Q3 2020 Arlington Asset Investment Corp Earnings Call

[music].

Good morning, I would like to welcome everyone to the Arlington asset third quarter 2020 earnings call.

Please be aware that each of your line is in a listen only mode.

After the company's remarks, well open the floor for questions.

If youd like to ask a question. Please press the star key followed by the one key on your Touchtone phone and.

If you'd like to relieve yourself from the questioning queue. Please press star team.

I'd like to now turn the conference over to Richard Konzmann Mr. Konzmann you may begin.

Thank you very much and good morning, Rich gossiping, Chief financial officer of Arlington asset.

Before we begin this morning's call I would like to remind everyone that statements concerning future financial or business performance market conditions business strategies or expectations and any other guidance on present for future periods constitute forward looking statements are subject to a matter of factors risks and uncertainties that might cause actual results could differ materially.

Okay from stated expectations or current circumstances. These forward looking statements are based on management's beliefs assumptions and expectations, which are subject to change risk and uncertainty as a result of possible events or factors.

These and other material risks are described in the company's annual report on form 10-K, and other documents filed by the company with the FCC from time to time.

Which are available from the company and from the FCC and you should read and understand these risks when evaluating any forward looking statement.

I would now like to turn the call over to rock Tonkel for his remarks.

Sure Rich good morning, and welcome to the third quarter 2020 earnings call for Arlington asset also joining me on the call today is John Murray our portfolio manager.

Continued federal monetary and fiscal support contributed to improved economic conditions on a risk on investor sentiment during the quarter risk asset prices rallied with the equity markets continuing to strengthen and credit spreads on most fixed income asset classes tightening against the backdrop of muted interest rate volatility during.

The quarter.

With low interest rate volatility and ongoing federal reserve balance sheets support agency mortgages performed well during the third quarter three.

Repo funding for agency MBS readily available at attractive funding costs investing in Levered agency MBS continues to be an appealing investment opportunity for the company.

However, certain investment risks continue to exist, including the uncertain path of prepayments in a low rate environment and higher pay up premiums embedded in the current price pricing of specified pools.

Along with most fixed income products mortgage credit asset values generally increased during the third quarter, reflecting overall tightening of credit spreads with the improved economic outlook.

Supported by favorable housing supply dynamics, low mortgage rates and stabilization of delinquencies residential mortgage credit asset prices strengthened during the quarter.

Commercial mortgage credit performance was mixed during the quarter as the economic impact of the pandemic has more adversely impacted certain commercial asset classes than others.

In the current environment. The company's focus is to grow earnings in the near term and raise overall returns to shareholders over time through investments in agency MBS credit and other financial asset classes, which offer attractive returns today in.

In addition to securing multiple income sources, which diversify risk and improve the level and reliability of returns.

The comedy seeks to maintain a stable financial position by keeping leverage low and financial flexibility high while using termed non margin financing structures were available.

To protect against higher interest rates and simultaneously permit underlying asset values to rise with lower rates.

Such a posture provides the company flexibility through volatile periods and the ability to be opportunistic and nimble in approaching potential investments.

Further the company is focused on creating asset partnerships or platforms, where possible to promote predictability of investment flows growth and compounding value creation opportunities that layer on top of the current income returns embedded in the company's investments generally.

During the third quarter agency MBS in certain mortgage credit sector satisfied each of the companys portfolio objectives.

However, as expected future returns on some mortgage credit segments within the company's portfolio have tightened as a result of appreciation.

The company is evaluating investment opportunities in MSR related investments.

As well as real estate opportunities and other financial asset types, which may meet the company's objectives for low leverage robust returns.

Diversification of risk as well as attractive financing structures.

Turning to the actual results for the quarter. The company reported GAAP net income of 12 cents per share and non-GAAP core operating income of three cents per share. The company's book value was $5.92 per share as of September thirtyth of 5.2% improvement from last quarter as both its agency MBS.

Mortgage credit investment strategies experienced positive performance.

The company maintained a low leverage profile with net repo financing to investable capital ratio at 1.5 to one as of September Thirtyth and returned capital to shareholders through accretive stock repurchases during the third quarter at significant discounts to book value.

During the third quarter, the company repurchased 5.8% of its outstanding common stock at an average repurchase price of $2.80 per share.

The company will evaluate future common stock dividends on a quarterly basis based on multiple factors, including opportunities to return capital to shareholders through accretive stock repurchases overall economic and market conditions available returns on new investments ongoing liquidity needs and the REIT distribution requirements.

The company does not expect to have any further REIT distribution requirements for 2020.

The company was encouraged by the performance of both its agency MBS and mortgage credit investment portfolios during the third quarter as both physicians benefited from spread tightening and attractive investments made during the quarter.

While continuing to operate with overall low leverage and financial flexibility as of September Thirtyth. The comedies Investable capital is allocated 69% to its agency mortgage strategy and 30 for 31% to mortgage credit investments.

Although lower repo funding costs have benefited returns and Levered agency MBS investments bond prices continued to be relatively expensive due to the federal reserve's ongoing support through its substantial purchases of agency MBS.

Within its agency MBS investment portfolio the content. The company continues to decrease its allocation to higher coupon securities during the third quarter.

And as elevated prepayment speed expectations have significantly diminished the return opportunities in this end of the coupon stack. The company currently sees greater return opportunities in the lower coupon agency mortgages with available Levered returns in the high single digits.

The company's mortgage credit investments currently consists of a diversified portfolio of financings collateral by collateralized by mortgage servicing rights business purpose residential mortgage loans commercial mortgage loans and residential mortgage loans.

Here the company is actively pursuing investment opportunities across various asset classes.

It it believes will generate high risk adjusted returns with the potential for greater value creation for shareholders overtime.

The comedy continues to see attractive return opportunities in the mortgage servicing rights sector.

Current purchase price multiples for mortgaging servicing rights are attractive as the company believes the future performance of MSR will exceed the implied prepayment expectations and the anticipated servicer advance requirements embedded in current MSR values, while also offering appreciation potential associated.

With any further retracement back toward free cobot MSR multiple levels.

Although credit spreads on financing of mortgage servicing rights tightened during the third quarter along with other fixed income assets. The company continues to see opportunities in MSR financing investments as well.

However, in the MSR asset class the company sees higher risk adjusted returns by investing directly in mortgage servicing rights.

The company made progress during the quarter towards a partnership that could lead to direct economic investments in MSR with positive implications for returns on MSR investments and overall company returns going forward.

During the quarter business purpose residential loans offer, particularly attractive risk adjusted returns business person purpose residential mortgage loans are low LTV loans to professional real estate investors.

That are secured by a first lien position on non owner occupied residential real estate that generally requires construction repair overbid rehabilitation.

During the third quarter the company added to its business purpose loan portfolio with a first loss piece of a newly issued securitization for $11 million with an expected loss adjusted return on capital in the mid teens.

As a result of the Companys loss mitigation rights.

On the underlying loan collateral an option to purchase any significant any delinquent loans from the trust the company consolidates for financial reporting purposes, the underlying mortgage loan collateral and term notes issued by the trust. However.

The term notes issued by the trust have recourse only to the loan collateral of the trust with no economic recourse to the company.

The company does not currently have significant repo funding exposure and its mortgage credit investment portfolio as of September Thirtyth. The company did not have outstanding repo funny on any of its non agency MBS or MSR financing investments the companys sole funding exposure on its mortgage credit investment portfolio 'cause it.

So the $32 million repo funding for a commercial mortgage loan with strong credit statistics that has performed better than expected at origination has a repo funding maturity in August of 21 and has had no margin calls today.

Going forward the company will continue to limit its use of marginal repo funding for mortgage credit investments instead, the company will focus on financing mortgage credit investments either directly or indirectly through long term and non marginable financing structures.

The company has made solid progress toward establishing a portfolio comprised of multiple financial asset channels to provide diversification of risk in multiple income sources to raise overall returns to shareholders. We.

We expect to maintain a strong financial position highlighted by low leverage high financial flexibility and the use of term financing structures, where possible. In addition to its existing agency MBS and mortgage credit strategy the content and the company continues to evaluate additional mortgage credit real estate and other investment opportunities with a phone.

Focus on developing investment platforms, and strategic partners, where possible that will result in longer term enterprise value creation and provide a compounding opportunity that complements the current income embedded in the bulk of the company's investments.

This should enable the company to deliver a positive economic return to shareholders in the near term.

While retaining sufficient liquidity to be opportunistic and capture attractive investment opportunities that may arise across sectors as economic conditions evolve over coming quarters offer.

Operator, I would now like to open the call for questions.

Thank you at this time, we will open the floor for questions. If you would like to ask a question. Please press the star key followed the Doe one key on you touched on phones now questions will be taken in the order with Stanley. Steve is it any time, you would like to remind yourself from the question Keith just.

Yes, our team again star one if you would like to ask the question.

Our first question will come from Doug Harter with credit Suisse.

Hey, guys. This is Josh on for Doug.

Hi, Jon you saw the Cygnus, Hey rock Hayden.

We saw the buyback activity during the quarter I was wondering if you could talk a little bit about how you're thinking about the attractiveness of buyback versus paying out a dividend and then.

When we think about the expense base for the company can expense reduction keep up with an accelerated share buyback or how should we think about expenses as a percentage of equity going forward. Thanks.

Oh, great. Thanks, Josh So I think with the with the stock you know in the neighborhood of a recent prices.

It seems pretty clear to us that buyback is a more compelling opportunity then.

Dividending at this stage, particularly given that we don't.

I don't have a distribution requirement for the remainder of the year. So from a shareholder value creation standpoint, it seems to us that the better path is the repurchase versus the dividend.

And that's why you've seen the ongoing.

Scream of repurchases over the last couple of quarters.

And we have the benefit of you know as I've said, a stable financial position will grow.

Strong liquidity.

And flexibility in the balance sheet to be able to do that.

As to the expense base I'd say look there are some constraints there and how fast the.

Expense line can come down, but we've made good progress.

In.

Reducing the expense line and I think that there is room for more of that to occur.

And the next a year.

Over the course of this year and into next year and through next year. So I think that there are further opportunities for reductions on the cost side.

You know, whether those keep up or don't exactly keep up with the pace of buybacks will be dependent on what the market does with the stock and so you know the.

At the pace that we've been on I think you know expense reductions can can reasonably keep pace with that sort of type activity, but to the extent there is any acceleration there that may be more challenging except over the longer term, but I do see the possibility of further expense reductions over the next 12 months.

That will be helpful in reducing the.

Burden on the capital and improving returns to shareholders by by so doing.

Okay makes sense and then any update on how book value is trending so far in the fourth quarter. Thank you.

I'd say, so far our book value is up by a point or two we've had a couple of spots of good performance in the portfolio and some other factors that have been helpful in and pushing the book value of <unk>.

Somewhat during the course of October.

Great. Thanks Chuck.

Thank you. Our next question will come from Jason Stewart with Jones trading.

Hey, good morning, and good morning rock Thanks for the question.

On the agency side I was wondering if you could give a little bit of commentary with regard to the origination environment. How do you think that plays out with regard to spec pool pay ups.

As we get through this seasonally slow period of time.

Great. Thanks, I'd say, we continue to be pretty significantly invested on the spec pool side.

For pretty obvious reasons the the.

Protection from the prepayment.

Speeds, which have been volatile and I don't think we really expect them to the pattern of them to change materially or we would expect them to remain relatively high a and a bit uncertain. So on the one hand, we like the we like the.

The protection offered by the spec pools, but at the margin you know they have gotten to be a quite expensive and so.

I wouldn't be surprised if if if you see us be a little bit more active on the role in the fourth quarter. They maybe than we were proportionately in the third quarter and Ah and so I think you know it wouldn't surprise me if between now and the end of the quarter, depending on our role plays out for the rest of the year if.

If we were to be in the end more active on the roll side.

Oh, you know proportionally in the portfolio and maybe at the margin.

Emphasize disconnects I'd just a touch here in the <unk> in these conditions.

Great. That's that's helpful. Thank you and on the credit portfolio, how much the H.P.A. play into the thesis on the credit side.

Were really not relying on.

The H.P.A. side terribly notch I'd say that you know if it has any involvement in that equation it's modest.

We feel like the credit investments, we've made to date stand on their own two feet based on where you know H.P.A. where housing prices are today to the extent, we continue to see some appreciation great. We've got more protection in those most of those in those assets to the extent that were.

You know reviewing other real estate opportunities you know as I mentioned in the script and then that HP a factor will come a bit more into play. So for example, a we have spent a lot of time over over the last months are taking a hard look at single family rentals. That's.

Segment seems to have some compelling characteristics to it both from a carry.

Kerry retiring, but also a total return character characteristic including H.P.A. or to your point on so in that calculation, we would expect there to be either very little or modest depreciation, but it really isn't the driver for our investment thesis in single family rental if we were to enter.

To that space.

But we do feel like those returns have become.

A more compelling I mean, we're not alone I don't think but.

We feel like those returns to become more compelling relative to some other alternatives EPS as spreads have tightened on CUSIP securities and and rates have remained very low. So absolute returns are are more modest and therefore, I think single family rental and MSR for that matter a stand out as having out.

Sort of Outdistance return potential in this in this environment.

Right.

I'll jump out after this last question on the MSR side and you it.

Can you share any details on how you think about recapture and when you entered these agreements on the MSR side.

With rates, where they are it seems to be that you know one of the driving forces of returns is how much you can negotiate on the recapture side.

You know, it's a it's a very important aspect of it and and to the extent that as I said in the in the in the script, we made progress on a per.

Potential partnership in that regard then that partner a we'd be working very closely with that partner to maximize the the recapture on that portfolio.

Okay.

Thank you for the questions appreciate it.

You bet. Thank you Jason.

[noise], Christopher Nolan with Ladenburg Thalmann.

Hey, guys.

Brock is the Akron.

Fourth quarter to date is the investment mix in terms of capital allocation sort of staying weighted towards the agency investments.

Oh, I'd say in the fourth quarter, so far it's probably not much different than what we stated in the script I think in the script. We said it was about two thirds one third.

And I'd say, it's not terribly different at this stage versus that stage.

Okay, and then I guess.

The lower CPR in the quarter is that simply just a function of going to lower coupon agency RMBS.

Yes.

Exactly.

Great and then.

I noticed that the deck does not have the traditional metrics you guys provide like net interest margin funding cost and all that stuff. So you know new feature times. If you guys can consider putting us back they'd be great.

Parent and a lot of that will be in the.

Thank you as well.

Understood understood, but it's helpful. Before the call to have that stuff Handy final question, Rob just a clarification your <unk> outlook for leverage.

It seems to me that you're indicating that you want to keep the leverage levels relatively low.

Below two times, but did I hear you correctly or misinterpret that yeah, I don't I think in general you heard me correctly I don't I don't put a a particular part number on it Chris but I think Ah.

Just as we saw a slight migration in the from the third from the second quarter to third quarter, we may see a slight migration, but generally as I've said repeatedly through the scripted.

From our perspective, Paramount to maintain a a low leverage and high financial flexibility.

On the balance sheet, and where we will continue to seek to do that so I think that means.

You know there may be some modest expansion in leverage, but I don't expect it to be a substantial.

Okay. That's it for me thank you.

And to the point I made in the script, we're seeking to use structural leverage where possible versus repo leverage and so we.

We would first be if we were increasing leverage it would first be done through that feature versus.

Though if if if that where it all achievable.

Yeah, No I think they echoes what you've said in past quarters for this current strategy on mortgage credits.

Yep.

Thank you.

Thank you.

Mr. <unk> at this time there are no more questions.

Okay, well. Thank you very much everyone. We appreciate it if you have any follow on pleased to reach out. Thank you very much have a good day.