Western Asset Mortgage Capital Corp (WMC) 2014 Q1 法說會逐字稿

Welcome to the Western Asset Mortgage Capital Corporation's first-quarter 2014 earnings conference call. Today's call is being recorded and will be available for replay beginning at 5 PM Eastern Standard Time today. (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 three months ended March 31, 2014.

By now you should have received a copy of today's press release. If not, it's 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 from management are Gavin James, Chief Executive Officer; Stephen Sherwyn, Chief Financial Officer; and Anup Agarwal, Chief Investment Officer.

Before we begin, I'd 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 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 Securities and Exchange Commission. Copies are available on the SEC's website. 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.

Thank you, Larry, thank you everyone for joining us today for our first-quarter conference call. I'll begin the call by providing some opening comments, and Steve Sherwyn, our CFO will then discuss our financial results. And then Anup Agarwal, our Chief Investment Officer, will provide an overview of our investment portfolio, our liability profile and our future investment outlook. After our prepared remarks, we will conduct a brief question-and-answer session.

The first quarter of 2014 was a quarter transition for WMC. We declared a dividend of $0.67 per share and continue to implement our strategic decision to move from a pure agency mortgage REIT to a hybrid model.

During the quarter, we recorded a GAAP net loss of $0.32 per share while generating core earnings of $0.46 per share. For the first time since our inception, we had a material amount of drop income resulting from our increased use of TBAs in the portfolio. Our core earnings and drop income was $0.61 per share in the first quarter. This excludes the catch-up for premium amortization of $0.05 per share.

As we indicated on our last conference call, we believe that the hybrid mortgage REIT model can deliver greater value for our stockholders in the current environment. The strategic actions we took as a part to this transition resulted in a smaller overall portfolio as compared to the fourth quarter of 2013, impacting our effective net interest income.

Combined with higher hedge-adjusted financing costs that reduced our net interest spread, we generated a lower level of core earnings than we have in prior quarters. In addition, our book value per share was impacted by unrealized losses on our interest rate hedges as rates move towards the lower end of our expected trading range. That being said, we estimate that our unaudited book value per share has increased to between $14.92 and $15.02 as of May 5, 2014.

While we are not satisfied with our first-quarter results, we consider them to be a necessary cost of the repositioning of our portfolio over the last six months and believe that we are better positioned to generate improved returns for shareholders going forward. We now have the ability to move to more fully capitalize on the overall breadth and expertise across the broad mortgage spectrum possessed by our [manager in] Western Asset Management Company.

With the hybrid mortgage REIT model, we are better able to increase our exposure to the non-agency assets including potential investments in residential and commercial real estate holdings and other asset-backed securities, which we believe currently present more attractive risk-adjusted returns than in the agency market alone.

Our transition to a hybrid mortgage rate was further accelerated with the successful follow-on offering we completed in early April. This offering, along with a concurrent private offering of 650,000 shares of common stock that was sold to Western Asset Management Company, raised net proceeds of approximately $200 million. The offering was accretive on a book value basis to existing shareholders and increased the market capitalization of the Company by approximately 50%.

Last week, a portion of the overallotment option was exercised by our underwriters, which resulted in another $14.7 million in proceeds.

Using the broad fixed income investment platform available to us at Western both, the initial $200 million and $14.7 million from the overall allotment option, were fully invested on the same day the proceeds were received. We continue to have an overabundance of repo availability which enables us to lever our capital to our targeted levels and fund that portfolio with repo that remains very stable from both a rate and haircut perspective.

It should be noted that since quarter end, we've increased our leverage rate -- leverage to approximately 8 times, whereas the availability of repo has become a key risk factor for the mortgage REIT industry, we believe the overall strength of Western Asset as an organization and our long-standing relationships with repo accounts parties, both domestically and internationally, significantly mitigates funding risk for WMC going forward.

With the adjustments we've made in the portfolio and the new capital we have deployed early in the second quarter, we have created a portfolio that we believe will perform well given the following assumptions. Interest rates at the long end of the curve will be range bound of the course of the year with the overall trend pointing towards a very gradual increase in rates. And short-term rates will remain near zero.

Economic growth in the US will remain subdued over the next several quarters and the Fed will continue to be supportive of the economy.

Mortgage spreads on agency RMBS are more likely to narrow rather than widen as the spreads tapering program continues against a backdrop of lower net new supply. And the supply of non-agency assets will be somewhat constrained given a low level of expected new production.

We are optimistic that the hybrid mortgage REIT model will enhance the returns we intend to deliver for our shareholders. Given the increased portfolio size and diversification and the lower expense ratio following capital rates, we believe we are all well-positioned to generate sufficient core earnings to support an attractive dividend while also reducing the overall volatility of our book value.

At this time I'm 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 first quarter ended March 31, 2014, where specifically indicated all metrics are as of that date.

On a GAAP basis we incurred a net loss for the quarter of approximately $8.4 million or $0.32 per basic and diluted share. Included in the net loss was approximately $31.1 million of net unrealized gains on MDS, approximately $2 million of net unrealized gains on MDS, and approximately $57.7 million of net loss on derivative instruments and linked transactions.

At the quarter, our core earnings were approximately $12.4 million or $0.46 per basic and diluted share, which is a non-GAAP financial measure which we define 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.

Included in our core earnings of $12.4 million is approximately $1.4 million of estimated catch-up premium amortization resulting from the quarterly adjustments in our projected constant prepayment rate or CPR estimates for our MBS portfolio and the retrospective application of such adjustments of certain of our MBS securities consisting almost entirely of our agency RMBS hopefuls.

In addition to our core earnings for the quarter, we generated drop income of approximately $2.7 million or $0.10 per basic and diluted share. We should also point out that at year-end we had substantial undistributed taxable income from 2013.

As we have been transitioning our portfolio to more of a hybrid REIT model, we've also been utilizing more to be announced or TBA forward contracts on agency RMBS in the form of dollar roll transactions, which is a result of an incremental drop income.

Drop income represents a non-GAAP financial measure and is defined as the difference between the spot price and the forward settlement price for comparable security on the trade date.

For the quarter, our core earnings plus drop income, excluding estimated catch-up premium amortization, was approximately $16.5 million or $0.61 per basic and diluted share. This compares to core earnings plus drop income excluding estimated catch-up premium amortization of approximately $18.9 million, or $0.70 per basic and diluted share for the fourth quarter ended December 31, 2013.

After adjusting for additional shares issued as a result of the stock portion of the dividend declared on December 19, 2013 and paid on January 28, 2014, core earnings plus drop income excluding estimated catch-up premium amortization would've been approximately $0.70 per basic and diluted share for the fourth quarter of 2013.

For the quarter ended March 31, 2014 our average amortized cost of MBS health, including agency and non-agency interest-only strips accounted for with derivatives and linked transactions was approximately $3.09 billion as compared to approximately $3.47 billion for the fourth quarter ended December 31, 2013.

Our net interest income for the first quarter was approximately $20 million. This number is a GAAP financial measure and does not include the interest we received and pay on our linked transactions, interest we receive 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 are included in the gain on the derivatives instruments line in our income statement.

On a non-GAAP basis, our net interest income including the interest we receive from IO securities treated as derivatives and interest we received from linked transactions was approximately $15.7 million. Included in this calculation was approximately $46.1 million of coupon interest, offset by approximately $18.9 million of net premium amortization, discount accretion, and amortization recovery of basis.

This compares to non-GAAP net interest income including interest we received from IO securities treated as derivatives and interest we receive from linked transactions of approximately $20.4 million for the fourth quarter of 2013.

Our weighted average net interest spread for the first quarter of 2014, which takes into account the interest that we received from our non-agency RMBS and IO securities as well as the fully hedged cost of our financing was 1.8%, reflecting a 3.57% gross yield on our portfolio and a 1.77% effective cost of funds.

This compares to a weighted average net interest spread of 2.15%, reflecting a 3.61% gross yield on our portfolio and a 1.46% effective cost of funds for the fourth quarter of 2013. Our cost of funds increased by 31 basis points compared to the fourth quarter, which is primarily attributable to the increased hedging we put in place near the end of the fourth quarter, as well as some of our previously entered into forward starting swaps becoming effective.

During the first quarter our constant prepayment rate or CPR for our agency RMBS portfolio was 3.8% on an annualized basis. This compares to 5% for the fourth 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 $3.9 million, which includes approximately $2.1 million for general and administrative expenses and approximate $1.8 million in management fees. Included in the G&A expenses were non-cash stock-based compensation of approximately $600,000.

On a book value per share -- our book value per share as of March 31, 2014 was $14.19, which takes into account the $0.67 regular cash dividend that was declared on March 20, 2014. For purposes of comparison, our December 31, 2013 book value per share was [$15.27]. As Gavin previously mentioned, our book value per share declines are in the first quarter primarily as a result of unrealized losses in our interest rate hedges as rates move towards the low end of our expected range.

We estimate that our book value per share has partially recovered to between $14.92 and $15.02 per share as of May 5, 2014, in part due to our investing of the approximately $200 million in proceeds that we received on April 9, 2014 from our common stock offering and concurrent placement that occurred shortly after the quarter's end.

It should be noted that this estimate of book value is an unaudited number which does not include any adjustment for the catch-up premium amortization. Our book value may change due to a number of factors, including market conditions and our actions in managing the portfolio. And/or our actual book value as of today may be different than the estimated number from May 5.

As of March 31, the estimated fair value of our portfolio was approximately $3.3 billion and we had borrowed a total of approximately $2.8 billion under our existing master repurchase agreements. Our leverage ratio was approximately 7.4 times at quarter end. Our adjusted leverage ratio was approximately 8.2 times at quarter end, adjusted for $300 million notional value of net long positions in TBA mortgage pass-through certificates that we held at the end of the quarter.

As Gavin mentioned, since quarter end we've increased our leverage to approximately 8 times.

We continued to be in an attractive position of having repo capacity well in excess of our current needs. At March 31, we had master repurchase agreements with 20 counterparties and outstanding borrowings with 16 counterparties. We continue to have excellent relationships with our bank counterparties and we feel comfortable with our existing group.

We have a highly diversified repo lender book and believe that we 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?

Thanks, Steve. Good morning and thank you for joining us today. Let me spend a few minutes discussing our investment results for the quarter and update you on our portfolio strategy.

As indicated earlier, our book value declined by approximately 2.7% during the first quarter after adjusting for the $0.67 dividend we declared. This was primarily due to the decline in value of our liability hedges, which were negatively impacted by approximately 30 basis point decrease in 10-year treasury rate during the quarter.

Our agency and non-agency MBS positions increased in value during the quarter, but not enough to offset the decline in value of our hedges. You may recall that we reported our -- an economic return of 4.8% in the fourth quarter of 2013, primarily due to the increase in the value of our liability hedges.

So, in the first quarter of 2014, we gave some of that return back when the rates decreased to a lower end of our expected range.

On our call last quarter, we talked about our belief that long-term interest rates would remain range-bound given the slow growth environment of the economy. While we continue to believe that this will be the case, we believe that we are presently at the low end of the range and that there is a meaningful probability that rates will gradually head back up towards the mid or high end of the range over the remainder of the year. And therefore, we have continued to position our agency portfolio with a modest negative duration of 1.5 years.

Interest rate volatility remains low and we feel comfortable increasing our exposure to TBA securities as a way to supplement our core earnings with incremental drop income which, as Steve mentioned, contributed approximately $2.7 million in the quarter.

During the quarter, we increased our exposure to higher coupon 20-year and 30-year fixed-rate pools as we believe these securities offer an attractive relative value on a hedge-adjusted basis. We maintained our exposure to non-agency MBS, which performed well during the quarter and we believe will continue to do so in a gradually improving economy, while also exhibiting less interest rate sensitivity.

We want to emphasize that we intend to continue to be proactive portfolio managers. Continually monitoring the relative value opportunities we have across a broad mortgage universe, we have access to and benefit from Western Assets' comprehensive platform where we are able to draw upon the experience of a full team of experts across a number of sectors and mortgage markets, and the broader fixed income and credit markets.

We are currently seeing opportunities to generate levered ROE at relatively attractive levels on new capital invested in non-agency assets, including GSE credit risk transfer securities and other asset-backed securities. We also continue to explore potential investments in residential and commercial whole loans.

With that, let me turn to some of the portfolio details as of the end of the first quarter. As of March 31, 2014, the total estimated market value of our portfolio was approximately $3.3 billion and consisted primarily of agency mortgages, complemented by holdings and non-agency RMBS, and agency and non-agency IOs and inverse IOs and CMBS.

Our portfolio remains weighted toward 30-year fixed-rate mortgage pools which represented approximately 52% of the value of the total portfolio. Our exposure to 20-year fixed-rate mortgage pools at the quarter end was approximately 25%. Non-agency RMBS represented 13% of our portfolio. Agency and non-agency interest-only strips and inverse interest-only strips represented 9% of the total. And agency and non-agency CMBS represented just under 1% of the portfolio.

Our agency specified pools continue to be invested in mortgage pools with low loan balance or high LTVs, which is consistent with our investment strategy of minimizing our prepayment risk. Our non-agency pools consist of approximately 16% of prime loans, 43% Alt-A and the remaining 41% being in subprime loans.

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. At March 31, we had borrowed $2.6 billion under these agreements resulting in leverage of approximately 7.4 times, prior to adjusting for our $300 million net long TBA position that we carried at the end of the quarter.

As of March 31, we had entered into approximately $4.1 billion in notional value or [free] fixed interest rate swaps, of which approximately $654 million are forward starting and $527 million are fair variable interest rate swaps, giving us net pay fixed swap position of approximately $2.9 billion.

At the quarter end, we increased our hedges in anticipation of the increase in our portfolio due to stock offering. Additionally we have entered into approximately $2.1 billion notional amount of net pay fixed interest rate swaptions with swap terms that range between seven and ten years, and have exercised expiration dates that range from May 2014 to October 2014.

As a result of our hedge positions, our agency portfolio had a net duration of negative 1/2 year at quarter end, up modestly from negative 1 year at December 31, 2013. We continue to have slightly positive duration at the short end of the yield curve, which is more than offset by negative duration at the longer end.

Since quarter end, we have increased our leverage to approximately 8 times and our estimated in unaudited book value as of May 5 is approximately in the range of $14.92 to $15.02. We are comfortable with our current leverage given our view of the environment of continued lower interest rate volatility. We can adjust our leverage fairly quickly through the use of TBAs and re-determine 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 assemble our diversified portfolio with 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're always looking for ways to improve our returns without increasing the overall risk level of the portfolio.

We expect to remain proactive, and as opportunities present themselves, to further diversify our sources of return by increasing our exposure to non-agency RMBS and CMBS, GSE credit risk transfer securities, and other asset-backed securities. Though our allocations to these asset classes will vary based on market conditions, we also continue to explore potential exposure to residential and commercial real estate whole loans.

We are confident that given our broad opportunity set of investments, and with our world-class investment expertise, we'll be able to generate a consistently strong dividend for our shareholders while reducing the overall volatility of our book value per share.

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

(Operator Instructions) Dan Furtado, Jefferies.

The first question is -- I think you went over it relatively quickly, but I want to be absolute here, is that the pro forma book value after quarter end. That's entirely due to the capital raise or is there some asset appreciation baked in that number as well?

That is based on asset appreciation since the quarter end.

Okay, got you. And then the other question I had is I get it that you, in essence, bought the swaps in front of buying the assets. But when we roll out a quarter or two from here, is it safe to -- is the way to think about -- and I know this is imprecise, but like a ratio of derivatives to the portfolio to be in that 80% to 100% range like it's been running the last couple of quarters. Or how should we think about kind of that ratio? And again I know the duration is more important than the ratio, but duration is harder from our end, frankly, to model.

Look, I think you exactly hit it on the head. I kind of focus more on the duration and the duration GAAP than necessarily the ratio. But the way I would also kind of think about is more driven by that as we transition of the portfolio more and more towards credit opportunities. Then you will kind of see the ratio continue to decrease because when I think about as we are adding more and more non-agency or CMBS securities, then the duration for those securities is significantly different.

For example, most of the non-agency securities are floaters or GSE risk transfer deals are floaters. What you kind of see is that ratio will continue to come down as we shift our portfolio more and more towards hybrid or more credit spectrum.

And now the other part also within that for the ratio is also driven to a great degree by our view on mortgage spreads. When I think -- the way I think about the portfolio is that if we are very constructive on mortgage spreads, we will still have more TBA positions and effectively hedge the duration or keep the duration gap to minimal based on our views on the rates, and kind of have TBA position to express our view on mortgage spreads.

Understood, that makes perfect sense. And turning to the whole loan -- the potential for whole loan strategy moving forward, I assume this is likely to be in the non-agency space but could be incorrect. And then the follow-up to that would simply be what options do you currently see to fund those whole loans on a go forward basis?

Sure, so I think for portfolio loans, I think, one, our focus in whole loans is primarily on non-QM more than anything else. And I think that is -- our whole loans, our focus is on both the commercial and residential side. And on the commercial side our focus right now is more on legacy [AJs]. But on whole loans, the efforts are both on the residential and commercial.

And within residential our focus on nonqualified mortgage, mortgage pool, and the funding for that is with the thought process that we are ready have funding facilities. Or we are working towards putting funding facilities together as we partner up with originators and servicers to originate these loans. And ultimately, along the way, we've been working with the rating agencies and they've been more clarity in -- for non-QM loans. So our expectation is as these loans get originated, they will get funded from the repo facilities and ultimate path to securitization.

Understood. And can I sneak one more in, if you don't mind, on the whole loan strategy? I guess there's little bit of a chicken and the egg issue here, where I believe there's demand from originators who originate them but not necessarily to exit the positions if they don't want to balance sheet them.

So is the strategy here to approach originators and say, hey, look, we'll be in the market for you on a consistent basis for loans that fit these parameters. We'll buy a certain amount off of you over a certain period time, and then that gives them the surety of a backstop for lack of a better word? Or how should we broadly think about the strategy?

I think this is where we have the benefit of Western as an organization that, in that same framework, when we talk to these originators that, hey, we'll be there to have access to these loans, we have a benefit that as a larger AM, we're responsible for significant size of agency and non-agency book as part of the Western platform. And we carry bigger value in terms of our capability to be able to affect that versus somebody else.

But that's how we have been going to the originators that -- this is kind of the box we like within non-QM kind of framework. And if you originate these we will be -- you will have access to us where we will be buying them along the way.

Dan, it's Gavin here. I just wanted to chip on the end of that. As Anup said, it's great having a larger AUM of Western behind us. We've seen a lot of demand from clients outside of the REIT for sort of whole loans strategies, especially people or entities like sovereign wealth funds, central banks around the world. So we are privileged to see those inquiries and put that money to work for them. So we would be a pretty constant bid in the market for the banks.

Great, thank you for the commentary. I really appreciate it, everybody.

Rick Shane, JPMorgan.

Thanks for taking my question. It's sort of a follow-up on what Danny just asked. So you provided an update or estimate of where you think book value might be as of May 5. Can we disaggregate that?

So there is basically somewhere between $0.70 and $0.80 of increase since the end of the quarter. Some of that comes from an accretive stock offering. Some of that comes from appreciation on the non-agency book. Some of that comes from appreciation on the agency book presumably.

Can you at least sort of give us -- thinking about that $0.70 can you give us a pie chart of what the contribution from each of those three elements would be?

(inaudible) it's a great question, I think it's something that -- it's just something that will be difficult for us to provide. I know exactly where the -- it's a combination of both agency as well as non-agency market. I mean you have seen in the last one week mortgage spreads of come in very dramatically, and I think if you talk to all the different investors in the marketplace, you would kind of see -- for example yesterday was mortgage spreads tightened very, very dramatically.

I think at the same time you've seen non-agency market come in quite a bit. Just as a framework of non-agency market, just GSE risk transfer deal at month-end, kind of at the end of March you saw the risk transfer deals were trading more at 330, 340 basis points broadly in the marketplace bid-ask. Right now, those risk transfer deals are at -- this morning it was at 282, 288 market.

So that tells you that both of these markets have come in quite dramatically. Same is true for CMBS. I think that as CMBS has been added to the market and that market has been on fire, so offering was accretive to the book but the main driver really was kind of the spreads tightening all across the board.

This is -- and the reason for that is I think our long-held belief has been that rates will be rate bound and the slow growth in economy. And in that environment, as I have said in my prior calls, that mortgage spreads will continue to tighten. They will stay stable, as well as the credit spreads will continue to tighten.

And that's really why we have kept the leverage at the higher level at 8 times levered, because our belief is that the spreads will continue to tighten while we keep the duration gap as close to zero as possible. You've seen from us, given our view, that we've kept the duration gap anywhere from negative half-year, negative one year to zero, while keeping the leverage high and kind of continue to increase in the credit book.

And it's all driven by the same view that global slowdown in economy, kind of US to have a slow growth but continued growth and the rates to be range found.

Rick, the vast majority of that appreciation is portfolio performance as opposed to the stock offerings. (multiple speakers) apply the exact number, but the vast majority would be more -- would be the portfolio.

Absolutely.

Got it. And to follow up on this a little bit, the trade-off here is this. That the tighter spreads -- the enhanced security values are good from a book value perspective, but the tighter spreads from a margin opportunity perspective diminish things. And I think the hope was that as we enter taper that there would be opportunity for margin expansion. And what's ended up happening is limited supply has constrained that.

Do you think that there is still that opportunity for margin expansion out there? Or is that just not realistic given where we are right now?

I think this is where I get excited about. I love this part of the question, because this is where we have the benefit of Western Asset as an organization, that this is where, one, depending upon our views of mortgage rates, we can increase and decrease our leverage from just adding more TBAs, less TBAs. And as those spreads tighten, we reduce our position in TBAs and then as the spreads widen out back again, we can increase that position.

The second is this is where we can diversify pretty actively in kind of other asset classes. So, as on one end you have kind of seen the spreads for GSE transfer deals and non-agency deals come in, but we have diversified into CMBS, or CMBS or CRMB notes or whole loans in RTM.

So this is where we have I have the benefit of having large teams were not only for the REIT but for broad investor base, we can take advantage of these opportunities. So when you kind of think about another REIT or another manager to shift the portfolio from GSE to CMBS to whole loans to CRE B-notes, other people don't have the capabilities we do. So this is where our active management of the portfolio and to find opportunities wherever the spreads still exist.

So, for example, we can still buy the notes for -- at [70] LTV at 78% yield and you can add half a term leverage or a little more to get better risk to (inaudible). Or you can buy the legacy CMBS AJs which have 6%, 6.5% yield. This is where our capability is a REIT and as a part of broader Western Asset platform really gives me and gives us as an organization an edge versus anybody else.

Got it, thank you very much guys.

Mike Widner, KBW.

I think it might be a little confused, and so maybe just a couple of points of big picture clarity on some of the things you've said.

In the press release, and I think in your opening remarks you said that a lot of the results in the quarter reflected the strategic decision to move away from the pure agency model and sort of more towards hybrids. So that seems to be the theme you guys are talking about quite a bit. I mean, is that right?

That's correct.

Mike, you remember that I think even in past calls we have guided in that direction. I think that has been a constant theme from us for a while, because I think it's driven by our -- where we see the opportunity set.

That makes sense. And certainly we hear no shortage of peers talking about the same thing. I guess where I am sort of puzzled is, if I look at your portfolio breakdown, whether I look at it on a percent of the portfolio basis or an absolute dollar basis, your allocation the gross amount of dollars and the percentage of assets in non-agency RMBS, for example, was down Q over Q. And your agency mix is up Q over Q.

So there's that piece that I'm just not sure I reconcile it Q over Q. And then also, what you've talked about in terms of deploying the capital is saying that, again, if I heard you right you're back up -- you grew your equity base by basically 50% and you are back up to 8 times leverage already. And you did so largely through use of the TBA market, which is agency.

So I guess I'm sort of struggling to reconcile the transition and what you described as an impact to the operating results in the quarter from a transition toward a portfolio that it doesn't -- I guess I'm not making the connection between the shift and what I'm actually seeing in your disclosure of the portfolio composition.

I think, Mike, what you would see is that you will see a continued transition. And I think as you see future over a period of time you'll see that both non-agency buckets, CMBS buckets, all those buckets will continue to increase.

The way I think about it is that as we had 50% more, 50% more in our equity offering, the percent of capital to non-agency will continue to increase. So, as we deployed that capital the way we look at it is initially we deploy the capital in agencies and as a placeholder, and then continue to actively go out the marketplace find opportunities in non-agencies and CMBS.

And a lot of those have a little longer lag time. So, for example, whole loans they just have a little longer lag time; same way CMBS B-notes. They just have a little more lag time than I would like to have, but it does.

So I think the second part in terms of the leverage, that's also part of it is driven by our views on the mortgage spread. So the way I think about the world is think about the world where we want to continue to develop it to more credit, so the portfolio composition continues to transition more and more into credit spread product, whether it's whole loans or whether it's on CRE loans or whether it's B notes or non-agencies.

But at the same time if you are constructive on mortgage spreads what you would kind of see -- what you can expect is the overall leverage without TBAs come down. But we have more TBAs just because we are very constructive on market spreads.

Okay. So what I think I'm hearing in there is that the migration more towards non-agencies and credit is a slow transition that's still in process and we should expect that to continue. But my eyes are not deceiving me, portfolio is the portfolio and where we stood at Q end was still pretty much 77% side of the portfolio in agencies. And it sounds like as of today it's probably still roughly in that -- I've got to pick something for modeling purposes. Is that the ballpark today including the TBAs?

I think what you will see it will continue to increase at a good pace along the way for both credit and non-agency and CRE B-notes and the whole loan bucket will continue to increase at a pretty good pace.

Let me ask a second one, if I could, on the swaps. I know you talked about this a little bit in your comments but I'm not sure I got everything. At quarter end you had about $4 billion in pay fixed swaps, a little more than that. You talked about still having a net negative, slightly negative perhaps duration gap, but adding a lot to TBA position.

So did you say how much you added in swaps? Because I think you said where we added swaps in advance to the capital raise, and then I thought I also heard that maybe you added swaps since then.

No, I think a lot of the swaps are added just in anticipation of the offering.

So --

In net (inaudible) it's about $2.9 billion and I think a decent amount was added just with anticipation of offering and we expected. The way we kind of talk about it is with expectation of offering, we will add the -- initially we will take all our offering proceeds and convert it into and invest in agency collateral.

And then we will rotate out of that into and we will continue to rotate into non-agency and CMBS and CRE opportunities. But initially we invested the capital within 24 hours and that was just in anticipation of adding swaps for that.

But looking forward, would we add more? No, I think we are in a pretty good place. If anything, the way I think about it is if we continue to add more non-agency, you'll just those notionals come down.

Okay, so let me just make sure I understand what you are saying correctly. At the end of Q4 you had $2.7 billion in pay fixed swaps. You finished Q1 at basically $4.1 billion so that's net addition of $1.4 billion. I think I just heard you reference adding $2.9 billion. So I guess am just trying to square the numbers and understand, again, for modeling purposes, what -- where the swap book stands today.

I think the way you are thinking about it was right. We net added pay variables. But I think the way you're thinking about it is exactly correct.

Okay. But the way I'm thinking about it is I'm confused on what number you are -- again the $4 billion, does that represent -- the $4 billion where you were at the end of Q1, does that represent having put on swaps in anticipation of the capital raise? Or are you saying that you added swaps in April in anticipation of the capital raise?

We added swaps in anticipation of a raise.

Okay, I still don't think that answers my question. But it doesn't sound like I'm going to get one. So thanks, guys.

We added [half] at the end of the quarter.

Jackie Earle, Compass Point.

Just a specific question on pay-ups on specified pools; any movement in the quarter on pay ups there?

I think, not really. A tad bit but I don't think --

Yes, so we're not seeing pay-ups move either. And it just -- I'm wondering why the market is describing such little optionality to whether it's a CQ pool or low loan balance pool. What's your thought on why there is virtually zero optionality priced into those bonds?

Look, I think you have seen market kind of give credit to that in just this week. I think you've seen the spreads tighten and I think you have seen that get impacted right now. And I think in last week we have seen pretty significant impact.

Could you be more specific in terms of what you own, you've seen an impact in terms of price appreciation on specified pools? Is that what you are saying?

That's correct. I think not only what we own we have seen the appreciation, but just kind of broadly in the marketplace you have seen that optionality getting priced.

Okay, all right. All our other questions were answered, thank you.

There are no further questions at this time. Mr. James?

Thank you everybody for joining us on the call this morning. We look forward to speaking with you in person in the months ahead. You may close the call, operator.

This concludes today's conference. Thank you for attending. You may now disconnect.