There’s no principal attached to it, but when interest rates rise, especially the front end part of the curve, the coupon, the earnings that you get also rises. So the cash in it’s typical servicing portfolio, the cash flows will extend because prepayments slow. And the rate that you earn on those cash flows for longer also increases. Now, it’s true that with the pool that’s 450 basis points out of the money, the cash flows aren’t really extending anymore. Prepayments fees have bottomed out. But the other effect is still present, right? That the earnings rate that you earn on the cash flows is going up as rates rise. And in fact, while it might be true that the interest rate duration of the pure service fee strip of the servicing asset has switched from having negative duration to positive duration, right, meaning that part will go down as rates rise.
The floating rate components are still negative duration and in fact are larger in magnitude than the positive duration of the strips so that the overall duration is still slightly negative, which gives you the overall minus three duration rather than the minus three. That explains the question?
Trevor Cranston: Okay. Yeah, it’s a very good answer. Thank you.
William Greenberg : Thank you.
Operator: Thank you. Our final question will be from Arren Cyganovich with Citi. Please proceed with your question.
Arren Cyganovich: Thanks. I was wondering if you could talk a little bit about the outlook for rate volatility and maybe spread volatility. I know it’s kind of crystal ball kind of question, but in this kind of higher for longer and the Fed, getting hopefully close to this tightening cycle. With the natural expectation be for that volatility to subside a bit?
Nicholas Letica : Hey, Arren. This is Nick. Thank you for the question. It’s really the question – I’d say of the day and it’s really been a question frankly for the last year. I think we’ve talked about this almost every call that we’ve been on, and, the, the markets are giving us signals that things are – that we’re close to an end of this hiking cycle. And that, that maybe the Fed really is going to hold now. And we see that if you look at the shape of the yield curve, for example, we’ve seen the two tens curve for example, go from something like wider than minus 100 basis points. Not long ago to only minus 20 now, it’s that curve has become less inverted or has become steeper by about 80 basis points. That’s a signal the market is giving you that we are getting closer to the end of this cycle.
But the reality is, these things are, famously difficult to predict and to tell. And, that’s the reason why in our comments as we’ve said, we are being very respectful of the risk in the market. And we are – we believe that our position is balanced and is as we described our leverage position is being neutral. It gives us enough return potential, enough upside to as to a spread tightening event that we feel, that we will capture that. But yet at the same time, don’t have an excessive amount of downside exposure should things continue to happen as with spreads widening. We have talked about spreads being wide historically, which they are. The problem is they keep getting a little bit wider every quarter. And we are we are respectful. And so, we’ve kind of built into the portfolio, the level of leverage and risk and composition between our MSR and our securities holdings that we know – that generates we think a very, very attractive return potential, and should spreads tighten and we get a cycle change.
We will definitely participate in that upside, as well.
Arren Cyganovich: Thanks. And then, second question I had was, you had mentioned, shifting a little bit higher in coupon, I guess, I think you said in the TBA side. How do you – or how are you hedging that? And what’s the risk to the extent that, I don’t know the economy falters and there’s a flight to quality and you start to see the 10-year fall again?
Nicholas Letica : Oh! there has been, I mean, good question. And there certainly has been a correlation between the performance of lower and higher coupons with the rate directionality. Now we hedge it the same way we hedge everything else. We use our models and we have – we think as accurate representations of the risk of those securities versus the lower coupons. And we hedge it with a combination of futures and swaps. And of course, with our again, with our MSR, we have as Bose talked about it in the prior question about the sensitivity of our MSR to mortgage rates. There is still some sensitivity that impacts where – how our hedging ultimately resides where exposure is ultimately reside on the coupon stack. And one of the reasons that we did go up in coupon was the fact that the current coupon went higher.
I mean, that was part of it. And part of it was also, as I said, the rotation out of – as coupons we thought did really well. And also just the fact that if you aren’t a higher for longer environment, the higher the current coupon should provide a lot of good return.
Arren Cyganovich: Got it. All right. Thank you.
William Greenberg : Yeah, I might just add that that, we do actively manage the portfolio not just in the interest rate rebalancing and so forth, above but also in coupon selection and where we are on the coupon stack. And some of that relates also to how we think that does relate also into how we hedge the portfolio and what risk we want to take in different environments. And so, as rates move sometimes in addition to, to hedging, block the theoretical interest rate exposures, we will often sometimes modify our coupon positioning which has an impact as well. And so, as we see the lower coupons underperforming, we may choose to increase exposure there from time to time or as rates fall, we might be moving that down a coupon or up a coupon, as well. And so it’s a dynamic portfolio. But the hedging strategy is the same in any environment.
Arren Cyganovich: Got it. Thank you.
Operator: Thank you. Our next question is from Eric Hagen with BTIG. Please proceed with your question.
Eric Hagen: Hey, thanks. Good morning, guys. Hope all are well. How do you see the bulk market for MSR developing its interest rates maybe even higher from here? Like, how much overall capital do you feel like you can maybe devote to the MSR in that scenario where there’s bulk MSRs to buy and rates are higher at the same time?
William Greenberg : Sure, thanks for the question, Eric. Look, there’s ample supply of MSR in the bulk markets, right? And as we’ve said in the quarters passing and it continues to be true that the market is trading rationally, and professionally and orderly. And the sellers, especially of large portfolios seem to be, strong hands that understand how the market works and isn’t going to flood the market. Then in no way shape or form, is the MSR market trading as a distressed market. It’s happening in a very, very orderly way. As I said a little bit earlier, we like our capital allocation right here. We’re trying to balance the relative attractiveness of MSR with the relative attractiveness of MBS, along with making sure that we have ample liquidity in the portfolio and so forth of which the MBS portfolio provides more so than the MSR.
