Lloyd McAdams - Chairman and Chief Executive Officer Joe McAdams - President and Chief Investment Officer Brett Roth - Senior Vice President Chuck Siegel - Chief Financial Officer.

Douglas Harter - Credit Suisse Steve Delaney - JMP Securities.

Good afternoon and welcome to the Anworth First Quarter 2018 Earnings Conference Call. [Operator Instructions] Before we begin the call, I will make a brief introductory statement.

Statements made on this earnings call may contain forward-looking statements within the meaning of Section 27A of Securities Act of 1933 as amended and Section 21E of the Securities Exchange Act of 1934 as amended and we hereby claim that 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 that do not relate solely to historical matters.

You should not rely on our forward-looking statements because the matters they describe are subject to assumptions, known and unknown risks, uncertainties and other unpredictable factors, many of which are beyond our control.

Statements regarding the following subjects are forward-looking by their nature, our business and investment strategy, market trends and risks, assumptions regarding interest rates and assumptions regarding prepayment plans 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 the various factors and uncertainties.

Certain risks and uncertainties and factors, including those discussed under the heading Risk Factors and 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 is not possible to predict those events or how they may affect us.

Except as required by law, we do not intend to publicly update or revise any forward-looking statements, whether as a result of new information or expectations, future or a change in events, conditions or circumstances or otherwise. Thank you. Please note this event is being recorded. I would now like to introduce Mr.

Lloyd McAdams, Chairman and Chief Executive Officer of Anworth. Please go ahead, Mr. McAdams..

Thank you very much. I am Lloyd McAdams and I welcome you to this call today where we will discuss the first quarter operating results of our company. With me today is Joe McAdams, President and Chief Investment Officer; Brett Roth, Senior Vice President; and Chuck Siegel, our Chief Financial Officer. I will participate on the call later.

I will now turn the call over to Joe McAdams, our President and Chief Investment Officer. Thank you..

Thanks. This is Joe discussing our financial results for the first quarter. During the first quarter of 2018, there was significant volatility across financial markets with interest rates rising by close to 0.5%, equities declining with sharply higher volatility and corporate and credit spreads widening in general, including agency MBS.

The widening of agency MBS spreads as well as the effect of rising interest rates resulted in our MBS portfolio underperforming its hedges, resulting in an economic loss for the quarter.

Comprehensive income, which includes the effects of all gains and losses realized and unrealized in our investment portfolio was a loss of $24.9 million for the quarter or $0.25 per common share.

The Federal Reserve raised short-term rates by 25 basis points during the quarter and our interest rate, swap hedges and significant adjustable rate MBS holdings were effective at offsetting the effect of this increase in our borrowing costs.

Core earnings for the quarter were $13.7 million or $0.14 per share versus $13.9 million or $0.14 per share during the fourth quarter of 2017.

In fact, as LIBOR increased relative to our repo borrowing cost during the quarter, our swaps had the effect of actually reducing the net cost of the specific borrowings they were hedging, which in turn allowed us to increase the amount of our interest rate swap hedges and reduced the portfolio’s net exposure to rising interest rates going forward without significantly increasing our hedged borrowing cost or net interest rate spread.

Turning to the details of the mortgage-backed securities portfolio, agency MBS, including our TBA positions, decreased from 78% to 77% of the portfolio, while non-agency MBS increased from 12% to 13%. Overall, the investment portfolio decreased to $6.2 billion at quarter end.

Within the agency MBS portfolio, the allocation was divided 23% fully indexed and adjusting ARMs, 18% hybrid ARMs, 40% 15-year fixed mortgage-backed securities, and 19% 20-year and 30-year fixed mortgage-backed securities.

The fully indexed portion of their portfolio, the full indexed ARMs continue to see their average coupon rise along with short-term interest rates, it was up 9 basis points on the quarter to 3.54%. Also during the quarter, we looked to capture a potentially wider spreads by trading up in coupon in some of our fixed rate MBS positions.

So you can see that the average coupon in both the 15-year fixed and the 20-year and 30-year fixed sectors increased as well. So overall, the average agency MBS portfolio coupon rose on the quarter from 3.02% to 3.19%.

Unamortized purchased premium decreased to $111 million and the prepayment rate on our agency MBS decreased from 15 CPR to 13 CPR for the first quarter. With that, I would turn the call over to Brett Roth to discuss our mortgage credit investments..

Thanks, Joe. During the first quarter, there was some volatility in mortgage credit spreads. We saw spreads continue to significantly tighten at the beginning of the quarter with a strong get back toward the end of the quarter. The net result being a tightening of mortgage credit spreads during the quarter.

Investor appetite has remained strong and it appears that the bid for these assets will continue to remain strong. In terms of valuations, our portfolio has and continues to benefit from spread tightening, which during the quarter offset the impact of higher interest rates.

While maintaining our disciplined approach to valuing assets, we were still able to continue to selectively add assets at attractive yields to the portfolio during the quarter and investment activity exceeded portfolio runoff.

Specifically, we added assets mainly in the nonperforming and the agency risk transfer assets sectors of the portfolio with a limited amount of acquisition in the legacy CUSIP Alt-A sector portfolio. The portfolio continues to benefit from the credit performance of its underlying assets as well as experiencing strong voluntary prepayment activity.

Turning to our loans held in securitization trust, the credit performance of these assets continues to remain strong. These assets have been benefiting from positive HPI and the overall positive economic environment we have experienced over the last few years.

The result is that we see, in general, that the underlying mortgage holders in these securitizations have further strengthened their credit and the value of their properties has increased, which has resulted in lowering the HPI adjusted LTVs.

We continue to see that these mortgagees have opportunities to refinance their current mortgage and in spite of higher rates are continuing to do so at elevated voluntary rates that are still in line with our original expectations.

On the 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. This activity has allowed us to help offset some of the cost of the rise in interest rates.

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

Great. Turning to take a look at our portfolio financing, you will see that agency repo declined to $3.7 billion, non-agency repo increased slightly and overall repo borrowing decreased from $4.4 billion to $4.25 billion as of March 31.

While the average repo rate increased 28 basis points to 1.92%, our swap hedges were effective at limiting the net increase to 11 basis points up to 1.88%.

As I discussed earlier, this was inclusive of an addition of $400 million notional and new interest rate swaps, which increased the effective maturity of our hedged borrowings from 674 days to 972 days or effectively 2.7 years.

With the comprehensive loss for the quarter decreasing our stockholder equity, leverage increased from 5.9x at year end to 6.1x at March 31 despite the smaller borrowing balance we held at quarter end. Effective leverage, which includes the effect of the synthetic borrowings of TBA dollar roll financing, similarly rose to 7.2x.

Our interest rate swap balance grew to $3.1 billion, the equivalent of 73% of our total repo borrowings, and I point out that over 20% of the mortgage-backed securities financed with repo are currently adjustable ARMs. The average fixed pay rate on the swaps increased 18 basis points to 1.88%.

But as I mentioned previously, the spread between our repo rates and the LIBOR rate, which were paid on the swaps, tightened by 16 basis points on the quarter. So, the overall effect of the increased hedges on net interest income was lessened significantly.

These new swaps generally have longer maturities, so the average maturity of our swap positions increased to 3.7 years.

Looking at our effective net interest rate spread, higher MBS coupons, lower agency prepayment costs and relatively stable borrowing costs resulted in a wider effective net interest rate spread for the quarter increasing from 124 to 132 basis points. The company declared a $0.15 dividend during the quarter.

This represented a 12.5% dividend yield based on the quarter’s closing stock price. And due to the quarter’s comprehensive loss, book value per common share decreased from $5.91 to $5.48 at March 31. So combining the $0.15 quarterly dividend, less the $0.43 decrease in book value resulted in a negative 4.7% return on common equity for the quarter.

And with that review of our financial results, I will turn the call back over to Lloyd..

Thank you very much, Joe and Brett. Before we answer your questions that you may have, I will briefly make some observations about the first quarter of 2018 being the 20th anniversary of our IPO in 1998.

I ill comment briefly on the period itself and then discuss the capital markets results during these 20 years and how they maybe relevant for the future.

First, I believe that mortgage REIT is becoming recognized as an investment sector, begins in the 12-month window in 1997 and 1998, when about half a dozen mortgage REITs completed their IPO and joined Thornburg and Redwood, whose IPO was a few years earlier. Anworth’s IPO was toward the end of this 1997 1998 period.

Unfortunately, 1998 and 1999 were not good years for mortgage REITs as you may recall.

During the second quarter of 1998 and into the third quarter, it seems like déjà vu, but economic problems in Russia caused problems for their currency, the ruble and many post-Berlin Wall, Russian bonds issued to Western investors and only using leverage by many hedge funds, these bonds declined sharply in value resulting in margin calls.

Since the Russian bonds have become illiquid, other bonds holdings had to be sold by these investors and these bonds declined also.

By the fourth quarter of 1998, the Federal Reserve is sufficiently concerned that it is now convening all the major banks in United States to meet, to discuss the rescue of the widely admired long-term capital management since its failure was reportedly and supposedly would disrupt the entire United States’ economic financial system.

We know now that the U.S. financial system did survive, but weakness persisted into 1999 and by that year end and concerns about Y2K and computers only using 2 digits for a 4-digit year was the next great concern for everybody.

Mortgage REIT – the mortgage REIT index of FT, NAREIT mortgage REIT index had declined by 55% from April 1, 1998 to December 31, 1999. As a back end of this period, which is the 90 days of the 20 years ended on March 30, meaning the first quarter of 2018 also had the same mortgage REIT index declining by an additional 4%.

So all-in-all the bookings of this period were not the best times of return. So finally, what actually did happened in the capital markets using this – during this rather interesting 20 years? Well first, most relevantly, Fannie Mae 30-year mortgage rates declined from 7.1% to 4.4%.

But Bloomberg Barclays’ mortgage-backed security fixed rate index annual return was 4.7% per year, which is 152% with reinvested interest over the 20 years. And this being so close to the current rate that certainly is consistent with the investment concept that the bulk of long-term bond returns comes from the reinvestment of income.

The FT NAREIT mortgage REIT index annual return was 4.1% per year versus 122% with reinvested dividends, clearly slightly below the Bloomberg Barclays MBS fixed rate index.

However, it is important here to recall that this mortgage REIT index annual return continues to include nearly half of the public mortgage REITs, which existed during parts of this 20-year period and that they lost most or nearly all of their equity capital and are no longer part of the index.

I don’t know if the mortgage REIT index, which eliminates these companies that were dropped out of the index during this 20-year period, but Anworth has been a 20-year member of this all-inclusive index and its compounded annual return during this specific 20 years is 8.6% with dividends reinvested.

And this is definitely not the highest among the mortgage REITs during the period. The total return of 8.6% compounded is 423% for the 20 years, which interestingly is greater than that of most stock returns during this 20-year period, including the S&P 500.

The returns of the survivors to me, seems to point to the fact that a leverage mortgage-backed securities strategy is attractive relative to an un-levered mortgage-backed securities strategy.

So, what do I take from these statistics? Briefly, it appears to me that mortgage-backed securities long-term return is enhanced by using some leverage to own mortgage-backed securities. It would also appear that using too much actual or embedded leverage can lose a lot of money.

Without going too far with this goldilocks analogy, it would appear that the many largest institutional investors, who are long-term owners of many trillions of un-leveraged mortgage-backed securities or mortgage assets, would take note of results of this real life 20-year case study relative to mortgage-backed securities and leverage.

But if these investors were to use 1x, 2x leverage to own mortgage-backed securities, it could matter in their world of unfunded liabilities.

As to the next 20 years of owning mortgage-backed assets or mortgage securities, it will most likely be a different tune, but the role of the government guarantees still relatively uncertain, but leverage will play a role just it has in the past. U.S.

residential mortgages will likely increase in size by many trillions of dollars over this next 20 years. This time investors may focus more on survival of the strategies and they are achieving the maximum possible income.

If that occurs, I would think that caution, nimbleness and enough scale will be the important components of an alpha-producing strategy. So with that, return the call back to Anita so that we can respond to any questions that you might have..

Thank you. [Operator Instructions] The first question today comes from Douglas Harter with Credit Suisse. Please go ahead..

Thanks.

Lloyd, sort of touching on your last comment there about sort of size and scale and nimbleness, can you just give your thoughts as the industry consolidation that we seem to be seeing over the past couple of weeks?.

Yes. Thank you, Doug. I think you are referring to that some – in the last few weeks, I believe two mortgage REITs have been acquired by much larger mortgage REITs. The principal way – the thing that is happening is the larger mortgage REITs seem to trade by cause of size at a higher price to book value.

Statistic analysis would say that whether I would probably rely on you telling me that, that’s really is a causing effect, but statistically it definitely appears to be the case.

So, clearly, a stock-for-stock transaction of smaller company being merged into a larger company, the larger company would probably have a stock price that trades at a higher price to book. I think that is the primary motivation. The issue of size probably works in the opposite direction if the purpose is long-term rate of return.

The two examples that I think of are as long as repo capacity as a requirement for mortgage REIT to be successful, there comes a time when you probably do not want to be too large in repo capacity. I mean, you want to – you don’t want to have that need simply because there may not be a market for it.

And so that would be the primary reason why you would say, well, maybe size is not that important. Similarly, nimbleness is important. I point out that of the mortgage REITs that were in that first group in 2000 – 2000 that were in existence, quite a few disappeared.

Two of the mortgage REITs that continued were ones that followed fairly conservative investment strategies, in fact the only two that invested primarily in ARMs at that time and we have been part of that and continue.

So clearly, more leverage and more duration and the portfolio and more negative convexity clearly are recipe that the companies to follow that path probably had a higher failure rate than those who didn’t. So in that case, investing in size, which is the fixed rate market, probably was not a good thing for many.

Now there are mortgage REITs and clearly mortgage REITs that it did well investing in the fixed rate market and they have clearly still exist and are active in the business of acquiring other companies. But from a historical perspective, I gave it to you from that historical perspective..

That’s very helpful perspective there, Lloyd. Thank you..

[Operator Instructions] The next question comes from Steve Delaney with JMP Securities. Please go ahead..

Thanks for taking the question and Lloyd congratulations on making it to your 20-year anniversary. I think we all can remember people who didn’t accomplish that, so something to be proud of. Joe, I would like to pickup on the swap positive arbitrage, I guess we have been of referring to it versus 30-day repo versus the swap receive side.

Of your $3.1 billion of swaps, what percent are setups that you received 3-month LIBOR as opposed to 1-month LIBOR?.

Sure, Steve. I don’t have actually the exact number it’s virtually all of them. We have a small – of 1 months but we do tend to try to put a lot of our repos on initially for 3 months at a time on the agency side.

And again, I think the spread between sort of the OIS spread as well as the spread between our repo rates and LIBOR has certainly moved pretty sharply wider and I think it’s been more pronounced in the 3-month sector – 3-month LIBOR versus our repos..

Right.

Is it correct that there was a benefit in the first quarter but that widening of 3-month LIBOR versus repo it strikes us as it probably moved even farther and the benefit might even be greater in the second quarter than the first quarter?.

Yes. Those spreads have continued to move in that direction. You are correct..

Okay..

The swaps are setup versus LIBOR and it’s really the sense that LIBOR has moved up relative to a lot of other short-term benchmark spreads, right. If you look at the forward LIBOR curve versus the forward Fed Funds curve, those spreads have widened. So I don’t think it’s a function necessarily have that repo has gotten dramatically cheaper.

I feel our repo continues to improve versus other short-term cost, it’s simply that LIBOR has widened out during this period versus other short-term high-quality yields..

Right. And 3-month LIBOR more so than 1-month LIBOR it would seem..

So far, yes..

Yes, okay. Thank you. That’s helpful and for confirming that, because we have made an adjustment to our models where we are actually trying to build that into the cost of funds that credit if you will.

And I don’t know who wants to tackle this, whether it’s Chuck or Lloyd, but just looking at your – you are pretty consistent with this $0.14 level of core EPS and I am wondering if there is anything about your portfolio that would somehow cause taxable earnings, the basis for having to distribute your dividend, if anything is causing taxable to exceed your reported core EPS?.

It is.

You mean taxable earnings at the REIT level?.

Yes, taxable earnings at the REIT level that would trigger your distribution requirement..

We have a – I don’t think that’s likely anytime in the near future like several years.

It obviously could change, but we are more likely that if we have taxable – plus you referred to core earnings but if taxable earnings is $0.14 and we pay a $0.15 dividend, obviously, the shareholder gets $10.99, which says $0.01 of the $0.14 was a return of capital..

Exactly. And that leads me into kind of what I am saying, we have seen the market kind of brush-off what I would consider to be relatively modest dividend changes.

We had a problem recently where a company went from monthly to quarterly and that was pretty disruptive, but you are yielding 12.7% now, which is a fairly high yield, we have some that are resi mortgage REITs that are maybe more in the 10% or 11%.

And I am just wondering if you feel the board would consider lowering the dividend by $0.01 or so just to help preserve book value given that we are in sort of a tough market for book value stability?.

I do know that board members have discussed that and whether it occurs in 2018 or 2019, I can’t say, but we are very much aware of the – because you said, we aren’t – dividend yield is 12%, but obviously our earnings are slightly less than that. And so it has been discussed and it could well happen. I don’t want to say....

Okay, can’t. Yes, I understand..

Sorry, Steve.

Just I think our policy on the dividend has – the board’s policy has been to try to maintain a relatively stable dividend and not have it be one that moves up and down frequently by small increments, but you are correct, we have had several quarters in a row where the core earnings have been stable around $0.14 and we have decided to maintain the $0.15 dividend.

But certainly, if the outlook was, if it was going to continue in that area for a long time, I think you would want to bring the dividend and core earnings back in line..

And that’s our view. We think stability bouncing at around quarter – quarterly is just crazy, drives investors and analysts crazy. And you don’t want to hear that.

So, I think this stability is great and I just – I have had feedback from long-time PMs, especially up in Boston, who want to say look I am indifferent between a 10% yield and a 12% yield and the difference really doesn’t do it. What I want to make sure is that you are not – don’t overpay it and put pressure on the book value.

So I just wanted to share that and say that we share that view from where we sit. Thank you all for your comments..

Thank you, Steve..

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 very much for participating on the call. And for those of you who are on the call today in person, for those of you who will be listening to our replay shortly on the Internet and for those of you who will be reading the transcript, we look forward to having this call again in late July.

And so thank you very much and we look forward and appreciate your support and have a good day..

This conference has now concluded. Thank you for attending today’s presentation. You may now disconnect..