As used in this Quarterly Report on Form 10-Q, "Company," "we," "us," "our," and
"Anworth" refer to
You should read the following discussion and analysis in conjunction with the unaudited consolidated financial statements and related notes thereto contained in Item 1 of Part I of this Quarterly Report on Form 10-Q. The information contained in this Quarterly Report on Form 10-Q is not a complete description of our business or the risks associated with an investment in our stock. We urge you to carefully review and consider the various disclosures made by us in this Quarterly Report on Form 10-Q and in our other reports filed with theSEC , including our Annual Report on Form 10-K for the fiscal year endedDecember 31, 2019 .
Forward-Looking Statements
This Quarterly Report on Form 10-Q contains, or incorporates by reference, not only historical information but also forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act, that are subject to the safe harbors created by such sections. Forward-looking statements involve numerous risks and uncertainties. Our actual results may differ from our beliefs, expectations, estimates, and projections and, consequently, 40
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you should not rely on these forward-looking statements as predictions of future events. Forward-looking statements are not historical in nature and can be identified by words such as "anticipate," "estimate," "will," "should," "expect," "believe," "assume," "intend," "seek," "plan," "target," "goals," "future," "likely," "may," and similar expressions or their negative forms, or by reference to strategy, plans, or intentions. These forward-looking statements are subject to risks and uncertainties including, among other things, those described in our Annual Report on Form 10-K under the caption "Risk Factors." Other risks, uncertainties, and factors that could cause our actual results to differ materially and adversely from those projected are described below and may be described from time to time in reports we file with theSEC , including our Current Reports on Form 8-K. Forward -looking statements speak only as of the date they are made and we undertake no obligation to update or revise any such forward-looking statements, whether as a result of new information, future events, or otherwise. Statements regarding the following subjects, among others, that may affect our actual results may be forward-looking: risks associated with investing in mortgage-backed securities, or MBS, and related assets; changes in interest rates and the market value of our target investments; changes in prepayment rates of the mortgage loans securing our mortgage-related investments; changes in the yield curve; the credit performance of our Non-Agency MBS and residential mortgage loans; the concentration of the credit risks we are exposed to; the state of the credit markets and other general economic conditions, particularly as they affect the price of earnings assets and the credit status of borrowers; the availability of our target investments for purchase at attractive prices; the availability of financing for our target investments, including the availability of repurchase agreement financing; declines in home prices; increases in payment delinquencies and defaults on the mortgages comprising and underlying our target investments; changes in liquidity in the market for mortgage-related assets, the re-pricing of credit risk in the capital markets, inaccurate ratings of securities by rating agencies, rating agency downgrades of securities, and changes in the supply of MBS available-for-sale; changes in the values of the MBS and other mortgage-related investments in our portfolio and the impact of adjustments reflecting those changes on our consolidated financial statements; our ability to generate the amount of cash flow we expect from our target investments; changes in our investment and financial strategies and the new risks that those changes may expose us to; changes in the competitive environment within our industry; changes that may affect our Manager's ability to attract and retain personnel; our ability to successfully diversify our business into new investments and manage the new risks they may expose us to; our ability to manage various operational and regulatory risks associated with our business; our ability to establish, adjust and maintain appropriate hedges for the risks to our portfolio; risks associated with investing in mortgage-related assets; the scope and duration of the COVID-19 coronavirus pandemic, including actions taken by governmental authorities to contain the spread of the virus, and the impact on our business and the general economy; legislative and regulatory actions affecting the mortgage and derivatives industries or our business; implementation of or changes in government regulations or programs affecting our business; changes due to the consequences of actions by theU.S. government and other foreign governments to address various financial and economic issues and our ability to respond to and comply with such actions and changes; our ability to maintain our qualification as a REIT for federal income tax purposes; our ability to maintain our exemption from registration under the Investment Company Act of 1940, as amended; limitations imposed on our business due to our REIT status as exempt from registration under the Investment Company Act of 1940, as amended; and our ability to manage our growth. All forward-looking statements speak only as of the date they are made. New risks and uncertainties arise over time and it is not possible to predict those events or how they may affect us. Except as required by law, we do not intend to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
Our Business
We were incorporated inMaryland onOctober 20, 1997 and we 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
Mortgage Corporation , or Freddie Mac; 41 Table of Contents
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 52) 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.
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 these mortgage assets. We have elected to be taxed as a real estate investment trust, or REIT, under the Internal Revenue Code of 1986, as amended, or the Code. As long as we retain our REIT status, we generally will not be subject to federal or state income taxes to the extent that we distribute our taxable net income to our stockholders, and we routinely distribute to our stockholders substantially all of the taxable net income generated from our operations. In order to qualify as a REIT, we must meet various ongoing requirements under the tax law, including requirements relating to the composition of our assets, the nature of our gross income, minimum distribution requirements and requirements relating to the ownership of our stock. We believe that we currently meet all of these requirements and that we will continue to qualify as a REIT. We view our strategy as being a hybrid investment model because our target investments are influenced primarily by either interest rate risk, credit risk, or a combination of both risks. Our Agency MBS are primarily sensitive to changes in interest rates and related prepayment rates. Our Non-Agency MBS and residential mortgage loans held-for-investment are sensitive to both mortgage credit risk and interest rate risk.
Our Agency MBS assets are also categorized as:
(1) Agency MBS whose interest rate presently adjust or will adjust; and
(2) Agency MBS whose interest rate is fixed during the life of the mortgage.
We believe that our hybrid investment model allows us to allocate assets across various sectors within the residential mortgage market with a focus on security selection and a relative value investment approach. Our asset allocation process takes into account the opportunities in the marketplace, cost of financing, cost of hedging interest rates, prepayment risks, credit risks, and other portfolio risks. As a result, our asset allocation reflects our management's opportunistic approach to investing in the residential mortgage marketplace.
Our Manager
We are externally managed and advised byAnworth Management LLC , or our Manager. Effective as ofDecember 31, 2011 , we entered into a management agreement, or the Management Agreement, with our Manager, which effected the externalization of our management function, or the Externalization. Since the effective date of the Externalization, our day-to-day operations are being conducted by our Manager through the authority delegated to it under the Management Agreement and pursuant to the policies established by our board of directors, or our Board. Our Manager is supervised by our Board and is responsible for administering our day-to-day operations. In addition, our Manager is responsible for (i) the selection, purchase, and sale of our investment portfolio; (ii) our financing and hedging activities; and (iii) providing us with portfolio management, administrative, and other services relating to our assets and operations as
may be appropriate. 42 Table of Contents Our Manager will also perform such other services and activities as described in the Management Agreement relating to our assets and operations as may be appropriate. In exchange for these services, our 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). The COVID-19 coronavirus pandemic has generally not affected our Manager's ability to manage our day-to-day operations and provide other services to us under the Management Agreement, as the Manager's key employees and personnel who manage our operations are able to effectively work from home and provide such services to us under applicable local and state shelter-in-place orders.
Our Investment Portfolio
The table below provides the asset allocation among our Agency MBS, Non-Agency MBS, and residential mortgage loans atSeptember 30, 2020 andDecember 31, 2019 : September 30, December 31, 2020 2019 Dollar Amount Percentage Dollar Amount Percentage (in thousands) (in thousands) Agency MBS$ 1,609,761 71.56 %$ 3,510,051 73.66 % Non-Agency MBS 198,586 8.83 643,610 13.51 Total MBS$ 1,808,347 80.39 %$ 4,153,661 87.17 % Residential mortgage loans held-for-securitization 123,247 5.48 152,922 3.21 Residential mortgage loans held-for-investment through consolidated securitization trusts 317,887 14.13 458,348 9.62 Total mortgage-related assets$ 2,249,481 100.00 %
$ 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 projected annualized yields but also by taking into account the uncertainty of faster or slower prepayments, extension risk, and credit-related events.
At
September 30, December 31, 2020 2019 (dollar amounts in thousands) Fair value of MBS$ 1,808,347 $ 4,153,661
Adjustable-rate Agency MBS less than 1-year reset 20 % 12 % Adjustable-rate Agency MBS 1-3 year reset 8 2 Adjustable-rate Agency MBS 3-5 year reset - 3 Adjustable-rate Agency MBS greater than 5-year reset 4 2 Total Adjustable-Rate Agency MBS 32
% 19 % 15-year fixed-rate Agency MBS 2 1 20-year fixed-rate Agency MBS 9 5 30-year fixed-rate Agency MBS 46 60 Non-Agency MBS 11 15 Total MBS 100 % 100 % Results of Operations
Three Months Ended
For the three months ended
43
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shares outstanding, respectively. This included net income of$21.9 million and the payment of preferred dividends of$2.3 million . For the three months endedSeptember 30, 2019 , our net loss to common stockholders was$(19.8) million , or$(0.20) per basic and diluted share, based on a weighted average of 98.7 million basic and diluted shares outstanding. This included a net loss of$(17.5) million and the payment of preferred dividends of$2.3 million . Net interest income after provision for credit losses for the three months endedSeptember 30, 2020 totaled$6.5 million , or 30.1% of gross income, as compared to$9.0 million , or 20.8% of gross income, for the three months endedSeptember 30, 2019 . Net interest income, after provision for credit losses, is comprised of the interest income earned on our mortgage investments (net of premium amortization expense) and other income, less interest expense from borrowings and less provision for credit losses. Interest and other income (net of premium amortization expense) for the three months endedSeptember 30, 2020 was$12.7 million , as compared to$36.9 million for the three months endedSeptember 30, 2019 , a decrease of 65.7%, due primarily to a decrease in income on securitized residential mortgage loans of approximately$1.6 million (due primarily to paydowns on this portfolio), a decrease in the weighted average portfolio outstanding, from$3.60 billion during the three months endedSeptember 30, 2019 to approximately$1.80 billion during the three months endedSeptember 30, 2020 , and a decrease in the weighted average coupons on MBS, from 4.00% during the three months endedSeptember 30, 2019 to 3.72% during the three months endedSeptember 30, 2020 , a decrease in other interest income of approximately$669 thousand (due to less income earned on restricted cash balances), and an increase in premium amortization expense of$2.7 million , partially offset by an increase in interest income on loans held-for-securitization of approximately$43 thousand . Interest expense for the three months endedSeptember 30, 2020 was approximately$6.1 million , as compared to approximately$27.9 million for the three months endedSeptember 30, 2019 , a decrease of approximately 78.1%, which resulted primarily from a decrease in the average repurchase agreement borrowings outstanding, from$3.23 billion atSeptember 30, 2019 to$1.59 billion atSeptember 30, 2020 , a decrease in the weighted average interest rates, from 2.62% atSeptember 30, 2019 to 0.37% atSeptember 30, 2020 , and a decrease in interest expense on ABS of approximately$1.6 million (due primarily to paydowns), a decrease in interest expense on the warehouse line of credit of approximately$342 thousand , and a decrease in interest expense on junior subordinated notes of approximately$188 thousand . The results of our operations are affected by a number of factors, many of which are beyond our control, including the negative effects on the economy and on our business resulting from the COVID-19 coronavirus pandemic, and primarily depend on, among other things, the level of our net interest income, the market value of our MBS, the supply of, and demand for, mortgage-related assets in the marketplace, and the terms and availability of 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, or CPR, 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 MBS purchase premiums; and (v) the value of our interest rate swaps 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 MBS and loan 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 swaps 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 three months endedSeptember 30, 2020 , premium amortization expense increased$2.7 million , or 42.8%, to approximately$9.1 million , from approximately$6.4 million during the three months endedSeptember 30, 2019 , due primarily to increased future prepayment assumptions. 44
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The CPR assumptions used in our projection of long-term CPR percentages are based primarily on historical prepayment rates on our MBS assets as well as assumptions about future mortgage rates and their expected impact on future prepayments.
The following table shows the quarterly prepayment of principal of our MBS during 2020 and 2019: 2020 2019 Third Second First Third Second First Portfolio Quarter Quarter Quarter Quarter Quarter Quarter MBS 39 % 33 % 18 % 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 three months endedSeptember 30, 2020 , we did not sell any Agency MBS. During the three months endedSeptember 30, 2019 , we sold approximately$59.6 million of Agency MBS and realized a net gain of approximately$0.4 million . During the three months endedSeptember 30, 2020 , we did not have any Agency MBS trading investments, as compared to unrealized gains of$1.9 million on Agency MBS trading investments during the three months endedSeptember 30, 2019 . During the three months endedSeptember 30, 2020 andSeptember 30, 2019 , we recognized a gain (including derivative income) of approximately$4.3 million and approximately$4.0 million , respectively, on TBA Agency MBS. During the three months endedSeptember 30, 2020 andSeptember 30, 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 an unrealized gain or loss on our statement of operations. During the three months endedSeptember 30, 2020 , we had a net gain on these securities of approximately$13.7 million . During 2019, we did not classify our Non-Agency MBS as trading securities. During the three months endedSeptember 30, 2019 , approximately$3.7 million of Non-Agency MBS were called or sold for a net loss of$0.2 million . During the three months endedSeptember 30, 2020 , we had a loss on interest rate swaps, recognized in our consolidated statements of operations, of approximately$0.3 million , consisting primarily of$4.1 million in net cash settlements paid, approximately$0.8 million in AOCI amortization, and the difference of approximately$4.6 million in the positive change in fair value (see the section entitled "Derivative Financial Instruments-Accounting for Derivative and Hedging Activities" in Note 1, "Organization and Significant Accounting Policies," to our accompanying unaudited consolidated financial statements for additional information). During the three months endedSeptember 30, 2019 , we had a loss on interest rate swaps recognized in our consolidated statements of operations of approximately$28.7 million , consisting primarily of$2.1 million in net cash settlements received, approximately$1.0 million in AOCI amortization, and the difference of approximately$29.8 million in the negative change in fair value. During the three months endedSeptember 30, 2020 , we earned rental income on our residential properties portfolio of approximately$416 thousand , as compared to rental income on our residential properties portfolio of approximately$469 thousand during the three months endedSeptember 30, 2019 . Total expenses were approximately$2.8 million for the three months endedSeptember 30, 2020 , as compared to approximately$3.3 million for the three months endedSeptember 30, 2019 . For the three months endedSeptember 30, 2020 , we incurred management fees of approximately$1.4 million , which is based on a percentage of our equity (see Note 13, "Transactions With Affiliates," to our accompanying unaudited consolidated financial statements for more information), as compared to management fees of approximately$1.6 million for the three months endedSeptember 30, 2019 . Rental properties depreciation and expenses decreased by approximately$42 thousand during the three months endedSeptember 30, 2020 . "General and administrative expenses" decreased by approximately$90 thousand during the three months endedSeptember 30, 2020 .
Nine Months Ended
For the nine months endedSeptember 30, 2020 , our net loss to common stockholders was$(134.0) million , or$(1.35) per basic and diluted share, based on a weighted average of 99.0 million basic and diluted shares outstanding. This included a net loss of$(127.1) million and the payment of preferred dividends of$6.9 million . For the nine months 45
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endedSeptember 30, 2019 , our net loss to common stockholders was$(92.1) million , or$(0.93) per basic and diluted share, based on a weighted average of 98.6 million basic and diluted shares outstanding. This included a net loss of$(85.2) million and the payment of preferred dividends of$6.9 million . Net interest income, after provision for credit losses of approximately$620 thousand , for the nine months endedSeptember 30, 2020 totaled$28.7 million , or 32.3% of gross income, as compared to$25.6 million , or 18.4% of gross income, for the nine months endedSeptember 30, 2019 . Net interest income, after provision for credit losses, is comprised of the interest income earned on our mortgage investments (net of premium amortization expense) and other income, less interest expense from borrowings and less provision for credit losses. Interest and other income (net of premium amortization expense) for the nine months endedSeptember 30, 2020 was$68.8 million , as compared to$119.3 million for the nine months endedSeptember 30, 2019 , a decrease of 42.3%, due primarily to a decrease in income on securitized residential mortgage loans of approximately$3.9 million (due primarily to paydowns on this portfolio), a decrease in the weighted average portfolio outstanding, from$4.05 billion during the nine months endedSeptember 30, 2019 to approximately$2.56 billion during the nine months endedSeptember 30, 2020 , and a decrease in the weighted average coupons on MBS, from 3.93% during the nine months endedSeptember 30, 2019 to 3.75% during the nine months endedSeptember 30, 2020 , and a decrease in other interest income of approximately$1.1 million (due primarily to less income earned on restricted cash balances), and an increase in premium amortization expense of$0.1 million , partially offset by an increase in interest income on loans held-for-securitization of approximately$2.1 million . Interest expense for the nine months endedSeptember 30, 2020 was approximately$39.5 million , as compared to approximately$93.7 million for the nine months endedSeptember 30, 2019 , a decrease of approximately 57.8%, which resulted primarily from a decrease in the average repurchase agreement borrowings outstanding, from$3.58 billion atSeptember 30, 2019 to$2.34 billion atSeptember 30, 2020 , a decrease in the weighted average interest rates, from 2.76% atSeptember 30, 2019 to 1.35% atSeptember 30, 2020 , and a decrease in interest expense on ABS of approximately$3.9 million (due primarily to paydowns), partially offset by an increase in interest expense on the warehouse line of credit of approximately$0.8 million . During the nine months endedSeptember 30, 2020 , premium amortization expense increased$0.1 million , or 0.7%, to$19.9 million , from$19.8 million during the nine months endedSeptember 30, 2019 , due primarily to increased future prepayment assumptions, partially offset by a smaller portfolio balance. During the nine months endedSeptember 30, 2020 , we sold approximately$1.4 billion of Agency MBS and realized a net gain of approximately$19.8 million . During the nine months endedSeptember 30, 2019 , we sold approximately$2.3 billion of Agency MBS and realized a net loss of approximately$12.4 million . During the nine months endedSeptember 30, 2020 , we had unrealized losses of approximately$1.1 million on Agency MBS trading investments, as compared to unrealized gains of$17.8 million on Agency MBS trading investments during the nine months endedSeptember 30, 2019 . During the nine months endedSeptember 30, 2020 , we had a net loss on Non-Agency MBS trading securities of approximately$20.6 million . We also had a net loss on the sale of available-for-sale Non-Agency MBS of approximately$55.4 million . During the nine months endedSeptember 30, 2019 , approximately$23.7 million of Non-Agency MBS were called or sold and we realized a loss of approximately$208 thousand . During the nine months endedSeptember 30, 2020 andSeptember 30, 2019 , we recognized a gain (including derivative income) of approximately$19.4 million and approximately$14.6 million , respectively, on TBA Agency MBS. During the nine months endedSeptember 30, 2020 andSeptember 30, 2019 , we did not sell any of our residential mortgage loans. During the nine months endedSeptember 30, 2020 , we had a loss on interest rate swaps, recognized in our consolidated statements of operations, of approximately$110.3 million , consisting primarily of$7.6 million in net cash settlements paid, approximately$2.7 million in AOCI amortization, and the difference of approximately$100.0 million in the negative change in fair value (see the section entitled "Derivative Financial Instruments-Accounting for Derivative and Hedging Activities" in Note 1, "Organization and Significant Accounting Policies," to our accompanying unaudited consolidated financial statements for additional information). During the nine months endedSeptember 30, 2019 , we had an unrealized loss on interest rate swaps recognized in our consolidated statements of operations of approximately$120.1 million , consisting primarily of$11.4 million in net cash settlements received, approximately$3.0 million in AOCI amortization, and the difference of approximately$128.5 million in the negative change in fair value. During the nine months endedSeptember 30, 2020 , we earned rental income on our residential properties portfolio of 46
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approximately
Total expenses were approximately$8.9 million for the nine months endedSeptember 30, 2020 , as compared to approximately$10.0 million for the nine months endedSeptember 30, 2019 . For the nine months endedSeptember 30, 2020 , we incurred management fees of approximately$4.3 million , which is based on a percentage of our equity (see Note 13, "Transactions With Affiliates," to our accompanying unaudited consolidated financial statements for more information), as compared to management fees of approximately$5.1 million for the nine months endedSeptember 30, 2019 . Rental properties depreciation and expenses increased by approximately$58 thousand during the nine months endedSeptember 30, 2020 . "General and administrative expenses" decreased by approximately$372 thousand during the nine months endedSeptember 30, 2020 .
Financial Condition
MBS Portfolio
AtSeptember 30, 2020 , we held Agency MBS which had an amortized cost of approximately$1.54 billion , consisting primarily of$0.56 billion of adjustable-rate MBS and$0.98 billion of fixed-rate MBS. This amount represented a decrease of approximately 56% from the approximately$3.46 billion held atDecember 31, 2019 . Of the adjustable-rate Agency MBS owned by us, approximately 64% were adjustable-rate pass-through certificates which had coupons that reset within one year. The remaining 36% consisted of hybrid adjustable-rate Agency MBS that have an initial interest rate that is fixed for a certain period, usually one to ten years, and thereafter adjust annually for the remainder of the term of the loan. AtSeptember 30, 2020 , as our Non-Agency MBS are now designated as trading securities, they had a carrying value and fair value of approximately$198.6 million . AtDecember 31, 2019 , our 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 balance of approximately$801.9 million . Due to the COVID-19 coronavirus pandemic, there was much volatility in the markets, and we sold a substantial portion of our Agency MBS and Non-Agency MBS portfolios to meet margin calls from our lenders.
The following table presents a schedule of the fair value of our MBS owned at
September 30, 2020 December 31, 2019 Fair Portfolio Fair Portfolio Agency Value Percentage Value Percentage (in thousands) (in thousands) Fannie Mae (FNM)$ 966,123 53.4 %$ 2,617,084 63.0 % Freddie Mac (FHLMC) 643,638 35.6 892,967 21.5 Non-Agency MBS 198,586 11.0 643,610 15.5 Total MBS$ 1,808,347 100.0 %$ 4,153,661 100.0 % 47 Table of Contents
The following table classifies our portfolio of MBS owned at
September 30, 2020 December 31, 2019 Fair Portfolio Fair Portfolio Index Value Percentage Value Percentage (in thousands) (in thousands) Agency MBS: One-month LIBOR $ 337 - % $ 386 - % Six-month LIBOR 1,174 - 1,426 - One-year LIBOR 557,786 30.8 767,275 18.5
Six-month certificate of deposit 189 - 297 - One-year constant maturity treasury 13,774 0.8 17,552 0.4 Cost of Funds Index 1,903 0.1 2,532 0.1 15-year fixed-rate 38,219 2.1 48,226 1.2 20-year fixed-rate 168,948 9.4 194,577 4.7 30-year fixed-rate 827,431 45.8 2,477,780 59.6 Total Agency MBS$ 1,609,761 89.0 %$ 3,510,051 84.5 % Non-Agency MBS 198,586 11.0 643,610 15.5 Total MBS$ 1,808,347 100.0 %$ 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. For more detail on the fair value of our MBS, see Note 9, "Fair Values of Financial Instruments," to our accompanying unaudited consolidated financial statements. Agency MBS
The weighted average coupons and average amortized costs of our Agency MBS atSeptember 30, 2020 ,June 30, 2020 ,March 31, 2020 , andDecember 31, 2019 were as follows: September 30, June 30, March 31, December 31, 2020 2020 2020 2019 Agency MBS Portfolio: Weighted Average Coupon: Adjustable-rate Agency MBS 3.16 % 3.47 % 3.78 % 3.95 % Hybrid adjustable-rate Agency MBS 2.74 2.76 2.78 2.78 15-year fixed-rate Agency MBS 3.50 3.50 3.50 3.50 20-year fixed-rate Agency MBS 3.56 3.56 3.56 3.56 30-year fixed-rate Agency MBS 4.00 4.00 3.79 3.56 Total Agency MBS 3.58 % 3.66 % 3.64 % 3.54 % Average Amortized Cost: Adjustable-rate Agency MBS $ 102.02$ 102.16 $ 101.96 $ 102.04 Hybrid adjustable-rate Agency MBS 101.51 101.84 102.09 102.11 15-year fixed-rate Agency MBS 101.51 101.72 101.75 101.81 20-year fixed-rate Agency MBS 103.35 103.76 103.83 103.96 30-year fixed-rate Agency MBS 102.23 102.51 102.54 102.33 Total Agency MBS $ 102.18$ 102.44 $ 102.47 $ 102.35 Current yield on Agency MBS (weighted average coupon divided by average amortized cost) 3.51 % 3.57 % 3.56 % 3.46 %
At
48 Table of Contents AtSeptember 30, 2020 , the current yield on our Agency MBS increased to 3.51%, from 3.46% atDecember 31, 2019 . This increase was due primarily to an increase in the weighted average coupon. As noted in the trend above, the weighted average coupon has increased by approximately 4 basis points fromDecember 31, 2019 . 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 CPR, 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 includes 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 a significant amount of 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
The following table summarizes our Non-Agency MBS portfolio by type at
September 30, 2020 Weighted Average Fair Fair Market Portfolio Type Value Coupon Price (in thousands) Legacy Non-Agency MBS$ 104,180 5.23 %$ 62.80 Non-performing 1,000 5.00 100.00 Credit Risk Transfer 93,406 4.11 97.06 Total Non-Agency MBS$ 198,586 4.82 %$ 75.47 49 Table of Contents 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
September 30, June 30, March 31, December 31, 2020 2020 2020 2019 (dollar amounts in thousands) Total repurchase agreements outstanding$ 1,464,593 $ 1,697,181 $ 2,473,134 $ 3,657,873 Average repurchase agreements outstanding during the quarter$ 1,587,115 $ 1,919,736 $ 3,476,576 $ 3,322,672 Average repurchase agreements outstanding during the year $ N/A $ N/A $ N/A$ 3,516,634 Maximum monthly amount during the quarter$ 1,621,431 $ 1,847,853 $ 3,607,774 $ 3,657,873 Maximum monthly amount during the year $ N/A $ N/A $ N/A$ 4,214,226 Average interest rate on outstanding repurchase agreements 0.35 % 0.39 % 1.86 % 2.07 % Average days to maturity 26 days 23 days 29 days 28 days Average interest rate after adjusting for interest rate swaps 1.44 % 1.24 % 2.15 % 2.13 % Weighted average maturity after adjusting for interest rate swaps 1,091 days 983 days
859 days 978 days 50 Table of Contents
At
September 30, 2020 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 915,000 0.22 55,783 2.00 970,783 0.32 30 days to 90 days 450,000 0.23 36,961 2.08 486,961 0.37 Over 90 days - - 6,849 3.00 6,849 3.00 Demand - - - - - -$ 1,365,000 0.22 % $ 99,593 2.10 %$ 1,464,593 0.35 % Weighted average maturity 25 days 43 days 26 days Weighted average interest rate after adjusting for interest rate swaps 1.44 % Weighted average maturity after adjusting for interest rate swaps 1,091 days MBS pledged as collateral under the repurchase agreements and interest rate swaps$ 1,440,188 $ 161,184 $ 1,601,372
At
December 31, 2019 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 weighted average interest rate on outstanding repurchase agreements, after adjusting for interest rate swaps, decreased from 2.13% atDecember 31, 2019 to 1.44% atSeptember 30, 2020 . The decrease was due primarily to a decrease in the repurchase agreement weighted average interest rate, from 2.07% atDecember 31, 2019 to 0.35% atSeptember 30, 2020 . 51
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Residential Mortgage Loans Held-for-Securitization
AtSeptember 30, 2020 , we owned approximately$123.2 million of Non-QM loans, which are being held-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 unaudited 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. AtSeptember 30, 2020 , the amount outstanding on this line of credit (including warehouse transaction costs) was$101.7 million . The interest rate on the amounts advanced under this line of credit is at LIBOR + 3.00%, which was approximately 3.46% for the three months endedSeptember 30, 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 three months endedSeptember 30, 2020 , this funding fee was$150 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 our accompanying unaudited 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
AtSeptember 30, 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 our accompanying unaudited consolidated financial statements for more information regarding consolidation of the securitization trusts. See Note 9, "Fair Values of Financial Instruments," to our accompanying unaudited consolidated financial statements for more information regarding the fair value of these investments and their related financing.
Residential Properties Portfolio
AtSeptember 30, 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$12.8 million . During the three and nine months endedSeptember 30, 2020 , we sold one property and three properties, respectively, for a gain of approximately$78 thousand and$201 thousand , respectively. AtDecember 31, 2019 , we owned 85 single-family residential properties which were carried at a total cost, net of accumulated depreciation, of approximately$13.5 million .
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 test. To qualify for this exclusion, the hedging transaction must be clearly identified as such before the close of the day 52 Table of Contents
on which it was acquired, originated, or entered into. The transaction must hedge indebtedness incurred or to be incurred by us to acquire or carry real estate assets.
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 interest rate swaps, 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 relates to our interest rate swaps at
September 30, June 30, March 31, December 31, 2020 2020 2020 2019
Aggregate notional amount of interest$915 $1.276 $2.501 rate swaps$765 million million billion billion Average maturity of interest rate swaps 5.8 years 5.1 years 4.6 years 4.0 years Weighted average fixed-rate paid on interest rate swaps 2.34 % 2.23 % 2.10 % 2.02 % Interest rate swaps are used to provide protection from increases in interest rates having a negative impact on the market value of our portfolio, which could result in our lenders requiring additional collateral for our repurchase agreement borrowings. An increase or decrease in the notional value of these agreements usually provides an increase or decrease in protection to our portfolio's change in value due to interest rate changes. Other methods that can also lessen our portfolio's change in value due to interest rate increases include 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 related to these interest rate swaps in AOCI remains in AOCI and is amortized over the remaining term of the interest rate swaps. AtSeptember 30, 2020 , the net unrealized loss in AOCI on the interest rate swaps was approximately$4.9 million , as compared to a net unrealized loss in AOCI of approximately$7.6 million 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 our accompanying unaudited 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 approximately$1.46 billion atSeptember 30, 2020 . As collateral for the repurchase agreements and interest rate swaps, we had pledged approximately$1.44 billion in Agency MBS and approximately$161 million in Non-Agency MBS. Our other significant sources of funds for the three months endedSeptember 30, 2020 consisted of payments of principal from our MBS portfolio in the amount of approximately$219.6 million .
For the three months ended
Net cash provided by operating activities for the three months ended September
? 30, 2020 was approximately
income of approximately$21.9 million and adjusting for 53 Table of Contents
the following non-cash items: the amortization of premiums and discounts on MBS
of approximately
approximately
amortization of premium on residential loans of approximately
a loss on interest rate swaps of approximately
settlements on interest rate swaps of approximately
Agency MBS, net of derivative income, of approximately
on Non-Agency MBS of approximately
residential properties of
activities also included a decrease in accrued expenses and payables of
approximately
of approximately
approximately
Net cash provided by investing activities for the three months ended September
30, 2020 was approximately
? from principal payments on MBS; principal payments on residential mortgage
loans of
approximately
properties of approximately
Net cash used in financing activities for the three months ended
2020 was approximately
repurchase agreements of approximately
repurchase agreements of approximately
? margin of approximately
million on common stock; dividends paid of approximately
preferred stock; repayments on our warehouse line of credit of approximately
$3.2 million , partially offset by net settlements of TBA Agency MBS of approximately$4.9 million and common stock issued of approximately$170 thousand . AtSeptember 30, 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 atSeptember 30, 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$1.57 billion atSeptember 30, 2020 , partially offset by a decrease in our total capital (as described above), from$609.4 million atDecember 31, 2019 to$456.8 million atSeptember 30, 2020 . In the future, we expect that our primary sources of funds will continue to consist of borrowed funds under repurchase agreement transactions and 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 three months ended
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 as set forth in the FBR Sales Agreement. During the three months endedSeptember 30, 2020 , we did not sell any shares of our Series B Preferred Stock, Series C Preferred Stock, or our common stock under the FBR Sales Agreement. OnOctober 3, 2011 , we announced that our Board had authorized a share repurchase program which permits 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. The manner, price, number, and timing of share repurchases will be subject to market conditions and applicable rules of theSEC . 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 . During the three months endedSeptember 30, 2020 , we did not repurchase any shares of our common stock under our share repurchase program. 54
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Disclosure of Contractual Obligations
During the three months endedSeptember 30, 2020 , there were no material changes outside the normal course of business to the contractual obligations identified in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019. Stockholders' Equity We use available-for-sale treatment for 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 atSeptember 30, 2020 was approximately$399.9 million . Common stockholders' equity was approximately$301.7 million , or a book value of$3.04 per share. Common stockholders' equity serves as the basis for how book value per common share is calculated. Under available-for-sale accounting treatment, unrealized fluctuations in fair values of MBS are assessed to determine whether they are other-than-temporary. To the extent we determine that these unrealized fluctuations are 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 these assets and reflecting the change in stockholders' equity under "Accumulated other comprehensive income (loss) consisting of unrealized gains and losses." 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 AFS Agency MBS have one significant and direct effect on our potential earnings and dividends: positive mark-to-market 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 AFS Agency MBS might reduce our liquidity, requiring us to sell assets with the likely result of realized losses upon sale. "Accumulated other comprehensive income" on AFS Agency MBS was approximately$66.6 million , or 4.3% of the amortized cost of our AFS Agency MBS, atSeptember 30, 2020 . This, along with "Accumulated other comprehensive (loss), derivatives" of approximately$(4.9) million , constituted the total "Accumulated other comprehensive income" of approximately$61.7 million .
Non-GAAP Financial Measures Related to Operating Results
In addition to our operating results presented in accordance with GAAP, the following table includes the following non-GAAP financial measures: core earnings (including per common share), total interest income and average asset yield, including TBA dollar roll income, paydown expense on Agency MBS, effective total interest expense, and effective cost of funds. The table below reconciles our net income to common stockholders for the three and nine months endedSeptember 30, 2020 to core earnings for the same period. Core earnings represents net income to common stockholders (which is the nearest comparable GAAP measure), adjusted for the items shown in the table below.
Our management believes that:
these non-GAAP financial measures are useful because they provide investors
? with greater transparency to the information that we use in our financial and
operational decision-making process; the inclusion of paydown expense on Agency MBS is more indicative of the
current earnings potential of our 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
MBS";
the adjustment for depreciation expense on residential rental properties is a
? non-cash item and is added back by other companies to derive core earnings or
funds from operations; and 55 Table of Contents
the presentation of these measures, when analyzed in conjunction with our GAAP
operating results, allows investors to more effectively evaluate our
? performance to that of our 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 our operating results for the three and nine months endedSeptember 30, 2020 . An analysis of any non-GAAP financial measure should be used in conjunction with results presented in accordance with GAAP.
Core Earnings
Three Months Ended Nine Months Ended September 30, 2020 September 30, 2020 Amount Per Share Amount Per Share (in thousands) (in thousands)
Net income (loss) to common stockholders $ 19,572$ 0.20 $ (134,004) $ (1.35) 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 Realized net (gain) on sales of Agency MBS held as trading investments - - (2,840) (0.03) Net (gain) loss on Non-Agency MBS held as trading securities(1) (13,679) (0.14) 20,617 0.21 Loss on interest rate swaps, net 341 - 110,348 1.11 (Gain) on derivatives-TBA Agency MBS, net (4,327) (0.04) (19,376) (0.20) (Gain) on sales of residential properties (78) - (201) (0.00) Net settlement on interest rate swaps after de-designation(2) (4,076) (0.04) (7,631)(0.08) Dollar roll income on TBA Agency MBS(3) 2,586
0.03 3,439 0.03 Premium amortization on MBS 9,075 0.09 19,935 0.20 Paydown expense(4) (5,926) (0.06) (16,580) (0.17) Depreciation expense on residential rental properties(5) 118 - 358 - Deferred payments on modifications/forbearance agreements(6) - - 301 - Core earnings $ 3,606$ 0.04 $ 13,951$ 0.14 Basic weighted average number of shares outstanding 99,108 98,995
At
previously done, is now recognized through earnings. Net settlements on interest rate swaps after de-designation include all
subsequent net payments made or received on interest rate swaps which were
(2) de-designated as hedges in
swaps entered into after that date. These amounts are recorded in "Unrealized
loss on interest rate swaps, net."
Dollar roll income on TBA Agency MBS is the income resulting from the price (3) discount typically obtained by extending the settlement of TBA Agency MBS to
a later date. This is a component of the "Gain (loss) on derivatives, net"
that is shown on our unaudited consolidated statements of operations.
Paydown expense on Agency MBS represents the proportional expense of Agency (4) MBS purchase premiums relative to the Agency MBS principal payments and
prepayments which occurred during the three-month period.
Depreciation expense is added back in the core earnings calculation, as it is (5) a non-cash item, and it is similarly added back in other companies'
calculation of core earnings or funds from operations.
(6) The trustee reported these as losses in the securitization trusts, but these
payments are due upon liquidation or maturity.
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.
56
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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 unaudited consolidated financial statements. In preparing these unaudited 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 unaudited 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 our accompanying unaudited consolidated financial statements. Management believes the more significant of our accounting policies are the following: 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 "Loans and Debt Securities 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 endedDecember 31, 2019 , we stated the following: "On the Non-Agency MBS that were in an unrealized loss position, atDecember 31, 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, 2019 , 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, 57
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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 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 was 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. AtSeptember 30, 2020 , we did not have the intent to sell these investments, nor is it more likely than not that we 58 Table of Contents 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 our accompanying unaudited 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 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. AtMarch 31, 2020 , we designated these securities as trading securities, and they are carried at fair value. See the section on Non-Agency MBS under the caption, "Mortgage-Backed Securities ," in Significant Accounting Policies in Note 1.
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 warehouse lines 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 these borrowing facilities, 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. 59 Table of Contents
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.
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. AtSeptember 30, 2020 , none of our derivative instruments were designated as hedges for accounting purposes. 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 unaudited 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 60 Table of Contents
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 our accompanying unaudited 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 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 severely affected population health worldwide and created unprecedented economic disruption. In addition, measures to prevent the spread of the COVID-19 coronavirus pandemic have caused, and may continue to cause, substantial business closures, travel restrictions, and self-isolation. Most states 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. In response, theFederal Reserve has taken the following actions:
? On
lowered the fed funds rate to a target range of 0% to 0.25%;
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; 61 Table of Contents 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
to support 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
Reserve for this 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.
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 theFederal Reserve , theU.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 broaderU.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. InAugust 2019 ,Congress agreed to increase the spending caps by$320 billion and also to remove the debt ceiling limit for two years. This bill 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. 62
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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 had 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 amongst all three nations
Subsequent Events
None.
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