Arlington Asset Investment Corp.

Good morning. I'd like to welcome everyone to the Arlington Assets second quarter 2021 earnings call. Please be aware that each of your line is in a listen-only mode. After the company's remark, we will open the floor for questions. If you'd like to ask a question, please press the star key followed by the one key that is star one on your touchtone phone. If you'd like to remove yourself from the questioning queue, please press star two. I'd now like to turn the conference over to Richard Consman. Sir, please go ahead.

Thank you very much and good morning. This is Rich Consman, Chief Financial Officer of Arlington Asset. Before we begin this morning's 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 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 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 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 Tonkel for his remarks.

Thank you, Rich. Good morning and welcome to the second quarter 2021 earnings call for Arlington Asset. Also joining me on the call today is John Murray, our portfolio manager. During the second quarter, the Federal Reserve struck a more hawkish tone at 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 US Treasury rate almost 30 basis points and both flattened the yield curve. Against this backdrop, agency mortgage spreads widened and swap spreads tightened during the second quarter. In 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 an 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 expects to complement its allocation of capital and agency mortgages 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 or 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 in 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 30th, the company's investable capital was allocated 39% to agency mortgages, 25% 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 that enables the company to garner the economic return of an 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 MSRs directly, and the company in turn receives all the economics of the MSRs, less a fee payable to our partner. At our option and direction, our partner has the capacity to add leverage to increase 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 in the economics of mortgage servicing rights differentiates Arlington. Our MSR investment portfolio has produced strong returns year-to-date through June 30th despite the significant fall in 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 MSR-related investments, growing its MSR investment portfolio to $75 million, or 25% of our investable capital as of quarter end. Subsequent to June 30th, we have invested an additional $14 million in MSR-related assets. Newly created mortgage servicing rights of Fannie Mae and Freddie Mac loans currently offer attractive return opportunities and provide a strong complement to agency MBS investment characteristics. At current purchase price multiples of approximately four times for current coupon MSRs, Unlevered MSR investments offer base returns in the high single digits. Furthermore, MSRs generally increase in value as interest rates rise, agency durations extend, and or mortgage spreads widen. According 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 in the high single digits on levered agency MBS with an appropriate hedge position. However, a reduction in 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 in agency MBS relative to the current spread return opportunity today, and therefore remains cautious about significantly increasing the leverage in capital allocation to its agency mortgage investment strategy. Taken together, incorporating a levered agency MBS investment with MSR investment combines investments with complementary characteristics, decreases overall risk, while increasing ROEs. 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, MSRs offer an attractive standalone return in the high single digits, and by reducing the need for swaps as a hedge for agency MBS and their associated cost, MSRs provide a positive carry hedge for levered agency securities. Replacing negative carry swaps with positive carry MSRs turns the largest drag on levered agency MBS returns into a carry positive. Going forward, we would expect to replace components of our interest rate swap position on our agency MBS investment portfolio with MSRs as the company scales its MSR investments, thereby increasing combined returns by several hundred basis points into the low double digits while improving the protection to 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 end, the company received full repayment of its largest mortgage credit investment, one 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 in residential business purpose loans. Turning to the actual results for the quarter, the company reported book value of $5.94 per share as of June 30th, a decline of 2.9% from the prior quarter end. The company continued to operate with low overall leverage and significant financial flexibility with an overall at risk leverage ratio of 2.2 to one as of June 30th. For the second quarter, the company reported a gap net loss of $0.24 per share and growth in operating income, core operating income, of $0.04 per share from the prior quarter to a total of $0.07 per share. During the second quarter, the company returned capital to shareholders through accretive stock repurchases by repurchasing 2.6% of its outstanding common stock that accreted $0.05 per share to book value. Since June 30th, the company repurchased an additional 1.1% of its outstanding common stock that accreted an additional $0.02 per share to book value. The company has a large remaining authorization from its board to repurchase shares of its common stock and 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 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 redistribution requirements. In July, The company successfully completed a public offering of $37.8 million of five-year unsecured 6% senior notes using the proceeds to redeem its six and five-eighths 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. The company has spent considerable time evaluating investment opportunities in single-family rental that offer potential attractive long-term returns supported by favorable supply-demand dynamics, a healthy U.S. home financing market, and increasingly flexible term financing structures for institutional-level single-family residential investments. We expect this favorable dynamic in 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 on expected 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 in the transition for its long-term goals and is optimistic about its prospects going forward. The company has taken positive steps toward its objective of complementing our core agency MBS portfolio with high-return, 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 to the portfolio from 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, highlighted by low leverage, high flexibility, and the use of term financing structures where possible, 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 to shareholders over time. Thank you very much. Operator, I would like to now open the call for questions.