Invesco Mortgage Capital Inc (IVR) 2013 Q2 法說會逐字稿

This presentation and comments made in the associated conference call today may include forward-looking statements. Words such as believes, expects, anticipates, intends, plans, estimates, projects, forecasts and future or conditional verbs such as will, may, could, should and would, as well as any other statement that necessarily depends on future events are intended to identify forward-looking statements. Forward-looking statements are not guarantees and they involve risks, uncertainties and assumptions. There can be no assurance that actual results will not differ materially from our expectations.

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Good morning, ladies and gentlemen. Welcome to Invesco Mortgage Capital Inc.'s Investor Conference Call. All participants will be on a listen-only mode until the question-and-answer session. (Operator Instructions).

As a reminder, this call is being recorded. Now I would like to turn the call over to the speakers for today, Richard King, Chief Executive Officer; John Anzalone, Chief Investment Officer; and Don Ramon, Chief Financial Officer. Mr. King, you may now begin.

Thank you. Good morning, everybody and as always, thank you for dialing in. I plan to first review the second quarter environment and our results and then talk about what we're doing going forward, including the strategy for hedging and leverage and of course our asset strategy. And then John Anzalone, our CIO, will talk before we open up for questions.

The second quarter was challenging and surprising in some respects in that rates rose rather dramatically, even as economic growth remained quite lackluster. The unemployment rate at 7.6% is still well above the Fed's 6.5% threshold for removing accommodation and core inflation at 0.8 annualized over the last three months has actually fallen further below the Fed's threshold, with rates hovering near historic lows and the Fed repressing yields. Investment flows out of bond and into stocks were to be expected, however. Given this environment, we expected rates to increase this year and we increased hedges accordingly. I'm not saying we were expecting a 100-basis-point rise in the tenure in less than two months, because we continue to see an economy that's growing only modestly and a Fed policy that's likely to remain accommodative, even when the economy gains strength.

But our understanding of the environment encouraged us to take a number of actions to reduce rate risk in the first quarter, namely increasing the amount of and lengthening the term of interest-rate swap hedges, adding hedges in the form of swaptions, issuing fixed-rated exchangeable notes, and reducing our repo leverage. All of those actions did benefit our shareholders in Q2.

We also took further actions throughout Q2 that helped, namely adding more payer swaptions and reducing Agency MBS holdings. In fact, when we look at the attribution of the factors that caused the roughly 12.5% drop in our fair-market value; we can see that the actions we took were very helpful. Because of those steps, the rise in the level of interest rates and the steepening of the yield curve did not cause the majority of the book-value decline. In fact, by far most of the decline was a result of widening in credit spreads across the mortgage market; not only in the Agency mortgage market, but also in Non-Agency RMBS and CMBS; those are really the factors that caused book value to decline, primarily.

And unlike rates, we see the spread widening as an aberration, not a trend. As a mortgage REIT, we hedge interest-rate risk and we accept mortgage credit risk that we've underwritten. We generally accept mortgage spread risk as well. And to that point, over the last year, rates are higher by about 80 to 85 basis points, whether you look at five-year swap rates or 10-year treasuries. And IVR's economic return, that is the dividend plus the change in our book value, is up about 11.5%.

So given that rates are up more than most investors would have thought with prepaid speeds much faster than we'll likely see going forward; the knowledge that we generated that type of return on book value should indicate that we can generate attractive returns in an up-rate environment going forward.

We're pleased that spreads have become more attractive for redeployment of our cash flows, going forward. So the good news here is we're a hybrid mortgage REIT whose high-level strategy is to generate an attractive dividend, primarily via owning high-quality assets with attractive credit spreads. We especially find attractive those assets with predictable cash flows that we can hedge effectively. We're not generating the dividend primarily by accepting interest-rate risk. And again, because rates are still very low, and it's reasonable to expect that a trend toward higher rates could be persistent.

We expect that the credit spreads dislocation in Q2 though, is not likely to persist. We find credit spreads in the mortgage space very attractive and supportive of our fair-market value. What we saw in Q2 was more of a knee-jerk reaction, where mutual-fund managers were surprised with outflows. They had to sell credit assets into quarter end. And in addition, there was convexity-related selling out of our industry to reduce interest-rate risk as rates went up and mortgage bonds lengthened in average life. This coincided with dealers also trying to reduce assets into quarter end.

Now let me say a few words about earnings. In the second quarter, GAAP earnings were very high, despite our core earnings remaining stable at close to $0.60. The $1.03 GAAP earnings per share easily supported the $0.65 dividend, partly due to $0.39 of increase in the value of swaptions. We also took gains in the second quarter by selling Agency MBS, which we believed were exposed to extension of the HARP cutoff date.

While we're pleased with $1.03 of earnings, we want investors to realize we have taken some losses in early Q3 and the swaptions positions are going to increase earnings volatility. While they are hedges, the change in the value of the swaptions flows directly to our earnings, unlike interest-rate swaps.

So what does all of this mean for IVR going forward? Our goals this year have been to transition the Company to a lower interest-rate risk strategy and to reduce Agency MBS in favor of mortgage-credit assets. We favor securitizing mortgage loans and retaining the subordinate positions to gain financing and to invest in commercial real estate mezzanine loans. All of these actions will reduce repo borrowings and position us for the future.

Our goals remain the same. We expect that as credit spreads recover, our book value will improve and you should see our repo leverage decline as well. In the meantime, we're in a period of higher volatility and therefore will hold down repo leverage and interest-rate risk primarily in two ways. First, we didn't reinvest our cash flow into Agency MBS in the second quarter and that's part of why our balances declined, rather we're holding additional cash and unencumbered assets as a cushion. We also added to swaps and swaptions to reduce the interest-rate duration of our equity. Due to these actions, we're currently seeing core earnings somewhat lower early in Q3 versus Q2, and while we may see our net interest margin improve because of slower prepaid speeds and better reinvestment yields; that does take some time to play out.

We think everything we're doing in this environment is prudent and in the best interest of our shareholders, and because of these actions we're very bullish on the future of Invesco Mortgage Capital. We believe we can grow book value, reduce repo leverage and generate an attractive dividend. We see plenty of opportunity for Invesco Mortgage Capital that does not entail taking undue interest-rate risk. And IVR is an investment in an industry where we see a lot of opportunity for a number of years in the mortgage industry.

We remain very excited about playing a meaningful role in the rebuilding of the U.S. mortgage market and John Anzalone will now discuss our investment strategy and portfolio in more detail.

Thank you, Rich and thanks again to everyone joining us on the call this morning. I'll go through our current portfolio positioning, some of the steps we took during the quarter, and how we are set up for the future.

I'll start on slide four of the deck; the portfolio update. As you can see on the chart on the left of the slide, we've continued to evolve the portfolio during the quarter. We completed three securitizations during the quarter which added $1.1 billion in consolidated loans. The total MBS portfolio declined about 7% to just under $20 billion and this was due to a combination of assets sales, pay downs and price declines.

The sales were concentrated on the Agency side, as early in the quarter we sold approximately $340 million of pools that we did at risk to higher prepayments if the HARP program is extended by one year. Later in the quarter, we sold an additional $950 million in order to maintain our leverage and duration-gap discipline.

We also continued to add credit assets, as our Non-Agency book increased by $195 million and our CMBS book increased by $149 million.

Finally, we added about $9 million in commercial real estate loans, which was part of a larger $40 million commitment.

Moving to slide five, we entered the quarter with our overall leverage at 7.6 times, which drops to 7.1 when you back out the impact of unsettled trades. This was an increase from last year's figure of 6.4 times and this increase is due to lower equity levels, credit asset purchases, as well as the additional residential loan securitizations.

As we talked about on last quarter's call, we are more focused on reducing the leverage that is associated with repo, as opposed to the structural leverage associated with securitizations. Our repo leverage ended the quarter at 6.1 times.

Moving to slide six and our interest-rate hedges; as you can see in the chart at the top of the slide, we were fairly active in adding interest-rate hedges during the quarter; as we were disciplined in keeping our duration gap within our target range of one to one-and-a-half years. We added $1.85 billion in interest-rate swaps, all of which were five years or longer.

We also ended the quarter with an additional $1.4 billion in swaption positions. It's important to note that these swaptions were all struck on longer term swaps; seven to ten years; and most were only 25 to 75 basis points out of the money at the time they were struck.

This proved to be important in the recent environment as these positions offer a very effective hedge against increasing short-term volatility which we obviously saw a lot of during the quarter. As far as where we stand now, we ended the quarter with 113% of our Agency repo book hedged with swaps and swaptions, and 82% of all repos hedged with swaps and swaptions. As such, maintaining our discipline during the recent quarter has left us in a very good position going forward.

Next, I'll go through the various buckets of the portfolio, starting with Agencies on slide seven. As I mentioned earlier, our Agency portfolio is down $1.8 billion for the quarter. Agency leverage ended the quarter at 9.6 times, but taking our unsettled trades into account, that number was unchanged for the quarter at 9.1 times.

Prepays remained very well-behaved with our 30-year book paying at 9.5 CPR for the second quarter in a row. Given the sharp backup in rates, we would expect this number to decrease over the coming months.

On the Non-Agency side, our holdings increased by $195 million as we continue to add legacy non-Agencies. We remain positive on the sector as housing fundamentals are still improving, technicals remained extremely favorable, and these bonds provide a favorable return profile in a rising-rate environment.

In CMBS, our holdings increased by $149 million, as we continue to focus on adding triple-A and double-A newer vintage bonds. As with residential housing, we are positive on this sector, as fundamentals are improving and the technical picture still remains favorable. Our leverage here increased to 3.9 times due to a combination of lower asset prices as well as a focus on higher quality bonds.

I'll finish with slide 10, residential and commercial loans. It was an active quarter for us in the residential loan space as we completed three securitizations which added $1.1 billion in consolidated loans to our balance sheet. These served to add $121 million in net credit exposure to our book and participating in these deals provides us with an opportunity to gain exposure to new production prime jumbo mortgages.

On the commercial side, we closed our first mezzanine loan, which was about a $40 million commitment. We also purchased approximately $25 million in CRE mezzanine loan pass-throughs. We continue to view both the loan side of both resi and commercial is very attractive and we'll continue to explore opportunities in each. So with that, I'll open the floor up to questions.

(Operator instructions). Douglas Harter, Credit Suisse.

Thanks. John, I'm hoping you can give us an update as to how credit spreads have fared in July.

Yes, in July I would say credit has broadly been flat to maybe a little bit tighter, so I think CMBS has done a little bit better. Our Non-Agency positions I think were mostly flat up through now.

Great. And then on the new residential securitizations, can you talk about the impact that higher rates have on the four deals you've done so far, and then also your outlook for the ability to continue to do more deals there?

Sure, Doug. This is Rich. On those, the beauty there is we gained leverage through selling triple-A. So we really don't have exposure to having our financing rates rise on us. We're locked in. And the subordinate position; I mean they're credit positions that we're getting paid over the life of the deal to accept. So really, there's not a lot of impact from rates on those.

Rich, did you retain the IOs on those bonds?

Yes.

So those should benefit as rates rose?

Right. I mean so you have some interest-rate duration on credit subs because they're fixed rate, but you have the IO that offsets that.

Got it.

Trevor Cranston, JMP Securities.

Thanks. Just to kind of follow up on the increased allocation towards credit type of assets and assets that aren't so much levered as repo; can you give us any kind of indication of kind of what your outlook is for the commercial loan opportunities and how much you think you could potentially originate over the balance of the year?

Sure. We can't really give you a forecast because it really-- every deal is unique. There is a lot of credit work involved, obviously. And it is a competitive space. We think over the next number of years, obviously there is a huge wall of maturities that need to be refinanced and with rates higher, there will be a need for some mezzanine financing, clearly. So we think it's a big opportunity, but right now we're working on several opportunities but I hate to give a forecast for the likelihood of the size that we're going to put to work. Anything else John?

I think that that covers it.

Okay, that's fair. And on the residential side, can you guys comment if you participated in the Freddie Mac credit deal and how you think about that relative to the opportunities in the jumbo space?

Right; yes absolutely. We did not participate in the Freddie Mac deal. And the main reason is we can manufacture what we think is a better risk asset at a better yield. And the reasoning is that A, they didn't give the granular information that we typically get in terms of the borrower and the actual real estate, so we didn't have the competitive advantage in that deal that we would say in a prime jumbo deal; understanding exactly what collateral we're guaranteeing there.

And then in addition to that, the way it was structured, it was quite a thin tranche and it wasn't a [first loss piece]; so you had also a fixed severity and we would rather take actual losses as opposed to dealing with delinquencies for whatever reason.

So all that said it's the first of many risk-sharing transactions. We could participate in it. It works as far as it's an eligible REIT asset. But just from a relative value perspective, we just like the prime jumbo securitization better.

Got it. And last thing on the swaption portfolio; do you guys have handy what the average expiration term of the swaptions are and what the average strike rate is?

Yes Trevor, this is Don. The average- it's about 8.4 months on the average of the-- when it's going to expire. And then the average duration of the swap; all of them are struck at 10 years is what the underlying swap is.

And do you have the strike rate on that?

You know, I don't have it right in front of me, but it will be in the Q.

Okay, perfect. Thank you.

But we can say that-- we struck most of them in the 25 to 50-ish out of the money.

Right.

Got it. Okay, thanks, guys.

Mark DeVries, Barclays.

First, just a quick follow up on the swaptions; given the spike in interest rate vol we've seen; is that still an economic form of protection for you guys-- that kind of-- just barely out of the money swaption?

Yes, in fact you'll see that we--I think it's on the hedging slide, but-- let's turn to that. But we did take off a few swaptions during the month as they got very, very close to the money and re-struck them a little bit further out of the money. So we're definitely managing that book.

You can see we terminated about $1.75 billion during the quarter and so those were basically swaptions that had moved very close to the money that we re-struck another 50 basis points out of the money, something like that.

Right. So Mark, can I just comment; that also brings up a great point. I mean it's important to highlight that several of the gains on swaptions were realized during the quarter and then some were unrealized. So again, as we saw those swaps come closer to the money, basically; as John mentioned, we went ahead and realized the gains to lock in that change and then put new ones on, on a go-forward basis.

Got it.

So if you were having-- your point is right. I mean obviously the swaps that we put on at 70 to 80 basis points sort of implied volatility were cheaper than they were at the end of the quarter. But we do expect volatility to be higher going forward than it has been, so; it's just a reality.

Yes, that makes sense. The next question; did your credit bonds end up having more duration than you might have modeled, or was the weakness you saw in your credit assets mainly just due to widening of spreads?

It wasn't more duration that we modeled; like the CMBS primarily is-- those are the longer duration credit assets. And there is no cash flow variability. They're bullet-type assets, so you know what the duration is. It was really purely spread widening. And then in the Non-Agency stuff, close to half the book is re-REMICs which are very short duration; so there's no question there and then we do have some legacy Non-Agency but once again, that's not a meaningful duration component.

Understood; so last question; I understand you commented that you viewed the spread widening as a little bit more of an aberration than the rate move that we saw in the quarter. But did you do anything to reposition the Agency book, other than just kind reducing the position to mitigate your risk to spread widening?

Through the quarter we did sell primarily lower coupon, low-ish coupon mortgages. I mean that was just to keep the duration of the portfolio stable or more stable. So I mean that would reduce interest-rate risk, obviously. So combining that with the swaptions is how we managed to keep our duration gap kind of stable. So going forward, we have less exposure to Agencies obviously since we have a smaller portfolio.

Also if you look at kind of the convexity, with mortgages having extended obviously, there's less extension risk and with the swaptions positions and so forth, we have not-- the convexity risk is not very meaningful from here.

Okay, got it. Thanks.

Cheryl Pate, Morgan Stanley

Hi, good morning. Question on the Non-Agency portfolio; I'm just wondering if you could give us some color on the credit assets that were added this quarter relative to the portfolio overall? I recognize there was obviously some pricing pressure that went on this quarter. But when I look at sort of discount to par, it looks like it increased from about 7% to about 14%; so just any color would be helpful there.

Yes, so we added a small amount of Non-Agencies over the quarter; I mean a couple hundred million overall. I believe they were a little bit further from par than the book that we owned just because we didn't add re-REMICs which are obviously a lot higher in dollar price. So I think that would obviously be a lower-priced bond there.

And we sold a little bit of like- high dollar priced bonds.

Right the senior re-REMICs, we sold a couple of those, yes.

Okay and then another question just on--

I just wanted to add that adding credit IO, lowers the average price. So I think that's what you're seeing there.

Okay, that's helpful. And then just another question; in terms of the provisioning this quarter; how should we be thinking about that? Sort of what are the assumptions underlying the provisioning?

Cheryl, the way that we look at that is we take a look at the credit pool; just like we do any of our other credit bonds. We do a loan-level detailed analysis that come up with and basically estimate what we think the losses may be in the portfolio. So in other words, those new securitizations that we put on, we basically estimated what we think the life of losses are kind of baked into that pool right now. And that's what we came up with; just over $600,000 worth of expected losses on that.

I think the way to think about that is unless something changes dramatically, I wouldn't expect that number to continue to increase unless again the portfolio characteristics change which right now we don't anticipate that. You'll probably see with the next quarter, since we put one on right at the end of the quarter; we will probably see a little bit of increase in that number, but I wouldn't anticipate a huge increase on a go-forward basis unless we add additional securitizations.

Okay, got it. Thanks.

Mike Widner of KBW.

Good morning, guys. Let me just follow up a little more philosophically on the swaps and hedges question. When you guys talked about your swaps and your hedges, you do what pretty most of the group does and most of us have become accustomed to; is talk about the hedges as a percent of the repo on the Agency part of the portfolio, which I think makes a whole lot more sense when you're thinking about locking in funding costs. But now that hedges are much more of a book-value hedge; I'm just wondering if your thinking about them has kind of changed at all. And as I think you guys indicated, there certainly is an interest-rate risk component to most of, or at least a large portion, of the credit risk side of the portfolio and so I guess the question is-- does it broaden the way or change at all, the way you think about how to hedge and what you would use to hedge and what durations; specifically at what durations along the curve you need to hedge?

We look at the portfolio in parts and holistically and we have really very robust analytics to look at the duration and spread duration in key rate buckets and understand where our risk is. And we put on swaps for that reason and longer tenures because you tend, like on a 30-year fixed rate mortgage or CMBS, you have a decent amount of key rate duration out of the curve. So to protect from not only rising rates, but curves deepening; that's why we put really all the additional swaps and swaptions out in the ten-year area. And so we're managing on a daily basis, kind of our overall-- the duration of the equity. And we report the amount of swaps and swaptions relative to the amount of repo. But on a daily basis, we're really managing those key rate durations.

Got you; it makes sense. On a different topic; I guess you guys have obviously added a lot of hedges which I think is the prudent course. At the same time, book value is down. You haven't really covered $0.65 with core earnings power in a year. And I guess when you think about assets running down and leverage maybe drifting lower rather than higher; I'm wondering if you could talk at all about how you think about that dividend rate and sustainability of the dividend and sort of what your expectations are for how the relative economics look going forward versus looking back.

Sure. I think just like we talked about last quarter on the call, core earnings have been running at let's say $0.60 for quite some time and we've been paying $0.65 so it's reasonable to think that the dividend could come down, as you're suggesting. And given more swaps and swaptions and somewhat reduced balances; core is probably going to run a little lower than even the $0.60. So I think it's reasonable to expect; but on the other hand, we have generated additional taxable earnings which will need to be distributed.

So I'm not going to give specific earnings or dividend guidance, but I think your point is well taken that core earnings are below the dividend; so in the long run, it's likely to come down. And then additionally you have to think about the fact that asset yields are up, prepayments are going to come down; so we really haven't made that determination yet in terms of what the dividend is going to be this quarter of the rest of the year.

All right; well, thank you. That's definitely good color, though; I appreciate it.

Joel Houck, Wells Fargo.

Good morning. Just kind of back on the interest-rate hedging strategy here; obviously, it took the hedge ratio up substantially reducing that out of some of your peers. Yet you continue, at least in your slides, you've got a target duration gap of one to one-and-a-half year range. I guess the question is-- what would it take or what are you guys looking for to maybe move the hedge ratio back down? Because I'm assuming the duration gap here is fairly tight, given the overall hedge ratio.

So what we've seen is obviously since rates went up 70 basis points, let's call it, in the quarter; you did have the mortgage portfolio extend in duration. And so adding the additional hedges; it reduced the duration of the equity but we've actually still probably preferred it to take that and shrink duration a little lower still, rather than go the other way. Because I think the point is we want to deliver an attractive dividend, but also an attractive economic return, like I said over the last year with rates up 80 to 85 basis points; even though book value is down $0.50 over the last year. It's still pretty attractive all in return and I think we can continue to do that and the key thing being that when you look at what happened over the last quarter, a relatively small part of the 12.5% decline was driven by interest rates. So I think we're pretty well hedged. We don't think we're over-hedged or under-hedged in an interest-rate sense. But it was essentially spread widening, so and what we've seen since quarter end is the directionality of the mortgage basis has really kind of gone away in the sense that during the quarter when rates were going up, mortgages were underperforming swap hedges pretty consistently. And then when we'd get some type of relief rally, they'd tighten.

But what we've seen since quarter end is mortgage is kind of-- we've seen days when rates go up and mortgages outperform and so I think the dynamic has changed. So we feel like our interest-rate hedges are doing what they're supposed to do and we feel like we have support in book value because we think spreads are attractive.

I mean I guess I get the part that you're more insulated against rate changes, given the actions you've taken and (inaudible) risk or spread widening is something that's impossible to hedge. I guess I was more curious as to-- is it your intention once things kind of settle down, to let the duration gap move back out to the one to one-and-a-half year range or are you going to run kind of a tighter book, if you will, for the foreseeable future; just given the uncertainty and volatility in rates? That's what I was trying to say--

We'd be leaning much more towards running a tighter duration gap than a longer one, given our outlook.

Okay. And then if I could, another maybe kind of strategy or positioning question; the Non-Agency marks, not surprisingly, were down given kind of technical issues near the end of the quarter. And your Non-Agency bonds tend to be higher quality which at least near term means they're more correlated with the Agency book. Have you guys thought about maybe doing more deeper sub-prime so kind of the credit element acts as kind of a non-correlated asset to the Agency strategy or is it the case where you kind of feel like it is more of a technical transitory issue and you're just kind of stand pat with the Non-Agency strategy as it is today?

Two things; the first thing, on the bonds we own, we own on legacy bonds they tend to be, like you said, of higher quality, mostly prime and Alt-A. Those we saw negative marks obviously in the quarter and I think some of that has to do with that those are out of the Non-Agency space, they're probably the most liquid bonds. So when there is selling pressure, those (inaudible) were affected, obviously. So the preference there is not to go buy sub-prime or option ARMs. I think if we're going to go down in credit, what we're trying to do is go down in credit in the new-issue space. And the best way to do that is through securitizations. I mean that's part of the idea of participating in these securitizations, is to be able to take and to play into what we feel is our competitive advantage which is doing more granular credit work. And I think the new-issue securitization space and buying the subs on those really lends itself to our strength. So I think that's where you're going to see us try to add more like sort of deeper-dive credit.

Yes and I think from what we saw in the market in the quarter, subprime wouldn't have helped. It would have been worse. We saw prices of subprime bonds down more than the type of bonds we own.

So I mean it was just over the quarter, spreads widened. It wasn't necessarily the duration of those positions as much, because we do hedge that.

Okay, all right. Thanks for the answers, guys.

Dan Altscher, FBR.

Thanks. Good morning, everyone. I was wondering; I understand you can't really size the commercial loan opportunity at the moment, but can we talk about your capabilities in terms of staff; how many people are doing credit? Are you working with other partners to originate first mortgages and you're partnering to take the subordinate pieces? Or can you maybe just give us a little bit more detail as to how you envision maybe that strategy working out, as opposed to just pure size?

Yes, absolutely. We have a commercial real estate team that's several hundred people who we partner with on the commercial real estate side, in addition to our credit team. On a daily basis, that's kind of leveraging the strengths of that commercial real estate team. And it's a great arrangement because we have the capability. It's no additional cost to Invesco Mortgage Capital. That's just all within Invesco. So we have a ton of capability. We see a lot in terms of deal flow from all the commercial real estate brokers and so forth.

So I think it's just a matter of having the right opportunities come along and the right sizes and we're focused on quality real estate and anything else John?

No, I mean I think that the point though, of having access to deal flow and getting-- having the right relationships within the larger Invesco in terms of what that brings is really important. I mean it's a competitive advantage because I think given the size of most REITs, we have a lot more resources at our disposal that we don't necessarily need to-- that while they work for us, they're just part of Invesco, so we can tap them when we need them. We can use their expertise as needed. So that's really important.

Okay, thanks. And I just had one more and this is kind of addressing, or going back to what Doug was saying I think, initially on interest rates and securitization. Can you talk about how you think maybe the higher interest-rate environment that we're currently in; is that creating any dislocation in the new securitization market for new prime jumbo RMBS? Or was that kind of just a one-month kind of dislocation and now we're kind of back to chugging along?

I think there is a dislocation that is going to need to be worked through going forward. What we've seen is spreads on the triple-As have persistently widened and they haven't really come back in yet. And I think what's happening there is it's making-- I think bank portfolios have a better bid for prime jumbo loans right now than conduits. And so we have seen a decrease in deal flow. And I think we need to either see rates higher so that conduits are more competitive; or we'll rate that as rates to the borrower; or have spreads on the triple-As come back in to really get the deal flow going again.

Okay. Thank you.

Daniel Furtado, Jefferies.

Good morning, everybody. Thank you for the opportunity. As a follow up to the last question; spreads coming in and rates going higher on the securitization front; I mean I know it's a guess, but what would your guess be in terms of how long that market is in a dysfunctional state?

It's tough to say but I think I guess if bank portfolios continued to put spreads for prime jumbo or yields pretty close to on top of Agency; then it's just not a very attractive space. I think that's the issue; how long that goes on. And so it could be awhile. It could be that we just don't see a lot for the rest of the year, potentially.

Understood; and so is the takeaway from the bank standpoint; is what you believe happening at the banks with this more aggressive bid for jumbos; do you think that that's due in essence that the banks can hold those at amortized costs and don't have to mark them to market like they would say in Agency or in MBS or is there something else driving that behavior?

I think that's probably a big part of it; and then just maybe the prime jumbo customer base is a strong bank customer.

Got you; that make perfect sense. And then turning to the securitizations you guys did this quarter; I noticed their accounted for as a financing, so you're bringing all the loans on your balance sheet. Over the course of time, I know they're not really on your balance sheet, but from an accounting perspective; over the course of time will that help you to, in essence, push away from the 55% Agency requirement in terms of the whole pool test? Will those qualify as whole pool assets?

Dan, that's something that we are certainly exploring. We think that that's a distinct probability that we will be able to do that over time. We certainly see those as-- the rules are kind of tricky on that so I don't want to get into a long discussion on that at this point. But we do see that as an opportunity in the future that we can move away from having to meet the 55% test with pure Agencies and be able to use the securitizations, yes.

Got you. And without getting into the technical aspect of that conversation; that I assume, given the right environment you'd be willing to reduce the Agency exposure below the 55% if in fact it qualified from an accounting perspective?

Yes, you're absolutely correct. If that's the case, we'd prefer that credit tranche rather than the agency trade, yes.

Okay. And then my last question and I think it's more just a calculation question and thank you for the answers; is the Agency leverage-- when I just do a more simple leverage calculation if I look at the delta between the repo funding and the fair value of the Agency, I get a different leverage number than you're reporting. Am I missing some equity contribution or am I just in essence, doing my math wrong?

You're probably missing some of the equity contribution and Dan, the challenge you have when you do a number like that and you're allocating it to buckets; what we do is we take the entire balance sheet and we allocate each aspect of the balance sheet, both assets and liabilities, to the buckets to which they apply. And so for example, we allocate cash to the individual strategies. We allocate the hedging strategies, since most of those are for Agency side, predominantly to the Agency. So you're probably just missing some of the little nuances of that. And that's a little challenging to do, I understand. So as long as you're in a relative ballpark of where we're at, I think you probably are close to what we're doing.

Got it. Thanks for the color, everybody. Take care.

Mr. King, there are no further questions from the phone lines at this time.

Okay. Thank you, Operator. And thanks, everybody. Once again, we appreciate your time today.

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your line.