MFA Financial Inc (MFA) 2015 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the MFA Financial Incorporated Third Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode and later we'll conduct a question-and-answer session and instructions will be given at that time. (Operator Instructions) And as a reminder, this call is being recorded. I would now like to turn the conference over to our host, Mr. Bill Gorin. Please go ahead.

Good morning. The information discussed on this conference call today may contain or refer to forward-looking statements regarding MFA Financial, Inc., which reflect management's beliefs, expectations, and assumptions as to MFAs future performance and operation. When used, statements that are not historical in nature including those containing words such as will, believe, expect, anticipate, estimate, should, could, would, or similar expressions are intended to identify forward-looking statements.

All forward-looking statements speak only as of the date on which they are made. These types of statements are subject to various known and unknown risks, uncertainties, assumptions, and other factors, including those described in MFA's annual report on Form 10-K for the year ended December 31, 2014 and other reports that it may file from time to time with the Securities and Exchange Commission. These risks, uncertainties, and other factors could cause MFA's actual results to differ materially from those projected, expressed, or implied in any forward-looking statements it makes.

For additional information regarding MFA's use of forward-looking statements, please see the relevant disclosure in the press release announcing MFA's third quarter 2015 financial results. Thank you for your time.

I would now like to turn this call over to Bill Gorin, MFA's Chief Executive Officer.

Thanks very much Danielle. I'd like to welcome everyone to MFA's third quarter 2015 financial results webcast. With me today are Craig Knutson, MFA's President and Chief Operating Officer; Gudmundur Kristjansson, Senior Vice President; Bryan Wulfsohn, Senior Vice President; Steve Yarad, CFO and other members of senior management.

In 2015, we continued to execute our strategy for orderly investment within our expanding residential mortgage asset investment universe. As we identify opportunities in the residential mortgage assets sector, MFA has the focus and the requisite capability to analyze the investment and to be a significant investor.

Turning to page three. Despite the low interest rate environment, we continue to identify and acquire attractive credit sensitive residential mortgage assets. In the third quarter of 2015, we generated net income of $75.8 million or $0.20 per common share. The dividend was again $0.20 per share. Book value per common share was $7.70.

For the nine years since June 29, 2006, since the last federal funds rate increase, the unemployment rate has declined and may continue to decline. The Fed certainly has signaled a desire to raise the Fed funds rate in 2015. Yet the labor force participation rate remains low, inflation remains low in US and borders on deflation in Europe and Japan. Interest rates remain low across the yield curve on a global basis. Commodity prices are weak and the strong dollar is impacting US companies.

As a result, future US Federal Reserve actions including those to be potentially announced at the next Fed meeting scheduled for December continue to remain dependent on the incoming data. The probability of changes in the Fed funds rate has gone up by time. The exact liftoff date still remains uncertain, but we currently anticipate that changes in monetary policy will be measured and gradual. At MFA, we continue to limit the interest rate sensitivity of our portfolio. We have a net duration of 0.58, we have a leverage ratio of 3.3 to 1, and 73% of our mortgage-backed securities are adjustable rate, hybrid, or step-up.

Turning to page four. In the third quarter, we continued to identify and acquire credit sensitive residential mortgage assets that generate earnings without increasing MFA's overall interest rate exposure. We significantly increased our holdings of credit sensitive residential whole loans from $429 million to $777 million. In the quarter, our most interest rate sensitive assets, agency MBS continued to pay down.

Turning to page five. As you can see, MFA's yields and spreads remain attractive despite the interest rate environment. Leverage again remained consistent at 3.3 debt-to-equity ratio. Turning to page six, we present yields and spreads for our more significant holdings. Given the leverage we're utilizing or may utilize in the future, each of these asset types are generating attractive returns to MFA's shareholders. On page seven, we illustrate how our holdings of credit sensitive loans have grown throughout 2015. At today's market prices, these mortgage loans generate higher yields than residential mortgage-backed securities. Importantly, these loans are qualifying real estate assets. They are more credit sensitive and less interest rate sensitive. The third quarter increase was due to access to a good supply of investment opportunities within the sector. Turning to page eight, undistributed REIT taxable income was approximately $0.04 per share at the end of the quarter. There are two items that we want to highlight, which we believe may increase taxable income but not GAAP income over the next several quarters. So it's important, what we're not trying to do here is forecast absolute GAAP earnings or taxable earnings, what we're trying to highlight to you is why we currently estimate there'll be a difference that taxable income will exceed GAAP income over the next couple of quarters. We anticipate a re-securitization unwind in 2016, which is expected to generate taxable income by an amount estimated to exceed $0.15 per share. In addition, there is an expected countrywide settlement, which we expect to increase taxable income by an estimated $0.05 per share. Turning to page nine, Gudmundur will present the slide, which is an update on MFA's interest rate sensitivity.

Thank you, Bill. On slide nine, we show the interest rate sensitivity of MFA's assets and liabilities. In the third quarter, our asset duration declined 8 basis points to 142 basis points at the end of the quarter. The decline was primarily caused by an increase in assets with low sensitivity to interest rates and a reduction in assets with higher sensitivity to interest rates as we added approximately $350 million of non-performing whole loans in the quarter, while our agency MBS portfolio declined by about $310 million in the quarter. The notional amount of our swap hedges remained unchanged at approximately $3 billion at the end of third quarter, but the hedge duration declined 20 basis points to minus 3.7 at the end of the quarter as our swap hedges shorten naturally over time. In aggregate, MFA's portfolio net duration declined modestly to 58 basis points at the end of the third quarter from 61 basis points at the end of the second quarter. MFA's strategy of limiting interest rate sensitivity to asset selection has allowed us to be well positioned for the substantial increase in interest rate volatility we've experienced this year. And our portfolio continues to exhibit limited sensitivity to changes in long-term interest rates and spreads. By maintaining low net duration and limited sensitivity to the long end of the curve, we believe MFA is well positioned for continued interest rate volatility and a potential gradual increase in Fed funds in the near future. With that, I will turn the call back over to Craig.

Thank you, Gudmundur. Moving to page 10, we continue to increase our usage of Federal Home Loan Bank advances in the third quarter and subsequent to quarter-end. We currently have $800 million of borrowing with the Federal Home Loan Bank of Des Moines. The average cost of this borrowing is 25 basis points with a term of a little less than five years. For the time being, we have pledged agency collateral [to] securities advances. We're excited about this partnership with an extremely solid counterparty and we look forward to working together with the FHLB to further their core mission of supporting housing finance. As a condition of membership, MFA Insurance has purchased stock in the FHLB of Des Moines, thus helping them to build their capital base. In addition, when we access FHLB advances to finance the mortgage position, we purchase additional stock in the FHLB in the form of activity stock. So we were effectively capitalizing any borrowings that we undertake with the FHLB.

Moving to page 11. We purchased approximately $232 million of RPL/NPL mortgage backed securities in the third quarter while experiencing pay downs of about $333 million. We continue to like these assets due to their low sensitivity to interest rates and what we believe to be low credit risk while at the same time providing low-double digit ROEs. Spreads on new issue deals have widened somewhat recently and we've been able to invest at attractive yields of 4% and better since quarter-end. The fourth quarter has been a heavy issuance quarter in past years. So, we are hopeful that there will be attractive opportunities to invest in these assets in the next two months.

Moving to page 12, the credit metrics on the loans underlying our legacy non-agency portfolio continue to improve. 76% of the loans underlying our legacy non-agency portfolio are now amortizing. This principal amortization together with home price appreciation continues to reduce LTVs. Delinquencies are curing. 60 plus day delinquencies as of September 30 for the portfolio have declined to 13.8%. On this page, we illustrate the LTV distribution of current loans in the portfolio. The red bars represent at-risk loans where the homeowner owes more on the mortgage than the property is worth. These are loans we worry most about transitioning to delinquent in the future because the borrowers are underwater. As you can see, these red bars are disappearing. Please also note the increasingly large green bars on the left side, loans of LTVs below 80% are attractive refinance candidates. The combination of low rates available today and a 30-year amortization term versus the 20-year remaining term on most of these loans today can offer homeowners substantially lower monthly payments and of course, given our deeply discounted purchase price for these assets, we're very happy when the underlying loans prepay.

On pages 13 and 14, we saw home price appreciation in the two states with the highest concentration of loans. 44% of the underlying loans are located in California. Although HPA has declined from the frothy levels of the last couple of years, we're still seeing good progress in the last 12 months. Page 14 illustrates the last 12 months HPA in Florida, our second largest state concentration. Improving home prices obviously bode well for the credit performance of this portfolio.

On page 15, we show realized credit losses experienced on the portfolio over the last three calendar years and for the first nine months of 2015. After realizing losses of $164 million in both 2012 and 2013, losses decreased to $90 million in 2014. The run rate thus far in 2015 is a little lower than it was in 2014. We released $6.9 million of additional credit reserve in the third quarter based on updated projected future performance on the underlying loans in this portfolio. Our credit reserve now stands at $815 million and will be reduced in the future if actual losses are realized on the underlying loans.

These realized losses occur when the properties securing the mortgage loans are liquidated for less than the outstanding loan amount. In addition, as we have discussed previously for many of the fixed rate bonds in the portfolio, unrealized losses are generated when mortgage loans are modified through coupon reductions to troubled homeowners. While the loan modification reduces the interest rate paid by the borrower, the bond that we own has a contractual fixed rate coupon. So the interest collected from the borrower, maybe less than the interest owed to the bondholder. In order to cure this interest shortfall, the trustee uses principal receipts to pay interest on our bond. This use to principal to pay interest effectively under-collateralizes our bond as the underlying principle balance of the loans is now less than the principal balance of the bonds that we own. For some bonds, this loss is recognized in the period in which it occurs as a realized loss, but in most cases, this loss is not realized until the loan balances reduce to zero and yet we still have a bond balance outstanding, which is likely many years from now. At that point, the unrealized loss will become a realized loss. Approximately $50 million of these unrealized losses have already occurred.

Turning to page 16. We made good progress growing our credit sensitive residential whole loan portfolio in the third quarter increasing this asset class to $777 million as of September 30. Our credit sensitive whole loans appear on our balance sheet on two lines, loans held at carrying value and loans held at fair value. This selection is permanent and it is made at the acquisition of the loans. Typically, we elect carrying value for re-performing loans and fair value for non-performing loans. We had an additional warehouse borrowing capacity during the third quarter and now have three warehouse lines with aggregate borrowings of approximately $427 million. We've also added additional staff to help with the asset management function associated with this portfolio. We're excited to have the ability to oversee servicing decisions on troubled loans and we believe we can achieve improved returns on these loans through thoughtful and diligent asset management.

On slide 17, we illustrate the five largest state concentrations in our whole loan portfolio with five states comprising over half of the portfolio. Property value is typically the single most important metric in determining the value of re-performing and non-performing loans, so obviously home price appreciation is a good omen for returns on these investments.

And with that, I'd like to turn the call back over to Bill.

Thanks, Craig. In summary, we continue to utilize our expertise to identify and acquire attractive credit sensitive residential mortgage assets. We've substantially grown our holdings of RPL/NPL mortgage loans in 2015. Our credit sensitive assets continue to perform well. Future Federal Reserve decisions on monetary policy will remain dependent on incoming data, but MFA is well positioned for changes in monetary policy and/or interest rates. This completes today's MFA presentation. Operator, could you please open up the lines for questions.

(Operator Instructions) Dan Altscher, FBR.

I want to touch on the slide Bill that you referred to with I think slide eight with the future items to future taxable income, I guess one can you just talk about what or why they do not impact GAAP and why they only impact taxable income? And I guess the point you're trying to make also that when we think about distribution requirements for 2016 that these are obviously favorable items that support the dividend or [regardless of GAAP] or that have implications that would drive a higher distribution because of the taxable income?

I'll take the second part of the question and then I'll hand it over to a GAAP or tax expert. To answer the first part because I haven't decided which yet. So, the second part of your question, it's almost algebraic. You got three variables and they are all unknown. So, I won't be able to answer your question. What we're saying is, as I pointed out, I'm not forecasting what GAAP income is but based on what we currently know, we imagine that taxable income will exceed GAAP income and, yes, you're right, historically, taxable income has driven the dividend, which is a Board of Director decision. So I would say, to the extent that taxable income exceeds GAAP income and to the extent the dividend is more in line with taxable income, we shouldn't be surprised that [tax at] the dividend possibly exceeds GAAP income. So, I think I answered part two of your question. Part one, I'll actually hand over to our tax expert Terry Meyers.

Hi Dan, as it relates to (technical difficulty) base and definition of income for tax purposes and not for GAAP purposes is really because the transaction, the re-securitization that we're referring to is not a [debt to tax] transaction. For financial reporting purposes, it was however for tax purposes, it is not and as a consequence, since the securities have increased in value, since we originally undertook the transaction [to when we collapsed the transaction], we are called to recognize the results from that increase in value.

Dan, this is Steve Yarad, I'll just add to that from a GAAP perspective. When we did the re-securitization transactions, there was no impact on GAAP financial reporting when we did the initial transaction because we consolidated the underlying assets, transferred to the trust and similarly when we unwind transactions, it's also no impact on GAAP reporting because everything remains on the balance sheet before and after.

Got it, okay. That's a good hopeful explanation. I don't think any of us are surprised to once again see gains from sale of non-agency, but I think what was striking in my view was I guess the size of the gain relative to the notional amount of securities sold. So, can you just provide us a little bit of context as to what those bonds actually looked like, whether it's vintage or credit or anything like that?

Sunil is not here, but I [would its] relative to the cost basis. You saw how bonds are traded, we like the prices we sold comparable assets and really is relative to our particular cost basis, but you're right, that's not indicative of a whole portfolio for average amortized costs about 74 and we have these marked at 90. It just so happens, these gains were above average and is probably due the fact that these were assets we acquired earlier on and that's why it was such a large gain.

Okay. And that would make sense. Next, I want to talk a little bit about FHLB. Craig, I think you mentioned in your script that you pledged agency collateral and the term was for five years. So I guess, can you give us a little bit sense of the differential in terms of the borrowing rates that you're seeing for five years versus if you were try and be like a five year term repo or anything of that nature and then also or is that exposure also, did that have a hedge against it to, obviously not meant to protect against the duration of the borrowing, but I guess a comparable move against the asset if you will from a capital or book value perspective.

The hedge against the assets we've had all along. We haven't bought agency securities in almost two years. So we pledged agency securities and they've been hedged as they've been hedged for years. As far as the borrowing rate, it's a five-year term, but it's a monthly reset. So yes, contractually it's a five-year term, but it adjusts monthly. So it's not unlike normal repo other than for the fact that the cost is lower.

Can you help us just give a sense as to what the differential is then in the cost?

I said that the average cost is 25 basis points and our monthly repo cost is what 36 or so. So 36 to 38, so 10 to 12 and in addition, not to make it more complicated, but because we've repurchased activity stock and the activity stock is typically 4% of the borrowing, that activity stock actually pays us a dividend, which is currently about 3.5%. So if you factor the 3.5% dividend into the 4% activity stock, it probably lowers our cost by another 12 basis points, 13 basis points, 14 basis points. It doesn't show up as lower interest expense, it shows up as an income item, but the two are obviously related.

Doug Harter, Credit Suisse.

Can you guys talk about the liquidity in the whole loan market and the availability of product?

Hey Doug, this is Bryan Wulfsohn. We're assuming sort of significant supply of home loans throughout this year, so we've seen almost $30 billion, $38 billion worth of supply across non-performing and re-performing loans and that supply has been met with sort of equivalent demand as you've seen, you know, a few large players between five and six that tend to soak up the majority of the supply and they you have a lot of other participants that participate on a smaller level.

And I guess is there a typical size deal that you guys prefer to play in or that you find as more economic?

So it really will depend on the assets underlying. So really we can look at deals as small as $10 million and as large as $300 million, it's really all going to depend on the specific pricing and the specific underlying assets.

And then taking a step back, you guys have run a conservative leverage historically. I guess have the spreads widened enough that you would be willing to put a little extra leverage on or are you going to sort of maintain leverage around current levels, so obviously depending on the mix?

Yes. I look at that question as do you want to grow your asset base at this particular time because how you fund it is how you fund it and basically we're replacing asset run-off. It's hard to say that spreads are wider than they'll be, but we've been very active in acquiring loans and in a rapid pace while allowing the more interest rate sensitive assets to run off. So this 3.3 number plus or minus that's been the right number for years now. So there's nothing I see in the availability of assets that makes us think that number is going to change a lot at the moment.

Joel Houck, Wells Fargo.

So you guys are in an unusual position in that the price to book has come down with the rest of the group. And so you haven't really been asked about buybacks, curious as to your thoughts about the merit of buybacks relative to opportunity you have on the investment side and at what level if it all makes sense to go to the Board to authorize buybacks and actually start doing buybacks?

So, even though you've had some certainty about interest rates, to us it's an uncertain interest rate environment. Volatility has increased. We've said before we're right sized. We very much like our investment strategy and our investment opportunities, and as you point out, we're not at a large discount, [about 10%] discount is friction cost of raising equity.

So, I don't envy people that trade at large discounts, but I guess at large discount at times, we share prices with good investment opportunities like -- I don't rule it out forever, but we're very happy executing our strategy, which is very high value add strategy for investors. These are assets that they really cannot buy themselves particularly our focus on loans now and I think that's -- we wish we were at a premium or at book. We can't control [where you are] moment to moment but we have not been trading at large discounts and I think that reflects the market's comfort with our strategy and the execution.

Okay, fair enough. And on the investment allocation I think for you guys your strategy makes sense given the opportunities that you have on the non-agency side. Nonetheless, I'm curious as to what would it take either spread widening in agency or Fed action or lack of action in order to get more enthusiastic about agency and I ask the question that is more for insights because it does seem that the theme we've now heard for many quarters on these calls, you and your peers is that no one likes the agency complex risk-reward trade-off.

I would say that on a number of these phone calls, I've said that our expertise, which I believe exists here and have sort of shown is to make superior credit decisions. And in no way our investment strategy is based on the same that we have the best call into the Fed or even the best call on prepays. Agency asset, the absolute yield, because historically we've refrained for investing in fixed rates. Absolute yield is close to 2%. It's really a leverage game and a hedging game and even if you had the exact right call on interest rates in the prior quarter, the hedging proved difficult. So, I think ours is the more value-added strategy. How many companies do you need to invest in agencies for you over time, and I think we've evolved to a strategy less dependent on leverage, less dependent on interest rate exposure, and more dependent on doing credit work. So, if the yields were very different, I'd give you a different answer, but based on the market we see and based on what you've seen [we do] the last two years, I think we continue to focus on the credit assets, which we're very interested in and we're seeing very good supply and good investment opportunities.

Rick Shane, JPMorgan.

I really appreciate slide six where you break down the spreads and cost of funds by line and show the leverage. When we do the quick math, it looks like in general the ROEs for the different products are pretty similar. I'd like to hear you, how you think about that and I think it really goes back to Joel's comment that this is not a strategy as you migrate into -- you grow the RPL/NPL portfolio of trying to per se enhance ROE, but dampen volatility given the environment we're in.

Well said Rick and you're right. I think what I said in my preamble, we're looking to add interest rate earning assets without increasing our interest rate exposure. So it's not an ROE maximizing strategy. In a zero interest rate environment, how can I continue to generate ROEs close to 10% without incrementally adding interest rate risk because if we added interest rate risk on the asset side, you would have to be adding hedges and sometimes that's difficult to do. I think it is in a zero interest rate world, when you have to look at how much risk you've to take to earn something, we're very excited to continue to invest in assets that generate ROEs close to 10%. So I think that's similar to what you said, but that's how we look at it.

Mike Widner, KBW.

So I think you covered everything pretty thoroughly and most of the reasonable questions [hadn't] been answered, so I'm going to ask you one that's maybe a little out there. You've had the agency MBS portfolio pretty much on rundown or autopilot for everyone to look at it for a couple years now and in the non-agency portfolio, you guys have been opportunistic from time to time, this quarter included of selling things that or at prices that you think are for or perhaps at prices where you wouldn't buy them today, so it makes sense to sell them. So my question I guess is, if you look across your whole portfolio and I think this is universally true across mortgage REITs, but the one asset you couldn't fathom buying at current prices is current reset ARMs and so I'm just wondering why not sell those, why continue to hold on to them if the market yields are so low, the prices are so high, so out of line with kind of historical norms, I know that they show as having no duration on paper and I'm just not sure that, that risk is worth taking given where the prices are. So, I'm just interested in your view specifically on current reset ARMs and why hold on to them?

First of all, Mike, that's a very reasonable question. So, thank you. And as you know, there are certain requirements and [40 Act] requirements which we need to have qualifying real estate assets and I think what you're seeing during our evolution, which has been orderly, qualifying real estate assets in the main have included agencies but now the growth is in loans, which are also qualifying real estate assets. So you sort of see one asset running-off while another one is growing, keeping us in a required compliance. So, hopefully that will give you an answer to the flows in and out of those two asset classes. Does that answer your question, Mike?

Well, I mean, sort of, but I guess what I'd say is like, the issue with current reset ARMs are sort of the longer reset ARMs run down and turn into current set ARMs so, if I look specifically at those, you're not really or don't appear to be shrinking, your balance of current reset ARMs and again as the other stuff runs into those is probably shrinking, but not as much as the whole portfolio, the whole agency portfolio is shrinking.

Well, that's actually a very good thing that your shorter duration less interest rate assets is not going away rapidly. We actually, Gudmundur, can actually give you an update on the merits. People talk about, I wish I had a highly seasoned burnt out portfolio, well, that's what we're talking about here. Gudmundur, you want to talk about some of the merits of our short duration?

I guess when you talk about the short-reset, you're referring to the fact that they are trading under premium in the marketplace and so the risks (technical difficulty) as the rapid increase in prepayments, so you asset goes away quicker than you expect. Over the last couple of years, what has surprised people actually about current reset ARMs is that their speeds have been very low and therefore the carry has been fairly nice on them. So one has to think when one looks forward what will cause that to change and why would prepayments increase. Well, one of them would be okay, if the Fed is about to raise rates very quickly, then a rational homeowner would say well, you maybe the rate is going to up 200 basis point, I should lock in a fixed rate that's 150 basis points higher and I don't think a lot of people on this call expect Fed to raise rates rapidly. So the rational homeowner is in no rush to reef out of his very low mortgage that he has on the current reset ARM. So, the risk to the market value of that part of the portfolio, I don't view it as being large but I'm sympathetic to your view that there is potential risk regarding high prepayments, but that would predominantly come through if the Fed is raising rates quickly and these people would feel the need to lock in lower funding rates for 30 year or 20 year mortgage.

I certainly appreciate that and that's a thoughtful response. I guess what I'd say is, my personal concern isn't at all with the prepays, I don't think there's a whole lot of risk of prepay speeds on those jumping higher. It's more the absolute price and it's -- you guys are carrying in the vicinity of 107. I think you guys know historically, if you look back at the last tightening cycle and I don't want to say we're heading into a similar tightening cycle but a dollar price around 103.5 might be more normal and I guess very specifically, my question is, have you looked across your portfolio, your entire assets, I'm pretty sure if you had to rank what would I buy today at current market prices, those I'm pretty sure would be dead last on your list at 107-ish. And so again, I do believe there's pricing risk that doesn't have to do with pre-payment risk and it has to do with more the distortions created by the Fed being at zero, and anyway, I mean it's just a more philosophical question, if you wouldn't buy them here, why sell other things that aren't quite as low on your list of things you'd buy at current prices.

The amount of sales was $25 million. So it's not like we're actively selling. It's really making sure we're in compliance that we need to be, not adding interest rate risk. These of course are very short duration assets. You're right, they are highly valued in the market but these are pretty burnt out in terms of prepay. So incrementally we're not growing there. They are going away at their own pace and part of the rationale is [40 Act] Compliance and our re-compliance.

Thanks, I appreciate your thoughts as always and nice job in the quarter as I think I'm used to saying now.

(Operator Instructions) Steve DeLaney, JMP Securities.

I know we've run on a little bit here, but one quick one, obviously the big change in the balance sheet in third quarter was the $348 million doubling -- almost doubling of the RPL/NPL whole loan portfolio. And Craig, thanks for the color. I think it was slide 16 you told us how you were financing those currently with warehouse lines. I'm just curious guys if you look at that portfolio in terms of the scale, diversity of both our RPLs and NPLs, is securitization an option for you going forward in that asset class and is there any possibility to either boost the spread or increase the leverage through a securitization transaction. Thanks.

In interests of boosting the spread, I think I can safely say that securitization would not boost that because as you know, we're active participants in the RPL/NPL security space and [we've done purchases at 4% yields] and slightly higher. So we look at that as an attractive asset and therefore, I think we would have to say that we view it at the same time as an expensive liability. So, yes, it's certainly a possibility, we certainly could do that, but I think right now, I would say that we're a better buyer of those securities than we are a seller. As far as the leverage on that portfolio, it's a little more complicated to add leverage on the loans because the lender has to do due diligence on the package. So it's typically easy to do when we acquire a package because we're doing that due diligence together with the lender. It's a little more of a process to take loans that we may be have owned for a while and finance those. So we've said over time that our leverage there will increase and it has and obviously as you can see, we do have additional borrowing capacity there.

And so Craig, to think about the leverage, obviously, it looks like if we blend it between the two given the [427], it looks like about 1.2 times on $350 million of equity. Are we thinking about that right?

You are and again it's not -- we've said before we don't target leverage. We don't try to optimize that, but if you consider that, it's typically 25% haircut, maybe a little bit higher. We certainly could -- that leverage number could be a little bit higher. I think what is it [2 to 2.5] or so on the non-performing --

NPLs, yes.

So we don't have that much leverage on that re-performing book, but that could change over time.

Thanks for the comments and Bill really appreciate the clarity on the taxable income excess for next year. That will be helpful.

Thanks. We try to make it as clear as we could.

Alan Strauss, Schroders.

I have two questions. One is on the $0.20 I guess of taxable income that you'll have to distribute. Can you just let us know how quickly you have to distribute that income just hypothetically, assume you've got it in the first quarter, how long till you have to distribute it? And two, if that gives you a cushion on your dividend, would you change your investment strategy a little bit and invest in securities with higher capital gain, you're buying at a discount, you get a capital gain versus the net interest income, you know would change the metrics of what analysts look at, but actually, it's a better total return.

So only to go back to what I said originally. We're saying there's a differential between GAAP and tax of $0.20 as you pointed out, but we're not telling you what the GAAP income is so it doesn't necessarily mean there is some excess relative to the dividend. I know you understand what I'm saying, but starting with that in terms of when one needs to distribute taxable income, it's when you file your taxable return, which is September of the following calendar year. So, the answer would be we have approximately 18, 19 months to distribute all your taxable income. Does that answer your question, Alan?

Yes, that answers that question. What about on the strategy that gives you somewhat of a cushion that you could buy things at a discount, get a capital gain versus spread income. Does it alter any of that strategy because you have --

Not really. We look at the way you'd look at it. You look to invest in the asset that gives you the best total return. We've always operated that way. So it does not increase our flexibility. By the way, when we purchase an asset at a discount, we are accreting to the appropriate number, which generates GAAP and taxable income. So, realizing a gain through the income statement, we are different -- we always have invested for total return and there's not been any tax or dividend problem with that.

Yes, I know you look at it that way, I looked at it that way, but the analysts always looked at it as one-time in nature. Okay, thanks.

And there are no further questions in queue. I'll turn it back over to you.

Great, well I want to thank everyone for participating today and we look forward to speaking to you again next quarter. Thanks. Operator, you can disconnect.

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