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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good morning, and welcome to the Annaly Capital Management Quarterly Conference Call. All participants will be in a listen-only mode. [Operator Instructions] Please note, this event is being recorded.
I would now like to turn the conference over to Purvi Kamdar, Head of Investor Relations. Please go ahead.
Thank you. Good morning, and welcome to the second quarter 2019 earnings call for Annaly Capital Management Inc. Any forward-looking statements made during today’s call are subject to certain risks and uncertainties which are outlined in the Risk Factors section in our most recent annual and quarterly SEC filings. Actual events and results may differ materially from these forward-looking statements. We encourage you to read the forward-looking statements disclaimer in our earnings release, in addition to our quarterly and annual filings.
Additionally, the content of this conference call may contain time-sensitive information that is accurate only as of the date of the earnings call. We do not undertake and specifically disclaim any obligation to update or revise this information.
During this call, we may present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in our earnings release. As a reminder, Annaly routinely posts important information for investors on the Company’s website at www.annaly.com.
Content referenced in today’s call can be found in our second quarter 2019 investor presentation and second quarter 2019 financial supplement, both found under the presentation section of our website. Annaly intends to use our webpage as a means of disclosing material, non-public information, for complying with the Company’s disclosure obligations under Regulation FD and to post and update investor presentations and similar materials on a regular basis. Annaly encourages investors, analysts, the media and others interested parties to monitor the Company’s website in addition to following Annaly’s press releases, SEC filings, public conference calls, presentations, webcasts and other information it posts from time to time on its website. Please also note this event is being recorded.
Participants on this morning’s call include Kevin Keyes, Chairman, Chief Executive Officer and President; David Finkelstein, Chief Investment Officer; Glenn Votek, Chief Financial Officer; Tim Coffey, Chief Credit Officer; Mike Fania, Head of Annaly’s Residential Credit; and Tim Gallagher, Head of Annaly’s Commercial Real Estate.
And with that, I’ll turn the conference over to Kevin Keyes.
Thanks Purvi. Good morning everyone and welcome to our second quarter earnings call. Yesterday officially marked the end of the Federal Reserve’s hiking cycle, which began back in late 2015, the same time I started my tenure as Chief Executive Officer of Annaly. I spoke as incoming CEO on our second quarter earnings call exactly four years ago. At that time the market was exhibiting extreme paranoia as the beginning of the Fed hiking cycle approached.
To recall, I highlighted three ways Annaly planned on positioning ourselves for the Fed’s upcoming lift off in rates. Number one, aggressive build out of our investment teams and corporate infrastructure. Number two, the prioritization of specific internal and external growth strategies including joint ventures and acquisitions. And number three, I set the course for the initiation of our diversified shared capital business plan. The strategy we laid out has been largely successful and arguably one of the most difficult operating environments in quite a while, marked by the Fed hiking interest rates nine times over the past four years.
Summarizing our efforts since 2015, Annaly has delivered a total return of over 60% to our shareholders, outperforming agency peers by 40% and the broader yield sectors by almost 20%. We have also grown our market cap by over 50%, paid out $5.1 billion in dividends, acquired two less efficient mortgage REITs for $2.4 billion and formed over 20 exclusive investment and strategic partnerships.
And finally, members of this management team have voluntarily purchased nearly $20 million of stock in the open market since 2015, while not selling a single share ever.
Annaly’s performance over the recent hiking cycle is an endorsement of our shared capital model and human capital advantage we’ve built at our firm. Now as we enter a new phase of monetary policy, we believe that our efforts taken over the past four years will serve to benefit Annaly in the coming years as well.
While the market dissects the Fed’s intentions following yesterday’s cut, there’s no doubt we have gained further clarity. The hiking cycle is over. The last time the Fed cut rates with the S&P 500 at all time highs and credit spreads tightening was in July of 1995. Over the following two years, spreads continued to tighten 20% to just 50 basis points on investment grade credit and the $0.02 treasury curve remained below 50 basis points.
During this time, the emerging mortgage REIT industry outperformed the broader market by 50% benefiting from attractive funding levels and declining interest rate volatility. Then in the years that followed in each and every one of the subsequent periods of monetary easing after the demise of long-term capital management in the fall of 1998 the burst of dot com bubble in 2000, and the financial crisis in 2007, Annaly outperformed the broader market by 18%, 207%, and 71% respectively in the two years subsequent to the initial Fed reduction in rates.
So fast forward to today, paradoxically, after rising from the zero bound combined with other central banks accommodation monetary policies actually produced second order effects of higher leverage, hypnotizing low volatility and contributed to the market selective amnesia of certain fundamentals. All fueled by the hunt for yield. Global debt has continued to increase to record levels reaching another high of 250 trillion following the continued borrowing binge this year.
This unprecedented level is the equivalent of 320% of GDP raising serious implications for the global economic outlook over the near and long term. Furthermore, the global inventory of negative yielding debt is now at $13.7 trillion, a new record. While the threat of growing debt levels has been masked by the resilient U.S. economy, broad market downturns have historically been preempted by subsectors of over levered credit with deteriorating credit quality hitting the wall as growth slowed. The past scenarios are also irrefutable.
In the 1990s, leverage for telecom companies grew by approximately 140% to fund the over-investment in expansion of that industry sector leading to that debt fueled telecom crash. In the 2000s, a 100% growth in real estate credit and the LBO activity precipitated the housing crisis. Now corporate credit has ballooned again, this time nearly 120% since 2007 led by non-financial BBB minus rated debt and leverage loans which are up over 200% and 130% respectively. So something has got to give.
Other flashing red lights we’ve seen in the economy over the course of the second quarter this year include deteriorating economic data, weak inflation ratings that continue and the unresolved global trade outlook. They all have added uncertainty about future economic growth. The weakness in global data is alarming. The Euro area manufacturing PMI just hit a 75-month low, while in Germany, it’s an 84-month low. Domestically, the ISM manufacturing index has continued to decline since reaching post crisis high last summer.
The Fed along with other central banks globally have become increasingly vocal about recognizing these growing risks in the market, as we also have, which is why we’ve increased our capital allocation to our agency business, attributing a premium to more liquid, higher quality and cycle agnostic investment options. We also think the market is under appreciating the fact that we are coming out of a de facto 400 basis point tightening cycle accounting for the rate increases and the impact of the Fed balance sheet online, much of which still has yet to be understood in the market.
The combination of constraint debt service capabilities and the headwinds in macroeconomic fundamentals have led to an impaired earnings recession in corporate America. This current reality we’re witnessing, I previewed with the Annaly Board at our year end meeting in December of 2018.
For the second quarter, Analyst expect the S&P earnings per share to drop approximately 3% across the board with eight of 11 industry sectors expected to report a decline. This quarter marks the second highest number of companies issuing reduced forward guidance since 2006 and much like the forecast of this first – this year’s first three quarters, 2019 fourth quarter, expectations have been cut dramatically and they are now half the original growth estimates made at the beginning of the year.
However, despite the deterioration and the earnings outlook, equity markets remain in rally mode and investors are ignoring signs of slower output growth and placing more chips on the Fed bet effectively cheering for lower discount rates in the near future. In this euphoric equity market at approximately one times book value Annaly remains a conservatively valued and defensive option for investors producing attractive risk adjusted returns while maintaining high margin, high liquidity, and the low beta versus the rest of the market.
Against this backdrop, we continue to proactively navigate the current market conditions to ensure we remain nimble, and prepared to take advantage of any opportunities as we have in volatile times before.
As I discussed earlier this year, capital optimization, capital efficiency and growth and partnerships are top priorities for the firm and we’ve continued to make significant progress on each of these goals during the past quarter. Back in June, we authorized $1.5 billion buyback program and while we have not reached the return levels justifying the repurchase of shares, the program underscores our commitment to responsible capital management.
Additionally, we continue to reduce our cost to capital through the issuance of over $440 million in preferred equity and the redemption of existing more expensive preferred stock this quarter. And finally, within our residential credit business, we completed three successful whole loans securitizations totaling over $1.2 billion, bringing aggregate issuance since the beginning of 2018 to $2.7 billion. This securitization program now in place is a testament to the capabilities and quality of our expensive network of whole loan partners and network, which increased by over 25% during the quarter and provides us the access to 100s of originators resulting in three times the quarterly loan volume this year versus last.
We are now at top five non-bank RMBS issuer and this outlet represents a diversified non-recourse term funding alternative for the whole loan business. The Fed has began the ease as it recognizes that record high debt levels I just described in slowing economies have negatively impacted corporate earnings all over the world. This reality is not yet reflected in the higher priced and higher risk equity market.
Annaly recognizes these uncertainties and we will continue to operate defensively and conservatively as we welcome the reduction in our primary costs of doing business. We’ve demonstrated growth and outperformance during the latest hiking cycle and we look forward to the numerous opportunities of the upcoming easing cycle in any form it may take.
With that, I’ll turn the call over to David Finkelstein to discuss our investment activity and outlook.
Thank you, Kevin. As all are aware, Fed drove price action across U.S. fixed income markets in the second quarter. Interest rates rallied 40 basis points to 50 basis points in turn modestly steepening the yield curve while risk assets perform reasonably well on the quarter. Agency MBS lagged, however, as a consequence of higher volatility as well as the reintroduction of refinancing risk into the agency market at current lower rate levels.
Agency performance did adversely impact our book value in Q2. However, it is worth noting that just over half of this deterioration has reversed thus far in the third quarter. Our portfolio leverage increased to 7.6 times due to both additional assets added to the agency portfolio in light of water spreads as well as the decline in equity value.
Turning to portfolio activity and beginning with the agency sector, our additions were focused in specified pools, while we also reallocated a portion of our TBA holdings into pools. Specified pools continued outperformed TBAs in the second quarter that we do feel that pool pricing is justified given both the interest rate environment as well as continued deterioration of the deliverable float that is characterize in the TBA market this year.
While our portfolio is well protected from higher prepayments as 80% of our assets exhibit prepayment protection, we do expect peak in the third quarter given both the lagging effect of lower mortgage rates as well as seasonal factors. We continue to believe that the investments we have made over the last few years in both people and technology to significantly elevate our prepayment expertise are a differentiator. In today’s market, we are balancing the convexity risks with our pay up exposure and therefore focused our additions in the quarter in cohorts, we feel have an appropriate relative value tradeoff between the two factors.
Financing rates for agency MBS have been elevated relative to other short term rates so far in 2019 which remains a modest head wind in the third quarter, though we expect to accommodate of policy in the end of Fed balance sheet runoff to ease pressures on the repo market going forward.
With respect to our rate hedges, we continue to reallocate our swap hedges to reflect the lower rate environment but we do so strategically as we stress the quality of our hedges, not quantity depending on our market outlook and only if it is in our best economic interest. Despite the reduction of our hedge ratio to 74%, we remain well-insulated from interest rate volatility across the yield curve as indicated by the rate shock tables provided in our supplement.
Shifting to residential credit, as Kevin discussed, our securitization program was very active this past quarter as we securitized nearly $800 million in whole loans, which explains the roughly $300 million decline in the size of our residential credit holdings.
Our April transaction was backed by expanded prime loans while the June deal consisted of agency eligible investor collateral. With an additional expanded prime transaction completed in July, we have now securitized over $2.7 billion of whole loans since the beginning of 2018 which has generated just over $500 million in market value securities retained on our balance sheet with levered yields in the low to mid double digits.
FHLB financing remains a valuable resource for our resi credit business, but the development of our securitization platform has considerably reduced our reliance on the FHLB and we expect to continue to gravitate further towards the securitization model as our programmatic will be at show further attracts investors sponsorship.
Secondary market residential credit spreads remain relatively tight in the organic creation of securities has been and like we will continue to be the mechanism to grow our resi credit business while still earning attractive returns with only modest leverage.
Our loan acquisitions have accelerated in 2019 as the expanded prime sector has developed further and securitization execution has improved steadily with additional participants and enhanced liquidity, which is why we expect this channel to remain the dominant strategy for our residential business for the foreseeable future.
In our commercial business, we continue to ramp our CLO, which explains a very modest decline in economic interest in the portfolio. Assets acquired did exceed runoff in the combination of new assets and optimized financing through our CLO improved the levered return on the portfolio to roughly 11.5%. Double digit levered returns for high quality assets remain more of an exception in the rule in the CRE sector as pricing remains challenging however.
In spite of the environment, we have been able to selectively add assets that are higher up the capital structure and lower end risks as we are focused on more liquid products or financing better sponsors on higher tier markets. We are looking to grow the portfolio and if the market offers modestly lower returns for attractive assets, we are prepared to accept the lower return to maintain the health of the portfolio over the long term.
Our middle market lending portfolio experienced very modest growth quarter-over-quarter as new additions outpaced runoff. Our private equity partners continue to be active and our pipeline remains solid. Disciplined is essential in our corporate lending business, given the stage in the business cycle, however. And as we said last quarter, we do not expect the portfolio to grow with a robust pace experienced in prior years. We will remain – we will maintain our emphasis on first lean investments in industries that tend to exhibit low cyclicality, and similar to CRE, we will not sacrifice credit quality for asset growth in the current environment.
Now lastly, turning to our outlook, we do anticipate remaining in this relatively low rate environment for the foreseeable future given the low global growth and subdued inflation that Kevin discussed. Accommodative monetary policy should be supportive of agency spreads as we have already seen thus far in the third quarter.
Higher prepayments will prevail this summer and MBS financing rates may continue to lag other short-term rate markets over the very near term. However, looking beyond the third quarter, we do expect the agency carry environment to improve and we are very comfortable with our current exposure in the sector.
While our allocation to credit has declined over the past number of quarters as the relative value equation has shifted towards the agency, we are close to the lower limits on credit given the benefits of diversification and overall portfolio risk adjusted returns. Maintaining credit exposure through residential does not present a challenge as we are less exposed to the reality of tight spreads given our ability to generate attractive yield through securitization. However, nourishing our commercial and middle market lending businesses may necessitate a modest sacrifice of return for asset quality in the face of relatively tighter spreads, but we believe this is a small price to pay ensure resilience and diversity of the overall Annaly portfolio and keeps us on a path to generate attractive longer-term returns for our shareholders.
And now with that, I’ll hand it over to Glenn to discuss the financials.
Thanks David. Our earnings release discloses both GAAP and non-GAAP financial results. I’ll be focusing this morning primarily on our non-GAAP metrics while excluding PAA. So beginning with the GAAP results, the decline in rates during the quarter lead to mark-to-market losses on our swaps portfolio which contributed to a reported GAAP loss of $1.24 per share. Offsetting mark-to-market gains in our agency portfolio which run for equity reducible loss on a comprehensive basis at $0.09 per share.
We generated core earnings at $391 million or $0.25 a share compared to $433 million or $0.29 in the prior quarter. A few factors impacted our core results this quarter beginning with interest income. Return on PAA adjusted basis was up 13% or $119 million driven by the increase in agency investments that David had just mentioned and discussed.
Additional factors impacting the improvement in interest income were slightly higher average asset yield which was up about three basis points sequentially partially offset by a $13 million increase in PAA’s adjusted premium amortization.
A higher amortization expense was due to projected CPR is increasing a 14.5% from 11.6% in Q1 with the magnitude of the change, also contributing towards a greater premium amortization adjustment for the quarter. And the improved interest income was offset by increased interest expense attributable to higher repo balances.
But most meaningful factor in the quarter was the persistent dislocation between repo funding costs and LIBOR that we had foreshadowed on our last call. While repo rates were relatively unchanged for the quarter, LIBOR based resets on the received legs of our swaps declined about 20 basis points which contributed to $15 million decline in income generated to the interest component of our swaps. This is the key factor causing both core earnings and net interest margin declines.
Despite this headwind, we generated attractive returns using relatively conservative leverage levels, we’ve been judicious in using leveraged enhance earnings and returns with economic leverage roughly two to three turns below our Agency peers. Core ROE was just under 10% and importantly our core ROE per unit of leverage was 131 basis points, comparing favorably to peers.
Our annualized year-to-date economic return of 10.5% is in line with our dividend yield, which is the goal of our model, that being able to produce stable income for minimizing while the volatility that comes with delivering such an attractive deal in today's low yield environment.
And finally, as part of our continued focus on capital management, as Kevin mentioned, we issued $400 million of 6.75% for stock. The overallotment option for the offering was exercised in July, bringing the total size to approximately $443 million. Additionally, we called $55 million, 8.125% [ph] Series H preferred. And we also announced a call of 175 million remaining on the 7.58% Series Cs. And as a result, in the past two years with these additional actions, we've now cumulatively reduced the cost of our preferred capital by approximately 70 basis points or 9%.
And with that Ian, we're ready to open up the questions.
This will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Eric Hagen of KBW. Eric, please proceed. Eric, your line is live. Please proceed.
Hello, am I coming through?
Hi Eric.
Hi. I'm not sure what happened there. Good morning. I just wanted to get your thoughts on the relative value as you see it right now between specified pools, and TBAs, or generics and the types of specified pools that you like.
And as a follow-up to that, your presentation notes that the total premium in the portfolio is more than a third of total shareholder equity. So I'm just curious how you guys think about the longer term prepayment risk at Annaly? And how that factors into the percentage of overall capital that you have devoted to Agency MBS over time? Thanks.
Sure Eric, this is David. To start with your question on our allocation between pools, TBAs and within the specified sector, as I said in my prepared comments, specified pools have obviously done quite well, it's obviously a function of the interest rate environment, but again, it is also driven by deterioration in the TBA deliverable, which has occurred pretty continuously over – about the past year. What we've seen in the TBA market is that coupon swaps are relatively flat. So it's advantageous for originators to deliver higher loan rate coupons or mortgages into lower coupons, more profitable, number one.
Number two, as the GSEs have gravitated toward this UMBS model, they haven't really been able to compete with one another, given the similarity or the essential, identical securities that are created. So they have been more aggressive with originators on buying IO from them, which also has incentivized those originators to deliver higher loan rate loans into coupons. And in addition, originators have differentiated themselves based on their aggressiveness in terms of refinancing. There's a lot of originators out there that are very aggressive about getting their borrowers to refinance. And so the deliverable isn’t that much worse from that standpoint. So it's not so much a function of the richness in specified pools, but also driven by what the deliverable looks like.
Now within specified pools, we are certainly cognizant of pay ups, and we are very sensitive to that. And so our focus has been largely over the last quarter on lower pay up pools, differentiating between gross WAC and servicer, and paying small premium to get what we think is good relative value compared to TBAs and not elevating that overall pay up exposure too much. That's where we've been focused, but we do hold considerable amount of very high quality specified pools. We're not of the mindset that we're going to transition out of those in the lower pay up pools, because we need that protection. But the marginal dollars spent on relatively lower pay up pools.
Now in terms of your question about premium, coupon premium relative to equity, certainly it's a concern obviously given the fact that we are in a lower rate environment and we do have a lot of premium in our portfolio. But we also have to understand that the portfolio is very well hedged from a duration standpoint and quite dynamically hedged, both in up rate and down rate scenarios. And so we actively manage that exposure. And obviously if the market sells off, pay ups will diminish, but we actively manage it and we're certainly aware of exposure relative to equity.
Eric well I’ll just add three points to that in terms of the premium. Looking forward, well my commentary is about the credit valuations versus our Agency business. And in the past quarter or so we’ve chosen to redirect into Agency because of just the obvious value arbitrage there. So that’s the positioning. Going forward, our liquidity position gives us extreme flexibility roughly $1 billion, $1.5 billion a month of cash flow to redirect our capital allocation, is more flexibility. And it certainly dwarfs any company in our sector.
The second point is we're a third less levered. So we have additional, incremental financing capabilities that we do want to shift our capital.
And lastly, regarding the arbitrage, I mean, it really has never been as dramatic in terms of a valuation differential Agency versus our three other credit businesses. My overall commentary is the Fed is signaling, other central banks are signaling that we're at a position now where a high debt growth has impacted combined with the slowing of the economy and a lot more uncertainty has impacted corporate earnings and valuations are too high in most of the other sectors.
So we're waiting for that impact again to fundamentally hit the market. And then we would anticipate just shifting into better valuations in the credit, frankly. So the portfolio is an accordion, it's always going to be dynamic. And I just view this opportunity sitting here today with more visibility on the central bank and not enough focus on the fundamentals of valuation across the asset classes. And once there as the market begins to focus, I think, you'll see us take advantage of that and redirect our capital and the portfolio will adjust accordingly.
Got it, that's helpful color. Thank you.
Thanks Eric.
Yes, thanks. And then it looks like about half year swap portfolio is rolling over in the next, call it 18 months. And that's on a blended average basis that you give us the weighted average maturity. I'm curious what percentage rollover just by year end? And maybe you do or don't have strong views on Fed policy and whether the forward curve is appropriately priced or not. But, where along the yield curve do you think it makes the most sense to add new hedges?
Yes two good questions. Look with respect to our short term hedges, we constantly maintain that and as we do get close to roll-off, we'll push hedges out. I think we have 34 billion or thereabouts in the lower or shorter duration bucket. And we'll certainly maintain that. Now with respect to new hedges that's a function of our overall rate outlook, not just over the very near term, but really well out the horizon. So if you look at the swaps curve right now, twos, tens is priced around relatively flat, it's about four, five basis points. One year forward, it's roughly 26 basis points. So that says that a year from now the market is priced twos, tens to be 26 basis points.
Now our view is we are very sensitive to the uncertainty surrounding Fed policies. And I think communication that we've seen is obviously necessitated that. And certainly volatility we experienced yesterday, for example, during the press conference we had a 12 basis points to 14 basis point trading range for the two-year note, which is just an example of how much uncertainty there is with respect to Fed policy.
But when we look far out the horizon, we do feel like we are in an easing cycle. The curve should be a little bit steeper than what the forwards are implying. 26 basis points a year from now is probably a little light in our view. And so the marginal hedge is pushed a little bit further out the curve and it's not a strong view because we do feel like we're pretty spread across the curve, but marginally we do feel like longer term hedges are better bet.
And consistent with your prior question in terms of pay up exposure in specified pools which are longer duration, having longer term hedges does help manage the potential for a drift higher in rates and some dissipation in those pay ups as well.
Got it. Thank you so much. Thanks for the comments.
You bet.
Our next question comes from Matthew Howlett of Nomura. Matthew, please proceed.
Thanks for taking my question. Just what explains the reduction in the interest rate sensitivity quarter-over-quarter with the increase in leverage that happen?
Shorter duration of the assets, our asset duration is around three-and-a-quarter years. Our hedge duration is a little bit longer, closer to four years. So in spite of the 74% hedge ratio, we do have the same or slightly better protection, or actually better protection than when you look at the rate shocks last quarter. And with respect to spread shocks, that's the same factor driving that. Shorter duration, we have more leverage, but because the assets are shorter, they're less sensitive to spread changes.
Got it. And then just quickly, do you know – is there any repo rolled over today? Just curious if you give any real time quotes on repo rates?
Sure. Overnight we set it around 230. With the decrease in the Fed funds rate yesterday it's a little bit elevated relative to where it should be all else equal. We would expect it to be about five basis points inside of that level. But we do feel like ultimately as things settle, you will get better repo rates on an overnight basis and a near term basis relative to LIBOR.
Got it. And then just one last question is, Kevin, you about some point reallocating to credit. I mean, how do I look at the sort of trajectory in the next couple of quarters? You said carry might improve on the Agency side. So would do we expect that portfolio to – can it grow leverage to can it grow higher? And at some point if credit spreads do normalize, you go into – you sell some Agency MBS and you're moving into credit. And how do you – what sort of the cadence, the next few quarters of leverage trends and then, allocation?
Yes, I mean, I think you hit on kind of all the levers that we have. We don't necessarily have to sell agencies to allocate more credit. But that is certainly available to us again, given the liquidity agency strategies and the relative valuation are that we could take advantage of. I think the biggest thing for our credit businesses is our pipelines are basically two to three times more full today than they were this time last year just because of the businesses have matured, and they're more seasoned in terms of our origination capabilities and our partnerships. So we have the ability to invest more into credit, frankly we'll do more when it cheapens up. It's as simple as that.
The second thing is our credit businesses are virtually they're way under levered, relative to the market. So in terms of earnings power on incremental credit, if we decide to increase the leverage there, and by definition we shrink the Agency book, then the financing of the company frankly becomes more efficient and the returns, which is the goal of this whole thing, this whole model, more levered, higher quality of earnings, more balanced towards credit. But we just can't, we don't want to overstep, given my prepared commentary on what's not reflected in the markets. These credit buckets are relatively very expensive certainly in two of three – two of our three businesses.
But at the end of the day, I think, as you've heard us talk before Matt we are pretty much set up for, I feel like we're in the calm before the storm again. And similar to other time periods, like first quarter of 2016, 2018 when we made another acquisition, we're kind of waiting in the wings, we're paying you 10% to 11% to wait with us. And I really believe there's capital appreciation potential for this company now that we're in an easing cycle versus the last four years.
So, I view the Agency businesses as our bank, these credit businesses frankly are undervalued in terms of their track records in their under levered returns. But over time, I think, as things normalize, that means volatility comes and that's when we take advantage of things. I would throw out there, just for sport our three credit businesses when you look at some of the parts of the company and how they're undervalued, we could monetize any one of them and recognize the gain based on where levels have gone.
Are we going to do that any time soon? Not necessarily because I believe in the long-term strategy and durability of having all the strategies together. But sufficed to say, when you take a valuation grid and apply to our credit portfolios relative to where we are valued overall, and we've talked about different valuation metrics over time in the yield sectors, most credit businesses are undervalued relative to the marketplace. But we’ll pave the way and there's definitely capital appreciation opportunities when the fundamental, reasonable demand returns to the market.
Right, it makes a lot of sense. And it's nice that you have – I hear you on the strategy and I like the buyback. I guess I'll have to throw in the question. You said that the buyback hasn't quite reached your return hurdles, what point does it, because of all – all the things you mentioned, all these intrinsic value in these other businesses that’s not being recognized.
You can look at historically when we repurchase shares is we’re the first company to put a buyback up in 2012 and we've purchased shares, repurchased shares along the way in 2016. In the first quarter we repurchased about 200 million shares worth, and then a couple of weeks later we bought Hatteras., because of the relative value are between repurchasing stock or buying someone else's stock.
In terms of me translating or giving you preview of when or if we buy stock, it's really down to relative value across our 37 options. And if it's more accretive for our shareholders to do it, we'll do it. But right now we have, like I said, pipelines and liquidity that are generating higher cash-on-cash returns than if we were to soon than if we were to shrink the company.
Right. Thank you.
Thank you.
[Operator Instructions] Our next question comes from Rick Shane of JP Morgan. Rick, please proceed.
Hey guys, thanks for taking my questions this morning. Look, I think, what we're hearing is, when we look at the Annaly wheel of choices, a strategic push towards the Agency bucket. David, I think I also heard you say that in the near term the tactic is to be up in volatility, but that might be lower levered returns, in that bucket. You guys show a 10% to 12% range, in the Agency opportunity. Where do you see that playing out as you sort of go through this transitory period of dampening volatility by potentially giving up a little bit of return?
Yes. So to separate Agency from credit, first of all, that 10% to 12%, I would say that over the near term, the third quarter the return is a little closer to 10%, but when we look at the forwards, out the fourth quarter and beyond, that's really when the return on Agency starts to look more attractive. So the range is appropriate but near-term it's a little bit lower over this quarter and elevates after that.
In terms of substituting credit for Agency in low returns that I didn't mention, Agency is the liquidity engine in the portfolio. And as Kevin talked about that's where the dominant activity is certainly. But we have reduced our allocation in credit over the past few quarters. And when we look at the portfolio on a broad basis and capital allocation, what risk adjusted returns look like out the horizon, we do feel like we're at the lower end of the range on credit, just given the diversification benefits.
And so to the extent we want to maintain the credit exposure, and not simply gravitate more towards Agency. In light of tighter spreads, re-investing is going to necessitate sacrificing some return. But again, where we're at in the business cycle, we're not going to chase yield, we're going to move up in quality except a slightly lower return as we re-invest, run runoff from those businesses, and it will compliment the Agency portfolio, just given the lack of correlation. And then on a total risk adjusted return, we'll have a better outcome as our view.
That's great. It's actually a perfect segue into the second part of my question, which is that when I look at some of your allocations, for example, when I'm looking at your commercial real estate allocation, it strikes to me that one opportunity is for you guys to particularly on the security side, really move up the stack and it seems consistent with your outlook on credit. Should we expect to see, for example, more super senior CLOs more AAA CMBS in that portfolio going forward?
Yes. And Rick, I'm going to hand it over to Tim Gallagher, who heads our Commercial Business and he can help you.
Yes. Hey Rick, it's Tim Gallagher. I think you're spot on with that. We have been doing some of it already and to the degree that spreads continue to tight and assets continue to persist at rich levels. We will look to grow up the capital structure in CMBS, CMBX more liquid products in areas where we feel like we can make the returns that we need to make on a better risk adjusted basis.
All right. Hey Tim and I apologize to my peers for asking one last question, but any exposure to the – what change rules in New York in the portfolio?
No, we don't have any material exposure to that.
Great, thank you guys.
Thanks.
This now concludes our question-and-answer session. I would like to turn the conference back over to Kevin Keyes for any closing remarks.
Thanks everyone for joining the call today and for your support of Annaly. We look forward to speaking to you all again next quarter. Thank you.
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.