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Ares Commercial Real Estate Corporation. (NYSE:ACRE)

Q2 2014 Results Earnings Conference Call

August 06, 2014, 04:30 PM ET

Executives

Carl Drake - Head of Ares Management Investor Relations

John Bartling – Chairman

Todd Schuster – President and CEO

Tae-Sik Yoon - Chief Financial Officer

John Stilmar - Investor Relations.

Analysts

Steve DeLaney - JMP Securities

Jade Rahmani - KBW

Charles Nabhan - Wells Fargo Securities

Ken Bruce - Bank of America Merrill Lynch

Operator

Good afternoon and welcome to Ares Commercial Real Estate Corporation Conference Call to discuss the company’s Second Quarter 2014 Earnings results. During today's presentation all callers will be pleased in listen-only mode. Following management prepared remarks the conference call will be opened up for questions. As a reminder, this conference is being recorded on August 6, 2014.

I would now like to turn the call over to Carl Drake, Head of Ares Management Investor Relations.

Carl Drake

Thank you, operator, and welcome everyone, to our earnings call this afternoon. I am joined today by John Bartling, Chairman, Todd Schuster, President and CEO, Tae-Sik Yoon, our Chief Financial Officer and John Stilmar from Investor Relations.

On this afternoon’s call, we will reference an earnings slide presentation that can be accessed by going to our website at arescre.com. And by clicking on the second quarter 2014 earnings presentation link on homepage of the Investor Resources section of the website.

As a reminder, comments made during the course of this conference call and webcast and the accompanying documents may contain forward-looking statements and are subject to risks and uncertainties. Many of these forward-looking statements can be identified by the use of the words such as anticipates, believes, expects, intends, will, should, may and similar expressions. We don't undertake to update our forward-looking statements unless required by law.

The company's actual results could differ materially from those expressed in the forward-looking statements for any reason including those listed in its SEC filings. Ares Commercial Real Estate Corporation assumes no obligation to update any such forward-looking statements. Please also note the past performance or market information is not a guarantee of future results.

I will now turn the call over to President and CEO, Todd Schuster.

Todd Schuster

Thank you, Carl, and good afternoon, everyone. We are pleased to report that we have made substantial progress with ACRE with respect to our net income, capital raising imitatives and product capabilities. In principal lending, we closed on several attractive new loans to further enhance our already strong portfolio. We also continue to strengthen our balance sheet by lowering our cost of capital with non-recourse funding.

In Mortgage banking, our originations within ACRE Capital ramped up to over $100 million enabling us to swing to a modest profit for the second quarter as the benefits of our repositioning in this business is starting to make a positive impact on our results. Tae-Sik will provide additional details on our quarter later in the call, but I want to highlight three recent transactions or events that we believe will add considerable value to our shareholders.

Consistent with our goals to optimize our balance sheet, we deepened our access to cost efficient leverageable capital with the closing of our second credit facility from City National Bank, thanks to the credit support from our external manger Ares management.

Similar to the $50 million facility we put in place with CNB earlier this year, this new $75 million credit facility maybe used as capital to allow ACRE to obtain financing under its other funding facilities. To put it simply, assuming a debt to equity ratio of 3:1 this facility will provide us the capacity for an additional $300 million of senior loans.

Further enhancing our balance sheet, we recently priced at $379 million securitization transaction where we will be selling approximately 309 million of bonds at an initial coupon of LIBOR plus 145, materially improving our funding cost as compared to our first securitization transaction that we closed in November 2013. This marked our second securitization in the past 12 months and demonstrates the strong market acceptance for the quality of our loans.

Finally, we are very excited to announce that ACRE Capital has been approved as a Freddie Mac seller servicer which we believe is doing part to Ares overall relationship with Freddie Mac. We believe we have created significant value in ACRE Capital since acquiring the business last year and over the past several months we have repositioned it with what we believe is some of the best personnel in the industry.

Now with the Freddie license, we have expanded the opportunities for these same producers to gain market share and grow revenues for ACRE Capital. Ultimately we believe ACRE Capital possesses meaningful competitive advantages and positions ACRE as the only full service public REIT with a full suite of flexible capital and GSE products.

Importantly, we believe we have enhanced the value of this business over the past year from these activities. From a market standpoint competition increased this quarter as some traditional vendors have expanded their appetite for real estate lending resulting in some spread compression in our market and which has triggered some pre payments in the portfolio, the impact of which Tae-Sik will speak to in a few minutes. Importantly, our business model is very well positioned to capitalize on the current environment. A great example of the benefits of our direct origination and flexible [stock] capital occurred during the second quarter when we partnered with an established domestic first mortgage lender to invest in a large multi family portfolio where we were able to structure a $60 million commitment for a floating rate preferred equity investment yielding approximately 12%.

Our skilled national platform allows us to be highly selective and source what we believe are the most attractive risk adjusted return. As you can see on slide four, despite continued spread compression in the market particularly in the liquid capital markets; our senior loan originated returns have remained relatively resilient, demonstrating the benefits of our integrated origination platform.

As such, our portfolio is 100% directly originated, diversified and positioned for increased earnings from rising interest rates. Current market conditions also provide opportunity for us to lower our cost of capital, to mitigate spread compression as evidenced by our recent securitization, execution and the new flexible capital.

I will now turn the call over to Tae-Sik to discuss additional details surrounding our second earnings and our financial position.

Tae-Sik Yoon

Great. Thank you, Todd, and good afternoon, everyone. Today, I will be reviewing the financial results of our company for the second quarter of 2014 and discussing in more detail the numerous improvements we have made lowering our cost of funding and increasing the availability of capital.

So let me start of with our financial results for the quarter. Our consolidated net income for the second quarter was $6.6 million or $0.23 per common share. That represents a 40% quarter-over-quarter increase versus our results in the first quarter of 2014. This strong growth in net income is primarily attributable to the profitability of Acre Capital and the benefits of closing new investments in principal lending.

Our $6.6 million in net income was composed of a $5.6 million in earnings from principal lending and $1 million in earnings from mortgage banking. For principal lending, we originated three senior loans and one preferred equity investment during the second quarter, totaling $137 million in commitments of which $96 million was funded at closing. We received $69 million of principal repayments from one loaned in the second quarter.

At quarter end, we had 40 loans totaling more than $1.3 billion in commitments, and $1.2 billion of outstanding principal. And, as we have mentioned before, all of our loans continue to perform in accordance with their terms and we have recognized no impairments at June 30, 2014.

Shifting now to our Mortgage Banking business, ACRE Capital rate logged approximately $103 million of Fannie Mae DUS and FHA HUD commitments. This consists of five Fannie Mae DUS loans and three FHA HUD loans. We expect that origination activity and, therefore, our fee income and the creation of new mortgage servicing rights in the segment will begin to ramp more meaningfully in the latter part of 2014.

Let me now turn to two of the key building blocks to our earning stream. First, expanding our access to capital and second lowering our funding cost overall. On July 1, with credit support from Ares management, we closed a new $75 million revolving credit facility with City National Bank with pricing the Acre of approximately LIBOR plus 300 basis points. The pricing at this facility is consistent with the first $50 million facility we closed earlier in the year with City National Bank. This facility also provides capital that can be drawn down and repaid as needed. So unlike a common stock or convertible note offering where all the proceeds are received upfront, have structured this CNB facility minimizes the potential impact of earnings of holding univested cash.

In addition, since its new $75 million facility did not require us to post senior loans as collateral, we can further leverage the $75 million as equity like capital using our warehouse lines to fund for example $300 million of new senior loans assuming a debt-to-equity ratio of 3:1. We would like to thank Ares Management for providing the credit support to obtain this new $75 million facility we believe it as a strong testament to the commitment and confidence in ACRE by Ares Management and significantly increases our access to capital.

On August 3, we announced further improvements in our capital structure with the pricing of a $379 million securitization transaction to which we will be contributing 15 senior loans. In this transaction we will be offering $309 million of investment grade bonds to third parties and retain the remaining $70 million of non investment grade securities and the equity in the [issuer]. It is expected to close on or about August 15 subject ofcourse to customary closing conditions. While we cannot assure you that it will close, we believe that the securitization will have a number of positive impacts on our business.

First, the initial weighted average coupon or the $309 million investment grade bonds we will be selling is LIBOR plus 145 basis points before expenses, more than 40 basis points lower than initial weighted average coupon of our first securitization that we closed in November 2013. Second, similar to our first transaction, this upcoming securitized financing will be non recourse to us and match funded in terms of maturity and interest rate risk. And finally, the initial advance rate on the 15 loans we are contributing will be more than 80%.

Both the upcoming securitization and the closing of the $75 million City National Bank facility demonstrates our continued access to cost efficient sources of capital. In fact, since our follow on common equity offering in June of last year to new facilities and more efficient financing we have now raised over 200 million of incremental capital that can be further leveraged to scale the business without the need for incremental common equity capital protecting the book value of our common shares.

Subject to the closing of our upcoming securitization transaction as well as obtaining financing commitments in accordance with the terms of our existing funding and credit facility, we expect to have approximately $115 million of net capital that we can further leverage to give us capacity to fund more than $400 million of additional senior loans going forward assuming a 3:1 debt to equity ratio.

Turning to our balance sheet, we continue to believe that we are well-positioned to benefit in a rising interest rate environment. We ended the quarter with more than $1.1 billion in loans, and $1.4 billion in assets with approximately 94% of the loans in our principal lending portfolio comprised of floating rate loans based on LIBOR.

In addition, we have crafted our liabilities to match fund our assets, with approximately 93% of our debt liabilities also based on LIBOR. And, because both our assets and liabilities are predominantly floating rate, if LIBOR rises our unlevered effective yield and our earnings would rise commensurately. Before I turn it back over to Todd, let me discuss prepayments of loans in our principal lending portfolio and the impact it may have on our earnings.

As I mentioned at the outset, we had approximately $69 million in prepayments late in the second quarter. In addition, so far into the third quarter, we have had an additional $49 million of prepayments. The loans that are prepaid were financed through our first securitization and as a result these prepayments reduced our overall liabilities creating additional leverage capacity in our balance sheet to pursue new market opportunities.

At this point, we believe that prepayments will cause short term volatility to our earnings including in this upcoming third quarter. However, as we continue to invest our remaining capital we believe that we can offset much of the earnings impact to prepayments. With that, I will now turn the call back over to Todd for some closing remarks. Todd.

Todd Schuster

Thanks Tae-Sik. In closing, we are enjoying enhanced capital positions with the anticipated closing of our securitization and recent incremental CNB facility, a growing loan pipeline which is expanding into new products and geographies and an improving mortgage banking subsidiary which just received additional product capability with Freddie Mac. We also appreciate the confidence and endorsement of our business from Ares management which help make our $75 million CNB facility possible.

Due to our expanded avenues of revenue growth in both principal lending and in ACRE Capital, and in concert with our new sources of efficient capital, we believe that we have the building blocks in place for dividend coverage from earnings in the fourth quarter. WE are excited about the opportunity for our businesses and the multiple ways we can succeed given the growing demand for transitional loans, improving real estate fundamentals and the potential for rising interest rates which can contribute to our earnings.

This concludes the prepared remarks, operator, would you please open up the lines for Q&A.

Question-and-Answer Session

Operator

(Operator Instructions).And our first question will come from Steve DeLaney of JMP Securities.

Steve DeLaney - JMP Securities

Thank you, congratulation Scott. It feels like this is something of a break out quarter for you and nice job. I wanted to start with the mortgage banking and the $5.4 billion of mortgage banking gain. I was wondering how do we think about this from if we were to think about that as a margin on volume. You originated 103 but you still had on the books 56 million loans held for sale, I assume the help for sale loans have been marked to reflect how they can be sold, is that correct so that the if we’re going to try to think of a gain on sale margin we would look at 5.4 million over the entire 1.3. Am I thinking correctly there?

Tae-Sik Yoon

Steve, its Tae-Sik.

Steve DeLaney - JMP Securities

Hi, Tae-Sik.

Tae-Sik Yoon

Hey Steve. I think you are looking at it correctly. As you saw on our disclosures we recognized gains from mortgage banking when we rate lock a loan and not when we sell the loan.

Steve DeLaney - JMP Securities

Got it.

Tae-Sik Yoon

So the 103 million is the volume of loans that we rate locked. As you saw, $56 million or so were rate locked or were unsold at quarter end sale, that’s right. The mortgage banking revenue that you see really should be if you want to call divided by 103 and not $56 million to really get to the right margin. And one other comment I’ll make is that the margin that you see this quarter I would tell you that it’s higher than we would normally see. You can see that it’s a margin of about 5.3%.

Steve DeLaney - JMP Securities

Yes.

Tae-Sik Yoon

That’s approximately 100, 130 basis points higher than we would normally see. I think we benefited this quarter from a number of loans that we achieve, premiums on sale. I would not suggest that that is a that is something that is readily repeatable over and over again. I do think we are very good at what we do and we can achieve strong margin but 5.3 is probably more than what I would tell you would be the normal range of margins.

Steve DeLaney - JMP Securities

And is it the HUD loans that add that extra gain on sales, so the mix is what is in play there Tae-Sik.

Tae-Sik Yoon

I think its right. I think there is probably more variability in the HUD loans and the FHA HUD loans versus Fannie Mae, so when you see that the mix of rate locks in a quarter consists more of FHA HUD loans you’ll probably see a little bit of more variability in the margins.

Steve DeLaney - JMP Securities

Okay. And just Todd if the turnaround is pretty dramatic, you know in the fourth quarter last year, first quarter this year you know you were telling us that you were re staffing and that to look really I think you guided us to look to the second half of this year so, we really had very modest expectations for the second quarter. Just comment on what really was the key, I mean was it 90% personal in just recruiting and re-staffing or is you mentioned something about new products if you could just comment kind of operationally and strategically what really flipped the switch and turned Acre Capital around?

Todd Schuster

Hey Steve, thanks for the question. I appreciate it. So I think for a while we’ve been saying that we would start to see signs of getting traction in the second quarter in that business from a production perspective which I think is exactly what just played out. I’m not suggesting to you that we are there yet, we have some more work to do, but I think you know as the second half of the year progresses especially the fourth quarter, I would suggest that we should start to see a meaningful pickup in production in that company. I think that a lot of that is just part of the hard work we’ve done in the repositioning of the business, we brought in some fairly heavy if you will and talented folks on the production side in particular but we’ve also done that even on places, in places like the loan servicing side, but in production in particular we’ve brought in some very high quality folks.

And you know it takes a few months for these guys to ramp up, it just doesn’t happen overnight. But they are starting to happen and of course getting the Freddie Mac license is going to be a big plus for these folks cause they cannot go out and sell multiple products not just one or two and I think the combination of those things is going to result in even more traction especially towards the back half of the second half of the year if you will.

Steve DeLaney - JMP Securities

That’s great. So I’m – loud and clear that the $100 million is not a fluke and you know the expectation with the new products and the additional traction if anything we should expect something higher on average going forward, understanding it maybe lumpy quarter-to-quarter.

Todd Schuster

Yes it gets a little lumpy from quarter to quarter. There is some seasonality to the business. Again, I would expect and I would say we have more visibility in to the fourth quarter right now and that that is looking I would say pretty strong and we should expect that this business is going to continue to grow up. I mean, we’ve got the right people in place, the right systems, the right products, we’re in a really good position in that company and I think we got a lot of value in that business over the last year.

Steve DeLaney - JMP Securities

Great. Well thanks for the comments guys and congratulations.

Todd Schuster

Thank you very much.

Operator

The next question is from Jade Rahmani of KBW

Jade Rahmani - KBW

Hi, thanks for taking the question. Regarding the prepayment I think you know several of your peers have also reported and it seems that there is a spike in prepayment activity. Can you just talk to what you think is driving this and also confirm that on these prepayments you are receiving fees?

Todd Schuster

So I think, Jade, hey Jade its Todd. How are you? Look, I think that the prepayments are being driven by a couple of things, one is I think it’s a sign of the quality of the product we’re putting on the books. And it’s a sign that the – of the quality of the sponsors in particular and the progress they are making in their business plans and the value they are adding to their assets so I think that’s a big part of it. I also think that we are seeing as I noted in my scripted remark that we are seeing some spread compression in the market place, so I think that’s creating some appetite for folks they got to look at repayments.

You should also know that many times when if we see a – when there is a prepayment we often get what I would call the last look, so we get to decide whether or not we want to defend that loan or not. And there is instances where we decide we do want to defend and there is instances where we decide that it doesn’t make sense because of risk return metric don’t make sense to us. Tae-Sik, do you want to comment on the fees.

Tae-Sik Yoon

Sure. Hey Jade, its Tae-Sik. That’s right. I think your question about acceleration of fees when a loan prepays we will accelerate the remainder of the deferred fees that we haven’t recognized so that would be the upfront fee and/or an exit fee if that outgrows, so we would accelerate the recognition of those fee. I think offsetting part of the recognition of some additional revenue from acceleration of fees we would also potentially accelerate recognition of deferred expenses related to financing of those same loans. So there is somewhat of an offsetting impact, but in both cases, both the revenue component and the expense component of deferred fees and expenses will be accelerated, that’s right.

Jade Rahmani – KBW

Okay and when you look at the spread compression and increased competition in the market. I mean what aspects of deals are seeing you know the most pressure. Is it just the pricing of the loans or is it you know borrowers asking for more proceeds or is it you know having to be flexible, more flexible on fees o structure for them….

Todd Schuster

I think it’s mostly around spread and again in situations where we finance the business plan and they have added, the sponsor has added meaningful value to the asset, there are often times there are additional proceeds that come into play as well, which is infact, if you will an acknowledgement of that added value.

Jade Rahmani – KBW

Okay. And then just lastly I think the pace of originations seemed to moderate modestly. I wanted to see if you could provide some color on whether investment capacity was a constraint at all on volumes or you know you also made some comments in the press release regarding you are being selective and focused on risk adjusted returns. And also commenting on the competitive environment. So, I just want to see if it was investment capacity related or something else?

Todd Schuster

That’s a good question. The production numbers are little misleading in that. I mentioned $60 commitment for preferred equity investment, for example. That loan initially started as a – what I would call it stretch senior if you will of about $250 million. And it’s turned out a very efficient capital source came into the first mortgage of that transaction. And so we thought it would be better off and it would provide us with a much better return if we just came in to the subordinate piece if you will, in this case it was preferred equity.

So that’s a loan that actually started. That was $250 million transaction and ultimately ended up being a $60 million -- shows as a $60 million transaction. If that would have been a similar amount of hold if you will or equity that we would had invested in that deal if we had originated the entire loan.

So that’s why I say the number -- so that 137, if we had actually originated that entire loan it would have been – it’s called another $200 million or so higher. So it’s a funny number and it just -- I think it’s important to point out that issue. The second part of your…

Jade Rahmani – KBW

Well, I was just going to ask if as a follow-up, are you guys -- were you looking at the same number of deals and volume of deals and maybe your win rate was declining or you’re bidding on fewer transactions refusing to look at more transactions?

Todd Schuster

We’re seeing - if anything we’re seeing a growing number and volume of transactions, we are selective and but there’s no question, we’re seeing more and more opportunities as the year has gone on. And I would tell you that we expect to see that expand over time. And I also want to just address the question around capacity that you asked, Jade, capacity was really not an issue in any of this. We feel like we have plenty of capacity to originate new product for the foreseeable future.

Jade Rahmani – KBW

Great. Thanks for thanking the questions.

Todd Schuster

Thank you.

Operator

And the next question is from Charles Nabhan of Wells Fargo.

Charles Nabhan - Wells Fargo Securities

Hi, guys. Good afternoon. Thank you for taking my questions. Looking at Fannie Mae and Freddie multifamily volumes during the second quarter, it looks like there was an acceleration in June that based on some commentary from your peers lasted into the third quarter thus far. I was wondering if you’re seeing something similar in terms of acceleration in volumes heading into the third quarter for multifamily lending considering the third quarter has historically been seasonally weak.

Todd Schuster

Yeah. Thanks for the question. We are seeing similar theme if you will. It’s our view that the GSEs are going to pick up market share going into the second half of the year. It was a light first half of the year for them. And from the activity we’re seeing and the dialogue we’re having around transactions and flow, it appears like they are going to be picking up market share in the second half of the year, that’s our belief anyway.

Charles Nabhan - Wells Fargo Securities

Okay. And then principal lending business, Todd, you had commented that you are looking at some new products and geographies, and I was hoping you could comment on that in further detail and maybe talk a little about if there’s any specific geographies that you are avoiding and what would you may like at this point in particular?

Todd Schuster

So on the opportunity side as it relates to the geographies, we are spending a lot of time in Europe right now. We’ve got 30 real estate professionals on the ground in Europe. Ares as a firm has been involved in Europe for over 10 years. And we think there’s a meaningful opportunity there. We’ve been spending the last, I’d say, four to six months building a pipeline there. We think it’s an actionable pipeline. We think -- we’ll start to see some of the benefits of that accrued to us in the fourth quarter. And we think Europe in particular will generate higher ROEs maybe 100 basis points, 50 to 100 maybe some cases 150 basis points and we think that in certain markets in Europe we won’t have to go as deep into the credit stack to get those returns.

Charles Nabhan - Wells Fargo Securities

Okay. Great. Thank you.

Todd Schuster

Yeah, thank you.

Operator

And our next question is from Ken Bruce of Bank of America Merrill Lynch.

Ken Bruce - Bank of America Merrill Lynch

Hi, thank you. Good evening gentlemen. First question, I guess maybe I would echo it’s nice to see a pickup in the activity, its encouraging that you’re talking to making the dividend in the fourth quarter. I think that will help to elevate at least one of the issues that the stocks have with from an evaluation standpoint. And it’s nice to see traction on the originations front.

Just a follow-up maybe from – just your response to Chuck’s question what do you think that is motivating the GSEs to pickup share in the back half of the year. Is there something that change, if you could maybe explain a little bit more of the comment about the pickup in share?

Todd Schuster

Hard to speculate what’s driving the GSEs in any moment. I will tell you this is not unusual behavior in years where they are – their production is lower in the first half of the year. They or in any part of the year, they will tend to come back and get there what they consider to be their right for market share in any -- at any given moment in time. So, I just think they feel like they’ve lost too much market share and they want to get some of it back.

Ken Bruce - Bank of America Merrill Lynch

Interesting, and is there anything that has changed in terms of maybe their thinking around what their rate for share should be? I mean, it seems that there were some discussion for a period of time that maybe they were back away from multifamily because the view that they have -- the mandate wasn’t necessarily needing to be they sell it in the same way and there’s a lot of cross current just as from a general policy standpoint that impact these agencies and I’m just wondering if there’s been any change that you’ve noticed?

Todd Schuster

Yeah. So what I would say is last year -- some of that thinking comes from the fact that last year the GSEs had a stated goal to be 10% down. And then they had a change of leadership at FHA sort of towards the end of the last year, beginning of this year. And that change of leadership has seemed to bring sort of breath of fresh air to GSEs in terms of their ability to come out and get business done, and there has been no discussion of a cut this year in production like there was last year.

And keep in mind, I mean, last year I think the numbers, I don’t know them exactly, but between Fannie and Freddie were something like $60 billion. So its still a lot of multifamily production they’re doing and it definitely feels like -- they feel like they have a right for place in this market and they want to maintain some meaningful market share. And I will tell you, two years ago or whatever, it was 80% or some incredibly high number. I certainly wouldn’t expect they’re going to maintain an 80% market share. But there is some meaningful market share that they will continue to have for the foreseeable future in my opinion.

Ken Bruce - Bank of America Merrill Lynch

Okay. And that segways into my next line of question, questioning which is in terms of the way, I’m just pulling back maybe higher level, is there a mix in terms of the way you want to think about the business going forward in terms of what is principle investing versus what is effectively the gain on sale business in the servicing side. I mean, obviously you’ve got -- what looks to be changing composition for you P&L over the next several quarters if the pace is originations -- ACRE capital continues to ramp up. I’m just wondering if you have a view as to what the right mix of businesses between the portfolio in your ACRE capital business?

Todd Schuster

Of course, they are such different businesses in some respect, right, because one creates the assets as a loan and the other creates an MSR asset if you will. So we think about them a little differently. But our goal is to significantly grow both of those businesses over the next few years, both in ACRE capital, the mortgage banking, now that we’ve got those three products in place, plus access to the balance sheet if you will to the originators in that business. We think there is real opportunity to grow that business meaningfully and similarly, principal lending business is a business where I’m credibly excited about over the next few years given the dynamics of commercial real estate market, fundamentals in that market, supply of product coming in that market over the next few years, and specifically supply of product coming in a space that we play actively in which is sort of that kind of added value space. So the theme is we’re looking to build both businesses meaningfully over the next few years.

Ken Bruce - Bank of America Merrill Lynch

Right. And just maybe to try to come out of it a little different way. Is there a thought in terms of how much fee income you are looking to generate relative to the spread income overtime, I mean you got the principle business is capital intense you know what growth that is going to be require more capital formation over a period of time obviously you have got more of a turnover business in your MSR manufacturing business and so they just you know what drives that growth is you know significantly different in terms of the way that we think about the business from a capital standpoint and something from that just a P&L optic standpoint?

Todd Schuster

So you know one thing I would mention is that if you think about the way our capital is constructed right about 18% or so of it is in Acre cap, the mortgage banking business and you know 82% if you will is in the principle lending business. So the principle lending business is in many respects the driver, right, just think about it. But again, I don’t have a specific answer for you as to exactly what that’s going to look like two years from now. What I want you to take away from this conversation is that we are committed to building this businesses and on a principle lending side we want to be – we’re going to continue to be selective, we are going to be smart, we are going to be looking at the appropriate risk adjusted returns in that space and the mortgage banking business we are going to continue to hire the best people to build that business and try and grow that production so we can get to level that incredibly efficient for the running of that business.

Tae-Sik Yoon

And Ken I think its also important to note that I think it is something you mentioned or you alluded to is that because the mortgage banking cap, the mortgage banking business itself is not as capital intensive you know should there be for whatever reason a little bit lack of capital that part of the business is something that we can continue to grow. So as Todd said, I think having both businesses are highly complementary. I think the originators for both sides of businesses can cross sell we think by having both the balance sheet as well as the mortgage banking business we can provide bridge to new sources of capital, so it’s a highly [competitive] business that we are very pleased at both end.

Ken Bruce - Bank of America Merrill Lynch

Great, well I’ll leave it there. Thank you for your comments. Appreciate it.

Todd Schuster

Thank you.

Operator

I’m showing no further questions. This will conclude the question-and-answer session. I’d like to turn the conference back over to management for any closing remarks.

Todd Schuster

Thank you everyone. I appreciate your time and this concludes our call. Thanks very much.

Operator

Ladies and gentlemen, this concludes our conference call for today. If you missed any part of today's call, an archived replay of this conference call will be available approximately one hour after the end of this call through August 19, 2014 to domestic callers by dialing (877) 344-7529, and to international callers by dialing area code 1(412) 317-0088. For all replays, please reference conference number 10048784. An archived replay will be also available on a webcast link located on the home page of the Investor Resources section of our website. Thank you. You may now disconnect.

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