Lloyd McAdams - Chairman of the Board, CEO Joseph McAdams - President, Director, CIO Brett Roth - SVP, Portfolio Manager.

Douglas Harter - Credit Suisse Steven Delaney - JMP Securities.

changes 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 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 exemption from the Investment Company Act of 1940, as amended; risks associated with our home rental business; and the manager's ability to manage our growth.

These and other 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 we make.

All forward-looking statements speak only as of the date they are made. New risks and uncertainties arise over time, and it's 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 such 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..

Thank you very much. I'm Lloyd McAdams, and I welcome you to this call today where we will discuss our third quarter operating results. And with me today are Joe McAdams, our Chief Investment Officer and President; Brett Roth, Senior Vice President and Portfolio Manager; and Chuck Siegel, our Chief Financial Officer.

I will now turn the call over to Joe McAdams..

Thank you. Turning to our financial results for the third quarter. Anworth's core earnings for the quarter were $11.9 million or approximately $0.12 per weighted share. That's a small decline from $12.1 million in the previous quarter. Our GAAP net income was $10.5 million or $0.11 per share.

And the comprehensive income, which includes not just the core earnings but all of the realized and unrealized gains and losses on our portfolio and hedges, was $16.3 million or $0.17 per share for the quarter. That was an increase from $14.5 million the previous quarter.

While the core earnings for the quarter was little changed from the prior quarter, I'd like to take just a moment to highlight how some of the factors that were a drag on portfolio earnings during the summer months have largely dissipated as the third quarter progressed and we moved into the fourth quarter of the year.

Core earnings have declined during the second quarter, due largely to the combination of higher paydown expense on the agency portfolio and lower portfolio leverage overall due to higher repayment rates on both the agency and credit portfolio.

Agency prepayment rates for our portfolio peaked in July and had been declining sequentially each month since, with further prepayment reduction seen in October. Portfolio leverage has increased back to its target levels during the quarter, which should further improve the earning potential of our agency portfolio.

In addition, new agency assets continue to be focused in fixed-rate mortgage-backed securities where the hedged net interest spreads remain higher than on new ARM assets.

Our mortgage credit investments have been performing well on a price basis, and that trend continues, it continued during the third quarter, with price increases on our non-agency MBS, driving most of the excess in comprehensive income over core earnings that we saw during the quarter.

Our mortgage credit portfolio also grew in the quarter as we redeployed cash that had been largely repaid early on our nonperforming loan securities. However, as prices on bonds go up, yields go down.

So most of the increase in the overall portfolio size has been in agency investments where we currently see slightly higher leverage yield opportunities and have correspondingly increased our allocation.

Looking at the subsequent table on our earnings release, you'll see that allocation, with total agency MBS up to $5.04 billion now up to 78% of the overall portfolio. Non-agency MBS grew from $690 million to $728 million.

It's still roughly 11% of the portfolio of assets with our securitized residential mortgage loans that are held on, accounted for on-balance sheet through VIEs and the residential real estate portfolio making up the balance. Looking with a little more detail at our agency MBS portfolio.

You'll see that the percentage of the agency portfolio that isn't fully indexed, fully resetting adjustable-rate mortgage. Securities declined from 31% to 26% on the quarter. As we said, the repayments we are getting on the portfolio are largely being reinvested in fixed-rate MBS.

And you'll see the overall ARM allocation, including hybrid ARMs, at 46%, with the balance being fixed-rate securities. We did add in both 15-year, 20-year and 30-year fixed-rate categories during the quarter. Looking at some of the summary statistics on our agency MBS portfolio. The overall coupon increased 5 basis points from 2.94% to 2.99%.

That increase was almost entirely driven by the increase of our adjustable-rate mortgage coupons, which increased almost 15 basis points to 3.4%.

So obviously, as these mortgages reset on an annual basis, the cumulative effect of the Fed rate increases we've seen over the past 12 months continue to be reflected on sort of a lagging basis in our asset yield. Overall, the unamortized premium of the portfolio increased to $117 million, largely because the portfolio was larger.

We did see a similar premium amortization expense, $8.9 million, on the quarter. The overall prepayment rate on the agency portfolio decreased from 22% to 20%, with a more significant reduction being seen in the agency MBS portfolio.

As I mentioned previously, the prepayment rates peaked in agency portfolio in July and continue to decline, with the average being 20%. The prepayment rate on our agency portfolio on October was a 16% CPR. So with that, I'd turn it over to Brett to go over some of the details of our mortgage credit investments..

Thanks, Joe. Over the course of the third quarter, spreads and mortgage credit products continue to tighten. Investor appetite has remained strong in spite of ever-tighter spreads. And it appears that at least in the short run, we will continue to see spreads growing tighter.

In terms of valuations, the legacy non-agency market as well as our portfolio has and still continues to benefit from the spread tightening. During the quarter, we continue to selectively add positions to our legacy CUSIP portfolio, namely, within the Alt-A sector of the portfolio. We also added to our investment in agency risk transfer assets.

Overall, the portfolio was benefiting from the credit performance of its underlying assets as well as experiencing strong voluntary prepayment activity. Further, in our loans held in securitization trusts, we are also experiencing the benefits of the high credit quality performance. Turning to funding side.

We continue to add new counterparties to our mix of lenders and to prudently manage our financing book, and therefore, our cost of funds. Thus, activity has allowed us, this activity has allowed us to help offset some of the costs of the rising interest rates. Thus, we are working on at a minimum to maintain the net spreads on our assets.

Looking forward, we feel that we are in a good position to take advantage of investment opportunities as they arise in the current market. We continue to look to find attractive assets to add in the portfolio across all of the mortgage credits. Thanks, Joe..

Thanks, Brett. Turning back to the portfolio financing and leverage for the entire portfolio. We did have an increase, as you would expect, in our repurchase agreement borrowings, $4.3 billion, up from $3.9 billion, again because we had a larger asset side of the balance sheet to finance and an increase, corresponding increase in leverage.

Repo costs themselves un-hedged increased. The agency MBS repo rate increased from 1.2% at June 30 to 1.32% as the effect of the most recent Fed rate increase worked its way through our entire repo book.

However, on a hedged basis, our overall repo cost at quarter end was relatively unchanged at 1.57% overall, taking into account our interest rate swaps, giving us an average maturity of 603 days. Our leverage increased on the quarter to 5.9% from 5.3% the previous quarter. This is simply the leverage based on our repo balance.

If you take into account the synthetic financing, the effective leverage, which includes our TBA agency dollar roll financing, the effective leverage was 6.9% at quarter end. Looking at our interest rate hedges, we have been increasing our allocation to fixed rates as well as a reduction in our ARM portfolio.

Correspondingly, we did increase the notional amount of our swaps, $2.3 billion at quarter end, with a weighted average fixed rate of 1.51%. So we do have a larger swap balance. We also moved some of the maturities of the swaps around during the quarter.

So we do, so we did wind up with a lower average cost with a higher balance to reflect a larger fixed-rate position. When you look at our swap balance as a percentage of total repo, it increased from 53% to 59%.

As we normally point out in these calls, the main reason we have un-hedged swap balances is because we have significant investments in agency ARM assets. So as the amount of the portfolio in ARMs decreased by 5% on the quarter, the amount of the swap balance that was un-hedged also decreased by 6% on the quarter.

So those 2 generally move in line together. Our effective net interest spread on the quarter was 1.14%. This reflected about a 15 basis point increase in our effective cost of funds to 1.96%.

But as I pointed out previously, due to some of the changes in the structure of our swap portfolio, we're heading into the third quarter, I'm sorry, heading into the fourth quarter with approximately the same average rate that we began the third quarter with. The, we declared a dividend of $0.15 during the quarter.

Based upon the closing price, that was an annualized dividend yield of 9.98%. Our book value was unchanged at $6.04 on the quarter.

So when you add together the $0.15 dividend with the unchanged book value, that gives a quarterly un-annualized return on equity to common shareholders of 2.48% and brings the un-annualized year-to-date return on equity to common shareholders to 9.3%.

During the quarter, we did raise some additional capital in preferred capital in both our Series B and Series C preferred. That's $670,000 of the Series B preferred, which is convertible, and about $5.6 million of the Series C.

Subsequently, as you can see in the press release, we've also raised some additional capital in both of these preferred issues subsequent to quarter end. So with that, I would turn the call back over to Lloyd for his comments..

one, that the returns produced by mortgage REITs that stayed in business during this period are considerably greater than the overall market returns during that period, and this applies to Anworth also; and number two, that there's a large number of mortgage REITs that did not survive due to portfolio losses.

And for me, and I assume for most other investors, losing money anytime is a painful experience. It is not easily forgotten. And having talked with many mortgage REIT investors during these almost 20 years, I believe that many of them do focus significantly on possibilities of repeating such poor results.

And they factor into their ownership decisions this concept, even though, of course, the stocks they are buying did not experience those types of losses.

This, of course, now begs the question, how can anybody separate the moneymakers from the money losers? My view on this is that identifying money winners is quite difficult because luck, also known as insight or good timing, seems to have a lot to do with it.

On the other hand, the lack of asset type diversification appears to be a frequent thread among the mortgage REIT portfolio strategies that have had problems in the past.

In Anworth, a focus on diversification has been important for us during these 20 years, whether it was the times when we discussed how a mixture of ARMs and fixed-rate MBS was more efficient than our 100% fixed-rate portfolio even if the yield was less or how we believe that a fluctuating mixture of agency, mortgage-backed securities and mortgage credit securities is more efficient than 100% of either.

And so with that, I'll turn the call over to Brandon, our operator, and we look forward to hearing your questions and comments..

[Operator Instructions]. Our first question comes from Doug Harter with Credit Suisse..

Can you talk about your level of interest rate risk as you move to more fixed rates and obviously adjust the hedges? But if you could just talk about the overall level of interest rate risk you have today..

Sure. The, as we went over in the earnings results, we did have a larger swap position, which, a longer duration on our liabilities. We also have a longer duration on our assets. So overall, at quarter end, we had a net, based on a net duration gap of approximately 0.9 years, which is still pretty consistent....

How did that compare to the last quarter?.

I believe that was approximately the same. It does fluctuate. Rates have moved a little higher subsequent to quarter end. So that gap has moved out closer to a year. But overall, our, the shift, the continued shift of having more fixed-rate assets has not changed our duration gap, however..

Makes sense. You mentioned in your script that you are still replacing some of the legacy non-agencies.

I guess, can you just talk about the relative value you see between non-agencies and agencies today?.

Sure. And I'll let Brett speak about maybe the non-agencies first. We had a good mix between legacy mortgage-backed securities that were issued prior to 2008. As well as we've moved forward, I think we've had more of a focus on some newer securitizations of legacy assets in both the credit risk transfer space as well as in the nonperforming loans.

Brett, I don't know if you want to....

Well, that's kind of it. As the non-agency market, legacy market, has grown to be tighter and tighter, it is harder and harder to find assets that makes sense for us. And so we've been able to augment our investment in that area by shifting into other categories such as the credit risk transfer assets. And as you know, that market is developing.

There's been securitizations, redeveloping securitization post the close of third quarter. So that's the way that we can, we're able to continue to find ways to put our money to work in places that make sense and yields that make sense for us. As well we're, we look within the NPL space as well, and we're selective in acquiring assets there.

So it's just being, sticking to your discipline, purchasing assets that makes sense when you can find them and understanding when assets don't make sense and passing on them, right?.

And on the agency side, new agency assets with a yield of roughly 3% and a hedged spread again with an asset liability gap of a little less than a year would have a net margin of 100 to 110 basis points.

So while our, if you think about what's the incremental leverage on an agency investment relative to non-agency, if you think about 8x to 9x leverage on an agency investment, the current market would drive sort of an 11% or 12% leveraged ROE on a marginal agency investment, which is a little higher than what we've been seeing on some of the credit opportunities, which is why that's been where the majority of our new assets have been deployed..

Our next question comes from Steve Delaney with JMP Securities..

And Lloyd, I appreciate the thoughts back over the last 20 years and your comment on diversification. So I'm going to touch on that in my questions in just a second on the diversification. I think that the near-term item on most investors' mind is the December Fed hike. I'm curious, your thoughts if you've kind of factored that into your thinking.

It seems the market has.

And specifically, as we look at 60-day repo rolling into January, talk speaking of agency repo, how much of that hike do you think is priced in? And if it's not fully priced in, what would you expect repo to do at in the late December, early January?.

Sure. Thanks, Steve. Starting with the repo first. I, we always do see, as you know, every year-end some incrementally higher cost of funds. And so as we're at a point now where we can start to look at some longer-term repos that would be getting over into January, you can start to make some estimates of what the cost of that is.

It does seem to us that a December hike is pretty well priced into the repo cost, although it is, December 31 is a tough day to attribute exactly how much of the higher repo cost is due to a Fed increase versus the normal sort of end of the, right.

So, but, so I think when we look at it that way, there always is the potential for a little bit of a lag as rates rise for it to work itself through our portfolio. I mean, we're still seeing increases in our ARM coupon in the third quarter, and we should, and you'd see some of that going forward.

Likewise, most of our repos that we enter into are between 30 and 90 days. Our interest rate swaps typically have their payment reset every 90 days.

So I think that, and to your bigger picture, I think the market has certainly significantly priced in the likelihood of a December rate hike, we haven't certainly positioned our portfolio to bet against that in any significant way. So we, but I do think the likelihood of further rate increases is going to be, continue to be an open question.

And the market obviously continues to largely reduce that probability..

Okay. That's helpful. And if we, you gave your repo rates at September 30, 1.32%, up from 1.20%.

Should we be thinking about at year-end, in the December, January time frame that we're going to be looking at something closer to 1.50%? Or is that too high?.

Probably too high. I mean, if it is 1.50%, it will be because the financing over the term got to be significantly, it was a bigger factor. But part of the change in the quarter was that not all of our repos that were still outstanding at June 30 had been, there certainly was an expectation that the Fed was going to raise rates.

I mean, it wasn't as if it was a surprise. But there were still some increases in repo rates in early July as we had, rates were higher after the Fed hike than ever before..

Another part of Lloyd's comments that he may have added in terms of why Anworth is one of the survivors is you guys always seem to be averse to too much duration, certainly un-hedged duration. And I would say probably have left some earnings on the table by not having a larger component of 30-year MBS.

And just curious, when you look at the 15-year part of your portfolio, the fixed-rate portfolio, how much of an ROE give-up, un-annualized ROE, I think you mentioned 11 to 12, Joe, is the current opportunity. I assume that's a 30-year security.

How much do you think you'd give up on 15, shorter-duration, 15-year MBS versus 30 in terms of a levered return?.

It can be definitely in excess of 20 basis points of spread. So when you lever that up, you're moving into the high single digits on an ROE basis..

Yes. Yes. So could be 200 basis points lower, for sure, is what you're saying. Okay. Well, always try to look at things on a, go ahead..

No, I mean, if, yes, that might be the upper end of the range, but it would definitely be of a significant magnitude..

Okay. And with prices so high, we know there's not a lot to buy in credit these days. But you seem to be, when we look at where the portfolio is, the RMBS, the non-agency, just under 700, I'm not seeing any indication that you're intentionally trying to sell that down in any kind of major reallocation of, from credit into agency MBS.

And should we expect that you will continue to try to have a meaningful credit allocation even when it's tough to find value?.

No. Absolutely. I think that we have, we're happy with the legacy assets we have. Certainly, they are, it's, they're not making any more of them. So it is a declining asset class. We have not had any major efforts to sell off securities. We're happy with the performance of the ones we have. Most of, you're correct.

Most of our allocation to mortgage credit investments that we've seen over the past few quarters, and I expect that will continue, will be in new securitizations, either through opportunities in agency credit risk transfer relative to new loans that are originated; whether it's new securitizations of legacy loans through some of these nonperforming or re-performing securitizations; and also looking for opportunities in the securitized, non-agency market for newly originated loans as well.

So I, so when you expect, go ahead, please..

I'm just going to say, I'm sorry to cut you off.

I was going to say in the RPLs on the step-ups, have you seen, I mean, have they tightened like everything else? And maybe if you were to look at the senior piece of that, what type of ROE do you think you could gather given that short-duration asset? And because I'd like to see sort of how that compares to the 11 to 12 Joe mentioned on agency..

Yes. First of all, on the RPL, to your question about tightening, yes, that market has tightened in step with the rest of the market significantly. A couple of new deals out just this week, and again, pretty good aggressive rates. You're asking me about that A1 piece.

We do not invest in the A1 because it's just too tight and we just can't make the economics make sense to us. So....

And also, I think overall, from a strategic standpoint, when we think about the diversification that we're talking about between interest rate-sensitive agency assets versus credit-sensitive mortgage assets, in general, our preference has been to have investments that are less dependent on repo leverage to generate the return maybe at the expense of some additional credit support but having those investments be in securitizations and loans where we feel very comfortable to credit.

So being a little lower down the structure where the, our returns are coming from the credit risk that we're comfortable with, as opposed to simply taking more repo. Because the repo and the sensitivity to the yield curve and all those factors that add risk to repo financing, we're always going to have that on the agency side.

So, and again, I think, and generally, Steve, about RPLs and NPLs, our investments in that space to date have been in NPL securitizations..

[Operator Instructions]. At this time, I'm seeing no further questions. So this concludes our question-and-answer session. I would like to turn the conference back over to Lloyd McAdams for any closing remarks..

Thank you. To those of you who are on the call today, those of you who'll be listening to the replay and those of you who will be reading the transcript, we thank you very much for participating in our call. We look forward to having this call again about 3 months, and so thank you very much. And we look forward to that, and appreciate your support.

Have a good day..

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