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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2014

OR

¨

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission File Number 001-13709

 

ANWORTH MORTGAGE ASSET CORPORATION

(Exact name of registrant as specified in its charter)

 

 

MARYLAND

52-2059785

(State or other jurisdiction of
incorporation or organization)

(I.R.S. Employer
Identification No.)

 

1299 Ocean Avenue, Second Floor,
Santa Monica, California

90401

(Address of principal executive offices)

(Zip Code)

Registrant’s telephone number, including area code: (310) 255-4493

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large Accelerated Filer

x

Accelerated Filer

¨

 

 

 

 

Non-Accelerated Filer

¨  (Do not check if a smaller reporting company)

Smaller Reporting Company

¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No   x

At August 4, 2014, the registrant had 121,582,996 shares of common stock issued and outstanding.

 

 

 

 


ANWORTH MORTGAGE ASSET CORPORATION AND SUBSIDIARIES

FORM 10-Q

INDEX

 

 

 

 

Page

Part I.

 

FINANCIAL INFORMATION

1

 

Item 1.

Consolidated Financial Statements

1

 

 

Consolidated Balance Sheets as of June 30, 2014 (unaudited) and December 31, 2013

1

 

 

Consolidated Statements of Income for the three and six months ended June 30, 2014 and 2013 (unaudited)

2

 

 

Consolidated Statements of Comprehensive Income (Loss) for the three and six months ended June 30, 2014 and 2013 (unaudited)

3

 

 

Consolidated Statements of Stockholders’ Equity for the three months ended March 31, 2014 and June 30, 2014 (unaudited)

4

 

 

Consolidated Statements of Cash Flows for the three and six months ended June 30, 2014 and 2013 (unaudited)

5

 

 

Notes to Unaudited Consolidated Financial Statements

6

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

25

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

36

 

Item 4.

Controls and Procedures

40

Part II.

 

OTHER INFORMATION

41

 

Item 1.

Legal Proceedings

41

 

Item 1A.

Risk Factors

41

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

42

 

Item 3.

Defaults Upon Senior Securities

42

 

Item 4.

Mine Safety Disclosures

42

 

Item 5.

Other Information

42

 

Item 6.

Exhibits

42

 

 

Signatures

45

 

 

 


 

ANWORTH MORTGAGE ASSET CORPORATION AND SUBSIDIARIES

Part I. FINANCIAL INFORMATION

 

Item 1.

Consolidated Financial Statements

ANWORTH MORTGAGE ASSET CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands, except per share amounts)

 

 

 

June 30,

 

 

December 31,

 

 

 

2014

 

 

2013

 

 

 

(unaudited)

 

 

 

 

 

ASSETS

 

 

 

 

 

 

 

 

Agency MBS:

 

 

 

 

 

 

 

 

Agency MBS pledged to counterparties at fair value

 

$

7,598,607

 

 

$

8,060,567

 

Agency MBS at fair value

 

 

431,597

 

 

 

462,478

 

Paydowns receivable

 

 

39,160

 

 

 

33,401

 

 

 

$

8,069,364

 

 

$

8,556,446

 

Residential properties

 

 

10,421

 

 

 

-

 

Cash and cash equivalents

 

 

1,184

 

 

 

7,368

 

Interest and dividends receivable

 

 

21,742

 

 

 

23,310

 

Derivative instruments at fair value

 

 

432,649

 

 

 

22,551

 

Prepaid expenses and other

 

 

19,428

 

 

 

9,816

 

Total Assets:

 

$

8,554,788

 

 

$

8,619,491

 

LIABILITIES AND STOCKHOLDERS' EQUITY

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

Accrued interest payable

 

$

28,160

 

 

$

30,117

 

Repurchase agreements

 

 

7,118,500

 

 

 

7,580,000

 

Junior subordinated notes

 

 

37,380

 

 

 

37,380

 

Derivative instruments at fair value

 

 

465,639

 

 

 

55,914

 

Interest rate swaps at fair value

 

 

34,831

 

 

 

-

 

Dividends payable on Series A Preferred Stock

 

 

1,035

 

 

 

1,035

 

Dividends payable on Series B Preferred Stock

 

 

394

 

 

 

394

 

Dividends payable on common stock

 

 

17,332

 

 

 

11,097

 

Accrued expenses and other

 

 

3,355

 

 

 

1,368

 

Total Liabilities:

 

$

7,706,626

 

 

$

7,717,305

 

Series B Cumulative Convertible Preferred Stock: par value $0.01 per share; liquidating

    preference $25.00 per share ($25,241 and $25,241, respectively); 1,010 and 1,010

    shares issued and outstanding at June 30, 2014 and December 31, 2013,

    respectively

 

$

23,924

 

 

$

23,924

 

Stockholders' Equity:

 

 

 

 

 

 

 

 

          Series A Cumulative Preferred Stock: par value $0.01 per share; liquidating

              preference $25.00 per share ($47,984 and $47,984, respectively); 1,919 and 1,919

              shares issued and outstanding at June 30, 2014 and December 31, 2013,

              respectively

 

$

46,537

 

 

$

46,537

 

          Common Stock: par value $0.01 per share; authorized 200,000 shares, 123,798 and

              138,717 issued and outstanding at June 30, 2014 and December 31, 2013,

              respectively

 

 

1,238

 

 

 

1,387

 

Additional paid-in capital

 

 

1,107,796

 

 

 

1,185,369

 

Accumulated other comprehensive (loss) consisting of unrealized gains and losses

 

 

(52,830

)

 

 

(92,008

)

Accumulated deficit

 

 

(278,503

)

 

 

(263,023

)

Total Stockholders' Equity:

 

$

824,238

 

 

$

878,262

 

Total Liabilities and Stockholders' Equity:

 

$

8,554,788

 

 

$

8,619,491

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

See accompanying notes to unaudited consolidated financial statements.

 

 

1


 

ANWORTH MORTGAGE ASSET CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(in thousands, except per share amounts)

(unaudited)

 

 

 

Three Months Ended

June 30,

 

 

Six Months Ended

June 30,

 

 

 

2014

 

 

2013

 

 

2014

 

 

2013

 

Interest income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest on Agency MBS

 

$

41,400

 

 

$

45,231

 

 

$

85,796

 

 

$

88,680

 

Other income

 

 

16

 

 

 

13

 

 

 

27

 

 

 

31

 

 

 

 

41,416

 

 

 

45,244

 

 

 

85,823

 

 

 

88,711

 

Interest expense:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense on repurchase agreements

 

 

25,807

 

 

 

20,046

 

 

 

53,213

 

 

 

40,948

 

Interest expense on junior subordinated notes

 

 

315

 

 

 

320

 

 

 

629

 

 

 

640

 

 

 

 

26,122

 

 

 

20,366

 

 

 

53,842

 

 

 

41,588

 

Net interest income

 

 

15,294

 

 

 

24,878

 

 

 

31,981

 

 

 

47,123

 

Gain on sales of Agency MBS

 

 

1,594

 

 

 

2,076

 

 

 

1,594

 

 

 

7,246

 

Loss on interest rate swaps, net

 

 

(2,006

)

 

 

-

 

 

 

(1,378

)

 

 

-

 

Gain on derivatives-TBA securities

 

 

1,578

 

 

 

-

 

 

 

1,578

 

 

 

-

 

Recovery on Non-Agency MBS

 

 

33

 

 

 

103

 

 

 

70

 

 

 

232

 

Expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Management fee to related party

 

 

(2,724

)

 

 

(3,029

)

 

 

(5,640

)

 

 

(6,027

)

Other expenses

 

 

(3,722

)

 

 

(1,030

)

 

 

(4,786

)

 

 

(1,952

)

Total expenses

 

 

(6,446

)

 

 

(4,059

)

 

 

(10,426

)

 

 

(7,979

)

Net income

 

$

10,047

 

 

$

22,998

 

 

$

23,419

 

 

$

46,622

 

Dividend on Series A Cumulative Preferred Stock

 

 

(1,035

)

 

 

(1,035

)

 

 

(2,070

)

 

 

(2,072

)

Dividend on Series B Cumulative Convertible Preferred Stock

 

 

(394

)

 

 

(394

)

 

 

(788

)

 

 

(806

)

Net income to common stockholders

 

$

8,618

 

 

$

21,569

 

 

$

20,561

 

 

$

43,744

 

Basic earnings per common share

 

$

0.07

 

 

$

0.15

 

 

$

0.16

 

 

$

0.30

 

Diluted earnings per common share

 

$

0.07

 

 

$

0.15

 

 

$

0.16

 

 

$

0.30

 

Basic weighted average number of shares outstanding

 

 

126,787

 

 

 

144,252

 

 

 

131,790

 

 

 

143,581

 

Diluted weighted average number of shares outstanding

 

 

130,867

 

 

 

148,126

 

 

 

135,843

 

 

 

147,539

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

See accompanying notes to unaudited consolidated financial statements.

 

 

 

2


 

ANWORTH MORTGAGE ASSET CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(in thousands)

(unaudited)

 

 

 

Three Month Ended

June 30,

 

 

Six Month Ended

June 30,

 

 

 

2014

 

 

2013

 

 

2014

 

 

2013

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

10,047

 

 

$

22,998

 

 

$

23,419

 

 

$

46,622

 

Available-for-sale Agency MBS, fair value adjustment

 

 

46,006

 

 

 

(188,986

)

 

 

75,728

 

 

 

(209,129

)

Reclassification adjustment for gain on sales of Agency MBS included in net income

 

 

(1,594

)

 

 

(2,076

)

 

 

(1,594

)

 

 

(7,246

)

Unrealized (losses) gains on derivatives

 

 

(45,291

)

 

 

29,616

 

 

 

(74,946

)

 

 

30,148

 

Reclassification adjustment for interest expense on swap agreements included in net income

 

 

19,535

 

 

 

11,640

 

 

 

39,990

 

 

 

23,793

 

Other comprehensive income (loss)

 

 

18,656

 

 

 

(149,806

)

 

 

39,178

 

 

 

(162,434

)

Comprehensive income (loss)

 

$

28,703

 

 

$

(126,808

)

 

$

62,597

 

 

$

(115,812

)

See accompanying notes to unaudited consolidated financial statements.

 

 

 

3


 

ANWORTH MORTGAGE ASSET CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(in thousands, except per share amounts)

(unaudited)

 

 

 

Series A

Preferred Stock Shares

 

 

Common Stock Shares

 

 

Series A

Preferred Stock

Par Value

 

 

Common Stock Par Value

 

 

Additional

Paid-In

Capital

 

 

Accum. Other

Comp.

Income (Loss)

Agency MBS

 

 

Accum. Other Comp. (Loss) Derivatives

 

 

Accum. (Deficit)

 

 

Total

 

Balance, December 31, 2013

 

 

1,919

 

 

 

138,717

 

 

$

46,537

 

 

$

1,387

 

 

$

1,185,369

 

 

$

(58,646

)

 

$

(33,362

)

 

$

(263,023

)

 

$

878,262

 

Issuance of common stock

 

 

 

 

 

 

56

 

 

 

 

 

 

 

1

 

 

 

257

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

258

 

Redemption of common stock

 

 

 

 

 

 

(5,281

)

 

 

 

 

 

 

(53

)

 

 

(26,465

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(26,518

)

Other comprehensive income, fair

   value adjustments and reclassifications

 

 

 

 

 

 

 

 

 

 

 

 

 

 

-

 

 

 

 

 

 

 

29,722

 

 

 

(9,200

)

 

 

 

 

 

 

20,522

 

Net income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

13,371

 

 

 

13,371

 

Treasury Stock

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(1,805

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(1,805

)

Amortization of restricted stock

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

24

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

24

 

Dividend declared - $0.539063 per Series A

   preferred share

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(1,035

)

 

 

(1,035

)

Dividend declared - $0.390625 per Series B

   preferred share

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(394

)

 

 

(394

)

Dividend declared - $0.14 per common share

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(18,708

)

 

 

(18,708

)

Balance, March 31, 2014

 

 

1,919

 

 

 

133,492

 

 

$

46,537

 

 

$

1,335

 

 

$

1,157,380

 

 

$

(28,924

)

 

$

(42,562

)

 

$

(269,789

)

 

$

863,977

 

Issuance of common stock

 

 

 

 

 

 

82

 

 

 

 

 

 

 

1

 

 

 

389

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

390

 

Redemption of common stock

 

 

 

 

 

 

(9,776

)

 

 

 

 

 

 

(98

)

 

 

(51,802

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(51,900

)

Other comprehensive income, fair

   value adjustments and reclassifications

 

 

 

 

 

 

 

 

 

 

 

 

 

 

-

 

 

 

 

 

 

 

44,412

 

 

 

(25,756

)

 

 

 

 

 

 

18,656

 

Net income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

10,047

 

 

 

10,047

 

Treasury Stock

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1,805

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1,805

 

Amortization of restricted stock

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

24

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

24

 

Dividend declared - $0.539063 per Series A

   preferred share

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(1,035

)

 

 

(1,035

)

Dividend declared - $0.390625 per Series B

   preferred share

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(394

)

 

 

(394

)

Dividend declared - $0.14 per common share

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(17,332

)

 

 

(17,332

)

Balance, June 30, 2014

 

 

1,919

 

 

 

123,798

 

 

$

46,537

 

 

$

1,238

 

 

$

1,107,796

 

 

$

15,488

 

 

$

(68,318

)

 

$

(278,503

)

 

$

824,238

 

 

See accompanying notes to unaudited consolidated financial statements.

 

 

 

4


 

ANWORTH MORTGAGE ASSET CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

 

 

 

Three Months Ended

June 30,

 

 

Six Months Ended

June 30,

 

 

 

2014

 

 

2013

 

 

2014

 

 

2013

 

Operating Activities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

10,047

 

 

$

22,998

 

 

$

23,419

 

 

$

46,622

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amortization of premium and discounts (Agency MBS)

 

 

11,791

 

 

 

15,981

 

 

 

21,678

 

 

 

35,003

 

(Gain) on sales of Agency MBS

 

 

(1,594

)

 

 

(2,076

)

 

 

(1,594

)

 

 

(7,246

)

Amortization of restricted stock

 

 

24

 

 

 

50

 

 

 

48

 

 

 

101

 

Recovery on Non-Agency MBS

 

 

(33

)

 

 

(103

)

 

 

(70

)

 

 

(232

)

Amortization related to interest rate swaps

 

 

(756

)

 

 

-

 

 

 

(1,001

)

 

 

-

 

Loss on interest rate swaps, net

 

 

2,006

 

 

 

-

 

 

 

1,378

 

 

 

-

 

(Gain) on derivatives - TBA Securities

 

 

(1,578

)

 

 

-

 

 

 

(1,578

)

 

 

-

 

Changes in assets and liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Decrease (increase) in interest receivable

 

 

1,345

 

 

 

(635

)

 

 

1,568

 

 

 

(15

)

(Increase) decrease in prepaid expenses and other

 

 

(4,459

)

 

 

7,042

 

 

 

(9,612

)

 

 

7,225

 

Increase (decrease) in accrued interest payable

 

 

2,423

 

 

 

(2,748

)

 

 

(1,926

)

 

 

(3,060

)

Increase in accrued expenses

 

 

552

 

 

 

128

 

 

 

1,955

 

 

 

1,562

 

Net cash provided by operating activities

 

$

19,768

 

 

$

40,637

 

 

$

34,265

 

 

$

79,960

 

Investing Activities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Available-for-sale Agency MBS:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Proceeds from sale

 

$

197,703

 

 

$

92,111

 

 

$

197,703

 

 

$

294,328

 

Purchases

 

 

(99,228

)

 

 

(1,131,487

)

 

 

(337,976

)

 

 

(2,021,159

)

Principal payments

 

 

351,078

 

 

 

658,916

 

 

 

681,538

 

 

 

1,309,008

 

Residential properties purchases

 

 

(9,792

)

 

 

-

 

 

 

(10,485

)

 

 

-

 

Net cash provided by (used in) investing activities

 

$

439,761

 

 

$

(380,460

)

 

$

530,780

 

 

$

(417,823

)

Financing Activities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Borrowings from repurchase agreements

 

$

8,976,965

 

 

$

10,975,727

 

 

$

17,710,065

 

 

$

22,547,073

 

Repayments on repurchase agreements

 

 

(9,368,465

)

 

 

(10,595,727

)

 

 

(18,171,565

)

 

 

(22,162,073

)

Net settlement on TBA commitments

 

 

704

 

 

 

 

 

 

 

704

 

 

 

 

 

Proceeds from common stock issued, net of common stock repurchased

 

 

(49,705

)

 

 

(11,154

)

 

 

(77,770

)

 

 

526

 

Proceeds on Series B Preferred Stock issued

 

 

-

 

 

 

-

 

 

 

-

 

 

 

1,335

 

Proceeds on Series A Preferred Stock issued

 

 

-

 

 

 

-

 

 

 

-

 

 

 

1,090

 

Series A Preferred stock dividends paid

 

 

(1,035

)

 

 

(1,035

)

 

 

(2,070

)

 

 

(2,047

)

Series B Preferred stock dividends paid

 

 

(394

)

 

 

(411

)

 

 

(788

)

 

 

(827

)

Common stock dividends paid

 

 

(18,689

)

 

 

(21,653

)

 

 

(29,805

)

 

 

(42,955

)

Net cash (used in) provided by financing activities

 

$

(460,619

)

 

$

345,747

 

 

$

(571,229

)

 

$

342,122

 

Net (decrease) increase in cash and cash equivalents

 

$

(1,090

)

 

$

5,924

 

 

$

(6,184

)

 

$

4,259

 

Cash and cash equivalents at beginning of period

 

 

2,274

 

 

 

1,245

 

 

 

7,368

 

 

 

2,910

 

Cash and cash equivalents at end of period

 

$

1,184

 

 

$

7,169

 

 

$

1,184

 

 

$

7,169

 

Supplemental Disclosure of Cash Flow Information:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash paid for interest

 

$

24,455

 

 

$

23,114

 

 

$

56,799

 

 

$

44,648

 

Conversions of Series B Preferred Stock into common stock

 

$

-

 

 

$

1,044

 

 

$

-

 

 

$

2,633

 

Common stock repurchased

 

$

50,094

 

 

$

17,591

 

 

$

78,417

 

 

$

18,170

 

Change in payable for securities purchased

 

$

(100,064

)

 

$

238,899

 

 

$

-

 

 

$

35,673

 

 

See accompanying notes to unaudited consolidated financial statements.

 

5


 

ANWORTH MORTGAGE ASSET CORPORATION AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

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

 

NOTE 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES

We were incorporated in Maryland on October 20, 1997 and we commenced operations on March 17, 1998. We are in the business of investing primarily in United States, or U.S., agency mortgage-backed securities, or Agency MBS. Agency MBS are securities representing obligations guaranteed by the U.S. government, such as Ginnie Mae, or guaranteed by federally sponsored enterprises, such as Fannie Mae or Freddie Mac. Our principal business objective is to generate net income for distribution to our stockholders based upon the spread between the interest income on our mortgage assets and the costs of borrowing to finance our acquisition of those assets.

We have elected to be taxed as a real estate investment trust, or REIT, under the Internal Revenue Code of 1986, or the Code. As a REIT, we routinely distribute substantially all of the taxable income generated from our operations to our stockholders. As long as we retain our REIT status, we generally will not be subject to federal or state taxes on our income to the extent that we distribute our taxable net income to our stockholders.

In February 2014, the Company incorporated its wholly-owned Qualified REIT Subsidiary (“QRS”), Anworth Properties, Inc., which commenced operations in March 2014.  The Company also incorporated Anworth Property Services, Inc., a Taxable REIT Subsidiary (“TRS”) that is wholly-owned by the Company. The Company’s QRS will provide the entity through which the Company may own REIT-qualified real estate assets such as: (1) other types of mortgage assets, from which the Company would receive interest income; and (2) real estate assets, from which the Company would receive rental income and potential price appreciation. The Company’s TRS will provide the entity through which the Company may participate in various real estate-related activities which would earn profits that the IRS considers to be taxable income. Unlike a REIT, a TRS pays standard corporate taxes on its income earned from these activities in the mortgage and real estate markets. These other activities include almost everything other than receiving rent on properties owned and collecting interest on real estate mortgages owned. Examples of these other activities include: the securitization of mortgage loans; mortgage origination; leasing and managing rental properties; and owning properties acquired through the foreclosure process.

Effective as of December 31, 2011, we entered into a Management Agreement, or the Management Agreement, with Anworth Management, LLC, or the Manager, which effected the externalization of our management function, or the Externalization. Since the effective date, our day-to-day operations are being conducted by the Manager through the authority delegated to it under the Management Agreement and pursuant to the policies established by our board of directors. 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).

BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements are prepared on the accrual basis of accounting in accordance with generally accepted accounting principles utilized in the United States of America, or GAAP. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Material estimates that are susceptible to change relate to the determination of the fair value of securities, amortization of security premiums and accretion of security discounts and accounting for derivatives and hedging activities. Actual results could materially differ from these estimates. In the opinion of management, all material adjustments, consisting of normal recurring adjustments, considered necessary for a fair presentation have been included. The operating results for the three and six months ended June 30, 2014 and 2013 are not necessarily indicative of the results that may be expected for the calendar year. The interim financial information in the accompanying unaudited consolidated financial statements and the notes thereto should be read in conjunction with the audited financial statements included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013.

The following is a summary of our significant accounting policies:

6


 

Cash and Cash Equivalents

Cash and cash equivalents include cash on hand and highly liquid investments with original maturities of three months or less. The carrying amount of cash equivalents approximates their fair value.

Reverse Repurchase Agreements

We use securities purchased under agreements to resell, or reverse repurchase agreements, as a means of investing excess cash. Although legally structured as a purchase and subsequent resale, reverse repurchase agreements are treated as financing instruments under which the counterparty pledges securities (U.S. treasury securities or Agency MBS) and accrued interest as collateral to secure a loan. The difference between the purchase price that we pay and the resale price that we receive represents interest paid to us and is included in “Other income” on our unaudited consolidated statements of income. It is our policy to generally take possession of securities purchased under reverse repurchase agreements at the time such agreements are made.

Mortgage-Backed Securities (MBS)

Agency MBS are securities that are obligations (including principal and interest) guaranteed by the U.S. government, such as Ginnie Mae, or guaranteed by federally sponsored enterprises, such as Fannie Mae or Freddie Mac. Our investment-grade Agency MBS portfolio is invested primarily in fixed-rate and adjustable-rate mortgage-backed pass-through certificates and hybrid adjustable-rate MBS. Hybrid adjustable-rate MBS have an initial interest rate that is fixed for a certain period, usually three to ten years, and then adjusts annually for the remainder of the term of the asset. We structure our investment portfolio to be diversified with a variety of prepayment characteristics, investing in mortgage assets with prepayment penalties, investing in certain mortgage security structures that have prepayment protections and purchasing mortgage assets at a premium and at a discount. Our portfolio also includes a small amount of Non-Agency MBS (approximately $21 thousand) and this is included with the Agency MBS. Prior year balances have been presented consistent with this treatment.

We classify our MBS as either trading investments, available-for-sale investments or held-to-maturity investments. Our management determines the appropriate classification of the securities at the time they are acquired and evaluates the appropriateness of such classifications at each balance sheet date. We currently classify all of our MBS as available-for-sale. All assets that are classified as available-for-sale are carried at fair value and unrealized gains or losses are generally included in “Other comprehensive income (loss)” as a component of stockholders’ equity. Losses that are credit-related on securities classified as available-for-sale, which are determined by management to be other-than-temporary in nature, are reclassified from “Other comprehensive income” to income (loss).

The most significant source of our revenue is derived from our investments in MBS. Interest income on Agency MBS is accrued based on the actual coupon rate and the outstanding principal amount of the underlying mortgages. Premiums and discounts are amortized or accreted into interest income over the estimated lives of the securities using the effective interest yield method, adjusted for the effects of actual and estimated prepayments based on the Financial Accounting Standards Board, or FASB, Accounting Standards Codification, or ASC, 320-10. Our policy for estimating prepayment speeds for calculating the effective yield is to evaluate historical performance, street consensus prepayment speeds and current market conditions. If our estimate of prepayments is materially incorrect, as compared to the aforementioned references, we may be required to make an adjustment to the amortization or accretion of premiums and discounts that would have an impact on future income, which could be material and adverse.

Securities are recorded on the date the securities are purchased or sold. Realized gains or losses from securities transactions are determined based on the specific identified cost of the securities.

The following table shows our investments’ gross unrealized losses and fair value of those individual securities that have been in a continuous unrealized loss position at June 30, 2014 and December 31, 2013, aggregated by investment category and length of time (dollar amounts in thousands):

June 30, 2014

 

 

 

Less Than 12 Months

 

 

12 Months or More

 

 

Total

 

Description

of

Securities

 

Number

of

Securities

 

Fair

Value

 

 

Unrealized

Losses

 

 

Number

of

Securities

 

 

Fair

Value

 

 

Unrealized

Losses

 

 

Number

of

Securities

 

 

Fair

Value

 

 

Unrealized

Losses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Agency MBS

 

131

 

$

1,745,928

 

 

$

(33,185

)

 

 

314

 

 

$

2,460,702

 

 

$

(43,200

)

 

 

445

 

 

$

4,206,630

 

 

$

(76,385

)

7


 

December 31, 2013

 

 

 

Less Than 12 Months

 

 

12 Months or More

 

 

Total

 

Description

of

Securities

 

Number

of

Securities

 

 

Fair

Value

 

 

Unrealized

Losses

 

 

Number

of

Securities

 

 

Fair

Value

 

 

Unrealized

Losses

 

 

Number

of

Securities

 

 

Fair

Value

 

 

Unrealized

Losses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Agency MBS

 

 

202

 

 

$

4,262,712

 

 

$

(122,890

)

 

 

230

 

 

$

763,911

 

 

$

(23,089

)

 

 

432

 

 

$

5,026,623

 

 

$

(145,979

)

We do not consider those Agency MBS that have been in a continuous loss position for 12 months or more to be other-than-temporarily impaired. The unrealized losses on our investments in Agency MBS were caused by fluctuations in interest rates. We purchased the Agency MBS primarily at a premium relative to their face value and the contractual cash flows of those investments are guaranteed by the U.S. government or government-sponsored agencies. Since September 2008, the government-sponsored agencies have been in the conservatorship of the U.S. government. We do not expect to sell the Agency MBS at a price less than the amortized cost basis of our investments. Because the decline in market value of the Agency MBS is attributable to changes in interest rates and not the credit quality of the Agency MBS in our portfolio, and because we do not have the intent to sell these investments nor is it more likely than not that we will be required to sell these investments before recovery of their amortized cost basis, which may be at maturity, we do not consider these investments to be other-than-temporarily impaired at June 30, 2014.

Residential Properties

Residential properties are stated at cost and consist of land, buildings and improvements, including other costs incurred during their acquisition, possession and renovation. Residential properties purchased that are not subject to an existing lease are treated as asset acquisitions and, as such, are recorded at their purchase price, including acquisition and renovation costs, all of which are allocated to land and building based upon their relative fair values at the date of acquisition. Residential properties acquired either subject to an existing lease or as part of a portfolio level transaction are treated as a business combination under Accounting Standards Codification (“ASC”) 805, Business Combinations, and, as such, are recorded at fair value, allocated to land, building and the existing lease, if applicable, based upon their relative fair values at the date of acquisition, with acquisition fees and other costs expensed as incurred.

Building depreciation is computed on a straight-line basis over the estimated useful lives of the assets. We will generally use a 27.5 year estimated life with no salvage value. We will incur costs to prepare our acquired properties to be leased. These costs will be capitalized and allocated to building costs. Costs related to the restoration, renovation, or improvement of our properties that improve and extend their useful lives are capitalized and depreciated over their estimated useful lives. Expenditures for ordinary repairs and maintenance are expensed as incurred. Costs incurred by us to lease the properties will be capitalized and amortized over the life of the lease. Escrow deposits include refundable and non-refundable cash and earnest money on deposit with independent third parties for property purchases.

Repurchase Agreements

We finance the acquisition of MBS primarily through the use of repurchase agreements. Under these repurchase agreements, we sell securities to a lender and agree to repurchase the same securities in the future for a price that is higher than the original sales price. The difference between the sale price that we receive and the repurchase price that we pay represents interest paid to the lender. Although structured as a sale and repurchase obligation, a repurchase agreement operates as a financing under which we pledge our securities and accrued interest as collateral to secure a loan which is equal in value to a specified percentage of the estimated fair value of the pledged collateral. We retain beneficial ownership of the pledged collateral. Upon the maturity of a repurchase agreement, we are required to repay the loan and concurrently receive back our pledged collateral from the lender or, with the consent of the lender, we may renew such agreement at the then-prevailing financing rate. These repurchase agreements may require us to pledge additional assets to the lender in the event the estimated fair value of the existing pledged collateral declines.

Derivative Financial Instruments

Interest Rate Risk Management

We primarily use short-term (less than or equal to 12 months) repurchase agreements to finance the purchase of MBS. These obligations expose us to variability in interest payments due to changes in interest rates. We continuously monitor changes in interest rate exposures and evaluate hedging opportunities.

Our objective is to limit the impact of interest rate changes on earnings and cash flows. We achieve this by entering into interest rate swaps, which effectively convert a percentage of our repurchase agreements to fixed-rate obligations over a period of up to ten years. Under interest rate swap contracts, we agree to pay an amount equal to a specified fixed rate of interest times a notional

8


 

principal amount and to receive in return an amount equal to a specified variable-rate of interest times a notional amount, generally based on the London Interbank Offered Rate, or LIBOR. The notional amounts are not exchanged. We generally account for these swaps as cash flow hedges in accordance with ASC 815-10. We do not issue or hold derivative contracts for speculative purposes.

For all interest rate swaps entered into prior to September 9, 2013, we are exposed to credit losses in the event of non-performance by counterparties to interest rate swap agreements. In order to limit credit risk associated with swaps, our practice was to only enter into swaps with large financial institution counterparties who are market makers for these types of instruments, limit our exposure on each swap to a single counterparty under our defined guidelines and either pay or receive collateral to or from each counterparty on a periodic basis to cover the net fair market value position of the swaps held with that counterparty.

For all interest rate swaps entered into on or after September 9, 2013, all swap participants are required by rules of the Commodities Futures Trading Commission, or CFTC, under authority granted to it pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act, or the Dodd-Frank Act, to clear swaps through a registered derivatives clearing organization, or “swap execution facility,” through standardized documents under which each swap counterparty transfers its position to another entity whereby a central clearinghouse effectively becomes the counterparty on each side of the swap. Both the swap execution facility and the central clearing house could require greater initial and periodic margin (collateral) requirements and additional transaction fees. It is the intent of the Dodd-Frank Act that the clearing of swaps in this manner is designed to avoid concentration of risk in any single entity by spreading and centralizing the risk in the clearinghouse and its members.

Accounting for Derivatives and Hedging Activities

In accordance with ASC 815-10, a derivative that is designated as a hedge is recognized as an asset/liability and measured at estimated fair value. In order for our interest rate swap agreements to qualify for hedge accounting, upon entering into the swap agreement, we must anticipate that the hedge will be highly “effective” as defined by ASC 815-10.

On the date we enter into a derivative contract, we designate the derivative as a hedge of the variability of cash flows that are to be received or paid in connection with a recognized asset or liability (a “cash flow” hedge). Changes in the fair value of a derivative that is highly effective and that is designated and qualifies as a cash flow hedge, to the extent that the hedge is effective, are recorded in “Other comprehensive income” and reclassified to income when the forecasted transaction affects income (e.g., when periodic settlement interest payments are due on repurchase agreements). The swap agreements are carried on our balance sheets at their fair value, based on values obtained from large financial institutions who are market makers for these types of instruments. Hedge ineffectiveness, if any, is recorded in current-period income.

We formally assess, both at the hedge’s inception and on an ongoing basis, whether the derivatives that are used in hedging transactions have been highly effective in offsetting changes in the cash flows of hedged items and whether those derivatives may be expected to remain highly effective in future periods. If it is determined that a derivative is not (or has ceased to be) highly effective as a hedge, we discontinue hedge accounting.

When we discontinue hedge accounting, the gain or loss on the derivative remains in “Accumulated other comprehensive income” and is reclassified into income when the forecasted transaction affects income. In all situations in which hedge accounting is discontinued and the derivative remains outstanding, we will carry the derivative at its fair value on our balance sheet, recognizing changes in the fair value in current-period income. All of our swaps have historically been accounted for as cash flow hedges under ASC 815. However, on March 17, 2014, we discontinued hedge accounting on certain of our swaps totaling approximately $1.685 billion in notional amounts by de-designating these swaps as cash flow hedges. No swaps were terminated in conjunction with this action and our risk management and hedging practices were not impacted. As a result of discontinuing hedge accounting, beginning March 18, 2014, changes in the fair value of our swaps are recorded in “Gain on interest rate swaps, net” in our consolidated statements of income rather than in other comprehensive income (loss). Also, net interest paid or received under these swaps which, up through March 17, 2014, was recognized in “interest expense,” is instead recognized in “Gain on interest rate swaps, net.” These continue to be reported as assets or liabilities on our consolidated balance sheets at their fair value.

As long as the forecasted transactions that were being hedged (i.e. rollovers of our repurchase agreement borrowings) are still expected to occur, the balance in accumulated other comprehensive income (“AOCI”) from swap activity up through March 17, 2014 will remain in AOCI and be recognized in our consolidated statements of income as “interest expense” over the remaining term of the swaps.

For purposes of the cash flow statement, cash flows from derivative instruments are classified with the cash flows from the hedged item.

For more details on the amounts and other qualitative information on our swap agreements, see Note 13. For more information on the fair value of our swap agreements, see Note 7.

9


 

To-Be-Announced (TBA) Securities

We may also enter into TBA contracts, where we agree to purchase or sell, for future delivery, agency securities with certain principal and interest terms and certain types of collateral, but the particular agency securities to be delivered are not identified until shortly before the TBA settlement date. We may also do TBA dollar roll transactions, which involve moving the settlement of a TBA contract out to a later date by entering into an offsetting short position (referred to as a “pair off”), net settling the paired off positions for cash and simultaneously purchasing a similar TBA contract for a later settlement date. The agency securities purchased at the forward settlement date are typically priced at a discount to securities for settlement in the current month. This difference is referred to as the “price drop”. The price drop represents compensation to us for foregoing net interest margin (interest income less repurchase agreement financing cost) and is referred to as “dollar roll income”.

We account for TBA securities as derivative instruments since we do not meet the exemption allowed as a “regular-way” security trade under ASC 815, as either the TBA contracts do not settle in the shortest period of time possible or we cannot assess that it is probable at inception that we will take physical delivery of the security or that we will not settle on a net basis. Gains, losses and dollar roll income associated with the TBA securities are recognized in our consolidated financial statements of income as “gains (losses) on derivatives – TBA securities.”

We estimate the fair value of TBA securities based on similar methods used to value our agency securities.

Credit Risk

At June 30, 2014, we have attempted to limit our exposure to credit losses on our MBS by purchasing securities primarily through Freddie Mac and Fannie Mae. The payment of principal and interest on the Freddie Mac and Fannie Mae MBS are guaranteed by those respective enterprises. In September 2008, both Freddie Mac and Fannie Mae were placed in the conservatorship of the U.S. government. While it is the intent that the conservatorship will help stabilize Freddie Mac’s and Fannie Mae’s losses and overall financial position, there can be no assurance that it will succeed or that, if necessary, Freddie Mac or Fannie Mae will be able to satisfy its guarantees of Agency MBS. In August 2011, the ratings of each of U.S. sovereign debt, Fannie Mae and Freddie Mac were downgraded from AAA to AA+ by Standard & Poor’s, and affirmed at Aaa by Moody’s Investors Service, or Moody’s, with each of Standard & Poor’s and Moody’s revising the outlook on U.S. sovereign debt, Fannie Mae and Freddie Mac to negative. Each of Standard & Poor’s and Moody’s has indicated that it would likely change its ratings on Fannie Mae and Freddie Mac if it was to change its rating on the U.S. government. In June 2013, Standard & Poor’s affirmed its AA+ long-term sovereign credit rating on the United States and revised the outlook from negative to stable, and in July 2013, Moody’s affirmed its Aaa government bond rating of the United States and revised the outlook from negative to stable. These ratings have remained unchanged through June 30, 2014. We do not know what effect any changes in the ratings of U.S. sovereign debt, Fannie Mae and Freddie Mac will ultimately have on the U.S. economy, the value of our securities, or the ability of Fannie Mae and Freddie Mac to satisfy its guarantees of Agency MBS if necessary.

Our adjustable-rate MBS are subject to periodic and lifetime interest rate caps. Periodic caps can limit the amount an interest rate can increase during any given period. Some adjustable-rate MBS subject to periodic payment caps may result in a portion of the interest being deferred and added to the principal outstanding.

Other-than-temporary losses on our available-for-sale MBS, as measured by the amount of decline in estimated fair value attributable to credit losses that are considered to be other-than-temporary, are charged against income, resulting in an adjustment of the cost basis of such securities. Based on the criteria in ASC 320-10, the determination of whether a security is other-than-temporarily impaired, or OTTI, involves judgments and assumptions based on both subjective and objective factors. When a security is impaired, an OTTI is considered to have occurred if (i) we intend to sell the security, (ii) it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis or (iii) we do not expect to recover its amortized cost basis (i.e., there is a credit-related loss). The following are among, but not all of, the factors considered in determining whether and to what extent an OTTI exists and the portion that is related to credit loss: (i) the expected cash flow from the investment; (ii) whether there has been an other-than-temporary deterioration of the credit quality of the underlying mortgages; (iii) the credit protection available to the related mortgage pool for MBS; (iv) any other market information available, including analysts’ assessments and statements, public statements and filings made by the debtor or counterparty; (v) management’s internal analysis of the security, considering all known relevant information at the time of assessment; and (vi) the magnitude and duration of historical decline in market prices. Because management’s assessments are based on factual information as well as subjective information available at the time of assessment, the determination as to whether an other-than-temporary decline exists and, if so, the amount considered impaired, is also subjective and therefore constitutes material estimates that are susceptible to significant change.

10


 

Income Taxes

We have elected to be taxed as a REIT and to comply with the provisions of the Code with respect thereto. Accordingly, we will not be subject to federal income tax to the extent that our distributions to our stockholders satisfy the REIT requirements and that certain asset, income and stock ownership tests are met.

We have no unrecognized tax benefits and do not anticipate any increase in unrecognized benefits during 2014 relative to any tax positions taken prior to January 1, 2014. Should the accrual of any interest or penalties relative to unrecognized tax benefits be necessary, it is our policy to record such accruals in our income taxes accounts; and no such accruals existed at June 30, 2014. We file REIT U.S. federal and California income tax returns. These returns are generally open to examination by the IRS and the California Franchise Tax Board for all years after 2009 and 2008, respectively.

Cumulative Convertible Preferred Stock

We classify our Series B Cumulative Convertible Preferred Stock, or Series B Preferred Stock, on our balance sheets using the guidance in ASC 480-10-S99. The Series B Preferred Stock contains certain fundamental change provisions that allow the holder to redeem the preferred stock for cash only if certain events occur, such as a change in control. As redemption under these circumstances is not solely within our control, we have classified the Series B Preferred Stock as temporary equity.

We have analyzed whether the conversion features in the Series B Preferred Stock should be bifurcated under the guidance in ASC 815-10 and have determined that bifurcation is not necessary.

Stock-Based Expense

In accordance with ASC 718-10, any expense relating to share-based payment transactions is recognized in the unaudited consolidated financial statements.

Restricted stock is expensed over the vesting period (see Note 11).

Earnings Per Share

Basic earnings per share, or EPS, is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted EPS assumes the conversion, exercise or issuance of all potential common stock equivalents (which includes stock options and convertible preferred stock) and the adding back of the Series B Preferred Stock dividends unless the effect is to reduce a loss or increase the income per share.

The computation of EPS for the three and six months ended June 30, 2014 and 2013 is as follows (amounts in thousands, except per share data):

 

 

 

Net Income

Available to

Common

Stockholders

 

 

Average

Shares

 

 

Earnings

per

Share

 

For the three months ended June 30, 2014

 

 

 

 

 

 

 

 

 

 

 

 

Basic EPS

 

$

8,618

 

 

 

126,787

 

 

$

0.07

 

Effect of dilutive securities

 

 

394

 

 

 

4,080

 

 

 

-

 

Diluted EPS

 

$

9,012

 

 

 

130,867

 

 

$

0.07

 

For the three months ended June 30, 2013

 

 

 

 

 

 

 

 

 

 

 

 

Basic EPS

 

$