Past fortunes no guarantee of future gains in mortgage game. (Corporate Focus).

THREE years of falling interest rates have meant a windfall for a little-known Santa Monica company that invests in the arcane area of mortgage-backed securities.

Shares of Anworth Mortgage Asset Corp. have risen 28 percent over the past year, to $15.09 on May 28. Analysts warn, however, that the strong performance, which started in January 2001 when the Federal Reserve first began easing short term interest rates, may be coming to an end.

"The door is definitely closing," said Merrill Ross, an analyst at Friedman Billings Ramsey Group, which served as an underwriter in May of a public offering of Anworth stock. "It is very definitely a bear market play."

Anworth has fewer than 10 employees and an executive team that also runs a private money management firm.

Structured as a real estate investment trust, Anworth owns and manages a portfolio of adjustable-rate and fixed-rate mortgage-backed securities.

The company has raised nearly $400 million in four public offerings since 1998. It invests the money in mortgage-backed securities, then borrows against the securities and reinvests in longer-term securities.

"They're borrowing short-term and investing in assets that are slightly longer term, so they make money on the spread," said David Chiaverini, an analyst at Advest Inc. in New York.

Anworth and similar companies serve a critical role in providing liquidity to the mortgage market by purchasing pools of mortgages from Fannie Mae and Freddie Mac, the government-sponsored entities that buy mortgages from lenders and encourage home ownership.

The company went public five years ago, about the same time as a number of competitors -- including Annaly Mortgage Management Inc., Apex Mortgage Capital Inc. and Redwood Trust Inc. These companies stepped in to fill a void left by traditional owners of residential mortgages such as Countrywide Financial Corp. and Washington Mutual Inc., which exited the market looking for higher profits.

The danger for Anworth is if interest rates don't cooperate, the spreads on their investments can diminish, or even disappear altogether, along with any profits.

Under the REIT structure, nearly all of those profits are passed through to investors as dividends so Anworth can avoid paying a corporate income tax. But the dividends are already starting to drop.

In April, the company lowered its quarterly dividend to 45 cents, from the 50 cent level it had been paying the previous four quarters.

Lloyd McAdams, 57, Anworth's chairman, president and chief executive, said stockholders are still happy with the dividend -- yielding 11.9 percent as of last week -- considering Treasury bond yields are at 5 percent.

"Our job is to manage the risk," McAdams said. The company created its own computer model to manage the investment portfolio, he said.

Family ties

Anworth Mortgage shares its offices with another firm McAdams co-founded and chairs, Pacific Income Advisors in Santa Monica. The privately held firm manages Anworth Mortgage's portfolio of mortgage-backed securities.

The firms' ties date back to 1997, when McAdams, who was running a mortgage industry consulting firm, Anworth Advisory, was approached by investment bankers at Advest Inc. urging him to start a new company.

On the day it went public in 1998, Anworth Mortgage purchased Anworth Advisory for $3.2 million.

The ties extend to family as well.

In addition to McAdams' $1.8 million in salary and bonus in 2002, his son, Joseph McAdams, earned $1.3 million. At 34, the younger McAdams is Anworth's chief investment officer.

McAdams, who co-founded Pacific Income Advisors 15 years ago, married that company's chief executive, Heather Baines, in 1995.

Analysts note that the McAdams' compensation is far lower than what portfolio managers make at hedge funds.

"The kind of returns these three executives are earning today are reflecting the fact that the return on equity for the business are at the widest level they've been," said Ross. "There will be a downside as well."

Anworth Mortgage Asset Corp.

YEAR (Dec. 31)                2002   2001

Revenue (millions)           $66.8  $10.8
Total Expenses (millions)     35.2    7.1
Operating Income (millions)   31.7    3.7
Net Income (millions)         31.7    3.7
Earnings Per Share           $1.81  $1.52

SUMMARY

Business: Real estate investment trust

Headquarters: Santa Monica

CEO: Lloyd McAdams

Market Cap: $479 million Dividend Yield: 11.9%

Total Liabilities: $2.5 billion P/E Ratio: 8.7

Long-Term Debt: $0

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