Q1 2022 Arlington Asset Investment Corp Earnings Call
Including a top 10 economic return among peers with low book value volatility during turbulent markets.
On September 30th of last year.
Double digit returns from into MSR and credit portfolio since the beginning of 2021, including a 53% annualized return on the MSR portfolio and high teens returns from our credit portfolio.
Significant progress towards building, our asset portfolio, including the opportunity to capture a substantial gain and associated 7% book value pick up.
During the second quarter.
Expenses down double digits over a two year period.
And the current market environment. Our primary goal continues to be to protect shareholder capital from the impact of inflation rising rates and federal reserve monetary tightening policies, while maintaining low leverage.
In anticipation of the effects of federal reserve tightening policies on mortgage basis risk.
We continued down the path of lowering our investment exposure to agency MBS at.
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 expected federal reserve tightening.
Company has grown its MSR portfolio of 50% of its capital as of year end.
As interest rates rise in prepayment speeds declined.
<unk> should generally outperformed.
With the substantial rise in interest rates, the company's low coupon MSR portfolio produced exceptional returns during the first quarter in both current returns.
And through further multiple expansion.
Since we acquired our first MSR investment five quarters ago. The portfolio has produced strong current cash yields along with asset appreciation through multiple expansion that has resulted in an annualized total return of 53% all while employing very modest leverage.
As of March 31, the company's MSR investments had $180 million of underlying mortgage servicing rights valued at a multiple of 521 with leverage of three times.
Newly created mortgage servicing rights of Fannie Mae and Freddie Mac loans currently offer <unk>.
Unlevered yield opportunities in the high single digits with the potential for further multiple expansion if rates continue to rise.
Continued to make significant progress in our strategy of acquiring operating and leasing single family residential homes.
The company's goal is to invest up to $55 million of capital to acquire $200 million homes, and we have made great strides towards that objective.
As of March 31, the company had acquired or committed to acquire 454 homes for $137 million and as of today we.
We have acquired or committed to acquire a total of 566 homes.
For $177 million.
To finance the acquisition of our <unk> properties. The company has a $150 million five year secured term debt facility with an 18 month draw period at an effective fixed cost of funds of 276% with limited recourse to Arlington.
Company expects its investment in <unk> properties to generate average current unlevered yields of four 5% to 5% and Unlevered net yields of 8% to 11%.
8% to 12% pardon me once the opportunity to realize any home price appreciation.
To date, we are pleased with the progress we've made in building our asset for our portfolio.
Currently carries an expected average unlevered yield of four 9%.
The timing of the earnings benefit to the company from investing in SF, our rental properties will be dictated by the pace of home purchases.
The level of any property level refurbishment the length of the lease marketing period, and the timing of any future sales. We expect the time period between the date of settlement of the home purchase for the data houses occupied by a tenant to average between 30 and 60 days.
Certainly as we continue to ramp up our investments our <unk> portfolio has not yet contributed to current earnings.
Once the company's asset for our portfolio was fully scaled the company expects to generate double digit returns on capital that is not currently reflected in the company's earnings.
The company also announced yesterday that <unk> signed a purchase and sale agreement on May 10th to sell 378 of its FSFR properties for sale price of $130 million to $75 million.
This opportunistic sale captures a strong bulk premiums for our portfolio.
Wholly owned leased homes, we constructed from individual purchases with strong rental yields an attractive market.
The sale is expected to close around the end of the second quarter and subject to normal closing conditions, including the right of the buyer to terminate the sale transaction for any reason during the diligence period.
The company is very pleased with this potentially significant return on our investment in such a short period of time.
This is expected to result in a positive impact of the company's book value of approximately 45 per share upon closing.
Following the sale pending market conditions, the company expects to continue to reinvest capital in excess of our properties to reach its goal of $200 million of homes and to take full advantage of its well below market fixed rate five year funding facility.
Somebody also continued to identify and evaluate opportunities in credit investments that offer high risk adjusted returns.
During the first quarter the company made a new $20 million investment in a first loss piece in excess interest only strips.
And the securitization of recently originated originated performing nonqualified residential mortgages that is expected to generate mid teen returns.
With risk free rates up about 200 basis points and risk spreads about 100 basis points wider this year.
We believe there will be attractive new investment opportunities available in mortgage credit going forward.
Turning to the actual results for the quarter. The company reported book value of $6 19 per share as of March 31.
5% increase from the prior period end.
In addition, during the month of April the company's book value per share has remained relatively unchanged.
That does not include the potential approximately <unk> 45 per share gain associated with the FSFR bulk sale, which represents an increase of 7% over first quarter book value.
Company continues to operate with overall low leverage and significant financial flexibility with its overall at risk leverage ratio standing at one three to one as.
As of March 31 for the first quarter. The company reported GAAP net loss of <unk> 12 per share and core operating income of <unk> <unk> per share.
The three per share <unk> <unk> per share increase from last quarter.
We continue to believe there is far greater value in arlington's business than the public markets recognized.
Until we believe the stock price more accurately reflect the intrinsic value of arlington's business, the company and its insiders, who own 7% of the outstanding shares.
Expect to continue to purchase substantial shares of the company's common stock.
During the first quarter the company returned capital to shareholders by repurchasing over 3% of outstanding shares that accretive <unk> per share to book value and equivalent and offer an equivalent annualized dividend yield of 10, 4%.
Based on the average stock price during the quarter.
Subsequent to quarter end the company has already purchased 2% of its common stock outstanding at accretive and additional <unk> <unk> per share to book value with an equivalent annualized dividend yield of 16%.
Since re instituting its current common stock repurchase program in 2020. The company has returned 68 per share to shareholders.
Purchasing over 23% of its outstanding shares.
Notably the company has a substantial remaining authorization of over 11 million shares from its board to repurchase shares of common stock.
By positioning itself for a rising rate inflationary environment and federal reserve tightening cycle. The company has been able to produce solid economic returns during a period of quite challenging market conditions.
As our investor presentation clearly demonstrates.
Compared to our peers and the FTSE NAREIT mortgage for home financing index. The company has outperformed the index in total economic return and both recent quarters in the last 12 months, including being a top 10 performer over the last six months, while also experiencing among them.
Lowest volatility of quarterly economic returns over the last year.
Looking forward.
We believe that as monetary policy tightening runs its full course impact.
The impact on market conditions may present investors with historically high investment return opportunities.
We believe our diversified portfolio structure and low leverage.
<unk> us well to capture opportunities as they become available.
We have strong conviction about arlington's differentiated strategy.
We believe that the company's diversified investment platform and generate strong returns that will deliver ongoing substantial returns of capital to shareholders and growth in book value.
The market will recognize and value over time.
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.
But the ones.
On your Touchtone phone now.
<unk>.
On the order in which they are.
Any time, we would like to remove yourself from the question queue, perhaps starting.
Again star one.
I'll ask a question.
Well take our first question from Doug Harter with credit Suisse.
Hi, This is John <unk> on for Doug.
I guess first question I was just kind of like to get a little color around.
Sort of capital allocation, so far in the quarter, and particularly the MSR mix and how that's trending.
Thanks for the question John .
As I think I said last quarter.
When the MSR capital allocation was approaching 50%, we sort of felt like that was.
A level that we were comfortable.
But we didn't really feel like we would be inclined to move considerably above that number. So I think we feel like we're in the right.
Right ZIP code for overall capital allocation to MSR, and and I think it's fair to say we'd.
It to remain sort of in that neighborhood.
A 40% to 50%, maybe a little higher based on valuation movements in the asset, but I think thats, probably about the limit that we would expect an allocation to MSR.
Got it thank you.
And my next question.
Looking at the episodic excuse me.
Stefan a portfolio.
Talking about sort of 200 million being that right size for you at what point.
Sure.
Once we reach that Mark should we start to expect to not see these opportunistic sales or do you kind of see them at a certain pace going forward, you're trying to keep her somewhere around that 200 million Mark to China.
Understand how to think about that.
Well, we expect as we said in the in the script and as you see in the presentation, we sort of expect returns comfortably in the double digits current cash returns on the SSR portfolio on a fully levered and stabilized basis in the sort of high single digits plus depreciation gets you come.
Probably to the dividend.
Double digits.
Even assuming very modest.
Appreciation if any.
So we feel like that given that return profile in this particular circumstance, we had a unique opportunity.
On a portfolio of assets built one by one by one to receive a significant both premium that essentially had the effect of frontloading to us.
Several years of those returns and so we expect to reinvest that capital into the into the FSFR.
Portfolio with consistent returns to what we've described.
And we would expect those returns to be delivered once that portfolio.
Reaches that $200 million, Mark plus a little bit of time after that for stabilization of the properties.
At that point, we would expect to be receiving ongoing returns current in the high single digits and total returns in the double digits from that point forward.
Okay. Thank you very much.
Well take our next.
Question from Trevor Cranston with JMP Securities.
Hey, thanks.
Good morning.
Can you talk about how much.
Remaining upside.
You could potentially see.
The lower coupon MSR is in particular, given how much mortgage rates has increased.
And if.
You guys have looked at or considered potentially.
Realizing some of the gains on lower coupon MSR is neither reallocating it to.
More current coupon or even into.
The current strategy on the credit side.
Great question, Trevor two things one I think I said last quarter in response to a similar question about valuation multiples that we felt like probably somewhere in the high fives to six was probably sort of a.
Rough cap on valuations and I still think we feel like that is true.
<unk> two so we feel like there is there is some more movement, there, but not a great deal of movement not the movement that there has been historically number one.
But we do think there is still some available number two.
I would say that we as you would expect us to be doing we're constantly evaluating competing risk return opportunities versus where our capital is invested so naturally. The question. You asked is one we ask ourselves every day.
And and I think it's fair to say with.
Risk free rates up a couple of hundred basis points, this year and risk spread out 100.
Our general view that we.
We see the possibility of sort of historic opportunities coming down the pike as the fed completes its mick.
<unk>.
Tightening mission then.
I wouldn't be surprised people shouldn't be surprised if they see some potential reduction in that allocation in <unk>.
The MSR and reallocation to assets that have may have higher current or higher overall return expectations versus those msr's today. So I think it's an insightful question.
It's one we try to focus on every single day and we're actively reviewing alternative allocations for the Msr's as we are with all of our other assets in the portfolio and our capital allocation will continue to do that in pursuit of what we view as high return assets that are less commoditized.
And can deliver us attractive returns with low leverage.
Okay got it and then on.
The proceeds you're going to be receiving on the sale of the <unk>.
Portfolio do you have a sense sort of.
Roughly how long it will take you guys to redeploy that capital back into the strategy.
Yeah.
Well if you look at the calendar right. There are periods in the year when that process moves a little more quickly and a little less quickly, but I think we feel like we.
Should be able to.
We re ramp that portfolio.
But by late in the year I think we feel like we should have that we should have the ability to ramp that back to our full scale in the next couple of quarters.
Okay, great. Thank you.
Hello, gentlemen.
A question Please press star one.
We'll take our next question from Christopher Nolan.
You bet.
Hey, guys, Hey rock given the sale on <unk> should we expect a bump in profitability.
In the third quarter given the portfolio.
Portfolio was unprofitable.
Well, we'll recognize so a couple of responses to that Chris number one.
We will receive from the sale are basis back plus the gain from the premium on the sale.
We would expect as I just described that we would reinvest our basis into fully ramping the into a fully ramped scale on the <unk> portfolio.
On the other hand.
The gain is growth in capital and that growth in capital, we would and those proceeds we would expect to be able to deploy to.
<unk>.
Current returns that today are considerably more attractive than they would've been just four months ago.
And so we feel like.
We should be able to deploy that capital.
Prudently I would think.
During this quarter.
And realize the earnings benefit of that going forward.
But I'm not sure it would have much of an impact in the second quarter, but I think it would be expected to have an impact in the fourth quarter, the reinvestment of that gain and solid double digit returns.
As a follow up on the buybacks would you take any of this gain and just ramp up the buybacks from the already strong levels and are we going.
Uh huh.
We've been pretty clear in the script and historically about our view on the buyback.
On behalf of shareholders today with the ability to buy a dollar of book value.
For 50.
That's an opportunity that we will continue to pursue on behalf of shareholders.
And as I've said in the past.
Our focus every day is the allocation of capital between the buyback given the stock price.
The stock trades at.
Our return opportunities, which are higher today.
And they were when we have spoken in prior quarters. So I would say we.
Been clear on what our expectation is we've been clear on the execution of that.
I think people should be surprised.
And what we've said in the script and what we have executed this quarter and we will expect to execute in FERC future quarters, and very clear, we expect to continue that buyback at a substantial level given that return opportunity and on the other hand, we do expect the ability to reinvest that gain capital and other.
Redeployed capital Thats being freed up through the portfolio from different parts of the portfolio overtime to be reinvested in solid mid teens double digits, even mid teens returns, which would provide for some earnings growth room.
Going forward. In addition is simply that the redeployment of the <unk> portfolio.
Great. Thank you.
Mr. Tong Court there are no more questions at this time.
Okay, well, thank you very much.
When you are happy to speak afterward.
What you'd like to do as well. Thank you very much I appreciate it.
That concludes today's teleconference. Thank you for their participation.
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