Anworth Mortgage Asset Corporation (NYSE:ANH) Q3 2018 Results Conference Call November 5, 2018 1:00 PM ET
Joe McAdams - President and Chief Executive Officer
Brett Roth - Senior Vice President and Portfolio Manager
Chuck Siegel - Chief Financial Officer
Douglas Harter - Credit Suisse
Good day. And welcome to the Anworth Third Quarter Earnings Conference Call. All participants today will be in listen-only mode [Operator Instructions]. After today’s presentation, there will be an opportunity to ask questions [Operator Instructions]. Please note that today’s event is being recorded.
Before we begin the call, I will make a brief introductory statement. Statements made on this earnings call may contain forward-looking statements within the meaning of Section 27A of 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 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, 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. Certain risks, uncertainties and factors, including these discussed under the heading Risk Factors and 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 such 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 or expectations, future or a change in events, conditions or circumstances or otherwise.
I would now like introduce you to Mr. Joe McAdams, President and Chief Executive Officer of Anworth. Please go ahead, sir.
Thank you for joining our call today to discuss Anworth's third quarter results. Also with me here today are Brett Roth, Senior Vice President and Portfolio Manager as well as Chuck Siegel, our Chief Financial Officer.
Turning straight to the quarter's financial results. Anworth's core earnings were $11.6 million or $0.12 per common share, a decline from $0.13 in the second quarter. This decline was driven predominantly by increasing financing costs of our repo borrowings that were not effectively offset by our interest rate swap hedges during the quarter. GAAP net income to common shareholders was $15 million for the quarter or $0.15 per share. Comprehensive income, which also includes all realized and unrealized gains and losses in the market value of the entire portfolio and related liabilities, was a loss of $4.3 million or $0.04 per share. With interest rates rising approximately 20 basis points during the quarter and some sectors of our agency MBS portfolio underperforming their hedges, the net value of our investment portfolio decreased and offset the income earned during the quarter, resulting in comprehensive loss as reported.
Looking to the portfolio and the asset side of the balance sheet. Anworth's investment portfolio consists at quarter-end of 77% agency mortgage back securities, including our TBA positions, 13% non-agency mortgage backed securities, 10% residential mortgage loans and a continued small allocation to residential real estate. The mix between interest rate sensitive agency MBS and credit sensitive residential mortgage investments remained similar from the prior quarter.
Looking with a little more detail at our agency MBS portfolio. We have 37% of our agency allocation in adjustable rate mortgage back securities with 21% of the total portfolio in ARMs that have less than one year to interest rate reset. 39% was invested in 15 year fixed rate mortgage backed securities. During the quarter, the majority of our new Agency MBS investments were 30-year mortgage backed securities, and you can see the allocation increased from 19% to 24% in the 20 and 30 year fixed rate bucket. The currently resetting ARMs continue to increase the average coupon of our ARM holdings. It went from 3.71% at June 30, up to 3.88% at the end of the third quarter. Overall, the average agency MBS coupon rose to 3.39 from 3.26. The average cost of our agency MBS declined to 102.44, resulting in an $104 million unamortized purchase premium on our agency MBS.
With regards to the agency prepayments, the overall prepayment rate was unchanged at 16% CPR. With higher mortgage rates in general combined with slower seasonal prepayments expected in the fall and winter months, we would expect to see reduced prepayment activity going forward over the next several quarters. Our ARM portfolio has been prepaying at a significantly faster rate than the fixed rates bonds due to the interest rates paid by the borrowers resetting higher. Our ARMs had a 23% CPR rate during the quarter. Subsequent to quarter-end, the October prepayment report showed a decline in ARM prepays to 20 CPR in an overall portfolio average CPR declining to 13%.
With that, I'd like to turn the call over to Brett to discuss our non-agency MBS and residential mortgage credit investments.
Thanks Joe. During the third quarter, there was some volatility in mortgage credit spreads. The action on spreads was a bit of a roller-coaster ride that spreads tightening a bit at the beginning of the quarter, then widening out and then tightening back in again. By the end of the quarter, spreads were basically back to where they were at the beginning of the quarter.
In general, investors' appetite for mortgage credit assets has remained strong. As we moved into September, the volume of new securitizations brought to the market began to increase. Assets were quickly snapped up by investors, and then as we continued into October, the number of new deals being brought to market continued to increase. Ultimately, this did lead us to see a bit of a widening in the spread at which deals were clearing. In terms of valuations as mentioned previously, we saw volatility in credit spreads, which offset the volatility we saw on rates. Ultimately, the credit spread movement moved to offset some of the negative impact of the increase in rates on the value of the non-agency portfolio.
During the quarter, we maintained our disciplined approach to valuing assets and we were able to continue to selectively add assets at attractive yields to the portfolio. Our overall investment activity exceeded portfolio run off. Most of our acquisitions were in the agency risk transfer and non-performing sectors of the portfolio with very limited amount of acquisition in the legacy CUSIP Alt-A sector of the portfolio.
In looking at the portfolio makeup from quarter-to-quarter, you'll notice that other than in the risk transfer sector run-off and/or call actions outpaced reinvestment activity. We will continue to opportunistically rotate our reinvestments into those sectors of the market that provide us with attractive returns. The legacy portfolio continues to benefit from the credit performance of its underlying assets. In general, during the quarter, CDRs continued their downward trend. At the same time, the voluntary prepayments of this part of our portfolio did experience an increase in prepayment fees. The agency risk transfer assets in our portfolio continue to experience negligible if any credit issues. However, they did realize slight slowing of voluntary prepayments fees.
Turning to our loans held in securitization trust. The credit performance on these assets continues to strong with defaults continuing to run at a zero CDR. These assets have benefited from positive HPI and the overall positive economic environment we have experienced over the last few years. The result of this is that we continue to see that these mortgages have opportunities to refinance their current mortgage and in spite of higher rates, are continuing to do so as elevated voluntary rates that are still in line with our original expectations.
Turning to funding, we continue to add to counterparties to our mix of lenders and to prudently manage our financing book and therefore our cost of funds. This activity has allowed us to help offset some of the costs of the rise in interest rates. Looking forward, we continue to feel that we are in a good position to take advantage of investment opportunities as they arise in the current market. We are actively pursuing opportunities to add attractive assets to the credit portfolio across all sectors of residential mortgage credit.
As we noted in our news release, subsequent to the close of the third quarter, we purchased a small pool of non-QM residential mortgage loans. We see this as an area of opportunity within the mortgage credit sector. We continue to actively bid on these types of loans for the portfolio and are building our network of sources for these assets as we continue to grow our footprint in this sector of the market.
Thanks Brett. Turning to look at our overall portfolio financing, you'll see that total repo borrowing at of September 30th stood at $4 billion. The average interest rate paid on our repos rose from 2.24% to 2.38% at quarter-end. However, you'll also notice that our average interest rate after adjusting for swap hedges also increased by similar amount.
With our interest rate swaps, we paid a fixed interest rate and receive LIBOR floating each quarter. During the third quarter, three months LIBOR was virtually unchanged for most of the quarter, only rising by 6 basis points in the last few days of the quarter. As a result, the swaps were not terribly effective in offsetting those increases in repo rates. While we would expect some variability between our repo cost and LIBOR, the basis between those two rates has been particularly volatile during 2018. As a positive for the portfolio, going forward, three months LIBOR has already risen by approximately 20 basis points during the third quarter to-date and the spread between LIBOR and other benchmark short term rates has been moving more favorably for our interest rate swap positions.
The overall leverage multiple was 6.09 times. If you include the synthetic financing that is implied in the agency TBA transactions, our total effective leverage stood at 7.24 times at quarter-end. Both of these measures were up between 0.1 or 0.2 of return of leverage on the quarter due to the reduction in the mark-to-market value of our portfolio. Our swap position increased to $3.3 billion of face value with an average fixed rate that we pay of 2.04%, and 3.9 years on average until the maturity of the swaps. These swaps hedge 83% of our total repo borrowings and when you combine that with our currently adjusting agency ARM positions, over 100% of our total short term repo borrowings are either hedged with swaps or collateralized by adjustable rate assets.
During the quarter, we declared $0.14 dividend per common share based on the closing stock price at quarter-end. This reflected an annualized dividend yield of 12.1%. Book value per common share declined $0.21 on the quarter or 3.9% and being at $5.12. Taking into account the dividend paid of $0.15 and the book value decline, the total economic return to common shareholders is minus 1.3% for the quarter.
At this point, I'd like to turn the back over to Brian, our operator and we would welcome any questions you have at this time.
Thank you. We will now begin the question-and-answer session [Operator Instructions]. And looks like today's first question will be from Mr. Douglas Harter with Credit Suisse. Please go ahead.
Joe, given the spread weakness in agency we've seen or what we saw on October. Can you just talk about how you see yourself positioned and how comfortable you are with current leverage?
So, spreads have interest rates that moved up by about 15 basis points in the quarter, but spreads on agency MBS are wider. They've underperformed by roughly three eighth of a point in price relative to underlying hedges. So, on the positive side that means that marginal new investments, we see a gross ROE in the 11% area given our current leverage targets and the assets we're acquiring. On the flip side as you mentioned, we do see leverage creeping up a little bit. It is 0.1 to 0.15 higher than it was at quarter-end as a result of declining mark-to-market.
We have been so far not been making significant reinvestments of the pay down so far this quarter. I think at 7 times total economic leverage target is still what we're pointing at. So, I don’t expect to see a significant shift in our leverage target. And likewise there are attractive gross ROEs available from new investments, I do think we maybe have a little less capital to deploy as we led to leverage slide back down towards our target level.
And then on the non-QM loans you brought. Can you talk about the financing that's available given that you're still below the size that would be economic to do a securitization?
So we're actually engaged with several counterparties in terms of setting up some warehouse facilities. We've been looking at this actually for some time in this environment as we're seeing on repo side, we're seeing spreads on this come in. And there is -- and the haircuts are also decreasing on these assets. So there is plenty of opportunity in the interim for us to effectively finance these on the balance sheet at attractive levels.
[Operator Instructions] At this time, I'm not showing any more current questions. So I'd like to turn the conference back over to Mr. McAdams for any closing remarks.
Great. Well, thank you to everyone for your participation in today's call and for your continued interest in Anworth. We look forward to talking to you again next quarter. Thanks.
The conference is now concluded. We want to thank you for attending today's presentation. And at this time, you may now disconnect.