Joseph Lloyd McAdams - Chairman, Chief Executive Officer and President Joseph E. McAdams - Chief Investment Officer, Executive Vice President and Director Brett Roth - Senior Vice President and Portfolio Manager.

Michael R. Widner - Keefe, Bruyette, & Woods, Inc., Research Division Richard A. Eckert - MLV & Co LLC, Research Division Howard Henick.

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 including, but not limited to, change in interest rates; changes in the market value of our mortgage-backed securities; changes in the yield curve; the availability of mortgage-backed securities for purchase; increases in the prepayment rates on the mortgage loans securing our mortgage-backed securities; our ability to use borrowings to finance our assets and, if available, the terms of any financing; risks associated with investing in the mortgage-related assets; 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; implementation of or changes in government regulations affecting our business; our ability to maintain our qualification as a real estate investment trust for federal income tax purposes; our ability to maintain an exception from the Investment Company Act of 1940 as amended; risks associated with our home rental business; and the managers' ability to manage our growth.

These and other risks and 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 these 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, future events or otherwise.

Except as required by law, we expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements that may be made today or that reflect any change in our expectations or any change in events, conditions or circumstances based on which any statements are made. Thank you.

I would now like to introduce Mr. Lloyd McAdams, Chairman and Chief Executive Officer of Anworth. Please go ahead, sir..

What are we doing today to cause a good result over the next 3 to 5 years if rates either stay low or are much higher? Among the more important parts of my job is to communicate to shareholders that achieving this good result over this time period, whatever the scenario, is what we believe is important.

I believe that the below-average interest rate sensitivity of much of our spread income from our agency mortgage-backed securities and our ongoing non-agency additions to the portfolio are a very good start to achieving this good result over the next several years.

As to our current portfolio, approximately 1 quarter or specifically 28% of our agency assets is invested in fully indexed ARM securities which have annual coupon resets at or about the 1.75% above LIBOR resetting each and every year until their final maturity.

Also, another 45% of our agency assets are hybrid ARMs, whose interest rates will begin to reset on average in about 3 years, during which time we have hedges to provide more stable financing cost.

I believe it is accurate to say that these types of ARM securities, unlike most other mortgage-backed securities, decline in interest rate sensitivity each and every day as they move 1 day closer to the next coupon reset date. This is a very important characteristic of these assets.

So in summary, I believe that our management of our albeit smaller agency portfolio and the investments in non-agency securities are providing tangible, positive results for us today, and I expect that they will continue to do so in the future.

With that, I would like to turn the meeting over to Joe McAdams and Brett Roth, who will discuss the detail of our portfolio and outlook. Thank you very much..

Thanks. This is Joe. For the first quarter, Anworth's portfolio generated $16.2 million or $0.15 per share of core earnings. This was another quarterly increase, up from $0.14 in the fourth quarter of last year and $0.13 the quarter prior to that.

While the company's GAAP net income reflected a $0.17 per share loss due to declines in the fair value of the company's interest rate hedges, these declines were completely offset by increases in the fair value of our MBS assets, which are not reflected in GAAP net income.

Thus, the company's comprehensive income for the quarter, which includes all changes in fair value realized and unrealized, was $16.3 million or the same $0.15 per share as core earnings. Turning to the data disclosed in our earnings release about the composition of our portfolio of assets.

On the quarter, our assets decreased as a result of a smaller equity base due to share repurchase activity during the quarter, and portfolio acquisitions were focused in non-agency MBS with close to $400 million or 5% of total assets now invested in mortgage credit assets.

In the agency MBS portfolio, as Lloyd mentioned, the majority of our assets continue to be adjustable rate MBS with the percentage of adjustable rate MBS whose interest rate will be adjusting within 12 months and will continue to do so going forward, continuing to increase as seasoned hybrid ARMs roll into this currently resetting ARM bucket.

The percentage of the portfolio that are currently resetting ARMs increased to 28% during the quarter with an additional 7% of the portfolio in hybrid ARMs, which will be rolling into this category over the next 12 months.

Including the TBA agency MBS positions, exposure to fixed-rate MBS represents a total of 27% of the portfolio, with the vast majority continuing to be invested in 15-year maturity bonds.

Looking at other agency MBS portfolio characteristics, the average coupon declined to 2.60%, with the average cost declining to 103.27%, resulting in a current yield of 2.52% on our agency MBS prior to the amortization of purchase premiums. Premium amortization expense decreased slightly to $11.8 million on the quarter.

This actually represents a small increase relative -- on a percentage basis relative to the total unamortized premium, which now stands at $211 million. The portfolio's actual prepayment rate decreased from 15%, 15% CPR to 14% CPR during the first quarter.

We do expect to see some increase in prepayments as a response to the decline in mortgage rates in January and early February but expect that increase to be relatively modest as mortgage rates have been higher in recent months than seen in January.

The most recent monthly portfolio prepayments, which are not reflected in the reported data for the first quarter on the agency MBS portfolio, were at an annualized rate of 18% CPR. Looking at the non-agency MBS portfolio, I'd like to turn the call over to Brett Roth to discuss what's going on there..

Thanks, Joe. On the non-agency portfolio, as Lloyd mentioned earlier, we grew the portfolio -- continued to grow the portfolio during the first quarter to approximately $376 million. That represented approximately $176 million of additional assets that were added during the quarter.

As we -- as I look at the breakdown of the asset mix that were acquired, approximately 61% of those purchases were in the Alt-A legacy CUSIP specifically area; 27% of that would be in newly securitized, nonperforming loans; and the 11% balance -- approximately 11% balance would be in newly securitized subprime.

We continue to add these assets at levels that are accretive to our earnings. Overall, the portfolio we see projected yield on that of 5.60%, 5.60%, with a weighted average coupon of 4.34%.

Again, I just want to point out, in terms of -- as we're acquiring these assets, on the Alt-A legacy CUSIPs, we continue to acquire those assets at deep discounts relatively speaking versus both the subprime and the nonperforming assets, where we're paying higher dollar prices but we're purchasing assets with additional subordination and structural support in order to work in supporting the return profile that we see for those assets.

So again, we continue to see these being accretive, and we feel the opportunity will continue for us to acquire those assets on a going-forward basis..

Great. If we turn and look at the company's portfolio financing, repo borrowings now stand at slightly less than $6.3 billion with an average interest rate on these borrowings of 41 basis points.

This rate increased from prior quarter end in part driven by higher agency repo rates but also from the addition of higher-cost non-agency repo related to our continued growth of the non-agency MBS position.

When taking into account our interest rate swaps, our average interest rate now stands at 1.10%, with an average adjusted maturity of 729 days or approximately 2 years.

Given that we estimate our asset portfolio's duration at approximately 2.0 years as of March 31, you can see that we continue to have a very narrow duration gap between our assets and liabilities, which was reflected in the book value stability of our portfolio on the quarter.

Our leverage multiples stand at 7.8x our long-term capital, which is unchanged on the quarter. If we take into account the implied financing embedded in our TBA positions, the effective leverage is 8.7x long-term capital, which is a slight increase from the prior quarter.

The total interest rate swap position has a notional balance of $3.3 billion, and all of the swaps have maturities greater than 12 months with an average maturity of 3.8 years. Relative to total repo borrowing of $6.3 billion, this leaves approximately $3 billion of repo financing not currently hedged by swaps.

It's important to recall that $2.1 billion of the MBS assets these repos finance are currently resetting ARMs whose interest rate will reset primarily to 12-month LIBOR, so the interest income on these assets will adjust to increases in the short-term rates going forward.

And in addition, the euro-dollar future position protects against unexpected increases in short rates on an average notional amount of approximately $1.3 billion over the next year. So taking all of that into account, we believe the portfolio is well positioned to provide stability as short-term rates rise in the future.

The effective net interest rate spread on our portfolio, which reflects the components of core earnings, increased 5 basis points to 1.12%. This was due primarily to the increased allocation to non-agency assets, which not only provide a significantly higher spread than the agency investments but also are accretive to earnings on a levered basis.

As discussed earlier, the non-agency investments helped drive the increase in core earnings on the quarter to $0.15 and we increased our quarterly dividend distribution to $0.15 for the quarter as a result.

While changes in the value of the company's assets and hedges largely offset each other on the quarter, the book value per share increased by $0.04 due to the accretive effect of share repurchases. The $0.15 quarterly dividend and the $0.04 increase in book value per share resulted in a return on equity to common shareholders of 2.9% for the quarter.

With that, I'd like to turn the call back over to Lloyd to discuss capital markets activity for the quarter..

Thanks, Joe. During the first quarter, as I think most everyone is aware, we issued a 7 5/8% Series C nonconvertible preferred stock at $24.50 per share, received proceeds of about $7 million. We then entered into a Section 415 "aftermarket offering agreement" to sell additional Series C shares when market conditions are attractive.

Since then we've sold $2 million of additional Series C shares. I expect that the Series C will be accretive to common stockholder net income at the current net financing cost of this source of additional equity capital.

I also expect that this security will become an important part of our equity capital structure going forward subject to, obviously, attractive rates of financing. Also during the first quarter, we repurchased about 4 million common shares at a discount to book value, which added about $0.04 per share to our book value per share.

As I often say, this $0.04 per share does not go through the income statement and is, therefore, somewhat invisible to many stockholders. But I believe that it is just as real as $0.04 earned from our interest rate spread, even though it never appears in our earnings per share statements.

So with that, we'll turn the call over to our conference operator to take your questions. Thank you very much..

[Operator Instructions] Our first question is from Mike Widner of KBW..

I want to just follow up on -- a little bit on some of the non-agency stuff and your moves in that direction. I think you said that the non-agency RMBS you're buying was new issue.

And just to be clear on that, you mean legacy loans that are being newly securitized, either having been collapsed in securitizations or just whole loans that they're now getting around to securitizing.

Is that correct?.

In the newly securitized, there were 2 different areas that we were acquiring assets. The area you seem to be speaking to is the nonperforming portfolio. And those are all loans that are being securitized by these special servicers.

So they were old legacy -- these are obviously old legacy loans that are nonperforming that are being securitized with a tremendous amount of structural support in order to get us the coupons that -- the asset classes that we're purchasing..

Okay. And then, I mean, is there anything else there? Again, I was just sort of following up on what I thought I heard you say about new issue stuff. So those I understand. You have some Alt-A and some -- a little bit of subprime..

Right..

I assume those were all legacy loans, too? I mean, I haven't heard of anyone doing new securitizations of newly originated subprime. But I just wanted to make sure that you're not doing something that I'm not aware exists right now..

You're correct. These are not subprime. The subprime are resecuritizations of older transactions. So these are all legacy, pre-crisis loans and securities backed by pre-crisis loans..

Yes. Okay, makes sense. And I mean, as far as the allocation goes, I mean, I guess you guys are about what, 5% of assets are in that, I mean the non-agency RMBS in general. How do you see that trending over time? And I mean, it seems like you think that's attractive now.

But I mean, is there a -- I mean, how do we think about how to ramp that? I mean, you almost doubled the size of it. Obviously we don't want to project it doubling every quarter.

But I mean, is it a run rate of adding $150 million, $200 million or something or you're just kind of taking it as it goes?.

I think we're definitely looking to expand our allocation. Since there is a lower level of leverage involved with the non-agency investments, the 5% of assets that we have invested, if you look at the net investment relative to the non-agency repo is -- I think it's like approximately 17% of equity at this point.

So I -- that is an area where we look to expand our exposure. I also think we're viewing the overall strategy as being looking to expand our equity investment in mortgage credit investments, which, to date, have only included these securities relative to legacy loans one way or the other.

But we also will obviously be looking at ways to gain some exposure to newer mortgage credit that's being originated under sort of the current sort of 2.0 underwriting guidelines. But we haven't done any of that to date..

Got it.

And when -- and if and when you do, do that, I mean, is there -- would you be just kind of buying them in bulk transactions or are you working on flow arrangements or plan on doing underwriting yourself? Or how are you guys thinking about that?.

I think we would view all of the above as opportunities we'd look to investigate. I would -- I think this is a process that goes in steps. So I think you probably laid them out in the order that we would probably be investigating them..

Yes, that makes sense. And then I guess, just finally, on the single-family rental piece, I guess, how does that fit the strategy at this point? I mean, I guess I ask that from the perspective that the market for purchasing those assets has kind of gotten thinner. It's 0.2% of the portfolio right now.

It makes it feel like it's a little bit in a place where it's kind of hard to grow it to a point where it becomes meaningful. And if you're not going to grow it, then what exactly is it you're doing there? So just wondered about the disposition of that and how you guys are thinking about that piece these days..

This is Lloyd. The first point is, I believe, when I think about where the mortgage business is going to be 3 to 5 years from now and what it's going to look like, I believe that there is some linkage between people who are involved in owning mortgages and people who have something to do with managing houses. So I think that's going to be the future.

It's not all one or the other. It's a very small part of our portfolio. We are simply developing expertise. We are particularly interested in seeing what the rental increases will be during the summer. We're moving into the rental increase period. That will tell us more about the viability of this business than anything.

But my logic is that mortgages and renting and leasing houses will someday be connected much more so than they have been in the past, and that's the principal reason we're doing it. Abandoning the strategy just because it's small is not part of the thought. It will be what it is, and we are pleased with the results so far..

Okay, that makes sense. And definitely appreciate the share repurchases. I think a lot of investors have. It's worked well for you so far in terms of helping book value. Obviously, buying back 25% of the shares also impacts things like overall market cap and trading liquidity on the stocks.

I mean, as you buy back more and more, how do you think about those trade-offs?.

You are precisely correct, and I have a long list of what I consider the pros and cons of share repurchases. The principal benefit is you are adding something to book value. It's -- if you're buying shares at a 3% discount to book value, you're adding practically nothing to book value. So a meaningful discount to book is pretty much needed.

The negative would be if you bought so many shares you dropped out of the Russell 2000 Index, no one would say that had anything good for stockholders because a very, very large percentage of our company's shareholders are index funds. So we have those types of trade-offs.

And the other negative is we are shrinking our agency portfolio, a, because we like the non-agency space, but also because we have -- we have less capital to work with every quarter. That is a fairly big negative. I assume everyone has been able to easily figure out what the ROE on the non-agency portfolio is.

And that and increasing the ROE is the one way that book value per share -- I should say discount of the book value to share goes up. Buying shares back does not cause book value, the discount to shrink.

Producing higher rates return and, as I alluded to in my opening comment, giving people confidence that there's a good result going to occur over the next several years and the management is thinking about and working hard to produce that good result, whether interest rates stay low or interest rates rise, that's what produces stability of income.

And I don't hear about it much anymore, but stocks get valued based on discounting dividends and income into the future. And people do care about the future. They care about how you'll be doing 5 years from now to value the stock today.

And as I said, our goal is to explain to people that, that is very important and we're thinking about the future here and thinking about what the earnings will be like several years from now..

Well, that makes sense to me. And I guess I'll say a couple congratulatory messages before I drop off. I think, if my math is right, you guys buying back 25% of your shares is actually more than the sum total of the rest of the sector combined in terms of percentages, of course, not absolute shares or absolute dollars.

And I believe you did see some value -- price-to-book expansion last year. And by my math, you were the #1 total return stock in the sector last year. So yes, the share repurchases have accomplished something, and I think nice job for that..

Well, thank you very much. But I know the next question is, what are you going to do this year? So we'll do the best we can..

Our next question is from Richard Eckert of MLV & Co..

agency assets, non-agency assets, share repurchases.

How do you go about deciding on how to allocate capital between those 3 alternatives?.

To date, we've allocated capital by saying we're not going to buy any more agency securities and we may start to buy them back again. But right now, when you buy back a lot of stock and you have such attractive investments in the non-agency space, you're deciding between repurchasing shares and investing in non-agency securities..

Okay.

So it just comes down to a projected ROE type of calculation?.

More of a total return calculation. The good news about buying non-agency securities is you can -- hopefully it will help increase the yield of the company and give people more confidence due to the lack of less interest rate sensitivity that they have a higher projection of the total rate of return over their projected -- over the next 3 to 5 years.

And I believe that as that projection increases, the discount to book will be smaller. And therefore, to the shareholder, the best thing they can have is to have a very attractive rate of return, plus, say, a 5% increase in stock price relative to the book value per share.

That is what you look at to try to make the asset allocation decision to deploy your capital..

Our next question is from Howard Henick of ScurlyDog Capital..

One question. I'm a little confused. Again, I agree with Mike's point about buying back stock. I think that's great. But you're also issuing the preferred stock. And admittedly, I don't have a total understanding of preferred.

But doesn't the preferred have a catch-up to the common in terms of the dividend? And are we kind of like just moving stuff from our left pocket to our right pocket? If you can explain to me how that math works, the common -- substituting preferred for common, how that benefits us, I'd love to hear that..

The answer is there is no catch-up. You're probably thinking about the Series B preferred stock, which we certainly have not issued any more of. The Series C preferred stock is just like the Series A preferred stock. It has no catch-up..

So it's just a fixed coupon?.

It sure is....

So then it makes sense because, right, because the return on the stock, you're paying 10% or 11% on the stock and you're paying whatever it is, 6% or 7% on the preferred, so it's a positive carry trade kind of thing..

I believe strongly it will be accretive to stockholders for at least the next several years..

Yes, I agree. Okay, great. And again, I reiterate my keep on buying back stock. And I agree that your point about dropping out of the Russell, but you're hundreds of millions away from that, so that's not an issue..

Yes, we're a long way from that happening. But I do keep a list. Just so you know, I keep a list of pros and cons..

This concludes our question-and-answer session. I'd like to turn the conference back over to Lloyd McAdams for any closing remarks..

Well, thank you, everybody, for participating. And we appreciate the questions, and I hope they were beneficial. And we look forward to having this call again about this time next quarter. Thanks again..

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect..