overall, we expect organic growth in the agency market to be around $200 billion this year, which is manageable. Most of the supply will come from the Federal Reserve, adding a couple of hundred billion more. In the banking sector, we have about $100 billion tied to SVB and Signature. As I mentioned earlier, we anticipated net demand from banks later in the year to be around $100 billion, but now we’re facing net supply instead. Regarding regional banks, we don't foresee much selling, but we expect runoff without reinvestment and minimal buying activity. As a result, our expectation of $100 billion in net demand from the banking sector has shifted to an immediate supply of $100 billion due to SVB and Signature. Furthermore, the runoff from the banking sector could range between $150 billion and $200 billion for the year, which likely will not be reinvested. This results in a net decline of about $300 billion, in addition to the $100 billion we thought they would purchase, significantly altering the dynamics.

Richard Shane, Analyst

Got it. Okay. That's very helpful.

Operator, Operator

Our next question will come from Jason Stewart with Jones Trading.

Jason Stewart, Analyst

David, I would like to just follow up on Rick's question in where you think the most opportunistic investments are if it includes credit? Or where in the capital structure you'd like to be?

David Finkelstein, CEO and Chief Investment Officer

Sure. like we can talk about both credit and then agency, but let's actually start with agency and Srini will talk a little bit about what we're thinking in terms of agency and investments.

Unidentified Company Representative, Unnamed Representative

In the agency space, government-guaranteed assets currently have wide financing spreads at SOFR, falling between $150 million and $180 million. We prefer the middle range of the coupon, which offers some protection against rapidly rising rates. We're open to paying more for specialized pools higher in the coupon stack. Given the current rates and spreads, with eight times leverage, even at the lower end of the range, you can comfortably reach a mid-15 yield target. Agencies appear quite appealing at the moment. However, the last decade has been primarily influenced by the Fed and banks, which are not as active in the market now. Additionally, over the past ten years, there has been a noticeable lack of private capital flowing into the agency MBS sector, but we expect that with these attractive spread levels, some of that private investment will return to the sector. This process will take time as it requires organic growth. Over the long term, we anticipate that the entrance of private capital will help address the current supply-demand imbalance.

David Finkelstein, CEO and Chief Investment Officer

And on the credit side, we would say that it's probably a continuation of last quarter. We've allocated to credit risk transfer. We think that there is support of both positive short-term and long-term technicals. CRT M1b, which is the BBB bond. They're low mid-300s, they're 250 basis points of NIM, given our cost of financing. The M2, which is below IG, that's low mid-500s. So that's 400 basis points of NIM. That's a low mid-teens ROE on 1 turn of leverage. We've seen the GSEs be reactive to market conditions, potentially pulling deals just given where spreads are. So we do think that that is limited in terms of new originations. There's been $15 billion of tenders, 2 tenders already announced this year. So we feel pretty good in terms of our portfolio there and continuing to allocate and then also a continuation of the correspondent channel and buying loans through OBX. So whole loans right now, non-QM home loans, the 10 to 12 rates, probably 8% to 8.25%. We'll call it a 7.25% to 7.50% unlevered yield. And we think in securitization, you're achieving mid-teens ROEs on that asset class.

Unidentified Company Representative, Unnamed Representative

Yes, regarding the MSR side, we can enhance our existing portfolio and add more given the current state of the mortgage industry. As you pointed out about the primary and secondary spreads and origination, there is a significant amount available. We are observing volumes of several hundred billion a quarter still trading. The characteristics of the cash flows are exceptional for the mortgage servicing rights industry, allowing us to purchase contractual cash flows at 250 to 300 basis points out of the money with double-digit yields. This is an unprecedented opportunity that, as Dave mentioned, we will continue to leverage.

Jason Stewart, Analyst

Okay. Two final questions. Where do you think the MSR multiples end up at, number one? And then two, what do you think the best capital opportunity is on the investment side? Is it on the loan side or in the security side?

David Finkelstein, CEO and Chief Investment Officer

On the MSR multiples, it really uses a discounted cash flow method, which depends heavily on interest rates. For the deep out of the money assets we’re focusing on in our portfolio, the analysis is quite straightforward since the cash flows are highly reliable. As prepayment speeds have slowed down, the volume has actually increased. This presents a great opportunity because the mortgage industry's necessary selling has prevented those multiples from aligning with their expected values. We're pleased to see those multiples remain stable, allowing us to continue investing capital. We don't anticipate that they will increase significantly, which is favorable for our capital allocation strategy and our long-term perspective on this asset class.

Unidentified Company Representative, Unnamed Representative

And Jason, in terms of credit, whether loans versus securities, we have the ability to flex into both. I would say our preferred approach remains purchasing loans. We control the product, we control the strategy, our partners. We control pricing where on third-party securitizations you obviously don't have that level of control. So going into a little bit of a more uncertain economic environment, we certainly want to have that control and dictate all aspects of the strategy.

Jason Stewart, Analyst

That makes sense.

Operator, Operator

This concludes our question-and-answer session. I would like to turn the conference back over to David Finkelstein for any closing remarks.

David Finkelstein, CEO and Chief Investment Officer

Thanks, Anthony, and thank you everybody for joining us today. Good luck, and we'll talk to you next quarter.

Operator, Operator

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