Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Executives

Mark Collinson – Investor Relations

Michael Hough – CEO

Ben Hough – President and COO

Ken Steele – CFO, Secretary and Treasurer

Bill Gibbs – EVP and Co-Chief Investment Officer

Fred Boos – EVP and Co-Chief Investment Officer

Analysts

Steve Delaney – JMP Securities

Mike Taiano – Sandler O’Neill

Bose George – KBW

Mike Widner – Stifel Nicolaus

Henry Coffey – Sterne Agee

Matthew Howlett – Macquarie Capital

Jim Delisle – Cambridge Place

Matthew Larson – Morgan Stanley

Hatteras Financial Corp. (HTS) Q4 2009 Earnings Call Transcript February 17, 2010 10:00 AM ET

Operator

Good day and welcome to the Hatteras Financial Corporation fourth quarter 2009 earnings conference call and webcast. All participants will be in a listen-only mode. (Operator Instructions) After today's presentation, there will be an opportunity to ask questions. (Operator Instructions) Please note this event is being recorded.

I would now like to turn the conference over to Mark Collinson. Mr. Collinson, the floor is yours, sir.

Mark Collinson

Thank you, Mike. Good morning, everyone and welcome to the Hatteras financial fourth quarter 2009 earnings conference call. With me today, as usual, are the company's Chairman and Chief Executive Officer, Michael Hough, the company's President and Chief Operating Officer, Ben Hough and the company's Chief Financial Officer, Ken Steele. Also available to answer your questions are the company's Co-Chief Investment Officers, Bill Gibbs and Fred Boos.

Before I hand the call over to them, please note that on this call, certain information presented contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. And these statements are based on management's current expectations and are subject to risks, uncertainties and assumptions. Should one or more of these risk or uncertainties materialize or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, expected, estimated or projected.

The following factors, among others, could cause actual results to differ materially from those described in the forward-looking statements. The company's limited operating history, changes in its business and investment strategy, changes in interest rates, interest rate spreads, the yield curve or prepayment rates, changes in economic conditions generally, inflation or deflation, availability of suitable investment opportunities, availability terms and deployment of capital, the degree and nature of the company's competition, general volatility of the capital markets, dependence on the company's manager and the company's ability to find a suitable replacement if the manager were to terminate its management relationship and other factors that are set forth in the company's most recent Annual Report on Form 10-K filed with the Securities and Exchange Commission and subsequent reports on forms 10-Q and 8-K.

The content of this conference call contains time-sensitive information that is accurate only as of today, February the 17, 2010 and the company undertakes no obligations to make any revisions to the statements contained in these remarks or to update and to reflect the events or circumstances occurring after this conference call.

So that's all from me. And with that, it's my pleasure to turn the call over to Michael Hough.

Michael Hough

Okay. Thanks Mark. Good morning and thanks for being on our year-end 2009 earnings call and for your interest in Hatteras. We are happy to report on a very good fourth quarter and 2009 year and the entire management team is here looking forward to your questions, following first some brief introductory remarks.

What we are going to do today is two things, go over our fourth quarter and full year '09 results with an update and discuss the recent development for the agency MBS market and how it relates to Hatteras. I am sure you all are interested.

We try to provide you enough information to help you assist how our company performs and will perform. So hopefully the information and the release is helpful to you. We started the company over two years ago. We implemented a very focused plan in an effort to achieve stability and predictability through market cycles. We have not strayed from our plan and are pleased to have been able to deliver another strong year performance.

What we are most pleased with Hatteras portfolio was able to consistently capture the return opportunities provided last year by steepening yield curve and appreciating asset values and at the same time be able to reduce our risk exposures.

In 2009, Hatteras shareholders enjoyed four dividend increases, consistent earnings growth and asset appreciation. At the same time, the portfolio matured was shortening asset durations and lengthening liability durations.

We've always managed this strategy with a long-term perspective and that helps us to make conservative and well thought out decisions. By managing for the long term, we make the powerful decisions and balance the risk we have to deal with on a daily basis.

Looking back over 2009, I want to highlight just a few things that have helped shape this portfolio today. As we have been telling -- first, as we have been telling you all last year, we almost exclusively bought local fund new production paper throughout the year. The reasons were, a, we can manage prepayment risk best by earning the lower dollar price as possible but more importantly, b, while we assume that the durations on this security should be longer, it is a good thing because we know that interest rates drop prepayments on this recently issued mortgages and we can better hedge them for longer.

Two, we continue to narrow the net duration of our balance sheet even as earning opportunities grew with repo rates fail. Three, we focused on preserving as much portfolio yield as we could by holding on to the cheap assets we were fortunate to earn. And four, we resisted to be able to aware of marginally higher current yield available on another types of securities and did not raise new investment capital even for the controlled equity offering. We have yet to do that in 2010 as well.

So the benefit from these decisions may be tough to see directly but in our minds. Our portfolio is significantly stronger now than it would have been, had we taken a different approach. We want our portfolio to be as consistent as possible. So we focus the strategy onto a specific part of the yield curve to generate this consistency. The better we know the underlying characteristics and variables of the assets we earn, the better we can extend the liabilities against them is our way of achieving this.

We are going to be most effective as interest rate risk managers, so we try to turn all of the risks in that direction. Our job is to deliver the best long-term risk adjustment return to our shareholders as possible as interest rates and market conditions change.

So before handling the call over to Ken to discuss the quarter, I want to introduce the recent development that will help some near-term impact of the agency MBS market and consequently on Hatteras.

Last year, Freddie Mac and Fannie Mae announced that they planned to accelerate their purchases of seriously delinquent mortgage loans held existing mortgage-backed security pools. Noticed that we have included a table on this release showing the MBS we earned that likely will have the most exposure to potential Freddie Mac and Fannie Mae buyouts as may be indicated by Freddie's table of delinquency rates.

The background is that Freddie announced that all purchase, substantially all 120 day or more delinquent loans from its guaranteed securities in February. Fannie Mae announced that it intends to significantly increase its purchase of seriously delinquent loans beginning in March to purchase a significant portion of those delinquencies within a few month period.

Since the announcement of new accounting standard in the beginning of this year, Fannie and Freddie now have a meaningful economic reason to pull non-performing loans out of their securities and hold them themselves. What this will mean for security holders like us in Freddie's case is most likely a significant increase in prepayments that will be reflected in the March factors and advantage case of few months of accelerated prepayments beginning in April.

The impact on the portfolio will be that we receive poor value for those loans that we currently own in a moderate premium. The news last week with a timing of this buyouts not that were and would not happen. For a while, we have debated internally the best course of action to take an advantage and our conclusion has been that it makes the most long-term economic fence to continue to hold lot of our securities regardless of this potential prepayments buy.

Remember, we own these bonds at very attractive prices. Most were accumulated during the disconnected agency market in 2008. We determine that there were significantly more long-term value and what would be left in these pools in realizing the near-term pricing gains and reinvesting.

We're comfortable with what the impacts of these buyouts could be on our portfolio as we calculate our possible exposure to these loans to likely to be limited to less than 10% of our overall holdings. Why? Because first, our liquidity position is very strong right now. We have been running lower leverage and higher liquidity for some time.

We are being proactive with the market to help ensure an orderly process in April. And second, the vast majority of our MBS are currently in high demand which will likely support prices specifically for ARMS as the new reinvestment capital hits the street. There is going to be plenty of new demand hitting the market over the next several months and we have the desire to stay invested. So we took some steps to get out in front of this as we have a lot of pre-bought paper coming in during this timeframe. We continue to see value in low dollar prices as the only real way to hedge prepayment volatility.

So in a few minutes, then we'll go over in more detail this table on our portfolio but first I'll hand the call to Ken to discuss the fourth quarter and the year.

Ken Steele

Thanks, Michael. Good morning, everyone and thanks again for being on the call today. I will quickly go over this quarter's numbers and provide some brief discussion of the trends in our operations that were evident in the fourth quarter of 2009.

Overall, the operating fundamentals for our strategy continued to be quite strong. Our net income for the fourth quarter of 2009 was $46.3 million or $1.28 per share, up slightly from $45.8 million or $1.26 per share for the third quarter of the year. Although, part of this increase was due to growth in our portfolio as our average earning assets grew by $200 million from $6.3 billion in the third quarter to $6.5 billion in the fourth quarter and more important trends were lower funding cost and increased amortization expense which resulted in lower asset yield.

Our portfolio yield for the quarter was 4.43% following 14 basis points with 457 in the third quarter as prepayment kicked up slightly from the previous quarter and our asset purchases were at lower coupons than our overall portfolio average.

Our repayment rate for the quarter was 22.7% on an annualized basis, up slightly from the third quarter rate of 22.26%. Less obvious event here is that despite a relatively similar rate of repayment, the higher premium mortgage holders saw lower overall mortgage rate and took the opportunity to refinance.

Our net premium amortization expense for the fourth quarter of 2009 was $6.2 million, up from $5.4 million in the third quarter. Our cost of funds again fell, despite the continued addition of interest rate swaps to our liability portfolio. The overall cost of funds went from 1.64% in the third quarter to 1.53% in the fourth quarter, an increase of 11 basis points as competition among repo lenders pushed rates further down.

This led to an interest rate spread of 290 basis points, a three basis point decrease from the third quarter spread of 293. Our G&A expenses were well-contained again, with an annualized rate of 132 basis points on average equity for the quarter. Our book value remained relatively constant, as the upward price moves experienced in the third quarter remained mostly in place.

Our book value at the end of the year was 25.74, down from the third-quarter number of $26.07, a 1.3% decrease and up $5.39 from $20.35 at December 31, 2008, a 26% increase since the beginning of the year.

Components of our book value at December 31, 2009 on a per-share basis are $21.28 of permanent book, $0.24 of undistributed earnings, $5.21 of unrealized gains on our MBS and an unrealized loss of $0.99 on our swap. A slight decrease in equity, combined with addition repo, increased our leverage from the previous quarter. Our debt-to-equity at year-end was 6.8 to 1 compared to 6.4 to 1 at September 30.

In summary, we declared a dividend of $1.20 for the fourth quarter and generated a return of equity of 19.4%. 2009 was very positive year for Hatteras. While maintaining a relatively low risk profile, we had full-year earnings of $4.82 and paid out $4.50 in dividends, a dividend payout ratio of 93.3%, which is right in our target range. For all of 2009, we generated a 19.9% return on equity and a 22% total return.

I will now turn the call over to Ben for details regarding the portfolio.

Ben Hough

Thank you, Ken. I would like to quickly go over a few highlights of the activity in the fourth quarter as well as some in the current quarter. From a portfolio standpoint, Q4 was a fairly stable one.

Our focus was primarily on keeping ahead of cash flow and looking for opportunities on the liability side. As for assets, we continue to find value in forward settling new production, 5/1 hybrids for the most part. Leverage ended up slightly at 6.8 debt-to-equity at year-end, due in part from a lower mark to market and also from a $300 million net increase in MBS.

We settled $650 million mostly new production 5/1s in the quarter. And at the end of the year, we had $7 billion in total MBS with a weighted average coupon of 488, a dollar price of about 101.50 and 44 stated average months reset. Prepayments for the quarter were nearly unchanged from the third quarter at 22.7%, but gradually moved a little higher throughout the quarter and into January.

The trend higher is well within expectations and it has been our strategy to estimate cash flows ahead of time and preinvest those proceeds as efficiently as possible. But the announcement last week of the acceleration of delinquent loan buyouts, our cash flow over the next three months or so will likely increase from these levels, but our current leverage position is appropriate. And in 2010, we have about $700 million or purchases of mostly new production settling between January and April of this year.

I want to take a minute now to talk about the GSE buyouts and how it might affect us and would like to refer to the table Michael mentioned that we included in the press release yesterday. For those of you who do not have in front of you, this table shows our current positions in the securities expected to be most affected by the buyouts, which are 2005 through 2008 vintages with 5% plus coupons.

I will let the table speak for itself, but the key takeaway here is that of those vintages and coupons, the exposure for us is highest in the lower of the three coupon categories and also in the 2008 vintage as compared to earlier issuance. Note that our portfolio was constructed over the last two years initially using capital raised in late 2007 and throughout 2008.

Proceeds from those deals were invested into lower dollar priced securities and we bought a lot of cheap bonds back when the agency ARMs market was dislocated. As rates have steadily declined over the past year or so, much of those earlier vintages and higher coupons most at risk of buyout have become a lower percentage of the overall portfolio, as they have already significantly paid down and have been reinvested into more recent production.

On top of that, a vast majority of the $2 billion of growth in the portfolio that came in 2009 was in new production ARMs. That said, I think the best way to approximate our exposure is to take this table and apply the Freddie Mac delinquency estimates. And we put a link to their table in our press release as well. And then use your own estimates for Fannie Mae delinquencies until we get their numbers.

In doing our own analysis, what we find is a range of outcomes that is manageable, given a $7 billion portfolio. There are a lot of variables in these estimates and it will vary security by security and while our numbers are actual positions in our portfolio, the Freddie and Fannie numbers are estimates and the actual impact on us won't be known until the data is released by the GSEs.

Not included in this table are also some securities with coupons less than 5% that could be affected as well, but we view this as a less material number. But Michael said, this is really only an issue of timing, we've enjoyed slow prepayments on these securities over the last year or so and now they are playing catch-up.

We like that we own these securities at a low cost basis of around 101.25 and we see long-term benefit of owning them going forward. The delinquent loan issue has been a growing problem within the agency MBS universe that needed to be addressed. Obviously, we would prefer a more gradual approach from Fannie and Freddie, but fast or slow, GSE buyouts will ultimately result in a more predictable assets by removing some of the cash flow uncertainty and eventually we expect repayment rates to move back to trend.

One immediate impact we have already seen is that the increased cash flow expected by investors has spurred demand for new production lower coupon ARMs, tightening spreads by as much as 10 to 15 basis points and increasing the value of a large part of our portfolio.

Another positive is that the increased cash flow from the buyouts is coming at a potentially good time, given the phase-out of the Fed buying program and we expect attractive investment opportunities going forward. Leading into this, we have been preinvesting a lot of this expected runoff by buying down dollar price in the forward market and like I mentioned before, we already have $700 million settling between January and April.

As we have regularly alluded to, is because of exactly this type of uncertainty from government involvement in our markets that we maintain a low average dollar price, thereby mitigating some negative effects of prepayment volatility. Now on the liability side, the trend continues to be favorable. Our average repo rate including our extended repo was 41 basis points and the average short repo rate ranged from the high teens to mid 20s. Repo availability continued to increase from new and existing counterparties.

During the quarter and so far this year, we continue to follow our hedging plan and broaden our duration gap further by opportunistically adding new interest rate swaps. In the fourth quarter, we added $400 million in new interest rate swaps at an average paid fixed rate of 2.06% at an average maturity of 45 months.

So at year's end, we had $2.7 billion in swaps, with an average rate of 2.68% and an average maturity of 28 months. When combined with our existing $300 million of extended repo, our total in long-term liabilities was $3 billion at 2.72% for 27 months, which was 47% of our repo book at year-end. Since year-end, we have added $400 million in additional swaps, averaging 2.42% paid fixed rate and 50 months. Some of these are forward starting to replace maturing positions in Q2, which have paid fixed rates of about 2.8%. We will continue to hedge opportunistically as the right cycle evolves going forward.

With that, I will turn it back over to Michael.

Michael Hough

Okay. Thanks for taking the time today to be here. We really do want you all to understand our company and what will impact future performance. This is a pretty transparent strategy anyway and hopefully our disclosures enhance your ability to do your work. We will continue to provide this type of information going forward if it is helpful. So now we can open this up to questions.

Question-and-Answer Session

Operator

Yes, sir. We will now begin the question-and-answer session. (Operator Instructions) The first question comes from Steve Delaney of JMP Securities. Please go ahead

Steve Delaney – JMP Securities

Hey, good morning everyone. How are you?

Ben Hough

Very much, Steve.

Steve Delaney – JMP Securities

Thanks as usual for the excellent disclosure. That table was very thoughtful. Ben, I had one question just to clarify – reconcile two numbers. Your overall average cost basis that I calculated based on the data in the book, you didn't give us a figure, but it looks like it is 101.52.

Ben Hough

That's correct.

Steve Delaney – JMP Securities

Okay. Now you mentioned 101.25. And I just want to clarify that, that 101.25 relates to those – the cohort that is in the table, the 5% and higher coupons.

Ben Hough

That's correct. That is really just a round estimate, but yes, that is related to those particular.

Steve Delaney – JMP Securities

The point being that because of the timing and when you bought those you have actually got a lower cost. Those were bonds you bought before the big rally and you bought those bonds at a lower cost than the stuff you are buying now is the point.

Ben Hough

Exactly.

Steve Delaney – JMP Securities

Okay. Then I think this is obvious from what you said, but the 4s and 4.5s and of course it could be anything with a hybrid, but the coupons below 5%, it is accurate to assume those would be almost exclusively 2008, even maybe more 2009 vintage, is that correct?

Ben Hough

Yes. For the most part, I mean, there may be a couple odd lots here and there, but yes, for the vast majority that is probably correct. We don't think that is going to -- that is not going to move the needle a whole lot in the overall number.

Steve Delaney – JMP Securities

Okay. You've got about 29% Freddie's. Cash management, I know you guys have always sort of talked more about liquidity than leverage per se. But I was wondering if you could kind of take us through that in terms of your liquidity position, your cash, your unpledged MBS, etc?

I'm assuming it is probably somewhere around an 8% figure, when we look at a percentage of total -- the total portfolio. Can you give us a sense from your planning for cash flow with this March? I guess, it is March 7 factor date, kind of how much of that you're going to need to take care of the Freddie's if the inside – just inside of 10% buyout rate is what you actually see?

Ken Steele

Sure, Steve. This is Ken. You are right, we do focus a lot on liquidity and that is what we always talk about leverage in terms of. Right now we are trying to generally keep that 5 to 10% liquidity range and we are at the high end of that right now.

Now we are estimating and certainly looking at these things. We think on the Freddie's there is going to be somewhere in the -- if those averages are correct and depending upon what pools. They are somewhere in the $200 million range that will come in. And we are well-positioned to take care of that with no problem.

Steve Delaney – JMP Securities

Okay. And do you think some -- I put a call actually into South Street this morning to the desk to ask them about this assignment of principal receivable transaction, I guess or documentation, if you will. Is that something that you have in your hip pocket that you might be able to – it doesn't sound like you're going to need it, but I am thinking about the broader market and hopefully that there won't be any a disruption in repo as a result of this from people who are maybe more highly levered. Do you think that is something that the lenders might consider to avoid problems here with margin?

Bill Gibbs

Yes, Steve. This is Bill. We don't want to comment on any specific counterparties or banks, but discussions have been undertaken with people and that is ongoing.

Steve Delaney – JMP Securities

Very good. Thank you guys. Great color. I appreciate it.

Operator

And the next question we have -- the next question we have comes from Mike Taiano of Sandler O'Neill. Please go ahead.

Mike Taiano – Sandler O’Neill

Hey, good morning. A couple of questions. Just to clarify, you said that -- just to make sure I heard it right -- less than 10% you think of the $3.2 billion in that table you think would be effectively subject to GSE buy-outs, is that right?

Michael Hough

Yes. That’s what – I mean it’s to just applying the initial percentages that we have from Freddie across these bonds that seems to be a reasonable number.

Mike Taiano – Sandler O’Neill

Okay. And I had come up with a similar number, so that is consistent with what I was thinking. Then just in terms of -- you mentioned what had happened to prices on some of the longer reset MBS last week. Can you may be comment on what has happened on the shorter to reset market? I had heard may be in the first couple of days after the GSE announcements that some of those bonds had dropped about 1 point. Is that similar to what you have seen in the market?

Bill Gibbs

Yeah. There has been, in all honesty, very little trading action that has gone on. But from what we have seen since the announcement and if you look at Freddie, it is probably the cleanest one to look at since they have the information furnished already, it looks like most people for February settlement, depending on the coupon and the vintage, I think somewhere between 1 and 2 points. The higher the coupon of course, the more damage. It is interesting to note though if you take a look at the Freddie’s and look out to March settlement, once you get past the initial blip, these bonds are trading back up probably off a 0.5 point from where they were before the announcement. So it seems to be a temporary phenomena in terms of pricing on the higher coupon paper.

Mike Taiano – Sandler O’Neill

Okay. Great. Then just in terms of what you're going to do with the cash flow from these prepayments, is it fair to say you will probably stick with your, what has been your strategy to buy the newly issued hybrid ARMs or will you potentially look at some other things as well?

Michael Hough

A year from, for right now, Mike, it's -- that what we are doing. That is what we have been doing. It is our way of mitigating prepayment risk. I think that is where we see the value now. But we are evaluating the full spectrum here and I think in the near term that is what we will be doing.

Mike Taiano – Sandler O’Neill

Okay. And just a final question. Is it your expectation that the GSEs, now that they are doing this catch-up adjustment on the delinquent loans, is it -- do you think that basically going forward that is the way they are going to act and they're not going to let this buildup of delinquent loans happen again? Is that what you are assuming at this point?

Michael Hough

As you read the release from Freddie and Fannie, I think they are making that clear that they're going to look to be pulling these loans out on more of a monthly basis. If you take a look prior to the announcement, you were seeing some pretty decent removal of these loans, especially from Fannie in the third quarter. I think you'll see that again in the fourth quarter. I believe the latest data they showed was Fannie had bought in, I think about $15 billion in the third quarter and the fourth quarter should be somewhat similar.

Mike Taiano – Sandler O’Neill

Okay. Thanks very much.

Michael Hough

Thank you Mike.

Operator

And the next question we have comes from Bose George of KBW. Please go ahead.

Bose George – KBW

Hey guys, good morning and good quarter.

Michael Hough

Good morning.

Bose George – KBW

I have got a couple of things. First, I just wanted to find out where do you see the spread -- incremental spreads on the capital that you are reinvesting, now where those spreads stand.

Bill Gibbs

Sure. Taking a look at, as Michael and Ben had mentioned looking at the newer production paper, we are looking at a yield on that of approximately 330. If we fund it using 50% repo and three-year swaps 50% we come in with about a 90 basis point cost of funds giving us about 240 basis points in spread.

Bose George – KBW

Okay. And then actually just on that issue, on the funding side, is that where you guys are, swapping out about half your liabilities?

Bill Gibbs

Correct.

Bose George – KBW

Okay. Great. In terms of your duration gap, you guys mentioned your duration gap is getting tighter and where does that roughly stand at year end?

Fred Boos

About one-half duration, Bose. This is Fred. In from about one duration, say, a year ago.

Bose George – KBW

Okay. Great. Thanks very much guys.

Fred Boos

Thank you, Bose.

Operator

And the next question we have comes from Mike Widner of Stifel Nicolaus.

Mike Widner – Stifel Nicolaus

Hey, good morning guys and congratulations on a solid quarter.

Michael Hough

Good morning, Mike.

Mike Widner – Stifel Nicolaus

A couple of my questions have been asked. Just let me ask you a little bit about where leverage stands, how it progressed over the quarter and what your thoughts are going forward. Going into that with the observation that average leverage over the period of the quarter looked like, it was around 6.3 times, you finished the quarter at about 6.8 times. I am just wondering what kind of drove that trend, if we should expect anything comparable going forward. If you can provide any color on that?

Michael Hough

Yeah. We -- I mean like we mentioned earlier, Ben said that we added net $300 million bonds in the fourth quarter. Some of the increase in leverage also was driven by a slightly lower equity number. What we have done since the end of the year is basically pre-invested what we anticipate some of this cash flow to be that is going to be coming on a little bit later.

Our intention is really to manage is stay -- keep our cash flow invested and this is a comfortable leverage ratio for us. If we had to peg a number on it, it's -- and we have said this before it is more about liquidity. And liquidity is right where we want it to be in this market and I think that's what is going to be the driver going forward. I think any real change in leverage ratio that you're going to see in the near-term would be just from changes in equity values.

Mike Widner – Stifel Nicolaus

Got you. So let me just -- I don't know if this is nitpicky or not, but there is certainly going to be some lag between the time that they stop paying the interest on the principal that they're buying out and you actually get the principal payment back from a cash flow standpoint. And so when you talk about reinvesting the proceeds in advance, I guess are we going to see some potential in the quarter, both in first quarter and 2Q, where the portfolio may actually be smaller because if you're waiting to get the cash the principal payment back from Fannie or Freddie, if that makes sense?

Michael Hough

Okay. I mean that's -- that will be the case and there is no way we can match settlements up perfectly to our cash flow. But from more of a higher perspective, I think it will be pretty close but at any point in time, yes, there will be some underinvested periods maybe even overinvested periods.

Mike Widner – Stifel Nicolaus

Okay. Yes, I guess that is really what I was trying to get the sense for is could we see six weeks of underinvested periods, because you're waiting on the cash flow to actually redeploy or is it going to be closer than that kind of a wash or maybe a couple of weeks over a couple of weeks under?

Bill Gibbs

Right. Keep in mind too that it would be more impactful to us if both Fannie and Freddie would have announced similar programs that hit at the same time. But the way it is being lagged into with Freddie going first, then Fannie over a period of time. I think it's going to have less of an impact in terms of where we are invested.

Michael Hough

Yeah. Six weeks seems like a long time, but we are going to have to see how this thing truly unfolds and pay attention to it and manage as conditions become more clear.

Mike Widner – Stifel Nicolaus

Okay. Great. And then I am not sure if you can comment on this one at all. But the prepayments are going to -- as you amortize the premium presumably have an impact on earnings. Any thoughts on kind of how you view the dividend over the course of the year? So if this is going to be sort of a semi one-time hit, I realize it's spread out and it's actually going to be over two quarters. But would you attempt to smooth that in the dividend over the course of the year or would you kind of just reflect it as it goes?

Ken Steele

Sure. Mike, this is Ken. I think we have always tried to look at that as generally something that is consistent without a lot of jumps up and down and we will see how this plays out. We do have $0.24 that we have not distributed, so I think we've got good room to kind of to keep a measured pace and just see exactly how these buyouts affect us and how we can get reinvested.

Mike Widner – Stifel Nicolaus

All right. Great. Well, again, congratulations on a solid quarter guys and I appreciate the comments.

Ken Steele

Thanks.

Michael Hough

Thanks, Mike.

Operator

The next question we have comes from Henry Coffey of Sterne Agee.

Henry Coffey – Sterne Agee

Yeah. Good morning everyone and let me add my thanks. The disclosure on this issue is very helpful. And hopefully some of your competitors are listening and planning on doing the same thing. In terms of quantifying the earning impact, is there a simple metric where we look at the existing premium assume a number of somewhere between 8 and 10% and then say, okay, that's -- those are accelerated amortizations that you're going to suffer over the next say, 2Q, 3Q? Do something stupid like divide the number in half and then, but then also assume that in 4Q and in 2011 in essence your earnings will be in line or higher than that? And basically just assume a very, very high payment speed June Q, September Q or is there a different way we should be looking at this?

Ken Steele

I think -- this is Ken. That's a reasonable way to look at it, all things being equal. As you get into other periods, we are certainly dealing with other factors to consider. But in the static environment we think that it will be fairly short lived starting toward the end of this and maybe rolling in. But you're right that in general a lot of this is just a timing thing that somewhat moved up things that would have come to us over the next six to nine months potentially anyway.

Henry Coffey – Sterne Agee

And can you -- we have heard some numbers like "down one point", but can you give some -- give us some sense of how the market has reacted to this in terms of valuing specific securities?

Bill Gibbs

Yeah. It's pretty specific to the security. They are looking at whatever the vintages and then the coupons. They break it down looking at geography. There are various factors that go into what people are willing to bid for these securities. Keep in mind too that it's -- there hasn't been a lot of trades since this announcement. So what data points we're able to gather are showing us that you are seeing somewhere in that neighborhood of down one points to two points depending.

But like I mentioned earlier, when you go into the next month, which would be the March forward month. You're going back up another one point to 1.5 point in value after you have gone through this one-time event. But as…

Henry Coffey – Sterne Agee

And the March forward is new issue?

Bill Gibbs

No. This is the open coupon higher '06, '07 vintages. What the market has done is just discount the prepayments for that one month. And then going forward they are using assumptions of similar prepays to what we were seeing on those securities prior to this announcement.

Henry Coffey – Sterne Agee

Okay. So this is becoming the infamous one-time event of a sort?

Bill Gibbs

As far as pricing is concerned.

Henry Coffey – Sterne Agee

This is helpful. Again, this level of disclosure is unique and thank you.

Bill Gibbs

Thank you, Henry.

Operator

The next question we have comes from Matthew Howlett of Macquarie Capital.

Matthew Howlett – Macquarie Capital

Hey, thanks for taking my question. Guys, just a -- your general thoughts around investing in such a low yield environment, the headlines in Bloomberg the last few days have been MBS at record low yields and record tight spreads to Treasuries. I know they are generally talking about the 30 year fixed rate market. But generally what are your thoughts and when managers like yourself speak about locking in a spread and I know you said that 240 spread is generally what you're looking at. Is that -- are we to assume I know you can't perfectly be hedged there, can we assume that rates are much higher next few years that that 240 spread will be sustainable on those new investments?

Ken Steele

I mean there is a -- in our view, we have been investing in the low rate environment now for a pretty good while. And yes, spreads have tightened on this news and primarily has been in the 30 year fixed market. But spreads have tightened in the ARMs as well. We are very cautious when we select a security and we made choose not to invest in deals that we think are unsustainably low. The way we look at hedging is to offset the cash flows on the assets with extended liabilities. And the effect is in an up rate market that our expectation would be that the income from the hedges would offset the cash flow from the -- on the liabilities. And it would effectively lock in earnings.

Matthew Howlett – Macquarie Capital

So the 240 spread on say an acquisition you made today, generally if -- short-term interest rates were a lot higher in the next few years, let's just say it is 3.5 year duration asset. And generally, you could maintain a good portion of that really under any sort of interest rate scenario?

Michael Hough

The estimate we gave was using 50% swaps. So obviously, the other 50% in that example is floating.

Matthew Howlett – Macquarie Capital

Got you. Yeah, got you. And then just -- the second question is just what's the expectations on voluntary prepayment sort of this quarter and then going forward this year? And I know you guys want to grow and you would like to go in long-term, I think the prospects are very good. But would you consider the stock down here returning capital in the form of pure buybacks or even special dividends or something of that nature?

Ken Steele

We haven't considered that yet. I am not going to say we never would, but it's not on our radar screen right now. We still have a very, very healthy balance sheet and we are very confident with our outlook going forward. So it is not something that we have considered but never say, never.

Matthew Howlett – Macquarie Capital

Got you. And then just on the voluntary prepays, I know a lot of talk has been on the involuntary. Where do you see those running the rest of the year? Any color would be great on that? And thank you very much.

Bill Gibbs

On the voluntary side, it's going to be of course, interest rate determined. If we stay at these levels you are primarily going to be looking at our 2008, 2009 production, whether they are in the money or out of the money. I think you're going to need a little bit more of a downward move in rates in order to see any pickup in those speeds. So I think you could consider where we have been running the last two quarters right about what I would use going forward.

Matthew Howlett – Macquarie Capital

Very good. Thank you.

Bill Gibbs

Thanks.

Ken Steele

Thanks, Matt.

Operator

The next question we have come from Steve Delaney with JMP Securities.

Steve Delaney – JMP Securities

Hey guys, this is just a quick follow up to -- I think Mike touched on it. But the impact of the timing of these cash flows on dividends. I think Mike was just asking about sustainability based on earnings. It looks like you will have -- the earnings won't be the problem especially with that $0.24 undistributed. But I mean is it possible that in order to maintain as much cash as possible that you might like delay a full payment of a dividend until you get through like these first couple of quarters and then catch up or do you think that the cash flow won't require you to alter your dividend policy?

Ken Steele

Steve, once again, I'm going to say the never say never, but we don't see that as likely.

Steve Delaney – JMP Securities

Okay.

Ken Steele

But we feel well-positioned and to handle this and that we will -- one of the dividend payments is going to come after the Freddie repayment anyway.

Steve Delaney – JMP Securities

Right.

Ken Steele

So we would have all that cash back.

Steve Delaney – JMP Securities

You would get that when April 15, right?

Ken Steele

Yeah.

Steve Delaney – JMP Securities

Okay. Thank you, Ken.

Ken Steele

You are very welcome.

Operator

The next question we have comes from Jim Delisle of Cambridge Place.

Jim Delisle – Cambridge Place

Hi, guys.

Ken Steele

Hi, Jim.

Jim Delisle – Cambridge Place

Good morning. This is getting more towards practice of repo and face-to-face with the Street here. I'm wondering if the repo that you have done with the Street, presumably it is on a pooled basis a Q set basis, right?

Ken Steele

Correct. Yes.

Jim Delisle – Cambridge Place

Has the Street basically gone through that? And obviously, you have given us a lot of disclosure. But it doesn't have it on a pool-by-pool basis, one would presume they see something that they had marked at 105, it looks like in 2004, 6% coupon or 2007, 6% coupon, they are going to assume that is going to be part of the ones that Freddie is going to call. And I would presume they would call you back for a margin call on that one?

Bill Gibbs

Yeah. What we have seen so far has been minimal in all honesty. We had seen some margin calls as a result of the lowering of the prices on the higher coupon paper. But it has been in that context of what we said earlier of about one point.

Jim Delisle – Cambridge Place

And but has it been on a pool specific basis based on the same kind of probabilities you would assign to the stuff being called?

Bill Gibbs

Well, when you get your margin calls. You will normally see a breakdown, a spreadsheet of all the collateral you had with a specific broker. And it will show you where the deficiencies are on each piece. So it has been pretty much specific to the higher coupon bonds. But like I mentioned, it hasn't been anything severe. It's -- for the most part it has been somewhere in the context of one point.

Ben Hough

So while you might see a reduction in the higher coupon collateral that your counterparty is holding, it could be offset in that same repo pool of lower coupon TBAs whose prices have actually increased.

Jim Delisle – Cambridge Place

Okay. So syllogistically, one would suggest that any concerns people have about the unexpected call of this collateral and the cash flow effect particularly on the Freddie would already be priced in if the Street was doing their job into margin calls or their repo valuation? Would that be a fair assumption?

Ben Hough

I would agree with that statement.

Bill Gibbs

Yeah.

Jim Delisle – Cambridge Place

Thank you.

Ben Hough

Thank you.

Operator

The next question we have comes from Henry Coffey of Sterne Agee.

Henry Coffey – Sterne Agee

Yeah. I don't ask the obvious, but in analyzing this and giving some consideration to your regular cash position and industry leverage. This is an earnings book value issue, but at least for you all and probably for most of your public peers there is not a "liquidity repo challenge" here. Is that the correct assessment?

Bill Gibbs

Yeah. We believe that's the case as well. And from the book value standpoint, as we mentioned before, as you look forward past the initial blip we are seeing the prices go back more to what they were preannouncement. So I definitely agree with that statement.

Henry Coffey – Sterne Agee

Thank you.

Bill Gibbs

Thank you.

Operator

The next question we have comes from Matthew Larson of Morgan Stanley.

Matthew Larson – Morgan Stanley

Hi, guys, Thanks for taking my call. I got on a little late, because I was on a couple of other calls simultaneously, unfortunately. But listen, it seems to me that most of the people in the mortgage REIT area are conducting their business at the lowest leverage they have been historically. Whether it's three to four to five or even six or seven times leverage versus maybe 8 to 12. And yet we have the most appealing yield curve to take advantage of leverage that we have ever seen. And it seems to me that almost everybody is keeping leverage low because they are hesitant about whether it is the Fed's shutdown of their mortgage buying activities or whether they just think things are overpriced.

I mean many securities are at 1045 and I can go on and on. But everybody -- my point is everybody is pretty much positioning themselves in the same frame of mind. And me, as I've got a few contrarian bones in my body, I am kind of wondering is everybody right here, where you can coin money by basically just borrowing short and lending long. And if everybody is playing it safe, maybe the cycle has got longer to run. I mean can you comment on it please?

Ken Steele

I think that's definitely a possibility. We took our leverage down to below the seven times for the first time January of last year or at the end of 2008. And prior to that, our intention was and we raised capital in December by the way, with the full intention of getting up to 8.5 or 9 times leverage. Because we sought -- we thought bonds were really cheap at the time. When things really started changing and things in the government started changing, we saw additional risk out there that we had not seen before.

And we thought, it prudent from a risk management perspective to reduce leverage. And we have had that same feeling this entire year. This is a great case in point of why we do want lower leverage and why we should higher liquidity. It is a risk management decision. It could be that this cycle plays out much longer than anyone expects. If that is the case, we are still going to make a lot of money at six to seven times leverage. But I think it's very prudent with all of the uncertainties out there to run with higher liquidity and lower leverage. I think that is where we are for the time being anyway.

Matthew Larson – Morgan Stanley

I will just say that, just in the FYI area, I mean if everybody is keeping low leverage and everyone is waiting for some sort of blow out in the spreads or what have you, then it may or may not happen. I have been around the business unfortunately a long time. But in the early 90s I was told the best trade in the world would be shorting Japanese government bonds, that JGBs were yielding like 1.5 or 2 at the time. Well, it is 18 years later, they are still yielding that. So I mean, I am a huge investor with you all and many other mortgage REITs, because I think that at book value or below it is a lay-up, because you guys have -- your securities are transparent. They are liquid unlike what might be on the balance sheets, so major banks which trade at significantly above book value.

So it's -- I guess, I'm just kind of cheerleading here saying that people should be buying your stock here at 25 or $26, which is book value area. Because you could push a button and pretty much liquidate your portfolio. And yet I have never seen a cycle low hit where you could get 15 to 20% yields when the competing yield is essentially zero. I mean, it just doesn't make any sense to me, which tells me the consensus is probably wrong. I mean so that's, I guess my point. Thank you.

Michael Hough

We sure do appreciate your point and thanks for calling.

Matthew Larson – Morgan Stanley

Okay.

Operator

It appears that we have no further questions at this time. I would like to hand the conference back over to Mr. Hough.

Michael Hough

Okay. Well, thank you all for your interest and for being on the call. And we look forward to next quarter and hopefully everything plays out well. Thanks.

Operator

Thank you, gentlemen for your time. The conference is now concluded. We thank you for attending today's presentation. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Hatteras Financial Corp. Q4 2009 Earnings Call Transcript
This Transcript
All Transcripts