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Hatteras Financial Corp (NYSE:HTS)

Q4 2010 Earnings Call

February 16, 2011 10:00 am ET

Executives

Kenneth Steele - Chief Financial Officer, Principal Accounting Officer, Secretary and Treasurer

Benjamin Hough - President, Chief Operating Officer and Director

Mark Collinson - Partner

William Gibbs - Co-Chief Investment Officer and Executive Vice President

Michael Hough - Chairman and Chief Executive Officer

Analysts

Bose George - Keefe, Bruyette, & Woods, Inc.

Michael Taiano - Sandler O’Neill & Partners

Joel Houck

Jason Arnold - RBC Capital Markets, LLC

Daniel Furtado - Jefferies & Company, Inc.

James Ballan - Lazard Capital Markets LLC

Michael Widner - Stifel, Nicolaus & Co., Inc.

Matthew Howlett - Macquarie Research

Henry Coffey - Sterne Agee & Leach Inc.

Operator

Good day, and welcome to the Hatteras Q4 Earnings Conference Call and Webcast. [Operator Instructions] I would now like to turn the conference over to Mark Collinson. Mr. Collinson, the floor is yours, sir.

Mark Collinson

Thanks so much, operator. Good morning, everyone, and welcome to Hatteras' fourth quarter and year-end earnings conference call. With me today are the company's Chairman and Chief Executive Officer, Michael Hough; President and Chief Operating Officer, Ben Hough; Chief Financial Officer, Ken Steele; and Co-Chief Investment Officer, Bill Gibbs. Just 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 events and results can differ materially from these forward-looking statements. And in addition, the content of this conference call also contains time-sensitive information that's accurate only as of today, Wednesday, February 16, 2011. 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. Now over to CEO, Michael Hough.

Michael Hough

Okay, good morning, and thanks for your interest in Hatteras Financial. This morning, following some brief prepared remarks, our management team is here and available to answer any questions you may have regarding our operations for the fourth quarter or since then. I'd like to first say that we are pleased to have been able to deliver another very positive year of returns to our investors in 2010. Our goal has always been to deliver a non-correlated alternative to other asset classes as a way to mitigate volatility and enhance the overall return in your portfolios. And again this year, we've done that.

While it was a nice recovery off of the bottom of the equity markets last year, 16.63% ROE in 2010 combined with 19.91% in '09 and 16.98% in '08 earned and distributed, is a good addition to any portfolio. If we can achieve these returns in the low risk-adjusted way we do then we feel the value we create is even greater. Ken and Ben will go over the fourth quarter shortly, but I'd like to highlight a couple of things first.

It's nice to be working in a high net interest margin environment for sure, and the fourth quarter reflects that even though the EPS did not reflect Hatteras' full earning potential. You should remember that the company grew by about 25% through accretive equity sales in the third quarter and noted that we would be thoughtful and deliberate in investing the proceeds, which we were. At that time, deals were lower, premiums were high and we wanted to be selective in our investing and hedging.

We operated with average leverage for the quarter below what our target number was. I wouldn't consider Hatteras fully invested and settled until the end of December, just as we said would be the case. Along with that though, we got the bonds on the books we wanted and the prices we wanted them and swapped against them at very attractive levels, a very good transaction that improved the long-term position of the balance sheet.

We completed another accretive transaction of a proportionately similar size in early January with the same goal of enhancing the long-term performance of Hatteras. This time, however, premiums were lower and we invested into proceeds more quickly. We should basically have those proceeds fully invested and settled by the end of next week, again, a positive for the long-term position of the company.

Because we've been so active in the market, I'd like to briefly emphasize how and why we structure Hatteras in such a straightforward and transparent way. First, I think the most important aspect of our strategy is that we take a long-term approach to managing risks. We try to minimize the risks inherent in this business. These risks include interest rate and liquidity risk, repayment risk, credit risk, event risk and government risk. We are very aware the changing markets can bring different risks to the forefront, so if we do things like owning top rate collateral to minimize credit risk, low-dollar price MBS to minimize prepayment and government risk, high relative liquidity to minimize event tail risk, we can focus on the risk that is the most manageable, interest rate risk.

As a whole, the careers and expertise of this management team has been in managing interest risk for financial institutions and is why we focus the risks of Hatteras there. We designed our strategy at Hatteras based on our experience managing a privately-held agency REIT for over 12 years through two complete interest rate cycles. And before that, at various bank portfolios through multiple interest rate cycles. It's been a pretty good while since we would consider it tough going for this type of strategy and not really since Hatteras has been in business. It's been a one-way ticket so far.

So I'd like to highlight just a couple of things we've learned over time. One, that we want Hatteras to perform consistently well throughout an entire cycle, not a quarter here or there or even if it means sacrificing some short-term gain. For example, we have no problem delaying settlement on a bond like we did in the third quarter if it means we've mitigated some future amortization risk and put us in a more defensive position in the future. Focusing on the long term, we'll equate the higher long-term risk adjusted returns to our shareholders.

Two, we want to construct a portfolio that we are confident in our understanding of how it will perform over time. Predictability is our friend. If we create a balance sheet that we can accurately model in different scenarios, it will translate into more consistency in the future.

Three, we have learned that our assets and liabilities will be better matched over time if they both are on the short end of the yield curve. Hatteras operates on the five-year and end part of the curve. We know that in mortgage-backed securities, we need to hedge the extension of duration, not current duration because you only need to hedge when rates rise. So you may see us putting longer dated swaps on versus shorter current duration bonds. And we've learned that liquidity is our top priority and must be maintained throughout the cycle. Purchasing and funding bonds requires cash as do swaps, caps, other derivatives and other assets. Understanding how liquidity will be impacted on these line items as conditions change is paramount and why we remain so focused on our asset liability mix. We've experienced much, good and bad, as we've been in the business over the years, and the lessons learned are invaluable. Our strategy has been called plain vanilla, it may appear passive, but the reality is we're running an active-defensive strategy today, just as we will tomorrow and in the future.

So in conclusion here, Hatteras delivered another great year of returns in 2010 to the shareholders, and we continue to see opportunities that will help improve the balance sheet appropriately for our long-term approach to the interest rate cycle. And one thing, finally, on the recent white paper on how they finance reform. It's obviously early in the game, and it will probably take years before real structural changes in how the finance market could be implemented, but we're reassured that treasury has recommended that the government stand behind the guarantees issued now and in the future, and are taking a thoughtful and non-disruptive approach to the issue. Improvements to the system are needed, and we intend for Hatteras to be a part of the fix.

And with that I'll give the call over to Ken now to expand on the fourth quarter.

Kenneth Steele

Thanks, Michael. Good morning, everyone, and thanks again for joining us on the call. We are pleased to report another strong quarter and year to you today. Throughout the year, our main driver on earnings was the timing of investment. In addition to the planned investing from our September offering, we continue to invest cash flow as refis seem to peak in the fourth quarter of 2010. While we were settling on new security purchases throughout the quarter, most of those settled in November and December, thus never really being fully levered until year end.

Our net income for the fourth quarter of 2010 was $45.6 million or $0.99 per weighted average share compared to $43.2 million or $1.12 per weighted average share for the third quarter of the year. Our average share count was significantly higher in the fourth quarter due to the September common stock issuance. Our net interest income increased to $43.2 million in the fourth quarter from $40 million in the third quarter as we brought more earning assets on the books.

While our average earning assets for the fourth quarter was $8 billion, we ended the year with around $9.6 billion settled. So you can see where in the calendar the bulk of those additions occurred. In addition to many of our purchases being done forward similar to the third quarter, we moved a few positions from the portfolio. And this also added some lag in reaching our targeted investment level.

At December 31, 2010, our portfolio of aged[ph] CMBS had an average dollar price of $102.13 and an estimated weighted average coupon of 3.87%. The yield for the fourth quarter was 3.39%. Amortization expense rose to $11.6 million, up from $9.7 million over the third quarter of 2010. And our repayment rate for the fourth quarter was approximately 31% on an annualized basis.

Our cost of funds dropped meaningfully 18 basis points lower in the fourth quarter than the third to 1.35% as we added new lower-cost swaps and replaced runoff. This led to an interest rate spread of 204 basis points, falling 13 basis points from the third quarter.

We also realized $5.8 million in capital gains on the sales of approximately $222 million of our MBS. Our G&A expenses were right on average at $3.4 million, of falling to an annualized rate of 113 basis points on average equity for the quarter as our capital position increased. This significant drop in our expense load is one of the many benefits of our September equity raise.

Our book value remained in a tight range all year and declined modestly in the fourth quarter, 3.75% to 24.84% on December 31. This was a combination of several things including of course the movement on marks on ARMs and swaps books.

For an FYI, here's how we price the portfolio at period end. We use five pricing services and throw out the high and low on each bond and average the three. While this may not accurately reflect the market every time, it does give consistency and a method of pricing of securities that are each individual and unique, and it does reflect the bid side of the market. As for December 31, the pricings came in less consistent than usual; not sure why but they indicated that the volatility on the 30th and the 31st in the treasury market was tough to get right in ARMs. The treasury rally on the 31st, for example, a loan represented a hit of $0.40 per share to our NAV on swaps books, yet it wasn't that obvious that it was reflected in our asset prices. Who knows why that happened, but our NAV is higher today.

Our leverage rose to a debt-to-equity ratio at quarter end of 7.6:1 compared to 5.6:1 of September 30. Keep in mind at September 30, we were cash heavy following the deal, and that the December change in book value also contributed slightly to this increase. We invested deal proceeds to the roughly low 70s range as we intended, but we ramped up slightly in anticipation of cash flow, driving leverage towards the high end of our current target range at December 31.

In summary, we were pleased with our performance for the quarter and all of 2010 as our fundamentals remain strong. We declared dividends of $4.40 for the full year, taking advantage of some of our prior retained earnings to offset some of the timing lags we experienced during the year as we invested diligently. If you had bought our stock on December 31, 2009, you would've enjoyed a dividend yield of approximately 15.7% for 2010 as we generated return on average equity of 16.6%.

I'll now turn the call over to Ben for the details regarding the portfolio and our investment progress.

Benjamin Hough

Thanks, Ken. Good morning, everybody. First, I'd like to give a little color on some of the main drivers of the portfolio performance for the fourth quarter and putting the proceeds to work from our September stock offering. Then, I'll give some color on the first quarter of this year and what we've done since our most recent offering in early January.

As we've already pointed out, on a settlement date basis, investing the proceeds from September deal was completed by late December. So on our last earnings call in October, we laid out the settlement schedule at that point in time, and the final settlements came out like this: We had about $600 million that settled in October, about $742 million in November and $1.6 billion in December. So timing of earning interest spread on these was heavily weighted to the back end of the quarter. These ARMs were a mix of a mostly new production of five ones and seven ones.

Also in the quarter, we selectively sold a few assets. Given the volatility and interest rates and the prepayment expectations, we continued to identify certain pools that it made economic sense to sell given their prepayment characteristics and current market prices. These bonds were bid at high-dollar prices that we didn't believe sustainable given our elevated prepayment expectations, so we chose to swap them into securities with less prepayment risk over the long term.

One thing we saw on the quarter was that when rates moved higher and the curve steepened, demand for hybrid ARMs picked up and spreads tightened, especially for five ones. Some of the usual agency MBS investors like banks and money managers immediately shifted focus to shorter duration hybrid ARMs to protect asset values. So while we did experience lower valuations on some of our securities, spreads tightened and the relative price movement was more moderate than for the longer end of the curve.

On the hedging side, we again focused on longer duration interest rate swaps. Prior to the end of September, we had already executed some of our swaps against new asset purchases from the equity offering then, and thus, they were already reflected in our third quarter numbers. But over the fourth quarter, we added an additional $400 million pay fix swaps at an average rate of 106 and 47 months to maturity. So at year end, our swaps book totaled $4.4 billion, with an average rate of 215 and a maturity of 34 months.

In mid-September, prior to the third quarter equity raise, our swaps book had an average rate of 238 and a term of about 31 months. So at year end, via that raise, we were able to decrease the average rate by 23 basis points and extend the term by three months. The hedge ratio of swaps to repo at year end was 51%.

Now as far as prepayments are concerned, they were elevated somewhat but within our expected range throughout the quarter. The average annual percentage rate of about 31% reflected the very low mortgage rates we saw in October and November. The 31% annual payment rate translates into a CPR of about $0.20 [ph]. And for a look into the current quarter, January's prepayments dropped slightly to around 29%, and the larger decline we've been expecting materialized in our February prepayment numbers at a percentage rate of 21.7% or about 19 CPR. Going forward, we expect prepayments to remain on the low side, best [ph] mortgage rates stay where they are now or go higher. Those were the key takeaways from portfolio activity in Q4.

So now, to update investment activity in 2011 up to today, our focus in January was deploying the proceeds from our more recent equity offering and staying ahead of monthly cash flow. Even with the increase in rates, we were still able to add over 200 basis points of net interest margin, buying hybrid ARMs hedged 50% with longer dated swaps. So on the asset side, with that move up in rates, which is really the first significant move higher in rates we've seen in almost two years, we were able to find more attractive absolute dollar prices for agency ARMs. So we again bought newer production ARMs but settled them more quickly. So overall, we were able to get invested sooner than we did in the fourth quarter. As it stands now, we had about $1.7 billion ARMs that settled in late January, and about $825 million is expected to settle later this month. Again, this is a blend of mostly new issued five ones and seven ones.

As for hedging, since year end, we've added $800 million swaps at an average pay fixed rate of 155 for 44 months. This brings our total swaps book on January 31 to $5.1 billion with an average rate of 203 and an average of 36 months to maturity. This is about the same hedge percentage as at year end. When we replace the higher cost swaps we have maturing over the next couple of quarters, we expect our average swaps duration to keep trending longer.

And a quick comment on the repo market. Liquidity continues to be good, and we've added a few new counterparties. And a few haircuts have even moved lower. We did have some year-end pressure on repo rates of about five basis points or so, but they came right back down to the 28 basis point range. Since then, the repo curve has gotten flatter, with 90- to 180-day rates moving lower. We think there could be some pressure on 30-day rates to move a little lower in the near term.

With that, I'll turn it back over to Michael.

Michael Hough

That concludes our prepared remarks, and we are available for questions.

Question-and-Answer Session

Operator

[Operator Instructions] The first question we have comes from Bose George of KBW.

Bose George - Keefe, Bruyette, & Woods, Inc.

I just wanted to follow up on the comment Ken had made about book value, actually the comment you said about the swap move at the end of the quarter, did you say that book values were up since quarter end?

Kenneth Steele

Yes, we did. There's a lot of components, Bose, that go into that, but they don't always move together. Different things affect it may run through the income statement as well. So that was one just example of how right there at the end of the quarter that seemed to move pretty sharply on that side but not so much that we could tell in the assets. But yes, we're up a little bit since quarter end.

Bose George - Keefe, Bruyette, & Woods, Inc.

Just switching to another subject. You've seen a number of mortgage REITs that traditionally invest in ARMs, invest in the 15-year fixed rate product, just curious what you guys -- your thoughts on that product?

Michael Hough

This is Michael. We've always focused on the short part of the curve and look for assets that were predictable and that we felt comfortable that we could hedge appropriately through a cycle. And we're always evaluating all the options available to us in agency land, and we look at everything. And as to date we've remained in ARMs, but we'll never shut the door long term to other options.

Bose George - Keefe, Bruyette, & Woods, Inc.

But at the moment, you'd say the predictability of what your product is preferable to you guys?

Michael Hough

Yes. I mean there's various reasons I outlined them just very briefly in the introduction. It's something that's important to us that our hedges hedge the extension risk in our assets and for us to be comfortable that durations are going to perform hand-in-hand between the assets and liabilities. Then, that's what we're looking for. And if we see that as an opportunity in 15-year fix, we may take advantage of the opportunity. But right now, to date, we have not.

Operator

The next question we have comes from Jason Arnold of RBC Capital Markets.

Jason Arnold - RBC Capital Markets, LLC

I guess I was curious on the prepayment side, assuming rates stay here, how much downside to prepay speed did you guys expect from the 19% CPR level you guys were citing from February.

Kenneth Steele

I think we could probably expect to see right around this level continue throughout. It really -- the big drop off in our prepays occurred on our newer production papers, a three-month to 18-month in seasoning. We would expect that to continue. Most of that paper is very interest rate sensitive in terms of refi capability. And we're very good borrowers and as rates drop then we're going to take advantage of it. That's about 75% of our portfolio right now. So we would expect to probably see somewhere in this range going, at least for the foreseeable future, as long as interest rates stay where they are.

Jason Arnold - RBC Capital Markets, LLC

You guys have about a quarter of your swap book rolling off on the under 12 month category; is that spread pretty evenly across the year? Are there any lumpy spots?

Michael Hough

Well, Jason, yes, it's pretty even. It's weighted a little bit to this quarter a little bit. But it's pretty even and it's probably around a 320-ish kind of rate on average across the whole year.

Jason Arnold - RBC Capital Markets, LLC

The average pay fixed rate for the whole year is 336 on the maturities. It's pretty high, so it seems like there should be some nice benefits to average borrowing costs as those come off. I guess it sounds like the replacements you were mentioning earlier that you're targeting have longer tenures. Is it safe to assume you'll target three to four-year tenure swaps or maybe you can offer some more thoughts there?

Michael Hough

Well, I think that that's where we've been, it doesn't necessarily mean that's where we'll stay. But we're going to match the cash flows and as the duration and extension risk changes on the types of assets we're buying and the types of assets we currently hold, we'll make that determination. But I mean, it's pretty safe to say that that's the range we've been in, and at the moment that seems to be the spot.

Operator

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

Henry Coffey - Sterne Agee & Leach Inc.

We're trying to figure out what the sort of accretive, dilutive impact of your last two equity offerings has been on earnings. If we would've focused just on 12/31 when you had all the issuance invested from the first deal, can you give us a sense about where your reported earnings per share would have stood relative to what you reported? And maybe you could give us a sense of what the impact of the new issuance would be on that same figure?

Kenneth Steele

I guess, this is always a little sketchy to -- it gets about as forward-looking as you can get. But I think, given all the different things that can go into that run rate, we would have probably been close to $1.10. A lot just still depends on prepayments, which as you know, last year were hard to predict at times so...

Henry Coffey - Sterne Agee & Leach Inc.

Yes, I just mean if we just sort of froze things at 12/31.

Kenneth Steele

No, I think that's a pretty good area.

Henry Coffey - Sterne Agee & Leach Inc.

And then the impact of the more recent issuance on that dollar, we'll call it close to $1.10. What would the impact of the second issuance have been on the same figure?

Kenneth Steele

We're pretty much putting on same, similar spreads. So I don't think it's going to impact it significantly one way or the other. I think that's, as we've done these deals we're kind of their beneficial in a lot of different ways. But from a spread, basically somewhat portfolio neutral to slightly accretive. But you know, that's a good ballpark.

Henry Coffey - Sterne Agee & Leach Inc.

The question I got a lot yesterday about other mortgage REITs, given Annaly's recent offering, is why not leverage? Is there something about the market that's concerning the industry? Or is there a dynamic that we're missing? I guess, it would be natural to assume you would simply add leverage in here rather than issue additional shares?

Michael Hough

Henry, I mean, that's something obviously that we're looking at here. The reason that we took the approach on the last two capital raises that we did was because we really feel comfortable with the risk profile that we're carrying today. We told you that in the past and on the last call, and we think being hedged at about 50% at this leverage ratio gives us a ton of flexibility. We were able to invest the proceeds of the two deals to a similar percentage type of profile and it really improved the long-term nature of the balance sheet. That's what we wanted to do. We didn't -- from our standpoint, it's not as much about adding bonds as it is about the accretion that we get from these capital raises. And going forward, if you think about it, we have [indiscernible] we have a lot of drop out on the swap side and on the asset side. So we have a lot of flexibility.

Operator

The next question we have comes from Mike Widner of Stifel, Nicolaus.

Michael Widner - Stifel, Nicolaus & Co., Inc.

I guess I was just wondering, if you could -- I mean you've talked a little bit about it, but I wonder if you might elaborate a little bit more. So for the prepayments that we did see, I mean, was there a distinct concentration in sort of by vintage and coupon? And can you just talk a little bit about that?

Kenneth Steele

Yes, Mike. It was definitely concentrated in the newer issue paper. I would say late 2009, or throughout 2010. Once again, it was coupons in the 3.25 to probably 3.75 range, the borrowers that were very capable of refi-ing, very interest rate sensitive type borrowers. As far as the older vintage paper, the '06, '07, the bulk of that was I/O [ph] paper that we had that was very well behaved throughout this process. What we're seeing now is with the increase in the interest rates, it's kind of flipped a little bit. The newer production paper's definitely slowing down as you would expect, because it's more interest rate sensitive. We're starting to see a bit of a pickup in 2006, 2007 and '08 I/O [ph] paper. Freddie Mac now gives you a breakdown of what's delinquency, and what's 120-, 90-, 60-day behind on payment. And some of it's attributable to delinquencies being pulled from the pools, but the bulk of it doesn't seem to be delinquency. It seems to be there's some type of refi activity going under the Hamper Heart Program [ph] and in particular with certain issuers in particular. They seem to be very aggressive in trying to refi some of these '06, '07, '08 vintage items.

Michael Widner - Stifel, Nicolaus & Co., Inc.

And then maybe, you guys again talked a little bit about leverage so far. Certainly, a bit higher at the end of the quarter partly due to the -- you indicated the drop in book value. Just wondering if you could talk a little bit about sort of what you're expecting -- what you guys are thinking for a normal level and appropriate level of leverage given what we're seeing in the environment today, all things equal kind of running forward?

Michael Hough

Yes, we said we wanted to be in the seven to low-sevens comps debt. And that is basically where we are. I would say at the end of the quarter at 7.6, that would be toward the higher end of where we want to be right now. We want to have dry powder and we want to have liquidity right now. But we've had cash flow from prepayments and we've had cash flow from raising capital. And we're trying to stay ahead of that the best we can. So that's really been our driver, but I think in the low 7s is a good target for us in the way we look at our risks.

Michael Widner - Stifel, Nicolaus & Co., Inc.

You guys have also talked about this a little bit. But you indicated that you expected to have all the proceeds put to work sort of by later this month. Could you just talk a little bit more about what you've been buying and kind of dollar prices and expected yields on that stuff?

Michael Hough

Most of it has been new production five ones and seven ones. So last quarter and this quarter has probably been around, I think, it's safe to say around 3.25 of type coupon. And the prices last quarter were in the high 102s and then this quarter with the raise we did in January, the prices come down some on that. So the coupon's been similar, but the price has been in the low- to mid-102s, and we've been able to settle it sooner. So it's been much more attractive this quarter than last.

Operator

The next question we have comes from Jim Ballan [Lazard Capital Markets].

James Ballan - Lazard Capital Markets LLC

Michael, you talk about wanting to have the dry powder and keep the leverage similar to where you are today. How do you balance that with the slope of the yield curve and sort of the net interest spread opportunity that we're seeing right now that seems to be pretty wide relative to sort of where historical numbers have been at. How do you balance those two things?

Michael Hough

Well, I mean, it's like we've always said that it's an entire balance sheet that we're looking at. It is a very good earning environment for us. We are earning a lot of money with the leverage that we're using now. There has been uncertainties really since the start of 2009 when we took leverage down from an 8.5-plus number to six to seven to where we are now. We've gradually increased our leverage over time, and that's primarily because we have seen a lot of unknowns come into the market, specifically from the government side. And we wanted to be defensive against anything unusual or unanticipated that might come with that. I think right now, it's a great place to be. And we're generating relatively consistent earnings, and we want to continue to be able to do that. And by doing that, we have a lot of flexibility here. The haircuts have started trending lower a little bit, which is always good from a liquidity standpoint. And if they continue to trend down, that could possibly be a driver for slightly higher leverage. But right now, we feel like we're in a very good place, and we're set up to generate a pretty consistent return.

James Ballan - Lazard Capital Markets LLC

The other thing that I wanted to ask was, this is, I guess the second quarter in a row where we've seen you guys sell some assets and really the first time you've done that in the time that Hatteras has been around. Maybe you could give me a little color on your thought process about continuing to take gains, especially given the expectation of the CPRs coming down in the coming months. Just maybe what your thought process about maybe not having any more sales going forward?

Michael Hough

I don't know what exactly is going to happen going forward. Selling securities is not part of our strategy or our model. It really doesn't have anything to do with it. However, we saw some situations, especially as prepayments were accelerating here when interest rates came down so low at the end of the third quarter and beginning of the fourth quarter that it made sense for us to get out of the way of some of the paper that was most exposed to those prepayments. I can let Bill tell you what kind of we were looking at.

William Gibbs

Yes, and in spite of the fact that we're starting to see prepays pick up, we were till seeing what we thought were very aggressive pricing and bids. So we ended up looking at the portfolio and some of the paper that we looked to unload had characteristics we thought were going to be more inclined to give us a much higher prepay. Some of those characteristics would be all the paper that was amortizing and selling IOs at that point. In addition to that, we were looking at the high third-party originators. High third-party origination really has been extremely fast. And that's the type of paper we were looking to unload.

Operator

The next question we have comes from Joel Houck of Wells Fargo.

Joel Houck

Just wondering if you can talk about -- did you guys to see much volatility last week given the treasury report? I think the headlines were worse than the report. But maybe some color on what you saw in terms of pricing of your assets. And then I guess a related question is when you talk in your press release about expecting to see volatility going forward, how do you think about leverage in that sense? Would you pull it down in anticipation of more volatility? Are you comfortable in the low 7s regardless of where prices might go?

Michael Hough

Well, the first part of the question. It was not a tremendous amount of volatility. It was, in the white paper it was released and leading up to that, I think it was the same. It was a fairly non-event. It was kind of what it was expected. It wasn't specific enough to cause any real concern in any of the fears that the market or us may have had, that something was going to be in a more Draconian, that was alleviated. So that really did not draw volatility going forward. This is going to be a political football I think, and there is going to be a lot of a jawboning on both sides throughout this whole process. And I'm sure we're going to hear some scenarios we might not like and the market might not like. So we have to expect there could be some volatility. I think we're in a great place from a liquidity standpoint and from a leverage standpoint, to handle volatility in the markets. And I think it's important to us to remain diligent on the issue, but I don't think it changes the way we set things up today.

Operator

The next question comes from Daniel Furtado of Jefferies.

Daniel Furtado - Jefferies & Company, Inc.

Just one quick one. Noticing that the weighted average month to reset on the portfolio expanded again to I think you're at 53 months now at the end of the year. And I appreciate that that's largely a function of recent capital raises than new production purchases. But can you help me understand kind of what you're seeing in the market, because it seems that most participants are viewing a slowing prepay environment and a rising extension rate environment, thus kind of going shorter on the duration side. But the expanding months to reset seems to go counter to that. Am I just reading into this too deeply? Are you guys seeing something or approaching the market slightly different than kind of the rest of the herd?

Michael Hough

You're right, the months to reset have moved out primarily because of the new capital raises and what we have been putting on the books. This goes I guess to the heart of why we're selecting ARMs. If you take a look at where we're looking at the durations in today's environment, when you say for example, five one ARMs with approximately a 3.25 coupon, the duration on that, depending on whose model you're looking at, is coming in somewhere in the neighborhood of around 3.25. So even in a 100, 200 or 300 environment, the amount of extension risk you're going to get on that duration is not that great. I mean, at the most you could see that moving out maybe to close to four to 4.25. What we've done to mitigate this, as Ben mentioned earlier, is we've been going further and further out on our swap book. So we're putting on swaps in the neighborhood of 3.5 to four years to basically help curtail any kind of duration risk and income risk we would have off of buying those longer presets.

Michael Hough

It is part of the business. We are operating still on the short part of the yield curve. And having some duration is important to us because like Bill said, we can hedge it more aggressively and predictably and hedge the extension risk on this stuff. And 53 months to reset while it's longer than what our portfolio how it was seasoning before, this is going to walk down the curve pretty quickly. And durations are going to shorten on this. And if we put a four-year, a 48-month swap against this, then that is going to walk down the curve simultaneously and also hedge against the potential extension risk that we're going to get when rates go up. So it is -- duration is good and some duration is good. We just can't go on the part of the curve that we feel like we can't predict the extension risk of the securities.

Operator

And the next question we have comes from Matthew Howlett of Macquarie.

Matthew Howlett - Macquarie Research

Just on the -- did you give the purchase yields on the new you said mainly five months you're putting on this quarter and the sort of long-term speeds estimates of those?

Michael Hough

What was it about, 3.25?

Benjamin Hough

Yes, around 3.25 coupons and 1.02, 3/8, 102.5 range.

Matthew Howlett - Macquarie Research

Is that yielding like, 2.5?

Kenneth Steele

The yield is going to be closer to 290 on that paper. We're using very low prepayment speeds because that's what we're expecting. I would say use somewhere between a five and a 10 CPR on the new paper that's going on.

Matthew Howlett - Macquarie Research

Okay, up until reset. And then you guys have always been on new issuance and new paper and those speeds should come down on those with higher rates. But there's been talk on maybe expanding or increasing HARP [ph] lately, with particularly I think the MBA came out with some recommendations. Would that have any impact on your legacy portfolio if they were to take HARP and say from mid '09 and go to I think October 2010 and maybe lift some caps on those?

Benjamin Hough

That could have an impact. Like I mentioned earlier we're starting to see that. We've seen it since maybe September, October, really with certain originators or servicers that really been aggressive in refi-ing that kind of paper. And you're correct, it would mainly affect our 2007, 2008, 2006 vintages, which with the latest capital raises and purchases has really lowered I think our percentage of our overall portfolio is around 20% of that paper right now.

Matthew Howlett - Macquarie Research

Okay so it's down, post those deployments can be down 20%?

Benjamin Hough

Okay.

Matthew Howlett - Macquarie Research

And then just the last question on supply demand, economics in the ARMs space. Are you seeing supply pick up? Is the bank appetite just -- do you think that will just overwhelm that and spreads will remain tight? Or do you see possibly some widening with supply?

Kenneth Steele

The bank demand has been fairly strong and I think as Michael mentioned, a lot of people are starting to move especially into the five-one sector to get some protection against potential duration risk. We've been averaging somewhere in the neighborhood of around $7 billion to $8 billion a month. I believe in January, it was close to $9 million. A lot of that was refi activity from back in October, November. With the increase in rates, we would probably expect to see overall mortgage production, agency production decline from, I guess, about $1.4 trillion, down maybe into the $1.2 trillion range. But with the steepness in the curve, we would expect to see a greater portion of that origination being in the form of ARMs.

Operator

The next question we have comes from Mike Taiano of Sandler O'Neill.

Michael Taiano - Sandler O’Neill & Partners

You said that yields were in sort of the 2.9% on new purchases. So in order to get a spread north of 200, does that imply you're all in funding costs are less than 90 basis points with the swaps at 50%?

Kenneth Steele

That would've been purchases that we put on the books from the previous deals, last two deals. For new additions that we add to the books, if we look to settle this two months forward, I think you're going to find the yields are going to be closer if we use a blend of five-ones and seven-ones to 320. So if you still take a look at a 50% hedge ratio of four-year swaps, as well as current 30-day funding rate of 28 basis points. We're still looking north of 200 basis points in new additions to the portfolio.

Michael Hough

And yes, looking back to the bonds that we recently purchased that we mentioned, we were putting on, on average cost of bonds of 90 basis points or less. So, yes, there was 200-plus basis points there.

Michael Taiano - Sandler O’Neill & Partners

And then just a follow-up on an earlier question with respect to the capital raising that we've seen across your industry lately. Is there any reason to think that that won't continue just because, assuming that spreads stay wide and obviously it seems like there is an increased demand for yield given the low rate environment and a lot of financial stocks that cut their dividend, it just seems like greater demand, and why not just raise capital and keep leverage low?

Michael Hough

I'm not going to -- I don't know if you're asking for the whole industry, I can't speak for anyone else. But, yes, there is a lot of demand, and it is something that obviously some of the participants are taking advantage of very aggressively. And it is something that we will always have to look at, and it's going to be a trade-off between the accretion that we get from a deal and how it impacts both the long-term portfolio that we have. And that's what's going to determine our capital raising going forward.

Operator

The next question we have is a follow-up from Bose George of KBW.

Bose George - Keefe, Bruyette, & Woods, Inc.

Just a quick follow up on the comment Ken had made about the $1.10 as kind of the whatever run rate at December 31; that excludes the asset gains, right? Is that correct?

Kenneth Steele

Yes. That's just -- I probably shouldn't have thrown that out, but I mean that's just kind of a real straightforward pro forma kind of run rate based on these 200 basis points.

Bose George - Keefe, Bruyette, & Woods, Inc.

Yes. I just wanted to confirm that.

Operator

I'm showing that we have no further questions at this time, we will go ahead and conclude our question-and-answer session. I would now like to turn the conference back over to Mr. Hough and management for any closing remarks.

Michael Hough

Thank you. We sure do appreciate everyone taking the time to be on the call, and we look forward to talking to you again next quarter.

Operator

And we thank you gentlemen for your time. The conference is now concluded. We thank you all for attending today's presentation. At this time, you may disconnect your lines. Take care.

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