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Executives

Alexandra Giladi [ph]

Stewart Zimmerman – Chairman and CEO

Craig Knutson – EVP

Ron Freydberg – EVP

Bill Gorin – President, Director

Analysts

Bose George – KBW

Steve DeLaney – JMP Securities

Jason Arnold – RBC Capital Markets

Mike Taiano – Sandler O'Neill

Matthew Kelly – Morgan Stanley

Henry Coffey – Sterne Agee

Gabe Poggi – FBR Capital Markets

Dan Furtado – Jefferies

Douglas Harter – Credit Suisse

Mike Widner – Stifel Nicolaus

Jim Ballan – Lazard Capital Markets

Matthew Howlett – Macquarie

Jim Young – West Family

Stephen Zadeklik – Private Investor

MFA Financial, Inc. (MFA) Q3 2010 Earnings Conference Call November 4, 2010 10:00 AM ET

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the MFA Financial Incorporated Third Quarter 2010 Earnings Conference Call.

(Operator Instructions)

At this point I’d like to turn the meeting over to Ms. Alexandra Giladi. Please go ahead.

Alexandra Giladi

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

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

These and other risks, uncertainties and factors including those described in MFA’s annual report on Form 10-K for the year ended December 31, 2009, quarterly reports on Form 10-Q for the quarters ended March 31, 2010, June 30, 2010 and September 30, 2010 and other reports that it may file from time to time with the Securities and Exchange Commission could cause MFA’s actually results, performance and achievements to differ materially from those projected, expressed or implied in any forward-looking statement it makes.

For additional information regarding MFA’s use of forward-looking statements, please see the relevant disclosure in MFA’s quarterly report on Form 10-Q for the quarter ended September 30, 2010 and/or the press release announcing MFA’s third quarter 2010 financial results. Thank you for your time.

I would now like to turn this call over to Stewart Zimmerman, MFA’s Chief Executive Officer.

Stewart Zimmerman

Good morning. Good morning and welcome to MFA’s third quarter 2010 earnings call. With me this morning are Bill Gorin, President; Ron Freydberg, Executive Vice President; Craig Knutson, Executive Vice President; Tim Korth, Senior Vice President and General Counsel; Teresa Covello, Senior Vice President and Chief Accounting Officer; and Kathleen Hanrahan, Senior Vice President. By way of introduction, also joining us this morning is Stephen Yarad, our Chief Financial Officer.

Today we announced financial results for the third quarter ended September 30, 2010. Recent financial results and other significant highlights for MFA include third quarter net income per common share of 27 cents and core earnings per common share of 22 cents. Book value was $7.83 per share at the end of the third quarter.

In the third quarter our non-agency residential mortgage-backed security portfolio including mortgage-backed securities, underlying mortgage-backed security forwards, generated non-levered loss adjusted yield of 9.27%. At September 30, 2010, we owned $2.351 billion of non-agency mortgage-backed securities including MBS forwards, advertise cost of 68.1% of par.

In the third quarter our agency MBS portfolio generated unlevered yield of 3.93%. At September 30, 2010, we owned $6.181 billion of agency MBS consisting of 5.731 billion of hybrid and floating rate mortgage-backed securities and $449.3 million of 15-year fixed rate mortgage-backed securities. These agency MBS had an average cost basis of 101.6% of par.

Subsequent to quarter-end, we sold $985 million in principal value of non-agency mortgage-backed securities as part of a re-securitization. In connection with this transaction, $246 of AAA senior bonds were issued to third-party investors or via a trust at a pass-through rate of LIBOR plus 125 basis points. As required under GAAP, we will consolidated the re-securitization and will account for this transaction as a financing of the underlying mortgage-backed securities.

For the third quarter ended September 30, 2010, we generated net income available to common stock of $75.2 million or 27 cents per share of common stock. Core earnings in the third quarter were $61.70 million or 22 cents per share of common stock. Core earning represents a non-GAAP financial measure which reflects net income excluding changes in the unrealized net gains on MBS forwards.

On October 1, 2010 we announced our third quarter 2010 dividend of 22.5 cents per share of common stock, which is paid on October 29, 2010 to stockholders of record as of October 12, 2010.

I would like to go over certain additional data highlights as they pertain to our third quarter 2010 results. Leverage overall debt to equity, 2.62 times. Portfolio spread, interest-earning assets minus cost of funds, 2.56%. Our MBS net spread, which is mortgage-backed securities net yield minus cost of funds, 2.84%. Our repricing that [ph] assuming a 15% CPR of 17 months and our agency CPR, 23.8%

I would also like to take this opportunity to briefly touch upon the issues relating to the foreclosure moratorium, mortgage loan put-backs and other servicing-related deficiencies impacting the mortgage and mortgage-backed security markets that have been the recent subject of many highly-publicized news reports, conferences and public debates. We are actively monitoring these issues and are currently evaluating all of our options. We are focused on protecting MFA’s rights and interests in these matters.

We are aware of several actions presently underway by investor groups, state attorneys general and various trade groups relating to both the foreclosure and put-back issues and are closely watching how these actions play out. Several of these groups are acting to protect the interest of investors in non-agency securities such as MFA, and these actions may be potentially in order to the benefit of all investors in the impacted securities.

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

Question-and-Answer Session

Operator

(Operator Instructions)

And we do have a question from the line of Bose George with KBW.

Bose George – KBW

Hey, good morning, guys. Congratulations on a good quarter.

Stewart Zimmerman

Thank you, Bose.

Bose George – KBW

Just wanted to – first question I had, just on the re-REMIC that you did. I was just curious how you see the economics of doing the re-REMIC versus getting funding in the repo market. And when you do that, should we see it as kind of a substitute for repo or incremental leverage?

Craig Knutson

Hi, Bose, it’s Craig.

Bose George – KBW

Hi, Craig.

Craig Knutson

I think the answer is probably both. The securities that we issued to third-party investors were in a rate of LIBOR plus 125, which obviously looks very much like repo except that there’s no haircut and no recourse obviously. But in addition, it also creates a large portion of securities that have investment grade ratings that make it very easy to finance. So I really think it’s both. It’s a form of repo in the bonds that are issued to third-party investors, but it also facilitates repo financing on much of the rest of the securities.

Bose George – KBW

Okay, great. Thanks. And then just a question on the agency side. I think this is the first move that you guys have had into the 15-year fixed sector. Can you just comment on your approach to what you’re doing there?

Stewart Zimmerman

Ron [inaudible] I believe on our last press release we also talked about adding 15 years.

Bose George – KBW

You did? Okay.

Ron Freydberg

It was – we did some in the second quarter.

Bose George – KBW

Okay.

Ron Freydberg

We did have a little bit in the third quarter. We think from an incremental basis it gives us better yields and a little bit better duration than some of the longer hybrids that have been out there. So we pick specific bonds that we thought were going to protect us and going to protect us from a duration and from an earnings standpoint.

Stewart Zimmerman

Bose, what we did, as you know, we have basically been a non-buyer [ph] in terms of hybrids. What we saw, we saw a bit of opportunity in the 15-year, we took advantage of it. That’s really what it was.

Bose George – KBW

Okay. And from a duration perspective, you think it’s whatever equal to or less than maybe a 7.1?

Ron Freydberg

I think depending upon the coupon, the higher coupons are closer to 5.1’s, as you get to the 4% you’re probably closer to 7.1’s.

Bose George – KBW

Okay, great. Thanks.

Craig Knutson

Let me just add two things. In terms of the non-agency strategy on the re-securitization, so, one, obviously gives us some permanent funding, it also gives us higher-rated assets to borrow against, so it makes the availability of repo funding more predictable in the future.

Bose George – KBW

Okay.

Stewart Zimmerman

And therefore you’ll see over time we may be comfortable running with more leverage on the non-agency side. So that’s the key to that execution.

The other thing I’d like to add on Ron’s answer on the 15 years, we did a lot of the buying in the second quarter. We bought these well, we bought them at the right time, on the 15 years.

Bose George – KBW

Okay, great. Thanks for that.

Stewart Zimmerman

Thank you.

Operator

Thank you. And we’ll move on to the line of Steve DeLaney with JMP Securities.

Steve DeLaney – JMP Securities

Hey, good morning everyone.

Stewart Zimmerman

Hi, Steve.

Steve DeLaney – JMP Securities

In the third quarter you continued to steadily add the non-agency paper but also sort of an equal amount of agency paper, a little over 350 million, 370 million each, kind of a 50/50. Is that – should we expect that as you go forward and add additional fund, additional non-agency, that you’ll keep this relationship relatively even?

Stewart Zimmerman

Steve, there really wasn’t a bogey, it was really where the opportunity was.

Steve DeLaney – JMP Securities

Okay.

Stewart Zimmerman

And during the quarter we saw our opportunity both in the agency and non-agency side. So it wasn’t that we wanted to be 50/50 or 70/30 –

Steve DeLaney – JMP Securities

I see.

Stewart Zimmerman

– [inaudible].

Steve DeLaney – JMP Securities

Okay. On your ‘40 Act exemption, I mean I believe that your kind of absolute level is to maintain at least 55% of agency hold pulls [ph], right?

Stewart Zimmerman

Right. That’s the rule. However, just to let you know, we are always significantly above that.

Steve DeLaney – JMP Securities

Right. I think you’re about 70%, is actually the balance sheet here now.

And then I guess the last piece or the follow-up to that would be, given the balance sheet that you have today, and the leverage looks pretty low, combined at 2.8, but the agency leverage at about 5.6 and non-agency at 1, you certainly have reasonable leverage, what is your capacity? Let’s assume the opportunities, you know, Craig and Ron still are finding good opportunities, but I guess I’m asking specifically on the non-agency side, given where those prices have moved, what is your capacity to continue to add more non-agency RMBS to the portfolio without having to come to the market for more capital. Is there some way to quantify that in terms of how you sort of see your liquidity and your borrowing capability and your current leverage?

Stewart Zimmerman

In terms of our current leverage, again this is a very good time to be very prudent, to be cautious. Again we have more than ample opportunities to be able to continue to roll repo both agency and non-agency. So we’re very, very comfortable about how we’re situated.

In terms of going forward, in terms of kind of ratcheting up leverage, again we have been and will continue to be cautious. We have the opportunity to do that mathematically, we could certainly go significantly higher in leverage, but it’s not a place that I think we want to go. Could it be extended slightly? The answer is yes.

Unidentified Company Representative

Steve, I think to answer your question, in terms of the assets we acquired, and I don’t want to sound like a broken record, but we continue to grow the non-agency portfolio on a net basis almost 100 million a month.

Steve DeLaney – JMP Securities

Right.

Unidentified Company Representative

And I think I’ve been saying that about eight quarters now. On the agency side, we publicly said we’d like to keep the portfolio between 6 billion and 6.5 billion. So we’ve basically been replacing run-off. So it’s a coincidence that they were the same number for the same quarter.

Steve DeLaney – JMP Securities

Okay, got it. So I mean, should we – it sounds like you’re still on the plan of targeting or looking to add about 100 million per month on the non-agency side. Did I hear you right on that?

Unidentified Company Representative

Yes. And sort of falls back to your initial question which means we’re comfortable having some more assets relative to our existing equity base, and that ties in with the re-securitization answer.

Steve DeLaney – JMP Securities

Okay, great.

Unidentified Company Representative

You could see us increasing our leverage on the non-agency side somewhat.

Steve DeLaney – JMP Securities

All right, great. That’s what I was looking for. Thanks a lot. Nice quarter.

Operator

Thank you. And our next question will come from the line Jason Arnold with RBC Capital Markets.

Jason Arnold – RBC Capital Markets

Hi, good morning guys. Just a quick follow-up on Bose’s question on the re-REMIC transaction. Would you expect to do more re-REMICs ahead or was this kind of a one-off opportunistic deal?

Craig Knutson

No, I think you could expect that we could certainly do more in the future. It’s a nice transaction both from an availability of financing but also in sort of shoring up the assets that we have and making them more easily financed.

Jason Arnold – RBC Capital Markets

Terrific. Okay, thank you. And then just one other quick one, looking at my screen here today, I’ve got roughly 70 basis points on a three-year swap, so I was curious, what are your thoughts on adding additional swap exposure to lock in borrowing rates here for down the road? I guess the risk is that rates could still go lower from here. But would just be great to hear your perspective on this.

Stewart Zimmerman

We don’t really try and bet on interest rates. And I think where we’re swapped now in terms of our swap percentage, we’re very comfortable with where we are. So, just to go ahead and increase this swap ratio for the sake of doing it, it doesn’t make a lot of sense. As again, as swaps roll off and expensive ones, as you can see, are rolling off, and the opportunities to buy additional assets will become a little less swap, we’ll look at that opportunity. But it’s not something we’re just going to do for the sake of doing it.

Unidentified Company Representative

We are getting questioned a lot [inaudible] if we’re not adding a lot of interest rate risks to our assets, we don’t need to buy interest rate insurance on our liabilities. Does that answer the question?

Jason Arnold – RBC Capital Markets

Absolutely. No, that makes tons of sense. Thank you.

Operator

Our next question comes from the line of Mike Taiano. Mike Taiano is with Sandler O’Neill.

Mike Taiano – Sandler O’Neill

Hey, good morning. Just to hit on the question about potentially doing additional re-REMICs. My understanding was that it could become more difficult to do re-REMICs with the Dodd-Frank Act I guess in terms of the additional regulatory requirements and I guess they’re going to require that private placements have the same disclosures as public deals and on one-by-one basis. Can you maybe comment on the changing landscape on the regulatory side with respect to re-REMICs?

Craig Knutson

Yes. It’s far from certain at this point, so we continue to follow it. As I think you know, these transactions are typically private deals, so they would certainly be more difficult than public deals, but it’s something that we’re continuing to follow and, for the time being, these private re-securitizations are still being done every month.

Mike Taiano – Sandler O’Neill

Okay, great. And then just to visit on the leverage point again, you sort of suggested that leverage at least on the non-agency side could increase. Can you maybe just give us some general sense of, is it as high as two times leverage would you be comfortable with? And just trying to get a sense of, obviously yields have come down on non-agency paper recently, and I would assume, in order to kind of keep returns where they are, you’d have to increase leverage all else being equal. Maybe you can just give us some comments on that.

Unidentified Company Representative

Yes. In terms of the – look, we’re incrementally going to increase the leverage on the non-agency side and – were not considered a bogey. I don’t think we’re immediately going to go from one time to two times, but you will see an incremental increase in the non-agency. And it could increase more rapidly depending on availability.

Mike Taiano – Sandler O’Neill

Okay. Great, thanks very much.

Operator

Thank you. And we’ll now move on to the line of Matthew Kelly. Matthew Kelly is with Morgan Stanley. Please go ahead.

Matthew Kelly – Morgan Stanley

Thanks guys. Can you give us a little bit more color on what you see as the most attractive non-agency MBS both in the third quarter and fourth quarter, what are the best opportunities you guys are seeing out there?

Stewart Zimmerman

I really prefer not to. Again I think one of the advantages we have is kind of the group here [ph] would look at these assets and we’ve been able to see some value. So again you kind of know what we bought, and as we continue to see value, we will continue to buy those types of assets. But just to let kind of the whole world understand exactly what we’re doing I don’t think is the most prudent thing for us.

Matthew Kelly – Morgan Stanley

Right, okay, understood. Then just a broader question on the Fed’s announcement yesterday, what are your thoughts there and how do you think it could impact your book and purchasing strategy going forward?

Stewart Zimmerman

In terms of QE2, I guess we’re in the position where interest rates don’t look like to be going up relatively soon. So in terms of the company, I think we are very, very well-positioned in terms of how the book is now and the continued opportunities that we’ll continue to see.

Unidentified Company Representative

Look, the move was fairly well-telegraphed and we were expecting it. People have – we have been focused on QE2 since August, and that’s why we’ve been growing this high yielding on agency portfolio.

Matthew Kelly – Morgan Stanley

Okay. And then just one quick follow-up on the non-agency leverage question that you guys have gotten a little bit, what do you guys kind of look for in terms of when is a good time to potentially start increasing that leverage? Like when is it less risky? What are the couple of indicators you look for?

Unidentified Company Representative

One, we are increasing it, and part of that was the re-securitization which will give us some permanent funding without haircut. And two, it took us a number of assets that were below investment grade and made them investment grade, which makes them more easily forward against now and in the future. We are increasing the leverage on the non-agency side.

Matthew Kelly – Morgan Stanley

Okay, thanks.

Unidentified Company Representative

In increments.

Operator

Thank you. And we’ll move on to the line of Henry Coffey with Sterne Agee.

Henry Coffey – Sterne Agee

Yes, good morning everyone, and appreciate all this information you’re sharing with us. You sound pretty confident that rates aren’t going to go up for a while, I think that’s almost a given. Yes, but the Republicans are going to fix everything.

Once we look at this re-REMIC transaction which will get a chance to kind of examine when you report your December results, what are the component pieces going to look like in terms of how you’re going to lay it out? Do you break the bonds into three or four different classes the way one of your competitors does? Or does it get presented as a pure financing? And just a related question, were there any kind of unusual costs related to that that could impact the fourth quarter?

Unidentified Company Representative

Is your question the exact execution or how is it going to be accounted for?

Henry Coffey – Sterne Agee

How is it going to be accounted for.

Unidentified Company Representative

Well, I think from an accounting standpoint, as we’ve mentioned in the press release, we will be consolidating the trusts [ph] and issues –

Henry Coffey – Sterne Agee

Right.

Unidentified Company Representative

But in terms of the presentation and in terms of GAAP presentation as well as our MD&A trust [ph] disclosure, it’s fair to say that we’ve been working through that exact presentation and how we’ll disclose it, whether we’ll disclose it similar to some of our competitors or not. So at this point in time, yes, we’re still working through that.

Henry Coffey – Sterne Agee

And let me just ask the question a different way, and if you can’t put any light on it, that’s understandable. But I mean will it be presented with a senior bond, an off balance sheet bond, an IO, a sub-bond, and all those different component pieces? Which seem to have a way of kind of complicating the book value marks. Or is it more just we look at the aggregate portfolio and see how that gets valued?

Craig Knutson

Again, are you asking an accounting question or how is the re-securitization structured?

Henry Coffey – Sterne Agee

Both really.

Craig Knutson

Okay, well, as far as the re-securitization, and it’s available on Bloomberg, the structure is a little bit different from some of the other structures that you may have seen. We actually split the securities in different classes and we sold the top AAA piece. There’s another AAA piece that we retained. And then we’ve got AA, A, BBB, BB, B, and then a non-rated. So what we really try to do here is to preserve flexibility in the future to take advantage of market opportunities, either repo those securities or sell them into the marketplace.

Henry Coffey – Sterne Agee

Did you create an IO in this process as well or – and then obviously the non-rated bonds are the equivalent of a sub-bond.

Craig Knutson

There is an IO that’s associated with the A1 tranche that was issued to third parties, basically to get the coupon to a par-type execution. And we also have the flexibility in the sub-bond [ph] tranches at the time that those could be also be [inaudible] to third-party investors to [inaudible] a piece of those to get into a par execution.

Henry Coffey – Sterne Agee

Would there be any unusual cost with this or is everything just going to get amortized over the expected life of the financing?

Unidentified Company Representative

Yes [inaudible] the costs that we incurred, it will get spread over the life. The other thing that I would just add purely from a disclosure standpoint, bear in mind that the pieces that we took back, that will eliminate in consolidation because we consolidate the trusts, and I think from a balance sheet presentation perspective, it’s really just the piece that’s sold to third parties that gets grossed [ph] up on our balance sheet.

Unidentified Company Representative

And let me add one thing. So the exact GAAP accounting is yet to be finalized, but whatever that is, we will strive to explain the economics in the Q and in the press release too.

Henry Coffey – Sterne Agee

Great. Well, thank you very much. I look forward to seeing this.

Stewart Zimmerman

Thanks, Henry.

Operator

And we’ll now move on to the line of Gabe Poggi with FBR Capital Markets.

Gabe Poggi – FBR Capital Markets

Hey, good morning, guys. A quick question, kind of going back to your opportunity set. I’ve heard that dealers are long quite a bit of paper heading into the end of the year. Are you guys expecting any volatility in paper and expect to see maybe a bigger opportunity set as we get closer to year-end? I’m trying to get a gauge on how many pitches you guys think you can hit over the course of the rest of the year, so to speak.

Stewart Zimmerman

Ron, just on the agency side.

Ron Freydberg

The agency side, we’re having – we’re finding assets that meet our internal bogey. I don’t think the Street is all that long on the agency side, especially on the hybrid. But I don’t anticipate a whole lot of price volatility coming in that sector just because it’s still backed by the agencies and we’re still good with that. Craig?

Craig Knutson

And as far as non-agencies, we’ve seen some pretty heavy activity over certainly the last month or so, and there has been rumored selling in the fourth quarter. But the market is pretty orderly, and if anything, the market is probably up a little bit stronger now than it was a month ago.

Unidentified Company Representative

The important thing to – month to month, day to day is one thing, but the technicals for non-agencies are so in our favor. They’re not producing any more non-agency securities.

Gabe Poggi – FBR Capital Markets

Right.

Unidentified Company Representative

And in fact they’re prepaying either voluntary or delinquent. So the technicals are there with QE2, we’re pretty optimistic about prices, but we’re still a buyer.

Gabe Poggi – FBR Capital Markets

Right. Okay, great. That’s very helpful. Thanks guys. Good quarter.

Stewart Zimmerman

Thank you, Gabe.

Operator

Thank you. And we do have a question from the line of Dan Furtado with Jefferies.

Dan Furtado – Jefferies

Hey, good morning everybody. Thanks for the time. Nice quarter.

Stewart Zimmerman

Thank you, Dan.

Dan Furtado – Jefferies

You’re welcome. A couple of quick questions. Do you mind disclosing what the CPR was on the agency-only side of the business?

Ron Freydberg

For the agencies, it was 24.

Dan Furtado – Jefferies

Twenty-four? And generally speaking, I guess this would be for Ron, when you’re looking to purchase agency bonds in the market today, are you – do you tend to gravitate towards generic agencies or specified pools?

Ron Freydberg

Dan, we look at all the sectors in the marketplace and we tend to purchase where we think that we’re going to get the best value. I would say that over time specified pools have worked better for us than the TBA [ph], but we still look at all different markets.

Dan Furtado – Jefferies

Excellent, okay. And I guess this would be for Craig. When I’m thinking about the re-REMIC, and I appreciate how the structure is different, how do I think about the actual haircuts and financing costs on the repo as we move down the stack? Is it kind of like if it’s investment grade or above, you get one rate? Or is it going to be more tranched out where the AAs are going to come at some type of haircut versus the singles, et cetera, et cetera?

Craig Knutson

Again it varies by counterparties, but I would say generally, and I think we’ve said this before, that investment grade rated assets are fairly easy to finance and typically the haircuts on those are approximately 10%.

Dan Furtado – Jefferies

Okay.

Craig Knutson

For CCC assets, not re-securitizations but CCC assets, financing is available on those. It depends on the dollar price on the particular bond, but those haircuts could be possibly as well as 20 and more likely 25% or 30%.

Dan Furtado – Jefferies

Okay, okay. So I guess the way when I’m thinking about the all-in economics on this deal, using – again, I don’t know – have a clue what type of repo you’re going to put specifically towards the re-REMIC, and I appreciate that, but just from a modeling standpoint I can assume whatever bonds you repo that are DD and above are going to come at about a 10% haircut?

Craig Knutson

BBB, right?

Dan Furtado – Jefferies

I’m sorry, I’m sorry, yes, BBB. Okay.

Craig Knutson

Generally that is true. BBBs that are locked out might be a 15% haircut, but you’re in the right ballpark.

Dan Furtado – Jefferies

Excellent. Well, thanks. Hey, congratulations again on the quarter.

Stewart Zimmerman

Thank you.

Operator

Thank you. And we’ll now move to the line of Douglas Harter with Credit Suisse.

Douglas Harter – Credit Suisse

Thanks. My questions have been answered.

Stewart Zimmerman

Thank you.

Operator

Okay. Very well. And let’s move on to the line of Mike Widner with Stifel Nicolaus.

Mike Widner – Stifel Nicolaus

Hey, good morning guys, and congrats on a solid quarter.

Stewart Zimmerman

Thank you.

Mike Widner – Stifel Nicolaus

I was just wondering, maybe this is in the press release and I haven’t found it, but in your reconciliation of GAAP to core, you backed out 13.5 million of the 21.3 million of the forwards. And why that split? I mean, why not the entire thing? I mean, what’s the other 8 million that is included in core?

Unidentified Company Representative

Yes, the other 8 million is the net accrued interest on the underlying repurchase [ph].

Mike Widner – Stifel Nicolaus

Okay, got you. Another question, just wondering how you guys are thinking about dividend policy. And I say that because we’ve heard sort of different views from a number of the different mortgage REITs out there and some think about paying the dividend out of current total earnings, some think about it relative to core earnings, some think about it relative to expected run rate earnings, others talk about economic earnings. And for you guys, just wondering what we should sort of expect going forward and how you think about what the right level for the dividend is?

Stewart Zimmerman

I think when you look at what we’ve done historically, and there’s no reason to change, we’ve looked at our core earnings [ph].

Mike Widner – Stifel Nicolaus

Okay. So I mean your 22.5 versus 22 I guess is pretty right in line. I mean is that kind of what we should think about sort of around that level going forward?

Stewart Zimmerman

Going forward I really don’t really want to comment on.

Mike Widner – Stifel Nicolaus

Right. I don’t mean – sorry, I – continuing to pay pretty much right around your core earnings level, give or take half a penny as opposed to 90% of core or something like that?

Bill Gorin

Actually it gave us a number of options of earnings to look at, but I don’t know if you included the absolute right one which is the taxable income. And historically we’ve always said, and remains the case, on an annualized basis we’re going to look at what our taxable income is and we’re going to distribute. So it may not be tied exactly to the earnings that quarter and it may not be tied to core earnings or GAAP earnings. It’s going to be tied to taxable income over the year. So it’s not completely predictable for you quarter to quarter.

Mike Widner – Stifel Nicolaus

That’s too bad because I would like it to be 100% predictable.

Bill Gorin

I know.

Mike Widner – Stifel Nicolaus

One other quick one if I could. Just looking at the kind of leverage you have on the two halves of your portfolio, and you finished the quarter at about 5.6, 5.5 times on the agency side and then just about one time on the non-agency side. Is that a level you’re comfortable with, looking for more, looking for the same, looking for less?

Bill Gorin

Well, it is a repeat – we have answered the question. I think we’re looking for more than one time on a non-agency side. And that’s because we want to grow the assets there. On the agency side we’re sort running in place [ph].

Mike Widner – Stifel Nicolaus

Okay. So we should continue to think of the agency side as 5.5-ish and then –

Bill Gorin

It could become – it could be six. I can’t – it can move but it’s not going to be a huge increment.

Mike Widner – Stifel Nicolaus

You’re not targeting 7.5 or something like that?

Bill Gorin

Correct, correct.

Mike Widner – Stifel Nicolaus

Okay. And then, yes, I think you answered the question on the non-agency side.

Great, that’s all mine. Thanks.

Stewart Zimmerman

Thank you.

Operator

And we’ll move on to the line of Jim Ballan with Lazard Capital Markets.

Jim Ballan – Lazard Capital Markets

Great. Thanks a lot. It looks like you had some of the higher cost swaps roll off in the quarter. The total notional amount has gone down some. Do you think, especially with the expectation that you’re going to be increasing assets, that maybe we would see that notional number come back up by the end of the year?

Stewart Zimmerman

When you look at it, you look at the assets that we’re placing, and again if there’s – it depends what interest rate risk we think we have. So again we’re really not replacing as much on the interest rate side. So again I’m really comfortable with where we are.

Bill Gorin

Again, the way we answered the question before, if we’re not adding a lot of interest rate risk on the asset side, we don’t need to build more interest rate insurance on the liability side.

Jim Ballan – Lazard Capital Markets

So I mean, should I take from that on the non-agency side there’s less interest rate risk and so that’s where the incremental dollars are being spent, that maybe we don’t see the need to have that swap number come up? Is that the right way to interpret that?

Bill Gorin

That’s a good assumption.

Jim Ballan – Lazard Capital Markets

Okay, great. Thanks a lot.

Operator

And we’ll now move on to the line of Matthew Howlett with Macquarie.

Matthew Howlett – Macquarie

Good morning guys, thanks for taking my question. Just on the re-REMIC subs, did you guys give the accrual rate that you’re going to use to book those?

Craig Knutson

Sorry?

Matthew Howlett – Macquarie

The accrual rate on the subs you take down under re-REMIC, I mean what can we assume for what will be the GAAP accrual rate? Presumably it’s higher than your unlevered yield of 9%.

Craig Knutson

Again I think the way to look at it is to look at the underlying assets that went in, right? And you’ll see in our Q today what the average yield on the assets that go in, that the assets that went in looked like the overall portfolio. So, and this is really the way that we think about it, so it’s really not so much about the securities that we create and the re-securitization, it’s a means of financing. And that’s how we account for GAAP.

Matthew Howlett – Macquarie

Okay, I just didn’t know if you run some IRR analysis on the subs and what they would come out to be. I realize that was going to [inaudible] on the GAAP, I just didn’t realize – I just wanted to get a point on what type of sort of yield can we assume and imply that’s on those securities that you create.

Bill Gorin

Yes, I think what you have to do is look at the underlying assets. And what we’re telling you is the nature of the underlying assets hasn’t changed for our accounting purposes, still at 900-some-odd million that was yielding us whatever. That doesn’t change because of the re-REMIC. It’s all consolidated. Then you have to subtract what you’re going to pay out on the A1s. So the asset yield and our whole asset yield on non-agencies was 9-ish percent. That’s similar to what we’re going to yield on the whole 900 million of assets underlying the re-REMIC.

Matthew Howlett – Macquarie

I guess the question is, what was the leverage that was – should be higher than re-REMIC I guess. I mean, are you talking leverage up in a non-recourse manner, but is the structured leverage inside the REMIC you create higher than what you would have done just by rebuilding out the assets?

Craig Knutson

If you want, we could take this off line because just explaining the –

Matthew Howlett – Macquarie

Okay, fair enough. And then just on the taxable income, you mentioned that taxable income is how you pay your dividends. Presumably when you sell these re-REMICs, I know for GAAP that’s financing, but is there a taxable gain in the sale?

Craig Knutson

We try to select the assets such as there wouldn’t have been a taxable impact.

Matthew Howlett – Macquarie

Got you, okay. And then just moving towards the overall non-agency book, I know you addressed, Stewart, you addressed the moratoriums, foreclosure moratoriums. Do you think – I mean, are any of those from paid bonds? Could they be impacted negatively if these foreclosure moratoriums get strung out in terms of hurting loss severities or extending the liquidation timeline?

Craig Knutson

Sure. And as you point out, pretty much all the securities are senior-most capital [ph], so they are front-page securities. And foreclosure moratorium does delay the liquidation. So we’ve heard that it’s sort of a zero-some gain that they advance, the principal and interest, and then they deduct it from the liquidation. So you get it now and that your loss severity goes up by that amount. It’s not really is zero-some gain, right, because on a present value basis, you’d rather pick the loss sooner than later.

In addition, you also have insurance and property taxes on the properties that have to get paid during that period. So it’s certainly not a positive, it’s a negative, but we’ve run some numbers, and a lot of Street run numbers to try to quantify that, and it’s really not a whole lot. It really depends on the assets going in as well. If you have – if you took option ARM or subprime paper where you might have 50% 60-plus days delinquent, it’s going to have a much more significant effect than if you have prime and alt-A paper where your delinquency pipeline is much smaller. So the numbers that we’ve seen around the Street, most of these are for option-type ARM collaterals. It’s anywhere from maybe 20 to 70 basis points in yield. But it’s very hard to quantify and it’s very hard to predict as well.

Matthew Howlett – Macquarie

Okay. And prices since quarter-end, they haven’t really been impacted one way or the other from all these announcements, is that fair to say?

Craig Knutson

Not very much. If there’s any impact, it’s probably on the less clean collateral, so the much higher delinquency type paper is maybe a little bit weaker because that’s obviously what’s affected the most or could be affected the most.

Matthew Howlett – Macquarie

Got you. Great. Thanks guys.

Craig Knutson

Sure.

Operator

Thank you. (Operator Instructions)

And we’ll move on to the line of Jim Young with West Family.

Jim Young – West Family

Yes, hi. You’ve mentioned that it’s a good time to be prudent and that you competed [ph] to be cautious. Can you share with us some of your major concerns or issues that are on your mind that’s leading you in this direction? And how do you see those issues changing over the next couple of months? Thank you.

Stewart Zimmerman

We’ve always been prudent and cautious, and we’ll continue to be that way. So again, you look at the landscape, you look at some of the unknowns, so again it’s not a good time – you don’t have your agency leverage at an eight or nine times where we are, as Bill said a moment ago, whether it’s 5.5 or kind of bumps up the six, that’s fine. We’ve said a few times on the call that the non-agency side may go off a touch. And we’ll continue to be at those types of levels.

Jim Young – West Family

No, I can appreciate that, but I’m just thinking, when you’re looking and thinking about the economy and when you’re thinking about the expense direction and other issues out there, what are some of those factors and issues that are most concerning to you and how do you see from your views on these developments, how do you see those issues changing over the next couple of months or quarters?

Stewart Zimmerman

It’s tough to have a crystal ball today, especially when we have – we’re going to have a new Congress starting in January. So again we’ve touched on the idea of the moratorium, we’ve touched on the idea of the put-backs. So all of that, all of that is something that we look at and we monitor.

Having said that, again very, very comfortable with where we are. Are there unknowns out there? The answer is yes, there are unknowns. But that’s the nature of it. And on top of that, you have QE2 and they’re going to continue I think for – into the economy to try and get it moving again.

Operator

And we’ll now move back to the line of Henry Coffey with Sterne Agee.

Henry Coffey – Sterne Agee

I was just looking at the balance sheet. The use of the forwards, is that going to change as you get a more natural financing structure with the re-REMICs, or does that continue to be viewed as just a real viable way of funding and leveraging non-agency purchases?

Unidentified Company Representative

I think with the forwards, whether your account for those [inaudible] forwards or whether they become unlinked [ph] is going to depend primarily on our ability to be able to substitute the collateral or finance those positions with someone other than we would purchase the bonds from. So that’s going to be the key driver of the go-forward accounting on those positions.

Stewart Zimmerman

Let me just clear a possible misunderstanding from your question. We finance them, these assets are assets we purchase them at a firm and we put them on repo there. And for accounting purposes, those are considered linked transactions and they show up as forwards on the balance sheet. They really are assets we own that are repoed [ph] at the firm where we purchased them. So it has nothing to do with economics or structure, this is just GAAP accounting.

Henry Coffey – Sterne Agee

That’s helpful. Thank you.

Stewart Zimmerman

You’re welcome.

Operator

And our next question comes from the line of Stephen Zadeklik with – or actually is a private investor. Please to ahead.

Stephen Zadeklik – Private Investor

Yes. With regard to the non-agency MBSs, what is the portion that’s in judicial stage versus non-judicial?

Craig Knutson

We’d have to look. I don’t know that we have that.

Stephen Zadeklik – Private Investor

Okay. And when a non-agency property goes through foreclosure, why is that not carried on your balance sheet as real estate owned?

Craig Knutson

Because we own a security, right, so the REO is in the trust, but we still own a security.

Stephen Zadeklik – Private Investor

Okay.

Craig Knutson

So that we still get advanced principal on interest on those loans until they’re liquidated, as long as they advances are deemed recoverable.

Stephen Zadeklik – Private Investor

Okay.

Craig Knutson

Again we own securities, not loans.

Stephen Zadeklik – Private Investor

Okay. Thank you.

Craig Knutson

You’re welcome.

Stewart Zimmerman

I would just like to add to Craig’s answer. We do easily know the percentage in California which is –

Craig Knutson

Yes, yes. And that’s in the Q on page 51, that you’ll see later today. But it’s about 46% California. We listed the top five states. So 46% California, 8.5% Florida, about 5% New York.

Stewart Zimmerman

And California is not a judicial state.

Stephen Zadeklik – Private Investor

Thank you.

Stewart Zimmerman

You’re welcome.

Operator

Thank you. And we’ll return to the line of Bose George with KBW.

Bose George – KBW

Hi. I just wanted to follow up on the unlevered yields you’re seeing in the non-agency market and the spreads you’re seeing in the agency market right now.

Stewart Zimmerman

Hey, Ron, why don’t you tell the agencies?

Ron Freydberg

In the agency market, a lot of it depends upon the assets and the duration of the average life. But we’re seeing yields in the mid-twos and funding cost really hasn’t changed. One month funding is still in the high 20s, three-month funding is still in the low 30s, or high 20s to low 30s. So spreads are within that band.

Bose George – KBW

Okay, great. And then on the non-agency side?

Craig Knutson

Non-agency, again it also depends on the asset, but I would say those yields range anywhere from mid-sixes to in the eight type range.

Bose George – KBW

Okay, great. Thanks.

Craig Knutson

Adjusted obviously.

Bose George – KBW

Yes.

Operator

Thank you very much. And at this point we have no additional questions in queue.

Stewart Zimmerman

Well, I’d like to thank everybody for participating on today’s earnings call. We look forward to speaking with you next quarter. Thank you.

Operator

Thank you. And ladies and gentlemen, this conference will be made available for replay after 11:30 a.m. today through November 11 at midnight. You may access the AT&T teleconference replay system at any time by dialing 1-800-475-6701 and entering the access code 177459. International participants may dial 320-365-3844. Those numbers again are 1-800-475-6701 and 320-365-3844 with the access code 177459.

That does conclude our meeting for today. We do appreciate your participation. And you may now disconnect.

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