ANWORTH MORTGAGE ASSET CORPORATION Our Business
We were incorporated inMaryland onOctober 20, 1997 and commenced operations onMarch 17, 1998 . Our principal business is to invest in, finance and manage a leveraged portfolio of residential mortgage-backed securities and residential mortgage loans which presently include the following types of investments:
Agency mortgage-backed securities, or Agency MBS, which include residential
mortgage pass-through certificates and collateralized mortgage obligations, or
CMOs, which are securities representing interests in pools of mortgage loans
? secured by residential property in which the principal and interest payments
are guaranteed by a government-sponsored enterprise, or GSE, such as the
Federal National Mortgage Association, or Fannie Mae, or the Federal Home Loan
Non-agency mortgage-backed securities, or Non-Agency MBS, which are securities
? issued by companies that are not guaranteed by federally sponsored enterprises
and that are secured primarily by first-lien residential mortgage loans; and
Residential mortgage loans. We acquire non-Qualified Mortgage, or Non-QM,
residential mortgage loans (which are described further on page 86) from
independent loan originators with the intent of holding these loans for
securitization. These loans are financed by a warehouse line of credit until
? securitization. We also hold residential mortgage loans through consolidated
securitization trusts. We finance these loans through asset-backed securities,
or ABS, issued by the consolidated securitization trusts. The ABS, which are
held by unaffiliated third parties, are non-recourse financing. The difference
in the amount of the loans in the trusts and the amount of the ABS represents
our retained net interest in the securitization trusts.
Proposed Merger with Ready Capital Corporation
OnDecember 6, 2020 , we entered into the Merger Agreement with Ready Capital and Merger Sub, pursuant to which, subject to the terms and conditions therein, our Company will be merged with and into Merger Sub, with Merger Sub remaining as a wholly owned subsidiary of Ready Capital (such transaction, the "Merger"). Under the terms of the Merger Agreement, at the Effective Time, each share of Anworth Common Stock issued and outstanding immediately prior to the Effective Time (excluding any shares held by Ready Capital, Merger Sub or any of their respective subsidiaries) will automatically be converted into the right to receive from Ready Capital (i) 0.1688 shares of Ready Capital Common Stock, plus (ii)$0.61 in cash minus the Per Share Excess Amount, in each case, subject to adjustment as provided in the Merger Agreement. Additionally, at the Effective Time, each share of our 8.625% Series A Cumulative Preferred Stock will be converted into the right to receive one share of Ready Capital Series B Preferred Stock; each share of our 6.25% Series B Cumulative Convertible Preferred Stock will be converted into the right to receive one share Ready Capital Series C Preferred Stock; and each share of our 7.625% Series C Cumulative Redeemable Preferred Stock will be converted into the right to receive one share of Ready Capital Series D Preferred Stock. The Merger Agreement provides that each of our Company and Ready Capital will, until the Effective Time, operate their respective businesses in all material respects in the ordinary course and consistent with practice, and preserve substantially intact its current business organization and preserve key business relationships. Each of our Company and Ready Capital are subject to restrictions as specified in the Merger Agreement on certain actions each company may take prior to the Effective Time, including, among other things, actions related
to
amending organizational
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documents, declaring dividends, issuing or repurchasing capital stock, engaging in certain business transactions and incurring indebtedness.
Completion of the proposed Merger is subject to the satisfaction of certain customary conditions, and is subject to the approval of the stockholders of both Ready Capital and our Company. We cannot provide any assurance that the proposed Merger will close in a timely manner or at all.
Our Business Strategy
Our principal business objective is to generate net income for distribution to our stockholders primarily based upon the spread between the interest income on our mortgage assets and our borrowing costs to finance our acquisition of those assets. We generally view our target investments as being influenced primarily by either interest rate risks or credit risks. Our Agency MBS are sensitive to changes in interest rates and related prepayment speeds. Our Non-Agency MBS and residential mortgage loans held-for-securitization or held-for-investment through consolidated securitization trusts are sensitive to changes in both interest rate risk and credit risk.
The assets which we allocate to Agency MBS are also allocated to one of two subcategories:
1. Agency MBS which have a fixed interest rate during the life of the mortgages;
and
2. Agency MBS whose interest rates will change or adjust to current market levels
at varying times.
We believe our hybrid investment model allows us to allocate assets across various sectors within the residential mortgage market with a focus on security selection and implementation of a relative value investment approach. Our asset allocation process takes into account the opportunities in the marketplace, cost of financing and cost of hedging interest rate, prepayment credit, and other portfolio risks. As a result, mortgage-related asset allocation reflects management's opportunistic approach to investing in the marketplace.
The following table provides the MBS asset allocation and asset allocation
between our Agency MBS, Non-Agency MBS and residential mortgage loans at
December 31, December 31,
2020 2019
Dollar Amount Percentage Dollar Amount Percentage
(in thousands) (in thousands)
Agency MBS $ 1,624,354 73.58 % $ 3,510,051 73.66 %
Non-Agency MBS 206,933 9.37 643,610 13.51
Total MBS $ 1,831,287 82.95 % $ 4,153,661 87.17 %
Residential mortgage loans
held-for-securitization 109,312 4.95 152,922 3.21
Residential mortgage loans
held-for-investment through
consolidated securitization trusts 267,107 12.10 458,348 9.62
Total mortgage-related assets $ 2,207,706 100.00 % $ 4,764,931 100.00 % When we change the allocation of our investment portfolio, our annualized yields and cost of financing will change. As previously discussed, our investment decisions are not driven solely by annualized yields but also by taking into account the uncertainty of faster or slower prepayments, extension risk and
credit-related events.
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Our MBS Portfolio
At December 31, 2020 and December 31, 2019 , the fair value of our MBS portfolio
(which consists primarily of Agency MBS and Non-Agency MBS) and its allocation
were approximately as follows:
December 31, December 31,
2020 2019
(dollar amounts in thousands)
Fair value of MBS $ 1,831,287 $ 4,153,661 Adjustable-rate Agency MBS less than 1-year reset 18 % 12 % Adjustable-rate Agency MBS 1-3 year reset 7 2 Adjustable-rate Agency MBS 3-5 year reset - 3 Adjustable-rate Agency MBS greater than 5-year reset 3 2 Total Adjustable-Rate Agency MBS 28 % 19 % 15-year fixed-rate Agency MBS 2 1 20-year fixed-rate Agency MBS 9 5 30-year fixed-rate Agency MBS 50
60
Non-Agency MBS 11 15
Total MBS 100 % 100 %
Results of Operations
Years Ended
For the year endedDecember 31, 2020 , our net loss to common stockholders was approximately$(112.9) million , or$(1.14) per basic and diluted share, based on a weighted average of 99.0 million basic and fully diluted shares outstanding. This included a net loss of$(103.7) million and the payment of preferred dividends of$9.2 million . For the year endedDecember 31, 2019 , our net loss to common stockholders was approximately$(64.6) million , or$(0.65) per basic and diluted share, based on a weighted average of 98.7 million basic and fully diluted shares outstanding. This included a net loss of$(55.4) million and the payment of preferred dividends of$9.2 million . Net interest income after provision for loan losses for the year endedDecember 31, 2020 totaled$37.5 million , or 34.9% of gross interest income, as compared to$35.6 million , or 19.7% of gross interest income, for the year endedDecember 31, 2019 . Net interest income after provision for loan losses is comprised of the interest income earned on mortgage investments (net of premium amortization expense) and other interest income less interest expense from borrowings and provision for loan losses. Interest and other interest income net of premium amortization expense for the year endedDecember 31, 2020 was$83.1 million , as compared to$154.4 million for the year endedDecember 31, 2019 , a decrease of 46.2% due primarily to a decrease in interest income on securitized residential mortgage loans of approximately$5.8 million due to paydowns on this portfolio, a decrease in the weighted average portfolio outstanding, from approximately$3.95 billion in 2019 to approximately$2.34 billion in 2020, and a decrease in the weighted average coupons on MBS (from 3.93% in 2019 to 3.71% in 2020), and a decrease in other interest income of$1.2 million due primarily to less interest earned on restricted cash balances, partially offset by a decrease in premium amortization expense of$2.2 million and an increase in interest on residential mortgage loans held-for-securitization of$1.7 million due to a greater weighted average outstanding balance during 2020. Interest expense for the year endedDecember 31, 2020 was$44.9 million , as compared to$118.8 million for the year endedDecember 31, 2019 , a decrease of approximately 62.2%, which resulted primarily from a decrease in the weighted average interest rates, from 2.64% in 2019 to 1.18% in 2020, a decrease in interest expense on asset-backed securities issued by securitization trusts of approximately$5.7 million due to paydowns on this portfolio, and a decrease in the average borrowings outstanding, from$3.52 billion in 2019 to$2.11 billion in 2020, partially offset by an increase in interest expense on our warehouse line of credit of$0.3 million . Our results of our operations are affected by a number of factors, many of which are beyond our control, and primarily depend on, among other things, the level of our net interest income, the market value of our mortgage-related assets, the supply of, and demand for, mortgage-related assets in the marketplace, and
the
terms and availability of
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financing. Our net interest income varies primarily as a result from changes in
interest rates, the slope of the yield curve (the differential between long-term
and short-term interest rates), borrowing costs (our interest expense) and
prepayment speeds on our MBS and loan portfolios, the behavior of which involves
various risks and uncertainties. Interest rates and prepayment speeds, as
measured by the constant prepayment rate, vary according to the type of
investment, conditions in the financial markets, competition and other factors,
none of which can be predicted with any certainty. With respect to our business
operations, increases in interest rates, in general, may, over time, cause:
(i) the interest expense associated with our borrowings, which are primarily
comprised of repurchase agreements, to increase; (ii) the value of our MBS and
loan portfolios and, correspondingly, our stockholders' equity to decline;
(iii) coupons on our MBS and loans to reset, although on a delayed basis, to
higher interest rates; (iv) prepayments on our MBS and loan portfolios to slow,
thereby slowing the amortization of our purchase premiums; and (v) the value of
our interest rate swap agreements and, correspondingly, our stockholders' equity
to increase. Conversely, decreases in interest rates, in general, may, over
time, cause: (a) prepayments on our MBS and loan portfolios to increase, thereby
accelerating the amortization of our purchase premiums; (b) the interest expense
associated with our borrowings to decrease; (c) the value of our MBS and loan
portfolios and, correspondingly, our stockholders' equity to increase; (d) the
value of our interest rate swap agreements and, correspondingly, our
stockholders' equity to decrease; and (e) coupons on our MBS and loans to reset,
although on a delayed basis, to lower interest rates. In addition, our borrowing
costs and credit lines are further affected by the type of collateral pledged
and general conditions in the credit markets.
During the year ended December 31, 2020 , premium amortization expense decreased
by $2.2 million , or 8.4%, to $24.6 million from $26.8 million during the year
ended December 31, 2019 , due primarily to less unamortized premium from a lower
average MBS portfolio outstanding. The prepayment rate assumptions used in our
projection of long-term CPR percentages are based on historical prepayment rates
on our MBS assets as well as assumptions about future mortgage rates and their
expected impact on future prepayments. Given our current expectations for
prepayments and market conditions, we do not expect a significant change in
future prepayment assumptions.
The table below shows the approximate constant prepayment rate of our MBS:
2020 2019
Fourth Third Second First Fourth Third Second First
Portfolio Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
MBS 40 % 39 % 33 % 18 % 25 % 21 % 18 % 13 %
We review our MBS portfolios relative to current market conditions, trading prices of individual MBS, the general level of mortgage interest rates, prepayment activity, other investment opportunities and the duration of our portfolio versus the duration of our liabilities. During the year endedDecember 31, 2020 , we sold available-for-sale Agency MBS (including Agency MBS trading securities) of approximately$1.4 billion and realized net gains of approximately$19.4 million . During 2020, we sold a substantial portion of our MBS in order to reduce leverage, maintain adequate liquidity, pay-down the balance on our repurchase agreements, and preserve over-collateralization for our repurchase agreements. During the year endedDecember 31, 2019 , we received proceeds of approximately$2.95 billion from the sales of Agency MBS (including Agency MBS trading securities) and recognized a combined net gain of approximately$7.2 million . During 2019, we sold a substantial portion of our MBS to reallocate our portfolio from lower-yielding assets to higher-yielding assets. During the years endedDecember 31, 2020 and 2019, we recognized a gain (including derivative income) of approximately$28.2 million and approximately$14.2 million , respectively, on TBA Agency MBS. During the years endedDecember 31, 2020 and 2019, we did not sell any of our residential mortgage loans. AtMarch 31, 2020 , we designated our Non-Agency MBS as trading securities. The unrealized gain or loss on these securities, which had been formally recorded in AOCI, is now recorded as a net gain or loss on our consolidated statements of operations. During the year endedDecember 31, 2020 , we had a net loss on these securities of approximately$15.5 million . During 2019, we did not classify our Non-Agency MBS as trading securities. During the year endedDecember 31, 2020 , we also had a net loss on available-for-sale Non-Agency MBS of approximately$55.4 million . During the year endedDecember 31, 2019 , we received proceeds of approximately$30 million from the sales (including calls) of Non-Agency MBS and recognized a net gain of approximately$76 thousand . During the year endedDecember 31, 2020 , we had a loss on interest rate swaps recognized in our consolidated statements of operations of approximately$106.3 million , consisting primarily of$91.5 million in the negative change in fair value (see the section entitled "Derivative Financial Instruments-Accounting for Derivative and Hedging Activities" 80
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in Note 1, "Organization and Significant Accounting Policies," to the accompanying audited consolidated financial statements for additional information), and approximately$3.3 million in AOCI amortization and approximately$11.5 million in net cash settlements paid. During the year endedDecember 31, 2019 , we also had a loss on interest rate swaps recognized in our consolidated statements of operations of approximately$98.9 million , consisting primarily of approximately$106.5 million in the negative change in fair value and approximately$3.9 million in AOCI amortization, partially offset by approximately$11.5 million in net cash settlements received. During the year endedDecember 31, 2020 , rental income from our residential rental properties decreased by approximately$93 thousand . During the year endedDecember 31, 2020 , we sold three of our residential rental properties and realized a gain of approximately$201 thousand . During the year endedDecember 31, 2019 , we sold one of our residential rental properties and realized a gain of approximately$31 thousand . During the year endedDecember 31, 2020 , there was no impairment charge on our Non-Agency MBS, as compared to an impairment charge of approximately$2.1 million during the year endedDecember 31, 2019 . Total expenses were approximately$13.5 million for the year endedDecember 31, 2020 , as compared to approximately$13.3 million for the year endedDecember 31, 2019 . For the year endedDecember 31, 2020 , we incurred management fees of approximately$5.6 million , which is based on a percentage of our equity (see Note 12, "Public Offerings and Capital Stock," to the accompanying audited consolidated financial statements), as compared to management fees of approximately$6.7 million for the year endedDecember 31, 2019 . Rental properties depreciation and expenses increased by$470 thousand during 2020. "Other expenses" increased by approximately$0.8 million , due primarily to approximately$1.4 million in expenses related to the Merger Agreement.
Years Ended
The discussion comparing the results of operations for the years endedDecember 31, 2019 andDecember 31, 2018 can be found in, and is incorporated herein by reference to, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations-Years EndedDecember 31, 2019 and 2018," of our Annual Report on Form 10-K for the fiscal year endedDecember 31, 2019 . Financial Condition MBS Portfolio AtDecember 31, 2020 , we held Agency MBS which had an amortized cost of approximately$1.56 billion , consisting primarily of approximately$0.5 billion of adjustable-rate MBS and approximately$1.06 billion of fixed-rate MBS. This amount represents a decrease of approximately 55% from the$3.46 billion held atDecember 31, 2019 . This decrease was due primarily to paydowns and sales of the portfolio. AtDecember 31, 2020 , as our Non-Agency MBS are now designated as trading securities, they had a carrying value and a fair value of approximately$206.9 million . AtDecember 31, 2019 , the Non-Agency MBS had an amortized cost of approximately$613.6 million , a fair value of approximately$643.6 million , and a contractually required principal of approximately$801.9 million . Due to the COVID-19 coronavirus pandemic, there was much volatility in the markets, and we sold a substantial portion of our Agency MBS and Non-Agency MBS portfolios during March andApril 2020 to reduce leverage, maintain adequate liquidity, pay-down the balances on our repurchase agreements, and preserve over-collateralization for our repurchase agreements.
The following table presents a schedule of our MBS at fair value owned at
December 31, 2020 December 31, 2019
Fair Portfolio Fair Portfolio
Agency Value Percentage Value Percentage
(in thousands) (in thousands)
Fannie Mae (FNM) $ 1,067,375 58.3 % $ 2,617,084 63.0 %
Freddie Mac (FHLMC) 556,979 30.4 892,967 21.5
Non-Agency MBS 206,933 11.3 643,610 15.5
Total MBS $ 1,831,287 100.0 % $ 4,153,661 100.0 %
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The following table classifies our portfolio of MBS owned at
December 31, 2020 December 31, 2019
Fair Portfolio Fair Portfolio
Index Value Percentage Value Percentage
(in thousands) (in thousands)
Agency MBS:
One-month LIBOR $ 322 - % $ 386 - %
Six-month LIBOR 1,069 0.1 1,426 -
One-year LIBOR 495,532 27.1 767,275 18.5Six-month certificate of deposit 147 - 297 - One-year constant maturity treasury 12,801 0.7 17,552 0.4 Cost of Funds Index 1,757 0.1 2,532 0.1 15-year fixed-rate 34,755 1.9 48,226 1.2 20-year fixed-rate 156,369 8.5 194,577 4.7 30-year fixed-rate 921,602 50.3 2,477,780 59.6 Total Agency MBS$ 1,624,354 88.7 %$ 3,510,051 84.5 % Non-Agency MBS 206,933 11.3 643,610 15.5 Total MBS$ 1,831,287 100.0 %$ 4,153,661 100.0 %
The fair values indicated do not include interest earned but not yet paid. With respect to our hybrid adjustable-rate Agency MBS, the fair value of these securities appears on the line associated with the index based on which the security will eventually reset once the initial fixed interest rate period has expired. The fair value of our MBS is reported to us independently, either from third-party pricing services or from dealers who are major financial institutions and are considered to be market makers for these types of instruments. For more detail on the fair value of our MBS, see Note 9, "Fair Values of Financial Instruments," to the accompanying audited consolidated financial statements.
Agency MBS
The weighted average coupon and average amortized cost of our Agency MBS at
December 31, September 30, June 30, March 31, December 31,
2020 2020 2020 2020 2019
Agency MBS Portfolio:
Weighted Average Coupon:
Adjustable-rate Agency MBS 2.80 % 3.16 % 3.47 % 3.78 % 3.95 %
Hybrid adjustable-rate Agency MBS 2.73 2.74 2.76 2.78 2.78
15-year fixed-rate Agency MBS 3.50 3.50 3.50 3.50 3.50
20-year fixed-rate Agency MBS 3.56 3.56 3.56 3.56 3.56
30-year fixed-rate Agency MBS 3.61 4.00 4.00 3.79 3.56
Total Agency MBS 3.34 % 3.58 % 3.66 % 3.64 % 3.54 %
Average Amortized Cost:
Adjustable-rate Agency MBS 101.99 % 102.02% 102.16 % 101.96 % 102.04 % Hybrid adjustable-rate Agency MBS
101.30 101.51 101.84 102.09 102.11
15-year fixed-rate Agency MBS 101.50 101.51 101.72 101.75 101.81
20-year fixed-rate Agency MBS 103.28 103.35 103.76 103.83 103.96
30-year fixed-rate Agency MBS 102.81 102.23 102.51 102.54 102.33
Total Agency MBS 102.49 % 102.18 % 102.44 % 102.47 % 102.35 %
Current yield on Agency MBS
(weighted average coupon divided by
average amortized cost) 3.26 % 3.51 % 3.57 % 3.56 % 3.46 %
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At
AtDecember 31, 2020 , the current yield on our Agency MBS decreased to 3.26% from 3.46% atDecember 31, 2019 . This was due primarily to the decrease in the weighted average coupon. As noted in the trend above, the weighted average coupon has decreased by approximately 20 basis points fromDecember 31, 2019 . During the three months endedDecember 31, 2020 , the weighted average coupon for our total Agency MBS decreased by 24 basis points, due primarily to the decrease in the coupon on 30-year fixed-rate MBS. One of the factors that also impact the reported yield on our MBS portfolio is the actual prepayment rate on the underlying mortgages. We analyze our MBS and the extent to which prepayments impact the yield. When the rate of prepayments exceeds expectations, we amortize the premiums paid on mortgage assets over a shorter time period, resulting in a reduced yield to maturity on our mortgage assets. Conversely, if actual prepayments are less than the assumed constant prepayment rate, the premium would be amortized over a longer time period, resulting in a higher yield to maturity. Non-Agency MBS
Non-Agency MBS yields are based on our estimate of the timing and amount of future cash flows and our cost basis. Our cash flow estimates for these investments are based on our observations of current information and events and include assumptions related to interest rates, prepayment rates and the timing and amount of credit losses and other factors.
Non-Agency MBS include the following types of securities:
Legacy Non-Agency MBS - These are collateralized by loans that were generally
originated prior to the 2008 financial crisis and, therefore, trade at a deep
? discount due to having experienced high levels of defaults by the underlying
borrowers. While these underlying loans will generally experience losses, the
securities were generally acquired at deep discounts to face/par value, which
we believe serves to mitigate this potential exposure to credit risk; Non-performing - These are collateralized by loans that were generally
originated prior to 2008 and have been repackaged into newer securitization
pools. They may or may not be currently non-performing or delinquent but there
? is a higher expectation of loss on these loans. Resolution of these loans
typically occurs from loan modifications, short sales, and foreclosures. These
loan pools usually have a greater degree of overcollateralization to support
the securities; and
Credit Risk Transfer - These securities are designed to synthetically transfer
mortgage credit risk from Fannie Mae, Freddie Mac, and other issuers to private
? investors. As loans default, the securities may incur principal write-downs.
These are allocated to the tranches within a deal according to the cash flow
structure of the securities.
At
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The following table summarizes our Non-Agency MBS portfolio by type at
December 31, 2020 Weighted Average Fair Fair Market Portfolio Type Value Coupon Price (in thousands) Legacy Non-Agency MBS$ 101,149 5.21 %$ 62.57 Non-performing 9,860 6.35 98.60 Credit Risk Transfer 95,924 4.12 101.20 Total Non-Agency MBS$ 206,933 4.86 %$ 77.67 December 31, 2019 Weighted Average Fair Amortized Contractual Amortized Portfolio Type Value Cost Principal Cost Coupon Yield (in thousands) Legacy Non-Agency MBS$ 497,408 $ 477,786 $ 655,447 72.9 % 5.52 % 5.49 % Non-performing 11,052 10,938 11,000 99.4 5.50 6.05 Credit Risk Transfer 135,150 124,852 135,489 92.2 4.20 5.80 Total Non-Agency MBS$ 643,610 $ 613,576 $ 801,936 76.5 % 5.30 % 5.56 % Financing
The following information pertains to our repurchase agreement borrowings at
December 31, September 30, June 30, March 31, December 31, December 31,
2020 2020 2020 2020 2019 2018
(dollar amounts in thousands)
Total repurchase
agreements outstanding $ 1,470,620 $ 1,464,593 $ 1,697,181 $ 2,473,134 $ 3,657,873 $ 3,811,627
Average repurchase
agreements outstanding
during the quarter $ 1,400,044 $ 1,587,115 $ 1,919,736 $ 3,476,576 $ 3,322,672 $ 3,891,158
Average repurchase
agreements outstanding
during the year $ 2,106,400 $ N/A $
N/A $ N/A
$ 1,470,620 $ 1,621,431 $
1,847,853
$ 3,607,774 $ N/A $ N/A $ N/A$ 4,214,226 $ 4,357,754 Average interest rate on outstanding repurchase agreements 0.33 % 0.35 % 0.39 % 1.86 % 2.07 % 2.67 % Average days to maturity 30 days 26 days 23 days 29 days 28 days 32 days Average interest rate after adjusting for interest rate swaps 1.38 % 1.44 % 1.24 % 2.15 % 2.13 % 2.23 % Weighted average maturity after adjusting for interest rate swaps 1,047 days 1,091 days 983 days 859 days 978 days 1,217 days 84 Table of Contents
At
Agency MBS Non-Agency MBS Total MBS
Weighted Weighted Weighted
Average Average Average
Interest Interest Interest
Balance Rate Balance Rate Balance Rate
(in thousands) (in thousands) (in thousands)
Overnight $ - - % $ - - % $ - - %
Less than 30 days 710,000 0.21 48,936 2.01 758,936 0.32
30 days to 90 days 655,000 0.21 56,684 1.85 711,684 0.34
Over 90 days - - - - - -
Demand - - - - - -
$ 1,365,000 0.21 % $ 105,620 1.92 % $ 1,470,620 0.33 %
Weighted average maturity 29 days 49 days 30 days
Weighted average interest
rate after adjusting for
interest rate swaps 1.38 %
Weighted average maturity
after adjusting for interest
rate swaps 1,047 days
MBS pledged as collateral
under the repurchase
agreements and interest rate
swaps $ 1,437,565 $ 166,140 $ 1,603,705 At
Agency MBS Non-Agency MBS Total MBS
Weighted Weighted Weighted
Average Average Average
Interest Interest Interest
Balance Rate Balance Rate Balance Rate
(in thousands) (in thousands) (in thousands)
Overnight $ - - % $ - - % $ - - %
Less than 30 days 1,680,000 2.04 427,873 2.80 2,107,873 2.20
30 days to 90 days 1,550,000 1.89 - - 1,550,000 1.89
Over 90 days - - - - - -
Demand - - - - - -
$ 3,230,000 1.97 % $ 427,873 2.80 % $ 3,657,873 2.07 %
Weighted average maturity 30 days 11 days 28 days
Weighted average interest rate
after adjusting for interest
rate swaps 2.13 %
Weighted average maturity
after adjusting for interest
rate swaps 978 days
MBS pledged as collateral
under the repurchase
agreements and interest rate
swaps $ 3,419,375 $ 535,315 $ 3,954,690
The average interest rate on outstanding repurchase agreements, after adjusting
for interest rate swap transactions, decreased from 2.13% at December 31, 2019
to 1.38% at December 31, 2020 . The decrease was due primarily to a reduction in
the repurchase agreement weighted average interest rate, from 2.07% at December
31, 2019 to 0.33% at December 31, 2020 . The weighted average term to next rate
adjustment after adjusting for interest rate swap transactions increased from
978 days at December 31, 2019 to 1,047 days at December 31, 2020 . This was due
primarily to the increase in the weighted average maturity of the swap
agreements, as shown in the table under "Hedging Strategies."
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Residential Mortgage Loans Held-for-Securitization
AtDecember 31, 2020 , we owned approximately$109.3 million of residential mortgage loans which are being held until we have a sufficient quantity for securitization. Non-QM loans do not comply with the rules of theConsumer Financial Protection Bureau , or theCFPB , relating to Qualified Mortgages. Post-crisis, theCFPB issued rules on what is required for a loan to be qualified as a Qualified Mortgage, or QM. These rules have certain requirements, such as debt-to-income ratio, being fully-amortizing, and limits on loan fees. Non-QM loans do not comply with at least one of these requirements, but that does not necessarily imply that they carry more risk. Even though these loans may not have traditional documentation of income, such as a Form W-2 or paychecks, they generally have stated income and may have alternate documentation, such as bank statements, CPA letters, or tax returns. The loans we are acquiring have high FICO scores, as well as other strong borrower attributes, which are factors we analyze in making acquisitions. See Note 4, "Residential Mortgage Loans Held-for-Securitization," to our accompanying audited consolidated financial statements for more information regarding the residential mortgage loans held-for-securitization. These loans are financed by a warehouse line of credit. InJuly 2020 , we entered into a new agreement with the same lender to renew the line of credit in the amount of$300 million and a term of one year. AtDecember 31, 2020 , the amount outstanding on this line of credit (including warehouse transaction costs) was$90.2 million . The interest rate on the amounts advanced under this line of credit is at LIBOR + 3.00%, which was 3.50% atDecember 31, 2020 . Additionally, we paid a facility fee on this line of credit for the first six months of 2020, which was approximately$375 thousand . Under the terms of the new agreement, the facility fee was terminated, and we now pay a funding fee of 0.50% on new advances under this line of credit with a minimum fee of$150 thousand per quarter. During the year endedDecember 31, 2020 , this funding fee was$300 thousand . Various fees plus legal fees paid to secure this line of credit are being amortized over one year. See Note 9, "Fair Values of Financial Instruments," to the accompanying audited consolidated financial statements for more information regarding the fair value of these investments and their related financing.
Residential Mortgage Loans Held-for-Investment Through Consolidated Securitization Trusts
AtDecember 31, 2020 , we owned approximately$8.7 million in net interests on certain securitization trusts. The underlying mortgage loans held in the securitization trusts (classified as residential mortgage loans held-for-investment through consolidated securitization trusts) and the related financing (asset-backed securities issued by the securitization trusts) are consolidated on our consolidated balance sheets and are carried at cost. See Note 5, "Variable Interest Entities," to the accompanying audited consolidated financial statements for more information regarding consolidation of the securitization trusts. See Note 9, "Fair Values of Financial Instruments," to the accompanying audited consolidated financial statements for more information regarding the fair value of these investments and their related financing.
Residential Properties Portfolio
AtDecember 31, 2020 , we owned 82 single-family residential properties which are all located inSoutheastern Florida and are carried at a total cost, net of accumulated depreciation, of approximately$12.7 million . During the year endedDecember 31, 2020 , we sold three properties for a gain of approximately$201 thousand . AtDecember 31, 2019 , we owned 85 single-family residential properties which are all located inSoutheastern Florida and were carried at a total cost, net of accumulated depreciation, of approximately$13.5 million . During the year endedDecember 31, 2019 , we sold one of our residential properties for a gain of approximately$31 thousand . Hedging Strategies As we intend to hedge our exposure to rising rates on funds borrowed to finance our investments in securities, we periodically enter into derivative transactions, primarily in the form of interest rate swaps. We designate interest rate swaps as cash flow hedges for tax purposes. To the extent that we enter into hedging transactions to reduce our interest rate risk on indebtedness incurred to acquire or carry real estate assets, any income or gain from the disposition of hedging transactions should be qualifying income under the REIT rules for purposes of the 75% and 95% gross income 86
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test. To qualify for this exclusion, the hedging transaction must be clearly identified as such before the close of the day on which it was acquired, originated or entered into.
As part of our asset/liability management policy, we may enter into hedging agreements, such as interest rate swaps. These agreements are entered into to try to reduce interest rate risk and are designed to provide us with income and capital appreciation in the event of certain changes in interest rates. We review the need for hedging agreements on a regular basis consistent with our capital investment policy. Interest rate swaps are derivative instruments as defined by ASC 815-10. We do not anticipate entering into derivative transactions for speculative or trading purposes. In accordance with the swap agreements, we pay a fixed-rate of interest during the term of the interest rate swaps and we receive a payment that varies with the three-month LIBOR rate.
The following table pertains to all of our interest rate swaps at each
quarter-end for the years ended
Year Ended December 31, 2020 Year Ended December 31, 2019
Q4 Q3 Q2 Q1 Q4 Q3 Q2 Q1Aggregate notional amount of interest
$2.501 $2.191 $2.956 $3.356 rate swaps(1)$715 million $765 million $915 million $1.276 billion billion billion billion billion Average maturity of interest rate swaps 5.9 years 5.8 years 5.1 years 4.6 years 4.0 years 3.9 years 3.6 years 3.9 years Weighted average fixed-rate paid on interest rate swaps 2.38 % 2.34 % 2.23 % 2.10 % 2.02 % 2.08 % 2.09 % 2.13 %
(1) This table excludes
received in the transition from LIBOR to OIS rates.
Interest rate swaps are used to provide protection from increases in interest rates having a negative impact on the market value of our portfolio that could result in our lenders requiring additional collateral for our repurchase agreement borrowings. An increase or decrease in the notional value of these agreements or contracts usually provides an increase or decrease in protection to our portfolio's change in value due to interest rate changes. However, there are other methods that can also lessen our portfolio's change in value due to interest rate increases. Among them are acquiring mortgages that are inherently less sensitive to interest rate changes and borrowings using long-term agreements. AfterAugust 22, 2014 , none of our interest rate swaps were designated for hedge accounting. For both terminated interest rate swaps and the de-designated interest rate swaps, as long as there is the probability that the forecasted transactions that were being hedged (i.e., rollovers of our repurchase agreement borrowings) are still expected to occur, the amount of the gain or loss in AOCI remains in AOCI and is amortized over the remaining term of the interest rate swaps. AtDecember 31, 2020 , the net unrealized loss in AOCI on the interest rate swaps was approximately$4.3 million , as compared to an unrealized loss of approximately$7.6 million atDecember 31, 2019 . AtDecember 31, 2020 , we had approximately$700 million in notional amount of TBA Agency MBS, as compared to approximately$250 million in notional amount of TBA Agency MBS atDecember 31, 2019 . For more information on the amounts, policies, objectives and other qualitative data on our derivatives, see Notes 1, 9, and 15 to the accompanying consolidated financial statements.
Liquidity and Capital Resources
Agency MBS and Non-Agency MBS Portfolios
Our primary source of funds consists of repurchase agreements which totaled$1.47 billion atDecember 31, 2020 . As collateral for the repurchase agreements and interest rate swaps, we had pledged approximately$1.44 billion in Agency MBS and approximately$166 million in Non-Agency MBS. Our other significant sources of funds for the year endedDecember 31, 2020 consisted of payments of principal from our MBS portfolios in the amount of$825.8 million and proceeds from the sales of MBS of approximately$1.7 billion . 87
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For the year endedDecember 31, 2020 , there was a net increase in cash, cash equivalents, and restricted cash of approximately$32.2 million . This consisted of the following components:
Net cash provided by operating activities for the year ended
was approximately
amortization of premium and discounts on Agency MBS of approximately
million; accretion of discounts on Non-Agency MBS of approximately
million; depreciation on rental properties of
premium on residential loans of
available-for-sale Non-Agency MBS of approximately
loan losses of
loss on Non-Agency MBS held as trading investments of approximately
? million, partially offset by net settlements on interest rate swaps, net of
amortization, of approximately
derivative income on TBA Agency MBS, of approximately
gain on sales of available-for-sale Agency MBS of approximately
a net gain on Trading Agency MBS of approximately
of residential properties of
residential mortgage loans of approximately
operating activities also included a decrease in interest receivable of
approximately
approximately
approximately
Net cash provided by investing activities for the year ended
was approximately
principal payments on MBS; proceeds from sales of MBS of approximately
billion; payments on residential mortgage loans held-for-investment through
? consolidated securitization trusts of approximately
payments on loans held-for-securitization of
residential properties of approximately
purchases of MBS of approximately
mortgage loans held-for-securitization of approximately
improvements on residential properties of approximately
Net cash (used in) financing activities for the year ended
was approximately
agreements of approximately
agreements of approximately
? of approximately
approximately
partially offset by repayments on the warehouse line of credit of
million; dividends paid of
approximately
swaps of
AtDecember 31, 2020 , our leverage (excluding the ABS issued by securitization trusts) on total capital (including all preferred stock and junior subordinated notes) decreased from 6.2x atDecember 31, 2019 to 3.4x atDecember 31, 2020 . The decrease in our leverage was due primarily to a decrease in repurchase agreements and credit line outstanding, from$3.79 billion atDecember 31, 2019 to$1.56 billion atDecember 31, 2020 , partially offset by a decrease in our total capital (as described above), from$609.4 million atDecember 31, 2019 to$465.9 million atDecember 31, 2020 . In the future, we expect that our primary sources of funds will continue to consist of borrowed funds under repurchase agreement transactions and of monthly payments of principal and interest on our MBS portfolios. Our liquid assets generally consist of unpledged MBS, cash and cash equivalents. A large negative change in the market value of our MBS might reduce our liquidity, requiring us to sell assets with the likely result of realized losses upon sale.
During the year ended
At
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Convertible Preferred Stock, or Series B Preferred Stock, and Series C Cumulative Redeemable Preferred Stock, or Series C Preferred Stock.
OnAugust 10, 2016 , we entered into an At Market Issuance Sales Agreement, or the FBR Sales Agreement, withFBR Capital Markets & Co. , or FBR, pursuant to which we may offer and sell from time to time through FBR, as our agent, up to$196,615,000 maximum aggregate amount of our common stock, Series B Preferred Stock, and Series C Preferred Stock, in such amounts as we may specify by notice to FBR, in accordance with the terms and conditions set forth in the FBR Sales Agreement. During the year endedDecember 31, 2020 , we did not sell any shares of stock under the FBR Sales Agreement. AtDecember 31, 2020 , there was approximately$152.7 million available for sale and issuance under the FBR Sales Agreement. OnOctober 3, 2011 , we announced that our Board had authorized a share repurchase program which permitted us to acquire up to 2,000,000 shares of our common stock. The shares are expected to be acquired at prevailing prices through open market transactions. Our Board also authorized the Company to purchase an amount of our common stock up to the amount of common stock sold through our Dividend Reinvestment and Stock Purchase Plan. Subsequently, our Board authorized the Company to acquire an aggregate of an additional 45,000,000 shares (pursuant to six separate authorizations) betweenDecember 13, 2013 andJanuary 22, 2016 . InDecember 2019 , our Board decided to no longer include the amount of common stock sold through our Dividend Reinvestment and Stock Purchase Plan as an amount of stock available for repurchase. During the year endedDecember 31, 2020 , we did not repurchase any shares of our common stock under our share repurchase program.
Disclosure of Contractual Obligations
The following table represents the contractual obligations of the Company atDecember 31, 2020 : Less Than More Than Total 1 Year 1-3 Years 3-5 Years 5 Years (in thousands) Repurchase agreements(1)$ 1,470,620 $ 1,470,620 $ - $ - $ - Warehouse line of credit 90,185 90,185 - - - Junior subordinated notes(2) 37,380 - - - 37,380 Lease commitment 822 545 277 - - Total$ 1,599,007 $ 1,561,350 $ 277 $ -$ 37,380
(1) These represent amounts due by maturity.
These represent amounts due by contractual maturity. However, we do have the (2) option to redeem these as more fully described in Note 8, "Junior
Subordinated Notes," to the accompanying audited consolidated financial
statements.
Stockholders' Equity
We use available-for-sale treatment for most of our Agency MBS, which are
carried on our consolidated balance sheets at fair value rather than historical
cost. Based upon this treatment, our total equity base at December 31, 2020 was
$409.0 million . Common stockholders' equity was approximately $310.8 million , or
a book value of $3.13 per common share. Common stockholders' equity serves as
the basis for how book value per common share is calculated.
Under our available-for-sale accounting treatment used for most of our MBS,
unrealized fluctuations in fair values of assets are assessed to determine
whether they are other-than-temporary. To the extent we determine that these
unrealized fluctuations are not other-than-temporary, they do not impact GAAP
income or taxable income but rather are reflected on our consolidated balance
sheets by changing the carrying value of the assets and reflecting the change in
the "Stockholders' Equity" section under "Accumulated other comprehensive
income, unrealized gain (loss) on available-for-sale securities."
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As a result of this mark-to-market accounting treatment, our book value and book value per share are likely to fluctuate far more than if we used historical amortized cost accounting on all of our assets. As a result, comparisons with some companies that use historical cost accounting for all of their balance sheets may not be meaningful. Unrealized changes in the fair value of MBS have one significant and direct effect on our potential earnings and dividends: positive fair value changes will increase our equity base and allow us to increase our borrowing capacity, while negative changes will tend to reduce borrowing capacity under our capital investment policy. A very large negative change in the net market value of our MBS might reduce our liquidity, requiring us to sell assets with the likely result of realized losses upon sale. "Accumulated other comprehensive income, unrealized gain" on available-for-sale Agency MBS was approximately$58.8 million , or 4.06% of the amortized cost of our Agency MBS, atDecember 31, 2020 . This, along with "Accumulated other comprehensive loss, derivatives" of approximately$4.3 million , constitutes the total "Accumulated other comprehensive income consisting of unrealized gains and losses" of approximately$54.5 million .
Non-GAAP Financial Measures Related to Operating Results
In addition to the Company's operating results presented in accordance with GAAP, the following table includes the following non-GAAP financial measures: core earnings (including per common share), TBA dollar roll income, and paydown expense on Agency MBS. The table below reconciles the Company's net loss to common stockholders for the year endedDecember 31, 2020 to core earnings for the same period. Core earnings represents the net loss to common stockholders (which is the nearest comparable GAAP measure) adjusted for the items shown in the table below.
The Company's management believes that:
these non-GAAP financial measures are useful because they provide investors
? with greater transparency to the information that the Company uses in its
financial and operational decision-making process;
the inclusion of paydown expense on Agency MBS is more indicative of the
current earnings potential of the Company's investment portfolio, as it
reflects the actual principal paydowns which occurred during the period.
? Paydown expense on Agency MBS is not dependent on future assumptions on
prepayments or the cumulative effect from prior periods of any current changes
to those assumptions, as is the case with the GAAP measure, "Premium
amortization on Agency MBS";
? the adjustment for merger expenses, as these are not indicative of current
earnings potential; and
the presentation of these measures, when analyzed in conjunction with the
Company's GAAP operating results, allows investors to more effectively evaluate
? the Company's performance to that of its peers, particularly those that have
discontinued hedge accounting and those that have used similar portfolio and
derivative strategies.
These non-GAAP financial measures should not be used as a substitute for the Company's operating results for the year endedDecember 31, 2020 . An analysis of any non-GAAP financial measure should be used in conjunction with results presented in accordance with GAAP. 90 Table of Contents Core Earnings Year Ended December 31, 2020 Amount Per Share (in thousands) Net (loss) to common stockholders$ (112,882) $ (1.14) Adjustments to derive core earnings: Realized net (gain) on sales of Agency MBS (15,805) (0.16) Realized net loss on sales of Non-Agency MBS 55,390 0.56 Net (gain) on Agency MBS held as trading investments (3,629) (0.04) Net loss on Non-Agency MBS held as trading securities 15,537 0.16 Loss on interest rate swaps, net 106,334 1.07 (Gain) on derivatives-TBA Agency MBS, net (28,213) (0.28) (Gain) on sales of residential properties (201) - Net settlement on interest rate swaps after de-designation(1) (11,539)(0.12) Dollar roll income on TBA Agency MBS(2) 8,514 0.09 Premium amortization on MBS 24,577 0.25 Paydown expense(3)
(22,092) (0.22) Depreciation expense and non-recurring expenses on residential rental properties
891 0.01
Deferred payments on modifications/forbearance
agreements(4) 301 -
Expenses related to the Merger Agreement(5) 1,369 0.01
Core earnings $ 18,552 $ 0.19
Basic weighted average number of shares outstanding 99,048
Net settlement on interest rate swaps after de-designation include all (1) subsequent net payments made on interest rate swaps which were de-designated
as hedges in
net."
Dollar roll income on TBA Agency MBS is the income resulting from the price (2) discount typically obtained by extending the settlement of TBA Agency MBS to
a later date. This is a component of the "Loss on derivatives, net" that is
shown on the Company's consolidated financial statements.
Paydown expense on Agency MBS represents the proportional expense of Agency (3) MBS purchase premiums relative to the Agency MBS principal payments and
prepayments which occurred during the three-month period.
(4) The Trustee reported these amounts as losses in the securitization trusts,
but these payments are due upon liquidation or maturity.
(5) Expenses related to the Merger Agreement are added back, as they are not
indicative of earnings potential.
Critical Accounting Policies and Estimates
Management has the obligation to ensure that its policies and methodologies are in accordance with GAAP.
Management has reviewed and evaluated its critical accounting policies and believes them to be appropriate.
The preparation of financial statements in accordance with GAAP requires
management to make estimates and assumptions in certain circumstances that
affect amounts reported in the accompanying audited consolidated financial
statements. In preparing these audited consolidated financial statements,
management has made its best estimates and judgments on the basis of information
then readily available to it of certain amounts included in the audited
consolidated financial statements, giving due consideration to materiality.
Application of these accounting policies involves the exercise of judgment and
use of assumptions as to future uncertainties and, as a result, actual results
could differ materially and adversely from these estimates.
Our accounting policies are described in Note 1, "Organization and Significant
Accounting Policies," to the accompanying audited consolidated financial
statements. Management believes the more significant of our accounting policies
are the following:
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Income Recognition
The most significant source of our income is derived from our investments in
Agency MBS. We reflect income using the effective yield method which, through
amortization of premiums and accretion of discounts at an effective yield,
recognizes periodic income over the estimated life of the investment on a
constant yield basis, as adjusted for actual prepayment activity and estimated
prepayments. Management believes our revenue recognition policies are
appropriate to reflect the substance of the underlying transactions.
Interest income on our Agency MBS is accrued based on the actual coupon rate and
the outstanding principal amounts of the underlying mortgages. Premiums and
discounts are amortized or accreted into interest income over the expected lives
of the securities using the effective interest yield method, adjusted for the
effects of actual prepayments and estimated prepayments based on 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 incorrect, 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.
The vast majority of our Non-Agency MBS had previously been accounted for under
"
Acquired with Credit Deterioration" (ASC 310-30). Under CECL, debt securities previously accounted for as assets acquired with credit impairment (PCI) are treated as assets acquired with credit deterioration (PCD). Under ASC 326,
PCD assets that are also available-for-sale debt securities follow the available-for-sale debt security impairment model.
This compares the fair value of a security with its amortized cost. If the fair value of a security exceeds its amortized cost, there is no credit loss. If the fair value of a security is less than its amortized cost, then the security is impaired and further assessment needs to be done to determine if the decline in fair value is due to a credit loss or to other factors. The first step in this assessment process is for an entity to determine whether it had the intent to sell the security, or the ability to hold the security until the expected recovery of its amortized cost basis, or until maturity. If an entity did not have either the intent or the ability to hold the security until the expected recovery of the amortized cost basis, then the amortized cost basis is written down to the debt security's fair value through earnings. Upon the adoption of CECL atJanuary 1, 2020 , we reviewed those Non-Agency MBS that were in an unrealized loss position to determine if there was any credit loss. In our Annual Report on Form 10-K for the year ended December
31, 2019, we stated the following: "On the Non-Agency MBS that were in an
unrealized loss position, at
2019, we did not expect to sell these Non-Agency MBS at a price less than the amortized cost basis of our investments.
Because the decline in market value on these Non-Agency MBS is attributable to changes in interest rate and not the credit quality of the Non-Agency MBS in our portfolio, and because we did 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." OnJanuary 1, 2020 , when we adopted CECL, we reviewed our assessment of the Non-Agency MBS in an unrealized loss position atDecember 31, 2020 , and concluded that there was no credit loss on these securities. Our conclusion included a review of factors such as the ratings of these securities by rating agencies, the payment structure of these securities, whether the issuer has continued to make payments of principal and interest, and review of prepayment speeds, delinquency, and default rates. AtMarch 31, 2020 , we changed the designation of our Non-Agency MBS from available-for-sale securities to trading securities. The reason for this change in designation was due to the negative effects on the economy resulting from the COVID-19 coronavirus pandemic and the high volatility in the market for Non-Agency MBS. Starting in the third week inMarch 2020 , we began receiving requests from our repurchase agreement counterparties for margin calls, increases in the haircuts (the amount of coverage on the collateral securing the repurchase agreement financing), and higher interest rates. This all resulted from the perceived damage to the economy from the COVID-19 coronavirus pandemic. After theFederal Reserve stepped in and supported the Agency MBS market, the prices for Agency MBS stabilized. The Non-Agency MBS market was still volatile (with non-agency prices continuing to decline). We sold a substantial portion of our Non-Agency MBS in order to reduce leverage, maintain adequate liquidity, pay-down the balances on our repurchase agreement borrowings, and preserve over-collateralization for our repurchase agreement 92
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lenders. Due to the high volatility in the market for Non-Agency MBS, and the more restrictive terms by our repurchase agreement counterparties on these securities, we felt that we could no longer state that we had the intent and the ability to hold these securities until recovery of their amortized cost basis, or until maturity. Therefore, we changed the designation of these securities to trading securities as ofMarch 31, 2020 . Once an entity elects to classify a security as a trading security, it should be prepared to maintain that classification until the security is sold or matures. Transfer of securities from available-for-sale to trading securities means that the unrealized gains and losses that were in accumulated other comprehensive income are reported through earnings as unrealized gains or losses as of the date of the change in designation. Trading securities are subsequently measured at fair value, with the changes in fair value reported in income in the period the change occurs.
Interest income on the Non-Agency MBS that were purchased at a discount to par value, and were rated below AA at the time of purchase, was previously recognized based on the security's effective interest rate. The effective interest rate on these securities was based on the projected cash flows from each security, which was estimated based on our observation of current information and events, and include assumptions related to interest rates, prepayment rates, and the timing and amount of credit losses. On at least a quarterly basis, we reviewed and, if appropriate, made adjustments to our cash flow projections based on input and analysis received from external sources, internal models, and our judgment about interest rates, prepayment rates, the timing and amount of credit losses, and other factors. Changes in cash flows from those originally projected, or from those estimated at the last evaluation, resulted in a prospective change in the yield/interest income recognized on such securities. Actual maturities of these Non-Agency MBS were affected by the contractual lives of the associated mortgage collateral, periodic payments of principal, and prepayments of principal. Therefore, actual maturities of these securities are generally shorter than stated contractual maturities. Stated contractual maturities are generally greater than ten years. AtMarch 31, 2020 , we designated our Non-Agency MBS as trading securities. On a prospective basis, interest income is recognized based on the actual coupon rate and the outstanding principal amount. Securities transactions 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.
Valuation and Classification of
We carry our investment securities on our consolidated balance sheets at fair value. The fair values of our Agency
MBS are primarily based on third party bid price indications provided by independent third-party pricing services. If, in the opinion of management, one or more securities prices reported to us are not reliable or unavailable, management reviews the fair value based on characteristics of the security it receives from the issuer and available market information. The fair values reported reflect estimates and may not necessarily be indicative of the amounts we could realize in a current market exchange. We review various factors (i.e., expected cash flows, changes in interest rates, credit protection, etc.) in determining whether and to what extent an other-than-temporary impairment exists. The unrealized losses on our Agency MBS were primarily caused by fluctuations in interest rates due to market volatility resulting from the COVID-19 coronavirus pandemic and its negative effect on the economy, and not due to credit quality. AtDecember 31, 2020 , we did 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. The payments of principal and interest on these securities are guaranteed by Fannie Mae and Freddie Mac, which are under the conservatorship of theU.S. government. Accordingly, there is zero loss expectation on these securities, and no allowance for credit losses has been recorded. Assets classified as trading investments are reported at fair value with unrealized gains and losses included in our consolidated statements of operations. For more detail on the fair value of our Agency MBS, see Note 9, "Fair Values of Financial Instruments," to the accompanying audited consolidated financial statements. In determining the fair value of our Non-Agency MBS, management considers a number of observable market data points, including pricing from independent pricing services, prices obtained from well-known major financial brokers that make markets in these instruments, and timely trading activity in the marketplace. Management reviews these inputs in the valuation of our Non-Agency MBS. We understand that in order to determine the fair market value of a security, market participants not only consider the characteristics of the type of security and its underlying collateral but also take into consideration the historical performance data of the underlying collateral of that security including loan delinquency, loan losses and credit enhancement. In addition, we also collect and consider current market intelligence on 93
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all major markets, including benchmark security evaluations and bid list results from various sources. Upon the adoption of CECL onJanuary 1, 2020 , the unrealized losses on our investments in Non-Agency MBS were primarily caused by fluctuations in interest. We purchased the Non-Agency MBS primarily at a discount relative to their face value. At
Non-Agency MBS under the caption, "
Our MBS are valued using various market data points as described above, which management considers to be directly or indirectly observable parameters. Accordingly, our MBS are classified as Level 2 in the fair value hierarchy.
Residential Mortgage Loans Held-for-Securitization
Residential mortgage loans held-for-securitization are held at our wholly-owned subsidiary, Anworth Mortgage
Loans, Inc. , in connection with our intent to sponsor our own securitizations. Loans purchased with the intent to securitize are recorded on the trade date. Any fees associated with acquiring the loans held-for-securitization, as well as any premium paid to acquire the loans, are deferred. These are included in the loan balance and amortized using the effective interest yield method. Upon securitization, the costs of securitization such as underwriting fees, legal fees, and accounting fees are added to the loan balances and amortized using the effective interest yield method. Interest income is recorded as revenue when earned and deemed collectible or until a loan becomes more than 90 days' past due, at which point the loan is placed on non-accrual status. When a non-accrual loan has been cured, meaning when all delinquent principal and interest have been remitted by the borrower, the loan is placed back on accrual status. Alternatively, nonaccrual loans may be placed back on accrual status after the loan is considered re-performing, generally when the loan has been current for 6 months. The estimates for the allowance for loan losses require consideration of various observable inputs including, but not limited to, historical loss experience, delinquency status, borrower credit scores, geographic concentrations and loan-to-value ratios, and are adjusted for current economic conditions as deemed necessary by management. Many of these factors are subjective and cannot be reduced to a mathematical formula. In addition, since we have not incurred any direct losses on our portfolio, we review national historical credit performance information from external sources to assist in our analysis. Changes in our estimates can significantly impact the allowance for loan losses and provision expense. The allowance reflects management's best estimate of the credit losses inherent in the loan portfolio at the balance sheet date. It is also possible that we will experience credit losses that are different from our current estimates or that the time of those losses may differ from our estimates. The residential mortgage loans held-for-securitization are financed by a warehouse line of credit. Fees incurred in securing the credit line are deducted from the amount outstanding under the line and are amortized to interest expense over the term of the credit line. Under this borrowing facility, we make various representations and warranties and the loans must also meet certain eligibility criteria. We may be required to remove a loan from a warehouse line of credit. We do not maintain a loan repurchase reserve, as any risk of loss due to loan repurchase would normally be covered by recourse to the companies from which we acquired the loans.
Residential Mortgage Loans Held-for-Investment Through Consolidated Securitization Trusts
Residential mortgage loans held-for-investment through consolidated
securitization trusts are carried at unpaid principal balance net of any
allowance for loan losses. These estimates for the allowance for loan losses
require consideration of various observable inputs including, but not limited
to, historical loss experience, delinquency status, borrower credit scores,
geographic concentrations and loan-to-value ratios, and are adjusted for current
economic conditions as deemed necessary by management. Many of these factors are
subjective and cannot be reduced to a mathematical formula. In addition, we
review national historical credit performance information from external sources
to assist in our analysis. Changes in our estimates can significantly impact the
allowance for loan losses and provision expense. The allowance reflects
management's best estimate of the credit losses inherent in the loan portfolio
at the balance sheet date. It is also possible that we will experience credit
losses that are different from our current estimates or that the time of those
losses may differ from our estimates.
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Accounting for Derivatives and Hedging Activities
In accordance with ASC 815, we recognize all derivatives as either assets or liabilities and we measure these investments at fair value. Changes in fair value for derivatives not designated as hedges are recorded in our consolidated statements of operations as "(Loss) on derivatives, net." 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.
Prior toMarch 18, 2014 andAugust 22, 2014 (the dates when we de-designated our interest rate swaps from hedge accounting), on the date we entered into a derivative contract, we designated the derivative as a hedge of the variability of cash flows that were 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 were highly effective and that were designated and qualified as a cash flow hedge, to the extent that the hedge was effective, were recorded in "other comprehensive income" and reclassified to income when the forecasted transaction affected income (e.g., when periodic settlement interest payments were due on repurchase agreements). The swap agreements were carried on our consolidated balance sheets at their fair value based on values obtained from large financial institutions who were market makers for these types of instruments. Hedge ineffectiveness, if any, was recorded in current-period income. We formally assessed, both at the hedge's inception and on an ongoing basis, whether the derivatives that were used in hedging transactions were highly effective in offsetting changes in the cash flows of hedged items and whether those derivatives were expected to remain highly effective in future periods. If it was determined that a derivative was not (or ceased to be) highly effective as a hedge, we discontinued hedge accounting. When we discontinued hedge accounting, the gain or loss on the derivative remained in "Accumulated other comprehensive income (loss)" 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 carry the derivative at its fair value on our consolidated balance sheets, recognizing changes in the fair value in current-period income. At
For purposes of the cash flow statement, cash flows from derivative instruments were classified with the cash flows from the hedged item. Cash flows from derivatives that are not hedges are classified according to the underlying nature or purpose of the derivative. For more detail on our derivative instruments, see Notes 1, 9, and 15 to our accompanying audited consolidated financial statements. Income Taxes Our financial results do not reflect provisions for current or deferred income taxes. Management believes that we have and intend to continue to operate in a manner that will allow us to be taxed as a REIT and, as a result, management does not expect to pay substantial, if any, corporate level taxes. Many of these requirements, however, are highly technical and complex. If we were to fail to meet these requirements, we would be subject to federal income tax.
Recent and Recently Adopted Accounting Pronouncements
A description of recent and recently adopted accounting pronouncements, the date adoption is required, and the impact on our consolidated financial statements is contained in Note 1, "Organization and Significant Accounting
Policies," to the accompanying audited consolidated financial statements.
Government Activity
Developments Concerning Fannie Mae and Freddie Mac
Payments on the Agency MBS in which we invest are guaranteed by Fannie Mae and Freddie Mac, which are stockholder corporations chartered byCongress with a public mission to provide liquidity, stability, and affordability to 95
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theU.S. housing market. Since 2008, Fannie Mae and Freddie Mac have been regulated by theFederal Housing Finance Agency , or the FHFA, theU.S. Department of Housing and Urban Development , theSEC , and theU.S. Department of the Treasury , or theU.S. Treasury , and are currently operating under the conservatorship of the FHFA. TheU.S. Treasury has agreed to support the continuing operations of Fannie Mae and Freddie Mac with any necessary capital contributions while in conservatorship. However, theU.S. government does not guarantee the securities or other obligations of Fannie Mae or Freddie Mac. Over the past several years, separate legislation has been introduced in both houses of theU.S. Congress to wind-down or reform both of these agencies. None of these bills have garnered enough support for a vote. It is currently unknown if, and when, any of these bills would become law and, if they did, what impact that would have on housing finance in general and what the impact would be on the existing securities guaranteed by Fannie Mae and Freddie Mac, as well as the impact on the pricing, supply, liquidity, and value of the MBS in which we invest.
Actions of the
The outbreak of the COVID-19 coronavirus pandemic has created unprecedented economic disruption. In addition, measures to prevent the spread of the COVID-19 coronavirus have caused, and may continue to cause, substantial business closures, travel restrictions, and self-isolation. Most state and local governments, in coordination with the Federal government, have ordered people to stay home and mandated non-essential businesses to close. Millions of people have been laid off and have filed for unemployment benefits, potentially affecting their ability to make payments on their mortgage, rent, or other debt. InMarch 2020 , theFederal Reserve took the following actions:
On
? lowered the fed funds rate to a target range of 0% to 0.25%. At its January
2021 meeting, the
The
?
that it would also reinvest the principal from its holding into further acquisitions of Agency MBS;
The
? operations by trillions of dollars, which was designed to stabilize these
markets;
The
Bank of Japan, the
announced a coordinated action to enhance liquidity via standing
? liquidity swap line agreements. The new lower rate will be the
Index Swap, or the OIS, rate plus 25 basis points. This announcement is
designed to reduce stress in global funding markets and to mitigate the stress
on the supply of funds to households and businesses, both domestically and
globally; TheFederal Reserve enhanced the ability of banks and other financial
institutions to access the Fed discount window, which supports the liquidity
? and stability of the banking system and the effective implementation of the
monetary supply.
0.25%;
The
the flow of credit to consumers, such as through auto loans and mortgages, and
? to provide liquidity for the operational needs of a wide range of businesses.
The
facility; andCongress passed the$2.2 trillion CARES Act to provide, through theU.S.
? this Act, lenders were encouraged to work with consumers struggling to make
their loan payments by offering forbearance of several months to any persons
who requested such assistance.
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We cannot predict the economic impact of COVID-19 and the ultimate effect it
will have on our business, nor can we predict whether the actions of the Federal
Reserve , the U.S. government, state and local governments, and foreign
governments will be successful, or whether future actions may be necessary.
Although some of the actions have provided economic relief to individuals and
businesses and may have stabilized, for the present time, certain lending
markets, we cannot predict how the actions already taken, or those that may be
taken, could impact our business, results of operations, and financial
condition. These actions, while intending to help the economy currently, could
have longer-term and broader implications, and could negatively affect the
availability of financing and the quantity and quality of available mortgage
products, and could cause changes in interest rates and the yield curve, any and
each of which could materially and adversely affect our business, results of
operations, and financial condition, as well as those of the entire mortgage
sector in general, and the broader U.S. and global economies.
Other Recent Activity
During the past several years, there have been continuing liquidity and credit concerns surrounding the mortgage markets and the general global economy. While theU.S. government and other foreign governments have taken various actions to address these concerns, there are also concerns about the ability of theU.S. government to reduce its budget deficit as well as possible future rating downgrades ofU.S. sovereign debt and government- sponsored agency debt. InDecember 2020 ,Congress passed a$2.3 trillion COVID-19 relief and government funding bill, which was signed byPresident Trump . A failure by theU.S. government to reach agreement on future budgets and debt ceilings, reduce its budget deficit, or a future downgrade ofU.S. sovereign debt and government-sponsored agencies' debt, could have a material adverse effect on theU.S. economy and the global economy. These events could have a material adverse effect on our borrowing costs, the availability of financing, and the liquidity and valuation of securities in general, and also on the securities in our portfolio. Over the past several years,U.S. and British banking authorities assessed fines on several major financial institutions for LIBOR manipulation. LIBOR is an unregulated rate based on estimates that lenders submitted to theBritish Bankers' Association , a trade group that compiled the information and published daily the LIBOR rate. OnFebruary 1, 2014 , the administration of LIBOR was transferred from theBritish Bankers' Association to theIntercontinental Exchange Benchmark Administration , or the IBA, following authorization by theFinancial Conduct Authority (theUnited Kingdom regulators). InJuly 2017 , theFinancial Conduct Authority announced that by the end of 2021, LIBOR would be replaced with a more reliable alternative. At this time, we do not know what changes will be made by theFinancial Conduct Authority . Inthe United States , the Alternative Refinance Rates Committee selected the Secured Overnight Financing Rate, or SOFR, an overnight securedU.S. Treasury repurchase agreement rate, as the new rate, and adopted a proposed transition plan for the change fromU.S. LIBOR to SOFR. The calculation of LIBOR under the IBA is the average of the interest rates that some of the world's leading banks charge each other for short-term loans. It is unclear at this time as to how the change to another alternative to LIBOR will affect the interest rates that repurchase agreement counterparties and lenders charge on borrowings in general and how they could specifically affect our borrowing agreements. OnJune 23, 2016 , the citizens of theUnited Kingdom , or theUK , voted to leave, or Brexit, theEuropean Union , or the EU. TheUK had two years from its formal notification of withdrawal (given onMarch 29, 2017 ) from the EU to negotiate a new treaty to replace the terms of its EU membership. TheUK was due to leave the EU inMarch 2019 and EU leaders had adopted formal guidelines about the future relationship between the EU and theUK . It is unknown at this time what effects the Brexit vote and theUK /EU relationship will have on interest rates, on stock markets (over the longer term), and the effect on theU.S. economy and the global economy. TheUK formerly left the EU onJanuary 31, 2020 . OnJanuary 16, 2020 , theU.S. Congress passed the USMCA trade agreement, which became effective after the legislatures ofthe United States ,Mexico , andCanada all approved it. It is believed that the USMCA trade agreement will be beneficial toU.S. workers, manufacturers, and farmers in particular, as well as improving trade relations among all three nations. 97 Table of Contents Subsequent Events
Special Meeting of Stockholders
We have setMarch 17, 2021 as the date for the special meeting of our stockholders to, among other things, consider and vote on a proposal to approve the Merger. Stockholders of record as of the close of business onFebruary 4, 2021 are entitled to vote at the special meeting. The Merger is subject to certain customary closing conditions and the receipt of approvals of the respective stockholders of the Company and Ready Capital.
Litigation Relating to the Merger
Seven putative class action lawsuits have been filed by purported stockholders of the Company relating to the Merger.
OnJanuary 7, 2021 ,Shiva Stein , a purported shareholder of the Company, filed a lawsuit in theUnited States District Court for the Central District of California , styledShiva Stein v.Anworth Mortgage Asset Corporation , et al., No. 2:21-cv-00122 (referred to as the "Stein Action"). The Stein Action was filed against the Company and our board of directors in connection with the Merger Agreement. The complaint in the Stein Action asserts that the Form S-4 Registration Statement initially filed onJanuary 4, 2021 in connection with the Merger (referred to as the "Initial S-4 Filing") contained materially incomplete and misleading information concerning financial projections and financial analyses in violation of Sections 14(a) and 20(a) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and Rule 14a-9 promulgated thereunder. The Stein Action seeks, among other things, an injunction enjoining the Merger from closing, rescission of the Merger or rescissory damages if the Merger is consummated, compensatory damages against the defendants, and an award of attorneys' and experts' fees. OnJanuary 12, 2021 ,Giuseppe Alescio , a purported shareholder of the Company, filed a lawsuit in theUnited States District Court for the Southern District of New York , styledGiuseppe Alescio v.Anworth Mortgage Asset Corporation , et al., No. 1:21-cv-00258 (referred to as the "Alescio Action"). The Alescio Action was filed against the Company, our board of directors, Ready Capital, and Merger Sub. The complaint in the Alescio Action asserts that the Initial S-4 Filing omitted material information concerning financial forecasts and financial analyses in violation of Sections 14(a) and 20(a) of the Exchange Act and Rule 14a-9 promulgated thereunder. The Alescio Action seeks, among other things, an injunction enjoining the Merger from closing, rescission of the Merger or rescissory damages if the Merger is consummated, the filing of an amendment to the registration statement that does not contain any untrue statements of material fact and that states all material facts required in it or necessary to make the statements contained therein not misleading, and an award of attorneys' and experts' fees. OnJanuary 19, 2021 ,Joseph Sheridan , a purported shareholder of the Company, filed a lawsuit in theUnited States District Court for the Southern District of New York , styledJoseph Sheridan v.Anworth Mortgage Asset Corporation , et al., No. 1:21-cv-00465 (referred to as the "Sheridan Action"). The Sheridan Action was filed against the Company, our board of directors, Ready Capital, and Merger Sub. The complaint in the Sheridan Action asserts that the Initial S-4 Filing contained materially incomplete and misleading information concerning the sales process, financial projections, and financial analyses in violation of Sections 14(a) and 20(a) of the Exchange Act and Rule 14a-9 promulgated thereunder. The Sheridan Action seeks, among other things, an injunction enjoining the Merger from closing, rescission of the Merger or rescissory damages if the Merger is consummated, and an award of attorneys' and experts' fees. OnJanuary 20, 2021 ,Ken Bishop , a purported shareholder of the Company, filed a lawsuit in theUnited States District Court for the Eastern District of New York , styledKen Bishop v.Anworth Mortgage Asset Corporation , et al., No. 1:21-cv-00331 (referred to as the "Bishop Action"). The Bishop Action was filed against the Company and our board of directors. The complaint in the Bishop Action asserts that the Initial S-4 Filing contained materially false and misleading statements and omissions concerning financial projections, financial analyses, the sales process and potential conflicts of interest involving the Company's financial advisor,Credit Suisse Securities (USA) LLC ("Credit Suisse"), in violation of Sections 14(a) and 20(a) of the Exchange Act and Rule 14a-9 promulgated thereunder. The Bishop Action 98
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seeks, among other things, an injunction enjoining the Merger from closing, rescission of the Merger or rescissory damages if the Merger is consummated, and an award of attorneys' and experts' fees.
OnJanuary 21, 2021 ,Samuel Carlisle , a purported shareholder of the Company, filed a lawsuit in theUnited States District Court for the Central District of California , styledSamuel Carlisle v.Anworth Mortgage Asset Corporation , et al., No. 2:21-cv-00566 (referred to as the "Carlisle Action"). The Carlisle Action was filed against the Company and our board of directors. The complaint in the Carlisle Action asserts that the Initial S-4 Filing omitted or misrepresented material information concerning financial projections, potential conflicts of interest involving Credit Suisse, and the background of the Merger, in violation of Sections 14(a) and 20(a) of the Exchange Act and Rule 14a-9 promulgated thereunder. The Carlisle Action seeks, among other things, an injunction enjoining the Merger from closing, rescission of the Merger or rescissory damages if the Merger is consummated, and an award of attorneys'
and experts' fees. OnJanuary 26, 2021 ,Reginald Padilla , a purported shareholder of the Company, filed a lawsuit in theUnited States District Court for the Central District of California , styledReginald Padilla v.Anworth Mortgage Asset Corporation , et al., No. 2:21-cv-00702 (referred to as the "Padilla Action"). The Padilla Action was filed against the Company and our board of directors. The complaint in the Padilla Action asserts that the Initial S-4 Filing was materially deficient and misleading in regards to financial projections, potential conflicts of interest involving Credit Suisse, and the background of the Merger, in violation of Sections 14(a) and 20(a) of the Exchange Act and Rule 14a-9 promulgated thereunder. The Padilla Action seeks, among other things, an injunction enjoining the Merger from closing, rescission of the Merger or rescissory damages if the Merger is consummated, the filing of an amendment to the registration statement that does not contain any untrue statements of material fact and that states all material facts required in it or necessary to make the statements contained therein not misleading, and an award of attorneys' and experts' fees. OnFebruary 1, 2021 ,Diane Antasek , as Trustee forThe Diane R. Antasek Trust Agreement,April 8, 1997 , andRonald Antasek , as Trustee for the Ronald J. Antasek Sr. Trust Agreement,April 8, 1997 , purported shareholders of the Company, filed a lawsuit in theUnited States District Court for the Central District of California , styled Antasek et al. v.Anworth Mortgage Asset Corporation , et al., No. 2:21-cv-00917 (referred to as the "Antasek Action," and collectively with the Stein Action, Alescio Action,Sheridan Action ,Bishop Action ,Carlisle Action , and the Padilla Action, the "Actions"). The Antasek Action was filed against the Company and our board of directors. The complaint in the Antasek Action asserts that the Initial S-4 Filing was materially deficient in regards to potential conflicts of interest involving Credit Suisse, financial projections and financial valuation analyses in violation of Sections 14(a) and 20(a) of the Exchange Act and Rule 14a-9 promulgated thereunder, and that our board of directors violated their fiduciary duty as a result of an unfair process for an unfair price. The Antasek Action seeks, among other things, an injunction enjoining the Merger from closing, rescission of the Merger or rescissory damages if the Merger is consummated, an order directing our board of directors to exercise their fiduciary duties to commence a sale process that is reasonably designed to secure the best possible consideration for the Company and obtain a transaction which is in the best interests of the Company and its stockholders, an award of damages sustained, and an award of attorneys' and experts' fees.
We intend to vigorously defend the Company and our board of directors against the Action.
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