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Western Asset Mortgage Capital Corporation (NYSE:WMC)

Q4 2013 Earnings Conference Call

March 7, 2014 11:00 AM ET

Executives

Larry Clark - IR

Gavin James - President and CEO

Steve Sherwyn - CFO and Treasurer

Anup Agarwal - CIO

Analysts

Steve DeLaney - JMP Securities

Daniel Furtado - Jefferies

Mike Widner - KBW

Jim Young - West Family Investments

Operator

Welcome to the Western Asset Mortgage Capital Corporation's Fourth Quarter and Year End 2013 Earnings Conference Call. Today's call is being recorded and will be available for replay beginning at 5:00 PM Eastern Time. At this time, all participants have been placed in a listen-only mode and the floor will be opened for your questions following the presentation. (Operator Instructions) Now first I'd like to turn, the call over to Mr. Larry Clark, Investor Relations for the Company. Please go ahead, Mr. Clark.

Larry Clark

Thank you, operator. I want to thank you everyone for joining us today to discuss Western Asset Mortgage Capital Corporation's financial results for the three months and year ended December 31, 2013. By now, you should have received a copy of today's press release. If not, it is available on the Company's website at www.westernassetmcc.com. In addition, we are including an accompanying slide presentation that you can refer to during the call. You can access these slides in the Investor Relations section of the website.

With us today from management are Gavin James, Chief Executive Officer, Steven Sherwyn, Chief Financial Officer, Anup Agarwal, Chief Investment Officer.

Before we begin, I would like to review the Safe Harbor statement. This conference call will contain statements that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All such forward-looking statements are intended to be subject to the Safe Harbor protection provided by the Reform Act. Actual outcomes and results could differ materially from those forecast due to the impact of many factors beyond the control of the Company. All forward-looking statements included in this presentation are made only as of the date of this presentation and are subject to change without notice.

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

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

Gavin James

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

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

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

Our strong performance in the quarter was due to several factors. First, we were well positioned with our hedges which we significantly increased midway through the quarter, and the increase in the value of these hedge positions more than offset the declining value of our agency MBS portfolio. Second, we reduced our exposure to lower coupon 20 and 30 year fixed rate pools, the securities that were the hardest hit in the quarter. And third, we increased our holdings of non-agency securities which outperformed the agency sector during the quarter.

Our fourth quarter results validate our belief that are proactive style of management combined with our flexibility to invest across the entire mortgage sector positions us well to seek our objective of delivering superior risk adjusted returns. Including our fourth quarter results we have continued to generate a significant level of outperformance relative to our peer group. Since our initial public offering in May of 2012 through December 31, 2013, we have delivered a total economic return of 13.6%, which is well in excess of the average of our agency RMBS peers over the same timeframe. Even when compared to the larger group, containing both agency and hybrid mortgage REITs, we have delivered superior performance since our IPO, outperforming the group average by approximately 300 basis points.

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

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

Our continued view on interest rate is at the long-end of the curve, will be range bound over the course of the year and short-term rates will remain in zero. This view is based on our belief that economic growth in the U.S. will remain subdued over the next several quarters and that the Fed will continue to be supportive of the economy. We do not believe that the economy will materially weaken, nor do we expect it to accelerate any time soon. A gradually improving economy including a continuing yet more normalized housing market recovery should support low interest rate volatility, more stable agency MBS values and improve non-agency fundamentals.

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

With the expectation of lower interest rate volatility, we believe we are well positioned to create value for our shareholders in 2014. As always our goal will be to optimize the risk adjusted net economic return delivered to shareholders, primary through strong core earnings resulting in an attractive dividend while maintaining a stable book value. Our industry leading results to-date since our IPO are due to the hard work and dedication of the Western Asset’s structure products team, as well as the entire Western Asset platform which not only provides assistance with repo financing, but provides a wealth of fixed income knowledge and resources. We believe that our years of experience in the mortgage sector and our deep bench are key competitive advantages that produce tangible benefits for our shareholders.

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

Steve Sherwyn

Thanks, Gavin. Good morning everyone. I will discuss our financial results for the fourth quarter and year ended December 31, 2013. Except were specifically indicated all metrics are as of that date. On a GAAP basis we earned net income for the quarter of approximately $20.8 million or $0.83 per basic and diluted share. Included in the net income were approximately 13.4 million of net unrealized gains on mortgage backed securities. Approximately 50.5 million of net realized losses on mortgage backed securities and approximately 37.2 million of net gains on derivative instruments and linked transactions.

For the quarter, our core earnings was approximately $17.2 million or $0.70 per diluted share, which is a non-GAAP financial measure which we defined as net income or loss excluding net realized and unrealized gains and losses on investments. Net unrealized gains and losses on derivative contracts, non-cash stock-based compensation expense and other non -cash charges. Our net interest income for the period was approximately $24.1 million. This number is a GAAP number and does not include the interest we received in paying our linked transactions. Interest we received from our IO securities are treated as derivatives. Nor does it take into account the cost of our interest rate swaps. The latter two which are included in gain on derivative instruments aligned in our income statement.

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

For the full year 2013, we incurred a net loss of $27.9 million on a GAAP basis, or $1.19 per basic and diluted share. Including in the net loss was approximately $160.1 million of net unrealized losses on mortgage backed securities. Approximately 122.6 million of net realized losses of mortgage backed securities and approximately 161.7 million of net gain on derivative instruments and linked transactions. For the year, our core earnings which is a non-GAAP financial measure, was approximately $82.7 million or $3.38 per diluted share.

Our net interest income for the year was approximately $107.3 million on a GAAP basis. On a non-GAAP basis, our net interest income including interest we received from IO securities treated as derivatives, and interest we received from linked transactions was approximately $95.8 million, included in this calculation was approximately $206.7 million of coupon interest offset by approximately $59.6 million of net premium amortization and discount accretion.

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

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

Our operating expenses for the quarter were approximately $3.5 million, which includes approximately $1.7 million of general and administrative expenses, and approximately $1.8 million in management fees.

Our economic return for the quarter was a positive 4.8%, which as we have previously noted represents the change of book value plus dividends declared. Our book value per share as of December 31, 2013, was $15.27, which takes into account our year-end dividend and the incremental shares issued as a result of stock portion of that dividend. For purposes of comparison, we adjust our September 30, 2013 book value per share for the incremental shares, that book value would have been $15.21 per share.

As of December 31st, the estimated fair value of our portfolio was approximately $2.9 billion and we had borrowed a total of approximately $2.6 billion under our existing master repurchase agreements. Our leverage ratio was approximately 6.4 times at year-end. Our adjusted leverage ratio was approximately 6.9 times at year-end adjusted for $190 million notional value of net long positions in TBA mortgage pass-through certificates that we held at the end of the year. Our adjusted leverage decreased during the quarter from 9 times at September 30, 2013 through a combination of our decision to decrease leverage and increase holdings with non-agency mortgage backed securities which have a lower borrowings advance rate.

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

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

Anup Agarwal

Thank you, Steve. Good morning and thank you for joining us today. Let me spend a few minutes discussing our portfolio and then I would like to talk about our outlook going forward. As indicated earlier, we delivered an attractive 4.8% economic return for the quarter, which was due to a combination of factors including our strong core earnings, our liability hedges increasing in value and a positive contribution from our non-agency MBS positions. These positives more than offset the decline in value of our agency MBS portfolio, which were impacted by approximate 40 basis point increase in 10 year treasury rate during the quarter.

On our call last quarter, we talked about our belief that long-term interest rates will remain range bound given the slow growth environment of the economy, while we continue to believe that this will be the case I want to emphasize that within the range interest rate movements and the direction of their path matter. Midway into the fourth quarter, we recommend that risk of long-term rate moving higher within our estimated range was meaningful and therefore we increased our hedges in order to better position the portfolio in that environment.

At the same time, we continue to increase our allocation to non-agency MBS as we believe that these securities offer good relative value, will perform well in a gradually improving economy and also exhibit less interest rate sensitivity. As we rebalance the portfolio, during the quarter we sold down some of our exposure to 20 year and 30 year fixed rate RMBS particularly the lower coupon pools. The key takeaway here is that we intend to continue to be proactive portfolio managers continually monitoring the relative value opportunities we have across the broad mortgage universe. This management style has served us well since our IPO and the fourth quarter is just another validation of that strategy.

We want to emphasize to investors that the size of the WMC enables us to be nimble in rebalancing the portfolio when conditions warrant and that these portfolio reallocations can occur relatively quickly and can make a meaningful difference to the contribution of our total return. That being said while the small scale of the REIT as an advantage when making portfolio shifts, we also have access to and benefit from investment platform and resources of Western Asset Management where we’re able to draw upon the experts across a number of sectors in the mortgage market and the broader fixed income and credit markets.

With that, let me turn to some of the portfolio details as of the end of the fourth quarter.

As of December 31, 2013, the total estimated market value of our portfolio was approximately $2.9 billion and consisted primarily of agency mortgages complemented by holdings in non-agency RMBS and agency and non-agency IOs and inverse IOs. During the quarter, we modestly increased our position in CMBS securities and at the appropriate time we may look to increase our holdings of these securities going forward, based on our view of their expected risk adjusted return profile.

Our portfolio remains weighted towards 30 year fixed rate mortgage pools, which represented approximately 58% of the value of the total portfolio. Our exposure to 20 year fixed rate mortgage pools at quarter end was approximately 17%, non-agency RMBS represented approximately 15% of our portfolio. Agency and non-agency inverse only strips and inverse interest-only strips represented just under 10% of the total. And agency and non-agency CMBS, including IOs and inverse IOs represented just under 1% of the portfolio. If you breakdown our agency specified pools by sector, 49% of the total was invested in mortgage pools with low loan balances and the next largest sector was pools with MHA loans with high LTVs at 45%, which is consistent with our investment strategy of minimizing our repayment risk.

The remaining 6% consists of the pools representing new issuance and low WALA, high SATO, high spread at origination and low third-party origination loans. Our non-agency pools consist of approximately 16% of prime loans, 43% of Alt-A loans and the remaining 41% being subprime loans. We currently deploy a two-pronged strategy with our non-agency portfolio. About half of our loan pools are pools that will generally have higher prepayment characteristics in an improving economy in appreciating housing market. In the case of prepayments, the portfolio benefits because these loans are being repaid at par and we own them at discounts to par.

The other portion of our non-agency holdings are in pools, they have lower prepayment characteristics where in many instances the borrowers are essentially stuck in their mortgages due to LTV or other credit issues. We believe these securities will also perform well in an improving economy but just not have the same prepayment characteristics as the first group. Our weighted average loan age or WALA for agency portfolio was 28 months. We believe that managing our WALA ramp is another component towards keeping our agency prepayments low.

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

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

As of December 31st, we had entered into approximately 2.7 billion in notional value of pay fixed interest rate swaps of which approximately 492 million are forward starting and 127 million of pay variable interest rate swaps, giving us a net pay fixed swap position of approximately 2.1 billion. The swap contracts range in maturities of between 12 months and 29 years with the fixed pay contracts having a weighted average remaining maturity of eight years and bearing a weighted average fixed rate of 1.9%. Approximately 17% of notional value of our swap positions are held in forward starting swaps, that starts approximately 6.2 months forward. Additionally, we have entered into approximately 2.2 billion notional amount of pay fixed interest rate swaptions and 100 million notional amount of pay variable interest rate swaptions, with swap terms that range between seven and 10 years and have exercised expiration dates that range from May 2014 to October 2014.

As a result of our increased hedge positions, our agency portfolio had a net duration of negative one year at year-end down from positive 1.1 years at September 30, 2013. We have a slightly positive duration at the shorter end of the yield curve which is more than offset by negative duration at the longer end. We are comfortable with our current leverage, but as we progress through the year, we may tactically increase leverage in response to market conditions particularly if we believe that an environment of lower interest rate volatility will persist. We can adjust our leverage fairly quickly through the use of TBA and we determine our leverage based on what we believe will enable us to optimize our core earnings on a risk adjusted basis and maintain a relatively stable book value. Our primary investment strategy remains unchanged that is to buy securities that offer the best risk and hedge adjusted carry over our investment horizon.

While we are pleased with the composition of our portfolio, we are always looking for ways to improve our returns without increasing the overall risk level of the portfolio. Along those lines, we expect to remain proactive and as opportunities present themselves, we expect to diversify our sources of return by increasing our exposure to non-agency securities and CMBS through our allocations to these asset classes, will vary based on market conditions. We are also reviewing opportunities with regard to other segments and structures within the mortgage market including residential and commercial real estate for loans.

We’re confident that given our broad opportunity set of investments and with our world class investment expertise we will be able to generate a consistently strong dividend for our shareholders while maintaining a stable book value.

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

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. (Operator Instructions) And our first question will come from Steve DeLaney of JMP Securities.

Steve DeLaney - JMP Securities

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

Gavin James

Yes this is Gavin. Yes I wouldn’t say that’s probably accurate to be considered as a hybrid REIT would be consistent with our investment philosophy.

Steve DeLaney - JMP Securities

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

Gavin James

That’s right.

Steve DeLaney - JMP Securities

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

Anup Agarwal

Sure, so I mean I think having inverse IOs again it’s driven by our core thesis for our economic view as well our view on interest rates. Our view is that front-end of the curve will stay peg for a long time because of the slow growth in economy. And in that environment IO versus inverse IOs you just have a better carry profile from inverse IOs. Now within inverse IOs when we look across asset classes whether it’s a non-agency or agency or anywhere else where we can get the best carry, but again the role of inverse IOs is similar to IOs from the perspective is to achieve better carry. But again it’s driven by also the -- to a great degree it’s driven by the view that front-end of the curve will stay peg for a long time.

Steve DeLaney - JMP Securities

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

Anup Agarwal

That’s right.

Steve DeLaney - JMP Securities

So would we think if…

Anup Agarwal

As our view changes about that I think we will shift the portfolio.

Steve DeLaney - JMP Securities

Yes, so we should watch that fund’s futures and fetch chatter and look for expectations and we would expect you to maybe lighten that portfolio as your view changes as you just said. Okay gentlemen…

Gavin James

Sorry.

Steve DeLaney - JMP Securities

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

Operator

And the next question will come from Daniel Furtado of Jefferies.

Daniel Furtado - Jefferies

Good morning everybody. Thank you for the opportunity. The question I really had is really more from a policy perspective. I just wanted to get your thoughts on risk sharing securities from the GSEs. And do you think this becomes a meaningful change agent for the GSE policy going forward or kind of how you are looking at those potential investments? Thank you.

Anup Agarwal

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

Daniel Furtado - Jefferies

And then -- thank you for that and do you foresee the GSE’s teaming up with the specific originators to issue these or for them to kind of remain more I guess generic for lack of a better word when they kind of as they evolve this program?

Anup Agarwal

So I think instead of kind of teaming up with originators I think I can easily see GSEs to differentiate the deal by underlying product type versus kind of the originator because listen I think when it comes to the originator type I think that’s really where they are doing the underwriting to make sure that there is a homogeneous kind of pool I think the place where we continue to give feedback to them where we differentiate that one GSE risk sharing deal from another risk sharing deals is by based on how much layered risk you have. And I think as this market evolves what you would kind of see is that market will differentiate between how the underlying deals are or what kind of loans are there in underlying deals and what are the composition of layered risk on underlying each transaction. And you would kind of see the market differentiate in spread for all the bottom classes based on that composition. And you would kind of see the agencies to come up with one product type with different LTVs and other risk sharing with another different LTV and marketable price that risk accordingly.

Daniel Furtado - Jefferies

Okay, makes sense. And thank you for the commentary there.

Operator

And our next question will come from Mike Widner of KBW.

Mike Widner - KBW

Hi. Good morning guys. I guess first let me just get one simple one out of the way. I was wondering with the slowdown in prepays in the quarter, if there was any one-time benefits ketchup or anything like that in the premium amortization?

Gavin James

Good morning Mike. We run those calculations towards the end of the quarter with regard to the current quarter there has not been a material difference yet.

Mike Widner - KBW

I meant at so just to be clear I meant in the Q2 numbers.

Gavin James

As for 12/31?

Mike Widner - KBW

Yes.

Gavin James

I don’t have that in front of me but I’ll get back to you on that number.

Mike Widner - KBW

Okay, thanks. So a little more conceptual I guess you guys mentioned kind of carrying a negative duration, negative one year duration on the agency book overall right now. That certainly implies an expectation of further curve steepening. I guess I am just curious I mean is that your expectation and also given that if you’re carrying negative one year duration at quarter end and the curve has actually flattened since then how do you feel about where book value is today relative to the quarter end?

Anup Agarwal

Sure. I mean they’re getting Mike I think the way we actually manage our hedging book based on as we kind of mentioned the comment I think our views are that rates will be range down but the reason we move to as I said in the commentary we move to negative duration is because sitting in September it seemed like even within that range bound the rates will rise. And we kind of saw the rates that 10 year yields rose up quite a bit. And I think within that yes I mean I think with negative duration your point being that look you will pay more for your hedges or the cost or your net NIM will be little lower in the rate where you are flat kind of rate environment on one end look and I think our view is that to be able to protect the book by having the negative duration in this range bound environment and at the same time what we want to achieve is by changing the leverage and adding the leverage because we still view positively about mortgage spreads.

Mike Widner - KBW

Got you.

Anup Agarwal

Did it answer your question?

Mike Widner - KBW

Well, I mean it kind of sort of answers the question but not entirely I mean I guess if I just step back I mean your book value is for all practical purposes flat Q-on-Q which is fine I mean you’re up 0.3% once you make all the adjustments and what not. But I mean rates did move substantially higher in the quarter I mean if you went into it and like you said with a negative duration in September I mean we had actually marked your book value up more positively than that. So I guess I am a little surprised that book didn’t do better given that negative duration. And I guess the second part of it is it seems is if that’s where you’re still positioned today and in fact with the asset portfolio is smaller you might have and the swaptions the substantial swaption book you have now it looks like you’re positioned at least to me at 12/31 for still having an expectation of rising rates and obviously they haven’t gone that way and like you said if they are range bound I guess I am just sort of trying to figure out do you really think they’re going to be range bound or are you actually really still positioning for rising rates…?

Anup Agarwal

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

Mike Widner - KBW

Got you, well I appreciate that. And I guess maybe just one final question. If I look at the -- this sort of relates to duration gap I mean all else equal running higher leverage and a longer duration gap tends to be more positive in bond fund in terms of earnings power. So you guys have taken leverage down and you’re running kind of a negative duration gap which again all else equal is going to make it tougher to generate earnings. And yet you guys are still carrying the highest yield in this space. And so with regard to the $0.80 dividend and sort of what you described as currently available spreads and leverage, I guess I’m just wondering, when there is an obvious implication if I put the three of them together which is an $0.80 dividend, $0.70 core earnings, you are already earned earning the dividend plus you have the negative drag of the fully diluted share count going up in the next quarter from the stock dividends…

Anup Agarwal

I mean I think Mike, I think the part, the reason for reduced leverage at that point in the last quarter was more driven by our increased allocation to non-agencies, and I think that’s really what caused our leverage to go down. If you removed the non-agency then the answer would have been that as we move the duration gap to negative, increase the leverage. And I think that’s really what you would continually see that I think the leverage came down more because we allocated more to non-agency because even with hedge adjusted and with leverage we kind of saw that that was a better return profile for us to add what we are seeing in non-agencies, and I think if we still see better opportunities, net of leverage, and what not in non-agencies, you could see us move more or at the end of it is that if you’re not seeing as many opportunities in non-agencies, leverage based on available leverage, then you could see us shift the portfolio slightly more to agencies and increase the leverage, just on our agency portfolio by adding more TBA’s, given that the duration gap is negative.

Mike Widner - KBW

Yes, no I mean it all makes sense and hard to argue with that, and certainly I do think the migration in the portfolio and more toward a hybrid model and more toward a more balanced equity allocation makes sense. I’m just really trying to think about that in terms of the dividend, and again if I come back to $0.70 of core earnings last quarter, versus an $0.80 dividend plus the drag of the higher share count that’s going to be more fully rolled through in 1Q, just wondering if you can comment on how you view that dividend relative to the earnings power?

Anup Agarwal

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

Mike Widner - KBW

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

Operator

(Operator Instructions) And our next question comes from Jim Young of West Family Investments.

Jim Young - West Family Investments

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

Gavin James

In terms of our view on interest rates or the economy and…?

Jim Young - West Family Investments

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

Gavin James

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

Anup Agarwal

Yes, I mean I think look I think our view is really driven by kind of the data we are seeing. And I think within the data what we’re talking about is you still see -- you still kind of see very low, the participation rate still continues to be low. And I think what we -- the reason for our view that economic growth will be slow is that ideally for the GDP growth to be higher, we expect CapEx expenditures to pick up. And what you have seen is, you really haven’t seen CapEx to pick up that dramatically at this point in time and that really should, and that’s really what we’re watching out for, that if we see the CapEx pick up and pick up enough to cause us to change our view on economic growth that’s what we will adjust our portfolio, but at this point in time, that lack of, lots of policy uncertainties and a lot of the policy uncertainties which are there I don’t see them getting resolved before the next elections and kind of the lack of CapEx expenditures those are really some of the things which are driving our view for this slow growth economy.

Jim Young - West Family Investments

Great, thank you. And then as part of that you had mentioned that you expect the long-term rates to be range bound, what is your current expectation for the 10 years bonds in 2014. What is the range you’re looking at?

Anup Agarwal

So, we are still looking at, in 2014 for 10 years we’re still looking at the range of 2.5 to 3.25.

Jim Young - West Family Investments

Okay. And with your -- morphing from a more an agency structure as when you went public to more of a hybrid model today, is that basically an acknowledgement that the trust award in agency bond is unattractive at this time?

Anup Agarwal

I mean look, we still have a massive amount of portfolio in agencies, I think it’s more of trying to build a balanced portfolio for where we can build with the best trust award, we still see values in it but we also believe in continued diversifying in where all the different sub segments where we can find attractive value. So it’s not only just non-agencies, we’re looking at opportunities in whole loans and resi side we’re looking at opportunities in the commercial mortgage side. You’ve seen us add little bit of CMBS and I think you would see that part grow so it’s acknowledgement that there is a broad, across the whole structure product space, there are many places where we can have, where we can find value and as we find value, we will actively shift our portfolio from agencies to non-agency or non-agencies and CMBS.

Steve Sherwyn

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

Gavin James

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

Jim Young - West Family Investments

Great, thank you.

Operator

And we have no further questions Mr. James.

Gavin James

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

Operator

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.

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