Activist U.S. Fund Seeks Board Ouster at Anworth REIT: Mortgages

The McAdams family business is under attack.

Activist investor Arthur Lipson said in a regulatory filing this month that he’s seeking to oust the management and replace the board of Joseph “Lloyd” McAdams’s Anworth Mortgage Asset Corp., a real estate investment trust with $8.6 billion in assets that buys mostly government-backed home-loan bonds. McAdams, the chief executive officer, will have to fend off Lipson’s Midvale, Utah-based hedge fund, Western Investment LLC, to keep his job and secure the positions of his wife and son, both of whom have senior roles within the company.

After rallying since the financial crisis, REITs that buy mortgage debt fell last year as they struggled to navigate Federal Reserve moves to scale back its monthly bond buying. That made some REITs vulnerable to attack from activist investors. Shares of Santa Monica, California-based Anworth plunged almost 20 percent, including reinvested dividends, in 2013. Western began building its stake in December.

“Existing management, which is the McAdams family, has certainly failed shareholders,” Lipson, 71, said in a telephone interview. “The simplest route could be to liquidate the company.”

Jonathan Keehner, a spokesman for Anworth at Joele Frank, declined to comment for the story.

Five-Year Return

Anworth’s “abysmally poor performance” in the past decade drove Lipson’s firm to start acquiring its stake and take action this year by nominating five new directors to the board, according to Western’s April 4 filing. In the 10 years ending Dec. 31, Anworth shares lost 16 percent, including reinvested dividends. During the same period, Annaly Capital Management Inc., the largest mortgage REIT, gained about 63 percent, while a Bloomberg index of mortgage REITs fell 25 percent.

In an April 14 proxy statement, Anworth defended its performance and said it had returned money to investors through a dividend increase and repurchased shares.

“Over the past five years, including during one of the most difficult stock market environments and prolonged economic recessions in history, a continued investment in Anworth has produced a 60.7 percent cumulative return on investment (including reinvested dividends),” the firm said.

Lipson’s effort with Anworth follows a successful campaign by Phil Goldstein’s Bulldog Investors in pressuring Javelin Mortgage Investment Corp. management to repurchase stock. After Bulldog Investors threatened a proxy fight, Javelin repurchased 516,000 shares directly from the firm in December. Javelin’s stock gained 10 percent in the following three weeks.

Bulldog Investors

“Anworth looked the most vulnerable following what happened with Bulldog and Javelin” because it was trading at a larger discount than other mortgage REITs, said Steven DeLaney, an analyst in Atlanta at JMP Securities LLC.

At the end of December, when shares in mortgage REITs had been pushed down even more than the value of their assets, Anworth was trading at 73 percent of its book value, compared with the industry median of 84 percent, DeLaney estimated.

Western and its affiliates owned about 5.3 million shares, or 4 percent, of Anworth as of yesterday, Lipson said. During the past decade, Western has taken an activist role in 38 funds, according to the firm. It has had successful outcomes, including liquidation, increased dividends and share repurchases, in 31 of them.

Anworth Rebounds

Anworth’s shares have climbed 31 percent this year, the most in the 44-company Bloomberg index of mortgage REITs. If Lipson prevails in getting a new board elected and begins to liquidate the company, Anworth shares could gain up to 8 percent more, DeLaney said. The stock is currently trading at 88 percent of its book value, the analyst said.

Western’s 5.3 million shares make it one of Anworth’s 10 largest investors, according to data compiled by Bloomberg. The hedge fund had $123 million in assets, according to a recent regulatory filing. Lipson declined to comment on his firm’s returns.

Anworth primarily buys home-loan bonds backed by the government, which suffered their first annual loss last year in almost two decades. The firm repurchased at least 2.8 million shares in the fourth quarter when their stock was trading at the lowest levels since 2007, and in December announced board approval to buy back as many as 5 million more.

Repurchasing Stock

Jason Stewart, an analyst at Compass Point Research & Trading LLC, said Anworth hasn’t been aggressive enough in repurchasing stock. The company has bought back 13 million shares, or 9 percent, since 2013. That compares with 43.8 million shares repurchased, or 13 percent, by American Capital Agency Corp., the second-largest mortgage REIT.

If a company can buy back shares at a big discount and doesn’t boldly do so, it creates an opportunity for activist investors like Western, Stewart said.

McAdams takes a more retail approach to investing, by laddering, or buying shorter term bonds that mature at set periods of times, and staggering them so each year a portion of the portfolio is maturing, according to Stewart.

Lloyd McAdams, 68, started Anworth in 1997, and is currently its chairman and CEO. His wife, Heather Baines, is an executive vice president. His son Joseph E. McAdams is Anworth’s chief investment officer and a board member.

Anworth’s size -- it’s smaller than American Capital, which oversees about $76.3 billion of assets, and Annaly, with about $81.9 billion -- makes it more vulnerable, according to DeLaney. The management team may not garner as much support from institutional backers in mounting a defense for a proxy fight, he said.

$400 Billion

REITs buy property-linked assets and are exempt from taxes as long as they pay out 90 percent of their earnings in dividends. Mortgage REITs rely on leverage, typically borrowing about six to eight times their capital, helping firms that had virtually no assets six years ago expand to hold more than some regional banks.

At their peak last year, mortgage REITs held $400 billion of assets. The companies more than tripled holdings of government-backed home-loan bonds since 2009, growing so large that the International Monetary Fund, the U.S. Financial Stability Oversight Council and Fed governor Jeremy Stein warned last year that they posed risks to the markets. The firms were able to lure investors with returns of 19 percent in 2012 and dividends of more than 13 percent, almost twice the average yield on company junk bonds.

Fed Tapering

In May, they started plunging as investors speculated that the Fed would slow its bond-buying program as the economy started to strengthen. The next month, investors pulled about $60 billion from U.S. bond funds, the biggest monthly redemptions in records going back to 1961, according to estimates from the Investment Company Institute. Mortgage rates jumped to 4.46 percent at the end of June, up from a near-record low of 3.35 percent in early May.

Lipson said his hedge fund and its affiliates started buying Anworth stock in December when it was as low as $4.20 a share. On March 13, he went to Santa Monica to meet with management. He said he told CIO Joseph McAdams he was disappointed in the firm’s performance and that it hasn’t shown the ability to operate in a more innovative and credit sensitive environment.

“It was a polite meeting,” Lipson said. “Western is not like corporate raiders or activists who go in and lambaste management.”

Rental Bonds

The next day, Anworth issued a press release announcing that the board had authorized the company to acquire up to an additional 10 million shares of its common stock. The company also said it formed a subsidiary called Anworth Properties Inc. to invest in new classes of real estate assets, including rental bonds.

Some investors may be concerned about the firm’s efforts to explore other business lines. Its non-agency mortgage origination and securitization business, Belvedere Trust Mortgage Corp., failed during the housing crisis after providing subprime loans, said Daniel Altscher, an analyst at FBR Capital Markets & Co.

Even though the stock hasn’t shown much improvement in the last 10 years, Lloyd McAdams is among the longest standing mortgage REIT executives out there, according to Altscher.

“He knows how to be a survivor in the industry,” Altscher said.

Quitting Lehman

Activists don’t always produce big gains for investors, according to Compass Point’s Stewart. Funds where Western disclosed its involvement over the past five years have seen an average total return of about 15 percent, without dividends reinvested, from the time the hedge fund took a role through April 15, data compiled by Washington-based Compass Point show.

“We do have a long-term record,” Lipson said. “We’re hardly inexperienced in this space.”

Lipson started Western in 1995 from the second bedroom of his home in Utah, where he moved to learn how to ski after quitting his job as head of fixed-income research at Lehman Brothers Holdings Inc. in 1981.

“This was before cell phones, and I used to ski down to the pay phone at the lodge and call in and check with my broker and place orders and jump on the lift again,” Lipson said. The firm got its first institutional investor in 1998 and started taking an activist role in 2004.

Since Western disclosed it was trying to replace Anworth’s board and management team, the company’s shares have risen 5.5 percent. Lipson said he has spoken with potential new managers for Anworth and has encouraged them to make a bid for the company’s management contract. The annual meeting of Anworth stockholders is scheduled for May 22.

“From Western’s standpoint, if they win, great, they get what they want,” DeLaney said. “If they don’t win, they probably have already made good money on the stock.”

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