Earnings Call Transcript - NLY Q3 2025

Operator, Operator

Good morning, and welcome to the Q3 2025 Annaly Capital Management Earnings Conference Call. Please note, this event is being recorded. I would now like to turn the conference over to Sean Kensil, Director of Investor Relations. Please go ahead.

Sean Kensil, Director of Investor Relations

Good morning, and welcome to the Third Quarter 2025 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 third quarter 2025 investor presentation and third quarter 2025 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 Co-Chief Investment Officer; Serena Wolfe, Chief Financial Officer; Mike Fania, Co-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 Co-Chief Investment Officer

Thank you, Sean. Good morning, everyone, and thank you all for joining us for our third quarter earnings call. Today, as usual, I'll briefly review the macro and market environment as well as our performance for the quarter, then I'll provide an update on each of our three businesses, ending with our outlook. Serena will then discuss our financials before opening up the call to Q&A. Now starting with the macro landscape. The U.S. economy remained resilient in the third quarter, with GDP likely to be on pace with that of Q2. Growth was supported by healthier consumer spending as well as AI-driven business investment despite lingering uncertainty around tariffs and immigration. Inflation remained elevated near 3% during the quarter, though the anticipated uptick in goods inflation resulting from higher tariffs has been more muted than expected thus far. Labor market conditions did weaken with hiring slowing to a mere 30,000 jobs per month over the past three months, while sentiment around future hiring deteriorated. Although the unemployment rate has moved only slightly higher, the Fed's 25 basis point cut in September and forward guidance was supported by an outlook that suggests growing downside risks to its employment mandate. Yields fell modestly during the quarter, and the curve steepened given the market's expectation for modestly lower policy rates going forward. The treasury market also benefited from a shift in issuance towards the front end of the yield curve and strong tariff revenue, the combination of which helped ease concerns about long-term debt issuance. This led to lower term premium quarter-over-quarter and a 6 to 9 basis point widening in swap spreads relative to their forward implied levels, which benefited our returns. The precipitous decline in interest rate volatility during the quarter also provided meaningful support to our portfolio by lowering convexity costs and fueling much of the Agency spread tightening that occurred. We generated an economic return of 8.1% for the third quarter and 11.5% year-to-date, notably recording a positive economic return for eight consecutive quarters, exhibiting the benefits of Annaly's diversified housing finance strategy. Our portfolio's earnings power remains strong with EAD of $0.73 per share, out-earning our dividend each quarter since we increased it at the outset of the year. Also to note, we raised $1.1 billion of accretive equity in Q3, including $800 million through our ATM program. We also reopened the mortgage REIT preferred market with Annaly's first preferred issuance since 2019 and the first residential mREIT issuance in multiple years. Now turning to our investment strategies and beginning with Agency. Our portfolio ended the quarter at just over $87 billion in market value, up 10% quarter-over-quarter, as the majority of the capital raise was deployed in Agency MBS considerate of attractive relative returns. Total growth of our Agency portfolio was $7.8 billion in market value with about 15% of that increase coming from Agency CMBS and a similar share coming from market value appreciation. While the primary driver of Agency performance was lower interest rate volatility, also noteworthy is that the supply and demand dynamics in the Agency MBS market continue to improve. Specifically, fixed income fund inflows were more than 50% higher than the average over the past few quarters and an additional indication of favorable technicals is that CMO demand has been heavy with production running at over $30 billion per month, which has helped distribute MBS supply to a wider audience of investors. Overall Agency spreads tightened by 8 to 12 basis points to treasury in the quarter with intermediate and lower coupons outperforming higher coupons. Early in the quarter, we added Agency in line with our capital raise across coupons. And ultimately, as higher coupons began to look more attractive given cheapening into lower mortgage rates. We shifted purchases to specified pools in 5.5% and 6%. Our holdings in higher coupons have been methodically constructed over the past few years to mitigate prepayment risk, which gives us flexibility to add in areas that provide the best expected return. And on the hedging side, we had less need to intervene this past quarter, as realized volatility was somewhat muted but we did maintain our disciplined approach to rate risk management, as we added hedges alongside new asset purchases with a bias towards swaps in the front end of the yield curve. And as we mentioned previously relative value and the superior carry of swap hedges has informed our overweight in swaps, which added meaningfully to our economic return this past quarter. Shifting to Residential Credit, our portfolio increased to $6.9 billion in economic market value, representing $2.5 billion of the firm's capital. Investment-grade Residential Credit assets tightened during the quarter with new origination, non-QM AAA spreads ending Q3, 15 basis points tighter, providing a supportive backdrop for securitization issuance. Non-Agency gross securitizations have totaled $160 billion year-to-date, which is already the second largest annual gross issuance since 2008, and will end up being second only to the 2021 vintage. Our Onslow Bay platform closed 8 transactions for $3.9 billion in the quarter, generating $473 million of high-yielding OBX retained securities for Annaly and our joint venture. Year-to-date, we've now priced 24 transactions, representing $12.4 billion of UPB, solidifying Annaly as not only the largest nonbank issuer in the residential credit market but a top 10 issuer worldwide of asset-backed and mortgage-backed securities. We also redeemed OBX 2022-NQM8 during the quarter, exercising the transaction's 3-year call feature and we expect there to be significant embedded value in our late '22 and '23 vintage NQM issues, given current mortgage rates and securitization economics. With respect to our correspondent channel, we achieved record-setting quarterly volumes across both locks and fundings while remaining disciplined in our approach to credit. The channel locked $6.2 billion in whole loans and funded $4 billion in the third quarter with our quarter-end lock pipeline representing a 765 weighted average FICO, 68% LTV and over 96% first lien. Now with respect to the underlying housing market, as we foreshadowed on previous calls, the market is now experiencing relatively flat year-over-year HPA nationally, as consistently elevated mortgage rates weigh on affordability. There is potential for further depreciation in the winter seasonals as available-for-sale inventory has increased, although we do expect cumulative depreciation to be modest given the longer-term positive fundamentals of the housing market. Nonetheless, in light of softer housing, we remain focused on maintaining a high credit quality portfolio with a continued emphasis on manufacturing our own proprietary assets through our market-leading correspondent channel. Approximately 75% of our Residential Credit exposure is now comprised of OBX securities and residential whole loans, providing full control over both the acquisition and management of the assets. Now moving to MSR. Our portfolio increased by $215 million in market value to $3.5 billion, comprising $2.9 billion of the firm's capital. We purchased $17 billion in UPB across three bulk packages in our flow network during the quarter as well as committing to purchase an additional package for $9 billion in UPB subsequent to quarter end. Our MSR valuation multiple decreased very modestly quarter-over-quarter, driven largely by lower mortgage rates. Our portfolio remains well insulated as the aggregate borrower is approximately 300 basis points out of the money and the portfolio continues to exhibit highly stable cash flows as it pays sub-5 CPR over the past three months. The fundamentals associated with conventional MSR remain positive as evidenced by our portfolio of serious delinquencies being unchanged at 50 basis points. The competition for deposits remains strong, resulting in better-than-expected float income and subservicing costs decreasing given increased technology investments across our servicing partners. Also to note, we announced a new partnership with PennyMac Financial Services subsequent to quarter end, adding another industry-leading mortgage originator and servicer to our existing set of best-in-class subservicing and recapture partners. As part of this new relationship, we purchased $12 billion of low note rate MSR whereby PennyMac will handle all subservicing and recapture responsibilities for the portfolio sold. Now shifting to our outlook. Our investment strategies are well positioned for the balance of the year given declining macro volatility, additional Fed cuts expected and healthy fixed income demand. While Agency spreads are tighter, the sector remains compelling as spread compression has been achieved through lower volatility and a steeper yield curve, thus improving the fundamentals of the asset class. Furthermore, a more accommodated monetary policy should continue to support a strong technical backdrop for Agency MBS, not to mention the likelihood of regulatory reform and the potential for greater bank demand for the sector into 2026. Our Residential Credit business should further benefit from the growing private label market with our Onslow Bay correspondent channel and OBX securitization platform being clear market leaders. Our MSR portfolio stands out as the lowest note rate portfolio out of the top 20 largest conventional portfolios in the market, providing highly predictable, durable cash flows with limited negative convexity. Lower note rate MSR remains our preferred positioning, as investors are compensated more for selling convexity and Agency MBS. We also expect MSR supply to remain healthy as we maintain ample excess capacity to opportunistically grow our portfolio. Now this diversified housing finance model has delivered proven results, having generated a 13% annualized economic return over the past three years since scaling each business. While we maintain our positive outlook, we've carefully built our portfolio to guard against uncertainty, and we remain flexible in the current investing climate with historically low leverage and significant liquidity. Now with that, I'll turn it over to Serena to discuss the financials.

Serena Wolfe, Chief Financial Officer

Thank you, David. Today, I will provide a brief overview of the financial highlights for the quarter ended September 30, 2025. Consistent with prior quarters, while our earnings release discloses GAAP and non-GAAP earnings metrics, my comments will focus on our non-GAAP EAD and related key performance metrics, which exclude PAA. As of September 30, 2025, our book value per share increased 4.3% from $18.45 in the prior quarter to $19.25. After accounting for our dividend of $0.70, we achieved an economic return of 8.1% for Q3. This brings our year-to-date economic return to 11.5%. We generated positive economic returns for the quarter across all of our businesses. Our performance was driven by strong results in our Agency business, which benefited from spread tightening, leading to gains across the investment portfolio. These gains were partially offset by losses on our hedge positions in light of marginally lower interest rates on the quarter. Earnings available for distribution per share for the quarter were consistent with Q2 at $0.73 per share and again exceeded our dividend for the quarter. We maintained our EAD levels by generating average yields of 5.46% compared to 5.41% in the prior quarter, and our average repo rate improved by 3 basis points to 4.5%. Our Resi Credit business contributed to increased yields this quarter, driven by record securitization and loan purchases with average yields rising to 6.29%. Net interest spread ex-PAA increased again this quarter to 1.5% and net interest margin ex-PAA is comparable with the prior quarter at 1.7%. Turning to our financing. In conjunction with deploying the proceeds from our capital raised during the quarter, we added approximately $8.6 billion of repo principal at attractive spreads. As a result, our Q3 reported weighted average repo days maintained a healthy position of 49 days, comparable to the prior quarter and a modest economic leverage ratio of 5.7x, one tick lower than at the end of the second quarter. As of September 30, 2025, our total facility capacity for the Resi Credit business was $4.3 billion across 10 counterparties with a utilization rate of 40%. Our MSR total available committed warehouse capacity is $2.1 billion across 4 counterparties as of September 30, 2025, with a utilization rate of 50%. We continue to explore additional funding relationships as we invest in our credit businesses and add new facilities in anticipation of future business growth. Annaly's financial strength is further demonstrated by our $7.4 billion in unencumbered assets at the end of the quarter. This includes cash and unencumbered Agency MBS of $5.9 billion. In addition, we have roughly $1.5 billion in fair value of MSR pledged to committed warehouse facilities that can be quickly converted to cash subject to market advance rates. Combined, we have approximately $8.8 billion in assets available for financing, which is up $1.4 billion compared to the second quarter, in line with our asset growth and represents 59% of our total capital base. Finally, touching on OpEx. Our efficiency ratios improved significantly during Q3, decreasing by 10 basis points to 1.41% for the quarter and now standing at 1.46% for the year-to-date period. Using period end equity as of September 30, our OpEx-to-equity ratio was 1.34% for the quarter, highlighting the efficiency and scale of our diversified model. This ratio is one of the lowest in the mortgage REIT sector despite having three complementary businesses on the balance sheet. Now that concludes our prepared remarks, and we will now open the line for questions. Thank you, operator.

Operator, Operator

The first question comes from Bose George with KBW.

Bose George, Analyst

First, regarding returns, the Agency returns decreased a few points due to tighter spreads. Can you discuss how that compares now in terms of your preferred investment area, is there more parity now between agencies and some of the other sectors?

David Finkelstein, CEO and Co-Chief Investment Officer

Sure. From a capital allocation perspective, as we came into the third quarter, we obviously felt like Agency warranted an overweight, and that certainly came to fruition. As spreads have come in, Agency still looks very attractive, particularly because, as I mentioned in the prepared remarks, both fundamentally and technically, the sector has healed quite well from 2022 and 2023. Fundamentally, we have lower volatility. Fed cuts are going to continue, and we have slope to the curve. And also, equally as important from a technical perspective, the demand base has broadened quite a bit. Money managers are adding. Obviously, a lot of money is coming into fixed income, as I talked about. REITs are adding. And we haven't had banks in overseas as strong of a participation. But as the Fed does continue to cut and potentially bank deregulation occurs, we do expect more demand to come from that sector. So we feel good about the market. Spreads are tighter. We're still overweight Agency, even more overweight, which benefited us. We'd like to get our Resi and MSR weightings back up to a combined 40%. We're patient to do so. And we feel good about how the portfolio is positioned. Nonetheless, we would like to increase those two sectors from a near-term capital allocation perspective.

Bose George, Analyst

Okay. Great. And then actually, just following up on that. The MSR, you guys noted the bulk supply is up, I think, 50%. Where is that coming from? How is the pricing looking? And could we see the MSR increase as a result of that?

Ken Adler, Head of Mortgage Servicing Rights

Yes. Thanks, Bose. This is Ken. Yes, the bulk supply has been coming from large participants. Several of them have not previously been sellers. So that is encouraging for future bulk supply. Pricing has been relatively stable throughout the year. So we're pretty much encouraged by that like the return profile. And we opportunistically added through the quarter, as you can see.

David Finkelstein, CEO and Co-Chief Investment Officer

And subsequent to quarter end, Bose.

Operator, Operator

The next question comes from the line of Doug Harter with UBS.

Douglas Harter, Analyst

As you look at the Agency returns, can you help break down kind of how you see like OAS returns versus how much of it is coming from the swap spread and how that makes you think about the risk of the position?

V.S. Srinivasan, Head of Agency

The spread between swaps and treasuries is currently around 35 to 40 basis points. If you are fully hedged to swap, the spreads are about 35 to 40 basis points wider than they would be if hedged to treasuries. For instance, at 35.5% hedging ratio, we are using about 65% swaps and 35% treasuries, which gives us a blended yield of approximately 160 basis points, translating to just under a 17% return on equity. Additionally, if we account for option costs, I estimate these to be in the range of 60 to 65 basis points. However, depending on the specific pool you choose and how much you allow the duration to vary, you can significantly lower the hedging costs. The main factor that has contributed to our performance over the last quarter is the low realized volatility, which has been consistently below implied volatility, positively impacting hedging costs. We believe that the volatility environment will remain relatively low compared to what was experienced in 2023 and 2024. Does that address your question?

Douglas Harter, Analyst

That's very helpful. And then if you could just provide an update on how book value is faring quarter-to-date?

David Finkelstein, CEO and Co-Chief Investment Officer

Doug, as of last night, book pre-dividend accrual was up in upwards of 1%. And if you add the dividend accrual, 1.5% to 2% economic return.

Operator, Operator

The next question comes from the line of Harsh Hemnani with Green Street.

Harsh Hemnani, Analyst

So this quarter, it seems like you rotated up in coupon continued that rotation, but focused primarily on specified pools. Could you sort of talk through the puts and takes of how you're thinking about, given the rate backdrop we're in right now, weighing those higher coupon specified pools versus perhaps rotating into lower coupon to get some of that prepayment protection in that way?

V.S. Srinivasan, Head of Agency

We are continuously exploring the best methods for obtaining prepayment protection, whether that means moving to lower coupons or purchasing specified pools. Last quarter, when interest rates fell to their lowest point in over a year, expectations for prepayments on generic higher coupons increased significantly, which resulted in a reduction in duration and negatively affected our carry profile. Consequently, there was a notable shift in demand towards lower and intermediate coupons. According to our metrics, lower and intermediate coupons appeared to be more valuable compared to the trading levels of higher coupons. This situation meant that when evaluating specified pools, the premiums for cheaper assets were quite strong, although the TBA underperformed significantly. The primary benefit of specified pools is that these options can be held for an extended period. Unlike options that expire in six or nine months, once we purchase loan balance paper, it is not a concern how long it takes for rates to rise. Eventually, when they do, we still have the option available. The longevity of the option makes specified pools much more appealing than simply moving down in coupon or buying general collateral while trying to hedge against convexity.

Harsh Hemnani, Analyst

Got it. That's helpful. And then maybe one on the MSRs. So it seems like the purchase this quarter was fairly low coupon perhaps inline with your existing portfolio. But given the increase in supply we've seen perhaps over the last quarter, how is that sort of breaking down between the lower coupon MSRs and close to production coupons?

Ken Adler, Head of Mortgage Servicing Rights

Yes. Thank you very much for the question. And just a follow-up to what Srini said, we have the opportunity to look at OAS valuations in both MBS and MSR. So when we price convexity and opportunities, we're taking convexity on the MSR side by purchasing the lower note rates. When we do the valuations, we see more opportunity there and to participate in the higher note rates in the form of Agency MBS. So that's a big part of our strategy. And as a follow-up to the other point about the increase in bulk supply, what's going on is rates have come down and mortgage origination is at a much higher level. As mentioned previously, the industry just can't afford to retain all the MSR that's created in a high-volume environment.

David Finkelstein, CEO and Co-Chief Investment Officer

And Harsh, just to jump in here, Ken brings up a very important point in terms of we'd rather take negative convexity risk in MBS and pass-throughs and the TBA market than in the MSR market because it's cheaper there. Now your question to both Srini and Ken, from a big picture perspective in terms of how we manage convexity in both, we have a fair amount of options, and we look at everything on a portfolio basis. Diversification outside of Agency MBS in the form of Resi Credit and MSR is the biggest, most powerful way to reduce our negative convexity. In fact, in the Resi market, every time we do a securitization, we're buying an option essentially with the call option for a down rate type scenario. So we're buying both from that standpoint. We pick up a better convexity profile by buying low note rate MSR, which has very little negative convexity exposure to it. And then within the agency market, obviously, Srini talked about pools and how for years, we've built what we think is a very durable portfolio from a convexity profile, but also Agency CMBS, which we added over $1 billion this past quarter, which has virtually no negative convexity. The point being is that there's a lot of options for us to mitigate our convexity risk. I think we look at everything on a total portfolio basis and come up with the most efficient way to do it.

Operator, Operator

The next question comes from the line of Jason Weaver with Jones Trading.

Jason Weaver, Analyst

With your outlook you put out, with mortgage spreads now back at the tight, would you expect for the pace of lock volume and securitization issuance sort of towards and into year-end remains elevated despite the usual seasonal pressure?

Michael Fania, Co-Chief Investment Officer and Head of Residential Credit

Jason, this is Mike. Thanks for the question. In terms of where we're at in mortgage spreads, we've actually been tighter. In the beginning of the year, AAA spreads were 115 to 120 over the curve. Right now, I think that just given the supply that we've seen over the last 2 to 3 weeks and to your point, broader supply within the market, we're probably closer to that 135 area for generic issuance. What I will say, though, is that non-QM continues to make progress in terms of market penetration. There's market share that's being created. If you look at Optimal Blue, in the month of July, they said 8% of all outstanding locks were non-QM and DSCR, which is the highest percentage that we've ever seen. If you went back 2 to 3 years, I think that number is probably closer to 2% to 3%. So I think in terms of mortgage spreads, the fact that they've been in a range, mortgage spreads, AAA spreads, they've been in the kind of the 130 to 145 range. So maybe they're slightly wider than the beginning of the year. But the fact that they've been stable has allowed us to be very active. It's allowed the market to continue to grow. And I think that when you look at the last half of the year, at this point, we've done $60 billion of non-QM issuance last year in 2024. The entire year was $47 billion, $48 billion. I think we'll end up, call it, $65 billion to $70 billion. From our perspective, we actually had our most active month in September. We did $2.3 billion of locks within non-QM and DSCR, we did over $6 billion on the quarter. So I think that securitization may be a little bit slower than what we just did within Q2 and Q3. A lot of that is what you're mentioning. It's seasonal. It's the holidays. But I think that just the market penetration of non-QM continues to grow, and we do think it could be close to 10% of the market. So over long periods of time, we think it will continue to increase.

Jason Weaver, Analyst

Got it. That's helpful. And then maybe more on the agency side. There's some talk that Governor Logan is proposing shifting the Fed's primary policy tool to target tri-party repo away from Fed funds. Any sense on the likelihood there and if or how that might ultimately influence MBS repo?

David Finkelstein, CEO and Co-Chief Investment Officer

Well, it's President Logan, not Governor Logan. But to answer the question, so in a speech, she did discuss that tri-party GC was a better indicator in terms of short-term rates relative to Fed funds. The fact of the matter is the Fed has to evolve as the market evolves. The Fed funds market is just not as good of a barometer of financing rates as repo is, and that's simply a reflection of that. I wouldn't read anything more into it than the Fed thinking about rates that are most impactful to markets and making sure that they have all the best information to evaluate financing markets and conduct policy. That's simply how I would read it.

Operator, Operator

The next question comes from the line of Eric Hagen with BTIG.

Eric Hagen, Analyst

This is kind of a big picture question. There's a point at which mortgage REITs, including Annaly applied more duration to their portfolio. And then the taper tantrum in 2013 disrupted some of that since then, the mortgage rates have basically hedged out all the duration in their portfolio including yourselves. I mean, do you envision ever getting back to a point where a duration gap is part of the conversation again? Like how do you weigh the effect of like raising leverage versus letting your duration drift out a little bit more in order to create alpha?

David Finkelstein, CEO and Co-Chief Investment Officer

Sure. We have three main risks we focus on: spread basis risk in Agency, credit risk, and duration risk. We assess these risks based on their attractiveness and invest where we see the best risk-adjusted returns. Regarding our duration gap, we have maintained a close to zero duration gap recently, justified by the uncertainty in the rates market. I can present arguments for both lower and higher rates. On the side of lower rates, the Fed is cutting rates and may keep doing so, the deficit outlook is improving, leading to less long-term issuance. Quantitative tightening is winding down, demand for fixed income is strong and could increase with lower cash yields. Regulatory changes for banks may boost fixed income demand, and the labor market is weakening, all suggesting lower rates. Conversely, rates appear full right now; 5-year real rates are around 120, 10 years at 170, with nominal rates and inflation breakevens looking tight in the low to mid-2s. In the global context, U.S. rates are relatively low compared to other G7 countries, with an average difference of 90 basis points, making the market not cheap. Inflation persists, and we anticipate additional data this week. The Fed is expected to cut rates next week, but uncertainty remains. There are nine committee members who foresee one or two cuts this year, with some more hawkish members in the mix. The market has aggressively priced in cuts, with expectations that we will be through neutral by the end of next year, while the Fed is 50 basis points above that. We're aware of the fundamentals that could lead to lower rates, but there's also room for higher rates. Our strategy is to avoid taking on much risk in the rates market at this time. Thankfully, volatility has been low, allowing us to manage our duration with minimal impact on the portfolio. Until we have a clearer understanding of the direction things are heading, we intend to maintain this stance. In terms of the longer-term business model, REITs do take duration risk and leverage for maturity transformation, and there can be compensation for taking on rate risk, especially when the yield curve is steep. Currently, the near-term carry for rate risk is positive at 52 basis points on 2s and 10s, but it’s not particularly appealing. At some point, we will likely adopt a longer duration strategy, but for now, we prefer to stay close to where we are.

Eric Hagen, Analyst

Yes. Got you. That's really helpful. I mean, there's lots of speculation right now around the GSEs being buyers of Agency MBS again, certainly in a more meaningful way. I mean how much of that potential catalyst do you think is priced in to spreads right now? And more generally, I mean, do you think their presence in the market would have an impact on the MSR market or valuations in any sort of way?

David Finkelstein, CEO and Co-Chief Investment Officer

Well, a couple of points to note. There has been a lot of talk about the GSEs having entered into the market, but that's been very limited, and I wouldn't read too much into it. The market does have some expectations that they could be more active buyers as we're talking about this privatization potential and the fact that they do have capacity and the portfolios are relatively low. So there is a little bit priced into the market. But the demand for MBS has been broad and it's been strong. REITs have obviously been buyers of MBS. And again, the money flowing into fixed income funds and one-third of that money on average goes to mortgages. That's been the real driver. Speculation around the GSEs is not something that we want to bank on but it could materialize. And does it warrant consideration from a policy perspective? It certainly could. Back pre-financial crisis, the GSEs were very powerful stabilizers of spreads and that lowered spread volatility. As a consequence of that, you ended up at a lower baseline spread. So from a policy perspective, if the government does have this desire to get spreads tighter, giving the GSEs some capacity and acting somewhat as guardrails so long as it's well regulated and they don't get out over their skis, it could have some benefit, but it's very difficult to navigate that path and could be a slippery slope. It has to be looked at very carefully. But nonetheless, as stabilizers, they could be beneficial.

Operator, Operator

The next question comes from the line of Rick Shane with JPMorgan.

Richard Shane, Analyst

And there have been a lot of thoughtful questions and answers on this. So just one quick one. When we look at the NII adjusted for PAA. It's been really stable over the last four quarters. You guys have done a good job managing asset yields and funding costs. I'm curious at this point, how confident you are that it will remain stable over the next couple of quarters? And how do you sort of manage that given the uncertainty?

David Finkelstein, CEO and Co-Chief Investment Officer

So the question you're asking, I'll start from a big picture standpoint, and then Serena can get into the accounting. At the end of the day, the portfolio has been very stable from the standpoint of low leverage, and we haven't had a lot of volatility associated with the hedged returns from an EAD perspective. It's been $0.72, $0.73. That's how we feel about this quarter. We expect to earn EAD consistent with where we were this past quarter. Another point to note that I think helps the stability is the swap portfolio. In terms of runoff, we have about $1.25 billion running off in the first quarter of next year. Then we don't have any runoff until Q4 of 2026. The swap portfolio should stay relatively stable. The Agency portfolio, the average price of the portfolio is very close to par. The runoff doesn't add too much volatility to the overall accounting aspect of it. So we'll see. We can't forecast too far out. But this quarter, we feel good about out-earning the dividend. Overall, the portfolio is in a stable place. Anything to add, Serena?

Serena Wolfe, Chief Financial Officer

No, I think David covered it. Look, obviously, we have been doing really well at increasing yields as we are deploying additional capital, and that is showing up in the NII. From an accounting perspective, obviously, we lock in those yields. And so we should expect to continue to benefit from those. As David mentioned, we do expect future Fed cuts. So we will benefit on the cost of fund side of things. All things equal, I don't have a crystal ball. We should continue to see some good levels of NII going forward.

Operator, Operator

The next question comes from the line of Kenneth Lee with RBC Capital Markets.

Kenneth Lee, Analyst

And this is just a follow-up from a previous one. Fair to say that the risk appetite has been tempered down a bit. Just looking at the spread and rate sensitivity, they both declined a bit quarter-over-quarter. So I just wanted to check to see if that's reflective of Annaly taking a little bit less risk there.

David Finkelstein, CEO and Co-Chief Investment Officer

Yes, it's a good question, Ken. So on the rate side, there's a little bit more negative convexity in the portfolio with current coupon spreads, I think, 28 basis points lower. That does lead to what looks like a more deleterious outlook on both sides of the equation and the duration is hovering close to flat. We were a little bit lighter coming into the quarter on MBS. We do have a little bit of dry powder. I'd say our risk posture is not overly conservative. To the extent we see an opportunity, we could add to the Agency portfolio or an MSR or Resi package over the near term locally. Our risk view is not more negative at all by any stretch. We do just have a little bit more dry powder.

Kenneth Lee, Analyst

Great. And just one follow-up. I think you touched upon this, EAD looking around consistent to the third quarter's levels. Any updated thoughts around dividend coverage, especially just given the current macro rate outlook?

David Finkelstein, CEO and Co-Chief Investment Officer

Sure. Again, this quarter, we have line of sight into and we'll see what happens into 2026, but we feel very good about the dividend. It's at a healthy level. It's a little over 13% yield, close to 15% yield on book. It feels perfectly ample, and we feel like a good place. When we look at the forwards and also the Fed doesn't cut as much as the market, we still feel like the dividend is safe. Our hedge ratio is 92%. There is a lot of protection around the income stream, and we're perfectly comfortable with where things are at and we'll see what happens into 2026.

Operator, Operator

The next question comes from the line of Trevor Cranston with Citizens JMP.

Trevor Cranston, Analyst

Question on the non-Agency portfolio and I guess, particularly the OBX securitizations. Can you comment on kind of what you guys are seeing there in terms of refi responsiveness as mortgage rates have come down recently? More generally, if you could also just comment on kind of what the return sensitivity is on the subordinate positions if we do indeed see faster prepay speeds within that portfolio?

Michael Fania, Co-Chief Investment Officer and Head of Residential Credit

Sure. Thanks, Trevor. This is Mike. In terms of prepay protection and what we have been seeing within the OBX portfolio, 2023 vintage, the majority of those deals that are outstanding, they're between, call it, 8% and 8.5% gross WAC. Those deals are paying in the low 30s CPR, which I will say is a decent amount slower than we would have anticipated. Non-QM rates as we sit here today for the type of credit that we're underwriting, call it, 6 and 7, 8. So 100 to 150 basis points in the money, and it's only paying modestly above where we would where we would put at-the-money loans and where the market convention is, which is 25 CPR. I think we've been pleasantly surprised by the convexity profile of the underlying. Part of that is driven by prepayment penalties that we see within our investor loans. Investor loans are about 50% of the loans that we buy and about 3/4 of investor loans have prepayment penalties. The S-curves associated with those assets are significantly flatter than what you would see within the Agency conforming market. It's also significantly flatter than what you would see within the jumbo market as well. The portfolio and the broader market has been in pretty good shape in terms of prepay speed. Regarding the level of variability within our returns, as you see within the presentation, we've kind of been in this 13% to 16% ROE range. That is referencing OBX retained securities. That's forecasting what I'll say, a base speed of, call it, 20 to 25 CPR for at-the-money loans. The actual return profile has been higher within our retained transactions because speeds have been slower than anticipated. But yes, there is a lot of embedded IO that we are taking once we securitize these assets, given that we are retaining the excess. But I will say at this point, it's actually been a large positive as we've outearned our forecasted assumptions.

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. Thank you.

David Finkelstein, CEO and Co-Chief Investment Officer

Thank you Costas, and thank you, everybody, for joining us today. Enjoy the fall, and we'll talk to you real soon.

Operator, Operator

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