Amworth Mortgage Preferred "B" ANH-PB
October 14, 2008 - 8:47pm EST by
david101
2008 2009
Price: 15.00 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 15 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

The Anworth Mortgage Asset Corporation 6.25% Series B Cumulative Convertible Preferred Stock (Yahoo symbol = ANH-PB) is a simple idea with a 10.4% current yield and 67% appreciation potential. It is also a small idea because there are only one million shares outstanding and the trading is thin. Anworth Financial is an agency mortgage real estate investment trust or amREIT.

Their business model is simple - buy agency residential mortgage-backed securities (RMBS), lever the bonds via short-term repurchase agreements (a.k.a. repos) to 7-10X equity and pay dividends.

With the Federal conservatorship of Fannie Mae and Freddie Mac, all agency RMBS enjoy government guarantees and are near to Treasuries in that regard. Thus, there is little need to delve into the minutae surrounding agency RMBS. The Feds backing the agency RMBS make them very liquid and excellent collateral for repo lenders. So the assets and liabilities from the balance sheet are copacetic. Okay, there is a nit. Repo debt is short-term, so any sudden rises in short-term lending rates can cause spreads to shrink, which has happened before (hence the importance of the cumulative feature of the preferred). To give investors an idea of the volatility on the common stock dividend, here is a recap of all their dividends since coming public in 1998:

 

21-Jul-08 $ 0.29 Dividend

28-Apr-08 $ 0.20 Dividend

20-Dec-07 $ 0.12 Dividend

25-Oct-07 $ 0.05 Dividend

27-Jul-07 $ 0.05 Dividend

26-Apr-07 $ 0.05 Dividend

27-Dec-06 $ 0.02 Dividend

27-Oct-06 $ 0.02 Dividend

27-Jul-06 $ 0.02 Dividend

26-Apr-06 $ 0.02 Dividend

23-Dec-05 $ 0.02 Dividend

27-Oct-05 $ 0.08 Dividend

27-Jul-05 $ 0.18 Dividend

27-Apr-05 $ 0.27 Dividend

29-Dec-04 $ 0.27 Dividend

27-Oct-04 $ 0.27 Dividend

23-Jul-04 $ 0.33 Dividend

28-Apr-04 $ 0.38 Dividend

29-Dec-03 $ 0.33 Dividend

28-Oct-03 $ 0.33 Dividend

24-Jul-03 $ 0.45 Dividend

29-Apr-03 $ 0.45 Dividend

27-Dec-02 $ 0.50 Dividend

19-Sep-02 $ 0.50 Dividend

19-Jun-02 $ 0.50 Dividend

29-Apr-02 $ 0.50 Dividend

18-Dec-01 $ 0.30 Dividend

31-Oct-01 $ 0.79 Dividend

31-Jul-01 $ 0.24 Dividend

30-Apr-01 $ 0.20 Dividend

31-Jan-01 $ 0.11 Dividend

27-Oct-00 $ 0.10 Dividend

29-Jun-00 $ 0.15 Dividend

30-Mar-00 $ 0.15 Dividend

30-Dec-99 $ 0.14 Dividend

29-Sep-99 $ 0.14 Dividend

29-Jun-99 $ 0.13 Dividend

30-Mar-99 $ 0.12 Dividend

30-Dec-98 $ 0.12 Dividend

2-Oct-98 $ 0.10 Dividend

29-Jun-98 $ 0.15 Dividend

 

The preferreds are par $25, pay a quarterly dividend of $1.5625 for a current yield of 10.4%. The latest dividend will be paid on 10/15, so it is trading ex-dividend. The common stock has a higher dividend but that is not sustainable. Their spreads have widened this year with the initial drop in short-term interest rates but that is reversing. As their net spreads shrink, so will the dividend. Hence, the appeal of the preferreds is their stated dividend rate. Plus, these preferreds are convertible into 2.3809 shares of common stock at $10.50. The common trades under "ANH" with a recent price of $5.93. 67% appreciation for the common would imply a price of $9.87. Technically, the common could out perform the preferred if ANH trades between $9.87 and $10.50, but the closeness of the price to the conversion price would suggest that the conversion option would have value. Thus, ANH-PB will enjoy a similar economic outcome as the common, while enjoying a set dividend, being higher in the capital structure and with a put option for any fundamental change to Anworth.

Risks:

- Inverted yield curve

- high interest rates

Catalyst

Collect 10% dividend while waiting for pricing to return to par.
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    Description

    The Anworth Mortgage Asset Corporation 6.25% Series B Cumulative Convertible Preferred Stock (Yahoo symbol = ANH-PB) is a simple idea with a 10.4% current yield and 67% appreciation potential. It is also a small idea because there are only one million shares outstanding and the trading is thin. Anworth Financial is an agency mortgage real estate investment trust or amREIT.

    Their business model is simple - buy agency residential mortgage-backed securities (RMBS), lever the bonds via short-term repurchase agreements (a.k.a. repos) to 7-10X equity and pay dividends.

    With the Federal conservatorship of Fannie Mae and Freddie Mac, all agency RMBS enjoy government guarantees and are near to Treasuries in that regard. Thus, there is little need to delve into the minutae surrounding agency RMBS. The Feds backing the agency RMBS make them very liquid and excellent collateral for repo lenders. So the assets and liabilities from the balance sheet are copacetic. Okay, there is a nit. Repo debt is short-term, so any sudden rises in short-term lending rates can cause spreads to shrink, which has happened before (hence the importance of the cumulative feature of the preferred). To give investors an idea of the volatility on the common stock dividend, here is a recap of all their dividends since coming public in 1998:

     

    21-Jul-08 $ 0.29 Dividend

    28-Apr-08 $ 0.20 Dividend

    20-Dec-07 $ 0.12 Dividend

    25-Oct-07 $ 0.05 Dividend

    27-Jul-07 $ 0.05 Dividend

    26-Apr-07 $ 0.05 Dividend

    27-Dec-06 $ 0.02 Dividend

    27-Oct-06 $ 0.02 Dividend

    27-Jul-06 $ 0.02 Dividend

    26-Apr-06 $ 0.02 Dividend

    23-Dec-05 $ 0.02 Dividend

    27-Oct-05 $ 0.08 Dividend

    27-Jul-05 $ 0.18 Dividend

    27-Apr-05 $ 0.27 Dividend

    29-Dec-04 $ 0.27 Dividend

    27-Oct-04 $ 0.27 Dividend

    23-Jul-04 $ 0.33 Dividend

    28-Apr-04 $ 0.38 Dividend

    29-Dec-03 $ 0.33 Dividend

    28-Oct-03 $ 0.33 Dividend

    24-Jul-03 $ 0.45 Dividend

    29-Apr-03 $ 0.45 Dividend

    27-Dec-02 $ 0.50 Dividend

    19-Sep-02 $ 0.50 Dividend

    19-Jun-02 $ 0.50 Dividend

    29-Apr-02 $ 0.50 Dividend

    18-Dec-01 $ 0.30 Dividend

    31-Oct-01 $ 0.79 Dividend

    31-Jul-01 $ 0.24 Dividend

    30-Apr-01 $ 0.20 Dividend

    31-Jan-01 $ 0.11 Dividend

    27-Oct-00 $ 0.10 Dividend

    29-Jun-00 $ 0.15 Dividend

    30-Mar-00 $ 0.15 Dividend

    30-Dec-99 $ 0.14 Dividend

    29-Sep-99 $ 0.14 Dividend

    29-Jun-99 $ 0.13 Dividend

    30-Mar-99 $ 0.12 Dividend

    30-Dec-98 $ 0.12 Dividend

    2-Oct-98 $ 0.10 Dividend

    29-Jun-98 $ 0.15 Dividend

     

    The preferreds are par $25, pay a quarterly dividend of $1.5625 for a current yield of 10.4%. The latest dividend will be paid on 10/15, so it is trading ex-dividend. The common stock has a higher dividend but that is not sustainable. Their spreads have widened this year with the initial drop in short-term interest rates but that is reversing. As their net spreads shrink, so will the dividend. Hence, the appeal of the preferreds is their stated dividend rate. Plus, these preferreds are convertible into 2.3809 shares of common stock at $10.50. The common trades under "ANH" with a recent price of $5.93. 67% appreciation for the common would imply a price of $9.87. Technically, the common could out perform the preferred if ANH trades between $9.87 and $10.50, but the closeness of the price to the conversion price would suggest that the conversion option would have value. Thus, ANH-PB will enjoy a similar economic outcome as the common, while enjoying a set dividend, being higher in the capital structure and with a put option for any fundamental change to Anworth.

    Risks:

    - Inverted yield curve

    - high interest rates

    Catalyst

    Collect 10% dividend while waiting for pricing to return to par.

    Messages


    SubjectA few comments
    Entry10/16/2008 01:51 PM
    Memberjohn771
    I think ANH has hedged about 56% of the LIBOR rate exposure on its repos using swaps.

    I think ANH preferred is very attractive right now, but I own the A instead of the B. I don't think the conversion option will ever have any value since it's too far above book value and MREITs love to issue new shares when the stocks trade above book.

    I asked the CEO a few days about funding constraints and he made some interesting comments:

    1) If they had to sell 10% of the portfolio then it would be disclosed in an 8-k. There's no 8-K so you can conclude that the company has been able to operate its investment strategy and portfolio despite the tightness in money markets.

    2) Obviously some major broker/dealers have left the market or reduced their balance sheets. But some new private dealers have entered the market and gained significant market share. Some experienced lenders are able to deal directly with MREIT without trading via a dealer.

    SubjectRE: A few comments
    Entry10/16/2008 11:58 PM
    Memberdavid101
    John,

    Thanks for the comments.

    The fact that 56% of their repos are covered by interest rate swaps means 44% will be impacted by the 62.5% increase in interest rates. For the full quarter, that is about a 25% increase in interest expense. I would imagine that the cost of replacing the hedges went up, too. Not devastating but still enough to impact distributable income.

    As for the conversion option, my main point was to show that the preferreds are superior to the common due to being higher in the capital structure while retaining virtually unlimited upside. From Chapter 22 of "Security Analysis," Graham and Dodd wrote concerning senior securities with speculative features:


    "Such issues must therefore be considered as the most attractive of all in point of form, since they permit the combination of maximum safety with the chance of unlimited appreciation in value."


    What Buffett did with the GS and GE preferred was classic Graham and Dodd. Of course, he got a better deal on the warrants but having cash when no one else does allows you to dictate the terms.

    As for the repo market, I have heard anecdotally that there are a few less lenders due to mergers and other events and that capacity has shrunk. This is less a concern for a smaller REIT like ANH than one that relies on tapping the maximum amount from a lender to fund a much larger portfolio.

    David

    SubjectRE: Author Exit Recommendation
    Entry06/15/2009 11:54 AM
    Memberdavid101

    With almost 50% return from two dividends and appreciation, to quote Carl Spackler: "...and that's all she wrote."

    David

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