Earnings Call Transcript - NLY Q3 2022

Operator, Operator

Good morning and welcome to the Annaly Capital Management Third Quarter 2022 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] At this time, I would 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 2022 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 third quarter 2022 investor presentation and third quarter 2022 financial supplement, both found under the Presentations section of our website. Annaly intends to use our webpage 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. Please note this event is being recorded. Participants on this morning’s call include David Finkelstein, President and Chief Executive Officer; Serena Wolfe, Chief Financial Officer; Ilker Ertas, Chief Investment Officer; Ken Adler, Head of Mortgage Servicing Rights; and Mike Fania, Head of Residential Credit. And with that, I will turn the call over to David.

David Finkelstein, President and CEO

Thank you, Sean. Good morning and thank you all for joining us on our third quarter earnings call. Today, I will provide an update on the macroeconomic landscape, our financial results this quarter, and our positioning heading into year end. Ilker and Serena will then discuss our portfolio activity and financial performance. Now, beginning with the macro backdrop in what continues to be a historically challenging year, the third quarter brought about a further sell-off in the bond market and mortgage spreads widened to crisis era levels. Persistently high inflation readings, rapid and sustained Federal Reserve rate hikes, tightening financial conditions, elevated volatility, geopolitical turmoil, and rising financial stability risks have weighed heavily on markets that have put this in historical perspective, the total return for the Bloomberg U.S. aggregate bond market index was negative 14.6% in the first three quarters of 2022, far worse than the negative 2.9% in 1994, the previous worst year in the history of the index. In light of the continuation of this difficult environment, Annaly experienced a negative economic return of 11.7% for the quarter. Now, the Federal Reserve has signaled that it is determined to continue tightening monetary policy until inflation approaches its target, a commitment that has been echoed by virtually all Fed speakers since Chair Powell’s Jackson Hole speech at the end of August. This has caused a meaningful repricing of the rate path with markets currently expecting the hiking cycle to end at a Fed Funds rate of nearly 5% compared to expectations of just 3.5% at the end of June has led to a sharp sell-off in interest rates and exceptionally high levels of volatility. A consequence of volatility has been extremely weak investor demand for fixed income products, particularly for agency MBS. In fact, the third quarter represents only the third time in the past 10 years in which banks and mutual funds, critical private sector holders of mortgage securities and loans have reduced their agency MBS holdings simultaneously. In light of the sharp sell-off in rates and widening in MBS spreads, the Freddie Mac primary mortgage rate rose to 6.94% as of last Thursday, more than doubling in 2022 and contributing to the abrupt slowdown in housing market activity. Home price appreciation very likely peaked for the cycle and has begun to reverse course in many parts of the country. Given the mortgage affordability shock from high home prices and rapidly rising rates, we now expect the housing market to correct, potentially erasing the entire appreciation seen this year by early to mid-2023. Now, although prices could fall meaningfully from the recent highs, homeowners have built up substantial equity cushions, lending standards have been conservative, given low rates on existing mortgages, homeowners are unlikely to default unless labor markets weaken considerably from here. Despite volatility in interest rate and mortgage markets, funding conditions continue to be healthy as agency MBS repo, residential credit, and MSR facilities remain readily available. Our financing rates have risen certainly, but are commensurate with other benchmark short-term interest rates. While high volatility could drive an increase in repo haircuts, we have seen limited evidence of this thus far. The favorable financing conditions are driven by the high balances of investor cash and short-term interest-rate products best seen by the elevated bank reserve balances and reverse repo participation at the Federal Reserve and notwithstanding Fed portfolio runoff reaching its steady state run-rate of up to $95 billion per month, financing conditions should maintain support as cash remains ample. Now, shifting to our portfolio, our focus is on prudently managing our liquidity, leverage, and risk profile in the current environment. We continue to position ourselves defensively given sustained volatility, and have strong liquidity with more than $6 billion in unencumbered assets, including $4.3 billion in cash and agency MBS, which represents over 50% of our common equity as of quarter end. During the quarter, we maintained our economic leverage at 6.5 turns until mid-September when the sharp market sell-off over the last two weeks of the quarter brought our leverage up roughly 0.5 turn to end the quarter at 7.1 turns. While we are comfortable with our current portfolio positioning, we expect our leverage to trend modestly lower over the longer term reflective of our target capital allocation. With respect to portfolio mix, we modestly grew each of the three strategies with our total assets increasing to $86.2 billion as we selectively deployed capital from common equity issuance on the quarter. While the majority of new capital was committed to agency, our capital allocation to the sector decreased 4 percentage points to 67% as the agency portfolio absorbed the vast majority of the increase in leverage to end the quarter. Turning to residential credit, in light of deteriorating housing market fundamentals, portfolio growth was focused on opportunistic additions of securities that are less susceptible to home price declines. Though we believe our whole loan portfolio was well positioned to withstand further weakness in the housing sector, we have tightened our already stringent credit standards. We expect this pace of securitizations to moderate in the near-term. Nevertheless, we remain the largest non-bank issuer of prime jumbo and expanded credit MBS this quarter. This has largely been a result of our whole loan correspondent channel, which recently achieved over $2 billion in aggregated loans since inception in April 2021. With respect to our mortgage servicing rights business, we have now fully scaled our platform having more than tripled our portfolio size year-over-year. The MSR portfolio benefits from stable cash flows in the low prepayment environment and helps to hedge the risks of the further slowdown in housing activity. Although we were the second largest purchaser of MSR in 2022 as of the end of the quarter, we expect to be measured with respect to future growth, considering the sector’s relative attractiveness and our risk parameters. Overall, we anticipate market challenges will persist over the near-term and will maintain our defensive posture until volatility subsides, while spreads across our investment strategies are historically attractive. We are focused on preserving liquidity and optionality against additional market turbulence, and when the outlook improves, we are well positioned to take advantage of opportunities across our three businesses. Lastly, before handing it off to Ilker, I wanted to take a moment to provide some perspective on where we sit today. We understand that 2022 has been an immensely challenging period in financial markets. We recently marked 25 years as a public company, and I was reminded of Annaly’s resilience throughout numerous volatile market events, such as long-term capital in 1998, the 2008 financial crisis, the taper tantrum, and most recently, the financial market dislocation at the onset of COVID. Annaly has proven our ability to successfully navigate through these episodes of market turbulence and we are confident that our business model will emerge from this current period stronger than ever. Now, with that Ilker will provide a more detailed overview of our portfolio activity for the quarter and outlook for each business.

Ilker Ertas, Chief Investment Officer

Thank you, David. As you discussed earlier, in the first half of the quarter, interest rate volatility resumed its much higher, risk sentiment turned negative, and agency MBS sharply underperformed interest rate hedges, with spreads widening 25 to 30 basis points. Meanwhile, non-agency spreads also saw considerable volatility throughout the quarter, but ended Q3 roughly unchanged and MSR reservations remained relatively stable. Starting with agency portfolio activity, our holdings grew by roughly $3 billion in market value as we patiently deployed the equity raise during the quarter purchasing meaningful fewer assets than implied by constant leverage on new capital. We continued to rotate the portfolio of coupons significantly reducing our holdings of 3 and below, while adding to our positions in higher coupons, which benefit from lower sensitivity to spread movements and better carry. Our purchases were predominantly in specified pools, and we reduced our TBA holdings by $3.5 billion. During the quarter, specified pools outperformed TBA as investors gravitated toward the better convexity of specified collateral given the elevated volatility. Additionally, with TBA rose softening, pools provide incremental credit across nearly all coupons. Lastly, with the mortgage universe firmly out of the money from a refinance perspective, seasonal cash flows are in strong demand. The embedded home price appreciation should provide expansion protection benefiting our portfolio, which is on average over three years seasoned. In terms of prepayments, our portfolio pays 9.8 CPR in Q3 has slowed down from 14.9 CPR in the prior quarter, primarily driven by high rates. We expect a slow prepaid environment to persist over the near term as seasonal turnover declines and cash-out refinances diminish due to elevated rates and declining home price appreciation. In our hedge portfolio, we maintained a defensive posture consistent with prior quarters. We added over $5.5 billion notional primarily longer-dated swaps to match the expansion of our assets as rates continue to rise. Additionally, we added over $7 billion in Treasury futures hedges at the front end of the curve to maintain protection as our shorter maturity swaps drove down. Turning to our residential credit business, the economic market value of the residential portfolio ended Q3 at $5.1 billion, a modest increase over Q2. As David briefly touched on, portfolio growth was largely driven by the increase in our non-performing loans/re-performing loans structured securities positions, an area of the market that has very high credit enhancement and is collateralized by loans from seasoned borrowers with significant equity, who are less exposed to negative home price appreciation. In residential whole loans, we settled $900 million of expanded credit loans in Q3 and sponsored three securitizations, generating under $20 million market value of retained OBX bonds. We expect future whole loan purchases to moderate given increasing borrower rates and seasonal factors which will likely reduce housing market transactions. With respect to our MSR business, we continued to grow our MSR holdings with the purchase of one bulk package representing roughly $150 million in market value. In light of the fragility of the housing market, it’s important to note that our portfolio consists of very high credit quality, 760 FICO, 68% LTV, sub-3% coupon collateral, which has benefited from a steady rise in interest rates this year. Our MSR portfolio paid 4.3 CPR in the third quarter, providing very attractive and stable cash flows, while serving as a hedge to slow turnover speeds in the deep discount MBS universe. Year-to-date, through the third quarter, we have grown our MSR portfolio by over $1.2 billion in market value to nearly $1.9 billion. As the market stands to date, sales across our investable asset classes look very attractive from a historical perspective. However, to reiterate David’s point, our focus in this period of elevated uncertainty will be to preserve liquidity. In the MSR market, we anticipate that originators will continue to monetize MSR given the pressure on margins and cash requirements. We will be patient to further grow our portfolio given expectations for ongoing supply, while being cognizant that MSRs have been more resilient to the cheapening experience in other sectors. In residential credit, we will be patient about adding further exposure given the decelerating housing market. In agency MBS, the widening experience year-to-date has been particularly acute. Nominal spreads on production coupon mortgages are in excess of 150 basis points and option-adjusted spreads are over 50 basis points. As mentioned, these are levels not seen since prior crisis episodes, such as COVID and the 2008 financial crisis. Further, the differences from those periods versus today are: first, repo financing remains widely available; second, comparable assets such as corporate credit are meaningfully tighter; and third, the backdrop for agency MBS is more attractive, with mortgage universals way below par. Asset convexity is much better. With higher rates slowing housing activity, supply should contract materially. Lastly, the possibility of a broader economic slowdown has increased and agency MBS has historically outperformed comparable fixed income products during recessionary periods. Our outlook is optimistic for each of our three businesses over the medium term, but we will remain patient to grow the portfolio until we see evidence of volatility subsiding. With that, I will hand it over to Serena to discuss the financials.

Serena Wolfe, Chief Financial Officer

Thank you, Ilker. Today, I will provide brief financial highlights for the quarter ended September 30, 2022 and discuss select quarter-to-date metrics. Consistent with prior quarters while our earnings release discloses GAAP and non-GAAP earnings metrics, my comments will focus on our non-GAAP earnings available for distribution and related key performance metrics which exclude PAA. Additionally, our per share metrics are adjusted for our 1-for-4 reverse stock split effective in September 2022. Our book value per share was $19.94 for Q3, which decreased by $3.65 per share for the quarter, primarily due to higher rates, spread widening, and the continued declining valuations on our agency portfolio, along with lower credit valuations, albeit more modest declines in comparison to the agency book. Our swap and futures position supported book value providing a partial offset to the agency declines mentioned above contributing $6.93 per share to the book value during the quarter and our MSR position added $0.09. As noted in our Q2 earnings call, while our futures book does not offset higher repo rates in the earnings available for distribution, the derivatives are fully reflected in economic return. In Q3, they served their function with futures alone having contributed 60% of the hedge benefit to our book value. After combining our book value performance with our third-quarter dividend of $0.88, our quarterly economic return was negative 11.7%. We generated earnings available for distribution of $1.06 per share. Earnings available for distribution continued to outpace our dividend, though we experienced the beginning of the moderation in earnings available for distribution that we have discussed on our recent earnings calls, with earnings available for distribution per share reduced by $0.16 compared to last quarter. The lower earnings available for distribution for the quarter is primarily related to the continued rise in repo rates causing repo expense to more than triple during the quarter, as well as lower expected TBA dollar roll income, which declined by approximately $0.17. Earnings available for distribution did benefit from our improved swaps net interest benefit on higher received rates of $0.33 per share, reduced premium amortization excluding PAA on lowest EPS of $0.13, and continued growth in MSR-related income increasing by $0.06 per share compared to Q2. Given the challenges David and Ilker referenced in the current environment and the impact on earnings available for distribution of the composition of our hedging portfolio noted above, all things equal, we currently expect Q4 earnings to be roughly in line with the third quarter dividend. Average yield excluding PAA was 37 basis points higher than the prior quarter at 3.24% due to lower CPRs and a meaningful decline in amortization. Additionally, the portfolio generated 198 basis points of net interest margin excluding PAA, down 22 basis points from Q2, driven by the reduced TBA dollar roll income and higher repo rates. Net interest spread does not include dollar roll income, therefore, the decrease was more muted, down 6 basis points at 1.70% compared to Q2. Now, turning to our financing, David provided color on our view of the robustness of the funding markets. However, we continue to see uncertainty about the pace of future rate hikes. With most of the liquidity within the repo market continuing to trade to Fed dates are shorter. Because of this uncertainty, bilateral repo markets continue to price term markets more cautiously, resulting in wider term premiums. Access to term markets remains intact, however, we do not expect a meaningful shift in our positioning until we feel the Fed has reached the end of a tightening cycle. As a result, as we messaged in prior quarters, we continue to maintain a shorter-dated book over the near term versus prior years, but quarter-over-quarter weighted average repo maturity was up 10 days compared to Q2 at 57 days. Turning to our residential credit financing strategy, our discipline in accessing the securitization markets throughout the year has kept our net exposure to our unsecuritized whole loan book appropriately sized, with only $805 million on the balance sheet to end the quarter. 92% of our GAAP consolidated home loan portfolio is term funded through our residential securitization, with a weighted average financing rate of 3.05%, approximately 450 basis points below the current non-QM cost of funds. As the securitization market slowed in October and the cost of funds to access the securitization market has steadily risen, we remain well positioned with significant warehouse capacity approximately $1.4 billion across multiple partners with staggered renewal dates. Given our favorable positioning, we will continue to monitor the securitization market and are prepared to be opportunistic. Shifting to MSR financing, we drew on our MSR warehouse facility during the quarter for $250 million and after quarter end executed the accordion for a total facility of $500 million. To reiterate our message from last quarter, we put this facility in place primarily for liquidity purposes and expect to maintain lower leverage on this business. Overall, the upward trend in interest rates impacted our total cost of funds for the quarter rising by 44 basis points to 154 basis points in Q3. Meanwhile, our average repo rate for the quarter was 225 basis points compared to 81 basis points in the prior quarter. Our activity in the securitization market also impacted funding costs, increasing the weighting of securitizations on the composition of cost of funds, along with higher effective rates previously referenced above of 3.05% compared to 2.73%, resulting in an increase of 5 basis points to cost of funds. Lastly, swaps positively impacted cost of funds during the quarter as previously mentioned by 85 basis points, more than twice the benefit in comparison to Q2. Lastly, as David mentioned earlier, Annaly maintained an abundant liquidity profile with $6.1 billion of unencumbered assets, down modestly from the prior quarter at $6.3 billion. Much of the reduction in unencumbered assets was due to the pledging of a portion of our MSR to the previously mentioned warehouse facilities and higher leverage levels on agency MBS. With that, we will turn it over to questions.

Operator, Operator

[Operator Instructions] Our first question will come from Bose George of KBW. Please go ahead.

Bose George, Analyst

Hey, everyone. Good morning. Can I start just asking about mark-to-market book values so far this quarter?

David Finkelstein, President and CEO

Sure, Bose. Good morning. So, obviously, the turbulence continued into October notwithstanding the fact that we did pick up a few percentage points this week. But nonetheless, as of last night, book was off 6% to 7% at roughly 18.60?

Bose George, Analyst

Okay, great. Thank you. And then your current dividend implies a net ROE of around, I guess, 17.5ish and is that an attainable economic return on your portfolio? And then just in your comments, you noted the earnings available for distribution next quarter will be more in line with the dividend, but when you think about the dividend, should we really be focusing more on the economic return versus the earnings available for distribution just given your Treasury futures?

David Finkelstein, President and CEO

Sure, Bose. And to your point, we discussed this with you last quarter actually economic return or economic earnings is how we think about it. And just to review Serena’s comments as she mentioned, we do expect to earn the dividend this quarter. Earnings available for distribution is moderating. To Serena’s point, swap income is becoming an increasing portion of that earnings available for distribution as short rates are increasing, and futures do impact or benefit the economic income or economic return, but don’t flow through earnings available for distribution. There are some non-economic factors that may bring earnings available for distribution down. Nonetheless, to the point of moderation, there are real economic factors that are influencing earnings. For example, as we sit here today, leverage will likely be lower. Financing costs are going up and some swaps are rolling off. We do have to take those into consideration. With respect to the actual earnings yield, as you mentioned, we are right around 18% on quarter end book. It’s above the peer set, as it has been really since the onset of COVID and it's above where we have been historically. We will obviously take a look at that as the market evolves and make a determination as to what the appropriate yield should be. As we have said consistently, we expect to maintain a competitive yield with the peer set but also sustainable and in line with our historical average payout ratio. To give you a summary, we feel good about Q4 we will see how rates evolve over the next number of months. Always look at the dividend in conjunction with a Board and come up with the appropriate payout ratio.

Bose George, Analyst

Okay, great. Thanks.

David Finkelstein, President and CEO

You bet, Bose.

Operator, Operator

The next question comes from Doug Harter of Credit Suisse. Please go ahead.

Doug Harter, Analyst

Thanks. Can you talk about kind of how you’re thinking about leverage balancing, kind of near-term volatility versus kind of the wide level of spreads and kind of what you might be looking for in order to either take up or take down leverage from here?

David Finkelstein, President and CEO

Sure. We did take down leverage somewhat modestly, as we started, the quarter. Where we sit today is around six and three-quarter turns, and we feel good about it. Agency MBS, as well as other sectors we invest in, are historically cheap. But also volatility is historically high. The technical factors associated with agency specifically in terms of Fed runoff and where flows are coming from have also been somewhat negative. What we’re looking for in terms of how we’re managing the portfolio is that decline in volatility and money to flow into fixed income, particularly agency MBS. We’re comfortable with the current leverage ratios – leverage level. Currently, it is elevated to where we’ve been, but at the end of the day, assets are cheap, and we do expect there to be a decline in volatility, and with spreads at historically wide levels. We’re certainly comfortable with where we’re at now.

Doug Harter, Analyst

I guess in that construct, knowing that there is volatility, why not kind of lean into that leverage kind of creep higher, and sort of take a longer-term view and absorb near-term volatility?

David Finkelstein, President and CEO

Let’s talk about the last six weeks and what we’ve gone through with the market. Candidly, Doug, there has been virtually no good news over the past six weeks for fixed income investors beginning with the Jackson Hole speech in late August, where that was probably one of the most hawkish speeches we’ve seen from the Fed in quite some time. Subsequent to that, we move into September, we get a strong payrolls number. Then CPI ticks up from 5.9 to 6.3, again, not good news. We go into the September Fed meeting where the plots exceeded what the market was pricing with the foreign AAA’s rate at the end of the 2022 projected as well as reinforcing that hawkish tone. Then we get into late September, we have the UK gilt debacle, which led to a 140 basis points sell-off in gilt over the course of about five days, which is stunning for a very developed market like the UK. Then the Ministry of Finance intervention, and we move into October with September payrolls showing very strong results, 3.5% unemployment rate, as well as 5% year-over-year wage gains, and following that September CPI at 6.6%, which is obviously core CPI, which is quite high. This explains why we had a trough-to-peak sell-off across U.S. yields of about 120 basis points and 35 basis points wider MBS spread. We have to be respectful of all of that. We are sitting here at the quarter end with $4.3 billion in cash and agency MBS unencumbered, but we feel like we want to maintain our liquidity until we get out of this and we get some better news. We do expect things to turn; obviously, the economy, we have seen signs of slowing, but it remains resilient with a strong labor market and underlying inflation, which we haven’t seen turn yet. We need to really see a term before we would incrementally add to our portfolio. Does that help?

Doug Harter, Analyst

Very helpful. Thank you, David.

David Finkelstein, President and CEO

You bet.

Operator, Operator

Next question comes from Rick Shane of JPMorgan. Please go ahead.

Rick Shane, Analyst

Good morning, everyone, and thanks for taking my question. I am very intrigued by the hedge mix on Page 11. And I find it particularly interesting in the context of what we have seen for mortgage rates. We’ve had this incredible event that between December 21 and today, we basically reset the channel markers in terms of mortgage rates from a low to a high and those extremes were the lowest and highest in more than 20 years. You’ve seen your hedge ratio shift or your hedge composition shift fairly significantly. As we approach potentially a peak in terms of mortgage rates, how would we expect this to shift? I am particularly concerned about the swap ratio and adding a lot of duration there in an environment where you might actually start to see speed to pick up at some point in the future?

Ilker Ertas, Chief Investment Officer

Sure. I am assuming you are asking are we hedging too much? Are we like putting up too many hedges? That seems to be my understanding?

Rick Shane, Analyst

No. I think, yes. But I think the real question is, from our point of view, not being as sophisticated at this as you are, how do you mitigate that risk of being over-hedged if rates do start to shift? Is that what we are seeing in terms of this mix shift on the hedge portfolio?

Ilker Ertas, Chief Investment Officer

Sure. If you look at reasonably the performance of mortgages, you will see a correlation with the rates, and the correlation is that hedge rates are low; mortgages underperform. We expect this short-term negative correlation to persist. This is opposite of what it used to be in the long run. Usually, risk-off days or market rally days, but we are in an environment which David described very nicely in the previous question, that we are in a very different environment, that risk-off environments are like market setups. This explains a little bit of our high regulations. I see your point, and we have been looking into that. When we realize that correlation is turning off, we will take the appropriate actions. To reiterate, we do not take interest rate positions right now; we are trying to fully hedge. We are cognizant that correlation is on the other side of the system. Does that help?

Rick Shane, Analyst

It does and it's actually it puts language around some of the things that we are seeing that we have struggled to explain as well in terms of risk-on, risk-off as well. So, thank you.

Ilker Ertas, Chief Investment Officer

Yes, it has been a difficult episode where risk-off is coming with a great sell-off. That’s why it is particularly difficult for the financial players in the system, especially because you hear a lot on financial news, that 60-40 portfolio and all that kind of stuff. All they are really trying to describe is that this correlation breaks the other way around and that’s why it is very difficult.

Rick Shane, Analyst

Got it. Okay. Thank you.

David Finkelstein, President and CEO

Thanks, Rick.

Operator, Operator

[Operator Instructions] And the next question comes from Trevor Cranston of JMP Securities. Please go ahead.

Trevor Cranston, Analyst

Yes. Thanks. Good morning. Question on the composition of the agency portfolio, you guys have obviously been moving up in coupon as the current coupon has increased substantially over the course of the year. Can you talk about sort of how much liquidity and float there is, say, like above 5% coupons today? And kind of on incrementally what the current coupon where it is right now, kind of what coupons you would be sort of looking to move into within the agency portfolio? Thanks.

Ilker Ertas, Chief Investment Officer

Yes. That’s a good point. The liquidity above 5s, which are like 5.5s and 6s, are very, tend to say effective luck. The movements are so fast that we have been skipping coupons. David and I have been doing this for over 25 years. We have never seen that coupon skipping like this. Production coupons skip from 2.5% to 5% in a very short period of time. Even 5s are priced at $96. There is not that much liquidity and float. Above each of these, the wrong word to say. There is not that much float in 5.5s and 6s above. So, that’s why, when we say often coupon, we usually mean 5s, and we shifted most of our lower coupon exposure into 5s, and it’s like $96 price. Especially with the concern that Rick raised in the previous question, we really like that price point $96 to $98. Where we stand right now will probably be most of our focus going forward.

David Finkelstein, President and CEO

One more point about market liquidity. I think everybody has heard about some of the dislocations that have been exhibited in markets. Yes, liquidity is constrained, whether it's treasuries or agency MBS or at the spectrum. This is largely a function of volatility. When volatility does subside, liquidity will certainly improve. Nonetheless, you have to be very gentle with your approach to managing fixed income portfolios in the current environment.

Trevor Cranston, Analyst

Okay, that makes sense. And then one question on the MSR, obviously, valuations continued to move higher this quarter. Can you talk about sort of, theoretically, for low coupon MSR, kind of where you view the cap in terms of valuation? And if there is a point somewhere soon where the duration of it could actually become positive?

David Finkelstein, President and CEO

Yes. I will start and Ilker can certainly add. We are certainly in the context of that cap. If you just look at the increase in valuation in the quarter, it’s only a 10th of a multiple. We had roughly a 100 basis point increase in rates across the curve. The MSR CPR went down roughly 30%. You are starting to see that crest here in 10th.

Ilker Ertas, Chief Investment Officer

Your point is right, the cash flows are fully extended. There is only slow the pools can pay, but the certainty of them paying slower continues as rates rise. On an option-adjusted basis, it gets more favorable. The other point is, when you own MSR, you manage lots of cash balances. As rates rise, you earn the service of the MSR earns more return on those cash balances. So, that negative duration, particularly in the front end of the curve continues. There is always going to be that negative duration.

David Finkelstein, President and CEO

Yes. That float effectively provides more room as short rates do rise obviously. Another point to note in terms of the construction of our MSR, we felt very good about what we owned. We have achieved a lot of growth over the past year. The overall MSR is 400 basis points out of the money and the credit is quite good. So, with respect to how housing evolves, we think that asset is going to perform very well for us.

Ilker Ertas, Chief Investment Officer

To add to both David and Ken, the discount MSR may not be aging interest rate risk anymore, but it is still hedging the turnover risk in the mortgage market. Turnover risk is the biggest risk if the volatility subsides in the mortgage market. We like where we stand on the discount MSR.

Trevor Cranston, Analyst

Okay. That’s a good point. Thank you.

David Finkelstein, President and CEO

Thank you, Trevor.

Operator, Operator

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

David Finkelstein, President and CEO

Thank you, Andrea, and thanks everybody for joining us this morning and good luck over the next number of months. We will talk to you soon.

Operator, Operator

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