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Anworth Mortgage Asset Corp (NYSE:ANH)
Q3 2019 Earnings Call
Nov 5, 2019, 1:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

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

John Hillman -- Director of Investor relations

Thank you, Danielle. 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 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 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 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 or change in events, conditions or circumstances, or otherwise. Thank you.

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

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

Thank you, John. Also with me today are Bistra Pashamova, and Brett Roth, both Senior Vice Presidents and Portfolio Managers, as well as Chuck Siegel, Anworth's Chief Financial Officer. The third quarter saw a continuation of the economic uncertainty market volatility and falling long-term interest rates that have persisted for much of this year. This resulted in a continued price underperformance of our Agency MBS assets in particular, as well as heightened expectations for more rapid prepayments due to refinancing.

We had reduced our portfolio leverage during the second quarter. So although our overall balance sheet expanded somewhat during the third quarter, our earning assets were lower on average during the quarter relative to Q2. This smaller portfolio was the primary driver for core earnings declining $0.02 per share to $0.08, or $7.6 million on the quarter. GAAP income was a loss of $0.20 for the quarter, but only includes unrealized gains and losses on our swap hedges and some of our MBS assets. Comprehensive income, which includes both realized and unrealized gains on all of the MBS assets and related derivatives was $844,000 or $0.01 for the quarter.

The Fed cut interest rates twice during the quarter but the spread between our repo borrowing rates and other short-term benchmark rates remained elevated and was a significant headwind for earnings from our Agency MBS investments. There was the well publicized spike in short-term repo rates in mid-September. And while the extreme repo rates were short-lived, the borrowing environment was challenging in terms of the rates we paid during the quarter.

Recently, we've seen an improvement in our agency repo borrowing relative to LIBOR after the Fed cut rates were at third time this month in October -- or last month in October. So while borrowing over year-end can be unpredictable, we do expect to see improved borrowing terms over all moving forward.

Looking at our total portfolio, our Agency MBS investments remained approximately 73% of our portfolio. Although we added Agency MBS pools during the quarter and reduced our TBA positions. On the mortgage credit side, you can see that Non-Agency MBS was lower, this was primarily due to pay-downs and Non-QM loans held for securitizations increased.

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

Bistra Pashamova -- Senior Vice President and Portfolio Manager

Thank you, Joe. Looking at the composition of our Agency MBS portfolio, you will see, we continue to tell our MBS allocation to 30-year fixed-rate securities. As we view them providing more attractive risk-adjusted returns than other agency MBS sectors. At quarter end 30-year fixed-rate investments, including TBA positions comprised 65% of our Agency MBS portfolio. 15-year and 20-year fixed-rate securities combined with 7% and adjustable-rate MBS, 28%.

During the quarter, our new 30-year fixed-rate pool investments were focused on lower coupons, given the inherent limited prepayment risk. We further repositioned our TBA allocation, eliminating exposure to CPR 3.5 and 4 coupons. And our smaller TBA position consists of [Indecipherable] as less exposed to prepayments and providing relatively attractive role financing.

Turning to our adjustable-rate MBS allocation. ARMS would reset within the year, constituted 17% of the agency portfolio, a small decrease from the previous quarter. With one-year LIBOR declining a further 15 basis points in the third quarter, the coupons on these securities continue to reset lower. And we expect this will lessen prepayment fees going forward.

With regards to agency portfolio prepayments, the overall portfolio prepayment rate increased to 21 CPR in the third quarter from 18 CPR in the previous one. Adjustable-rate MBS prepayments similarly rose to 28 CPR from 24 CPR. As anticipated, Agency MBS prepayments have increased further in the fourth quarter to 27 CPR for the overall portfolio.

However, given the decline of the MBA Refi Index from its August high and went to seasonality, we expect prepayments to moderate in the next couple of months. So far in the quarter, our new investments remain focused on 30-year securities with lower coupons and some prepayment protection characteristics. This should also contribute to reduce portfolio prepayment speeds going forward.

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

Thanks, Bistra. And now I'd like to turn the call over to Brett to discuss our residential credit investments.

Brett I. Roth -- Senior Vice President and Portfolio Manager

Thank you, Joe. During the third quarter, spreads on mortgage credit assets were responsive to changes in rates, ultimately ending the quarter wider. However, this widening was more than offset by the rally we saw in rates during the quarter, resulting in a net positive change in asset valuation for the quarter. Looking at our loans held in securitization trust, the credit performance of these assets continues to remain strong with defaults remaining at zero CDR. As you would expect of these high credit quality in the money borrowers, voluntary prepayment speeds increased in response to interest rate changes.

As we looked to find assets to invest in over the quarter, we continue to see more value in investments in Non-QM loans rather than securitized credit product. Therefore, our investment activities were focused on Non-QM loans rather than securitized product. Thus during the quarter, we saw the securitized credit portfolio shrink due to run-off with the reinvestment dollars being committed to our loan portfolio.

In regard to Non-QM loans this sector, we continue to focus our investing activities on, 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 746, and LTV and CLTV of 70% and a DTI of 38%. Approximately, 82% of our portfolio is comprised of hybrid ARMs, of which the majority over seven months.

During the quarter we did see voluntary prepayment activity increase in our portfolio in response to lower interest rates. As mentioned earlier, over the course of the quarter, we continue to purchase loan assets, while we were also settling our previous trades. Further, we have continued to expand our network of strategic partnerships with several originators. We have rolled out our guidelines to several new partners and are working closely with them to roll-out our Non-QM programs. We are focused on continuing to expand these types of partnerships in the 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 on the spread we pay above LIBOR. 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. Our investment activities in the Non-QM mortgage loan sector is continuing to expand.

We anticipate that we will continue growing our network of sources for these assets and will continue to increase our footprint in this sector of the market.

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

Thank you, Brett. Turning to the portfolio financing repo borrowings increased to $3.25 billion at September 30, with an average interest rate of 2.41%. After taking into account our interest rate hedges, our effective borrowing costs was 2.34%, down 4 basis points from June 30. The average hedged term of these borrowings was 2.5 years. Our leverage multiple ticked up from 5.4 times to 5.7 times total capital as we added Agency MBS during the quarter. As discussed, we carried a lower balance of agency TBAs at September 30, so our effective economic leverage, which includes the synthetic borrowing implied in TBA purchases was little changed at 6.5 times.

Our interest rate swap balance declined from $2.9 billion to $2.2 billion on the quarter due to the combination of swap maturities as well as some swap terminations to offset the effect of lower MBS durations. While the average pay rate was little changed at 2.08%, the remaining average term of the swaps extended to 2.9 years due to the shorter swaps maturing during the quarter.

The overall effective net interest rate spread on our portfolio tightened 5 basis points to 91 basis points as evident from the breakdown of the components of this non-GAAP spread, which follows our financial statements. This tightening was driven primarily by a reduction in TBA roll income on the quarter. We declared a $0.10 dividend in September, which resulted in a 12.1% annualized dividend yield based on the September 30th closing stock price. Book value per common share declined a $0.11 to $4.42. When combined with the $0.10 dividend this book value decrease resulted in a negative 0.2% economic return for common shareholders during the quarter and a positive 1% economic return year-to-date.

With that, I would like to open the call up for any questions you might have. So I will turn the call back over to our operator, Danielle at this time.

Questions and Answers:

Operator

We will now begin the question-and-answer session. [Operator Instructions] Your first question comes from Douglas Harter of Credit Suisse. Please go ahead.

Joshua Bolton -- Credit Suisse -- Analyst

Hey guys, this is actually Josh on for Doug. I'm wondering if you could talk a little bit about if you felt any direct effects of the overnight repo market pressures we saw in the middle of September and then I guess, more broadly. How are you thinking about the term on your repos and your repo positioning heading into year-end? Thanks.

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

Sure. Thank you, Josh. We typically -- and they have -- our agency repos have typically two to three-months initial terms on our borrowings. Our Non-Agency repos typically had a one-month term. So we don't have on any given day or any given week a terribly large percentage of our repos rolling off. So while clearly we had some term repos and even a few overnight repos that came due during the period where we saw the spike in rates, the overall impact was certainly not significant relative to the overall portfolio.

I will say we, I think -- maybe some of the factors that led to that spike were also factors and overall repo rates remaining relatively elevated versus Fed funds and LIBOR in general. As for year-end, we do as I mentioned, a fair amount of term repo, so we are having repos going over the term already at this point. So we typically don't have a significant amount of the book that's sort of waiting till the last week or so to go over year-end.

Joshua Bolton -- Credit Suisse -- Analyst

Great. Thanks for that. I guess, looking at core earnings this quarter and then looking at where the dividend is set, any thoughts about the current dividend level. And maybe if you could walk us through some of the puts and takes around how you see core getting closer to the dividend level in the coming quarters would be helpful. Thanks.

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

Sure. As we mentioned, the primary driver for the reduced core earnings during the third quarter was this smaller overall portfolio size. Leverage went from a little north of 6 times back in the second quarter to where it's been more recently. So I do think, we could expect to see an increase in overall portfolio leverage as we move through the fourth quarter and into the first quarter, back to what maybe more of a normal level for us.

Secondarily, as Bistra pointed out, our core the way we report core earnings, it is based on the actual prepayment activity as opposed to sort of a smoothed long-term assumption. So we do tend to see a little more volatility in our core earnings due to actual prepayments, which again are quite elevated due to the decline in interest rates.

And then the third factor is, I think we do expect to see -- we've seen it for the last week or so some improved agency repo rates versus LIBOR. So I think all of those factors, which have been -- were the two headwinds of repo rates and prepayments as well as our -- sort of, I guess you could say, conservative decision to reduce our leverage somewhat in the face of the volatility in the late second quarter and into the third quarter. We see all three of those factors sort of mitigating a reversing as we move forward.

Joshua Bolton -- Credit Suisse -- Analyst

Great. I appreciate the comments, Joe.

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

Thank you, Josh.

Operator

The next question comes from Mikhail Goberman of JMP Securities. Please go ahead.

Mikhail Goberman -- JMP Securities -- Analyst

Good afternoon and good morning. Quick question on just general sense of where you're seeing CPR is trending in the fourth quarter. A lot of your peers, I guess have said that October -- the October report is definitely higher than September, and all indications are the November is going to be even higher than October, but probably than December, we're going to see a big drop off given seasonality end of year kind of stuff. Would you expect for the quarter as a whole though that speeds will be higher than the third quarter or just about the same, or any thoughts on that?

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

Sure. As Bistra pointed out, the speed and again, it was -- it's just the October report we've seen at this point for the fourth quarter was 27 CPR overall. And as rates trend -- prepayment rates trended up during the third quarter, I believe 24 was the speed for the month of September. So I think, we've sort of be in agreement with the sort of general framework you laid out that we should -- we'll see sort of similar or perhaps slightly higher speeds reported November and then coming back down. So I would expect the average speed for the fourth quarter that's realized on the agency portfolio to be higher than the average speed for the third quarter. But as Bistra pointed out, given the -- where interest rates have gone, what we've seen going on with the repo or the Refi index as well as the typical seasonal effects that the high prepayments are sort of in the pipeline at this point and we should see it moderate after that.

Mikhail Goberman -- JMP Securities -- Analyst

Great. Thank you. And just one quick question on your thoughts on the future growth of your Non-QM loan book.

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

As Brett pointed out, we expect that to continue to grow. We categorize them on our balance sheet, has held for securitization and that's certainly our plan to continue to find good quality loans from the network of sources that we've been developing and been move through the process of securitizing those loans when we have a critical mass in the pricing is right.

Mikhail Goberman -- JMP Securities -- Analyst

Okay, great. Thank you very much.

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

Thank you, Mikhail.

Operator

Seeing that there are no further questions, I would like to turn the conference back over to Mr. McAdams for closing remarks.

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

Thank you, Danielle, and thank you to everybody for joining us today. As always, we appreciate your interest in Anworth. And we look forward to speaking with you again next quarter in the interim. Please don't hesitate to call us if you have any additional questions or comments. Thank you.

Operator

[Operator Closing Remarks]

Duration: 20 minutes

Call participants:

John Hillman -- Director of Investor relations

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

Bistra Pashamova -- Senior Vice President and Portfolio Manager

Brett I. Roth -- Senior Vice President and Portfolio Manager

Joshua Bolton -- Credit Suisse -- Analyst

Mikhail Goberman -- JMP Securities -- Analyst

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