Anworth Mortgage Asset (ANH) Q2 2020 Earnings Call

Prepared Remarks:

Operator

Before we begin today’s conference, I’d like to introduce Mr. John Hillman, Anworth’s director of investor relations, who will make a brief introductory statement.

John Hillman — Director of Investor Relations

Thank you, Jamie. 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 or forward look at 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 U.S. 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.

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

I would now like to introduce Joe McAdams, our chief executive officer.

Joe McAdams — Chief Executive Officer

Thank you, John, and thank you for joining us on Anworth’s second-quarter 2020 earnings call. 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. Yes. In response to the significant market volatility and decline in valuations of our mortgage credit investments due to the effect of COVID-19 on the economy, we significantly reduced the size of our investment portfolio subsequent to the March 31st quarter-end.

These sales took place during the month of April and as discussed on our last quarterly earnings call, allowed us to reduce repo borrowings and build back up both the over-collateralization levels on remaining borrowings and our excess liquidity and cash to levels which we believe appropriate given the market uncertainties and volatility. Since April, we’ve seen increases in the market value of our investment portfolio, particularly in mortgage credit investments, resulting in an increase in the company’s book value per share. The impacts of COVID-19 on our near-term earnings power have and continue to be significant though, as higher prepayments, driven by the significant decline in mortgage rates due in part to the Fed’s intervention in the agency MBS market, as well as the effect of missed interest payments on non-agency loans in COVID forbearance plans, have impacted earnings during the second quarter. Core earnings were $1.6 million or $0.02 per common share during the second quarter, down from $0.09 in the first quarter.

GAAP net income was $0.35 per share and comprehensive income, which includes all realized and unrealized gains and losses reflected on our balance sheet was a gain of $28 million on the quarter relative to last quarter’s loss of $186 million. Focusing for a moment on core earnings. Our goal has been for that measure of earnings to reflect not just the core recurring components of our GAAP earnings, but also to attempt to most transparently reflect the actual economic performance of our portfolio, without relying heavily on the sorts of smoothing or assumptions based measures of income recognition required under GAAP. Most obviously, our recognition of the cost of higher agency prepayments via pay down expense in our core earnings was larger than the GAAP premium amortization measured by an amount nearly equivalent to $0.015 of core earnings for the quarter.

And similarly, we now recognize income on our non-agency MBS based on the actual interest collections as opposed to the GAAP-level yield method. These payments, as well as those on our loans, have been reduced during the quarter by approximately 20% primarily due to COVID-related forbearance. So while we expect many of these near-term shocks to earnings to persist during the current quarter, I do believe it’s important to highlight how we reflect these near-term economic costs into our core earnings measurement and that should be considered both when comparing Anworth’s core earnings to peers, and it’s also something that we consider when taking the current quarter’s earnings into account in evaluating our dividend policy. Turning to Anworth’s portfolio.

You’ll see that the total portfolio declined from $3.7 billion at March 31 to $2.97 billion at June 30 with the sales in agency and non-agency MBS occurring early in the quarter. Relative to our agency TBA positions, I would point out that, as discussed on our prior earnings call, we closed out all of our TBA positions early in the second quarter to reduce mark-to-market volatility. TBA trade has become attractive during the second quarter and our new portfolio investments during the quarter, as well as subsequent to June 30, have been in agency TBAs. So while there’s $100 million approximately increase in TBAs shown quarter over quarter, the average TBA position carried during the quarter was significantly lower, and the effect on core earnings from TBA dollar roll income should be more significant going forward than would simply be reflected in the quarter-over-quarter change.

With that, I’ll turn the call over to Bistra Pashamova to discuss the agency portfolio in more detail.

Bistra Pashamova — Senior Vice President and Portfolio Manager

Thank you, Joe. During the second quarter, the Fed’s continued strong phase of purchases led to further stability in the agency MBS market with low volatility and tighter spreads, particularly for production coupons. A pandemic-related slowdown in refinancing activity, widely anticipated by market participants, did not materialize, however. Higher coupons underperformed while specified core valuations improved materially.

At quarter-end, our agency MBS portfolio was approximately $2.1 billion. The reduction in portfolio size, as Joe mentioned, was driven by the sales in April of our 30-year, 3% coupon securities. As discussed on the last call, those were newer production pools were viewed as most exposed to the expected significant increases in prepayments and TBA fees. Our agency MBS new investments during the second quarter were focused entirely on lower-coupon two and two and a half 38 TBAs given the very attractive carry profile.

As you can see, our TBA position increased to 12% of the agency portfolio. With the continued shift in our 30-year fixed-rate allocation, the average coupon of our pool investments increased further to 4%. However, 84% of these pools have characteristics like loan balance or seasoning that mitigate prepayment risk. Regarding portfolio prepayments during the second quarter, the overall agency portfolio prepayment rate was 33% CPR.

And the adjustable-rate securities prepayment rate was 28. In July, agency MBS prepayment speeds have exceeded projections. Given unrepresented lows in mortgage rates and a potential narrowing of the primary/secondary mortgage rate spread, we anticipate fast prepayments for the remainder of the quarter. However, we expect to see the effect of burn out and the more subdued prepayment response in our specified pools subsequently.

With regards to new agency MBS investments, we remain focused on opportunistically adding to our TBA position given the roll specialness and significant implied financing advantage of lower-coupon TBAs.

Joe McAdams — Chief Executive Officer

Thank you, Bistra. With that, I’d like to turn the call over to Brett Roth to discuss our mortgage credit investments.

Brett Roth — Senior Vice President and Portfolio Manager

Thank you, Joe. During the second quarter, credit markets saw liquidity return. Spread has tightened in albeit not to the same tight levels as we were at previously but significantly tighter than we were at quarter-end and at the widest point observed during the crisis-driven widening. During the quarter, we also saw a return of new issue securitization deals with each new deal being priced better than the last.

We are seeing other signals in the marketplace that indicate to us that the market is resuming activity, again, at different pricing and risk expectation levels but in a manner that allows for assets to be cleared between participants on a systematic basis that does not imply draconian or liquidation assumptions. During the quarter, we did not conduct any additional asset sales other than the $111 million sold in April, which we had identified during our last call. Primarily due to increases in the value of the portfolio, but also due to improvement in haircuts on assets, we have been able to support portfolio leverage with our current assets, cash [Technical difficulty]. In fact, we have been able to completely remove leverage from certain assets where we thought that was the prudent decision.

As mentioned earlier, there were no other additional sales nor were there purchases in the securitized credit portfolio. The composition of the portfolio migrated due to the sale of the $111 million of assets sold in April, valuation changes, and prepayments. During our last call, our portfolio was comprised of approximately 72.5% of legacy CUSIP — I’m sorry, legacy MBS and 27% credit risk transfer assets. Currently, the balance is approximately 58% legacy MBS and 42% of credit risk transfer assets.

Approximately 75% of our CRT investments are focused on agency reperforming loans. Turning to our loan portfolios. We have been in very close contact with the servicers of our loans in both the loans held for investment portfolio and loans held for securitization. Looking at the residential loans held for investment portfolio.

This is a portfolio of high-quality jumbo loans originated in 2014 and 2015. Overall, the performance of the loans within this portfolio continues to be strong as reported. For our conversations with the servicers of these loans that are designated — excuse me, for our conversation with the servicer, loans that are designated as COVID are not being reported as delinquent. However, their missing principal and interest payments are being accounted for as forborne payments.

Based on the information we received from the servicer, we estimate approximately $300,000 of COVID-related principal and interest was for forborne during the quarter. It appears to us that approximately 7.7% of this portfolio is experiencing COVID forbearance. Voluntary prepayments increased from last quarter, moving to a range of 35 to 45 CPR during the quarter. Our portfolio of loans held for securitization is our non-QM loan portfolio.

Our current portfolio of assets has a weighted average FICO of 742, LTV, CLTV of 70%, and DTI of 38.4%. Approximately 84% of our portfolio is comprised of hybrid ARMs, of which the majority are 7/1s. As noted in our earnings release, at June 30, approximately $1.5 million of this loan portfolio was 30 days delinquent, approximately $13.3 million with 60 days delinquent and approximately $13 million was 90 days plus delinquent. Of these amounts, the percentage that is COVID-19-related are as follows: 30-day delinquent, 65%; 60 days delinquent, 96%; and 90-plus delinquent, 96%.

Our non-QM loan portfolio’s COVID experience was similar to what we understand other non-QM COVID portfolios experienced. Specifically, we were contacted and extended COVID payment plans to approximately 29% of our borrowers. This number does not include borrowers that called in but did not request paperwork to proceed with the plans. Of that group of 29% that entered into plans, 31% remained current.

Thus, overall, our non-QM loan portfolio experienced a 20% delinquency rate due to COVID forbearance plans. Looking at the latest statistics, we see that the COVID identified assets in the portfolio has declined from 29% to 26%. Of the 26%, 22% are current. Therefore, our portfolio has remained steady with COVID-related delinquencies reported at 20%.

However, of the COVID identified delinquent loans, 41% of these borrowers have resumed making some payment on their loan. Look at funding, since last quarter, the improved liquidity of the market has impacted the cost of financing our assets. On the securitized side of our business, we have seen our weighted average haircuts improve and funding spreads have tightened. On the loan side, we successfully negotiated a term repo facility to finance our portfolio.

Thanks, Joe.

Joe McAdams — Chief Executive Officer

Thank you, Brett. Continuing with our portfolio financing, in line with our asset sales and delevering early in the quarter, repo borrowings declined similarly to a total of $1.7 billion at quarter-end with an average rate of 39 basis points overall and a hedged rate of 1.24%. Our leverage multiple at June 30 was 4.1 times total capital. When implied TBA financing is considered, our effective leverage at June 30 was 4.7 times total capital.

While this leverage is lower than the 6.1 times reported at March 31, we have held leverage fairly constant subsequent to our portfolio sales early in the quarter. Our interest rate swaps declined in notional balance to $915 million as we had both swap maturities, as well as terminations of some of our shorter maturity swaps, we believe, offered little value given the outlook for the Fed to maintain rates near zero for an extended period. We still maintain a significant balance in swaps beyond the five-year maturity to protect book value from an increase in longer maturity interest rates even if short-term rates stay anchored. Our book value per share increased $0.16 to $2.85 per common share.

When taking into account that both the first and second-quarter dividends were declared subsequent to March 31, the total economic return on book value for common shareholders was 9.7% for the quarter. Lastly, I’d note as a subsequent even, as Brett mentioned, that we renewed our warehouse line of credit. We used to finance loans held for securitizations for a one-year term in July. As previously disclosed in our first-quarter 10-Q due to the significant decline in the company’s market capitalization, we were not in compliance with all of the covenants on our previous line, but we were able to obtain waivers on those covenants and have now modified the covenants on this line with this renewal, so we are in compliance at this point and expect to remain so going forward.

With that, I turn the call over to Jamie, our operator, for any questions you might have.

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