Arlington Asset Investment Corp. (AI) focuses on investment in agency-backed RMBS and some MBS that are private label. In the private label case, AI focuses on prime and Alt-A MBS. AI is a micro cap with a market cap of only $241.83 million. However, it is amazingly stable for such with a Beta of only 0.59. It has a 14.01% annual dividend, and this is a simple dividend. It has recently declared this dividend for Q3 2012.
The Fed is acting to keep interest rates low and stable. This makes a mortgage REIT an extremely profitable type of company. In the Fed's most recent announcement, Dr. Bernanke said the Fed would keep interest rates low well into 2015. The Fed continued Operation Twist until the end of the year; and it announced a new, open ended quantitative easing program that will buy $40B per month in MBS (to start). All this will tend to make mortgage rates fall, although likely only by a little. Mortgage rates are already low (3.44% for a 30-year fixed rate loan today, September 17, 2012). This will also tend to stabilize or even inflate prices in the real estate market. This should make mortgage REITs' current holdings more valuable, at least for the near term. This would be especially true of the non-Agency backed MBS. AI is working effectively to take advantage of this situation.
AI has approximately $1B in market value of Agency 30-year fixed rate MBS at a capital investment of $110 million. This has an expected 2.0% net interest rate spread. It is invested in with money from repos targeting a 7.5x leverage ratio of AI's own capital. This results in an ROE of 18.1%. AI also has $173 million in market value ($271 million at face value) of jumbo prime and Alt-A MBS at a capital investment of $138 million. This investment has a net interest rate spread of 8.4%. This last gives a 12.6% cash yield ROE (excluding appreciation) at market value. The target leverage for the private label investment is 0.25x.
AI selects MBS based on mortgages which should have low prepayment rates. The Agency MBS include 53% HARP loans, low FICO loans, high LTV loans, and low balance loans. AI's 3-month portfolio CPR (constant prepayment rate) is 4.4% with a cost of $104.4 for fair market value of $108.9. This far beats the market. For example FN 4.0% loan MBS on average have a 3-month CPR of 18.3% and a market price of $106.52. For the private label MBS portfolio AI focuses on prime and Alt-A MBS at deep discounts. AI's portfolio has no subprime, nor any option ARMs. AI focuses on improving credit performance, attractive yields, and positive technicals. Its weighted average cost for these MBS is 51% versus a 64% mark. This leaves a lot of room for profit. The three month CPR is 17%. This is as good as many companies are doing with agency backed MBS. The prime loans are mostly jumbo prime in popular areas. The most prominent areas are LA, SF, NYC, Washington, DC, and San Diego. This means the prime borrowers will have higher incomes with greater financial flexibility (and likely richer relatives). These MBS have possibly huge upside. The trends in the non-Agency investments have been steady improvements in serious delinquencies, CPRs, and loss severities.
In Q2 2012, AI earned $1.16 per share, which beat analysts estimates by $0.05. Further it recorded net cash gains from the sales of Agency MBS during Q2 of $0.14 per share. Further price appreciation of assets has allowed AI to make additional portfolio adjustments during Q3 (as of July 31, 2012). These have resulted in realized cash gains of about $5 million in Q3 2012.
On top of making good investments, AI has huge available tax advantages it accrued during the real estate market crash. It would have been bad to own AI during the market crash, but you can take advantage of its former losses. AI has $270 million in net operating loss carry-forwards. These are applicable to any form of taxable income with no annual limitation. They expire in 2027-2028. These amount to approximately $10 per share of potential after-tax value that is not reflected in the book value. The book value is $22.84 as of the end of Q2 2012. The current price is only 24.98. Further AI has $390 million of capital loss carry forwards. These expire in 2012-2015. They are applicable to realized gains. All this means that the current investor will profit from old losses. It never bothers me to have others effectively give me money. It should not bother you.
All told, AI is being well managed currently. The housing market has likely bottomed, especially with the Fed backstopping it. The old axiom, "don't fight the Fed," is applicable here. Yet there are still huge amounts of MBS available relatively cheaply because many are still shy of the housing market. This translates into opportunity for mortgage REIT companies and for investors. It is even better when the company has huge backlogged tax loss carry forwards from before you invested in the stock. AI is a buy.
The two-year chart gives some technical direction to this trade.
The slow stochastic sub chart is near overbought levels. It has spiked in the last few days after the Fed QE announcement. It may be due for a small retracement. However, the value is there, especially with the tax loss carry forwards. Plus AI has recently broken above its 200-day SMA. This is a buy signal. AI trades at a PE of 25.18 and an FPE of 5.59. Its average analysts' forecasts for EPS growth for FY2012 and FY2013 are 89.20% and 10.90%, respectively. It should do well. It is a buy. Still averaging in is probably a good strategy.
If you like this mortgage REIT, you may also like others such as American Capital Agency Corp. (AGNC), Annaly Capital Management Inc. (NLY), Two Harbors Investment Corp. (TWO), and Apollo Residential Mortgage Inc. (AMTG).
Note: Some of the above fundamental fiscal data is from Yahoo Finance.