Ellington Credit Co (EARN) 2016 Q2 法說會逐字稿

Good morning ladies and gentlemen thank you for standing by. Welcome to the Ellington Residential Mortgage REIT 2016 financial results conference call. Today's call is being recorded at this time all participants have been placed on it a listen only mode.

(Operator Instructions)

It is now my pleasure to turn the floor off to Maria Cozine, Vice President of Investor Relations. You may begin.

Thank you Paula.

Before we start it would like to remind everyone that certain statements made during this conference call may constitute forward-looking statements within the meaning of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are not historical in nature. As described under item 1A of our annual report on Form 10-K filed on March 10, 2016 forward-looking statements are subject to a variety of risks and uncertainties that could cause the company's actual results to differ from its beliefs, expectations, estimates and projections.

Consequently, you should not rely on these forward-looking statements as predictions of future events. Statements made during this conference call are made as of the date of this call, and the company undertakes no obligation to update or revise any forward-looking statements whether as a result of new information, future events or otherwise.

I have the call with me today Larry Penn, Chief Executive Officer of Ellington Residential, Mark Tecotzky our Co-Chief Investment Officer, and Lisa Mumford our Chief Financial Officer. As described in our earnings press release, our second-quarter earnings conference call presentation is available on our website www.earnREIT.com. Management's prepared remarks will track the presentation.

Please turn to slide four to follow along. As a reminder during this call we will sometimes refer to Ellington residential by its New York Stock Exchange ticker E-A-R-N or EARN for short.

With that I will now turn the call over to Larry.

Thanks, Maria.

It is our pleasure to speak with our shareholders this morning as we release our second quarter results. As always we appreciate your taking the time to participate on the call today.

First an overview: for the second quarter Ellington residential generated $0.38 per share on a fully mark-to-market basis. Our highly targeted asset selection process delivered solid performance this quarter as our agency specified pools and our hedging strategies performed well in the face of the historic market moves following the unexpected result of the Brexit vote.

Investor demand for agency RMBS, particularly from foreign investors, increased greatly in wake of the Brexit volatility. This is largely because agencies with the liquidity strong credit quality and higher yields represented attractive alternatives and compared to the substantially lower, and even sometimes negative yields on the highest credit quality sovereign debt.

Globally the sheer magnitude of bonds that have gone to 0% yield or below is leading investors to search for yield by reaching up in duration, down in credit quality, down in liquidity, down in convexity, or across currencies towards US dollar denominated assets. For agency RMBS investors can find that additional yield without having to sacrifice credit quality or liquidity. Long-term US Treasuries, US Corporate bonds, and public equities are all currently at or near post crisis highs. In such an environment, we need to remain disciplined in our hedging approach and we believe that maintaining a liquid portfolio will serve us extremely well should market conditions reverse.

We will follow the same format on the call today as we have in the past; first Lisa will run through our financial results, then Mark will discuss how the residential mortgage performed over the course of the quarter, how we positioned our portfolio, and what our market outlook is. Finally, I will follow with some additional remarks before opening the floor to questions.

Go ahead Lisa.

Thank you Larry and good morning everyone.

In the second quarter we had net income of $3.5 million, or $0.38 per share. The component of our net income were as follows. Our core earnings totaled approximately $2.9 million, or $0.32 per share, net realized and unrealized gain from our securities portfolio were $8 million, or $0.88 per share, as we had net realized and unrealized losses from derivatives of $7.4 million, or $0.82, excluded the net periodic costs associated with our interest rate swap.

Our core earnings include the impact of catch-up premium amortization, which in the second quarter decreased our core earnings by $1.5 million, or $0.16 per share. Catch-up premium amortization is calculated based and interest rate level and prepayment projections at the beginning of each quarter. If we add back the catch-up premium amortization adjustment, which tends to be volatile from quarter to quarter, our core earnings amounted to $4.4 million, or $0.48 per share in the second quarter. On the same basis our first quarter core earnings was $0.53 per share.

The quarter over quarter decrease in our core earnings adjusted to exclude the impact of catch up premium amortization was principally was a result of the decline in our interest income. If we exclude the impact of this adjustment from interest income in the second quarter our interest income was $9 million as compared to $9.3 million in the first quarter, the difference equating to $0.04 per share. The decrease in our interest income was primarily because the weighted average yield on our portfolio declined to 2.93% on an annualized basis in the second quarter from 3.04% in the first quarter. Each adjusted include the impact of the catch-up premium amortization.

In addition, while at the end of the second quarter our overall portfolio was larger relative to the first, our average holdings over the quarter declined slightly as compared to our average holdings over the first quarter. On the basis of amortized cost, our portfolio increased by $49 million quarter end to quarter end, while our average holdings over the second quarter declined by approximately $15 million as compared to our average holdings over the first quarter. This is only a minor impact from our interest income.

With respect to our cost of funding and as noted in the earnings release, our cost of repo increased during the quarter, but this is more than offset by a decrease in the periodic process associated with our interest rate hedges. During the second quarter, we shifted our interest rate hedges to be more heavily weighted to short TBA's and less weighted toward interest rate swap relative to the first quarter. Additionally, in the second quarter and relative to the first-quarter the weighted average maturity of our interest rate swap shortened by approximately one year to four years consistent with the drop in the effective duration of our agency pooled portfolio.

Ten-year interest rate swap spreads were two basis points less negative over the course of the second quarter, benefiting our existing interest rate swap hedges on a mark-to-market basis. Repo costs of steadily increase since the second half of last year, although most recently we have seen them stabilized somewhat.

The net impact of the decrease in our cost of funds was small at approximately $100,000 or $0.01 per share. Net interest margin was 1.28%, as compared to 1.92% for the first quarter and excluding the impact of the catch-up premium amortization's adjustment, our net interest margin was 1.76% for the second quarter, as compared to 1.83% for the first quarter.

Quarter over quarter our total expenses decreased slightly. Including base management fees our total expenses decreased to $1.3 million in the second quarter from $1.4 million in the first quarter, or $0.01 per share. Our second-quarter annualized expense ratio was 3.6%, and all things being equal that is what we would expect to see for the year.

During the second quarter we turned over approximately 31% of our agency RMBS portfolio as measured by sales and excluding pay downs, which generated net realized gain of approximately $2.5 million, or $0.28 per share, excluding hedges. In addition, this portfolio and our non-agency RMBS portfolio each appreciated in value, resulting in net unrealized gains of $6.4 million, or $0.71 per share. Pay up on our specified pools as a percentage of base increased in the second quarter to 1.03% from 0.88% in the first quarter.

Last quarter gains on our assets were overwhelmed by losses on our hedges leading to a meaningful net loss in these two categories. That was not the case in the second quarter, as agency yields were relatively sale stable quarter over quarter. We ended the second quarter with book value per share of $15.38, which when compared to the $15.39 per share as of the end of the first quarter reflects the fact that our total earnings essentially covered our second-quarter dividends of $0.40 per share. Adjusted for unsettled purchases and sales, our leverage ratio was 8.1 to 1, slightly higher than what it was at the end of the first quarter at 7.7 to 1.

I would now like to turn the presentation over to Mark.

Thank you Lisa.

Similar to the first quarter, the interest rate and volatility in the second quarter was elevated. But unlike the first quarter, agency MBS were consistently well bid throughout. Imagine that you had not been following the markets for the past three months and someone told you about the surprise of the Brexit vote, the magnitude of the ups and downs in rates, and that the ten-year US Treasury yield ended the quarter at 1.47%. You would probably assume it was a period of very weak agency mortgage performance relative to stocks and hedges.

However, the opposite was true and mortgages performed extremely well for investors that dynamically adjusted their durations. What was impressive about mortgage performance this quarter was that it happened in the face of increasing prepayment uncertainty, resulting from the lowest mortgage rates in three years.

When mortgage rates remain range bound, prepayments are much easier to predict than when they break out of a range. The drop in mortgage rates led to a pickup in refis, ribbon supply and these powerful forces of cyclical supply and prepayment risk were met by consistent demands from global investors seeking alternatives to negative sovereign yields.

We talked about this technical phenomenon last quarter. Agency MBS transitioned into a global investment class because of their high-yields and great liquidity. So while our own central bank is not been a net buyer of treasury mortgage bonds since October 2014, mortgages are still benefiting from a different source of quantitative easing, mainly the quantitative easing that's been done by the European Central Bank and the Bank of Japan if they crowd their countries investors out of Japanese and European sovereigns and into US agency MBS.

Take a look at slide seven. We had this presentation -- we had this in the presentation last quarter and here we extended. For the quarter MBS delivered healthy net interest margin at stable price performance. Given the low level of mortgage rates we have to focus on controlling prepayment risks to protect our net interest margins. This past quarter prepayments were higher but still manageable.

Look at slide eight. This slide shows both the price of Fannie 3s and the refi index over time. You can see back in February 2013, Fannie 3s were in the high 103's, which is right where they are now, but the refi index was much higher than a 4,500. Now the refi index is much lower at 2,400.

The cumulative impact of increased compliance and regulation is serving to mute prepayments. Obviously loan characteristics and services matter, but the overall prepayment landscape is hospitable which is particularly important for us in order to maintain our net interest margin. Assets that we bought a higher rate environment are prepaying slower than they might have, so they are staying on the books longer and they are now getting the benefit of lower hedging costs, protecting and even augmenting them when rates drop is a key focus right now.

The company had a good quarter essentially earning its dividend in a very low rate environment and compared to other fixed income centric companies. Our dividend yield is high at an attractive at 11.1%. Just like the global search for yield is boosting MBS prices, the same search for yield helped our stock prices this past quarter. EARN stock at a total return of 12.14% for the quarter and that is not annualized.

Other dividend focus stock such as high-yield EPS and closed end bank loan funds also did well. What differentiate agency mortgage rates is their lack of credit risk. The lower global rate environment and the lower for longer mentality is a response to weaker global growth expectations that may also bring credit concerns.

So unlike high-yield bonds where lower global rates are a double-edged sword, an agency mortgage REIT does not have credit concerns in a lower rate environment. The risk factors for agency mortgage rates are prepayment risk and interest rate risk. As always EARN tried to demand throughout the quarter to have limited interest rate risk, so our performance for the quarter did not get any boost from the drop in rates. Our performance was helped, though, from the continuing drop in the cost of TBA hedges.

Look at slide nine This slide shows that the annual cost of these short TBA, Fannie 4s continue to drop in the quarter and it dropped more than the decline in the asset yield of our pools helping our net earnings. So, while our holdings of MBS performed well in the quarter, it was really specified pools and lower coupon TBAs, not the higher coupon TBAs that were short that performed well. Keeping our hedges concentrated in higher coupon TBA short positions helped her performance with their declining role cost. In addition, the prepayment protection of our specified pools help this reduce delta hedging costs.

Turn to slide 10, which is an update of a slide from last quarter. While prepayment protective pools continue to offer substantial shelter from the prepay wave, so while earned with the targeted mutual interest rate posture did not benefit from the drop in rates, now that we're in this environment we believe our earnings potential is better. We see a healthy NIM on owning specified pools versus the combination of TBA shorts and other interest rate hedges.

The challenges that we face managing the company have changed since the end of last year. Last year before the first Fed rate hike the challenge was making sure that portfolios are properly hedged for the possibility that rates could increase. Now the challenge is structuring portfolios that can withstand the increase in prepayments we are seeing, and protecting that interest margin in the face of declining asset yields. To do that we focus on lowering our hedging cost in lock step with the declining asset yields. Given the uncertainty in rates we need to make sure our portfolio will be attractive if rates reverse course and increase.

That is where the drop in many TBA role level is helping us; it is lowering hedging cost of protecting earnings. Another trend to watch is the upward creep in three-month LIBOR over the last month. As we have said in the past the most important thing about interest rate swap that make them a good hedge for us is that we need the repo borrowing rate that we have paid to financial our pools to track three-month LIBOR that we get paid on the floating legs of the interest rate swap.

Of late these rates attract each other. So repo borrowing rates have gone up as LIBOR has gone, up but that has not cost us because you get paid LIBOR on the floating leg of our interest rate swaps.

Lately, there have been big money market flows out of prime money market funds into government money market funds, as investors react to the upcoming regulations for prime money market funds under which investors would no longer be guaranteed to be able to withdraw their prime money market investments immediately ended par. This has had two important effects.

First, this has put pressure on LIBOR as the private funds suffering redemption sell their short-term bank paper pushing borrowing costs up for banks, which is what LIBOR is based on. Second, many of the government funds gaining the additional subscriptions are big providers of agency repo.

So that's providing support for agency repo borrowing rates. The upward movement in LIBOR does not hurt us until receiving LIBOR on the floating leg of our interest rate swap, and in fact as LIBOR creeps up it may put upward pressure on interest rate swap spreads, which as Lisa mentioned, helps us on the mark to market basis for the interest rate swap hedges we already have on.

We think there are several reasons why prepayment have been slow relative to the level of mortgage rates. There is some burnout in the market as many borrowers have seen these mortgage rates before. Banks have been reluctant to hire additional staff in the mortgage company, the overall lack of the mortgage market has fallen, and the drop in mortgages rates that consumers are seeing has not kept pace with the drop in interest rates in the institutional markets. Put it all together and you get a refi index that is lower than what it has historically been for this level of rates.

While the cost of prepayment protection has gone up, given how much swap rates of gone now we believe we can generate a very attractive NIM because hedging costs have declined. Things can change and we expect them to change, but for now the high cost of mortgage origination and the reluctance of big banks to hire has kept prepayments manageable. The higher coupon specified pools we put on the books and higher rate environments are not prepaying at a very high rate and instead our hedging costs on them keeps dropping.

For the quarter we grew the portfolio a bit and it was mostly in the GinnieMae sector where we found specified pools that were attractive relative to TBAs. We held onto most of our deep prepayment protection pools even though the price of that protection went up, since we perceived substantial prepayment risking pools with that protection. Again our goal in managing the portfolio in this environment is to increase -- of increased prepayment risk is to protect and hopefully grow our net interest margin. So we look for parts of the market where the yield on the assets has not dropped as much as the cost of the hedges.

We recognize that interest rates can move quickly and unpredictably so we focus on assets that will not experience the duration changes in a quick 25 to 40 basis points move in interest rates. We also focused on assets that will not fall out of favor if interest rates were to rise 50 basis points. So, we are avoiding the lowest coupons.

Another important source of returns for us is capturing inefficiencies through active portfolio management. As disclosed in the earnings release, turnover was 31% last quarter, interest rate volatility, change in prepayment expectation, surprising financial news like Brexit, and the two recent reports create opportunities for us to add excess returns to active trading. So, while a static portfolio reduces itself to hedging its expenses, a dynamic market creates trading opportunities. Our focus is on sourcing stable cash flows that will remain in demand, even if rates increase, where we can generate an attractive NIM by taking advantage of today's lower hedging costs.

Now back to Larry.

Thanks Mark.

By the end of the second quarter our stock price had increased to 85% of our $15.38 second-quarter book value. After quarter end, earned stock prices continue to move even higher. When our stock price was closer to book value share repurchases become less attractive and less accretive for shareholders. As a small company we have to balance share repurchases carefully with the effects shrinking our capital base has on our expense ratios and liquidity of our stock.

In light of the upward trends in our stock prices this quarter, we did not repurchase any shares. But we do intend, as always, to be mindful going forward of the price of our stock and to be opportunistic with share repurchases.

You may have noticed that we lowered our dividend by $0.05 in the second quarter to $0.40 per share. This allowed for our core earnings, excluding the catch-up premium amortization adjustment, to comfortably cover our dividend this quarter. While our book value per share was basically flat from last quarter. Rather than pay dividends at a book value, we want to generate sustainable income that covers our dividend and we believe that most of our shareholders share that view.

While the long-term impact of the negative interest rate policies of global central banks is unclear, over time lower borrowing costs should create opportunities for companies and households. As Mark mentioned, there can be significant lags between drops in interest rates and peak levels of prepayment activity as it can take a while for the mortgage banking industry to expand its refi capacity to meet demand. As a result, we expect the prepayment activity, spurred by the sharp decline in interest rates that occurred towards the end of the quarter may be heightened for a sustained period in the coming months.

As evidenced this quarter, our portfolio is positioned well to weather a wave of prepayment activity. We continue to be vigilant as always in the maintenance of our hedges. In the event of any future interest rate increase by the Federal Reserve.

Looking ahead, yield curves around the globe are pricing in accommodating monetary policy at central banks for the foreseeable future, which is keeping interest rates at record lows globally. EARN is well-positioned with its highly liquid portfolio, sophisticated analytical team for proprietary technologies to take advantage of market developments as they occur. A sustained wave of prepayments could further enrich prices of our specified pool portfolio relative to our TBA short position.

We believe that EARN strategic advantage is clear in a heightened prepayment risk environment as Ellington has a 21+ year history of analyzing loan characteristics, servicer, and borrower behavior. We have a great success in the past, and especially in this past quarter, by being patient and disciplined in our asset selection, and maintaining prudent hedges to mitigate interest rate risk. In the old high interest-rate low prepayment rate environment the value of prepayment protective pools is mostly latent and does not translate directly into higher interest margins.

In this new potentially high prepayment rate environment there's much more opportunity for greater divergence between the prepayments in the specified pools that was long and the prepayments of the generic TBAs that were short. That divergence can really drive earnings.

Following on that theme, as you can see on slide 18 of the presentation, our short TBA position at the end of the second quarter was around two and a half times bigger as a percentage of our overall hedging portfolio than it was at the end of the first quarter.

Not only does this position create opportunities for prepayment divergence, as I've just discussed, but it is also a more conservative posture generally, that should help us better withstand increased interest rate volatility, increase prepayments speeds, or widening in agency RMBS yield spreads. As you can see on slide 9, TBA roll costs have plummeted this year, so these TBA hedges are considerably more efficient than they been in quite some time. Of course the TBA markets can be quite volatile, and our hedges and TBA short positions are liquid, so we do not hesitate to pair down our TBA short positions in favor of more interest rate swaps whenever we feel that risk reward balance has shifted.

As you can tell, we believe that there continues to be excellent opportunities in the agency MBS market for us to create value for our shareholders. As we capture the healthy net interest margin between the yield and our prepayment-protected specified pools, and the cost of our repo borrowings and our interest rate hedges, we continue to enjoy the benefits of a highly liquid portfolio, leaving us able to capitalize in any location in RMBS prepayments or RMBS credits, should such opportunity arise.

With that our prepared remarks are concluded. I will now turn the call to the operator for questions. Operator go ahead.

(Operator Instructions)

Steve DeLaney of JMP Securities.

Good morning, everyone. Thanks for taking the question.

Mark, you touched on rates a little bit. I am just curious if you have thoughts -- we have noticed LIBOR moving higher while obviously the feds have done nothing at their end. So, my naive conclusion is it must have something to do with Brexit or the Eurozone. I am curious if you have any thoughts, what is behind this 11 to 12 basis point move wider and three month LIBOR since June. That is the first part of the question. Tying it into the comments about money market reform and the increase in requirement to hold more government paper, is there a possibility -- where I'm really going, is there a possibility for us to see agency repo consistently being priced inside of LIBOR over the next six to 12 months? Thank you.

Thanks Steve. These are great questions. We have been watching this closely. The LIBOR creep -- a lot of people have not been paying attention, but it is interesting because it's been almost a monotonic increase in three-month LIBOR for the last two weeks.

So one thing we have been doing -- about for the last nine months or so, is most of our repo borrowings, we are putting out 98 for the last three months. Because what we have found is that the repo rates we've been getting on pools for the last eight, nine months, track -- when we get to three-month repo rates from our lenders, they track very closely to the three-month LIBOR, unless we get paid on floating legs of the swaps we receive. Whereas if we have -- where one-month LIBOR is versus one-month repo, there one-month repo rates are a lot higher than one-month LIBOR. So I'd say in the past several months, our three-month repo rates have within a couple basis points of three-month LIBOR.

So I think the LIBOR creep up, as I mentioned in the prepared remarks, is largely a function of this money market reform where prime funds are seeing outflows, so prime funds are either not rolling commercial paper or having to sell commercial paper. And I do think that the agency repo market is going to be the beneficiary as the government funds are getting big capital inflows, and they are big providers of repo.

So while in the last several months our repo costs have been a couple basis points higher than three-month LIBOR, I think there is a very good chance going forward that agency mortgage repo, as you mentioned, I think it will dip below three-month LIBOR, which is going to be a big benefit to us. If you get agency three-month repo 10 basis points below the three-month LIBOR that is essentially going to improve net interest margin and everything interest swapped by 10 basis points.

Yes. And at 8 times leverage you have got almost 1% on your our ROE, right?

Yes. So it's going to be -- we are going to be doing our next series of rolls in the next two weeks. I'll be very interested in seeing what sort of rates we get to relative to three-month LIBOR. I expect the repo rates that we get are going to be very similar to the repo rates we got a month ago, in which case they will be below three-month LIBOR. So this is sort of, I think, a definite upside to you can see an agency reach right now that is not priced in. And also, the other thing I mentioned in the prepared remarks, there also has potential. We've seen it on the shorter term swaps, like five years NIM, of making swap spread less negative or positive in the short end. You've already seen some of that, too.

That's helpful color. I really appreciate it. Your spec pool strategy and your dynamic hedging is obviously serving you well in terms of your ability to cover the dividend with $0.48 of earnings excluding the catch-up. As sit -- It's almost surprising to me, frankly, that the returns are as good as they are given how much yield curve flattening that we have seen over the past year, which is really a sign that you really are managing the basis and hedging as opposed to just taking blind interest rate risk. But as we sit today, what is the biggest risk to your spread and your ROE as you see it, as you look at this volatile market that we have out there? It sounds like things -- since your prepayment risk is being managed, your funding is improving, is there something out there that we are missing?

I just wanted to before -- I'm going to let Mark answer that from the risk perspective. But I just did want to make one point, which is that not every industry mortgage REIT, I believe, is as disciplined as we are about using swaps all out of the yield curve to hedge interest rate risk. Back in 2013 that really hurt a lot of them that were focusing just in the short end, say two year swaps. We had 10- and 30-year swaps, lots of them, and that really helped us, obviously, get through that --

Paper tantrum.

That [big] spike paper tantrum with minimal damage. So when it comes to a flattening yield curve, I would just say the corollary of that, that does not -- for us, hedging all along and including the longest end of the yield curve, that does not necessarily hurt our net interest margin when the curve flattens. I just wanted to make that point.

Thanks, Larry.

I think a challenging space in this environment, and it manifest itself in the second quarter. It was not a significant enough headwind to deter what was a good quarter. But when you get a lot of interest rate volatility, even if rates end up at the same point where they started, is that's still a cost to the Company. Because the Company needs to adjust its duration dynamically. If you remember, before the Brexit vote there was almost universal consensus that remain was going to win, so interest rates had gone from 10-year notes like1.50% to 1.75% and then immediately being rallied back at 1.50%. So moves like that, sharp up and down moves, require some delta hedging. That, almost by its nature, is an expense.

So I think that quick moves in rates, even if they revert back, we're seeing more of those than what we used to see, in part because liquidity in the market is not as good. I also think in part because a lot of these rates moves our driven by a central bank behavior, so you get news event days and sometimes they will behave in ways which is different than the expectation was. I think that is a little bit of a headwind.

The other thing we have seen is that as rolls -- higher coupon rolls have come down a lot, and we showed the example of the Fannie 4% roll. But it's true, basically, 3.5%, 4%, 4.5%, 5%, you are seeing many of the bigger asset manager platforms, not REITs but just traditional money managers are managing mortgage portfolios versus the Barclays Ag or whatnot, have been exiting TBAs and going into specified pools.

So there's a little bit more competition for specified pools than there used to be. But, in terms of net interest margin, even though mortgages performed well this quarter, it is a good environment because a lot of what we buy is prepayment protected but can stay on the books. It is a high enough coupon so it is anchored to a TBA and that TBA is relatively short duration. So we can hedge it with a relatively short duration swaps, which are very low in rate.

I think the NIM potential now this good. The act of creating potential now is good. I think quick moves in interest rates that mean revert, we are seeing more of those than we used to. That is a little bit of a headwind. And there's a little bit more competition for pools, but all in all I think it has been a -- it's a pretty good environment right now.

I just want to add one more thing, which is that this level of rates, the whole mortgage market -- the whole specified pool market is trading at much higher prices than they were before. And prepayments are high, potential poised to go higher. So even saying what the yield is on a specified pool, a 4.5% pool or something like that, is not so easy, right. And there is going to be a divergence of views in the market. So when you talk about buying pools and capturing that interest market, what we hope to do is to be buying pools that other people are selling because they are worried about prepayment risk, but that our experience and models are telling us are going to actually have a really good yield.

When everything is trading near par -- no, sort of, difference of opinion in terms of what yields are. But if things are $1.05 and $1.06 pricing, then you have got a potential prepayment wave coming. That is really where you can differentiate yourself. We can capture, hopefully, a big net interest margin by identifying pools that are going to have really good yields in the environment even with their high dollar prices.

Yes. Well thanks, guys. That is great color, and congrats on a strong quarter.

Thank you, Steve.

(Operator Instructions)

Douglas Harter of Credit Suisse.

Thanks. Just a follow-up on that last point you were making around specified pool prices. How do you see the efficiency of the pricings of those today? Do you still see attractiveness in those prices relative to your prepaid expectations?

Yes, we do. They're definitely up, and there's certain parts of the pool market that are relatively commoditized. But when you see an increase in prepayments, what is nice for us is that means there is an increase in supply. Every borrower that has refinanced out of their mortgage, now there is a mortgage company that is selling their new mortgage. There is an increase in supply, and we are able to source, through new origination, newer pools that have very favorable characteristics. So, I think there are certainly parts of the pool market that are relatively fully priced and commoditized, but there is many corners of the market that offer very good value versus more generic mortgages.

Great. Do you expect to need to make any changes -- further changes to your hedge portfolio, or would you be more willing to take on more risk given the changes that we have seen in the rate environment and the expectation that we're kind of lower for longer?

I think one thing that, as I mentioned, we are always looking at is to what extent we want to be hedged with TBA's? Mark mentioned the cost of delta hedging, when your hedged with TBA's that mitigates that to a large extent. Of course, in a stable rate environment you would rather be hedged with interest rate swaps. So that something that we look at all the time. Where is the mortgage basis, where is the right place for us to be short, whether it is TBAs or swaps and treasuries? In terms of saying, okay, we're coming to some conclusion that now there is a low probability of rates going up, so we're going to lift a lot of our rate hedges generally. No. That is not something that I think that we would consider, and that we have. That just not -- that's not our style. That's, I think, part of how we, frankly, brand the Company.

Given where rates now, it doesn't even make you that much money. The cost of not -- as rates drop it means the cost of not taking interest rate risk is lower and lower.

And the cost of having it on is low right now. So, we could take that risk and, yes, maybe we would earn an extra -- gosh, it could be many hundreds of basis points a year if we listed all of our hedges, but that is not -- that's just not our philosophy.

Got it. Thank you.

Ladies and gentlemen, that does conclude today's conference call. Thank you for your participation. You may now disconnect.