Hatteras Financial's CEO Discusses Q1 2014 Results - Earnings Call Transcript

Apr.23.14 | About: Hatteras Financial (HTS)

Hatteras Financial Corp. (NYSE:HTS)

Q1 2014 Earnings Conference Call

April 23, 2014 10:00 AM ET

Executives

Mark Collinson – Partner, Compass Investor Relations

Michael R. Hough – Chief Executive Officer

Kenneth A. Steele – Chief Financial Officer, Secretary and Treasurer

Benjamin M. Hough – President and Chief Operating Officer

Michael Buttner – Managing Director-Asset/Liability Risk/Strategy

Analysts

Steve C. DeLaney – JMP Securities LLC

Douglas M. Harter – Credit Suisse Securities LLC

Michael R. Widner – Keefe, Bruyette & Woods, Inc.

Richard A. Eckert – MLV & Co. LLC

Arren Cyganovich – Evercore Partners

Joel J. Houck – Wells Fargo Securities, LLC

Dan L. Furtado – Jefferies LLC

Cheryl M. Pate – Morgan Stanley & Co. LLC

Kenneth M. Bruce – Bank of America Merrill Lynch

Operator

Good day and welcome to the Hatteras Financial 2014 Q1 Earnings Conference Call. All participants will be in 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 Mr. Mark Collinson, Partner, Compass Investor Relations. Please go ahead, sir.

Mark Collinson

Thank you, Mori. Good morning everyone and welcome to the Hatteras First Quarter 2014 Earnings Conference Call. With me today 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 today are the Company’s Chief Investment Officer, Fred Boos and Chief Risk Officer, Mike Buttner.

Before I hand the call over to them, I need to remind all of you that any forward-looking statements made during today’s call are subject to risks and uncertainties, which are discussed at length in our annual and quarterly SEC filings. Actual results and events can differ materially from these forward-looking statements.

The content of this conference call also contains time-sensitive information that is accurate only as of today, April 23, 2014. and the company undertakes no obligations to make any revisions to these statements or to update these statements to reflect events or circumstances occurring after this conference call.

That’s all for me. and here is CEO, Michael Hough.

Michael R. Hough

Okay, good morning and welcome to our first quarter call. As always, our team is here and available to answer any questions you may have following the opening remarks. I keep my part short today, as the quarter was relatively uneventful and we continue to invest and fund around the parameters we’ve previously outlined. We were pleased with the results of the quarter; we continue the last quarter time duration gap position for stability, while the market is in its trading range.

We discussed last quarter that we were comfortable being invested to our target range of 5% to 10% liquidity and 7x to 8x leverage, which is where we’ve been and expect to be at least for the foreseeable future. Conditions last quarter warranted being toward the higher end and we’re still about there now. I can’t say for sure how long we’ll stay there.

Prepayments were slow during the quarter and earnings directly reflected that. with a lot of that’s surprising, we’d expect prepays in this environment to be slightly higher going forward. the increase in book value is to adjust a very well hedged portfolio, especially in the value of the curve were most of the upright movement occurred during the quarter.

We’ll continue to work this portfolio with an owned Fed policy, or accountable near-term with all the ARMs are seasoning and with the value proposition short duration assets are giving us. Basis has improved across all MBS over the last few quarters. As something we pay attention to, but today the demand for short duration asset is not driven by the Fed, but from real money investors looking for difference in assets. For that reason, we think there’s more basis risk on the long end of the curve than the short end.

One quick thing to update on is the progress we’re making with our ARM flow relationships. as we discussed last call, we are now pricing the agency ARM low program with 10 strong originators who are currently delivering wholesale product to us that covers more than half of our monthly cash flow needs. We’re price a lot of funding at primary market prices and we’ve become very confident hedging the pipeline. I think most important as we get additional insight into the market on a real-time basis that really helps us manage the entire portfolio. With this mechanism in place, it makes perfect sense for us to expand these relationships to include jumbo ARMs.

We continue to grow our capabilities and add expertise around these efforts and we expect we’ll have some specific news on this to share with you in the near future. Currently, we’re evaluating how to best build the box, so we can create a product that fits within our risk framework and complement the agency book. This is not a change in strategy; it’s our opportunity to correlate a successful initiative into something that should improve the long-term performance of Hatteras.

Vast majority of our business will continue to be interest rate risk management through agency securities and what we are doing here should not disrupt the risk – risk profile of the investment. But it is important that we create flexibility. so Hatteras can evolve as the overall mortgage market evolves. We’ll continue to update our progress and look forward to having more to discuss on the next call.

So I’ll hand it over to Ken now.

Kenneth A. Steele

Thanks, Michael. Today I wanted to flip things over a few specific things that you may have questions on around our results for the quarter.

First, components of gain or loss on derivative instruments, which is table down in the press release. All of our derivative transactions are included here. The first two items related to our interest rates swaps, and it’s giving up hedge accounting, the mark-to-market change is shown on the first slide with the net payments we make or receive show net as our monthly net settlement. Launch relating to our Eurodollar futures contracts are net. first, showing the mark-to-market gains or losses, which was the loss of $17.3 million for the quarter.

The second of these lines is the real asset component, which was a loss of $18.6 million for the quarter. Part of this was from a matching trade, as we move some hedges that we have paid with some of our asset sales. The remainder was due to some overall repositioning of our hedge book.

Next, an attempt to add some light to our earnings fee, our core income this quarter was $0.13 higher than in the fourth quarter. Prior breakdown to components of that increase, I’d say that $0.025 of that was due to slightly more earning asset, $0.05 came from slower prepays, $0.055 pickup was due to the improved funding costs of dollar roll funding.

Third, I’d also like to put some numbers around our dividend. as we have stated in the past, the policy is to pay out 100% of our REIT income over five quarters to 90% in any given year. We also try to indicate with our dividend and estimated earnings run rate based on what we know today. We have to balance that with several factors including tax considerations, timing in our outlook for the mortgage and interest rate markets. We have to manage a dividend due of tax here and we also have some tax loss carry forwards that we can take advantage of in the future.

We set the dividend in quarter for $0.50, with quarter one prepayments coming in, below what we’d expect for trend in 2014, and seasonal day count and weather issues considered. we thought it made sense to maintain that rate to positions we want to change. As the year progresses, we will have more clarity on the direction of earnings and adjusted accordingly.

With that, I’ll turn the call over to Ben for details on the portfolio and investment.

Benjamin M. Hough

Okay. Thanks, Ken. Michael and Ken already noted the quarter was fairly steady for the most part. by mid-January, we had leverage where we wanted it and a side from reinvesting cash flow we’re not real active after that. While the quarter may have been a little late typical with exceptionally slow prepayment rates and some intra-quarter volatility, net changes in rates were not that large.

The yield curve flattened with a two-year note rally in 30 basis points lower quarter-over-quarter, but the three-year part of the curve closer to where our portfolio is, moving more by around 10 basis points. Demand for hybrid ARMs continued to be very strong and ARM spreads tighten a little and offset the rise in nominal rates. So we have slight appreciation on both our hedges and our assets.

A quick note on supply, while overall agency MBS production is weighed down compared to this time last year. new production of hybrid ARMS has held steady of $2 billion to $3 billion per month. So ARM supply hasn’t really changed that much, it is more than sufficient for us. We started Q1 with leverage of 7.3, but took that up a little in January to the seven and three quarters range, where we saw good technicals in the MBS market and opportunities in 15-year paper.

We’ve been focusing mostly on 3 and 3.5 coupons that have a duration similar to that of a hybrid ARM and hedging them aggressively to a neutral net duration. We finance them in the dollar roll market and as long as that provides an economic advantage of a repo, we will continue to do so.

For many quarters now, we have been using 15 years for a 10% to 20% allocation and will continue to do that as long as that makes sense to our overall carry and risk positions. We’d like to use the liquidity of the 15-year market to easily dive into our leverage target as it changes.

For all of our monthly cash flow though, we had been reinvesting into ARMs with a bias toward new production 51s, which we believe offer the best relative value over the long-term, given their carry and seasoning characteristics. Target leverage going forward is still at that seven to eight level and then we will likely work within that range for now.

So far during the tapering, the lower supply dynamics are more than offset in the pullback from the Fed and we’ll watch this closely going forward and adjust accordingly. Prepayments in the quarter were a little lower than on average and came in at five-year low of 13 CPR. Some of this slowdown can be attributed to lower day counts, bad weather and overall seasonality. so we expect prepays back up into the mid-teens with the recent new lowering rates in the spring housing season. Our April pay-downs were 13.7 CPR, following 10.9 CPR at March.

Looking at our current portfolio, we estimate that only 20% of our assets are in the money from a refi perspective. If mortgage rates move up another 25 basis points or so, that number drops to only about 12%, so absent the strong moves, lowering rates, we think prepayments should remain modest looking ahead into the summer months and beyond, the lower and steadier prepayment rates being more predictable cash flows, and therefore more efficient reinvestment and better hedging results. All-in, and at the moment, this is a much more favorable environment than during that was in Q3.

One thing, I would like to reiterate though is the prepayments can be a net positive in a rising rate environment and the natural tendency of ARMs to prepay relatively faster, should give us more cash flow and more options to deleverage and reinvest going forward should we choose to.

On the liability side, the repo market has been solid and capacity is high. Agency collateral remains in high demand for cash providers, and that has kept pressure on repo rates and liquidity strong. And as for hedging, as we’ve mentioned in the last few quarters, we’ve been using Eurodollar futures contracts for new hedges and to replace swap runoff. This quarter again, we’ve been adding hedges mostly in the three to five-year part of the curve, which will likely be the most affected by any change in the Fed’s timetable.

Right now, we estimate our duration gap at around a half, which is lower than where we were at the end of last quarter and where we feel is appropriate given what is currently priced into the curve. As our ARMs season more and more every month, we have the flexibility to let our assets gradually shorten, or to extend them by adding new production paper and adjusting our GAAP accordingly. And then lastly, we estimate current book value to be basically unchanged, maybe slightly higher than our March 31.

I’ll now turn it back over to Michael.

Michael R. Hough

Okay. Well, that’s all we have, and we look forward to any questions you may have. Operator?

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. (Operator Instructions) Our first question is Steven DeLaney, JMP Securities. Please go ahead.

Steve C. DeLaney – JMP Securities LLC

Thank you. Good morning everyone and congratulations on a strong start to 2014. I wanted to ask a question about the repo market. I think short-term, the conditions are very good, and I think March 31, you were 30 basis points. Could you tell us if there has been any kind of further downward move and repo rates and kind of the range what you’re currently paying for a 30-day money?

Frederick J. Boos II

Yes. Hi, Steve. This is Fred.

Steve C. DeLaney – JMP Securities LLC

Hi, Fred.

Frederick J. Boos II

Hi. We are currently in the broker market. we’ve returned back after quarter-end. As you know, there is always a little elevation in repo rates at quarter-end. We’re back down in the broker market to around 10 bips for 30 days, and we’re currently in the 28 to 32, 33 basis point range for a 30-day money.

Steve C. DeLaney – JMP Securities LLC

Okay.

Frederick J. Boos II

We expect this to continue in that space and evidenced half of the curve, 30, 60, 90 days is very flat out in the repo land. So we see – continue to see downward pressure though for a number of reasons. But we think we’ll hold steady right in here around high-20s, low-30s.

Steve C. DeLaney – JMP Securities LLC

All right. Good, well that’s new – I’ve not heard below 30s, but interesting development. And I was curious, because we’re seeing a lot of regulatory issues and I know that you guys track them the proposal for the SLR, this new in SFR. and it really seems like that that is – and the regulators are trying to really rein in the wholesale fronting market. I was just curious if you’ve seen any changes or behavior among any of your counterparties, maybe, the global banks or they point back or other less regulated participants stepping up. I mean just sort of in the – I don’t think you disclose your counterparty list any longer, and I was just curious if there has been any kind of rotation or behavioral change relative to these regulatory things I’ve mentioned? Thanks.

Frederick J. Boos II

No, no. We have not seen any pullback in any of our counterparties in terms of the capacity to us. As you know, the entire repo market is much smaller due to deleveraging last summer and the fall. So well, we have seen overall reduction in repo levels. We think that’s beneficial to the market; there is less demand for repo right now. So we’ve not seen that, yes, the secondary players, the regional players will pick up some slack, but we have not seen to answer your question any pullback in any of the lines that are offered to us and that’s about approximately 30 counterparties that we have.

Steve C. DeLaney – JMP Securities LLC

Okay, helpful. Thank you. And just one final quick thing, Michael, you mentioned the potential to kind of leverage the relationships on the flow program into jumbo ARMs, which I mean anyway, you can get ARM product, I think is attractive for the business strategy. Have you thought down the road enough about funding those about how you will file leverage there and is that a piece of collateral would be a good fit for these federal home loan back advances? Thanks?

Michael R. Hough

Yes, Steve. We’re still working on this. So we really don’t have anything concrete to talk about today. However, we have had defensive conversations with several of the home loan banks who do offer funding for non-agency securities or loans et cetera that could very well be beneficial in the future for what we’re talking about. But I think right now, I think to look forward here; we don’t have any concrete answers. But home loan banks are definitely part of the equation.

Steve C. DeLaney – JMP Securities LLC

Got it. Appreciate that. Well, thanks for the comments guys.

Operator

Our next question is Douglas Harter, Credit Suisse. Please go ahead.

Douglas M. Harter – Credit Suisse Securities LLC

Thanks. You mentioned that the slow dynamic is favorable right now. When you look out to the next quarter or two, how do you see that changing and how does that influence your decisions around leverage in the coming quarters?

Michael R. Hough

Hi, Doug, I don’t foresee it changing significantly, I think some of the seasonal factors, we would have expected it to actually come down through the winter and it really didn’t come and most of that was because of the yield curves steepen, the incentive to take out ARMs is greater. So the ARM production as a percentage of the overall agency production has been up by – quite a bit.

So we don’t suspect that changing significantly. but as it affects our leverage decisions, we’ll just have to see going forward as rates go up and production slows down, our cash flow needs are going to go down as well, plus we have the flow relationships, which we can leverage in different ways to get production where we want it and try to tune it in that way. So we’re not, we’re not – we feel very good about the supply levels right now.

Douglas M. Harter – Credit Suisse Securities LLC

I guess what about the – when you’re looking at the broader market and I guess more particular, the 15, as you have the seasonal factors of more home buying and at the same time, the Fed is slowing down their purchases. So how do you think that plays out especially in your 15-year allocation?

Michael Buttner

Sure. hi, Doug, this is Mike Buttner. What we continue to see in the market is that there is strong demand from other financial institutions for short duration assets. So they’ve been stepping in and looking hybrid ARMs to develop 50-year securities and kind of feel that that will continue as long as the expectation is that the federal will continue, will raise rates more down the line.

Douglas M. Harter – Credit Suisse Securities LLC

All right.

Michael Buttner

So that that – what that means is that, we think there’s slight demand dynamic will stay fairly steady and we’re not anticipating the short running way, any significant oversupply or an impact of spread.

Douglas M. Harter – Credit Suisse Securities LLC

Right. And just switching tax a little bit, can you just talk about your decision to use the Eurodollars versus swaps and how you weigh kind of the book value benefit versus kind of the cash flow benefit of Eurodollars versus swaps?

Michael R. Hough

Yes. Eurodollars are basically, the building blocks of swaps; I mean a swap is a synthetic package of Eurodollar contracts. So we really not do anything different, it’s just a more efficient way to get access to the market for us from a margin and liquidity standpoint and flexibility. So in the long run, a strip of Eurodollar contracts is predicting what the yield curve will do, and if it plays out exactly as predicted in that strip, which obviously, it probably won’t, but it will have the same effect for us over the long-term. It is the good book value as just like a swap base in the mark-to-market is very similar as rates change and the cash flow nature of it go over the long-term depends on how the market plays out, but the biggest benefit for us is the flexibility to change as market conditions change pieces of that strip, which you can’t do with the swap.

We have to do something with the whole package if we’re in the swap. We can fine-tune and fix parts from the curve where we want to be short more or cover some of the shots on the Eurodollar future contracts as conditions change. So it just gives us a lot of flexibility, and it puts some of the auction in our pockets and some of the convexity in our pockets that we need when dealing with the agency MBS.

Douglas M. Harter – Credit Suisse Securities LLC

Great, thank you.

Operator

Our next question is Mike Widner, KBW. Please go ahead.

Michael R. Widner – Keefe, Bruyette & Woods, Inc.

Hey, excuse me good morning guys. Let me just follow up on that question, regarding the Eurodollar futures. And I guess specifically, you’ve got Table 11, breaking out to core earnings, net interest margins, et cetera. And on that, you have the line for the net settle on the interest rates swaps. But there is no line on there for Eurodollar futures. So just wondering if you could talk about sort of how you view this settling of Eurodollar futures, particularly, with regard to core earnings in that table.

Kenneth A. Steele

Yes, Mike. It’s Ken. Good morning. The way that is there’s most all of our swaps and pretty much all of the sort of the Eurodollars right now or forward starting positions. So as those actually settle in periods, we will bring that cost into core.

Michael R. Widner – Keefe, Bruyette & Woods, Inc.

Got you. And then so as I look at the Table 9 that you guys talk about in the call, there is a line on there. The realized gains and losses on the futures contracts. Those are contracts that you cancel as opposed to those that actually paid your settle.

Kenneth A. Steele

Right. There are ones that are out in the future that we just canceled and I think that part of a big chunk of that was due to kind of a fair investment we’ve made with some assets. So that’s kind of offset by the gains that you saw every term.

Michael R. Widner – Keefe, Bruyette & Woods, Inc.

Got you. And so we– I would also notice that the 2014 active balance fell by quite a bit to assume a fair amount of it’s related to that.

Kenneth A. Steele

That would be correct. Some of it’s related to that, some of it’s down further and some of those are just the quarter apart that we’ve gone to, but we do have a lot of swaps coming off in that period as well.

Michael R. Widner – Keefe, Bruyette & Woods, Inc.

Okay, great. And I guess just one other one. This is sort of a little more forward-looking, but you referred a number of fixed income strategies, as well as some other mortgage REITs talking about how they expect it, MBS prices particularly those, where the Fed is playing a dollar roll market, 15-year 3.5%, 30-year for just being very vulnerable as the Fed winds down its program and your people are talking about 0.5 drops in bond prices come midsummer, late-summer, et cetera. Just wondering if you guys – do you think that same – do you expect the same sort of thing, do you think it’s a real risk and does your position in a dollar – your sizable position in the 15-year dollar roll market expose you do that?

Michael Buttner

Hi, this is Mike Buttner. we think that the market has price in the Fed’s tapering fairly well, and we’ll also dive into the supply demand construction that we’ve seen supply come off significantly and related to that, there’s still demand from other financial institutions. So I guess for a little more sanguine on the spreads going forward, unless there’s some significant change in the Fed policy.

Kenneth A. Steele

It’s just some historical perspective in 2012, we had about 300 billion issuance in 15 years, that’s about 15% of the MBS market, agency market. That fell to 250 billion in 2013. right now, our run rate is now half of that about $125 billion for the 15-year sector and the 3.5s are a smaller subset of that origination, because the origination coupon now is 3s.

So as you can see, as Mike said, with the demand picking up and the supply shrinking and the demand for short duration assets, especially the more defensive coupons of 3.5s, we feel that that’s going to keep those prices in check. And lastly, the Fed really only buys a small amount of 15-year 3.5s on a monthly basis. So all of those would argue that we’re comfortable that we’re not going to see the sizable depreciation and the valuation of 15-year segment.

Michael R. Widner – Keefe, Bruyette & Woods, Inc.

Right, well, appreciate it and I think I tend to be more on your side and what we hear from so many others, but we’ll see how it goes when the Fed finally points down, but appreciate the comments as always.

Operator

Our next question is Richard Eckert, MLV & Company. Please go ahead.

Richard A. Eckert – MLV & Co. LLC

Just a couple of curiosity items. first of all, in the other comprehensive income, I see a $32.5 million net to unrealized gain on interest rate hedges. I would have thought that most of those flow through the bond, or the income statement now. Do you still have some swaps that are accounted for hedge instruments?

Kenneth A. Steele

No, we don’t have any swaps that are accounted for hedge instruments. We do have that gain is actually part to amortization of the balance coming out as what was – when we gave up hedge accounting that balance kind of freezes in there and then amortizes out over the coming periods. So that’s what that relates to.

Richard A. Eckert – MLV & Co. LLC

Okay. And my second question, your dollar roll income was much higher than I had anticipated in the quarter, kind of following up on the previous caller, was that – can I take that to mean that there was the demand significantly exceeded the supply in the first quarter and that there were certain dealer over commitments? It just – this seems unusually high.

Michael R. Hough

Hey, Rich. I think that the main reason is our position was bigger. So that we did on average, have a higher position of 15-year and we were financing those available markets that we have in the fourth quarter. but as far as, the execution of the roll and the value we got from it, I would say on average, it was probably a little bit better of course, this quarter than last. I mean there is a special we get, in the market that the market provides and that in the first quarter was probably a little bit – little bit better than it was in the fourth quarter. So those combined led to a bigger impact on our earnings. but I’ll take much of this is just because we had a bigger position.

Richard A. Eckert – MLV & Co. LLC

Okay. Thank you very much.

Operator

Our next question is Arren Cyganovich, Evercore. Please go ahead.

Arren Cyganovich – Evercore Partners

Thanks. Just following up on the dollar roll question, do you expect to take delivery of all of those or I think you’ll actually close out some of those positions?

Kenneth A. Steele

Well, Arren, it will depend on our view of 15 years overall. And then if we still like 15 years and the dollar roll benefit goes away, we have been taking specified pools that we deal, we set our risk reward position. So we’d like 15 years and we use it as a cooperative portfolio and even if we’re not using TBA and dollar rolls that it provides a lot with it.

Arren Cyganovich – Evercore Partners

And what was the benefit that you had during the quarter from the lower funding costs relative to TBA versus taking it on the balance sheet, do you have that handy?

Kenneth A. Steele

Yes. It was roughly $5 million is the benefit for the quarter.

Michael R. Hough

It is about $5 million for the share.

Arren Cyganovich – Evercore Partners

Okay. And then lastly, the commentary about jumbo ARMs, I’m assuming this is not confirming jumbo. so this would be your first for way in the credit risk and have you actually talked a little bit about or have you ever actually invested in credit assets and any of the other vehicles in the past?

Michael R. Hough

Hatteras has never invested in to-date in credit assets and which is why we’re taking such a slow and delivered approach this, we’re not jumping wholeheartedly, this is not a – this is not a reach for credit exposure, it’s a reach of an asset that we are – that we’re comfortable – comfortable managing the interest rate risk on, and that fits well within our portfolio. and so we are taking our time, we are – we’ve had some very strong people here to lead the effort and I think you’re going to get more information as we go forward, so that’s – and this is why we have – we talked about it last couple quarters and just kind of updating you as we make in small swaps.

Arren Cyganovich – Evercore Partners

Okay. Thank you.

Operator

Our next question is Joel Houck, Wells Fargo. Please go ahead.

Joel J. Houck – Wells Fargo Securities, LLC

Good morning. Is there any interesting chart last year that showed the basis widening for 51, 71 ARMs, can you update us where the Z spread is for the 51,71 at the end of March?

Michael R. Hough

Sure. At the end of March, Z spreads were – and for 51s, these are 525s in the low-20s and Z spreads for 71s in the low-30s. there is a bifurcation in the 51s now that the 525 cap structures are fading into the new 225 cap structures, but that’s about the levels to all of those 51s and 71s.

Joel J. Houck – Wells Fargo Securities, LLC

So they’ve obviously come in since June. but they would be fairly characterizing as to say they’re still kind of modestly elevated versus long-term historic levels.

Michael R. Hough

I would say that they are a little bit lower than long-term historical levels, but just in comparison to last April of – April of 2013, 51s we’ve got in tighter than we are now. but – and currently today, for example, if we switch to the LIBOR option, just its spread measure, we’re still around 30 – mid-30s in spread, that’s an option adjusted spread, whereas a year ago with even a tighter Z, we were down around fiver LIBOR adjusted spreads. so still on a spread basis, X options, we are still favorable today versus what we were last April of 2013, favorable meaning wider spread.

Joel J. Houck – Wells Fargo Securities, LLC

All right. Okay. Great, thank you very much.

Kenneth A. Steele

Joel, I’d like to add like that spreads are also at this point in the cycle, it’s hard to compare our long-term average, if you compare at this point in the cycle. this is what – what we would expect to be as demand has picked up for short duration asset. so if you were to look historic times at this point in the cycle, I think you will find the spreads would be tighter on average than the long-term average, and it’s a lot different than this time last year, when we were still looking at a very active Fed.

Michael R. Hough

And from a relative value standpoint, ARM still is very attractive versus other short duration assets.

Joel J. Houck – Wells Fargo Securities, LLC

Right. Obviously, as we talk to other REITs, they kind of cover what you guys are already owned and there’s not a quick way, I guess to build a portfolio like you guys already have. so this is kind of curious as to where, what you thought about the relative value of the space and it sounds like it’s consistent with what we’re hearing from others. so thanks for the color.

Operator

Our next question is Dan Furtado from Jefferies. Please go ahead.

Dan L. Furtado – Jefferies LLC

Good morning, everybody. Thank you for taking my questions. I have a couple, one general and one specific, both relating to this potential jumbo ARM strategy, I guess on the – just the general kind of high level philosophical side, it kind of strikes me as, I guess what am I missing here from the standpoint, I look at the jumbo ARMs and figure that the duration risk is likely greater there than in the confirming space, you’ve got pricing today that’s more or less on top of the confirming side, and you have that additional component of credit risk. And so when you look at the jumbo ARMs versus the confirming what’s getting you over the half or making you contemplate the strategy, because I think from first (indiscernible), it doesn’t necessarily, wouldn’t be something I would necessarily expect to hear?

Michael Buttner

Hey, Dan. This is Mike Buttner. when we – the pricing here for jumbo is tight. But you have to look kind of relative net of GPs too and when you get the all-in asset that you get confirming versus non-confirming, but when we are – we’re looking at a lot of work to really look at the underlying risks associated with the jumbo’s an ultimately, and we just think that we can reach in a high quality asset and again, down the road, it just has a flexibility, because we don’t know what’s going to happen to GSEs and this may be a way that we – a mechanism that we need in order to get access – continue to get access, excuse me to the hybrid ARM assets that we like we think is our core strategy we want to continue.

Michael R. Hough

It just from a big picture Dan, this is a – this is not something we’re looking at, for the near-term opportunity, but long-term part of this business. and it’s not going to be a huge part of the business like I said, kind of that gave here. So I just want to make that point.

Dan L. Furtado – Jefferies LLC

No, no, I understand. I think you led off the conversation, I think that’s relatively benign quarter. so I think that’s where frankly, I’m focusing here, because I think it’s one of the more interesting developments in the quarter. So it’s really more of an optionality strategy than anything else at this stage.

Michael R. Hough

Yes. We’d agreed with that.

Dan L. Furtado – Jefferies LLC

Okay, great. Well, thanks for taking my question.

Operator

Our next question is Cheryl Pate, Morgan Stanley. Please go ahead.

Cheryl M. Pate – Morgan Stanley & Co. LLC

Hi, good morning. Just a couple of quick questions. First on the dollar roll strategy. Obviously, it’s up to the – the size of the position increasing over that on average versus the fourth quarter. Can you give us a sense on sort of how you’re thinking about that size over the near-term or maybe you can give us a sense of where we are today there?

Michael R. Hough

Sure. Hey, listen. We’ve been investing 15 years now for a pretty good while and we told you, out of the gate, we’re going to be – we could be zero to 25% of the portfolio in 15 years and that’s kind of where we’ve been and we’ve used that – that part of the portfolio to affect the risk position of the company and leverage.

So today, I think, in this quarter, the opportunity was presented and we took 15-year piece up to about 20% in the portfolio and the financial with dollar rolls, because that was cheaper than financial repo and that’s how we’re going to look at going forward.

Cheryl M. Pate – Morgan Stanley & Co. LLC

Okay. And then just the second quick one from me. When we look at sort of the fair market value or the mark-to-market adjustments on the derivative side this quarter. I guess can you just maybe give some color as to the futures contracts with the negative mark-to-market versus the swaps that were marked up. I would have though that those would move the same directions, or maybe you can give a little bit of a sense as to the differential there.

Michael R. Hough

Yes. It’s really a kind of the accounting as we’ve given up hedge, accounting, you got to remember that this is kind of what led to the other question about the $32 million realized gains, that’s the amortization of the old loss that was locked in to that. So actually, you have to kind of net those two, we had $32 million coming out. But then another $15 million pickup. So net-net overall is the loss, but that was kind of the – how that plays down from the accounting standpoint.

Cheryl M. Pate – Morgan Stanley & Co. LLC

Okay, got it. Okay, thanks very much.

Michael R. Hough

Thank you.

Operator

(Operator Instructions) Our next question is Ken Bruce, Bank of America Merrill Lynch. Please go ahead.

Kenneth M. Bruce – Bank of America Merrill Lynch

Hi, thanks. Good morning, gentlemen. My first question is going to – basically have you repeat your answer, I just want to make sure I understand the general thesis around the 15 years. So basically you’re going to be identifying how much exposure you want to have in that particular asset that tender for a number of reasons to it sounds like those risk management in this overall size of the portfolio. And then effectively, you are going to be in today to 20%. It’s going to be near to 25% and I take it that you will decide on the financing solution app that you’ve kind of identified how much exposure you want to have to the 15-year, is that correct understanding?

Michael R. Hough

Yes. I mean I think you can look at it that way for sure, yes.

Kenneth M. Bruce – Bank of America Merrill Lynch

Okay. And I guess just – my other question is a little bit more big picture in nature. But we hear from a number of mortgage region, and yourselves included that in the first quarter things calm down benign and risk environment, and because of that it feels appropriate to take up risk. And I’m kind of trying to question a logic around buying into with strong market and then fading it after volatility increases, you may see it’s kind of counter productive. Could you give us some thoughts in terms of how you think about that more broad exposure and how what you’re going to be looking for to identify if risk comes back in, or volatility begins to pick up. How you’re going to be in front of that, because it just feels like it’s a pro-cyclical strategy and I guess trying to understand the logic behind it.

Kenneth A. Steele

First of all, last quarter, we took down leverage, we took down risk primarily, because we were hitting a period end, specifically year-end and we were positioning ourselves for the possibility of excess volatility, which we’ve seen in previous year ends. So we took risk off the table for that reason and I think we’ve basically reinvested and I don’t see that we’re adding risk in here, because we have a benign quarter.

So there’s opportunities in the market in the assets that we’re targeting, provide good short-term and long-term value and we’re taking advantage of that. So the risk position of the company today is probably lower than it has been in a while. we’ve been tightening our gaps and as Ben mentioned early on our gaps tighter than it was last quarter and that’s the way we’re looking at it and we’ve increased the position on the 15-year, which is still a short asset. but it’s been also said at the beginning of the call that we’ve been hedging that duration away for the most part on that paper.

So I would argue that the risk we’re taking today is lower than what we have, but it’s a long-term process and it’s a interest rates cycle that keeps on going that we have to always position ourselves for, at this point cycle with the box toward higher rates.

Michael R. Hough

And Ken, I’d like to add just on the ARMs part of the portfolio alone, I mean duration has shortened significantly and the risk profile has shortened significantly from this time last year. We had months to reset on that portfolio in the high-50s, near 60. And the portfolio even with the reinvesting and new production ARMs over the course of the last 12 months that months to reset has dropped down into the mid-40s. So I mean the portfolio is doing what it supposed to do and ARMs portfolio is supposed to do, so that has lowered our risk position as well on average.

Kenneth M. Bruce – Bank of America Merrill Lynch

So I guess maybe somewhat reacting or overreacting to it. Your prepared remarks around being vigilant around the risk you took up leverage, because you felt it was appropriate and I think I understand better where the starting point was and why you could take it up in the given quarter. but I guess I’m trying to understand what you’re going to be looking for to tell you to take it back down, if you think it needs to be taken down and have an understanding as to how you’ll kind of look at the market as it evolves in the next few quarters?

Michael R. Hough

That gives specific, that’s what we’re hired to do and that’s what we do on a daily basis. it’s to evaluate the market and evaluate the risk inherent in our portfolio and where we need to be positioned, or unexpected changes. So to answer that question that’s what we do all day every day.

Kenneth M. Bruce – Bank of America Merrill Lynch

Okay great. well, thank you for your comments and congratulations on a good quarter.

Michael R. Hough

Thanks again.

Operator

Having no further questions, this concludes our question-and-answer session. I would like to turn the conference back over to Michael Hough for any closing remarks.

Michael R. Hough

I just want to say thanks for participating again, this quarter and thanks for your interest in Hatteras Financial and we look forward to updating you more next quarter. Have a great day.

Operator

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

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