Cohen & Company Inc (COHN) 2007 Q3 法說會逐字稿

Good day, ladies and gentlemen. And welcome to the Alesco Financial Incorporated third quarter 2007 earnings conference call. Before we begin, Alesco Financial would like to remind everyone that information provided in its earnings release and during this call contains forward-looking statements, which involve a number of risks and uncertainties. Alesco Financial cautions readers that any forward-looking information is not guarantee of future performance and that actual results can differ materially from those contained in or implied in the forward-looking information. Factors that may affect future results are contained in Alesco Financial filings with the SEC, which are available at the SEC website at www.sec.gov.

At this time, all participants have been placed in a listen-only mode. Following formal remarks, the call will be opened to questions. I would like to now turn the call over to Mr. James McEntee, President and CEO. Please proceed.

Thank you very much. And good morning, everyone. Thank you for joining us. Also representing the company with me today is John Longino, our Chief Financial Officer.

Today, I would like to discuss the following. First I'll provide a brief overview of our performance. Second, I'll offer additional clarity on AFN's business model, including why we are favorably positioned relative to most of our peers as well as the company's true value proposition. Given the erratic nature of the market valuation of securities throughout this year and particular in the third quarter and the GAAP treatment that follows from such changes in valuation, this clarity is quite important.

Next, I'll provide you with information on our current portfolio and ongoing investment strategy. And I'll discuss where we see opportunities for our company going forward. Then I will hand it over to John Longino, who will discuss additional details on our results for the quarter and various key metrics.

With respect to the results for this quarter, I'm happy to report that we have adjusted earnings of $0.31 per share. As John will further explain, adjusted earnings is net income determined in accordance with GAAP, adjusted for significant non-cash items, such as realized and unrealized capital losses on investments, equity-based compensation, loan loss provisions and amortization of deferred financing costs.

Now as I discussed in some detail on the Q2 earnings call, I'd like to talk about how the significant headwind and the business climate in which we operate have impacted perceptions of our company. The marketplace clearly does not recognize the value proposition that AFN represented as reflected in the 30%-plus yield that our stock enjoys on its current run rate of dividends.

We believe that such perceptions are based on broad market conditions and do not give proper recognition to the following realities of our business. First, also keep in mind that we have a very simple business. Our business is much more boring than current market fluctuations would suggest. We loan money to financial services companies, mostly banks, and middle market companies. And we hold an ABS portfolio. And we earn spread income from this portfolio.

We have not been immune to the recent collapse of the mortgage securitization markets. But the remainder of our business, which is also the majority of our business in terms of invested capital and earnings power, remains attractive. In addition, looking beyond the exposure in the MBS portfolio, AFN continues to have a strong balance sheet consisting of historically low default assets funded with term non-recourse financing.

As John and I will further discuss, as of September 30th, we have $150 million of credit default swaps in place, $54 million of which were required this quarter, which should offset a portion of the losses we will ultimately sustain on our MBS portfolio. The unrealized gain on these credit default swap positions as of September 30 is $44 million.

Finally, and perhaps most importantly given current market conditions, we have no short-term, recourse, repo, or repo-like indebtedness, which might subject us to liquidity challenges. At the end of the quarter, we had unrestricted cash of $72 million. Following the October dividend distribution and the close of our recent Alesco XVII Bank TruPS transaction, we still have unrestricted cash of over $40 million with no contractual demands on that cash.

This brings me to my next point regarding the extremely erratic adjustments to our GAAP book value and GAAP earnings. This is a condition that effects most finance companies that are required to mark-to-market their securities portfolios. All of AFN's TruPS and MBS portfolios aggregating $7.7 billion are marked each quarter based upon the current market values of the underlying assets. The aggregate negative OCI and earnings adjustments recorded against AFN's book equity through September 30, 2007, related to these marks is over $1.7 billion.

It is important to note two key considerations that are now apparent from these adjustments. First, all of these assets are held subject to term financing. As asset spreads have widened, causing the negative mark-to-market adjustments, debt spreads used to finance these assets have also widened. However -- and this is the key point -- only the asset marks currently hit are book value.

A widening debt-spread environment means that, although there is a material value for AFN of having issued debt at levels that are now significantly tighter to the market and that such value should correlate well to the negative value reflected in assets as a result of widening asset spreads, this value is not currently evidenced in offsetting positive adjustments to our book equity.

Starting in January of 2008, if current market debt levels are maintained, there will be a substantial positive adjustment to GAAP book value as a result of AFN also being able to recognize changes in the fair market value of its debt under the new Fair Value Accounting Pronouncement 159.

In addition, the book value adjustments are required to be made under current GAAP rules regardless of economic risk. For example, the cumulative book value reduction for our Kleros real estate assets through September 30th is nearly $1.2 billion, although our aggregate amount at risk for these assets is limited to $120 million. If we were to dispose of the Kleros real estate assets, even by giving them away, we would enjoy a positive book value adjustment of $1.1 billion.

As a result of the GAAP treatment applicable to companies like AFN, we believe it is very important to understand the company's adjusted book value. We measure our adjusted book value by looking at the capital we initially invested in each asset class, reducing these amounts for any permanent impairments in the value of these assets. We have calculated AFN's adjusted book value in a table included in our Q3 earnings release.

Total capital of $629.9 million has been reduced by net cumulative impairments and losses recorded through the income statement at $109.2 million, resulting in adjusted capital of $520.7 million. Deducting recourse financing, our own trust-preferred debt and our convertible debt yields a net adjusted book value of $332.6 million or $5.62 per share at September 30.

Now let's move onto our current portfolio and ongoing investment strategy. Central to understanding how we are positioned to withstand current market conditions is understanding our investment portfolio and the strategy behind it. First, with respect to the overall strength of our portfolio, as we have detailed in the past, we have lived up to our commitment to investors to minimize interest rate risk and minimize funding risk by having long-term funding of our assets.

Of the $11.2 billion of debt on our balance sheet at September 30, 2007, only $190 million is recourse to Alesco Financial. This consists of $140 million of convertible bonds issues during the second quarter and $50 million of TruPS debt. The earliest due date for either of these is 2012.

As of September 30, we had $490 million of TruPS on warehouse facilities secured by $34 million of cash at AFN. These assets are held on three separate warehouse facilities, two of these warehouses having the aggregate $4.5 million of combined first-loss cash deposits, supporting approximately $132 million of TruPS assets. The third warehouse has $30 million of first loss deposited, supporting $368 million of TruPS.

The majority of the assets on this third warehouse were term financed through the closing of the Alesco XVII CDL last week. As of today, we have reduced our $368 million of TruPS on this warehouse to approximately $53 million, with the vast majority of this remaining balance being spoken for in other transactions. We expect to realize no meaningful loss on the $30-million first-loss position securing this warehouse.

The other two warehouses hold assets with spread below current market levels. Market conditions will dictate the ultimate disposition of these assets. However, the full $4.5 million of cash deposits on those warehouses have been written off at September 30, 2007, and are not included in our adjusted-book value calculation. While we continue to be a party to these warehouses, they represent no further liability to Alesco.

In addition, as of September 30, we had $196 million of middle-market loan assets on warehouse facilities secured by $20 million of cash from AFN. These assets are held in two separate facilities. The spreads on these assets are in line with, or very close to, current market spreads. And the warehouse agreements effectively extend until March 2008.

Consequently, we expect to be able to term finance these loans through future CLO transactions or through existing CLOs as paydowns occur. And therefore, we do not currently view our $20 million of cash deposits as being at significant risk of loss.

It is important to repeat that these warehouse lines are non-recourse to AFN beyond posted cash equity. They are not subject to margin calls. And AFN has no liability with respect to these lines beyond the posted cash collateral.

I stated during the earnings call for Q2 that we did not have clear visibility on how the securitization business would evolve over the remainder of this year. On October 30, we did close the Alesco XVII securitization. We were able to close this $400 million transaction, notwithstanding very difficult market conditions, without having to acquire any part of the debt in the securitization. Although the returns to us will be lower than prior deals, partly because the transaction is 97% bank TruPS, in view of the $30 million warehouse exposure we had, this is a hugely beneficial transaction to us.

We believe that our ability to execute the transaction was in part due to our strong reputation in this sector and to our manager Cohen & Company's ability and willingness to execute the transaction at significantly below market-debt placement fee levels.

We did consider waiting for the markets to evolve further before attempting to execute this transaction. But we balanced waiting against the risk of losing our $30-million warehouse position and concluded that preserving this first-loss position was critically important to us.

With respect to our overall investment portfolio today, our portfolio mix as of the end of the September quarter was as follows. Of the total of $630 million of capital, there was $221 million, or 35%, devoted to the bank and insurance TruPS business; $68 million, or 11%, devoted to the middle-market loan sector; $120 million, or 19%, in our consolidated MBS portfolio; $92 million, or 15%, in mortgage loans; $56 million, or 9%, in other investments; and finally, $72 million, or 11%, in unrestricted cash.

Our target equity allocations over the long term continue to be as follows -- 55% in the TruPS business, 20% in mid-market loans, 15% in MBS, 5% in mortgage loans, and 5% in cash and cash equivalents. Given current market conditions, we do not expect to continue to make additional investments at our historical pace until the ability of the company to raise additional capital in ways beneficial to existing shareholders becomes clear.

Now I would like to talk a little more specifically about our portfolios, starting with the TruPS, and why we remain positive on these asset classes. As of September 30, Alesco Financial held approximately $4 billion of TruPS loans to banks and approximately $1 billion of TruPS loans to insurance companies, continuing our consistent growth in this area from $1.8 billion in total back on September 30, 2006.

In addition to generating increased net investment income, the expansion of our TruPS portfolio has continued to enhance the granularity of that portfolio. Of the 323 distinct banks and insurance companies included in this portfolio, no single issuer represented more than 2.5% of the pool, 306 issuers each represented less than 1% of the pool, and 263 issuers each represented less than 0.5% of the pool. We continue to enjoy a total absence of deferral or default on this $5-billion portfolio.

Now we would like to turn to our middle market loan business, which also continues to develop quite well. We added over $176 million of loans to our balance sheet in the quarter, reaching $851 million as of September 30. This amount again represents slow and steady growth from the $266 million of middle-market loans on our balance sheet at September 30, 2006.

There have recently been varying reports of problematic conditions in the leverage loan market. However, we believe that the middle-market loans that have been acquired through our Emporia platform continue to represent an attractive investment opportunity for the following reasons. First, we believe that the inherent structural and credit protection built into the loans we do distinguishes them to the market as a whole.

Second, the diversification of this portfolio is quite significant. Further, we have intentionally avoided some of the borrower-friendly structural provisions that we have viewed as too aggressive. In particular, we have very limited exposure to covenant light loans. They represent less than 2.5% of our entire portfolio. The average borrower in our portfolio companies comprises 0.75% of the entire portfolio.

Through our proprietary platform, we have originated and retained about $190 million of our mid-market loans. Loans that we originate average nearly one full term less than the remainder of the portfolio in terms of leverage, which would be two full terms less than the broader market. Approximately 90% of our loans are senior secured first lien loans. These loans were made to companies in 34 industry sectors. And we have not experienced any significant credit losses or deterioration in our portfolio.

Going forward, we remain positive about this business for both the mid and long term. We are cautious given where liability spreads are currently and about access to available financing over the short term. Consequently, we are closely monitoring market conditions and reacting accordingly. However, what we are seeing in the marketplace generally and in the execution of the recent Alesco XVII transaction gives us some comfort that the market outside of the ABS business is stabilizing. And while the liability spreads are clearly wider than recent transactions, they fairly reflect broadening asset spreads.

Now let's turn our attention to our MBS portfolio. As we all know, it has been a very challenging time in this asset class. Conditions have only worsened since the close of the last quarter. Also, then as of September 1, 2007, none of the Kleros real estate CDOs are making cash distributions to AFN. The Kleros real estate CDOs have triggered overcollateralization tests as a result of significant rating agency downgrade activity. The net cash flow of the Kleros real estate CDOs is currently being used to pay down the most senior noteholders in such Kleros real estate CDOs.

Despite the fact that each CDO has triggered overcollateralization tests, the net interest earnings of these transactions continue to be reflected in AFN's net-investment income and taxable income. Further, the assets and income from these vehicles will continue to be factored into our requalification tests until such time as the underlying transactions are sold or otherwise disposed of.

The company has an additional $35.6 million in CDO investments collateralized by MBS securities. The value of these investments were deemed to be partially impaired as of September 30, resulting in a $12.2 million charge to the income statement. Over the last three to four months, we have taken steps to help mitigate the exposure related to our MBS portfolio.

As of September 30, 2007, we had in place $115 million of credit default swaps, or CDS. These represent short positions on bonds, which we believe will decline in value and possibly default over time. The CDS we had in place during the quarter generated an additional $32 million in unrealized gains, bringing the total unrealized gains to $43.8 million as of September 30th.

During the quarter, we also sold approximately $8.4 million of our CDS, realizing a gain of $1.5 million upon the sale. This $1.5 million is calculated in our adjusted earnings number. The $44 million number is not. We expect that any continued deterioration in mortgage market conditions may also result in additional gains in our CDS portfolio.

As of September 30, 2007, Alesco Financial holds a residual in $1.1 billion of prime whole residential mortgage loans. These loans are expected to perform in line with the industry. And cumulative losses in this portfolio are not expected to be significant. It's also important to know that our adjusted earnings, especially going forward, are not heavily dependent on our investments in this MBS portfolio.

In the third quarter, we had net investment income of $21.8 million, or $0.37 per share, and of this amount, approximately $3.7 million, or $0.06 per share, related to our MBS investments. Therefore, $0.31 per share of net investment income was generated from other investment classes. This does not give recognition to the income which we could generate from our CDS positions.

Now I would like to talk about our business going forward. Looking beyond the numbers, we think that there are various opportunities and challenges that are driving the markets in which we are active. First and foremost, we continue to see investment opportunities in the trust-preferred securities for the mid-market bank and insurance sectors. However, the current uncertainty surrounding the availability and cost of financing these assets has resulted in our taking a conservative approach to continuing to add assets beyond completing the open ramps and existing deals or in connection with deploying warehouse assets for which we have significant economic exposure.

We also see strong opportunities for investment done in the right way in the leverage loan sectors, which continue to deliver healthy risk-adjusted returns. Given what's happened to the price of our stock over the past several months, we also believe that using a portion of our liquidity to buyback shares of our own stock will provide a very attractive return to our shareholders.

To date, we have purchased only $2 million of stock at a weighted average cost of $4.64 per share. But we will consider an increase in our buyback activity as we certainly believe that buying our securities at a yield in excess of 30% is currently one of the best investments that we can make.

That being said, the timing and exact number of shares to be purchased going forward will be determined at management's discretion and will need to be balanced against the ongoing market conditions as well as our need to maintain an ample level of liquidity to effectively deal with our remaining Emporia first loss exposure as we did with Alesco XVII.

I will now turn the call over to John Longino, our Chief Financial Officer, who will discuss the company's financial results.

Thank you, Jay. For the second (sic - see Press Release) quarter ended September 30th, 2007, we had $18.7 million, or $0.31 per diluted share, of adjusted earnings, a non-GAAP measure of performance, as compared to $17.2 million, or $0.31 per diluted share for the second quarter. Adjusted earnings for the nine-months ended September 30 totaled $52.9 million, or $0.94 per diluted common share.

We define adjusted earnings as net income available to common stockholders, determined in accordance with GAAP, adjusted for the following non-cash items -- stock-based compensation, allowance for loan losses, unrealized gains or losses on derivatives, impairments on investments and amortization of deferred financing costs. We reported a GAAP net loss of $496.6 million, or $8.36 per diluted share, based on 59.4 million weighted average shares outstanding, as compared to a GAAP net loss of $47.2 million, or $0.86 per diluted share, based on 54.9 million weighted average shares during the second quarter. As I will discuss in more detail, this loss is primarily due to the $535 in losses related to other-than-temporary impairments of our MBS portfolio.

Adjusted earnings of $18.7 million reflects the following non-cash reconciling items arising during the quarter -- $535 million of impairments on MBS investments, $24.4 million of unrealized net gains on derivatives, $3.4 million of loan loss provisions, and certain other minor amounts reflected in the schedule attached to our earnings release. The result is $0.31 of adjusted earnings per share, which is consistent with the adjusted earnings of $0.31 per share for the second quarter and equals the dividend paid for the third quarter.

Net investment income was $21.8 million, or $0.37 per diluted share, for the third quarter and $20 million, or $0.36 per diluted share, for the second quarter. Related party management compensation, which is primarily asset management fees paid by the underlying CDOs, increased to $4.9 million as compared to $4.3 million for the second quarter.

General and administrative costs for the third quarter increased to $3.1 million as compared to $2.8 million for the second quarter. Both of these increases are in line with the increase in the number and average size of the CDOs in place during the quarter.

By far, the most significant number in the income statement for the third quarter is the $535 million unrealized loss on MBS investments. Our current application of generally accepted accounting principles requires us to mark the nearly $4 billion of MBS investments held on our balance sheet to fair value each quarter, but does not permit fair-value adjustments to the corresponding non-recourse liabilities supporting these investments.

GAAP also requires us to recognize in the income statement impairment losses on individual bonds within the $4-billion portfolio, which are deemed to be other than temporary. Through September 30, the fair value of these MBS investments has been decreased by a total of $1.2 billion, which includes $580 million reflected in other comprehensive income and a total of $590 million, including $535 million during the third quarter in the income statement.

As Jay previously indicated, this amount exceeds the maximum possible economic loss on this portfolio by $1.1 billion. While $590 million in losses have been recognized in the income statement to date on the MBS portfolio, the maximum amount of our economic loss exposure is $120 million. And none of this loss has actually been realized for tax purposes to date.

In addition, even at such time as these losses might be realized for tax purposes, they would represent capital losses, which would not be deductible in determining retaxable income and the related minimum dividend distribution requirement for REITs of 90% of retaxable income.

Interest and other income of $4.3 million consists primarily of interest earned on restricted cash held in deals which closed earlier in 2007. This is down from $5.6 million of interest and other income for the second quarter, as the restricted cash amount has decreased as proceeds are used to obtain additional TruPS and mid-market loans to fully ramp each of the closed deals.

Restricted cash totaled $174 million at September 30 as compared to $490 million at June 30. As Jay previously indicated, the $32 million of unrealized gains on credit default swaps for the quarter relates to short positions on bonds, which if the general mortgage market conditions continue to deteriorate, we believe will continue to decline in value and possibly default over time. During the third quarter, we also realized a gain of $1.5 million on the sale of approximately $8 million of credit default-swap positions.

As of September 30th, after reflecting mark-to-market adjustments, our investment portfolio totaled approximately $9.7 billion, including $4.9 billion relating to TruPS and subordinated debentures, $2.8 billion in mortgage-backed securities, $1.1 billion in residential mortgages, and $0.9 billion of leveraged loans.

Our investment portfolio was financed with approximately $11.2 billion of total indebtedness, including $9 billion of CDO notes payable, $1 billion of securitized mortgage debt, and $0.5 billion of trust-deferred obligations, $0.5 billion of warehouse indebtedness, and $0.2 billion of recourse indebtedness.

Also as of September 30th, we have negative GAAP book value per share outstanding of $21.30. Book value is calculated by dividing stockholders' deficit by the number of common shares outstanding. Total stockholders' deficit was over $1.2 billion. And total common shares outstanding were 59.2 million.

Our equity has been reduced by write downs of MBS by over $1.1 billion beyond our possible economic loss. During the three-month period ended September 30, we recorded an additional unrealized loss within other comprehensive income of $425 million on the mortgage-backed securities included in our portfolios.

We've also recorded an unrealized loss within our other comprehensive loss of approximately $650 million on the TruPS and subordinated debentures that are consolidated in our financial statements. The unrealized change in fair value of TruPS is primarily attributable to increases in credit spreads due to recent developments in the macro-credit markets. We currently do not expect to suffer any economic loss on our TruPS portfolio beyond the $4.5 million of warehouse deposit losses previously mentioned by Jay.

As a result of the erratic adjustments affecting our book value required under current GAAP, we believe it is very important to understand the company's adjusted book value. We measure our adjusted book value by looking at the capital we initially invested in each asset class and reducing those amounts for any permanent impairments in the value of those investments.

We've calculated AFN's adjusted book value in a table included in our Q3 earnings release. Total capital of $629.9 million has been reduced by cumulative impairments and losses recorded through the income statement of $109.2 million, which is net of $45.2 million of gains on our credit default swap positions, resulting in adjusted capital of $520.7 million.

Deducting recourse financing, represented by our own trust-deferred debt and convertible debt, totaling $188.1 million, results in net-adjusted equity of $332.6 million, or adjusted book value of $5.62 per share, based on 59.2 million common shares outstanding.

We've also reconciled GAAP book value to adjusted book value in a separate table included in our earnings release. We define adjusted book value as stockholders' equity or deficit determined in accordance with GAAP adjusted for the following items --accumulated other comprehensive income and loss, permanent impairments recognized in the income statement that are in excess of our potential economic loss, deferred financing costs that we anticipate adjusting in connection with our expected adoption of FAS 159, and other non-cash adjustments to retained earnings that are included within our adjusted earnings calculation.

Starting with stockholders' deficit as reported of $1.26 billion and adding back accumulated other comprehensive loss of $1.16 billion as well as the overimpairment on Kleros real estate MBS of $470 million and other non-cash items totaling $11.8 million and then deducting deferred financing costs of $7.7 million results in adjusted stockholders' equity of $332.6 million. Dividing this amount by 59.2 million total common shares outstanding results in adjusted-book value per share of $5.62.

We believe liquidity is vitally important, especially in the current difficult market environment. Fortunately, we entered the fourth quarter with over $72 million in unrestricted cash after allowing for our dividend payment on October 1st and absolutely no short-term financing, which would subject us to margin calls or termination of financing on any of our assets.

At this point, I'd like to turn the call back to Jay.

Thanks, John. We know that the broader-market issues have raised significant concerns. So we hope today's information about our business model, our competitive strengths and our portfolio is helpful in presenting the AFN story and convincing you why it is a good story.

We have a strong balance sheet. And we are excited about the outlook for the rest of the year and beyond. We have a clear strategy ahead of us, a great foundation behind us. And we are a leading force in our target asset classes.

Also, while we aren't interested in raising capital at current price levels, it is prudent to be prepared so that we can be opportunistic. To that end, you may see us replenish our shelf registration. But that should not be taken as a signal that a capital raise is imminent. We will evaluate opportunities as they arise.

Most importantly, we remain focused on translating our progress into value for shareholders. To that end, based upon results for the third quarter and what we know today, we expect to be able to maintain our dividend at or above current levels tracking the per share adjusted earnings.

I can specifically reaffirm dividend guidance for the fourth quarter at the previously announced $0.31. With respect to 2008, we believe investors should anticipate that the dividend will be in the range of $0.25 to $0.30 per quarter. Our portfolio's fairly well established at this time outside of the ABS assets. So we have confidence in this estimate. The performance of the ABS assets will dictate whether we reach the higher part of this range.

So now I would ask the operator to open the floor for questions.

(OPERATOR INSTRUCTIONS) And your first question comes from the line of Jason Arnold, RBC Capital Markets. Please proceed.

Hi. Good morning, guys. Thank you for, again, a very comprehensive earnings call. It's very helpful. A quick question on the other investments of $56.4 million. What exactly are those?

Well, as you can see, we've actually taken some impairments on some of those assets. There was about $20 million of those, which related to TruPS that we financed directly on our balance sheet, all of which have moved into Alesco XVII or a prior Alesco deal. We also then have minority positions in certain investments, which are supported by MBS. And the net position that's left on those is about $28 million.

Okay. What exact type of minority investments are those?

Yes, they were Libertas transactions that were done by our Strategos Team, the same team that does the Kleros transactions. So we have an aggregate of -- add this up for me, John.

The aggregate on the Libertas was 38 gross.

Notional was 38. We've impaired some of that.

Yes, it was 17 of that.

Okay. All right. Another quick one -- I guess just in terms of the TruPS credit performance expectations going forward --

Yes.

I don't actually foresee massive problems here over the near term. But I'm just curious given that there were a lot of issues in 3Q07 bank earnings, particularly in some of the smaller banks. Do you guys kind of shadow rate perhaps some of the TruPS in your portfolio and maybe try to actively dispose of anything or manage those credits? Or do you really foresee really any problems in the TruPS side?

Yes, well, we do shadow rate them when we acquire them so we have an understanding going in as to what we would expect the rating to be. And we do follow them quite carefully throughout the term of our holding of them.

What we see today is there's no question there's some earnings upset in the greater bank environment. We're seeing some of that -- not a tremendous amount -- but some of that in our portfolio. But we don't --sitting here today -- we don't expect to see material credit degradation there in that the portfolio has performed default and deferral free. We don't really expect that. We are in the lending business and do over time expect rational levels of deferral. And I'm sure that we'll see some of that at some point. But sitting here today, notwithstanding what's going on in the marketplace, we don't anticipate anything in the short term.

Okay. That's helpful. Thank you. And I guess just a couple other quick ones. On the GAAP book value perspective, I think most probably understand what the story is there. And thank you for your color. I'm curious about as to whether over the near term prior to adoption of the new accounting rules if there are any borrowing covenants or other auditor issues that could come up from having a negative book value.

We've had those discussions with the auditors. And we don't anticipate any such problems.

Okay. Perfect. And then just one other quick one -- could you give us the exact dollar amount of the TruPS assets and MBS assets at the end of the quarter? I think you offered the total. But I didn't see a --

Yes, the TruPS was approximately --

TruPS was $4.9 billion. I had those, $1 billion of which is insurance that balances banks.

Okay. Thank you very much.

And your next question comes from the line of Jim Ballan, Bear Stearns. Please proceed.

Hi. Thanks a lot.

Hi, Jim. How you doing?

I'm good. How are you guys doing?

Good.

Jay, you mentioned the leverage loan assets that are in the warehouse. Can you -- I guess two separate warehouses.

Yes.

Can you talk about your confidence given that those are assets that are sort of at market rates?

Yes.

Talk about your confidence in terms of your ability to get those done for those, I guess, by next March.

Sure.

Or what your other options are.

Yes, I would look at it in two ways. One, we're seeing -- we saw over towards the end of the summer a large number of CLO transactions being done in the marketplace. Those were dominated by warehouse-clearing transactions with people having assets that were below market. Of late, we're seeing a few more what I would say market-driven transactions, mostly on the broadly syndicated side, not the middle-market loan positions.

Okay.

So our expectation is that that market will evolve as well, so that by the time the warehouse expires we will be able to deal with these assets. Having said that, that's not really what we're planning towards. We're planning towards continued credit implosion, not with our assets, but just the investor interest for these assets. So we have -- from the summer -- have been in very active discussions with our warehouse lender. And that warehouse is, as I mentioned on the call, made up of close to if not at fair market-value assets. So there hasn't been degradation of the fair market value by virtue of credit spreads.

Right.

One of the main reasons why I haven't bought back stock is because I want the cash on my balance sheet to deal with a failure to otherwise deal with the assets. In other words, if I can't get a CLO done and I have to post additional first loss for that warehouse in order to stop the lender if he otherwise was so inclined from liquidating the assets, I would be in a position to do that. So and I've had lengthy conversations with the warehouse providers, actually an offer in front of us that is reasonable, not perfect, but reasonable to allow a reasonably long-term expansion of that warehouse.

So I'm quite confident that on the Emporia side, the middle market-loan assets, we will not suffer a loss on that first-loss piece, particularly given the liquidity I've maintained in our balance sheet. And I'm somewhat bullish, although I can't -- I don't have enough data to point to with certainty -- but I'm somewhat bullish on our ability to effectuate a securitization with those assets.

Great. That's terrific. Two other quick things -- can you talk at all about your expected returns on Alesco XVII? I mean, I know you talked about how it's probably less than what you've done on -- you have on X through XVI.

Right.

Can you give us any kind of feel there, or --

Yes, the equity return on that investment is just below 10%.

Now is that the gross ROI? Or is that the ROE after expenses?

After expenses.

That's after fees. Okay. And with your guidance of possibly having the dividend come off a little bit next year --

Right.

Just your thoughts on maintaining REIT status. I know it's something we've talked about for awhile.

Yes, REIT status doesn't appear to me to be a challenge. I think that the earnings estimate or the dividends guidance I'm giving doesn't count what I would call phantom income from some of those real estate transactions. But the phantom income does count towards requalification.

Right.

So I don't over the short term have any concerns about requalification really through '08. I don't think it's a challenge for us. I think at some point those transactions if they don't go back to performing at some level will go away. And we'll probably want them to go away. So we would have to wrestle with REIT status issues at that point in time.

But keep in mind that in the back of all of our minds is the potential to convert to PTP status. And one of the drivers for us in that conversion is to maximize flexibility for asset selection.

Right.

And so if we were to go down that route, obviously, we're voluntarily moving away from REIT status but maintaining the business in a past due vehicle. So part of the consideration long term for PTP status would be the focus on the retaxable income requirements and our obligation to invest in assets that maybe over the short term we don't really want to invest in.

Yes, I was actually--I mean, I understand what you're saying about the gross asset and income test. I was just thinking in terms of your requirement to pay out 90% that--I mean, just say if you're at--I mean, just let's say you're at the middle of the range at--

Right.

-- cents.

Right.

And if you're continuing to put more capital to work, that 90% number may be tough to hit. That's what I'm --

Yes, I mean, maybe. But a couple things. One, we're not going to allow the balance sheet to go down to zero. So part of the liquidity, I think you'd admit we've done a pretty good job of maintaining liquidity of the company. And we're not going to go to sleep on that issue. So part of that would be distribution requirements. But also, the spread is $0.06 a share for the two assets.

And the other thing that we're not paying attention to right now is the CDS. We've got tremendous amount of gain, which will convert to cash, embedded in the CDS assets that we have.

Okay. Great. Well, thanks a lot.

Sure.

And your next question comes from the line of Paul Berman from RBC Dain Rauscher. Please proceed.

Gentlemen, thank you. I'm a 27-year veteran of the securities business. I'm a retail broker with RBC. And you started your comments -- and I'm a personal shareholder as well. You started your comments that you're in a simple business and then proceeded to go on a half hour detailing all the details of your business, which sounds fairly complicated to me.

A couple questions -- one, our analyst just downgraded to sector perform your stock with a $4 target. Can you explain to me how -- I haven't seen too many times in my career where a stock trading at $4 has a $1 to 125 dividend per share. Is it just a mass confusion, misinformation, fear that you're part of the investment world it's currently going through that's creating this opportunity, one?

And two, at what point -- I heard your--the second part of the question is the liquidity issue, of maintaining liquidity. But recently, four or five months ago, doing an offering at $9, seems to me the best use of your cash is to be able to buy that stock back at $4 or $5.

Right. Well, sure. A couple things -- in terms of my comment relative to our business being simple, the business is quite simple. It's the accounting that's exceedingly complex. And it's unbelievable how complex the accounting has become. But the reality is we're in the business of lending to financial services institutions and mid-market loans, a business that has been around forever.

The ABS part of our business, which frankly we thought was going to be the simplest of the business, has become both complex from an accounting perspective, and also the reaction in the marketplace to that business is appropriately quite negative.

But in terms of the rating of your analyst at sector perform, I don't really have a comment on that except just to suggest that people don't believe in the dividend. That would be the only reason why the stock would trade at the levels relative to the dividend payout that it trades at. People don't believe it. And the market, the financial services business in general and our business in particular, is getting hammered. And so skepticism is understandable.

But I think taking some time to understand what we have here is a nice relatively small boutique franchise focused on financial services companies, mostly banks. And even in the worst of times and even in the height of the S&L crisis, there's certainly a lot of headline risk associated with banks. But when you look at the numbers, it's a pretty good performing sector.

And in terms of the insurance and mid-market loan portfolio, the insurance businesses are in general exceedingly overcapitalized at the moment. They have very transparent and non-sexy investment portfolio, at least in companies that we're investing in, the smaller ones. And the mid-market loan business is a business been around -- probably the second-oldest profession.

And it's one that we have a fantastic team devoted to. And they've done a great job. And performance there is -- I'm quite confident will continue to be very good. We're not seeing any deterioration in the credits that we have. We have focused on avoiding some of what are now the headline risks in that sector, which is the covenant light provisions and the large loans that are more bonds than they are loans.

And in terms of liquidity, I agree with you. I struggle constantly and we struggle internally about buying back stock. I'd love to buyback a tremendous amount of stock. One of the things that we have happening is we have been, as I mentioned, very focused on the liquidity issues surrounding the first-loss pieces that we have, or the first loss commitments that we have.

We've done a great job of working out of the Alesco first-loss commitments. And we're not quite out of it yet. But as I mentioned, we're down to about $50 million of assets on that $300-plus million line. And we're very quickly finding homes for all those assets. That $30 million is going to come back to me. So while my cash position, that's not counted in the cash numbers that we give you. So I'm hopeful of increasing my cash position by $30 million.

On the Emporia side, I have $20 million posted on a first-loss piece or two actually. And it's very important to me not to lose it. And I think I want to be in a position to increase it if I have to. But we're also working aggressively to enter into another transaction there. And we think that the cash position of the company is likely to get better, and that will offer greater opportunity. But until it actually gets better, I need to be fairly conservative.

Is there anything that you could comment that you would anticipate happening that you could not maintain at least a $1 per year dividend?

Well, I mean, we have positions in these various asset classes. So we've wiped out of our minds -- I wish I could stop talking about it -- but we've at least wiped out of the balance sheet the ABS position. So we're left with equity investments in the securitizations that provide financing to banks, insurance companies, and mid-market companies.

We expect, and we expected when we went into these transactions, to have some normalized level of default inside these portfolios. So far, we haven't suffered that normalized level of default. But I'm sure over time, everything reverts to the mean, over time we will. That normalized default level will not jeopardize the dividend payout.

If for some reason there is a deep prolonged recession that massively affects credit across the board, we will suffer from that as well. I think we'll do better than the market. But if the credit impact is deep enough, it will affect us as well.

Gentlemen, thanks for your hard work.

Thank you.

Your next question comes from the line of [Mark Kaverus], private investor. Please proceed, sir.

Yes, what percentage totally is all of your assets in the residential mortgage-backed securities now compared to what it was before the big problem happened?

Sure. The aggregate is 24%.

If you take the MBS out of the equation, if you look at residential commercial mortgages and the other investments which the portion that are supported by MBS, it's about 24%.

So that's what it is currently?

Yes, I'm taking the 19% related to the Kleros real estate MBS out of the number because --

Okay.

That's the capital that's devoted to those assets.

Capital that's devoted currently. What was it for the previous quarter?

It was a little bit lower at the end of the previous quarter.

It was a little bit lower. Okay. Just in that one sector alone, do you expect the increasing default in that sector to affect the bottom line?

Well, we have -- the income -- the return on that investment is incredibly low. And as I mentioned, we are somewhat mentally writing it down to zero when I give my dividend guidance. So we never expected to have a tremendous amount of yield from those investments. They were always viewed as, frankly, being somewhat safe. They're highly rated securities. The average rating in our portfolio is single A. And we didn't expect to have any credit issues, any meaningful credit issues, with these portfolios.

They assisted us in requalification. And they lined up well with the competency of our manager at Cohen & Co. So the reality is a continued deterioration in that sector is, frankly, something we're baking into our analysis.

Importantly, though, we began earlier this year adding -- getting a credit default swap portfolio together. We are $44 million in the money on that default swap today, meaningfully offsetting some of the money that we're going to lose on that portfolio. And if that portfolio -- if the credit default swaps were to go down in value, it would be because presumably the sector as a whole is coming back. So the value proposition on the other side, the assets that we hold, would probably correlate well with any reduction in that credit default swap value that we've realized.

Thank you very much.

Your next question comes from the line of Jim Delisle, Cambridge Place. Please proceed, sir.

Good morning, guys.

Hi, Jim.

Hi, Jim.

Hi. I think any of us -- I think you guys did a very, very good job laying out how the negative whatever it is book value under GAAP is complete and total bologna. That is going to be -- I won't even use the term likely -- but is going to be substantively reversed as soon as 159, 157 is adopted. Have you -- and I apologize if you've already disclosed it. I jumped on late. Have you come up with what a pro forma -- not your economic book value. I understand that -- but what a pro forma book value would have been this quarter had you had the good fortune, I guess, to have adopted 157 earlier this year?

Yes, I mean, it's not going to -- we're working through the exact calculation. We do not have that. But it should not be dramatically different from what we've presented as an adjusted-book value number. It will be directionally equivalent to that number.

All right. And I mean, to the extent that you are able to kind of work that through and deliver it sometime over the course of the quarter, that'd be a wonderful 8-K so we could start actually operating from a denominator on our GAAP models that doesn't give us a negative multiple.

Yes, I mean, Jim, it's both a huge task because we're valuing all the liabilities that we have reported on our balance sheet. And it's also a moving target because the liabilities change everyday. So there is some reluctance to throw numbers around until the date at which we're supposed to throw the numbers around. But I mean, the direction of these things, quite obviously, they all move together. They don't necessarily move penny per penny together. But in the correlation over quarter in and quarter out, we'll get -- I'm sure will be somewhat upset in one way or another from time to time. But I think it's safe to believe that they'll correlate quite well.

Great. And I think this is a great textbook example as to why 133 was insufficient for businesses like yours. Thanks a lot.

Okay.

Your next question comes from the line of Marvin Loh, W.R. Hambrecht. Please proceed, sir.

Hi. Morning, guys.

Hi, Marvin.

Quick question -- on the $0.31 that you guys are maintaining, that assumes a certain amount of cash flow still coming under the MBS portfolio. Is that correct? Or are the other portfolios sufficient to generate that kind of cash flow?

It assumes that we're going to be required to continue to continue recognize income on the MBS portfolio at some level. In order to be at $0.31, we would need to continue to recognize that income and be required to dividend out 90% of that.

Okay. So but in fact, is cash flow going to be there? I can understand the accounting with regard to needing to recognize it for the 90% level. But is there actually cash flow from those portfolios at this point? Or do you have to go more into your liquidity or reserves to make that payment?

Jim, the downside on cash flow is 25. If there's zero cash flow from any of this portfolio, what that doesn't recognize is, as time evolves, we're continuing to complete ramps on existing deals. So if you look at Alesco XVI, for example, we still haven't filled all those assets. We're doing that right now. So even with those, when those are filled up, if there's nothing realized on the mortgage portfolio, probably won't get quite to $0.31. But we're pretty close.

Okay. Okay. Outside of filling the Alesco transactions that still have some capacity, are you making any other loans at this point?

We have on the trust preferred side -- we will only make a trust preferred loan to the extent necessary or appropriate to fill unfilled ramp on deals that we've done, including now Alesco XVII. On the Emporia side, we have a warehouse there with significant exposure, almost $200 million as I mentioned. We've materially slowed down that effort until we can see what opportunity there may be to securitize those assets.

So if the securitization business continues to be very slow or not opportunistic for us, you could expect to see very little added to that Emporia warehouse on the next call. Conversely, if we're bullish and confident that we can get a securitization done, we'll have to ramp that a little bit more in order to effectuate the securitization.

Okay.

At the end of the quarter, we had unfilled in our various deals $153 million. We could continue to ramp $153 million of assets to fill up our Alesco and Emporia securitizations.

Does it stand to reason that the actual returns on those portfolios would be in theory higher because you've -- particularly with Alesco XVI, where you locked at a more favorable point in the market, you're able to fill with the current spread levels in the market. So your return could actually be higher than what you would've initially anticipated.

Yes, spreads are widening. They have certainly widened in the TruPS business. And the effectuation of that securitization did lock down liabilities at a tighter level than today. I mean, it's not dramatic. But there is some movement there. And on the Emporia side, that's more true from a dollar-volume perspective, although spread widening has not been acute there.

But over time, the Emporia assets tend to repay more. And there's much more active replenishment of assets on the that side. So we would expect to see that more on the Emporia transaction than the Alesco one.

Okay. Great. One just quick question--the MBS deal that you closed this fall, which is outside of the Kleros CDOs, is that performing still as expected? I know there were like 740 FICO score type profiles on that deal.

Yes, that's a mortgage portfolio that we acquired first quarter, I believe, and then securitized in the third quarter. And that's all very well performing now since we don't -- that type of asset is not really getting -- is not being affected by what's going on in the credit markets. We don't expect any material damage to be done to that portfolio over the short or long term.

Okay.

But the loan losses are running a little higher. So you'll see in the table we're only showing 1.35% return on that capital for the third quarter. We expect that'll get better in the fourth quarter.

It's almost a function of as long as you don't have to write it down, the market's going to be happy.

Right, right.

Good job maintaining the dividend. I quite frankly think you're the only company in this space that I know that hasn't cut it. So excellent job managing through this process.

Thank you.

Your next question comes from the line of Marc Berger, MKB Associates. Please proceed, sir.

Hi, John. How you doing?

Hi, Marc.

To echo all the other sentiments, thanks for the great breakdown on everything, and certainly is good guidance as most people can see. The question I have with regard to the credit-default swaps, how much do you actually have in there? I wasn't sure if you said $115 million or $150 million.

$115 million.

So 1-1-5.

Right.

Okay. And about $50 million or so were added on for this third quarter.

$64 million.

$64 million. Okay. So of that $115 million, you have an additional 44 as a gain.

Yes, unrealized gain.

Okay. So in effect, that whole credit-default swap is more than enough to cover the whole MBS portfolio going down of the $120 million.

No, the $115 million is the notional amount. The $44 million would be the potential gain that we have on that. That's the inherent gain today. So the $114 million, if all $114 million went to zero -- God forbid that happens -- but then yes, there would be -- that's the potential realization. But I mean, that's not what we expect. We don't expect to see all these bonds go to zero. But given what we're seeing in the marketplace today, additional diminution in value of those underlying bonds is quite possible and would increase the $43 million if it actually happened.

Okay. So that $44-million gain is part of the total of $115 million. You didn't invest the total of $115 million.

No, the $115 million is the notional amount. That's not an investment by us. We sold the bonds short effectively. And that short sale is currently reflecting a $43.8-million gain based on the market prices that we have today. $8 million of the $114 million notional was disposed of in the quarter.

Okay. Now do you also give the possibility of taking some more profits on that portfolio as you feel a little bit more comfortable that things aren't going to get a heck of a lot worse, use that money to purchase more shares and get the 30% dividend on it?

That's absolutely a possibility.

Okay. Now also your warehouse, how much is left in the warehouse? Is it $153 million left?

We have two -- you should look at the warehouses in two ways. We have remaining on our balance sheet a $20-million first loss for one trust preferred warehouse. That trust-preferred warehouse has today -- I'm sorry, $30 million. That trust-preferred warehouse today has $53 million of assets on it. We're quite active and encouraged that we'll use up those assets in a variety of different ways so that that first loss, that $30 million in restricted cash, will come back to us to be used as we see fit.

The second way to look at our warehouses -- we have two that work together. But we have two warehouses on the Emporia side, the middle-market loan side of our business. We have $20 million of first loss posted there. I don't have the same feeling of urgency that I did on the trust preferred side to utilize those assets in the short term, in part because the warehouse is good -- by its term -- good through March, and also because the assets there continue to be at our about fair-market value from a spread perspective.

So I'm not quite as nervous about that as I was the Alesco. And I'm confident that one way or another, whether extending that Emporia warehouse or effectuating a securitization that that $20-million first loss is safe.

And how much is the $20 million backing?

Just under $200 million in assets.

$200 million assets. Okay. All right. So basically, we're also looking at the possibility in the next quarter $30 million coming back into the cash also again to be used to buyback stock as well.

That is a possibility.

All right. And that would free up, again, your cash. So you're certainly in a very stable liquid position.

We have no liquidity concerns at all.

Okay. Thank you very much.

Thanks.

Your next question comes from the line of Tom van Buskirk, McMahan Securities. Please proceed, sir.

Hi. One of my questions was already answered. But I do have another one on the restricted cash. I understand what the two pieces in the warehouses that you just described are. But if you could just sort of breakdown the whole $174 million in restricted cash and warehouse deposits, just where the remainder of it is. I think I missed that.

The restricted-cash balance is basically cash that sits in the Alesco and Emporia deals that we've closed already but where we haven't fully acquired the assets to totally ramp those deals. So it's in several of the different Alesco deals. And a big piece of it is also in Emporia. But we don't count that in what we refer to our cash balance. That restricted cash is not available to us. So we don't count that as what's available.

That cash is dedicated to actually buy additional assets into the deals.

No, I understand that. I'm thinking more in terms of how that relates. So is that different then from the $30 million and the $20 million that you just discussed on the Emporia and Alesco pieces, the first-loss pieces that you expect to have come back to you?

Yes, that's part of the restricted-cash balance.

Okay. Then what I'm trying to do is just figure out what the rest of it is. So it's just spread among other facilities that are ramping?

Yes, so when we close the Alesco XVII transaction, for example, the equity commitment that we make to that might be $25 million. That $25 million, we write the check at closing. It goes into the account that, in effect, holds the securitization. Until the assets are fully ramped, it's not for GAAP purposes fully utilized. So it goes into an available but restricted cash bucket. And it's somewhat deceptive because it's not restricted to us. It's devoted --I mean, it's not available to us. It's devoted to that deal, already part of the transaction that we effectuated in connection with Alesco XVII. And the same is true of other transactions.

So it tends to reflect cash that's devoted to assets, in most cases permanently, not so with respect to warehouse, but in most cases permanently. And the restricted bucket evaporates as the assets are ramped.

The components will be laid out in our Q, which will be filed in the next couple days here.

Okay. That would be helpful. So basically, I could understand it as the pieces that you discussed separately, you will see at least portions of that come back over time. But other pieces will not. They'll stay within the trust.

They'll turn into TruPS or mid-market loan assets, which frankly should then give us additional yield beyond what we're getting on the cash.

Got it. One follow up -- and this is more of a general question. I think one of the problems that people have had in looking at Alesco and at other similar kind of entities is it's been very difficult to look inside. In some cases, you can look at trust data that's provided where the securitizations have been public deals. And in your case, you don't really have anything similar to that to show the underlying performance of the assets in the securitizations.

And I think if there were a way that you could provide more granularity there and more detail there, you might get some extra comfort from investors on that. Is there anything that you can do to add a little bit more in your disclosure on that?

Yes, and it's a fair comment. It's one that we struggle with. Not most, but many of the companies that we're lending to are private companies, and we're not allowed to provide any access to the information. We certainly -- and maybe we should focus on this -- we certainly can go securitization by securitization and demonstrate the performance of the aggregate securitization. That's not a hard thing to do.

I think that's more what I was going for. Even if you could show how the individual trusts were performing --

Sure.

-- I think that would help provide some [status] on those.

Yes, that's a good comment. And let us think about it a little bit.

Okay. Great. Thank you.

Your next question comes from the line of [Scott Barrett], [Feingold O'Keith]. Please proceed, sir.

Hi. Yes, thank you. It's [Scott Diorsey] at Feingold O'Keith. Could you comment a bit further on the $50 million in the warehouse, $30 million of which were the trust preferred and $20 million for the Emporia side? What exactly has to happen? What are the events for that cash or a portion of that cash to be released?

Sure. With respect to the Alesco, the trust-preferred warehouse, we participate in these businesses by first ramping assets and then securitizing them. In order to ramp the assets, you have to take a first loss at-risk position in the warehouse. So in the case of Alesco, we did that with $30 million -- actually with almost $35 million. I mentioned earlier two of the warehouses with much less first loss posted on them we think are below current market value. And so we've written off that first-loss equity.

On the remaining piece, the $30 million that is posted on the remaining line, that $30 million will come back to us as soon as we find a home or dispose of the assets that are in that underlying warehouse. So when we did the recent Alesco XVII transaction, we took most of the assets into that deal. There remains $53 million of assets being secured by that $30-million first-loss piece.

We have a tremendous amount of transparency to where most of that $53 million is going to go. So it's the reason I keep repeating my bullish view I'm getting that $30 million back is while the story's evolving, we're quite confident that there are homes for all of the $53 million, some of it in existing Alesco securitizations that are not yet fully ramped. And some of it will go away to third parties. So that $30 million will find its way back onto AFN's unrestricted cash bucket.

The Emporia $20-million first loss is a little bit different. It's the same story in the sense that the cash was deployed for the same reason and is used to fund ramping of assets to go towards the securitization. I believe we'll get a securitization done there. That $20 million's not likely to come back to us, because in order to get the securitization done I'm going to have to purchase the equity in the transaction like I traditionally do. So I would expect to use up that $20 million in connection with that transaction.

So I don't necessarily expect -- I may have misspoke a little bit earlier. I don't necessarily expect the full $50 million to come back. It would be different if I used up the Emporia assets in existing deals, which is possible and not out of the question. That, however, would take a much longer period of time. And so even taking that approach, the assets would come back. The $20 million would not come back for some period of time.

And what is the risk that that $20 million needs to turn into something north of $20 million in order to complete a transaction within the warehouse maturity date?

There is some possibility of that. The $20 million doesn't go to $40 million. I think that the $20 million is probably in more of a risk of going up in the event that I turn to the warehouse provider and negotiate for extended terms. They probably (technical difficulty) see additional first loss. And that wouldn't necessarily be offensive to me if that's -- if I can't get a securitization done and prefer to wait, that would be a rational way to go about it.

Okay. And can you comment at all on any ratings movement or migration in the TruPS in the MBS portfolio?

Sure. Well, the MBS portfolio, ratings is a large part of the story. In fact, it's the dominant part of the story. There's been massive ratings migration across the ABS business, not just the part of it that we play in, but really across the board. The rating agencies have very aggressively downgraded securities in these portfolios. And so that triggers -- because of the structure of a ratings-based portfolio or a ratings-based structure, that triggers the shutoff in cash.

The actual defaults that are being experienced in the underlying mortgages in these bonds isn't as bad as the experience of the investors in the sense that maybe people were projecting the faults will get worse. But it's been driven by ratings, not by actual experience. And so the Kleros transactions, for example, hit ratings-based triggers quite quickly.

In Alesco and Emporia, while we certainly take implied ratings into account, it's not a ratings-driven business. I keep getting back to this. It's very simple. It's a lending business. And unlike the ABS portfolio, we are the ones responsible actually for underwriting each loan, both on the Emporia and the Alesco TruPS side.

And once they're in a transaction, the structures do require implied ratings to close the transaction. However, they're not ratings driven. They're actual credit-performance driven. So there is no trigger in either the Alesco or Emporia deals that would cut off cash flow as a result of implied ratings migration. Only actual default experience could do that.

Have you seen any deferral yet in your TruPS portfolio, or --

We've not seen any within the AFN portfolio inside of Cohen. We've had what I would call sort of market normal default rates in that broader portfolio. But the default levels that we bake into a securitization, which is done long before the -- these levels were chosen long before the current issues we see in the ABS marketplace.

We expect those default levels to occur. At AFN, there haven't been any. So we've been lucky there that the TruPS has not had any deferral or default. But over time, we do expect some low level of default. And we have experienced and the TruPS marketplace generally has experienced defaults that I would -- I don't necessarily have total data to what others are doing. But I think in general the default characteristics have been below what has been modeled.

Okay. And just lastly, the pricing of the middle-market loan portfolio, if you could just walk us through how that takes place. Is that driven by your warehouse provider?

Well, it's the pricing when we enter into a loan transaction or from a valuation perspective today?

From a valuation today and what were you seeing in the asset impairments?

The leverage loan portfolio is actually carried at cost. And we effectively can put loan-loss reserves against those positions to the extend we feel there's been deterioration in the credit. So unlike our TruPS and MBS portfolios that are market to market, the leverage loan portfolio is carried the same way that our mortgage loan portfolio is, which is at cost adjusted for expected losses based on actual - based on the individual loans and a review of the individual loans in the portfolio.

Okay. So that $20 million that's in the warehouse for Emporia, which supports the middle market loans --

Yes.

-- is that then held at that amount? It hasn't seen any write down to the --

No, but it wouldn't be. First of all, the way that we look at the warehouse is we do this lending directly to these companies. And those loans find their way in the warehouse. We're engaged with them everyday. So we have an assessment as to the creditworthiness of the underlying loans. The $20 million is not marked by the warehouse provider, nor would be marked by us unless we thought an underlying loan was impaired. And we don't believe there are any of the loans in that are impaired or anything close to it.

All right. I was trying to equate that to you'd mentioned the $5 million write off from the $35 million that was --

Yes, the analogy would be in the event that the assets I hold on the Emporia $20 million lines -- it's two lines, but one $20 million -- in the event that the marketplace shifted dramatically so that spreads widened significantly, making on a PV calculation, making the aggregate of those loans worth $20 million less than what was paid for them, one would go through an analysis of whether you should turn your back on that $20-million first-loss deposit.

That analysis yields nothing anywhere near that type of look. In fact, as I mentioned, the spreads on those assets are at or very close to what is even the marketplace in this more difficult borrowing environment that we're experiencing right now.

Okay. Thank you.

(OPERATOR INSTRUCTIONS) At this time, sir, I'm showing you have no further questions. I would like to turn the call over for closing remarks.

Thank you very much. Again, I appreciate your time this morning and the questions and suggestions that you have. We look forward to meeting with you and talking with you at the next earnings call and perhaps in the interim. Thank you very much.

Thank you for your participation in today's conference. This concludes the presentation. And you may now disconnect.