American Capital Agency Corp. Q4 2009 Earnings Call Transcript

 |  About: American Capital Agency Corp. (AGNC)
by: SA Transcripts


Welcome everyone to the American Capital Agency fourth quarter 2009 earnings call. (Operator Instructions) I would now like to turn the conference over to our host Katie Wisecarver; please go ahead.

Katie Wisecarver

Thank you for joining American Capital Agency’s fourth quarter 2009 earnings call. Before we begin, I’d like to review the Safe Harbor Statement. This conference call and corresponding slide presentation contains statements that to the extent they are not recitations of historical fact, constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

All such forward-looking statements are intended to be subject to the Safe Harbor protection provided by the Reform Act. Actual outcomes and results could differ materially from those forecast, due to the impact of many factors beyond the control of AGNC.

Certain factors that could cause actual results to differ materially are included in the Risks Factors section of AGNC’s 10-K, dated February 17, 2009, and periodic reports filed with the Securities and Exchange Commission. Copies are available on the SEC’s website at We disclaim any obligation to update our forward-looking statements.

An archive of this presentation will be available on our website and the telephone recording can be accessed through February 22, by dialing 800-624-1687 and the conference ID number is 52724001.

To view the Q4 slide presentation turn to our website and click on the Q4 2009 Earnings Presentation link in the upper right corner. Select the webcast option for both slides and audio or click on the link in the conference call section to view the streaming slide presentation during the call. If you have any trouble with the webcast during this presentation please hit F5 to refresh.

Participants on today’s call including Malon Wilkus, Chairman, President, and Chief Executive Officer; John Erickson, Chief Financial Officer and Executive Vice President; Gary Kain, Chief Investment Officer; and [Bernie Belt], Vice President and Controller.

At this time I’d like to turn the call over to Gary Kain.

Gary Kain

Good afternoon everyone and thanks for joining us. I want to start by saying that I am particularly pleased with our results for the quarter because we were able to produce very strong results for our shareholders, while taking significant steps to curtail both prepayment risk and our exposure to changes in interest rates.

I’m going to touch on some specific actions we took later, the evolving prepayment landscape that we witnessed throughout 2009 and now in 2010 really underscores our commitment to active portfolio management and our actions highlight how we think about balancing the generation of attractive risk adjusted returns with book value preservation.

Early in 2009 we felt that the best investment was to purchase high coupon mortgage securities backed by weaker credit borrowers. This move produced handsome returns as a result of the extremely slow speeds registered by these securities and by price appreciation that followed.

But as delinquencies continued to accumulate in these pools these securities became considerably more exposed to the possibility that the nonperforming loans could be bought out by the GSCs which would result in much faster speeds.

At the same time the valuations remained extremely favorable because the market was focused on the slow speeds these securities had exhibited and was arguably somewhat complacent about the risk looking forward. Hence we chose to sell many of these securities, lock in our profits, reduce risk, and find other investment alternatives without this exposure.

Only time will tell if we made the right choice, but just because something worked well in 2009 does not mean that it will work in 2010. So what you can expect from us is to continue to rebalance our portfolio as market conditions, valuations, and risks evolve.

Now with that said, why don’t we look at some highlights on page five, for Q4 we again declared a dividend of $1.40 per share. Our dividend was both below our GAAP net income of $1.79 per weighted average share and our taxable income of $1.69 per share.

The net income number included $0.78 of other income which included realized gains, derivative mark to market and hedging effectiveness. We also had $0.16 worth of amortization expense associated with our terminated swaps.

Earnings net of these two items were $1.01 per share. Overall our undistributed taxable income increased during the quarter by $4.4 million from $17.3 million to $21.7 million. Now given that we raised $122 million in equity during the quarter via the issuance of 5 million shares, on a per share basis our undistributed income remained at $0.90. I want to emphasize that we intend to distribute all of our remaining 2009 taxable income during 2010 as we are required to do under REIT rules.

As of December 31 our investment portfolio totaled $4.3 billion in assets which was an increase of approximately $700 million from September 30. Unlike prior quarters we added a greater percentage of fixed rate assets as we diversified the portfolio in light of the changing prepayment landscape.

Now on average for the quarter our leverage was 6.8x, which was a half turn lower than our leverage at both the start and at the end of the quarter which were both 7.3x. Also last week our Board of Directors voted to remove our internal 10x leverage constraint in recognition of the considerably more favorable financing environment and given their comfort with AGNC’s multifaceted risk management and reporting framework.

This change in the leverage limit puts AGNC on par with its peers which have no hard leverage constraints. Now I do want to say that investors should not assume that this change portends higher leverage in the near-term as we don’t believe that it is warranted given current mortgage valuation, and as we sit today our leverage is actually lower than it was at year end.

Book value for the quarter increased to $22.48 from $22.23 at the end of the third quarter. Now if you turn to slide six, let’s take a second to look at on this call and we’ll go over some of the 2009 highlights, 2009 was clearly a banner year for AGNC shareholders both on an absolute basis and relative to our peer group.

The total return for holding AGNC stock inclusive of both price appreciation and dividends was 48% despite a difficult first quarter. Net income was $6.78 per share, which resulted in a 31% ROE. In addition when you combine our $5.15 per share in dividends, and our net increase in book value of another $5.28, the resulting economic return is approximately 60% for 2009 even exceeding the move in our stock.

AGNC was able to raise $222 million of net proceeds in follow-on offerings which were accretive and will allow the company greater economies of scale going forward and better liquidity. Producing these results was not as they say shooting fish in a barrel, as we transitioned to a new portfolio management team during the first quarter.

At that time we had the lowest leverage of the peer group and a portfolio of 100% fixed rate securities. As such despite significant industry concerns around prepayments, AGNC proactively set out to purchase higher coupon hybrid ARMs and build a portfolio that we were confident would outperform more generic securities.

We also were very transparent with respect to communicating our actions to a sometimes skeptical market and revamped our disclosure to show the performance of our assets versus market benchmarks. When during the year speeds came in slower than even we anticipated valuations of these securities improved significantly.

As such we chose to lock in those favorable valuations and reposition the portfolio for 2010. We also took a number of steps during the year to mitigate our exposure to interest rate volatility which included diversifying the portfolio into 50% variable rate product and increasing the duration of our swap book by terminating one year swaps and adding longer maturity protection.

So now let’s return to Q4 and turn to page seven and we’ll quickly review what happened in the markets, as you can see in the tables on the left treasury and swap yields increased during the quarter with 10 year rates rising around 50 basis points versus less than 20 basis points for two year rates.

Almost the entire move in rates occurred during the latter part of December. Also as we sit here this afternoon five year and shorter maturity treasuries and swaps are now lower in yield than they were at the end of both the third and fourth quarters. However 10 year rates have fallen since year end but they are still more than 20 basis points higher than they were at the end of the third quarter.

Therefore [inaudible] difference from the end of third quarter to today is that the yield curve have steepened significantly which is generally favorable for our business. Now commensurate with the increase in rates, fixed rate mortgage prices declined at year end leaving 5% at lower coupons, lower in price for the quarter. Hybrid ARMs also performed relatively poorly with new issue [five points] lower by more than a point and seasoned high coupon ARMs down slightly as well.

The best performing sectors of the ARM market were shorter reset ARMs and some higher coupon 7/1 and 10/1s which were generally higher in price. Now so far in 2010 mortgage performance has been very strong which will provide a significant tailwind for book value. For example 30 year 5% coupons are now well over 104.00 price and 30 year 6% coupons are well over 107.

These are both above their third and fourth quarter levels. Now with this as the backdrop let’s turn to slide eight so we can look at what we did with the portfolio during the quarter, first our portfolio grew 25% to $4.3 billion as we invested proceeds from our equity offering. We reduced our overweight to hybrid ARMs as we became more concerned about prepayments fees on ARM product particularly as the result of GSE buyouts.

As a quick review, GSE buyouts are merely prepayments that result from Freddie Mac or Fannie Mae, the moving or buying out seriously delinquent loans from their securities. Given the significant increase in both GSEs seriously delinquent loan populations and the fact that we know these nonperforming loans are concentrated in the subset of pools backed by higher coupon, interest only, and ARM loans, AGNC believes that reducing our exposure to these types of securities was warranted.

The GSEs have the financial incentive to pull these loans as soon as possible and that is irrespective of whether or not these loans end up getting modified or end up in foreclosure. Now importantly this buyout equation just changed in 2010, basically a month ago, as new accounting rules FAS 166, and 167 became effective.

Under the new rules the GSEs no longer recognize any incremental loss when they buyout a loan and thus do not need to hold any more capital for a loan that has [bought] out versus one that is left in a pool. They do however save a tremendous amount of interest payments if they buyout these loans. Why? Because they are paying us the security holders around the 6% coupon on average, which they are not receiving from the borrower.

They could on the other hand pay us off the prepayment and borrow at near zero percent interest rates to fund the delinquent loan until it reaches its resolution. Thus saving on average more than 5.50% in net interest on a monthly basis. So when you think about that on over $200 billion in delinquent loans this would save the GSEs over $10 billion per year in interest payments and so it is certainly not a rounding error even for them.

As such we do not feel it is prudent to expose our shareholders to this risk and just to sit around and hope these buyouts will not occur. As the press would say we are not going to just pray for the equivalent of another government bailout especially given the fact that we could sell the most at risk securities at extremely favorable valuations.

Given these issues we were more comfortable with a more diversified portfolio which minimized this exposure. Therefore we increased the percentage of 30 year and 15 year mortgages. Within the 30 year sector we concentrated on mortgages originated back in 2003. There very seasoned securities have the dual benefits of having favorable prepayment characteristics and shorter durations than new originations.

We also selectively added some newer issued 30 year and 15 year fixed rate securities as well. Now within the hybrid ARMs we concentrated our positions on 2005 and earlier originations, and some longer maturity 7/1s and 10/1s where delinquency rates are lower and where refinancing activity is still likely to be contained.

Another important thing we did this quarter was to expand our holdings of CMOs through the repackaging of our existing securities. While some may think of CMOs as potentially more risky, our motivation was exactly the opposite. Via the CMOs we essentially were able to purchase protection at very attractive prices against short-term spikes in prepayments on some of our highest coupon interest only ARMs and fixed rate securities.

In most cases the CMO securities that were sold to other investors and they were generally between 25% and 30% of the total received all the prepayments until they are retired. Thus our remaining CMO securities received no principal payments or net prepayments until after more than 25% of the original collateral is paid off.

Now overall the changes to our portfolio paid off for us as our speed for the quarter declined 3 CPR to 16% despite both the recent pickup in speeds and a decline in mortgage rates during most of the quarter. In the prepayment speed that was just released a few days ago, our portfolio paid around 15% CPR, close to the lowest level we have seen in more than a year.

More importantly while we’re pleased with the recent speed performance what’s more important is that it is reassuring to know that we have significantly reduced our prepayment exposure on a go forward basis especially with respect to GSE buyouts.

Now slides nine and 10 give a lot more detail regarding our fixed and ARM positions. Please turn to slide 12 and in sticking with the risk management theme we also increased the size and quality of our swap book by $650 million to just over $2 billion, and increase of 46%. Again that should be compared against only a 25% increase in our assets.

This brought the percentage of our repo balance hedged to 53%. But also of note is that we purchased $300 million in options to enter into swaps in the future. These swaptions as they are called in the market, help protect the portfolio against larger moves in interest rates in either direction.

Now let’s turn to page 13 and quickly look at the business economics, the thing that stands out is that it looks like not that much has changed from Q3. Our asset yields were down by fewer than 18 basis points during the quarter and our net interest spread contracted by only five basis points. When you look at the as of numbers, you will see that the net interest spread contracted only two basis points.

What is interesting here is and this is important, its against the backdrop of approximately $18 million or $0.78 per share of other income and a larger portfolio. Thus we were able to generate significant gains and grow the portfolio without necessarily depleting our core earnings power going forward. Now net ROE for the quarter was 30.3%. Even when you exclude other income, our gross ROE which you can see in the middle of the table was 22.1%.

Now I want to give you a little bit of insight as we look ahead, as mortgages have continued to strengthen this quarter, we have sold more of our highest coupon securities producing significant gains. In addition both as a function of these sales and in light of our quarter to date book value appreciation, our leverage is lower at this point.

But I need to caution everyone that we are still at an early point in the quarter so all of this information is both preliminary and clearly subject to change as the quarter develops. Now before I open the call up to questions, I do want to speak quickly about one question that I probably would have gotten anyway, and that is probably on a lot of people’s minds which is what happens to the mortgage market and our book value when the Fed stops buying mortgages.

Yes, I think mortgage spreads will widen post Fed. But that widening will likely be much smaller than what many are hoping for. It is important to be somewhat defensive, but one has to be careful on the other side not to bet the ranch on a major widening as well. Some people did that almost a year ago and have paid dearly both in lost income and price appreciation.

And given the strong mortgage performance we have seen to date, even after this widening, it is very possible that spreads are not that far from where they were at the start of this year. Some people in looking at this are too focused on the Fed’s day to day purchase volumes and that going away, and not enough on the impact the Fed’s massive $1.2 trillion worth of purchases have had on the existing stock of mortgages or what people call the float.

The bottom line is that way too many mortgages are put away between the Fed, the GSEs, banks, and [Ramix]. Also many market participants that could underweight, short, reduced leverage, whatever term you want to use for lightening have already done it. As such as major widening is not likely without a significant change in market conditions.

However, if interest rates were to continue falling then mortgage production would likely increase and under that scenario mortgage spreads could widen more but because prices would still be flat or rising, the erosion of book value even in this scenario would likely be related to hedges and therefore be pretty contained.

On the other hand if interest rates rise, new origination is likely to be very slow and so mortgages are likely to hold in better than they would be expected to versus other products. Now in conclusion, I think the pressure on book value due to the Fed’s exit is likely to be more moderate than most believe but there are likely to be some favorable buying opportunities in some products as spreads definitely become more volatile.

So at this point, I’ll open up the call to the operator and take questions.

Question-and-Answer Session


(Operator Instructions) Your first question comes from the line of Steve Delaney - JMP Securities

Steve Delaney - JMP Securities

Gary congratulations on it really was an outstanding year for you running the portfolio so good job. Your move to, you had some CMOs in September, maybe about 6% of the portfolio but its obviously much bigger now, could you share with us, we get good data here in the book on pages nine and 10 on the fixed and hybrids, but could you give us a little more color about the CMOs and we know the fair value, the market value is 707 million but could you share the par value and maybe your cost basis and the [inaudible].

Gary Kain

Let me give you a little bit of that data, and we will certainly look at trying to enhance disclosure on any part of the portfolio over time, but let me get you to the book value so the UPB is $682.4 million, our cost basis is around 102 and 0.77. And the weighted average coupon is 5.2%.

Steve Delaney - JMP Securities

And just for my simple mind, it sounds like you took some fixed pass throughs that you owned and you just basically carved off a first cash flow piece that you sold, and you kept the more delayed cash flow bonds, am I thinking right.

Gary Kain

You’re thinking about it right. This is not that complicated of a trade. We weren’t, what we did was we at a significant premium we’re able to sell the first 25% to 30% of the cash flows and to the extent that prepayments are very quick early, our class doesn’t get any prepayments until that tranche is paid off. Now this provides us kind of two benefits, the obvious one is economics in that the premium if prepayments are faster is lost on the earlier tranche whereas the second tranche, our tranche has a lot more time for the future slower prepayments after that spurt to maintain its yield.

But second of all just on the financing side, we don’t have our securities paying down rapidly and it gives us much better liquidity in terms of not having margin calls on those securities as well. So there were really two major benefits that we felt that really warranted doing something in albeit it a little less liquid part of the agency market.

Steve Delaney - JMP Securities

Could you comment on the jump in your G&A expenses, they’ve been running for three straight quarters pretty much right around $1.5 million and then they spiked up to $2 billion in the fourth quarter so do we have any one-time items there or should we look at that as the closer to the run rate going forward.

Gary Kain

Actually most of it was due to snow removal I think.

Steve Delaney - JMP Securities

I think that was 2010 wasn’t it.

Gary Kain

We had one in December as well, but outside of snow removal, no, I think you can think of that as mostly due to one-time items so we had incremental legal and tax expenses related to transactions, and some of our mortgage activity. We also had a little bit of higher transaction volume that also increased those costs but nothing that we would view as being in any way kind of setting a new bar to a much higher level or anything like that.

And clearly we expect to get operating leverage from the larger capital base, so you should look at that as mostly one-time items.


Your next question comes from the line of Bose George – KBW

Bose George – KBW

Very nice disclosure, I was just wondering what your view on how high prepayments speed could go this year especially on some of those securities that you sold and just relative to the stuff that you’re buying where you think prepayments would be on those securities.

Gary Kain

Its interesting everyone in the market clearly talks about CPR and how fast something can be in CPR terms, and obviously on a month by month basis that’s very dependent on how quickly these buyouts occur. The way we think about it is actually more in terms of the percentage of delinquent loans backing a pool.

So let me give you an extreme case, a high coupon interest only ARM that’s all day in nature could have up to 40% seriously delinquent loans. And so our fear is a security like that is that either over the course of a month or six months or maybe in a better case over the course of a year, all of those loans are pulled out and so again in that worse case scenario 40% of your pool disappears at par if the delinquent loans are bought out.

If that happens over six months, you essentially have locked in something in the neighborhood of its not one for one but its CRP well over 60 in the end. Its not just 40 times two because of the way the calculation works but it gets you to the point where you can’t recover from those kind of speeds and again so our evaluation of looking at the securities we’re worried about what to keep, what it could cost us is really to think about what is the percentage of delinquent loans, how big of a deal is it if they’re all pulled out over a three to six month period, and does that set us back too much that we can’t make up for it over time.

And that’s the way we’ve tended to evaluate it. Again on the high end you’ve got some agency ARM pools that are probably up to 40% delinquencies. A benchmark number is that Fannie released at the end of the third quarter that of their interest only mortgages, both ARMs and fixed, 17% were seriously delinquent. So that’s that whole category. That was three to four months ago so you’d be looking at something probably over 20% on that category and then again subsets of that category can be a lot worse.

Bose George – KBW

And [inaudible] again read the minds of, and the agencies are going to do it, but in your view how do you think they’ll balance keeping, preventing the market from being hit too hard versus pulling delinquencies that quickly to protect their potential interest payments if they have to pay.

Gary Kain

It’s a tough question, I think the reason why I think there’s sort of a misconception here in reality if the agencies did this quicker, very quickly, the prices of the securities which is what people focus on and which sets kind of liquidity going forward and helps the origination process and all those kinds of things, could actually appreciate. People would take material losses as their pay downs would be very high that month.

But the securities after the buyouts are better than they were before the buyouts. And so I think people misread and potentially even people in the government misread that equation because in many way the liquidity of the market is enhanced by getting this problem over with. By having these loans just pile up in pools and sit there over time people are going to realize there’s a bigger accident waiting to happen at some point and so I don’t really see that as being good for the market personally.


Your next question comes from the line of Jason Arnold - RBC Capital Markets

Jason Arnold - RBC Capital Markets

Great job this quarter, I know the portfolio allocation strategy tends to be more opportunistic based on the environment but just curious if you can comment on how you would envision the portfolio looking as the year progresses more CMOs, more fixed rate, maybe more swaps, if you could comment on that end.

Gary Kain

Sure, I think again obviously it is hard for us to predict because it will relate to relative [break in audio] and change in market conditions, but a couple of things to note, I don't see the CMO portfolio growing materially from here. We felt this was a unique risk return trade off that made sense for us right now, on an ongoing basis both for whole pool reasons and liquidity reasons and so forth, we don’t see the CMO portfolio growing that much from where it is today and it could very easily shrink.

I think the question on ARMs versus fixed rate is somewhat dependent on the resolution of going back to the earlier question of the buyout equation because a lot of the ARMs that we’ve tended to like now have this risk embedded in it that’s definitely making us defensive towards that product. We are looking at other sectors of the ARM market and we watch them for relative value versus fixed rate and its very possible we’ll find opportunities in newer issue ARMs over time which could help as well.

But big picture, we definitely, everything else being equal, we’ll prefer an ARM to a fixed rate. On the other had there are pricing and these types of risks vary over time. And so we’ll have to see and I don’t really want to set a target for the weightings but that’s the way we think about it.

Jason Arnold - RBC Capital Markets

And then on the swap side.

Gary Kain

On the swap side we are going to continue as we’ve been doing which is to make sure that the maturities of our swaps are reasonably long relative to over, well over two years because we feel that’s imperative in protecting book value as there’s clearly risk in both short-term and long-term rates and so we want to have, to maintain a decent duration of our swap portfolio.

And in terms of the size it is very correlated with the types of assets but I think in general we don’t see that coming down very much from here.

Jason Arnold - RBC Capital Markets

And then I may have missed it but can you give us the dollar value of the assets sold in the quarter.

Gary Kain

Actually we did not, I don't have it with me right now. I’m sure it will be in our Q.


Your next question comes from the line of Mike Widner - Stifel Nicolaus

Mike Widner - Stifel Nicolaus

Congratulations on a solid quarter, and a solid year, just wondering if you could provide any additional color commentary on your expectations for the sort of realized gains and the opportunity for gains on trading in the portfolio in the coming year. I’m sure you can’t give us an exact sort of ballpark range but as I look back at 2009 looks like about 40% of your total income came on realized gains on MBS sales, just wondering as you look at the market going forward do you think there’s going to be that, as big an opportunity, do you think we might see some pressure there, do you tend to be as active about rebalancing or any additional color there would be helpful.

Gary Kain

The first thing is I really can’t speak to the market conditions going forward in terms of rebalancing issues but again going forward there will be a time or there’s a likely opportunity where we will probably go back to more ARMs when the conditions are right so that’s something that may happen.

But big picture I want to stress that the realized gains are not, don’t only come from selling assets that were bought a long time ago at low cost basis. There are some that are absolutely generated on a go forward basis and those opportunities should be still be in any environment that remains reasonably volatile and as we see volatility picking up in the market we think that in general that adds to our opportunity set.

And then going back to the statement I said earlier on the call we have generated significant gains quarter to date and significant is a similar term to what I think we’ve used in the last couple of quarters.

Mike Widner - Stifel Nicolaus

Well its an answer and they paid off very well as a strategy in 2009 and you are fairly unique in the peer group in at least the degree to which you rebalance and so for those of us modeling going forward it continues to be a challenge to figure out if the opportunities for that in 2010 are going to be as big as they were in 2009, but good to hear that things are going well so far.

Gary Kain

We understand that and we’ve tried to be very clear over time as to the motivations and when we walk in every day we’re looking at for cheap assets, obviously to add to our portfolio and we’re also looking for either risky or over valued assets every day because there’s money to be made in shedding those and so both of those are on our radar screen on a continuous basis.


Your next question comes from the line of Daniel Furtado – Jefferies

Daniel Furtado – Jefferies

Great quarter, great year actually. Not that I disagree but I’m just trying to understand this, but do you mind helping me understand kind of the downside to the GSE repurchase strategy or whatever you’re calling it. Is it really as simple as if the GSE don’t accelerate repurchases what we’ll have here is just a slightly lower asset yields as well as a slightly less liquid portfolio. Is it that simple or how do I look, the risk of establishing the portfolio to prevent yourself, or to protect yourself from this GSE buyout risk.

Gary Kain

In general so if the GSEs don’t change at all their buyout behavior and over the next year or so what we see is just delinquent loans continue to just collect in pools, then in theory what you’d see happen is you’d have good carry on those positions and that carry might be better than what it would be on other securities.

But a lot of the price appreciation we’ve seen in those assets has taken away some of the downside so going back to something I said earlier we don’t feel like we have to bet the ranch that this is a real problem. Its just not a risk return that we want to take right now. So again the downside is that the prepayments on those types of assets will remain actually contained and we might have been in a sense rewarded or kind of been about the same, a little better if we had kept those assets.

But looking forward if that happens, you’d expect the markets still to react over time to the built up delinquencies so at some point you’d have to expect the prices of those securities to offset for the continued building risk of these delinquent loans. So its not even clear unless you could, the goal really would be to time that trade absolutely perfect to get out at the last month before the process began which let’s face it, is that simple of a timing exercise.


Your next question comes from the line of Mike Taiano – Sandler O’Neill

Mike Taiano – Sandler O’Neill

Good quarter, how should we think about your purchases during the quarter, the relative spread on those compared to your overall, your average throughout the quarter. Did it come down quite a bit relatively flat, how should we think about that.

Gary Kain

Well I think what you can say is the portfolio grew, I’ll go back to what we said earlier, one of the problems is when you, we purchased a wide range of asset classes and so the yields and the spreads are clearly different across the different asset classes, but what I think really speaks to the quarter from our perspective is the fact we were able to generate significant gains.

And yet our spread going forward when you look at the as of numbers, stayed relatively constant. And that includes a larger portfolio and a capital raise so keep in mind really that’s kind of the summation of the entire quarter.

Mike Taiano – Sandler O’Neill

And then you had given sort of where prices had tracked quarter to date on some of the fixed rate MBS, could you maybe give us a sense of also on the [inaudible] hybrid ARMs where those are right now versus the end of the year.

Gary Kain

They’ve also gone up quite a bit so longer reset so if you look at higher coupon 10/1s the close to 6% ARMs are around a 107 dollar price, new issue ARMs have come back a fair amount as well. Not as much as fixed rate but they’ve certainly improved in price. And some of the higher coupon 6% 36 month roll type ARMs that we’ve listed on our chart are also back into the 106’s. So across the board we’ve seen an improvement in prices in the mortgage universe with probably the new issue front relative to its expected price appreciation lagging a little bit.

Mike Taiano – Sandler O’Neill

And then how should we think about the undistributed income flowing through in 2010 and should we think about it just sort of flowing equally through the quarters or more front loaded, back loaded, any particular way to think about that.

Gary Kain

Not really, I think it’s a function of market conditions and results but clearly it will all be paid out in 2010 as we have to. Now the one thing to keep in mind is that the way it is recognized from a tax perspective is the first dividends paid are deemed to be paid off of 2009 income. And so essentially within, under most scenarios in the first or second quarter that income will have been paid out.

And but in terms of paying down which I think is more the gist of your question in terms of paying down the undistributed taxable income balance, its going to be a function of time, market conditions, and earnings going forward.


Your next question comes from the line of Matt Howlett – Macquarie Capital

Matt Howlett – Macquarie Capital

Congratulations on a nice job, just on the portfolio again you’ve done a good job obviously preparing for buyouts my question more relates to extension risk in the portfolio, you look at your fixed rate portfolio has been, prepaying very shortly which would be great but its almost alarmingly slow, how do you look at it if there was to say 100 basis point pickup in interest rates, is there sort of some type of color you can give us in terms of how much the assets would extend and so forth, [inaudible] in your longer dated hybrids.

Gary Kain

Clearly we recognize that the duration of our assets or the interest rates, sensitivity of the assets on their own has gotten longer as we’ve rebalanced the portfolio and we recognize that and have accounted for that with a larger swap book. And then I really do want to point to as well the swaption portfolio that we’ve begun to build which really does help us, the technical term in the mortgage market is convexity.

But basically it helps in, these are purchased options and they help us if interest rates move a lot in either direction, 200 of the 300 million are payer swaptions is the term, which protect us. It gives us the right to enter into a swap if interest rates go up essentially allowing us to at the price specified in the option to add 200 million more in pay fixed swaps but if and only if its needed.

The other 100 million helps us if rates were to fall. So that’s another important piece in addition to growing the size of the swap book. Adding the swaptions really gives us some incremental protection no matter which way interest rates go. Going to specifically the duration of the assets, yes they’re longer but we’ve taken a number of steps, again buying very seasoned fixed rate, helps significantly reduce the duration difference versus other types of products.

And in the longer term securities the coupons are higher but then the 7/1s and 10/1s which also help to keep the duration down. So we feel pretty confident that when we’re continuing to take steps to protect against interest rate increases without kind of setting ourselves up if rates fell a lot either.

Matt Howlett – Macquarie Capital

And I think the Fed mentioned that they would, or someone from the Fed mentioned that they would increase maybe buying if rates were to rise, mortgage rates were to rise significantly would you again look to maybe sell some of that fixed rate portfolio in that type of environment.

Gary Kain

Absolutely, if we feel that, if the Fed were to come back and fixed rates were to go much tighter especially versus ARMs, especially if we could get some kind of clarity and more comfort on the buyout side, for the higher coupon ARMs, we’re consistently looking at the relative value and that is absolutely a risk return basis and risk being a big piece of that equation and if fixed rates were to tighten up further, then we’d be very open to going back the other way.

Matt Howlett – Macquarie Capital

And then on leverage, the Board removed the cap on the leverage level, what do you view as the optimal level of leverage today. We’ve seen some new entrants come in and kind of look towards an 8x to 9x. If we were to see a sell off in MBS like we saw in May of last year, could agency get to that level very quickly, would you consider it.

Gary Kain

Absolutely we would consider it over time given where repo haircuts are and given our cash positions and our ability to manage risks, higher leverage than where we’ve been operating is absolutely something we would be comfortable with over time, but its very dependent on market conditions and so when we look at our leverage today, we see a number of factors, where the valuations on mortgages, the prepayment environment and the certainty, or uncertainty related to it, the interest rate and spread environment.

When you put all of those together in other environments there are times when I think leverage in the 8% to 10% area is certainly something we’d be comfortable with.

Matt Howlett – Macquarie Capital

And can you just remind us what you average haircut is.

Gary Kain

The average haircut right now is around 5% but we have some haircuts that are below that.


Your next question comes from the line of Unspecified Analyst

Unspecified Analyst

I think this is a little bit of a repeat from the Sandler question, but if I’m understanding correctly you have extended the duration of your liability side, with your swaps heading out a little bit, and obviously your repo book is repricing it at lower cost than Q4, but can you quantify any impact on spread in Q1 by the quote purchasing a wider range of asset classes, I’m guessing at presumably a lower yield of the portfolio, can you quantify the impact on spread for Q1.

Gary Kain

I can’t quantify the impact on any of the changes for Q1, but I think the key issue really relates to the types of assets we continue to look at because again yields on fixed rate are still quite a bit higher than ARMs and we did sell some of our higher coupon fixed rate securities this quarter which were higher yielding securities.

So there are a number of moving parts in the equation and so its hard to quantify things especially for Q1.


Your next question comes from the line of Jim Delisle - Cambridge Place

Jim Delisle - Cambridge Place

Could you, looking at swaption, would I be correct in assuming that any income generated from the sale of swaptions, non good [REIT] and income and as a result any losses generated by the purchase of swaptions that are not exercised might have the same treatment.

Gary Kain

First off the income or sales what we do is we mark to market our swaptions on a daily basis. They are not in a hedge relationship so in general the marks are going to be flowing through on a consistent basis whether they are realized or unrealized.

Jim Delisle - Cambridge Place

Okay but being that they are not for hedge, not on the hedge purpose it would be, I presume it would be not classic good REIT income for tax purposes.

Katie Wisecarver

That’s not necessarily the case the payer swaptions would result in good income only the receiver swaption book would be considered bad income.

Jim Delisle - Cambridge Place

And how is your book broken down right now.

Gary Kain

Its $200 million in payer swaptions and $100 million in receiver swaptions, but again even with that portfolio growing a decent amount we don’t see an issue in terms of bumping into any of the limitations there. Again I do want to highlight these are purchased options, we obviously did have over a year ago a fair amount of options, we were writing options to generate income. Not that we can’t get benefits and income out of these options but there are purchased options with a clear risk management objective.


Your final question is a follow-up from the line of Bose George – KBW

Bose George – KBW

I just had a follow-up on an earlier response you made on the dividend for this year, since it’s the first in first out and your dividend requirement would essentially be met probably by the first dividend in the first quarter, is there a requirement after that or could you just revisit this again in 2011 with an even bigger excess dividend.

Gary Kain

No that is the earlier paying out, the 2009 in the whatever as a first in first out method is the only requirement, and yes, technically we can evaluate whether we wanted to pay an excise tax on 2010 income and carry it forward into 2011. That is always an option that any REIT would have and clearly under certain circumstances we would think about that.

However we’re very early in the year and I think its very premature to start thinking along those lines.


There are no additional questions at this time; I would like to turn it back over to management for any additional or closing comments.

Katie Wisecarver

I think that’s it. Thank you.

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