Arlington Asset Investment Corp. (AAIC) CEO Rock Tonkel on Q4 2021 Results - Earnings Call Transcript
Arlington Asset Investment Corp. (NYSE:AAIC) Q4 2021 Earnings Conference Call March 3, 2022 10:00 AM ET
Company Participants
Richard Konzmann - CFO
Rock Tonkel - President and CEO
John Murray - Portfolio Manager
Conference Call Participants
Doug Harter - Credit Suisse
Jason Stewart - JonesTrading
Christopher Nolan - Ladenburg Thalmann
Mikhail Goberman - JMP Securities
Operator
Good morning. I'd like to welcome everyone to the Arlington Asset Fourth Quarter and Full Year 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. [Operator Instructions]
I would now like to turn the conference over to Richard Konzmann. Mr. Konzmann, you may begin.
Richard Konzmann
Thank you very much. Good morning, this is Richard Konzmann, Chief Financial Officer at 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 statement.
I would now like to turn the call over to Rock Tonkel for his remarks.
Rock Tonkel
Thank you, Rich. Good morning and welcome to the fourth quarter 2021 earnings call for Arlington Asset. Also joining us on the call today is John Murray, our Portfolio Manager. The company is pleased with the progress that has made towards its goal of establishing multiple high return non-commodity investment channels that should both diversify investment risk and improve reliability returns over time.
Having established new investment silos over the past year and mortgage servicing rights, single family residential rental properties and selective credit opportunities. The company has successfully allocated capital into new investments that - complements its historical agency mortgage strategy and position the company for strong growth and shareholder value over the long-term.
Going into the fourth quarter, our primary goal was and continues to be to protect shareholder capital from the impact of inflation, rising rates and Federal Reserve monetary tightening policies while maintaining, low leverage and plentiful liquidity. During the fourth quarter, we traded the potential for short-term incremental core operating income from levered agency MBS in exchange for capital preservation and potential long-term capital growth by lowering the company's investment allocation, the agency MBS and accompanying mortgage basis risk.
At the same time, the company continued to expand its investment allocation towards MSRs single family rentals and opportunistic credit investments that collectively should perform well in a rising rate and inflationary environment, while being defensive versus unexpected Federal Reserve tightening. The company has grown its MSR portfolio at attractive entry points over the course of the year to 43% of its capital as of December 31.
That portfolio has produced year-to-date high single-digit current cash yields, along with asset appreciation through multiple expansion, that has resulted in a year-to-date total return of 34%, all while employing very modest leverage. As of year-end, the company's MSR investments have $158 million of underlying mortgage servicing rights valued at a multiple of 4.38 with leverage of just 0.3 times.
Newly created mortgage servicing rights of Fannie Mae and Freddie Mac loans currently offer unlevered yield opportunities in the high single-digits with the potential for further multiple expansion if, rates continue to rise. The company continued to make significant progress in its recently announced strategy of acquiring, operating and leasing single family residential homes.
The company believes the investment opportunity in single family residential offers potential attractive long-term returns supported by favorable supply demand dynamics, a healthy U.S. home financing market and flexible financing structures with attractive terms or 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 trends.
And in a high inflationary environment, investments in single family residential rental properties should benefit from home price appreciation and rental income growth. As of December 31, the company has acquired or committed to acquire 283 homes for $83 million. As of today, we have either acquired or committed to acquire a total of 412 homes for $125 million.
Overall, the company has committed to invest at least $50 million of capital to acquire approximately $200 million of properties. To finance our SFR properties, the company has a $150 million five-year secured term debt facility with an 18 months draw period at an attractive fixed cost of funds of 2.76% with limited recourse to Arlington.
The company expects its investments in - SFR properties to generate average current unlevered net yields of 4.5% to 5% and levered net yields of 8% to 11.5% plus the opportunity to realize any home price appreciation. Today, we are pleased with the progress we've made in building our SFR portfolio and its expected average unlevered net yield of 4.9%.
The timing of the earnings benefits 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 we make and the length of the lease marketing period. We expect that time period between the date of settlement of a home purchase to the date the house is occupied by a tenant to average between 30 and 60 days.
Accordingly, during its initial ramp period, our SFR portfolio has not yet contributed to current earnings. We believe that is an opportunity for us going forward. Once the company's $50 million of committed capital and SFR is fully scaled, the company expects to generate double-digit returns on the capital that is not currently reflected in the company's earnings.
The company is also encouraged by the potential appreciation value the company may realize in its SFR portfolio over time, none of which is reflected in its book value today, as these assets are carried at the historical depreciated cost basis of the properties. The company also continues to identify and evaluate opportunities in credit investments that offer high risk adjusted returns, including securitizations of residential solar panel loans, and non-agency residential MBS.
Turning to the actual results for the quarter, the company reported book value of $6.16 per share as of December 31, a 3.2% increase from the prior quarter end. Furthermore, the company's book value per share grew an additional 2.5% in January, and we believe has remained relatively unchanged from there during the month of February.
The company continued to operate with overall low leverage and significant financial flexibility, with its overall at-risk leverage ratio standing at 1.5 to 1 as of December 31. And for the fourth quarter, the company reported GAAP net income of $0.10 per share, and core operating net income of $0.02 per share.
With the company stock trading at a significant discount to its book value, the company continues to aggressively repurchase shares of its common stock. During the fourth quarter, the company repurchased nearly 4% of its outstanding shares of common stock and accreted $0.09 per share to book value.
Subsequent to year-end, the company's already purchased 2.5% of its common stock outstanding and accreted an additional $0.07 per share to book value. Since reinstituting, its current common stock repurchase program in 2020. The company has repurchased 7.7 million shares of its common stock or nearly 21% of outstanding shares.
The company has a substantial remaining authorization of over 12 million shares from its Board to repurchase shares of its common stock, and the Board is prepared to increase that authorization if necessary. At current stock price levels, the company intends to return capital to shareholders through aggressive stock repurchases.
Overall, we are very encouraged by the progress the company has made to-date in its transition toward its long-term goals and is optimistic about its prospects going forward. The company has taken positive steps toward its objective of complementing its core agency MBS portfolio with high return non-commodity investment channels in mortgage servicing rights, single family rentals and opportunistic credit investments, while operating with balance sheet flexibility through low leverage and high liquidity.
As I indicated, we believe there is untapped earnings power yet to be generated from the existing portfolio. We continue to evaluate attractive opportunities for investments that fit our criteria for programmatic platforms with non-commodity return characteristics, which can further add to shareholder value. And we believe that over time, there are potential additional growth paths for our existing asset silos, beyond the scope of our current capital base.
As always, we will evaluate those opportunities and the use of capital to support their long-term value creation compared to the benefits of repurchasing the company stock or other potential distributions to shareholders. We are optimistic that the company's current diversified investment strategy can deliver attractive long-term returns to shareholders, while the company maintains the financial flexibility to return capital to shareholders through accretive stock repurchases at today's current stock prices.
Operator, I'd like to now open the call for questions.
Question-and-Answer Session
Operator
[Operator Instructions] Thank you. Our first question will come from Doug Harter with Credit Suisse.
Doug Harter
Thanks, Rock. Just wanted to follow-up on one of the last comments you made as you kind of weigh new investments versus buybacks. Obviously, you've been, as you mentioned, aggressive in buying back the stock. But you know, I guess, given the discount, how do you weigh, the potential to be, you know, continue to do that be more aggressive versus the returns you see just a little bit more thought on how you and the Board are thinking about that?
Rock Tonkel
Well, I think Doug, we think about that naturally every day, and observe the stock price closely. And as you noted, we've been aggressive buyers, and we continue to be aggressive buyers. We've been buyers corporately, we've been buyers personally and I would expect that those both would continue at these levels. So obviously, there's a - calculation there that's ongoing and that relates to the level of the capital and the scale of the organization versus a few things.
It's G&A and liquidity to stock and those sorts of things. I think we've been fortunate that we've been able to bring expenses down pretty significantly over the last couple of years. And that gives us even more flexibility in that equation. I'm not sure there's an enormous amount left and against this pretty massive inflationary tide. But that's been a bit of a boost and a wind in our back and giving us flexibility buyers in the stock without really changing the G&A burden on the company.
And so, we feel like at this level of capital with a level of appreciation that's occurred in our assets, and that we would be hopeful would continue to occur, that we would have the opportunity from both, current earnings, potentially appreciated capital, and potentially the use of existing capital to buy the stock at these levels. And find that balance, find the balance between that and the high returns that we can generate from non-commodity silos like MSRs, SFRs, and others like that, that we are constantly evaluating.
I feel like, I think we all feel as a team that we need to be able to do both, for in pursuit of the shareholders best long-term interests, and we're adjudicating that every day. Clearly at these prices, a substantial amount of capital is going into the buyback. And we would expect that we would continue to be aggressive there. But that does leave us still with flexibility in the capital structure to invest additionally in the silos that we have or potentially add to them.
Remember, we keep very low leverage in the overall portfolio 1.5 times and we think that we can - add earnings power, not only extract the earnings power that is yet to be extracted from the existing portfolio over coming months, but we can potentially add to that with additional return opportunities that can generate more capital to be utilized for distribution or repurchases of stock pardon me.
Doug Harter
Got it. And just to follow-up on kind of the cost and the stock liquidity, is there kind of a minimum size of, you know, equity or market cap that you feel won't be necessary to maintain, kind of the efficiency of the business. And just kind of how are you thinking about, how much of the company you could continue to buyback, if the stock didn't - the valuation didn't change?
Rock Tonkel
We're looking at that in the context of - assessing the value, the long-term value that can be created, from the pursuit of these existing silos to their full scale, on the one hand, versus the current one-time, but very significant benefit of buying the stock. And we're looking at it from the standpoint of what is the franchise value that, maybe attached to those two silos and others we may add, above book value and present value that against what the current returns are - our current returns on the equity are.
Where that has led us so far, is that with the kinds of returns that you see in these assets, we continue to believe that reinvesting part of the capital into those asset silos. And to the extent we identify others that can generate returns with pretty extraordinary returns of the nature you've just heard about. Well, then we will continue to do that, as well as buy the stock.
Doug Harter
I appreciate the answer, Rock. Thank you.
Rock Tonkel
And we look at that, the pursuit of that value, as more of a priority than focusing on exactly where the final you know, market cap of the stock lands.
Doug Harter
Understood, thank you.
Rock Tonkel
From a scale perspective, I mean.
Operator
Thank you. Our next question comes from Jason Stewart with JonesTrading.
Jason Stewart
Good morning. Thanks for taking the question. Rock, maybe - you could talk a little bit about what your expectation is for volatility around the MSR. I mean, given how low the underlying mortgage rates are struck there. I'd be curious to hear your thoughts on the current rate move and where you think sort of a top end valuation is given, you know, at least in my view, that it's still relatively low in terms of evaluation?
Rock Tonkel
Well, it's a great question, Jason. I think it's actually quite interesting that even as the MSR market pricing context for our - coupon type MSRs has evolved, you know, from threes to fours to now evolving toward five multiples. I actually am encouraged. We are encouraged by the resilience that they show on our model basis relative to rates moving in both directions, but particularly from a downgrade perspective.
One might have thought that as the valuations had improved pretty, so pretty meaningfully, that therefore the volatility of return in a downright scenario might have escalated. And in fact, we find today that that does not appear to be true that even as these assets have appreciated towards five times multiple that they continue to be quite resilient from a - interest rate move perspective.
I think we feel like, we've got 25 to 50 basis points of down rate move before we see meaningful downside price volatility, that isn't to say that there wouldn't be any, but - in terms of seeing some price movement that's other than marginal. I don't I think we feel like 25 to 50 bps down is the point at which you start to see some of that and we feel and that's, you know, we view that as a positive risk reward dynamic.
As to the - upside, I think our modeling would say that there's potential upside towards six, on a multiple basis might not get to six might be somewhere, you know, sort of shy of that. But that would imply something like, at least a multiple, an additional multiple or turn from here. I think our latest valuation was around 4.7 or 4.8. And so that would imply, you know, a point or so of additional multiple addition.
And obviously, that's pretty meaningful, right test. You know, a point on 4.7 or 4.8 is pretty meaningful additional appreciation. So, we're not predicting that that will happen. We just sort of feel like, you know, that seems like a boundary - an upward boundary. And on the other hand, the downgrade sensitivity we feel is quite resilient.
Jason Stewart
Right, that's helpful. And if you don't mind, do you have an estimate of what your view on natural turnover is for the MSR portfolio, just sort of get like, as a floor?
Rock Tonkel
I'd say it's in the neighborhood of high single-digits.
Jason Stewart
Got it, okay that's helpful. Thank you for that, and then switch…?
Rock Tonkel
Maybe eight - you know high single digits right, maybe it gets to 10. But it feels like it's below that feels like seven to nine, something like that feels like a good level.
Jason Stewart
Got it all right, that's helpful. Thank you. And then on SFR, in terms of the way you're thinking about growing that business, so they're geographies that you're focused on. Maybe a sense of where you're thinking them the best opportunity for capital deployment is?
Rock Tonkel
That's interesting questions. Our portfolio is sort of strong from the Southeast along the South to the South, sort of the near Southwest. I think our farthest Western market is sort of Texas. So we're sort of - we sort of, our portfolio, works from Charlotte, down around the South over to Dallas that's our concentration. In the overall scope of SFR, our portfolio is relatively small. So we've got sort of boundless room for opportunity there.
We've been very encouraged, very encouraged by the quality of the homes, that we've been able to put in portfolio, the quality and level of rent collections and yields. And so, we're so far very pleased with that. There's diversity in the types of markets, right, those that are the - viewed as the most core markets are a little more expensive. You're going to pay a little more, you're going to get a little bit less yield.
Those yields are going to be closer to low fours, maybe mid fours, whereas some of the other markets that - aren't quite as core, you get more yield out of and those are going to run for 4.75, 5, 5.25. But there are substantial in population and income growth occurring in those markets, that is driving higher yields and very encouraging rent growth now, and we would expect going forward.
So there's a complementary nature of our markets. The houses are pretty common across those markets. They're inside 10, 12 years old, so they're relatively new. They don't require a lot of refurbishment. They are truly in a sort of core type properties in the SFR market, and yet our yields are very healthy 4.9 is a pretty healthy - pretty, I'd say very healthy yield in that market. And of course, we benefit from having the ability to finance that against the 2.75, 2.76, five-year fixed rate structure, which generates the kinds of, double-digit - very meaningful double-digit returns.
We would expect in that asset class going forward, maybe, maybe over time, depending on appreciation in the 20s that would completely depend on the level of appreciation, but even with modest appreciation, given the character of this portfolio, the unlevered yields the quality of the underlying homes, we feel like we can generate double-digit returns of one level or another, and maybe exceptional ones.
Jason Stewart
Right thank you, that's helpful.
Operator
Thank you. Our next question comes from Christopher Nolan with Ladenburg Thalmann.
Rock Tonkel
Hi Chris.
Christopher Nolan
Hey guys, what - was the return on the SFR portfolio in the quarter please?
John Murray
So Chris it was not very meaningful for the quarter, because as you remember or think about it, we had to ramp up these portfolios. And from the time we settle the house, to the time that there's a tenant, paying rent in the house is usually an average around 30 to 60 days, because of any kind of refurbishments, we need to do the property in a lease marketing period. So for the quarter, I think it was a - small loss of a, few $100,000 you know, pretty negligible for the quarter.
And as we continue to ramp up the portfolio, you know, until it's fully ramped, meaning its fully invested at $50 million of committed capital to buy about $200 million of homes, you know, there's going to be a lag period as we ramp up that portfolio.
Christopher Nolan
Great. And then for these properties, are you guys the owner of record or does your partner own it?
John Murray
We own it. So the -- yes, the title of the homes are in our name.
Christopher Nolan
So in the case that you have a renter who decides not to pay rent and sort of take you through the landlord tenant courts, that would show up as a non-accrual loan?
John Murray
No it's not a loan - it's a rent receivable. But yes, so if a, you have a borrower who doesn't or a tenant doesn't pay it, then we put on non-accrual or we'd reserve against the rent receivable.
Rock Tonkel
In fact, we haven't before experienced that yet in future periods.
Christopher Nolan
And then what's the current headcount at AAIC, please?
John Murray
10 as of today.
Rock Tonkel
Keep in mind, Chris, as it relates to the - rent question. Keep in mind that underlying rent growth in each of the markets that were involved in is quite high. The appetite for rental property - for access to rental properties by renters is extremely - high, that appetite is extremely strong. And rent, as we all know, rent growth is quite significant.
So it's not impossible, but we would end up certainly not impossible, it's quite possible. We may end up with a house where the tenant doesn't pay, but it's not very difficult thing to replace them with someone who's willing to pay that rate or even more, because these rents are going up on sort of a monthly basis.
Christopher Nolan
Sure, unless they take you to landlord, tenant court Rock. And then you know, as a landlord, you are a distinct disadvantage of many municipalities?
Rock Tonkel
Well, we're pretty careful about the jurisdiction. We're very careful about the jurisdictions we're in, Chris, very.
Christopher Nolan
All right, and then now I'm going forward, how should we look at operating expenses for the company, please?
Rock Tonkel
As I said before, we've had success in reducing those levels, fairly significant in the last two years, but I'd say, from here, that's going to be more challenging. It's just a kind of environment where that's more difficult. So I would say something that's reasonably flat, maybe, you know, up or down a touch, but something that's in the neighborhood of reasonably in line with 21 is probably a fair number.
We keep working at the notion of knocking it down. And who knows, maybe, maybe a year from now, you know, I have a different answer, which is that we've able to successfully reduce expenses again. I don't want to leave that expectation. I think flat is - flat or low up or down is reasonable.
Christopher Nolan
Right, thank you.
Operator
Thank you. Our next question comes from Mikhail Goberman with JMP Securities.
Mikhail Goberman
Hi, good morning.
Rock Tonkel
Hi Mikhail.
Mikhail Goberman
Hi there, hi Rock. Apologies if you touched on this in your prepared remarks, but I'm wondering, could you give a breakdown of how you're allocating capital in light of all the recent and current market volatility, vis-à-vis all of these new silos that you're investing in?
Rock Tonkel
Well, about 40 we said what we said was about 43% as of the end of the year, is in MSRs. I would say that's probably not a lot different today than year-end. We're ramping toward 50 in SFR we're not there yet, but we're 50 million yes. Oh 50 million yes, we're ramping toward 50 million. So you know, call it 15%, 16%, 17% there. Credit probably has another 10%-ish, maybe a little higher and the rest is agency.
And the overall agency portfolio carries naturally, because it has a significant capital base and not a large balance. It carries leverage that I think we noted it was in about four, something like that. So the rest of the capital, and it's in the investor presentation, as well, you can see both the asset allocation and the capital allocation.
I think its Page 12 if isn't, I may be wrong about that. It's in the investor presentation. But that's sort of his, you know, sort of 45 ultimately, fully ramped, the SFR - the SFR will be about 15 to 17. And credit is, you know 10 or 12, something like that the rest is today is agency.
Mikhail Goberman
So nothing materially different since the end of the year?
Richard Konzmann
No - growth and SFR as we ramp up the portfolio and probably a corresponding decline in the agency side.
Rock Tonkel
Yes, exactly I mean, if there's a specific question you're trying to get at, go ahead and ask it. But I guess it's fair to say, Rich's comment, I think is accurate. And it's fair to say that our view, our cautious view on agencies, has not changed, despite the fact that they have widened by 30, 40 basis points, at least. Our cautious view there has not changed. So, we are keeping that portfolio in a relatively muted volume and leverage accordingly, and favoring other asset classes with more resilient characteristics in our opinion in these market conditions.
Mikhail Goberman
Great, thanks a lot, guys. Appreciate it.
Rock Tonkel
You bet.
Operator
Thank you, Mr. Tonkel, there are no more questions at this time.
Rock Tonkel
Okay, well thank you, everyone. Please feel free to call additional questions and we appreciate your time and support. Thank you.
Operator
Thank you, ladies and gentlemen, this concludes today's teleconference. You may now disconnect.
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Comments (6)
Wow, that was one scary paragraph! Sort of!