Attached files
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| 8-K - Arlington Asset Investment Corp. | v211627_8k.htm |
| EX-99.1 - Arlington Asset Investment Corp. | v211627_ex99-1.htm |
ARLINGTON
ASSET INVESTMENT CORP
Moderator: Kurt
Harrington
February
10, 2011
9:00
a.m. ET
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Operator:
|
Good
morning my name is Rebecca and I will be your conference operator
today. At this time, I would like to welcome everyone to the
Arlington Asset fourth quarter and full year 2010 earnings
call. All lines have been placed on mute to prevent any
background noise. After the speakers remarks, there will be a
question and answer session. If you would like to ask a
question during this time, simply press star then the number one on your
telephone keypad. If you would like to withdraw your question,
press the pound key.
|
|
|
Thank
you. I would now like to turn the call over to Mr. Kurt
Harrington. You may
begin.
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Kurt
Harrington:
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Thank
you very much. Good morning. This is Kurt
Harrington, chief financial officer of Arlington
Asset.
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Before we
begin this morning's call, I would like to remind everyone that statements
concerning future performance, returns, leverage, portfolio allocation, plans
and steps to position the Company to realize value, 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
factors include, but are not limited to, changes in interest rates, increased
costs of borrowing, decreased interest spreads, changes in default rates,
preservation of our net operating loss and net capital loss carry-forwards,
impacts of regulatory changes and changes to Fannie Mae and Freddie Mac,
availability of opportunities that meet or exceed our risk adjusted return
expectations, ability to effectively migrate non-agency mortgage-backed
securities into agency mortgage-backed securities, ability and willingness to
make future dividends, ability to generate sufficient cash through retained
earnings to satisfy capital needs, changes in mortgage pre-payment speeds,
ability to realize book value growth through reflation, the realization of gains
and losses on principal investments, available technologies, competition for
business and personnel, and general economic, political, regulatory and market
conditions.
These and
other risks are described in the Company's Annual Report on Form 10-K and
Quarterly Reports on Form 10-Q that are available from the Company and from the
SEC and you should read and understand these risks when evaluating any
forward-looking statement.
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I
would now like to turn the call over to Eric Billings for his
remarks.
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Eric
Billings:
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Thank
you, Kurt. Good morning and welcome to the fourth quarter
earnings call for Arlington Asset Investment Corp. I am Eric
Billings, Chief Executive Officer of Arlington Asset. And
joining me on the call today are Rock Tonkel, president and chief
operating officer and Kurt Harrington, our Chief Financial
Officer. In addition, we have members of the senior management
team attending. Thank you for joining us
today.
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As you
can see from last night's press release, Arlington reported core operating
income of $7.7 million or $0.99 per share. Book value was $28.46 per
share at December 31st up 14 percent from September 30, 2010 and $8.92 per share
or 46 percent from December 31, 2010. Core income return on equity
was 17 percent for the year and 15 percent for the
quarter. Debt-to-equity at year end 2010 was less than
0.9-to-one.
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For
the fourth quarter, Arlington shareholders experienced a $3.44 per share
increase in book value after payment of a $0.60 per share quarterly
dividend. This dividend plus the increase in book value
resulted in a 16 percent return to investors for the quarter (65 percent
annualized return), and a 55 percent return on the same basis for the
twelve months ended December
31st.
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The
Company repurchased approximately 21,000 shares of its Class A common stock at a
price of $23.96 during the quarter and had 256,000 shares remaining available
for repurchase under the repurchase program.
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During
the fourth quarter, Arlington benefited from increased capital flows and
positive price performance in the non-agency mortgage-backed security
sector. We realized $2.7 million of gains from sales of
non-agency mortgage-backed securities in the fourth quarter, and key
credit and prepayment measures in the Company’s non-agency mortgage-backed
securities portfolio continued a stable trend. Total 60 day plus
delinquencies in the Company’s non-agency mortgage-backed securities
portfolio were 20.2 percent at December 31st, credit enhancement was 10
percent, and trailing three month average loss severities on liquidated
loans were 44.5 percent. In addition, trailing three-month
average voluntary prepayment rates, which increase protection to our
invested capital and positively impact returns, rose again during the
fourth quarter to 11.9 percent.
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At
December 31st, the non-agency mortgage-backed securities portfolio had an
average cost of 49 percent of face value, and repurchase financing of $25
million compared to a market value of $253 million. Our OCI
related to the non-agency mortgage-backed securities increased by $21
million for the quarter to $63 million primarily due to an increase in the
fair value of the securities. The assumptions used to value the
portfolio at December 31st included a constant default rate of 6.5
percent, loss severity on liquidated loans of 43.2 percent, constant
voluntary pre-payment rate of 8.6 percent and a discount rate of 12.6
percent. A 10 percent improvement in each of those assumptions
would yield an additional increase in the value of the non-agency
portfolio of approximately $30 million or $3.95 per
share.
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The
reflation process in our non-agency mortgage-backed securities has been
developing steadily throughout 2010 and has progressed to a point where
unlevered returns in certain non-agency mortgage-backed securities, particularly
front pay securities, are now below our target returns.
Values on
non-agency mortgage-backed securities in the first quarter of 2011 continued to
reflate toward par. The Company has taken advantage of this price
movement with sales of these non-agency mortgage-backed securities of $32
million, realizing $3.2 million in cash gains or a 20 percent gain on the
invested capital.
As a
result of the substantial appreciation in the Company’s non-agency
mortgage-backed securities portfolio, the Company expects to migrate portions of
reflated capital from non-agency mortgage-backed securities to the agency
mortgage-backed securities portfolio which we expect will produce significantly
higher cash and total returns on invested capital.
The
Company has identified approximately $113 million of investable capital
currently allocated to non-agency mortgage-backed securities that have a cash
yield of 7.5 percent and a total expected annual yield including reflation over
two years of 10.5 percent. As market conditions allow, the Company
expects to liquidate portions of the non-agency mortgage-backed securities
portfolio and purchase Agency mortgage-backed securities that we expect will be
moderately leveraged at up to 6 times, substantially hedged against market value
fluctuations, and produce cash returns in excess of 20 percent on invested
capital based on the current conditions.
As of
February 8th, the Company has sold approximately $31 million of face value
non-agency mortgage-backed securities with a 6.25 percent current cash yield and
a 7.3 percent total annual yield generating $23 million of liquid
capital. It has reallocated this capital along with previously
allocated capital to an agency mortgage-backed securities portfolio of
approximately $360 million in face value at February 8th, with a
4.61 percent coupon, 102.8 cost, and a funding cost of 28 basis
points.
The
Company expects that this reallocation will have a meaningful positive impact on
cash earnings as the reallocation to date has increased expected current cash
returns on invested capital from 6.25 percent on the non-agency mortgage-backed
securities sold to over 20 percent on the agency mortgage-backed securities
acquired with this portion of the Company’s investable capital. The
reallocation of the $23 million of capital from non-agency mortgage-backed
securities already sold plus the $113 million expected to migrate to agency
mortgage-backed securities, for a total of $136 million, would mean that
approximately 50 percent of the Company’s invested capital would be reallocated
to agency mortgage-backed securities.
If
effected, this redeployment of capital would increase the Company’s current cash
spread earnings by approximately $2 per share annually and continue to provide
potential reflation from the remaining capital allocation to the non-agency
mortgage-backed securities. Assuming the $113 million capital
migration previously mentioned, the Company’s remaining capital invested in
non-agency mortgage-backed securities of approximately $130 million is expected
to have approximately a 10 percent current cash yield and more than 15 percent
expected annual yield assuming reflation over a two year period. This
ongoing allocation to the non-agency mortgage-backed securities would allow the
Company to provide higher current income and still retain the potential for
reflation and book value growth on approximately 50 percent of the investable
capital.
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With
low leverage, attractive current cash yields and reflation potential in
the company's non-agency mortgage-backed securities portfolio amplified by
the Company’s $800 million of net operating and capital loss
carry-forwards and a 15 percent Federal tax rate on Arlington’s dividends,
we are optimistic about the Company's ability to provide significant
potential growth in cash earnings and book value per share going
forward.
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Operator,
I would like to now open the call for
questions.
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Operator:
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At
this time if you would like a question please press star one on your
telephone keypad. You have a question from the line of Steve
Delaney with JMP Securities.
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Steve
Delaney:
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Good
morning everyone.
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Rock
Tonkel:
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Hi
Steve.
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Steve
Delaney:
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Hi,
good morning. So I wanted to talk a little bit about where this
agency reallocation could take us. If we are talking about $113
million of capital that you’re going to shift in addition to what you
already have and maybe 6 times leverage, I guess that’s about a potential
another $800 million and if we add that to what you had, we're talking
about a target portfolio that might be in the range of what, $950 million
to $1 billion? Does that seem reasonable to you guys based on
that $136 million total capital?
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Eric
Billings:
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Yes
Steve. It would be about $900 million to $1 billion; something
like that.
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Steve
Delaney:
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OK
great. I just wanted to make sure we're in the right ball park
there and within that, you know, that’s significant - you've added a
couple hundred million, but can you give us a little color, sort of within
the whole agency sphere, what products, where are you seeing the best
relative value in the agency space currently as far as products
go.
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Rock
Tonkel:
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Steve,
we've been focused primarily in the fixed rate area and what we have found
is a very attractive opportunity to put in place a mix of coupons with low
to moderate premiums and protected by swap hedges as well as other forms
of hedges that allow us to feel very protected on our capital, certainly
at 6:1 in terms of leverage and generate very attractive current cash
returns on that.
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Steve
Delaney:
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OK
so, like we have within the universe of companies, there are some people
that have some pretty strong, I would say almost dogmatic opinions about
where they’re going to put capital. It sounds like, while you
want to focus on the more liquid larger fixed rate, you are going to try
and find value across the capital
stack.
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Rock
Tonkel:
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That
is exactly right Steve, we are looking across the spectrum in the mortgage
area and seeking the highest risk adjusted returns for our capital and
where we find that we will allocate
capital.
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Steve
Delaney:
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OK
great and then just one last thing guys. You have had your
agency portfolio classified as trading securities and most of your hedging
has been in Eurodollar futures rather than plain vanilla
swaps. With this shift in 50 percent of the equity, do you plan
to make the new agency portfolio, will that be available for sale
accounting and on the hedging should we expect you to use, you know, more
just plain vanilla swaps since you are going to be accounting for it more
as AFS rather than trading? That’s probably several questions
in one, but I hope it make sense.
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Rock
Tonkel:
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Well,
I wouldn’t necessarily be definitive that it would only be
AFS. I think the trading based accounting may, in the end, be
utilized from a swap perspective, again same thing there on the asset
side. We are looking for what maximizes our risk adjusted
return and if we find that in a vanilla swap then that’s what we will use
and if we find that in a Eurodollar swap then that’s what we
use. We are simply looking to maximize risk adjusted
return.
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Eric
Billings:
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Our
primary focus is to protect the
capital.
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Steve
Delaney:
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Right.
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Eric
Billings:
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But
not necessarily to protect the spread as much as to protect the capital
and in that regard give ourselves the flexibility along the way to the
degree that the particular asset is not meeting hurdle returns; we have
flexibility.
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Steve
Delaney:
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OK
well good luck with the small shift in strategy and we look forward to
seeing the results here at the end of March. Thank you for your
time.
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Eric
Billings:
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Thank
you Steve.
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Operator:
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Your
next question comes from the line of Bose George with
KBW.
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Rock
Tonkel:
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Hi
Bose.
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Bose
George:
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I
had a question, just on the improvement in booked value. Was
the improvement in the seniors and the subs, was the move fairly similar
or was there disproportionate strength in one or the
other?
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Rock
Tonkel:
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I
think Bose, it was probably more disproportionate to the
re-remics. As you know the front pays have been reflating
pretty much consistently since late 2009 and the re-remics, as well, have
been reflating but they have really come on very strong in the last
quarter or two, and we definitely saw that demonstrated in the fourth
quarter and that’s been the case thus far in January or through this point
in 2011. That continues to be the case with re-remic
securities. They continue to
outperform.
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Bose
George:
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OK
and then just in terms of the securities you are selling, is it, just to
make sure, is it going to be the seniors or the re-remics or a bit of
both.
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Rock
Tonkel:
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In
essence, what we are doing is prioritizing the risk adjusted return we
expect to get on every asset looked at from a current cash yield
prospective as well as from a total yield including expected reflation and
we just run right down the priority list. Naturally today,
given the reflation that has already occurred over the last year and a
half in the front pays, generally those will be first in line for
migration because they are carrying returns in the low single digits on a
cash basis, excuse me, mid-single digits on a cash basis. So
they will be first in line for migration and then from there we move to
the next lowest return category and ultimately we will get to the
re-remics at some point presuming that they continue on the reflation
trend that we hope and expect for.
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Bose
George:
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OK
great thanks and good job this
year.
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Rock
Tonkel:
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Thank
you.
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Operator:
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Your
next question comes from the line of Jim Fowler with Harvest
Capital.
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Rock
Tonkel:
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Hi
Jim.
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Jim
Fowler:
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Hey
guys how are you?
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Rock
Tonkel:
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Good.
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Jim
Fowler:
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Just
a real quick question, actually two, just details, if I look at your third
quarter press release and your fourth quarter on your senior securities,
credit enhancement has gone from 14 down to just below 10. What
do I take from that?
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Rock
Tonkel:
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In
the front pays?
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Jim
Fowler:
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Your
credit enhancement in your senior securities is 14.2 in the third quarter
to 9.8 in the fourth quarter. Does that mean that a third of
the credit support under those bonds burnt
off?
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Rock
Tonkel:
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No,
it means primarily that the mix has shifted as we migrated capital from
the third quarter to the fourth quarter from front pays more into
re-remics. If you remember in the script we said we took $2.7
million of gains from the fourth quarter that presumably most of that is
related to migration of front pay capital being sold and moved to re-remic
capital and so the change in the credit characteristics really reflects
that more than anything else. I think overall credit basically
has been stable to improving, generally, in all of these portfolios and
that it is really a mix shift, I think
significantly.
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Jim
Fowler:
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So
face value from 75 to 64 quarter-over-quarter down 14 percent and moves in
the third of credit support, I mean that all makes
sense.
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Rock
Tonkel:
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Yes
and remember we may be shifting from bonds that have a little higher
credit exposure and a little higher enhancement to those that have lower
delinquent, lower total sixty days and lower enhancement. It’s
really sort of the ratio that we are focused on, in that neighborhood of
that two to one range across the portfolio, obviously not every bond is
going to be two to one, some are one to one, some are below one to one and
some are above two to one. But we are seeking to be in that
range in the non-agency sector and I think that’s really just a function
of portfolio shift. I don’t think there has been any meaningful
deterioration in credit. I think probably more just the
opposite.
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Jim
Fowler:
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OK. On
your expenses, your comp and benefits are up about $600,000 in the fourth
quarter versus the third quarter, is that year end related or is that a
new base line of comp?
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Rock
Tonkel:
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No
that is year-end related.
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Jim
Fowler:
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OK
great. Well deserved. One last question I guess, on
the statistics on the senior bonds. The severity, three month
average was 50. Do you have an idea what the December monthly
severities were or how that trended? That was up from 44 in the
third quarter and it wasn’t noted in the third quarter press
release. That was a three month average where it was in the
fourth quarter. Any idea what the trends are month by month in
the quarter?
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Rock
Tonkel:
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Jim,
as you probably know, at least in the assets that we focus on in the
non-agency arena, the severities really peaked in the spring of last year
and then generally trended down over the course of the year and I’d say in
recent months they've sort have been up and down. So one month
they are up 2 percent or 3 percentage points on an overall portfolio basis
and in other months they are down a little bit. They are
bouncing around sort of in the low 40s. Now that’s not on every
single asset. You can see from our exposure that we are
generally prepared to take a little more credit risk in terms of total 60
day plus on a front pay than generally in the re-remics. We are
maintaining in essence, a two to one ratio or better in both
categories. But because we're not structurally levered in the
front pays, we take on a little bit more 60 day plus exposure and so in
those assets you may see in one particular month the severities move up
sort of the magnitude you've talked about. They have also in
some months come down on that magnitude and I’d say in recent months we've
seen them flat to maybe up a touch but they are moving, they are pretty
stable.
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Jim
Fowler:
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And
last question; as you look at the agency market and your shift here, how
big do you think that opportunity is for your company? You have
repositioned your current capital but potential additional
capital? Is this a near term strategy or do you think this
could grow to be a large portion of your balance sheet and essentially
became a new strategy for the
Company?
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Eric
Billings:
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Well
I think it’s an ongoing process and it’s a process which is just measured
by the total risk adjusted returns we can receive based on evaluation,
etcetera, of the different assets, and so in our current back pay
portfolio, to the degree that today, that's got an average price in that
sort of the 67, 68 kind of range with a 5.5 coupon where we might
anticipate over two years that could reasonably anticipate a price
appreciation to the low 80’s.
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That
generates an acceptable return and having said that, if those assets move
into the 70’s, the mid 70’s, the high 70’s then your annualized return on
a risk adjusted basis start to change meaningfully and I think for us the
ongoing question will be to assess the environment and to see other places
on a risk adjusted basis where we can do better and if we can, then we
would anticipate migration.
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At
this point I think we feel a 50-50 mix is very optimal and that the
returns in the back pay re-remic portfolio are still extremely attractive
and represent great risk adjusted opportunity. We also believe
that the agency, properly hedged today, represents very attractive
potential returns and so the combination to those two maximize the return
of the business but I think we, just as we always have, will continue to
be mindful and watch the environment and make decisions as the environment
changes.
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Jim
Fowler:
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What
do you think, when you quoted the cost of funds, you were quoting a cash
LIBOR. What do you think or what are you employing when you say
properly hedging and what would a reasonable hedge ratio that you think on
an ongoing basis whether you are using your Euros or swaps, what ratio do
you think is appropriate?
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Rock
Tonkel:
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Well
as Eric said, we're really focused on hedging for market value movements;
more so then necessarily just protecting the spread and so if we are using
a swap of, for example, a similar duration to the asset then we'd be
pretty fully hedged in that in order to protect the capital from adverse
movements in the bond.
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So
we will be pretty fully hedged in that swap position and then we would
expect to compliment that with some optionality that protects against
extreme moves. I think all of that has a beneficial impact on
the spread, not just near term, but over the life. It does mean
that there is potential for some compression in the spread from its day
one starting point.
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Having
said that, the key for us, as Eric mentioned, is to protect that capital
so we have the flexibility to reallocate it, if in fact returns at a given
point in time, that spread compresses and returns compress to a point
where it makes sense for us to allocate that capital
elsewhere. The key is keeping that capital flexible so we can
always be looking for the highest risk adjusted return across the
spectrum.
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Eric
Billings:
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We
do believe the mix, the approximate 50-50 mix that we anticipate moving to
here, as having a nice complimentary character to it, without getting too
macro and prospective because these things are obviously hard to predict,
but it would be our assessment that something that might cause spreads to
tighten would undoubtedly have a very positive effect and maybe a much
more rapid positive effect on the back pay
portfolio.
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So
we do think the compliment is a very good one and it does help optimize,
and as we've said in the release, increase our cash returns and our total
returns from what we've seen historically, fairly
meaningfully. So we increased the earnings in the Company
fairly substantially and they are much more in the form of cash versus
reflation and it also has a blend which we think in many ways optimizes
the character and structure of the
portfolio.
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In
the meantime, obviously as we said, as these things evolve, then we will
maintain flexibility and I think we view that to be the most important
thing to protect capital in all the different environments and to maintain
as much flexibility so that we can take advantage of opportunities as they
arise.
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Rock
Tonkel:
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I
would just add Jim, another relevant factor there is that, with something
like half the capital remaining allocated in the non-agency, which is
essentially unlevered, it is carrying very, very modest external leverage
on it. And then something like six times on the agency, you can
see that on an overall balance sheet basis the entity wide leverage is
still very, very low. So it gives us a lot of protection and
flexibility to the return and to the
capital.
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Jim
Fowler:
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Great. OK,
thanks gentlemen.
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Operator:
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Once
again, if you would like to ask a question please press star one on your
telephone keypad. And your next question comes from Jonathan
Hollander with Chesapeake Advisors.
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Rock
Tonkel:
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Hi
Jonathan.
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Jonathan
Hollander:
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Hey
guys, how is everybody doing?
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Eric
Billings:
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Great
thanks.
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Jonathan
Hollander:
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Congrats
on such a great quarter. Just a quick question, I jumped on a
little bit late. So I'm not sure if you guys hit this but just
very briefly, what are you guys seeing going on in pre-payments given the
recent rise we've seen in the ten year for both agencies and
non-agencies.
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Rock
Tonkel:
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Well
they are going to lag a little bit because the data that we see in the
non-agencies has lagged a little bit. In recent months, the
voluntary pre-payment speeds in the non-agencies have actually increased
which is a very friendly thing to
us.
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And
while we saw a little bump for a month or so in the agencies it's come
right back down to quite low numbers. So the speeds on the
existing portfolio we laid out were quite attractive and very
low. They are generally low WALA assets and have other
characteristics that we think lend to them lower pre-payments or muted
pre-payment characteristics and we've actually seen that be the case in
lower pre-payment speeds than that of the market, and in the recent month
we've seen very low, very low
speeds.
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Jonathan
Hollander:
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OK,
and in terms of, just for the non-agencies, you were saying that it had
increased and what are the trends right now because obviously now the ten
year has been moving, we're already into February and I recognize that we
are six to eight weeks after the end of the
quarter?
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Rock
Tonkel:
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Its
stable.
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Jonathan
Hollander:
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Stable
OK.
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Rock
Tonkel:
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Yes,
steady.
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Jonathan
Hollander:
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OK
guys, thanks. Great quarter. All my other questions
were answered.
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Eric
Billings:
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Thank
you.
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Operator:
|
At
this time you have no further question. Do you have any closing
remarks?
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Eric
Billings:
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No
thanks very much for joining us everybody and we would look forward to
speaking with you next quarter.
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Operator:
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Thank
you for participating. You may disconnect at this
time.
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END