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Anworth Mortgage Asset Corp (NYSE:ANH)
Q4 2019 Earnings Call
Feb 26, 2020, 1:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Before we begin the call I'd like to introduce Mr. John Hillman, Anworth's Director of Investor Relations to make a brief introductory statement. Please go ahead.

John T. Hillman -- Vice President and Director of Investor Relations

Thank you, Nick. The 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 loan 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 we file from time of 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 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. 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

Thanks, John. And thank you for joining our call today to discuss Anworth's fourth quarter 2019 results. With me today on the call are Bistra Pashamova, Senior Vice President and Portfolio Manager; Brett Roth, Senior Vice President and Portfolio Manager and Chuck Siegel, Anworth's CFO. The fourth quarter was generally positive for Anworth's portfolio. The Fed cut rates for the third time on the year in October and was largely successful at coming the repo markets following the spike in overnight rates seen in the third quarter. As interest rates moved higher, our Agency MBS holdings significantly outperformed their hedges and with the stock market and most at-risk assets in general performing well, our mortgage credit securities had similarly solid price performance.

Following the interest rate declines seen during the summer months, the follow through of higher refinancings and prepayments on our MBS portfolio was realized during the fourth quarter with the higher cost of prepayments being the primary drag on quarterly core earnings versus the prior quarter. Core earnings were $6.8 million or $0.07 per common share for the quarter, down from $0.08 in the third quarter. Again, the primary driver of this decline was the higher cost of prepayment expense realized and we will discuss later in more detail how prepayments have been lower during the first quarter to date both due to seasonal effects, as well as shifts in the agency portfolio composition.

GAAP net income was $27.4 million or $0.28 per share. Comprehensive income, which includes realized and unrealized gains on all of the MBS assets and related derivatives was $28.9 million or $0.29 per share for the quarter. Overall, our Agency MBS investments increased from 73% to 75% of our total asset portfolio with the shift from Agency TBA positions to fixed rate agency pools. On the mortgage credit side, non-Agency MBS was lower due primarily to pay downs and we continue to add newly originated non-QM loans currently held for securitization. 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 further increased our 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 73% of our Agency MBS portfolio. 15-year and 20-year fixed rate securities combined was 6%. Total adjustable rate MBS declined to 21% and arms with coupon resets within a year declined to 13% of the agency portfolio. During the quarter, we continued to rotate our fixed rate 30-year allocation into lower coupon securities with limited prepayment risk. Our new investments were focused on specified pools with loan balance or other characteristics that mitigate prepayments. We also further reduced our exposure to higher coupon 30-year securities that were most exposed to prepayments. As you can see, the coupon of our 30-year fixed-rate MBS declined almost 30 basis points to 3.56% at quarter end. Our TBA position, while still consisting of lower coupon 30-year securities only was small at quarter end given weaker roll in-flight financing. With regards to portfolio prepayments, the overall agency portfolio prepayment rate increased to 25 CPR in the fourth quarter from 21 CPR in the previous one. Adjustable rate MBS prepayments similarly rose to 32 CPR from 28 CPR. As expected, given the repositioning of our portfolio toward lower coupon securities and the declining seasonal refinancing effect, agency portfolio prepayments have decreased so far in the quarter to 17 CPR for the overall portfolio in the month of January and February. We continue to focus our new investments on lower coupon 30-years that provide attractive spreads and have certain prepayment protection characteristics.

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

Thanks Bistra. And to discuss the non-Agency MBS and other mortgage credit investments, I'd like to have Brett Roth takeover.

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

Thanks, Joe. During the fourth quarter, spreads on mortgage credit assets tightened in as treasury and swap rates rose. This tightening did not offset fully the increase we saw on rates during the quarter, but did reduce the negative impact on the valuation of our portfolio at quarter end. During the quarter, the securitized credit portfolio continued to shrink due to bonds being called, run-off and some strategic bond sales. Our view remains that there is no [Phonetic] more value in the non-QM loan space than in the securitized credit space, and therefore we continue to commit our reinvestment dollars to our loan portfolio. During the quarter we closed on approximately $38 million of new loans while we saw prepayment speeds on our existing loan portfolio increase to the high 30 voluntary prepayment rate area. However, we did continue to benefit from negotiated EPD protection on these assets, the assets in our portfolio, somewhat lowering the impact of prepayments on premium dollars paid. We continue to focus our investing activities on 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 744 and LTV CLTV of 70% and DTI of 38%. Approximately 84% of our portfolio is comprised of hybrid ARMs, of which the majority are [Indecipherable]. As we anticipated with these assets, their credit performance continues to remain strong with defaults remaining at zero CDR and no loans in the 60 plus delinquent bucket. Over the course of the quarter, we have continued to expand our network of strategic partnerships with several originators. We have continued to roll out our guidelines to several new partners and are working closely with them to roll out our non-QM programs. We also entered into a new strategic partnership with a new partner in order to acquire loans on a flow basis over the next 18 months. 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 on funds. 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. 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. Thanks, Joe.

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

Thank you, Brett. Turning to the portfolio financing. Repo borrowings increased to $3.7 billion at year-end, as we increased our Agency MBS pool holdings relative to TBAs with an average interest rate on these borrowings of 2.07%. After taking into account our interest rate hedges, our effective borrowing cost was 2.13%, down 21 basis points from September 30. The average hedge term of these borrowings was approximately 2.7 years. Our leverage multiple moved up from 5.7 times to 6.2 times total capital as we added Agency MBS pools financed with repos during the quarter. As discussed, we reduced Agency TBA positions over the quarter. So our effective economic leverage, which includes the synthetic borrowing applied in the TBA purchases increased less from 6.5 times to 6.6 times total capital at year-end.

Our interest rate swap balance increased from $2.2 billion to $2.5 billion on the quarter with the swaps average maturity remaining around four years. This increase in swap balance helped offset the increased agency asset duration from both the larger agency portfolio as well as the shift from higher coupon into lower coupon, lower duration agency fixed rate MBS. The average pay rate on the overall swap book fell 6 basis points to 2.02%. The overall effective net interest rate spread tightened 2 basis points to 89 basis points annualized. As is evident from the breakdown of the components of this non-GAAP spread, which follows our financial statements, the higherly quarterly paydown expense on Agency MBS narrowed this spread by an annualized 10 basis points. We declared a $0.09 dividend in December, which resulted in a 10.2% annualized dividend yield based on the year-end closing stock price. Book value per common share increased $0.18 to $4.60. When combined with $0.09 dividend, this book value increase resulted in a 6.1% economic return for common shareholders for the quarter and 7.2% economic return for 2019.

With that I'd like to open up the call for any questions you might have. So I will turn the call back over to Nick, our operator.

Questions and Answers:

Operator

We'll now begin the question and answer-session.

[Operator Instructions]

First question comes from Mikhail Goberman, JMP Securities. Please go ahead.

Mikhail Goberman -- JMP Securities -- Analyst

Good morning everybody. Thanks for taking the call. Congratulations on a very solid book value performance. I was wondering if you could give any insight into where book value is trending through the first two months of this year?

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

Sure. Thanks Mikhail. Obviously, we've had a good deal of volatility this week, but our estimate with rates down and Agency MBS underperforming their hedges would be quarter-to-date a book value decline in approximately down 1.5% area.

Mikhail Goberman -- JMP Securities -- Analyst

Okay, thanks for that. Just a question on the dividend. I know now three dividend cuts in a row and core earnings came in a little light this quarter, $0.02 below the current dividend. How are you guys sort of thinking going forward about a sustainable dividend level given the sort of reductions that we're seeing currently in the market with rates going down, I guess that's my question?

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

Sure. Well, when we think about core earnings, one of the primary drivers in the quarter-to-quarter volatility of the core earnings has been the fact that we recognize the actual prepayment costs on the agency side. And so clearly the sharp decline in rates we saw during the summer drove that -- those, the cost of those paydowns higher during the fourth quarter as Bistra pointed out. We're clearly seeing a substantially lower rate of prepayments so far during the first quarter for several reasons. And likewise, rates have come down now in the first quarter. So we would similarly expect to see a few quarters down the road and another increase in prepayments. So in terms of a longer-term earnings potential, we do set our dividend based on at the time, what we feel is the long-term earning potential for the portfolio. I'd also like to think that while we would expect to see prepayments arise over the next quarter or two if rates stay as low as they are right now. As Bistra pointed out, by having moved into some lower coupon agency fixed rate during the fourth quarter and continuing that with our new investments during this period, we would hope to expect to see that those fluctuations from quarter to quarter and core earnings due to paydown expense won't be as volatile, may be perhaps more muted than we saw during 2019.

Mikhail Goberman -- JMP Securities -- Analyst

Got you. Thank you. And that 17% prepay speed that was mentioned that's comparable to the 25% Agency MBS prepay speed? Is that right?

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

That's correct, that's correct.

Mikhail Goberman -- JMP Securities -- Analyst

Okay. Just curious, one more for me. What percentage of your agency book right now is in specified pools?

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

In terms of pools that have a specific characteristics in terms of low balance FICO, I believe the number is between 60% and 65%?

Bistra Pashamova -- Senior Vice President and Portfolio Manager

Around 60%. Yes.

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

We also have other pools that have relatively lower prepayments than TBAs because they might have a significantly lower gross WAC or some other characteristics, but we wouldn't count those in terms of sort of what I think the market generally views as sort of prepayment protected specified pools.

Mikhail Goberman -- JMP Securities -- Analyst

Understood. Thank you very much. Thank you for your time.

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

Thanks, Mikhail.

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Joe McAdams for any closing remarks. Please go ahead.

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

Thank you, Nick. And thank you to everyone for your participation in today's call and your continued interest in Anworth. We look forward to talking to you again next quarter. Thanks.

Operator

[Operator Closing Remarks]

Duration: 17 minutes

Call participants:

John T. Hillman -- Vice President and 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

Mikhail Goberman -- JMP Securities -- Analyst

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