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Executives

Danielle Rosatelli – Financial Analyst-Investments Department

Stewart Zimmerman – Chief Executive Officer

Craig L. Knutson – Executive Vice President

Stephen D. Yarad – Chief Financial Officer

Gudmundur Kristjansson – First Vice President

Analysts

Steve C. DeLaney – JMP Securities LLC

Douglas M. Harter – Credit Suisse Securities, LLC

Jason Arnold – RBC Capital Markets, LLC

Joel J. Houck – Wells Fargo Securities, LLC

Martin J. Kemnec – Jefferies & Company

Christopher R. Donat – Sandler O'Neill & Partners LP

Michael R. Widner – Keefe, Bruyette & Woods, Inc.

Jordan Neil Hymowitz – Philadelphia Financial Management of San Francisco LLC

MFA Financial, Inc. (MFA) Q2 2013 Earnings Conference Call August 1, 2013 10:00 AM ET

Operator

Ladies and gentlemen, thank you for standing by, and welcome to MFA Financial, Inc.'s Second Quarter 2013 Earnings Call. At this time, all lines are in a listen-only mode. Later, there will be an opportunity for your questions and instructions will be given at that time. (Operator Instructions) And as a reminder, this conference is being recorded.

I'll now turn the conference over Analyst, Danielle Rosatelli. Please go ahead.

Danielle Rosatelli

Good morning. The information discussed on this conference call today may contain or refer to forward-looking statements regarding MFA Financial, Inc., which reflects management's beliefs, expectations and assumptions as to MFA’s future performance and operations. When used, statements that are not historical in nature, including those containing words such as will, believe, expect, anticipate, estimate, plan, continue, intend, should, could, would, may or similar expressions are intended to identify forward-looking statements. All forward-looking statements speak only as of the date on which they are made.

These types of statements are subject to various known and unknown risks, uncertainties, assumptions, and other factors including, but not limited to those relating to changes in interest rates and the market value of MFA’s investment securities; changes in the prepayment rates on the mortgage loans securing MFA’s investment securities; changes in the default rates and management’s assumptions regarding default rates on the mortgage loans securing MFA’s MBS; MFA’s ability to borrow to finance its assets; implementation of or changes in government regulations or programs affecting MFA’s business; MFA’s ability to maintain its qualification as a real estate investment trust for federal income tax purposes; MFA’s ability to maintain its exemption from registration under the Investment Company Act of 1940; MFA’s estimates regarding taxable income and the timing and amount of distributions to stockholders; and risks associated with investing in real estate related assets, including changes in business conditions and the general economy.

These and other risks, uncertainties and factors, including those described in MFA’s Annual Report on Form 10-K for the year ended December 31, 2012, and other reports that it may file from time-to-time with the Securities and Exchange Commission could cause MFA’s actual results to differ materially from those projected, expressed or implied in any forward-looking statements it makes. For additional information regarding MFA’s use of forward-looking statements, please see the relevant disclosure in the press release announcing MFA’s second quarter 2013 financial results.

Thank you for your time. I would now like to turn this call over to Stewart Zimmerman, MFA’s Chief Executive Officer.

Stewart Zimmerman

Good morning, and welcome to MFA’s second quarter 2013 earnings call. Joining me this morning on the call are Bill Gorin, President; Stephen Yarad, Chief Financial Officer; Ron Freydberg, Executive Vice President; Craig Knutson, Executive Vice President; Terence B. Meyers, Senior Vice President; Harold Schwartz, Senior Vice President and General Counsel; Kathleen Hanrahan, Senior Vice President and Chief Accounting Officer; Gudmundur Kristjansson, First Vice President.

Today, we announced financial results for the second quarter ended June 30, 2013, recent financial results and other significant highlights for MFA include the following; our second quarter net income per common share of $0.19 and core earnings per common share of $0.19. On July 31, 2013, we paid our second quarter 2013 dividend of $0.22 per share of common stock to stockholders of record as of July 12, 2013. On August 1, 2013, our Board of Directors declared a special cash dividend of $0.28 per share of common stock. This dividend will be paid on August 30, 2013 to stockholders of record on August 12, 2013.

After the special dividend, we will have distributed approximately $155 million in dividends in 2013, not allocated to prior years. The company has until the filing of its 2013 tax return, due not later than September 15, 2014, to declare the distribution of any 2013 REIT taxable income not previously distributed. The company is currently working on completing a taxable income calculation for the first six months of 2013 and we expect that we will be able to provide you with the calculation of taxable income for the first six months of 2013 at the time of our third quarter earnings presentation. As a result, we are not at this time able to give you guidance or an estimate of MFA’s 2013 taxable income.

Book value per common share declined to $8.19 as of June 30, 2013, from $8.84 as of March 31, 2013. Increased uncertainty about the pace and amount of future Federal Reserve asset purchases impacted the value of our mortgaged backed securities during the second quarter of 2013.

Strong home price appreciation continues to decrease the loan-to-value for many of the mortgages underlying our Non-Agency portfolio, and we believe that due to underlying mortgage loan amortization and based on regional home price appreciation, the loan-to-value of mortgage loans underlying our Non-Agency MBS has declined from approximately 105% to approximately 90% since January of 2012. As a result, we continue to reduce our estimated future losses.

In the second quarter, we transferred $54.8 million to accretable discount from credit reserve, bringing the total transferred over the last 12 months to $224.3 million. This increase in accretable discount prospectively increases yield on our Non-Agency mortgaged backed securities and we will be realizing income over the life of the assets. Due primarily to increases in accretable discount and to changes in the forward curve, the loss-adjusted yield on our Non-Agency portfolio increased from 6.80% in the first quarter to 7.15% in the second quarter.

I thank you for your continued interest in MFA Financial. And at this time, I would like to open the call for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question will come from Steve Delaney with JMP Securities. Go ahead please.

Steve C. DeLaney – JMP Securities LLC

Thank you and thanks. Good morning, everyone. I guess, we should say solid quarter all things considered with what you went through in the bond market in the second quarter. My first question has to do with the indicated fair value of the Non-Agency portfolio at June 30. In page 2 of the press release, there is the fair value and the face amount and the math there works out to $84.2 as far as an average dollar price, that would appear to be up slightly from $82.8 at March, am I interpreting that correctly?

Stewart Zimmerman

Craig.

Craig L. Knutson

Yeah, Steve, I think that if you look at the FICO table, which is around page 80 of our Q for March, I think you’ll see that the average fair value price for Non-Agencies was a little over $85.

Steve C. DeLaney – JMP Securities LLC

Got it.

Craig L. Knutson

In the Q that we’ll file today, you’ll see that it’s $84.3.

Steve C. DeLaney – JMP Securities LLC

Okay, that makes sense. My table here from March may have a better number. But I’ll go to that table you referred to and we were only expecting 1 points to 2 points given the quality of your bonds anyway, which I guess really brings me to my real question. We’re now having to face higher rates for the first time in several years and I think we’ve always viewed the Non-Agency book as credit assets, and you know back when things had $60 and $70 prices, we thought that they had maybe negative duration or at worst no duration.

Now, we are up into mid-80s. I’m just wondering as we go forward from here and even thinking about the price action in June, we hear the terms spread widening thrown around on all types of mortgage assets these days. And I’m just wondering if part of what’s going on is that the market is starting to look at these bonds in a positive duration expectation to them rather than minimal duration, if you could comment on that and how that sort of might impact your view towards future price appreciation. And we also noticed you added some long dated swaps, I’m just curious if adding the swaps, you may have in the mind, not just the Agency book, but maybe this appreciating Non-Agency book? Sorry for the long-winded question.

Stewart Zimmerman

Well, Steve, thank you for the questions and thank you for also answering the question. As you know, because you’ve paid a lot attention to us over the last numbers of years. The asset prices for Non-Agencies were a lot lower and what that meant was the expected yields were a lot higher than yields on non-credit sensitive assets. As a result, Non-Agency prices were not correlated to changes in market interest rates. Now this made a lot of sense, because in the periods of time when rates did trend up over the last couple of years, that was generally accompanied by an improvement in economic expectations. And therefore, the market priced in more positive scenarios for Non-Agencies. In addition, because of a very wide risk premiums, spreads can tighten to allow Non-Agencies to hold value despite increases in interest rates.

Now Fed actions have helped to increase the prices of all financial assets over the last couple of years. But more significantly for Non-Agencies, there has been very strong mortgage credit fundamentals, there has been increasing home prices decline, to fall, stable severities and high voluntary prepays. As of June, we sort of reached the point where there is increased uncertainty about future Federal Reserve actions and Non-Agency prices have become more volatile, and I think you mentioned the term credit spreads have widened.

We sort of agree with where you are leading. Non-Agency assets have become more interest rate sensitive and in fact, we do believe the exhibited positive duration now. The good news is the majority of our Non-Agencies, our hybrids and even better news the majority of those hybrids, the majority of our Non-Agencies are actually in the one-year reset period. So while there is positive duration, it’s not a high number and we think across the Non-Agency portfolio, the duration is probably 1.5. As a result, in your ride, we now believe there is more interest rate sensitivity across the entire MFA portfolio. And as a result, we did add swaps in the month of July.

Steve C. DeLaney – JMP Securities, LLC

And there is look to be – just looking at your blended swap tenant rate; it looked to be relatively long swaps maybe as long as 10 years is that correct?

Stewart Zimmerman

Yeah, that is correct. Gudmundur, you want to give some detail on the swaps we added?

Gudmundur Kristjansson

Yes. so we added about – I’m going to go through or go back to the second quarter. We also started adding a loan related swaps towards the end of the second quarter. We added about $700 million of loan related swaps there, an average life of about 5. And then in July, we added about $950 million at an average life of 6.5. And you are right they range from being 5 year swaps to 10 year swaps.

Stewart Zimmerman

So as a result, as of the end of July, our calculated duration, Gudmundur?

Gudmundur Kristjansson

So our calculated duration including the 150 on the Non-Agencies at the end of July is about 1.25%, so 125 basis points.

Steve C. DeLaney – JMP Securities, LLC

Okay, your net duration. Thank you, and one final very quick follow-up. Craig, your average price on your Non-Agency, could you give us sort of the wings there, roughly, what would be the sort of the low range of dollar prices and what would be the high range around that $80, $85 figure?

Craig L. Knutson

I would say the probably the lowest prices are, and again, I’m sure there is a bond, there were bonds that have lower prices, but I would say that the low band is probably in the 70s so maybe the low 70s.

Steve C. DeLaney – JMP Securities, LLC

Okay.

Craig L. Knutson

And the high is probably in the low 90s.

Steve C. DeLaney – JMP Securities, LLC

Low 90s. All right, thank you guys so much for the color. I appreciate it and good job, keep it up.

Stewart Zimmerman

Thanks.

Craig L. Knutson

Thank you

Operator

Thank you. Our next question is from Douglas Harter with Credit Suisse. Go ahead, please.

Douglas M. Harter – Credit Suisse Securities, LLC

Thanks. I was hoping you could talk about the decline you saw on the Agency MBS yields, how much of that was from resets and what impact premium amortization, if any had on that?

Gudmundur Kristjansson

Hi, this is Gudmundur. So our coupon as the quarter went down 11 basis points. And the increased amortization costs a 12 basis point decline. So I guess, it’s half to lower coupons, but that also includes new investments lower coupons.

Douglas M. Harter – Credit Suisse Securities, LLC

So, given the move in rates, would it be reasonable to expect that some of that drag from the higher premium amortization should either go away or could reverse itself in the coming quarters?

Craig L. Knutson

Well, I mean mortgage rates have gone up by about 100 basis points over the last few months. And when you look at mortgage refinancing applications, they’ve gone down significantly. So I think it’s safe to say that prepayments will decline going forward.

Stewart Zimmerman

Doug, you actually bring up a point that we’ve been focusing on the trend of the yield on agencies has been down for mortgage reach in general for the last couple of years, and we’re included. And now in this new interest rate environment, we no longer would have a down trend on yields, due to the fact that we are replacing assets at lower yields. So for example, our yield for agencies in the second quarter was 2.19% and we can now invest at higher yields in 2.19%.

Douglas M. Harter – Credit Suisse Securities, LLC

So in that new yield environment Bill or anyone, how do you view the attractiveness of Agency with higher yields, but higher volatility and interest rates?

William S. Gorin

I think that…

Stewart Zimmerman

I’ll do it. We still view the Agency sector in a positive manner, but again, we really kind of step to our knitting. So again, I would think as Gudmundur might have mentioned, you will see the queue where what we’ve replaced are basically either 15 year or some of your hybrids and again, we like to accept that we think that’s where there is value.

Douglas M. Harter – Credit Suisse Securities, LLC

And I guess, just Stewart on a relative value, how would you compare Agency to Non-Agency today?

Stewart Zimmerman

Yeah, that’s interesting. But we like both sectors. But I think the Agency side, we found a little bit more attractive over the last couple of weeks and months, but that doesn’t mean to say that we still haven’t purchased Non-Agencies what we have.

Douglas M. Harter – Credit Suisse Securities, LLC

Great, I appreciate that.

Operator

Thank you. We’ll go next to Jason Arnold with RBC Capital Markets. Please go ahead.

Jason Arnold – RBC Capital Markets, LLC

Hey, good morning guys. Just a follow-up on the last question, would you say that, from a capital allocation perspective, would you be putting 50% of new capital to work in the Agency side or more kind of how would you break that out in terms of relative attractiveness again on that question?

Stewart Zimmerman

Well, again, there isn’t Jason, thanks for the question, but there isn’t a magic number. But again, we look Douglas asked the question a moment ago where there is relative value. and again, as you know vis-à-vis we have to a certain percentage in where we’d call good real estate assets. So there are limitations. So again, it’s where we see value and again, we are seeing value on the agency side. but again, as Craig has also said, we’ve been able to fund in rich bonds that have really set us very well. So I can’t give you the absolute answer that you’re looking for I’m sorry.

Jason Arnold – RBC Capital Markets, LLC

Yeah, that’s good color. As you said, I mean certainly better prices these days for sure on the Agency side relative to where we were a few months ago. But my other question I guess was hopefully slow, steady ramp to home price improvement here over time. could you envision your $1.3 billion credit reserve embedded in the Non-Agency side, if your broke eventually being say 50% or more released and then maybe could you update us on the current average delinquencies on the Non-Agency and in kind of your loss assumptions there, please? Thanks.

Stewart Zimmerman

So as far as what we do to that credit reserve going forward. I can’t really speculate, I mean you see that over the last year, we’ve released money of each quarter, but it really depends on the performance of those bonds for the last three, six, nine months or so. So, as LTVs have continued to improve, basically, what we’ve done is, we’ve decreased our assumption of future defaults on ones that are current today. So those are loans that are current today that may have high LTVs, as those LTVs decline or predictions for future defaults of current mortgages today goes down.

As far as delinquency on the portfolio, 60 plus days delinquent is 18.3%. I don’t have the exact number, but I think if you look a year ago, that number was probably 21% or 22%. so clearly, we’ve seen that come down. More importantly, you would see in the transition rates go down as well. So, all good, but way too soon to speculate on future credit reserve changes.

Jason Arnold – RBC Capital Markets, LLC

Okay, it makes sense. Yeah, I was just thinking of as you mentioned going from 105 to 90 on LTV, if that number is suddenly again, totally speculative could or could not happen, but two years from now going from say 90 to 70 or something like that, what sort of thoughts you would have around the credit release there?

Stewart Zimmerman

Again that’s not good, but what we worry about are the tails.

Jason Arnold – RBC Capital Markets, LLC

Yeah.

Stewart Zimmerman

So the average might be 105 to 90, but there’s still plenty of loans that have LTVs higher than 100.

Jason Arnold – RBC Capital Markets, LLC

Gotcha.

Stewart Zimmerman

So those are the ones that we’re concerned about in terms of current loans today that could default in the future.

Craig L. Knutson

But Jason, I think your point and the point I’d like to make is that what we’ve seen across the portfolio is that the housing values have increased a lot, amongst our portfolio, I won’t say that we’re doing very good about that. And again, that will be accreted and he’s back into the company over time that would lighten the asset.

Stewart Zimmerman

Jason, the other thing I would add is, we’ve also seen voluntary speeds pick up on Non-Agencies. and I’ve always said that I think that’s much more a function of the LTV than it is mortgage rates. So these people are now going to position where they can refinance without writing a check, because their LTV is down to 80% or 85%. So I think you’ll continue to see that drives prepayment speeds, and I think the LTV outweighs mortgage rate. So yes, mortgage rates are higher than they were a few months ago, but I don’t really think that’s affected non-agencies materially.

Jason Arnold – RBC Capital Markets, LLC

Makes sense, yeah. I think you guys are on a great spot with that portfolio. so congrats and thanks for the answers there. I appreciate it.

Stewart Zimmerman

Thanks, Jason.

Craig L. Knutson

Thank, Jason.

Operator

Thank you. We have a question from Joel Houck with Wells Fargo. Please go ahead.

Joel J. Houck – Wells Fargo Securities, LLC

Yeah, good morning. I guess my question is more of a philosophical one, and that is, how transitory do you think the kind of the correlation we saw later in the second quarter between Non-Agency pricing and rates going up? It’s going to be, because the thesis, we start anyway on names like MFA, the Non-Agency credit book would also do well on a rising rate, strengthening housing environment. I think that’s intact, let us be curious to see your viewpoints on when you think that correlation starts to dissipate or if it’s kind of stay here for the foreseeable future?

Stewart Zimmerman

So people can always debate philosophies and we could be right or wrong, but so we try to look at that way, which we try to quantify to the extent, we can. and clearly, when the assets rated at 72 or 73, which is our average cost basis. there is less correlation and as we get to the mid-80s, there is more correlation. That’s pretty quantitative. but no matter what answer we decide upon, what’s very important is even if these were Agency assets; you would still consider them lower durations, because we really did purchase assets, which were [5.1s, 7.1s, 10.1s] that were issued seven years ago.

The majority of our Non-Agencies or one-year reset asset, even if these were agencies, Joel, I think you would be saying, gee, these are really low duration assets. The fact that there are non-Agencies we enforce with that argument. so the majority is Non-Agencies, probably have a duration of 0.5 that’s the grouping that’s within one year of reset. so we don’t have to – even if we defer it on the philosophy, I think the numbers would get you to the point where the duration is probably 1.5 with added swaps and probably, that’s the right duration going forward despite what the Fed does.

Joel J. Houck – Wells Fargo Securities, LLC

Yeah, that’s a very good point. I guess, I hadn’t been taking that step further, but you have a very short duration kind of asset strategy regardless of whether it’s Agency, Non-Agency and as others did, you took up the hedge ratio, I guess, is that something, given kind of where you’re at, you would look to move back down and once volatility subside, or do you just say, look, we’re comfortable with where the net duration is right now, we’re going to look that, run as it is?

William S. Gorin

Yeah. I would have to say it’s the latter, because we were always going to approach the point where the Non-Agency prices have moved up so much that they would be adding durations. So really, it’s not so much the interest of the Fed statements or communications in June. We were getting close to having to start to hedge Non-Agencies anyway, because as I said, the prices went from 72 to mid 80s and hopefully higher than that. So I think what we did is permanent.

Joel J. Houck – Wells Fargo Securities, LLC

Okay, great. Thanks, Bill.

William S. Gorin

Sure.

Operator

Thank you. Our next question is from Daniel Furtado with Jefferies & Company. Go ahead, please.

Martin J. Kemnec – Jefferies & Company

Hi. Can you hear me?

William S. Gorin

Yes, we hear fine.

Martin J. Kemnec – Jefferies & Company

Great. This is Martin Kemnec in for Dan Furtado, thanks for my question. First, just a clarify question on book value. Is it safe to assume that the August special dividend is not included in the second quarter end book value?

William S. Gorin

Yeah, it’s correct.

Stewart Zimmerman

Yes.

Martin J. Kemnec – Jefferies & Company

Okay. Thanks, great. and then have you guys given any thought to investing in the new Freddie Mac risk sharing securities?

Stewart Zimmerman

We’ve looked at it, we certainly find an interesting security. but at this point, we haven’t made a decision to invest in those.

Martin J. Kemnec – Jefferies & Company

Okay, great. And then, I guess, looking forward, what are your expectations for basis risk in the market over the next quarter or two, I mean, you guys are expecting widening there or tightening?

Stewart Zimmerman

You’re taking the difference between Agencies and Non-Agencies or just the market in general?

Martin J. Kemnec – Jefferies & Company

Just on the basis whereas I guess the movement in between your hedges and the assets if you have any color there?

Stewart Zimmerman

Do you wonder any feelings?

William S. Gorin

Well, I mean, I would say on the Agency side, stuff has lightened to a point where the risk reward is more compelling today than it was three to four months ago. So I do feel more comfortable about the basis risk today than I did three to four months ago. I think that I leave it at that.

Martin J. Kemnec – Jefferies & Company

Okay. And then have you guys contemplated bringing on additional hopeful credit assets that could kind of reduce your percentage of Agency MBS that you have to qualify for the hopeful tests?

Stewart Zimmerman

We monitor that very, very closely. and we’re comfortable where we are and then when we buy as an example, when we buy any particular asset, we’re always looking at where we are on the percentage basis as you know, it’s got to be at least 55% in good real estate assets. I know I can’t say every agency, but almost every agency we buy, in fact it’s a hopeful and again, we look at other asset classes that would also qualify as good real estate assets.

Martin J. Kemnec – Jefferies & Company

Okay, great, that helps. And that’s all I have. Thanks for taking my questions.

Stewart Zimmerman

Thank you

Operator

Thank you. Then we’ll go next to Chris Donat with Sandler O’Neill. Go ahead, please.

Christopher R. Donat – Sandler O'Neill & Partners LP

Good morning, everyone. I got a question on the – if you could remind me on the accretable discount, since it accretes over the remaining life of the assets, just what sort of life should we think about for those Non-Agency assets?

Stewart Zimmerman

So I would say if you, if you boil down our assumptions of voluntary speeds, default rates, loss severities and the various structures of the securities that the average life is probably around seven years or so. But as you know, you can’t really straight-line that calculation over seven years.

Christopher R. Donat – Sandler O'Neill & Partners LP

Right, right. And then any change in those assumptions from – like over the last 12 months, it’s $224 million that’s been transferred, is it sort of safe to assume the same sort of seven-year average life underline that the bigger chunk, not just the 54 or 55, but 224.

Stewart Zimmerman

Are you asking, has the average life changed in the last year?

Christopher R. Donat – Sandler O'Neill & Partners LP

Yeah. Or if the assets that were affected, for some reason, would have had a different average life?

Stewart Zimmerman

I don’t think so. No, I don’t think the average life has changed materially and I don’t think that the assets that we’ve changed assumptions on have materially different average life than the rest of the portfolio.

Stephen D. Yarad

But I would just like to add though, Craig and his group, they are continually looking and monitoring these assets, so that there are times that these assumptions do change. But again, that’s part and parcel of what we do in order to determine what’s accretable.

Stewart Zimmerman

Well, and keep in mind as we decrease our future default assumptions, that actually could lengthen the securities, right, because those defaults would come to its liquidations. Now to some extent, we’ve also increased some of our prepayment speed. So those too may bounce out, but there are several moving parts to that.

Christopher R. Donat – Sandler O'Neill & Partners LP

Right. That’s part of the reason why I am asking you rather than me make the assumption, because yeah, appreciating all the moving parts is sometimes a little more challenging. And then just also a methodology kind of question, when you’re looking at the loan-to-value ratios and you mentioned the regional home price appreciation, I know in your presentations, you typically use the data from CoreLogic. But as you look at the LTVs, are you going through sort of like county-by-county in California, that’s like what you show in your presentation, are you able to get more granular than that?

Stewart Zimmerman

In most parts, it’s actually more granular than that, it’s really down to zip codes.

Christopher R. Donat – Sandler O'Neill & Partners LP

Okay.

Stewart Zimmerman

So for the most part, again, we don’t have every single zip code, but for the most part, it’s zip code based. So it’s median home price in each zip code. So it’s pretty granular.

Christopher R. Donat – Sandler O'Neill & Partners LP

Okay. Thanks very much then.

Stewart Zimmerman

Sure.

Stephen D. Yarad

Thank you.

Operator

Thank you. (Operator Instructions) Our next question is from Mike Widner with KBW. Go ahead, please.

Michael R. Widner – Keefe, Bruyette & Woods, Inc.

Hey, good morning guys. I guess a two-part question here. And the first one is, might sound a little silly, but what percent of your intellectual effort for lack of a better word, do you think goes to asset selection versus hedge selection, and do you think it changed the environment, for indeed, in the changed environment suggested that should shift it off?

Stewart Zimmerman

I guess, that’s an interesting question – very interesting question. I would tell you that we spent a lot of time looking at the entire portfolio and in terms of the other side of the ledger, in terms of looking at how we hedge it, and again, you have to be fluid in this business. You have to be able to try and anticipate a lot of the moving parts as one of the previous questions answered. So in terms of the intellectual energy, the intellectual energy you spent on both parts. If you’re suggesting in a more volatile, which I think is what you’re suggesting, in a more volatile market, are we certainly spending certainly the equivalent amount of time, looking at the hedge side of it and making sure that we are adequately hedged. Of course, the answer is yes. When you have a less volatile time, doesn’t mean you don’t spend the same amount of time, but you may not be pulling the trigger quite as quickly.

Stephen D. Yarad

If I might add, I would say we probably have a bias on the asset side and I will tell you why. When we focus on the assets, we purposely buy assets that have less interest rate risk. So by plan, we don’t have to focus as much on the hedge. If we were dynamically hedging a 30-year asset, we’d be giving you a different answer. If we’re telling you to focus on the credit work on assets that we set within one year, get a different answer. So we probably mix or we put the right assets in and therefore, we don’t have to focus as much on the hedge.

Michael R. Widner – Keefe, Bruyette & Woods, Inc.

So that makes perfect sense and that’s kind of what I would have expected to hear. So let me ask you part two, which is a little more philosophical. I mean we hear a lot of you guys talking about, it was really spread widening on the credit side and that was number one, it’s hard to hedge and number two, it’s a little bit maybe unexpected. And I guess I’d counter that by saying, Bernanke has been telling us for a very, very long time that the whole point of what the fed has been doing is to actually force credit spreads tighter, you take away other options for yield, credit spreads will tighten. That’s the whole point of QE really.

And now everyone did sort of, but credit assets is sitting back and growing, oh my god, spreads widened, when everyone thought the fed was going to stop buying. and so I guess, the philosophical question is, is it really at all unexpected and is it really something that doesn’t need to be hedged? Yeah they can find, they are very short duration assets. But does not mean you don’t need to find some way to hedge the credit component of them or that the fact that these spreads are expected to widen, or maybe I’m wrong and they’re not expected. But I guess that’s a broad question?

Stewart Zimmerman

We had two philosophy questions, on one of these calls, so I would say when the fed communicated that an end to QE, might be approaching, 10%, it went from 160%, 260%, which was a very large percentage increase. No matter how well they telegraph that change in fed policy, it’s disruptive and as you point out the reaction was broad-based. There was increased volatility, there was credit spread widening, there was outflows from bond funds and impacted all financial assets, emerging market equities, high yield bonds, U.S. equities, so what do we about that, likely the question is when the value of a Non-Agency change, how much of it was credit spread and how much was due to the fact that the interest rate sensitivity changed and that’s what we debate, and we said, gee, there is more interest rate sensitivity.

So maybe you’d be arguing, there is no interest rate sensitivity, this is all just credit spread widening. So we sort of have to allocate it and we did allocate a part of it in interest rate, and part of it is credit spread widening. So Non-Agencies now yield close to 5 and treasuries yield 260. So is that a widening of credit spread, when there is more disruption with the credit spread widened, it might on the disruption, but we think that’s about the right spread over the medium-term. So we’re comfortable that the value of the Non-Agencies will not go down a lot if there’s a credit spread widening. So hopefully, I was close to addressing your question.

Michael R. Widner – Keefe, Bruyette & Woods, Inc.

I think you did. I think that again, everyone sort of talks about the credit spread widening, it happened most recently, but I mean, you guys have been in this business for a while and running credit assets for a while, I mean, longer than a lot of guys in the business. And so, our credit spreads really wide to treasuries right now relative to historical norms or is it really we’re removing from artificially tight levels to on the journey back to something that’s a little more normal and if you approach it from that angle, again, it suggests that maybe one needs to hedge differently and obviously the reason for all this question is, I mean, the reason most of the stocks are trading at discounted book and investors are having a hard time, but the sector is everyone is trying to wrap their head around, god, if we’re really in a secular bond bear market, what do I need to believe about management’s ability to hedge in order to be willing to buy these things, as leverage bond funds effectively?

Stewart Zimmerman

Right, but if we were just to leverage bond funds, we would say interest rates change crisp as wine, but we are saying something different. We are seeing those two things did happen, but we’ve got the fundamental still right, that the yield on our high yielding assets went up. So you really can’t compare us to a high yield bond fund there. We’ve got the fundamentals still right that we have an increasing yield. And that’s different than any other asset question you can compare us to we believe.

Michael R. Widner – Keefe, Bruyette & Woods, Inc.

But I would certainly agree with that and I don’t want to make the comparison. Certainly, the employer, you guys are, anybody in the sectors like a high yield bond fund. But there is a difference I mean, you are asking for equity investors to buy you, not bond investors to buy you and equity investors do need to get comfortable with the fact that your hedges can be will be effective and a lot of that will depend on having a changed view of how to hedge in a changed interest rate environment where for the first time and arguably 30 years the expectation is – rates will be moving higher or not 50-50 chance of going higher or lower. And again, I mean, it hedging it properly next quarter and the quarter after and the quarter after that, I guess, again, the question is really, there is a change you are thinking about hedging more than just swap hedge more than just a credit, the interest rate risk, it’s also about signaling how is, how our credit spreads going to widen or tighten or whatever relative and can that be hedged versus, we are just hoping for the best.

Stewart Zimmerman

We’re not just hoping for the best, I’ll answer that definitively. We have put a lot of work into – again getting back to your initial question on both sides of the ledger, yes credit spreads have widened. This could be the new normal or getting back to where when I got into the business, God knows how many years ago. But having said that, we are in the position where we think our portfolio is very well placed. And again it’s in fact, again, we have put on some additional hedges, we feel comfortable about where we are and our Non-Agency portfolio has reacted very, very well with this widening. So what’s going to happen in the future, where we are on top of it, but I don’t have a personal war.

Michael R. Widner – Keefe, Bruyette & Woods, Inc.

Well, I appreciate that. And you guys in all fairness, clearly, did a better job on book value than the majority of the guys reporting so far, and you stock those trade better on a price-to-book basis than most of the others. So I think the market does have some confidence and I certainly have some confidence as well. But it’s tough being at the end of the queue and having no real good questions left to add. So I had to make you go philosophic.

Stewart Zimmerman

And you don’t know how we appreciate it, Mike.

Michael R. Widner – Keefe, Bruyette & Woods, Inc.

I do. Thanks guys.

Stewart Zimmerman

Thank you.

Operator

Thank you. And next we have Jordan Hymowitz with Philadelphia Financial. Please go ahead

Jordan Neil Hymowitz – Philadelphia Financial Management of San Francisco LLC

Hey guys two quick questions, one, can you confirm that when they look at your leverage for refill lines, they look at it an aggregate and not just the agency basis.

Stewart Zimmerman

Jordan, the answer for that, is yes.

Jordan Neil Hymowitz – Philadelphia Financial Management of San Francisco LLC

Okay, second question is American homes for rent just went public last night and there has been several of these homes for rent companies going public. Have you looked at the geographic focus of these areas compared to your Non-Agencies and the reason why I say this is many of these companies are concentrating in raising the prices for the most of these regions, there is more capital comes there, it should be a greater push up on price in those regions, does that make any sense to you and have you done any overlap?

Stewart Zimmerman

It does make sense, I don’t know we are about to have done an absolute study, I know some of it, as an example, around Henderson, Nevada and that area, I’m certainly aware of that, but I don’t know that we’ve done an absolute study on it.

Stephen D. Yarad

And Jordan I think, we certainly see it, but it happens somewhat slow, it happens overtime, but portfolio performance will be in perhaps lower loss severities. But that’s something that is really, it’s a pretty much happens overtime.

Jordan Neil Hymowitz – Philadelphia Financial Management of San Francisco LLC

And on your Non-Agency book, what’s the newest stuff.

Stewart Zimmerman

What types of assets, is that what you are asking?

Jordan Neil Hymowitz – Philadelphia Financial Management of San Francisco LLC

Oh no, no, what year?

Stewart Zimmerman

What?

Stephen D. Yarad

The portfolio is pretty much 2005, 2006, 2007, so there is very little if any newer than 2007 origination.

Jordan Neil Hymowitz – Philadelphia Financial Management of San Francisco LLC

Okay, thank you, Jordan.

Stewart Zimmerman

Thank you, Jordan.

Operator

Thank you, and gentlemen, we have no further questions in queue.

Stewart Zimmerman

Well, I’d like to thank everybody for joining us on the call. We look forward to speaking with you next quarter. Thank you.

Operator

Thank you. And ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and for using AT&T Executive TeleConference. You may now disconnect.

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