Q4 2021 Arlington Asset Investment Corp Earnings Call
Good morning, I'd like to welcome everyone to the Arlington asset fourth quarter and full year 2021 earnings call. Please be aware that each of your line 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.
<unk> followed by the one key on your Touchtone phone, if you'd like to remove yourself from the question in queue. Please press star two.
I would now like to turn the conference over to Richard constant Mr. Kannan, you may begin.
Thank you very much. Good morning. This is rich <unk> Chief financial officer of Arlington asset 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 and any other guidance on present or future periods constitute forward looking statements.
They are subject to a number of factors risks and uncertainties that might cause actual results to differ materially from the stated expectations or current circumstances.
These forward looking statements are based on management's beliefs.
And expectations, which are subject to change risk and uncertainty as a result of possible events or factors. These.
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 statements.
I would now like to turn the call over to rock <unk> for his remarks.
Thank you rich good morning, and welcome to the fourth quarter of 2021 earnings call for Arlington asset.
Also joining us on the call today is John Murray our portfolio manager.
The company is pleased with the progress it has made towards its goal of establishing multiple high return non commodity investment channels.
Both diversify investment risks and improve reliability of returns over time.
Having established new investment silos over the past year in mortgage servicing rights.
<unk> family residential rental properties.
Selective credit opportunities. The company has successfully allocated capital into new investments that complement complement its historical agency mortgage strategy.
And position the company for strong growth in shareholder value over the long term.
Going into the fourth quarter. Our primary goal was and continues to be to protect shareholder capital from the impact of inflation rising rates and federal reserve monetary tightening policies, while maintaining low leverage and plentiful liquidity.
During the fourth quarter, we traded the potential for short term incremental core operating income from Levered agency MBS in exchange for capital preservation and potential long term capital growth by lowering the company's investment knowledge allocation to agency MBS and accompanying mortgage basis risk.
At the same time the company continued to expand its investment allocation towards Msr's single family rentals, and opportunistic credit investments that collectively should perform well in a rising rate and inflationary environment, while being defensive versus unexpected federal reserve tightening.
The company has grown its MSR portfolio at attractive entry points over the course of the year and a 43% of its capital as of December 31.
That portfolio has produced year to date high single digit current cash yields.
Along with asset appreciation through multiple expansion.
It has resulted in a year to date total return of 34% all while while employing very modest leverage.
As of year end, the Companys MSR investments had $158 million of underlying mortgage servicing rights.
Valued at a multiple of $4 38.
With leverage of just three times.
Newly created mortgage servicing rights of Fannie Mae and Freddie Mac loans currently offer unlevered yield opportunities in the high single digits with the potential for further multiple expansion if rates continue to rise.
The company continued to make significant progress.
And its recently announced strategy of acquiring operating and leasing single family residential homes the.
The company believes the investment opportunity in single family residential offers potential attractive long term returns supported by favorable supply demand dynamics are healthy U S home financing market and flexible financing structures with attractive terms or 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 unexpected demographic trends.
And in a high inflationary environment.
Investments in single family residential rental properties should benefit from home price depreciation and rental income growth.
As of December 31, the company has acquired or committed to acquire 283 homes for $83 million as of today, we have either acquired or committed to acquire a total of 412 homes for $125 million.
Overall, the company is committed to invest at least $50 million of capital to acquire approximately $200 million of properties.
The finance Rsfsr properties. The company has a $150 million five year secured term debt facility.
Within 18 months draw period at an attractive fixed cost of funds of 276% with limited recourse to Arlington.
The company expects its investments in several of our properties to generate average current unlevered net yields of four 5% to 5% and Levered net yields of 8% to 11, 5% plus the opportunity to realize any home price appreciation.
To date, we are pleased with the progress we have made in building our CFR portfolio and its expected average unlevered net yield of four 9%.
The timing of the earnings benefit to the company from investing in SSR rental properties will be dictated by the pace of home purchases the level of any property level refurbishment refurbishments we make.
And the length of the lease marketing period, we expect that time period between the date of the settlement of a home purchase.
So the data houses occupied by a tenant to average between 30 and 60 days.
Accordingly.
During its initial ramp period, our <unk> portfolio has not yet contributed to current earnings.
We believe that is an opportunity for us going forward.
Once the company's $50 million of committed capital in <unk> as fully scale the company expects to generate double digit returns on the capital that is not currently reflected in the company's earnings.
The company has also encouraged by the potential appreciation value of the company may realize and FSFR portfolio over time, none of which is reflected in its book value today as these assets are Kerry.
At the historical depreciated cost basis of the properties.
The company can also continues to identify and evaluate opportunities in credit investments that offer high risk adjusted returns, including securitization of residential solar panel loans and non agency residential MBS.
Turning to the actual results for the quarter. The company reported book value of $6 16 per share as of December 31, a three 2% increase from the prior quarter end.
Furthermore, the company's book value per share grew an additional two 5% in January and we believe has remained relatively unchanged from there during the month of February .
The company continued to operate with overall low leverage and significant financial flexibility with its overall at risk leverage ratio standing at one five to one as of December 31.
For the fourth quarter. The company reported GAAP net income of <unk> 10 per share and core operating net income of <unk> <unk> per share.
With the Companys stock trading at a significant discount to its book value. The company continues to aggressively repurchase shares of its common stock.
During the fourth quarter, the company repurchased nearly 4% of its outstanding shares of common stock and accretive <unk> per share to book value.
Subsequent to year end the company has already purchased two 5% of its common stock outstanding and accreted, an additional <unk> <unk> per share to book value.
Since re instituting its current common stock repurchase program in 2020, the company has repurchased.
Seven 7 million shares of its common stock or nearly 21% of outstanding shares.
The company has a substantial remaining authorization of over 12 million shares from the board to repurchase shares of its common stock and the board is prepared to increase that authorization if necessary.
At current stock price levels, the company intends to return capital to shareholders through aggressive stock repurchases.
Overall, we are very encouraged by the progress the company has made to date and its transition towards its long term goals and is optimistic about its prospects going forward.
The company has taken positive steps towards its objective of complementing its core agency MBS portfolio with high return non commodity investment channels.
And mortgage servicing rights single family rentals in opportunistic credit investments, while operating with balance sheet flexibility through low leverage and high liquidity.
As I indicated we believe there is untapped earnings power yet to be generated from the existing portfolio.
We continue to evaluate attractive opportunities for investments that fit our criteria for programmatic platforms with non commodity return characteristics, which can further add to shareholder value.
And we believe that overtime there are potential additional growth paths for our existing asset silos beyond the scope of our current capital base.
As always we will evaluate those opportunities and the use of capital to support their long term value creation.
Compared to the benefits of repurchasing the company's stock or other potential distributions to shareholders.
We are optimistic that the company's current diversified investment strategy can deliver attractive long term returns to shareholders. While the company maintains the financial flexibility to return capital to shareholders through accretive stock repurchases at today's current stock prices operator, I'd like to now open the call for.
<unk>.
Thank you Sir 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 <unk> that is star one on your Touchtone phone now.
Is that any time, you would like to remove yourself from the question in queue. Please press star two.
Thank you our first question will come from Doug Harter with credit Suisse.
Thanks Rock.
Just wanted to.
Follow up on one of the last comments you made as you kind of weigh on new investments versus buybacks.
Obviously, you've been as you mentioned aggressive in buying back the stock.
But I guess given the discount how do you weigh.
The potential to be continue to be more aggressive.
The returns you see just a little bit more thought on how you and the border.
Well I think Doug.
We think about that naturally every day.
And observe the stock price closely and as you noted we've we've been aggressive buyers and we continue to be aggressive buyers. We've been buyers corporately would've been buyers personally and I would expect that those both would continue.
At these levels.
So obviously there is there is there is a.
Our calculation there thats ongoing that relates to the.
The level of the capital and the scale of the organization versus a few things. It's it's it's G&A and.
And liquidity of the stock and those sorts of things I think we've been fortunate that.
We've been able to bring expenses down pretty significantly over the last couple of years.
And that gives us even more flexibility in that equation.
Im not sure Theres, an enormous amount left in against this pretty massive inflationary type, but that's been a bit of a boost in a wind at our back and giving us flexibility to be buyers of the stock without really changing the G&A burden on the company.
And so we feel like at this.
Level of capital with.
Our level of appreciation that has occurred in our assets and that we would be hopeful would continue to occur.
That we that we would have the opportunity from both current earnings potentially appreciated capital.
And potentially the use of existing capital too.
To buy the stock at these levels.
And find that balance find the balance between that and the high returns that we can generate.
Non commodity silos like Msr's, fsfr's and others like that that we are constantly evaluating.
I feel like I think we all feel is a team that we need to be able to do both.
In pursuit of the shareholders' best long term interests.
And we are adjudicating that everyday.
Clearly at these prices.
Substantial amount of capital is going into the buyback and we would expect that we would continue to be aggressive there.
But that does leave us still with flexibility in the capital structure.
Two to invest additionally, in the silos that we have or potentially add to them remember, we keep very low leverage in the overall portfolio of one five times and we think that.
We can we can we can add earnings power not only extract the earnings power that has yet to be extracted from the existing portfolio over coming months, but we can potentially add to that with additional return opportunities that can generate more capital to be utilized for.
Our distribution of repurchases.
Stock.
Stock pardon me.
Okay.
Got it.
To follow up on kind of the cost and the stock liquidity is there kind of.
Minimum size.
Equity or market cap that you feel.
Yes.
To maintain.
Kind of the efficiency of the business and just kind of how are you thinking about.
How much of the company you could continue to buyback our stock Didnt the valuation didn't change.
We're looking that we're looking at that in the context of.
Of assessing.
The value of the long term value that can be.
It could be created.
From the pursuit of these existing silos to their full scale.
On the one hand versus the current one time, but very significant benefit of buying the stock.
And we're looking at it from the standpoint of what is the franchise value that may be attached to those those two silos and others, we may add above book value.
And present value that against what the current returns our current returns on the on the equity or equity or where that has led us so far.
Is that with the kinds of returns that you see in these assets. We continue to believe that reinvesting part of the capital into those assets silos and to the extent, we identify others that can generate returns quick pretty extraordinary returns of the nature you just heard about.
And then we will continue to do that as well as by the stock.
I appreciate the answers.
And we look at that the pursuit of that value.
More as more of a priority than focusing on exactly where the final market cap of the stock lands.
Understood. Thank you.
From a scale perspective.
Thank you. Our next question comes from Jason Stewart with Jones trading.
Hey, good morning, Thanks for taking the question maybe.
Maybe you could talk a little bit about whats your expectation is for volatility around the MSR I mean, given how low the underlying mortgage rates are struck there.
I'd be curious to hear your thoughts on the current rate move and where you think sort of a top end valuation is given.
And at least in my view that it is still relatively.
Low in terms of evaluation.
Well, it's a great question Jason.
I think it's actually quite interesting that even as the MSR.
Market pricing context for our our coupon type MSR has evolved.
Threes to fours.
To now evolving towards five multiples.
I actually I'm encouraged and we are encouraged by the resilience that they show on a model basis.
Relative to rates moving in both directions, but particularly from a downrate perspective.
One might have thought that as the valuations had improved pretty pretty meaningfully.
Therefore, the volatility of return in a down rate scenario might have escalated.
And in fact, we find today that that does not appear to be true that even as these assets have appreciated toward towards five times multiple.
That they continue to be quite resilient from a from a from a.
Interest rate move perspective.
I think we feel like we've got 25 to 50 basis points of down rate move.
Before we see meaningful downside price volatility that isn't to say that there wouldn't be any but.
But but but.
But in order in terms of seeing some price movement thats other than marginal.
I don't I think we feel like 25% to 50.
Bps down is the point at which you start to see some of that and we feel in that and Thats.
We view that as a positive risk reward dynamic.
As.
As to the.
As to the upside.
I think our modeling would say that.
There is potential upside towards six.
On a multiple basis might not get to six might be somewhere.
Shy of that but that would imply.
Something like at least a multiple additional multiple a turn.
I'm here.
I think our latest evaluation was around.
Four seven or four eight and so that would imply.
A point or so of additional multiple edition.
And obviously, that's pretty meaningful right tests.
On.
Four seven or four eight is pretty meaningful additional appreciation.
So we're not predicting that that will happen.
We just sort of feel like.
That seems like a bound on up.
Upward boundary.
And on the other hand, the down rate sensitivity, we feel is quite resilient.
Great that's helpful.
If you don't mind do you have an estimate of what your view on natural turnover is for the MSR portfolio.
As a floor.
I'd say, it's in the neighborhood of high single digits.
Got it okay. That's helpful. Thank you for that and then switching gears.
<unk> eight high single digits, maybe it gets to 10, but it feels like it's below that feels like 7% to nine something like that feels like a good level.
Got it alright. That's helpful. Thank you and then on FSFR in terms of the way Youre thinking about growing that business are there geographies that you're focused on.
Maybe a sense of where youre thinking the best opportunity for capital deployment is.
Well, it's interesting question.
Our portfolio is sort of strong from the southeast along the south of the south sort of the near southwest.
I think our farthest western market and sort of.
Texas.
So we're sort of we sort of our portfolio.
It works from Charlotte down around the south over to.
Over to Dallas.
Our concentration.
In the overall scope of <unk> our portfolio is relatively small so we've got sort of boundless room for opportunity there.
Been very encouraged very encouraged by the quality of the homes that we've been able to put into portfolio, the quality and level of rent collections and yields.
And so we're so far very pleased with that.
There is diverse there is diversity in the types of markets. Those that are viewed as the most core markets are a little more expensive youre going to pay a little more youre going to get a little bit less yield those yields are going to be closer to <unk>.
Low fours.
Mid fours, whereas some of the other markets that are.
That arent quite as core you get more yield out of and those are going to run 470 555 in a quarter.
But there are substantial.
In the <unk> population and income growth occur.
Occurring in those markets that is driving.
Higher yields and very encouraging rent growth now and we would expect going forward.
So there's a complementary nature of our markets.
They are all the houses are pretty common across those markets Theyre inside 10, 12 years old so they're relatively new they don't require a lot of refurbishment.
They are truly sort of core type properties in the <unk> market and yet our yields are very healthy four nine is a pretty healthy pretty pretty I'd say very healthy yield in that market and of course, we benefit from having the ability to finance that against the $2 75.
276, five year fixed rate structure, which generates the kinds of.
Double digit.
Very.
Very.
Meaningful double digit returns.
We would expect in that asset class going forward, maybe maybe over time, depending on appreciation.
In the twenties.
That would completely dependent on the level of appreciation, but even with modest depreciation given the character of this portfolio. The unlevered yields the quality of the underlying homes, we feel like we can generate.
Double digit.
Returns of of one level or another and maybe exceptional ones.
Okay.
Great. Thank you that's helpful.
Thank you. Our next question comes from Christopher Nolan with Ladenburg Thalmann.
Hi, Chris.
Yes.
The return on the.
Portfolio in the quarter. Please.
So Chris it was.
Not very meaningful for the quarter because as you remember I think about it we have to ramp up these portfolios.
From the time, we settled the house to the time that a tenant paying rent in the house is usually on average around 30 to 60 days.
Because of any kind of refurbishment, we need to do to the property and a lease marketing period.
So for the quarter I think it was a small loss of a few hundred thousand dollars.
Pretty negligible for the quarter.
And as we continue to ramp up the portfolio.
Until its fully ramped.
Pulling that $50 million of committed capital to buy about $200 million of the homes.
Theres going to be a lag period, as we ramp up that portfolio.
Great.
And then for these properties are you guys the owner of record or does your partner on it.
We own it.
The title of the homes are in our name.
So in any case, you have a renter, who decides not to pay rent and.
Take you through the landlords and then courts that would show up as a nonaccrual loan.
And with that alone it's a it's a rent receivable, but yeah. So.
You have a borrower doesn't or a tenant doesn't doesn't pay it.
We put on non accrual.
Reserve against the rent receivable.
We haven't and then against that.
Recent period.
And then what's the current head count.
I see please.
Got it.
10 as of today.
Keep in mind, Chris as it relates to the.
As it relates to the rent question.
Keep in mind that underlying rent growth.
In each of the markets that we're involved in is quite high.
The appetite for rental property for access to rental properties by renters is extremely.
Extremely high that appetite is extremely strong.
And as we all know rent growth is quite significant so it's not impossible, but we would end up certainly not impossible. Its quite possible. We may end up with a house, where the tenant doesn't pay but it's.
It's not very difficult thing to replace them with someone who's willing to pay that rate or even more.
Because these rents are going up on sort of a monthly basis.
Sure unless they take you to landlord tenant court rock and then as a landlord you are a distinct disadvantage of many municipalities.
Well, we're pretty careful about the jurisdiction.
We are very careful about the jurisdictions we're in growth very.
Alright, and then going forward, how should we look at our operating expenses for the company. Please.
As I said before we.
Had success.
Reducing those levels fairly significantly in the last two years, but I would say.
From here Thats going to be more challenging than just a kind of environment, where thats more difficult. So I would say something thats reasonably flat maybe.
Up or down a touch but.
That's in the neighborhood of reasonably in line with 'twenty. One is probably a fair number we keep working at the notion of knocking it down and who knows maybe.
Maybe a year from now.
I have a different answer which is that we've been able to successfully reduce expenses again.
Don't want to leave that expectation I think flat is flat or a little up or down is reasonable.
Great. Thank you.
Thank you. Our next question comes from Macau government with JMP Securities.
Hi, good morning.
Hi, there Iraq.
Apologies if you touched on this in your prepared remarks, but I'm wondering.
Could you give a breakdown of how you are allocating capital in light of all the recent and current market volatility vis vis all of these new silos that youre investing in.
Well Bob.
<unk>, we said, what we said was about 43% as at the end of the year.
As in MSR.
I would say, that's probably not a lot different today than year end.
We're ramping toward 50 and that <unk>, we're not there yet but we're.
$50 million.
$50 million, we're ramping towards $50 million, so call. It 15, 16%, 17% there.
Credit probably has another 10% ish, maybe a little higher.
And the rest of US agency and the overall agency portfolio carries naturally because it.
It has a.
Significant capital base and not a large balance.
<unk> leverage that I think we've noted it was about four something like that so the rest of the capital and that's in the Investor presentation as well you can see both the asset allocation and the capital allocation I think it's page 12 visit.
Sorry about that.
It's been the investor presentation, but thats sort of at sort of 45.
Ultimately fully ramped.
<unk> will be about 15% to 17 and credit is 10 or 12, something like that the rest of US today is agency.
So nothing materially materially different since the end of the year.
No.
Yes.
Growth in <unk>, as we ramp up the portfolio and probably a corresponding decline in the agency side, yeah exactly if there's a specific if there's a specific question youre trying to get at go ahead and ask it.
<unk>.
But but.
I guess, it's fair to say richest comment I think is accurate and it's fair to say that our view our cautious view on agencies.
Has not changed despite the fact that they have widened by.
30, 40 basis points at least.
Our cautious view there has not changed so we are keeping that portfolio at a relatively muted volume and leverage accordingly, and favoring other asset classes with more resilient characteristics in our opinion in these market conditions.
Great. Thanks, a lot guys I appreciate it.
You bet.
Thank you Mr. Chemical there are no more questions at this time.
Okay, well. Thank you everyone. Please feel free to call or additional questions and we appreciate your time and support thank you.
Thank you ladies and gentlemen. This concludes today's teleconference. You may now disconnect.
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