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Anworth Mortgage Asset Corporation (NYSE:ANH)

Q2 2012 Earnings Call

July 27, 2012 01:00 pm ET


Lloyd McAdams - Chairman, President & CEO

Joe McAdams - CIO & EVP


Bose George - KBW

Jason Weaver - Sterne Agee

Stephen Laws - Deutsche Bank

Gabe Poggi - FBR


Good day and welcome to the Anworth Mortgage Asset Corporation second quarter 2012 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. Please note this event is being recorded.

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 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 and do not relate solely to historical matters. You can generally identify forward-looking statements as statement 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.

These forward-looking statements are subject to various risks and uncertainties, including those relating 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 pre-payment 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 US Government and other foreign governments to address the global financial crisis, implementation of or changes in government regulations or programs affecting our business, our ability to maintain our qualification as a real estate investment trust, under the internal revenue code, our ability to maintain our exemption from registration under the Investment Company Act of 1940 as amended and management’s 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’re made.

New risks and uncertainties arise overtime 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 statements that maybe 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.

Lloyd McAdams

Andrew, thank you very much and good day, ladies and gentlemen. I am Lloyd McAdams and I welcome you to this conference call. We will summarize the company’s recent activities and most importantly answer your questions about the past and future during our question-and-answer session, which immediately follows these brief remarks.

During the second quarter of 2012, Anworth earned net income to common stockholders of $24.4 million, which is $0.18 per diluted share, based on the weighted average of 141.3 million fully diluted shares outstanding during the quarter.

Before our question-and-answer period of course, I would like to get into the information about our balance sheet and also provide some information about the portfolio characteristics in mortgage-backed securities, but first the balance sheet.

Anworth’s portfolio of agency mortgage-backed securities at its fair value at quarter-end was approximately $9.15 billion. Stockholders equity available to common stockholders of Anworth at quarter-end was approximately $993 million with $7.19 per share based on 138.1 million shares of common stock outstanding as of June 30th. This represents an increase of $7.17 book value at March 31, 2012.

Floating fixed rate interest rate swaps were $3.18 billion which represents approximately 41% of our repo balance. If the purposes of making this percentage of repo balance calculation, we were to eliminate the amount of repurchase agreements which finance our portfolio of ARMs which we set within one year which have reduced interest rate sensitivity and do not requires significant hedging, this ratio increases from 41% to approximately 56%.

While the size of our swap position is a significant component of our balance sheet, I believe that its positions average remaining term of [34] months is more significant. Management’s current decision about this size and the term of the swap position are the important determinants of our current return on equity and therefore a dividend payout.

Information about statistics on the portfolio with a purchase agreement financing of our Agency MBS assets was 7.1 times our total equity which is common stockholders equity plus all preferred stock and junior subordinated notes, and it was 7.9 times common stockholder equity alone.

Out assets can be assigned to three major categories of agency mortgage-backed securities. The first is ARMs, whose interest rates we set within a year. Secondly, Hybrid ARMs whose interest rates we set after one year. And lastly, fixed rate mortgage-backed securities whose interest rates never reset. Those are the three major categories each with different risk and return characteristics in our portfolio.

Further important information about the details of each of these categories; the one year reset just for the agency ARM represents 24% of our portfolio and we break down the ARMs that reset in more than one year into a three categories of one to two years, two to five years and more than five years.

The one to two category are less than 1% we’ll reset in that period. In the two to five year period 54% of our portfolio we’ll reset within that period. And then greater than five year period 3% of our portfolio we’ll reset.

The balance of the 81%, the 19% of remaining, 14% is in 15 year fixed rate agency mortgage-backed securities and 5% is in 30 year fixed-rate agency mortgage-backed securities. The weighted average coupon of our Agency MBS was 3.18 at quarter-end; more specifically the coupon rates on Anworth’s mortgage-backed securities at quarter-end were as follows:

The one year adjustable rate Agency MBS is 3.23%. A hybrid adjustable rate MBS which means it resets in more than a year is 2.94%, but the 15 year fixed rate MBS was 3.35% and the 30 year fixed rate MBS was 5.56%.

These are all agency mortgage-backed securities. The weighted average term to reset on Anworth's adjustable-rate agency mortgage-backed security was therefore 36 months at quarter end.

The outstanding repurchase agreement balance which financed Anworth’s agency mortgage-backed security portfolio at quarter end was approximately $7.82 billion, the average term of our agency MBS related repurchase agreement is 32 days and the average interest rate on our repurchase agreements was 38 basis points or 0.38%.

After adjusting for interest rates paid through our swap transactions the average interest rate was 1.11% and the average term to interest rate reset on our liabilities was therefore 436 days. We should note that when determining the nature of a prudent hedging strategy, we take into account the specific characteristics of the assets which we have invested in each of the three major categories of agency MBS which I discussed earlier.

The prepayment of principal a very important part of our income return which Anworth experienced during the quarter was as follows. The one year adjustable-rate category agency MBS prepaid at 18 CPR. The hybrid adjustable-rate category prepaid at 26 CPR, 15 year fixed rate prepaid at 23 CPR and the 30 year fixed rate which for those of you familiar with the portfolio remember these have very high coupons that were bought quite a few years ago at a 32 CPR.

CPR of Anworth’s agency portfolio during the quarter was therefore approximately 24%. The average amortized cost of our agency MBS was 102.82 which is the same as during the previous quarter. Also here with me today are Joe McAdams, our Chief Investment Officer and Director of the Company; Thad Brown, our Chief Financial Officer; and Charles Siegel, our Senior Vice President of Finance.

What I’d like to do now is turn the call over to Andrew our conference operator, to begin our question-and-answer session.

Question-and-Answer Session


We will now begin the question and answer session. (Operator Instructions) The first question comes from Bose George of KBW.

Bose George - KBW

My first question was just about the spread that you guys are seeing on stuff that you are adding to the portfolio?

Joe McAdams

The spreads we are seeing on new security purchases we are making are a little lower than the portfolio spread of 127 basis points but still on that general area. I guess the point I would make when we think about spreads going forward is when we buy new assets. We are thinking about having, making a projection for a longer term CPR.

Obviously, branded securities have very low prepayment rates. So when we talk about our, we put assets in the books, make the long-term CPR assumptions that's going to have a higher rate of premium amortization than your actual CPR for the first several months.

So when we see portfolio spreads in sort of 115 sort of area, that would incorporate not like a low single-digit CPR we see on an asset right after purchase, but I think the more realistic longer-term assumption which on a new security where its not currently having a large prepayment incentives, its probably going to be in low to mid teen area. So slightly lower portfolio yields, obviously mortgage rates are lower again in July than where they were during the prior quarters. So, I do think we're on margin adding, new assets hedged appropriately and similar but slightly over spread where the portfolio is in the second quarter.

Bose George - KBW

And then actually just on the increase in asset prices since quarter end, just can you characterize that how much of an increase you seen?

Joe McAdams

We're still seeing an increase in values. We do have significant part of our portfolio as Lloyd pointed out that is inside of 12 months the reset or has already reset. So there is not a lot of price depreciation on that part of the portfolio. 15 year mortgages have performed well. So I would think on a sort of pro forma basis, we're still expecting to see an increase in book value quarter-to-date so far even though we would have negative mark-to-market adjustments on our swaps.

Bose George - KBW

Okay, and then just on last thing, your price-to-book is obviously low. So in the past you repurchased shares I think when you got closer to that 90% of book number, I am just curious about your thoughts there and just where the authorization stands?

Lloyd McAdams

We have an authorization to repurchase shares back. Right now we have not purchased any shares back during the quarter. We will always consider it, if we don’t think we have the opportunity to find investments that we think are attractive. Right now, we are very comfortable with the structure of the portfolio and repurchasing shares would obviously increase the leverage of the portfolio.


The next question comes from Jason Weaver of Sterne Agee. Please go ahead.

Jason Weaver - Sterne Agee

I actually just have one. As we are seeing this higher cost swaps with around 375 coupons roll off over the next six months or so, just curious if and if you are what maturities you are targeting to replace those hedges?

Joe McAdams

Yeah this is Joe. We are not looking to replace those hedges in the sense that the assets that would have been purchased in the past when those hedges were put on, are at a stage where we generally we don’t believe they need much of the hedge going forward for two reasons, one many of them are getting very close to the reset date as hybrids and the other is that since rates have come down fairly significantly over the past several years, the prepayment rates we have experienced in those securities are such that we have a smaller balance of those securities and we probably would have targeted back when we initially put those hedges on.

So the new hedges that will be going on over the next six months to a year will be our anticipation as they will be related to new security purchases.


Our next question comes from Stephen Laws of Deutsche Bank. Please go ahead.

Stephen Laws - Deutsche Bank

I think you guys just hit on one, I guess to expand on that with the swaps and now would really replacing them as the assets become more current reset. What kind of change in prepayment speeds would be necessary on those assets for you guys to change that and add additional swaps?

Joe McAdams

The majority I guess if we are talking about current reset ARMs, we are going to go forward with a position where their coupons are going to reset every 12 months and that kind of asset liability management we take care of through the repo market by either using longer, shorter term repos.

In terms of it, the issue could be with their fixed rates. And the majority of our fixed rate position has been purchased more recently than when these swaps were put on if that makes sense. 2010 and 2011 has been where more significant part of our fixed rate position has been acquired. So the swaps they are rolling up now may be informally the way we would match those up, are really more tied to pre-2009 purchases or potentially some shorter hybrids that would have been bought in 2010.

Stephen Laws - Deutsche Bank

Right I guess if you see a significant increase in prepayments you are buying, you are redeploying more capital now given what kind of expected duration are you expecting on those new assets and what types of swaps you will get for that or are you thinking you just repo finance for those new purchases?

Joe McAdams

No, no we are putting new swaps on our entire portfolio at June 30; we felt our estimate of the duration was about $1.4 years, it’s a little shorter now. We have seen a decline in mortgage rates so far in July and when you look at our repos plus our swaps they are about 1.2 years on the liability side. So that is a very narrow asset liability mismatch driven predominantly by the fact that rates have come down in the first quarter and they came down again in the second quarter, that is brought down the duration of assets.

In this environment we are targeting our new purchases to have initially an asset liability mismatched about a half to three quarters of a year. So we are looking at on the asset side duration of about 2.5 years between the mix of newly originated hybrids and 15-year fixed rates securities that we are buying and then with the swaps we are adding on the liability side, you know about a year and three quarters on that.

So the marginal investment is going on at about a 2.5 year duration, one and three quarters liability for about a three quarters will be a mismatch, but the overall portfolio again with the short reset on the higher coupons, season bonds and some of these legacy swaps has a much narrower mismatch.

Stephen Laws - Deutsche Bank

And then a second question on the repo rates, can you just talk about what you are seeing in the repo markets today. I think repo financing costs I guess are up about 5 basis points sequentially, kind of where is that today, what are you guys seeing and I appreciate the answers, thanks.

Lloyd McAdams

Sure. Repo rates did move up during the quarter, it's about five basis points. We are in an environment now where so far this quarter we haven't seen a real abatement of that. It's still, a one month repo is going to be in the high 30 basis point area and a three months repo is going to be in the low 40 basis points area. So we haven't seen a reversal of that move up.

Clearly if you look at other short-term rates or LIBOR rates, that does seem to be an increase in repo costs relative to other short-term benchmarks. Whether that's -- clearly some of that's driven by some of the uncertainty in Europe and other areas. So that is something I would expect to see come back down a little bit going forward. But we have not seen that yet so far this quarter

Stephen Laws - Deutsche Bank

Great and I guess we will see the fiscal spike kind of at yearend is not correct?

Lloyd McAdams

Yeah there was -- yearend always has a little bit of a spike, but you know that tends to get moved out because we tend to do 90 day repo is kind of our average new repo we put on. So the yearend spike gets moved out a bit by that.


The next question comes from Terrance O' Dwyer, a Private Investor. Please go ahead.

Unidentified Analyst

I would like to follow up on that George question about the share repurchase program. But given that the book value has substantially exceeded the market price of the shares, what is the philosophy against or not having a very vigorous and a material share repurchase program, if you can just fix down on that

Lloyd McAdams

Historically, we have repurchased a higher percentage of our own shares and I believe any mortgage REIT in existence. So our philosophy is to be aggressive share repurchaser in the space of mortgage REITs. Historically we have repurchased the shares during periods of time when interest rates went up and yields on mortgage REITs went down dramatically. 2006 is a good example when a lot of mortgage REITs did not produce sufficient income to cover their dividend.

And they continue to pay off the same dividend. In that environment when the dividend level goes down, the stocks tend to trade at a deeper discount to book than they do now. So I guess what I would say is while I'm not particularly inclined to say, we will repurchase shares at this precise discount to book. I do know the levels that they go to when that environment occurs and we have been extremely aggressive in repurchasing shares in that environment and it is deeper than a 10% discount to book.

A 10% discount to book is a bit of a modest decline and from our perspective, I understand that the shares may trade there and investors may be more interested at other mortgage REITs which take more interest rate risk. We could very easily manage the portfolio in such a strategy that takes more risk, increases the dividend and possibly the discount to book would disappear which seems irrational that it would happen. But we are not inclined to take that level of risk because interest rates are very low and the most likely direction they will go to next some day is up.

Unidentified Analyst

Okay I guess it's good to see some dry powder. Thank you for that explanation.


The next question comes from Gabe Poggi of FBR. Please go ahead.

Gabe Poggi - FBR

Guys, I don't know if you mentioned this earlier, if I missed it, did you talk about or can you tell us what your CPR was for July or what's it tracking towards and kind of your thought process for the back half of the year?

Lloyd McAdams

The average CPR for the quarter was 24 on the portfolio, the most recent prepayment report that we've received which was released in July worked out to a 25 CPR for the portfolio. So I do think we will see some continued increase in prepayments mostly driven by some of the newer securities in our portfolio that are going to have part of the most sensitivity to refinancing.

And when we look at the various components of our portfolio you will see that generally the fixed rates and some of the newer hybrids that are seeing the increase in prepayments. We don’t have in our portfolio a lot of exposure to the sort of credit or HARP related prepayments, is more driven by newer securities that are going to have a more heightened sensitivity to their refinancing incentives.


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

Lloyd McAdams

Thank you very much for joining us today. I did have one thing I was thinking about during the question-and-answer session which I will mention very briefly. When we were discussing the asset liability mismatch of our portfolio -- since we have a portfolio that is predominantly invested in ARM securities, be the hybrid or the one-year fully indexed ARMs, the quarterly shortening of time to maturity because they may reset in two, three, four or even possibly five years, that has a larger effect on shortening the price volatility of the securities. And say it does on the part of our portfolio which have 30-year fixed rates, a 30-year fixed rate which is going to re-mature in 27 years; going from 27 years to 26¾ years has very little impact on the price volatility subject to interest rate changes.

But for an ARM that’s resetting in four years, one quarter going by, so when Joe was mentioning the very narrow asset liability mismatch of our own portfolio and how we were investing at a larger mismatch, one thing you should think about is during the quarter the mismatch on our existing portfolio will have the benefit of ARMs which – whose price sensitivity, we lose more dramatically than does the price sensitivity changes, just over time nothing to do with interest rate changes.

So I thought that’s one of the important benefits of owning ARM securities, whether they are fully indexed or hybrid. And so with that, thank you again for joining us today and we look forward to your participation in next quarter's conference call and hope we have the opportunity here to visit with you in the mean time. Thanks again.


The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.

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