Q3 2021 Arlington Asset Investment Corp Earnings Call
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Good morning, I'd like to welcome everyone to the Arlington asset third quarter 2021 earnings call.
Please be aware that each of your lines is in a listen only mode. After the company's remarks, we will open the floor for questions. If you would like to ask a question. Please press the star key followed by the one key on your telephone keypad. If you would like to remove yourself from the questioning queue Press star two.
I would now like to turn the conference over to you Ben Strickler. Mr. Strickler, you may begin.
Thank you very much and good morning. This is Ben Strickler, Chief Accounting officer at our Arlington assets before we begin this mornings call I would like to remind everyone that statements concerning future financial or business performance market conditions business strategies or expectations.
Any other guidance on present periods constitute forward looking statements that are subject to a number of factors risks and uncertainties that might cause actual results to differ materially from stated expectations or current circumstances.
These forward looking statements are based on management's beliefs assumptions and expectations, which are subject.
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 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 Taco for his remarks.
Thank you Ben Good morning, and welcome to the third quarter 2021 earnings call for Arlington asset also joining us on the call today is John Murray our portfolio manager.
Beginning last year, the company initiated a process of identifying and evaluating various investment strategies to complement its historical focus of Levered agency mortgage investing.
And leverage the company's historic expertise in the mortgage housing and structured product sectors.
The company's primary objective was to establish a platform for partnerships that provide the pathway to deploy capital into less commoditized investments with high barriers of entry that offer attractive Unlevered returns and also provide the opportunity to us term financing structures where available.
We are pleased to announce that we have made substantial progress towards the execution of this strategy, having constructed a unique portfolio of differentiated high return asset classes with compelling growth opportunities in large scale markets, which combined favorable risk return profile and low leverage.
We have successfully established new investment channels over the past year that allow the company to allocate capital in the mortgage servicing rights single family residential rental properties and selective mortgage credit opportunities.
These new investment channels should complement the company's existing agency mortgage strategy diversify risk and improve the level and reliability of returns overtime.
We believe the formation of our differentiated investment strategy creates strong building blocks for the company's future growth profitability and value creation for shareholders.
To be able to invest in mortgage servicing rights. The company established a strategic relationship with a licensed GSE approved servicer that enables the company to garner the economic return of investment in 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 in direction, our partner has the capacity to add leverage to increase potential returns to us.
We believe this efficient cost effective and lower risk channel for investing in the economics of mortgage servicing rights differentiates Arlington.
The company has grown its MSR portfolio at attractive entry points over the course of the year to 36% of its capital as of 70 as of September 30th.
The WAC on the company's MSR portfolio is currently under 3%.
Which is unique in the marketplace given the portfolio almost have no production before pre second half 2000.
Year to date the comedies MSR portfolio has produced high single digit current cash returns along with asset appreciation through multiple expansion that has resulted in very attractive year to date annualized total returns, while employing very modest leverage a 0.1.
As of quarter end.
Newly created mortgage servicing rights of Fannie Mae and Freddie Mac loans continue to offer attractive return opportunities, while providing a strong complement to agency MBS investment characteristics.
At current purchase price multiples of approximately four times for current coupon Msr's Unlevered MSR investments offer base returns in the high single digits.
Turning to Levered agency MBS. We are currently seeing available returns in the high single digits with an appropriate hedge position aided by ongoing low repo costs.
However, with the federal Reserve's recent announcement announcement to begin tapering this month.
An increased market expectations that the federal reserve will begin to raise short term interest rates next year.
The volatility around agency mortgage investing could increase.
Against this backdrop and Theres still historically rich valuations. The company continues to remain cautious without significantly increasing leverage and capital allocation to its Levered agency mortgage strategy.
With their complementary characteristics combining investments in Levered agency, MBS and Msr's should decrease overall risk while increasing our Roe.
Mortgage servicing rights tend to increase in value as mortgage rates rise and more specifically when durations on agency MBS extend.
This increase in value, resulting from mortgage extension typically occurs when mismatches between Levered agency MBS and hedges are highest.
Furthermore, <unk> offer an attractive standalone return in the high single digits and by reducing the need for interest rate swaps as a hedge for agency MBS and their associated costs MSR is provide a positive carry hedge.
For Levered Agency Securities.
Replacing negative carry swaps with positive carry msr's turns the largest drag on Levered agency MBS returns in the current environment.
Intuit carry positive.
And during the third quarter the company reduced its negative carry interest rate swap hedge position on its agency MBS investment portfolio as the company increased its positive carry MSR investments.
Which should improve combined returns going forward without meaningfully changing the company's interest rate risk posture.
As of September 30, the company's duration gap of its hedged agency MBS are in MBS portfolios was relatively neutral that's positive 0.1 years.
After a comprehensive evaluation period. The company is also pleased to announce that during the third quarter.
<unk> launched a new investment strategy of acquiring operating and leasing single family residential homes.
The company believes the investment opportunity in single family residential rentals offers attractive long term potential returns supported by favorable supply demand dynamics are healthy U S home financing market and flexible financing structures with attractive returns for institutional investors we.
Expect a favorable dynamic in U S single family residential 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 on expected demographic and home formation trends.
The company has partnered with a leading global asset manager that has approximately $140 billion of assets under management include.
Including approximately $1 1 billion invested in more than 4200 single family residential properties.
This this relationship will enable us to leverage our partners scale intellectual capital and access to compelling investment and growth opportunities in the vast single family residential space.
The company is committed to initially invest at least $50 million of capital to acquire approximately $200 million.
<unk>, Yeah, we expect to lever approximately three to one.
To finance the purchase of the properties the company entered into a $150 million five year secured term debt facility at attractive terms with a large and highly reputable financial institution.
That facility has an 18 month draw period at fixed cost of funds of $2 seven 6%.
With very limited recourse to Arlington.
Based on current conditions the company expects its investments in single family residential properties to generate current unlevered net yields of four 5% to 5% and.
And levered yields of 8% to 12% plus the opportunity to realize home price appreciation on top of that current carry that could push total net returns toward the mid to high teens.
The company is focusing on high quality newer homes and is currently active in seven growth markets in the southeast and the southwest.
As of September 30, the company had acquired 33 homes for an additional or excuse me for an aggregate purchase price of $9 $4 million and commitments to purchase an additional 75 homes for a total purchase price of $19 $9 million.
As of November 2nd we have acquired or have commitments to acquire a total of 178 homes for an aggregate purchase price of $52 $4 million.
Timing of the earnings benefit to the company from investing in S. F. Our rental properties will be dictated by the pace of home purchases the level of any property level refurbishments necessary and the length of the lease marketing period, we expect the time period between the date of settlement.
The home purchase to the date the houses occupied by the tenant tenant to average between 30 to 60 days.
The evolution of the single family rental market over time is increased liquidity to the asset class through bulks potential bulk sales as well as potential enhancements to profitability over time by accessing favorable funding characteristics using structural debt.
Bulk sales can result in lower cap rates than individual home purchases well securitized debt solutions for single family rental offer reduced cost of funds and increased leverage based on recent market conditions.
Driving potential increases over time.
Of three to 500 basis points and overall expected Roe.
From single family rental investments.
Going forward.
The company also continues to identify and evaluate opportunities in mortgage credit investments that offer high risk adjusted returns, including residential business purpose loans commercial mortgages and non agency MBS.
Underlying credit performance of the company's mortgage credit investments produced solid results during the third quarter supported by a strong economic environment.
Turning to the actual results for the quarter. The company reported book value of $5 97 per share as of September 30th a slight increase from the prior quarter end.
The company continued to operate with overall low leverage and significant financial flexibility with its overall at risk lever leverage ratio standing at one eight to one as of September 30th.
For the third quarter the company reported a GAAP net loss of <unk> <unk> per share and core net operating income core operating income of six cents per share.
During the third quarter. The company continued to return capital to shareholders through accretive stock repurchases by repurchasing three 3% of its outstanding common stock.
That accretive to <unk> per share book value.
The company has repurchased approximately 16% of total shares outstanding to date and is a large remaining authorization from its board.
The company will look to continue to return capital to shareholders by Opportunistically repurchasing shares of common stock at highly accretive prices.
This is an exciting time of positive and dynamic growth at Arlington. The company is very encouraged by the progress that is made in the transition to its objective of complementing its core agency MBS portfolio with high return non commodity investment channels in mortgage servicing rights single family rentals and mortgage credit.
We have created innovative partnerships and non commoditized businesses, which provide access to scaled high return opportunities.
Our active and growing in the MSR MSR in S F. Our businesses, making Arlington, a unique and differentiated platform and the small cap arena.
Our new businesses offer attractive double digit return profiles, well structured which currently trade at valuations in the market above book value.
We are optimistic about completing our goal of building a differentiated investment platform that should generate higher returns reduce overall risk and increased earnings power over time that conform the pathway for returning more capital to shareholders in the future.
Operator, I would like to now 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 by the one key on your telephone keypad now questions.
Questions will be taken in the order in which they are received.
Any time, you would like terminated yourself in the question queue Press Star two.
Our first question comes from Doug Harter with Credit Suisse. Please go ahead.
Thanks, Rocky you briefly mentioned this but can you just talk about you.
The partnership for single family rental on the operating side, you know kind of how you plan to to to kind of operate.
And then if you could just also remind us of kind of the partnership you have with the sub servicing on the MSR side.
Yes.
Sure.
Just starting with the servicing side. So we've got a national servicer are that we are partnered with a with a long experience.
In this in that arena.
And I think.
The the capability of that partnership is borne out to be honest by the by.
By the nature of the assets that we've been able to put in place.
The performance, we've had a very disciplined process with our partner.
Works very fluidly.
We've had on.
On those.
On those loan pools for which recapture as relevant in our earlier ones, it's not really relevant yet because we haven't hit the point, yet where recaptures are really necessary, but we've had a good recapture experienced and we're optimistic about how that will.
Move forward and obviously our returns have been.
Very very a.
Very handsome there and we don't have to absorb either the expense or the or more importantly, the regulatory burden of actually operating the servicer. So to us that's been a very favorable outcome to date.
We're very enthusiastic about our partnership in the single family rental business. This is a global financial institution on both the <unk> acquisition.
Vision refurbishment and leasing side as well as on the our financial partner on the on the financing facility.
Which we think is about as robust as one could could find for a non investment grade company in this space.
And our partner is extremely capable and experienced they've been in the business for at least if not more than a decade.
And as I said in my comments they own currently and have owned over time I suspect anymore.
<unk> of homes, but today they own about 44000 homes.
They we and they worked together through third party property managers.
And refurbishment entities.
And that is thus far it's early days.
But the early results there are our appear to be promising.
With the yields thus far at or above our expectations.
And and the pace of our activity on track with our expectations, we wanted to take a bit of a patient approach.
To acquiring assets. So that if there is a little bit of a pullback on the back of the appreciation we've seen over the recent periods that will get the benefit of that with the with our new capital in.
Going into this space, we feel like there is a really exciting and explosive growth opportunity in that space for us honestly in both of these MSR in the <unk> space. We think there are growth extensions off of the partnerships that we have created here.
That are quite innovative we believe.
And these growth extensions can be very powerful over time, we're already in conversation with different parties about our potential growth pathways for us to capture the benefit of more scale in each of these two businesses. So we're very enthusiastic about both our return profiles and MSR as have been in excess of our <unk>.
Expectations in our portfolio is at least as attractive as we expect it to be we're very pleased with that partnership.
It's early days on the Emmis on the <unk> side, but at the same same same principles apply.
Very pleased with the partnership very accomplished experienced responsible stable 30 party and our partner.
And as good a financing partner and facility as one could ask for.
So we're very pleased on both counts and excited about trying to capture what we think are potentially explosive growth opportunities going forward.
I appreciate it thank you.
Thank you once again to ask a question press star one.
Our next question comes from Eric Hagen with BP I G. Please go ahead.
Hey, Thanks, Good morning, maybe just one for me.
What do you guys think is the right amount of liquidity in the sources of that liquidity to carry as you guys move into these new strategies and you also focus on buying back stock at the same time.
Thanks, Eric so.
As you as you May know we've.
Historically carried a very liquid balance sheet, we continue to seek to keep our liquidity our overall liquidity very high.
To date, that's been a that's been accomplished through maintaining low leverage as well as.
A cross section of assets that are that are highly liquid including of course the agency side.
We do expect to continue to have a substantial participation on the agency side. It's the natural pair for the MSR and so obviously that will be continue to be a source of capital for us. If you think about the MSR side and I think today.
We're just a little above 100 million or so in capital we've applied very little leverage there and we do have the flexibility to apply more over time, but we're cautious about that.
On the MSR side as we have said in the past.
In any event, if we've got call it $100 million ish or a little more over time don't excuse me $100 million round numbers that would imply that we'd have we'd want to have at least I think generally as a general mark or $50 million or so about half the amount of the MSR capital in an agency.
Long book and and so that together that's about half the capital between those two obviously, the the $50 million or so in the agency side as liquid.
We maintain our mortgage credit portfolio that has a CUSIP securities in it and those generally tend to be liquid.
As we sit here today with the expectation that we'll grow our that.
That will grow our capital investment in the <unk> to something like $50 million well, then that's going to leave us with with solidly in excess of the you know call. It 150 in the age and the agency MSR side and another 50.
In the <unk>.
In the ER and the asset far side, that's going to leave us with somewhere between a third and a half of our capital, but its pretty liquid.
To the extent that we grow that MSR book, where that FSFR book, a little bit over time, which is possible.
I'm not telegraphing that that will happen, but it is certainly possible given the return characteristics and those and the strength of those you know the robust partnerships that we've built there.
It could extend.
Somewhat but as we sit here today, you know somewhere between a third and a half the balance sheet of our capital is highly liquid.
And that probably comes down a little bit over time, but you know I would think that we'd probably be trying to keep give or take a third of our capital over time to be in a in a highly liquid form so we'd have complete flexibility to it to adapt to new opportunities to buy the stock.
To assess what the best risk return wasn't any given day and time between an incremental investment in our key strategies and buying the stock and to be prepared with a low leverage approach for rainy days and.
In volatile times, when they come in the market and try to take advantage of them.
Thanks, a lot that's helpful detail appreciate it.
Thank you Mr.
Mr. <unk> there are no further questions in queue at this time.
Okay well. Thank you very much we appreciate your time and your thoughts and if you have follow up please feel free to give us a ring. Thank you very much.
Thank you all for your attention. This concludes today's teleconference. You may now disconnect.
Okay.
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