Anworth Mortgage Asset Corporation (NYSE:ANH)
Q4 2015 Earnings Conference Call
February 16, 2016 1:00 PM ET
Joseph Lloyd McAdams - President and Chief Executive Officer
Joseph McAdams - , Executive Vice President and Chief Investment Officer
Brett Roth - Senior Vice President and Portfolio Manager
Charles Siegel - Chief Financial Officer, Treasurer and Secretary
Sam Choe - Credit Suisse
Good day, and welcome to the Anworth Mortgage Fourth Quarter 2015 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this 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 can generally identify forward-looking statements as statements containing the words may, will, believe, expect, anticipate, intend, estimate, assume, continue or other similar terms or variations on those terms or the negative of those terms.
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, 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.
Our actual results may differ materially and adversely from those expressed in any forward-looking statements as a result of various factors and uncertainties including, but not limited to, changes in interest rates; changes in the market value of our mortgage-backed securities; changes in the yield curve; the availability of mortgage-backed securities for purchase; increases in the prepayment rates on the mortgage loans securing our mortgage-backed securities; our ability to use borrowings to finance our assets and, if available, the terms of any financing; risks associated with investing in mortgage-related assets; changes in business conditions and the general economy, including the consequences of actions by the U.S. government and other foreign governments to address the global financial crisis; implementation of or changes in government regulations affecting our business; our ability to maintain our qualification as a real estate investment trust for federal income tax purposes; our ability to maintain an exemption from the Investment Company Act of 1940 as amended; risks associated with our home rental business; and the managers’ ability to manage our growth.
These and 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.
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 or 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, future events or otherwise.
Except as required by law, we expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statement 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 and Chief Executive Officer of Anworth. Please go ahead, sir.
Joseph Lloyd McAdams
Thank you very much. I’m Lloyd McAdams and with me today are Joe McAdams, Chief Investment Officer of the company; Brett Roth, Senior Vice President; and Chuck Siegel, Chief Financial Officer.
I will now turn the call over to Mr. Joe McAdams, our Chief Investment Officer.
Thanks, Lloyd. In going over the reported financial results that were released last Friday. I’ll start with the earnings of the company, core earnings during the quarter were $14.9 million, or $0.15 per share that was up slightly from $0.14 per share of core earnings in the third quarter of last year.
Comprehensive income, which reflects all realized and unrealized gains and losses on our asset portfolio as well as liabilities and related hedges was $12 million for the quarter, or $0.12 per share.
Looking at the investment portfolio of the company as of 12/31, you’ll see that agency mortgage-backed securities declined to approximately $5.6 billion, including agency TBA positions. This was a reduction on the quarter that resulted from the sale of adjustable and fixed-rate agency pools of approximately $720 million during the quarter, as well as the paydown of principal scheduled and unscheduled on our agency positions.
These reductions were made to facilitate the expansion of the portfolio to include mortgage credit investments as has been going on for during all of 2015, in addition facilitating share repurchase activity and to reduce overall portfolio leverage. Not surprisingly, non-agency MBS and residential loans consolidated on the balance sheet increased to a combined 23% of investment assets as of 12/31.
Getting into more detail on the agency MBS portfolio, the percentage of adjustable rate MBS that are either currently in a reset period or within 12 months of their first contractual reset now stands at 38% of the agency portfolio with fixed rate mortgage backed securities now at 28%. Fixed rate assets – fixed rate gency MBS assets continue to be heavily weighted in 15-year maturity bonds, which will obviously have less sensitivity to changes in long-term interest rates than traditional 30-year mortgage-backed securities.
The average coupon on the agency MBS portfolio was little changed at 2.6%, as I’m sure you’re all aware, during the quarter the Fed raised their target rate for Fed funds by 0.25%, the first change in that rate since 2008. And I think it would be worth noting that, while we have, as discussed a significant amount of our portfolio in adjustable-rate MBS, these coupons are tied to the LIBOR rate and adjust annually with typically a one to two-month look back in setting that rate.
So the increase of a little over 30 basis points in LIBOR that we saw during the fourth quarter is not yet reflected in these numbers in the average coupon of the portfolio. And we should begin to see increases related to these moves in the agency ARM coupons in the coming – the current quarter, as well as the coming quarters.
The sale of agency MBS during the quarter focused on higher cost, higher price mortgage-backed securities that we felt would be more vulnerable to increases in prepayments should be either the overall level of mortgage rates decline, or the yield curve flattened, which would tend to elevate prepayments on adjustable-rate mortgages relative to fixed rates.
So you’ll see that the average cost of the portfolio now stands at 102.95%, which is a decline versus 103.22% at September 30. So the total unamortized premium of the agency portfolio declined $40 million to $147.5 million at year end.
Actual prepayment activity on the agency MBS portfolio declined from 21% annualized in the third quarter to 17% during the fourth quarter. Subsequent to year-end, we have seen a decrease in interest rates and mortgage rates as well. We’ve also seen some increase in prepayment activity on the agency portfolio relative to the fourth quarter, but so far quarter to-date prepayments are still running below the level they were at during the third quarter.
Amortization expense of that premium was $10.2 million during the quarter. This is a reduction that was driven primarily, in fact, almost entirely by simply the reduction in the balance of premium to be amortized and does not reflect any significant change in the rate of amortization on the portfolio.
In discussing the non-agency MBS portfolio, I’ll turn it over to Brett Roth. Please?
Thanks, Joe. As Joe mentioned during the quarter, we did continue to grow the non-agency portfolio, both in the legacy CUSIP area as well as in the newly securitized product area. In the legacy CUSIP area, the growth or the additions were approximately $65 million, and that was across all the various loan types we do take advantage of the opportunities in the subprime and rotating some assets out and some in, as well as adding additional assets, as I said in across the Board as well as in the non-performing sector.
On the 2.0 area, we were involved in the securitization this last quarter, which allowed us to continue to grow the portfolio and was again against prime jumbo type collateral across the product types for 30, 15 and a little piece of hybrid product in there as well. Thank you.
Thanks, Brett. Turing to the financing of our assets, both agency and non-agency, you’ll see that the overall repo balance decreased on the quarter not surprisingly this was due to the reduced agency MBS portfolio and the paydowns on that portfolio.
So at year-end, the leverage stood at 6.65 times our long-term capital, which is described in press release, it’s common plus preferred, plus preferred – plus trust preferred capital used as the denominator in that calculation. That’s – the swap position itself was mostly unchanged. Overall, we did sell some – a few longer dated swaps and replaced them with similar face value of shorter maturity swaps to reflect the reduction in duration from some of the asset sales.
But the overall average maturity after adjusting for swaps at year-end was 736 days, or approximately two years. Once you include the – our short euro, dollar position that would bring the duration of our liabilities – the interest rate sensitivity of those liabilities to approximately 2.25 years.
At December 31, the duration of our entire portfolio agency and non-agency was close to, but a little less than 2.25 years, 2.1, I believe was the duration, resulting in a flat to slightly negative asset liability mismatch. Now, given that interest rates ended higher on the quarter than they were on average during the quarter, there’s a small, but negative asset liability mismatch during the quarter was a positive for book value.
Turning to the statistics for net interest spread adjusted for core income components, including TBA dollar roll income, you’ll see not surprisingly that the reduction in some of the lower yielding agency MBS assets resulted in the increase in the average asset yield including TBA dollar roll increased to 2.7% from 2.39% the quarter before. There was an increase on the cost of funds side from 1.38% to 1.49%, largely a function of the higher cost of borrowing on the quarter, but also due to the reduction of some of the lowest cost agency repo versus non-agency.
So while the overall spread increased 20 basis points, we did, as I discussed at lower portfolio leverage. So this could result in similar, but slightly higher core EPS on the quarter, which cleared a $0.15 dividend during the fourth quarter, given the closing price at year-end. This reflected a 13.8% dividend yield.
The company’s book value per share was $6.25 per share of common stock. This was a small decrease on the quarter. As we discussed, there was a decline in the value of the portfolio due to rising interest rates and spread widening. But largely this decline was offset by the positive impact of share repurchase activity during the quarter. 2.6 million shares were repurchased on the quarter, and you can estimate the economic value reflected in book value from those purchases to be about $0.04.
So the net effect of dividend paid and book value change resulted in a return on equity to common shareholders of 2.24% on the quarter, that’s unannualized and brought the total ROE for 2015 to 5.88%.
With that, I’d turn the call back over to Lloyd for his comments. Thanks.
Joseph Lloyd McAdams
Thank you very much Joe and Brett. I believe that we provided a good picture of our continuing allocation of assets from the more interest rate sensitivity agency strategy to the less interest rate sensitivity credit strategy. I believe this will well serve our shareholders in the future. Before we begin the answering of the questions you may have, I will very briefly summarize what I think is important issue that shareholders consider and that is the measuring of the interest rate sensitivity of our earnings.
In our prior quarterly earnings press releases like the one we issued on Friday, we provide detailed tables about the directional interest rate sensitivity of both our assets and our hedges.
On page two of Friday’s press release, where you will find the table describing the interest sensitivity of the assets, you will notice that the agency asset table has 38% of our agency MBS will reset within one year, 7% will be resetting between 1 and 2 years, and so forth until we note at the bottom of the table that 3% of the portfolio will not reset until the original 20 to 30-year maturities are reached. Thus, it is the interest rate sensitivity in each of these 10 categories of assets that produces the interest rate sensitivity of our asset portfolio.
I should point out that the amounts assigned to each of these asset categories reflect only the scheduled changes in interest rates of the mortgages. The asset table does not take into account either the scheduled monthly principal payments that homeowners made, or the unscheduled prepayments of principal, which homeowners make when they refinance their mortgage, both of which can be reinvested from our perspective at thethen current interest rates, where they would be higher or lower. This usually also reduces the overall interest rate sensitivity of our portfolio strategy.
Then on page four of the press release, you will also notice that our interest rate hedges are similarly presented. In that the table is ranked by maturity. The hedges are of a total value of $3.86 billion, with an average remaining term or life of 2.67 years. The general purpose of these hedges during their life is to fix our usually fluctuating financing rate to be more like that of the interest rate of our assets whose interest rate is fixed for a known period of time. And I emphasize fixed for a known period of time.
I believe that a good first step in estimating this interest rate sensitivity, if you chose to do it would be to think of our net income and also indirectly our dividend as being determined by this interest rate sensitivity. Therefore, you would compare the two tables by matching the swap hedges to the assets starting at the bottom of each table and moving up quite simply. For those of you who intend to do this calculation yourself, I advise you to add the $682 million of our non-agency securities into the long maturity category in the page two table.
So to conclude after doing this for the 2031 – December 31, 2015 data, you will see that we have interest rate swaps for the assets whose interest rates are fixed between the period of 2 to 30 years. The unhedged portion of our assets is 45% of the total. It has interest rates will reset between one and 24 months. As noted earlier of this amount, 38% will reset within the next 12 months, the other 7% will reset contractually between one and two years.
While certainly not calculated the level of detail and depth which we as portfolio managers would do, I believe that this abbreviated method will provide a reasonable measure of the overall level of interest rate sensitivity of our assets and our directional interest rate hedges, as they effect our earnings.
So that said, I will now turn the call over to Allison, our operator, to open the meeting for questions.
Thank you. We will now begin the question-and-answer session. [Operator Instructions] And our first question will come from Douglas Harter from Credit Suisse. Please go ahead.
Hi. This is actually Sam Choe filling in for Doug. I was wondering if you could share your thoughts on the investment landscape this year, how the relative attractiveness of agency is factoring into portfolio allocations?
Joseph Lloyd McAdams
Sure, Sam. This is Joe. We certainly have seen some spread widening, both into the fourth quarter as well as continuing into this quarter, and I think that’s really been, as you’re aware across the Board and really almost every asset class. So from our perspective we see an improving spread environment for the agency MBS investments spreads themselves a little wider and in addition for our existing portfolio the – obviously the effect that we’ve seen recently that would tend to be pushing off both the rate of Fed fund increases, as well as any curve flattening that will come about from significant increases on the short end.
I think the more that gets pushed off, the more positive the investment landscape for agency MBS investments are. That said, we’ve also seen widening in spreads on the non-agency side as well. There’s always the trade-off between – when interest rates go down because of some perceived weakening and strength in economic activity that usually is relatively good for the least risky sorts of assets.
So, I think, we see good investment opportunities. In fact, in many cases higher marginal yields coming in on the non-agency side. So I would expect to continue to see the majority of our deployment of net new investments to still be on the credit side. We’re about 35% of equity in credit versus rate exposure and I would expect to see that continue to move up, although probably at a slower pace than it did last year. I also feel pretty positive for the earnings outlook for our existing agency MBS portfolio.
Got it. So I guess to follow-up, I mean, you mentioned spread widening across other asset classes. Could that put potentially other types of opportunities into play, maybe like the commercial space?
Joseph Lloyd McAdams
We don’t have any plans in the near-term to expand outside of the residential space either credit related or non-credit related. But obviously in the long run, we’re looking to provide an attractive risk-adjusted return, as a mortgage REIT. So you never want to take anything off the table, but that’s not in our sites in the near-term.
Got it. Thank you.
[Operator Instructions] And having no further questions, this will conclude our question-and-answer session. I would like to turn the conference back over to Mr. McAdams for any closing remarks.
Joseph Lloyd McAdams
Well, thank you very much everyone for participating in the program. If any of you did have a question and haven’t been able to get in or do not hesitate to send us an e-mail, we will do our best to answer your question.
So, thank you, again, for participating, and we look forward to revisiting with you again next quarter at about the same time. Thank you very much.
The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.
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