Hatteras Financial : Announces Fourth Quarter and Full Year 2015 Financial Results

Hatteras Financial Corp. (NYSE: HTS) (“Hatteras” or the “Company”) today announced financial results for the quarter ended December 31, 2015.

Fourth Quarter 2015 Highlights

• Comprehensive income of $0.08 per weighted-average common share
• Core earnings of $0.45 per weighted-average common share
• Dividend of $0.45 per common share
• Quarter end book value of $19.38 per common share
• GAAP leverage of 6.3 to 1 at period end
• Effective leverage of 7.6 to 1 at period end
• Weighted-average constant prepayment rate (“CPR”) of 17.2 for the quarter
• Repurchased 1,069,400 common shares at a weighted average price of $13.53 per share

Full Year 2015 Highlights

• Comprehensive loss of $0.80 per weighted-average common share
• Core earnings of $1.95 per weighted-average common share
• Dividend of $1.90 per common share
• Closed on the Pingora acquisition August 31
• Executed the Company’s first whole loan securitization
• Purchased $259 million of mortgage servicing rights (“MSR”)

Fourth Quarter 2015 Results

For the quarter ended December 31, 2015, the Company had comprehensive income (loss) available to common shareholders of $7.4 million, or $0.08 per weighted-average common share, as compared to $(84.9) million, or $(0.88) per weighted-average common share, for the quarter ended September 30, 2015. The change in comprehensive income available to common shareholders was largely due to the volatility in the interest rate markets in the third quarter, when the value of the Company’s hedges changed disproportionately to the increase in the Company’s investments. For the quarter ended December 31, 2015, the Company had core earnings of $0.45 per weighted-average common share, unchanged from $0.45 per weighted-average common share during the quarter ended September 30, 2015. Due to the continued diversification of the Company’s investments, the composition of core earnings reflected a smaller mortgage-backed securities (“MBS”) portfolio and a larger MSR position. The Company purchased $88 million of MSR on conforming loans during the quarter from Pingora’s flow purchase partners.

“While 2015 was a challenging year, the introduction of mortgage servicing rights and mortgage credit to our portfolio will enhance our ability to manage risk more comprehensively and to position the business going forward,” said Michael R. Hough, the Company’s Chairman and Chief Executive Officer. “Combined with share repurchases, we expect these new revenue sources to diversify our portfolio, lessen our exposure to interest rate and basis risk and create long-term shareholder value.”

Net interest margin for the quarter ended December 31, 2015 was $56.1 million, compared to $51.7 million for the quarter ended September 30, 2015. The Company’s net interest spread increased to 1.42% for the fourth quarter of 2015 compared to 1.19% for the third quarter, driven by higher portfolio yield. The yield on the Company’s interest-earning portfolio increased to 1.97% in the fourth quarter compared to 1.77% in the third quarter from owning higher coupon assets combined with a decrease in premium amortization as prepayments slowed. Average interest-earning portfolio yield including to-be-announced (“TBA”) dollar roll income was 2.00% in the current quarter, up from 1.86% in the third quarter. Effective net interest margin, which includes certain adjustments related to derivatives as well as TBA dollar roll income as detailed later in this release, was $49.0 million for the fourth quarter of 2015 as compared to $54.2 million for the third quarter due to a decline in the average size of the Company’s portfolio. Effective interest rate spread was 0.82% for the quarter ended December 31, 2015, up from 0.80% for the previous quarter.

The Company’s average financing rate was 0.47% in the fourth quarter of 2015, compared to 0.43% in the third quarter. The Company’s effective cost of funds, which includes certain adjustments related to derivatives, was 1.18% for the fourth quarter as compared to 1.06% for the third quarter. Total expenses excluding Pingora’s servicing expenses and reduced by expense recoveries from third parties were $14.4 million for the fourth quarter as compared to $10.3 million in the third quarter. This increase was largely due to inclusion of a full quarter of Pingora’s operating expenses as compared to only one month of such expenses in the third quarter, and due to $1.5 million of deal costs related to the non-agency securitization completed in the fourth quarter. The annualized operating expense ratio was 2.60% of average shareholders’ equity for the quarter ended December 31, 2015 as compared to 1.78% for the quarter ended September 30, 2015. The following table breaks out fourth quarter expenses by asset class, on the basis just described:

Dividend

The Company declared a dividend of $0.45 per common share with respect to the quarter ended December 31, 2015, unchanged from the previous quarter ended September 30, 2015. Based on the closing share price of $13.15 on December 31, 2015, the fourth quarter dividend equates to an annualized yield of 13.7%.

Portfolio

The Company’s weighted-average earning assets, consisting of residential mortgage assets, primarily MBS issued by Fannie Mae and Freddie Mac, were $18.1 billion for the quarter ended December 31, 2015 compared to $19.9 billion for the quarter ended September 30, 2015. The fair values of the Company’s earning assets as of December 31, 2015 and September 30, 2015 are summarized below.

During the fourth quarter of 2015, the expense of amortizing the premium on the Company’s securities was $24.9 million, compared to $33.5 million during the third quarter. The weighted-average principal repayment rate (scheduled and unscheduled principal payments as a percentage of the weighted-average portfolio, on an annualized basis) on the Company’s securities during the fourth quarter of 2015 was 23.4%, compared to 29.0% during the third quarter. The Company’s weighted-average one-month CPR on securities for the quarter ended December 31, 2015 was 17.2, down from 21.1 for the quarter ended September 30, 2015. CPR measures the unscheduled repayment rate as a percentage of principal on an annualized basis.

At December 31, 2015, the Company owned 15-year TBA securities financed in the dollar roll market with a fair value of approximately $2.7 billion, as shown in the table above. The Company accounts for TBA securities as derivative instruments and recognizes dollar roll gains and losses in other income (loss) in the Company's financial statements. As of December 31, 2015, the Company's net TBA securities had a cost basis of approximately $2.7 billion and a net carrying value of $(32.4) million reported in derivative liabilities at fair value on the Company's balance sheet. The Company uses dollar rolls as alternative financing for its 15-year fixed-rate positions.

The Company earned interest of $2.2 million for the quarter ended December 31, 2015 from prime jumbo ARM loans held for investment, on an average unpaid principal balance of $309.1 million. For the third quarter of 2015, the Company earned $1.8 million of interest from prime jumbo ARM loans, on an average unpaid principal balance of $212.8 million. The Company owned $343.8 million of these loans at December 31, 2015, up from $265.3 million owned as of September 30, 2015. The loans had an average size of $762,000, a weighted-average interest rate of 3.42% and a weighted-average loan-to-value of 70% (at origination) as of December 31, 2015.

The Company began investing in MSR through Pingora in July 2015. For the three months ended December 31, 2015, the Company earned gross servicing fee income of $15.5 million on an average MSR balance of $199.6 million as compared to $4.6 million of gross servicing fee income in the third quarter on an average MSR balance of $62.5 million. All of the Company’s MSR investments pertain to agency MBS, spanning all three government owned or sponsored enterprises.

Portfolio Financing and Leverage

At December 31, 2015, the Company financed its portfolio with approximately $13.6 billion of borrowings, primarily under repurchase agreements. The Company’s debt-to-shareholders’ equity ratio at December 31, 2015, was 6.3 to 1 compared to 6.5 to 1 at September 30, 2015. The Company’s effective leverage, which includes the effects of TBA dollar roll financing, was 7.6 to 1 at December 31, 2015, down from 7.8 to 1 as of September 30, 2015. Weighted-average effective leverage in the fourth quarter of 2015 was 7.5 to 1, down from 8.0 to 1 for the third quarter of 2015. At December 31, 2015, the Company’s repurchase agreements had a weighted-average remaining term of approximately 28 days.

The Company uses interest rate swap agreements and Eurodollar futures contracts to synthetically extend the fixed interest period of these liabilities and hedge against the interest rate risk associated with financing the Company’s portfolio. From time to time, the Company also enters into swaptions (option agreements to enter swaps at future dates) as part of its hedging strategy. See Tables 8 through 10 for detailed information regarding these positions as of December 31, 2015.

Book Value

The Company’s book value (shareholders’ equity less preferred stock liquidation preference) per share on December 31, 2015 was $19.38, decreasing from $19.69 on September 30, 2015 primarily resulting from a modest decrease in asset prices. On a per share basis, book value at December 31, 2015 consisted of $25.36 of common equity, $(7.01) of retained losses, $1.02 of unrealized gains on agency securities including TBA securities, and $0.01 of unrealized losses on interest rate swaps. This last item relates to the unamortized balance of the Company’s interest rate swaps remaining from when the Company accounted for these derivatives as cash flow hedges and does not include changes related to other derivatives, which flow through earnings.

Common Share Repurchases

During the three months ended December 31, 2015, the Company repurchased 1,069,400 shares of its common stock in the open market under its previously-announced Stock Repurchase Program. These shares were purchased at a weighted-average price, after commissions and fees, of $13.53. For the year ended December 31, 2015 the Company repurchased 1,443,283 common shares at a weighted-average price of $14.38 per share after fees and commissions. Subsequent to December 31, 2015, the Company repurchased an additional 1,273,625 common shares at a weighted-average price of $11.60 per share after fees and commissions.

Full Year 2015 Results

The Company had comprehensive loss of $77.4 million or $0.80 per weighted-average common share for the year ended December 31, 2015, compared to a comprehensive income of $248.3 million or $2.57 per weighted-average common share for the year ended December 31, 2014. The decline was primarily driven by the unfavorable swing in fair value adjustments on the Company’s MBS portfolio, which are presented in other comprehensive income. The Company had net income of $29.7 million or $0.31 per weighted-average common share for the year ended December 31, 2015, compared to net $34.4 million or $0.36 per weighted-average common share for the year ended December 31, 2014.

Core earnings were $1.95 for 2015, down from $2.37 for 2014, both on a weighted-average common share basis. The decrease was driven by a lower yields on the Company’s average interest-earning portfolio, which was 1.91% during 2015 as compared to 2.09% during 2014, along with lower earnings from TBA securities financed in the dollar roll markets. The most significant factor to the decline in portfolio yield was higher premium amortization due to higher prepayment levels. The average MBS portfolio repayment rate was 24.98% for the year ended December 31, 2015 as compared to 20.93% for the year ended December 31, 2014.

For the year, the Company distributed $1.90 per common share for 2015. Book value per common share at December 31, 2015 was $19.38 compared to $22.05 at December 31, 2014 a decrease of 12.1%.

Conference Call

The Company will host a conference call at 10:00 a.m. ET on Wednesday, February 17, 2016, to discuss financial results for the quarter ended December 31, 2015. A slide presentation will accompany the call and will be available prior to the call here or by going to the Company’s website at www.hatfin.com and selecting “presentations” from the “news and presentations” tab. Select the Q4 2015 Earnings Presentation link to download and/or print the presentation in advance of the call. To participate in the event by telephone, please dial (877) 507-4471 five to 10 minutes prior to the start time (to allow time for registration) and ask to join the “Hatteras Financial” conference call. International callers should dial (412) 317-6040. Canada callers should dial (855) 669-9657. A digital replay of the call will be available on Wednesday, February 17, 2016 at approximately 12:00 noon ET through Thursday, February 25, 2016 at 9:00 a.m. ET. Dial (877) 344-7529 and enter the conference ID number 10080542. International callers should dial (412) 317-0088 and enter the same conference ID number. Canada callers should dial (855) 669-9658. The conference call will also be webcast live over the Internet and can be accessed at Hatteras' web site at www.hatfin.com. To monitor the live webcast, please visit the web site at least 15 minutes prior to the start of the call to register, download, and install any necessary audio software. An audio replay of the event will be archived on Hatteras' web site.

About Hatteras Financial Corp.

Hatteras Financial is a real estate investment trust formed in 2007 to invest in residential mortgage real estate assets. Based in Winston-Salem, N.C., Hatteras is managed and advised by Atlantic Capital Advisors LLC. Hatteras is a component of the Russell 2000® and 3000® indexes.

Non-GAAP Measures

In addition to the Company’s results presented in accordance with GAAP, this press release includes certain non-GAAP financial information. Management’s decision to present these supplemental non-GAAP measures arose largely from three developments during 2013: 1) the Company’s cessation of hedge accounting for its interest rates swaps effective September 30, 2013, 2) increased use of Eurodollar futures contracts as interest rate hedges, and 3) the Company’s use of TBA dollar rolls, which generate non-traditional investment income and embody off-balance sheet financing. These changes, along with the Company’s election of the fair value option with respect to accounting for mortgage loans and MSR, result in the recognition of material fair value adjustments in net income, as well as line item classifications that make it difficult to clearly explain the economics of the Company’s results and strategies without supplemental disclosures. The non-GAAP measures the Company employs include effective interest expense, effective net interest margin, amortization on MSR, core earnings, and certain financial metrics derived from non-GAAP information, such as effective cost of funds and effective leverage. Effective interest expense and effective net interest margin each represent their respective GAAP measure adjusted for certain derivatives impacts as well as TBA dollar roll income. Amortization on MSR represents the portion of the change in MSR fair value that is attributable to the realization of cash flows, and is a non-GAAP measure because the Company accounts for MSR under the fair value option. Core earnings is effective net interest margin plus MSR income net of amortization, management fee income and gain from mortgage loans held for sale, less adjusted operating expenses and dividends on preferred stock. For purposes of core earnings, operating expenses are adjusted to exclude transaction expenses, amortization of intangibles stemming from business combinations, and the change in the Company’s representations and warranties reserve. Reconciliations of these non-GAAP measures to their nearest directly comparable measure calculated in accordance with GAAP are included below.

The Company uses these measures internally to assess its results and financial condition. Therefore, the Company believes that providing these measures gives users of financial information additional clarity regarding its performance and financial condition, and better enables them to see “through the eyes of management.”

These measures involve differences from results computed in accordance with GAAP, and should be considered supplementary to, and not as a substitute for, the Company’s results computed in accordance with GAAP. Further, the Company’s definition of these non-GAAP measures may not be comparable to other similarly-titled measures of other companies.

Forward-Looking Statements

This press release, together with other statements and information publicly disseminated by the Company, contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The Company intends such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 and includes this statement for purposes of complying with these safe harbor provisions. Forward-looking statements, which are based on certain assumptions and describe the Company's future plans, strategies and expectations, are generally identifiable by use of the words "believe," ”will,” "expect," "intend," "anticipate," "estimate," ”should,” "project" or similar expressions. You should not rely on forward-looking statements since they involve known and unknown risks, uncertainties and other factors that are, in some cases, beyond the Company's control and which could materially affect actual results, performances or achievements. Forward-looking statements in this press release include, among others, statements about economic conditions, interest rates, the Company’s risk strategies and exposures, the Company’s investments in MBS, MSR and prime jumbo ARMs, and share repurchases under the Company’s Stock Repurchase Program. Factors that may cause actual results to differ materially from current expectations include the risk factors discussed in the Company’s most recent Annual Report on Form 10-K and Quarterly Reports on Form 10-Q. Accordingly, there is no assurance that the Company's expectations will be realized. Except as otherwise required by the federal securities laws, the Company disclaims any obligation or undertaking to publicly release any updates or revisions to any forward-looking statement contained herein (or elsewhere) to reflect any change in the Company’s expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.

⁽¹⁾ The consolidated balance sheet as of December 31, 2015 includes $227,444 of assets of a consolidated collateralized financing entity (CFE) that can only be used to settle obligations of the CFE as well as liabilities of $58,228 of the CFE for which creditors do not have recourse to Hatteras Financial Corp.

⁽¹⁾ This table includes non-GAAP financial measures. See the earlier section on non-GAAP Measures for important disclosures, as well as Tables 12 and 13 which contain reconciliations to the most comparable U.S. GAAP measures.

⁽²⁾ The averages presented herein are computed from the Company’s books and records, using daily weighted values. Percentages are annualized, as appropriate.

⁽³⁾ Average interest-earning portfolio yield, including TBA dollar roll income was calculated the same as average interest-earning portfolio yield other than to include TBA dollar roll income in the numerator and the Company’s average TBA dollar roll position in the denominator.

⁽⁴⁾ Effective interest expense includes certain interest rate swap adjustments and gains/losses on maturities of Eurodollar futures. Effective cost of funds is effective interest expense for the period on an annualized basis divided by average debt for the period. See Table 12.

⁽⁵⁾ Effective net interest margin includes certain interest rate swap adjustments, gains/losses on maturities of Eurodollar futures and TBA dollar roll income. See Table 13.

⁽⁶⁾ Effective interest rate spread is the difference between average interest-earning portfolio yield including TBA dollar roll income and effective cost of funds for the period.

⁽⁷⁾ Core earnings consists of effective interest margin plus MSR income net of amortization, management fee income and gain from mortgage loans held for sale, reduced by adjusted operating expenses and dividends on preferred stock for the period. See Table 13.

⁽⁸⁾ The debt to paid-in capital ratio was calculated by dividing outstanding borrowings at period end by the sum of the par value of the Company’s common stock and additional paid-in capital at period end.

⁽⁹⁾ The effective debt to equity ratio was calculated the same as the debt to equity ratio other than to include the Company’s off-balance sheet TBA dollar roll liability at period end in the numerator. The Company’s off-balance sheet TBA dollar roll liability was $2,730,705 as of December 31, 2015.

Fixed

(1) Reduced by ($2,367) and ($520) of MSR fair value change that represents estimated amortization of the MSR asset for the three months ended December 31, 2015 and September 30, 2015.

(2) Excludes gain (loss) on mortgage loans held for investment.

(3) Excludes ($1,730) of transaction expenses related to the Company’s acquisition of Pingora and the Company’s whole loan securitization, ($568) of amortization of intangible assets, and ($478) of change in representation and warranty reserve on MSR for the three months ended December 31. Excludes ($805) of transaction expenses related to the Company’s acquisition of Pingora, ($189) of amortization of intangible assets, and ($290) of change in representation and warranty reserve on MSR for the three months ended September 30, 2015. Excludes transaction expenses of ($916) related to the Company’s acquisition of Pingora for the three months ended June 30, 2015.

(1) Reduced by ($2,887) of MSR fair value change that represents estimated amortization of the MSR asset for the twelve months ended December 31, 2015.

(2) Excludes gain (loss) on mortgage loans held for investment.

(3) Excludes ($3,451) of expenses related to the Company’s acquisition of Pingora and the Company’s whole loan securitization, ($757) of amortization of intangible assets, and ($768) of change in representation and warranty reserve on MSR for the twelve months ended December 31, 2015.

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