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Hatteras Financial Corp (NYSE:HTS)

Q3 2011 Earnings Call

October 26, 2011 11:00 am ET

Executives

Michael R. Hough - Chairman and Chief Executive Officer

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

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

Benjamin M. Hough - President, Chief Operating Officer and Director

Mark S. Collinson - Partner

Frederick J. Boos - Co-Chief Investment Officer and Executive Vice President

Analysts

Steven C. Delaney - JMP Securities LLC, Research Division

Michael Taiano - Sandler O’Neill & Partners

Stephen Laws - Deutsche Bank AG, Research Division

Daniel Furtado - Jefferies & Company, Inc., Research Division

Joel Houck - Wells Fargo Securities, LLC, Research Division

Michael R. Widner - Stifel, Nicolaus & Co., Inc., Research Division

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

Boris Pialloux - National Securities

Matthew Howlett - Macquarie Research

Jason Arnold - RBC Capital Markets, LLC, Research Division

Operator

Good morning, and welcome to the Hatteras Financial Q3 2011 Earnings Conference Call. [Operator Instructions] Please also note, this event is being recorded. I would now like to turn the conference over to Mark Collinson. Please go ahead, sir.

Mark S. Collinson

Thank you, Morgan. Good morning everyone, and welcome to Hatteras' Third Quarter Earnings Conference Call. With me today as usual are the company's Chairman and Chief Executive Officer, Michael Hough; the company's President and Chief Operating Officer, Ben Hough; and the company's Chief Financial Officer, Ken Steele. Also available to answer your questions are the company's Co-Chief Investment Officers, Bill Gibbs and Fred Boos.

Before I hand the call over to them, I need to briefly remind you all 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 those forward-looking statements. The content of this conference call also contains time-sensitive information that is accurate only as of today, October 26, 2011, and the company undertakes no obligations to make any revisions to these statements or to update these statements to reflect events and circumstances occurring after this conference call.

So that's all for me. Thank you very much. And now here is Michael Hough.

Michael R. Hough

Good morning, and welcome to our third quarter call. As always, we have the entire management team here to answer any and all questions you may have following some brief prepared remarks. But first, I'd like to introduce a new member of our team, John Dalena. We're excited to have John on board as Chief Strategist and his experience are going to be instrumental in the growth of the development of our company long-term.

So what I'd like to do today is quickly address a few of the headlines of what was a pretty volatile quarter and how we view them in relation to Hatteras. Where we typically say in one or two good market movers a quarter over the past couple of years, we were graced with a multiple about this time. So just to take a look at a few of them.

The first one was the turmoil around the U.S. debt back in early -- late July and early August. Through August, given the issues surrounding the debt ceiling cogs and the debt downgrade, we saw an opportunity to increase liquidity as a defensive measure by paring out of some prepay exposed paper and delaying the reinvesting until conditions somewhat stabilized. While this reduced our earnings power for the quarter a good bit, we felt an increased level of liquidity was prudent in preparation for the unknown. It was also a positive for the MBS portfolio.

Back end was an accelerated Fed accommodation. The Fed's announcement of its intention to keep interest rates at 0 until 2013 and Operation Twist certainly impacted our portfolio this quarter as the shift in the rate curve caused a moderate prepayment increase with lower yields on reinvestment. While trending higher in Q2, the experience with prepayments was consistent with our expectations that we have predicted over the past year. We do expect the fourth quarter is likely to be similar to the third this way because of the record low rates in August and September that will pass through to the MBS this quarter. We do expect them to slow after that as the recent backup into 10-year should reverse this trend, but it'll still be dependent on the direction of rates from here. Either way, the portfolio is well positioned for this quarter and for 2012.

Third being the euro crisis. As the crisis in Europe expanded this quarter, we were precautionary and managed our exposure to the EU banks back to just 7% of the overall portfolio. We continued to diversify our funding sources as well. We haven't really seen any issues in the repo market today even at the EU banks, with stable haircuts and consistent pricing being the norm. In sum though, we remain comfortable but wary as we head into year end. Since quarter end, we've been extending some of the repo book to January.

The fourth being the SEC's concept release regarding mortgage rates. There is a continuation of the ongoing Request for Information. We are working with Council, NAREIT and other trade groups on developing the proper response for us and others on the November 7 due date. This obviously has been something that investors have been concerned with and we understand.

While we're confident that Congress intended to exempt companies like Hatteras from the 1940 Act, we take their request very seriously and we'll do our best to help the SEC however possible. Companies like Hatteras are a valuable source of capital for the mortgage market and a good result will recognize this.

This didn’t really come in the third quarter, but Monday's announcement from FHFA on the expansion of the HARP Program came with a few surprises. We don't perceive too much of an impact from it here and don't think it will alter the mortgage landscape dramatically, but prepayments on '06 to '08 finished paper will increase to some degree. We don't have much of that paper at Hatteras, and you can see the table we added to the release that shows the breakdown that should help to quantify the exposure.

It's obvious that government intervention is something that MBS investors are going to have to contend with for a while, and as always, our focus on buying current down to coupon paper is how we deal with it.

And one last point on our complementary addition of 15-year fixed paper to our portfolio, we've been focused on ARMs for a reason and we'll continue to be, but as you see, we added some 15-year paper during the course of the quarter. As we mentioned on previous calls, we've been looking at them as an option for a while. The market action this quarter meant we wanted to add some additional maturation to the portfolio. And our ARM portfolio was shortening as we've planned, but looking out to 2013 and beyond, we see the need to have an exposure to something a little longer to allow us to better hedge for the long term. Don't expect this to be a major part of the portfolio though. We're just adding some term and stability to combine with our ARM portfolio. So with that, I'll hand this over to Ken to go over the results of the quarter.

Kenneth A. Steele

Thanks, Michael. Good morning, everyone and thanks again for joining us on the call today. As Michael mentioned, we are pleased to report another good quarter for Hatteras amidst what would appear to be somewhat turbulent times. Our net income for the third quarter of 2011 was $79 million or $1.04 per weighted average share, as compared to $77.5 million or $1.04 per weighted average share for the second quarter of the year. Our netted interest income was $70.1 million in the third quarter of 2011 as compared to $77.6 million in the second quarter. Our average MBS for the quarter was $16.2 billion, up from $15 billion in the second quarter and ending the quarter at $17.6 billion. We also sold approximately $678 million of securities during the quarter for a gain of $13.3 million.

At September 30, 2011, our portfolio of MBS had a weighted average cost basis of 102.39 and an estimated weighted average coupon of 3.56, a 5 basis point decrease in coupons from the June 30, 2011 portfolio rate of 3.61. The yield on our portfolio for the third quarter of 2011 was 2.72%, which was 31 basis points less than the second quarter rate of 3.03%. While the average coupon on our portfolio was fairly constant, amortization expense for the third quarter of 2011 rose to $30.1 million, up from $17.8 million in the second quarter of the year. This was reflected in our repayment rate as it rose from 19% on an annualized basis in the second quarter to 28% for the third quarter. Our cost of funds was essentially unchanged at 1.08%. While repo rates drifted slightly higher later in the quarter, we had some higher-rate long-term borrowings and swaps matured during the period. This led to an interest rate spread of 164 basis points for the third quarter of 2011, a decrease of 33 basis points from the second quarter of the year.

Our G&A expenses was $4.6 million, which was an annualized rate of 90 basis points on average equity for the quarter. Our average leverage for the quarter was 7.3:1 and 7.9:1 at September 30. Our book value on September 30 was $26.32 per share, dropping slightly from our June 30 number in response to the effect of the current flattening on our swaps book. Year-to-date, our book value is up $1.48.

In summary, despite the market volatility, our balance sheet and liquidity position remains strong, with a quarter-ending liquidity position of $1.2 billion or 7.1% of our MBS. Our performance on a financial basis was very consistent to each of our previous 4 quarters as we've generated an annualized return on average equity of 15.4% and paid $1 dividend. With that, I will now turn the call over to Ben for details regarding the portfolio and our investing.

Benjamin M. Hough

Thanks, Ken. I'd like to give just a little more detail on some of the numbers in the release, as well as some additional color around Michael's comments.

Overall, the 2 main drivers of performance for the quarter were lower average leverage and modestly higher prepayments. First, in regard to leverage, we started the quarter around 7.4x, but as market uncertainty picked up and rates fell in July and August, we decided to get out of certain paper that we thought would prepay faster, basically those bonds that we thought were going to yield as less than what we could replace them with. So for the month of August, average leverage probably was below 7x and then we gradually brought it up to 7.9x at the end of the quarter.

Of the securities we bought for the quarter, $273 million settled in July, $1.3 billion settled in August and $1.4 billion in September. $1.8 billion of those were hybrid ARMs and $1.1 billion were 15-year fixed, almost all new or recent production.

Now looking at prepayments, we did see some pickup in speeds across most [indiscernible] and coupons as we would expect with the curve shift like this. As we've noted in the past, ARM borrowers can be more interest rate-sensitive than fixed borrowers at times, and therefore, they tend to have higher average prepayment rates. However, the trade-off for shorter duration is one we like and is why we focused on premium management as part of this strategy to reduce that impact. For the quarter as a whole, prepayments were 28.3% annualized as a percentage of the MBS portfolio, well within our expected range. For an apples-to-apples comparison, that equated to a weighted average CPR of 21.7%. The monthly CPR breakdown was pretty consistent, with 21.7% in July, 20.5% in August and 23% in September. So while these are higher, they are only about 6 CPR higher than last quarter, and they are slower than what we had this time last year when the rates dropped by a similar amount. And for the first look at Q4, the annual prepayment percentage rate in October was 27.7%, which is a CPR of 21, so a little lower than last month.

Now regarding our 15-year fixed purchases during the quarter, like Michael said, with the additional Fed transparency, it was a great opportunity for us to add duration to the asset side of the balance sheet by buying MBS that fit well within our existing swaps book. Because the existing portfolio duration has shortened and will continue to, adding this paper was an opportunity to maintain a neutral interest rate risk profile and improve earning capacity at the same time. The duration and extension profiles of 15-year fixed are comparable to those of 7/1 ARMs and they offer some diversification.

We still prefer the long-term performance of ARMs throughout an interest rate cycle, but with the Fed's current stance, a modest allocation of 15-year fixed fits well within our portfolio. And lastly, on the liability side, repo liquidity is good, haircuts are stable, and our number of counter-parties continues to grow. Repo rates have drifted slightly higher recently from their Q2 lows and the high teens to the high 20s range, along with [indiscernible] LIBOR. We will likely see some additional pressure on repo rates as we go through year end. As for hedging, we ended the quarter at about 47% of our repo book hedged with a 36-month average maturity. We will look to replace swap run-off and for opportunities to improve the hedge book as the cycle revolves. With that, I'll turn it back over to Michael.

Michael R. Hough

Okay. Before questions, I just have one last philosophical point. As you've likely heard us say in the past, it's our straightforward approach to this business that what we know from experience will offer the greatest long-term value for our investors. This quarter, we had interest rates at the lowest level of our careers, and the stewards of monetary policy indicate a strong desire to keep them that way for the foreseeable future. Now that creates some tension for us as we have in place a duration matched balance sheet and a steady ongoing bias towards protecting investors during times of rising rates. We are not traders but mortgage real estate investors. We've always been willing to sacrifice some return for a consistently short duration portfolio, recognizing the primary risk to the mREIT model's rising rates. Our strategy is not going to change and we will keep it flexible enough to generate attractive risk-adjusted returns and be able to maneuver headline bill in volatile environments like we recently had. A long-term approach is necessary to where the ultimate value in this investment lies.

So now we'd like to open this up to any questions you may have.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Bose George of KBW.

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

I had a couple of questions. First, can you just talk about where incremental spreads are and specifically just on the 15-year stuff versus the hybrid ARMs?

Kenneth A. Steele

Sure, Bose. If you take a look at what we're seeing today, if you did a blend -- and I'll break it out afterward into 15 years. If you do a blend of primarily ARMs with some 15-year, we're looking at yields of about 270. After we hedge that out, you're still looking at around 200 basis points in net interest spread. As far as 15 years are concerned, we're picking up around 15 basis points over a comparable ARM, which would be about 7 more. So you are still [indiscernible] additional spread by looking at 15 years versus the ARMs.

Michael R. Hough

And Bose, just to clarify just a little bit that when we're talking incremental spread, we will be talking about putting new capital to work and with the new liability match.

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

Right. Okay, great, thanks. And then just any comments on asset prices over the last month since quarter end?

Kenneth A. Steele

Yes. The asset prices are relatively unchanged. They're down in the ARM sector probably around 0.25 point or so and a little bit more on the 15-year, but I think if you take a look on the liability side, it's pretty much offset by the swaps coming back.

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

Okay, great, thanks. And just one last thing, just wanted to explore the drag on your earnings from the asset sales. So your average balance looked like it was about $1.4 billion lower than your quarter end balance, so if I assume like a 175 basis point spread or something like that, I get about $0.08 light on the earnings from that. Does that seem reasonable, something in that ballpark?

Kenneth A. Steele

That sounds about right.

Operator

Our next question comes from Mike Taiano of Sandler O'Neill.

Michael Taiano - Sandler O’Neill & Partners

I guess, just wanted to confirm that the 15-year purchases, were those all TBAs?

Kenneth A. Steele

No, they weren't all TBAs, but they were -- if they weren't TBAs they were new production, maybe 1 month to 2 months' worth of seasonal, and we concentrated in the 3 to 3.5 coupons, primarily in the 3s.

Michael Taiano - Sandler O’Neill & Partners

Okay, great. And I guess just a follow-up on the spread question, just given where CPRs are right now, where do you think spreads could go here in the near term? I guess you were at 164 average for last quarter. I mean, can you see them dipping below like the 150 level over the next quarter or 2?

Kenneth A. Steele

Well, I think if you take a look at where the mortgage apps were, and then Michael I think touched on this a little bit in his opening remarks, we would expect to see -- we did see a drop in October from September on speeds, and if you look forward, we'll probably see a pickup in speeds or a peaking of speeds in November and potentially December, and then we would expect to see a drop-off based on, as once again as Michael mentioned, the increase in yields on the 10-year note. As far as how much of a hit that will be, I think probably you would assume somewhere near the third quarter would be fairly close to look at if we do get that to play out.

Michael R. Hough

Those rates kind of flattened around early August. August 9 I think was when the FOMC announced its decision to stay on hold or at least likely through mid-'13. That's where you saw the big decline and flattening of the curve and that's going to translate probably to a slight elevation in prepays in the November, December factor prints.

Michael Taiano - Sandler O’Neill & Partners

I got you. And you still expect to be somewhere in between the 20 and 30 level on the CPR?

Michael R. Hough

Yes.

Kenneth A. Steele

Yes.

Operator

Our next question comes from Steve Delaney of JMP Securities.

Steven C. Delaney - JMP Securities LLC, Research Division

Guys, I was wondering if you feel that the reduction in the GSE max loan limit from 729, 750 down to I guess 625, I think that expired in September. Did that have any impact in terms of high-loan balance ARMs, especially third-party originated? Could that have been a factor in sort of the pickup that you saw in July and August?

Kenneth A. Steele

Steve, I think it did have some impact but I don't think it was terribly significant. It would have -- as you're all aware, it definitely probably has more of an impact on ARMs than it would have on fixed. But -- yes, it's interesting. If you take a look at some of the newer production that started coming out in September and October, there was a lot of higher loan balance that I think some people guided under the wire on. So we would probably get some relief from that going forward, but I don't think it's going to be great.

Steven C. Delaney - JMP Securities LLC, Research Division

Weren't those large loans -- was there a cap as to how many could be in any individual pool like 10% or something?

Kenneth A. Steele

That is more on the fixed side. On the ARMs side, you have higher percentages of that.

Steven C. Delaney - JMP Securities LLC, Research Division

You had higher percentages, okay. So that mean that could be -- I'm not trying to look at everything through rose-colored glasses, but just trying to parse it out, because obviously we went from a very low-speed environment to a fast-speed environment and certainly we had lower rates. But I'm just trying to understand all the different pieces that were going on here over the last couple of months and importantly what does that mean going forward. The other thing is this. And I think runoff rate, you give runoff rate, which I think, and a couple of others do, some people just give a CPR, but it seems to me that economically it's all about the runoff rate when we're talking about amortization or premium. But it seemed to me, I had not noticed you were at, like, 29 on runoff versus, say, 22, I'm just rounding, so 7% higher runoff, and I guess we've got scheduled principal that's 1.5%, maybe 2%. That other -- the additional runoff, is that defaults? Is that CDR that's separate from the CPR? Help me try to understand the higher runoff versus CPR that might be an addition to scheduled principal?

Michael R. Hough

Well, I think, Steve, it is a combination of all those things, but those things do go in the CPR as well. I think it's more the effect of which CPR you're looking at and how you calculate it. I mean, I think there is certainly some confusion in the -- amongst some of the reporting that we look at because I think some people take CPRs or prepayment rates and back them into CPRs versus calculate an actual CPR. And we did add CPRs this time to try to make it comparable but we're not going to take the prepayment rate out. That doesn't completely answer your question but I think that the defaults are all considered in with prepayments. That's all...

Steven C. Delaney - JMP Securities LLC, Research Division

That's all part of your CPRs is what you're saying? That's already in there?

Michael R. Hough

That's correct.

Steven C. Delaney - JMP Securities LLC, Research Division

Okay. But am I hearing you can't say that from a standpoint of modeling and the actual percentage of premium that were expiring each quarter, that are you suggesting you do think that the runoff rate is the better percentage to work with?

Michael R. Hough

We think so because it's really -- and that's the main function of how we manage the portfolio, and it's all about the cash flow that we get back and where it comes from. So that's -- we think it's more useful and that's more of our internal guide that we want to give everybody the other number as well.

Steven C. Delaney - JMP Securities LLC, Research Division

Okay. I guess the last thing, I guess I'll throw this to you, Michael, obviously, on the existing book that resulted in a 164 spread, obviously we've got faster speeds and you've got some legacy swaps in there that tend to maybe push that down a little bit. So, I mean, on the margin here looking at 200 basis points, shouldn't we look at that and say "Well, it's to Hatteras' benefit to try to selectively grow the portfolio here" if you're putting on new assets at 200 versus the legacy book in the 160, 170 range?

Michael R. Hough

Well, I would say that's obvious by the way we've taken leverage up this quarter and the assets that we've put on, and on a going-forward basis, always it's going to -- we're going to look at that question from the portfolio's perspective, and today, if we do add securities or if we added capital it could be beneficial to the net interest spread.

Operator

And our next question comes from Stephen Laws of Deutsche Bank.

Stephen Laws - Deutsche Bank AG, Research Division

A lot of my questions on spread have been answered. Michael, can you maybe just touch on the revised HARP Program, what you think the broader market indications to be? I know it's a very minimal impact to Hatteras. And then whether or not you think it's going to have an impact that they hope it will, and if not, what you think the risk is of some other program being announced or something else that could drive prepayments coming out of Washington?

Michael R. Hough

As we mentioned, it really is not a big issue at Hatteras. I'm going to let Fred take the question on HARP in general.

Frederick J. Boos

Well, we've all reviewed HARP 2 and [Edward] DeMarco's comments. I think that the impact on the market on the whole, it's a very modest impact to Hatteras as Michael just said and we announced in our earnings release. From what we've read, Bill and I looking at not a modest, say, 2 to 12 CPR increase on vintage '05, '08, 30-year production loans with coupons around 5% or greater, it does increase the refi production pipeline, which is already fairly full. However, it does streamline some of the efficiencies. This will slow the refi process as originators struggle to process these new loans, so we'll probably see capacity constraints in the system with these new efficiencies. Certain refs and warranties we'll find out further on November 15 will be waived or lowered, so all of those will impact on greater efficiency of the production line process, but it's still a full capacity process now. So the other point is industry participation at this point is not mandatory, so implementation will vary among market participants and originators over time. So this will take time, 3 to 6 months to really filter through. As far as the broader HARP 3, the administration and the FHFA have looked at this for a lengthy period of time, mostly -- most of all this year, so our view is this is the best program they can come up with in terms of a HARP 2 announcement. They pretty much sidelined the streamline refi issues, or initiatives rather, as being very difficult to implement as the banks generally will set the rates ultimately. And that's important to notice, because our 30-year fixed rate now at 4 3/8 is actually up from a low 4s that we've seen in recent months. So all in all, we think it's not going to impact Hatteras. It may have slight impact to speeds going forward. It will speed up the process through the origination pipeline on many loans, but HARP 1 wasn't that successful in terms of the percentage of borrowers that actually modified, it was like 10%. So I know there is 2 million to 3 million eligible borrowers under HARP 2, but our feeling is it remains to be seen whether this will be a significant improvement.

Operator

Our next question comes from Mike Widner of Stifel, Nicolaus.

Michael R. Widner - Stifel, Nicolaus & Co., Inc., Research Division

Just wanted to follow up really on a couple of other topics that have been touched on. Maybe first, whether you want to pose it in terms of leverage or in terms of average portfolio sizes, as Boos indicated, you are about $1.4 billion light on the average as opposed to the ending balance of MBS, and I'm just wondering if you could talk about how you expect again either leverage or portfolio size to run going forward relative to kind of where you were in the quarter and where you are at quarter end?

Michael R. Hough

I think where we are now is probably a pretty good indication of where we want to be for the market that we're in right now. We have been operating earlier this year at somewhere between 7x and 7.5x leverage. I think we're comfortable and -- with the clarity that we may have in interest rates for a period of time and the prepayment environment here and something a half a turn higher than that. So I think we're looking in the 7.5 to 8 range now and probably what you see is indicative of where we want to be for the foreseeable future.

Michael R. Widner - Stifel, Nicolaus & Co., Inc., Research Division

Great. And unlike Steve Delaney, I do like to view the world through rose-colored glasses, and so if I could just go back to the math that Boos touched on. He basically took, as I understand his question, random $1.4 billion x in that spread in the 170 basis point range and kind of ran that out and said $0.08 a quarter. If I looked at that a little differently, I mean, if you guys haven't changed, and I guess the question here is have you changed or will you change your hedging as a result? If I run Boos ‘s ame math without that, and I'd say you're $1.4 billion higher average MBS x a 270 basis points yield, assuming you keep the same swaps in place, you get more to a sort of $0.12 a quarter relative to where you end up with the smaller average portfolio. So I guess the question there is how do you think about the swaps in the context of the larger or smaller portfolio and where you are now as opposed to where you were during the quarter?

Michael R. Hough

Well, Mike, I'll take that. We, like I've said in the comments here, we went in with a pretty closely matched book into the beginning of the quarter, and as conditions changed, our assets shortened, our liabilities stayed where they are, and the assets shortened because of prepay expectations. So that was an opportunity for us to add MBS without having to feel the need to add hedging against them because it basically maintained our net duration profile. We basically ended the quarter same place we started the quarter and we were able to -- we added duration on the asset side. So we still feel like we have a very much closely matched book at the moment, and -- but it's on a bigger portfolio where we do not add any significant hedging. We did have one swap, a $200 million swap earlier in the quarter, but we end the quarter basically where we started it from an interest rate risk profile.

Michael R. Widner - Stifel, Nicolaus & Co., Inc., Research Division

Got you. And so -- I mean the reason I ask you is market -- and as you talked to investors earlier this morning, there are certainly some concerns out there about a fairly sizable drop in the net spreads and people scratching their heads and going "So where our net spread's going to be?" And my math suggests that you get a fairly decent rebound on spreads. I'm certainly not going back where they were, but getting back up into the high 270s sort of all in going forward as opposed to kind of the 260 range, I mean, does that sort of make sense in context of what your expectations are for prepayments and sort of what you look at in the swap book?

Michael R. Hough

Yes, I think that's very consistent to what we've figured, and it is something that we actually wanted to note on the call that all of that compression was driven by the lower leverage that we had, and what we've done since, it's definitely additive.

Michael R. Widner - Stifel, Nicolaus & Co., Inc., Research Division

And I think I misspoke there and added a 100 basis points to that spread calculation, but yes, in the high 170s and -- okay, appreciate the comments there. And I guess the last question in -- there's questions out there from investors on is capital raising off the table for a long time as long as this SEC sort of question is out there, or under the right conditions, assuming spreads get better and there's a chance to put capital in accretively and to book in earnings in all the appropriate normal caveats, I mean, how do you guys think about it in the short term as long as this SEC thing is out there? Is that kind of not doing anything until that's resolved or you'd contemplate it under the right circumstances?

Michael R. Hough

The SEC thing is a concern obviously in the market but it's not offering the way we're doing business right now. We're continuing to do business the way we've always done it, and if there was an opportunity to raise capital in a similar fashion as we have in the past where it made sense from all angles, we would consider it. Keep in mind, we do have more transparency in the yield curve and interest rates here than we've had in a while, so it's kind of both sides of the equation here. But the SEC issue doesn't change the way we're doing our business right now. It's just something that we are having to address.

Benjamin M. Hough

Keep in mind, this could go on for -- maybe why you're asking the question, for many months or longer before anything -- either whether they're going to be happy as they are or trying to pose something even comes up. So we think it's really -- maybe to answer your question is end of the day ask the lawyers, but I think that that's kind of -- it could be a while, and like Michael said, it's not affecting our day-to-day in any fashion.

Operator

Our next question comes from Jason Arnold of RBC Capital Markets.

Jason Arnold - RBC Capital Markets, LLC, Research Division

Just kind of circle back to the swap question, Michael, you mentioned the desire for adding some duration of the portfolio with the 15-year swaps, of course, subtract duration. So I was just curious if you could consider letting some of those maturing swaps roll-off instead or would you really rather control duration with the asset into the equation?

Michael R. Hough

I think both sides of the equation are important, but we do have a few swaps rolling off this year that as they -- as it happens, we'll make the decision at the time based on current market conditions how we want to proceed from there. I mean, it is something that we always consider and it's not one side of the balance sheet or the other but it's a combination of the 2.

Operator

Our next question comes from Joel Houck of Wells Fargo.

Joel Houck - Wells Fargo Securities, LLC, Research Division

More of just a clarification question. On your latest investor presentation in the end of September, you listed Q3 approximate CPRs by month. I think July was 25, August was 23 and September was 26. Those are much different than the monthly CPRs you've outlined in today's call. I'm wondering, am I missing something here?

Michael R. Hough

Yes. I mean, the difference is, those were meant to be a rate of -- a percentage rate of prepayments, not CPR. So the CPRs that we were showing today are lower but the prepayments should be close to that. It's not bad.

Joel Houck - Wells Fargo Securities, LLC, Research Division

Okay. And then the last thing is just again to clarify, when you guys calculate your yield, you're using actual prepayments, not projected, is that correct?

Michael R. Hough

That's correct.

Kenneth A. Steele

Correct.

Operator

Our next question comes from Matthew Howlett of Macquarie.

Matthew Howlett - Macquarie Research

Just going back to the pickup of CPRs, do you know if the refinancing is more borrowers going to new ARM loans or is it to fixed rate loans? What can you tell?

Kenneth A. Steele

To be honest, it's very difficult to get that information. If you take a look at the mortgage curve, I mean, first, you would assume you're seeing a good deal of ARM effects, but as we like to point out, if you look at the steepness of the mortgage curve, it's about 175 basis points in lower yield by taking out the 5/1 and taking out the 30-year. So we think -- for the most part, what you're seeing is ARM to ARM refi, and if you take a look at the newer production paper, that's bearing out because about 75% to 80% of new production paper is refi versus purchase.

Matthew Howlett - Macquarie Research

Got you. And then does Operation Twist, I mean, if it is expanded into buying 30-year paper, does that change Hatteras' strategy at all? I mean, if the curve does stay flat for a while or does -- or would the ARM portfolio's you think prepay at a rate that you think is consistent with your projections?

Michael R. Hough

We've already seen a flattening and then a steepening again. The mortgage curve has stayed relatively steep, steeper than the treasury curve through this, and having Operation Twist to come through will flatten the curve and probably create some additional incentives. It's just going to depend on how and when that happens, I think. I don't see it generating anything in excess to what's already happened.

Matthew Howlett - Macquarie Research

So you think overall, the hybrid speeds will stay 20 to 30 sort over a lifetime? There's nothing that you think could really deviate from sort of that lifetime projections that you guys embed with when you make acquisitions?

Michael R. Hough

I [indiscernible] that's a lifetime assumption. That's an assumption for today's markets and in a falling rate market that we've seen, and 20 to 30 is what we've been guiding kind of on a quarter-to-quarter basis. And that's where we are right now, as rates have kind of been a one-way game for the last 3 years. So that is definitely not a lifetime assumption.

Benjamin M. Hough

And keep in mind, that 20 to 30 we've been offering for a long time, it's more of a percentage range, not a CPR range. The CPR range would be shifted lower, about 5 to 7, so…

Matthew Howlett - Macquarie Research

Got you. And then just on the next question, just to go back to what happened in August, I mean, you said you didn't really see any increase in haircuts. I know there was some loss increase in volatility. Would that just a -- you said just a proactive in front of the unknown, or did you see anything with specific counter-parties happen during that month? And then on that note, has there anything recently gone on with the European counter-parties? Do they still have an appetite for this business?

Frederick J. Boos

This is Fred. We didn't see anything unusual going on in the European counter-parties. They certainly have repo available and still do. Ours is a more prudent decision to pare it back a bit with the EU counter-parties, and that's due to -- the potential that they could limit their balance sheet size to preserve equity and therefore reduce perhaps some of the repo that they are offering, repo line limits, et cetera. So nothing really -- I think that there's more caution on our part. Michael did say 7% is fairly modest and we feel very -- that we could move that 7% very easily if we should decide to do so and perhaps Europe deteriorates. The news there is still somewhat positive, although as we've seen even today, delay, delay, but at least they're still pursuing a viable alternative end game which hopefully will support confidence globally and especially in their banking system. But as Don and I would like to point out, BNP for example and Deutsche Bank for example are 2 of the largest banks in the world. I mean, that's 2 of the cornerstones of the European banking system. So we're not nervous. We've reduced our exposure but we'll continue to repo freely and repo is available. There is still fluid cash providers out there. The rate perhaps has bubbled up a bit into the high 20s but -- and over year end, there's always some pressure there from balance sheet perspective. So I would say high 20s, maybe mid-30s for the turn for, say, 90 days right now, but still the inside market on a 30-day repo is down in the high-teens. So you can see that the repo market is still very sound and very solid in that 20 basis point range for 30-day repo.

William H. Gibbs

And to the first part of your question about earlier in the quarter, we didn't see anything. We're just more matter or prudent because the events there were pretty unprecedented. But there's a lot of cash out there and assumed as anything appeared to tighten the cash stepped up. So it wasn't a problem.

Matthew Howlett - Macquarie Research

Have any major European counter-parties just walked away from the business? I mean, have you seen that recently or is everyone just sort of still involved and just being more cautious?

Frederick J. Boos

We've not seen any of the major ones that we deal with walk away. In fact, they would like more of our business.

Operator

Our next question, and pardon the pronunciation, comes from Boris Pialloux from National Securities.

Boris Pialloux - National Securities

I've like 2 questions. One is regarding your -- it's more a modeling question, and second is about the repo counter-parties. The first one is, do you have any kind of target number in terms of run rate for a gain on sales? And second question is regarding the repo counter-parties. It's not the French banks, more the Japanese banks. There was an article today about the situation about Nomura kind of cutting back in Europe but just try to get color about the Japanese banks?

Michael R. Hough

The first question on target number on gains. No, we have taken gains periodically and it's been opportunistic for us when we see -- time and time we'll see securities on the portfolio, we would rather, I guess rather not own, and that's really what drives that number. There is no target and it is not part of the business model. It's just something we do to be defensive and proactive. From a repo point of view , Fred?

Frederick J. Boos

No, we've not seen any significant change in the Japanese counter-parties that we deal with. They are freely rolling our repo positions, so we haven't asked them for more repo but we don't see anything significant on that horizon.

Boris Pialloux - National Securities

And I also just have one last question. It's regarding -- is there a level at which the homeowners would switch from ARMs to 30-year? Let's say, the Fed is actually buying 30-years and has this program buying 30-year mortgages, mortgage-backed securities, at what level would there be -- like a switch for maybe a homeowner switching from ARMs to 30-year, what level of this 30-year mortgage?

Michael R. Hough

Historically, we have seen that when the spread from an ARM rate to a fixed rate approaches 100 basis points, ARM origination picks up, and because there isn't a real economic incentive to go from a fixed into an ARM. So I don't know what the number is to go from an ARM to a fixed necessarily, and there are more factors to that decision than just rate. But from an economic perspective today, with the spread and difference between the 2, we don't see that being the primary driver.

Operator

Our next question comes from Dan Furtado of Jefferies.

Daniel Furtado - Jefferies & Company, Inc., Research Division

I would -- just a quick modeling -- one of my quick questions is a quick modeling question. This blended spread of 200 basis points, should we consider that incorporating the amortization costs or is that pre-amortization cost?

Kenneth A. Steele

That's net.

Daniel Furtado - Jefferies & Company, Inc., Research Division

Net, okay. Great. And when you say that there's 13% of portfolio exposed to HARP 2 but you don't think it's going to be material, do -- when we read this, it's just that, yes, you have 13% but the number of eligible borrowers who actually hit the bid will be far less than that?

Michael R. Hough

That's our view, yes.

Daniel Furtado - Jefferies & Company, Inc., Research Division

Okay, great. And then the other question I had is just the cash balances at the end of the period, they looked a little bit low compared to kind of historical levels. And I appreciate you probably got some unencumbered cash returned to you with the recent movement in rates, but can you just kind of walk us through what you're thinking comfort levels on the cash. You guys are obviously a very conservative management team, and I was just wondering what your thoughts were there?

Benjamin M. Hough

Really, the main driver of that is our unencumbered securities, I mean, as we call them our free and clears, and right now, cash earned so little that we can get 25, 28 basis points of return going ahead and not having repo. So it's just purely cash management.

Michael R. Hough

Dan, as Ken mentioned in the release, the number that I think you're getting at is our liquidity position, which is a very -- it's very important to this business, and Ken was saying all in our liquidity position including cash was a $1.2 billion, which was over 7% of the MBS portfolio, so...

Daniel Furtado - Jefferies & Company, Inc., Research Division

Got you. And so I guess the read through here is that you obviously wouldn't be encumbering -- you wouldn't be embarking on this strategy if you had any counter-party concerns?

Michael R. Hough

I think that's reasonable, yes.

Operator

This concludes our question-and-answer session. I'd like to turn the conference back over to Michael Hough for any closing remarks.

Michael R. Hough

Okay. Thank you all for being on the call today. We appreciate your interest in Hatteras and look forward to talking next quarter. Have a good day.

Operator

The conference is now concluded and we thank you for attending today's presentation. You may now disconnect your lines.

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