Western Asset Mortgage Capital Corp (WMC) 2013 Q4 法說會逐字稿

Welcome to Western Asset Mortgage Capital Corporation's fourth-quarter and year-end 2013 earnings conference call. Today's call is being recorded and will be available for replay beginning at 5 PM Eastern time.

(Operator Instructions)

Now, first, I'd like to turn the call over to Mr. Larry Clark, Investor Relations for the Company. Please go ahead, Mr. Clark.

Thank you, Operator.

I want to thank everyone for joining us today to discuss Western Asset Mortgage Capital Corporation's financial results for the 3 months and year ended December 31, 2013. By now you should have received a copy of today's press release. If not, it is available on the Company's website at www.westernassetmcc.com.

In addition, we are including an accompanying slide presentation that you can refer to during the call. You can access these slides in the Investor Relations section of the website.

With us today for Management are Gavin James, Chief Executive Officer; Steven Sherwyn, Chief Financial Officer; and Anup Agarwal, Chief Investment Officer.

Before we begin, I would like to review the Safe Harbor statement. This conference call will contain statements that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All such forward-looking statements are intended to be subject to the Safe Harbor protection provided by the Reform Act.

Actual outcomes and results could differ materially from those forecast due to the impact of many factors beyond the control of the Company. All forward-looking statements included in this presentation are made only as of the date of this presentation and are subject to change without notice.

Certain factors that could cause actual results to differ materially from those contained in the forward-looking statements are included in the risk factors section of the Company's reports filed with the SEC. Copies are available on the SEC's website at www.SEC.gov. We disclaim any obligation to update our forward-looking statements unless required by law.

With that, I will now turn the call over to Gavin James, Chief Executive Officer.

Thanks, Larry, and thank you everyone for joining us today for our fourth-quarter and year-end conference call.

I will begin the call by providing some opening comments. Steve Sherwyn, our CFO, will then discuss our financial results; and then Anup Agarwal, our new Chief Investment Officer, will provide an overview of our investment portfolio, our liability profile, and our future outlook. After our prepared remarks we will conduct a brief question-and-answer session.

We were really pleased with our fourth quarter results, as we delivered a strong finish in what was a very turbulent and often challenging year for the US mortgage markets. During the first quarter we recorded net income of $0.83 per share while generating core earnings of $0.70 per share. We delivered an economic return on book value of 4.8% for the quarter, which represents the change in book value plus dividends declared.

In many ways the fourth quarter was comparable to how the US mortgage market played out over the course of 2013. Early on in the quarter, agency mortgage prices rallied followed the no taper decision by the Fed in September. However, as the quarter progressed, fixed income investors became more concerned about Fed tapering, and long-term interest rates steadily moved higher, negatively impacting agency MBS values.

Our strong performance in the quarter was due to several factors. First, we were well-positioned with our hedges, which we significantly increased midway through the quarter. And the increase in the value of these hedge positions more than offset the decline in value of our agency MBS portfolio.

Second, we reduced our exposure to lower-coupon 20- and 30-year fixed-rate pools, the securities that were the hardest hit in the quarter. And third, we increased our holdings of non-agency securities, which outperformed the agency sector during the quarter.

Our fourth-quarter results validate our belief that our proactive style of management, combined with our flexibility to invest across the entire mortgage sector positions us well to seek our objective of delivering superior risk-adjusted returns. Including our fourth-quarter results, we have continued to generate a significant level of outperformance relative to our peer group.

Since our initial public offering in May of 2012, through December 31, 2013, we have delivered a total economic return of 13.6%, which is well in excess of the average of our agency RMBS peers over the same time frame. Even when compared to the larger group containing both agency and hybrid mortgage REITs, we have delivered superior performance since our IPO, outperforming the group average by approximately 300 basis points.

For the first two months of 2014, the fixed income markets, including the mortgage markets, have rallied based on more clarity about Fed policy and economic data that points to continued slow growth and a gradual recovery in the job market. As a result, we have experienced increases in the value of our agency and non-agency holdings, partially offset by a decline in the value of our hedge positions. Anup Agarwal will go into more detail on our outlook and investment strategy for 2014.

With respect to the repo market, we continue to have ample access beyond our needs. We continue to monitor the potential impact of the regulatory changes and legislation brought on by Dodd-Frank and Basel III. However, we do not believe that there will be any impact on our business based on the overall strength of Western Asset's platform and its long-standing relationship with Wall Street and other financial institutions that make up the majority of our repo accounts [bodies].

Our continued view on interest rates is that the long end of the curve will be range-bound over the course of the year, and short-term rates will remain near zero. This view is based on our belief that economic growth in the US will remain subdued over the next several quarters, and that the Fed will continue to be supportive of the economy.

We do not believe that the economy will materially weaken, nor do we expect it to accelerate anytime soon. The gradually improving economy, including a continuing yet more normalized housing market recovery, should support low interest rate volatility, more stable agency MBS values, and improved non-agency fundamentals.

We believe that the Fed's activities will continue to influence the mortgage market in 2014, but to a much lesser degree than in 2013, as they systematically wind down their purchases of agency MBS against the backdrop of lower net supply.

With the expectation of lower interest rate volatility, we believe we are well-positioned to create value for our shareholders in 2014. As always, our goal will be to optimize the risk-adjusted net economic returns delivered to shareholders, primarily through strong core earnings, resulting in an attractive dividend while maintaining a stable book value.

Our industry-leading results to date since our IPO are due to the hard work and dedication of the Western Asset structured products team, as well as the entire Western Asset platform, which not only provides assistance with repo financing, but provides a wealth of fixed-income knowledge and resources. We believe that our years of experience in the mortgage sector and our deep bench are key competitive advantages that produce tangible benefits for our shareholders.

At this time I am going to turn the call over to Steve Sherwyn, our CFO, to discuss our financial results.

Thanks, Gavin. Good morning, everyone.

I will discuss our financial results for the fourth quarter and year ended December 31, 2013. Except where specifically indicated, all metrics are as of that date.

On a GAAP basis we earned net income for the quarter of approximately $20.8 million or $0.83 per basic and diluted share. Included in the net income was approximately $13.4 million of net unrealized gains on mortgage-backed securities, approximately $50.5 million of net realized losses on mortgage-backed securities, and approximately $37.2 million of net gains on derivative instruments and linked transactions.

For the quarter our core earnings was approximately $17.2 million or $0.70 per diluted share, which is a non-GAAP financial measure, which we define as net income or loss excluding net realized and unrealized gains and losses on investments, net unrealized gains and losses on derivative contracts, non-cash stock-based compensation expense, and other non-cash charges.

Our net interest income for the period was approximately $24.1 million. This number is a GAAP number and does not include the interest we received and paid on our linked transactions, interest we received from our IO securities that are treated as derivatives, nor does it take into account the cost of our interest-rate swaps. The latter two, which are included in gain on derivative instruments line in our income statement.

On a non-GAAP basis, our net interest income, including interest we received from our IO securities treated as derivatives and interest we received from linked transactions, which approximated $20.4 million. Included in this calculation was approximately $46 million of coupon interest offset by approximately $14.5 million of net premium amortization and discount accretion.

For the full year 2013 we incurred a net loss of $27.9 million on a GAAP basis, or $1.19 per basic and diluted share. Included in the net loss is proximately $160.1 million of net unrealized losses on mortgage-backed securities, approximately $122.6 million of net realized losses on mortgage-backed securities, and approximately $161.7 million of net gain on derivative instruments and linked transactions.

For the year, our core earnings, which is a non-GAAP financial measure, was approximately $82.7 million or $3.38 per diluted share.

Our net interest income for the year was approximately $107.3 million on a GAAP basis. On a non-GAAP basis our net interest income, including interest we received from IO securities treated as derivatives and interest we received from linked transactions, was approximately $95.8 million. Included in this calculation was approximately $206.7 million of coupon interest, offset by approximately $69.6 million of net premium amortization and discount accretion.

On our weighted average net interest spread for the fourth quarter, which takes into account the interest that we received from non-agency RMBS and IO securities, as well as the fully hedged cost of our financing, was 2.15%, reflecting a 3.61% growth yield on our portfolio and a 1.46% effective cost of funds. Our cost of funds increased by 32 basis points compared to the third quarter, which is primarily attributable to the increased hedging we put into place during the quarter, as well as some of our previously entered-into forward starting swaps taking effect.

During the fourth quarter our constant prepayment rate, or CPR, for our agency RMBS portfolio was 5% on an annualized basis. This compares to 5.3% for the third quarter of 2013. We believe our CPR continues to remain low due to our focus on buying securities that exhibit low prepayment characteristics.

Our operating expenses for the quarter were approximately $3.5 million, which includes approximately $1.7 million of general and administrative expenses and approximately $1.8 million in management fees. Our economic return for the quarter was a positive 4.8%, which, as we had previously noted, represents the change in book value, plus dividends declared.

Our book value per share as of December 31, 2013 was $15.27, which takes into account our year-end dividend and the incremental shares issued at the result of the stock portion of that dividend. For purposes of comparison, we adjust our September 30, 2013 book value per share to the incremental shares. That book value would have been $15.21 per share.

As of December 31, the estimated fair value of our portfolio was approximately $2.9 billion and we had borrowed a total of approximately $2.6 billion under our existing master repurchase agreements. Our leverage ratio was approximately 6.4 times at year end.

Our adjusted leverage ratio was approximately 6.9 times at year end, adjusted for $190 million notional value, net long position from TBA mortgage pass-through certificates that we held at the end of the year. Our adjusted leverage decreased during the quarter from nine times at September 30, 2013, due to a combination of our decision to decrease leverage and our increased holdings of non-agency mortgage-backed securities, which have a lower borrowing advance rate.

We continue to be in the attractive position of having repo capacity in excess of our needs. At December 31 we had master repurchase agreements with 19 counter-parties and outstanding borrowings with 16 parties. We continue to have excellent relationships with our bank counter-parties and we feel comfortable with our existing group. We have a highly diversified repo lender book and we believe that we will have more than ample liquidity to meet our present and expected funding requirements.

With that, I will now turn the call over to Anup Agarwal. Anup?

Thank you, Steve. Good morning and thank you for joining us today.

Let me spend a few minutes discussing our portfolio, and then I would like to talk about our outlook going forward.

As indicated earlier, we delivered an attractive 4.8% economic return for the quarter, which was due to a combination of factors, including our strong core earnings, our liability hedges increasing in value, and a positive contribution from our non-agency MBS positions. These positives more than offset the decline in value of our agency MBS portfolio, which were impacted by an approximate 40 basis point increase in 10-year treasury rate during the quarter.

On our call last quarter, we talked about our belief that long-term interest rates will remain range-bound, given the slow growth environment of the economy. While we continue to believe that this will be the case, I want to emphasize that, within the range, interest rate movements and the direction of their path matter.

Midway into the fourth quarter, we'd recommend that risk of long-term rates moving higher within our estimated range was meaningful, and therefore we increased our hedges in order to better position the portfolio in that environment. At the same time, we continued to increase our allocation to non-agency MBS, as we believe that these securities offer good relative value, will perform well in a gradually improving economy, and also exhibit less interest rate sensitivity.

As we rebalance the portfolio, during the quarter we sold down some of our exposure to 20-year and 30-year fixed-rate RMBS, particularly the lower-coupon pools. The key takeaway here is that we intend to continue to be proactive portfolio managers, continually monitoring the relative value opportunities we have across the broad mortgage universe. This management style has served us well since our IPO and the fourth quarter is just another validation of that strategy.

We want to emphasize to investors that the size of WMC enables us to be nimble in rebalancing the portfolio when conditions warrant, and that these portfolio reallocations can occur relatively quickly and can make a meaningful difference to the contribution of our total return.

That being said, while the small scale of the REIT is an advantage, when making portfolio shifts we also have access to, and benefit from, investment platform and resources of Western Asset Management, where we are able to draw upon the experience of a full team of experts across a number of sectors in the mortgage market and the broader fixed-income and credit markets.

With that, let me turn to some of the portfolio details as of the end of the fourth quarter. As of December 31, 2013, the total estimated market value of our portfolio was approximately $2.9 billion and consisted primarily of agency mortgages complemented by holdings in non-agency RMBS, and agency and non-agency IOs and inverse IOs.

During the quarter, we modestly increased our position in CMBS securities, and at the appropriate time we may look to increase our holdings of these securities going forward, based on our view of their expected risk-adjusted return profile.

Our portfolio remains weighted towards 30-year fixed-rate mortgage pools, which represented approximately 58% of the value of the total portfolio. Our exposure to 20-year fixed-rate mortgage pools at quarter end was approximately 17%.

Non-agency RMBS represented approximately 15% of our portfolio. Agency and non-agency inverse-only strips and inverse interest-only strips represented just under 10% of the total. And agency and non-agency CMBS, including IOs and inverse IOs represented just under 1% of the portfolio.

If you break down our agency-specified pools by sector, 49% of the total was invested in mortgage pools with low loan balances; and the next largest sector was pools with MHA loans with high LTVs, at 45%; which is consistent with our investment strategy of minimizing our prepayment risk. The remaining 6% consists of the pools representing new issuance and low [awwah], high spread of origination and low third-party origination loans.

Our non-agency pools consist of approximately 16% of prime loans, 43% of all day loans, and the remaining 41% being subprime loans. We currently deploy a two-pronged strategy with our non-agency portfolio.

About half of our loan pools are pools that will generally have higher prepayment characteristics in an improving economy and appreciating housing market. In the case of prepayments, the portfolio benefits because these loans are being repaid at par and we own them at discounts to par.

The other portion of our non-agency holdings are in pools. They have lower prepayment characteristics where, in many instances, the borrowers are essentially stuck in their mortgages due to LTV or other credit issues. We believe these securities will also perform well in an improving economy, but just not have the same prepayment characteristics as the first group.

Our weighted average loan age, or WALA, for our agency portfolio was 28 months. We believe that managing our WALA ramp is another component towards keeping our agency prepayments low.

As Steve noted, our CPR was 5% for the quarter, which compares with an average of around 10% for our agency peers, and has contributed to our higher-than-peer-average net interest spread on the portfolio.

Now turning to the liability side of our balance sheet, as Steve mentioned, we have funded our portfolio through the use of short-term repurchase agreements, or repos. As of December 31, we had borrowed $2.6 billion under these agreements, resulting in leverage of approximately 6.4 times prior to adjusting for our $190 million net long TBA position that we carried at year end.

As of December 31, we had entered into approximately $2.7 billion in notional value of pay-fixed interest rate swaps, of which approximately $492 million are forward-starting and $127 million of pay-variable interest rate swaps; giving us a net basic swap position of approximately $2.1 billion.

The swap contracts range in maturities of between 12 months and 29 years, with the fixed-pay contracts having a weighted average remaining maturity of 8 years and bearing a weighted average fixed rate of 1.9%. Approximately 17% of notional value of our swap positions are held in forward-starting swaps. That starts approximately 6.2 months forward.

Additionally, we have entered into approximately $2.2 billion notional amount of pay-fixed interest rate swaptions, and $100 million notional amount of pay-variable interest rate swaptions, with swap terms that range between 7 and 10 years, and have exercise expiration dates that range from May 2014 to October 2014.

As a result of our increased hedge positions, our agency portfolio had a net duration of negative one year at year end, down from positive 1.1 years at September 30, 2013. We have a slightly positive duration at the shorter end of the yield curve, which is more than offset by a negative duration at the longer end.

We are comfortable with our current leverage, but as we progress through the year, we may tactically increase leverage in response to market conditions, particularly if we believe that an environment of lower interest rate volatility will persist. We can adjust our leverage fairly quickly through the use of TBAs and redetermine our leverage based on what we believe will enable us to optimize our core earnings on a risk-adjusted basis and maintain a relatively stable book value.

Our primary investment strategy remains unchanged. That is, to buy securities that offer the best risk- and hedge-adjusted carry over our investment horizon. While we are pleased with the composition of our portfolio, we are always looking for ways to improve our returns without increasing the overall risk level of the portfolio.

Along those lines, we expect to remain proactive, and as opportunities present themselves, we expect to diversify our sources of return by increasing our exposure to non-agency securities and CMBS, through our allocations to these asset classes will vary based on market conditions.

We are also reviewing opportunities with regard to other segments and structures within the mortgage market, including residential and commercial real estate loans. We are confident that, given our broad opportunity set of investments, and with our world-class investment expertise, we will be able to generate a consistently strong dividend for our shareholders while maintaining a stable book value.

With that, we will now entertain your questions. Operator, please open up the call.

(Operator Instructions)

Steve Delaney, JMP Securities.

We were impressed by the commitment -- the larger commitment to the non-agency RMBS market in the fourth quarter, and as you point out, those bonds continue to be very well bid here and help book value. I'm running, doing some quick math looking at the fair value of the non-agency portfolio and the detailed, the repo disclosure that you provided, and it would appear that net equity allocated to the non-agency trade was approximately $200 million at year end or just under 50% of your total equity. So my question is, as analysts should we begin to consider Western, WMC, to a hybrid REIT at this point as opposed to sort of the historical classification as a traditional pure agency REIT? Thanks.

This is Gavin, I would say that is probably accurate to be considered as a hybrid REIT would be consistent with our investment philosophy.

Right, so you would think Gavin, that this percentage, while it may bounce around based on relative value, it seems like this commitment to credit is going to remain fairly significant going forward. We don't want to be bouncing you back and forth, but it looks like to me that that is where you are now.

That's right.

Okay, thank you. I guess for a new, and I don't want to get into the weeds on too much bond -- too deep on bond strategies, but I think we all understand the benefit of IO and we are seeing multiple mortgage REITs embrace that, whether it is trust IO or whether they are buying MSRs for protection in a rising rate environment. But could you maybe just comment briefly on the role of the inverse IOs, and how we should think of those as far as what you're really looking to achieve by having inverse IOs in your portfolio. Thank you.

Sure, I think that having inverse IO 's, again, it is driven by our core pieces for our economic view as well our view on interest rates. Our view is that front end of the curve will stay pegged for a long time because of the slow growth in economy, and in that environment, IOs versus inverse IOs, you just have a better carry profile from inverse IOs.

Now, within inverse IOs, when we look across asset classes, whether it is a non-agency, or agency, or anywhere else where we can get the best carry. But again, the role of inverse IOs is similar to IOs from the perspective is to achieve better carry. But again it is driven by also the, to great degree it is driven by the view that the front end of the curve will stay pegged for a long time.

Understood. So, what you're saying is you see -- I'm not trying to put words in your mouth, but what I'm hearing you saying is where the inverse IO is priced today, you see attractive absolute returns today and when you match that with your outlook for a short end peg to zero, looking out, you see from a risk return standpoint that is a good trade?

That's correct.

So would we think if --

And, as our view changes about that, I think we will shift the portfolio.

So we should watch Fed funds futures and Fed chatter and look for expectations, and we would expect you to maybe lighten that portfolio as your view changes, as you just said. Okay, gentlemen --

Sorry.

No, I was just going to say thanks, appreciate the time, and appreciate the color. Thank you.

Daniel Furtado, Jefferies.

The question I really had is really more from a policy perspective. I just wanted to get your thoughts on risk sharing securities from the GSE's and if you think this becomes a meaningful change agent for the GSE policy going forward, or kind of how you're looking at those potential investments? Thank you.

Sure, we have been very actively involved in GSE risk sharing deals from first deal to the last one, which was issued, and we kind of think that from a policy perspective this will become a pretty standard process for GSE's to keep doing the risk sharing deals. And as you kind of saw in the last deal, that they moved up in credit and start to kind of do more and more larger part of it as a credit share deal, and I think that will become a standard practice from both Fannie, Freddie, and you will see continued increased frequency from them for doing that.

Thank you for that. Do you foresee the GSE's teaming up with the specific originators to issue these, or for them to remain more generic, for lack of a better word, when they, as they evolve this program?

I think instead of teaming up with originators, I think I can easily see GSE's to be -- to differentiate the deal by underlying product type versus the originator, because when I think it comes to the originator type, I think that's really where they are doing underwriting to make sure that there is a homogenous pool. I think the place where we continue to give feedback to them, where we differentiate that one GSE risk sharing deal from another risk sharing deal is by based on how much layered risk you have.

I think as this market evolves, what you would see is that market will differentiate between how the underlying deals are -- what kind of loans are there on underlying deals and what are the composition of layered risk on underlying each transaction. You would see the market differentiate in spreads for all the bottom classes based on that composition, and you would see the agencies to come up with one product time with different LTVs, and other risk sharing with another different LTV and the market will price that risk accordingly.

Okay, makes sense. Thank you for the commentary there.

Mike Widner, KBW.

First let me just get one simple one out of the way. I was wondering with the slowdown in prepays in the quarter if there was any one-time benefit to catch up or anything like that in the premium amortization?

Morning Mike, we run those calculations toward the end of the quarter. With regard to the current quarter, there has not been a material difference yet.

Just to be clear, I meant in the Q --

For 12/31?

Yes.

I don't have that in front of me, but I will get back to you on that number.

Okay, thanks. A little more conceptually I guess, you guys mentioned carrying a negative duration, negative one year duration on the agency book overall right now. That certainly implies an expectation of further curve steepening. I'm just curious, is that your expectation? And also given that you are carrying a negative one year duration at quarter end and the curve has actually flattened out a bit since then, how do you feel about where book value is today relative to quarter end?

Sure, Mike, I think the way we actively manage our hedging book based on, as you mentioned, I think our views are the rates will be range bound, but the reason we moved, as I said in the commentary, we moved it to negative duration is because sitting in September it seemed like even within that range bound rates will rise and we saw the rates -- 10-year yields rose up quite a bit.

And I think within that, I think with negative duration, your point being that you will pay more for your hedges or the cost of --or your net NIM will be a little lower in the rate we you are flat rate environment. On one end, I think our view is that to be able to protect the book by having the negative duration in this range bound environment, and at the same time, what we want to achieve is by changing the leverage in adding the leverage because we still feel positively about mortgage spreads.

Got you.

Does that answer your question?

It did kind of answered the question, but not entirely. I guess if I just step back, your book value is, for all practical purses, flat Q-on-Q, which is fine, you're up 0.3% once you make all the adjustments and whatnot. But rates did move substantially higher in the quarter, and if you went into it, like you said, with a negative duration in September, we had actually marked your book value up more positively than that.

I guess I am a little surprised that book didn't do better given that negative duration, and I guess the second part of it is it seems as if that's where you are still positioned today. In fact, with the asset portfolio smaller, you might have, in the swaptions, the substantial swaption book you have now, it looks like you're positioned, at least to me, at 12/31 for still having an expectation of rising rates, and obviously they haven't gone that way. And like you said, if they are range bound, I guess I am trying to figure out, do you really think they're going to be range bound or are you actually really still positioning for rising rates?

Look, I think what we're trying, what you would see from us is we are still expecting that there will be some rise in rates, but you also see from us that that duration gap will adjust as we are at different points of the range. If we were sitting at 10 years at high end of that range, then you would see from us the duration gap going from negative to zero or even slightly positive, so it really depends upon where we are within that range bound kind of range for us to adjust the duration gap.

Got you, well I appreciate that. I guess maybe just one final question. If I look at the, this sort of relates to the duration gap, all else equal, running higher leverage and a longer duration gap tends to be more positive in bond fund in terms of earnings power, so you guys have taken leverage down and you are running a negative duration gap, which again, all else equal, is going to make it tougher to generate earnings. And yet you guys are still carrying the highest yield in the space.

And so with regard to the $0.80 dividend and what you describe as currently available spreads and leverage, I am just wondering -- there's an obvious implication if I put the three of them together, which is an $0.80 dividend, $0.70 core earnings, you are already underearning the dividend, plus you have negative drag of the fully diluted share count going up next quarter from the stock dividend --

I think, Mike, I think the part -- the reason for reduced leverage at the point in the last quarter was more driven by our increase allocation to non-agencies. And I think that's really what caused our leverage to go down. If you removed the non-agency, then the answer would have been that as we move the duration gap to negative, increase the leverage.

And I think that's really what you would continually see that I think the leverage came down more because we allocated more to non-agency because even with hedge adjusted and with leverage we saw that that was a better return profile for us to add what we are seeing in non-agencies. And I think if you -- and if we still see better opportunities net of leverage and whatnot in non-agencies, you could see us move more, or the end of it is that if we are not seeing as many opportunities in non-agencies leverage based on available leverage, then you could see us shift the portfolio slightly more to agencies and increase the leverage just on our agency portfolio by adding more TBAs, given that the duration gap is negative.

Yes, that all makes sense and hard to argue with that. And certainly I do think the migration in the portfolio more toward a hybrid model and more toward a more balanced equity allocation make sense. I am just really trying to think about that in terms of the dividend. Again, if I come back to $0.70 of core earnings last quarter versus an $0.80 dividend, plus the drag of the higher share count that is going to more fully roll through in 1Q, I am just wondering if you can comment on how you view that dividend relative to the earnings power.

Look, I still see enough opportunities where based on our reallocation in the portfolio that we will be able to generate pretty attractive core earnings and still have a pretty stable base. And again, I think it is going to come from not only from changing and leverage, but it will also come from us looking at other opportunities outside of just pure agencies to look at, and on hold-on opportunities or in commercial mortgage space, and I think that's really where we will drive the core earnings.

All right, well thank you. I appreciate all the comments and the color.

(Operator Instructions)

Jim Young, West Family Investments.

Gavin, you mentioned in your economic outlook you basically subscribe to the Goldilocks outlook. Can you talk a little bit more about what is driving that perspective in 2014?

In terms of value on interest rates or the economy?

The economy, first of all, because again, you seem to subscribe to this Goldilocks outcome, which is not too hot, not too cold, which is obviously an ideal environment for mortgage REITs.

Yes, from my perspective, and I will let Anup join in here and talk about his view, but, and the view of the firm in general is that we see a mediocre economic recovery bumping along around -- just a little bit under trend growth. We don't see any inflation materializing, so overall, a pretty positive picture for the fixed income markets overall. Don't really see any event risk to change that. Obviously, we will look at the data as it materializes before us, but our view is that we will just sort of bump along here and -- around this sort of 2% or 3% growth rate in the economy.

Yes, I think, look, our view is really driven by the data that we are seeing, and I think within the data what we are talking about is you still see -- you still see very low -- the participation rate still continues to be low. And I think what we -- the reason for our view that economic growth will be slower is that ideally for the GDP growth to be higher, we expect CapEx expenditures to pick up.

What you have seen is you really haven't seen CapEx to pick up that dramatically at this point in time, and that really should -- that's really what we are watching out for, that if we see the CapEx pick up and pick up enough to cause us to change our view on economic growth, that's what we will adjust our portfolio. But at this point in time, that's -- lack of -- lots of policy uncertainties and a lot about policy uncertainties which are there, I don't see them getting resolved before the next elections and kind of -- lack of CapEx expenditures, those are really some of the things which are driving our view for this slow growth economy.

Thank you. And then as part of that, you had mentioned that you expect the long-term rates to be range bound. What is your current expectation for 10-year bonds in 2014? What is the range you are looking at?

We're still looking at in 2014 for 10 years, we are still looking at the range of 2.5% to 3.25%.

Okay. And with your morphing from more of an agency structure when you went public to more of a hybrid model today, is that basically an acknowledgment that the risk reward in agency bonds is unattractive at this time?

Look, I think we still have massive amount of portfolio in agencies. I think it is more of trying to build a balanced portfolio for where we can build with the best risk reward. We still see values in it, but we also believe in continuing diversifying in where -- all the different sub-segments where we can find attractive values.

It is not only just non-agencies, we're looking at opportunities in whole loans and resi side. We are looking at opportunities in the commercial mortgage side. You have seen us add a little bit of CMBS, and I think you would see that part grow. So it's acknowledgment that there is a broad, across whole structure product space, there are many places where we can have -- where we can find value. And as we find value we will actively shift our portfolio from agencies to non-agency or non-agencies and CMBS.

I would just add that this is one of the advantages that WMC has as an externally managed REIT is that we have the whole of Western Asset's fixed income platform available to us for idea generation. We have experts covering all the various sectors that Anup just outlined. So from a relative value position we are able and nimble enough, and expert enough, just to switch between the sectors.

And because of our size we see every transaction out there, so we have great opportunity in that regard as well.

Okay, thank you.

And we have no further questions, Mr. James.

Thanks again for joining us on the call this morning. We look forward to visiting with many of you that have asked the questions today, and thanks again for your sponsorship.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.