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Executives

Rick Cleary – COO and Assistant Secretary

Kevin Grant – Chairman, President and CEO

Frances Spark – CFO

Bill Shean – Managing Director, Investments.

Analysts

Steve Delaney – JMP Securities

Bruce Harting – Barclays Capital

Jim Ballan – Lazard Capital Markets

Douglas Harter – Credit Suisse

Mike Widner – Stifel Nicolaus

Larry Ramon [ph]

Eugene Fox – Cardinal Capital Management

Jim Young – West Family Investment

Henry Coffey – Sterne Agee

Kevin Casey – Casey Capital

Cypress Sharpridge Investments, Inc. (CYS) Q3 2010 Earnings Call Transcript October 21, 2010 9:00 AM ET

Operator

Good morning and welcome to the Cypress Sharpridge Investments, Inc. third quarter 2010 earnings conference call. During management’s presentation your line will be in a listen-only mode. At the conclusion of management’s remarks there will be a question-and-answer session. (Operations instructions)

Management has asked me to remind you that certain information presented and certain statements made during management’s presentation with respect to future financial or business performance, strategies and expectations may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

Forward-looking statements indicate or are based on management’s beliefs, assumptions and expectations of the CYS future performance taken into account information currently in the Company’s possession. Beliefs, assumptions and expectations are subject to change, risk and uncertainties are result of possible events or factors, not all of which are known to management or within control.

If management’s underlying beliefs, assumptions and expectations prove incorrect or change than the company’s performance and its business, financial condition, liquidity and results of operations may vary materially from those expressed, anticipated or contemplated in any of the forward-looking statements. In any events actual results may differ.

Management invites you to refer to the forward-looking statements disclaimer contained in the Company’s annual report on Form 10-K filed with the SEC, which provides the description of some of the factors that could have the material impacts on the Company’s performance and could cause actual results to differ from those that maybe expressed in forward-looking statements.

The company has asked me to note that the content of this conference call contain time-sensitive information that is accurate only as of today, Thursday, October 21, 2010. The company does not intend to undertake no duty to update the informations like future events or circumstances.

For opening remarks and introductions I’ll now turn the call over to Rick Cleary, CYS’s Chief Operating Officer. Please go ahead, Mr. Cleary.

Rick Cleary

Thanks Keisha. Good morning and welcome to CYS’s 2010 third quarter earnings conference call. Today’s call is being recorded and access to the recording will be available on the Company’s website at www.cysinv.com starting at 3:00 P.M. this afternoon.

With me here this morning are Kevin Grant, the Company’s Chairman and CEO, Frances Spark, the company’s CFO and Bill Shean, Managing Director of Investments.

To better understand today’s discussion, it’ll be helpful to have the earnings release that we issued last night. This release is available at the investor relations section of our website and as in past releases the earnings release includes information regarding non-GAAP financial measures including reconciliation of those measures to GAAP measures which will be discussed on this call.

I’m pleased to turn the call over to Kevin.

Kevin Grant

Thank you, Rick, and good morning. Welcome to our third quarter 2010 earnings conference call. This was another good quarter for us. The portfolio is performing well and we did two capital raises in the past four months, so we are making a significant dent in the expense ratio and we are able to invest the capital very, very quickly, it’s very good spread. We feel very good about the timing of the raises and the timing of our new investments. On the portfolio authority in place, we continue to experience light prepayments owing to the stability of 15 year mortgages and we believe this can produce a stable net interest margin for many quarters to come.

We invested in new capital right away after the September raise and had all the trades executed before the Fed meeting on September 21. This was a key date and key time to help inform our timing decision. During the Jackson Hole conference Chairman Bernanke’s first surfaced the notion of further large-scale asset purchases also known as QE2 and if this would provide more benefits than costs for this fluttering economy in Bernanke’s view. So we felt that the next FOMC meeting on September 21 was a key date to inform our investing phase. This decision process allowed us to execute very swiftly after this past capital raise.

We continue to spend a lot of time on liability management, we took advantage of the market and reset some hedges at lower rates and we extended their maturities which we think will help continue the net interest margins for longer than originally planned. We are also starting to use small amounts of long dated caps. Now caps provide the cheapest insurance we can find anywhere against the surprise interest-rate move in case our view of the economy proves to be incorrect. This, insurance is very cheap right now and using cap should allow us once again to lock up more of the cheap financing for much longer. The September raise was motivated by the same reasons as the June raise. We felt spreads were still good, and we could take the opportunity to make further dent in the expense ratio.

We also wanted to improve the liquidity of our stock, really after suggested over a number of our shareholders. It was very helpful to get invested quickly. As we have done in the past, we entered into forward settling purchases and this reduces our cost bases by nearly a point and helps our net interest spread for as long as we have been owned that asset once it settles. We feel very good about the execution and timing of the offering. The new capital from the June offerings cut our expense ratio by 57 basis points and the September raise will cut the expense ratio further in Q4.

It looks to us right now that the combination of the two capital raises will have successfully reduced our expense ratio by around a point since the first quarter of 2010. In summary, during the quarter, we scaled the portfolio in the business, this will help the company meaningfully going forward and help improve the stability of the dividend. Now I would like to turn it over to Frances to walk you through some of the highlights of Q3.

Frances Spark

Thank you Kevin and good morning everyone. I am pleased to report that the third quarter is highlighted by the following. We raised approximately $184.7 million in net proceeds through the public offering of common stock that closed on September 24 and as already mentioned by Kevin, all proceeds were invested prior to September 30 primarily adding to our portfolio of forward settling purchases. Our net asset value was $12.53 per share on 9-30 after declaring $0.60 dividend per share on September 9.

Our non-investment expenses as a percentage of net assets was 2.64%. As we see significantly with our recent capital raises as Kevin has already mentioned, around 57 basis points from Q2 of 3.21% and down 99 basis points from Q1 of 3.63%. Our GAAP net income was $1.9 million or $0.05 per diluted share. Our Core earnings for the quarter was $7.7 million or $0.24 per diluted share. Our component to the company's net income for the quarter was $11.3 million or $0.38 per diluted share, depreciation on forward purchases that accounted for unrealized depreciation [ph] on our income statement and that was excluded from our core earnings.

Our interest rate segment of hedge was 1.9% and this was impacted by the expense of hedging forward purchases in advance to the generating interest income. Once the forward purchase is settled we will return to more (inaudible) to 2.5%. Our weighted-average cost of Agency RMBS 102.5 reflecting the positive impact of the lower cost to forward purchases as already mentioned. As of September 30, 2010 the company had net assets of approximately $560 million. As you know we signed up Agency RMBS investment and as of September 30, 2010. Our Agency portfolio was approximately $4.5 billion. We had repurchase agreements of $1.5 billion and $2.6 billion impairable for forward purchases with the leverage ratio of approximately 7.5 to 1.

The leverage ratio at September 30 was higher than the leverage of 5.3 to 1 at June 30 (inaudible) to the June offering and being deployed throughout the quarter end. At the end of the third quarter our liquidity position was approximately $433 million of unpledged Agency RMBS, cash and cash equivalents. Lastly, I would like to not that as a result of the company adjusting to the hedges during the third quarter company realized $6.3 million of swap losses during the quarter. These losses will be amortized as three to four years for tax purposes (inaudible). I would now like to ask Bill to discuss the portfolio.

Bill Shean

Thanks Frances and good morning everyone. We are pleased with the portfolio we have constructed. In this environment it is helpful to have a flexible approach to asset allocation. We are now roughly evenly rated in fixed-rate mortgage in Hybrid ARMs and the vast majority of our fixed-rate mortgages are 15 year with some 20 year paper as well. So far it looks like the current wave of foreclosure related volatility will not impact our Agency mortgage market. We do expect prepayments to pick up some on our 2009 vintage mortgages. However it looks like processing delays and equity constraints remain and will continue to keep it damper on prepayments.

The bulk of the portfolio is now in new production and will be many months before these assets season and are exposed to normal prepayment behavior. As Kevin mentioned in his opening comments we completed all the purchases for the new capital from the September offering in very short order. Typically we will settle purchases forward about three months and this gives us a discount on the price of above one point for a 15 year mortgage and about three quarters of a point for a Hybrid in the current market. The earnings release provides a lot of details of the portfolio and our forward purchases. As of September 30, the company’s borrowing under repurchase agreement had a weighted-average rate of 29 basis points and a weighted-average maturity of approximately 30 days.

Our borrowings were at quarter end were stuck with an aggregate of 17 counterparties. Our borrowings remain widely spread amongst those counterparties so that we do not have a substantial portion of our borrowings with any one counter party. Haircuts will generally remain in the 5% area in the third quarter and the availability of government Repo continues to be good and competitive. Investing environment continues to be solid for our business. With that I would like to turn the call back to Kevin.

Kevin Grant

Thanks, Frances and Bill and Rick and now without any further review I just like to open up for question. We are happy to discuss whatever questions you have got about the third quarter and I’ll turn it over to Keisha. It takes a few moments to establish a queue but whatever is on your mind we are happy to talk about.

Question- and- Answer Session

Operator

(Operator instructions).Your first question comes from the line of Steve Delaney with JMP Securities. Please proceed.

Steve Delaney – JMP Securities

Hi, Good morning, everyone. Kevin I take it from your comments that and with leverages 7.5 that you got your portfolio is fully deployed at the current size including that $2.5 billion [ph] of forwards. What I want to know is your total hedge positions including the caps were about $2.4 billion at September so about 52% of total MBS and so do you look at your swap position as being fully in place as well as the portfolio side.

Kevin Grant

Yes. I think the swap positions are about right. If we get an opportunity we might add another cap just because they are so darned cheap but I think the hedge is above were we wanted.

Steve Delaney – JMP Securities

So pretty much the balance sheet as we have obviously got forward settlements in the fourth quarter but absent any further capital activity kind of which you are holding right now is a kind of the portfolio will go into 2011 within the first quarter with everything fully deployed in all pretty much all the forwards settled.

Kevin Grant

Yes that’s what it looks like. I really don’t anticipate any tweaks between now and year-end with may be the exception of the cap but we will just wait and see on that.

Steve Delaney – JMP Securities

Okay, and then Kevin obviously we kind of have to throw out the actual reported spread for the quarter just because basically you had the way effectively your entire funding was it your swap in cap rate given it to, because the bonds have been settled and the 28- 29 basis points Repo was in place. I think in your press release you disclosed, I don’t want to put words in your mouth, but its sound like you trying to say a normalized spread for the quarter, many of them were like 255 basis points or something like that?

Kevin Grant

Yes, we actually calculated for you and (inaudible) put it in there, its 255. Yes, we understand its little confusing to make all these adjustments that we did it for you.

Steve Delaney – JMP Securities

Alright great and so just looking at the $2.5 billion, the forward settlements and looking at those coupons and what we think the dollar price work. Can you just comment on sort of which you think the average spread on the stuff that is not on the books for the third quarter so how that will compare on the new positions held or compared to that sort of legacy run rate of about 255.

Kevin Grant

It should be about the same. It’s really a carbon copy. The September raise was a carbon copy pretty much of the June raise.

Steve Delaney – JMP Securities

In terms of the way you see spreads?

Kevin Grant

Yes, in terms.

Steve Delaney – JMP Securities

Okay, alright thanks a lot. Thanks for taking the time.

Kevin Grant

Okay.

Operator

Your next question comes from the line of Bruce Harting with Barclays Capital. Please proceed.

Bruce Harting – Barclays Capital

Yes thanks. So Kevin there is not – there is no risk of any – this does not impact dividend in this period or future periods. Just wanted to clear.

Kevin Grant

Well the way to board looks at it is, what they ask us same as the last dividend, what they ask us is, they are happy to pay out the ROE’s and look past some of the issues with forward settlement transactions, if the ROE exists and it is sustainable, which it is then they are completely content maintaining. Do you notice that, the way I look at it is the economic earnings in the quarter were $0.62 we paid $0.60. So the board is actually doing a little bit concerned not massively concerned but a little bit conservative on the payout and looking at the market now looking at the environment now I don’t see any reason that the board would change their mind on that approach of course.

Bruce Harting – Barclays Capital

Okay and from a cash flow prospective it is not at timing issue in terms of cash ability. Just to be clear.

Kevin Grant

No, we have tons of liquidity.

Bruce Harting – Barclays Capital

Okay. And any changes you can discuss in terms of pricing on product you're buying any – or the swaps cost right now?

Kevin Grant

For the month of October and you could pull these numbers up on Bloomberg. Interest rates on the hedges are ritually unchanged, and 30 year mortgages are up about a point we really don't have any, 15 year mortgages are up about half a point. Hybrids probably unchanged.

Bruce Harting – Barclays Capital

Unchanged, yes.

Kevin Grant

Hybrids are about unchanged on the month of October.

Bruce Harting – Barclays Capital

Okay, thanks I will get back in the queue.

Operator

Your next question comes from the line of Jim Ballan with Lazard Capital Markets. Please proceed.

Jim Ballan – Lazard Capital Markets

Great thanks a lot. Kevin could you talk a little bit about what the distributable taxable income for the quarter was, maybe some sort of just maybe some sort of an estimate taking into account the gains in the quarter.

Kevin Grant

Well, we look at it a little bit differently Jim. We think Core Earnings are really our proxy for the dividend. And distributable earnings its really, it's not a concept that we really use here, so we really use Core Earnings plus some adjustments to get us closer to an estimate of what the ROE is, and that’s just as the way we do it.

Jim Ballan – Lazard Capital Markets

Right. When you think about the adjustment side, what type of adjustments do you need.

Frances Spark

Jim this is Frances. As you know we have this amortization of the foreclosures which factors into against the taxable income over the period, over the next few years so that comes through as an adjustment something that we can pinpoint for you at this stage, yes we need to wait till the end of the year is to be clear when we provide the characterization of the distributions to shareholders. That's one of the components that Kevin mentioned, the differences between the core earnings and the unrealized gain on the Ford, that we have mentioned that we included in this quarter's dividend.

Jim Ballan – Lazard Capital Markets

Okay, great thanks a lot.

Operator

Your next question comes from the line of Douglas Harter with Credit Suisse. Please proceed.

Douglas Harter – Credit Suisse

Thanks. Something you could just help us through sort of the appreciation on the swaps, how much of that is from some sort of covering that the discount versus underlying moves in the (inaudible) prices.

Kevin Grant

Are you talking about the swaps?

Douglas Harter – Credit Suisse

The forwards, the forwards, I’m sorry.

Kevin Grant

We will break that up for you is just one number. Its $0.38 am not sure you want us to teeth out.

Douglas Harter – Credit Suisse

You talk about the fact that you are buying, when you buy these forwards you're buying about discount what you would pay in the current market, so some of that gain, some of that appreciation would be sought of recovery of that discount versus the underlying assets when up price. That would result in appreciation as well correct?

Kevin Grant

Right, right.

Douglas Harter – Credit Suisse

Could you separate those two components?

Kevin Grant

Yes, I mean just for round numbers just for the sake of, give all the purchases and the settlement dates so you can go through the details of (inaudible). But, when you buy 15 year mortgage three months forward, not all the purchases three months forward, a portion of from the mark. In this market is it about a point discount, so you make that point back just through the passage of three months. For the hybrid market that discounts about three quarters of a point.

Douglas Harter – Credit Suisse

Okay, thank you.

Operator

Your next question comes from the line of Mike Widner with Stifel Nicolaus. Please proceed.

Mike Widner – Stifel Nicolaus

Hey, good morning guys and congrats on solid but difficult to interpret quarter.

Kevin Grant

Appreciate it Mike.

Mike Widner – Stifel Nicolaus

To that last point, last question I guess, last question. You have provided all the details, and for the forwards you have out there, just wondering if I can do my own math, or wondering if you wouldn’t mind quantifying your math with the forward discounts right now what you see happening in 4Q, and that’s just simply applying the drop that you guys talk about to, the weighted average duration or the individual bond duration of how far forward you are purchasing it.

Kevin Grant

Yes Mike, we're kind of getting it to the level of guidance and we really don't like to provide guidance so I don't want to say no but I think you can use the one-point discount on 15 years on (inaudible) forward purchases and three quarters on a hybrid and that is for three months so you have two are just like a settlement date.

Mike Widner – Stifel Nicolaus

Okay, so if I assume 24 basis points from a month across the board, my math comes out with basically $10.5 million or $.24 per share. Does that sound ballpark to you?

Kevin Grant

I have not done that math, we have not done that math so we cannot answer, no

Mike Widner – Stifel Nicolaus

Ok let me ask u a question, I can quickly use the topic. You have talked about that you like the balance sheet the way it is, the hedges and swaps, it is actually two related questions. First is, I just wanted you to walkers through the math on how the caps flow through the income statement and then second just given their swaps are in the three-year swaps at 75 basis points today and four-year swaps basically ran at 100 basis points. Wondering , given the kind of hedged spreads you could get with that, you would contemplate taking leverage even higher. Swapping an even larger portion of the portfolio (inaudible) looking at the ability to get four year swaps at 100 basis points versus three and quarter say on 15 year bonds. It is just a great environment. So anyway two related questions there. Just the math on the cap and that he could contemplate, sort of taking leverage a little higher given the environment.

Kevin Grant

Yes, got it. On that is caps, the way caps work is you pay for them in priority on day one, and that impacts your liquidity. A cap is far and away to the cheapest way to hedge, but because it impacts your liquidity because you got to pay for it on day one. You would not do that, it would impact your liquidity too much. But far and away the cap is the cheapest, the cheapest hedge. So a little bit of cap makes sense but to replace all this swaps with caps really does not make sense just because of the liquidity impact. The way they flow through as market to market just like anything, so it flows through the GAAP Income statement just like any market to market item and then it is expensed through time basically in a straight line. So that is how we flow through the income statement.

Now, if interest rate back up a lot to where the capital was struck, then obviously that is going to be reflected in the market to market in the future but if it rates back up and goes above the strike when we start receiving interest every quarter. And where you can set a strike right now on cap is really low. It is lower than you would never think you would ever buy a mortgage back security.

Mike Widner – Stifel Nicolaus

And the just, a quick point of clarity. You basically pay for the Upfront and then let's say it is a four-year duration and it's like you pay $2 million for whatever it is. You amortize that $2 million basically straight line over the next four years, is that how it is?

Kevin Grant

That's right. And then on the leverage question, Can I go on to the leverage question?

Mike Widner – Stifel Nicolaus

Given the opportunity to use caps in particular and how cheap they are and how much excess liquidity you have, if that does not, I would like to talk about opportunity.

Kevin Grant

Some amount of cap I think is very helpful because it allows you to lock in off your cheap financing for longer so be do like that. Now on the leverage, we are about where we want to be essentially what we before September 21 is we not only put the new capital to work but we do think it's going to be a little bit of a pickup in prepayments here, so we did an estimate on what we think that might be, a reinvestment need might be during the quarter and we got ahead of that curve and obviously we're glad we did. I think the leveraged is going to be around, or maybe just slightly ahead of seven times, some people have asked, well if spreads were tighter would you take the leverage up and I think the, there is no easy answer to that, the question is going to be why are spreads tighter. The spreads are tighter just because, it’s a freight train that I might feel comfortable taking the leverage o a little bit but if presence are – it’s all a function that a reason the spreads are tighter, so it’s hard to answer the question right now. The principal governor on leverage is liquidity and in the Repo market haircuts are still 5% generally speaking. There are a few hints of haircuts drifting a little bit lower but I don’t think that’s going to be wide spread for a long, long time and then given the fragility of the system and the amount of government involvement ,I really think that we want to have a lot of access liquidity in this environment. So I see seven, seven and a quarter kind of ballpark going forward. I think that’s a good number for modeling purposes.

Mike Widner – Stifel Nicolaus

Oh great thanks. I appreciate it guys and again congrats in the quarter.

Kevin Grant

Thanks Mike.

Operator

(Operator instructions) Your next question comes from the line of Larry Ramon (inaudible). Please proceed.

Larry Ramon

Hi good morning and thanks for the clarity. I’m un-muted to the story. I just wanted to make sure I understood the one comment that you had made earlier with regards to the economic earnings you mentioned by $.62 for the quarter. Would that be stabilized portfolio once all the pieces have now been settled with a stabilized and interest margin of 2.55%, as the spread on a per-share basis is that, I how I look at that $.62

Kevin Grant

Yes that’s a pretty good proxy.

Larry Ramon

Okay good. That's what I wanted to make sure and that is what you are using, and that is what the Board looked at as you mentioned earlier with regard to what the core earnings are as per determining the dividend I have asked earlier?

Kevin Grant

You got it.

Larry Ramon

Okay great. Thank you very much for that.

Kevin Grant

Thank you.

Operator

Your next question comes from the line of Eugene Fox for Cardinal Capital Management. Please proceed.

Eugene Fox – Cardinal Capital Management

Hi, Kevin. Thanks, Looking at the change in the book value it look like most of the hit in the quarter Kevin related to marking your swap portfolio at the market and it did not appear that you got, it should have been an offset on the portfolio. Can you sort of comment on the market to market in the swap portfolio, and how you would expect that to behave. I sort of think about it as an opportunity cost in terms of financing, you are basically locking in a spread but normally I think you would probably get a pickup in the portfolio to offset some of that market to market. It did really seem to happen. So I just like any thoughts that you have

Kevin Grant

Well it’s really the timing of how these markets are moving against one another. There is a big rally in a rate in the summer and the mortgage market did not keep up and this was one of the motivation to do another transaction in the September. So, essentially mortgages underperformed swap. So that’s why you did get to see the financial the swaps going against us in the mark-to-market and the mortgages just did not keep up. Now as I mentioned a little bit earlier and I (inaudible) for you, in the month of October as the prices are up but swap rates are virtually unchanged, so some of this summer behavior has already reversed.

Eugene Fox – Cardinal Capital Management

And Kevin what do you think drove that was there anything that, you would point to?

Kevin Grant

Yes there was a- if you remember in July there was a big drop in rate and the refin-index spike and all of a sudden the mortgage market said, aha, prepay wave on and that has not compared and in the October prepayment report, prepays were very, very subdue. I think the market was a kind of shocked at how light prepays were and how non-responsive the home owner is to this incredible rate environment and this story is just continuing to unfold so this is a big reason that mortgages have done well in October.

Eugene Fox – Cardinal Capital Management

That’s great. Thanks Kevin.

Operator

Your next question comes from the line of Jim Young with West Family Investment. Please proceed.

Jim Young – West Family Investment

Yes hi. Kevin I was wondering what is your view and expectations for (inaudible) and how have you adjusted the portfolio work from an asset and liability perspective to reflect these views.

Kevin Grant

Well the upcoming said meeting – this is a roll out of QE 2. That’s really what this really this looks like. My personal feeling is that the economy kind of itching along and trying to recover on its own so I don't think it's necessary but. The sentiment of the FED is, I guess that they lost patience; they've floated the trial balloon (inaudible) and then we last (inaudible) meetings and the market generally thinks that they are going to announce QE2 in this, November Fed meeting, so this is really the big motivator for us to just make sure that we are fully invested and not dillydally about putting a new capital to work. So we have already kind of, rolled out the next couple of Fed meetings. We're not taking debt on this, but we just want to make sure that we're fully invested.

Operator

We have a follow-up question from the line of Mike Widner with Stifel Nicolaus. Please proceed.

Mike Widner – Stifel Nicolaus

Hey, thanks guys. Just wanted to go to I thought we haven’t talked much about the (inaudible) in the comments on the general expenses. How we might see this adjust even the higher share count here. I see the line items in your expenses, you got management fees, and I think we know how those scale with, equity. But then we are related party management compensation and G&A and other. So there is latitude, should we generally expect us the flattish, or should we expect this sort of scale with the portfolio, so how should we look at those.

Kevin Grant

Will you know they generally, they are generally prefixed. I don't think we expect some of those things to go out up and (inaudible) is big item and you don't know what 2011 is going to look like, and you haven't got a quote yet because it would be six months out before we could get that, so most of these things are pretty close to fixed.

Mike Widner – Stifel Nicolaus

Okay, so the latitude, we should expect it to be fixed and then again you have told us how to stay in the other one so we should see the basic drop that you talked about, estimating about 100 basis points in terms of overall (inaudible) where you were prior, previous to the two capital raises.

Kevin Grant

Yes, in my mind, and this is just me talking. I have in my own mind a goal getting the expense ratio below 2%. And I don't know exactly at what capital level because I don't know what the (inaudible) is going to cost two years from now until (inaudible), but in my mind I'd really would like to get the expense ratio below 2.

Mike Widner – Stifel Nicolaus

Okay, and for you to do that, yes that certainly implies the need to, for most likely the need to raise more capital and so on that front we are not providing any specific guidance. How do you think about when is the right opportunity to raise capital and as you said the three variables, like people talk about. Is the spread environment good, would it be earnings accretive, and would it be value in accretive, are all three of those necessary requirements of how do you look at kind of what it takes.

Kevin Grant

Well all those things, all those three things are really requirements as the mix is changed though, because when we were at $250 million, then we were we were kind of in a small cap, you could make a huge impact on the expense ratio and by scaling the company getting better liquidity in our stock, it is obviously it saturates better so it makes the other things possible. At our scale now, we're really in a spot where, and it is terrific, where the next capital raise, the hurdle can be higher. And not only does the investing environment need to be good but all the other metrics needs to be good as well. So I think the hurdle tier now, and really it's a good spot for the company to be in right now.

Mike Widner – Stifel Nicolaus

Okay, should I think of this threshold at some point of the stock trading where it could be a book value in accretive and possibly earnings accretive to neutral that kind of threshold.

Kevin Grant

I think that is a minimum threshold, I can't…

Mike Widner – Stifel Nicolaus

You would not do something, at this juncture you would not see, certainly doing something that is diluted for you either?

Kevin Grant

I cannot imagine an environment where it would be that compelling.

Mike Widner – Stifel Nicolaus

Ok great, appreciate it guys.

Operator

Your next question comes from the line of Henry Coffey with Sterne Agee. Please proceed

Henry Coffey – Sterne Agee

Good morning and I apologize if we go over some ground here, I got on the call about 10 minutes late. I am looking at your disclosure on the full issue of. Forward discount, it is $11.3 million of unrealized appreciation, when does that cash come your way so to speak.

Kevin Grant

Well, it is not cash, it is a movement in the market as you approach (inaudible) settlement dated security.

Henry Coffey – Sterne Agee

So in theory you bought the bonds that are 1% discount, and you had an appreciation that normally would be recorded in book value. When we look at the fourth quarter, are you going to, is the mechanism going to be the same that a portion of the dividend distributed is going to be this unrealized gain related to quote the drop or well be back on course for more normal order.

Kevin Grant

Well I think Q1 will be much easier to look at all the metrics in the traditional way. Q4 still have this mattering of forward settles and you can do the math by line item because we give you line by line detail.

Henry Coffey – Sterne Agee

Great. And that was really helpful, yes.

Kevin Grant

Yes, so it's just easy to build that out.

Henry Coffey – Sterne Agee

So, it is moreover still a sizeable view that, that instead of putting these unrealized gains in book value you distributing them. There is no real like cash component to this element of the transaction.

Kevin Grant

No, there is no cash component. The way the board looks at it is the ROE commences on the day you do the trade to buy the assets. It does not come in when you settle the assets, it commences when you do the trade. So as long as the ROE is there why look around with your payout ratio and if the ROE is there and you're earning a ROE ahead of your dividend, why does the share holder care, the share holder cares about the return you earn which is obviously the dividend. So what the board says as long as the ROE exists and if it exist on a trade date it helps.

Henry Coffey – Sterne Agee

It is the, the return is there, but in this case it is from kind of locked in realized depreciation.

Kevin Grant

Right. And the thing is going forward Henry, this is, because the company is kind of got into a good spot in terms of scale. This is going to be a lot less of a factor going forward, and we really went from $250 million of capital to $550million or whatever, the rate has had a big impact but going forward into 2011, 2012 whatever. It's going to be a lot less of an impact, but all the companies do forward transaction it is just the way the mortgage market works.

Henry Coffey – Sterne Agee

Great, right and then the you are looking at the swap breakage what is your, you are a couple of quarters to add. Is there a point you obviously got your pay rate down pretty dramatically. I was wondering if you do the math for me really quickly, what is the weighted average pay rate on the portfolio now and how likely to simply do 151and is that the way you're going to keep it or if rates keep falling it's going to be more swap breakage in subsequent quarters.

Kevin Grant

Well you know that 151 is pretty down low and the way we look at it is just kind of help as in our own minds to answer this question, because obviously we don’t know, is will we ever by a mortgage with a coupon less than 151. And I think the answer is no, but in this (inaudible) will never say never so any assets that we put on against that stocking hedge is going to produce a positive net interest spread. So, it's probably no more than this but we just going to redefine the opportunity in the marketplace that's all.

Henry Coffey – Sterne Agee

In terms of, I know we talked a little bit about leverage, but in the current market you are going to be intent to kind of keep your portfolio where it is.

Kevin Grant

Yes, on leverage I see it is basically sticking about where it is, I did mention earlier that we did invest a little bit ahead of the curve... so kind of low... where I see a kind of normalized out.

Henry Coffey – Sterne Agee

Alright. Thank you, thank you very much.

Operator

We have a follow-up question from Bruce Harting with Barclays Capital Inc. Please proceed.

Bruce Harting – Barclays Capital

Thanks for providing the schedule that everything you purchased in the forward market, but what, can you just talk is, when you are picking, can you just talk about the decision-making three as you laddering these into your portfolio. Considerations on rate risk Kevin, weighing against a coupon and while the decay in the hybrid coupon as you go forward is that just time value and money in terms of when you are purchasing and then what are the hybrids exactly, are they 3151 and how do you make that selection. Just a little bit of behind the curtains on your portfolio management decisions.

Kevin Grant

Yes on the asset side we are really buying new productions. So we are kind of limited in the coupons that are available and the mix of production that’s available. This is particularly true in the hybrid market, even by any (inaudible), we are really not making any so it’s principally 51s and a small amount of 71s. The fixed rate decision for the 15 year purchases that’s much more generic. There are the decision 3 really is, are bonds available for short settled meaning today and generally they are not or where is the best liquidity and the best pricing out in the forward months and usually that has been about three months out and in the 15 year market what they are making now are three and a half’s.

You can probably still get some 4s but not very many but they are really making three and a half right now. So the asset selection decision is less about coupon in that kind of mix because you are limited to what’s being produced. The hedging decision there we got, I think there is more magic in the hedging decision than on the asset decision in this market. There are the questions is do you set a cap, you set a three year swap, you set a five year swap, you do a forward settler and we price all these things out to basically figure out where the best and most sustainable net interest spread is and what we see is the mix of we have got right now.

Bruce Harting – Barclays Capital

How granular can you get into the any of these pools? Are you able to cherry pick geographies or not at all.

Kevin Grant

Well typically with the forward market and this is one of the beauties of the forward market. We can stipulate how the pool will be constructed. So we can say to the originator, we can give them a list of things we want in the pool and list of things that we don’t want, some of those stipulations you might have to pay for and some of them you can get for free, obviously the ones you get for free, go for it. And then on the other step, you got to make a decision whether it’s worth it.

Bruce Harting – Barclays Capital

And just to conclude all the noise on foreclosures (inaudible) virtually no impact on you other than could it create a little bit of delay in some foreclosure activity and make it look, foreclosure prepays look artificially well for the next month or two until this is worked it out and then you get a little bit of a surge in say December, January or.

Kevin Grant

So for agencies everything is brought out now. Once it goes to 120 days delinquent so the foreclosure pays really have nothing to do with the agencies forward at this point. I do think this is putting a lot of cold water on mortgage originators and it is really slowing down the new application process, because nobody wants to mortgage put back to them. And what that is doing is slowing down just normal prepays then I think, home owners broadly, all home owners are suffering from this in the form of a very, very delayed reside [ph] process.

Bruce Harting – Barclays Capital

So how do you, what you, my concluding question would be how do you think it gets worked out, I mean, today it looks like just, have hour ago I got an e-mail from some new service saying New York is now making the lawyers responsible to make sure there is no, one of those, someone who came out of the court in Albany saying that they are going to hold the lawyers that are representing the banks responsible that they have made sure that all of the foreclosure documentation has been properly completed. But the…

Kevin Grant

But, this so (inaudible). I have no idea of how it’s going to be worked out.

Bruce Harting – Barclays Capital

Alright, unfortunately right. Okay thanks.

Kevin Grant

Okay.

Operator

Your next question comes from the line of Kevin Casey with Casey Capital. Please proceed.

Kevin Casey – Casey Capital

Two questions. I just want to clarify the unrealized is that obviously it is not included in the core earnings, but is it not included also in the book value?

Kevin Grant

No .It’s included in the book value.

Kevin Casey – Casey Capital

Okay, have you thought about the quantities [ph], and it seems like it is consensus, than it is (inaudible). What if it doesn't happen or if they do something probably knew or creative that nobody has kind of thought about?

Kevin Grant

If it doesn’t happen the curve is going to steepen up because it’s probably 50 basis points of value in the ten year treasury and this is a principal motivation for putting on another cap and the caps are very, very helpful so it’s one of the thing, that you saw in the quarter is putting on cap. And these are very, very leveraged to forward rates and that’s and that’s really the tenure so in that scenario of 50 basis points back up we really got this portfolio we think. We got the NAV nailed down.

Kevin Casey – Casey Capital

Okay. And what is it some sort of bonds or small businesses were some other creative thing that nobody has kind of thought about. I don’t know.

Kevin Grant

I don’t know Kevin. I hope they come up with something that works.

Kevin Casey – Casey Capital

Alright, thanks.

Kevin Grant

Thanks.

Operator

We have a follow-up question from the line of Eugene Fox for Cardinal Capital Management. Please proceed.

Eugene Fox – Cardinal Capital Management

Hi Kevin, I think you are going there anyway, but just a couple of questions related to the hedging aspects of the portfolio. Were a three-year swap today?

Kevin Grant

Generally 70, 72, 72 basis points.

Eugene Fox – Cardinal Capital Management

Okay, obviously if they are cheap. In terms of the cap you did a 2% cap, any rational wide that particular strike price, as opposed to low-end, how do you think about replacing some of your existing swaps with caps .

Kevin Grant

The strike is really a function of timing because when you go into the market, then, it is kind of normal default strike is we have forward rate is where the forward rate arc. So it’s called an at the money cap. If you want to put on in the money cap in other words it’s buy down that rate you will pay for it. You will pay a lot for it.

Eugene Fox – Cardinal Capital Management

Okay.

Kevin Grant

You can definitely set an out of the money cap and kind of look at it is disaster insurance, and that’s obviously cheaper too but you don’t really get the bang for the buck in the mark-to-market, in just like a 50 basis points stock up and rates. So that is really why, so the (inaudible) level is really a function of when you are in the market. What was the other part Eugene?

Eugene Fox – Cardinal Capital Management

Will Clayton [ph] come as basically buying out some of your existing swaps and replacing them with caps at different points along the old curve. Forward curve.

Kevin Grant

We look at that. We look at that from time to time and you know the thing is, I mentioned earlier is that when you put on a cap, you pay for it on day one, so it really impacts your liquidity. It is (inaudible) way of hedging, plus it is the liquidity drags that you really got to take into account. So there is a possibility but I am pretty reluctant to do that generally.

Eugene Fox – Cardinal Capital Management

So the bottom line is, you are pretty comfortable with what you have but as your existing swaps roll often, it does not look like you have anything rolling off until next May. We can assume that he would replace those.

Kevin Grant

Yes, I mean we're going to, long-term this portfolio is going to be hedged, so we went ahead at long-term.

Eugene Fox – Cardinal Capital Management

Okay, thanks Kev.

Operator

There are no further questions in the queue, I will now turn the call back over to Mr. Cleary for closing remarks. You may proceed.

Rick Cleary

Thanks Keisha, and thanks everyone for taking the time to participate in our call this morning, and have a good rest of the day.

Operator

Ladies and gentlemen, thank you for your participation in the conference. This concludes the presentation. You may now disconnect and have a great day.

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