Ellington Financial Inc (EFC) 2011 Q4 法說會逐字稿

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Ellington Financial Fourth Quarter 2011 Financial Results Conference Call. During today's presentation, all parties will be in a listen only mode. Following the presentation, the conference call will be opened for questions.

(Operator Instructions)

This conference call is being recorded today, February 14, and I would now like to turn the conference over to our host, Ellington Financial Vice President, Neha Mathur. Please go ahead.

Thank you, Operator. Good morning, all, and welcome to our fourth quarter of 2011 Ellington Financial Earnings Call. I'm Neha Mathur, Vice President of Ellington Financial. Before we start, I'd like to read the following cautionary statement.

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 and can be identified by words such as, anticipate, estimate, may, will, should, expect, believe, intend, seek, plan, and similar expressions or their negative forms, or by references to strategy, plans or intentions.

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.

Factors that could cause the Company's actual results to differ from its beliefs, expectations, estimates and projections include, among other things, the risks described under Item 1A of our Annual Report on Form 10K, filed on March 16, 2011, and under Item 1A of our Quarterly Report on Form 10Q, filed on November 9, 2011, which can be accessed through the Company's website at www.ellingtonfinancial.com, or the SEC's website at www.sec.gov.

Other risks, uncertainties and factors that could cause actual results to differ materially from those projected may be described from time to time in reports the Company files with the SEC, including reports on Forms 10-Q, 10-K and 8-K.

We further caution you that the 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.

Okay, let's get started. Let me introduce everyone I have on the call with me today. Larry Penn, Chief Executive Officer of Ellington Financial; Mark Tecotzky, our Co-Chief Investment Officer; and Lisa Mumford, our Chief Financial Officer. First, we'd like to provide some prepared remarks highlighting the events of the quarter, the then we'd be happy to answer any questions you may have.

We issued an earnings release yesterday following the close, covering several relevant performance statistics for the quarter, as well as some information on our portfolio. We also posted to our website an Investor Presentation, which contains more in-depth information on our portfolio. This presentation should make it easier for investors and analysts to follow our Company's portfolio and performance over time.

In the presentation, you'll find a great deal of detail on both our Agency and non-Agency portfolios and details on our hedging portfolios and exposure, as well as additional disclosure on our current use of capital across the different strategies within the Company, and leverage within each strategy.

To better follow this call, it would be very helpful to have the earnings release and the Investor Presentation with you. You can access both of these on our website, and we'll be going over several details of both items on this call. And with that, I'll turn it over to Larry Penn.

Thanks, Neha. It's our pleasure to speak with our shareholders this morning as we released our 2011 fourth-quarter results, and we all appreciate you taking the time to participate on the call today.

Following the sizeable price declines in non-Agency RMBS during the second and third quarters of 2011, and despite stable credit performance of the underlying mortgage loans, we saw continued weakness in non-Agency RMBS during the fourth quarter, with a variety of factors contributing to this weakness.

First, as the European Sovereign Debt crisis failed to be resolved, the market began to ascribe higher probabilities to such tail risks as forced deleveraging by European banks; distressed-asset sales of their US MBS holdings; and even systemic risks to the global financial system.

Second, bulge bracket broker-dealers deleveraged and became more risk averse, in part in response to the Sovereign Debt crisis, in part in response to continued implementation of the Volcker Rule, and in part in response to typical year-end balance-sheet pressures.

One relatively minor effect of this was a temporary tightening of repo borrowing terms as we approached year-end. But more importantly for us, we were able during the last two months of the year to purchase non-Agency RMBS assets at what we considered bargain prices--in many cases, the most attractive prices that we've seen in well over a year.

As illustrated on page three of the Investor Presentation, in response to these market movements, we continued to significantly reposition our non-Agency RMBS portfolio, and we're very pleased to be heading into 2012 with our current portfolio.

Page four of the Investor Presentation shows that projected loss-adjusted market yields on our portfolio, on average and before leverage, now exceed 12%, assuming home prices remain at current levels. That's an approximately 7% increase from where these yields were at the end of the third quarter. As you can also see on the same slide, even in a down-15% home price scenario, we estimate that our portfolio still yields well over 10%.

One phenomenon that we have observed both in the fourth quarter and since year-end is a widening of the so-called "basis" between derivative instruments, such as CDS on the ABX indices, and comparable RMBS bonds. While this has made hedging a bit more difficult, and cost us a bit of money in the fourth quarter, we expect this discrepancy to reverse and we are positioned accordingly.

I'd like to mention a small but noteworthy addition to our portfolio management tools. In the fourth quarter, we entered into a small re-securitization to achieve long-term financing on a particular RMBS asset. We accomplished this by selling our RMBS asset to a dealer as collateral for a securitization trust; the dealer then sold a rated senior tranche of this trust to a third party, and we purchased the equity of this trust. We will account for this transaction, which closed at the end of January, as a secured debt financing, with the underlying collateral remaining as an asset on our balance sheet, and the senior tranche as our long-term debt.

While we don't currently plan to make this a huge component of our financing strategy as long as repo financing remains readily and cheaply available, we may continue to selectively execute these types of transactions to achieve secure long-term financing when appropriate.

Let me shift gears momentarily to our Agency RMBS strategy. Interest rates and mortgage rates are at all-time lows, and government refinancing programs such as HARP, have been in flux. This creates excellent opportunities for our Agency RMBS strategy, where we acquire, hedge, and actively trade Agency mortgage pools with particular pre-payment advantages.

As you can see in our Earnings Attribution table, on page two of our earnings release, our Agency RMBS strategy significantly contributed to our returns both for the fourth quarter and for the full year, while utilizing a relatively small portion of our capital, as you can see by referring to the Capital Usage graph on page 13 of the Investor Presentation. We have been extremely pleased with the performance of this strategy, and moreover the environment for this strategy remains excellent. Mark Tecotzky will speak to this strategy in greater detail later in this call.

In retrospect, 2011 was a year where, much to the surprise of many market participants, and in contrast to almost all other fixed-income asset classes, non-Agency RMBS performed poorly on a total return basis. Nevertheless, thanks to the flexible nature of our strategy, and in particular, our ability to hedge, we were able to achieve a positive return on equity. Most importantly, we entered 2012 with a much larger, higher yielding non-Agency RMBS portfolio than we have had in some time, so we feel we have positioned ourselves well to capitalize on the upside.

As you may have seen in our press release, our Board of Directors declared a fourth-quarter 2011 dividend of $0.40 per common share, payable on March 15th to holders of record on March 1st, with no special dividend for 2011.

The chart on page 15 of the Investor Presentation should be helpful in analyzing the Company's earnings and dividends paid for the entire year.

And, now, I'll turn it over to Lisa to discuss some of the financial highlights of the second quarter.

Thank you Larry and good morning everyone. As you can see in our earnings release, in the fourth quarter, we earned net income of $1.7 million, or $0.10 per share. We ended the 2011 year with net income of $10.3 million, or $0.61 per share. You will recall that our income statement includes the full impact of all of our mark to market adjustments on our investment and derivative portfolios.

The downward non-Agency valuation trend that overshadowed our second and third quarter results slowed and began to stabilize in the fourth quarter. With respect to our non-Agency results, we recognized a 19% increase in interest income compared to the third quarter. This increase was in part related to growth in the overall size of our non-Agency holdings, as we have purposefully allocated more of our capital to that strategy in light of the opportunities that we have seen in that sector of the market, and, was also related to the impact of the increase in yields on new assets purchased, which, for many bonds, were in excess of 10% on a loss-adjusted basis.

While we did continue to recognize non-Agency valuation declines in the fourth quarter, they were muted somewhat when compared to quarters two and three, representing only about 2% of our end-of-third-quarter total value. Also included in our non-Agency results for the quarter are losses on our credit hedges, equivalent to $0.18 per share, and the first such quarter of the year wherein we had net losses on our credit hedges.

For the full year, our credit hedges generated income of approximately $20 million or $1.18 per share.

As Larry said, our Agency strategy performed very well this quarter, generating income of $6.4 million, and was driven in part by trading gains in that portfolio.

At quarter end, our leverage stood at 2.42 to 1, compared to 2.35 to 1 at the end of September, modestly up. Slightly more of our capital was allocated to our non-Agency strategy at quarter end. This can be seen on page 13 of our quarterly Investor Presentation.

We did so by continuing to shift capital away from our liquidity management strategy. However, we still had almost 24% in our liquidity management strategy at year end--which equates to about $90 million, and provides us both a safety margin against market dislocations and operating flexibility. Our liquidity management strategy includes cash and unencumbered Agency whole pools.

With respect to our debt financings, repo terms tightened at year end for most market participants, including us, as counterparty banks sought to manage their December 31 balance sheets. Given the climate at year end, it made sense for us to shorten our repo terms on our Agency holdings. However, immediately following the end of the year, we saw terms moderate back to pre year-end levels and in many cases we are now availing ourselves of longer term repo, meaning in excess of 60-day terms. At year end we also saw a slight increase in haircuts for our non-Agency repo--from around 33% on average at the end of September to around 35%, on average, at the end of December.

Finally, for the quarter, our expense ratio, which includes other operating expenses and base management fees, was 2.7% on an annualized basis. Expenses for the quarter reflected less expense for compensation-related costs and certain other professional fees. For the full year, our expense ratio was 3% and all things being equal, this is what we estimate 2012's ratio to be. With that, I'd like to turn the presentation over to Mark.

Thanks, Lisa. The fourth quarter presented us with declining prices on non-Agency mortgages without any material changes in the drivers of underlying cashflows - mainly prepayments, delinquencies and loss severities. Instead, what drove price declines was a combination of two factors - firstly, primary dealers reduced balance sheets in anticipation of stricter capital guidelines and stricter risk limits. This negatively impacted liquidity and valuations. The second factor that weighed on prices was fear of supply from the government's holdings of Maiden Lane and European bank portfolios. So, in the face of these price declines unrelated to any fundamental data on housing or the U.S. consumer, we increased our holdings of non-Agency securities at what we believed to be very attractive yields.

On page three of our Investor Presentation, you can see that our long non-Agency portfolio increased by $30 million, with the bulk of that increase in low-dollar-priced newer vintage subprime and Alt-B securities. These are the same types of securities that bore the lion's share of last year's price declines in non-Agency mortgages. These newer vintage and Alt-B securities, on average, are priced in the mid-$40's and are currently taking losses or are expected to very soon, but before applying any leverage, the loss-adjusted yields are near 15% in a flat home price scenario. This is illustrated on page four of the presentation.

Speaking generally about what has taken place since the start of the year, and supported by our estimate of January book value, many factors that weighed on prices in the fourth quarter have largely abated. Two-thirds of what had remained of the Maiden Lane portfolio following the suspension of sales in the middle of last year, has already been sold just this year, leaving only approximately $6 billion current face remaining.

We acquired portions of the Maiden Lane portfolio that traded in the two recent auctions, and clearly that supply cloud has largely lifted. The pace of investment bank de-risking has also slowed and they now have a much more balanced approach to risk. Against this back drop, so far this year we have started to see some of last quarter's price declines reverse.

I want to expand on what Larry said about the Agency portfolio. The Agency portfolio contributed significant profits in the fourth quarter and for the entire year. Even though prices of 30-year Agency pass-throughs were largely unchanged in the quarter, our strategy was able to generate significant profits. Our selection of pool attributes chosen to protect the Company from fast prepayments appreciated significantly in price during the quarter, allowing us to capture gains relative to both mortgage hedges and swap hedges.

The realized speed on our portfolio was, on average, only 4.6 CPR, as shown on page seven of our presentation. Because of this very slow realized average speed, the Company earned significant interest income relative to the cost of our hedges.

Additionally, the fast pace of announced and contemplated housing policy changes that can potentially impact prepayment speeds afforded us ample opportunity to actively trade our portfolio. We wound up taking full advantage, buying over $700 million worth of pools in the quarter and selling over $800 million.

Notably, we achieved these results without taking material interest-rate risks, and while keeping much of our Agency mortgage exposure hedged with mortgages, reducing our basis risk. We expect prepayment uncertainty and prepayment risk to be with us in 2012, and that should provide the Company with many investment opportunities.

As Larry said, we are very excited about the coming year. 2011 was a year where we were very focused on protecting shareholder value and positioning ourselves for what we think is an eventual market upturn, and we did just that. We produced a positive total return for the year, and we were able to do this in a year when, as we've mentioned, non-Agency securities lost a third of their value in many cases. Our hedging strategy was a key part of being able to protect shareholders' equity.

Heading into 2012, we remain optimistic and look forward to producing positive results for shareholders. The non-Agency markets have fundamentals working in their favor, and we hope to deliver great returns to shareholders this year. Thank you for your support this year ,and with that, I'll turn it back over to Larry.

Thanks, Mark. This concludes our prepared remarks. Before we open the call up for Q&A, I'd like to remind everyone that, as usual, we will be happy to respond to your questions to the extent they are directed to matters related either specifically to Ellington Financial, or more generally to the mortgage and asset-backed marketplace in which it operates. We will not be responding to questions on Ellington's private funds or other activities.

Also, as you probably saw last week, we released an estimate of our January month-end book value per share. While we're happy to discuss overall market events and trends, as usual, we won't be answering any questions concerning Ellington Financial's performance or portfolio composition beyond the period covered by yesterday's earnings release, namely December 31, 2011. Operator?

Thank you, Sir. We will now begin the question-and-answer session.

(Operator Instructions)

Our first question comes from the line of Steve DeLaney with JMP Securities.

Please go ahead.

Thanks. Good morning, everyone.

Good morning.

So, Larry, I guess the thing that struck me -- and thank you for that detailed report -- the thing that struck me in the fourth quarter -- and you touched on it -- but you -- in your non-Agency portfolio, you had the -- I guess the somewhat unique and short-term unpleasant outcome of having lost value on both the long and the short, if I'm reading that right. And it seems -- and that's obviously unusual for Ellington's history because you've got a long record of making money on your shorts.

Could you talk a little more about the corporate CDS piece of that and -- I didn't exactly follow you -- I think you said there was sort of some basis change -- but as I heard you describe it, you believe that that was temporary and that that will correct as we go into 2012? So it sounds to me like you're continuing your corporate-CDS short despite the underperformance of that in the fourth quarter.

Okay, yes. Thanks, Steve. So first of all, on page 12 of the Investor Presentation, you will see a history, year by year, going back to 2008, of where we've made money -- credit hedging, interest-rate hedging, and then just on the long side of the portfolio in both Agency and non-Agency. And you're exactly right. This was an unusual quarter for us in that we did lose money both in terms of having some unrealized and realized gains and losses on the long side of an Agency book, as well as in the credit hedges.

And as -- you're exactly right; that is what I was referring to in terms of a widening of the basis in -- especially comparing ABX to cash bonds. So, yes, that is something that we do expect to reverse. That basis actually continued to widen coming into this year, in the beginning of the year. But we've seen that now start to come back. So that's something that we definitely opportunistically trade around as we see that basis. So as we see it widening, we will tend to sell more ABX. And as we see it depressing, we'll tend to have less of ABX shorts on our books.

So now, in terms of the corporate hedges -- yes, those -- in the fourth quarter, those did underperform. They actually underperformed not only relative to our long assets, but they underperformed relative to ABX. But again that's something that -- as we looked at that trade coming into year end, we decided that it was a better -- it was an even better hedge to have on in the -- coming into the new year, than it was even at the beginning of the fourth quarter. And that's something that we have not changed our position on.

Okay.

So we're looking forward to keeping that diversification of our hedges in place on -- as long as that trade makes sense for us.

And, Larry, just one final thing for me -- on Maiden Lane -- I mean I think the reaction of the market seems to be positive that the Fed has cleared $13 billion of face here in these two transactions. Is there a general understanding among the trading community -- I mean, and you indicated you actually purchased some bonds and -- from one of those blocks.

Is there a general understanding -- do you think the market has good insight kind of into cash-price levels? I understand the Fed will, 90 days after the last Maiden coupon is sold -- that they're going to give us a list by security and price. But do you think that the transparency from that, or the price discovery -- do you think that's already in the market from the trading desk communicating on these blocks?

Yes. Hey, Steve, this is Mark.

Hey, Mark.

Hey. How are you?

Good.

So, yes. We actually bought securities from each of the two Maiden Lane sales. The first block of securities was sold to Credit Suisse and the second block was sold to Goldman Sachs. I think that the -- in the face of dealer de-risking in the fourth quarter -- that kind of capital commitment from investors and from dealers alike wouldn't have taken place. So I think the market viewed it as a very positive sign that not only the first block traded, but the second block traded too.

And I think that two things came out of it -- one, the sort of anecdotal price discovery came out in the investment community at levels much higher than where securities were trading in the fourth quarter. But the other thing is just that capital commitment from investors and from primary dealers to underwrite these blocks of securities. So these are each about roughly $3-odd billion in capital as far as (inaudible - multiple speakers).

Sure.

I think it was the good terms -- that, coupled with the fact that you haven't had material sales of portfolios coming out of Europe; and if you look at the -- where European debt trades -- French debt, Italian debt -- that's all up substantially from where it was the fourth quarter. So I think that there was a lot of people, I think, thought non-Agency market was cheap at the end of last year, but they were concerned about tail risk. They thought maybe if they'd waited, they'd get a better entry point. And now I think sort of the consensus of the market is that if you are not invested, you waited a little bit too long -- that prices have definitely reversed course.

And after the last Maiden Lane sale -- and whenever the next Maiden Lane block of securities trades of that remaining $6 billion, I think the market's going to start talking about, where is the supply going to come from? So I think that that -- those Maiden Lane sales provided some clear price point to the market, but also it sort of tipped the hand about how much capital is really out there for this opportunity.

I appreciate the comments. Thank you.

Thank you. And our next question comes from the line of Stephen Laws with Deutsche Bank.

Please go ahead.

Hi. Good morning. I guess I'll start with one quick question -- and you may have hit on it a little bit in the prepared remarks -- but the other expenses look like they dropped a decent amount sequentially in the fourth quarter. Can you maybe talk about where you saw the benefits there, and how you drove expenses down?

Yes. Hey, Steve -- it's Lisa. We had some reduced expenses in the compensation line coming into the end of the year, as well as some professional fees. But what I had said earlier was we expect that to moderate back to about 3% on a full-year basis.

Okay. Great; and then talking a little bit about the liquidity management -- and I guess I'm talking to slide 13. And I realize that the liquidity position has probably improved a little bit, given the comments earlier in the presentation about non-Agency pricing improving some since year end. But can you talk about really the band of where we are -- it looks like about 25% at year end. I guess I'll keep the comments focused on that.

It sounds like you expect pricing to continue to recover as dynamics in the market play out the way you've described. But if it doesn't work that way, where -- at what point, from a price-drop standpoint, do you start to get concerned with current leverage levels in the portfolio?

Okay. This is Larry. Hey, Steve.

Hey, Larry.

So, you're right. Our liquidity-management strategy has shrunk in size as we wanted to become more invested. We still consider ourselves as having relatively low leverage, especially when you look at the non-Agency book, which is really the type of leverage that is of most concern, especially if borrowing terms tighten and financing becomes scarce.

So when you look at our portfolio, you can see that we've been increasing the non-Agency book in size in response to better pricing. Our leverage in that strategy really hasn't changed much. And we do keep actual liquidity aside for all of our strategies. This is kind of -- it's in that -- there's a long footnote that I encourage you to read that's underneath the Capital Usage graph. And what it explains is that we basically -- our liquidity management strategy -- we think of it as having a couple of components. The first component is extra cash that we keep aside in case repo, for example, doesn't roll, or other things -- big market dislocations -- maybe we get margin calls on some of our derivatives that we use to hedge.

So that's a very key component of that. And that's something that we want to obviously keep intact. The other part would be a portion that is just free cash and available liquidity. And what I will say at this point is that we are definitely getting closer to where we would consider ourselves kind of fully invested in some sort of loose sense of the word.

Now, of course, if some opportunity were extraordinary, we could decide to go a little bit over those limits. But we're getting close. And we still have some dry powder, but less than we've had before. We, of course, could always re-jigger within the strategy.

So, for example, we could decide to allocate less to Agencies than to non-Agencies. And given the liquidity of the Agency portfolio, that's something that we could do in a very, very short period of time to reposition that way; and even with the non-Agencies -- if you look at the composition of our portfolio, we have more stable -- typically more seasoned securities that are slightly lower-yielding but have less risk.

And we have more of the '06, '07 vintages, which are much higher yielding. And, again, that's something that we would do as well -- is reposition -- in an extraordinary opportunity, we would probably -- where financing was getting more scarce -- we would probably go into securities that gave us higher yields with less leverage. So these are all things that will still be on the table. But we are getting closer to fully invested.

Great. And in there, Larry, kind of leads me to my third and final question, which really is -- as you guys move across Agency versus non-Agency -- it seems like given pricing and comments in this presentation about really -- since March 31 -- taking advantage of attractive pricing on non-Agencies.

Can you talk about maybe what -- at what point, given the current environment -- is it pricing? Is it some other economic data you're looking at that would -- I guess cause you to shift back the other way and take down your non-Agency position and move more into Agency? Or do you really see the portfolio kind of staying with kind of year-end mix with the non-Agency being most attractive now? What changes that?

I mean I think it would have to be a -- it would have to be a big move from where we are today. Prices are still very attractive. There's still a lot of volatility. We're able to -- we've also had excellent returns in Agencies. So I think we're happy with where that size is right now. But it would take -- as you can see, if you look on page 13, we definitely shrunk the non-Agency portfolio. You can see from the end of the first quarter to the end of the second quarter -- and then, since then, as we got -- and when prices sort of came close to what we thought was the bottom -- we have been increasing that.

So if you think about where prices were at the end of the first quarter, when we really started to shrink the portfolio -- I mean we've come a long way, right? So I think that it would take a pretty big move for us to shift back to where we were to -- at June 30.

Great. And I guess we'll have -- I'll drop off after I ask this question -- but maybe any comments about broader refinancing activity driven by Washington? I know, on the non-Agency side, would, from the way I understand it -- the modifications on non-Agency would need some type of act of Congress to get the capital on the Agency side maybe a little bit more active through Fannie and Freddie. But can you maybe just generally comment about your views on that on a macro basis, and then kind of also any specific impact that it could have on your portfolio at EFC? And thanks for taking my questions.

Sure. This is Mark. There have been just this year a lot of proposals put out there. There are changes to the HAMP programs. There were changes to the HARP program in the last year that created a lot of trading opportunities for us in the fourth quarter that we took advantage of on the Agency side. There are proposals out there that would change mortgage insurance premiums for FHA, which is on the Ginnie Mae side.

And you rightly point out-- there's also this $25 billion state Attorneys General settlement that got announced last week, where you may very well see some balance reduction in non-Agency deals. So there are a lot of things out there. Some of them do require Congressional approval. And I think, generally, market participants are less optimistic that those things will get done. But there are definitely some proposals out there that the individual Agencies can implement themselves.

So that's part of what I was referring to when I said we were looking at the trading opportunities this year. We think it's extraordinary on the Agency side. We would just say that we think the skew of the non-Agency portfolio is generally positive. We think a lot of these programs won't get off the ground and won't have much impact. But if something does, we think they're generally supportive of non-Agency prices.

The other big program out there where we do expect something to happen this year is the REO to Rental programs that have been discussed by Fannie, Freddie and FHA. We think there's a very good likelihood you'll see a program put in place that will allow some transitions from -- REO properties could go sell those entities to investors that want to rent them out. There may very well be leverage on that. And a program like that may reduce the forward supply of REO properties, which could be beneficial to home prices.

So I would say, if you look at all of them, it's really almost a week-by-week -- it's something you really have to follow week by week, as the changes are coming really fast. And some of the proposals seem as though they're generally politically motivated. Some of them seem like they have definitely some possibility of getting implemented. So that's a big part of what we look for. But I would just say, for the non-Agency market -- it also gets back to the question Larry just answered about our capital allocations.

We see very high loss-adjusted yields in the non-Agency markets. We think prices got really beaten down last year based on technical things, not fundamentals. We see a lot of that reversing this year. So we're very bullish on non-Agency prices. And we think the political skew for them is also favorable -- it's another reason that we like the non-Agency sector.

Thank you. Our next question comes from the line of Jim Fowler with Harvest Capital Strategies. Please go ahead.

Good morning, and thank you for taking the question. I have two. Could you go through, please, the securitization economics that you discussed -- the re-securitization?

Sure. So let me just talk -- let me talk a little more generally in terms of what we see as being available in the market. The -- basically, what you can do is you can re-securitize one of these -- not quite the lowest-dollar-priced securities, but more in the range of a lot of the securities that are trading, say, around a $70 price, that have slightly more stable cash flows. And you can create a front tranche that has a -- roughly a two-year average life. And you can get it rated by one of the not -- slightly lesser-known rating agencies; and sell about half the cash flows, or half the principal in a rated -- it could be AAA-rated or AA-rated tranche at a dollar price of somewhere in the low-to-mid $90s.

And the bottom line is that you can achieve financing on a longer-term basis. When I say long-term, it's roughly a four-year maturity, but it's a, of course, a shorter average life -- maybe more like two years. And you can get financing of anywhere from, say, LIBOR + 300 to LIBOR + 500. It really depends on the cash flows.

Now, that, obviously, is more expensive than repo in the short term, but it is locked in for the life of -- or for the first part of the life of the security -- so for four years -- and an average life of two years.

So if repo starts to really crack and -- then this will turn out, even though it's more expensive than repo -- given how high-yielding these securities are -- as you know, we project yields, as you can see, anywhere from 10% to 15% on a lot of what we buy -- that can really make sense to be able to have secured financing that, on a leveraged basis, obviously -- that would increase the yield on the equity tranche that we would take back to a very, very high level.

So, again, it's something that we did a little bit as a pilot program. And it's something that, especially now that the repo market is -- it looks slightly healthier -- it's not something that we plan to repeat in the immediate future -- but it's something that we definitely have our eye on. And it's something that I think can make sense for certain securities that -- where we can basically lock in leverage and -- over a very long period of time, and achieve very high return on equity on what we retain.

Got it. Thank you for that. One question -- a little less specific -- if I think about sort of information that's been in the market versus that that hasn't been in the market as it might pertain to non-Agency pricing -- I mean Maiden Lane was somewhere between fully and partially in the market. The deleveraging process has been mostly in the market.

I'm wondering if you might -- you made mention of the principal reduction in non-Agency as part of the servicing settlement. I don't know if you might have seen the research report that came out of Amherst the day after the settlement, talking about the negative impact of the goings on in the settlement as it pertains specifically to private-label securities. I'm wondering if that is more -- more so explains some of the potential price risk in these securities from here going forward. Any comments on that would be helpful. Thank you.

Yes. Hey, Jim; this is Mark. Yes, that Amherst piece did point out rightly the potential for conflicts of interest -- how a bank might own a HELOC in their portfolio -- Home Equity Line of Credit in portfolio. They might have the first, the first lien in front of that HELOC securitization that they don't own. Maybe they could hypothetically forgive principal balance on that first lien in order to strengthen their position in the HELOC.

So I think those potential issues exist. Those potential conflicts of interest exist. I also think, though, that servicer behavior is under much greater scrutiny. If you look at the proposed Countrywide settlement, the $8 billion-dollar settlement that was still pending -- a big part of that had to do with servicer behavior. It wasn't just representation of that loan.

So I think the reporting and the scrutiny of investors on servicers will serve, to some extent, as a governor on servicer behavior, and will make it very difficult for someone that wanted to take advantage of the situation to be able to do it.

So I would say that, as you look at what's happened since that sum was announced, that did act -- basically didn't have any impact on pricing. I think there are some people that think -- and they rightly raise the issue -- there are the potential conflicts of interest. But it's the fact that people have been so vocal about potential conflicts of interest -- makes it almost less likely that there will be abuse of these programs. So I think the market is generally thinking that that's not going to have a big impact. Some big portion of that debt forgiveness may take place in portfolios and not in securitizations, too.

Okay, great. Mark, thanks very much. Larry, thanks.

Thank you. And our next question comes from the line of Brad Golding with CRC. Please go ahead.

Hi, guys.

Hi.

I'm just trying to reconcile some of the numbers, and would appreciate your help. I guess the first question is probably for Mark. Having heard you just say, and having heard comments from you guys earlier about the expansion of the non-Agency book, I was surprised to see the non-Agency book only grew $30 million and that the hedge grew almost $100 million.

Can you just talk to the sensitivity of the hedge, understanding a lot is corporate CDS and just the flavor for the portfolio? And maybe my lack of understanding is the -- how you view the delta in terms of reallocation within the portfolio.

This is Lisa. Could I just first say that on the basis of amortized cost, the non-Agency book grew about $60 million.

$60 million.

Yes. Sorry, yes.

Okay.

What we try to measure is we try to measure sensitivity to all the assets in the portfolio to forward home prices -- so the non-Agency securities, ABX hedges, corporate hedges; and depending on the view of forward home prices, we've managed -- you do one of those portfolio management tests -- is to manage what exposure we're taking to forward home prices.

So a lot of the securities we bought in the fourth quarter had relatively high sensitivity to forward home prices. And some of the hedges that we added -- the -- away from the mortgage hedge -- don't have that same degree of sensitivity.

Okay.

Right. So, basically, right -- on the long side, the -- we have -- you used the word "delta." We have much more delta on the long side than we had before because of the change of the mix, which you can't even fully see in the pie chart because -- I mean that shows you some of it in terms of increasing the newer vintage securities. But even within those sectors, we added delta.

And, then, on the hedging side, as you suspect, things like investment-grade corporate CDX is -- has a very low delta relative to everything else that we invested.

Okay.

It's just difficult for -- it's difficult for me to know what corporate -- first of all, the corporate CDS is, if it is a CDX; or if it's a CDS on a home builder; or it's whatever. But from where I sit, this -- opening this presentation this morning, the portfolio didn't look any longer to me, and it did not look like you had trimmed your ABX hedge, which, for whatever reason, I thought had happened.

Right. So we -- so, first of all, just to go to page five of the presentation -- the corporate CDS -- that is -- there's just one -- there's one big pie with no slices, and it's all CDX, okay?

I see. Okay, fine. Indeed.

So it is all -- there's no single names in there right now. That is something that we did a lot in 2009, for example. And I will say that we did end the quarter, we believe -- even with these hedges -- somewhat longer the market, if you will, from a risk basis than we saw in the quarter.

Okay. Okay. I guess that leads into another question. From looking at the individual moves in understanding this tremendous basis, and looking at the individual moves, or looking at the monthly NAV moves against the CDS -- what is the static carry on the portfolio, assuming nothing happens? One month, three month passes -- there are obviously costs to your hedges, there are obviously interest rate hedges, but there is tremendous pickup on the Agency side and, I would assume, also, on the non-Agency side -- what's the number for the static carry?

So there are so -- with our hedges being in so many different securities where the -- like TBAs, where technically there isn't any carry, but practically there is. You've got other instruments. That's not something that we -- that we disclose. We think that there are just too many underlying assumptions there.

So I think that what we -- the way that we have presented in the presentation -- and, again, if you sort of go to page -- the sort of historical hedging results on page 12 -- is that we start with the long side of the portfolio and you kind of see what the yield is there and what our leverage is. And then we hope, given -- and I think our performance over time has demonstrated that over the long term -- and even the medium term -- we are able to -- we are able to hedge and have our hedges actually not detract from the returns. That's the hope. So it's just too rife with uncertain assumptions to try to compute what our carry is on so many of our hedges. So that's --

What about on the Agency side, Larry?

Well, again, with TBAs, it's tricky, because you're dealing with the rolls and things like that. So it's a very -- and, again, I think if you look at the performance of that strategy, I think it speaks for itself.

Well, Larry --?

From an OAS standpoint -- no, but from an OAS standpoint -- so if you looked at -- if you looked at where our assets -- what kind of option-adjusted spread we see them trading at -- if you were to, then, apply the leverage -- you might only get a high-single-digit, low-double-digit return on equity, even with a lot of leverage. But, again, because we actively trade that strategy so much, as Mark mentioned, we had 100% portfolio turnover in terms of just volumes of buys and sells throughout the quarter, that it's not really a static buy-and-hold, clip-the-coupon, carry-type of strategy.

So it's -- find pools that the market is undervaluing, buy them; earn carry probably for a relatively short amount of time; and, then, when the rest of the market catches up to how you view these pools, and those payoffs expand -- sell into that, and then move to the next thing. Mark, you want to answer that?

Yes, I would just say that right now, in the fourth quarter of last year, if you look at the speed assumptions that are priced into the TBA roll market, it's much, much faster than where our portfolio has been paying down. So right now is a time of very, very high carry from the Agencies strategies. If you're hedging -- either versus swaps or versus TBAs -- because there is so much prepayment risk and so much prepayment uncertainty for a lot of these TBA coupons -- that the rolls are priced assuming the very best CPRs.

The CPRs, in some cases, were an order of magnitude higher than where our pools are paying down. So right now is a very high -- very high carry in an Agency strategy. And then, on top of that, there's trading gains to be made. But there's a lot of carry right now in the Agency portfolio.

Okay. The place I'm trying to get -- and I do understand that buy-low, sell-high strategy that you're trying to employ, Larry -- that -- and I respect you for it. But what I'm trying to get is -- I'm looking at the past couple of months -- and if you don't want to talk about anything in 2012, then let's look at November to December -- I'm seeing ABX trade up a decent amount. And I'm not seeing corresponding increases in the NAV. And I what I feel, as an investor, I should be seeing is a little bit of love on the bond prices and underlying positive carry because that, to some extent -- that's the game, right --?

Well, I mean, again --

-- of all Agency REITs and all people who are investing in mortgages -- is that they -- particularly with the 0% interest rate -- that they carry pretty darn well.

Right. Well, again, I'm not -- I'll speak to anything sort of in the first quarter of this year. I'll speak to that on the next earnings call. I'm not going to speak to that today.

Okay, then talk about November; talk about whatever you want, Larry. But you see where I'm going with this?

Yes, well, I think that -- so, first of all, I think if you look at the -- if you only look at a one or two-month timeframe, I think that's a mistake because there is definitely a volatility in a lot of our hedges and a lot of our assets. But over a longer timeframe -- even just looking at -- over the course of last year -- I think that the point is made that the assets did decline in price a lot. And from a total-return standpoint -- return on equity -- we outperformed.

So I think that -- I would discourage anyone from looking at a one or two -- monthly book values -- and trying to ascertain from that what kind of carry we have or what kind of tracking error we have to some index. I think that's a real mistake. I would have to look over a longer timeframe.

And we do -- it's true that we've -- as we've been saying, for the second half of the year -- we do -- we have had a long bias -- but that, again, is something that we do change, even over the course of a month sometimes. So we -- what we hope to deliver for investors is to preserve capital during stretches where the assets -- the underlying assets are declining -- and to capture a big chunk or most -- but maybe not 100% of that upside -- when the assets recover.

I mean -- so less downside -- much less downside but somewhat less upside. That's what we try to achieve. And I think if you look over the history of our Company, starting from its formation in 2007, we've done that. And that's what we're obviously looking forward to doing in 2012.

Okay. Just to -- if you -- for me it's a little difficult because if you can't give me any idea of what the carry is, and you tell me not to use the NAV and any external inputs --

No, I can give you --

I'm kind of flying blind. And I'm not sure that's going to be the best result for the Company.

Well, I mean, the -- you can see the yields on the assets. And the hedges are complicated. And some of them have explicit carry and some of them have implicit carry. And some of them are going to be volatile. And that's just -- and I think that's -- if I'm -- as you can see, we're short stocks -- I just think it's a mistake to try to put carry numbers on some of these things. It's just -- and I think that it's -- like I said, I think for now, the way that we're positioned in terms of having a fairly diverse hedging portfolio -- I think that it's -- to try to sort of put explicit numbers on that as a whole, I think, will -- is a -- is not something that we think makes sense to do for us.

Okay. That's it for me.

Thanks.

Thank you. And it appears that there are no further questions. I'd like to turn the call over to Larry Penn for any closing comments.

Thank you everyone for joining us this morning, and we look forward to a great 2012 and seeing you all on the next call.

Ladies and gentlemen, that concludes our call for today. Thank you very much for your participation. You may now disconnect.