Arlington Asset Investment Corp.

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 Ben Strickler. Mr. Strickler, you may begin.

Thank you very much and good morning. This is Ben Strickler, Chief Accounting Officer at Arlington Assets. 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 statement. I would now like to turn the call over to Rock Tonkle 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 that complement its historical focus of levered agency mortgage investing and and leverage the company's historic expertise in the mortgage, housing, and structured product sectors. The company's primary objective was to establish platforms or 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 use 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 combine favorable risk-return profiles and low leverage. We have successfully established new investment channels over the past year that allow the company to allocate capital into 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 over time. 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 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. 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 September 30th. The WAC on the company's MSR portfolio is currently under 3%, which is unique in the marketplace given the portfolio almost has no production before pre-second half 2000. Year-to-date, the company's 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 of 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 MSRs, 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 to begin tapering this month and 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 the still historically rich valuations, the company continues to remain cautious about significantly increasing leverage and capital allocation to its levered agency mortgage strategy. With their complementary characteristics, combining investments in levered agency MBS and MSRs should decrease 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 interest rate 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 in the current environment into a 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 30th, the company's duration gap of its hedged agency MSR and MBS portfolios was relatively neutral at positive 0.1 years. After a comprehensive evaluation period, the company is also pleased to announce that during the third quarter, it 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, a healthy U.S. home financing market, and flexible financing structures with attractive returns for institutional investors. We expect the 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, including approximately $1.1 billion invested in more than 4,200 single-family residential properties. This relationship will enable us to leverage our partner's scale intellectual capital, and access to compelling investment and growth opportunities in the vast single-family residential space. The company has committed to initially invest at least $50 million of capital to acquire approximately $200 million of properties that 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. The debt facility has an 18-month draw period of fixed cost of funds of 2.76%, 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 4.5% to 5%. 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 30th, the company had acquired 33 homes for an additional for an aggregate purchase price of $9.4 million and had 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. The timing of the earnings benefit to the company from investing in SFR 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 of the home purchase to the date the house is occupied by the tenant to average between 30 to 60 days. The evolution of the single-family rental market over time has increased liquidity to the asset class through 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, while 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 300 to 500 basis points in overall expected ROEs 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. The 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 leverage ratio standing at 1.8 to 1 as of September 30th. For the third quarter, the company reported a gap net loss of $0.03 per share and core net operating income of $0.06 per share. During the third quarter, the company continued to return capital to shareholders through accretive stock repurchases by repurchasing 3.3% of its outstanding common stock that accreted $0.07 per share to book value. The company has repurchased approximately 16% of total shares outstanding to date, and has 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 it has 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 in non-commoditized businesses, which provide access to scaled high-return opportunities. We are active and growing in the MSR and SFR businesses, making Arlington a unique and differentiated platform in 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 increase earnings power over time that can form the pathway for returning more capital to shareholders in the future. Operator, I would like to now open the call for questions.