Chimera Investment Corp (CIM) 2010 Q3 法說會逐字稿

Good morning and welcome, ladies and gentlemen, to the third-quarter earnings call for Chimera Investment Corporation. At this time I would like to inform you that this conference is being recorded and that all participants are in a listen-only mode. At the request of the Company, we will open the conference up for questions and answers after the presentation.

The Company has asked me to read the following statement. This earnings call may contain certain forward-looking statement within the meaning of SECTION 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements, which are based on various assumptions, some of which are beyond our control, may be identified by reference to a future period or periods or by the use of forward-looking terminology such as may, will, believe, expect, anticipate, continue, or similar terms or variations of those terms or the negative of those terms.

Actual results could differ materially from those set forth in forward-looking statements due to a variety of factors including but not limited to our business investment strategy; our projected financial and operating results; our ability to maintain existing financing arrangements, obtain future financing arrangements, and the terms of such arrangements; general volatility of the securities markets in which we invest; the implantation, timing, and impact of and changes to various government programs relating to the capital markets; our expected investments; changes in the value of our investments; interest-rate mismatches between our mortgage-backed securities and our borrowings used to fund such purchases; changes in interest rates and mortgage prepayment rates; effects of interest rate caps on our adjustable rate mortgage-backed securities; rates of default or decreased recovery rates on our investments; prepayment of the mortgage and other loan underlying our mortgage-backed or other asset-backed securities; the degree to which our hedging strategies may or may not protect us from interest-rate volatility; impact of and changes in governmental regulations, tax law, and rates; accounting guidance and similar matters; availability of investment opportunities in real-estate-related and other securities; availability of qualified personnel; estimates relating to our ability to make distributions to our stockholders in the future; our understanding of our competition and market trends in our industry, interest rates, the debt securities market, or the general economy.

For a discussion of the risks and uncertainties which could cause actual results to differ for those contained in the forward-looking statements, see Risk Factors in our most recent annual report on Form 10-K and all subsequent quarterly reports on Form 10-Q. We do not undertake and specifically disclaim any obligation to publicly release the results of any revisions which may be made to any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements.

Now I'd like to turn the conference over to Matthew Lambiase, President and Chief Executive Officer of Chimera Investment Corporation. Please go ahead, sir.

Thank you, Diana. Hello and welcome to the third-quarter 2010 Chimera Investment Corporation earnings call. I am Matt Lambiase, President and CEO, and joining me on the call this morning are Alex Denahan, our CFO; Chris Woschenko, our Head of Investments; Rose Lyght, CIO of FIDAC, our manager; Choudhary Yarlagadda, the head of structuring at FIDAC; and Jay Diamond, managing director at FIDAC and a member of the Board of Directors of Chimera.

I'd like to make a few brief comments and then have Alex review the Company's results the quarter. As always, we are all here to answer any questions that you may have afterward.

The Company invested the proceeds of its June offering late in the third quarter. The income from those investments was not fully reflected in the earnings of this quarter, but will be evident in future periods.

Chimera's taxable income on which we base our dividend remains strong. We believe our portfolio is structured to continue to deliver long-term performance for our investors.

There have been several major news stories affecting the mortgage market in recent weeks. Foreclosure moratoriums has been the prevailing story. At the request of a coalition of state attorney generals, several major banks with large mortgage servicing operations have temporarily halted their foreclosure proceedings in order to review the legality of their procedures.

There have been questions regarding the effect of the delays in the foreclosure process on the cash flow of our non-agency mortgage-backed securities in the event that they are serviced by one of these banks. We currently do not believe that the foreclosure moratorium will adversely affect our portfolio of mortgage-backed securities.

This is because mortgage servicers routinely advance principal and interest payments on delinquent mortgages to bondholders up to the point they deem the advances are recoverable when the property is eventually sold. Chimera and other bondholders continue to receive payments on the delinquent mortgages even if the foreclosure process is delayed. Thus the proceeds we receive from the eventual sale of the property will be lowered by the amount of the payments that were advanced to us, but we end up with roughly the same amount of cash flow.

The other major news story relates to putbacks for violations of representations and warranties. There are a number of legal actions under way in which investors in certain non-agency mortgage-backed securities are seeking to force the original issuers of those securities to repurchase or buy back loans that they believe were misrepresented when the securities were created.

Buying out these loans at 100 cents on the dollar by the issuing banks could create a windfall for any security holder who owns an instrument at a discounted dollar price. Chimera owns many deeply discounted bonds, and we believe we could potentially benefit from the buyouts if they occur.

However we do not believe it will be easy to get the issuing banks to buy back the mortgages. Not only are the banks preparing to defend themselves by setting aside large legal reserves, but determining which loans were misrepresented is not clear-cut.

Barring a settlement of some kind, this will likely be a legal war of attrition that will keep the issue in the courts for a long time and reduce the amount that will be bought back. While Chimera may be a beneficiary in the future, we would caution anyone from thinking that it will happen soon.

The fixed-income market is now dealing with the threat of more large-scale asset purchases from the government. All investors in fixed income need to be aware that another round of quantitative easing from the Federal Reserve will reduce yields across all investment products, including mortgage-backed securities, and that we may be entering a challenging period of prolonged low interest rates.

Even with all this news the mortgage-backed securities market continues to provide in our opinion very attractive risk-adjusted returns. We continue to see attractive investment opportunities, particularly as the asset flows begin to pick up heading into year-end. And we believe that our strategy will continue to produce competitive rates of return that are attractive in a low-rate environment. With that, I'll hand it over to Alex and we will answer your questions afterward.

Chimera reported core earnings for the quarter ended September 30 of $139 million or $0.16 per share. As compared to core earnings, we reported GAAP income for the quarter of $126.4 million or $0.14 per share.

We declared a dividend for the period of $0.18 per share, producing an annualized dividend yield of 18.23%. Our book value at September 30 was $3.29 and we were levered, including nonrecourse debt, 1.3 times.

At September 30, our portfolio was weighted to be approximately 83% non-agency residential mortgage-backed securities, 12% agency RMBS, and 5% secured residential mortgage loans of high credit quality.

As Matt discussed, the spread compression during the quarter is the result of our slower deployment of capital from the secondary offering completed at the close of the second quarter. A significant percentage of new purchases settled in the last couple of weeks of the quarter; and as such we did not benefit from a full quarter run rate on the assets.

In addition, the Company had a full quarter run rate of interest expense associated with $450 million in notional of interest rate swaps that had a weighted-average pay rate of 259 basis points and a weighted average receive rate of 26 basis points, as opposed to last quarter, when the interest rate hedges had newly settled.

Also adding to the compression was an increase in interest expense associated with the amortization of the discount on sales of nonretained senior tranches of the resecuritizations that we completed in prior quarters.

During the quarter we sold RMBS with a carrying value of $206 million for realized gains on sale of $2 million. We did not engage in any resecuritization transactions during the third quarter.

At this time, we will turn the call back over to the operator and answer any questions you may have.

(Operator Instructions) Bose George, KBW.

Good morning. I had a couple of things. First, could you just go over the amortization impact on your cost of funds from the increased amortization of the nonretained seniors?

Sure. Because we consolidate the resecuritization transactions, for any tranches that were sold to third parties where we sold them at less than par, you record a discount on that debt. And over time as those seniors pay down, that discount between the proceeds you received on the sale and par is run through interest expense.

So for all of the nonretained pieces that are on our books, the expense associated with selling any of those seniors below par will run through income as those seniors pay down -- will run through interest expense as the seniors pay down.

So did the seniors pay down faster than expected? Was that why the amortization number went up?

Right, we have one deal in particular where we sold all of the seniors; and that deal paid a little faster than prior quarters. In addition to that, you see a full quarter of -- last quarter we reported we sold an additional $1 billion of nonretained seniors, and so you are picking up that now as the full quarter run rate as well.

Okay, but so from an economic perspective I guess it's a positive the seniors paying down faster, but --

Right, so that discount which you can see by looking at the Q, you can see the dollar amount. As those seniors pay down over whatever, the weighted-average life, between two to three years, you should expect that discount to run through interest expense on the nonretained portion.

Okay, great. Then just switching to the -- it looks like there was a $400 million increase in your subordinate bond holdings. Is that right?

I was curious how that worked, since you guys didn't sell any or create any new re-REMICs during the quarter.

We were still buying mezzes in the market rather than creating them. We were accumulating them off-balance sheet and then just buying the pieces back.

Okay. So you were -- so the increase was on securities that were mezzanine pieces that were purchased versus created by you guys?

Yes.

Right. They were straight purchases in the market.

Okay, great. Thanks.

Ken Bruce, Bank of America Merrill Lynch.

Thanks, good morning. So is it the intention to continue to buy mezz in the secondary market? Or do you expect to continue to create your own mezzanine going forward?

No, we will continue to buy them the same way.

Yes. I think it's whatever is cheapest.

Okay. From the -- can you give us any color as to what kind of subs you're looking at? Are these subs off a prime deal, Alt-A? What is your preferred investment area?

It's all similar. It's whatever provides the best relative value.

Yes. I think it was very similar to the collateral that we had been buying.

Similar to the collateral you had been buying in the first two quarters?

Yes.

Okay. Then as it relates to just in terms of the market itself, are you seeing any shifts? You had mentioned that your yields are possibly going to come under pressure with QE2. Have you seen any other either improvements or deterioration in the market that is going to -- changing your view in terms of how to invest in --?

No, I think we have the same view. Maybe paper is a little cheaper, but I think we are still putting it to work about the same levels.

Yes.

But paper being cheaper just at the -- you've seen increased bid lists that have been floated around.

A little bit.

I think the uncertainty in the mortgage market is starting to cheapen it up a little bit. I also think that we've seen a lot more -- at least a larger velocity of asset sales coming in the last couple of weeks.

I would also say that the dynamics of the market are such that the dealers I think are pretty long paper going into year-end. So I think there's a probability of prices could be stable to weaker going into year-end.

Okay. Just lastly, the pickup in prepayment activity, was that also what led to the deterioration in fair value, market values for the senior interest-only component (multiple speakers)?

Yes, we have a lot of I/O, and it's a confluence of things. You have higher prepayments, and then also we had a big rally in interest rates as well. So that does not bode well for prices of I/O.

Okay, thank you.

[Peter Holman, Parkman].

Hi, good morning. Good quarter. I was -- I've been seeing a lot of articles in the last week about spreads between TIPS and Treasury yields. I guess one article in the Financial Times said that the expectations for inflation this month are around 1.75%, up from 1.13% in August. Are you seeing any effect implied by the change in inflation expectations on your asset side?

And is higher inflation, i.e. cheapening of the paper that you referred to, widened spreads at all? So decreases book value; does it have any implications for what you might do with leverage or any sort of meaningful change in operational investment of the additional funds that you have yet to invest?

Thank you, Peter. I think these are all parts of the fixed-income market that make it very challenging to invest in. Inflation expectations I think we currently believe inflation is pretty muted and it will be muted in the foreseeable near future.

I don't think that we are particularly worried about how inflation will affect our portfolio. One of the nice things about being so lowly levered is that you don't have an awful lot of inflation risk embedded in the portfolio.

You know, we always consider leverage. That's one of the nice things about being low levered is that if you did believe that the market was sound enough and the counterparties were strong enough, we could take up our leverage and increase our earnings.

But I think all in all, I think the inflation aspects of our portfolio I think it's -- of all the things, all the risks we are taking right now I think it's pretty muted.

If I may ask just one follow-on to that, it seems to me -- but I am nowhere near as close to it as you guys are. You just mentioned the strength of counterparties and that sort of thing.

It seems like the market risk of weak counterparties, high volatility due to people, forced unwindings or things of that nature, has been reduced. Is that the case? Or are you keeping leverage low because some of that risk still exists?

I think in these assets, they are -- mortgage-backed secured, non-agency mortgage-backed securities still trade like a distressed market. And to borrow a lot of money from banks is still I think a dangerous proposition.

If they get scared again or something happens, they need to have capital, they could bump people off their balance sheets. I think in the non-agency space you have to be cognizant of those risks.

I think that's one of the things we are always weighing and thinking about. But we are always watching our counterparties very closely.

Good answer. Thanks very much and good quarter.

Douglas Harter, Credit Suisse.

Thanks, I was wondering if you could talk about what the market for doing new resecuritization looks like, and how that spread you can earn versus new assets is today versus a quarter ago.

Chris, you want to take that?

Sure. I mean, we can still mid to high teens in the mezzanine pieces. The collateral would probably trade anywhere, depending on the quality, anywhere from high single digits to low double digits. But by the time we get done resecuritizing it, it's still sort of mid to high teens for a number.

Has the overcollateralization or subordination changed at all?

Yes, I mean the rating agencies are a little more conservative than they were. But the market has gotten a little more liquid too, so we can sell a little further down the credit stack. So that's kind of takes care of that problem.

Great, thank you.

(Operator Instructions) Steve DeLaney, JMP Securities.

Good morning, everyone. When we look at the balance sheet as you reported it as at September 30, and your comments that a lot of things closed at the quarter end, should we look at what you're holding in these positions as the portfolio being fully invested, in terms of what you are showing at 9/30? Or do you have some flexibility with some additional repo?

It looks like the seniors, just specifically the seniors, which is kind of your raw material for your re-REMIC engine, it looks like they went up a couple hundred million from June to September. So how should we view your -- the reported portfolio vis-a-vis what it might grow to in the fourth quarter?

We can still do relative value trades, so we are always looking to trade up in yields.

I think that has been the constant. The portfolio is -- we have always been selling the AAAs off and buying and reinvesting. And that's really the portfolio activities that we undertake.

Okay, so just maybe moving out of seniors, moving into the mezz as Chris described earlier?

Right.

Okay. So I think what I am hearing is maybe we shouldn't necessarily assume that there will be another re-REMIC trade in the fourth quarter. You have been sort of doing one each quarter so far this year.

Well, if we can buy the mezzanine pieces, it wouldn't show up as a re-REMIC.

No, exactly.

But we get to the same place.

Okay. I guess this is just a housekeeping thing for Alex. You reported $1.57 billion of total repo. Can you give us a breakout between what was agency what was non-agency?

Roughly $200 million, which is unchanged from the prior quarter, is non-agency.

Okay, all right. Very good. Okay, I think that covers what I had. Thanks, guys.

Matthew Kelley, Morgan Stanley.

Thanks for taking my question. I'm just curious in getting your expectations for the final rules on risk retention and any comments on what the Fed put out last week.

From our point of view, it really doesn't change the nature of Chimera's business. We hold the subs anyway, and so it's not an issue for us in terms of can we resecuritize.

It creates opportunity for us. The banks can't or may not want to hold these pieces. So it's an opportunity for us because there is not a regulatory constraint on us regarding those transactions.

Yes, I think that's going to be a theme that we are going to see going forward here especially as the banks try to figure out how to optimize their balance sheets. Chimera doesn't have to hold regulatory capital against assets that consolidates on its balance sheet.

That will give I think banks an out in order to sell assets into the marketplace. We can securitize it and consolidate it on our balance sheet without a problem.

I think structurally that gives us an advantage; and we will see how that plays out over the next several quarters.

Okay, that's helpful. Then just on the topic of the resecuritization market, what is your outlook there? I know you have been doing about a deal a quarter in the past. But where do you see that going? How much demand is returning? And what are you looking for there?

It still seems like -- there's not a whole lot of -- there aren't any new issues in the mortgage market in the non-agency space. So there's a pretty good bid for re-REMICs.

It seems like it's still one of the cheapest sectors, so I think it's likely that the super seniors are going to keep ratcheting in it.

And to Chris's earlier point is that we can sell down deeper now in the credit stack. In the past, Chimera had only sold off AAA bonds.

The market is becoming liquid and people are stretching incrementally more for yield, and that means that we are able going forward probably to sell off double-A credit pieces and single-A credit pieces as well, and in fact more leverage on the securities.

Okay. Then just one quick follow-up for me. Can you guys give us an idea of your duration gap at the end of the quarter?

Duration gap?

Our borrowers are so low.

Yes. I mean our agency book is pretty well hedged. Got the non-agency stuff, I mean --

We really only have about $200 million worth of repo against (multiple speakers).

Yes, and I mean the relative duration of the non-agencies, it's not all that correlated to the Treasury market, right?

Okay. Thanks, guys.

Henry Coffey, Sterne, Agee.

Good morning, everyone, and thanks for going over all of this for us. In terms of trying to figure out the fourth quarter, obviously you have much higher balances now.

Looking at the weighted-average yield data you gave us, if we're going to try to translate that into sort of realized income, should we simply divide the yield by the average cost basis to get a sense of what the interest income generating potential of the portfolio is? Or what's the best way to think about this?

I can't tell you how to model the portfolio. I can tell you the disclosures in the Q give you a little bit more information.

The yield that is presented in the press release is a loss-adjusted yield, which does not -- as you can see, the portfolio is not taking a tremendous amount of credit losses. So it's a much more forward long-term yield.

So I can give you an idea that the balances and the annualized yield is loss-adjusted, and you should back out where we are currently seeing losses. But I can't really tell you how to --

And the denominator on the yield figure you gave us, that --?

It's weighted based on the current face of the actual assets in the quarter.

That's based on face value? Okay. So we just have to adjust for costs?

Yes.

In the Q there a way to figure out what kind of loss assumptions you are taking versus what you are realizing?

No, there is not. We don't disclose our expected losses.

But they are above your experience, so there's some pickup there.

No, our expected losses have been -- our expected losses are significantly higher than what has run through --

The portfolio is performing better than our expectations when we purchased it.

The portfolio is performing much better than our assumptions at the purchase date.

Given where cash balances are and if you do see some good opportunities in the fourth quarter, what's the logical funding source, the sort of permanent funding source? Is it more likely to be resecuritizations or equity or --?

Absolutely. I think the game is still or the business model is still to sell off senior bonds and retain the credit pieces.

And you are finding that market still pretty rich?

Oh, yes.

Thank you very much. I appreciate the help here.

Dan Furtado, Jefferies.

Thanks for the time. I think all my questions, my real questions have been asked. But just for clarification, can you help me understand the movement in the subordinated interest-only strips, the fair market value?

It looks that it's gone from call it $1.50 to $10 quarter-over-quarter.

The purchases that we had on sub I/Os during the quarter were purchases straight from the market. So the cost basis on those rather than the cost basis on the securitization is different.

Okay.

In addition, simply the weighting of the bucket is changing the weighted-averages there.

Roger that. Okay. Well, thank you. Nice quarter. Have a nice day. Appreciate it.

(Operator Instructions) Steve Mead, Anchor Capital Advisors.

From just a strategy standpoint, how are you dealing with the agency market at this point as a -- in terms of how much capital you commit to the agency market?

Well, we run our agency book of business relatively low levered. It serves a purpose on our balance sheet to qualify for the '40 Act test, so we keep a certain percentage of our assets in whole pool. We maintain our REIT status.

We normally think about meeting that test with buying raw loans, residential whole loans, and then securitizing them. Unfortunately that's not an option that's available to us in the marketplace. So we need to buy whole pool agencies.

And as such we only keep as much as we need to meet our whole pool test, and it's a very low levered investment. On a spread basis, it's a very attractive investment; but we want to be as pure a play in mortgage credit as we can be.

Then just help me out on the subordinated part and also the accretion of the discount. How does that work relative to how much you take in, in terms of accretion relative to par? Or what time frame, or what assumptions are you using?

On the subordinated pieces, depending on whether it's in a securitization, a resecuritization transaction, or whether we purchased it straight from the market, you amortize your cost basis to par as the securities pay down.

So based on the last caller's question, why was there such a significant move in prices? The newly purchased subs in some cases have a much higher dollar price, so will accrete from that dollar price to par versus what was previously in the portfolio at a lower dollar cost -- but would still accrete to par.

For GAAP purposes, we have a loss-adjusted yield that we accrete that discount. For tax purposes you accrete to par until the actual losses occur in those pieces.

But how much of the accretion in a sense is non-cash versus cash?

Well, the accretion for every dollar of principal that we receive back -- if we have a weighted dollar cost on the portfolio of 72 and we are receiving back par, that is real --

Real cash, right?

Yes.

Okay.

So that is real cash coming back to the portfolio.

Okay. And then in the quarter when you talked about the $450 million that was in a sense there that you had to carry through the quarter because you didn't put capital to work, do you have a sense of what that cost you in terms of how much that raised your cost of funds?

Are you referring to the swaps?

Yes, the swap, and the cost of funds that went from 293 basis points in June to 458 basis points in September.

Right, okay. So the swaps is $450 million at a weighted average cost of 233, of 233 basis points; so roughly $2.5 million in swap expense. And then what was the second part of your question?

No, that was it. Just sort of how much of the spread. But what other -- what were some of the other things that affected the cost of funds in the quarter?

Right. On the non-retained pieces that we've sold to third parties, if we sell the non-retained piece to a third party below par, there's a certain amount of discount that has to be run through interest expense as those bonds pay down.

And if they pay down faster, you take more?

Right. We may be selling those pieces above our cost basis and not -- for GAAP you don't recognize a gain. So we could in fact be selling them above our cost. But the debt, the way the debt is recorded for GAAP, the difference between par and where we sold it is interest expense to us.

Just going back to the senior nonretained, the $1.967 billion, how long do you have those bonds? In other words what's the maturity? How fast do those pay down?

You know, it's going to depend on the prepayment speed. It could be -- we have bonds that are as short as a year. We have bonds that are going to be five or six years.

Okay, but in general it's sort of one to five years in terms of how long you have that?

Yes, three years.

Okay, okay.

Some of those assets have been in the portfolio for over a year and a half or two years now, so some of them have paid down significantly on the non-retained pieces.

Okay, thanks.

Jeff Bronchick, RBC.

Asked and answered. Thank you, guys, ladies.

Bruce Harting, Barclays Capital.

Why isn't there more voluntary prepays or repays on your non-agency book? Is it just simply that the folks are underwater? That with rates where we are -- I'm just surprised that there is not a little bit bigger percentage of the folks who are performing that are actually able to prepay in this interest-rate environment.

Well, I think what we are seeing across the board is that paper that was originally labeled as Alt-A has very slow voluntary prepayments. Paper that was originally labeled and has higher FICO scores and better documentation in the prime paper, we are seeing higher voluntary prepayments on that paper.

By and large, I think you are seeing slow prepayments in the whole mortgage market because people don't have the equity in their homes that they once had. And that's probably a very large determinant of why people aren't prepaying.

Okay. Then all the headlines on -- if we could just go through, maybe you did in the beginning of the call and I missed. But the foreclosure issue, obviously no impact on your agency. On your non-agency, does that impact credit in any way? (multiple speakers) slightly higher?

No, I think that the foreclosure moratorium issue, the servicers continue to advance to us the principal and interest payments on the delinquent mortgages. They can delay the process and we are going to still get paid.

Net-net is that the proceeds -- when they sell the house in foreclosure the proceeds are reduced by the advances that they made to us. In the big picture our cash flows come out the same.

So we do have a larger I/O position in our book and the delay might be beneficial to that I/O position; but it's marginal at best. I think, we think it's a neutral thing for the portfolio.

With regard to the rep and warranty issue, again we have a very large discount on our book of business. Having the mortgages paid back to us at par would be a good thing.

We just caution people getting very aggressive in their thoughts on the time frame of how that could happen. We are in a very crazy world where you have the Federal Reserve in part of a legal action against one of the banks that it regulates. We've never seen anything like that.

Then you have all 50 state attorney generals also involved. I mean, so it's going to be in the courts. It's a very strange environment, and a lot of things are happening that we would've never thought possible even for the mortgage market.

So we just think that it's going to be something that's going to be adjudicated and be in the courts for a very long period of time. Unless of course (multiple speakers).

Matthew, does the trust --? Is it correct that you need 25% of the holders of the bonds to get together to enforce prepays? Or are you involved in any of that? I don't understand how that works.

There is a group of investors that have gotten together that have 25% of bonds, and they are going to try to compel the trustee till I give them access to the file and have them do due diligence on the loans. They review the loans.

I would imagine that there will be some legal issues with the trustees. I don't believe that the trustees will be that eager to do that.

At the moment we are evaluating all the options. We are looking at all the different proposals from people with regard to the rep and warranty issue, and we have yet to make any decision on how we want to act.

There is a certain amount of free ride in this. We'd like to see how the first couple attempts go, and we don't have to pay for legal costs of doing that, and we can see how things go in the future.

So the view that it's very difficult to organize bondholders is not correct?

No, it is. It's difficult to organize the bondholders. Even once you organize the bondholders, you still have to compel the trustee to let you in to do the due diligence on the loans. And then the due diligence is a labor-intensive, expensive process.

And then once you do the due diligence you have to then sue the issuer that he made material rep and warranty violations. The reps and warranties on these securities are not clear-cut.

The reps and warranties are heavily lawyered documents, and there are loopholes. It's very hard to push the loans back out.

Bank of America and JPMorgan has set aside very large legal reserves. I think that there will be some buyouts in the future. I think there will be -- there is some fraud in these securities; but probably not to the extent that some people have said there is.

I think it's going to be a time-intensive legal expensive progress. We will see how it goes. So we remain cautious.

Sorry to dwell on this. Are the parties that are initiating these actions and trying to pull together the bondholders in any group? Is that like a class? In other words if they approach you and you don't -- as you said, I think you called it a free option. If you don't help pay for the legal costs and they win, are you still covered on that?

Yes.

Okay. I don't know if I'm the last on the queue here, but on resecuritization I follow you, the text and everything. But just pulling back to 40,000 feet for a second, just what are you putting into these resecuritizations? And what is the decision-making model or decision tree for what gets resecuritized versus what's kept? Can you go back a step or two?

The underlying collateral that's being resecuritized is largely Alt-A and prime senior securities.

Generally the first cash flow (multiple speakers).

Generally, well in almost all cases the first cash flow. The bonds that we decide to ultimately buy and resecuritize, it's based on our view of which bonds are going to resecuritize the best and provide us with the highest yields on the sub piece based on the price where we can buy it.

So each bond has to do with what we think the prepayments are going to be, what we think the ultimate losses are going to be. And we run it through the rating agencies, what we think the credit support levels are going to be. And we factor in all those things before we actually make an acquisition.

Right now given rating agency restrictions or views of the bonds, you are still keeping everything below AAA and just selling the AAA?

Well, as we said before we have now have the opportunity to sell below AAA, so we will probably start selling double-As and single-As as well.

Okay, sorry, I missed that. Thank you.

I will now turn the conference back to Mr. Lambiase.

Thank you all for listening to our third-quarter 2010 earnings call. We look forward to speaking to you early next year. Thank you very much.

Ladies and gentlemen, if you wish to access a replay for this call, you may do so by dialing 888-286-8010 or 617-801-6888 with an ID of 61985205.

This concludes our conference for today. Thank you all for participating and have a nice day. All parties may now disconnect.