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AG Mortgage Investment Trust (NYSE:MITT)

Q1 2013 Earnings Conference Call

May 6, 2013 11:00 a.m. ET

Executives

Lisa Yahr – Head of IR

David Roberts – CEO

Jonathan Lieberman – Chief Investment Officer, Secretary

Frank Stadelmaier – CFO

Analysts

Douglas Harter – Credit Suisse

Trevor Cranston – JMP Securities

Stephen Laws – Deutsche Bank

Mike Widner – Keefe, Bruyette & Woods

Boris Pialloux – National Securities

Operator

Welcome to the AG Mortgage Investment Trust First Quarter 2013 Earnings call. My name is Christine and I will be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note that this conference is being recorded.

I will now turn the call over to Lisa Yahr. You may begin.

Lisa Yahr

Thanks, Christine. Good morning, everyone, and welcome to AG Mortgage Trust Q1 2013 earnings conference call. Joining me on today's call are David Roberts, our Chief Executive Officer; Jonathan Lieberman, our Chief Investment Officer; and Frank Stadelmaier, our Chief Financial Officer.

Before we begin, I would like to review our Safe Harbor statement. Today's conference call and corresponding slide presentation contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All such statements are intended to be subject to the protection provided by the Reform Act. The Company's actual results may differ materially from those projected due to the impact of many factors beyond its control.

All forward-looking statements included in this conference call and the slide presentation are based on our beliefs and expectations as of today, May 6, 2013. Additional information concerning the 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 periodic reports filed with the Securities and Exchange Commission. Copies of the reports are available on the SEC's website at www.SEC.gov. Finally, we disclaim any obligation to update our forward-looking statements unless required by law.

With that I will turn the call over to David Roberts.

David Roberts

Good morning, everybody. This quarter AG Mortgage Investment Trust had core earnings of $0.75 per share, compared to $0.85 last quarter. Jonathan and Frank will discuss our portfolio strategy and performance in detail but I wanted to make three comments about our core earnings.

First, we added materially to our hedges during the quarter, lowering our interest-rate exposure. Second, we purchased some very attractive credit positions, which had the effect of lowering our average leverage in the quarter. Third, we realized an after-tax gain of $0.14 per share in the quarter from selling one of those credit positions effectively bringing forward core earnings.

Given the context of these factors, we are very pleased with our core earnings results. In terms of our dividend, based on current conditions and everything we see today, we do not anticipate a change in our dividend rate through the remainder of calendar 2013.

Finally, we seek to create value for our shareholders not only through our dividend stream but through achieving a premium valuation. Accordingly, our strategy for 2013 is to continue to add resources to the Angelo, Gordon platform to take advantage of what we see as a long-lasting opportunity in whole loan residential mortgages, both in secondary trades and originations.

With that I will turn it over to Chief Investment Officer, Jonathan Lieberman.

Jonathan Lieberman

Thank you, David. I am going to be referring to our slide presentation, which has been posted to our website. So, first I’d just like to lead off with some highlights set forth on slide number three for Q1.

For the quarter, as David mentioned, we generated $0.75 of core earnings and also retained undistributed taxable income of over $2.10 per share. As I’ve mentioned in previous calls, we believe that earnings retention provides the Company with two important sources of strength for our shareholders. It provides us with the cheapest source of capital for reinvestment and it also provides dividend durability.

For the quarter, book value at quarter end stood at $23.16, a decline of a little over a 1% from year-end. The decline was primarily a function of soft performance in Agency MBS into quarter end. Book value has since nicely rebounded, as asset prices in both Agency MBS and credit appreciated into April and this past week, the first week of May. Agency values are up over about 1% and credit asset values are up from 2% to 4% over the past five weeks.

As – moving to slide number four – sorry slide number five – as the slide will show our portfolio is approximately $5.1 billion. We continue to execute our strategy of systematically rotating more capital into credit assets, while paring back our overall Agency MBS exposure.

Our investment portfolio grew from $4.9 billion to $5.1 billion over the quarter and we continue to shift the portfolio towards credit assets. As of March 31, approximately 26.5% of our portfolio is allocated to credit, with the remaining 73.5% deployed into Agency MBS. Prepayments speeds for Agency MBS continue to track with anticipated prepayments speeds. Our Agency book paid approximately 8.8% CPR for the quarter, with a decrease to 7.7% for the month of March.

Leverage in our NIM were modestly higher quarter over quarter, with respect to leverage. Our leverage ticked up incrementally from 5.26 times at year end to 5.3. Our NIM at quarter end was 2.25%, up 10 basis points from prior quarter end, and our annualized return on the stock was over 48%.

With respect to core earnings, we selectively rotated out of certain 15-year MBS into 20- and 30-year Agency MBS, concurrent with the adding of the of longer duration Agency securities we extended the maturity profile of our interest-rate hedges by adding interest-rate swaps. We also, from time to time, will supplement our hedge book to compensate for ordinary seasoning and roll down of the existing hedge book.

The additional cost of hedging was among the contributing factors to a modest decline in core earnings. Other variables impacting reported core include the accrued yields for certain credit assets and the timing of capital deployment into credit investments.

Finally, we continue to see consistent activity in warrant exercises from our private placement investors. And as of the end of March, approximately 62% of our outstanding warrants had been exercised.

Now, turning to the economic outlook, which is basically the building blocks for portfolio allocation decisions, I’d like to walk you through what we see as the global economic outlook and the US economic outlook.

Like clockwork, it seems every spring, we have a growth in interest-rate scare but the facts tell a different story. Each year at this time the government, with more complete data to work with, recalculates the job estimates it made in the previous year. What the revised figures show is not encouraging. At the beginning of 2012, jobs grew at approximately a 1.9% annual rate.

But since then, there has been a steady erosion to roughly about 1.5% in March 2013. The employment participation rate continues to deteriorate with people exiting the workforce at roughly the same pace as people are joining. The long-term implications of this increase in structural unemployment do not bode well for our Social Security system and the deficit.

Although, I’m painting a pretty tepid economic picture here, we do not believe that this tepid economic picture will stop the recovery in housing. We expect that housing will increase by approximately 5% to 8% this year and 3% to 4% in 2014. It will then moderate the speed of further increases because of basically stagnant personal income levels.

Now, it will moderate the speed of which new construction takes place and new households buy homes. You have to remember that many college grads are severely encumbered by student loan debt and basically this is going to be very favorable for the rental income market. In the long term, an economy stuck at the current level of growth will alter its housing demand picture will see more urban rentals, smaller homes and less suburban development.

You throw in the fact that basically with cuts in federal spending, a recession in our export markets – you've got to remember basically the largest economic zone in the world is – remains Europe. And Northern Europe is in basically a recession and Southern Europe is really in a managed depression, we’re going to have a sluggish economy. Income growth is going to barely outpace the rate of inflation. And once housing resets to an equilibrium level, we would expect housing prices to really increase in pace with inflation, unless there is a significant widening of the credit box or there is more leverage brought into the system.

With this backdrop, we do not believe that monetary policy will change pre-2014. We expect a continued push by the Obama administration to increase credit availability to non-prime homebuyers, and we are actively participating in conversations with the administration on the privatization or the basically scaling down of Fannie and Freddie. We believe that REITs will play an important role in the evolution of the US housing finance markets, as the story continues.

Now, turning to slide six of the presentation, we have a quick snapshot highlighting the quarter-over-quarter changes in rates and the credit market. The credit rally that started last year continued in the first quarter, as the ongoing low rate environment fueled the quest for yield. Improving housing and commercial real estate fundamentals are filtering through resulting in higher asset prices across the RMBS and CMBS credit markets.

On the flip side, we saw rates back up in the – and Agency MBS struggle into quarter end. We’re seeing increasingly a bipolar manic depressive kind of behavior in the treasury markets, and this is becoming the new norm. A piece of information comes out, the markets sell off. Another piece of information comes out, the markets rally. For days the markets will obsess over whether the Fed is withdrawing stimulus and then reality will intervene and thoughts of QE forever take over.

Marks move in rates has more than reversed itself with the 10-year treasuries at (175) and Fannie three-years at (104 spot 2) as of Friday's close.

On slide seven, we lay out our portfolio. As of quarter end, we held just over $5.1 billion in securities, up approximately $200 million from prior quarter. The size of our Agency portfolio increased slightly, although we did conduct a rotation within the Agency book. With respect to our credit book on a gross asset basis, we crossed the 25% mark during the quarter, with the credit portfolio growing from approximately 22.2% to 26.5% of gross assets on the overall portfolio. Equity capital allocation to credit assets has now approached approximately 40%.

Now, moving to more detail on our Agency book, we continue to invest in bonds that we believe will exhibit favorable prepayment behavior, given our views that as capacity constraints ease and competition increases, organic refinance activity should trend higher.

Within – this in mind, we have over 60% of our portfolio deployed in lower loan balanced high LTV paper and good Geo story paper. We have also maintained over 15% exposure to newer production securities basically similar to current production par type of assets.

Prepayments continue to be in line with our expectations with the book printing at 8.8% CPR for the quarter and 7.7 per CPR in March. Within the Agency portfolio, we did a little bit of portfolio rotations, some active rotation, where we basically reduced our 15-year exposure to less than 19% of the current face of our Agency book. This is down from 27% in the prior quarter.

We redeployed into 20s and 30s, which now account for over 7% and 52% of our Agency book up from 3% and 46% respectively. We have also selectively trimmed our exposure to inverse IO Agency MBS, which materially reduces overall portfolio volatility. As this repositioning within the Agency MBS results in lengthening of our duration for our assets, we did add over $500 million of hedges to our book quarter over quarter, as we previously mentioned.

Turning to the credit side of the portfolio, you can see that we continued to deploy capital into credit during the quarter across multiple asset classes within the credit space. The mezzanine commercial loan investment we mentioned on last quarter's call is now disclosed in this table, and we look forward to continuing to build out this segment of our book in order to gain scale and enable us to put attractive financing around these opportunities in the future.

With respect to our fourth-quarter whole loan activity, we had an opportunity to crystallize gains in these assets at an attractive price. We elected to opportunistically accelerate several years of income by selling these assets during the first quarter.

Now, as David discussed, we believe that the opportunity set sourced by and available to Angelo, Gordon, on behalf of MITT, will continue to develop and be a value-added business model. Post quarter end, Angelo, Gordon hired another investment professional to support our whole loan strategy, and we continue to look at adding additional personnel to further build out our credit strategies.

Now, turning to slide 10, overall portfolio leverage increased a touch from 5.26 times to 5.38 times as of March 31. The table at the right details our leverage breakdown by asset class, overall leverage is within our target range, and allows us the flexibility to respond to any attractive opportunities that may come up in the marketplace.

At quarter end, excess liquidity was approximately $269 million. Quarter end liquidity was at the high end of our needs, primarily due to the timing of anticipated redeployment of investments, so we did have a series of investments that we had identified and sought to make but the timing of some of the credit investments can lag when we have capital available.

On slide 11, turning to the funding side, the weighted average original maturity of our repo book remained at 87 days. The table you’ll see at the bottom of the page has been pro forma-ed to account for the fact that we just renewed our dedicated one-year facility, just after quarter end, so the first week of April we did renew a facility that we have with Wells Fargo. We’re very pleased with being able to upsize that facility to $125 million.

With respect to our overall counterparties, we have 30 repo counterparties. We believe that we have more than ample access to financing. We haven’t seen no material changes in haircuts or credit availability. We continue to actively engage in seeking out longer tenure facilities for our credit book.

Now, turning to the hedging side, as we noted at the end of March, approximately 83% of our total Agency repo notional was covered by hedges. As I mentioned earlier in the call, we extended the maturity of our swap book by shedding $100 million of our 2014 maturing swaps and increasing our 2018 maturity bucket by over $400 million, as well as layering in $225 million of notional maturing in 2020.

As we have previously discussed on our prior earnings calls, we do not seek to fully hedge out rate and market value risk but rather seek to be prudent in managing our exposure to shifting interest-rate scenarios.

As my comments about the economy indicate, we are far from bullish on our outlook for growth. That said, there is a rather wide range of opinions in the market place about the prospects for growth, the timing of the Fed's exit from QE3 and the resulting implications for the level of interest rates. In addition, the rotation of the Agency portfolio out of 15s and into 20s and 30s added duration to our overall asset book. With these factors in mind, we elected to deploy additional capital into managing our book value against potential rises in future rates.

Now, moving to slide 14, as you can observe from the next slide, our duration gap at quarter end was approximately 1.3 years. This represents a decline of roughly a third of a year from the prior quarter through – though, the duration of our assets did extend slightly, our increase in hedge activity more than offset this. Given the composition of the portfolio and its actual prepayment experience, we’re comfortable with the current level of interest-rate exposure retained by the Company.

And with that I'm going to turn the floor over to Frank, who will walk you through our financial performance.

Frank Stadelmaier

Good morning. For the quarter, we reported net income of $13.4 million or $0.49 per fully diluted share. We reported core earnings of $20.5 million or $0.75 per fully diluted share versus $19.8 million or $0.85 per share in the prior quarter. The decrease in core earnings was primarily driven by increased costs from our hedging and the effect of levered return on our assets.

The yield on our assets increased from 3.37% to 3.45%. This was primarily the result of an increase in our credit portfolio, where yields are higher, from 22.2% of assets to 26.5% of total assets.

The weighted average cost of our swaps increased during the period from 0.35% to 0.49%. The increase came from the addition of $538 million of notional interest rate swap contracts. This increased our total cost of funds from 1.11% last quarter to 1.27% this quarter, and was the primary driver of the decrease in weighted average NIM from 2.26% to 2.18%.

We used less leverage on our credit assets, which decreased our average leverage during the quarter to 5.37 times from 6.02 times. Our NIM at quarter end was 2.25 and our leverage at quarter was 5.38 times.

In addition to the $0.75 of core earnings, our GAAP net income of $0.49 per share includes $0.10 per share of net realized gains and $0.36 per share in unrealized losses. The unrealized losses were primarily attributable to $1.15 per share mark to market losses on our Agency portfolio, offset by mark to market gains on our credit portfolio of $0.60 per share and $0.19 per share on our interest-rate swaps.

There is a new line item on our income statement provision for income taxes. As we mentioned earlier, we disposed of an investment in whole loans recording a substantial gain. To comply with REIT dealer rules, we conducted this sale through a taxable REIT subsidiary. The provision relates predominantly to the tax on the gain on sale and is not recurring.

US GAAP requires the gain and the related tax to be presented on two separate line items of our income statement. Throughout the presentation, where gains on sales are identified as net, the tax has been deducted from the gain. The net gain on this transaction was approximately $0.14 per share.

Our G&A, as a percentage of equity continued to decrease changing from 1.26% in prior quarter to 1.15% this quarter. The business is at a point where the cost structure scales better and the decrease is primarily the result of the December capital raise being an average capital for a full quarter.

We continue to maintain undistributed earnings. At quarter end, the amount stood at $2.12 per share. During the quarter, our taxable income and dividend per share were approximately the same. The per-share change in undistributed was primarily the result in new shares sold through our ATM program and warrant issuances.

This concludes our prepared remarks and we would now like to open the call for questions.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. (Operator Instructions). And our first question is from Douglas Harter of Credit Suisse. Please, go ahead.

Douglas Harter – Credit Suisse

Thanks. I was hoping you guys could talk a little bit more about the pipeline you have for either direct commercial loans or starting to put more residential – new production residential loans back on the balance sheet?

Jonathan Lieberman

On the commercial side Angelo, Gordon has a large brick and mortar real estate team of over 30 professionals. And that team has been sourcing commercial loan opportunities for us. We have several we are looking at. It’s just difficult to determine the timing but we do hope in the next several months to begin to close several of the deals that we have been engaged and in dialogue and provided term sheets for execution.

On the residential side, we have plugged in Jason Biegel and recently are propping up his business line with additional resources. We think over the next, say, 30 to 90 days, we’ll be in a position to start to basically put some more capital to work. We have taken some runs at several different assets, and we’ve been reluctant to rush things too rapidly before we have all of the nuts and bolts of the operation in place.

But we are looking. We are active in the markets on a daily basis. We have been seeking out product, and we just don't have anything that is ready to cross the finish line at this moment.

Douglas Harter – Credit Suisse

Great. I guess back on the commercial, would you continue to look towards mezzanine loans or would you do more senior? I guess how are you thinking about where the opportunities lie?

Jonathan Lieberman

We would look at stretch senior, repositioning senior, and mezzanine credit.

Douglas Harter – Credit Suisse

Great, thank you.

Operator

Thank you. Our next question is from Trevor Cranston of JMP Securities. Please, go ahead.

Trevor Cranston – JMP Securities

Hi. Thanks. Just a follow-up on the last question a little bit. Is most of your new investment activity on the credit side really focused on the whole loan space right now? Are you still finding kind of attractive pockets of investments in the legacy security side also?

Jonathan Lieberman

All of the assets that were added this past quarter were security or security like participations. They were a mix of new securitizations, legacy securitizations and some attractive kind of semiprivate securitizations.

The whole loan activity, the only activity was the opportunistic sale of residential whole loans in the quarter. We did seek out several packages of whole loans but we did not achieve an execution at a level that was attractive to the REIT.

Trevor Cranston – JMP Securities

Okay, that’s helpful. On the Agency side, you guys shifted a little bit away from the 15 years into some longer duration securities this quarter. Should we expect that kind of incremental shift to continue? Or are you kind of happy with the split you have in the Agency portfolio right now?

Jonathan Lieberman

There may be some incremental paring of the 15s but I would say that the vast majority of the 15-year product that we exited, we exited for – either we thought that we were achieving attractive execution on that product or we anticipated we sold the product in anticipation of faster prepays on those individual assets.

We also liked adding some duration to the Agency book and locking in hedges at the market levels. So, for the 30-year product we added, we like the timing, we like the ability to hedge and we like the specific assets that we were able to add to that Agency book.

Trevor Cranston – JMP Securities

Okay. Just last one, you mentioned you sold some inverse IOs in the quarter. On page eight is the remaining interest only position you show there, is there still any inverse IO in that or is that just regular IO securities?

Jonathan Lieberman

I would say probably the preponderance of it is still inverse IO.

Trevor Cranston – JMP Securities

Okay.

Jonathan Lieberman

And it’s – a lot of is story inverse IO, very – a loan balance, CQs, very, very stable prepayment profile, very, very good carry. We basically exited out of any sort of IO that we thought had material interest rate risk and special prepayment – sorry, prepayment risk, not interest-rate risk. And we – part of the rationale for also increasing our hedges was to make sure that we had some interest-rate protection against the inverse IO book.

Trevor Cranston – JMP Securities

Okay, great. Thank you.

Operator

Thank you. Our next question is from Stephen Laws of Deutsche Bank. Please, go ahead.

Stephen Laws – Deutsche Bank

Hi. Good morning and thanks for the detailed shareholder presentation on the website. I just wanted to touch base on the commercial loans. You know I know it was touched on earlier but can you talk about how big of a percentage you think the commercial loan will be at any point? And do you intend to put leverage on there? Are you working on any financing facilities that would enable you to add some leverage to that asset class?

Jonathan Lieberman

Our expectation is that we would like to add certainly a material amount of capital, certainly somewhere 5% to maybe 15% of the portfolio in commercial loans. When we have added significant assets, it will give us the critical mass to put the proper financing arrangements around that asset class and create some accretive earnings for our shareholders. But it is a little bit of a chicken and egg that we have to accumulate sufficient volume and we can basically at that point work with our lenders to basically put those assets on – in a levered position.

Stephen Laws – Deutsche Bank

Great. Thanks for the color. Appreciate it.

Operator

Thank you. Our next question is from the line of Mike Weidner of KBW. Please, go ahead.

Mike Widner – Keefe, Bruyette & Woods

Hey, guys. Good morning. Let me just follow up on some of the comments you made about the credit environment. In particular, I guess, I think what you said was you expected the Obama administration to continue making credit more available to homeowners and just wondering if you could talk a little bit about how maybe that might work together with QRM rules, which arguably actually make it more difficult to get any sort of nongovernment mortgage going forward. But just wondering how you see that playing out, in particular, how you see your involvement in the reprivatization, as everyone calls it, of the mortgage market?

Jonathan Lieberman

Look. I think the Administration, Treasury, the Fannie, Freddie, they would like to push credit or make sure that there is credit available to more than just 750 FICO and up borrowers. They’ve – we’ve seen them start to respond by the lack of credit availability for what they would consider still high credit quality borrowers, minorities and other interest groups, who seem to have less access to the market place, and they have done so by basically tailoring some of the rules. Recently, they elected not to increase the guaranty fee for Ginnie loans and that led to a selloff in the IO market for Ginnie but that is a direct response by HUD to basically make sure that credit is available at the cheapest possible cost to some of the lower income borrowers.

The Consumer Protection Bureau elected not to codify a hard down payment number and instead concentrate on the ability of the borrower to be able to have income sufficient to pay the mortgage over its life. Once again, a response to different housing coalition members making sure that basically large down payments do not preclude different groups in society from getting financing. And then, you continue to see them press on on lenders to make credit available.

So, our expectation is those trends will continue. To your point specifically about QRM, QM, I know there’s discussions about making the rules consistent. I think there’s maybe a desire in Congress to review and revisit those points specifically because they are finding it very, very difficult to implement.

But I think that you are going to see a renewed focus there in trying to open up the credit box and push credit and you have seen members of the administration come out as well as the Fed come out and advocate for further opening the credit box and I think that they’re trying to come up with methods to balance that opening of the credit box to 700, 720 FICO, 680 FICO borrowers, keep the down payment under – somewhere under 20% and open up the market to different population groups like you see on the auto finance side.

Mike Widner – Keefe, Bruyette & Woods

Yes, thank you for that. And I think with all of the conflicting sort of messages that the administration has sent to banks and lenders I guess it is probably continued slow progress but definitely appreciate your comments.

I guess then the other question is, as you talk about continuing to sort of reallocate towards the credit side of the portfolio as the opportunities come about, do you see yourselves participating in the whole loan and securitization market and how do you see that part of the business progressing going forward?

Jonathan Lieberman

When do you foresee ourselves participating in the whole loan market, we – securitization or some form of financing term financing would be part of the planned. We don't believe that we need to rush into the market place and stand up a vehicle and stand ourselves up in the marketplace. We believe that there is still time here to establish the right platform, the right brand, the right systems to basically access product in an efficient manner, and we don't want to get caught up in a rush into the market place and just be kind of a bid out there.

Mike Widner – Keefe, Bruyette & Woods

Got you. Then, one final one, if I could. If maybe we could talk a little bit about the dividend. And you guys, I think, very clearly addressed that core earnings power is about $0.75, $0.10 of net gains realized gains on sales and that appears to be part of the strategy. But just wondering if you could comment a little bit on that and in particular how you see dividend policy with respect to core earnings versus the combination of core and other earnings like gain on sale and how you might see those going forward?

David Roberts

Sure. It’s David Roberts speaking. As we said before, over a longer period of time, we’d expect that core earnings and dividends will move in the same general direction. I think if you look at it, our core earnings have generally been above our dividend rate. This quarter they were a little bit below but as you pointed out and as I pointed out, some of that was moving gains or core earnings into gains.

So, as we look at the storehouse we have of undistributed income, as we look at the portfolio, it is really what I said, based on everything we see now, we think the current dividend rate makes sense and it is our current intention to keep it for the remainder of the year.

Mike Widner – Keefe, Bruyette & Woods

Well, great. Appreciate the comments and the clarity. Thanks.

Operator

Thank you. Our next question is from Dick Agrawal of Wells Fargo Securities. Please, go ahead.

Unidentified Analyst

Hi. Good morning, guys. I got a question on 5-5, you paint sort of a weaker economic environment with improvement in HPA. Can you talk about some of your thoughts around the weaker economy affecting the favorable housing outlook?

Jonathan Lieberman

Sure. I mean the economy clearly is struggling to gain significant traction to accelerate growth at 3%, 4%, 5%, as it historically has. But the headwinds are fairly significant that you’re seeing US corporations struggle with earnings due to pressure in Europe. You’re seeing exports decelerating as our markets once again are struggling. You’re seeing China try to transition to an organic growth model, as opposed to an export model.

And so, you’re left with predominately a domestic economy here in the United States that is trying to accept some level of austerity at the federal level. We’re not painting a picture of basically the US economy going into recession but what we are painting is an economy that is basically growing at an organic speed that is just much slower and that where basically you have significant headwinds and the fact that basically our citizens need to compete against basically wage levels that are now being set worldwide. And until there is meaningful increases in basically meeting an income in the United States and/or significant spending by corporations or government, you’re not going to see a picture of a robust US economy.

That said, housing is in a different place because we have chewed through over 6 million units of surplus housing in the past four, five, six years. And now, supply and demand is actually returning to a synchronized level. They’re not building a tremendous number of new homes yet. Most of the building has occurred in the multifamily sector. You’re not seeing a dramatic pickup in purchase money and you’re seeing investors lead a charge to push home prices back to a level of basically attractive valuation.

So, housing, we believe, has somewhere between 5 and 10 points of additional incremental gain. You have very low interest rates. You have organic growth; basically you have household formation has resumed. And you are now seeing people being able to move across the country to where jobs are.

And so, all of that is very healthy, and we think that we have one to two to three years of healthy rebounding in the housing markets with low rates, good supply demand, no inflation that would help housing prices and no organic growth in median income. But generally speaking at least on the front of lower interest rates and supply demand, we think the markets are very healthy for housing.

Unidentified Analyst

So, I appreciate your comments. What would you think you would need to see in the economy to cause your outlook to ratchet down?

Jonathan Lieberman

I think we would need to see a significant decline in consumer spending or some impact out of the Washington, DC. Those would be the two areas that we would keep a close eye on. But Washington, DC, probably being even the biggest driver here that if they engage in a much more forceful level of austerity beyond the sequester that you could see a significant abatement in demand and income levels.

Unidentified Analyst

Okay. Well, I appreciate your comments. Thank you.

Operator

Thank you. (Operator Instructions). And our next question is from Boris Pialloux of National Securities. Please, go ahead.

Boris Pialloux – National Securities

Hi. Thank you for taking my questions. I have three quick questions. The first one is you have an investment in (inaudible) of $7.4 million, what is it exactly?

Frank Stadelmaier

That’s a credit investment we made in commercial real estate lending that is done through a partnership with some other Angelo, Gordon entities. So, all of – think of it like a CMBS fund that’s held down below and all of the accounting flows up through core earnings the same.

Boris Pialloux - National Securities - Analyst

Okay. The second is on your – on page 20 of your presentation, you mentioned that you’re expecting a much easier or an easing of capacity constraints. (Inaudible) how do you view that for your low prepayment pool investments? Would that have an impact, if some (technical difficulty) actually do more refinancing? And how would you mitigate this type of risk?

Jonathan Lieberman

We do believe that there has been additional capacity put into the lending space. We do believe that basically there has been new entrants into the lending space that will lead to we believe higher levels of organic prepayments that will be more consistent with the way the mortgage market had traditionally operated.

So, some of the ways you see this in the day to day is you see more and more lenders offering no-cost refinances. So, if you turn on your TV set or you go to websites, you will see more and more lenders offering to basically take on the cost of the refinancing on behalf of borrowers, given the record profitability.

You’ll also see lenders increasingly target what I would call higher hanging fruit, low balance loans and other loans, which previously maybe they did not target as much because the profitability of those loans was not as great as some of the higher coupon product and some of the higher dollar price bonds.

We have tried to mitigate some of that risk by going into new production that does not require as large a pay ups as, maybe some of the certain types of spec pools, where you could pay 1, 2 points in addition of premium to acquire pools that theoretically have better protection against refinance activity.

Boris Pialloux – National Securities

Thank you. And the last question I had is how do you view the readings of the very low CPI, I mean, since the downtrend in the CPI numbers, is that – would that have an impact on the sale at one point if you end up with a CPI closer to zero?

Jonathan Lieberman

Well, I mean, I think the Fed is specifically targeting a 2% inflation rate. It’s kind of – they’re kind of caught in between that they like the fact that there is little inflation in the marketplace and that the market seems to correct very nicely. But that shows you once again how tight household spending is that every time basically gasoline prices go up, the consumer decelerates their spending and then the economy comes back into kind of sync and then you see oil prices go down and then we go back the other way. That is actually very, very healthy that the consumer is watching their pocketbook.

But at the same time, it is abundantly clear that the Fed would like to generate some level of inflation to basically make it easier for households and for the government to meet their debt service requirements and to pay back all of this debt with basically haircutted money. And so ,you –theoretically, if CPI continues to track down that would be very supportive of more QE and ultimately their goal is to create inflation.

Boris Pialloux – National Securities

Okay. Thank you.

Operator

Thank you. We have no further questions at this time.

David Roberts

Thank you.

Operator

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.

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