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Hatteras Financial Corp. (NYSE:HTS)

Q2 2010 Earnings Call

July 28, 2010 10:00 am ET

Executives

Mark Collinson - Partner. CCG Investor Relations

Michael Hough - CEO & Director

Ben Hough - President & COO

Kenneth Steele - CFO, Treasurer & Secretary

Bill Gibbs - EVP & Co-Chief Investment Officer

Fred Boos - EVP & Co-Chief Investment Officer

Analysts

Steve DeLaney - JMP Securities

Stephen Laws - Deutsche Bank

Michael Taiano - Sandler O'Neill

Daniel Furtado - Jefferies & Co

Jim Ballan - Lazard Capital Markets

Bose George - KBW

Henry Coffey - Sterne, Agee

Matthew Howlett - Macquarie

Mike Widner - Stifel Nicolaus

Operator

Good morning and welcome to the Hatteras Financial Corporation Q2 2010 Earnings Conference Call. (Operator Instructions). Please note that this event is being recorded. I now would like to turn the conference over to Mark Collinson. Mr. Collinson, please go ahead.

Mark Collinson

Thank you, good morning everyone. Welcome to the Hatteras second quarter earnings conference call. With me today as usual are the company's Chairman, Chief Executive Officer, Michael Hough; the company's President and Chief Operating Officer, Ben Hough; and the company's Chief Financial Officer, Kenneth 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 I need to remind all of you that any forward-looking statements made during today's call are subject to risk and uncertainties which are discussed at length in our annual and quarterly SEC filings. Actual events and results can differ materially from these forward-looking statements.

The content of this conference call also contains time-sensitive information that’s accurate only as of today July 28, 2010 and the company undertakes no obligations to make any revisions to these statements or update these statements to reflect events or circumstances occurring after this conference call. And that’s all from me. Here is Michael Hough.

Michael Hough

Hi, good morning and welcome to our second quarter earnings call. The entire Hatteras management team is here with me on the call and following a few short prepared remarks we will all be available to answer each and any of your questions.

The second quarter was a different one for us as pre-payments for the first time were the predominant factor in our quarterly performance. It’s not something I want to harp on because for the most part, the GSE buyback program has now been completed, but Fannie Mae did the bulk of their loan purchases as it relates to our portfolio in April, May and June.

Non-buyback prepayments also increased somewhat as mortgage rates keep hitting new lows and mortgages written in late 2009 and early 2010 are now on the money to re-finance. We would expect this prepayment trend to continue across the entire spectrum of agency MBS, but we believe they will come in within a manageable range.

Ben and Ken will discuss the numbers in detail, but I would like to mention that the primary issue for us in the quarter was the timing of getting the cash from prepayments reinvested at levels that made sense to us.

As most of you know MBS premiums are high in both seasoned and new issue paper and balancing our long-term management philosophy of mitigating risk where we can made it tough to get new paper with low premiums on the books quickly. As we have done since we since we started in this business years, we chose to manage prepayment risk the best way we can and the most effective way is by keep our cost basis and premium reasonably low.

In a market like we are in now, we opt to sacrifice immediate return for longer settle dates with lower premiums and more future repayment protection. We also view that there is one time prepayment spike is really more of catch up from last year’s amazingly low prepayment rate in light of the low interest rate, steep U-curve environment that we’ve had.

It’s for this reason that it made perfect sense to us to distribute some of the excess earnings we retained last year and offset some of earnings shortfall we had this quarter from the catch up. The $1.10 dividend is the number that feels good to us and somewhat reflects current market conditions.

Going forward we and as much as the market now see many uncertainties as to the direction of interest rates, monetary and regulatory policy and the health of the global credit markets. Even though our thoughts tilt toward a low rates steep U-curve for a longer period of time than most expect, we must not maneuver our strategy to the latest whim or current expectations.

We don’t think directional bets are the way to go with this type of strategy and we want to mitigate risks where we can and when we can. Even though we see low short funding rates continuing for the foreseeable future, we continue to protect against a possibility of higher rates coming sooner than we think. There are credible opportunities available to us in interest rates swaps for example and we have selectively taken advantage of them by slightly increasing our notional as well as the term as long-term protection against higher rates.

We continue to purchase assets that we view is the most manageable and can most easily hedge in up and down rate times. We are buying securities we think fit into our long-term portfolio goals and expect to hold and hedge them unless we see their value proposition to the portfolio change.

We are in the market today when we see value and are attempting to maintain consistency in our bond position going forward. There is still great spread in earnings opportunities available out there especially when you considered the long-term spread you can get investing against the swaps curve. As of today, swap rates are very attractive, all the way out five plus years especially we are considering the relative opportunities available to us in MBS.

Keep thinking that some of the price pressure on MBS will ease, but as treasury and swaps rates fall proportionately, we are still seeing good investing options. The market for ARMs keeps getting more liquid, but demand for them is keeping up. We continue to view ARMs as most the attractive asset for our AL model as we evaluate the MBS curve as it relates to the swaps curve.

Now I would like to hand this over to Ken for a financial review of the quarter.

Kenneth Steele

Thanks Michael. Good morning everyone and thanks again for joining us on the call today. I’ll quickly go over this quarter’s numbers and provide some brief discussion of the trends in our operations that were evident in the second quarter of the year.

Our net income for the second quarter of 2010 was $36.8 million or $1.01 per share, a decrease from $43.7 million or $1.27 per share for the first quarter of the year. This decrease was essentially the result of the prepayment spike caused by the GSE buybacks and the subsequent reinvestment timing of those proceeds.

The immediate and direct impact was the increase in amortization expense which lowered our portfolio yield for the quarter. The second is the yield decrease from purchasing new assets at current yields. While from an income statement standpoint, this program was largely a second quarter event, it affected the first quarter somewhat and will have some carryover into the third quarter of the year as well.

Ben will give you some thoughts about that, while I will just mention the financial effects on the second quarter. At June 30th 2010, our portfolio of MBS was $6.8 billion with an average dollar price of 101.58 and a coupon of 4.56%. The 20 basis point coupon decrease from the March 31st portfolio, coupon is 4.76%.

Second quarter’s additional prepayments compressed our portfolio yield falling 25 basis points from 4.1% in the first quarter to 3.85% in the second quarter. Amortization expense rose to $11.3 million for the quarter, up from $9.2 million for the first quarter of 2010 and almost twice that of the $6.2 million of expense incurred in the fourth quarter of 2009.

Our repayment rate for the second quarter was approximately 45% on an annualized basis, a significant rise from our first quarter rate of 36% and basically twice that of the 22.7% rate from the fourth quarter 2009. Our cost of funds rose very slightly from a slight uptick in the repo market rates and the continued edition of interest rate swaps to our liability portfolio.

The overall cost of funds went from 1.51% in the first quarter to 1.55% in the second quarter, an increase of four basis points. This lead to an interest rate spread of 230 basis points dropping 29 basis points from the first quarter spread of 259. Our G&A expenses were well within our norm at $3.3 million or an annualized rate of 138 basis points on average equity for the quarter.

Our book value trended upward during the quarter with the upward price moves continuing on MBS as rates stayed low and buyback uncertainty dissipated. Our MBS strengthened significantly in value, but this was somewhat offset by the falling value of our interest rate swaps which fell as the long run of the curve directed downward. Our book value at the end of the second quarter of 2010 was $25.83, up 1.2% on the March 31 value of $25.48.

The components of our book value at June 30, 2010 on a per share basis are $21.50 of common equity, $0.12 of undistributed earnings, $6.36 of unrealized gain on our MBS and $2.15 of unrealized loss on our interest rate swaps. Our leverage fell with debt-to-equity ratio at the end of the quarter of 6.2 to 1 compared to 6.6 to 1 at March 31st.

This decrease can be attributed largely to our increased equity as our repo position remained static. In summary, core fundamentals remained strong and we were able to declare a dividend of a $1.10 for the second quarter which as Michael mentioned included returning some of our retained income from 2009 to our current investors.

The net result was a yield of approximately 15.8% based on the June 30, 2010 share price and return on average equity for the quarter of 15.6%. I will now turn the call over to Ben for details regarding the portfolio.

Ben Hough

Thanks Ken, good morning everyone. Our investment portfolio totaled $7.7 billion on June 30th including forward-settling purchases, up from $7.1 billion on March 31st . As Michael and Ken have noted already, the main story for us over the quarter was not just lower yield on agency ARMs in the market place, but also the timing of growing our total bond position back to where it was prior to the GSE buybacks.

We actively took advantage of wider spreads during the quarter, but we continue to settle most purchases forward as we’ve consistently done over the last year and half, settling bonds not only into late Q2, but also into the third quarter.

In this environment, we will forego some of short-term income in order to add long-term value to the portfolio and mitigate future prepayment risk by purchasing at lower dollar prices. So to update investment activity so far in the third quarter in addition to the $850 million of forward-settling purchases that show up in our earnings release, those being the hybrid ARMs we purchased prior to June 30th, but settled after June 30th, we’ve purchased an additional $550 million of hybrid ARMs making a total of $1.4 billion that either has settled already in July or are scheduled to settle from August through October.

With these investments, we think our total bond position returns to our pre-buyback levels by August settlement depending of course on prepayments. Of the $1.4 billion about $480 million settled in July already, $450 million is currently slated for August, $266 million in September and the rest in October.

Now that the whole buyback episode is basically behind this, while they didn’t fall on the exact month as laid out in the tables Freddie and Fannie provided us, the overall total for both of them appears to have come in as we originally estimated. As Michael mentioned prepayments in the second quarter continued toward the high end of our expected range, if we back out what we assume were buybacks, the annualized prepayment percentage rate was about 29% which when expressed as a CPR measure was about 25%.

Looking into the current quarter, July prepayments were basically on the same trend. Our Freddie Macs paid down at a percentage rate of about 29% and our Fannie Macs came in at about 50% due mostly to the last phase of their buybacks. Combining the two, the percentage rate in July was about 43%, the equivalent of about a 35.5 CPR.

Our prepayment expectations for the last year or so have been in that 20% to 30% range and with the recent leg down and mortgage origination rates to new lows we could average near the high end of that range over the next few months. We may identify some candidates in our portfolio that we prefer to swap for more predictable cash flows. Today, investment opportunities are still attractive even with today’s market yields.

Heavy demand for high quality, short duration paper are steadily improving repo market and lower treasury rates have driven new production agency ARM yields down, but hedging costs have dropped as well. Yields on lower premium new 5-1s have to climb to around 3%. But with current repo rates, the low 30 basis points and three to four years swap rates ranging from 1% and 1.5%, we can still add well over 200 basis points of well-hedged spread while at the same time improving our overall average funding rate in term.

As for our hedging during in the second quarter, we took advantage of the lower rates and added four additional pay fix swaps at a $100 million each. Each of those swaps is forward starting to replace maturing position in future months. Even though we end up with a slightly higher rate for the forward start, the rates are still well below those of the maturing swaps and will be accretive to our net interest spread when they start.

In the meantime, we will continue in the markets and we will get the book value protection they provide in the event rates shift higher. Our swap book now totals $3.4 billion with a weighted average rate of $2.61 and 29 months to maturity. This represents about 57% of our June 30th repo position, but will be closer to about 52% by the end of Q3 when our forward purchases settle and are financed.

Of the $3.4 billion total, $1 billion of them mature over the next 12 months and have an average rate of 3.34%. Though we are in a great position to continue to replace future swap run-off at accretive levels with longer maturities to further tighten our duration gap, if we decide to do so. With that I’ll turn it back over to Michael.

Michael Hough

Okay, that’s all for the prepared remarks. Operator, we’d like to open the call up for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Okay, the next question comes from Steve DeLaney of JMP Securities.

Steve DeLaney - JMP Securities

Ben, thanks for the recap on the purchases. So just looking ahead maybe the next three to four months, if you are at $1.4 billion in forwards and I guess your runoff rate monthly you could be what, $100 million to $125 million per month, I mean it looks like your sort of assumed portfolio growth might be somewhere around $800 million to $900 million. Is that kind in the ballpark?

Ben Hough

I think that our runoff at the prepayment percentage rates we have seen and we expect in the high 20% range, puts a runoff more likely $150 million to even as high as $200 million in some cases could be possible. So, I think the runoff is a little higher there, so, I don’t think the portfolio there is (inaudible) as you may think.

Steve DeLaney - JMP Securities

Okay, so you may be more down a bit, may be $600 million. It appears you're trying to do more than just, you're trying to grow it slightly, not just maintain as the current level?

Ben Hough

I think the math would show that, yes.

Steve DeLaney - JMP Securities

Okay, great. and then one question about your swaps. I was looking at your schedule. I don't know whether it's one swap or a couple, but you've got $1 billion that's coming off in, it looks like January. It's got seven months to go, they're paying 330 on. You've got to save a couple hundred basis points I guess. That would work out to about $0.50 a share when benefit to earnings, when that runs off.

Have you guys considered just given how low swaps are, just going ahead and it sounds like you're feathering in these forward starts. But I mean, have you thought about just shutting that thing down and putting some new three-year swaps on in its place?

Ben Hough

Well that is always an option to us, we can either reposition when we can replace that run-off forward or we can just wait so they come due and replace it with whatever we have at the time. I think that the economics are pretty similar to us either way. And I think we prefer to take the current environment and interest rate outlook and make separate decisions each time.

So we don’t see a lot of advantage to reposition right now all of them, but it doesn’t mean that we won’t do it.

Kenneth Steele

To evaluate it Steve and just so you know that is feathered in over the next 12 months, this is an average remaining turn of seven.

Steve DeLaney - JMP Securities

I see what you're saying. So, okay, it's not all hitting just in one or two positions hitting it. That's an average is what you're saying, Ken?

Kenneth Steele

(inaudible) different positions.

Steve DeLaney - JMP Securities

Ben, if you could comment on your forwards had an average. You had a whack of 3.6 and an average cost of $102.5 based on what you had positioned at the end. You give us some sense of how these new production hybrids have moved in terms of dollar price? Just the dollar price change approximately since say June to the current levels?

Bill Gibbs

Since June 30th, really if you take a look at the hybrid market there has been very little change maybe a few ticks up, but not a lot since June 30th.

Operator

Thank you and we have another attempt from Stephen Laws of Deutsche Bank.

Stephen Laws - Deutsche Bank

I know you talked during your prepared remarks about the volatility in rates and how that is impacting refinance activity. Can you talk about kind of with where we see the long end of the curve now and available mortgage rates to borrowers, how you think prepay speeds will change here in the next few months?

Second question, can you talk about returns on new money invested today, whether or not you guys would be interested in growing the portfolio here through raising capital as a way to again grow the portfolio without taking leverage back up above seven times?

Bill Gibbs

I’d like to take the question first on the on prepay speed as far as how it’s going to affect our portfolio. One thing, I think we’ve gone through if you break it down in the older vintage, the 2006-2007 that we just came through with the buyouts for the delinquencies.

We would expect them to remain relatively tame. What we think where you are going to see the pick up in prepays is going to be in the newer vintage, the 2009-2010 and I gave you guidance. We would expect to see the overall portfolio to fall in the 20-30 CPR range so we would expect to be towards the high end of that. That’s primarily because the newer production is very refinanceable right now.

We have very quality borrowers, good LTVs and we would especially expect to see the amortizing paper be a little bit quicker. So we would expect to be in the higher end to that 20 to 30 range.

Fred Boos

In terms of the mortgage curve, which is around 100 basis points for our chart to be a little more, that always is beneficial towards ARM production, but the flattening of the treasury curve off late, we would envision that as being more conducive to more third-year longer-term, fixed originations which would also detract from ARM production.

So, we do see as Bill mentioned speeds elevating a bit in that 4 to 4.5 coupon range on ARMs, but we see some counter-balance effect as well with the flattening of the treasury curve.

Michael Hough

This is Michael to your second question on raising capital and put money to work. We can put cash to work very attractively now and we can hedge it fairly aggressively if we choose and get some very good spreads, 200 basis point plus spreads. We don’t have any plans to raise capital. We are in the process of growing the portfolio from the prepayments we experienced here and we are going to evaluate that on an ongoing basis.

Operator

The next question comes from Michael Taiano of Sandler O'Neill.

Michael Taiano - Sandler O'Neill

In terms of the forward purchases that you made during the quarter, the average price at $102.5, I think that's what you said in the past is sort of the higher end of where you're comfortable buying paper. So does that suggest that if we see further increase in MBS on the hybrid side that you would pull back in terms of purchases at this stage?

Michael Hough

Well I think what you would see is we'll be looking to go down in coupon, are you starting to see production in a hybrid market, it’s getting the dollar price a little bit lower by going down in coupon.

Michael Taiano - Sandler O'Neill

Okay and would that still produce spreads north of 200 basis points?

Ben Hough

Depending on how we hedge it, yes. We may hedge that paper a little differently than would hedge higher coupon paper but, yes, I think that there is 200 basis points plus spread, even hedged fairly aggressively.

Michael Hough

That’s kind of what we have been doing, the all year is, we have been coming down the coupon curve as rates have fallen and we have taken our liabilities out longer as we get this lower coupon paper. And I think going forward if we see rates continue to fall that we are going to just have to make those decisions as they come.

Michael Taiano - Sandler O'Neill

I guess in terms of sort of the risk portfolio of the portfolio, it looks like it shortened on the asset side in terms of months to reset. You've extended on the liabilities. So can you give us a sense of net duration gap at this point? Has it improved from the prior quarter?

Michael Hough

I guess we never really put our exact duration gap, our gap since last quarter and since our last call has come in a little bit and if we had to put a number on it, we are probably less than half, less that 0.5 right now, somewhere in that ballpark.

Ben Hough

Flat to 0.5, yes. Asset durations come down a bit with the low origination rates which generally drive OES models and the consequent duration.

Michael Taiano - Sandler O'Neill

And then just lastly, I think your comment with respect to the dividend, the $1.10 seems like you sound comfortable with that. Should we take that to mean that that's sort of a level you think you can produce over the next couple quarters?

Michael Hough

Guess what we said and that’s a comfortable number in the current market conditions. But there are so many variables going forward and it is hard to say where we are going to be but I think that was our intention.

Operator

Next question comes from Daniel Furtado from Jefferies & Co.

Daniel Furtado - Jefferies & Co

Just two relatively quick questions. The first is, was the 5/1 product the primary MBS you were purchasing in the quarter?

Bill Gibbs

It was primarily 5/1s, but we also 7/1s in there as well.

Daniel Furtado - Jefferies & Co

Do you mind letting us know the split between the two roughly?

Kenneth Steele

Well I think that if you look at that $1.4 billion I don’t have those numbers for what we’ve purchased. But most everything, I think the weighted average much to reset is between is the between 60 and 65 somewhere. So it is majority 5/1s, but there are 7/1s mixed into it.

So I would probably put the number between 60 and 65 months to reset and you get back into it.

Daniel Furtado - Jefferies & Co

Other question is just to get a handle on how you think about hedging in this environment. Like this forward settling production, when you think about hedging that, are you targeting a spread or are you targeting a length of time that your swap will be in place?

Kenneth Steele

I think it is a combination of both, but we have hedged always the duration of our assets and cash flow of our assets. And we have these forward star, we obviously are taking on some additional risk here and so that has been our intention. I think what Ben told you that our percentage is up from a hedge position, but this paper comes on our books, we are going to be back in line to where we have been, the difference being that the term and the overall notional of our portfolio is going to be up or [hedged] a bit.

Ben Hough

We are taking price risks on the assets that we buy forward and we are offsetting that with the price risk on the swaps as they settle forward. So we try to match them, not exactly but they do work with each other, so we are trying to manage those risks.

Operator

The next question comes from Jim Ballan from Lazard Capital Markets.

Jim Ballan - Lazard Capital Markets

You've talked about this a little bit regarding the forward purchases but maybe you could elaborate a little bit more for us, just the benefits of doing the forward purchases versus buying in the current market. It sounds like you are taking some price risk. So it sounds like you're not able to actually lock in a coupon when you actually make these purchases. Maybe just talk about, are you making a bet on future spreads versus today? If you could talk a little bit about that, that would be great

Michael Hough

I would like to address one thing there, we are locking in coupon at a set price in advance. We are taking on basis risk that the widening or contraction of the spreads to the treasury curve, but we are locking in the coupons. So we do know exactly what we are getting when we are buying it. The benefit of buying forward is if you are lowering the overall average dollar price and by doing that from a long-term perspective, you are locking in a higher yield and more protection against amortization expense as prepays come in.

So as prepays pick up by locking in for a longer-term to lower dollar price, you are picking up significant yield and we are seeing depending on your prepay assumptions, it could be anywhere from 20 to 40 basis points of additional yield over the life of the security. But that’s the benefit of going forward.

Ben Hough

I think also supplies is a factor. There is not a lot of supply of season and current coupon hybrids out there in the marketplace. So by far that the larger supply is the one, two, three months forward, DBA hybrids supply and that’s the market we choose to do.

Jim Ballan - Lazard Capital Markets

Just one other question on the purchases. The forward purchases don't seem to show up on your balance sheet. Am I missing it or how do the forward purchases get accounted for?

Kenneth Steele

The forward purchases are treated as a hedge and they are just shown at a net value and with our rest of our hedges so that, but counting forward is basically where you net the commitment and, and actual bond amount. So you have a net mark-to-mark on the balance sheet that runs through OCI, as unrealized gain, but they will come on the books as we settle on at the previously contracted price.

Jim Ballan - Lazard Capital Markets

The increase in restricted cash in the quarter, is that related to the forward purchases as well?

Kenneth Steele

That’s related to the swaps being more out of the money.

Operator

The next question comes from Bose George of KBW.

Bose George - KBW

Had a couple of questions. One, just wanted to go back to the 200 basis point plus spread on new investments. Given the 362 coupon on your purchases that you noted, what kind of yield does that work out to and what should we think of them on the cost of funds on that stuff?

Ben Hough

Well, I think the yield, obviously depends on your prepayment assumptions, but for the purpose of that statement, we see a 3% yield is available to us or around 3% yield and in some cases slightly lower and in some would maybe slightly higher. But that was kind of a benchmark number that we feel we can achieve and for the cost of funds, I was using a 28 basis point repo rate with a swap addition of about 50% hedged for 3.5 years just as kind of a benchmark sort of matching cash flows and that came up with a net cost of funds of about 80 basis points give or take a couple. So, that was 220 basis points of spread in that example.

Bose George - KBW

Just switching to the leverage, in terms of the target leverage, once you guys have the capital redeployed, should we assume it kind of settles back in whatever, 6.6 times or something in that range?

Ben Hough

Yes I think that range is reasonable, in the 6.5 to 7 is kind of where we are comfortable right now and that’s what I would expect.

Bose George - KBW

Just one last thing, what was the number for the July settle, the percentage of loan settling in July?

Ben Hough

$480 million, this is already settled in July.

Operator

The next question comes from Henry Coffey of Sterne, Agee.

Henry Coffey - Sterne, Agee

Annually when you went out and issued equity, made a statement that they weren't comfortable with raising the leverage "in this environment." At least that was what they said to us when we asked them why they were doing it. You just kind of gave us a sense of 6.5 to 7 times. What would allow you at least in your own mind to kind of push that number to 8 to 9 or is it just with rates as low as they are and prices as high as they are, is it just too risky to put that kind of leverage on? And given the spreads are great, obviously what's driving your considerations?

Ben Hough

Well, I think it was said this for a while, but there is a comfortable place to be especially in light of all the uncertainties in the market including interest rates, including the credit, markets, including policy et cetera.

And so they are available, there is available spread out there. I think we’ve no problem putting cash to work. But from a risk management standpoint, we are very, very comfortable there. And I think we would tend to agree with the statement you made earlier from (inaudible) that they would like to maintain leverage at this environment kind of around where we’ve been for the past year or so.

Henry Coffey - Sterne, Agee

But given where reinvestment rates are, I don't want to tie you too much down because I think it was very helpful, some of the guidance you have given us. But you talked about being comfortable at $1.10 in dividends. If I calculated the undistributed right, it's around $0.11 to $0.12 per share.

Ben Hough

That will be right.

Henry Coffey - Sterne, Agee

Is it likely over the next few quarters that that $1.10 dividend will be sustained by some use of that undistributed or is this the kind of environment where now that you're getting back to a sort of more normal CPRs, you can start to reearn the dividend?

Kenneth Steele

I think that’s what we are doing as ramping the leverage back up to the pre-buyback levels. I think what the dividend is going to be is going to be driven by so many different variables in this quarter and future quarters, but we do have $0.12 there we can use if we choose to and even if we don’t.

Operator

The next question comes from Matthew Howlett of Macquarie.

Matthew Howlett - Macquarie

Good momentum going through the back half of the year. Just a clarification on the purchase yields going forward, the ability to sort of buydown that premium in the forward market, a point or so, that improves the yield between 40 to 50 basis points. So that’s why we are seeing sort of street pricing around 2.25 for what you’ve seen for the type of coupon you are targeting?

Kenneth Steele

I think we said closer to 20, not 40.

Ben Hough

20 to 40 depending on your prepay assumptions. The higher your prepay assumptions, the more additional yield it ads.

Matthew Howlett - Macquarie

Just a broader question, there has been a lot of talk in terms of what other stimulus the Fed will do in terms of propping up the housing market. I think Bernanke was talking about maybe bringing the purchase program back as an option. Is there anything out that’s unforeseen that you guys envision, that could come down the pipe to kickstart the refinance market?

Fred Boos

I mean we talked about it in the last call a little bit, there is always potential initiatives coming out of Washington. Back to our comment Michael was just making. One of the reasons leverage is where we keep it is also liquidity and we find that keeping ample liquidity here in this kind of environment its very favorable and prudent. And the GSC delinquent loan buyout initiative that we just saw in the last quarter is the prime example of that whereby liquidity was required in order to beat those prepayments and those buydowns.

As far as initiatives go, no but we wouldn’t be surprised, the housing market is recovering albeit slowly there is some bright spots of late in that. We have seen origination rates come down, we think they might come down perhaps a little further but nevertheless the housing market still has some distance to go before it rebounds, we think one to two years.

Housing prices have to stabilize further, jobless rate has to fall certainly to spur more home owners and the collateral performance is probably beginning to improve as well with delinquency rates. So, we think bottom line, it’s a slow and steady recovery, we think that will make initiatives less likely at Washington, but certainly we are always trying to be prepared and be nimble for anything that can happen.

Matthew Howlett - Macquarie

Great, and then when you talk about asset sales possibly, would that be on older seasoned higher coupon, type product you have in the portfolio? Any more clarity you can give us on that?

Kenneth Steele

Not really as this far as anything specific. We are seeing some trends out there in prepayments that we are paying attention to and something makes sense to us to take advantage of maybe we will, but we have no plans to do so and we’ve not targeted any specific assets.

Operator

The next question comes from Mike Widner from Stifel Nicolaus.

Mike Widner - Stifel Nicolaus

Just one quick follow up. Do you guys have any perspective on whether there might be some Fannie buyouts still left that trickle into July or do you think that that is entirely behind you at this point?

Ben Hough

I think that that’s possible, I think it’s a small number. We try to give a little color on what came through in July for us, for the buybacks of the previous month but, yes I think the coupon rates and the dispersion in each pool can vary significantly. So there could be specific loans with higher coupons that may still be around that don’t follow the exact month. So, yes, there could be a little bit of noise, but I think by far the bulk is behind us. I mean as far as the previously delinquent loans and as far as new buybacks go, that’s why we don’t expect the big number will be a factor.

Mike Widner - Stifel Nicolaus

Right, we just assume that that’s part of the higher prepayments that you guys are projecting basically for the rest of the year I guess?

Ben Hough

Right.

Mike Widner - Stifel Nicolaus

Just one other one on the schedule of the forward purchases. So let me just make sure I have the numbers right, you said 480 in July, 450 August, 250 September and the rest October, is that right?

Kenneth Steele

Yes, it was 266 in September.

Operator

The next question comes from Ken Bruce of Bank of America Merrill Lynch.

Ken Bruce - Bank of America Merrill Lynch

Could you give us any additional information about the months of the reset? You've got about 40% of your portfolio in zero to 36 months. How much of that is coming up in the next 12 and 24 months?

Fred Boos

I think in the next 12 months, not including the affect of prepayments. I think it is $625 million. So I would use $600 million to $650 million coming due over the next 12 months. That of course does not include any prepayments between now and then.

Ken Bruce - Bank of America Merrill Lynch

Are you seeing or are you looking at the probability behind borrowers actually just rolling into adjustable rates and what the impact is on yield if they do? Is that a yield neutral situation for you? How do you kind of look at that potential?

Fred Boos

It would be net decline in yield on existing hybrids that approach reset to the tail. Probably to the tune of 150 basis points, if you look at current coupons on these $600 million and then having them reset to current base index levels, mostly LIBOR, most of our ARMs are indexed to one-year LIBOR. Which has actually been coming down a bit in a couple of CMTs. So a drop of about 100 to 150 basis points, if they were to reset given today’s base levels.

Ken Bruce - Bank of America Merrill Lynch

Okay, would the spread in that case is 250 over one-year LIBOR?

Fred Boos

No, the 175 on average would be an approximation for the portfolio. We have to go back and look at exactly on 600, but I think that’s a fair approximation.

Michael Hough

Some of those are capped out too. They have a 226 structure. So they won't go down to the base.

Ken Bruce - Bank of America Merrill Lynch

So they'll roll off of, say, 5.5 and then just go directly in that case to 3.5 because they hit their low end cap?

Michael Hough

Correct.

Ken Bruce - Bank of America Merrill Lynch

And are you seeing that in 2005 vintage agency hybrids or are borrowers doing that?

Michael Hough

At a much higher percentage, they are holding on and staying in the mortgage a lot longer, now than what they did in 2005 simply because they are resetting down so significantly that it makes sense to stay with our current mortgage.

In the past in '03, '04,'05 we were seeing CPRs for the previous months to the reset of about 60 or 70 and that slowed down dramatically over the last six months.

Fred Boos

You can see that in the tail prices out in the market place right at 103.5, 104.5 levels and that’s reflective of the value of the IO/strip if you assume that payments are neutral in that tail in the value of that strip goes up.

Ken Bruce - Bank of America Merrill Lynch

Would that be part of the portfolio, you might consider selling in this type of an environment? Would you prefer to get rid of those assets that might roll over into [adjustment]

Michael Hough

We look at that bond by bond, but certainly there would be something and that is we would evaluate. There’s values in all the assets in some way, so we would definitely look at those as we would for the rest of the portfolio.

Operator

Thank you. There are no more questions at the present time. I'd like to turn the call back over to the speakers for any closing remarks.

Michael Hough

We have no closing remarks. Thank you all for being on the call and for your interest in Hatteras. Have a good day.

Operator

Thank you. That concludes today's teleconference. You may now disconnect your phone lines.

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Source: Hatteras Financial Corp. Q2 2010 Earnings Call Transcript
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