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ANH > SEC Filings for ANH > Form 10-Q on 7-Nov-2012All Recent SEC Filings

Show all filings for ANWORTH MORTGAGE ASSET CORP

Form 10-Q for ANWORTH MORTGAGE ASSET CORP


7-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

As used in this Quarterly Report on Form 10-Q, "Company," "we," "us," "our," and "Anworth" refer to Anworth Mortgage Asset Corporation.

You should read the following discussion and analysis in conjunction with the unaudited financial statements and related notes thereto contained in Item 1 of Part I of this Quarterly Report on Form 10-Q. The information contained in this Quarterly Report on Form 10-Q is not a complete description of our business or the risks associated with an investment in our stock. We urge you to carefully review and consider the various disclosures made by us in this Quarterly Report on Form 10-Q and in our other reports filed with the SEC, including our Annual Report on Form 10-K for the fiscal year ended December 31, 2011.


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Forward-Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the 1933 Act and Section 21E of the Securities Exchange Act of 1934, as amended, and, as such, may involve known and unknown risks, uncertainties and assumptions. Forward-looking statements are those that predict or describe future events or trends and that do not relate solely to historical matters. You can generally identify forward-looking statements as statements containing the words "may," "will," "believe," "expect," "anticipate," "intend," "estimate," "assume," or other similar expressions. 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. Therefore, our actual results could differ materially and adversely from those expressed in any forward-looking statements as a result of various factors, some of which are listed under the section "Risk Factors," Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2011.

Statements regarding the following subjects, among others, may be forward-looking: changes in interest rates and the market value of our mortgage-backed securities ("MBS"); risks associated with investing in mortgage assets; changes in the yield curve; the availability of MBS for purchase; changes in the prepayment rates on the mortgage loans securing our MBS; our ability to borrow to finance our assets and, if available, the terms of any financing; implementation of or changes in government regulations or programs affecting our business; changes in business conditions and the general economy, including the consequences of actions by the U.S. government and other foreign governments to address the global financial crisis; our ability to maintain our qualification as a real estate investment trust ("REIT") for federal income tax purposes; our ability to maintain our exemption from registration under the Investment Company Act of 1940, as amended; and our ability to manage our growth. 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 update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

General

The Company

We were formed in October 1997 and we commenced operations on March 17, 1998. We are in the business of investing primarily in U.S. agency mortgage-backed securities, or Agency MBS, which are obligations guaranteed by the U.S. government, such as Ginnie Mae, or federally sponsored enterprises, such as Fannie Mae or Freddie Mac. Our principal business objective is to generate net income for distribution to stockholders based upon the spread between the interest income on our mortgage assets and the costs of borrowing to finance our acquisition of these assets.

We are organized for tax purposes as a real estate investment trust, or REIT. Accordingly, we generally distribute substantially all of our taxable earnings to stockholders without paying federal or state income tax at the corporate level on the distributed earnings. At September 30, 2012, our qualified REIT assets (real estate assets, as defined under the Code, cash and cash items and government securities) were greater than 99% of our total assets, as compared to the Code requirement that at least 75% of our total assets must be qualified REIT assets. Greater than 99% of our 2011 revenue qualified for both the 75% source of income test and the 95% source of income test under the REIT rules. At September 30, 2012, we believe we met all REIT requirements regarding the ownership of our common stock and the distributions of our taxable net income. Therefore, we believe that we continue to qualify as a REIT under the provisions of the Code.

At our annual stockholders meeting held on May 25, 2011, our stockholders approved the entry by us into a management agreement, or the Management Agreement, between us and Anworth Management, LLC, or the Manager. We entered into the Management Agreement effective as of December 31, 2011, pursuant to which our day-to-day operations are now being conducted by the Manager. The Manager is supervised and directed by our board of directors and is responsible for (i) the selection, purchase and sale of our investment portfolio; (ii) our financing and hedging activities; and (iii) providing us with management services. The Manager will also perform such other services and activities relating to our assets and operations as may be appropriate. In exchange for these services, the Manager receives a management fee paid monthly in arrears in an amount equal to one-twelfth of 1.20% of our Equity (as defined in the Management Agreement). The term of the Management Agreement expires on December 31, 2013 and will automatically renew for successive one-year renewal terms unless either party elects not to renew. If we terminate the Management Agreement, or elect not to renew without cause, then we will be required to pay a termination fee equal to three times the average annual management fee earned during the prior 24-month period.


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On September 13, 2012, the Federal Reserve announced that it would be implementing a third round of "quantitative easing" by buying $40 billion of MBS per month. These purchases will be open-ended, meaning they will continue until the Federal Reserve is satisfied that economic conditions, primarily in unemployment, improve. The Federal Reserve also announced that the Fed Funds rate would remain at exceptionally low levels until at least mid-2015.

Although the U.S. government and other foreign governments have taken various actions (including placing Fannie Mae and Freddie Mac in conservatorship) intended to protect financial institutions, their respective economies and their respective housing and mortgage markets, we continue to operate under very difficult market conditions. There can be no assurance that these various actions will have a beneficial impact on the global financial markets and, more specifically, the market for the securities we currently own in our portfolio. We cannot predict what, if any, impact these actions or future actions by either the U.S. government or foreign governments could have on our business, results of operations and financial condition. These events may impact the availability of financing generally in the marketplace and also may impact the market value of MBS generally, including the securities we currently own in our portfolio.

In August 2011, Standard & Poor's downgraded each of U.S. sovereign debt and Fannie Mae and Freddie Mac from AAA to AA+. We do not know what effect this will ultimately have on the U.S. economy, the value of our securities and the ability of Fannie Mae and Freddie Mac to satisfy its guarantees of Agency MBS if necessary. A failure by the U.S. government to meet the conditions of the August 2011 debt ceiling agreement or to reduce its budget deficit or a further downgrade of U.S. sovereign debt and government-sponsored agency debt could have a material adverse effect on the U.S. economy and on the global economy. These events could have a material adverse effect on our borrowing costs, the availability of financing and the liquidity and valuation of securities in general and particularly the securities in our portfolio.

Our Portfolio

Our operations consist of the following portfolios: agency mortgage-backed
securities, or Agency MBS, and non-agency mortgage-backed securities, or
Non-Agency MBS. Essentially our entire total portfolio is Agency MBS.



                                                            September 30,
                                                                 2012
      Total assets                                          $ 9.31 billion

      Fair value of Agency MBS                              $ 9.26 billion

      Adjustable-rate Agency MBS (less than 1 year reset)               22 %
      Adjustable-rate Agency MBS (1-2 year reset)                        0 %
      Adjustable-rate Agency MBS (2-5 year reset)                       51 %
      Adjustable-rate Agency MBS (> 5-year reset)                        6 %
      15-year fixed-rate Agency MBS                                     17 %
      30-year fixed-rate Agency MBS                                      4 %

                                                                       100 %

Stockholders' equity available to common stockholders at September 30, 2012 was approximately $1.056 billion, or $7.45 per share. The $1.056 billion equals total stockholders' equity of $1.104 billion less the Series A Preferred Stock liquidating value of approximately $46.9 million and less the difference between the Series B Preferred Stock liquidating value of approximately $26.4 million and the proceeds from its sale of approximately $25 million.

Results of Operations

Three Months Ended September 30, 2012 Compared to September 30, 2011

For the three months ended September 30, 2012, our net income available to common stockholders was $20.5 million, or $0.15 per diluted share, based on a weighted average of 143.1 million fully diluted shares outstanding. This includes net income of $22 million minus the payment of preferred dividends of $1.5 million. For the three months ended September 30, 2011, our net income available to common stockholders was $29.1 million, or $0.22 per diluted share, based on a weighted average of 136.1 million fully diluted shares outstanding. This included net income of $30.6 million minus the payment of preferred dividends of $1.5 million.

Net interest income for the three months ended September 30, 2012 was approximately $25.4 million, or 38.2% of gross income, compared to approximately $33.2 million, or 46.7% of gross income, for the three months ended September 30, 2011. Net interest income is comprised of the interest income earned on mortgage investments (net of premium amortization


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expense) less interest expense from borrowings. Interest income (net of premium amortization expense) for the three months ended September 30, 2012 was approximately $47.2 million, compared to approximately $54.5 million for the three months ended September 30, 2011, a decrease of 13.4%, due primarily to an increase in premium amortization of approximately $2.9 million, a decrease in the coupons on our MBS (from 3.526% during the three months ended September 30, 2011 to 3.036% during the three months ended September 30, 2012), partially offset by an increase in the average MBS outstanding (from $8.04 billion during the three months ended September 30, 2011 to $8.76 billion during the three months ended September 30, 2012). Interest expense for the three months ended September 30, 2012 was approximately $21.7 million, compared to approximately $21.3 million for the three months ended September 30, 2011, an increase of 2%, which resulted primarily from an increase in the average repurchase agreement borrowings outstanding from $7.3 billion at September 30, 2011 to $7.96 billion at September 30, 2012, partially offset by a decline in weighted average interest rates after the effect of the swap agreements (from 1.142% at September 30, 2011 to 1.066% at September 30, 2012).

The results of our operations are affected by a number of factors, many of which are beyond our control, and primarily depend on, among other things, the level of our net interest income, the market value of our MBS, the supply of, and demand for, MBS in the marketplace, and the terms and availability of financing. Our net interest income varies primarily as a result of changes in interest rates, the slope of the yield curve (the differential between long-term and short-term interest rates), borrowing costs (our interest expense) and prepayment speeds on our MBS portfolios, the behavior of which involves various risks and uncertainties. Interest rates and prepayment speeds, as measured by the constant prepayment rate, or CPR, vary according to the type of investment, conditions in the financial markets, competition and other factors, none of which can be predicted with any certainty. With respect to our business operations, increases in interest rates, in general, may, over time, cause:
(i) the interest expense associated with our borrowings, which are primarily comprised of repurchase agreements, to increase; (ii) the value of our MBS portfolios and, correspondingly, our stockholders' equity to decline;
(iii) coupons on our MBS to reset, although on a delayed basis, to higher interest rates; (iv) prepayments on our MBS portfolios to slow, thereby slowing the amortization of our MBS purchase premiums; and (v) the value of our interest rate swap agreements and, correspondingly, our stockholders' equity to increase. Conversely, decreases in interest rates, in general, may, over time, cause:
(i) prepayments on our MBS portfolios to increase, thereby accelerating the amortization of our MBS purchase premiums; (ii) the interest expense associated with our borrowings to decrease; (iii) the value of our MBS portfolios and, correspondingly, our stockholders' equity to increase; (iv) the value of our interest rate swap agreements and, correspondingly, our stockholders' equity to decrease; and (v) coupons on our MBS to reset, although on a delayed basis, to lower interest rates. In addition, our borrowing costs and credit lines are further affected by the type of collateral pledged and general conditions in the credit markets.

During the three months ended September 30, 2012, premium amortization expense increased $2.9 million, or 17.6%, from $16.5 million during the three months ended September 30, 2011 to $19.4 million, due primarily to the increase in the amortization of unearned premium on securities acquired in 2011 and 2012 at higher premiums.

The following table shows the approximate CPR of our Agency MBS and Non-Agency MBS for each of the following quarters:

                                                      2012                                            2011
                                      First          Second           Third           First          Second           Third
Portfolio                            Quarter         Quarter         Quarter         Quarter         Quarter         Quarter
Agency MBS and Non-Agency MBS              22 %            24 %            26 %            21 %            22 %            28 %

During the three months ended September 30, 2012 and 2011, there was no gain or loss recognized in earnings due to hedge ineffectiveness. We have determined that our hedges are still considered "highly effective." There were no components of the derivative instruments' gain or loss excluded from the assessment of hedge effectiveness.

During the three months ended September 30, 2012, there were recoveries of approximately $299 thousand related to a previous write-down on our Non-Agency MBS, as compared to recoveries of approximately $830 thousand related to a previous write-down on our Non-Agency MBS for the three months ended September 30, 2011.

Total expenses were approximately $3.8 million for the three months ended September 30, 2012, compared to approximately $3.4 million for the three months ended September 30, 2011. For the three months ended September 30, 2012, we incurred management fees of approximately $2.9 million, which are based on a percentage of our equity. From September 30, 2011 to September 30, 2012, we had raised capital of approximately $62 million. This had the effect of an increase in the management fee for the third quarter of 2012 of approximately $186 thousand (see Note 10 to the accompanying unaudited financial statements). Due to the Externalization, we no longer incur compensation costs, compared with compensation and related costs of approximately $2.64 million for the three months ended September 30, 2011. "Other expenses" increased $108 thousand (as detailed in Note 14 to the accompanying unaudited financial statements).


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Nine Months Ended September 30, 2012 Compared to September 30, 2011

For the nine months ended September 30, 2012, our net income available to common stockholders was approximately $72.6 million, or $0.52 per diluted share, based on a weighted average of 141.3 million fully diluted shares outstanding. This includes net income of approximately $76.9 million minus the payment of preferred dividends of approximately $4.3 million. For the nine months ended September 30, 2011, our net income available to common stockholders was approximately $90.1 million, or $0.70 per diluted share, based on a weighted average of 131.2 million fully diluted shares outstanding. This included net income of approximately $94.5 million minus the payment of preferred dividends of approximately $4.4 million.

Net interest income for the nine months ended September 30, 2012 was approximately $87.1 million, or 42.8% of gross income, compared to approximately $103.7 million, or 48.8% of gross income, for the nine months ended September 30, 2011. Interest income (net of premium amortization expense) for the nine months ended September 30, 2012 was approximately $150.8 million, compared to approximately $170.5 million for the nine months ended September 30, 2011, a decrease of 11.5%, due primarily to an increase in premium amortization of approximately $10.7 million, a decrease in the average coupons on our MBS (from 3.656% during the nine months ended September 30, 2011 to 3.152% during the nine months ended September 30, 2012), partially offset by an increase in the average MBS outstanding (from $7.75 billion during the nine months ended September 30, 2011 to $8.60 billion during the nine months ended September 30, 2012). Interest expense for the nine months ended September 30, 2012 was $63.7 million, compared to approximately $66.8 million for the nine months ended September 30, 2011, a decrease of 4.7%, which resulted primarily from a decline in weighted average interest rates after the effect of the swap agreements (from 1.27% at September 30, 2011 to 1.07% at September 30, 2012) and partially offset by an increase in the average borrowings outstanding, from $6.96 billion at September 30, 2011 to $7.79 billion at September 30, 2012.

During the nine months ended September 30, 2012, premium amortization expense increased approximately $10.7 million, or 25.6%, from approximately $41.9 million during the nine months ended September 30, 2011 to $52.6 million, due primarily to the increase in the amortization of unearned premium on securities acquired in 2011 and 2012 at higher premiums.

During the nine months ended September 30, 2012 and 2011, there was no gain or loss recognized in earnings due to hedge ineffectiveness. We have determined that our hedges are still considered "highly effective." There were no components of the derivative instruments' gain or loss excluded from the assessment of hedge effectiveness.

During the nine months ended September 30, 2012, there were recoveries of approximately $1.27 million related to a previous write-down on our Non-Agency MBS, as compared to recoveries of approximately $1.7 million related to a previous write-down on our Non-Agency MBS for the nine months ended September 30, 2011.

Total expenses were approximately $11.5 million for the nine months ended September 30, 2012, compared to approximately $10.9 million for the nine months ended September 30, 2011. For the nine months ended September 30, 2012, we incurred management fees of approximately $8.6 million, which is based on a percentage of our equity. From September 30, 2011 to September 30, 2012, we had raised capital of approximately $62 million. This had the effect of an increase in the management fee for the nine months ended September 30, 2012 of approximately $558 thousand (see Note 10 to the accompanying unaudited financial statements). Due to the Externalization, we no longer incur compensation costs, compared with compensation and related costs of approximately $8.46 million for the nine months ended September 30, 2011. "Other expenses" increased $470 thousand (as detailed in Note 14 to the accompanying unaudited financial statements).

Financial Condition

Agency MBS Portfolio

At September 30, 2012, we held agency mortgage assets which had an amortized cost of approximately $8.98 billion, consisting primarily of approximately $7.16 billion of adjustable-rate Agency MBS, approximately $1.82 billion of fixed-rate Agency MBS and approximately $2 million of floating-rate CMOs. This amount represents an approximately 4.8% increase from the $8.57 billion held at December 31, 2011. Of the adjustable-rate Agency MBS owned by us, 27.8% were adjustable-rate pass-through certificates which had coupons that reset within one year. The remaining 72.2% consisted of hybrid adjustable-rate Agency MBS which had coupons that will reset between one year and ten years. Hybrid adjustable-rate Agency MBS have an initial interest rate that is fixed for a certain period, usually three to ten years, and thereafter adjust annually for the remainder of the term of the asset.


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The following table presents a schedule of the fair value of our Agency MBS owned at September 30, 2012 and December 31, 2011, classified by type of issuer (dollar amounts in thousands):

                               September 30, 2012                December 31, 2011
                             Fair          Portfolio           Fair          Portfolio
    Agency                   Value         Percentage          Value         Percentage
    Fannie Mae (FNM)      $ 6,293,275             67.9 %    $ 6,008,951             68.6 %
    Freddie Mac (FHLMC)     2,955,496             31.9        2,735,842             31.2
    Ginnie Mae (GNMA)          15,982              0.2           17,101              0.2

    Total Agency MBS:     $ 9,264,753            100.0 %    $ 8,761,894            100.0 %

The following table classifies the fair value of our Agency MBS owned at September 30, 2012 and December 31, 2011 by type of interest rate index (dollar amounts in thousands):

                                               September 30, 2012                    December 31, 2011
                                                            Portfolio                             Portfolio
Index                                    Fair Value         Percentage         Fair Value         Percentage
One-month LIBOR                          $     2,467                0.0 %      $     3,130                0.0 %
Six-month LIBOR                               66,624                0.7             73,345                0.8
One-year LIBOR                             6,992,246               75.5          6,699,300               76.5
Six-month certificate of deposit               1,138                0.0              1,177                0.0
Six-month constant maturity treasury             324                0.0                360                0.0
One-year constant maturity treasury          290,643                3.2            329,685                3.8
Cost of Funds Index                           21,864                0.2             24,968                0.3
15-year fixed-rate                         1,502,852               16.2          1,121,500               12.8
30-year fixed-rate                           386,595                4.2            508,429                5.8

Total Agency MBS:                        $ 9,264,753              100.0 %      $ 8,761,894              100.0 %

The fair values indicated do not include interest earned but not yet paid. With respect to our hybrid adjustable-rate Agency MBS, the fair value of these securities appears on the line associated with the index based on which the security will eventually reset once the initial fixed interest rate period has expired. The fair value of our Agency MBS is reported to us independently from dealers who are major financial institutions and are considered to be market makers for these types of instruments. For more detail on the fair value of our Agency MBS, see Note 6 to the accompanying unaudited financial statements.

The weighted average coupons and average amortized costs of our Agency MBS at September 30, 2012, June 30, 2012, March 31, 2012 and December 31, 2011 were as follows:

                                       September 30,         June 30,          March 31,          December 31,
                                           2012                2012              2012                 2011
Weighted Average Coupon:
Adjustable-rate Agency MBS                       3.14 %           3.23 %             3.22 %                3.27 %
Hybrid adjustable-rate Agency MBS                2.87             2.94               3.09                  3.22
15-year fixed-rate Agency MBS                    3.16             3.35               3.65                  3.66
30-year fixed-rate Agency MBS                    5.56             5.56               5.55                  5.55
CMOs                                             1.03             1.05               1.05                  1.09

Total Agency MBS:                                3.09 %           3.18 %             3.31 %                3.42 %

Average Amortized Cost:
Adjustable-rate and hybrid
adjustable-rate Agency MBS                     102.99 %         102.89 %           102.86 %              102.83 %
15-year fixed-rate Agency MBS                  103.11           103.04             103.36                103.29
30-year fixed-rate Agency MBS                  100.86           100.84             100.83                100.82

Total Agency MBS:                              102.92 %         102.82 %           102.82 %              102.78 %

Current yield (weighted average
coupon divided by average
amortized cost)                                  3.00 %           3.09 %             3.22 %                3.33 %


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The following information pertains to our repurchase agreement borrowings at September 30, 2012, June 30, 2012, March 31, 2012 and December 31, 2011:

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