Ellington Credit Company (EARN) Q2 2016 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Ellington Residential Mortgage REIT 2016 Financial Results Conference Call. Today's call is being recorded. At this time, all participants have been placed on a listen-only mode and the floor will be open for your questions following the presentation. [Operator Instructions] It is now my pleasure to turn the floor off to Maria Cozine, Vice President of Investor Relations. You may begin.

Thanks, Paula. Before we start, I would like to remind everyone that certain statements made during this conference call may constitute forward-looking statements within the meaning of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are not historical in nature. As described under Item 1A of our Annual Report on Form 10-K filed on March 10, 2016, forward-looking statements are subject to a variety of risks and uncertainties that could cause the company's actual results to differ from its beliefs, expectations, estimates and projections. Consequently, you should not rely on these forward-looking statements as predictions of future events. Statements made during this conference call are made as of the date of this call and the company undertakes no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. I have on the call with me today Larry Penn, Chief Executive Officer of Ellington Residential; Mark Tecotzky, our Co-Chief Investment Officer; and Lisa Mumford, our Chief Financial Officer. As described in our earnings press release, our second quarter earnings conference call presentation is available on our website, earnreit.com. Management's prepared remarks will track the presentation. Please turn to slide 4 to follow along. As a reminder, during this call, we’ll sometimes refer to Ellington Residential by its New York Stock Exchange ticker, E-A-R-N or EARN, for short. With that, I will now turn the call over to Larry.

Thanks, Maria. It's our pleasure to speak with our shareholders this morning, as we release our second quarter results. As always, we appreciate your taking the time to participate on the call today. First, an overview. For the second quarter, Ellington Residential generated $0.38 per share on a fully mark-to-market basis. Our highly targeted asset selection process delivered solid performance this quarter, as our agency specified pools and our hedging strategies performed well in the face of the historic market moves, following the unexpected result of the Brexit vote. Investor demand for agency RMBS, particularly from foreign investors, increased greatly in the wake of the Brexit volatility. This was largely because agencies, with their liquidity, strong credit quality and higher yields, represented attractive alternatives when compared to the substantially lower and even sometimes negative yields on the highest credit quality sovereign debt. Globally, the sheer magnitude of bonds that have gone to 0% yield or below is leading investors to search for yield, by reaching up in duration, down in credit quality, down in liquidity, down in convexity or across currencies towards US dollar-denominated assets. For agency RMBS, investors can find that additional yield without having to sacrifice credit quality or liquidity. Long-term US Treasuries, US corporate bonds and public equities are all currently at or near post crisis highs. In such an environment, we need to remain disciplined in our hedging approach and believe that maintaining a liquid portfolio will service extremely well should market conditions reverse. We’ll follow the same format on the call today as we have in the past. First, Lisa will run through our financial results. Then, Mark will discuss how the residential mortgage-backed securities market performed over the course of the quarter, how we positioned our portfolio and what our market outlook is. Finally, I'll follow with some additional remarks before opening the floor to questions. Go ahead, Lisa.

Thank you, Larry. Good morning, everyone. In the second quarter, we had net income of 3.5 million or $0.38 per share. The components of our net income were as follows. Our core earnings totaled approximately $2.9 million or $0.32 per share. Net realized and unrealized gains from our securities portfolio were $8 million or $0.88 per share and we had net realized and unrealized losses from derivatives of $7.4 million or $0.82 per share, excluding the net periodic costs associated with our interest rate swap. Our core earnings includes the impact of catch-up premium amortization, which in the second quarter, decreased our core earnings by $1.5 million or $0.16 [ph] per share. Catch-up premium amortization is calculated based on interest rate level and prepayment projections at the beginning of each quarter. If we add back the catch-up premium amortization adjustments, which tends to be volatile from quarter-to-quarter, our core earnings amounted to $4.4 million or $0.48 per share in the second quarter. On that same basis, our first quarter core earnings was $0.53 per share. The quarter-over-quarter decrease in our core earnings, adjusted to exclude the impact of catch-up premium amortization was principally the result of a decline in our interest income. If we exclude the impact of this adjustment from our interest income, in the second quarter, our interest income was $9 million as compared to $9.3 million in the first quarter, the difference equating to $0.04 per share. The decrease in our interest income was primarily because the weighted average yield on our portfolio declined to 2.93% on an annualized basis in the second quarter from 3.04% in the first quarter, each adjusted to exclude [ph] the impact of a catch-up premium amortization. In addition, while at the end of the second quarter, our overall portfolio was larger, relative to the end of the first, our average holdings over the quarter declined slightly as compared to our average holdings over the first quarter. On the basis of amortized costs, our portfolio increased by 49 million at quarter end, but our average holdings over the second quarter declined by approximately $50 million as compared to our average holdings over the first quarter. This had only a minor impact on our interest income. With respect to our cost of funding and as noted in our earnings release, our cost of repo increased during the quarter, but this was more than offset by a decrease in the periodic costs associated with our interest rate hedges. During the second quarter, we shifted our interest rate hedges to be more heavily weighted to short TBAs and less weighted toward interest rate swaps, relative to the first quarter. Additionally, in the second quarter and relative to the first quarter, the weighted average maturity of our interest rate swap shortens by approximately 1 year to 4 years, consistent with the drop in the effective duration of our agency pools portfolio. 10-year interest-rate swap spreads were two basis points less negative over the course of the second quarter, benefiting our existing interest rate swap hedges on a mark-to-market basis. Repo costs have steadily increased since the second half of last year although, most recently, we've seen them stabilize somewhat. The net impact of the decrease in our cost of funds was small at approximately $100,000 or $0.01 per share. Net interest margin was 1.28% as compared to 1.92% for the first quarter and excluding the impact of the catch-up premium amortization adjustment, our net interest margin was 1.76% for the second quarter as compared to 1.83% for the first quarter. Quarter-over-quarter, our total expenses decreased slightly. Including base management fees, our total expenses decreased to $1.3 million in the second quarter from $1.4 million in the first quarter, or $0.01 per share. Our second quarter annualized expense ratio was 3.6% and all things being equal, that is what we would expect it to see for the year. During the second quarter, we turned over approximately 31% of our agency RMBS portfolio as measured by sales and excluding paydowns, which generated net realized gains of approximately $2.5 million or $0.28 per share, excluding hedges. In addition, this portfolio and our non-agency RMBS portfolio, each appreciated in values, resulting in net unrealized gains of $6.4 million or $0.71 per share. Pay-ups on our specified pool, as percentage of base, increased in the second quarter to 1.03% from 0.88% in the first quarter. Last quarter gains on our assets were overwhelmed by losses on our hedges, leading to a meaningful net loss from the two categories. That was not the case in the second quarter as agency yield spreads were relatively stable quarter-over-quarter. We ended the second quarter with book value per share of $15.38, which when compared to the $15.31 per share as of the end of the first quarter, reflects the fact that our total earnings essentially covered our second quarter dividend of $0.40 per share. Adjusted for unsettled purchases and sales, our leverage ratio was 8.1:1, slightly higher than what it was at the end of the first quarter at 7.7:1. I would like to now turn the presentation over to Mark.

Thank you, Lisa. Similar to the first quarter, the interest rate volatility in the second quarter was elevated. But unlike the first quarter, agency MBS were consistently well bid throughout. Imagine that you had not been following the markets for the past three months and someone told you about the surprise of the Brexit vote, the magnitude of the ups and downs in rates and that the 10-year U.S. treasury yield ended the quarter at 1.47%. You’d probably assume it was a period of very weak ABC mortgage performance, relative to swaps and hedges. However, the opposite was true and mortgages performed extremely well for investors that dynamically adjusted their durations. What was impressive about mortgage performance this quarter was that it happened in the face of increasing prepayment uncertainty, resulting from the lowest mortgage rates in three years. When mortgage rates remain range bound, prepayments are much easier to predict than when they break out of a range. The drop in mortgage rates led to a pickup in refi driven supply and these powerful forces of cyclical supply and prepayment risks are met by consistent demand from global investors seeking alternative to negative sovereign yields. We talked about this technical phenomena last quarter. Agency MBS has transitioned into a global investment class because of their high yields and great liquidity. So while our own central bank has not been a net buyer of treasury and mortgage bonds since October 2014, mortgages are still benefiting from a different source of quantitative easing, namely, the quantitative easing that's been done by the European Central Bank and the Bank of Japan to crowd their country’s investors out of Japanese and European sovereigns and into US agency MBS. Take a look at slide 7. We had the presentation -- we had this in the presentation last quarter and here we extend it. For the quarter, MBS delivered healthy net interest margin and stable price performance. Given the low level of mortgage rates, we have to focus on controlling prepayment risks to protect our net interest margin. This past quarter, prepayments were highly, but still manageable. Look at slide 8, this slide shows both the price of Fannie 3s and the refi index over time. As you can see back in February 2013, Fannie 3s were in the high-103s, which is right where they are now, but the refi index was much higher than it, 4500. Now, the refi index is much lower at 2400. The cumulative impact of increased compliance and regulation is serving to mute prepayments. Obviously, loan characteristics and servicers matter, but the overall prepayment landscape is susceptible, which is particularly important for us in order to maintain our net interest margin. Assets that we bought in higher rate environments are prepaying slowly, prepaying slower than they might have, so they’re staying on the books longer and they are now gaining the benefits of lower hedging costs. Protecting and even augmenting NIM when rates drop is a key focus right now. The company had a good quarter, essentially earning its dividend in a very low rate environment and compared to other fixed income centric companies. Our dividend yield is high and attractive at 11.1%. Just like the global search for yield is boosting MBS prices, that same search for yield helped their stock price this past quarter. EARN’s stock had a total return of 12.4% for the quarter and that’s not annualized. Other dividend focused stocks such as high yield ETS and closed-end bank loan funds also did well. What differentiates agency mortgage REIT is their lack of credit risk. The lower global rate environment and the lower for longer mentality is response to weaker global growth expectations that may also bring credit concerns. So unlike high yield bonds where lower global rates are double-edged sword, an agency mortgage REIT doesn't have credit concerns in a lower rate environment. The risk factors for agency mortgage REITs are prepayment risk and interest rate risk. As always, EARN tried to manage itself throughout the quarter to have limited interest rate risk. So our performance for the quarter didn't get any boost from the drop in rates. Our performance was helped though from the continuing drop in the cost of TBA hedges. Look at slide 9, this slide shows that the annual cost of being short TBA Fannie 4 has continued to drop in the quarter and it dropped more than the decline in the asset yield of our pools, helping our net earnings. So while our holdings of MBS performed well in the quarter, with really specified polls and lower coupon TBAs, not the higher coupon TBAs that were short that performed well. Keeping our hedges concentrated in our higher coupon TBA short positions helped our performance with their declining world costs. In addition, the prepayment protects now a specified pool, helped us to reduce the hedging costs. Turn to slide 10, which is an update of a slide from last quarter. While prepayment protected pools continued to offer substantial shelter from the prepaid way, it’s EARN, with its targeted neutral interest rate posture, did not benefit from the drop in rates. Now that we’re in this environment, we believe our earnings potential is better. We see a healthy NIM on only specified pools versus a combination of TBA shorts and other interest rate hedges. The challenges we face managing the company have changed since the end of last year. Last year, before the first fed rate hike, the challenges of making share portfolios were properly hedged with a possibility that rates could increase. Now, the challenge is structuring portfolios that can withstand the increase in prepayments we’re seeing and protecting net interest margin in the face of declining asset yields. To do that, we focus on lowering our hedging costs and lockstep with the decline in asset yields. And given the uncertainty in rates, we need to make sure our portfolio will be attractive, if rates reverse and of course an increase. That's where the drop in many TBA roll level is helping us. It’s lowering hedging costs and protecting earnings. Another trend to watch is the upward creep in three months LIBOR over the last month. And as we have said in the past, the most important thing about interest rate swaps that make them a good hedge for us is that we need the repo borrowing rate that we pay to financial our pools to track three-month LIBOR that we get paid and the floating leg of the interest-rate swaps. Of late, these rates have tracked each other. So our repo borrowing rates have gone up as LIBOR has gone up, but that hasn't cost us, because we get paid LIBOR on the floating leg of our interest rate swaps. Lately, there have been big money market flows out of prime money market funds into government money market funds. As investors, we add to the upcoming regulations for prime money market funds, under which investors will no longer be guaranteed to be able to withdraw their prime money market investments immediately and at par. This has had two important effects. First, this has put pressure on LIBOR as the prime funds suffering redemptions sell their short-term bank paper, pushing borrowing costs up for banks, which is what LIBOR is based on. Second, many of the government funds gain the additional subscriptions are big providers of agency repo. So that's providing support for agency repo borrowing rates. The upward movement in LIBOR doesn't hurt us, since we’re receiving LIBOR on the floating legs of our interest rate swaps and in fact, as LIBOR creeps up, it may put upward pressure on interest rate swap spreads, which, as Lisa mentioned, helps us on a mark-to-market basis for the interest rate swap hedges we already have on. We think there are several reasons why prepayments have been slow, relative to the level of mortgage rates. With some burn out in the market, as many borrowers have seen these mortgage rates before, banks have been reluctant to hire additional staff in their mortgage companies, the overall whack of the mortgage market has fallen and the drop in mortgage rates that the consumers are seeing hasn't kept pace with the drop in interest rates in the institutional markets. Put it altogether and you get a refi index that is lower than what it has historically been for this level of rates. While the cost of prepayment protection has gone up, given how much swap rates have gone down, we believe we can generate a very attractive NIM, because hedging costs have declined. So things can change and we expect them to change, but for now, the high cost of mortgage origination and the reluctance of big banks to hire has kept prepayments manageable. The higher coupon specified pools we put on the books and higher rate environments are prepaying at a very high rate and instead our hedging cost on them keeps dropping. For the quarter, we grew the portfolio a bit and that was mostly in the Ginnie Mae sector, where we found specified pools that were attractive relative to TBAs. We held on to most of our deep prepayment protection pools, even though the price of that protection went up since we've perceived substantial prepayment risk in pools without protection. Again, our goal in managing the portfolio on this environment is to increase -- of increased prepayment risk is to protect and hopefully grow our net interest margin. So we look for parts of the market where the yield on the asset has not dropped as much as the cost of the hedges. We recognize that interest rates can move quickly and unpredictably, so we focus on assets that will not experience big duration changes and a quick 25 to 40 basis point move in interest rates. We also focus on assets that won’t fall out of favor if interest rates were to rise 50 basis points. So we are avoiding lowest coupons. Another important source of returns for us is capturing inefficiencies through active portfolio management. As disclosed in the earnings release, turnover was 31% last quarter, interest-rate volatility, changing prepayment expectations, surprise in financial news like Brexit and the two recent employment reports create opportunities for us to add excess returns to active creating. So while our [indiscernible], a dynamic market creates trading opportunities. Our focus is on sourcing stable cash flows that will remain in demand, even if rates increase. But we can generate an attractive NIM by taking advantage of today's lower hedging costs. Now, back to Larry.

Thanks, Mark. By the end of the second quarter, our stock price had increased to 85% of our $15.38 second quarter book value. After quarter-end, EARN’s stock prices continued to move even higher. When our stock price was closer to book value, share repurchase have become less attractive and less accretive for shareholders. as a small company we have to balance share repurchases carefully with the FX shrinking our capital base has on our expense ratios and liquidity of our stock. In light of the upward trend in our stock price this quarter, we did not purchase any shares but we do intend as always to be mindful going forward of the price of a stock as we opportunistic with share repurchases. You may have noticed that we lowered our dividend by $0.05 in the second quarter to $0.40 per share. This allowed for our core earnings excluding the catchup premium amortization adjustment to comfortably cover our dividend this quarter, while our book value per share was basically flat from last quarter. Rather than pay dividends at a book value, we want to generate sustainable income that covers our dividend. And we believe that most of our shareholders share that view. While the long-term impact of the negative interest rate policies of global central banks is unclear. Over time lower borrowing costs should create opportunities for companies and households. As Mark mentioned there can be significant lags between drops in interest rates and peak levels of repayment activity. As it can take a while for the mortgage banking industry to expand its refi capacity to meet demand. As a result, we expect the prepayment activity spurred by the sharp decline in interest rates that occurred toward the end of the quarter may be hiding for a sustained period in the coming months. As evidenced this quarter, our portfolio is positioned well to weather away the prepayment activity. We continue to be vigilant as always in the maintenance of our hedges, in the event of any future interest rate increase by the federal reserve. Looking ahead, yield curves around the globe are pricing an accommodative monetary policies of central banks for the foreseeable future which is keeping interest rates at record low as globally. EARN is well positioned with its highly liquid portfolio, sophisticated analytical team and proprietary technologies to take advantage of market developments as they occur. A sustained way for repayment can further enrich prices of our specified pool portfolio relative to our TBA short positions. We believe that EARN’s strategic advantage is clear in a heighten prepayment risk environment as Ellington has a 21 plus year history of analyzing loan characteristics, servicer and borrower behavior. We have a great success in the past and especially in this past quarter by being patient and disciplined in our asset selection and maintaining prudent hedges to mitigate interest rate risk. And the old high interest rate low prepayment rate environment value of repayment protected pools is mostly latent and doesn’t translate directly into higher net interest margins. In this new potentially high prepayment rate environment there is much more opportunity for greater divergence between the repayments on the specified pools that were long and the prepayments on the generic TBAs that were short. And that divergence can really drive earnings. Following on that theme, as you can see on slide 18 of the presentation our short TBA position at the end of the second quarter was around 2.5 times bigger as a percentage of our overall hedging portfolio then it was at the end of the first quarter. Not only does this position create opportunities for prepayment divergence as I’ve just discussed but it is also more conservative poster generally that should help us better withstand increased interest rate volatility, increased prepayment speeds or a widening in agency RMBS yield spreads. As you can see on slide 9, TBA roll costs have plummeted this year, so these TBA hedges are considerably more efficient than they have been in quite some time. Of course the TBA markets can to be quite volatile and our hedges in TBA short positions are liquid, so we do not hesitate to pairdown our TV short positions in favor of more interest rate swaps whenever we feel that the risk award balance has shifted. As you can tell, we believe that there continues to be excellent opportunities in the agency MBS market for us to create value for our shareholders. As we capture the healthy net interest margin between the yield in our prepayment protected specified pools and the costs of our REPO borrowings in our interest rate hedges, we continue to enjoy the benefits of a highly lucrative portfolio leaving us able to capitalize at any dislocations, in RMBS prepayment or RMBS credit should such opportunities arise. And with that, our prepared remarks are concluded; I will now turn the call to the operator for questions. Operator go ahead.

[Operator Instructions] Your first question comes from Steve DeLaney of JMP Securities.

Mark you touched on rates a little bit, I'm just curious if you have thoughts, you know, we’ve noticed LIBOR moving higher while obviously the Fed has done nothing at [indiscernible], so my naive conclusion is it must have something to do with Brexit or the Eurozone. I’m curious if you have any thoughts what's behind this 11 to 12 basis points move wide in three-month LIBOR since June that’s the first part of the question. And I guess tying it into the comments about money market reform and the increase in requirement to hold more government paper. Is there a possibility where I'm really going, is there a possibility for us to see agency REPO consistently been priced inside of LIBOR over the next 6 to 12 months? Thank you.

Thanks Steve, these are great questions and we have been watching this closely, LIBOR creep, a lot of people have been paying attention but interesting because it's almost a monotonic increase in three-month LIBOR for the last two weeks. So one thing we've doing about for the last nine months or so most of our repo borrowings we are putting out 90 days, three months because what we've found is that the repo rates we've been getting on pools for the last 8, 9 months track - when we get to three-month repo rates from our lenders they track very closely to the three-month LIBOR and that’s we get paid on floating legs of the swaps you receive, or is if we think, where one month LIBOR versus one month repo there one month repo are a lot higher than one-month LIBOR. So I've seen in the past several months, our three month repo rates are within a couple of basis point of three-month LIBOR, so I think this LIBOR creep up as a mentioned in the prepared remarks is largely a function of this money market reforms where prime funds are seeing outflows so prime funds are not either not rolling commercial paper or having to sell commercial paper. And I do think the agency repo market is going to be the beneficiary as the government funds are getting big capital inflows and they are providing repo. So while in last several months, our repo cost have been a couple of basis points higher than three-month LIBOR. I think there is a very good chance going forward that agency mortgage repo as you mentioned. I think it will dip below three-month LIBOR which is going to be a big benefit to us and that if you get agency three-month repo 10 basis points below three-month LIBOR that’s essentially going to improve net interest managing margin on everything hedges swapped by 10 basis points. So, I think…

And eight times levered, you’ve got - almost 1% on your ROE, right?

So it is going to be, we are going to be doing our next series of rolls in the next two weeks, not only very interested in seeing what sort of rates we get relative with LIBOR. I expect the repo rates that we get are going to be very similar to the repo rates we got a month ago, in which case there will be below three-month LIBOR. So this is sort of I think a definite upside to you can see in agency REITs right now that's not priced in. And also the other thing I mentioned in the prepared remarks potentially we've seen it on the shorter tender swaps like five years NIM of making swap spreads less negative or positive on the short end, we've already seen some of that, so.

That's helpful color I really appreciated it. Your spec pool strategy and you’re kind of dynamic hedging is obviously serving you well in terms of your ability to cover the dividend, $0.48 of earnings excluding the catchup, so is that fit, I mean it’s almost surprising to me frankly that the returns are as good as they given how much yield curve flattening that we’ve seen over the past year which is really a sign that you really are managing the basis and hedging is opposed to just taking blind industry risk. But as we sit today, I mean what is the biggest risk to your spread and your ROE as you see it, as you look at this volatile market that we have out there, it sounds like things since your prepayment risk is being managed, your funding is kind of improving, is there something out there that we're missing.

I just, I want it, before I’m going to let Mark answer that from the risk perspective but I just did want to make one point which is not every industry mortgage REIT I believe is as disciplined as we are about using swaps all out of the yield curve to hedge and straight risk. So and back in 2013 that really hurt a lot of them that were focusing just in the short end, say two year swaps, we had 10 and 30 year swaps lots of them and that really helped us obviously get through the…

Taper Tantrum.

It’s like Taper Tantrum with minimal damage. So, when it comes to a flattening yield curve, I would just sort of say that car layer of that does not - for us right hedging all along and including the longest end of the yield curve that does not necessarily hurt our net interest margin when the curve flats, I just wanted to make that point.

I think a challenge we face in this environment and it manifests itself in the second quarter. it wasn't significant enough headwind to deter what was a good quarter but when you get a lot of interest rate volatility even if rates end up at the same point where they started, that’s still a cost to the company right because the company needs to adjust its duration dynamically. So if you remember before the Brexit vote there was almost universal consensus that remaining was going to win, so interest rate had gone from like 10-year, it’s like 150 to 175 than they immediate rallied back to 150. So moves like that sharp up and down, moves require some delta hedging and that almost by nature it’s an expense. So I think that quick moves in rates even if the revert back we are seeing more of those then what we use to see having in part because liquidity in the market side is not as good, also in part, because a lot of these rate moves are driven by Central Bank behavior so you get sort of like news event days and sometimes they will behave in ways which is different than what the expectation was. So I think that's a little bit of a headwind. The other thing we've seen is that as a roll, focus on rolls have come down a lot and we showed the example of Fannie 4, but it's true basically 3.5, 4, 4.5., 5. You’re seeing many of the bigger asset management platforms not lead but just you know traditional money manager are managing mortgage portfolios versus the Barclays agg or whatnot have been exiting TBAs and going into specified pools. So it’s a little bit more competition for specified pools than they used to be but in terms of net interest margin, mortgage has performed well this quarter, it’s a good environment because a lot of what we buy is prepayment protected, can stay on the books but it's a high enough coupon, so it's anchored to a TBA and that TBA is relatively short duration. So we can hedge with a relatively short duration flock which are very low in rate. So I think the NIM potential is good, the active trading potential now I good. I think with moves in interest rates that mean revert, we've seen more of those than used to, that’s a little bit of a headwind and there is a little bit more competition for pools but all in all I think it's been a pretty good environment right now.

And I just want to add one more thing which is that this level of rates right, the whole mortgage market, the whole specified pool market is trading at much higher prices than they were before. And repayments are high potentially poised to go higher so even saying what the yield is on a specified pool, four and a half or something like that is not so easy, right and there is going to be divergence of use in the market, so when you talk about buying pools and capturing net interest margin, what we hope to do is to be buying that other people are selling because the word about repayment risk that that our experience in models are telling us are going to actually have a really good yield. So when everything is trading near par, no sort of difference of opinion in terms of what yields are but, things are $105, $106 price and you’ve got a potential prepayment wave coming that's really where you can differentiate yourself and we can capture hopefully a big net interest margin by identifying pools that are going to have really good yields in this environment even with our high dollar prices.

[Operator Instructions] Your next question comes from Douglas Harter of Credit Suisse.

Just a follow-up on that last point you were making around specified pool prices, how do you see the kind of efficiency of the pricing of those today you still see sort of attractiveness in those prices relative to your prepay expectations?

Yes, yes we do, so they are definitely up and there are certain parts of the pool market that are relatively commoditized but when you see an increase in payment, it was nice for us is that means they is an increase in supply right so every borrower that’s refinanced out of their mortgage now there is a mortgage company that selling their new mortgage, right. So, there is a increase in supply and we are able to source through new originations, newer pools that have very favorable characteristics. So I think there is certainly parts of the pool markets that are relatively fully priced and commoditized but there is many, many corners of the market that offer very good value versus more generic mortgages.

And then, have you or do you expect to need to make any changes further changes to hedge portfolio or would you be more willing to take on more risk given the changes that we've seen in the rate environment and the expectation that we are kind of lower for longer?

I mean I think one thing that, as I mentioned we are always looking at is to what extent we want to be hedged with TBAs, Mark mentioned the cost of delta hedging, when you’re hedged with TBAs that mitigates that to a larger extent of course in a stable rate environment you’d rather be hedged within straight swaps so that's something that we look at all the time where is the mortgage space, where is the right place for us to be short whether it's TBAs or swaps and treasuries. So, but in terms of saying okay, we are coming to some conclusion that now there is a low probability, our rate is going up, so we are going to lift a lot of our rate hedges generally, no, that's not something that I think we would consider and that we have, you know, that’s just not – that’s not our style and that is I think part of how we frankly ran the company.

And given where rates are now, it doesn't even make you that much money, right like the cost of not, as rates drops it means the cost of not taking interest rate risks is lower and lower. So…

And the cost of having it on is low right now, right I mean, so we could take that risk and yes maybe we would earn an extra [indiscernible] many hundreds of basis points a year, if we lifted all of our hedges but that's not - that's just not our philosophy.

Ladies and gentlemen that does conclude today's conference call. Thank you for your participation, you may now disconnect.