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Anworth Mortgage Asset Corporation (ANH) Q2 2019 Earnings Call Transcript

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Anworth Mortgage Asset Corporation (NYSE: ANH)
Q2 2019 Earnings Call
August 5, 2019, 1:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good afternoon and welcome to the Anworth second quarter earnings conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the * key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press * then 1 on your touch tone phone. To withdraw your question, please press * then 2. Please note this event is being recorded.

Before we begin the call, I would like to introduce Mr. John Hillman, Anworth's Director of Investor Relations, who will make a brief introductory statement.

John Hillman -- Vice President and Director of Investor Relations

Thank you, Ben. 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 21(e) 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 and that do not relate solely to historical matters. You should not rely on our 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.

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Our business and investment strategy, market trends and risks, assumptions regarding interest rates, and assumptions regarding pre-payment rates on the mortgage loans, securing our mortgage-backed securities. Our actual results may differ materially and adversely from those expressed in any 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 any forward-looking statements that we make. All forward-looking statements speak only as of the date they are made.

New risks and uncertainties arise over time and it is not possible to predict those events and how they may affect us. Except as required 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 changes in events, conditions, or circumstances, or otherwise. Thank you.

I would now like to introduce Joe McAdams, our Chief Executive Officer.

Joseph McAdams -- President, Chief Executive Officer and Chief Investment Officer

Thanks, John and thank you for joining our call today to discuss Anworth's second quarter 2019 financial results. Also with me today are Bistra Pashamova, Senior Vice President and Portfolio Manager, Brett Roth, Senior Vice President and Portfolio Manager, and also, Chuck Siegel, Anworth's CFO.

During the second quarter, increasing fears of a slowing global economy, uncertainty as the global trade and its economic impact as well as shifting expectations around the end of the Fed's tightening cycle all contributed to increased market volatility and significantly lower interest rates.

Anworth's book value declined in the quarter, driven by market to market underperformance of our agency MBS holdings. Agency prices lagged their hedges due to both higher volatility as well as concerns over higher prepayment risk driven by lower long-term interest rates.

Our mortgage credit investments performed in line with expectations as the benefits of lower interest rates and more accommodative policy offset any credit concerns around global economic weakness. The volatile market conditions also impacted Anworth's near-term earnings as we saw the spread between our borrowings and LIBOR widen during the quarter, impacting our overall net interest margin. Similarly, the role income earned on our agency TBA investments was reduced as well.

Subsequent to quarter end, we have seen some narrowing in that repo/LIBOR spread and could see a further improvement going forward now that the Fed's rate cuts have begun and forward expectations should clarify going forward. Higher prepayments on agency MBS also reduced core earnings and a lower longer-term rate seen during the quarter should keep near-term prepayment speeds elevated into the fall.

Lower short-term interest rates should help reduce prepayments on our agency adjustable rate mortgages and we continue to focus our fixed rate agency holdings on pools with attractive prepayment mitigating attributes.

So, the results for the quarter were we had core earnings at $9.9 million or $0.10 per common share. That was down from $0.12 the prior quarter. GAAP net income was a loss of $50 million, but as we discussed in the past, captures the market to market changes in our derivatives and hedges but not market to market changes in most of our assets. Comprehensive income, which includes realized and unrealized gains and losses on the balance sheet of all of our assets and liabilities was a loss of $8.7 million for the quarter.

In light of this increased volatility and higher prepayment risk, we reduced our agency MBS holdings during the quarter to effectively reduce our agency leverage by approximately one turn from prior quarter end. While we have selectively added some new agency positions so far during the third quarter, our agency leverage remains below a more typical target level.

So, you'll see that reflected in the total agency MBS from $4.5 billion down to $3.7 billion in market value on the quarter, representing 73% of total investment assets. Non-agency MBS holdings decreased through portfolio run-off and mortgaged credit investments in total, represented 27% of total assets at quarter end.

To discuss the agency MBS portfolio in more detail, I'd like to turn the call over to Bistra Pashamova.

Bistra Pashamova -- Senior Vice President and Portfolio Manager

Thank you, Joe. Looking at the composition of our agency MBS portfolio, you'll see we continued to rotate our fixed rate MBS allocation into 30-year fixed rate securities, as we view them providing more attractive risk adjusted returns than 15-year and 20-year fixed rates. At quarter end, 30-year fixed rate investments, including TBA positions, comprised 60% of our agency MBS portfolio. 15-year and 20-year fixed rate securities combined were 9% and adjustable rate MBS, 31%.

Given our concern about a further elevation of refinancing risk, we reduced our exposure to higher coupon and relatively generic 30-year fixed rate pools. At quarter end, 71% of our fixed rate pools had characteristics that mitigate prepayment risk. We also repositioned our TBA allocation with a focus on lower coupon securities, as less exposed to prepayments and providing more attractive role financing.

Turning to our adjustable rate MBS allocation, you'll notice arms with resets within the year constituted 18% of the agency portfolio, a small decrease from the previous quarter. With a more than 50-basis point drop in one-year LIBOR, the coupons on these securities are now resetting lower and we expect this will moderate prepayment speeds going forward.

With regard to agency portfolio prepayments, the overall portfolio prepayment rate increased to 18 CPR in the second quarter from 13 CPR in the previous quarter. Adjustable rate MBS prepayment similarly increased to 24 CPR from 19 CPR. So far in the third quarter, agency MBS prepayments have shown only a small increase, 19 CPR for the overall portfolio and 25 CPR for the arms in July.

We do anticipate higher prepayments in the next several months given the sharply higher levels of the MBA Re-Fi Index in June and July. However, re expect the increase in prepayments to moderate somewhat subsequently as the summer seasonal turnover effect tapers off.

Joseph McAdams -- President, Chief Executive Officer and Chief Investment Officer

Thank you, Bistra. With that, I'd like to turn the call over to Brett Roth to discuss our mortgage credit investments.

Brett Roth -- Senior Vice President and Portfolio Manager

During the second quarter, spreads on mortgage credit assets were volatile, ultimately ending the quarter a bit wider. However, this widening was more than offset by the rally we saw in rates during the quarter. In terms of valuation of the portfolio for the second quarter overall, our portfolio benefited from the rally we saw in the market which resulted in a gain of market valuation.

Looking at our loans held in securitization trust, the credit performance of these assets continues to remain strong with defaults remaining at 0 CDR. During the quarter, we saw voluntary prepayment speeds pick up.

We continue to see more value in investments in non-QM loans rather than securitized product. Therefore, our investment activities were focused on non-QM loans rather than on securitized product. During the quarter, we saw the securitized credit portfolio shrink due to runoff with the reinvestment dollars being committed to the growth of our loan portfolio.

In regard to our non-QM loans, the sector we are investing in is the higher credit quality near-miss type non-QM loans, which use non-traditional forms of documentation. Our current portfolio of assets has a weighted average FICO of 745, LTV of 69%, and DTI of 39%. Approximately 80% of our portfolio is comprised of hybrid arms, of which the majority are 7-1s.

Over the course of the quarter, we were focused on settling our previous trades as well as acquiring assets. Further, we have been working on developing strategic partnerships with several originators. We have rolled out our guidelines to several partners and worked closely with them so that we have now begun slow origination programs with some of these partners. We are focused on continuing to expand these types of partnerships in the near future.

On the funding side, we continue to prudently manage our financing book and therefore our cost of funds. Over the quarter, we were able to further improve the spread we were paying on these funds. Going forward, we continue to feel 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 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.

Joseph McAdams -- President, Chief Executive Officer and Chief Investment Officer

Thank you, Brett. Turning to the financing of our MBS portfolio, you'll see repo borrowings totaled $3.16 billion at June 30th. Agency repo rates fell 7 basis points to 2.61%. Non-agency repo rates fell 10 basis points to 3.5%. And the overall rate averaged 2.76% at the end of the quarter. However, the average effective interest rate after accounting for our interest rate swaps rose 6 basis point from 2.32% to 2.38% as the floating LIBOR rate that we received payment on the swaps fell faster than our repo rates did.

Portfolio leverage decreased due to the reduction of agency MBS leverage with overall portfolio leverage at 5.4 times. If you include the synthetic borrowings applied in our agency TDAs, rolling the effective economic leverage was 6.6 times at June 30th. Similarly, our interest rate swap position fell to just under $3 billion of notional balance with the fixed rate we pay down to 2.09% and a remaining term to maturity of 3.6 years.

The effective interest rate spread fell from 114 basis points to 96 basis points on the quarter due primarily on the widening of the repo/LIBOR spread, but also due to the higher paydown expense recognized in core earnings from agency prepayments.

We declared a dividend of $0.11 for the quarter, which reflected an 11.6% dividend yield on the closing stock price for the quarter. Book value per common share decreased $0.23 to $4.53 per share. Taken together, the $0.11 dividend and decrease in book value resulted in an economic return on a book value of negative 2.5% for the quarter and lowered the year to date economic return to 1.2%.

With that, I would like to turn the call back over to Ben, our operator, to open up for any questions you may have. Thank you.

Questions and Answers:

Operator

Thank you. We will now begin the question and answer session. To ask a question, you may press * then 1 on your touch tone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press * then 2. At this time, we will pause momentarily to assemble our roster.

Our first question comes from Doug Harter with Credit Suisse. Please go ahead.

Josh -- Credit Suisse -- Analyst

Hey, guys. This is actually Josh on for Doug. You spoke a little bit about leverage ticking down in the quarter. Are you comfortable with where your leverage is today, just given the asset mix of the portfolio or should we expect leverage to drift higher going forward to support future distributions? Thanks.

Joseph McAdams -- President, Chief Executive Officer and Chief Investment Officer

Thanks, Josh. We do see our current leverage as below a more typical target. I do think it's clearly over the last several days, we've continued to see some significant volatility in the interest rate markets.

As Bistra mentioned, we do expect to see potentially higher prepayments through the fall. In the near-term, given where we see market volatility, given where we see the spreads on new investments, I think we're likely to maintain this level of leverage, but certainly looking opportunistically, especially if spreads on new investments were to continue to widen to look to move our agency MBS back up to a more typical target level.

Also, as Brett pointed out, most of our mortgage credit investments have been focused on continuing to build our residential loans held for securitization portfolio. So, obviously, depending on the pace of those acquisitions continuing, that does have some impact on the overall portfolio leverage.

Josh -- Credit Suisse -- Analyst

Great. That makes sense. I appreciate the quarter on how CPRs are trending in the third quarter. Do you have an update on how book value has performed quarter to date?

Joseph McAdams -- President, Chief Executive Officer and Chief Investment Officer

Sure. Book value had performed fairly well through most of July. I'd say given the volatility and underperformance in agency MBS late last week, I'd say we ended the week down to roughly flat on book value and clearly, it looks like there's some continued underperformance today in the market. Book values had recovered somewhat in July but now we're back down to quarter end levels. Not to give real time book value updates, but I would expect them to be down somewhat if the market closes where it is now.

Operator

Our next question comes from Mikhail Goberman with JMP Securities. Please go ahead.

Mikhail Goberman -- JMP Securities -- Analyst

Good morning, everybody. I appreciate the color on book value. I'm wondering if you could perhaps give some color on where you're seeing 30-day repo rates today.

Bistra Pashamova -- Senior Vice President and Portfolio Manager

This is Bistra. As of last Friday, one-month repo rates were mid-230s, 235, a couple of basis points lower today, so, 233.

Mikhail Goberman -- JMP Securities -- Analyst

Kind of in the mid-230 range?

Bistra Pashamova -- Senior Vice President and Portfolio Manager

Low to mid-230s, yes.

Mikhail Goberman -- JMP Securities -- Analyst

Thank you very much. One other question I had was on TBAs. I know they've been cheapening significantly the past couple of quarters. I'm wondering what you're seeing in the TBA marketplace right now and if there's any further appetite to rotate further into TBAs. I know you guys kind of rotated into a higher TBA position at the margin in the second quarter.

Joseph McAdams -- President, Chief Executive Officer and Chief Investment Officer

Well, we maintained a fairly similar TBA overall position. So, if you view that in the context of a smaller overall agency portfolio, we did increase our relative allocation to TBAs. Clearly, there are two components to the role income on the TBA. There's the underlying implied yield that as you point out, has certainly gotten more attractive.

The flip side of that is the implied financing. So, TBAs have not been as special over the last few months as they typically would be. Part of that is related to the implied repo cost on the breakeven TBA role being higher, all things equal, than we might have expected given where LIBOR was.

I do think that as we expect to see the repo LIBOR basis improve some as we move forward, we should see some improvement on the role income we earn on the TBAs. I'd say where we stand now is as I described at the beginning. We have increased our relative allocation. Yet, at this point, we haven't been looking to increase our overall TBA position.

Mikhail Goberman -- JMP Securities -- Analyst

Thanks a lot. That's all I have.

Operator

This concludes our question and answer session. I would now like to turn the conference back over to Joe McAdams for any closing remarks.

Joseph McAdams -- President, Chief Executive Officer and Chief Investment Officer

Thank you again for joining us today to discuss Anworth's second quarter results. We appreciate everyone's continued interest and attention and look forward to talking to you again next quarter. Thank you.

Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

Duration: 21 minutes

Call participants:

John Hillman -- Vice President and Director of Investor Relations

Joseph McAdams -- President, Chief Executive Officer and Chief Investment Officer

Bistra Pashamova -- Senior Vice President and Portfolio Manager

Brett Roth -- Senior Vice President and Portfolio Manager

Josh -- Credit Suisse -- Analyst

Mikhail Goberman -- JMP Securities -- Analyst

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