Q2 2021 Arlington Asset Investment Corp Earnings Call
[music].
Good morning, I'd like to welcome everyone to the Arlington asset second quarter 2021 earnings call. Please be aware that each of your line is in a listen only mode. After the company's remarks, he will open the floor for questions.
You'd like to ask a question. Please press the star key followed by the <unk> that is star 1 on your Touchtone phone, if you'd like to remove yourself from the questioning queue. Please press star 2 and now I'd like to turn the conference over to Richard Carson.
Sir Please go ahead.
Thank you very much and good morning, rich content and Chief financial Officer of Arlington asset before we begin this mornings call I would like to remind everyone that statements concerning future financial and business performance market conditions business strategies or expectation and.
And any other guidance on present or future periods constitute forward looking statements that.
And that are subject to a number of factors risks and uncertainties that might cause actual results to differ materially from day to expectation for 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 weighted with the SEC from time to time.
Which are available from the company and from the SEC 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 <unk> for his remarks.
Thank you rich good morning, and welcome to the second quarter of 2021 earnings call for Arlington asset also joining me on the call today is John Murray our portfolio manager.
During the second quarter and federal reserve struck a more hawkish tone and its June meeting leading to market concerns that it may begin to taper its bond purchases and raise interest rates sooner than previously expected, which rallied the 10 year U S treasury rate, almost 30 basis points and both flattened yield curve.
Against this backdrop agency mortgage spreads widened and swap spreads tightened during the second quarter.
And an improving economy residential mortgage credit spreads tightened and home price appreciation continued its strong annual growth during the second quarter supported by favorable supply demand dynamics.
The company's long term strategy is to construct and investment portfolio with multiple sources of income, which complement our historical agency MBS portfolio diversify risk and improve the level and reliability of returns.
Over time, the company expect to complement its allocation of capital and agency mortgages by.
And by redeploying capital into its other targeted segments, including mortgage servicing rights mortgage credit and other asset classes.
We expect to maintain a strong stable and liquid financial position by keeping leverage low and financial flexibility high.
While utilizing term financing structures where available.
In addition, the company is focused on creating proprietary partnerships for our platforms where possible to promote the predictability of cash flows.
Growth and the potential for compounding value creation opportunities layer on top of the current investment returns embedded and the company's investments.
During the second quarter the company made solid progress towards these goals by reallocating capital into both its MSR and mortgage credit strategies as of June 30, the company's investable capital was allocated 39% to agency mortgages.
5% to mortgage servicing rights and 36% to mortgage credit.
As discussed on our prior earnings call. The company has a strategic relationship with a licensed GSE approved servicer.
It enables the company to garner the economic return of and investment and mortgage servicing rights without holding the requisite license directly.
Under the terms of our partnership the company provides capital to our partner to purchase MSR is directly.
And the company and turn receives all the economics of the MSR lesser fee payable to our partner.
At our option and direction our partner has the capacity to add leverage the increased potential returns to us. Although the company has not utilized any leverage through its committed facility on its MSR investment portfolio to date.
We believe this efficient cost effective and lower risk channel for investing and the economics of mortgage servicing rights differentiates Arlington.
Our MSR investment portfolio has produced strong returns year to date through June 30, and despite the significant fall and long term interest rates and valuation multiples on mortgage servicing rights have been resilient declining only slightly during the second quarter.
During the quarter the company made $39 million of new related MSR related investments growing at the MSR investment portfolio to $75 million.
Or 25% of our investable capital as of quarter and.
Subsequent to June 30, we have invested an additional $14 million and MSR related assets.
Newly created mortgage servicing rights of Fannie Mae and Freddie Mac loans currently offer attractive return opportunities and.
And provide a strong complement to agency MBS investment characteristics at current purchase price multiples of approximately 4 times for current coupon Msr's Unlevered.
Unlevered MSR investments offer base returns and the high single digits.
Furthermore, msr's generally increase and value as interest rates rise.
Agency durations extend and or mortgage spreads widened.
Turning to Levered agency MBS returns continue to benefit from low repo funding costs and ongoing federal reserve support against this backdrop. We are currently seeing available returns and the high single digits on Levered agency MBS with an appropriate hedge position.
However, a reduction and support from the Federal reserve could lead to further widening of agency mortgage spreads.
And the company continues to believe there is meaningful basis risk and agency MBS relative to the current spread return opportunity today, and therefore remains cautious about significantly increasing the leverage and capital allocation to.
Agency mortgage investment strategy.
Taken together and.
Corporate and a Levered agency MBS.
Investment with MSR investment combines investments with complementary characteristics decreases overall risk while increasing Roe.
Mortgage servicing rights tend to increase and value as mortgage rates rise and more specifically when durations on agency MBS extend this increase and value resulting from mortgage extension typically occurs when mismatches between Levered agency MBS and hedges are highest.
Furthermore, msr's offered attractive Standalone return and the high single digits and by reducing the need for swaps as a hedge for agency MBS and their associated costs.
MSR and provide a positive carry hedge for Levered Agency securities.
Replacing negative carry swaps with positive carry msr's current for the largest drag on Levered agency MBS returns.
And do a carry positive.
Going forward.
We would expect to replace components of our interest rate swap position.
On our agency MBS investment portfolio with Msr's as the company scales.
<unk> investments, thereby increasing combined returns by several hundred basis points into the low double digits, while improving the protection for the company's capital.
The underlying credit performance of the company's mortgage credit investments produced solid results during the second quarter supported by strong economic environment.
Subsequent to quarter and the company received full repayment of its largest mortgage credit investment.
1 that was originated prior to the onset of the pandemic and delivered Levered returns of approximately 13%.
During the second quarter, the company made $58 million of new mortgage credit investments and continues to evaluate new opportunities that offer high risk adjusted returns, particularly potential opportunities and residential business purpose loans.
Okay.
Turning to the actual results for the quarter. The company reported book value of $5.94 per share as of June 30, a day.
Decline of 2.9% from the prior quarter and the.
The company continued to operate with low overall leverage and significant financial flexibility with and overall at risk leverage ratio of 2.2.
And to 1 as of June 30 for.
For the second quarter, the company reported a GAAP net loss of <unk> 24 per share and growth and operating income core operating income of <unk> <unk> per share from the prior quarter.
Order to a total of <unk> 7 per share.
During the second quarter, the company returned capital and.
Capital to shareholders through accretive stock repurchases by repurchasing 2.6% of its outstanding common stock.
Net accretive <unk> per share to book value.
Since June 30, the company repurchased an additional 1.1% of its outstanding common stock.
And that accretive and additional <unk> <unk> per share to book value.
The company has a large remaining authorization from its board to repurchase shares of its common stock and we will look to continue to return capital to shareholders by Opportunistically repurchasing shares of its common stock at accretive prices.
The company did not declare a dividend on its common stock for the second quarter.
The board of directors will continue to evaluate the payment of quarterly dividends on the common stock based on a multiple factors, including current earnings results overall market conditions liquidity needs available returns on new investments.
Opportunities to return capital to shareholders through accretive stock repurchases.
And REIT distribution requirements.
And July the.
The company successfully completed a public offering of $37.8 million of 5 year unsecured 6% senior notes using the proceeds to redeem.
It's 6 and 5.8 senior notes due in 2023 with an outstanding balance of $23.8 million.
The issuance allowed the company to both extend the maturity date and lower the interest rate of its debt, while also raising additional investable capital at an attractive cost.
Company has spent considerable time evaluating investment opportunities and single family rental that offer potential attractive long term returns supported by favorable supply demand dynamics are healthy U S home financing market and increasingly flexible term financing structures for institutional.
And level of single family residential investments.
We expect this favorable dynamic and U S single family rental homes to continue for some time as we believe the limited supply of new homes will likely not meet the growing demand of housing based unexpected demographic trends.
The company hopes to make significant progress towards adding this segment to our capital allocation channels and potentially investing in this asset class in the coming quarter.
Overall the company is very encouraged by the solid progress. It has made to date and the transition for its long term goals and is optimistic about its prospects going forward.
The company has taken positive steps towards its objective of complementing our core agency MBS portfolio with high return non.
<unk> non commodity quality investment channels, which provide diversification of risk.
Multiple income sources to raise overall returns to shareholders and offer sustainable ongoing investment flow.
During the second quarter, the scaling of our MSR channel provided improved protection from.
The portfolio from Asia agency, MBS rate and spread volatility.
And raised profitability appreciably.
As the company continues to expand its diversified investment strategies, we expect higher returns from these investments to provide increased earnings power over time, which can form the potential pathway for returning additional capital to shareholders as that deployment process occurs we expect to maintain a strong financial position.
<unk> highlighted by low leverage.
Hi, flexibility and the use of term financing structures, where possible and enabling the company to be opportunistic and capture attractive investment opportunities that may arise across sectors as conditions evolve and very importantly to sustain the ongoing ability to utilize its stock repurchase authority and deliver attractive returns.
Shareholders over time.
Thank you very much and operator, I would like to now open the call for questions.
Thank you Sir at this time, we will open the floor for questions. If you would like to ask a question. Please press the Starkey followed by the <unk> that is star 1 on your question from now.
Questions will be taken and the order, which they are received.
That any time, you would like to remove yourself from the question in queue. Please press star 2.
Thank you. Our first question comes from Trevor Cranston with JMP Securities.
Hey, Thanks, good morning Trevor.
First question and a little bit bigger picture.
But the progress you guys have made building up the portfolio and improving core earnings.
Can you share your thoughts on how youre thinking about potentially reinstating a dividend.
I guess, where you guys have also been buying back shares, but I'd be curious to get your thoughts and how you're how you're thinking about the prospects of the package for them.
Sure.
Sure. So we are encouraged.
By the ramp.
And earnings and.
Capital deployment, that's providing that ramp and earnings.
We have.
And made meaningful progress.
Not only and the MSR side, but we're hopeful that we have.
Additional opportunities to discuss as I referred to and the script.
Here over the course of the coming quarter.
And.
And and I think that leaves us with a positive picture and expectation over the course of the rest of the year.
And I think debt.
And that's something we'll be talking more about over the course of the remainder of the year.
So I think the basis.
The improved basis and earnings and capital allocation combined with the additional partnerships that.
We hope to have in place here over the.
Not too distant term.
Certainly in the coming quarter will provide us with additional ramp to deployment and earnings and.
And set the basis for further conversation about that over the course of the rest of the year.
Okay got it that's helpful.
And then a couple of questions on the MSR asset.
I guess first I was curious.
What's your guys thoughts are and the continued rally and rates, which has happened in July.
And you know what the what the risk is the significant pickup in and prepay speeds on the MSR assets.
Particularly if we were to get 30 year mortgage rates to drift back down.
Meaningfully below that 290 for no worry at all yet.
Yes.
Yes, I think.
Trevor certainly that's something we think about daily.
And we're adjusting our.
8 are combination of agencies and.
Our agency durations.
Against that possibility every day, we would expect positive performance up rate from the from the MSR portfolio, both in terms of value and in terms of cash flows.
And we would expect.
The agency duration.
From a lower coupon.
Portfolio emphasis on the agency side to provide the downright support.
And value.
And.
And what we've seen.
Is that.
A couple things 1 and the primary rate.
And has been a bit more.
More resilient.
For the.
And remained.
And not fallen as much as the underlying.
Rate curve.
We also have had a reasonable if not more than reasonable recapture experience and we expect that to improve.
Over time, given the tenor of the tenure of this relationship as it as it as it expands and as it goes on and time, we expect that recapture capability to improve.
And and we really need for the prime rate 1 would need for the prime rate to really translate back to the low twos.
To create significant.
James in the income and value characteristics of that MSR book.
Thus far as you I'm sure know Msr's have remained fairly resilient.
Both in terms of their cash flows and in terms of their multiples to.
To the rate fall and Thats, partly explained by the fact that the primary rate has been a bit more resilient.
And has not fallen in lockstep with the with the rate curve.
Yeah, Okay that makes sense.
And I guess last thing do you guys have.
Book value update you can get from quarter to date performance.
Yeah, I'd say, we're about flat.
Okay perfect. Thank you guys.
Okay.
Thank you. Our next question comes from Jason Stewart with Jones trading.
Hi, Thanks for taking the question and good morning.
And I wanted to go back to the stock repurchase I mean, obviously with the stock where it is it's super accretive to book value, but theres going to be some limitation in your mind in terms of how much capital you can return.
And stock repurchases and any update you can give us there.
Well.
What I can say Jason is.
What you would probably expect 1.
The level of the level and amount of buyback that we're conducting is directly related naturally to the combination of other investment alternatives and the scale.
The organization overall.
I would say you also I'm sure know that we have a very significant sized buyback authorization in place. So we have great flexibility in that regard.
And and.
So I think you should expect to see us continue to be vigilant and.
And repurchasing the stock.
Whether that means that it's more at a faster pace and larger amounts or a slower pace and lesser amounts than we have been is completely dependent on.
And those variables the price levels of stock the alternative investments and the overall scale of the organization, having added a little bit of additional capital.
To the.
Investable capital of the firm over the course of the last quarter, obviously that gives us more flexibility.
So so it's a core mainstay of our <unk>.
Investment strategy and intent.
And the magnitude will changes and the magnitude will depend on the variables I talked about.
But we view.
And we view it as undervalued and very appealing both corporately and personally.
Yeah I would agree.
And the question is about I would also say I would also say that as the ramp and earnings is occurring it gives us more flexibility on the buyback side.
Right and 1 would hope that would perhaps change devaluation as well.
1 question from the asset on the asset for our portfolio.
Yeah, I understand sort of the initial allocation to the loan side, but as you're thinking forward are you looking at the sector is more and owner operator or still is as a lender.
Well we have.
We have a.
Modest position as the lender in this through our business purpose loan investments for that.
And that had been very attractive and we're very encouraged by and we are on the lookout for and.
New opportunities in that space every day.
And business purpose loans, including asset far loans.
And we.
We're also hopeful about a possible opportunity to expand that capability.
Over the next over over the coming months.
But specifically answer your question about single family rentals.
We would conduct this as we have on the MSR side through a partnership with a highly credible owner, operator, and we would be partnered with them.
And owning and operating.
And a portfolio of a single family rental homes and.
And taking advantage of that by financing it through.
The term structure is term and non term, but term structures ideally ultimately available to institutional level of investors and that asset class that have become increasingly compelling.
From a financing cost and advance and term structure perspective.
The combination of the.
The supply demand dynamic the funding dynamic.
At the home level and the in the housing market and the United States and specifically.
From a funding capability for institutional level investors in that space.
The combination of all those things produces we think a attractive.
And our return profile.
Not just from the carry the net carry of the rental stream versus the.
Funding cost.
Cost, but also including the potential for additional appreciation.
From here, obviously, we would not expect accretion level depreciation levels to continue with their recent historical levels.
We would but we are positive and constructive on the overall supply demand and price dynamic and the single family rental space over time.
Okay got it and then 1 last question and I'll jump out and follow up on travelers on the MSR I would assume that the acquisitions on the MSR. The additional $14 million doesn't materially change the note rate, but let's use to 90 for I mean, you'd have to see primary rates to borrowers to be $2.40, something before your meaningfully and the money.
Is it your expectation that that happens when and if its not and rates move back up materially where do you think this multiple based on your analysis could go from 4 times debt to 1.
Well a couple of things there as I said before and agreement with you that we'd have to see we think we'd have to see prime rates and the lower twos in order to really create a.
A substantial surge.
Serge and that in that prepayment and a reduction and the cash flow features.
So thats not our expectation, but we are hedged for it.
So we're hedging every day.
To that dynamic as a possibility.
1 of the.
Compelling flexibility and.
Elements that the combination of the MSR with the agency portfolio provides is.
Is it perfect that cant be perfect and every and every circumstance, but we are hedging for exactly that dynamic against the MSR book, knowing that as rates go up that there is a substantial opportunity for both the improvement and the cash flows as prepayment rates decline, but also the expansion and the multiple now.
Historically, we would have.
<unk> pre pre pandemic multiples well above current levels.
We're not expecting that into a higher rate move.
But the combination of a multiple expansion from right now maybe in for range.
Right around 4 to something more like 4 and a quarter or so.
The change and the cash flows we expect would provide for a substantial surge in value and.
And operate move and that MSR portfolio and provide really attractive current returns, but also a protection against the agency portfolio that is throwing off its own set of returns and hedging the down rate.
Protection.
Non rate scenario against the Msr's.
Got it thanks for taking the questions I appreciate it.
Yeah.
Thank you again as a reminder, please press star 1 now if you would like to ask a question.
Our next question comes from Christopher Nolan with Ladenburg Thalmann.
Rock and <unk>.
Anticipate increasing the capital allocation MSR and the third quarter.
Well, we've already as we've said and the script.
Chris we already have allocated additional $14 million.
To that portfolio in the third quarter.
And I think there's room for that to migrate up.
To some degree Additionally, I think that will depend on where we see relative.
Where we see multiples.
And relative returns and that we continue to see flow.
Some of which we some of which we think is attractive and so we continue to.
Bid.
Tranches of that both through the flow agreements that we have in place as well as limited bulk opportunities.
<unk>.
I think.
And.
So so I think we would expect that that probably would grow some during the third quarter. Additionally, and keep in mind, we do have a committed facility available to us we haven't used it yet, but we do have that flexibility.
I'm not sure we would see the capital allocation increased that much but we may begin to apply from leverage.
As we further deploy the rest of the balance sheet.
And.
And I think that would have the consequence of improving returns.
On the MSR portfolio into the lower double digits from the high single digits.
And then is there any type of mortgages and excuse me for the MSR book is there any type of mortgages.
Targeting to be the receiver and the economics.
Well.
We're looking what we're evaluating.
Typically.
It is our current current coupon mortgage that's been originated.
And at reasonably proximate to the current <unk>.
Current rates so at a given point in time, we're investing in a.
Right for underlying a pool and mortgages that were originated in recent history at something around then.
And then current coupon.
Today that current coupons is going to be and the high twos, and we're going to and and it would cost about 4 for multiple to buy it you'd buy it and that circumstance to what would what would model to about an 8.
Give or take 8 unlevered return, but our experience has actually been modeled.
Modeled and <unk> have.
And have turned in to be more like 9 and above.
So thats been our actual experience is that the actual receipt of cash flows has exceeded our expectations.
And generally generically this origination that we're investing and is going to look like banker savings and loan originated.
Paper generically.
Great. That's it for me thank you.
And it's all Fannie and it's all it's all basically Fannie Mae.
Back.
Thank you.
Thank you. Our next question comes from Doug Harter with Credit Suisse.
Thanks.
Can you just talk about.
Given the way you're structuring some of these investments and the Msr's or if you look at single family partnerships.
And how much does scale matter.
And just how do you think about that.
And the diversity versus kind of not being able to deploy that much capital and to any 1.
Best and opportunity.
Well I think that's the that's 1 of the compelling elements of the approach that we're taking dog is that.
We're able to access the scale of very very significant.
Organizations.
2 and do that without the infrastructure intensity.
That 1 would have to undertake to do that directly so.
In essence, that's a form of leverage meaning its operational leverage right. So we're we're benefiting from operational leverage and banning for from their scale and we've seen that we've seen the benefit of that now and msr's and to the extent that we proceed down the <unk> path.
Expect to see.
See the same benefit.
So what that means is that it allows us.
2.
To invest and provide a level of diversification.
Between complementary.
<unk> opportunities.
That provide together.
The attractive combination of returns can each be financed to the extent that that's necessary to support returns can each be financed and favorable financing structures from a cost and term perspective and work together to offset risks in each of the others. So that's the goal.
So far the MSR opportunities playing out that way, it's early days, but it's playing out that way the expectation would be that we can leverage scale of a highly credible.
Partner and the single family rental opportunity as well.
And to the extent, we can do that we can enjoy the same benefit of and attractive return stream without the infrastructure intensity. So we think it actually AIDS diversity and returns and allows us at us as a smaller company to participate with positive and powerful economics and.
Spaces that we wouldn't otherwise at our scale, but can do so through these arrangements.
Helpful. Thank you rock.
Thank you Mr. Taco at this time there are no more questions.
Okay, well. Thank you very much and if there are further thoughts for questions. Please feel free to call. Thank you very much.
Thank you for your time.
Thank you ladies and gentlemen. This concludes today's teleconference. You may now disconnect.