| Organization and Significant Accounting Policies | NOTE 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES Our Company We were incorporated in Maryland on October 20, 1997 and commenced operations on March 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; ◾ 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 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 our acquisition of those 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. At December 31, 2020, we believe we met all REIT requirements regarding the asset tests, income tests, the ownership of our common stock and the distributions of our taxable net income. Therefore, we believe that we continue to qualify as a REIT under the provisions of the Code. Proposed Merger with Ready Capital Corporation On December 6, 2020, we entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Ready Capital Corporation, a Maryland corporation (“Ready Capital”), and RC Merger Subsidiary, LLC, a Delaware limited liability company and a wholly owned subsidiary of Ready Capital (“Merger Sub”), pursuant to which, subject to the terms and conditions therein, our Company will be merged with and into Merger Sub, with Merger Sub remaining as a wholly owned subsidiary of Ready Capital (such transaction, the “Merger”). Under the terms of the Merger Agreement, at the effective time of the Merger (the “Effective Time”), each share of our common stock, par value $0.01 per share (“Anworth Common Stock”), issued and outstanding immediately prior to the Effective Time (excluding any shares held by Ready Capital, Merger Sub or any of their respective subsidiaries) will automatically be converted into the right to receive from Ready Capital (i) 0.1688 shares of common stock, par value $0.0001, of Ready Capital (“Ready Capital Common Stock”), plus (ii) $0.61 in cash minus the Per Share Excess Amount, in each case, subject to adjustment as provided in the Merger Agreement. The Per Share Excess Amount means an amount, if any, per share by which our termination expenses and transaction expenses exceed $32.5 million. Cash will be paid in lieu of any fractional shares of Ready Capital Common Stock that would have been received as a result of the Merger. Additionally, at the Effective Time, each share of our 8.625% Series A Cumulative Preferred Stock, $0.01 par value per share, will be converted into the right to receive one share of a newly designated series of Ready Capital preferred stock, par value $0.0001 per share, which Ready Capital expects will be classified and designed as Ready Capital’s Series B Preferred Stock; each share of our 6.25% Series B Cumulative Convertible Preferred Stock, $0.01 par value per share, will be converted into the right to receive one share of a newly designated series of Ready Capital preferred stock, par value $0.0001 per share, which Ready Capital expects will be classified and designed as Ready Capital’s Series C Preferred Stock; and each share of our 7.625% Series C Cumulative Redeemable Preferred Stock, $0.01 par value per share, will be converted into the right to receive one share of a newly designated series of Ready Capital preferred stock, par value $0.0001 per share, which Ready Capital expects will be classified and designed as Ready Capital’s Series D Preferred Stock. The Merger Agreement provides that each of our Company and Ready Capital will, until the Effective Time, operate their respective businesses in all material respects in the ordinary course and consistent with practice, and preserve substantially intact its current business organization and preserve key business relationships. Each of our Company and Ready Capital are subject to restrictions as specified in the Merger Agreement on certain actions each company may take prior to the Effective Time, including, among other things, actions related to amending organizational documents, declaring dividends, issuing or repurchasing capital stock, engaging in certain business transactions and incurring indebtedness. Completion of the proposed Merger is subject to the satisfaction of certain customary conditions, and is subject to the approval of the stockholders of both Ready Capital and our Company. We cannot provide any assurance that the proposed Merger will close in a timely manner or at all. Our Manager We are externally managed and advised by Anworth Management, LLC, or our Manager. Effective as of December 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, 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. Our Manager is supervised and directed by our board of directors 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 and administrative services. Our Manager will also perform such other services and activities 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. In connection with the execution of the Merger Agreement, we, our Manager, and Ready Capital entered into an amendment to the Management Agreement (the “Management Agreement Amendment”). The Management Agreement Amendment provides that upon the completion of the transactions contemplated by the Merger Agreement, the Management Agreement will terminate, and as a result of the completion of the transactions contemplated by the Merger Agreement and the termination of the Management Agreement, we will pay our Manager a termination fee of $20.3 million, and Ready Capital or Merger Sub (as the surviving company following the Merger) will reimburse our Manager for certain unpaid expenses and pay to our Manager all accrued and unpaid management fees then owed under the Management Agreement, as and when specified in the Management Agreement Amendment. BASIS OF PRESENTATION AND CONSOLIDATION The accompanying consolidated financial statements are prepared on the accrual basis of accounting in accordance with generally accepted accounting principles utilized in the United States of America, or GAAP. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Material estimates that are susceptible to change relate to the determination of the fair value of investments and derivatives, cash flow projections for and credit performance of Non-Agency MBS and residential mortgage loans, amortization of security and loan premiums, accretion of security and loan discounts, and accounting for derivatives activities. Actual results could materially differ from these estimates. In the opinion of management, all material adjustments, consisting of normal recurring adjustments, considered necessary for a fair presentation have been included. Our consolidated financial statements include the accounts of all subsidiaries. Significant intercompany accounts and transactions have been eliminated. Our consolidated financial statements also include the consolidation of certain securitization trusts that meet the definition of a variable interest entity, or VIE, because the Company has been deemed to be the primary beneficiary of the securitization trusts. These securitization trusts hold pools of residential mortgage loans and issue series of ABS payable from the cash flows generated by the underlying pools of residential mortgage loans. These securitizations are nonrecourse financing for the residential mortgage loans held-for-investment through consolidated securitization trusts. Generally, a portion of the ABS issued by the securitization trusts are sold to unaffiliated third parties and the balance is purchased by the Company. The Company classifies the underlying residential mortgage loans owned by the securitization trusts as residential mortgage loans held-for-investment through consolidated securitization trusts in its consolidated balance sheets. The ABS issued to unaffiliated third parties are recorded as liabilities on the Company’s consolidated balance sheets. The Company records interest income on the residential mortgage loans held-for-investment through consolidated securitization trusts and interest expense on the ABS issued to third parties in the Company’s consolidated statements of operations. The Company records the initial underlying assets and liabilities of the consolidated securitization trusts at their fair value upon consolidation into the Company and, as such, no gain or loss is recorded upon consolidation. See Note 5, “Variable Interest Entities,” to the accompanying audited consolidated financial statements for additional information regarding the impact of consolidation of securitization trusts. The consolidated securitization trusts are VIEs because the securitization trusts do not have equity that meets the definition of U.S. GAAP equity at risk. In determining if a securitization trust should be consolidated, the Company evaluates (in accordance with the Financial Accounting Standards Board, or FASB, Accounting Standards Codification, or ASC, 810-10) whether it has both (i) the power to direct the activities of the securitization trust that most significantly impact its economic performance and (ii) the right to receive benefits from the securitization trust or the obligation to absorb losses of the securitization trust that could be significant. The Company determined that it is the primary beneficiary of certain securitization trusts because it has certain delinquency and default oversight rights on residential mortgage loans. In addition, the Company owns the most subordinated class of ABS issued by the securitization trusts and has the obligation to absorb losses and right to receive benefits from the securitization trusts that could potentially be significant to the securitization trusts. The Company assesses modifications, if any, to VIEs on an ongoing basis to determine if a significant reconsideration event has occurred that would change the Company’s initial consolidation assessment. On January 1, 2020, we adopted FASB Accounting Standards Update, or ASU, 2016-13, “Financial Instruments– Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments” (CECL). Please see the section in Note 1, “Organization and Significant Accounting Polices,” under “Recently Adopted Accounting Pronouncements” to the accompanying audited consolidated financial statements for the effect of our adoption of this ASU on our retained earnings as of January 1, 2020. All prior periods are shown under the previously-existing GAAP. The cumulative effect on any change to accumulated deficit at January 1, 2020 is shown in our consolidated statements of stockholders’ equity. The following is a summary of our significant accounting policies: Risks and Uncertainties The outbreak of the COVID-19 Coronavirus pandemic around the globe continues to adversely impact global commercial activity and has contributed to significant volatility in financial markets. The impact of the outbreak has been rapidly evolving around the globe, with several countries taking drastic measures to limit the spread of the virus by instituting quarantines or lockdown and imposing travel restrictions. While some of these restrictions have been relaxed or phased out, many of these or similar restrictions remain in place, continue to be implemented or additional restrictions are being considered. Such actions are creating significant disruptions to global supply chains, and adversely impacting several industries, including, but not limited to, airlines, hospitality, retail, and the broader real estate industry. The major disruption caused by COVID-19 significantly reduced economic activity in most of the United States, resulting in a significant increase in unemployment claims. COVID-19 has had a continued and prolonged adverse impact on economic and market conditions and has triggered a period of global economic slowdown, which could have a material adverse effect on the Company’s results and financial condition. The full impact of COVID-19 on the real estate industry, the credit markets, and, consequently, on the Company’s financial condition and results of operations is uncertain and cannot be predicted at the current time, as it depends on several factors beyond the control of the Company, including, but not limited to, (i) the uncertainty around the severity and duration of the outbreak, (ii) the effectiveness of the United States public health response, (iii) the pandemic’s impact on the U.S. and global economies, (iv) the timing, scope, and effectiveness of additional governmental responses to the pandemic, (v) the timing and speed of economic recovery, (vi) the availability of a treatment or vaccination for COVID-19, and (vii) the negative impact on our borrowers, real estate values, and cost of capital. Cash and Cash Equivalents Cash and cash equivalents include cash on hand and highly liquid investments with original maturities of three months or less, including U.S. Treasury bills. The carrying amount of cash equivalents approximates their fair value. Restricted cash includes cash pledged as collateral to counterparties on various derivative transactions. Reverse Repurchase Agreements We use securities purchased under agreements to resell, or reverse repurchase agreements, as a means of investing excess cash. Although legally structured as a purchase and subsequent resale, reverse repurchase agreements are treated as financing transactions under which the counterparty pledges securities (principally U.S. treasury securities) and accrued interest as collateral to secure a loan. The difference between the purchase price that we pay and the resale price that we receive represents interest paid to us and is included in “Other interest income” on our consolidated statements of operations. It is our policy to generally take possession of securities purchased under reverse repurchase agreements at the time such agreements are made. Mortgage-Backed Securities Agency MBS are securities that are obligations (including principal and interest) guaranteed by the U.S. government, such as Ginnie Mae, or guaranteed by federally sponsored enterprises, such as Fannie Mae or Freddie Mac. Our investment-grade Agency MBS portfolio is invested primarily in fixed-rate and adjustable-rate mortgage-backed pass-through certificates and hybrid adjustable-rate MBS. Hybrid adjustable-rate MBS have an initial interest rate that is fixed for a certain period, typically one to ten years, and then adjusts annually for the remainder of the term of the asset. We structure our investment portfolio to be diversified with a variety of prepayment characteristics, investing in mortgage assets with prepayment penalties, investing in certain mortgage security structures that have prepayment protections and purchasing mortgage assets at a premium and at a discount. A portion of our portfolio consists of Non- Agency MBS. Our principal business objective is to generate net income for distribution to our stockholders primarily based upon the spread between the interest income on our mortgage assets and our borrowing costs to finance our acquisition of those assets. We classify our Agency MBS as either trading investments or available-for sale, or AFS, investments. Our management determines the appropriate classification of the securities at the time they are acquired and evaluates the appropriateness of such classifications at each balance sheet date. We currently classify most of our Agency MBS as available-for-sale. We have also designated a portion of our Agency MBS as trading investments. All assets that are classified as available-for-sale are carried at fair value and unrealized gains or losses are generally included in “Accumulated other comprehensive income (loss),” or AOCI, as a component of stockholders’ equity. For AFS Agency MBS that are in an unrealized loss position, we first assess whether we intend to sell, or if it is more likely than not that we will be required to sell the security before recovery of its amortized basis. If we do not intend to sell or expect recovery of the amortized cost basis, we evaluate if the decline in fair value resulted from credit losses or other factors. In making this assessment, we consider the extent to which fair value is less than amortized cost, any changes to the rating of the security by a rating agency, adverse conditions specifically related to the security, and other factors. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected for the security are compared to its amortized cost basis. If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an allowance for credit losses is recorded, limited by the amount that the fair value is less than the amortized cost. Any impairment that has not been recorded through an allowance for credit losses is recognized in other comprehensive income. As the payments of principal and interest on the AFS Agency MBS are guaranteed by Fannie Mae or Freddie Mac, which are under the conservatorship of the U.S. government, there is currently zero loss expectation and no allowance for credit losses is currently recorded for these securities. Agency MBS classified as trading investments are reported at fair value with unrealized gains and losses included in our consolidated statements of operations. The most significant source of our income is derived from our investments in Agency MBS. Interest income on Agency MBS is accrued based on the actual coupon rate and the outstanding principal amount of the underlying mortgages. Premiums and discounts are amortized or accreted into interest income over the estimated lives of the securities using the effective interest yield method, adjusted for the effects of actual 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 materially incorrect as compared to the aforementioned references, 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 the Current Expected Loss Methodology, or 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 model 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 at January 1, 2020, we reviewed those Non-Agency MBS that were in an unrealized loss position to determine if there was any credit loss. In our Annual Report on Form 10-K for the year ended December 31, 2019, we stated the following: “On the Non-Agency MBS that were in an unrealized loss position, at December 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.” On January 1, 2020, when we adopted CECL, we reviewed our assessment of the Non-Agency MBS in an unrealized loss position at December 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, whether the issuer has continued to make payments of principal and interest, and review of prepayment speeds, delinquency, and default rates. At March 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 in March 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 the Federal 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 of March 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 included assumptions related to interest rates, prepayment rates, and the timing and amount of credit losses. On at least a quarterly basis, we reviewed and, if appropriate, made adjustments to our cash flow projections based on input and analysis received from external sources, internal models, and our judgment about interest rates, prepayment rates, the timing and amount of credit losses, and other factors. Changes in cash flows from those originally projected, or from those estimated at the last evaluation, resulted in a prospective change in the yield/interest income recognized on such securities. Actual maturities of these Non-Agency MBS were affected by the contractual lives of the associated mortgage collateral, periodic payments of principal, and prepayments of principal. Therefore, actual maturities of these securities are generally shorter than stated contractual maturities. Stated contractual maturities are generally greater than ten years. At March 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. 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. Interest income is recorded as income 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. We have elected not to measure an allowance for credit losses on accrued interest receivables. We establish an allowance for residential loan losses based on our estimate of credit 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 our management. Many of these factors are subjective and cannot be reduced to a mathematical formula. In addition, since we have not incurred any significant 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 timing of those losses may differ from our estimates. The residential mortgage loans held-for-securitization are financed by a warehouse line of credit. The payment and performance of the obligations by Anworth Mortgage Loans under the warehouse line is guaranteed by Anworth Mortgage Asset Corporation. 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. Debt issuances costs incurred in connection with this line of credit (such as facility fees and legal costs) are deducted from the debt’s carrying amount and amortized ratably to interest expense over the term of the debt. 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 balances net of any premiums or discounts and allowance for loan losses. We expect that we will be required to continue to consolidate the securitization trusts that hold the residential mortgage loans. We establish an allowance for residential loan losses based on our estimate of credit 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 our 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 esti |
