Q3 2022 Arlington Asset Investment Corp Earnings Call

Comic return.

Going forward Arlington's, low leverage and diversified investment strategy continues to be well suited for various market conditions and positioned to generate strong returns for shareholders over time.

Overall, we are pleased with the results achieved during the quarter and year to date.

An economic return of two 4% during the quarter and economic return of 8% over the last 12 months. We completed the initial sale of a portion of the company's <unk> portfolio for net cash proceeds of $42 million in the third quarter harvesting of $14 million gain.

We entered into an agreement to sell the company's remaining asset for our portfolio for expected net cash proceeds of $29 million in the fourth quarter.

If that is consummated the overall strategy will generate a 28% overall annualized return over.

Over the last.

15 months.

25% annualized total return on the company's MSR strategy during the third quarter, while lowering the leverage to 0.2 times.

The migrated credit investments upward toward high quality assets with 64% of credit investments in AAA rated assets that achieved a total 18% annualized total return during the third quarter.

And we repurchased shares of capital stock that accretive to <unk> per share during the third quarter and 2007 <unk> per share year to date to book value.

During 2022 Federal reserve policy, and economic developments have driven valuations and liquidity down and return opportunities on new investments higher.

In general available return opportunities in certain asset classes have nearly doubled and expected return profile over the course of the year.

While we have selectively taken advantage of these higher return opportunities over the course of the year.

Capital preservation and shareholder value creation have been the company's priorities.

In line with that focus this quarter, we reduced leverage and harvested gains capital and liquidity.

And extended our overall patient approach to portfolio management.

The company's low coupon MSR portfolio again produced strong results during the third quarter in both current interest yields of 16% and through further multiple expansion, resulting in a 25% total annualized return.

Since we acquired our first MSR investment less than two years ago strong current cash yields along with asset appreciation have resulted in an annualized total return of 47% while employing modest leverage.

As of quarter end, the Companys MSR investments had $190 million of underlying mortgage servicing rights valued at a multiple of five five times with a leverage of only two times.

Fortunately with a weighted average coupon of 314 in the underlying mortgage servicing rights.

The company's MSR investments are well positioned to mitigate declines in value if interest rates should fall.

The significant appreciation in value of the company's MSR investment portfolio has contributed to it becoming the companys largest investment allocation at 41% of capital at quarter end.

During the third quarter. The company successfully closed on its previously announced sale of 371 of its FSFR properties or sale price of $130 million and net cash proceeds of $42 million after pay down of the secured credit facility.

Sale resulted in a net GAAP gain of $14 million that contributed 47 per share to book value during the third quarter.

The company is also pleased to announced that it signed a purchase and sale agreement on November 11th to sell its remaining <unk> investment portfolio of 251 properties, including the assumption of its secured credit facility for a gross sales price of $87 $3 million, which would result in net cash proceeds of approximately.

<unk> $29 million and a slight positive impact to book value.

The sale transaction is expected to close in the fourth quarter and is contingent upon receiving lender consent and other closing conditions.

Assuming the second sale transaction is ultimately consummated it would represent the culmination of investment strategy that we expect would result in a total annualized return of approximately 28% over investment horizon, that's been just over one year.

Given the uncertain near to intermediate term outlook for housing, we felt that crystallizing and locking in a 28% return.

From our <unk> strategy was prudent for shareholders.

As of September 30, the company's investable capital allocation to its credit investment strategy increased to 20%.

The company elevated the overall credit quality of its credit investments with 64%.

And floating rate AAA rated senior commercial mortgage securities as of quarter end with remaining maturities under five years and that have attractive double digit levered returns.

As of quarter end, 11% of the company's credit portfolio consists of a high performing interest only investment and low LTV non QM residential mortgages for which the return is principally predicated on rates instead of credit and the average coupon of the underlying mortgages is approximately 400 basis points.

Out of the money.

Overall, the company's credit investments continue to produce strong returns delivering an 18% annualized total return during the third quarter.

Also during the third quarter continued interest rate volatility led to significant widening of agency MBS spreads, resulting an underperformance in values of agency MBS relative to interest rate hedges.

Although a wider spreads led to increased potential carrier returns the company does not expect to materially increase its <unk>.

Investment allocation toward Levered agency MBS in the near term is the risk to capital remains in excess of the current hedged carry return.

As of September 30, the company's investable capital allocation to agency MBS was 14%.

Turning to the results for the quarter. The company reported book value of $6 45 per share as of September of two 4% increase from the prior quarter end.

The company continue to operate with overall low leverage and significant financial flexibility with its overall at risk leverage ratio standing at one two to one.

As of September 30th.

For the third quarter. The company reported GAAP net income of <unk> 10 per share in earnings available for distribution of <unk> 11 per share an increase of <unk> <unk> per share from last quarter.

We believe there is greater value in arlington's business in the public markets recognize.

And the company continues to be an active buyer of the of the Companys common stock.

During the third quarter, the company repurchased capital stock that accretive to <unk> per share to book value, including repurchasing nearly 2% of its outstanding shares of common stock.

Subsequent to quarter end the company has repurchased an additional 1% of its common stock that accreted, an additional <unk> <unk> per share to book value.

And since re instituting its current common stock repurchase program in 2020, the company has repurchased 26% of its outstanding shares.

Notably the company has a substantial remaining authorization of $10 2 million shares or in excess of $32 million of current market capitalization from its board to repurchase shares of its common stock.

The company has been able to produce solid economic returns during a period of challenging market conditions, including an 8% return over the last four quarters.

As our investor presentation illustrates compared to our peers and the FTSE NAREIT mortgage home financing index the.

The company has significantly outperformed our peers in total economic return in both recent quarters in the last 12 months, while also experiencing the lowest volatility of quarterly economic returns over the last year.

During this period the company is focused on preserving capital and creating economic shareholder value principally through a common combination of low leverage.

Prudent high return asset selection and a strong emphasis on share repurchases.

As we approach year end, we believe that market volatility around fed tightening and the period of elevated interest rates.

Somewhat more prolonged in the most recent market actions imply.

Having monetize $42 million from our third quarter, Sfer sale and another expected $29 million from our pending fourth quarter FSFR sale for a total of $71 million.

Arlington is an attractive investment platform in a strong and flexible position with low leverage high return assets sound overall credit quality and substantial liquidity available from our current balance sheet configuration.

We have worked hard to successfully position Arlington to both preserve capital and grow book value per share through recent market turmoil.

In the current economic environment, we now intend to use Arlington strong position to capitalize on new opportunities as they may arise and continue to create and harvest the substantial value embedded in Arlington for its shareholders.

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

Thank you at this time, we will open the floor for questions.

Like to ask a question. Please press the star key followed by the number one key on your Touchtone phone now questions will be taken in the order in which they are received this at any time, you would like to remove yourself from the questioning queue Press star two.

We'll go ahead and take our first question from Doug Harter with credit Suisse.

Thanks.

As you mentioned you have a large remaining authorization.

A high percentage of your Outstandings float how do you balance.

Continuing the value you see in the stock versus kind of.

Declining liquidity in the stock and kind.

The negative scale of impacts of continuing to shrink the business.

Well I think Doug that the approach we've taken over the last two years.

Has has proved itself out in the results that.

That approach has been predicated on a combination of investing in high return.

High risk adjusted return opportunities that we see at the same time buying significant amounts of.

The shares of the company over that.

Two and a half year period, we bought about 10 million shares I believe.

And at the same time, we've made some successful investments high return investments in certain categories that have worked to add too.

Capital aggregation as well so I think that approach has worked well.

And I think that.

At Formula We would expect to continue that again, keeping a prudent eye on on markets today with a focus on capital preservation and as and as we said.

Seeking alternatives to create and harvest value for the shareholders.

Opportunities in that regard.

Thank you Ross.

And then I guess talking about the MSR portfolio that has you know.

I guess, how are you thinking about.

That.

Current levels, obviously, a nice attractive yield you've already.

Received a lot of.

Attractive appreciation in it.

Would you be willing sellers of it do you want to continue to accumulate kind of what are your thoughts around the MSR portfolio.

As we've said in the past Doug I think.

That portfolio has grown in value substantially.

Even at the same even at the same time as our purchases have been modest through this year. So we are incrementally added to that portfolio of it most of the growth in that capital allocation has come from appreciation in the asset and so as we sit here today, we're not really aggregating additional msr's.

In the in the present market.

And and at the margin as I think we've said in the past.

Folks shouldnt be surprised if they see us whittle that portfolio down to some degree over time. So I think we probably are at our peak for <unk>.

Capital allocation to that.

Absent further appreciation, which might take it up for incremental sales, which might take it down.

And that's that's a process that we're examining all the time as you can imagine for the best use of capital.

And as we sit here today clearly this asset still has very high performance associated with it.

It certainly is appreciated and so there is a.

Different element of price risk to it today than there than there was over at various points over the last two years, but as we sit here today.

With an asset that generates double digit.

Unlevered returns.

And can can be moved up with incrementally small leverage.

That's a pretty attractive asset.

So and today is at these valuations given the coupons in the asset there is less duration risk.

To the asset.

As we said at these valuations and keep in mind. There is no credit risk right. These are these are strong underlying assets that sit below this these servicing rights.

So it's.

Overall, we think it's a pretty pretty powerful asset opportunity and if.

If we feel like there are attract sufficiently attractive bids for components of it then we would look to.

Push that capital allocation down somewhat but we don't anticipate it moving up except to the extent there's further appreciation.

Great. Thank you.

Yeah.

Our next question comes from Jason Stewart with Jones trading.

Hey, guys. This is Matthew on for Jason. This morning, Congrats on a good quarter. So following up on the MSR, What's your view of the directionality of it from here.

Natural housing turnover lows CPR is a bottoming.

If rates kind of stabilize at this level what are your views on the multiple going forward.

Well I guess that depends in part Matt on.

Overall risk markets and risk risk parameters right. So.

The prepayment profile.

Is pretty steady and remember these are almost 400 basis points out of the money.

So you would expect them to continue to be pretty steady from a prepayment perspective and pretty protected and therefore, the cash flows to be quite high.

On the one hand.

On the other hand, the discount rate.

<unk> move around based on movements in risk markets. So to the extent, we see a rally in risk markets and ongoing strength in general risk markets then.

We wouldn't be surprised to see that discount rate come down and the multiple come up.

At the same time and the inverse is true as well to the extent that there is a significant risk off type move then it's possible that the discount rates could move up somewhat in the multiple move down somewhat we have seen that.

At one or two points over the course of the last.

The latter part of this year.

We have seen movements up and discount rate so.

That's been part of the normal course, and even as the discount rate has moved up obviously you can see the valuations have moved up so from here I would say I would say that.

The valuations depend more on the discount rate movement in overall risk parameters.

In the broader markets.

Yes, Hi, Jeff. Thank you and then did you guys provided updated book value number quarter to date.

I'd say, we're about flat best estimate is approximately flat.

Great. Thank you and then any other updated thoughts on dividend versus share repurchases.

Maybe maybe possibly a little bit up flat to a little bit up say that again, Matt.

Do you have any updated thoughts on dividend versus share repurchases.

No.

<unk> view there.

At this level at 50 50 cents on the dollar the stock continues to be very attractive and so.

We as we said we have been consistent buyers of it.

At this stage I don't.

I think there is a.

Not a meaningful change in our view.

Awesome. Thank you guys.

Our next question comes from Christopher Nolan with Ladenburg Thalmann.

Iraq right rich.

Hi, Chris.

Your comments rock in terms of.

Second in the second half sale of the <unk> portfolio that Youre also.

Part of the packages you're financing facility.

Should we read into that that youre sort of walking away from the <unk>.

Portfolio for the moment.

Yeah.

For now for now that's the case, yes.

Okay, Great and then.

The decline in the at risk leverage.

By the way, we still feel that the overall long term housing dynamic is positive. It's just as I've said in the script that the near to intermediate term outlook suggested to us the uncertainty around that near to intermediate term outlook suggested to us that locking in a 28% overall return was the right thing to do for shareholders. Okay.

And then so.

As we move forward into 2023, how do you see the portfolio composition is U S. Excuse me it will be mortgage servicing rates go up or.

Credit investments go up I mean, you sort of indicated that you are not really interested in our MBS portfolio growing.

Well that will depend right I think that depends on where opportunities.

We see opportunities unfold here over the next over the next few months I think.

We've seen.

As I said in the script, we've seen return opportunities in certain asset classes nearly doubled in the last.

Throughout the course of this year from the combination.

<unk>.

Outward movement in absolute rates and the significant widening in investment spreads.

That's that's left.

<unk> field of opportunities.

Within the credit spectrum that could fit in or could fit in our wheelhouse why because the very high credit quality opportunities with shorter duration.

Evolve to a point, where they can be attractive opportunities.

Attractive enough opportunities to be compelling so I think for now.

Assuming that the MSR portfolio is not moving around substantially which I spoke to that earlier.

Then than the than the opportunities that we see in front of us are generally liquid products.

With returns in the low to mid double digits pretty consistently now.

I would say that I think our overall view.

Is that while there has been a significant movement in adjustment in publicly traded risk markets.

In our view there is still a significant.

Reckoning in the private markets, and adapting and assets and companies adapting to a higher cost of capital and we expect that through the course of 'twenty three.

Going into 'twenty, three and through the course of 'twenty three that may create opportunities.

Are very attractive for <unk>.

Investors in our space.

And and those we will be keeping an eye on it's a little early.

Yet for some of those to take.

To take advantage of and as I said in the meantime, we will remain in a capital preservation mode first.

And stay with the Formula that's.

Derived this value for shareholders over the last year year, and a half two years, which is keeping leverage modest keeping liquidity high preserving capital staying in high credit quality assets and seeking to drive double digit returns on capital and intelligent investments and at the same time seeking to you.

Use where we can.

Our repurchase authorization.

Which has obviously been an important emphasis for us now for a good long while.

Final question in talking about the repurchases any thoughts by just putting in a token dividend.

So you guys can broaden the potential universe of funds that might invest in you.

Well, we're always surveying.

The landscape and we're evaluating that question constantly for the best use of capital.

New investments.

Repurchasing shares dividends.

Obviously, you've seen we've seen the incremental increase in the earnings power of the company.

And and.

So the company at least in the fourth quarter in the third quarter.

Had an earnings profile shift.

To a degree.

Which is a more supportive of improving aggregating capital or other uses repurchasing shares et cetera.

So we wrestle with that we feel like we're in a good position to wrestle with that question.

And.

For now I don't have anything new to say on that on that topic, but I think it's a good question.

We will we will wrestle with that again in the fourth quarter and beyond.

Okay. Thank you nice quarter rock.

And Mr. Telco there are no further questions at this time.

Okay. Thank you very much I appreciate it if you have any follow up please reach out.

Thank you ladies and gentlemen that does conclude today's program you may disconnect at any time.

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