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Edited Transcript of ANH earnings conference call or presentation 15-Feb-19 6:00pm GMT

Q4 2018 Anworth Mortgage Asset Corp Earnings Call

Santa Monica Feb 18, 2019 (Thomson StreetEvents) -- Edited Transcript of Anworth Mortgage Asset Corp earnings conference call or presentation Friday, February 15, 2019 at 6:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Brett I. Roth

Anworth Mortgage Asset Corporation - Senior VP & Portfolio Manager of Anworth Management, LLC

* Joseph E. McAdams

Anworth Mortgage Asset Corporation - Chairman & CEO, President, CIO and Director of Anworth Management, LLC

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Conference Call Participants

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* Douglas Michael Harter

Crédit Suisse AG, Research Division - Director

* Steven Cole Delaney

JMP Securities LLC, Research Division - MD, Director of Specialty Finance Research and Senior Research Analyst

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Presentation

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Operator [1]

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Good afternoon, and welcome to the Anworth Fourth Quarter 2018 Earnings Call. (Operator Instructions) And please note that today's event is being recorded.

Before we begin the call, I will make a brief introductory statement. Statements made on this earnings call may contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 as amended and Section 21E of the Securities Exchange Act of 1934 as amended, and we hereby claim the protection of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 with respect to any such forward-looking statements.

Forward-looking statements are those that predict or describe future events or trends that do not relate solely to historical matters. You should not rely on forward-looking statements because the matters they describe are subject to assumptions, known and unknown risks, uncertainties and other unpredictable factors, many of which are beyond our control. Statements regarding the following subjects are forward-looking by their nature, our business and investment strategy, market trends and risks, assumptions regarding interest rates and assumptions regarding prepayment rates on mortgage loans securing our mortgage-backed securities. Our actual results may differ materially and adversely from these expressed forward-looking statements as a result of various factors and uncertainties. Certain risks, uncertainties and factors, including those discussed under the heading Risk Factors in our annual report on Form 10-K and other reports that we file from time to time with the Securities and Exchange Commission, could cause our actual results to differ materially and adversely from those projected in forward-looking statements that we may make.

All forward-looking statements speak only as of the date they are made. New risks and uncertainties arise over the time and it's not possible to predict those events or how they may affect us. Except as requested by law, we do not intend to publicly update or revise any forward-looking statements, whether as a result of new information or expectations, future or change in events, conditions or circumstances or otherwise.

Thank you. And I would now like to introduce Mr. Joe McAdams, the Chief Executive Officer of Anworth. Please go ahead, sir.

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Joseph E. McAdams, Anworth Mortgage Asset Corporation - Chairman & CEO, President, CIO and Director of Anworth Management, LLC [2]

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Thank you for joining our call today to discuss Anworth's fourth quarter 2018 results. Also with me here today are Brett Roth, our Senior Vice President and Portfolio Manager; as well as Chuck Siegel, Anworth's Chief Financial Officer.

The fourth quarter of 2018 was a challenging one for our investment performance. There was significant market volatility, which led to an underperformance in all sectors of risk assets, including not only our residential credit investments, but Agency MBS as well. The Fed raised rates for the fourth time in the year, increasing the cost of our borrowings and continuing to pressure our net interest spread. As a result, the core earnings from our investments declined modestly from the prior quarter, and the mark-to-market book value declined 8% from September 30 to December 31.

Pricing on our investments has improved somewhat since year-end, and we would estimate current book value to be up approximately 2% so far in 2019. As is often the case, the challenging conditions in repricing during the fourth quarter have led to better opportunities on new and marginal investments and has strengthened our outlook going forward.

Agency investments, in particular, are offering net spreads that are accretive to current earnings. And the outlook for further Fed fund rate increases in 2019 has become increasingly benign. As a result, we would expect the combination of new agency investments, some rotation within our existing portfolio and the repricing of our existing adjustable-rate MBS to fully reflect 2018's rate hikes, all of those factors contributing together to increased core earnings in the coming quarters and provide increased support for our current dividend distribution level of $0.13 per quarter.

Turning to this quarter's -- turning to the fourth quarter's financial results. Anworth's core earnings were $10.7 million or $0.11 per common share, a decline from $0.12 in the third quarter; GAAP net income was a loss of $38 million or $0.39 per share for the quarter; and comprehensive income, which also includes all realized and unrealized gains and losses in the market value of the entire portfolio and related liabilities, was a loss of $25.6 million or $0.27 per common share.

Agency MBS assets declined from $4.6 billion to $4.5 billion during the quarter, with non-Agency MBS slightly higher as we opportunistically added some credit risk transfer investments later in the quarter. I would also note the addition of a $12 million position in residential mortgage loans held for securitization. We'll speak to this more in a minute, but we do expect increased investments of this sort relative to our other mortgage credit investments going forward.

Looking at the Agency MBS portfolio in more detail. You'll see our 30-year fixed-rate investments have increased now to 35% of total Agency MBS, including TBA positions; 15-year fixed rates are 30% and adjustable rate MBS are 35%. The currently resetting ARMs continue to increase their interest rate and the average coupon of our ARMs holdings as well. And the ARM coupon rate increased 21 basis points on the quarter to 4.09%. Overall, the average Agency MBS coupon rose to 3.54% from 3.39% at September 30.

With regards to agency prepayments, the overall prepayment rate decreased, as expected, from 16% to a 14% CPR, with ARM prepayments similarly decreasing from 23% to 21% CPR. So far, in 2019, Agency prepayments and the related costs from those paydowns have continued to decrease, averaging approximately 12% CPR so far in Q1.

To discuss our non-Agency MBS and other credit -- mortgage credit investments, I'll turn the call over to Brett Roth.

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Brett I. Roth, Anworth Mortgage Asset Corporation - Senior VP & Portfolio Manager of Anworth Management, LLC [3]

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Thanks, Joe. At the beginning of the fourth quarter, we continued to see the volume of new securitizations brought to market increase. Although new deals have quickly adjusted previously, eventually, investor appetite began to wane, and we began to see pricing concessions in order to get deals to clear the market. Further, as the quarter progressed, investors' appetite for mortgage credit assets in the secondary market also became more muted, the outcome being that we experienced a widening of spreads consistently throughout the quarter. During the quarter, we maintained our disciplined approach to valuing assets. We took advantage of the spread widening and added assets to the portfolio at attractive yields. Our overall investment activity exceeded portfolio runoff. Our acquisitions were in the credit risk transfer sector and the nonperforming loans sector of the portfolio.

During the first quarter of 2019, we have seen spreads in the mortgage credit sector tightening. In terms of valuations, we did benefit from a rally in rates in the belly of the curve. However, credit spread widening exceeded the positive impact of the rally in rates and thus did have a negative impact on the market value of the portfolio.

In looking at the portfolio makeup from quarter to quarter, you will notice that the credit risk transfer sector of the portfolio continued to grow. As mentioned earlier, we did also reinvest in the nonperforming sector of the portfolio. However, call actions outpaced reinvestment activity. We will continue to opportunistically rotate our reinvestment into those sectors of the market that provide us with attractive yield terms.

The legacy portfolio continues to benefit from the credit performance of its underlying assets. In general, during the quarter, CDRs and severities continued their downward trend. At the same time, the voluntary prepayments of this part of our portfolio did experience an increase in prepayments fees. The agency risk transfer assets in our portfolio continued to experience negligible, if any, credit issues. However, they did realize a slight slowing of voluntary prepayments speeds.

Turning to our loans held in securitization trust. The credit performance of these assets continues to remain strong, with the bulk remaining at 0 CDR. As mentioned previously, these assets have benefited from positive HPI and the overall positive economic environment we have experienced over the last few years.

During the first quarter of 2019, we closed on a purchase of non-QM loans and have, to date, purchased approximately an additional $90 million of these loans, bringing our investment up to approximately $100 million in this sector. Non-QM loans refers to a wide range of products. We are focusing on the high credit quality borrowers who, for other than credit reasons, do not need the qualification for a qualified mortgage.

On the funding side, we continue to add new counterparties to our mix of lenders and to prudently manage our financing book and, therefore, our cost of funds. This activity has allowed us to help offset some of the costs of the rise we experienced in interest rates during the quarter.

Looking forward, we continue to feel that we are in a good position to take advantage of investment opportunities as they arise in the current market. We are actively pursuing opportunities to add attractive assets to the credit portfolio across all sectors of residential mortgage credit. Our investment activities in the non-QM mortgage loan sector is continuing to expand, and we anticipate that we will continue growing our network of sources for these assets and we will continue to increase our footprint in this sector of the market. Thanks, Joe.

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Joseph E. McAdams, Anworth Mortgage Asset Corporation - Chairman & CEO, President, CIO and Director of Anworth Management, LLC [4]

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Thank you, Brett. Looking now at our portfolio financing. Total repo borrowings stood at $3.8 billion at December 31. The average interest rate paid on those borrowings rose from 2.38% to 2.67% at December 31. After taking account of our interest rate hedges, this 29-basis-point increase was reduced to a 9-basis-point increase in the average to 2.23% at year-end.

The company's overall leverage multiple was 6.16x capital, up slightly from 6.09x at September 30. If we include the synthetic financing embedded in Agency TBA transactions, our total effective leverage stood at 7.63x, up from 7.24. Despite the reduction in our repo balance, our swap position remains similarly positioned from the prior quarter, with a notional face value of $3.3 billion and an average fixed pay rate of 2.1% and a 3.9-year average maturity. These swaps hedged 87% of the balance of our total Agency and non-Agency repo borrowings.

During the quarter, we declared a $0.13 dividend per common share based on the closing stock price at year-end. This reflected an annualized dividend yield of 12.9%. As previously mentioned, book value declined $0.41 on the quarter or 8%, ending at $4.71 per common share. Taking into account the dividend paid of $0.13 and the book value decline, the total economic return to common shareholders was minus 5.5% for the quarter and brought the total economic return to common shareholders to minus 12.1% for 2018.

At this point, I'd like to turn the call back over to William, our operator, and we welcome any questions you have at this time.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And today's first questioner will be Doug Harter with Crédit Suisse.

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Douglas Michael Harter, Crédit Suisse AG, Research Division - Director [2]

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Can you talk about your outlook for leverage and/or kind of your appetite for raising additional capital to take advantage of the wider spread opportunity you highlighted?

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Joseph E. McAdams, Anworth Mortgage Asset Corporation - Chairman & CEO, President, CIO and Director of Anworth Management, LLC [3]

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Sure. Our leverage, as we point out, we did increase our TBA position during the fourth quarter. So our sort of implied leverage increased more than our actual repo leverage. So as we move toward the first quarter of 2019, I would expect to see our leverage drift a little higher as some of these TBA positions have been swapped into agency pools. I also think, on the margin, new investments, apart from the loan acquisitions that Brett discussed, are probably going to be tilted a little more towards Agency investments, which tends to be a higher-leverage strategy. So I would expect to see some modest increase in our leverage. In terms of how we take advantage of the new wider spread opportunities, I'd expect to see some rotation within our portfolio as well. You did see the shift out of 15-year fixed towards 30-year fixed during the fourth quarter. And given where pricing has been, I'd expect to see more of that as we go forward. So I think we have a number of avenues to take advantage of these accretive spread opportunities as we move forward. Relative to new capital, given where we see the investment opportunities in the Agency market, there's really not a limitation from a capital deployment side. We still are trading at a discount to book value, so that obviously is an impediment to raising common equity.

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Douglas Michael Harter, Crédit Suisse AG, Research Division - Director [4]

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Great. And then, Brett, as you're -- can you just think about how you're financing those -- or talk about how you're financing those non-QM mortgages, do you think you'll kind of aggregate to an upside that look for securitization or some more permanent financing? Or again, just any more color on that.

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Joseph E. McAdams, Anworth Mortgage Asset Corporation - Chairman & CEO, President, CIO and Director of Anworth Management, LLC [5]

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That's absolutely our plan. And I'm sorry, the question was for Brett. But yes, we have -- the loan purchases are being financed through a warehouse line. And certainly, our expectations are to securitize those when optimal. Do you have anything? Sorry.

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Brett I. Roth, Anworth Mortgage Asset Corporation - Senior VP & Portfolio Manager of Anworth Management, LLC [6]

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I think that covers it.

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Operator [7]

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(Operator Instructions) And the next questioner will be Steve Delaney with JMP Securities.

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Steven Cole Delaney, JMP Securities LLC, Research Division - MD, Director of Specialty Finance Research and Senior Research Analyst [8]

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We noticed that the ARMs CPR declined, which we expect -- would have expected seasonally for it to come in to '21. But I was just curious, given the shape of the yield curve today, the flattening that we've had and where 1-year LIBOR plus the margin is versus 30-year fixed, what is your kind of realistic outlook for the ARM portfolio for CPRs looking out into the second quarter and going forward? Do you think you'll get any relief there? Or, do you expect them to remain high?

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Brett I. Roth, Anworth Mortgage Asset Corporation - Senior VP & Portfolio Manager of Anworth Management, LLC [9]

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Thanks, Steve. You point out an important factor when you think about ARM prepayments. There's the economic incentive, which when you have a flat yield curve and you have ARM coupons repricing higher, gives homeowners an incentive to refinance out the curve and lock in a rate for a longer period of time. At the same time, our experience has been a decent factor in driving ARM prepayments higher is simply the expectation the borrowers have of continued increases in their ARM rate as they move forward. So I think, in 2018, we had both those factors sort of in alignment, right? We had a base increase and homeowners concerned that their coupon rate might go higher, combined with the fact that you had a flattening yield curve. I do think, as we look to 2019, clearly, the longer the curve stays flat, and it's gotten a little flatter in December and into January, you have a little more economic incentive for a homeowner. But what I think you're going to see a lessening of is the sort of headline risk of continued rate increases sort of pushing people off the fence to refinance even in a situation where it might not be economical. So as you point out, there's seasonal effects. We do continue to see our ARM prepayments decrease so far in 2019. Obviously, a good deal of that can be driven by seasonal effects as well. But I would expect ARM prepayments certainly to remain elevated over fixed rate prepayments. But I think that we did get a decent slug of the refinancing activity that this sort of shift in the yield curve and increase in rates we've seen. I think more of that is behind us than ahead of us.

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Steven Cole Delaney, JMP Securities LLC, Research Division - MD, Director of Specialty Finance Research and Senior Research Analyst [10]

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Understood. And I totally get your point about the fact that the Fed is on hold and the expectation for when your [LIBOR's] going higher has been taken off the table. Given that backdrop and also your comments about the attractiveness of Agency MBS, and I'm thinking of essentially 30-year MBS at this point, would you consider selling down a little bit of your ARMs and just gradually reallocating more to take advantage of the higher ROE trade and 30-year MBS?

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Joseph E. McAdams, Anworth Mortgage Asset Corporation - Chairman & CEO, President, CIO and Director of Anworth Management, LLC [11]

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It's certainly something we would consider. During the fourth quarter, we felt that all the sectors we invest in reducing our 15-year MBS was the best place to start. But -- so on the hierarchy of portfolio rotation, that's how it took place during the fourth quarter, but it's certainly something we'd consider going forward. The ARMs don't -- they're all liquid, but relative to 50 -- relative to fixed-rate securities, the market is less liquid. And so I think we're always looking for opportunities where there's a good bid for certain sectors of our ARM portfolio in thinking about rotating out.

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Steven Cole Delaney, JMP Securities LLC, Research Division - MD, Director of Specialty Finance Research and Senior Research Analyst [12]

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I understand. Liquidity does have a value, doesn't it, in terms of moving to a -- especially in a volatile market to be in more liquid securities, for sure? One thing we've noticed this year, obviously, we always expect repo to be stressed in December, especially late December, and maybe from time to time at quarter end. But we've been watching the GCF RMBS index, and it seems to have shown more volatility day to day and especially around the end of January. And I'm just curious if you're seeing that in the repo rates that -- your Agency repo you're being quoted for 30, 60 days? Have you seen that bouncing around? And could you give me an idea of kind of where things stand today on your repo rates you're paying?

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Joseph E. McAdams, Anworth Mortgage Asset Corporation - Chairman & CEO, President, CIO and Director of Anworth Management, LLC [13]

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Yes, I think you're correct, Steve. We -- there has been a little more volatility in the rates. Normally, I think, we would have expected to see repo rates maybe come down a little more relative to the pricing over the turn at year-end. But in terms of any particular guidance, I don't have sort of a long-term outlook based on the volatility we've seen in the past months. I think, by and large, while there may be sort of a wider range from day to day and where our repo rates are, I still think they're relatively stable from where they were at year-end.

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Steven Cole Delaney, JMP Securities LLC, Research Division - MD, Director of Specialty Finance Research and Senior Research Analyst [14]

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What would you expect to see that if you were going to pick up the phone right now and do a repo trade for 30 days on 30-year, what would you expect to see in a quote?

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Joseph E. McAdams, Anworth Mortgage Asset Corporation - Chairman & CEO, President, CIO and Director of Anworth Management, LLC [15]

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I'm sorry, I'm looking right now, Steve, at my -- I normally have all of our recent repo trades on a sheet in front us. I'm missing it.

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Steven Cole Delaney, JMP Securities LLC, Research Division - MD, Director of Specialty Finance Research and Senior Research Analyst [16]

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I'm sorry to put you on the spot.

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Joseph E. McAdams, Anworth Mortgage Asset Corporation - Chairman & CEO, President, CIO and Director of Anworth Management, LLC [17]

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Sorry about that. But yes, we've been -- I think -- I guess, I don't really have any more detail for you on that in terms of February 14 versus a week or 2 ago.

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Steven Cole Delaney, JMP Securities LLC, Research Division - MD, Director of Specialty Finance Research and Senior Research Analyst [18]

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Okay. But is it about 260 -- 260 currently? Does that sound about right?

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Joseph E. McAdams, Anworth Mortgage Asset Corporation - Chairman & CEO, President, CIO and Director of Anworth Management, LLC [19]

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I think that's sort of at the low end of where it's been sitting, but, yes, it's in that range. Yes.

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Steven Cole Delaney, JMP Securities LLC, Research Division - MD, Director of Specialty Finance Research and Senior Research Analyst [20]

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Okay. So definitely wider against 1-month LIBOR than, I think, maybe we were for most of last year. I appreciate you bearing with me on that, but I'm just trying to get a sense of that important market and where that is. And just one -- I'm sorry, go ahead.

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Brett I. Roth, Anworth Mortgage Asset Corporation - Senior VP & Portfolio Manager of Anworth Management, LLC [21]

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You're correct in a sense that one of the important factors, not just for our repo rate, but for our earnings level has been the volatility and the spread between repo and LIBOR, which we receive on our [box]. So that definitely improved during the fourth quarter, and I think some of that follow-through of that spread movement will improve results during the first quarter. But I think, as you correctly pointed out, that spread has sort of been moving in the other direction so far in the first quarter to what I would maybe call more of a normal level. So we're back to sort of 10 basis points over LIBOR on some of the repos.

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Steven Cole Delaney, JMP Securities LLC, Research Division - MD, Director of Specialty Finance Research and Senior Research Analyst [22]

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Got it. That's helpful. And then one final thing for Brett. I don't know -- in Doug's question, I don't know if you answered or discussed what the optimal size or the minimum size to securitize would be. Could you comment on that? And part of that, I'm curious to know sort of how you're -- with your loan coupons and your warehouse, what your NIM kind of looks like as you're in this aggregating phase?

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Brett I. Roth, Anworth Mortgage Asset Corporation - Senior VP & Portfolio Manager of Anworth Management, LLC [23]

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Sure. Well, I'll start off with the securitization question. Economically, to make a securitization make sense, I think you need $150 million minimum in that transaction, about 250 loans. So that's kind of barebones in terms of making a securitization work for you. I think, optimally, we would probably try to be a little bit larger. Looks like we're tracking toward something that might look a little bit larger than that initially. But I think somewhere between the $150 million and $250 million area is where I would ballpark what -- where we would come with the securitization. I know that's a wide box.

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Steven Cole Delaney, JMP Securities LLC, Research Division - MD, Director of Specialty Finance Research and Senior Research Analyst [24]

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No. I would have been shocked if you told me $300 million, frankly. So I take the $200 million to $250 million to be attractive, meaning that you're going to be able to get to that place sooner than you would if it was even higher, so. And then, could you comment on the kind of the current NIM? And I'm trying to get at, like, right now, you're obviously earning on the loans, but I suspect you would be viewing a higher return on equity once you were in a securitization, just the higher leverage.

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Brett I. Roth, Anworth Mortgage Asset Corporation - Senior VP & Portfolio Manager of Anworth Management, LLC [25]

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Yes. So roughly, on the warehouse, the net interest margin is somewhere in the neighborhood of 100, 125 basis points. And then, as you said in the securitization, where we're using leverage and we're going to be holding on to the bottom, those numbers increase.

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Joseph E. McAdams, Anworth Mortgage Asset Corporation - Chairman & CEO, President, CIO and Director of Anworth Management, LLC [26]

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Right. The cost of financing in the securitization is higher, but we're allowed -- we're going to have a higher level of economic leverage versus the recourse.

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Operator [27]

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And there looks to be no further questions. So this will conclude our question-and-answer session. I would now like to turn the conference back over to Joe McAdams for any closing remarks.

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Joseph E. McAdams, Anworth Mortgage Asset Corporation - Chairman & CEO, President, CIO and Director of Anworth Management, LLC [28]

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Well, thank you, everyone, for your participation in today's call and for your continued interest in Anworth. We look forward to talking to you again next quarter. Thank you very much.

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Operator [29]

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The conference has now concluded. Thank you for attending today's presentation, and you may now disconnect your lines.