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American Capital Agency Corp. (AGNC), Capstead Mortgage Corporation (CMO): Internal Activism will Help Anworth Mortgage Asset Corporation (ANH) in the Future

Due to the elevated dividend yields, mortgage REITs have become a retail investor’s favorite investment. Among the mortgage REITs, Anworth Mortgage Asset Corporation (NYSE:ANH) is a dominant mid cap mREIT that recently disclosed its performance for the second quarter of the current year. MREITs are faced with a lot of external factors, so their management teams must be on their toes to create attractive opportunities as new situations unfold. Let’s review Anworth’s latest disclosures  and see whether its management was able to create opportunities during the quarter.

Earnings highlights

First, let’s go over some dry figures and later try to interpret them given the prevailing environment.

Anworth Mortgage Asset Corporation (NYSE:ANH) reported earning per share of $0.15, outperforming the consensus estimate of $0.13 per share. The company reported a net interest rate spread of 1%, up 11 basis points over the first quarter of the current year. This was despite a 14 basis point decline in the average asset yield during the quarter. Interest income came in at $45.2 million, up 4% over the prior year, while the net interest income was up 12% over the same time period. Lesser gains on sales and higher expenses caused the net income to plunge 3%. Further, the company reported a book value decline of 14.6% over the prior quarter.

Is it actually an outperformance?

Anworth Mortgage Asset Corporation (NYSE:ANH) started with a top line that was higher than the prior quarter’s and ended with a bottom line that lagged behind. Could this actually be called a solid quarter and an outperformance? I don’t think so!

To explain my answer, I will have to go over the company’s portfolio composition. During the first quarter, fixed-rate Agency securities were 21% of the company’s entire portfolio. That proportion remained the same during the second quarter as well. The rest are adjustable-rate securities, similar to the ones Capstead Mortgage Corporation (NYSE:CMO) owns. Given that rates are on the rise, management should have gotten rid of some of exposure in 30-year fixed-rate securities, just like American Capital Agency Corp. (NASDAQ:AGNC) did. The 30-year fixed-rate security is more sensitive to changes in interest rates, making the book value more vulnerable.

Another reason that I think this was not an actual outperformance is because the company did not control its operating expenses very well during the quarter. Expenses surged 4% to $4.06 million. It was obvious that the rising interest rates would bring down mortgage-backed security prices, causing the bottom line to get little support from gains on sales. Gains on sales of Agency mortgage-backed securities plunged 60%. Given the expected lack of support from gains on sales of securities, the management should have focused more on expense control.

While no one can control external factors such as interest rates and prepayments, the management at other mREITs took some measures to ensure minimum book value erosion. At Anworth Mortgage Asset Corporation (NYSE:ANH), however, the management was not even able to control expenses well. I believe that internal activism could have capped book value erosion at Anworth.

Peers analysis

Let’s see how American Capital Agency Corp. (NASDAQ:AGNC) and Capstead Mortgage Corporation (NYSE:CMO) did during the second quarter for comparison.

There were significant signs of internal activism at American Capital Agency Corp. (NASDAQ:AGNC) during the quarter. The management got rid of some of its 30-year fixed-rate securities in order to provide some cushion against book value erosion. Management also decided to actively manage its assets and hedges to create attractive opportunities. This capped the company’s book value erosion at 11.8%.

This is even better because American Capital Agency Corp. (NASDAQ:AGNC) is exclusively invested in the fixed-rate Agency paper whose price is more vulnerable to changes in interest rates. The future for American Capital is tough, particularly in the prevailing environment rising interest rates. The company needs to raise more capital in order to purchase new mortgage-backed securities with higher yields.

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