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Anworth Mortgage Asset Corporation (NYSE:ANH)

Q4 2007 Earnings Call

March 12, 2008, 5:00 pm ET

Executives

Lloyd McAdams - Chairman, President, and Chief Executive Officer

Joseph E. McAdams - Chief Investment Officer and Director

Thad M. Brown - Chief Financial Officer

Charles J. Siegel – Senior Vice President - Finance

Analysts

Steven DeLaney - JMP Securities

Mike Widner - Stifel, Nicolaus & Company

Bose George - KBW

Shaumo Sadukhan - Lotus Partners

Hemanth Hirani – Litchfield Capital

Jason Stankowski – Castle Peak

Operator

Good day ladies and gentleman, and welcome to your Q4 2007 Anworth Mortgage Earnings Conference Call. (Operator Instructions) At this time, before we begin the call, I will make a brief introductory statement.

Statements made at this Earnings Call may contain forward-looking statements within the meaning of the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are those that predict or describe future events or trends and that do not relate solely to historical matters. You can generally identify forward-looking statements as statements containing the words “will,” “believe,” “expect,” “anticipate,” “intend,” “estimate,” “assume,” or other similar expressions. You should not rely on our forward-looking statements because the matters they describe are subject to known and unknown risks, uncertainties, and other unpredictable factors, many of which are beyond our control. Statements regarding the following subjects are forward-looking statements by their nature, our business and investment strategy, market trends and risks, assumptions regarding interest rates, and assumptions regarding prepayment rates on the mortgage loans securing our mortgage-backed securities. These forward-looking statements are subject to various risks and uncertainties including those relating to increases in the prepayment rates on the mortgage loans, securing our mortgage-backed securities, our ability to use borrowing to finance our assets and the extent of our leverage, risks associated with investing in mortgage-related assets including changes in business conditions, and the general economy, our ability to maintain our qualification as a real estate investment trust under the Internal Revenue Code, and management’s ability to manage our growth and planned expansion. Other 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 any forward-looking statements we make. We are not obligated to publicly update or revise any forward-looking statements whether as a result of new information, future events, or otherwise. We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements that may be made today or that reflect any change in our expectations or any change in events, conditions, or circumstances based on which any such statements are made. Thank you.

I would now like to introduce Mr. Lloyd McAdams, Chairman, President, and Chief Executive Officer of Anworth Mortgage. Please go ahead sir.

Lloyd McAdams

Good afternoon, Ladies and Gentlemen. I am Lloyd McAdams, Chairman and CEO of Anworth, and I want to welcome you to this conference call today where we will discuss the company’s recent activities. As you probably are aware, we recently filed our Form 10-K this morning. During the fourth quarter of 2007, Anworth posted a net loss to common stockholders of $7.3 million or 15 cents per share based on a weighted average 48.9 million fully diluted shares outstanding during the quarter. This amount consists of income from continuing operations which was $9.4 million; $1.5 million is dividends paid to our preferred shareholders and $15.2 million is the loss from continued operations which is Belvedere Trust. This $15.2 million loss consists of the remaining $7.2 million write-off of Anworth’s investment in Belvedere Trust and approximately $8 million in 3 claims against Belvedere Trust which Belvedere Trust has contested relating to the purchase agreement transactions. Relative to these contested claims, we believe that there will be an increase to Anworth’s earnings after the dissolution of Belvedere Trust, although there can be no assurances as to the timing of such dissolution. I will reminding you that Anworth is neither a co-party to nor a guarantor of Belvedere Trust repurchase agreements or any claims against Belvedere Trust.

I would like to spend a moment talking about the balance sheet information about Anworth at December 31, 2007. Our agency portfolio at year end was approximately $4.7 billion and our portfolio of non-agency mortgage-backed securities was approximately $43 million. Stockholders’ equity available to common stockholders of Anworth at the year end was approximately $352.5 million or $6.15 per share based on 57 million shares of common stock outstanding at quarter end. The $352.5 million equals total stockholder equity of $401.4 million less our Series A Preferred Stock liquidating value of $46.9 million and less the difference between the Series B Preferred Stock liquidating value of $30 million and the proceeds from its sale of $28 million. The book value per share of $6.15 also includes an adjustment of minus 63 cents per share which reflects the company’s net unrealized loss on its mortgage assets as of December 31, 2007 added back to common stockholders’ equity and a book value of $6.78 per share.

Comments about our agency portfolio: At December 31, 2007, Agency and Non-Agency assets were 10.5 times stockholders’ equity allocated to these portfolios. The Agency and Non-Agency assets in quarter end comprised of 4 categories: One-year agency adjustable-rate MBS which was 20% of our portfolio, hybrid agency adjustable-rate MBS was 62% of our portfolio, fixed-rate agency MBS was 17% of our portfolio, and Agency and Non-Agency CMO floaters were 1% of our portfolio. The average coupon of Agency MBS and Non-Agency MBS was 5.9% at quarter end at December 31, 2007. More specifically the coupon rates of Anworth’s Agency MBS and Non-Agency MBS at the quarter end was as follows: The one-year Agency MBS adjustable-rate 6.10%, hybrid agency adjustable-rate MBS 5.85%, Agency CMO floater MBS is 5.84%, fixed-rate agency MBS 5.92%, and the non-agency CMO floater with a coupon rate of 5.11%. The weighted average term to reset Anworth’s Agency MBS and Non-Agency adjustable-rate mortgage-backed securities was 36 months at December 31, 2007, quarter end. The outstanding repurchase agreement balance which financed Anworth agency MBS and non-agency MBS portfolios at year end was $4.2 billion. The average term of agency MBS and non-agency MBS related to repurchase agreements was 49 days, and the average interest rate on Anworth’s repurchase agreement was 4.91% at December 31, 2007. After adjusting for interest rate swap transactions, the average interest rate was 4.77 and the average term to interest rate reset was 418 days.

The prepayment of principal on Anworth’s agency MBS and non-agency MBS portfolios during the fourth quarter was as follows. One-year agency adjustable-rate MBS was 36 CPR, hybrid agency MBS was 13 CPR, fixed rate agency MBS was 10 CPR, Agency and non-agency CMO floaters was 15 CPR. CPR of Anworth Agency and non-agency portfolio during the quarter averaged 18%. The average cost of Anworth’s agency MBS was 101.23% which is a decline from the previous quarter, and Anworth’s non-agency MBS security was acquired at par value.

Brief comment about our discontinued operations of Belvedere Trust. You will notice on the 10-K that Belvedere Trust is shown as a discontinued operation, with assets of $38,0000, liabilities of approximately $8 million consisting of three claims against Belvedere Trust on which it has contested, leading to repurchase agreement transactions. Anworth is neither a co-party to nor guarantor of Belvedere Trust’s repurchase agreements or any claims against Belvedere.

About our stock, the stock price this afternoon closed at $6.01 per share. Also on the call with me today are Joseph McAdams, our Chief Investment Officer and Director, and Thad Brown, our Chief Financial Officer, and Charles Siegel, our Senior Vice President of Finance. What we would like to do now is turn the call over to Mike, our conference operator, to begin the session for questions and answers that relate to the report filed and our recent activities. Thank you very much.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Steve DeLaney with JMP Securities. Please proceed.

Steven DeLaney – JMP Securities

Good afternoon everyone. Lloyd and Joe, I think this is on everybody’s mind obviously more so than 4Q results with the current market conditions, and I was wondering if you could share with us any thoughts you have currently as to plans to sell any assets to de-lever a bit and if you discussed any new range for target leverage to help us as far as modeling if you think we should assume lower leverage than the 9.1 times that you are reporting here at the end of the year. Thank you.

Joseph McAdams

I would be happy to address your question. Maybe to take a little bit of a step back from it, I guess, the basic idea of what’s the appropriate leverage range and is there a new or different range that we should think about going forward, I think that has been a topic that has been in the market because of discussions about haircuts on agency mortgage-backed security and non-agency mortgage-backed security repurchase agreements as well as some of the price volatility and declines in values that we have seen for some of the same source of relatively high-quality and in the case of agency a very high-quality mortgage-backed securities. Maybe I could could take a second before I get to the leverage question, from our perspective what we see related to those aspects of the market we deal in.

Steven DeLaney – JMP Securities

That would be great.

Joseph McAdams

Historically, we have used relatively longer term repos to finance our own portfolio. We would routinely have 6 months or 12 months, even up to 2-year term repos in the past. In the summer of last year in 2007, when we had the real liquidity crunch in the market, most of our counter parties stopped doing longer term repos, and in fact for a brief period of time, it was difficult to get a repo beyond a term of 1 month. We have been pushing since then in the fourth quarter of 2007 and into 2008 to do longer term repos. Just about all the repos we have done over the past several months at the backend of 2007 have been typically 90-day repos, so we have paid a slightly higher haircut over the past several months because they were a little longer term repos. So our average haircut back in the summer of last year was approximately 4% on our overall portfolio, which again is 99% plus agency mortgage-backed securities and agency mortgage pools. Given the developments in the third quarter and fourth quarter of last year, that average haircut moved up to approximately 4.5% as of the end of the year. We are aware that haircuts on different types of securities particularly non-agency securities and agency CMO floaters have been increasing, and it is our expectation that we will see some additional increases in the haircuts on agency MBS. Given that we already have been operating a little bit of a higher end of the range for haircuts, given our current understanding talking to our repo counterparties, we don’t expect the vast majority of those counterparties to move haircuts outside of what has historically been in the 3% to 5% range. Again, we have been operating towards the high end of that rage over the past anyway, and we may see a few counterparties look to move agency haircuts a little higher than that, but it is our expectation that over the next 3 months as our various repos come due, and we do have them stretched out over a 3-month period, we could see our average haircut rise from about 4.5% to right around 5% as a result of some of the changes that we are anticipating, so it is certainly not a substantial change relative to our positioning and I think relative to the amount of leverage that we have historically taken in the past.

Also while we have seen volatility in fixed-rate mortgages and have seen agency hybrid mortgage-backed securities underperform fixed rates over the past week or two, which is not typical, these ranges of price volatility are certainly wide by the standards of agency mortgage-backed securities but not of the sort of magnitude of some of the reported volatility in CMO floaters or non-agency securities. As it pertains to our leverage policy, I think we have always felt that the range we operated in was from 8 to roughly 12 times capital allocated to our investments. Historically, we have been fairly near the mid point of that range, approximately 10 times leverage. We have subsequent to December 31, 2007, as related to making investments and principal pay downs during the first quarter as well as deploying the capital that was raised during the quarter moved our target leverage or the actual leverage on the portfolio down to approximately 8 to 1, so we had been operating at the low end of our historic range moving into the events of the past couple of weeks. There have been declines in the value of agency MBS. Given the rally in the market, we have seen decline in the fair value of our interest rate swaps, so it is very unusual to see both the assets and liability side decline at the same time over a brief period of time, and I think given our estimates of those fair value changes, I think that has moved our leverage, again taking into account if your liabilities are unchanged and as the change in the market value that flows through to the fair value and your equity that moves up your leverage again, so I believe given the market moves over the past week or so, I think our fair value estimate of where our leverage is back up to around 9 to 9.5 times leverage, so given everything we have seen to date, I don’t see a reason for us to feel we need to change the range of the leverage we operate in. We are still at a level after the move we have seen in this market that it is generally a fairly average level of leverage for us. I think it certainly helps that we moved into this period positioning ourselves at the low end of our historic range. We will certainly monitor what is going on in the market. The last day and a half to two days have certainly been a positive for the agency mortgage-backed security market, and we will monitor the development as we move forward to see if first and foremost where we would like to position our portfolio within our current leverage range. We have not sold any securities this quarter, and it’s not our anticipation given what we understand of our position and our view of the market and our agency MBS portfolio that we anticipate having any sales to make.

Steven DeLaney – JMP Securities

That’s extremely helpful and thorough, and I appreciate it. I had a couple of follow-ups, but you actually covered them all, especially just clarifying that at this point as you see your situation, you do not have any intentions or any plans to sell any material level of your portfolio.

Joseph McAdams

Again, it is a very fluid market, but I think we understand the position we are in. Given what’s happened in the market, we certainly have been in contact with our lenders. We understand that the haircuts for our agency MBS portfolio may increase slightly, but I believe we have ourselves positioned towards the conservative end of our historic leverage range, I think appropriately so, so we could handle this sort of volatility.

Steven DeLaney – JMP Securities

Okay. Very helpful, thank you so much Joe.

Joseph McAdams

Thank you.

Operator

The next question comes from the line of Mike Widner with Stifel, Nicolaus & Company. Please proceed.

Mike Widner - Stifel, Nicolaus & Company

Good afternoon guys, thanks for taking the call and solid 4Q. Hopefully, we will see reversal of the issues with Belvedere sometime in the future. Steve covered most of my questions; I just had two quick follow-ups. You guys regularly give an indication in your reporting here of the unpledged collateral at fair value. I was wondering if you could give us a guess on where that stands today, and then the second question is, I am wondering if you have had any repo lenders that have either to date decided not to continue relationships with you or any indication that there are others that may not roll, and I was thinking about that specifically related to the suit with Belvedere and whether there are specific counterparties there that you may not be pleased with, however, those suits turnout.

Joseph McAdams

Sure. We have had repo borrowings outstanding with between 13 to 15 different repo lenders fairly continuously over the past 5 or 6 months since the problem late last summer. We have historically had executed repo agreements with about a half dozen more counterparties than that. Several have left the business—some permanently, some temporarily; nothing specifically related to Anworth. Several were counterparties that we have not typically had a lot of borrowing or in many cases no borrowing outstanding in the summertime and have been reluctant to increase their repo lines with a number of our counterparties. So while there is a smaller pool of repo lenders that are active in the marketplace, I think we have relationships that I feel are fairly strong in all of the major currently active agency repo lenders. It is a slightly smaller pool than historically. We are still comfortable with the depth of having that number of counterparties, and it has not been our impression that any of the changes in that roster of counterparties was the direct relationship of anything that transpired with Belvedere. Because we have relationships with all of the major repo lenders, all of Belvedere’s lenders were Anworth’s lenders as well, and the ones that are still active in the agency market, we are continuing to still do business with as well.

Mike Widner - Stifel, Nicolaus & Company

Great, thanks, and just maybe an update on the unpledged collateral, a best guess of current market fair value.

Joseph McAdams

Sure. It's going to be an estimate obviously—the effort to give you a real time estimate given that most of what has caused the volatility in the market has really transpired in the last week or so. I would just take a step back when we think about our capital that’s allocated to our portfolio of agency mortgage-backed securities, we consider several sources of capital, not only our common stock, our two issues of Series A and Series B Preferred Stock as well as approximately $37 million of a trust preferred issue that shows up on the liability side of the balance sheet, so as of December 31, 2007, that number would be approximately $467 million. Subsequent to December 31, 2007, we raised additional common equity of approximately $150 million, so proforma just simply adjusting the December 31, 2007, balance sheet by the amount of equity that was raised during the first quarter, that would move us to approximately $615 to $620 million in capital even beyond shareholder equity. We posted margin overcollateralization, haircut amounts, as we mentioned approximately 4.5% of the value of our repos. I think I discussed on Steve’s question that we have been operating with about 8 times leverage before this period of time, so close to a little less than half of that equity would have been overcollateralization in the form of haircuts that we would have had with the various counterparties, and that would have left something in the area of $380 to $390 million of unpledged assets over and above those haircuts. As you may be aware on the fifth business day of the month, the factor changes come out for the Fannie Mae and Freddie Mac securities. We get margin calls based on that decline in principal values, although a few weeks later, on the 15th and 25th of the month, we receive that P&I. As of today, we have approximately $105 million principal and interest receivable outstanding over the next week and a half to two weeks. That would reduces that amount of unpledged assets.

We also have as we have discussed in the past our non-agency securities. None of those are currently on repo or collateralizing any repo agreements, so all of those are things hat should come out of our amount of unpledged agency MBS. If you look at the move we have seen in swap rates, our swap position has historically been approximately half in notional balance of our assets. We have had about a 100-basis point or so decline in swap rates since the beginning of the quarter, and our average term of our swaps is about 2-1/2 years, so we would have the equivalent of approximately a 2 percentage point decline in the value of the swaps given that their outstanding balance is approximately half of our overall portfolio balance. That should translate into approximately a 1% decline relative to the net value of our portfolio or approximately $50 million, and also as we discussed over the past week or so, our agency portfolio which had been up in value year to date because of the decline in rates has seen some fairly dramatic spread widening and again this is an estimate, but based on where we have seen bonds trade and where we see our collateral value by our counterparties, we would estimate that our overall portfolio could be down in the neighborhood of a half percentage point to three-quarters of a percentage point, so you put all that together, you would say that approximately $90 million or so of our unencumbered agency securities we would have been pledging quarter to date on a proforma basis relative to those either additional margin calls relative to the relatively small decline in the value of our portfolio or posting margin relative to our interest rate swaps, so just sort of back all those numbers out, and you start with a little under $400 million after you post a haircut. We have seen $90 million fair value estimated change quarter to date, and you have $105 million in P&I receivable, and that takes you to a number of about $180 million of unencumbered securities which would include our non-agency as well as agency securities. So a long answer to your question, but hopefully that helps you see how we would go about breaking down where the unencumbered assets are, and what I would again point out is on top of that approximately $180 million in unencumbered assets, there is an additional $105 million that when it is received later on in the month would be used to settle additional trades of agency mortgage-backed securities which will add to the balance of our unencumbered agency mortgage-backed securities.

Mike Widner - Stifel, Nicolaus & Company

Great, thank you, that’s a very thorough answer, and I think I can triangulate everything out I was looking for there, but one other thing that you didn’t really talk about is also one of the things I had in mind when asking the question. Just trying to back into where the portfolio stands today in terms of total assets, so we could do some price sensitivity changes and swap value changes from there and kind of triangulate to the same number I think.

Joseph McAdams

Okay, I think I will give you the approximate number. I believe the number of assets are approximately $5.7 billion subsequent to the deployment of the capital that was raised during the quarter.

Mike Widner - Stifel, Nicolaus & Company

Okay, and your total notional swaps is about 2.74 today, is that about right?

Joseph McAdams

That’s correct, I think it is 2.78. I do not believe we had any swaps mature during the quarter, and I think it is disclosed in the 10-K that we entered into a notional $740 million of additional swaps, so the sort of ratio of notional swap balance to overall portfolio balance is up a little bit I think from about 50% to about 55%, but again, our expectation is to keep it generally in the same area.

Mike Widner - Stifel, Nicolaus & Company

Great, thank you very much guys. I appreciate all the commentary.

Joseph McAdams

Thank you.

Operator

The next question comes from the line of Bose George with KBW. Please proceed.

Bose George - KBW

Good afternoon, this is Bose George from KBW. Actually a couple of things; one, just wanted to confirm the breakdown between agency pass-throughs and CMOs. I think it’s a very small number for the CMOs, but I just wanted to see what that was.

Joseph McAdams

We do have some positions in agency CMO floaters that were purchased a number of years ago that are paid down. I believe the total is approximately $10 million.

Bose George - KBW

Okay, great, and actually just wanted to confirm your book value for this quarter, I should just add back that $7 million from the discontinued operations to get the book value, is that reasonable?

Joseph McAdams

Technically, the $8 million.

Bose George - KBW

Okay, so it’s roughly $6.30 book value something like that?

Joseph McAdams

As we discussed in the remarks, that amount will flow through to earnings and book value upon the dissolution of Belvedere Trust. Again, the timing of that may or may not be within the first quarter.

Bose George - KBW

Great, thanks a lot.

Operator

The next question comes from the line of Shaumo Sadukhan with Lotus Partners. Please proceed.

Shaumo Sadukhan - Lotus Partners

Hi, I am just trying to understand this a little bit more clearly. Obviously agency securities are very safe securities. How much mark-to-market losses could you take on your entire book before you would really be in trouble from in terms of not being able to meet margin requirements from your repo counterparties? You have this unencumbered collateral, and you have some cash coming in, but what’s really your margin for error there in terms of taking marks on these securities because of just irrational panic out there in the agency market?

Joseph McAdams

Sure, if we had started at a point where we have debt the capital of approximately 8 times that would mean one-ninth of our investment in the securities would be with our own capital, and that would be our investment in the portfolio, so approximately 10% to 11% of the value of the security. We have to post haircuts, and if the value were to decline, we would be fced with margin calls to maintain that amount of overcollateralization. That’s currently in the 4.5% range; it seems like it might head up to 5%, so of that 11% portion of the portfolio that is not financed is funded with our investment capital, approximately 5% of that is tied up in this overcollateralization, so you would have a 6-percentage point move in the net value of our portfolio before you would say we don’t have any additional collateral, cash, etc., to meet margin calls, we only have 5% overcollateralization now. So that’s the magnitude of move in the market, approximately 6 points. Again, what we have seen with the entire episode that has happened, again predominantly in the last week or so, has been that we have seen a decline in the value of our portfolio that has been less than a point, but because we do hedge our portfolio with interest rate swaps to isolate against changes in the overall level of interest rates, we have also seen a decline in the value of that swap portfolio that is sort of equivalent of approximately a point or so of the value of that portfolio, so I guess you could say absent anything else going on, the 6-point cushion that we had has declined by a percentage point and a half to a percentage point and quarter over this episode we have seen in the past few weeks—about a third of our cushion. So we certainly have the ability to withstand much more significant swings in the markets for our portfolio than we have seen. One of the issues and I think one of the concerns might be that in addition to changes in the price of the assets what if the overall haircut requirements were to change also. I think we have the understanding that there are not going to be dramatic changes in the sorts of haircuts that counterparties require to finance agency MBS. We are already operating at the high end of what has historically been the range. Again, the haircut is the term of borrowing that’s set at the beginning of the transaction, just like the rate itself, so it is not subject to change during the life of the borrowing, so it were to be changes in haircuts, they would work their way into our portfolio because we have 90-day borrowings when we enter into them and 45 days or so on average, it would take a full 3-month for any of those changes to work through the portfolio, which is certainly not something we anticipate doing, but during that period of time, we have the ability to sell securities. On a relative basis, agency MBS are less liquid than they have been in the past, but it is still relative to just about any other security that is mortgage related, they are still relatively liquid. We could obviously liquidate securities to generate additional excess capital or we can use the approximately $100 million a month of P&I to pay down repurchase agreements and free up the overcollateralization requirement, so that’s the sort of magnitude of our portfolio positioning and what it means to have portfolio a position that is approximately 8 times debt to equity.

Shaumo Sadukhan - Lotus Partners

Right now, your typical repo agreement, you said you have about 3 months to meet margin calls or is it 1 month to meet margin calls if it were to happen?

Joseph McAdams

You have one day to meet a margin call. The issue would be if there are concerns going forward just what we have heard about in the non-agency market or even some areas of agency CMO market that the haircut requirements have moved up fairly dramatically, maybe 10%, maybe 20%, or more for non-agency securities, even AAA rated non-agency securities and north of 5% and more in the 7% to 10% range for agency CMO, so when those changes take place, that obviously changes the dynamics of your equity cushion because your initial investment, a higher percentage of it is now going to be taken up by the overcollateralization requirement. Those changes work their way in only with new borrowing, so given that our current repo balance will be maturing in a fairly even fashion over the next 3 months, if there were to be changes above and beyond what we are aware of and what we anticipate, it would not be the haircut issue, it is not going to be an overnight change that dramatically shifts the amount of excess capital that our business would have.

Shaumo Sadukhan - Lotus Partners

How much spare repo capacity do you have right now? You probably borrowing maybe $5.5 billion, but how much more do you have if one of your repo counterparties decides not to renew, how much more do you have in terms of negotiated agreements with other people who are willing to repo with you?

Joseph McAdams

None of our lines are committed repo lines. They are uncommitted lines. We have credit limits that are based on our counterparty’s assessment of our financial condition. We have a number of counterparties whose credit limit is greater than our outstanding balance, but I would hesitate to rely too much upon that because our experience during the summer and early fall of last year was that if there were to be a liquidity event, something similar to what we saw last year where lenders were really reluctant to continue to extend credit either to each other or to the agency repo market, it might very well be that there is very little willingness for counterparties to take on additional borrowings during a period of time like that, so we have the ability to move repo balances from one counterparty to the other. We have that ability currently; we have been if it comes down an issue of where there is a more attractive rate and where there is more attractive finance terms able to move repo trades from one counterparty to the other as they mature, but when it comes to thinking about whether your options during a liquidity scenario, I think it’s generally a fairly safe assumption that if there were counterparties that were looking to exit the business and not rollover repos, there would be some difficulty in placing those borrowings with other counterparties. When times are good, it's very easy to move those repos around; when times get more difficult, it becomes more difficult, and those are kind of scenarios that might lead to a situation where securities might need to be liquidated to pay off certain repo balances.

Shaumo Sadukhan - Lotus Partners

I see, and what’s your policy right now in terms of cash coming in the door? Are you planning to redeploy that back into mortgage to buy new agency mortgage-backed securities and maintain your current leverage targets or will you just maybe wait for a time when maybe the repo market is a little bit more settled down before you really go out and deploy that capital back into the market?

Joseph McAdams

I think what we are doing currently and what we have done this quarter is to use the paydowns off our portfolio as well as the deployment of the new capital that was raised during the quarter to buy new securities, but to do so in a fashion that took our portfolio leverage toward the low end of our historic range. My expectation is that as we move forward we will certainly be very cautious in taking the additional cash flows and invest them in new securities until we feel that our level of leverage is appropriate relative to the temperament of the financing market at that time. I think as of today our position is that we would like to keep our leverage near the low end of the range, and I would expect that in the near term, we would probably earmark some of the paydowns off the portfolio to build up some additional overcollateralization or pay off some of the repo, but again, as we move forward, those decisions will be based on our outlook for the market.

Shaumo Sadukhan - Lotus Partners

Thanks guys, I appreciate the high level of transparency.

Operator

The next question comes from line of Hemanth Hirani of Litchfield Capital. Please proceed.

Hemanth Hirani – Litchfield Capital

Hi guys, many of my questions have been answered, but one, could you give any update on what kind of spreads we should expect for the first quarter of 2008 which is compatible to 56 basis in the fourth quarter?

Joseph McAdams

Sure Hemanth, I think the piece of information that I think would be missing in that equation would be that we did raise additional capital during the quarter and the deployment of that capital was what we feel are in the long run very attractive spread. I think in late January, we had estimated as the treasury market rallied that spreads in the low 100s area were obtainable in the market at that time. We did move fairly cautiously in investing the proceeds of that transaction, wanting to minimize the premium we paid as well as the fact that the mortgage-backed security spreads begin to widen in February as well, so by our estimation, given our expectations for prepayment, it’s our belief that deployment of the new capital and the new investments made so far during the first quarter should have spreads of approximately 140 basis points.

Relative to the existing portfolio, we are sort of beyond the point where there is a significant change in the coupon of that portfolio, so the major changes we should see in the spread on our legacy portfolio should come through the financing side, and we have seen LIBOR come down during the quarter. I think if you look at the average LIBOR rate for the quarter, I think you would expect to see that you have a decline of over 100 basis points in short-term LIBOR rate on the quarter, and as we have discussed, we have a swap balance that has an offsetting payment in the swap to offset decline in rates, so about half of the balance of our legacy portfolio has an interest rate relatively fixed, so the idea that you could see a 50 basis point or so decline in our cost of funds given in excess of 100 basis point decline the benchmark rate during the quarter, I think is sort of a good ballpark for where the legacy spread should be going during the first quarter.

Hemanth Hirani – Litchfield Capital

Okay, thank you very much.

Joseph McAdams

Sure.

Mike

The next question comes from line of John Ibis, private investor. Please proceed.

John Ibis – Private Investor

Yes, I have two questions; the first is very simple. Do you see anymore writedowns or writeoffs as in the example of this last quarter of $15 million, and the second question is, will a reduced rate by the Feds of the anticipated of at least 0.5% or we think it’s going to be 0.5% from day to day, will that impact our cost of funds significantly, and if so, do you see big contribution by that onto earnings, and if so, how will that work exactly?

Joseph McAdams

Sure, I think I’ll take them all as you asked questions. The amount that we have written off relative to our investment of Belvedere actually exceeds our economic exposure to Belvedere by the $7 or $8 million that we discussed before, so we do not anticipate any additional writedowns relative to Belvedere.

John Ibis – Private Investor

But are there any other writedowns coming down the pike that you know of right now?

Joseph McAdams

No, and again, as we mentioned if anything there should be a reversal of that $7 to $8 million writedown upon the dissolution of Belvedere. As for the question of relative to the cost of funds, I think in some ways I think it’s sort of a similar answer to Hemanth’s question and that was we have approximately half; we have the interest rate swap agreements where we pay a fixed rate and receive a floating rate based on where short-term rates are. That has the effect of offsetting the effect of changes in interest rates on our cost of funds, so in terms of interest rates falling, having the interest rates swap positions on limit the amount that are cost of funds fall. That’s I guess the negative of the interest rate swap; the positive is, if interest rates were to rise, that would offset that as well and during normal times, although the last few weeks have not been normal, that does provide a significant market value offset to the changes in the value of our portfolio, so given that balance of those swaps is approximately half of our repo balance, it’s just been our experience that when there are decreases in short-term funds, that we see about half of that change flow through to our portfolio, and certainly we would expect that to have an impact on the portfolio earnings as well.

John Ibis – Private Investor

Thank you for that explanation.

Joseph McAdams

Thank you.

Operator

Our next question comes from the line of Jason Stankowski with Castle Peak. Please proceed.

Jason Stankowski – Castle Peak

Hi guys, I was just curious if most or all of your repo lenders have access to this new initiative by the treasury, how you are thinking about that in terms of providing a bid such that your paper does not have to be sold. Obviously the haircut issue seems like it would happen over time, and you would have time to react; however, if there was a massive price dislocation, that’s seems to be where the major risk is and just curious what you think of the new program and what you’re thinking about in terms of liquidity because of it.

Joseph McAdams

Sure, I think the biggest benefit to Anworth will be indirect. First answer to your question, all of the repo dealers we deal with would have access to this plan. As best I can understand it, the real benefit will be for repo lenders who have asset that they have taken as collateral for their loans that are outstanding that they have a very difficult time finding financing for elsewhere, they will in effect through this program be able to exchange those securities so long as they are AAA rated or some sort of agency security for treasury bonds which presumably will be much easier to find a counterparty to finance the other side of the trade. They are running a matched book to a large degree where they lend money against collateral from one set of customers and they turn around, they take that collateral, and they lend it out to another set of customers and receive capital back. In cases where they have taken in collateral on existing repos that they have a very difficult time finding other counterparties for or might potentially face a very large haircut to finance that collateral or even a capital charge, I think this will be a benefit to them and make them more willing to hold those kinds of collaterals.

I am not really sure, at least in what we have seen in the market so far, that this initiative is really pointed at agency mortgage-backed security pools given that they have continued to have a functioning repo market while prices have certainly had a tremendous amount of volatility relative to what you were seeing, this is in the context of the market where AAA-rated non-agency securities traded in the 90s, 80s, and 70s even and agency CMO floaters traded into the low 90s, so those are some pretty significant moves really driven by a lack of liquidity for those securities, so I think the greatest benefit will be for the other kinds of securities that are going to fit in this program. The AAA-rated non-agency securities or potentially agency securities that have less liquidity, so I don’t expect that we’ll see a counterparty take our collateral and have that be sort of on the top of their list of what they want to go exchange for treasures with the fed. I would think it would be the non-agency AAA collateral or in the case of some of the liquidation last week that involved various sorts of agency CMOs perhaps that collateral. That’s not to say that it’s not going to be a positive for us because one of the concerns about the willingness of the counterparties to continue to participate in the agency pool repo market to continue to want to rollover their repo lines with us and other agency mortgage REITs could be affected and we have seen it get affected in the past by issues they have with other sorts of financing or less liquid collateral. I do think it would be a positive for us but not because of the direct involvement of our specific collateral in the program.

Jason Stankowski – Castle Peak

Great, thanks.

Operator

At this time, I would like to turn the call back to Mr. Lloyd McAdams, Chairman, President, and Chief Executive Officer for closing remarks.

Lloyd McAdams

Thank you everyone for joining us today. We hope we have addressed the questions that you had and we hope we addressed them thoroughly and properly, so you can better understand how are dealing with the current marketplace. We thank you again for attending, and we look forward to visiting with you again about this time next quarter. Good day everyone.

Operator

Ladies and Gentleman, this does conclude the presentation. You may now disconnect.

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Source: Anworth Mortgage Asset Corporation Q4 2007 Earnings Call Transcript
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