Annaly Capital Management Inc (NLY) 2012 Q2 法說會逐字稿

Good morning and welcome to the second quarter earnings call for Annaly Capital Management, Incorporated.

At this time, I would like to inform you that this conference is being recorded and that all participants are in a listen-only mode. (Operator instructions.) At the request of the Company, we will open the conference up for questions and answers after the presentation.

This earnings call may contain certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements, which are based on various assumptions, some of which are beyond our control, may be identified by reference to a future period or periods, or by the use of forward-looking terminology such as may, will, believe, expect, anticipate, continue, or similar terms or variations on those terms or the negative of those terms.

Actual results could differ materially from those set forth in forward-looking statements due to a variety of factors, including but not limited to changes in interest rates, changes in the yield curve, changes in prepayment rates, the availability of mortgage-backed securities for purchase, the availability of financing and, if available, the terms of any financings, changes in the market value of our assets, changes in business conditions and the general economy, changes in governmental regulations affecting our business, our ability to maintain our classification as a REIT for federal income tax purposes, risks associated with the broker-dealer business of our subsidiary, the risks associated with the investment advisory business of our subsidiaries including the removal by clients of assets they manage, their regulatory requirements, and competition in the investment advisory business.

For a discussion of the risks and uncertainties which could cause actual results to differ from those contained in the forward-looking statements, see Risk Factors in our most recent annual report on Form 10-K and all subsequent quarterly reports on Form 10-Q.

We do not undertake and specifically disclaim any obligation to publicly release the result of any revisions which may be made to any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements.

I will now turn the call over to Michael A.J. Farrell, Chairman, Chief Executive Officer, and President. Please proceed, Mr. Farrell.

Good morning and thank you. Good morning and welcome to Annaly Capital Management's earnings call for the second quarter of 2012. I'm Mike Farrell, and joining me on the call today are Wellington Denahan-Norris and Kathryn Fagan.

Annaly's execution and performance in the second quarter was consistent with what we've been discussing with investors for some time. We have kept leverage low. We've strengthened and executed -- and extended the right side of our balance sheet. We've been careful in our asset selection and maintained a sizeable hedge position, all the while continuing to generate mid teens returns on equity.

Our portfolio positioning reflects our view that there are significant risks embedded in the financial system, some of which I will address in my prepared remarks, after which we will gladly take questions about the quarter.

As usual, my remarks this morning are up on our website already. The title of today's missive is Fiscal Union, Civil War.

As policymakers ponder the next steps to be taking in solving the world's fiat currency issues, I thought it would be helpful to remind people of one the precedents in particular for some historical lessons about the fundamental deterioration we are witnessing globally.

Much has been made about the contrast between the fiscal union in the United States and the lack of one in Europe. But, recall that in 1861, 11 southern states decided to dissolve their economic ties and political ties with the United States of America, leaving the Union, or the North, with 20 members and five border states.

The Confederate States of America had a virtual world monopoly on agricultural goods like cotton and tobacco and agriculture. These 11 states together ranked as the fourth largest economy in the world. However, they were unable to agree as a group on sharing treasury functions and responsibilities, so the Confederate Treasury issued unsecured notes.

When first distributed in 1861, Confederate notes traded at a premium to gold, based on the assumption that their value was ultimately secured by the combined revenue and resources of the South's tobacco and cotton assets. Unfortunately for the South and for Confederate note holders, this was not the case.

Since the leaders of the individual states maintained that secession was largely about state's rights, it would have been inconsistent for them to consolidate treasury functions under a central government. Besides, South Carolina did not trust a Virginian to run their treasury. And so the arguments went, state by state, issue by issue.

In late 1861, the Union Navy successfully blockaded the major Southern ports and naval trade routes, effectively killing Confederate trade and the value of the Confederate dollar. As exports fell, the value of a Confederate note fell to a 10% discount to gold.

This began with a downward spiral so violent that by mid-1862 it was at a 60% discount, and by the end of 1863, post Gettysburg, a 94% discount, and still lower into the last two years of the war. On our website, you'll find a graph of the gold exchange rate of the Confederate dollar.

By 1865, the Confederate economy was in ruins. The South had never fully recovered from the Civil War until the outbreak of World War II, meaning that it took 80 years to rebuild what had been the fourth largest economy in the world.

As the Confederacy showed, a common currency without fiscal union is a recipe for disaster. Today we have a Europe without federalism, as each individual country hangs on to its own sovereignty at different levels.

As we witness the flight of capital from Europe and the decline of the euro towards parity with the dollar, it's clear that the assembled countries of Europe need an Alexander Hamilton. If the Eurozone didn't have the money printing backstop of the modern central banks, I suggest that the euro would be no better than the Confederate dollar.

Meanwhile, the North was united behind the dollar but it was having its own problems struggling with a radical shift in its economy. To pay for the war and the agricultural products that the South had previously provided at cheaper levels, the Secretary of the Treasury, Salmon P. Chase, developed new revenue sources through taxes and tariffs and authorized and funded national banks. In addition, the Legal Tender Act of 1862 created the greenback, fiat money that was not backed by gold.

Federal debt quadrupled during the four years of the war. Eventually, the monetary system was so clogged and currencies held in such disdain that the bartering of gold and cotton become the main commercial tool for both the North and the South.

The cost of the war for the North was staggering, and was only met through punitive reparations by the South. Thus, another lesson of the Civil War is that fiscal union alone is no solution if an economy is facing a drastic change in fiscal circumstances and steep growth in debts and deficits.

Today the United States has a unique, historical opportunity to lead the world out of the current mess. But, it's my concern that our political system is so polarized that we'll be unable to seize the moment and we will -- and capitalize it for the benefit of all Americans.

We are heading towards a fiscal cliff with the election year debate of tax reform, tax increases, new protectionist tariffs on China, economic blockades on Iran and, surprisingly, immigration issues. States are attacking Amazon for the collection of Internet sales tax.

In the mortgage market alone, we watch carefully as the federal government mandates aggressive refinance and modification programs and as individual states consider reforms that actually will negate mortgage securitizations. These solutions threaten consumers with significantly limited access to capital. Investors will avoid such states.

I experienced a market like this earlier in my career. I was trained in the 1970s to avoid purchasing loans in the oil bust states that were tagged as C-O-L-T, Colorado, Oklahoma, Louisiana, and Texas. In the current swing of the pendulum to protect borrowers, the ultimate price could be fractured mortgage origination market that is unable to be scaled and therefore more expensive to finance. Liquidity is the key to attracting commodity-like savings, not customized rules state by state.

These are tough, unpopular decisions to be made across all markets. But, if we don't make them, history has shown us that it will take a very long time for the history and the system to repair itself.

Now with regard to the quarter, I'd like to put some highlights out there before beginning Q&A. Since our $2.4 billion common equity offering in July of 2011, we have raised over $1.1 billion in capital via the first ever concurrent, overnight convertible offering and perpetual preferred transaction in history.

These transactions represent the largest REIT convertible offering since 2007, the largest mortgage REIT convert ever, and the largest nonrated preferred deal ever. Annaly's weighted average cost of capital during these transactions was 5.75% versus 14.7% for the almost $11 billion of equity that was raised in the mREIT sector during the past 12 months.

Also, in the past year, one third of the 34 offerings in the sector have been dilutive to book and may have been dilutive to earnings. On average, the sector's deals have been done with a weighted average rate on the 10 year Treasury of 1.97% versus the 2.92% that we did our offering at last July.

As discussed on our last earnings call, we've focused on liability management. We have now extended our average days to maturity on interest bearing liabilities to 216 days, 156 days longer than the next closest agency REIT. Currently, we have over $12.2 billion in liabilities with a maturity greater than one year, 12.4% of total borrowings, versus an estimated $4 billion across the rest of the entire agency REIT sector, 3.5% of total borrowings.

With that stated, I open up the call for questions.

The question and answer session will begin at this time. (Operator instructions.) Jason Arnold of RBC Capital Markets.

Hi. Good morning, guys. And Mike, great commentary as usual. And also wanted to thank you for the added disclosures in the release, very helpful there.

One question on those in particular, on the zero to three year maturity bucket on swaps, can you add any context around the average paid fixed rate and the weighted average year to maturity with respect to the dispersion of those averages? Kind of looking specifically for whether or not you've got a lot of 4% and 5% paid fixed rate swaps maturing near term balanced against some 1% to 2% rate swaps at the longer end of the equation there.

Yes. I mean, Jason, you could tell just from the rate alone that there is older, higher pay rate swaps included in that. And obviously, by virtue of the rate, they are much older in time so they are nearer to maturity today. And so, you would expect that a lot of that higher pay rate stuff is nearer to maturity than not.

Okay, helpful there. Thank you. And then, I guess the other one I was interested in is on the prepayments side of the equation. We've certainly seen the 10 year yield fall quite a bit here, but we've also got a weakening macro and still damaged mortgage and housing market as an offset. So, I was just curious if you could kind of update us on your thoughts on the prepayment side.

I mean, it seems like with every rally there is less and less response to it. And I don't know if there's borrower burnout with respect to new rates being lower, but obviously a lot of the macroeconomic conditions continue to weigh on normal refinancing incentives.

I still think that the greatest risk is policy, known and unknown. And as the economy continues to falter, I think there is no limit to what the administration will roll out, whether it's real or not, that will weigh on the market psychology with respect to prepayments.

Nonetheless, they have remained subdued from a rate perspective. And we would continue to expect the worst case, but certainly welcome the subdued nature of borrowers' responses to the ever decreasing rate environment.

Okay. So, it sounds like you might think that there would be a verbal expression of some additional refinance help, but that it may not come in actual form. Is that a good summary?

I just think that you -- even with the imminent domain coming out of California, you just never know what to expect. And I think that is your greatest risk, given the fact that, as rates continue to go lower and lower, that borrowers' responses to that -- maybe they have been conditioned to think that there is never going to be just a small window to refinance. It's going to be a very long term situation, so it's a more subdued response.

I think clearly, just from the perspective of the statements that were made by DeMarco over the past couple of days about the global refinancing, it's really directly in line with what we've been talking about for the past four quarters, which is we have to realize that, if they decide to forgive principal and somehow override the Congress's wishes not to do that, the bottom line is that is more -- just redistribution of wealth. That money will come out of the tax coffers.

And by the way, one of the biggest holders is the Federal Reserve of bonds at a premium. So, it's self-damaging, and all it's doing is moving around on the balance sheet from the Fed to the Treasury stuff to finance more losses.

And I think that what DeMarco said is true. And I think what -- the message that Bernanke has been delivering for the past few testimonies to Congress is true, which is, hey, it's not about low interest rates, right? Affordability is at an all-time high when you want to measure it against that.

The rest of this is policy and also tax issues. Just because your house dropped by a third in value doesn't mean that your property taxes dropped by a third in value. So, what you're seeing is a bifurcation here in the markets between properties that are, say, $700,000 and lower and anything above $1 million.

It's the government guaranteed stuff. That's why there's 95% of that stuff clearing. It's not clearing at much higher prices, from my analysis, than it was several years back. So, it's like you've almost lost money by owning a house and it means you have to move up.

So, I think you're stuck in the mud exactly as Bernanke said, and this is going to be churning for a while. And I think that people have their heels dug in on the policy side about debt forgiveness. It's enough of that. We've done enough. If you haven't been able to refinance your house at 3.5%, the only thing that's going to really start this thing over again is real job creation and real income creation.

Makes sense. Excellent. Thanks for the color. I appreciate it.

Thank you, Jason.

Bose George of KBW.

Hi. Thanks for taking the question. This is Jade Rahmani from Bose's team. I wanted to ask, the issue of imminent domain has garnered much attention lately. Do you have a view on how this issue plays out and what you think the impact on the mortgage market could be?

Yes. I mean, we first saw this, the outline or the sketch of this plan, last fall. We don't feel like there's any true legal backing behind this. We cautioned the people who were going around trying to raise capital that this would be an issue that would threaten the securitization market but ultimately would cause a lot of noise and have to go away.

If you think about it, you have a bankrupt city that will be in the middle of the credit transaction between a mortgage holder and the new borrower. So, it's not like you're moving in the middle. All you're doing is transferring capital from an existing holder that, under contractual law underwriting standards, owns those cash flows. Now, to break that under imminent domain, that is an extremely tough hurdle to hit.

But, I will tell you that the concept of a national mortgage market is a relatively new concept in America's history. It really only started in the late 1970s and has continued up until today. And one of the reasons for that was because the loans become homogenous in their underwriting standards, and Fannie and Freddie and FHA's loan standards become the underwriting standards for the markets.

If you begin to carve out that you're going to be subject to imminent domain, well, as an investor, I'm not buying a California loan. As I said earlier, it's happened before in the market where we were told don't buy Colorado, Oklahoma, Louisiana, or Texas loans during the oil bust, because the duration on those loans was much longer because people were inverted on their properties.

It's happened before. And if they continue to try to go down this road, I think they're really beating their heads against a very solid wall.

Great. Thanks for that. Could you comment on where you're seeing incremental spreads and where you -- what part of the market you view as most attractive? Last quarter you mentioned prepayment protected bonds were expensive. Do you have that same view today? And also --.

There's no question everything is expensive. I mean, the weighted average dollar price of the fixed rate mortgage market is around $1.085, $1.09 depending on the day. By any historical perspective, that is rich.

Let me just go back to my opening comments, if I may. My point in these comments is that the fundamental strategy behind investing is to buy low and sell high. If you've been raising equity to buy assets aggressively over the past year, then what you've been doing is buying high in the hope that you can sell it higher.

That is not an investment strategy, right? The place where you need to be working right now is the place where we've told people we've been working for the past year, and it's demonstrated in the statistics I said.

We are working on the low side of the balance sheet where you can buy liabilities low. And they're not going to go much lower, right? We issued a three year bond at 5%. That's an incredible transaction for an unrated company.

So, my view is you have to be very careful what you can buy. There is value in market, but you have to be careful.

So, with that in mind, is it safe to say we could see your hedge ratio increase and your leverage remain at these levels or even ostensibly decline?

Well, if you go back to the opening comments again, if Europe becomes the Confederate States of America, which apparently they are willing to become, and you can bet that there are a lot of hedges that have to be put in place going forward for everybody which are going to be more expensive in the sector, it's going to change the cost of capital on the front and the back end, we think more on the borrowing side. The assets are going to get cheaper.

Thanks a lot.

Yes.

Bill Carcache of Nomura.

Good morning. Thank you for taking my questions. I just wanted to delve a bit more into the thought process that you've laid out and the viewpoint that -- your viewpoint that everything is expensive. That's certainly consistent with your relatively lower leverage levels compared to others in the industry.

But, I was wondering how you kind of reconcile that with -- to the extent that there is a QE3. Aren't prices going to be bid up even higher? And then, to --.

Hang on. I just said it. If you're a hedge fund, go do it. Get in front of the Fed and run in their face. That's not REIT business, period, and it's not a sustainable investment plan. What happens when they unwind QE3 or QE2 or QE1, right?

That is the point, is that buying these assets in the hope that a government program is going to bail them out -- the Fed has done everything it can do. It has run out of bullets. The next moves will be extremely difficult to implement.

It'll be like going to negative rates, as they have in some countries and in some states. You're going to start to see that kind of implementation on the liabilities side of the balance sheet.

So, if QE3 comes in, I can tell you, if I'm Ben Bernanke, I have to use that to buy Treasuries because I don't have tax receipts coming in and there are no normal buyers for the 30 year. I would like anybody on this call who's ever bought a 30 year government security outright for a buy and hold ever in history, except for maybe 1983, to tell me how that trade worked out for them. The only people who used to buy that were life insurance companies, and that's why the far end of the curve is out there.

Thanks, Michael. That's really helpful perspective. Can we talk a little bit about the swap book? The portion of your swap book -- it looks like about 18% of the notional value of your swap book goes out over six years. Is there a competitive advantage there that Annaly has relative to others? It just seems to me like being able to get swaps that go out longer than five years is not something that I've really seen. And so, is that -- do you guys have an advantage there? Can you talk a little bit about how difficult it is for other market participants to be able to get protection that far out?

Yes. I think what we -- we've broken the ice in a lot of different markets, and one of them was in the swap markets back in the early part of this decade. Wellington and the team here devised a method that we were finally satisfied with that allowed us not to concentrate on floating rate assets as much as the ability to swap them out versus collateral.

And we paid a price for that in our earnings over the past 10 years as we developed that market with the dealers. And of course the dealers began to spread that out to others. But, the reward for that in having that higher price of swap, if you will, is that today, since you've got a history with those guys and they know how you perform and they understand your operations, they are willing to extend, to go out further with you.

And I think that's a great advantage. Having been through three times of tightening, flattening, steepening, high prepayments, low prepayments, that gives all the credit departments a great deal of confidence in the way that we run the book. And as a result, they're willing to extend with us.

A lot of guys who were born over the past few years have not been through the reversal yet. I can tell you, when it comes it will be ugly.

So, many of the counterparties that are going out that far, six to 10 years or beyond, are they similar -- are they generally the same counterparties that you have shorter duration swaps with?

Well, they would generally be the too big to fail counterparties. So, yes, I mean, we --.

Let's call them nationalized banks.

Okay. And then finally, if I may, can you kind of incorporate your thought process and everything that you said maybe at the beginning in the missive about how kind of all of that fits in with your view on how concerned you are about extension risk? At the end of the day, is that certainly something that, by extending the duration of your swap book, you'd be protected against? But, can you just talk about that, and also maybe incorporate whether there's a role for swaptions in your strategy? And that's it. Thanks.

We constantly weigh all of the available options to try and reconcile the fact that, once borrowers get into a 30 year 2.5%, the likelihood of them ever refinancing is very slim, in that you're at the low in rates and so you do need to prepare for a reversal. Maybe we're here for 20 years. Maybe we're not.

But, as a levered player, you need to be able to handle the twists and turns. And if you use Japan as a guide, you can see there were periods where rates doubled at the low end, yet nonetheless there can be a lot of volatility associated with that.

And so, even if the two year doubles, it's still a very low rate but there can be significant market movement associated with that, especially as a levered player, which I don't have to tell anybody how it magnifies it.

So, we continue to weigh all the options. One of the things that we have obviously found to be most effective, given our years of going through these markets -- and this market is very different than all the others. I don't think any of us have ever experienced anything like this. But, what we have found is running at lower leverage, it may seem simplistic but it's really one of your most effective navigational tools through turbulent times.

So, combine that with swaps, IOs, all kinds of other things that you try and bake into the portfolio to allow it to perform the best through market moves. I will say once again nothing is perfect and there is no magic hedging tool out there that the market has mispriced.

Everything's relative. If something is cheaper, it's expensive in the long run. If it's more expensive today, it may be cheaper in the long run. So, it's all a relative value analysis that we put into it.

Yes. I think also if you just step back and do an autopsy on two of the biggest government agencies that ever existed with portfolios, Fannie Mae and Freddie Mac, and had government guarantees behind them and were issuing debentures as opposed to repurchase transactions, if you take a look at what destroyed them, take a look at the swaptions market. That's what a real autopsy will show you.

So, be careful in that market because of the counterparty risk and because of the inability to execute at levels -- it's like having flood insurance that says at the bottom invalid in the event of flood.

Okay. That's extremely helpful color. I really appreciate it. Thank you.

Steve Delaney of JMP Securities.

Thank you. Good morning, everyone.

Hi, Steve.

Morning.

Great to hear from you.

Likewise, Mike. It's great to be on the call with you. So, look, thanks -- I want to add to the thanks for the expanded swap disclosure. It really is helpful to us and will help us do a better job keeping track of book.

And also, I think it's clear this morning from your comments -- I just want to say thanks for stepping up and giving us a differentiated view of the MBS market. Ben Bernanke is kind of leading us all down the road, and I think it's easy to stay on the bandwagon. But, we have to step back sometimes and look at the market maybe in a little more historical fashion.

And so, I wanted to -- while you've covered a lot of this, the wording in your quote in the press release was -- I thought was pretty strong and I highlighted it to be my primary question. And that is the long term risk related to the general direction of monetary policy. And, one, I'm assuming you're talking about our Fed when you -- as far as domestic monetary policy.

And what I've heard -- what I read in that quote and what I've heard you say today is that we need to be focused, that QE3 does not come without a price, and that you're trying to focus on the other side of the coin, so to speak. We get this short-term feel good, but there'll be a price to pay. Am I reading you right in terms of the risk you see there and how that affects your portfolio management?

Yes. I think I would like to just broaden that, if I can, for a second.

Please.

This is in regard to really global monetary policy, right? If you look at the perch that I'm trying to create here, you can see that the largest economy in the world, and I've said this on other calls and I'll just do a quick recap, is our policies and all of the stuff that's going on in Washington, in my mind, is trying to save what is an anomaly in historical economic features, which is an economy that was run by 70% of gross domestic product coming from consumers.

The mortgage market, the retail markets, all of this stuff was all built around the baby boomers. And if you go back and look at all the other countries, there has never been an economy that's had that weighting, right?

Right.

So, it's all that most of the policymakers know today. And it's -- all they think of is this is what I can do. I need to get consumers out and spending. But, you have this huge demographic bubble that would have been natural deleveraging anyway because of age and the factors of retirement, etc., or just families moving on with their lives, etc.

But, at the same time, the income cannot grow underneath it because the wage pool is stagnant, right? We've got all of this new productivity that's come in, especially in the United States, and makes it really -- now you're even questioning why people go to college and pay $200,000, right?

So, the direction that they're taking the economy is based off of, I think, trying to save the wrong economy. I called it we're swimming back to the Titanic, right? We are now looking at an economy that's reemerging and is going to look like, I think at the end of the day, a lot of what other economies have been. Every other economy is based off of a lot of business to business and then distributions around the side of it, and then you're moving the wave through.

I was very interested watching the Olympic opening games and London's history, where they started with the Industrial Revolution and led up to Google at the end, or whatever it was. But, the steps here are all over the place.

And at the same time, the second largest economy in the world, the Japanese -- let's just go back a year, not the Chinese, the Japanese are demographically stuck, right? We've said it on some of our calls. They sell more adult diapers now than they do children's diapers. That economy is affected by everything from tsunamis to earthquakes to old age and demographics.

The third largest economy, the European economy, one of our biggest trading partners, as I said in the opening comments, to me it looks like the Confederate States of America, North versus South, and the South doesn't want to act as one. They want to act as different -- 17 different states.

And I think the Germans are eventually going to get tired of that. The French growth plan is for Germany to write a larger check. And if I'm a German, I'm not too happy with that, right?

So, all of this is going to lead to inflation at some point and a much steeper yield curve and a much more normalized yield curve. But, right now you have to assume the markets are being manipulated by the government across the globe. The CDS market basically got castrated by the Europeans when they changed the rules so that you couldn't collect on the insurance, right?

The US market, basically they tried to do that in the mortgage market by refinancing and HARP 1 and HAMP 2, etc., all of which have been big failures in the capital market structures here because the assets are still falling in price. You have to allow failure. You have to allow clearance.

What is the next biggest economy? Well, if you look at India, last I looked more than twice the population of the United States, didn't have electricity for four days there because their grid went out. They haven't invested in the grid. So, there's a lot of infrastructure investment that has to be done here, and it's going to be a painful, long way to do it.

And individually countries are going to have to make a decision between the long term liabilities of the baby boomers passing on and passing their wealth over to the new generation. And frankly, that's the war that's going on in Washington. Whether it's the AARP or if it's Occupy Wall Street, it doesn't matter, right? This is a war about resources.

Thanks, Mike. I appreciate those additional comments.

I hope they're helpful.

Yes.

Rick Shane of JPMorgan.

Hey, guys. Thanks for taking my question this morning.

Morning.

It seems that the mantra in the markets has been down in coupon, down in coupon, and everybody's been chasing that. And I think in some ways we see that within your numbers this quarter where you sold off a lot of stuff but you grew the book, and coupon clearly went down.

You guys are willing to be contrarians. At what point do you start looking at the other side of that trade? Is it pricing driven or do you think that the higher coupon stuff is just so structurally at risk that there's no reason that you would be looking at it?

No, I mean, we will constantly weigh the relative value propositions among the coupon stacks. What I would say, though, is the longer you're here, the coupon stack becomes more and more compressed.

So, it doesn't matter who you are, you're going to have limited choices that you can make. And then, your real choices are leverage and how you hedge that risk. So, the market is a very -- like I said, it's -- you're looking at $1.085, $1.09 kind of dollar prices, and weighted average coupon in the market in the fixed arena is about 4.5%.

Unless there is -- I am hopeful that we have a change in administration and that we have a change in our policy focus and that maybe the market can become a more normalized place, and maybe you do start to see more choices become available on the risk spectrum for investors. But, right now everybody's kind of forced into risk at the wrong price, in my mind.

Yes, including the banks.

Yes.

If you look at the banks, whatever loans they're generating they're keeping because there is no securitization model, right? So, it is a very interesting time that could change very quickly.

In my experience, these things do not happen in graduation. They go through big, giant leaps of change, and then the markets will settle out. And guys like Louis Bacon, instead of giving back money, will be taking money in because he wants to be able to take advantage of the new values that have been created.

But instead, what we're witnessing is this controlled burn spiral down by the global Central Banks trying to hold the social safety net together.

Okay. And that actually leads to a little bit of a philosophical question, and I think you guys have a tendency to be willing to talk philosophically. Given all of that, what is your balance right now in focus between capital preservation and protecting spread? I mean, when you come in every day, which are you focused on?

Yes, you have to be focused on all. It's either you -- we have to deal with every market that we're in and how we do it will vary.

But, again, these things -- as Mike said, these things can change quickly. We obviously have been in control of -- the government has been controlling the markets, not only domestically but internationally. And whether a new administration starts to change the tone of that, we as a company want to be in a position to capitalize on the fact that maybe there is a change in the way that we are going to deal with housing.

It's very interesting to me, as a long time observer of this, that this is one of the few times in my career where I can actually say that American companies are in much better shape generally than the American government is in terms of its balance sheet.

Now, there's two ways to get that fixed from the government. One is rearrange and restructure the liabilities so that you get these multitrillion dollar baby boomer entitlements out of the way, or you continue to let the capital markets do its job and clean up. And there's been no appetite.

All you had to do is be a holder of General Motors bonds or Chrysler bonds in 2008 to understand that contractual rights in the United States are under threat here, right? And anything could happen from that perspective.

So, I think -- when we come in in the morning, what do we look at? Well, rule number one is don't lose money, right? You try to preserve capital. That's how we think about the business. Sometimes -- look, a lot of people criticized me for the past year for not raising equity. I just summarized in about 10 minutes at the beginning of the call why we didn't do that.

As everyone knows from the mountainous articles that have been written about it, if we'd have raised a lot more equity, I would be paid a lot more money. But, we chose not to do that. That is a focus on shareholder value over the long run.

And what did we do? We focused on where we thought the real value was, which, while everybody was out running and buying assets and trying to get in front of QE1, QE2, and QE3, we were quietly building out and strengthening up our liabilities so that we had the firepower to buy that stuff when it's being puked out on short duration liabilities, or when haircuts change because clearinghouses now demand more or higher haircuts, or if interest rates change because the United States gets downgraded and, instead of rallying, you actually see spreads widen out.

Those things could occur and might occur within the next 120 days. We're like an aircraft carrier. We're plotting this course very carefully.

Guys, thank you very much.

Thank you.

Jasper Burch of Macquarie.

Hey, good morning, everyone. Thank you for taking my question. I guess just starting off with I wanted to dig a little bit into how you view taking on longer term debt. I mean, if you look at your three year bonds, I mean, if you're looking at it just in terms of leveraging up taking MBS, I mean, that would obviously be at a sort of a negative spread unless you have sort of a aggressive interest rate assumptions going forward.

And if you look at it sort of in terms of leveraging up the already levered equity, I mean, is that how you look at it? And then, sort of what risks are you protecting against by taking on the longer term debt? Is it just the risk of haircuts going up, or sort of how do you view it?

I mean, it's one of the many steps you take to -- if you look, we did a -- we also, concurrent with that transaction, did a preferred, a nonrated preferred which -- the way that we tend to look at that is relative to our common dividend. And sometimes it's necessary, and the debt is an unsecured position whereas repo is secured financing. And so, there is always a cost adjustment relative to those two.

We understand that the coupon on our debt is more than the coupon we can get on the mortgage position. And so, for certain periods, you weigh it in the capital stack so that it's accretive to shareholders knowing, yes, you are going to mature that at some point.

But, it's a -- as a nonrated company, it's a necessary step in the process to continue to migrate the capital structure of the Company into a -- into this lower rate environment in a more permanent fashion. And what we would like to see is a continued migration into the preferred market and have those coupon rates continue to come down relative to the common. So, it's just one of the many steps.

I kind of look at it as when we put on the swaps early on, we knew we were early acters in that position. We paid a price for that, but it gave us the history to go out and do things like what we just did. That bond was issued the same week that GE put a bond out there. And I think -- as them as an investment grade, I think we were only like maybe 50 or 60 basis points behind them in yield.

What's that tell you in the market? Well, no one trusts S&P and Moody's or the rating agencies, right? They're looking at the performance and behavior of the acters that are borrowing the money.

Okay. That's all really helpful. I appreciate the commentary on QE3. I found that really interesting.

And then, just going back, in the prepared remarks, Mike, you mentioned that you think Europe needs an Alexander Hamilton. I was just wondering, I mean, Alexander Hamilton was famous for having the Central Bank pay off the state debts.

Right.

I mean, is that what you're referring to?

Yes. Well, he was -- there's two -- in our office, there's two highlights to Alexander Hamilton. There's a bust and there's a portrait. It's the only stuff that we have that I would consider artwork, right?

And the reason for that was is Alexander Hamilton did figure out how to put all the scrip together into one currency, right? He made the exchange rates work, but the price of those exchange rates was to put yourself under one federal treasury, right?

You could still run an independent state's finance, but you still had to be underneath one federal treasury and one currency. And you were subject to the moves of that currency, your independent credit underneath it, just like the difference between California and New York and Texas and North Dakota.

That is what Europe needs. And I don't see Angela Merkel as being that person, and nor do I think that it's achievable to have this big catch up where there are no real resources that come out of Italy or Spain that are, say, global brands. Let me just say that.

Maybe you're got fashion coming out of Italy, but it's made in China or it's made wherever. It's made in Indonesia. Germans are making cars. Well, now they're making them in South Carolina and Georgia. When you buy a BMW, it's probably made in the United States, right?

The United States -- and that's what I meant by the United States has a unique opportunity here, right? While all of this distress is going on globally, we have an opportunity to do it. There have been two huge economies built out of exports -- actually three huge economies built out of exports in the past 70 years.

The first one and the most important one is the oil exporting business from the Middle East. And look what that's gotten us, right? If you look at what we owe them in terms of coupons and everything, it dwarfs what we pay China.

We built up Japan by letting them control their currency at a cheap level for a lot of time in the '60s and the '70s. And the next thing we knew, we were losing our manufacturing arms in the '80s and the '90s.

And then, the Chinese, the same thing. The Chinese have three times the world's capacity to build cell phones. Who's going to go out and build a cell phone factory when you can turn those things on on a dime, right?

But, if you go back and look at what's going on in China today, they had this huge build out of infrastructure for the 2008 Olympics. And I ask anybody on the call to take a look at this chart on Bloomberg. Put in C-R-Y Index and go back and look at 2005 to today. And you'll see basically the day that the torch got lit in China on August 8th in 2008, the commodity chart fell apart.

Today the Bird's Nest is where they hold flea market sales in China, right? They're not using the facilities for anything. They have cities that are empty, etc. There is a price to pay for this. That's overcapacity, and it has to be dealt with. And the only way to deal with it is to let it fail. That's an ugly scenario, but that's the reality.

Well, thank you. As always, quite interesting.

Thank you.

Ken Bruce of Bank of America Merrill Lynch.

Hi. Thanks. Good morning.

Good morning, Ken.

Most any question I could have asked at this point has been answered. So, I will pass, but I would like to thank you for the additional transparency into your financials. It's been very helpful. Thank you.

Good.

Thank you, Ken.

Thanks, Ken.

This concludes our question and answer session. I would like to turn the conference back over to Mr. Farrell for closing remarks.

Well, thank you, everybody, for joining us today. We think we're going to live in interesting times.

The next time we'll be talking to you will be on the third quarter's remarks, at which time we'll have had some decision made politically, we hope, where we'll have a lot of new walls being built in Washington between the different parties and the different interest groups.

But, we think that that's going to be very interesting between now and the end of the year. And we look forward to speaking to you and updating you with our remarks and our portfolio actions during that period. Thank you.

Ladies and gentlemen, if you wish to access the replays for this call, you may do so by dialing 877-344-7529 or 412-317-0088 with an ID number 10016746.

This concludes our conference for today. Thank you for attending today's presentation. All parties may now disconnect.