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Arlington Asset Investment Corp. - Quarter Report: 2022 June (Form 10-Q)

 

``` 11111

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2022

OR

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission File Number: 001-34374

 

ARLINGTON ASSET INVESTMENT CORP.

(Exact name of Registrant as specified in its charter)

 

 

Virginia

 

54-1873198

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

 

6862 Elm Street, Suite 320

McLean, VA

 

22101

(Address of Principal Executive Offices)

 

(Zip Code)

 

(703) 373-0200

(Registrant’s Telephone Number, Including Area Code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

 

Trading

Symbol(s)

 

Name of each exchange on which registered

Class A Common Stock

 

AAIC

 

NYSE

7.00% Series B Cumulative Perpetual Redeemable Preferred Stock

 

AAIC PrB

 

NYSE

8.250% Series C Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock

 

AAIC PrC

 

NYSE

6.000% Senior Notes due 2026

 

AAIN

 

NYSE

6.75% Senior Notes due 2025

 

AIC

 

NYSE

 

 

 

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes No

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (Sec. 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer

 

 

Accelerated filer

 

 

 

 

 

Non-accelerated filer

 

 

 

Small reporting company

 

 

 

 

 

 

 

 

Emerging growth company

 

 

 

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act): Yes No

Number of shares outstanding of each of the registrant’s classes of common stock, as of July 29, 2022:

 

Title

 

Outstanding

Class A Common Stock

 

28,890,953 shares

 


 

ARLINGTON ASSET INVESTMENT CORP.

FORM 10-Q

FOR THE QUARTER ENDED JUNE 30, 2022

INDEX

 

 

 

 

 

 

 

Page

PART I — FINANCIAL INFORMATION

 

 

 

 

Item 1.

 

Consolidated Financial Statements and Notes — (unaudited)

 

1

 

 

 

 

Consolidated Balance Sheets

 

1

 

 

 

 

Consolidated Statements of Comprehensive Income

 

2

 

 

 

 

Consolidated Statements of Changes in Equity

 

3

 

 

 

 

Consolidated Statements of Cash Flows

 

4

 

 

 

 

Notes to Consolidated Financial Statements

 

5

 

 

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

36

 

 

Item 3.

 

Quantitative and Qualitative Disclosures about Market Risk

 

57

 

 

Item 4.

 

Controls and Procedures

 

62

PART II — OTHER INFORMATION

 

 

 

 

Item 1.

 

Legal Proceedings

 

63

 

 

Item 1A.

 

Risk Factors

 

63

 

 

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

63

 

 

Item 3.

 

Defaults Upon Senior Securities

 

64

 

 

Item 4.

 

Mine Safety Disclosures

 

64

 

 

Item 5.

 

Other Information

 

64

 

 

Item 6.

 

Exhibits

 

64

 

 

 

 

Signatures

 

67

 

i


 

PART I

FINANCIAL INFORMATION

Item 1. Financial Statements

ARLINGTON ASSET INVESTMENT CORP.

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands)

(Unaudited)

 

 

 

June 30, 2022

 

 

December 31, 2021

 

ASSETS

 

 

 

 

 

 

Cash and cash equivalents (includes $247 and $2,118, respectively, from
  consolidated VIEs)

 

$

9,575

 

 

$

20,543

 

Restricted cash

 

 

1,270

 

 

 

1,132

 

Restricted cash of consolidated VIEs

 

 

4,649

 

 

 

111

 

Sold securities receivable

 

 

 

 

 

28,219

 

Agency mortgage-backed securities, at fair value

 

 

382,357

 

 

 

483,927

 

MSR financing receivables, at fair value

 

 

120,260

 

 

 

125,018

 

Credit securities, at fair value

 

 

113,419

 

 

 

26,222

 

Mortgage loans, at fair value

 

 

29,484

 

 

 

29,697

 

Mortgage loans of consolidated VIEs, at fair value

 

 

225,004

 

 

 

7,442

 

Single-family residential real estate (net of $326 and $299, respectively, of
  accumulated depreciation)

 

 

68,190

 

 

 

60,889

 

Single-family residential real estate held-for-sale (net of $1,288 and $-0-,
   respectively, of accumulated depreciation)

 

 

112,979

 

 

 

 

Deposits

 

 

4,623

 

 

 

4,549

 

Other assets (includes $1,401 and $547, respectively, from consolidated VIEs)

 

 

12,945

 

 

 

15,287

 

Total assets

 

$

1,084,755

 

 

$

803,036

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

Repurchase agreements

 

$

329,994

 

 

$

446,624

 

Purchased securities payable

 

 

114,410

 

 

 

 

Secured debt of consolidated VIEs, at fair value

 

 

205,497

 

 

 

508

 

Long-term unsecured debt

 

 

86,199

 

 

 

85,994

 

Long-term debt secured by single-family properties

 

 

122,770

 

 

 

39,178

 

Other liabilities (includes $275 and $2, respectively, from consolidated VIEs)

 

 

12,187

 

 

 

6,605

 

Total liabilities

 

 

871,057

 

 

 

578,909

 

Commitments and contingencies

 

 

 

 

 

 

Stockholders’ Equity:

 

 

 

 

 

 

Series B Preferred stock, $0.01 par value, 379,668 and 373,610, shares issued
   and outstanding, respectively (liquidation preference of $
9,492 and $9,340,
   respectively)

 

 

9,001

 

 

 

8,852

 

Series C Preferred stock, $0.01 par value, 1,044,671 and 1,117,034, shares issued
   and outstanding, respectively (liquidation preference of $
26,117 and $27,926,
   respectively)

 

 

25,607

 

 

 

27,356

 

Class A common stock, $0.01 par value, 450,000,000 shares authorized, 29,112,374
   and
30,676,931 shares issued and outstanding, respectively

 

 

291

 

 

 

307

 

Additional paid-in capital

 

 

2,025,345

 

 

 

2,030,315

 

Accumulated deficit

 

 

(1,846,546

)

 

 

(1,842,703

)

Total stockholders’ equity

 

 

213,698

 

 

 

224,127

 

Total liabilities and stockholders’ equity

 

$

1,084,755

 

 

$

803,036

 

 

 

 

 

 

 

 

 

 

June 30, 2022

 

 

December 31, 2021

 

Assets and liabilities of consolidated VIEs

 

 

 

 

 

 

Cash and restricted cash

 

$

4,896

 

 

$

2,229

 

Mortgage loans, at fair value

 

 

225,004

 

 

 

7,442

 

Other assets

 

 

1,401

 

 

 

547

 

Secured debt, at fair value

 

 

(205,497

)

 

 

(508

)

Other liabilities

 

 

(275

)

 

 

(2

)

Net investment in consolidated VIEs

 

$

25,529

 

 

$

9,708

 

 

See notes to consolidated financial statements.

1


 

ARLINGTON ASSET INVESTMENT CORP.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Dollars in thousands, except per share data)

(Unaudited)

 

 

 

Three Months Ended June 30,

 

 

Six Months Ended June 30,

 

 

 

2022

 

 

2021

 

 

2022

 

 

2021

 

Interest income

 

 

 

 

 

 

 

 

 

 

 

 

MSR financing receivables

 

$

3,983

 

 

$

1,390

 

 

$

7,365

 

 

$

1,748

 

Agency mortgage-backed securities

 

 

2,065

 

 

 

2,984

 

 

 

3,557

 

 

 

5,768

 

Credit securities and loans

 

 

991

 

 

 

1,770

 

 

 

1,844

 

 

 

3,039

 

Mortgage loans of consolidated VIEs

 

 

1,611

 

 

 

776

 

 

 

2,965

 

 

 

2,463

 

Other

 

 

113

 

 

 

125

 

 

 

438

 

 

 

286

 

Total interest and other income

 

 

8,763

 

 

 

7,045

 

 

 

16,169

 

 

 

13,304

 

Rent revenues from single-family properties

 

 

2,137

 

 

 

 

 

 

3,201

 

 

 

 

Interest expense

 

 

 

 

 

 

 

 

 

 

 

 

Repurchase agreements

 

 

763

 

 

 

403

 

 

 

1,039

 

 

 

891

 

Long-term debt secured by single-family properties

 

 

718

 

 

 

 

 

 

1,126

 

 

 

 

Long-term unsecured debt

 

 

1,400

 

 

 

1,150

 

 

 

2,770

 

 

 

2,301

 

Secured debt of consolidated VIEs

 

 

1,578

 

 

 

405

 

 

 

2,766

 

 

 

1,267

 

Total interest expense

 

 

4,459

 

 

 

1,958

 

 

 

7,701

 

 

 

4,459

 

Single-family property operating expenses

 

 

1,915

 

 

 

 

 

 

3,446

 

 

 

 

Net operating income

 

 

4,526

 

 

 

5,087

 

 

 

8,223

 

 

 

8,845

 

Investment and derivative gain (loss), net

 

 

370

 

 

 

(9,032

)

 

 

(457

)

 

 

(15,795

)

General and administrative expenses

 

 

 

 

 

 

 

 

 

 

 

 

Compensation and benefits

 

 

2,324

 

 

 

1,841

 

 

 

4,389

 

 

 

3,236

 

Other general and administrative expenses

 

 

1,463

 

 

 

1,349

 

 

 

2,682

 

 

 

2,591

 

Total general and administrative expenses

 

 

3,787

 

 

 

3,190

 

 

 

7,071

 

 

 

5,827

 

Income (loss) before income taxes

 

 

1,109

 

 

 

(7,135

)

 

 

695

 

 

 

(12,777

)

Income tax provision (benefit)

 

 

802

 

 

 

(76

)

 

 

3,089

 

 

 

322

 

Net income (loss)

 

 

307

 

 

 

(7,059

)

 

 

(2,394

)

 

 

(13,099

)

Dividend on preferred stock

 

 

(707

)

 

 

(723

)

 

 

(1,449

)

 

 

(1,446

)

Net loss attributable to common stock

 

$

(400

)

 

$

(7,782

)

 

$

(3,843

)

 

$

(14,545

)

Basic loss per common share

 

$

(0.01

)

 

$

(0.24

)

 

$

(0.13

)

 

$

(0.44

)

Diluted loss per common share

 

$

(0.01

)

 

$

(0.24

)

 

$

(0.13

)

 

$

(0.44

)

Weighted-average common shares outstanding
  (in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

28,766

 

 

 

33,066

 

 

 

29,296

 

 

 

33,123

 

Diluted

 

 

28,766

 

 

 

33,066

 

 

 

29,296

 

 

 

33,123

 

 

See notes to consolidated financial statements.

2


 

ARLINGTON ASSET INVESTMENT CORP.

CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

(Dollars in thousands)

(Unaudited)

 

 

 

Series B
Preferred
Stock
(#)

 

 

Series B
Preferred
Amount
($)

 

 

Series C
Preferred
Stock
(#)

 

 

Series C
Preferred
Amount
($)

 

 

Class A
Common
Stock
(#)

 

 

Class A
Amount
($)

 

 

Additional
Paid-In
Capital

 

 

Accumulated
Deficit

 

 

Total

 

Balances, December 31, 2020

 

 

336,273

 

 

$

7,933

 

 

 

1,117,034

 

 

$

27,356

 

 

 

33,517,018

 

 

$

335

 

 

$

2,040,918

 

 

$

(1,830,272

)

 

$

246,270

 

Net loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(6,040

)

 

 

(6,040

)

Issuance of Class A common
  stock under stock-based
  compensation plans

 

 

 

 

 

 

 

 

 

 

 

 

 

 

101,818

 

 

 

1

 

 

 

(1

)

 

 

 

 

 

 

Repurchase of Class A
  common stock

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(137,655

)

 

 

(1

)

 

 

(522

)

 

 

 

 

 

(523

)

Stock-based compensation

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

503

 

 

 

 

 

 

503

 

Dividends declared

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(723

)

 

 

(723

)

Balances, March 31, 2021

 

 

336,273

 

 

$

7,933

 

 

 

1,117,034

 

 

$

27,356

 

 

 

33,481,181

 

 

$

335

 

 

$

2,040,898

 

 

$

(1,837,035

)

 

$

239,487

 

Net loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(7,059

)

 

 

(7,059

)

Issuance of Class A common
  stock under stock-based
  compensation plans

 

 

 

 

 

 

 

 

 

 

 

 

 

 

76,592

 

 

 

1

 

 

 

(1

)

 

 

 

 

 

 

Forfeiture of Class A common
  stock under stock-based
  compensation plans

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(22,000

)

 

 

 

 

 

 

 

 

 

 

 

 

Repurchase of Class A
  common stock

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(855,835

)

 

 

(9

)

 

 

(3,481

)

 

 

 

 

 

(3,490

)

Stock-based compensation

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

537

 

 

 

 

 

 

537

 

Dividends declared

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(723

)

 

 

(723

)

Balances, June 30, 2021

 

 

336,273

 

 

$

7,933

 

 

 

1,117,034

 

 

$

27,356

 

 

 

32,679,938

 

 

$

327

 

 

$

2,037,953

 

 

$

(1,844,817

)

 

$

228,752

 

 

 

 

 

 

Series B
Preferred
Stock
(#)

 

 

Series B
Preferred
Amount
($)

 

 

Series C
Preferred
Stock
(#)

 

 

Series C
Preferred
Amount
($)

 

 

Class A
Common
Stock
(#)

 

 

Class A
Amount
($)

 

 

Additional
Paid-In
Capital

 

 

Accumulated
Deficit

 

 

Total

 

Balances, December 31, 2021

 

 

373,610

 

 

$

8,852

 

 

 

1,117,034

 

 

$

27,356

 

 

 

30,676,931

 

 

$

307

 

 

$

2,030,315

 

 

$

(1,842,703

)

 

$

224,127

 

Net loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(2,701

)

 

 

(2,701

)

Issuance of Class A common
  stock under stock-based
  compensation plans

 

 

 

 

 

 

 

 

 

 

 

 

 

 

404,746

 

 

 

4

 

 

 

(4

)

 

 

 

 

 

 

Forfeiture of Class A common
  stock under stock-based
  compensation plans

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(12,167

)

 

 

 

 

 

 

 

 

 

 

 

 

Repurchase of Class A
  common stock

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(1,009,566

)

 

 

(10

)

 

 

(3,487

)

 

 

 

 

 

(3,497

)

Issuance of preferred stock

 

 

6,058

 

 

 

149

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

149

 

Stock-based compensation

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

761

 

 

 

 

 

 

761

 

Dividends declared

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(742

)

 

 

(742

)

Balances, March 31, 2022

 

 

379,668

 

 

$

9,001

 

 

 

1,117,034

 

 

$

27,356

 

 

 

30,059,944

 

 

$

301

 

 

$

2,027,585

 

 

$

(1,846,146

)

 

$

218,097

 

Net income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

307

 

 

 

307

 

Repurchase of Class A
  common stock

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(947,570

)

 

 

(10

)

 

 

(3,232

)

 

 

 

 

 

(3,242

)

Repurchase of preferred stock

 

 

 

 

 

 

 

 

(72,363

)

 

 

(1,749

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(1,749

)

Stock-based compensation

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

992

 

 

 

 

 

 

992

 

Dividends declared

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(707

)

 

 

(707

)

Balances, June 30, 2022

 

 

379,668

 

 

$

9,001

 

 

 

1,044,671

 

 

$

25,607

 

 

 

29,112,374

 

 

$

291

 

 

$

2,025,345

 

 

$

(1,846,546

)

 

$

213,698

 

See notes to consolidated financial statements.

 

 

3


 

ARLINGTON ASSET INVESTMENT CORP.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

(Unaudited)

 

 

 

Six Months Ended June 30,

 

 

 

2022

 

 

2021

 

Cash flows from operating activities:

 

 

 

 

 

 

Net loss

 

$

(2,394

)

 

$

(13,099

)

Adjustments to reconcile net loss to net cash (used in) provided by operating activities

 

 

 

 

 

 

Investment and derivative loss, net

 

 

457

 

 

 

15,795

 

Net (discount) premium (accretion) amortization

 

 

(3,694

)

 

 

(1,297

)

Other

 

 

3,316

 

 

 

1,131

 

Changes in operating assets

 

 

 

 

 

 

Interest receivable

 

 

67

 

 

 

312

 

Other assets

 

 

(2,743

)

 

 

(537

)

Changes in operating liabilities

 

 

 

 

 

 

Interest payable and other liabilities

 

 

3,693

 

 

 

1,087

 

Accrued compensation and benefits

 

 

(1,337

)

 

 

(1,223

)

Net cash (used in) provided by operating activities

 

 

(2,635

)

 

 

2,169

 

Cash flows from investing activities:

 

 

 

 

 

 

Purchases of agency mortgage-backed securities

 

 

(400,331

)

 

 

(607,659

)

Purchases of credit securities

 

 

(120,335

)

 

 

(28,356

)

Purchases of MSR financing receivables

 

 

(21,220

)

 

 

(60,556

)

Purchases of single-family residential real estate

 

 

(121,919

)

 

 

 

Purchases of loans

 

 

 

 

 

(29,967

)

Proceeds from sales of agency mortgage-backed securities

 

 

586,693

 

 

 

625,812

 

Proceeds from sales of credit securities

 

 

10,395

 

 

 

13,640

 

Proceeds from sales of single-family residential real estate

 

 

351

 

 

 

 

Receipt of principal payments on agency mortgage-backed securities

 

 

20,463

 

 

 

29,735

 

Receipt of principal payments on credit securities

 

 

862

 

 

 

 

Receipt of principal payments on loans

 

 

212

 

 

 

282

 

Receipt of principal payments on mortgage loans of consolidated VIE

 

 

29,278

 

 

 

58,948

 

Receipt of distributions on MSR financing receivables

 

 

64,552

 

 

 

 

Restricted cash balance of VIE upon consolidation

 

 

9,637

 

 

 

 

Proceeds from (payments for) derivatives and deposits, net

 

 

5,979

 

 

 

(9,349

)

Other

 

 

6,231

 

 

 

3,583

 

Net cash provided by (used in) investing activities

 

 

70,848

 

 

 

(3,887

)

Cash flows from financing activities:

 

 

 

 

 

 

(Repayments of) proceeds from repurchase agreements, net

 

 

(116,630

)

 

 

39,374

 

Repayments of secured debt of consolidated VIE

 

 

(31,652

)

 

 

(65,350

)

Repurchase of common stock

 

 

(6,739

)

 

 

(4,013

)

Repurchase of preferred stock

 

 

(1,749

)

 

 

 

Proceeds from issuance of preferred stock

 

 

149

 

 

 

 

Proceeds from long-term debt secured by single-family properties

 

 

83,565

 

 

 

 

Repurchase of long-term unsecured debt

 

 

 

 

 

(7

)

Dividends paid

 

 

(1,449

)

 

 

(1,446

)

Net cash used in financing activities

 

 

(74,505

)

 

 

(31,442

)

Net decrease in cash, cash equivalents and restricted cash

 

 

(6,292

)

 

 

(33,160

)

Cash, cash equivalents and restricted cash, beginning of period

 

 

21,786

 

 

 

39,965

 

Cash, cash equivalents and restricted cash, end of period

 

$

15,494

 

 

$

6,805

 

Supplemental cash flow information:

 

 

 

 

 

 

Cash payments for interest

 

$

6,625

 

 

$

4,468

 

Cash payments for taxes

 

$

753

 

 

$

 

Non-cash investing activity:

 

 

 

 

 

 

Assets of VIE upon consolidation

 

$

287,282

 

 

$

 

Non-cash financing activity:

 

 

 

 

 

 

Liabilities of VIE upon consolidation

 

$

266,697

 

 

$

 

 

See notes to consolidated financial statements.

4


 

ARLINGTON ASSET INVESTMENT CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in thousands, except per share data)

(Unaudited)

 

Note 1. Organization and Basis of Presentation

Arlington Asset Investment Corp. (“Arlington Asset”) and its consolidated subsidiaries (unless the context otherwise provides, collectively, the “Company”) is an investment firm that focuses primarily on investing in mortgage related assets and residential real estate. The Company’s investment capital is currently allocated between mortgage servicing right (“MSR”) related assets, credit investments, single-family residential (“SFR”) properties and agency mortgage-backed securities (“MBS”).

The Company’s MSR related assets represent investments for which the return is based on the economic performance of a pool of specific MSRs. The Company’s credit investments generally include investments in mortgage loans secured by either residential or commercial real property or MBS collateralized by residential or commercial mortgage loans (“non-agency MBS”) or asset-backed securities (“ABS”) collateralized by residential solar panel loans. The Company’s SFR investment strategy is to acquire, lease and operate single-family residential homes as rental properties. The Company’s agency MBS consist of residential mortgage pass-through certificates for which the principal and interest payments are guaranteed by a U.S. government sponsored enterprise (“GSE”), such as the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”).

The Company is a Virginia corporation. The Company is internally managed and does not have an external investment advisor.

The Company has elected to be taxed as a real estate investment trust (“REIT”) under the Internal Revenue Code of 1986, as amended (the “Internal Revenue Code”). As a REIT, the Company is required to distribute annually 90% of its REIT taxable income (subject to certain adjustments). So long as the Company continues to qualify as a REIT, it will generally not be subject to U.S. Federal or state corporate income taxes on its taxable income that it distributes to its shareholders on a timely basis. At present, it is the Company’s intention to distribute 100% of its taxable income, although the Company will not be required to do so. The Company intends to make distributions of its taxable income within the time limits prescribed by the Internal Revenue Code, which may extend into the subsequent taxable year.

The unaudited interim consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and pursuant to the requirements for reporting on Form 10-Q and Article 10 of Regulation S-X. The Company’s unaudited interim consolidated financial statements and notes thereto should be read in conjunction with the Company’s audited annual consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2021.

The Company’s consolidated financial statements include the accounts of Arlington Asset and all other entities in which the Company has a controlling financial interest. All intercompany accounts and transactions have been eliminated in consolidation.

The preparation of financial statements in conformity with GAAP requires the Company to make estimates and assumptions that affect amounts reported in the consolidated financial statements. Although the Company bases these estimates and assumptions on historical experience and all other reasonably available information that the Company believes to be relevant under the circumstances, such estimates frequently require management to exercise significant subjective judgment about matters that are inherently uncertain. Actual results may differ materially from these estimates.

Certain prior period amounts in the consolidated financial statements and the accompanying notes may have been reclassified to conform to the current year’s presentation. These reclassifications had no impact on the previously reported net income, total assets or total liabilities.

 

Note 2. Summary of Significant Accounting Policies

Cash Equivalents

Cash equivalents include demand deposits with banks, money market accounts and highly liquid investments with original maturities of three months or less. As of June 30, 2022 and December 31, 2021, approximately 0% and 67%, respectively, of the Company’s cash equivalents were invested in money market funds that invest primarily in U.S. Treasuries and other securities backed by the U.S. government.

5


 

Investment Security Purchases and Sales

Purchases and sales of investment securities are recorded on the settlement date of the transfer unless the trade qualifies as a “regular-way” trade and the associated commitment qualifies for an exemption from the accounting guidance applicable to derivative instruments. A regular-way trade is an investment security purchase or sale transaction that is expected to settle within the period of time following the trade date that is prevalent or traditional for that specific type of security. Any amounts payable or receivable for unsettled security trades are recorded as “sold securities receivable” or “purchased securities payable” in the consolidated balance sheets.

Interest Income Recognition for Investments in Agency MBS, Mortgage Loans of Consolidated VIEs and Credit Securities of High Credit Quality

The Company recognizes interest income for its investments in agency MBS, mortgage loans of consolidated variable interest entities (“VIEs”) and credit securities that are considered to be of high credit quality (that is, those with a Standard & Poor's rating of AA or higher or an equivalent rating from another rating agency) by applying the “interest method” permitted by GAAP, whereby purchase premiums and discounts are amortized and accreted, respectively, as an adjustment to contractual interest income accrued at each investment’s stated interest rate. The interest method is applied at the individual instrument level based upon each instrument’s effective interest rate. The Company calculates each instrument’s effective interest rate at the time of purchase or initial recognition by solving for the discount rate that equates the present value of that instrument's remaining contractual cash flows (assuming no principal prepayments) to its purchase cost. Because each instrument’s effective interest rate does not reflect an estimate of future prepayments, the Company refers to this manner of applying the interest method as the “contractual effective interest method.” When applying the contractual effective interest method, as principal prepayments occur, a proportional amount of the unamortized premium or unaccreted discount is recognized in interest income such that the contractual effective interest rate on any remaining security or loan balance is unaffected.

For mortgage loans of consolidated VIEs, the Company ceases the accrual of interest income (i.e., places the loan in non-accrual status) when it believes collectability of principal and interest in full is not reasonably assured, which generally occurs when a loan is three or more monthly payments past due, unless the loan is well secured and in the process of collection based upon an individual loan assessment. Upon placing a loan in non-accrual status, any previously accrued but uncollected interest is derecognized and a corresponding reduction to current period interest income is recorded. While a loan is in non-accrual status, the Company recognizes interest income only when interest payments occur.

Interest Income Recognition for Investments in Other Credit Securities and MSR Financing Receivables

The Company recognizes interest income for its investments in credit securities (other than those considered to be of high credit quality) and MSR financing receivables by applying the prospective level-yield methodology required by GAAP for financial assets that are either not of high credit quality at the time of acquisition or can be contractually prepaid or otherwise settled in such a way that the Company would not recover substantially all of its recorded investment. The amount of periodic interest income recognized is determined by applying the investment’s effective interest rate to its amortized cost basis (or “reference amount”). At the time of acquisition, the investment’s effective interest rate is calculated by solving for the single discount rate that equates the present value of the Company’s best estimate of the amount and timing of the cash flows expected to be collected from the investment to its purchase cost. To prepare its best estimate of cash flows expected to be collected, the Company develops a number of assumptions about the future performance of the pool of loans that serve as collateral for its investment, including assumptions about the timing and amount of prepayments and credit losses. For investments in MSR financing receivables, the Company's estimate of cash flows expected to be collected reflects all components of its mortgage servicing counterparty's payment obligation, which is comprised of cash flows referenced to the monthly net cash flows of the underlying reference pool of MSRs net of (i) the counterparty's periodic interest payments and principal repayments related to advances obtained via its third-party secured financing facility collateralized by MSRs to which the Company's MSR financing receivables are referenced and (ii) fees payable to the counterparty. In each subsequent quarterly reporting period, the amount and timing of cash flows expected to be collected from the investment are re-estimated based upon current information and events. The following table provides a description of how periodic changes in the estimate of cash flows expected to be collected affect interest income recognition prospectively for investments in credit securities and MSR financing receivables:

6


 

 

Scenario:

 

 

 

Effect on Interest Income Recognition:

 

 

 

A positive change in cash flows occurs.

 

Actual cash flows exceed prior estimates and/or a positive change occurs in the estimate of expected remaining cash flows.

 

 

A revised effective interest rate is calculated and applied prospectively such that the positive change in cash flows is recognized as incremental interest income over the remaining life of the investment.

 

 

 

 

 

The amount of periodic interest income recognized over the remaining life of the investment will be reduced accordingly. Generally, the investment’s effective interest rate is reduced accordingly and applied on a prospective basis. However, if the revised effective interest rate is negative, the investment’s existing effective interest rate is retained while the reference amount to which the existing effective interest rate will be prospectively applied is reduced to the present value of cash flows expected to be collected, discounted at the investment’s existing effective interest rate.

An adverse change in cash flows occurs.

 

Actual cash flows fall short of prior estimates and/or an adverse change occurs in the estimate of expected remaining cash flows.

 

 

 

Other Significant Accounting Policies

Certain of the Company’s other significant accounting policies are summarized in the following notes:

 

Investments in agency MBS, subsequent measurement

Note 3

Investments in credit securities, subsequent measurement

Loans held for investment, subsequent measurement

Investments in MSR financing receivables, subsequent measurement

Investments in SFR properties

Note 4

Note 5

Note 6

Note 7

Consolidation of variable interest entities

Borrowings

Note 8

Note 9

To-be-announced agency MBS transactions, including “dollar rolls”

Note 10

Derivative instruments

Note 10

Balance sheet offsetting

Note 11

Fair value measurements

Income taxes

Note 12

Note 13

Stock-based compensation

Note 16

 

7


 

Refer to the Company’s 2021 Annual Report on Form 10-K for a complete inventory and summary of the Company’s significant accounting policies.

 

Recent Accounting Pronouncements

The following table provides a brief description of recently issued accounting pronouncements and their actual or expected effect on the Company’s consolidated financial statements:

 

Standard

Description

Date of

Adoption

Effect on the Consolidated

Financial Statements

Recently Issued Accounting Guidance Not Yet Adopted

ASU Nos. 2020-04 and 2021-01, Reference Rate Reform (Topic 848)

 

 

The amendments in these updates provide optional practical expedients and exceptions for applying GAAP to the modification of receivables, debt or lease contracts as well as cash flow and fair value hedge accounting relationships that reference a rate, such as the London Interbank Offered Rate (“LIBOR”), that is expected to be discontinued because of reference rate reform.

 

The practical expedients and exceptions provided by these updates are effective from March 12, 2020 through December 31, 2022.

Not yet adopted.

To date, any modifications due to reference rate reform have not had a material impact to the Company.

 

The Company has not elected to apply hedge accounting for financial reporting purposes.

 

The Company does not currently expect the adoption of ASU Nos. 2020-04 and 2021-01 to have a material effect on its consolidated financial statements.

 

Note 3. Investments in Agency MBS

The Company has elected to classify its investments in agency MBS as trading securities. Accordingly, the Company’s investments in agency MBS are reported in the accompanying consolidated balance sheets at fair value. As of June 30, 2022 and December 31, 2021, the fair value of the Company’s investments in agency MBS was $382,357 and $483,927, respectively. As of June 30, 2022, all the Company’s investments in agency MBS represent undivided (or “pass-through”) beneficial interests in specified pools of fixed-rate mortgage loans.

All periodic changes in the fair value of agency MBS that are not attributed to interest income are recognized as a component of “investment and derivative gain (loss), net” in the accompanying consolidated statements of comprehensive income. The following table provides additional information about the gains and losses recognized as a component of “investment and derivative gain (loss), net” in the Company’s consolidated statements of comprehensive income for the periods indicated with respect to investments in agency MBS:

 

 

 

Three Months Ended June 30,

 

 

Six Months Ended June 30,

 

 

 

2022

 

 

2021

 

 

2022

 

 

2021

 

Net gains (losses) recognized in earnings for:

 

 

 

 

 

 

 

 

 

 

 

 

Agency MBS still held at period end

 

$

(3,921

)

 

$

6,840

 

 

$

(3,922

)

 

$

(11,861

)

Agency MBS sold during the period

 

 

(6,670

)

 

 

290

 

 

 

(32,626

)

 

 

(10,224

)

Total

 

$

(10,591

)

 

$

7,130

 

 

$

(36,548

)

 

$

(22,085

)

 

The Company also invests in and finances fixed-rate agency MBS on a generic pool basis through sequential series of to-be-announced security transactions commonly referred to as “dollar rolls.” Dollar rolls are accounted for as a sequential series of derivative instruments. Refer to “Note 10. Derivative Instruments” for further information about dollar rolls.

 

 

Note 4. Investments in Credit Securities

The Company has elected to classify its investments in credit securities as trading securities. Accordingly, the Company’s investments in credit securities are reported in the accompanying consolidated balance sheets at fair value. As of June 30, 2022 and December 31, 2021, the fair value of the Company’s investments in credit securities was $113,419 and $26,222, respectively. As of June 30, 2022, the Company’s investments in credit securities primarily consist of non-agency MBS collateralized by pools of

8


 

business purpose residential mortgage loans or commercial mortgage loans and ABS collateralized by pools of residential solar panel loans.

All periodic changes in the fair value of credit securities that are not attributed to interest income are recognized as a component of “investment and derivative gain (loss), net” in the accompanying consolidated statements of comprehensive income. The following table provides additional information about the gains and losses recognized as a component of “investment and derivative gain (loss), net” in the Company’s consolidated statements of comprehensive income for the periods indicated with respect to investments in credit securities:

 

 

 

Three Months Ended June 30,

 

 

Six Months Ended June 30,

 

 

 

2022

 

 

2021

 

 

2022

 

 

2021

 

Net gains (losses) recognized in earnings for:

 

 

 

 

 

 

 

 

 

 

 

 

Credit securities still held at period end

 

$

(321

)

 

$

(186

)

 

$

(675

)

 

$

1,210

 

Credit securities sold during the period

 

 

(482

)

 

 

(75

)

 

 

(970

)

 

 

(80

)

Total

 

$

(803

)

 

$

(261

)

 

$

(1,645

)

 

$

1,130

 

 

Note 5. Loans Held for Investment

As of June 30, 2022 and December 31, 2021, the Company held a loan secured by a first lien position in healthcare facilities and guaranteed by the operator of the facilities with an outstanding principal outstanding principal balance of $29,484 and $29,697, respectively. The loan bears interest at a floating note rate equal to SOFR plus 5.61%. The original maturity date of the loan was March 23, 2022 with a one-year extension available at the option of the borrower. On March 23, 2022, the borrower exercised its one-year extension option resulting in a new maturity date of March 23, 2023. The loan has monthly principal amortization based upon a 30-year amortization schedule with the remaining principal balance due at loan maturity.

The Company has elected to account for its loan held for investment at fair value on a recurring basis with periodic changes in fair value recognized as a component of “investment and derivative gain (loss), net” in the accompanying consolidated statements of comprehensive income. As of June 30, 2022 and December 31, 2021, the Company’s investment was $29,484 and $29,697, respectively, at fair value. The Company recognizes interest income on its loan investment based upon the effective interest rate of the loan which, as of June 30, 2022 and December 31, 2021, was equal to the contractual note rate of the loan.

As of June 30, 2022 and December 31, 2021, the Company was party to a participation agreement pursuant to which the Company has committed to fund up to $30,000 of a $130,000 revolving credit facility that matures on July 7, 2024. Under the terms of the participation agreement, the Company funds the last $30,000 of advances under the revolving credit facility. Any draws under the revolving credit facility bear interest at SOFR plus 3.86% with a SOFR floor of 1.00% and are secured by a first lien on all accounts receivable and a second lien on all other assets of the borrower. The borrower is also required to pay an unused commitment fee of 0.50%. As of June 30, 2022 and December 31, 2021, the Company’s advances under the revolving credit facility were $314 and $0, respectively, which is included in the line item "other assets" in the accompanying consolidated balance sheets. As of June 30, 2022 and December 31, 2021, the Company's unfunded commitment was $29,686 and $30,000, respectively.

 

Note 6. Investments in MSR Financing Receivables

 

The Company does not hold the requisite licenses to purchase or hold MSRs directly. However, the Company has entered into agreements with a licensed, GSE approved residential mortgage loan servicer that enable the Company to garner the economic return of an investment in an MSR purchased by the mortgage servicing counterparty through an MSR financing transaction. Under the terms of the arrangement, for an MSR acquired by the mortgage servicing counterparty (i) the Company purchases the “excess servicing spread” from the mortgage servicer counterparty, entitling the Company to monthly distributions of the servicing fees collected by the mortgage servicing counterparty in excess of 12.5 basis points per annum (and to distributions of corresponding proceeds of sale of the MSRs), and (ii) the Company funds the balance of the MSR purchase price to the parent company of the mortgage servicing counterparty and, in exchange, has an unsecured right to payment of certain amounts determined by reference to the MSR, generally equal to the servicing fee revenue less the excess servicing spread and the costs of servicing (and to distributions of corresponding proceeds of sale of the MSRs), net of fees earned by the mortgage servicing counterparty and its affiliates including an incentive fee equal to a percentage of the total return of the MSR in excess of a hurdle rate of return. The Company has committed to invest a total minimum of $50,000 in capital with the counterparty with $25,000 of the minimum commitment expiring on December 31, 2023 and $25,000 of the minimum commitment expiring on April 1, 2024.

 

9


 

Under the arrangement, the Company is obligated to provide funds to the mortgage servicing counterparty to fund the counterparty’s advances of payments on the serviced pool of mortgage loans. The mortgage servicing counterparty is required to return to the Company subsequent servicing advances collected from the underlying borrowers. The mortgage servicing counterparty is entitled to reimbursement from the GSEs of any servicing advances that are not subsequently collected from the underlying borrowers. As of June 30, 2022 and December 31, 2021, the Company had provided funds of $2,348 and $3,731, respectively, to its mortgage servicing counterparty related to the counterparty’s servicing advances made pursuant to the MSRs to which the Company’s MSR financing receivables are referenced.

 

As a means to increase potential returns to the Company, at the Company’s election, it can request the mortgage servicing counterparty utilize leverage on the MSRs to which the Company’s MSR financing receivables are referenced to finance the purchase of additional MSRs. As of June 30, 2022 and December 31, 2021, the Company’s counterparty had drawn $60,868 and $40,398, respectively, of financing secured by the MSRs to which the Company’s MSR financing receivables are referenced.

 

The Company accounts for transactions executed under its arrangement with the mortgage servicing counterparty as financing transactions and reflects the associated financing receivables in the line item “MSR financing receivables” on its consolidated balance sheets. The Company has elected to account for its MSR financing receivables at fair value with changes in fair value that are not attributed to interest income recognized as a component of “investment and derivative gain (loss), net” in the accompanying consolidated statements of comprehensive income. As described in further detail in “Note 2. Summary of Significant Accounting Policies,” the Company recognizes interest income for MSR financing receivables by applying the prospective level-yield methodology required by GAAP for financial assets that are either not of high credit quality at the time of acquisition or can be contractually prepaid or otherwise settled in such a way that the Company would not recover substantially all of its recorded investment.

 

As of June 30, 2022 and December 31, 2021, the fair value of the Company’s investments in MSR financing receivables was $120,260 and $125,018, respectively. The following table presents activity related to the carrying value of the Company’s investments in MSR financing receivables for the periods indicated:

 

 

 

Three Months Ended June 30,

 

 

Six Months Ended June 30,

 

 

 

2022

 

 

2021

 

 

2022

 

 

2021

 

Balance at period beginning

 

$

139,225

 

 

$

36,005

 

 

$

125,018

 

 

$

9,346

 

Capital investments

 

 

18,032

 

 

 

39,278

 

 

 

21,219

 

 

 

59,622

 

Capital distributions

 

 

(49,432

)

 

 

 

 

 

(64,552

)

 

 

 

Accretion of interest income

 

 

3,983

 

 

 

1,390

 

 

 

7,365

 

 

 

1,748

 

Changes in valuation inputs and assumptions

 

 

8,452

 

 

 

(2,021

)

 

 

31,210

 

 

 

3,936

 

Balance at period end

 

$

120,260

 

 

$

74,652

 

 

$

120,260

 

 

$

74,652

 

 

Note 7. Investments in SFR Properties

 

The Company owns a portfolio of SFR homes that it operates as rental properties. The Company is party to an agreement with a third-party investment firm to identify, acquire and manage investments in SFR properties on behalf of the Company. Under the terms of the agreement, the Company has committed to fund up to $65,000 of capital to fund the acquisition of SFR properties. The Company’s commitment to fund up to $65,000 of capital may be reduced to $55,000 to the extent the Company utilizes debt financing to fund certain acquisitions of SFR properties. The Company is obligated to pay the third-party firm a minimum fee plus an incentive fee equal to a percentage of the total investment return in excess of a hurdle rate of return. If the Company were to terminate the commitment, the Company would incur a termination fee equal to a fixed amount less inception to date minimum fees paid to the third-party firm.

 

The Company’s investments in SFR properties are initially recognized on the settlement date of their acquisition at cost. The Company allocates the initial acquisition cost of each property to land and building on the basis of their relative fair values at the time of acquisition. To determine the relative fair value of land and building at the time of acquisition, the Company uses available market data, such as property specific county tax assessment records.

 

Subsequent to the acquisition of a property, expenditures which improve or extend the life of the property are capitalized as a component of the property’s cost basis. Expenditures for ordinary maintenance and repairs are recognized as an expense as incurred and are reported as a component of “single-family property operating expenses” in the Company’s consolidated statements of comprehensive income.

 

10


 

The Company subsequently recognizes depreciation of each property’s buildings and capitalized improvements over the expected useful lives of those assets. The Company calculates depreciation on a straight-line basis over a useful life of 27.5 years for buildings and useful lives ranging from five to 27.5 years for capitalized improvements. The Company reports depreciation expense as a component of “single-family property operating expenses” in the Company’s consolidated statements of comprehensive income.

 

Pursuant to its SFR investment strategy, the Company leases its SFR properties to tenants who occupy the properties. The leases generally have terms of one year or more and are classified as operating leases. Rental revenue, net of any concessions, is recognized over the term of each lease on a straight-line basis. If the Company determines that collectability of lease payments is not probable, any lease receivables previously recognized are reversed and rental revenue is limited to cash received.

 

Costs directly associated with the origination of a lease, such as a commission paid to a property manager when a lease agreement is obtained, are deferred at the commencement of the lease and subsequently recognized ratably as an expense over the lease term, consistent with the recognition of rental revenue from the lease. The ratable expense recognition of lease direct costs is reported as a component of “single-family property operating expenses” in the Company’s consolidated statements of comprehensive income. In addition to the expense items previously mentioned, “single-family property operating expenses” also include accruals for, but not limited to, third-party property management fees, local real estate tax assessments, utilities, homeowners’ association dues and insurance.

 

The Company evaluates its SFR properties for impairment whenever circumstances indicate that their carrying amounts may not be recoverable. Significant indicators of potential impairment include, but are not limited to, declines in home values, adverse changes in rental or occupancy rates and relevant unfavorable changes in the broader economy. If indicators of potential impairment exist, the Company performs a recoverability test by comparing the property’s net carrying amount to its estimate of the undiscounted future net cash flows expected to be obtained from the use and eventual disposition of the property. If the property’s carrying amount exceeds the Company’s estimate of the undiscounted future net cash flows expected to be obtained from the property, the Company recognizes an impairment loss equal to the amount that the property’s net carrying amount exceeds the property’s estimated fair value. As of June 30, 2022 and December 31, 2021, the Company had not recognized any impairment losses for its investments in SFR properties.

 

From time to time, the Company may identify SFR properties to be sold. At the time that any such properties are identified, the Company performs an evaluation to determine whether or not such properties should be classified as held for sale. Factors considered as part of the Company's held for sale evaluation process include whether the following conditions have been met: (i) the Company has committed to a plan to sell a property; (ii) the property is immediately available for sale in its present condition; (iii) an active program to locate a buyer and other actions required to complete the plan to sell a property have been initiated; (iv) the sale of a property is probable within one year (generally determined based upon listing for sale); (v) the property is being actively marketed for sale at a price that is reasonable in relation to its current fair value; and (vi) actions required to complete the plan indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn. To the extent that these factors are all present, the Company ceases depreciating the property, measures the property at the lower of its carrying amount or its fair value less estimated costs to sell, and presents the property separately on its consolidated balance sheets.

 

On May 10, 2022, the Company entered into a purchase and sale agreement to sell 378 SFR properties for $132,750 with an original closing date no later than June 23, 2022. Pursuant to the purchase and sale agreement, the buyer made a $2,655 initial deposit with an escrow agent. On May 27, 2022, the Company entered into an amendment to the purchase and sale agreement to remove two properties from the sale transaction reducing the total properties to be sold to 376 SFR properties for $131,921. On June 20, 2022, the Company entered into an additional amendment to the purchase and sale agreement that required the buyer to fund an additional $2,655 deposit with the escrow agent for a total deposit of $5,310 to extend the closing date to no later than August 19, 2022. During the three months ended June 30, 2022, the Company classified the 376 SFR properties as held for sale.

 

As of June 30, 2022 and December 31, 2021, the Company had investments in 586 and 214 SFR properties, respectively, for a total cost of $182,783 and $61,188, respectively. During the three and six months ended June 30, 2022, the Company recognized $604 and $1,319, respectively, of depreciation expense related to its SFR properties. The following table summarizes the Company’s net carrying amount of its SFR properties by component as of June 30, 2022:

 

11


 

 

 

Single-family Residential Real Estate

 

 

Single-family Residential Real Estate Held-for-Sale

 

 

Total

 

Land

 

$

11,423

 

 

$

18,913

 

 

$

30,336

 

Buildings and improvements

 

 

57,093

 

 

 

95,354

 

 

 

152,447

 

Investments in single-family residential real estate, at cost

 

 

68,516

 

 

 

114,267

 

 

 

182,783

 

Less: accumulated depreciation

 

 

(326

)

 

 

(1,288

)

 

 

(1,614

)

Investments in single-family residential real estate, net

 

$

68,190

 

 

$

112,979

 

 

$

181,169

 

 

The following table summarizes the Company’s net carrying amount of its SFR properties by component as of December 31, 2021:

 

 

 

Single-family Residential Real Estate

 

 

Single-family Residential Real Estate Held-for-Sale

 

 

Total

 

Land

 

$

10,128

 

 

$

 

 

$

10,128

 

Buildings and improvements

 

 

51,060

 

 

 

 

 

 

51,060

 

Investments in single-family residential real estate, at cost

 

 

61,188

 

 

 

 

 

 

61,188

 

Less: accumulated depreciation

 

 

(299

)

 

 

 

 

 

(299

)

Investments in single-family residential real estate, net

 

$

60,889

 

 

$

 

 

$

60,889

 

 

As of June 30, 2022, the Company had commitments to acquire 25 SFR properties for an aggregate purchase price of $9,034.

 

Note 8. Consolidation of Variable Interest Entities

 

The vehicles that issue the Company’s investments in securitized mortgage assets are considered VIEs. The Company is required to consolidate any VIE in which it holds a variable interest if it determines that it holds a controlling financial interest in the VIE and is, therefore, determined to be the primary beneficiary of the VIE. The Company is determined to be the primary beneficiary of a VIE in which it holds a variable interest if it both (i) holds the power to direct the activities that most significantly impact the VIE’s economic performance and (ii) has the obligation to absorb losses or the right to receive benefits that could potentially be significant to the VIE. The economic performance of the trusts that issue the Company’s investments in securitized mortgage assets is most significantly impacted by the performance of the mortgage loans that are held by the trusts. The party that is determined to have the most power to direct the loss mitigation actions that are taken with respect to delinquent or otherwise troubled mortgage loans held by the trust is, therefore, deemed to hold the most power to direct the activities that most significantly impact the trust’s economic performance. As a passive investor, the Company does not have the power to direct the loss mitigation activities of most of the trusts that have issued its securitized mortgage assets.

 

On September 30, 2020, the Company acquired for $10,693 an investment that represents a majority interest in the first loss position of a securitized pool of business purpose residential mortgage loans. As majority holder of the first loss position, the Company is required to approve any material loss mitigation action proposed by the servicer with respect to a troubled loan. The Company also has the option (but not the obligation) to purchase delinquent loans from the trust. As a result of these contractual rights, the Company determined that it is the party with the most power to direct the loss mitigation activities and, therefore, the economic performance of the trust. As holder of the majority of the first loss position issued by the trust, the Company has the obligation to absorb losses or the right to receive benefits that could potentially be significant to the trust. Accordingly, the Company determined that it is the primary beneficiary of the trust and consolidated the trust’s assets and liabilities owed to third parties onto its consolidated balance sheets.

 

On February 3, 2022, the Company acquired for $20,585 investments in the first loss position and the excess interest-only strip of a securitized pool of recently originated, performing “non-qualified” residential mortgage loans. The Company’s investment in the excess interest-only strip provides it with the option (but not the obligation) to purchase delinquent loans from the trust. As a result of this contractual right, the Company determined that it has the power to circumvent the loss mitigation activities that would otherwise be performed by the servicer and, therefore, is the party with the most power to impact the economic performance of the trust. As a result of its investments, the Company also has the obligation to absorb losses or the right to receive benefits that could potentially be significant to the trust. Accordingly, the Company determined that it is the primary beneficiary of the trust and consolidated the trust’s assets and liabilities owed to third parties onto its consolidated balance sheets.

 

The carrying values of the assets and liabilities of the consolidated VIEs, net of elimination entries, are as follows as of the dates indicated:

12


 

 

 

 

June 30, 2022

 

 

 

VIE of Business Purpose Residential Mortgage Loans

 

 

VIE of Residential Mortgage Loans

 

 

Total

 

Cash of consolidated VIEs

 

$

247

 

 

$

 

 

$

247

 

Restricted cash of consolidated VIEs (1)

 

 

13

 

 

 

4,636

 

 

 

4,649

 

Mortgage loans of consolidated VIEs, at fair value

 

 

4,548

 

 

 

220,456

 

 

 

225,004

 

Other assets of consolidated VIEs

 

 

657

 

 

 

744

 

 

 

1,401

 

Secured debt of consolidated VIEs, at fair value

 

 

(272

)

 

 

(205,225

)

 

 

(205,497

)

Other liabilities of consolidated VIEs

 

 

(1

)

 

 

(274

)

 

 

(275

)

Net investment in consolidated VIEs

 

$

5,192

 

 

$

20,337

 

 

$

25,529

 

 

(1)
Restricted cash represents cash collected by the trust that must be used solely to satisfy the liabilities of the VIE in the month following collection.

 

 

 

December 31, 2021

 

 

 

VIE of Business Purpose Residential Mortgage Loans

 

 

VIE of Residential Mortgage Loans

 

 

Total

 

Cash of consolidated VIEs

 

$

2,118

 

 

$

 

 

$

2,118

 

Restricted cash of consolidated VIEs (1)

 

 

111

 

 

 

 

 

 

111

 

Mortgage loans of consolidated VIEs, at fair value

 

 

7,442

 

 

 

 

 

 

7,442

 

Other assets of consolidated VIEs

 

 

547

 

 

 

 

 

 

547

 

Secured debt of consolidated VIEs, at fair value

 

 

(508

)

 

 

 

 

 

(508

)

Other liabilities of consolidated VIEs

 

 

(2

)

 

 

 

 

 

(2

)

Net investment in consolidated VIEs

 

$

9,708

 

 

$

 

 

$

9,708

 

 

(1)
Restricted cash represents cash collected by the trust that must be used solely to satisfy the liabilities of the VIE in the month following collection.

 

The debt of the Company’s consolidated VIEs have recourse solely to the assets of the respective VIE; it has no recourse to the general credit of the Company.

 

Consolidated VIE of Business Purpose Residential Mortgage Loans

 

The pool of business purpose residential mortgage loans and the third-party held debt obligations of the consolidated VIE had aggregate unpaid principal balances of $4,835 and $291, respectively, as of June 30, 2022. The trust is contractually entitled to receive monthly interest payments on each underlying mortgage loan net of a loan-specific servicing and asset management fee that is not remitted to the trust but is, rather, retained by the servicer. As of June 30, 2022, the weighted average net note rate to which the VIE was entitled was 6.01%.

 

The pool of business purpose residential mortgage loans held by the consolidated VIE consists of fixed-rate, short-term, interest-only mortgage loans (with the full amount of principal due at maturity) made to professional real estate investors and are secured by first lien positions in non-owner occupied residential real estate. The properties that secure these mortgage loans often require construction, repair or rehabilitation. The repayment of the mortgage loans is often largely based on the ability of the borrower to sell the mortgaged property or to convert the property for rental purposes and obtain refinancing in the form of a longer-term loan. Pursuant to the terms of certain of the mortgage loans, the borrower may draw upon a specified amount of additional funds as needed in order to finance construction on, or the repair or rehabilitation of, the mortgaged property (referred to as a “construction draw”). Pursuant to the terms of the securitization transaction, if the monthly principal repayments collected from the mortgage loan pool are insufficient to fund that month’s construction draws, such shortfall is to be funded by the holders of the first loss position on a pro rata basis. Any construction draws funded by holders of the first loss position accrue interest at the net note rate of the mortgage loan. The repayment of any construction draws funded by holders of the first loss position takes priority over the senior debt securities with respect to the cash flows collected from the mortgage loan pool in the following month. As of June 30, 2022, the aggregate unfunded construction draw balance commitment attributable to the Company’s subordinate debt security investment was $121.

 

Consolidated VIE of Residential Mortgage Loans

 

13


 

The pool of mortgage loans and the third-party held debt obligations of the consolidated VIE had aggregate unpaid principal balances of $237,483 and $239,574, respectively, as of June 30, 2022. As of June 30, 2022, the weighted average contractual interest rates of the loans and consolidated debt held by third parties were 4.79% and 1.37%, respectively.

 

The pool of mortgage loans of the consolidated VIE consists of performing, first lien “non-qualified” residential mortgage loans. “Non-qualified” residential mortgage loans are loans that do not fully comply with the “ability-to-repay” rule and related guidelines of the Truth-in-Lending Act established by the Consumer Finance Protection Bureau pursuant to the authority granted under the Dodd-Frank Act. A “qualified” residential mortgage loan (i.e., a residential mortgage loan that fully complies with the “ability-to-repay” rule of the Truth-in-Lending Act) must meet certain debt-to-income ratio requirements and cannot have certain features, such as an interest-only period, negative amortization, balloon payments or terms longer than 30 years. Qualified mortgage loans have limited upfront fees and points and, generally, cannot have prepayment penalties except for limited circumstances. Lenders of qualified mortgage loans are afforded certain legal protections not available to non-qualified mortgage loan lenders.

 

Accounting for Consolidated VIEs

 

The Company has elected to account for the mortgage loans and debt of its consolidated VIEs at fair value with changes in fair value that are not attributed to interest income or interest expense, respectively, recognized as a component of “investment and derivative gain (loss), net” in the accompanying consolidated statements of comprehensive income.

 

As described in further detail in “Note 2. Summary of Significant Accounting Policies,” the Company recognizes interest income for the mortgage loans of its consolidated VIEs by applying the “interest method” permitted by GAAP, whereby the premium or discount recognized at the initial recognition of each loan is amortized or accreted as an adjustment to contractual interest income accrued at the loan’s contractual interest rate. The Company ceases the accrual of interest income for a mortgage loan (i.e., places the loan in non-accrual status) when it believes collectability of principal and interest in full is not reasonably assured, which generally occurs when a loan is three or more monthly payments past due, unless the loan is well secured and in the process of collection based upon an individual loan assessment. Upon placing a loan in non-accrual status, any previously accrued but uncollected interest is derecognized and a corresponding reduction to current period interest income is recorded.

 

The following table presents information about the accrual status of the loans of the Company’s consolidated VIE of business purpose residential mortgage loans as of June 30, 2022:

 

 

 

Aggregate Fair Value

 

 

Aggregate Unpaid Principal Balance

 

 

Difference

 

Less than 90 days past due and in accrual status

 

$

151

 

 

$

151

 

 

$

 

90 days or more past due and in non-accrual status

 

 

4,397

 

 

 

4,684

 

 

 

(287

)

Total mortgage loans of consolidated VIE

 

$

4,548

 

 

$

4,835

 

 

$

(287

)

 

 

The following table presents information about the accrual status of the loans of the Company’s consolidated VIE of residential mortgage loans as of June 30, 2022:

 

 

 

Aggregate Fair Value

 

 

Aggregate Unpaid Principal Balance

 

 

Difference

 

Less than 90 days past due and in accrual status

 

$

219,118

 

 

$

236,145

 

 

$

(17,027

)

90 days or more past due and in non-accrual status

 

 

1,338

 

 

 

1,338

 

 

 

 

Total mortgage loans of consolidated VIE

 

$

220,456

 

 

$

237,483

 

 

$

(17,027

)

 

Note 9. Borrowings

Repurchase Agreements

The Company finances the purchase of mortgage investments through repurchase agreements, which are accounted for as collateralized borrowing arrangements. In a repurchase transaction, the Company sells a mortgage investment to a counterparty under a master repurchase agreement in exchange for cash and concurrently agrees to repurchase the same asset at a future date in an amount equal to the cash initially exchanged plus an agreed-upon amount of interest. Mortgage investments sold under agreements to repurchase remain on the Company’s consolidated balance sheets because the Company maintains effective control over such assets throughout the duration of the arrangement. Throughout the contractual term of a repurchase agreement, the Company recognizes a “repurchase agreement” liability on its consolidated balance sheets to reflect the obligation to repay to the counterparty the proceeds received upon the initial transfer of the mortgage investment. The difference between the proceeds received by the Company upon the

14


 

initial transfer of the mortgage investment and the contractually agreed-upon repurchase price is recognized as interest expense ratably over the term of the repurchase arrangement.

Amounts borrowed pursuant to repurchase agreements are equal in value to a specified percentage of the fair value of the pledged collateral. The Company retains beneficial ownership of the pledged collateral throughout the term of the repurchase agreement. The counterparty to the repurchase agreements may require that the Company pledge additional securities or cash as additional collateral to secure borrowings when the value of the collateral declines.

The Company’s MBS repurchase agreement arrangements generally carry a fixed rate of interest and are short-term in nature with contract durations generally ranging from 30 to 60 days, but may be as short as one day or as long as one year. The Company’s mortgage loan repurchase agreement arrangement has a maturity date of March 17, 2023 and an interest rate that resets monthly at a rate equal to SOFR plus 2.61%. Under the terms of the Company’s mortgage loan repurchase agreement, the Company may request extensions of the maturity date of the agreement for up to 364 days, subject to the lender’s approval.

The following table provides information regarding the Company’s outstanding repurchase agreement borrowings as of the dates indicated:

 

 

 

June 30, 2022

 

 

December 31, 2021

 

Agency MBS repurchase financing:

 

 

 

 

 

 

Repurchase agreements outstanding

 

$

224,566

 

 

$

425,836

 

Agency MBS collateral, at fair value (1)

 

 

237,373

 

 

 

447,979

 

Net amount (2)

 

 

12,807

 

 

 

22,143

 

Weighted-average rate

 

 

1.48

%

 

 

0.14

%

Weighted-average term to maturity

 

14.0 days

 

 

13.0 days

 

Non-agency MBS repurchase financing:

 

 

 

 

 

 

Repurchase agreements outstanding

 

$

84,788

 

 

$

 

MBS collateral, at fair value

 

 

99,901

 

 

 

 

Net amount (2)

 

 

15,113

 

 

 

 

Weighted-average rate

 

 

2.81

%

 

 

 

Weighted-average term to maturity

 

17.0 days

 

 

 

 

Mortgage loans repurchase financing:

 

 

 

 

 

 

Repurchase agreements outstanding

 

$

20,640

 

 

$

20,788

 

Mortgage loans collateral, at fair value

 

 

29,484

 

 

 

29,697

 

Net amount (2)

 

 

8,844

 

 

 

8,909

 

Weighted-average rate

 

 

3.77

%

 

 

2.60

%

Weighted-average term to maturity

 

260.0 days

 

 

319.0 days

 

Total mortgage investments repurchase financing:

 

 

 

 

 

 

Repurchase agreements outstanding

 

$

329,994

 

 

$

446,624

 

Mortgage investments collateral, at fair value (1)

 

 

366,758

 

 

 

477,676

 

Net amount (2)

 

 

36,764

 

 

 

31,052

 

Weighted-average rate

 

 

1.96

%

 

 

0.25

%

Weighted-average term to maturity

 

30.2 days

 

 

27.2 days

 

 

(1)
As of December 31, 2021, includes $28,219 at sale price of unsettled agency MBS sale commitments which is included in the line item “sold securities receivable” in the accompanying consolidated balance sheets.
(2)
Net amount represents the value of collateral in excess of corresponding repurchase obligation. The amount of collateral at-risk is limited to the outstanding repurchase obligation and not the entire collateral balance.

 

The following table provides information regarding the Company’s outstanding repurchase agreement borrowings during the three and six months ended June 30, 2022 and 2021:

 

 

 

June 30, 2022

 

 

June 30, 2021

 

Weighted-average outstanding balance during the three months ended

 

$

282,725

 

 

$

652,624

 

Weighted-average rate during the three months ended

 

 

1.07

%

 

 

0.24

%

Weighted-average outstanding balance during the six months ended

 

$

312,544

 

 

$

603,233

 

Weighted-average rate during the six months ended

 

 

0.66

%

 

 

0.29

%

 

15


 

As of June 30, 2022, the Company had an amount at risk under repurchase agreements with Credit Suisse Securities (USA) LLC and affiliates that was 11.2% of shareholders' equity that had a weighted average maturity of 65 days. The amount at risk is calculated as the value of the collateral in excess of the corresponding repurchase obligation.

Long-Term Unsecured Debt

As of June 30, 2022 and December 31, 2021, the Company had $86,199 and $85,994, respectively, of outstanding long-term unsecured debentures, net of unamortized debt issuance costs of $1,482 and $1,687, respectively. The Company’s long-term unsecured debentures consisted of the following as of the dates indicated:

 

 

 

June 30, 2022

 

 

December 31, 2021

 

 

 

Senior
Notes Due 2025

 

 

Senior
Notes Due 2026

 

 

Trust
Preferred Debt

 

 

Senior
Notes Due 2025

 

 

Senior
Notes Due 2026

 

 

Trust
Preferred Debt

 

Outstanding
  Principal

 

$

34,931

 

 

$

37,750

 

 

$

15,000

 

 

$

34,931

 

 

$

37,750

 

 

$

15,000

 

Annual
   Interest Rate

 

 

6.75

%

 

 

6.000

%

 

LIBOR+
2.25 - 3.00 %

 

 

 

6.75

%

 

 

6.000

%

 

LIBOR+
2.25 - 3.00 %

 

Interest
   Payment
   Frequency

 

Quarterly

 

 

Quarterly

 

 

Quarterly

 

 

Quarterly

 

 

Quarterly

 

 

Quarterly

 

Weighted-
   Average
   Interest Rate

 

 

6.75

%

 

 

6.000

%

 

 

3.79

%

 

 

6.75

%

 

 

6.000

%

 

 

2.87

%

Maturity

 

March 15, 2025

 

 

August 1, 2026

 

 

2033 - 2035

 

 

March 15, 2025

 

 

August 1, 2026

 

 

2033 - 2035

 

 

On July 15, 2021, the Company completed a public offering of $37,750 of 6.000% Senior Notes due 2026 and received net proceeds of $36,570 after deducting underwriter discounts. On August 6, 2021, the Company redeemed all $23,821 in principal amount of its outstanding Senior Notes due 2023 at a redemption price of 100% of the principal amount plus unpaid interest thereon.

The Senior Notes due 2025 and the Senior Notes due 2026 are publicly traded on the New York Stock Exchange under the ticker symbols “AIC” and “AAIN,” respectively. The Senior Notes due 2025 and Trust Preferred Debt may be redeemed in whole or in part at any time and from time to time at the Company’s option at a redemption price equal to the principal amount plus accrued and unpaid interest. The Senior Notes due 2026 may be redeemed in whole or in part at any time and from time to time at the Company’s option on or after August 1, 2023 at a redemption price equal to the principal amount plus accrued and unpaid interest. The indenture governing the Senior Notes contains certain covenants, including limitations on the Company’s ability to merge or consolidate with other entities or sell or otherwise dispose of all or substantially all of the Company’s assets.

Long-Term Debt Secured by Single-family Properties

On September 28, 2021, McLean SFR Investment, LLC (“McLean SFR”), a wholly-owned subsidiary of Arlington Asset, entered into a loan agreement with a third-party lender to fund McLean SFR’s purchases of SFR properties. Under the terms of the loan agreement, loan advances may be drawn up to 74% of the fair value of eligible SFR properties up to a maximum loan amount of $150,000. Advances under the loan agreement may be drawn during the advance period, which ends on the earlier of the date the outstanding principal balance equals the maximum loan amount or March 28, 2023. The outstanding principal balance is due on October 9, 2026 and advances under the loan agreement bear interest at a fixed rate of 2.76%. During the advance period, McLean SFR is subject to a commitment fee on the unfunded commitment if the outstanding loan balance is below certain thresholds. As of June 30, 2022 and December 31, 2021, the outstanding balance was $122,770 and $39,178, respectively, net of unamortized debt issuance costs of $237 and $264, respectively.

Through September 28, 2024, the outstanding principal balance may be prepaid in an amount equal to the excess of (i) the sum of the present value of all remaining scheduled payments of principal and interest on the principal amount of the loan being prepaid discounted using a U.S. Treasury rate over (ii) the outstanding principal balance of the loan. Subsequent to September 28, 2024, the outstanding principal balance may be prepaid in an amount equal to the outstanding principal balance plus accrued interest. On March 25, 2022, McLean SFR entered into a waiver agreement with the lender that would waive any prepayment fee determined in accordance with the prior sentence on the portion of outstanding loan balance prepaid with the sale proceeds from the potential sale of

16


 

376 SFR properties if the sale transaction is consummated by August 22, 2022 in exchange for a one-time waiver fee of 0.80% of the outstanding principal balance prepaid (See Footnote 7 - Investments in SFR Properties).

The loan is secured by a first priority interest in all the assets of McLean SFR and a first priority pledge of the equity interest of McLean SFR. If the outstanding principal balance of the loan is greater than 74% of the fair value of the eligible collateral, McLean SFR is required to either pledge additional collateral or prepay the loan in an amount so that the outstanding principal balance does not exceed 74% of the fair value of the eligible collateral. Under the terms of the loan agreement, if McLean SFR does not maintain a minimum debt service coverage ratio for a specified time period, then all available cash of McLean SFR will be held as additional collateral for the loan amount until the minimum debt service coverage ratio is met. The obligations under the loan agreement may become recourse to Arlington Asset upon the occurrence of certain enumerated acts committed by McLean SFR or Arlington Asset. The loan agreement contains a minimum net worth financial covenant of Arlington Asset.

 

Note 10. Derivative Instruments

In the normal course of its operations, the Company is a party to financial instruments that are accounted for as derivative instruments. Derivative instruments are recorded at fair value as either “other assets” or “other liabilities” in the consolidated balance sheets, with all periodic changes in fair value reflected as a component of “investment and derivative gain (loss), net” in the consolidated statements of comprehensive income. Cash receipts or payments related to derivative instruments are classified as investing activities within the consolidated statements of cash flows.

Types and Uses of Derivative Instruments

Interest Rate Hedging Instruments

The Company is party to interest rate hedging instruments that are intended to economically hedge changes, attributable to changes in benchmark interest rates, in certain MBS fair values and future interest cash flows on the Company’s short-term financing arrangements. Interest rate hedging instruments may include centrally cleared interest rate swaps, exchange-traded instruments, such as U.S. Treasury note futures, Eurodollar futures, interest rate swap futures and options on futures, and non-exchange-traded instruments such as options on agency MBS. While the Company uses its interest rate hedging instruments to economically hedge a portion of its interest rate risk, it has not designated such contracts as hedging instruments for financial reporting purposes.

The Company exchanges cash “variation margin” with the counterparties to its interest rate hedging instruments at least on a daily basis based upon daily changes in fair value as measured by the Chicago Mercantile Exchange (“CME”), the central clearinghouse through which those instruments are cleared. In addition, the CME requires market participants to deposit and maintain an “initial margin” amount which is determined by the CME and is generally intended to be set at a level sufficient to protect the CME from the maximum estimated single-day price movement in that market participant’s contracts. However, futures commission merchants may require “initial margin” in excess of the CME’s requirement. Receivables recognized for the right to reclaim cash initial margin posted in respect of interest rate hedging instruments are included in the line item “deposits” in the accompanying consolidated balance sheets.

The daily exchange of variation margin associated with a centrally cleared or exchange-traded hedging instrument is legally characterized as the daily settlement of the instrument itself, as opposed to a pledge of collateral. Accordingly, the Company accounts for the daily receipt or payment of variation margin associated with its interest rate swaps and futures as a direct reduction to the carrying value of the derivative asset or liability, respectively. The carrying amount of interest rate swaps and futures reflected in the Company’s consolidated balance sheets is equal to the unsettled fair value of such instruments; because variation margin is exchanged on a one-day lag, the unsettled fair value of such instruments generally represents the change in fair value that occurred on the last day of the reporting period.

To-Be-Announced Agency MBS Transactions, Including “Dollar Rolls”

In addition to interest rate hedging instruments that are used for interest rate risk management, the Company is a party to derivative instruments that economically serve as investments, such as forward commitments to purchase fixed-rate “pass-through” agency MBS on a non-specified pool basis, which are known as to-be-announced (“TBA”) securities. A TBA security is a forward commitment for the purchase or sale of a fixed-rate agency MBS at a predetermined price, face amount, issuer, coupon, and stated maturity for settlement on an agreed upon future date. The specific agency MBS that will be delivered to satisfy the TBA trade is not known at the inception of the trade. The specific agency MBS to be delivered is determined 48 hours prior to the settlement date. The Company accounts for TBA securities as derivative instruments because the Company cannot assert that it is probable at inception and throughout the term of an individual TBA commitment that its settlement will result in physical delivery of the underlying agency MBS, or the individual TBA commitment will not settle in the shortest time period possible.

17


 

The Company’s agency MBS investment portfolio may include net purchase (or “net long”) positions in TBA securities, which are primarily the result of executing sequential series of “dollar roll” transactions. The Company executes dollar roll transactions as a means of investing in and financing non-specified fixed-rate agency MBS. Such transactions involve effectively delaying (or “rolling”) the settlement of a forward purchase of a TBA agency MBS by entering into an offsetting sale with the same counterparty prior to the settlement date, net settling the “paired-off” positions in cash, and contemporaneously entering, with the same counterparty, another forward purchase of a TBA agency MBS of the same characteristics for a later settlement date. TBA securities purchased for a forward settlement month are generally priced at a discount relative to TBA securities sold for settlement in the current month. This discount, often referred to as the dollar roll “price drop,” reflects compensation for the net interest income (interest income less financing costs) that is foregone as a result of relinquishing beneficial ownership of the MBS for the duration of the dollar roll (also known as “dollar roll income”). By executing a sequential series of dollar roll transactions, the Company is able to create the economic experience of investing in an agency MBS, financed with a repurchase agreement, over a period of time. Forward purchases and sales of TBA securities are accounted for as derivative instruments in the Company’s financial statements. Accordingly, dollar roll income is recognized as a component of “investment and derivative gain (loss), net” along with all other periodic changes in the fair value of TBA commitments.

In addition to transacting in net long positions in TBA securities for investment purposes, the Company may also, from time to time, transact in net sale (or “net short”) positions in TBA securities for the purpose of economically hedging a portion of the sensitivity of the fair value of the Company’s investments in agency MBS to changes in interest rates.

In addition to TBA transactions, the Company may, from time to time, enter into commitments to purchase or sell specified agency MBS that do not qualify as regular-way security trades. Such commitments are also accounted for as derivative instruments.

Under the terms of commitments to purchase or sell TBAs or specified agency MBS, the daily exchange of variation margin may occur based on changes in the fair value of the underlying agency MBS if a party to the transaction demands it. Receivables recognized for the right to reclaim cash collateral posted by the Company in respect of agency MBS purchase or sale commitments is included in the line item “deposits” in the accompanying consolidated balance sheets. Liabilities recognized for the obligation to return cash collateral received by the Company in respect of agency MBS purchase or sale commitments is included in the line item “other liabilities” in the accompanying consolidated balance sheets.

Derivative Instrument Population and Fair Value

The following table presents the fair value of the Company’s derivative instruments as of the dates indicated:

 

 

 

June 30, 2022

 

 

December 31, 2021

 

 

 

Assets

 

 

Liabilities

 

 

Assets

 

 

Liabilities

 

Interest rate swaps

 

$

 

 

$

(1,008

)

 

$

 

 

$

(107

)

10-year U.S. Treasury note futures

 

 

 

 

 

 

 

 

16

 

 

 

 

Options on U.S. Treasury note futures

 

 

 

 

 

 

 

 

4

 

 

 

 

TBA commitments

 

 

1,216

 

 

 

(879

)

 

 

230

 

 

 

(121

)

Total

 

$

1,216

 

 

$

(1,887

)

 

$

250

 

 

$

(228

)

 

Interest Rate Swaps

The Company’s LIBOR based interest rate swap agreements represent agreements to make semiannual interest payments based upon a fixed interest rate and receive quarterly variable interest payments based upon the prevailing three-month LIBOR as of the preceding reset date. The Company’s Secured Overnight Financing Rate (“SOFR”) based interest rate swap agreements represent

18


 

agreements to make annual interest payments based upon a fixed interest rate and receive annual variable interest payments based upon the daily SOFR over the preceding annual period.

 

The following table presents information about the Company’s interest rate swap agreements that were in effect as of June 30, 2022:

 

 

 

 

 

 

Weighted-average:

 

 

 

 

 

 

Notional Amount

 

 

Fixed Pay Rate

 

 

Variable Receive Rate

 

 

Net Receive (Pay) Rate

 

 

Remaining Life (Years)

 

 

Fair Value

 

Years to maturity:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Less than 3 years

 

$

130,000

 

 

 

1.32

%

 

 

1.22

%

 

 

(0.10

)%

 

 

1.5

 

 

$

(279

)

3 to less than 10 years

 

 

100,000

 

 

 

1.68

%

 

 

1.30

%

 

 

(0.38

)%

 

 

5.4

 

 

 

(729

)

Total / weighted-average

 

$

230,000

 

 

 

1.48

%

 

 

1.25

%

 

 

(0.23

)%

 

 

3.2

 

 

$

(1,008

)

 

The following table presents information about the Company’s interest rate swap agreements that were in effect as of December 31, 2021:

 

 

 

 

 

 

Weighted-average:

 

 

 

 

 

 

Notional Amount

 

 

Fixed Pay Rate

 

 

Variable Receive Rate

 

 

Net Receive
(Pay) Rate

 

 

Remaining Life (Years)

 

 

Fair Value

 

Years to maturity:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Less than 3 years

 

$

50,000

 

 

 

0.71

%

 

 

0.13

%

 

 

(0.58

)%

 

 

1.8

 

 

$

(5

)

3 to less than 10 years

 

 

100,000

 

 

 

0.90

%

 

 

0.13

%

 

 

(0.77

)%

 

 

6.6

 

 

 

(102

)

Total / weighted-average

 

$

150,000

 

 

 

0.84

%

 

 

0.13

%

 

 

(0.71

)%

 

 

5.0

 

 

$

(107

)

 

U.S. Treasury Note Futures

The Company may purchase (“long”) or sell (“short”) exchange-traded U.S. Treasury note futures with the objective of economically hedging a portion of its interest rate risk. Upon the maturity date of these futures contracts, the Company has the option to either net settle each contract in cash in an amount equal to the difference between the then-current fair value of the underlying U.S. Treasury note and the contractual sale price inherent to the futures contract, or to physically settle the contract by purchasing or delivering the underlying U.S. Treasury note.

As of June 30, 2022, the Company had no outstanding positions of U.S. Treasury note futures. As of December 31, 2021, the Company held long positions of 10-year U.S. Treasury note futures with an aggregate notional amount of $25,000 with a maturity date in March 2022.

Options on U.S. Treasury Note Futures

The Company may purchase or sell exchange-traded options on U.S. Treasury note futures contracts with the objective of economically hedging a portion of the sensitivity of its investments in agency MBS to significant changes in interest rates. The Company may purchase put or call options which provide the Company with the right to sell to a counterparty or purchase from a counterparty U.S. Treasury note futures, and the Company may also write put or call options that provide a counterparty with the option to sell to the Company or buy from the Company U.S. Treasury note futures. The options may be exercised at any time prior to their expiry, and if exercised, may be net settled in cash or through physical receipt or delivery of the underlying futures contracts.

As of June 30, 2022, the Company had no outstanding options on U.S. Treasury note futures contracts.

Information about the Company’s outstanding options on 10-year U.S. Treasury note futures contracts as of December 31, 2021 is as follows:

 

 

 

Notional Amount
Long/(Short)

 

 

Weighted-average Strike Price

 

 

Implied Strike
Rate
(1)

 

 

Net Fair Value

 

Purchased call options:

 

 

 

 

 

 

 

 

 

 

 

 

January 2022 expiration

 

$

25,000

 

 

 

134.5

 

 

 

1.00

%

 

$

4

 

 

(1)
The implied strike rate is estimated based upon the weighted average strike price per contract and the price of an equivalent 10-year U.S. Treasury note futures contract.

19


 

 

TBA Commitments

The following tables present information about the Company’s TBA commitments as of the dates indicated:

 

 

 

June 30, 2022

 

 

 

Notional Amount:
Net Purchase (Sale)
Commitment

 

 

Contractual Forward Price

 

 

Market Price

 

 

Fair Value

 

2.5% 30-year MBS sale commitments

 

$

(25,000

)

 

$

(22,649

)

 

$

(22,472

)

 

$

177

 

3.0% 30-year MBS sale commitments

 

 

(30,000

)

 

 

(27,970

)

 

 

(27,932

)

 

 

38

 

3.5% 30-year MBS sale commitments

 

 

(100,000

)

 

 

(95,486

)

 

 

(96,172

)

 

 

(686

)

4.5% 30-year MBS purchase commitments

 

 

50,000

 

 

 

50,121

 

 

 

50,195

 

 

 

74

 

4.5% 30-year MBS sale commitments

 

 

(50,000

)

 

 

(50,929

)

 

 

(50,195

)

 

 

734

 

Total TBA commitments, net

 

$

(155,000

)

 

$

(146,913

)

 

$

(146,576

)

 

$

337

 

 

 

 

December 31, 2021

 

 

 

Notional Amount:
Net Purchase (Sale)
Commitment

 

 

Contractual Forward Price

 

 

Market Price

 

 

Fair Value

 

2.5% 30-year MBS purchase commitments

 

$

225,000

 

 

$

229,043

 

 

$

229,148

 

 

$

105

 

2.5% 30-year MBS sale commitments

 

 

(225,000

)

 

 

(229,152

)

 

 

(229,148

)

 

 

4

 

Total TBA commitments, net

 

$

 

 

$

(109

)

 

$

 

 

$

109

 

 

Derivative Instrument Gains and Losses

The following tables provide information about the derivative gains and losses recognized within the periods indicated:

 

 

Three Months Ended June 30,

 

 

Six Months Ended June 30,

 

 

2022

 

 

2021

 

 

2022

 

 

2021

 

Interest rate derivatives:

 

 

 

 

 

 

 

 

 

 

 

Interest rate swaps:

 

 

 

 

 

 

 

 

 

 

 

Net interest expense (1)

$

(282

)

 

$

(1,187

)

 

$

(573

)

 

$

(1,897

)

Unrealized gains (losses), net

 

3,231

 

 

 

(13,517

)

 

 

6,697

 

 

 

7,548

 

Gains (losses) realized upon early termination, net

 

288

 

 

 

(1,258

)

 

 

3,449

 

 

 

(1,271

)

Total interest rate swap gains (losses), net

 

3,237

 

 

 

(15,962

)

 

 

9,573

 

 

 

4,380

 

U.S. Treasury note futures, net

 

 

 

 

91

 

 

 

(782

)

 

 

2,710

 

Options on U.S. Treasury note futures, net

 

 

 

 

 

 

 

(4

)

 

 

(20

)

Total interest rate derivative gains (losses), net

 

3,237

 

 

 

(15,871

)

 

 

8,787

 

 

 

7,070

 

TBA commitments:

 

 

 

 

 

 

 

 

 

 

 

TBA dollar roll income (2)

 

280

 

 

 

1,778

 

 

 

1,103

 

 

 

2,614

 

Other losses on TBA commitments, net

 

(263

)

 

 

(890

)

 

 

(4,969

)

 

 

(10,122

)

Total gains (losses) on TBA commitments, net

 

17

 

 

 

888

 

 

 

(3,866

)

 

 

(7,508

)

Total derivative gains (losses), net

$

3,254

 

 

$

(14,983

)

 

$

4,921

 

 

$

(438

)

 

(1)
Represents the periodic net interest settlement incurred during the period (often referred to as “net interest carry”). Also includes “price alignment interest” income earned or expense incurred on cumulative variation margin paid or received, respectively, associated with centrally cleared interest rate swap agreements.
(2)
Represents the price discount of forward-settling TBA purchases relative to a contemporaneously executed “spot” TBA sale, which economically equates to net interest income that is earned ratably over the period beginning on the settlement date of the sale and ending on the settlement date of the forward-settling purchase.

20


 

Derivative Instrument Activity

The following tables summarize the volume of activity, in terms of notional amount, related to derivative instruments for the periods indicated:

 

 

 

For the Three Months Ended June 30, 2022

 

 

 

Beginning of
Period

 

 

Additions

 

 

Scheduled
Settlements

 

 

Early
Terminations

 

 

End of Period

 

Interest rate swaps

 

$

175,000

 

 

$

75,000

 

 

$

 

 

$

(20,000

)

 

$

230,000

 

TBA commitments, net

 

 

 

 

 

430,000

 

 

 

(275,000

)

 

 

 

 

 

155,000

 

 

 

 

For the Three Months Ended June 30, 2021

 

 

 

Beginning of
Period

 

 

Additions

 

 

Scheduled Settlements

 

 

Early
Terminations

 

 

End of Period

 

Interest rate swaps

 

$

675,000

 

 

$

 

 

$

 

 

$

(150,000

)

 

$

525,000

 

10-year U.S. Treasury note futures

 

 

 

 

 

165,000

 

 

 

(120,000

)

 

 

 

 

 

45,000

 

Purchased call options on 10-year U.S.
  Treasury note futures

 

 

65,200

 

 

 

 

 

 

(65,200

)

 

 

 

 

 

 

TBA commitments, net

 

 

100,000

 

 

 

450,000

 

 

 

(550,000

)

 

 

 

 

 

 

 

 

 

For the Six Months Ended June 30, 2022

 

 

 

Beginning of
Period

 

 

Additions

 

 

Scheduled
Settlements

 

 

Early
Terminations

 

 

End of Period

 

Interest rate swaps

 

$

150,000

 

 

$

145,000

 

 

$

 

 

$

(65,000

)

 

$

230,000

 

10-year U.S. Treasury note futures

 

 

25,000

 

 

 

50,000

 

 

 

(50,000

)

 

 

(25,000

)

 

 

 

Purchased call options on 10-year U.S.
  Treasury note futures

 

 

25,000

 

 

 

 

 

 

(25,000

)

 

 

 

 

 

 

TBA commitments, net

 

 

 

 

 

755,000

 

 

 

(600,000

)

 

 

 

 

 

155,000

 

 

 

 

For the Six Months Ended June 30, 2021

 

 

 

Beginning of
Period

 

 

Additions

 

 

Scheduled Settlements

 

 

Early
Terminations

 

 

End of Period

 

Interest rate swaps

 

$

275,000

 

 

$

450,000

 

 

$

 

 

$

(200,000

)

 

$

525,000

 

2-year U.S. Treasury note futures

 

 

 

 

 

50,000

 

 

 

(50,000

)

 

 

 

 

 

 

10-year U.S. Treasury note futures

 

 

 

 

 

540,100

 

 

 

(320,000

)

 

 

(175,100

)

 

 

45,000

 

Purchased call options on 10-year U.S.
  Treasury note futures

 

 

 

 

 

65,200

 

 

 

(65,200

)

 

 

 

 

 

 

TBA commitments, net

 

 

 

 

 

1,365,000

 

 

 

(1,365,000

)

 

 

 

 

 

 

Cash Collateral Posted and Received for Derivative and Other Financial Instruments

The following table presents information about the cash collateral posted by the Company in respect of its derivative and other financial instruments, which is included in the line item “deposits” in the accompanying consolidated balance sheets, for the dates indicated:

 

 

 

June 30, 2022

 

 

December 31, 2021

 

Cash collateral posted for:

 

 

 

 

 

 

Interest rate swaps (cash initial margin)

 

$

4,084

 

 

$

4,174

 

U.S. Treasury note futures (cash initial margin)

 

 

 

 

 

375

 

Repurchase agreements

 

 

539

 

 

 

 

Total cash collateral posted, net

 

$

4,623

 

 

$

4,549

 

 

Note 11. Offsetting of Financial Assets and Liabilities

The agreements that govern certain of the Company’s derivative instruments and collateralized short-term financing arrangements provide for a right of setoff in the event of default or bankruptcy with respect to either party to such transactions. The Company presents derivative assets and liabilities as well as collateralized short-term financing arrangements on a gross basis.

Receivables recognized for the right to reclaim cash initial margin posted in respect of interest rate derivative instruments are included in the line item “deposits” in the accompanying consolidated balance sheets.

The daily exchange of variation margin associated with a centrally cleared or exchange-traded derivative instrument is legally characterized as the daily settlement of the derivative instrument itself, as opposed to a pledge of collateral. Accordingly, the

21


 

Company accounts for the daily receipt or payment of variation margin associated with its interest rate swaps and futures as a direct reduction to the carrying value of derivative asset or liability, respectively. The carrying amount of interest rate swaps and futures reflected in the Company’s consolidated balance sheets is equal to the unsettled fair value of such instruments; because variation margin is exchanged on a one-day lag, the unsettled fair value of such instruments generally represents the change in fair value that occurred on the last day of the reporting period.

The following tables present information, as of the dates indicated, about the Company’s derivative instruments, short-term borrowing arrangements, and associated collateral, including those subject to master netting (or similar) arrangements:

 

 

 

As of June 30, 2022

 

 

 

Gross Amount
Recognized

 

 

Amount Offset
in the
Consolidated
Balance Sheets

 

 

Net Amount
Presented in the
Consolidated
Balance Sheets

 

 

Gross Amount Not Offset in the
Consolidated Balance Sheets

 

 

Net
Amount

 

 

 

 

 

 

 

 

 

 

 

 

Financial
Instruments
(1)

 

 

Cash
Collateral
(2)

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivative instruments:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

TBA commitments

 

$

1,216

 

 

$

 

 

$

1,216

 

 

$

(879

)

 

$

 

 

$

337

 

Total derivative instruments

 

 

1,216

 

 

 

 

 

 

1,216

 

 

 

(879

)

 

 

 

 

 

337

 

Total assets

 

$

1,216

 

 

$

 

 

$

1,216

 

 

$

(879

)

 

$

 

 

$

337

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivative instruments:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate swaps

 

$

1,008

 

 

$

 

 

$

1,008

 

 

$

 

 

$

(1,008

)

 

$

 

TBA commitments

 

 

879

 

 

 

 

 

 

879

 

 

 

(879

)

 

 

 

 

 

 

Total derivative instruments

 

 

1,887

 

 

 

 

 

 

1,887

 

 

 

(879

)

 

 

(1,008

)

 

 

 

Repurchase agreements

 

 

329,994

 

 

 

 

 

 

329,994

 

 

 

(329,994

)

 

 

 

 

 

 

Total liabilities

 

$

331,881

 

 

$

 

 

$

331,881

 

 

$

(330,873

)

 

$

(1,008

)

 

$

 

 

 

 

As of December 31, 2021

 

 

 

Gross Amount
Recognized

 

 

Amount Offset
in the
Consolidated
Balance Sheets

 

 

Net Amount
Presented in the
Consolidated
Balance Sheets

 

 

Gross Amount Not Offset in the
Consolidated Balance Sheets

 

 

Net
Amount

 

 

 

 

 

 

 

 

 

 

 

 

Financial
Instruments
(1)

 

 

Cash
Collateral
(2)

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivative instruments:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

TBA commitments

 

$

230

 

 

$

 

 

$

230

 

 

$

(105

)

 

$

 

 

$

125

 

10-year U.S. Treasury note futures

 

 

16

 

 

 

 

 

 

16

 

 

 

 

 

 

 

 

 

16

 

Options on U.S. Treasury note futures

 

 

4

 

 

 

 

 

 

4

 

 

 

 

 

 

 

 

 

4

 

Total derivative instruments

 

 

250

 

 

 

 

 

 

250

 

 

 

(105

)

 

 

 

 

 

145

 

Total assets

 

$

250

 

 

$

 

 

$

250

 

 

$

(105

)

 

$

 

 

$

145

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivative instruments:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate swaps

 

$

107

 

 

$

 

 

$

107

 

 

$

 

 

$

(107

)

 

$

 

TBA commitments

 

 

121

 

 

 

 

 

 

121

 

 

 

(105

)

 

 

 

 

 

16

 

Total derivative instruments

 

 

228

 

 

 

 

 

 

228

 

 

 

(105

)

 

 

(107

)

 

 

16

 

Repurchase agreements

 

 

446,624

 

 

 

 

 

 

446,624

 

 

 

(446,624

)

 

 

 

 

 

 

Total liabilities

 

$

446,852

 

 

$

 

 

$

446,852

 

 

$

(446,729

)

 

$

(107

)

 

$

16

 

 

(1)
Does not include the fair value amount of financial instrument collateral pledged in respect of repurchase agreements that exceeds the associated liability presented in the consolidated balance sheets.
(2)
Does not include the amount of cash collateral pledged in respect of derivative instruments and repurchase agreements that exceeds the associated liability presented in the consolidated balance sheets.

 

Note 12. Fair Value Measurements

Fair Value of Financial Instruments

The accounting principles related to fair value measurements define fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Financial Accounting Standards Board Accounting Standards Codification Topic 820, Fair Value Measurements and Disclosures, establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels, giving the highest

22


 

priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3) as described below:

 

 

Level 1 Inputs -

Unadjusted quoted prices in active markets for identical assets or liabilities that are accessible by the Company at the measurement date;

 

 

Level 2 Inputs -

Quoted prices in markets that are not active or financial instruments for which all significant inputs are observable, either directly or indirectly; and

 

 

Level 3 Inputs -

Unobservable inputs for the asset or liability, including significant judgments made by the Company about the assumptions that a market participant would use.

The Company measures the fair value of the following assets and liabilities:

Investments in Financial Assets

Agency MBS - The Company’s investments in agency MBS are classified within Level 2 of the fair value hierarchy. Inputs to fair value measurements of the Company’s investments in agency MBS include price estimates obtained from third-party pricing services. In determining fair value, third-party pricing services use a market approach. The inputs used in the fair value measurements performed by the third-party pricing services are based upon readily observable transactions for securities with similar characteristics (such as issuer/guarantor, coupon rate, stated maturity, and collateral pool characteristics) occurring on the measurement date. The Company makes inquiries of the third-party pricing sources and reviews their documented valuation methodologies to understand the significant inputs and assumptions used to determine prices. The Company reviews the various third-party fair value estimates and performs procedures to validate their reasonableness, including comparison to recent trading activity for similar securities and an overall review for consistency with market conditions observed as of the measurement date.

Credit securities – The Company's investments in commercial MBS are classified within Level 2 of the fair value hierarchy. Inputs to fair value measurements of the Company's investments in commercial MBS include quoted prices for similar assets in recent market transactions and estimates obtained from third-party sources including pricing services and dealers. In determining fair value, third-party pricing sources use a market approach. The inputs used in the fair value measurements performed by third-party pricing sources are based upon observable transactions for securities with similar characteristics. The Company reviews the third-party fair value estimates and performs procedures to validate their reasonableness, including comparisons to recent trading activity observed for similar securities as well as an internally derived discounted future cash flow measurement. The Company’s investments in a non-agency MBS collateralized by a pool of business purpose residential mortgage loans and ABS collateralized by residential solar panel loans are classified within Level 3 of the fair value hierarchy.

To measure the fair value of the Company’s non-agency MBS investment secured by a pool of business purpose residential mortgage loans, the Company uses an income approach by preparing an estimate of the present value of the amount and timing of the cash flows expected to be collected from the security over its expected remaining life. To prepare the estimate of cash flows expected to be collected, the Company uses significant judgment to develop assumptions about the future performance of the pool of business purpose residential mortgage loans that serve as collateral, including loan-level probabilities of default and loss-given-default. As of June 30, 2022 and December 31, 2021, the remaining population of business purpose residential mortgage loans serving as collateral to the Company's non-agency MBS investment represented less than 10% of the original collateral pool. Because the repayment of business purpose residential mortgage loans is often largely based on the ability of the borrower to sell the mortgaged property or to convert the property for rental purposes and obtain refinancing in the form of a longer-term loan, relatively high delinquency and default rates are common and expected attributes of this asset class. The following table presents the weighted-average of the significant inputs to the fair value measurement of the Company’s non-agency MBS secured by business purpose residential mortgage loans as of dates indicated:

 

 

June 30, 2022

 

 

December 31, 2021

 

Annualized default rate

 

81.6

%

 

 

77.7

%

Loss-given-default

 

13.8

%

 

 

15.8

%

 

Inputs to fair value measurements of the Company’s investments in ABS collateralized by residential solar panel loans includes quoted prices obtained from dealers and, when available, observable market information for the same or similar securities. In determining fair value, dealers may use a market approach or an income approach, depending upon the type and level of relevant market information available as of the measurement date. The significant inputs used in the fair value measurements performed by dealers are often unobservable as ABS collateralized by residential solar panel loans trade infrequently. The Company reviews the fair value estimates obtained from dealers and performs procedures to validate their reasonableness, including comparisons to an internally derived discounted future cash flow measurement and, when available, recent trading activity observed for similar securities.

23


 

Loans – The Company’s commercial mortgage loan investment is classified within Level 3 of the fair value hierarchy. To measure the fair value of its mortgage loan investment, the Company uses an income approach by preparing an estimate of the present value of the expected future cash flows of the loan over its expected remaining life, discounted at a current market rate. The significant unobservable inputs to the fair value measurement of the Company’s mortgage loan investment are the estimated probability of default and the discount rate, which is based on current market yields and interest rate spreads for a similar loan. As of June 30, 2022, the estimated probability of default and discount rate for the Company’s mortgage loan investment were 0% and 6.6%, respectively. As of December 31, 2021, the estimated probability of default and discount rate for the Company’s mortgage loan investment were 0% and 5.6%, respectively.

Mortgage loans and secured debt of consolidated VIEs – The Company has elected to apply a fair value measurement practical expedient permitted by GAAP to measure the fair value of the mortgage loans and debt obligations of its consolidated VIEs. The fair value measurement practical expedient is permitted to be applied to consolidated “collateralized financing entities,” which are VIEs for which the financial liabilities of the VIE have contractual recourse solely to the financial assets of the VIE.

As of June 30, 2022 and December 31, 2021, pursuant to the practical expedient, the Company measured the fair value of both the mortgage loans and the debt obligations of its consolidated VIE of business purpose residential mortgage loans based upon the fair value of the mortgage loans of the VIE. As of December 31, 2021, the senior debt obligations of the consolidated VIE had been fully extinguished and only the subordinate debt obligation of the consolidated VIE remained. The business purpose residential mortgage loans and subordinate debt obligation of the consolidated VIE are classified within Level 3 of the fair value hierarchy. To measure the fair value of the business purpose residential mortgage loans of the consolidated VIE as of June 30, 2022 and December 31, 2021, the Company used significant judgment to develop assumptions about the future performance of each business purpose residential mortgage loan, which included determining loan-level probabilities of default and loss-given-default. As of June 30, 2022 and December 31, 2021, the remaining population of business purpose residential mortgage loans represented less than 10% of the original collateral pool. Because the repayment of business purpose residential mortgage loans is often largely based on the ability of the borrower to sell the mortgaged property or to convert the property for rental purposes and obtain refinancing in the form of a longer-term loan, relatively high delinquency and default rates are common and expected attributes of this asset class. The following table presents the weighted-average of the significant inputs to the fair value measurement of the business purpose residential mortgage loans of the Company’s consolidated VIE as of the periods indicated:

 

 

June 30, 2022

 

 

December 31, 2021

 

Probability of default

 

85.5

%

 

 

66.2

%

Loss-given-default

 

6.8

%

 

 

8.6

%

 

As of June 30, 2022, the Company measured the fair value of both the residential mortgage loans and the debt obligations of its consolidated VIE of residential mortgage loans based upon the fair value of the debt obligations as the fair value of the debt securities issued by the VIE were more observable to the Company than the fair value of the underlying mortgage loans.

The senior and mezzanine debt obligations of the consolidated VIE of residential mortgage loans are classified within Level 2 of the fair value hierarchy. Inputs to the fair value measurements of the senior and mezzanine debt obligations of the consolidated VIE include quoted prices for similar assets in recent market transactions and estimates obtained from third-party pricing sources, including pricing services and dealers. In determining fair value, third-party pricing sources use a market approach. The inputs used in the fair value measurements performed by third-party pricing sources were based upon observable transactions for securities with similar characteristics.

The residential mortgage loans and the subordinate and excess interest-only debt obligations of the consolidated VIE of residential mortgage loans (held by the Company as investments and eliminated against the associated debt of the VIE in consolidation) are classified within Level 3 of the fair value hierarchy. To measure the fair value of the subordinate and excess interest-only debt obligations of the consolidated VIE of residential mortgage loans, the Company uses an income approach by preparing an estimate of the present value of the amount and timing of the cash flows expected to be collected from each security over its expected remaining life. To prepare the estimate of cash flows expected to be collected, the Company uses significant judgment to develop assumptions about the future performance of the pool of residential mortgage loans that serve as collateral, including assumptions about the timing and amount of credit losses and prepayments. The significant unobservable inputs to the fair value measurement include the estimated rate of prepayment, rate of default and loss-given-default for the underlying pool of mortgage loans as well as the discount rate, which represents a market participant’s current required rate of return for a similar instrument. The following table presents the weighted-average of the significant inputs to the fair value measurement of the subordinate and excess interest-only debt obligations of its consolidated VIE of residential mortgage loans as of June 30, 2022:

 

24


 

 

Subordinate Debt Obligation

 

 

Excess Interest-Only Debt Obligations

 

Annualized voluntary prepayment rate

 

18.5

%

 

 

18.5

%

Annualized default rate

 

0.5

%

 

 

0.5

%

Loss-given-default

 

17.5

%

 

 

17.5

%

Discount rate

 

7.3

%

 

 

17.7

%

MSR financing receivables – The Company’s MSR financing receivables are classified within Level 3 of the fair value hierarchy. The Company uses a nationally recognized, independent third-party mortgage analytics and valuation firm to estimate the fair value of the underlying MSRs from which the Company’s MSR financing receivables primarily derive their value. The third-party valuation firm estimates the fair value of the underlying MSRs using a discounted cash flow analysis using their proprietary prepayment models and market analysis. The Company corroborates the third-party valuation firm’s estimate of the fair value of the underlying MSRs and evaluates the estimate for reasonableness. The significant unobservable inputs to the fair value measurement of the underlying MSRs include the following:

the discount rate, which represents a market participant’s current required rate of return for similar MSRs;
expected rates of prepayment within the serviced pools of mortgage loans; and
annual per-loan cost of servicing.

The following table presents the significant unobservable inputs to the fair value measurement of the MSRs underlying the Company’s MSR financing receivables as of the periods indicated:

 

 

 

June 30, 2022

 

 

December 31, 2021

 

Discount rate

 

 

8.0

%

 

 

9.0

%

Annualized prepayment rate

 

 

7.1

%

 

 

10.1

%

Annual per-loan cost of servicing (current loans)

 

$

65.00

 

 

$

65.00

 

 

Pursuant to the Company’s MSR financing receivable arrangements, upon the consummation of three-year performance periods ending December 31, 2023 and April 1, 2024, the Company’s mortgage servicing counterparty is entitled to an incentive fee payment equal to a percentage of the total return of the underlying MSRs in excess of a hurdle rate of return. Accordingly, the fair value of the Company’s MSR financing receivables reflects the present value of any expected incentive fee payment that would be owed to its counterparty. The present value of the expected incentive fee payment is estimated based upon the timing and amount of capital contributions from (and cash distributions to) the Company to (from) its mortgage servicing counterparty to date as well as the future expected cash flows from the MSR financing receivables over the remaining performance periods, which is derived from the current fair value of the underlying reference MSRs. As of June 30, 2022 and December 31, 2021, the present value of the expected incentive fee payment reflected in fair value of the Company’s MSR financing receivables was $11,511 and $3,820, respectively.

Derivative instruments

Exchange-traded derivative instruments - Exchange-traded derivative instruments, which include U.S. Treasury note futures, Eurodollar futures, interest rate swap futures, and options on futures, are classified within Level 1 of the fair value hierarchy as they are measured using quoted prices for identical instruments in liquid markets.

Interest rate swaps - Interest rate swaps are classified within Level 2 of the fair value hierarchy. The fair values of the Company’s centrally cleared interest rate swaps are measured using the daily valuations reported by the clearinghouse through which the instrument was cleared. In performing its end-of-day valuations, the clearinghouse constructs forward interest rate curves (for example, three-month LIBOR or SOFR forward rates) from its specific observations of that day’s trading activity. The clearinghouse uses the applicable forward interest rate curve to develop a market-based forecast of future remaining contractually required cash flows for each interest rate swap. Each market-based cash flow forecast is then discounted using the SOFR curve (sourced from the Federal Reserve Bank of New York) to determine a net present value amount which represents the instrument’s fair value.

Forward-settling purchases and sales of TBA securities – Forward-settling purchases and sales of TBA securities are classified within Level 2 of the fair value hierarchy. The fair value of each forward-settling TBA contract is measured using price estimates obtained from a third-party pricing service, which are based upon readily observable transaction prices occurring on the measurement date for forward-settling contracts to buy or sell TBA securities with the same guarantor, contractual maturity, and coupon rate for delivery on the same forward settlement date as the commitment under measurement.

25


 

Other

Long-term unsecured debt - As of June 30, 2022 and December 31, 2021, the carrying value of the Company’s long-term unsecured debt was $86,199 and $85,994, respectively, net of unamortized debt issuance costs, and consists of Senior Notes and trust preferred debt issued by the Company. The Company’s estimate of the fair value of long-term unsecured debt is $81,350 and $84,821 as of June 30, 2022 and December 31, 2021, respectively. The Company’s Senior Notes, which are publicly traded on the New York Stock Exchange, are classified within Level 1 of the fair value hierarchy. Trust preferred debt is classified within Level 2 of the fair value hierarchy as the fair value is estimated based on the quoted prices of the Company’s publicly traded Senior Notes.

Long-term debt secured by single-family properties As of June 30, 2022 and December 31, 2021, the carrying value of the Company’s long-term debt secured by single-family properties was $122,770 and $39,178, respectively, net of unamortized debt issuance costs. As of June 30, 2022 and December 31, 2021, the Company’s estimate of the fair value of its long-term debt secured by single-family properties was $112,019 and $38,562, respectively. The Company’s long-term debt secured by single-family properties is classified within Level 3 of the fair value hierarchy.

Investments in equity securities of publicly-traded companies As of June 30, 2022 and December 31, 2021, the Company had investments in equity securities of publicly-traded companies at fair value of $511 and $5,267, respectively, which is included in the line item “other assets” in the accompanying consolidated balance sheets. Investments in publicly traded stock are classified within Level 1 of the fair value hierarchy as their fair value is measured based on unadjusted quoted prices in active exchange markets for identical assets.

Investments in equity securities of non-public companies and investment funds – As of June 30, 2022 and December 31, 2021, the Company had investments in equity securities of non-public companies and investment funds measured at fair value of $5,235 and $7,388, respectively, which are included in the line item “other assets” in the accompanying consolidated balance sheets.

Investments in equity securities of non-public companies and investment funds are classified within Level 3 of the fair value hierarchy. The fair values of the Company’s investments in equity securities of non-public companies and investment funds are not readily determinable. Accordingly, the Company estimates fair value by estimating the enterprise value of the investee which it then allocates to the investee’s securities in the order of their preference relative to one another. To estimate the enterprise value of the investee, the Company uses traditional valuation methodologies based on income and market approaches, including the consideration of recent investments in, or tender offers for, the equity securities of the investee, a discounted cash flow analysis and a comparable guideline public company valuation. The primary unobservable inputs used in estimating the fair value of an equity security of a non-public company include (i) a stock price to net asset multiple for similar public companies that is applied to the entity’s net assets, (ii) a discount factor for lack of marketability and control, and (iii) a cost of equity discount rate, used to discount to present value the equity cash flows available for distribution and the terminal value of the entity. As of June 30, 2022, the stock price to net asset multiple for similar public companies, the discount factor for lack of marketability and control, and the cost of equity discount rate used as inputs were 97 percent, 15 percent, and 16 percent, respectively. As of December 31, 2021, the stock price to net asset multiple for similar public companies, the discount factor for lack of marketability and control, and the cost of equity discount rate used as inputs were 95 percent, 15 percent, and 16 percent, respectively. For its investments in investment funds, the Company estimates fair value based upon the investee’s net asset value per share.

Financial assets and liabilities for which carrying value approximates fair value - Cash and cash equivalents, restricted cash, deposits, receivables, repurchase agreements, payables, and other assets (aside from those previously discussed) and liabilities are generally reflected in the consolidated balance sheets at their cost, which, due to the short-term nature of these instruments and their limited inherent credit risk, approximates fair value.

26


 

Fair Value Hierarchy

Financial Instruments Measured at Fair Value on a Recurring Basis

The following tables set forth financial instruments measured at fair value by level within the fair value hierarchy as of June 30, 2022 and December 31, 2021. Assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

 

 

 

June 30, 2022

 

 

 

Total

 

 

Level 1

 

 

Level 2

 

 

Level 3

 

Financial assets:

 

 

 

 

 

 

 

 

 

 

 

 

Agency MBS

 

$

382,357

 

 

$

 

 

$

382,357

 

 

$

 

MSR financing receivables

 

 

120,260

 

 

 

 

 

 

 

 

 

120,260

 

Loans

 

 

29,484

 

 

 

 

 

 

 

 

 

29,484

 

Credit securities

 

 

113,419

 

 

 

 

 

 

99,901

 

 

 

13,518

 

Mortgage loans of consolidated VIEs

 

 

225,004

 

 

 

 

 

 

 

 

 

225,004

 

Derivative assets

 

 

1,216

 

 

 

 

 

 

1,216

 

 

 

 

Other assets

 

 

5,746

 

 

 

511

 

 

 

 

 

 

5,235

 

Financial liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

Secured debt of consolidated VIEs

 

 

205,497

 

 

 

 

 

 

193,976

 

 

 

11,521

 

Derivative liabilities

 

 

1,887

 

 

 

 

 

 

1,887

 

 

 

 

 

 

 

December 31, 2021

 

 

 

Total

 

 

Level 1

 

 

Level 2

 

 

Level 3

 

Financial assets:

 

 

 

 

 

 

 

 

 

 

 

 

Agency MBS

 

$

483,927

 

 

$

 

 

$

483,927

 

 

$

 

MSR financing receivables

 

 

125,018

 

 

 

 

 

 

 

 

 

125,018

 

Loans

 

 

29,697

 

 

 

 

 

 

 

 

 

29,697

 

Credit securities

 

 

26,222

 

 

 

 

 

 

 

 

 

26,222

 

Mortgage loans of consolidated VIE

 

 

7,442

 

 

 

 

 

 

 

 

 

7,442

 

Derivative assets

 

 

250

 

 

 

20

 

 

 

230

 

 

 

 

Other assets

 

 

12,655

 

 

 

5,267

 

 

 

 

 

 

7,388

 

Financial liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

Secured debt of consolidated VIE

 

 

508

 

 

 

 

 

 

 

 

 

508

 

Derivative liabilities

 

 

228

 

 

 

 

 

 

228

 

 

 

 

 

Level 3 Financial Assets and Liabilities

The table below sets forth an attribution of the change in the fair value of the Company’s Level 3 financial assets that are measured at fair value on a recurring basis for the periods indicated:

 

 

Three Months Ended June 30,

 

 

Six Months Ended June 30,

 

 

2022

 

 

2021

 

 

2022

 

 

2021

 

Beginning balance

$

463,318

 

 

$

157,714

 

 

$

195,767

 

 

$

166,428

 

Net (loss) gain included in "Investment and derivative
   gain (loss), net"

 

(13,599

)

 

 

(1,183

)

 

 

1,616

 

 

 

5,135

 

Additions from consolidation of VIEs

 

 

 

 

 

 

 

276,594

 

 

 

 

Transfers to real estate owned by consolidated VIE

 

(199

)

 

 

 

 

 

(199

)

 

 

 

Purchases

 

18,032

 

 

 

72,669

 

 

 

21,219

 

 

 

93,013

 

Sales

 

(12,406

)

 

 

(1,662

)

 

 

(12,406

)

 

 

(1,662

)

Payments, net

 

(64,763

)

 

 

(22,764

)

 

 

(95,381

)

 

 

(59,540

)

Accretion (amortization) of discount (premium), net

 

3,118

 

 

 

1,955

 

 

 

6,291

 

 

 

3,355

 

Ending balance

$

393,501

 

 

$

206,729

 

 

$

393,501

 

 

$

206,729

 

Net unrealized (losses) gains included in earnings for the
   period for Level 3 assets still held at the reporting date

$

(13,037

)

 

$

(1,108

)

 

$

2,647

 

 

$

5,215

 

 

27


 

 

The table below sets forth an attribution of the change in the fair value of the Company’s Level 3 financial liabilities that are measured at fair value on a recurring basis for the periods indicated:

 

 

Three Months Ended June 30,

 

 

Six Months Ended June 30,

 

 

2022

 

 

2021

 

 

2022

 

 

2021

 

Beginning balance

$

13,615

 

 

$

611

 

 

$

508

 

 

$

576

 

Net (gain) loss included in "Investment and derivative
  gain (loss), net"

 

(1,081

)

 

 

29

 

 

 

(1,332

)

 

 

(10

)

Additions from consolidation of VIEs

 

 

 

 

 

 

 

14,278

 

 

 

 

Payments, net

 

(936

)

 

 

 

 

 

(1,796

)

 

 

 

(Amortization) accretion of (premium) discount, net

 

(77

)

 

 

 

 

 

(137

)

 

 

74

 

Ending balance

$

11,521

 

 

$

640

 

 

$

11,521

 

 

$

640

 

Net unrealized (gains) losses included in earnings for the
   period for Level 3 liabilities still held at the reporting date

$

(1,081

)

 

$

29

 

 

$

(1,332

)

 

$

(10

)

 

Note 13. Income Taxes

The Company has elected to be taxed as a REIT under the Internal Revenue Code commencing upon filing its tax return for its taxable year ended December 31, 2019. As a REIT, the Company is required to distribute annually 90% of its REIT taxable income. So long as the Company continues to qualify as a REIT, it will generally not be subject to U.S. federal or state corporate income taxes on its taxable income to the extent that it distributes all of its annual taxable income to its shareholders on a timely basis. At present, it is the Company’s intention to distribute 100% of its taxable income, although the Company will not be required to do so. The Company intends to make distributions of its REIT taxable income within the time limits prescribed by the Internal Revenue Code, which may extend into the subsequent taxable year. Accordingly, the Company does not expect to incur an income tax liability on its REIT taxable income.

As of June 30, 2022, the Company had estimated federal net operating loss (“NOL”) carryforwards of $167,491 that can be used to offset future taxable ordinary income and reduce its REIT distribution requirements. NOL carryforwards totaling $14,588 expire in 2028 and NOL carryforwards totaling $152,903 have no expiration period. For the NOL carryforwards that have no expiration period, the Company is limited to utilizing NOL carryforwards to 80% of the taxable income in any one year. As of June 30, 2022, the Company had estimated federal net capital loss (“NCL”) carryforwards of $171,835 that can be used to offset future net capital gains. The scheduled expirations of the Company’s NCL carryforwards are $3,763 in 2022, $110,323 in 2023, $13,036 in 2026 and $44,713 in 2027. The Company’s estimated NOL and NCL carryforwards as of June 30, 2022 are subject to potential adjustments up to the time of filing of the Company’s income tax returns.

The Company and certain subsidiaries have made joint elections to treat such subsidiaries as taxable REIT subsidiaries (“TRSs”). In general, a TRS may hold assets and engage in activities that the Company cannot hold or engage in directly and generally may engage in any real estate or non-real estate related business. As such, each of these TRSs is taxable as a C corporation and subject to federal, state and local income taxes based upon their taxable income. For the three months ended June 30, 2022 and 2021, the Company recognized a provision (benefit) for income taxes of $802 and $(76), respectively, on the pre-tax net income of its TRSs. For the six months ended June 30, 2022 and 2021, the Company recognized a provision for income taxes of $3,089 and $322, respectively, on the pre-tax income of its TRSs.

The Company recognizes uncertain tax positions in the financial statements only when it is more-likely-than-not that the position will be sustained upon examination by the relevant taxing authority based on the technical merits of the position. A position that meets this standard is measured at the largest amount of benefit that will more-likely-than-not be realized upon settlement. A liability is established for differences between positions taken in a tax return and the financial statements. As of June 30, 2022 and December 31, 2021, the Company assessed the need for recording a provision for any uncertain tax position and has made the determination that such provision is not necessary. If the Company were to incur income tax related interest and penalties, the Company’s policy is to classify them as a component of provision for income taxes.

The Company is subject to examination by the Internal Revenue Service (“IRS”) and state and local authorities in jurisdictions where the Company has significant business operations. The Company’s federal tax returns for 2018 and forward remain subject to examination by the IRS.

 

Note 14. Earnings (Loss) Per Share

28


 

Basic earnings (loss) per share includes no dilution and is computed by dividing net income or loss applicable to common stock by the weighted-average number of common shares outstanding for the respective period. Diluted earnings per share includes the impact of dilutive securities such as unvested shares of restricted stock, restricted stock units, and performance share units. The following table presents the computations of basic and diluted earnings (loss) per share for the periods indicated:

 

 

Three Months Ended June 30,

 

 

Six Months Ended June 30,

 

(Shares in thousands)

2022

 

 

2021

 

 

2022

 

 

2021

 

Basic weighted-average common shares outstanding

 

28,766

 

 

 

33,066

 

 

 

29,296

 

 

 

33,123

 

Performance share units, unvested restricted stock units,
   and unvested restricted stock

 

 

 

 

 

 

 

 

 

 

 

Diluted weighted-average common shares outstanding

 

28,766

 

 

 

33,066

 

 

 

29,296

 

 

 

33,123

 

Net loss attributable to common stock

$

(400

)

 

$

(7,782

)

 

$

(3,843

)

 

$

(14,545

)

Basic loss per common share

$

(0.01

)

 

$

(0.24

)

 

$

(0.13

)

 

$

(0.44

)

Diluted loss per common share

$

(0.01

)

 

$

(0.24

)

 

$

(0.13

)

 

$

(0.44

)

 

The diluted loss per share for the three and six months ended June 30, 2022 did not include the antidilutive effect of 534,170 and 508,274 shares of unvested shares of restricted stock, restricted stock units, and performance share units, respectively. The diluted loss per share for the three and six months ended June 30, 2021 did not include the antidilutive effect of 358,127 and 310,769 shares of unvested shares of restricted stock, restricted stock units, and performance share units, respectively.

 

Note 15. Stockholders’ Equity

Common Stock

The Company has authorized common share capital of 450,000,000 shares of Class A common stock, par value $0.01 per share, and 100,000,000 shares of Class B common stock, par value $0.01 per share. Holders of the Class A and Class B common stock are entitled to one vote and three votes per share, respectively, on all matters voted upon by the shareholders. Shares of Class B common stock are convertible into shares of Class A common stock on a one-for-one basis at the option of the Company in certain circumstances including either (i) upon sale or other transfer, or (ii) at the time the holder of such shares of Class B common stock ceases to be employed by the Company. As of June 30, 2022 and December 31, 2021, there were no outstanding shares of Class B common stock. The Class A common stock is publicly traded on the New York Stock Exchange under the ticker symbol “AAIC.”

Common Equity Distribution Agreements

On August 10, 2018, the Company entered into separate common equity distribution agreements with equity sales agents JMP Securities LLC, B. Riley FBR, Inc., JonesTrading Institutional Services LLC and Ladenburg Thalmann & Co. Inc. pursuant to which the Company may offer and sell, from time to time, up to 12,597,423 shares of the Company’s Class A common stock.

Pursuant to the common equity distribution agreements, shares of the Company’s common stock may be offered and sold through the equity sales agents in transactions that are deemed to be “at the market” offerings as defined in Rule 415 under the Securities Act of 1933, including sales made directly on the NYSE or sales made to or through a market maker other than on an exchange or, subject to the terms of a written notice from the Company, in privately negotiated transactions.

During the three and six months ended June 30, 2022 and the year ended December 31, 2021, there were no issuances of common stock under the common equity distribution agreements.

As of June 30, 2022, the Company had 11,302,160 shares of Class A common stock available for sale under the common equity distribution agreements.

Common Share Repurchase Program

 

On July 31, 2020, the Company announced that its Board of Directors authorized a share repurchase program pursuant to which the Company may repurchase up to 18,000,000 shares of Class A common stock (the "Repurchase Program"). Repurchases under the Repurchase Program may be made from time to time on the open market and in private transactions at management’s discretion in accordance with applicable federal securities laws. The timing of repurchases and the exact number of shares of Class A common stock to be repurchased will depend upon market conditions and other factors. The Repurchase Program is funded using the Company’s cash on hand and cash generated from operations. The Repurchase Program has no expiration date and may be suspended or terminated at any time without prior notice.

 

29


 

During the three and six months ended June 30, 2022, the Company repurchased 947,570 and 1,957,136 shares of Class A common stock for a total purchase price of $3,242 and $6,739, respectively. During the year ended December 31, 2021, the Company repurchased 3,242,371 shares of Class A common stock for a total purchase price of $12,475. As of June 30, 2022, there remain available for repurchase 11,033,142 shares of Class A common stock under the Repurchase Program.

Preferred Stock

The Company has authorized preferred share capital of (i) 100,000 shares designated as Series A Preferred Stock that is unissued; (ii) 2,000,000 shares designated as 7.00% Series B Cumulative Perpetual Redeemable Preferred Stock (the “Series B Preferred Stock”), par value of $0.01 per share; (iii) 2,500,000 shares designated as 8.250% Series C Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock (the “Series C Preferred Stock”), par value of $0.01 per share; and (iv) 20,400,000 shares of undesignated preferred stock. The Company’s Board of Directors has the authority, without further action by the shareholders, to issue additional preferred stock in one or more series and to fix the terms and rights of the preferred stock. The Company’s preferred stock ranks senior to its common stock with respect to the payment of dividends and the distribution of assets upon a voluntary or involuntary liquidation, dissolution, or winding up of the Company. The Company’s preferred stock ranks on parity with each other. The Series B Preferred Stock and Series C Preferred Stock are publicly traded on the New York Stock Exchange under the ticker symbols “AAIC PrB” and “AAIC PrC,” respectively.

The Series B Preferred Stock has no stated maturity, is not subject to any sinking fund and will remain outstanding indefinitely unless repurchased or redeemed by the Company. Holders of Series B Preferred Stock have no voting rights, except under limited conditions, and are entitled to receive a cumulative cash dividend at a rate of 7.00% per annum of their $25.00 per share liquidation preference (equivalent to $1.75 per annum per share). Shares of Series B Preferred Stock are redeemable at $25.00 per share, plus accumulated and unpaid dividends (whether or not authorized or declared), exclusively at the Company’s option. Dividends are payable quarterly in arrears on the 30th day of March, June, September and December of each year, when and as declared. The Company has declared and paid all required quarterly dividends on the Company’s Series B Preferred Stock to date in 2022.

The Series C Preferred Stock has no stated maturity, is not subject to any sinking fund and will remain outstanding indefinitely unless repurchased or redeemed by the Company. Holders of Series C Preferred Stock have no voting rights, except under limited conditions, and are entitled to receive a cumulative cash dividend (i) from and including the original issue date to, but excluding, March 30, 2024 at a fixed rate equal to 8.250% per annum of the $25.00 per share liquidation preference (equivalent to $2.0625 per annum per share) and (ii) from and including March 30, 2024, at a floating rate equal to three-month LIBOR plus a spread of 5.664% per annum of the $25.00 per share liquidation preference. Shares of Series C Preferred Stock are redeemable at $25.00 per share, plus accumulated and unpaid dividends (whether or not authorized or declared), exclusively at the Company’s option commencing on March 30, 2024 or earlier upon the occurrence of a change in control or under circumstances where it is necessary to preserve the Company’s qualification as a REIT. Dividends are payable quarterly in arrears on the 30th day of March, June, September and December of each year, when and as declared. The Company has declared and paid all required quarterly dividends on the Company’s Series C Preferred Stock to date in 2022.

During the three and six months ended June 30, 2022, the Company repurchased 72,363 shares of Series C Preferred Stock for a total purchase price of $1,749. There were no shares of Series C Preferred Stock repurchased by the Company during the year ended December 31, 2021.

Preferred Equity Distribution Agreements

The Company is party to an amended and restated equity distribution agreement with JonesTrading Institutional Services LLC and Ladenburg Thalmann & Co. Inc., pursuant to which the Company may offer and sell, from time to time, up to 1,647,370 shares of the Company’s Series B Preferred Stock. Pursuant to the Series B preferred equity distribution agreement, shares of the Company’s Series B Preferred stock may be offered and sold through the preferred equity sales agents in transactions that are deemed to be “at the market” offerings as defined in Rule 415 under the Securities Act of 1933, including sales made directly on the NYSE or sales made to or through a market maker other than on an exchange or, subject to the terms of a written notice from the Company, in privately negotiated transactions.

During the six months ended June 30, 2022, the Company issued 6,058 shares of Series B Preferred Stock at a weighted average public offering price of $24.87 per share for proceeds net of selling commissions and expenses of $149 under the Series B preferred equity distribution agreement. There were no issuances of Series B Preferred Stock during the three months ended June 30, 2022. During the year ended December 31, 2021, the Company issued 37,337 shares of Series B preferred stock at a weighted average public offering price of $24.99 per share for proceeds net of selling commissions and expenses of $919 under the Series B preferred equity distribution agreement. As of June 30, 2022, the Company had 1,602,566 shares of Series B Preferred stock available for sale under the preferred equity distribution agreement.

30


 

 

Shareholder Rights Agreement

On June 1, 2009, the Board of Directors approved a shareholder rights agreement (“Rights Plan”) and the Company’s shareholders approved the Rights Plan at its annual meeting of shareholders on June 2, 2010. On April 9, 2018, the Board of Directors approved a first amendment to the Rights Plan (“First Amendment”) to extend the term for an additional three years and the Company’s shareholders approved the First Amendment at its annual meeting of shareholders on June 14, 2018. On April 11, 2022, the Board of Directors approved a second amendment to the Rights Plan (“Second Amendment”) to further extend the term until June 4, 2025 and the Company's shareholders approved the Second Amendment at its annual meeting of shareholders on June 16, 2022. The Second Amendment also decreased the Purchase Price (as defined under the Rights Plan) from $70.00 to $21.30.

Under the terms of the Rights Plan, in general, if a person or group acquires or commences a tender or exchange offer for beneficial ownership of 4.9% or more of the outstanding shares of our Class A common stock upon a determination by our Board of Directors (an “Acquiring Person”), all of our other Class A and Class B common shareholders will have the right to purchase securities from us at a discount to such securities’ fair market value, thus causing substantial dilution to the Acquiring Person.

The Board of Directors adopted the Rights Plan in an effort to protect against a possible limitation on the Company’s ability to use its NOL carryforwards, NCL carryforwards, and built-in losses under Sections 382 and 383 of the Internal Revenue Code. The Company’s ability to use its NOLs, NCLs and built-in losses would be limited if it experienced an “ownership change” under Section 382 of the Internal Revenue Code. In general, an “ownership change” would occur if there is a cumulative change in the ownership of the Company’s common stock of more than 50% by one or more “5% shareholders” during a three-year period. The Rights Plan was adopted to dissuade any person or group from acquiring 4.9% or more of the Company’s outstanding Class A common stock, each, an Acquiring Person, without the approval of the Board of Directors and triggering an “ownership change” as defined by Section 382.

The Rights Plan, as amended by the Second Amendment, and any outstanding rights will expire at the earliest of (i) June 4, 2025, (ii) the time at which the rights are redeemed or exchanged pursuant to the Rights Plan, (iii) the repeal of Section 382 and 383 of the Internal Revenue Code or any successor statute if the Board of Directors determines that the Rights Plan is no longer necessary for the preservation of the applicable tax benefits, or (iv) the beginning of a taxable year to which the Board of Directors determines that no applicable tax benefits may be carried forward.

 

Note 16. Long-Term Incentive Plan

The Company provides its employees and its non-employee directors with long-term incentive compensation in the form of stock-based awards. On April 29, 2021, the Board of Directors adopted the Arlington Asset Investment Corp. 2021 Long-Term Incentive Plan (the “2021 Plan”), which was approved by the Company’s shareholders and became effective on July 15, 2021. The 2021 Plan replaced the Arlington Asset Investment Corp. 2014 Long-Term Incentive Plan (the “2014 Plan”). No additional grants will be made under the 2014 Plan. However, previous grants under the 2014 Plan and any long-term incentive plans prior to the 2014 Plan (collectively, the “Prior Plans”) will remain in effect subject to the terms of the Prior Plans and the applicable award agreement.

Under the 2021 Plan, a maximum number of 5,256,076 shares of Class A common stock of the Company, subject to adjustment as set forth in the 2021 Plan, were authorized for issuance and may be issued to employees, directors, consultants, advisors and independent contractors who provide bona fide services to the Company and its affiliates. If an award under the 2021 Plan or Prior Plans is canceled, terminated, forfeited or otherwise settled without the issuance of shares subject to such award, those shares will be available for future grants under the 2021 Plan. In addition, shares delivered or withheld for tax obligations arising from an award, other than a stock option or stock appreciation right (“SAR”), will be available for future grants under the 2021 Plan. As of June 30, 2022, 4,350,695 shares remained available for issuance under the 2021 Plan; however, the shares remaining available for issuance would be reduced by the potential future issuance of shares of common stock for the settlement of outstanding performance-based stock awards and dividend equivalents for such awards. If these outstanding performance-based stock awards are earned at “target” level performance, an additional 1,939,009 shares would be issued resulting in 2,411,686 shares remaining available for issuance under the 2021 Plan as of June 30, 2022.

Under the 2021 Plan, the Compensation Committee of the Company’s Board of Directors may grant restricted stock, restricted stock units (“RSUs”), stock options, SARs and/or other stock-based awards. Under the 2021 Plan, shares issued upon the exercise of a stock option or SAR or shares subject to a restricted stock award and any shares issued in settlement of restricted stock unit award, reduced by the number of any shares withheld to satisfy withholding taxes, may not be sold or transferred before the earlier of (i) the first anniversary of the exercise of the option or SAR or vesting of the restricted stock award or the settlement of restricted stock unit award, or (ii) the date the participant is no longer employed by or providing services to the Company or an affiliate. Non-employee members of the Board of Directors may not be granted awards under the 2021 Plan during any twelve-month period with respect to the number of shares that have a fair market value on the date of grant that exceeds $160. The 2021 Plan will terminate on the tenth anniversary of its effective date unless sooner terminated by the Board of Directors.

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Stock-based compensation costs are initially measured at the estimated fair value of the awards on the grant date developed using appropriate valuation methodologies, as adjusted for estimates of future award forfeitures. Valuation methodologies used and subsequent expense recognition is dependent upon each award’s service and performance conditions.

Performance-based Stock Awards

The Company has granted performance-based RSUs and performance stock units (collectively, “Performance-based Stock Awards”) to employees of the Company that are convertible into shares of Class A common stock following the achievement of performance goals over the applicable performance periods. Compensation costs for Performance-based Stock Awards subject to nonmarket-based performance conditions (i.e., performance not predicated on changes in the Company’s stock price) are measured at the closing stock price on the dates of grant, adjusted for the probability of achieving certain benchmarks included in the performance metrics. These initial cost estimates are recognized as expense over the requisite performance periods, as adjusted for changes in estimated, and ultimately actual, performance and forfeitures. Compensation costs for components of Performance-based Stock Awards subject to market-based performance conditions (i.e., performance predicated on changes in the Company’s stock price) are measured at the dates of grant using a Monte Carlo simulation model which incorporates into the valuation the inherent uncertainty regarding the achievement of the market-based performance metrics. These initial valuation amounts are recognized as expense over the requisite performance periods, subject only to adjustments for changes in estimated, and ultimately actual, forfeitures.

During the six months ended June 30, 2022 and 2021, the Compensation Committee granted Performance-based Stock Awards with performance goals based on (i) the compound annualized total shareholder return (i.e., share price change plus dividends on a reinvested basis) during the applicable performance period (“Absolute TSR Awards”), (ii) the compound annualized total shareholder return relative to a peer index during the applicable performance period (“Relative TSR Awards”), (iii) the compound annualized growth in the Company’s book value per share (i.e., book value change with such adjustments as determined and approved by the Compensation Committee plus dividends on a reinvested basis) during the applicable performance period (“Book Value Awards”), and (iv) the share price of the Company's common stock during the applicable performance period ("Stock Price Awards"). In addition, the Compensation Committee granted Performance-based Stock Awards in prior years with performance goals based on annual return on equity during the applicable performance period ("ROE Awards").

The Compensation Committee of the Board of Directors of the Company approved the following Performance-based Stock Award grants for the periods indicated:

 

 

 

Six Months Ended June 30,

 

 

 

2022

 

 

2021

 

Absolute TSR Awards granted

 

 

174,581

 

 

 

90,711

 

Absolute TSR Award grant date fair value per share

 

$

6.03

 

 

$

6.89

 

Relative TSR Awards granted

 

 

87,291

 

 

 

47,710

 

Relative TSR Award grant date fair value per share

 

$

5.83

 

 

$

6.55

 

Book Value Awards granted

 

 

103,000

 

 

 

 

Book Value Award grant date fair value per share

 

$

3.37

 

 

$

 

Stock Price Awards granted

 

 

1,225,490

 

 

 

 

Stock Price Award grant date fair value per share

 

$

1.72

 

 

$

 

For the Company’s Book Value Awards and ROE Awards, the grant date fair value per share is based on the close price on the date of grant. For the Company’s Absolute TSR Awards, Relative TSR Awards and Stock Price Awards, the grant date fair value per share is based on a Monte Carlo simulation model. The following assumptions, determined as of the date of grant, were used in the Monte Carlo simulation model to measure the grant date fair value per share of the Company’s Absolute TSR Awards, Relative TSR Awards and Stock Price Awards for the periods indicated:

 

 

 

Absolute TSR Awards

 

 

Relative TSR Awards

 

 

Stock Price Awards

 

 

 

Six Months Ended June 30,

 

 

Six Months Ended June 30,

 

 

Six Months Ended June 30,

 

 

 

2022

 

 

2021

 

 

2022

 

 

2021

 

 

2022

 

 

2021

 

Closing stock price on date of grant

 

$

3.58

 

 

$

4.08

 

 

$

3.58

 

 

$

4.08

 

 

$

3.06

 

 

$

 

Beginning average stock price on
  date of grant
(1)

 

$

3.60

 

 

$

4.07

 

 

$

3.60

 

 

$

4.07

 

 

N/A

 

 

$

 

Expected volatility (2)

 

 

69.20

%

 

 

69.27

%

 

 

69.20

%

 

 

69.27

%

 

 

51.17

%

 

 

 

Dividend yield (3)

 

 

0.00

%

 

 

0.00

%

 

 

0.00

%

 

 

0.00

%

 

 

0.00

%

 

 

 

Risk-free rate (4)

 

 

1.01

%

 

 

0.34

%

 

 

1.01

%

 

 

0.34

%

 

 

2.97

%

 

 

 

Discount for illiquidity (5)

 

 

0.00

%

 

 

0.00

%

 

 

0.00

%

 

 

0.00

%

 

 

8.42

%

 

 

 

 

32


 

(1)
Based upon the 30 trading days prior to and including the date of grant.
(2)
Based upon the most recent three-year volatility as of the date of grant.
(3)
Dividend equivalents are accrued during the performance period and deemed reinvested in additional stock units, which are to be paid out at the end of the performance period to the extent the underlying Performance-based Stock Award is earned. Applying dividend yield assumption of 0.00% in the Monte Carlo simulation is mathematically equivalent to reinvesting dividends on a continuous basis and including the value of the dividends in the final payout.
(4)
Based upon the yield of a U.S. Treasury bond with a three-year maturity as of the date of grant.
(5)
Based on restriction on ability to sell vested awards for one year after vesting.

The vesting of the Performance-based Stock Awards is subject to both continued employment under the terms of the award agreement and the achievement of the Company performance goals established by the Compensation Committee.

For Absolute TSR Awards and Relative TSR Awards granted during the six months ended June 30, 2022 and 2021, the Compensation Committee established a three-year performance period. The actual number of shares of Class A common stock that will be issued to each participant at the end of the applicable performance period will vary between 0% and 250% of the number of the Absolute TSR Awards and Relative TSR Awards granted, depending on performance results. If the minimum threshold level of performance goals is not achieved, no awards are earned. To the extent the performance results are between the minimum threshold level and maximum level of performance goals, between 50% to 250% of the number of Absolute TSR Awards and Relative TSR Awards are earned. Upon settlement, vested Absolute TSR Awards and Relative TSR Awards are converted into shares of the Company’s Class A common stock on a one-for-one basis.

For Book Value Awards granted during the six months ended June 30, 2022, the Compensation Committee established a one-year performance period. The actual number of shares of Class A common stock that will be issued to each participant at the end of the applicable performance period will vary between 0% and 100% of the number of Book Value Awards granted, depending on performance results. Any Book Value Awards earned at the end of the one-year performance period would be converted into an equal number of shares of restricted stock that will vest on the third anniversary of the original Book Value Award grant date subject to continued employment under the terms of the award agreement. If the threshold level of the annual performance goal is not achieved, no Book Value Awards are earned.

For Stock Price Awards granted during the six months ended June 30, 2022, the Compensation Committee established a three-year performance period. If the market price of the Company's common stock is equal to or greater than a stock price performance goal for 45 consecutive trading days at any time during the performance period, between 75% to 300% of the number of Stock Price Awards are earned and converted into an equal number of shares of restricted stock that will vest ratably over a three-year period beginning on the third anniversary of the date of grant subject to continued employment under the terms of the award of the agreement. If the minimum threshold level of stock price performance goals are never achieved, no awards are earned.

For the ROE Awards granted in prior years, the Compensation Committee established a one-year performance period. Any ROE Awards earned at the end of the one-year performance period would be converted into an equal number of shares of restricted stock that will vest on the third anniversary of the original ROE Award grant date subject to continued employment under the terms of the award agreement. If the threshold level of the annual performance goal is not achieved, no ROE Awards are earned.

Performance-based Stock Awards do not have any voting rights. No dividends are paid on outstanding Performance-based Stock Awards during the applicable performance period. Instead, dividend equivalents are accrued on outstanding Performance-based Stock Awards during the applicable performance period, deemed invested in shares of Class A common stock and are paid out in shares of Class A common stock at the end of the performance period to the extent that the underlying Performance-based Stock Awards vest.

For the six months ended June 30, 2022 and 2021, the Company recognized $565 and $182, respectively, of compensation expense related to Performance-based Stock Awards. As of June 30, 2022, the Company had 1,939,009 Performance-based stock awards outstanding. As disclosed above, the actual number of shares of common stock that could be issued for settlement of the Performance-based shares can be greater or less than the amount of Performance-based shares outstanding depending upon the actual results compared to the performance goals. As of June 30, 2022 and December 31, 2021, the Company had unrecognized compensation expense related to Performance-based Stock Awards of $3,986 and $878, respectively. The unrecognized compensation expense as of June 30, 2022 is expected to be recognized over a weighted average period of 3.61 years. For Absolute TSR Awards, Relative TSR Awards and Book Value Awards that had performance measurement periods ending during the six months ended June 30, 2022 and 2021, none of the performance measures were met and therefore no awards were earned or vested during those periods. For the six months ended June 30, 2022 and 2021, there were 0 and 82,124 ROE Awards, respectively, including dividend

33


 

equivalents, that were earned and converted into an equal number of shares of restricted stock that will vest on the third anniversary of the original ROE Award grant date.

Employee Restricted Stock Awards

Compensation costs for restricted stock awards subject only to service conditions are measured at the closing stock price on the dates of grant and are recognized as expense on a straight-line basis over the requisite service periods for the awards, as adjusted for changes in estimated, and ultimately actual, forfeitures.

The Company grants restricted common shares to employees that either vest ratably over a three-year period or cliff vest at the end of a three-year period based on continued employment over these specified periods. A summary of these unvested restricted stock awards is presented below:

 

 

 

Number of Shares

 

 

Weighted-average
Grant-date Fair
Value

 

 

Weighted-
average Remaining
Vested Period

 

Share Balance as of December 31, 2020

 

 

547,688

 

 

$

4.89

 

 

 

1.5

 

Granted

 

 

365,592

 

 

 

3.89

 

 

 

 

Conversion of ROE Awards

 

 

82,124

 

 

 

5.65

 

 

 

 

Forfeitures

 

 

(22,000

)

 

 

6.54

 

 

 

 

Vestitures

 

 

(214,369

)

 

 

5.89

 

 

 

 

Share Balance as of December 31, 2021

 

 

759,035

 

 

 

4.16

 

 

 

1.5

 

Granted

 

 

384,291

 

 

 

3.42

 

 

 

 

Forfeitures

 

 

(12,167

)

 

 

3.57

 

 

 

 

Share Balance as of June 30, 2022

 

 

1,131,159

 

 

$

3.91

 

 

 

1.3

 

 

For the six months ended June 30, 2022 and 2021, the Company recognized $988 and $604, respectively, of compensation expense related to restricted stock awards. As of June 30, 2022 and December 31, 2021, the Company had unrecognized compensation expense related to restricted stock awards of $2,129 and $1,847, respectively. The unrecognized compensation expense as of June 30, 2022 is expected to be recognized over a weighted average period of 1.3 years. For the six months ended June 30, 2022 and 2021, there were no restricted stock awards that vested.

In addition, as part of the Company’s satisfaction of incentive compensation earned for past service under the Company’s variable compensation programs, employees may receive restricted Class A common stock in lieu of cash payments. These restricted Class A common stock shares are issued to an irrevocable trust and are not returnable to the Company. No such shares were issued during the six months ended June 30, 2022 and 2021. As of June 30, 2022 and December 31, 2021, the Company had 9,155 vested shares of the undistributed restricted stock issued to the trust.

Employee Restricted Stock Units

In connection with the announcement in June 2019 that the Company’s Executive Chairman would retire on December 31, 2019 from all positions with the Company, including its Board of Directors, the Company and its Executive Chairman entered into a consulting agreement to provide consulting services through January 1, 2022. Pursuant to the consulting agreement, the Company granted the Executive Chairman 87,847 RSUs with a grant date fair value of $6.83 per share. The grant date fair value of the award was based on the closing price of the Class A common stock on the New York Stock Exchange on the date of grant. The RSUs were scheduled to vest equally on each of January 1, 2020, July 1, 2020, January 1, 2021, July 1, 2021 and January 1, 2022, subject to the individual’s continued employment through December 31, 2019 and providing consulting services through January 1, 2022. Upon vesting, the RSUs were convertible into shares of Class A common stock. The RSUs did not have any voting rights, and no dividends were paid on outstanding RSUs. Instead, dividend equivalents were accrued on outstanding RSUs, deemed invested in shares of Class A common stock and were paid out in shares of Class A common stock on the vesting date.

For the six months ended June 30, 2022 and 2021, the Company recognized $0 and $54, respectively, of compensation expense related to employee restricted stock units. For the six months ended June 30, 2022 and 2021, the intrinsic value of RSUs that were converted into shares of Class A common stock were $73 and $74, respectively. As of June 30, 2022 and December 31, 2021, the Company had 0 and 20,455, respectively, of employee restricted stock units outstanding.

34


 

Director Restricted Stock Units

Compensation costs for RSU awards subject only to service conditions are measured at the closing stock price on the dates of grant and are recognized as expense on a straight-line basis over the requisite service periods for the awards, as adjusted for changes in estimated, and ultimately actual, forfeitures. Compensation costs for RSUs that do not require future service conditions are expensed immediately.

The Company’s non-employee directors are compensated in both cash and RSUs. RSUs awarded to non-employee directors vest immediately on the award grant date and are convertible into shares of Class A common stock. For RSUs granted under the Company’s 2021 Plan, 2014 Plan, and certain of the Prior Plans, the RSUs are convertible into shares of Class A common stock at the later of the date the non-employee director ceases to be a member of the Company’s Board or the first anniversary of the grant date. For RSUs granted under certain Prior Plans, the RSUs are convertible into shares of Class A common stock one year after the non-employee director ceases to be a member of the Company’s Board. The non-employee director RSUs do not have any voting rights but are entitled to cash dividend equivalent payments. As of June 30, 2022 and December 31, 2021, the Company had 548,272 and 415,822, respectively, of non-employee director RSUs outstanding. A summary of the non-employee director RSUs grants is presented below for the periods indicated:

 

 

 

Six Months Ended June 30,

 

 

 

2022

 

 

2021

 

RSUs granted

 

 

132,450

 

 

 

98,035

 

Grant date fair value

 

$

3.02

 

 

$

4.08

 

 

The grant date fair value is based on the closing price of the Class A common stock on the New York Stock Exchange on the date of grant. For the six months ended June 30, 2022 and 2021, the Company recognized $200 and $200, respectively, of director fees related to these RSUs. There were no non-employee director RSUs that were converted into shares of Class A common stock for the six months ended June 30, 2022 and 2021.

35


 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Unless the context otherwise requires or provides, references in this Quarterly Report on Form 10-Q to “we,” “us,” “our” and the “Company” refer to Arlington Asset Investment Corp. (“Arlington Asset”) and its subsidiaries. This discussion and analysis should be read in conjunction with our financial statements and accompanying notes included in Item 1 of this Quarterly Report on Form 10-Q, as well as our audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2021.

The discussion of our consolidated financial condition and results of operations below may contain forward-looking statements. These statements, which reflect management’s beliefs and expectations, are subject to risks and uncertainties that may cause actual results to differ materially. For a discussion of the risks and uncertainties that may affect our future results, please see “Cautionary Statement About Forward-Looking Information” in Item 3 of Part I of this Quarterly Report on Form 10-Q and the risk factors included in Item 1A of Part I of our Annual Report on Form 10-K for the year ended December 31, 2021 and our subsequent Quarterly Reports on Form 10-Q.

Our Company

We are an investment firm that focuses primarily on investing in mortgage related assets and residential real estate. Our investment capital is currently allocated between the following asset classes:

mortgage servicing right (“MSR”) related assets
credit investments
single-family residential (“SFR”) properties
agency mortgage-backed securities (“MBS”)

Our MSR related assets represent investments for which the return is based on the economic performance of a pool of specific MSRs. Our credit investments generally include investments in mortgage loans secured by either residential or commercial real property or MBS collateralized by residential or commercial mortgage loans (“non-agency MBS”) or asset-backed securities (“ABS”) collateralized by residential solar panel loans. Our SFR investment strategy is to acquire, lease and operate single-family residential homes as rental properties. Our agency MBS consist of residential mortgage pass-through certificates for which the principal and interest payments are guaranteed by a U.S. government sponsored enterprise (“GSE”), such as the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”).

We may also invest in other asset classes that our management team believes may offer attractive risk adjusted returns outside the real estate or mortgage asset classes.

We are internally managed and do not have an external investment advisor.

Factors that Affect our Results of Operations and Financial Condition

Our business is materially affected by a variety of industry and economic factors, including:

conditions in the global financial markets and economic conditions generally;
the impacts of the coronavirus (“COVID-19”) pandemic;
changes in interest rates and prepayment rates;
conditions in the real estate and mortgage markets;
actions taken by the U.S. government, U.S. Federal Reserve, the U.S. Treasury and foreign central banks;
changes in laws and regulations and industry practices; and
other market developments.

Current Market Conditions and Trends

The 10-year U.S. Treasury rate was 3.01% as of June 30, 2022, a 67 basis point increase from the prior quarter end. The interest rate curve, measured as the spread between the 2-year and 10-year U.S. Treasury remained relatively flat at six basis points as of June 30, 2022. The spread between the current coupon agency MBS and the 10-year swap rate widened 21 basis points during the second quarter of 2022. Residential mortgage rates increased significantly evidenced by the Fannie Mae average primary mortgage rate

36


 

increasing by 103 basis points during the second quarter to 5.70% as of June 30, 2022. The rate of inflation continued to increase significantly with the Consumer Price Index rising 9.1% for the twelve month period ending June 30, 2022, the largest increase in over 40 years with the indices for energy and food being the largest contributors.

In order to address the significantly rising inflation, the U.S. Federal Reserve has taken actions with the objective of lowering inflation by significantly raising interest rates. At its May 4, 2022 meeting, the Federal Open Market Committee (“FOMC”) decided to raise its target range for the federal funds rate by 50 basis points to a range of 0.75% to 1.00% and also announced that it will begin reducing its holdings of Treasury securities and agency MBS starting June 1, 2022. At its June 15, 2022 meeting, the FOMC decided to raise its target range for the federal funds rate by an additional 75 basis points to a range of 1.50% to 1.75%. At its July 27, 2022 meeting, the FOMC decided to raise its target range for the federal funds rate by an additional 75 basis points to a range of 2.25% to 2.50% and that it anticipates ongoing increases in the target range will be appropriate. Subsequent to the July 27, 2022 FOMC meeting, the market is expecting additional hikes totaling approximately 100 basis points in the next six months followed by rate cuts beginning in 2023 based on federal funds futures.

Prepayment speeds in the fixed-rate residential mortgage market decreased during the second quarter of 2022 primarily due to the rise in the primary mortgage rate driven by the increase in the 10-year U.S. Treasury rate. Pay-up premiums on agency MBS, which represent the price premium of agency MBS backed by specified pools over a TBA security, decreased during the second quarter of 2022 as a result of declining prepayment concerns. The spread between the market yield on agency MBS and benchmark interest rates widened during the second quarter of 2022 resulting in agency MBS underperforming relative to interest rate hedges. Conversely, valuation multiples of MSRs increased during the second quarter of 2022 driven primarily by declining prepayment speed expectations.

Housing prices continued to strengthen significantly as evidenced by the Standard & Poor’s CoreLogic Case-Shiller U.S. National Home Price NSA index reporting a 19.7% annual gain in May 2022 with price gains the strongest in the south and southeast. The strong gains in housing continue to be driven by favorable supply demand dynamics as the low supply of homes for sale and new housing starts has been insufficient to meet the growing demand for housing driven by overall population growth, low mortgage rates, inflationary pressures as well as the impact of the COVID-19 pandemic increasing the number of potential home buyers moving from urban apartments to suburban homes. However, as the Federal Reserve ratchets up interest rates and housing affordability declines, ongoing support for extraordinary home price appreciation may not continue for much longer.

The following table presents certain key market data as of the dates indicated:

 

 

June 30,
2021

 

 

September 30,
2021

 

 

December 31,
2021

 

 

March 31,
2022

 

 

June 30,
2022

 

 

Change - Second Quarter 2022

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

30-Year FNMA Fixed Rate MBS (1)

 

2.0%

$

100.98

 

 

$

100.38

 

 

$

99.72

 

 

$

92.63

 

 

$

86.77

 

 

$

(5.86

)

2.5%

 

103.41

 

 

 

103.22

 

 

 

102.09

 

 

 

95.20

 

 

 

89.89

 

 

 

(5.31

)

3.0%

 

104.22

 

 

 

104.67

 

 

 

103.64

 

 

 

97.55

 

 

 

93.11

 

 

 

(4.44

)

3.5%

 

105.27

 

 

 

105.83

 

 

 

105.32

 

 

 

99.75

 

 

 

96.17

 

 

 

(3.58

)

4.0%

 

106.54

 

 

 

107.17

 

 

 

106.41

 

 

 

101.58

 

 

 

98.62

 

 

 

(2.96

)

4.5%

 

107.63

 

 

 

108.16

 

 

 

107.22

 

 

 

103.25

 

 

 

100.39

 

 

 

(2.86

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investment Spreads

 

FNMA Current Coupon vs.
   10-year Swap Rate

39 bps

 

 

46 bps

 

 

49 bps

 

 

108 bps

 

 

129 bps

 

 

21 bps

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

30 Year Fixed Mortgage Rate

 

Freddie Mac Average Primary
  Mortgage Rate

 

2.98

%

 

 

3.01

%

 

 

3.11

%

 

 

4.67

%

 

 

5.70

%

 

103 bps

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Treasury Rates ("UST")

 

2-year UST

 

0.25

%

 

 

0.28

%

 

 

0.73

%

 

 

2.33

%

 

 

2.95

%

 

62 bps

 

5-year UST

 

0.89

%

 

 

0.96

%

 

 

1.26

%

 

 

2.46

%

 

 

3.04

%

 

58 bps

 

10-year UST

 

1.47

%

 

 

1.49

%

 

 

1.51

%

 

 

2.34

%

 

 

3.01

%

 

67 bps

 

2-year UST to 10-year UST spread

122 bps

 

 

121 bps

 

 

78 bps

 

 

1 bps

 

 

6 bps

 

 

5 bps

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest Rate Swap Rates

 

2-year swap

 

0.33

%

 

 

0.38

%

 

 

0.94

%

 

 

2.55

%

 

 

3.28

%

 

73 bps

 

5-year swap

 

0.96

%

 

 

1.05

%

 

 

1.37

%

 

 

2.52

%

 

 

3.08

%

 

56 bps

 

10-year swap

 

1.44

%

 

 

1.51

%

 

 

1.58

%

 

 

2.41

%

 

 

3.09

%

 

68 bps

 

2-year swap to 2-year UST spread

8 bps

 

 

10 bps

 

 

21 bps

 

 

22 bps

 

 

33 bps

 

 

11 bps

 

10-year swap to 10-year UST spread

-3 bps

 

 

2 bps

 

 

7 bps

 

 

7 bps

 

 

8 bps

 

 

1 bps

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

London Interbank Offered Rates ("LIBOR") and Secured Overnight Financing Rate ("SOFR")

 

1-month LIBOR

 

0.10

%

 

 

0.08

%

 

 

0.10

%

 

 

0.45

%

 

 

1.79

%

 

134 bps

 

3-month LIBOR

 

0.15

%

 

 

0.13

%

 

 

0.21

%

 

 

0.96

%

 

 

2.29

%

 

133 bps

 

SOFR

 

0.05

%

 

 

0.05

%

 

 

0.05

%

 

 

0.29

%

 

 

1.50

%

 

121 bps

 

 

37


 

 

(1)
Generic 30-year FNMA TBA price information, sourced from Bloomberg, is provided for illustrative purposes only and is not meant to be reflective of the fair value of securities held by the Company.

 

Recent Regulatory Activity

 

Elimination of LIBOR

On March 5, 2021, the FCA, which regulates LIBOR, announced that all LIBOR tenors relevant to us will cease to be published or will no longer be representative after June 30, 2023. The FCA's announcement coincides with the March 5, 2021 announcement of LIBOR's administrator, the IBA, indicating that, as a result of not having access to input data necessary to calculate LIBOR tenors relevant to us on a representative basis after June 30, 2023, IBA would have to cease publication of such LIBOR tenors immediately after the last publication on June 30, 2023. These announcements mean that any of our LIBOR-based financial instruments that extend beyond June 30, 2023 will need to be converted to a replacement rate.

The U.S. Federal Reserve and the Federal Reserve Bank of New York jointly convened the ARRC, a steering committee comprised of private sector entities, each with an important presence in markets effected by LIBOR, and official-sector entities, including banking and financial sector regulators. The ARCC’s initial objectives were to identify risk-free alternative reference rates for USD LIBOR, identify best practices for contract robustness and create an implementation plan. The ARRC has recommended SOFR, plus a recommended spread adjustment, as LIBOR's replacement.

On April 6, 2021, the state of New York enacted the New York LIBOR Legislation, addressing the phase-out of LIBOR as a benchmark rate in financial instruments governed by New York law. The New York LIBOR Legislation generally tracks the legislation proposed by the ARRC and provides a statutory remedy for contracts that reference USD LIBOR as a benchmark interest rate but do not include effective fallback provisions in the event USD LIBOR is no longer published or is no longer representative. Under the New York LIBOR Legislation, if a contract governed by New York law that references USD LIBOR as a benchmark interest rate either does not contain benchmark fallback provisions or contains benchmark fallback provisions that would cause the benchmark rate to fall back to a rate that would continue to be based on USD LIBOR, then the fallback rate would be SOFR plus any applicable spread adjustment and any conforming changes selected or recommended by the Federal Reserve Board, the Federal Reserve Bank of New York or by the ARRC. The New York LIBOR Legislation also establishes a safe harbor from liability for the selection and use of the recommended benchmark interest rate.

These announcements mean that any of our LIBOR-based borrowings that extend beyond June 30, 2023 will need to be converted to a replacement rate. The likely market transition away from LIBOR and towards SOFR is expected to be gradual and complicated. There are significant differences between LIBOR and SOFR, such as LIBOR being an unsecured lending rate while SOFR is a secured lending rate, and SOFR is an overnight rate while LIBOR reflects term rates at different maturities. If our LIBOR-based borrowings are converted to SOFR, the differences between LIBOR and SOFR, plus the recommended spread adjustment, could result in interest costs that are higher than if LIBOR remained available, which could have a material adverse effect on our operating results. Although SOFR is the ARRC's recommended replacement rate, it is also possible that lenders may instead choose alternative replacement rates that may differ from LIBOR in ways similar to SOFR or in other ways that would result in higher interest costs for us. Furthermore, lenders may select alternative rates sooner than June 30, 2023, either in amendments to existing facilities or as we decide to enter into new facilities. It is possible that not all of our assets and liabilities will transition away from LIBOR at the same time, and it is possible that not all of our assets and liabilities will transition to the same alternative reference rate, in each case increasing the difficulty of hedging. We and other market participants have less experience understanding and modeling SOFR-based assets and liabilities than LIBOR-based assets and liabilities, increasing the difficulty of investing, hedging, and risk management. The process of transition involves operational risks. It is not yet possible to predict the magnitude of LIBOR's end on our borrowing costs and other operations given the remaining uncertainty about which rates will replace LIBOR and the related timing.

We are party to various financial instruments which include LIBOR as a reference rate that mature or expire after June 30, 2023. As of June 30, 2022, these financial instruments include interest rate swap agreements and preferred stock and unsecured notes issued by us.

As of June 30, 2022, we had $200 million notional amount of interest rate swaps outstanding that expire after June 30, 2023 in which we make semiannual interest payments based upon a fixed interest rate and receive quarterly interest payments based upon the prevailing three-month LIBOR on the date of reset. The interest rate swap agreements are centrally cleared by the Chicago Mercantile Exchange (“CME”) which acts as the calculation agent with the terms and conditions of each interest rates swap agreement defined in the CME Rulebook and supplemented by the rules published by the International Swaps and Derivative Association, Inc. (“ISDA”). The fallback terms of interest rate swap agreements that have LIBOR as a reference rate were not originally designed to cover a permanent discontinuation of LIBOR. On October 23, 2020, ISDA amended its rules to provide LIBOR fallback protocols and provisions for bilateral interest rate swap agreements, including defining the LIBOR cessation triggering events and robust fallback provisions. Under the fallback provisions, the existing contractual rate based on LIBOR rate would fall back to a rate based on SOFR

38


 

adjusted for the difference in tenor plus a spread adjustment for the historical differences between the two rates. On January 25, 2021, the CME amended its Rulebook to incorporate ISDA’s LIBOR fallback provisions for both new and legacy centrally cleared interest rate swap agreements.

As of June 30, 2022, we had $15.0 million of junior subordinated debt outstanding that require quarterly interest payments at three-month LIBOR plus a spread of 2.25% to 3.00% and matures between 2033 and 2035. Under the terms of the indenture agreement for the notes, if the publication of LIBOR is not available, the current fallback is for the independent calculation agent to obtain quotations for what LIBOR should be from major banks in the interbank market. If the calculation agent is unable to obtain such quotations, then the LIBOR in effect for future interest payments would be LIBOR in effect for the immediately preceding interest payment period. The indenture governing the junior subordinated notes are governed by New York law and would likely be subject to the fallback rate provisions of the New York LIBOR Legislation.

As of June 30, 2022, we had 1,044,671 shares of Series C Preferred Stock outstanding with a liquidation preference of $26.1 million. The Series C Preferred Stock is entitled to receive a cumulative cash dividend (i) from and including the original issue to, but excluding, March 30, 2024 at a fixed rate of 8.250% per annum of the $25.00 per share liquidation preference, and (ii) from and including March 30, 2024, at a floating rate equal to three-month LIBOR plus a spread of 5.664% per annum of the $25.00 liquidation preference. Under the terms of our Articles of Incorporation, if the publication of LIBOR is not available, the current fallback is for us to obtain quotations for what LIBOR should be from major banks in the interbank market. If we are unable to obtain such quotations, we are required to appoint an independent calculation agent, which will determine LIBOR based on sources it deems reasonable in its sole discretion. If the calculation agent is unable or unwilling to determine LIBOR, then the LIBOR in effect for future dividend payments would be LIBOR in effect for the immediately preceding dividend payment period. Notwithstanding the preceding section of this paragraph, if we determine that LIBOR has been discontinued, we will appoint an independent calculation agent to determine whether there is an industry accepted substitute or successor base rate to three-month LIBOR. If the calculation agent determines that there is an industry accepted substitute or successor base rate, the calculation agent shall use such substitute or successor base rate. If the calculation agent determines that there is not an accepted substitute or successor base rate, then the calculation agent will follow the original fallback language.

At this time, it is not possible to predict the effect of any such changes, any establishment of alternative reference rates or any other reforms to LIBOR that may be implemented in the U.K. or elsewhere. While we expect LIBOR to be available in substantially its current form until the end of 2022, and likely based on IBA's announced consultation through June 2023, if sufficient banks decline to make submissions to IBA, it is possible that LIBOR will become unavailable prior to that point. Uncertainty as to the nature of such potential changes, alternative reference rates or other reforms may adversely affect the market for, or value of, any securities, loans, derivatives and other financial obligations on which the interest or dividend is determined by reference to LIBOR, which could negatively impact our overall financial condition or results of operations. More generally, any of the above changes or any other consequential changes to LIBOR or any other “benchmark” as a result of international, national or other proposals for reform or other initiatives or investigations, or any further uncertainty in relation to the timing and manner of implementation of such changes, could have a material adverse effect on the value of and return on any securities based on or linked to a “benchmark.

 

Portfolio Overview

 

The following table summarizes our asset and capital allocation of our investment strategies as of June 30, 2022 (dollars in thousands):

 

 

 

June 30, 2022

 

 

 

Assets

 

 

Invested Capital
Allocation
(1)

 

 

Invested Capital
Allocation (%)

 

 

Leverage (2)

 

MSR financing receivables

 

$

120,260

 

 

$

120,260

 

 

 

41

%

 

 

0.5

 

Single-family residential properties

 

 

182,783

 

 

 

64,605

 

 

 

22

%

 

 

1.9

 

Credit investments (3)

 

 

168,432

 

 

 

63,058

 

 

 

21

%

 

 

1.7

 

Agency MBS (4)

 

 

235,781

 

 

 

48,102

 

 

 

16

%

 

 

4.0

 

Total invested capital

 

$

707,256

 

 

 

296,025

 

 

 

100

%

 

 

 

Cash and other corporate capital

 

 

 

 

 

5,486

 

 

 

 

 

 

 

Total investable capital

 

 

 

 

$

301,511

 

 

 

 

 

1.6

 

 

(1)
Our investable capital is calculated as the sum of our shareholders’ equity capital plus accumulated depreciation of our single-family residential properties and long-term unsecured debt.

39


 

(2)
Our leverage is measured as the ratio of the sum of our repurchase agreement financing, long-term debt secured by single-family properties, net payable or receivable for unsettled securities, net contractual forward purchase or sale price of our TBA commitments and leverage within our MSR financing receivables less our cash and cash equivalents compared to our investable capital.
(3)
Includes our net investment of $25,529 in VIEs with gross assets and liabilities of $231,301 and $205,772, respectively, that is consolidated for GAAP financial reporting purposes.
(4)
Agency MBS assets include the fair value of the agency MBS which underlie the Company's TBA forward purchase and sale commitments. In accordance with GAAP, the Company's TBA forward commitments are reflected on the consolidated balance sheets as derivative assets and liabilities at fair value in the financial statement line items "other assets" and "other liabilities". As of June 30, 2022, the fair value of the underlying agency MBS that underlie the Company's net short position in TBA commitments had a fair value of $(146,576) with a net carrying value of $337.

MSR Financing Receivables

As of June 30, 2022, we had $120.3 million of MSR financing receivable investments at fair value. We are party to agreements with a licensed, GSE approved residential mortgage loan servicer that enable us to garner the economic return of an investment in an MSR purchased by the mortgage servicing counterparty. The arrangement allows us to participate in the economic benefits of investing in an MSR without holding the requisite licenses to purchase or hold MSRs directly. The transactions are accounted for as a financing receivable in our consolidated financial statements. The following tables present further information about our MSR financing receivable investments as of June 30, 2022 (dollars in thousands):

 

 

Amortized Cost Basis (1)

 

 

Unrealized Gain

 

 

Fair Value

 

$

74,866

 

 

$

45,394

 

 

$

120,260

 

 

(1)
Represents capital investments plus accretion of interest income net of cash distributions.

 

 

MSR Financing Receivable Underlying Reference Amounts:

 

 

 

 

 

 

 

MSRs

 

 

Financing

 

 

Advances
Receivable

 

 

Cash and Other Net Receivables

 

 

Counterparty Incentive Fee Accrual

 

 

MSR Financing Receivables

 

 

Implicit
Leverage

 

$

176,408

 

 

$

(60,868

)

 

$

2,348

 

 

$

13,883

 

 

$

(11,511

)

 

$

120,260

 

 

 

0.51

 

 

Underlying Reference MSRs:

 

Holder of Loans

 

Unpaid Principal Balance

 

 

Weighted-Average Note Rate

 

 

Weighted-Average Servicing Fee

 

 

Weighted-Average Loan Age

 

Price

 

 

Multiple (1)

 

 

Fair Value

 

Fannie Mae

 

$

12,057,248

 

 

 

3.04

%

 

 

0.25

%

 

18 months

 

 

1.35

%

 

 

5.38

 

 

$

162,449

 

Freddie Mac

 

 

1,015,899

 

 

 

3.66

%

 

 

0.25

%

 

17 months

 

 

1.37

%

 

 

5.50

 

 

 

13,959

 

Total/weighted-average

 

$

13,073,147

 

 

 

3.09

%

 

 

0.25

%

 

18 months

 

 

1.35

%

 

 

5.39

 

 

$

176,408

 

 

(1)
Calculated as the underlying MSR price divided by the weighted-average servicing fee.

Credit Investment Portfolio

As of June 30, 2022, our credit investment portfolio was primarily comprised of a $29.5 million commercial mortgage loan secured by a first lien position in healthcare facilities and $138.9 million in non-agency MBS or ABS investments collateralized by commercial mortgage loans, pools of business purpose residential mortgage loans, residential mortgage loans and residential solar panel loans, including a $25.5 million net investment in VIEs consolidated for GAAP financial reporting purposes. The following table presents further information about our credit investments as of June 30, 2022 (dollars in thousands):

40


 

 

 

 

Fair Value (1)

 

 

Market Price

 

 

Leverage

 

Commercial MBS

 

$

99,901

 

 

$

99.90

 

 

 

5.6

 

Commercial mortgage loan

 

 

29,484

 

 

 

100.00

 

 

 

2.3

 

Residential MBS - interest-only (2)

 

 

19,255

 

 

 

8.12

 

 

 

 

Residential MBS (2)

 

 

1,082

 

 

 

67.11

 

 

 

 

Business purpose residential MBS (3)

 

 

15,683

 

 

 

93.51

 

 

 

 

Residential solar panel loan ABS

 

 

3,027

 

 

 

59.81

 

 

 

 

Total/weighted-average

 

$

168,432

 

 

 

 

 

 

1.7

 

 

(1)
For credit investments in securities, includes contractual accrued interest receivable.
(2)
Calculated as an annualized internal rate of return based upon our initial investment, cash received from the investment, cash paid for secured financing costs (if any) and assumes liquidation at period-end at an amount equal to estimated fair value plus accrued interest and the payoff of any secured financing and accrued interest thereon (if any).
(3)
Residential MBS – interest-only and residential MBS, in combination, reflect our net investment at fair value of $20,337 in a VIE with gross assets and liabilities of $225,836 and $205,499, respectively, that is consolidated for GAAP financial reporting purposes.
(4)
Includes our net investment of $5,192 in a VIE with gross assets and liabilities of $5,465 and $273, respectively, that is consolidated for GAAP financial reporting purposes.

SFR Rental Properties

The following tables present further information about our SFR rental properties as of June 30, 2022 (dollars in thousands):

 

Market

 

Number of
Properties

 

 

Gross Book
Value

 

 

Average Gross
Book Value

 

 

Average
Square Feet

 

 

Average
Year Built

 

Atlanta, GA

 

 

102

 

 

$

34,458

 

 

$

338

 

 

 

2,209

 

 

 

2008

 

Dallas, TX

 

 

88

 

 

 

30,920

 

 

 

351

 

 

 

1,915

 

 

 

2014

 

Huntsville, AL

 

 

86

 

 

 

28,510

 

 

 

332

 

 

 

2,306

 

 

 

2015

 

Tulsa, OK

 

 

103

 

 

 

27,130

 

 

 

263

 

 

 

1,762

 

 

 

2016

 

Birmingham, AL

 

 

69

 

 

 

18,606

 

 

 

270

 

 

 

1,690

 

 

 

2017

 

Kansas City, MO

 

 

52

 

 

 

15,510

 

 

 

298

 

 

 

1,944

 

 

 

2008

 

Memphis, TN

 

 

49

 

 

 

14,421

 

 

 

294

 

 

 

1,890

 

 

 

2006

 

Charlotte, NC

 

 

37

 

 

 

13,228

 

 

 

358

 

 

 

1,920

 

 

 

2010

 

Total/weighted average

 

 

586

 

 

$

182,783

 

 

$

312

 

 

 

1,971

 

 

 

2012

 

 

 

Status of Property

 

Number of
Properties

 

 

Gross Book
Value

 

In rehabilitation

 

 

38

 

 

$

12,693

 

In marketing

 

 

97

 

 

 

31,455

 

Leased not yet occupied

 

 

1

 

 

 

247

 

Leased and occupied

 

 

450

 

 

 

138,388

 

Total

 

 

586

 

 

$

182,783

 

 

 

As of June 30, 2022, we also had commitments to acquire 25 properties for an aggregate purchase price of $9.0 million.

As of June 30, 2022, we had a commitment pursuant to a purchase and sale agreement to sell 376 of our properties for $131.9 million with an expected closing date of August 19, 2022. As of June 30, 2022, the 376 properties have an investment cost basis of $113.0 million, net of accumulated depreciation of $1.3 million.

41


 

Agency MBS Investment Portfolio

Our agency MBS consisted of the following as of June 30, 2022 (dollars in thousands):

 

 

 

Unpaid Principal Balance

 

 

Net Unamortized Purchase Premiums (Discounts)

 

 

Amortized Cost Basis

 

 

Net Unrealized Gain (Loss)

 

 

Fair Value

 

 

Market Price

 

 

Coupon

 

 

Weighted
Average
Expected
Remaining
Life

 

30-year fixed rate:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

3.5%

 

$

68,634

 

 

$

(844

)

 

$

67,790

 

 

$

(1,440

)

 

$

66,350

 

 

$

96.67

 

 

 

3.50

%

 

 

9.2

 

4.0%

 

 

202,817

 

 

 

1,253

 

 

 

204,070

 

 

 

(3,191

)

 

 

200,879

 

 

 

99.04

 

 

 

4.00

%

 

 

9.0

 

4.5%

 

 

114,419

 

 

 

(9

)

 

 

114,410

 

 

 

710

 

 

 

115,120

 

 

 

100.61

 

 

 

4.50

%

 

 

8.1

 

5.5%

 

 

8

 

 

 

 

 

 

8

 

 

 

 

 

 

8

 

 

 

107.89

 

 

 

5.50

%

 

 

5.7

 

Total/weighted-average

 

$

385,878

 

 

$

400

 

 

$

386,278

 

 

$

(3,921

)

 

$

382,357

 

 

$

99.09

 

 

 

4.06

%

 

 

8.8

 

 

 

 

Unpaid Principal Balance

 

 

Net Unamortized Purchase Premiums (Discounts)

 

 

Amortized Cost Basis

 

 

Net Unrealized Gain (Loss)

 

 

Fair Value

 

 

Market
Price

 

 

Coupon

 

 

Weighted
Average
Expected
Remaining
Life

 

Fannie Mae

 

$

136,673

 

 

$

1,178

 

 

$

137,851

 

 

$

(2,391

)

 

$

135,460

 

 

$

99.11

 

 

 

4.00

%

 

 

8.8

 

Freddie Mac

 

 

249,205

 

 

 

(778

)

 

 

248,427

 

 

 

(1,530

)

 

 

246,897

 

 

 

99.07

 

 

 

4.09

%

 

 

8.8

 

Total/weighted-average

 

$

385,878

 

 

$

400

 

 

$

386,278

 

 

$

(3,921

)

 

$

382,357

 

 

$

99.09

 

 

 

4.06

%

 

 

8.8

 

 

The annualized prepayment rate for our agency MBS was 8.40% for the three months ended June 30, 2022. As of June 30, 2022, our agency MBS was comprised of securities specifically selected for their relatively lower propensity for prepayment, which includes approximately 37% and 29% in specified pools of high loan-to-value and low balance loans, respectively, while the remainder includes specified pools of loans originated in certain geographical areas. Weighted average pay-up premiums on our agency MBS portfolio, which represent the estimated price premium of agency MBS backed by specified pools over a TBA agency MBS, were approximately 0.34 of a percentage point as of June 30, 2022.

 

Our agency MBS investment portfolio may also include net long TBA positions, which are primarily the result of executing sequential series of “dollar roll” transactions that are settled on a net basis. In addition to transacting in net long positions in TBA securities for investment purposes, we may also, from time to time, transact in net sale (or “net short”) positions in TBA securities for the purpose of economically hedging a portion of the sensitivity of the fair value of our investments in agency MBS to changes in interest rates. In accordance with GAAP, we account for our net long and net short TBA positions as derivative instruments. Information about our net long and net short TBA positions as of as of June 30, 2022 is as follows (dollars in thousands):

 

 

 

Notional Amount:

 

 

 

 

 

 

 

 

 

 

 

 

Net Long (Short)

 

 

Implied

 

 

Implied

 

 

Net Carrying

 

 

 

Position (1)

 

 

Cost Basis (2)

 

 

Fair Value (3)

 

 

Amount (4)

 

2.5% 30-year MBS sale commitments

 

$

(25,000

)

 

$

(22,649

)

 

$

(22,472

)

 

$

177

 

3.0% 30-year MBS sale commitments

 

 

(30,000

)

 

 

(27,970

)

 

 

(27,932

)

 

 

38

 

3.5% 30-year MBS sale commitments

 

 

(100,000

)

 

 

(95,486

)

 

 

(96,172

)

 

 

(686

)

4.5% 30-year MBS purchase commitments

 

 

50,000

 

 

 

50,121

 

 

 

50,195

 

 

 

74

 

4.5% 30-year MBS sale commitments

 

 

(50,000

)

 

 

(50,929

)

 

 

(50,195

)

 

 

734

 

Total net long (short) agency TBA positions

 

$

(155,000

)

 

$

(146,913

)

 

$

(146,576

)

 

$

337

 

 

(1)
Notional amount represents the unpaid principal balance of the underlying agency MBS.
(2)
Implied cost basis represents the contractual forward price for the underlying agency MBS.
(3)
Implied fair value represents the current fair value of the underlying agency MBS.
(4)
Net carrying amount represents the difference between the implied cost basis and the implied fair value of the underlying agency MBS. This amount is reflected on the Company's consolidated balance sheets as a component of "other assets" and "other liabilities".

 

Economic Hedging Instruments

 

We attempt to hedge a portion of our exposure to interest rate fluctuations associated with our agency MBS primarily through the use of interest rate hedging instruments. Specifically, these interest rate hedging instruments are intended to economically hedge changes, attributable to changes in benchmark interest rates, in agency MBS fair values and future interest cash flows on our

42


 

short-term financing arrangements. As of June 30, 2022, the interest rate hedging instruments that we primarily used were interest rate swap agreements.

Our LIBOR-based interest rate swap agreements represent agreements to make semiannual interest payments based upon a fixed interest rate and receive quarterly variable interest payments based upon the prevailing three-month LIBOR as of the preceding reset date. Our SOFR-based interest rate swap agreements represent agreements to make annual interest payments based upon a fixed interest rate and receive annual variable interest payments based upon the daily SOFR over the preceding annual period. Information about our outstanding interest rate swap agreements in effect as of June 30, 2022 is as follows (dollars in thousands):

 

 

 

 

 

 

Weighted-average:

 

 

 

Notional Amount

 

 

Fixed Pay Rate

 

 

Variable Receive Rate

 

 

Net Receive (Pay) Rate

 

 

Remaining Life (Years)

 

Years to maturity:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Less than 3 years

 

$

130,000

 

 

 

1.32

%

 

 

1.22

%

 

 

(0.10

)%

 

 

1.5

 

3 to less than 10 years

 

 

100,000

 

 

 

1.68

%

 

 

1.30

%

 

 

(0.38

)%

 

 

5.4

 

Total / weighted-average

 

$

230,000

 

 

 

1.48

%

 

 

1.25

%

 

 

(0.23

)%

 

 

3.2

 

 

In addition to interest rate swap agreements, we may also use exchange-traded U.S. Treasury note futures that mature on a quarterly basis. Upon the maturity date of these futures contracts, we have the option to either net settle each contract in cash in an amount equal to the difference between the current fair value of the underlying U.S. Treasury note and the contractual sale price inherent to the futures contract, or to physically settle the contract by delivering the underlying U.S. Treasury note. As of June 30, 2022, we had no outstanding U.S. Treasury note futures.

 

Results of Operations

Net Operating Income

Net operating income primarily represents the interest and other income recognized from our investments in financial assets and rent revenues recognized from SFR properties net of the interest expense incurred from repurchase agreement financing arrangements or other short and long-term borrowing transactions and SFR property operating expenses.

Net operating income does not include TBA agency MBS dollar roll income, which we believe represents the economic equivalent of net interest income generated from our investments in non-specified fixed-rate agency MBS, nor does it include the net interest income or expense of our interest rate swap agreements, which are not designated as hedging instruments for financial reporting purposes. In our consolidated statements of comprehensive income, TBA agency MBS dollar roll income and the net interest income or expense from our interest rate swap agreements are reported as a component of the overall periodic change in the fair value of derivative instruments within the line item “investment and derivative gain (loss), net.”

Investment and Derivative Gain (Loss), Net

“Investment and derivative gain (loss), net” primarily consists of periodic changes in the fair value (whether realized or unrealized) of our investments in financial assets and periodic changes in the fair value (whether realized or unrealized) of derivative instruments.

General and Administrative Expenses

“Compensation and benefits expense” includes base salaries, annual cash incentive compensation, and non-cash stock-based compensation. Annual cash incentive compensation is based on meeting estimated annual performance measures and discretionary components. Non-cash stock-based compensation includes expenses associated with stock-based awards granted to employees, including our performance share units to named executive officers that are earned only upon the attainment of Company performance measures over the relevant measurement period.

“Other general and administrative expenses” primarily consists of the following:

professional services expenses, including accounting, legal, and consulting fees;
insurance expenses, including liability and property insurance;
occupancy and equipment expense, including rental costs for our facilities, and depreciation and amortization of equipment and software;

43


 

fees and commissions related to transactions in interest rate derivative instruments;
Board of Director fees; and
other operating expenses, including information technology expenses, business development costs, public company reporting expenses, proxy solicitation expenses, corporate registration fees, local license taxes, office supplies and other miscellaneous expenses.

Three and six months ended June 30, 2022 compared to the three and six months ended June 30, 2021

The following table presents the summary financial information for the three and six months ended June 30, 2022 and 2021, respectively (dollars in thousands, except per share amounts):

 

 

 

Three Months Ended June 30,

 

 

Six Months Ended June 30,

 

 

 

2022

 

 

2021

 

 

2022

 

 

2021

 

Interest and other income

 

$

8,763

 

 

$

7,045

 

 

$

16,169

 

 

$

13,304

 

Rent revenues from single-family residential properties

 

 

2,137

 

 

 

 

 

 

3,201

 

 

 

 

Interest expense

 

 

(4,459

)

 

 

(1,958

)

 

 

(7,701

)

 

 

(4,459

)

Single-family residential property operating expenses

 

 

(1,915

)

 

 

 

 

 

(3,446

)

 

 

 

Net operating income

 

 

4,526

 

 

 

5,087

 

 

 

8,223

 

 

 

8,845

 

Investment and derivative gain (loss), net

 

 

370

 

 

 

(9,032

)

 

 

(457

)

 

 

(15,795

)

General and administrative expenses

 

 

(3,787

)

 

 

(3,190

)

 

 

(7,071

)

 

 

(5,827

)

Income (loss) before income taxes

 

 

1,109

 

 

 

(7,135

)

 

 

695

 

 

 

(12,777

)

Income tax provision (benefit)

 

 

802

 

 

 

(76

)

 

 

3,089

 

 

 

322

 

Net income (loss)

 

 

307

 

 

 

(7,059

)

 

 

(2,394

)

 

 

(13,099

)

Dividend on preferred stock

 

 

(707

)

 

 

(723

)

 

 

(1,449

)

 

 

(1,446

)

Net loss attributable to common stock

 

$

(400

)

 

$

(7,782

)

 

$

(3,843

)

 

$

(14,545

)

Diluted loss per common share

 

$

(0.01

)

 

$

(0.24

)

 

$

(0.13

)

 

$

(0.44

)

Weighted-average diluted common shares
  outstanding

 

 

28,766

 

 

 

33,066

 

 

 

29,296

 

 

 

33,123

 

 

The following tables present our net operating income for the periods indicated, disaggregated by our investments in financial assets, investments in SFR properties and corporate and other (dollars in thousands):

 

 

 

Three Months Ended June 30, 2022

 

 

 

Investments in Financial Assets

 

 

Investments in SFR Properties

 

 

Corporate and Other

 

 

Total

 

Interest and other income

 

$

8,763

 

 

$

 

 

$

 

 

$

8,763

 

Rent revenues from single-family properties

 

 

 

 

 

2,137

 

 

 

 

 

 

2,137

 

Interest expense

 

 

(2,341

)

 

 

(718

)

 

 

(1,400

)

 

 

(4,459

)

Single-family property operating expenses

 

 

 

 

 

(1,915

)

 

 

 

 

 

(1,915

)

Net operating income (loss)

 

$

6,422

 

 

$

(496

)

 

$

(1,400

)

 

$

4,526

 

 

 

 

 

Three Months Ended June 30, 2021

 

 

 

Investments in Financial Assets

 

 

Investments in SFR Properties

 

 

Corporate and Other

 

 

Total

 

Interest and other income

 

$

7,045

 

 

$

 

 

$

 

 

$

7,045

 

Rent revenues from single-family properties

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

 

(808

)

 

 

 

 

 

(1,150

)

 

 

(1,958

)

Single-family property operating expenses

 

 

 

 

 

 

 

 

 

 

 

 

Net operating income (loss)

 

$

6,237

 

 

$

 

 

$

(1,150

)

 

$

5,087

 

 

44


 

 

 

 

 

Six Months Ended June 30, 2022

 

 

 

Investments in Financial Assets

 

 

Investments in SFR Properties

 

 

Corporate and Other

 

 

Total

 

Interest and other income

 

$

16,169

 

 

$

 

 

$

 

 

$

16,169

 

Rent revenues from single-family properties

 

 

 

 

 

3,201

 

 

 

 

 

 

3,201

 

Interest expense

 

 

(3,805

)

 

 

(1,126

)

 

 

(2,770

)

 

 

(7,701

)

Single-family property operating expenses

 

 

 

 

 

(3,446

)

 

 

 

 

 

(3,446

)

Net operating income (loss)

 

$

12,364

 

 

$

(1,371

)

 

$

(2,770

)

 

$

8,223

 

 

 

 

 

Six Months Ended June 30, 2021

 

 

 

Investments in Financial Assets

 

 

Investments in SFR Properties

 

 

Corporate and Other

 

 

Total

 

Interest and other income

 

$

13,304

 

 

$

 

 

$

 

 

$

13,304

 

Rent revenues from single-family properties

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

 

(2,158

)

 

 

 

 

 

(2,301

)

 

 

(4,459

)

Single-family property operating expenses

 

 

 

 

 

 

 

 

 

 

 

 

Net operating income (loss)

 

$

11,146

 

 

$

 

 

$

(2,301

)

 

$

8,845

 

 

Net Operating Income from Investments in Financial Assets

Net operating income from our investments in financial assets increased $0.2 million, or 3.2%, from $6.2 million for the three months ended June 30, 2021 to $6.4 million for the three months ended June 30, 2022. Net operating income from our investments in financial assets increased $1.3 million, or 11.7%, from $11.1 million for the six months ended June 30, 2021 to $12.4 million for the six months ended June 30, 2022. The increase from the comparative periods is primarily the result of a higher average investment balance in higher yielding MSR financing receivables.

The components of net operating income from our investments in financial assets are summarized in the following tables for the periods indicated (dollars in thousands):

 

 

 

Three Months Ended June 30,

 

 

 

2022

 

 

2021

 

 

 

Average

 

 

Income

 

 

Yield

 

 

Average

 

 

Income

 

 

Yield

 

 

 

Balance

 

 

(Expense)

 

 

(Cost)

 

 

Balance

 

 

(Expense)

 

 

(Cost)

 

Agency MBS

 

$

280,167

 

 

$

2,065

 

 

 

2.95

%

 

$

735,641

 

 

$

2,984

 

 

 

1.62

%

Credit investments

 

 

62,869

 

 

 

991

 

 

 

6.31

%

 

 

91,858

 

 

 

1,770

 

 

 

7.71

%

Mortgage loans of consolidated VIEs

 

 

262,098

 

 

 

1,611

 

 

 

2.46

%

 

 

53,534

 

 

 

776

 

 

 

5.80

%

MSR financing receivables

 

 

104,244

 

 

 

3,983

 

 

 

15.28

%

 

 

52,075

 

 

 

1,390

 

 

 

10.68

%

Other

 

 

2,297

 

 

 

113

 

 

 

 

 

 

4,394

 

 

 

125

 

 

 

 

 

 

$

711,675

 

 

 

8,763

 

 

 

4.93

%

 

$

937,502

 

 

 

7,045

 

 

 

3.01

%

Repurchase agreements

 

$

282,725

 

 

 

(763

)

 

 

(1.07

)%

 

$

652,624

 

 

 

(403

)

 

 

(0.24

)%

Secured debt of consolidated VIEs

 

 

246,642

 

 

 

(1,578

)

 

 

(2.56

)%

 

 

38,152

 

 

 

(405

)

 

 

(4.25

)%

 

 

$

529,367

 

 

 

(2,341

)

 

 

(1.76

)%

 

$

690,776

 

 

 

(808

)

 

 

(0.46

)%

Net interest income/spread

 

 

 

 

$

6,422

 

 

 

3.17

%

 

 

 

 

$

6,237

 

 

 

2.55

%

Levered net interest return (1)

 

 

 

 

 

 

 

 

14.09

%

 

 

 

 

 

 

 

 

10.11

%

 

 

45


 

 

 

Six Months Ended June 30,

 

 

 

2022

 

 

2021

 

 

 

Average

 

 

Income

 

 

Yield

 

 

Average

 

 

Income

 

 

Yield

 

 

 

Balance

 

 

(Expense)

 

 

(Cost)

 

 

Balance

 

 

(Expense)

 

 

(Cost)

 

Agency MBS

 

$

336,192

 

 

$

3,557

 

 

 

2.12

%

 

$

726,365

 

 

$

5,768

 

 

 

1.59

%

Credit investments

 

 

59,533

 

 

 

1,844

 

 

 

6.19

%

 

 

78,199

 

 

 

3,039

 

 

 

7.77

%

Mortgage loans of consolidated VIEs

 

 

226,120

 

 

 

2,965

 

 

 

2.62

%

 

 

68,398

 

 

 

2,463

 

 

 

7.20

%

MSR financing receivables

 

 

106,260

 

 

 

7,365

 

 

 

13.86

%

 

 

33,754

 

 

 

1,748

 

 

 

10.36

%

Other

 

 

3,545

 

 

 

438

 

 

 

 

 

 

5,318

 

 

 

286

 

 

 

 

 

 

$

731,650

 

 

 

16,169

 

 

 

4.42

%

 

$

912,034

 

 

 

13,304

 

 

 

2.92

%

Repurchase agreements

 

$

312,544

 

 

 

(1,039

)

 

 

(0.66

)%

 

$

603,233

 

 

 

(891

)

 

 

(0.29

)%

Secured debt of consolidated VIEs

 

 

210,703

 

 

 

(2,766

)

 

 

(2.63

)%

 

 

53,939

 

 

 

(1,267

)

 

 

(4.70

)%

 

 

$

523,247

 

 

 

(3,805

)

 

 

(1.45

)%

 

$

657,172

 

 

 

(2,158

)

 

 

(0.65

)%

Net interest income/spread

 

 

 

 

$

12,364

 

 

 

2.97

%

 

 

 

 

$

11,146

 

 

 

2.27

%

Levered net interest return (1)

 

 

 

 

 

 

 

 

11.87

%

 

 

 

 

 

 

 

 

8.75

%

 

(1)
Calculated as net interest income divided by the weighted average asset balance net of the weighted average secured financing balance.

The effects of changes in the composition of our investments in financial assets on net operating income are summarized below (dollars in thousands):

 

 

 

Three Months Ended June 30, 2022

 

 

Six Months Ended June 30, 2022

 

 

 

vs.

 

 

vs.

 

 

 

Three Months Ended June 30, 2021

 

 

Six Months Ended June 30, 2021

 

 

 

Rate

 

 

Volume

 

 

Total Change

 

 

Rate

 

 

Volume

 

 

Total Change

 

Agency MBS

 

$

927

 

 

$

(1,846

)

 

$

(919

)

 

$

888

 

 

$

(3,099

)

 

$

(2,211

)

Credit investments

 

 

(700

)

 

 

(79

)

 

 

(779

)

 

 

(1,034

)

 

 

(161

)

 

 

(1,195

)

Mortgage loans of consolidated VIEs

 

 

(2,187

)

 

 

3,022

 

 

 

835

 

 

 

(5,199

)

 

 

5,701

 

 

 

502

 

MSR financing receivables

 

 

1,200

 

 

 

1,393

 

 

 

2,593

 

 

 

1,862

 

 

 

3,755

 

 

 

5,617

 

Other

 

 

48

 

 

 

(60

)

 

 

(12

)

 

 

179

 

 

 

(27

)

 

 

152

 

Repurchase agreements

 

 

(585

)

 

 

225

 

 

 

(360

)

 

 

(329

)

 

 

181

 

 

 

(148

)

Secured debt of consolidated VIEs

 

 

1,043

 

 

 

(2,216

)

 

 

(1,173

)

 

 

814

 

 

 

(2,313

)

 

 

(1,499

)

 

 

$

(254

)

 

$

439

 

 

$

185

 

 

$

(2,819

)

 

$

4,037

 

 

$

1,218

 

Net Operating Loss from SFR Properties

We began to acquire SFR properties pursuant to our SFR property rental investment strategy in September 2021. The homes we acquire may require minor refurbishment prior to a tenant occupying the property. In addition, there is typically a lease marketing period prior to a new tenant occupying the home. We expect the time period between the date of settlement of the home purchase and the date the house is occupied by a tenant to average between 30 to 60 days. The timing of the earnings benefit to us will be dictated by the pace of home purchases, the level of any property level refurbishments and the length of the lease marketing period. During the period prior to a lease commencement date, we incur property costs such as real estate taxes, insurance, homeowner association fees and depreciation. For the three months ended June 30, 2022, we had rental income of $2.1 million, interest expense from long-term debt secured by the properties of $0.7 million and property operating expenses of $1.9 million, including $0.6 million of depreciation expense, for a net operating loss of $0.5 million. For the six months ended June 30, 2022, we had rental income of $3.2 million, interest expense from long-term debt secured by the properties of $1.1 million and property operating expenses of $3.5 million, including $1.3 million of depreciation expense, for a net operating loss of $1.4 million. The net operating loss for the periods are attributable to property costs incurred prior to the commencement of the leases for the newly acquired homes.

46


 

Investment and Derivative Gain (Loss), Net

As prevailing longer-term interest rates increase (decrease), the fair value of our investments in fixed-rate agency MBS and TBA commitments generally decreases (increases). Conversely, the fair value of our interest rate derivative hedging instruments and MSR financing receivables generally increase (decrease) in response to increases (decreases) in prevailing interest rates. While our interest rate derivative hedging instruments are designed to mitigate the sensitivity of the fair value of our agency MBS portfolio to fluctuations in interest rates, they are not generally designed to mitigate the sensitivity of our net book value to spread risk, which is the risk of an increase of the market spread between the yield on our agency MBS and the benchmark yield on U.S. Treasury securities or interest rate swaps. Accordingly, irrespective of fluctuations in interest rates, an increase (decrease) in agency MBS spreads will generally result in the underperformance (outperformance) of the values of agency MBS relative to interest rate hedging instruments.

The following table presents information about the gains and losses recognized due to the changes in the fair value of our investments and interest rate hedging instruments for the periods indicated (dollars in thousands):

 

 

 

Three Months Ended June 30,

 

 

Six Months Ended June 30,

 

 

 

2022

 

 

2021

 

 

2022

 

 

2021

 

(Loss) gain on agency MBS investments, net

 

$

(10,591

)

 

$

7,130

 

 

$

(36,548

)

 

$

(22,085

)

(Loss) gain on credit investments, net

 

 

(682

)

 

 

225

 

 

 

607

 

 

 

1,818

 

Gain (loss) on MSR financing receivables

 

 

8,452

 

 

 

(2,021

)

 

 

31,210

 

 

 

3,936

 

TBA commitments, net:

 

 

 

 

 

 

 

 

 

 

 

 

TBA dollar roll income

 

 

280

 

 

 

1,778

 

 

 

1,103

 

 

 

2,614

 

Other loss from TBA commitments, net

 

 

(263

)

 

 

(890

)

 

 

(4,969

)

 

 

(10,122

)

Total gain (loss) on TBA commitments, net

 

 

17

 

 

 

888

 

 

 

(3,866

)

 

 

(7,508

)

Interest rate derivatives:

 

 

 

 

 

 

 

 

 

 

 

 

Net interest expense on interest rate swaps

 

 

(282

)

 

 

(1,187

)

 

 

(573

)

 

 

(1,897

)

Other gain (loss) from interest rate derivative
  instruments, net

 

 

3,519

 

 

 

(14,684

)

 

 

9,360

 

 

 

8,967

 

Total gain (loss) on interest rate derivatives, net

 

 

3,237

 

 

 

(15,871

)

 

 

8,787

 

 

 

7,070

 

Other investments, net

 

 

(63

)

 

 

617

 

 

 

(647

)

 

 

974

 

Investment and derivative gain (loss), net

 

$

370

 

 

$

(9,032

)

 

$

(457

)

 

$

(15,795

)

General and Administrative Expenses

General and administrative expenses increased by $0.6 million from $3.2 million for the three months ended June 30, 2021 to $3.8 million for the three months ended June 30, 2022. The increase in general and administrative expenses for the three months ended June 30, 2022 is primarily due to an increase in compensation and benefits expense primarily as a result of an increase in performance based management incentive compensation. General and administrative expenses increased by $1.3 million from $5.8 million for the six months ended June 30, 2021 to $7.1 million for the six months ended June 30, 2022.

Income Tax Provision

Our TRSs are subject to U.S. federal and state corporate income taxes. As a result, for the three months ended June 30, 2022 and 2021, we recognized a provision (benefit) for income taxes of $0.8 million and $(0.1) million, respectively, on the pre-tax net income of our TRSs. For the six months ended June 30, 2022 and 2021, we recognized a provision for income taxes of $3.1 million and $0.3 million, respectively, on the pre-tax net income of our TRSs. As noted in “Non-GAAP Earnings Available for Distribution” below, our computation of non-GAAP earnings available for distribution includes a provision for income taxes on the earnings available for distribution of our TRSs. TRS earnings available for distribution is comprised of net interest income generated by TRSs net of the TRSs’ general and administrative expenses. In our consolidated financial consolidated statements of comprehensive income prepared in accordance with GAAP, the “income tax provision (benefit)” includes (i) the income tax provision for TRS earnings available for distribution and (ii) an income tax provision for (or benefit from) periodic increases (or decreases) in the fair value of the investments of our TRSs, which are recognized in net income as a component of “investment and derivative gain (loss) net.” Below is a reconciliation of the income tax provision for TRS earnings available for distribution, a non-GAAP financial measure, to the income tax provision determined in accordance with GAAP for the periods indicated (dollars in thousands):

 

47


 

 

 

Three Months Ended June 30,

 

 

Six Months Ended June 30,

 

 

 

2022

 

 

2021

 

 

2022

 

 

2021

 

Income tax provision for TRS earnings available for distribution

 

$

306

 

 

$

61

 

 

$

535

 

 

$

72

 

Income tax provision (benefit) for TRS investment gains
  (losses), net

 

 

496

 

 

 

(137

)

 

 

2,554

 

 

 

250

 

GAAP income tax provision (benefit)

 

$

802

 

 

$

(76

)

 

$

3,089

 

 

$

322

 

 

Non-GAAP Earnings Available for Distribution

In addition to the results of operations determined in accordance with GAAP, we also report a non-GAAP financial measure "earnings available for distribution" (formerly core operating income). We define earnings available for distribution as net income available to common stock determined in accordance with GAAP adjusted for the following items:

Plus (less) realized and unrealized losses (gains) on investments and derivatives;
Plus (less) income tax provision (benefit) for TRS realized and unrealized gains and losses on investments and derivatives
Plus TBA dollar roll income
Plus (less) interest rate swap net interest income (expense)
Plus depreciation of single-family residential properties
Plus stock-based compensation

Realized and unrealized gains and losses recognized with respect to our mortgage related investments and economic hedging instruments, which are reported in line item “investment and derivative gain (loss), net” of our consolidated statements of comprehensive income, other than TBA dollar roll income and interest rate swap net interest income or expense, are excluded from the computation of earnings available for distribution as such gains on losses are not reflective of the economic interest income earned or interest expense incurred from our interest-bearing financial assets and liabilities during the indicated reporting period. Because our long-term-focused investment strategy for our mortgage related investment portfolio is to generate a net spread on the leveraged assets while prudently hedging periodic changes in the fair value of those assets attributable to changes in benchmark interest rates, we generally expect the fluctuations in the fair value of our mortgage related investments and economic hedging instruments to largely offset one another over time. In addition, certain of our investments are held by our TRS which is subject to U.S. federal and state corporate income taxes. In calculating earnings available for distribution, any income tax provision or benefit associated with gains or losses on our mortgage related investments and economic hedging instruments are also excluded from earnings available for distribution.

TBA dollar roll income represents the economic equivalent of net interest income (implied interest income net of financing costs) generated from our investments in non-specified fixed-rate agency MBS, executed through sequential series of forward-settling purchase and sale transactions that are settled on a net basis (known as “dollar roll” transactions). Dollar roll income is generated as a result of delaying, or “rolling,” the settlement of a forward-settling purchase of a TBA agency MBS by entering into an offsetting “spot” sale with the same counterparty prior to the settlement date, net settling the “paired-off” positions in cash, and contemporaneously entering another forward-settling purchase with the same counterparty of a TBA agency MBS of the same essential characteristics for a later settlement date at a price discount relative to the spot sale. The price discount of the forward-settling purchase relative to the contemporaneously executed spot sale reflects compensation for the interest income (inclusive of expected prepayments) that, at the time of sale, is expected to be foregone as a result of relinquishing beneficial ownership of the MBS from the settlement date of the spot sale until the settlement date of the forward purchase, net of implied repurchase financing costs. We calculate dollar roll income as the excess of the spot sale price over the forward-settling purchase price and recognize this amount ratably over the period beginning on the settlement date of the sale and ending on the settlement date of the forward purchase. In our consolidated statements of comprehensive income prepared in accordance with GAAP, TBA agency MBS dollar roll income is reported as a component of the overall periodic change in the fair value of TBA forward commitments within the line item “investment and derivative gain (loss), net.”

We utilize interest rate swap agreements to economically hedge a portion of our exposure to variability in future interest cash flows, attributable to changes in benchmark interest rates, associated with future roll-overs of our short-term repurchase agreement financing arrangements. Accordingly, the net interest income earned or expense incurred (commonly referred to as “net interest carry”) from our interest rate swap agreements in combination with repurchase agreement interest expense recognized in accordance with GAAP represents our effective “economic interest expense.” In our consolidated statements of comprehensive income prepared in accordance with GAAP, the net interest income earned or expense incurred from interest rate swap agreements is reported as a

48


 

component of the overall periodic change in the fair value of derivative instruments within the line item “investment and derivative gain (loss), net.”

The following table provides a reconciliation of GAAP net income (loss) to non-GAAP earnings available for distribution for the three and six months ended June 30, 2022 and 2021 (amounts in thousands):

 

 

Three Months Ended June 30,

 

 

Six Months Ended June 30,

 

 

2022

 

 

2021

 

 

2022

 

 

2021

 

Net loss attributable to common stock

$

(400

)

 

$

(7,782

)

 

$

(3,843

)

 

$

(14,545

)

Add (less):

 

 

 

 

 

 

 

 

 

 

 

Investment and derivative (gain) loss, net

 

(370

)

 

 

9,032

 

 

 

457

 

 

 

15,795

 

Income tax provision (benefit) for TRS investment
   gain (loss)

 

496

 

 

 

(137

)

 

 

2,554

 

 

 

250

 

Depreciation of single-family residential properties

 

604

 

 

 

 

 

 

1,319

 

 

 

 

Stock-based compensation expense

 

992

 

 

 

537

 

 

 

1,753

 

 

 

1,040

 

Add back:

 

 

 

 

 

 

 

 

 

 

 

TBA dollar roll income

 

280

 

 

 

1,778

 

 

 

1,103

 

 

 

2,614

 

Interest rate swap net interest expense

 

(282

)

 

 

(1,187

)

 

 

(573

)

 

 

(1,897

)

Non-GAAP earnings available for distribution

$

1,320

 

 

$

2,241

 

 

$

2,770

 

 

$

3,257

 

Non-GAAP earnings available for distribution per
  diluted common share

$

0.05

 

 

$

0.07

 

 

$

0.09

 

 

$

0.10

 

Weighted average diluted common shares
  outstanding

 

29,300

 

 

 

33,424

 

 

 

29,804

 

 

 

33,434

 

 

Earnings available for distribution is used by management to evaluate the financial performance of our long-term-focused, net interest spread-based investment strategy and core business activities over periods of time as well as assist with the determination of the appropriate level of periodic dividends to common stockholders. In addition, we believe that earnings available for distribution assists investors in understanding and evaluating the financial performance of our long-term-focused, net interest spread-based investment strategy and core business activities over periods of time as well as its earnings capacity.

A limitation of utilizing this non-GAAP financial measure is that the effect of accounting for all events or transactions in accordance with GAAP does, in fact, reflect the financial results of our business and these effects should not be ignored when evaluating and analyzing our financial results. In addition, our calculation of earnings available for distribution may not be comparable to other similarly titled measures of other companies. Therefore, we believe that earnings available for distribution should be considered as a supplement to, and in conjunction with, net income and comprehensive income determined in accordance with GAAP. Furthermore, there may be differences between earnings available for distribution and taxable income determined in accordance with the Internal Revenue Code. As a REIT, we are required to distribute at least 90% of our REIT taxable income (subject to certain adjustments) to qualify as a REIT and all of our taxable income in order to not be subject to any U.S. federal or state corporate income taxes. Accordingly, earnings available for distribution may not equal our distribution requirements as a REIT.

 

Liquidity and Capital Resources

Liquidity is a measurement of our ability to meet potential cash requirements including ongoing commitments to repay borrowings, fund investments, meet margin calls on our short-term borrowings and hedging instruments, and for other general business purposes. Our primary sources of funds for liquidity consist of existing cash balances, short-term borrowings (for example, repurchase agreements), principal and interest payments from our mortgage investments, net rental payments from our SFR properties and proceeds from sales of mortgage investments. Other sources of liquidity include proceeds from the offering of common stock, preferred stock, debt securities, or other securities registered pursuant to our effective shelf registration statement filed with the Securities and Exchange Commission (“SEC”).

Liquidity, or ready access to funds, is essential to our business. Perceived liquidity issues may affect our counterparties’ willingness to engage in transactions with us. Our liquidity could be impaired due to circumstances that we may be unable to control, such as a general market disruption or an operational problem that affects us or third parties. Further, our ability to sell assets may be impaired if other market participants are seeking to sell similar assets at the same time. If we cannot obtain funding from third parties our results of operations could be negatively impacted.

49


 

As of June 30, 2022, our debt-to-equity leverage ratio was 3.5 to 1 measured as the ratio of the sum of our total debt to our stockholders’ equity as reported on our consolidated balance sheet. In evaluating our liquidity and leverage ratios, we also monitor our “at risk” leverage ratio. Our “at risk” leverage ratio is measured as the ratio of the sum of our repurchase agreement financing, long-term debt secured by single-family properties, net payable or receivable for unsettled securities, net contractual forward price of our TBA purchase and sale commitments, leverage within our MSR financing receivable less our cash and cash equivalents compared to our investable capital. Our investable capital is calculated as the sum of our stockholders’ equity plus our accumulated depreciation of our SFR properties and long-term unsecured debt. As of June 30, 2022, our “at risk” leverage ratio was 1.6 to 1.

As of June 30, 2022, our liquid assets totaled $39.5 million consisting of cash and cash equivalents of $9.6 million and settled unencumbered agency MBS of $29.9 million at fair value.

Sources of Funding

We believe that our existing cash balances, net investments in mortgage investments, cash flows from operations, borrowing capacity, and other sources of liquidity will be sufficient to meet our cash requirements for at least the next twelve months. We may, however, seek debt or equity financings, in public or private transactions, to provide capital for corporate purposes and/or strategic business opportunities, including possible acquisitions, joint ventures, alliances or other business arrangements which could require substantial capital outlays. Our policy is to evaluate strategic business opportunities, including acquisitions and divestitures, as they arise. There can be no assurance that we will be able to generate sufficient funds from future operations, or raise sufficient debt or equity on acceptable terms, to take advantage of investment opportunities that become available. Should our needs ever exceed these sources of liquidity, we believe that most of our investments could be sold, in most circumstances, to provide cash. However, we may be required to sell our assets in such instances at depressed prices.

Cash Flows

As of June 30, 2022, our cash totaled $15.5 million, which included cash and cash equivalents of $9.6 million, restricted cash of $1.3 million, and restricted cash of consolidated VIEs of $4.6 million, representing a net decrease of $6.3 million from $21.8 million as of December 31, 2021. Cash used in operating activities of $2.6 million during the six months ended June 30, 2022 was attributable primarily to net interest income less our general and administrative expenses. Cash provided by investing activities of $70.8 million during the six months ended June 30, 2022 was primarily generated by sales of agency MBS and credit securities, distributions received on our MSR financing receivables, receipt of principal payments from agency MBS and credit securities and principal receipts on loans and mortgage loans of consolidated VIEs, partially offset by purchases of new agency MBS, credit securities, MSR financing receivables and SFR properties. Cash used in financing activities of $74.5 million during the six months ended June 30, 2022 was primarily from repayments of repurchase agreements, net repayments of secured debt of consolidated VIEs, dividend payments to stockholders and from repurchases of our common stock, partially offset by proceeds from long-term debt secured by single-family properties.

Debt Capital

Repurchase Agreements

We have short-term financing facilities that are structured as repurchase agreements with various financial institutions to fund our mortgage investments. We have obtained, and believe we will be able to continue to obtain, short-term financing in amounts and at interest rates consistent with our financing objectives. Funding for mortgage investments through repurchase agreements continues to be available to us at rates we consider to be attractive from multiple counterparties.

Our repurchase agreements to finance our acquisition of MBS include provisions contained in the standard master repurchase agreement as published by the Securities Industry and Financial Markets Association (“SIFMA”) and may be amended and supplemented in accordance with industry standards for repurchase facilities. Certain of our repurchase agreements include financial covenants, with which the failure to comply would constitute an event of default. Similarly, each repurchase agreement includes events of insolvency and events of default on other indebtedness as similar financial covenants. As provided in the standard master repurchase agreement as typically amended, upon the occurrence of an event of default or termination, the applicable counterparty has the option to terminate all repurchase transactions under such counterparty’s repurchase agreement and to demand immediate payment of any amount due from us.

50


 

Our repurchase agreement to finance our acquisition of mortgage loans is subject to a master repurchase agreement between our wholly-owned subsidiary, for which we provide a full guarantee of performance, and a third party lender. The agreement contains financial covenants including our maintenance of a minimum level of net worth, liquidity and profitability, with which the failure to comply would constitute an event of default. Similarly, the agreement includes events of insolvency and events of default on other indebtedness as similar financial covenants. Upon the occurrence of an event of default or termination, the counterparty has the option to terminate all other indebtedness arrangements with us and to demand immediate payment of any amount due from us.

Under our repurchase agreements, we may be required to pledge additional assets to our repurchase agreement counterparties in the event the estimated fair value of the existing pledged collateral under such agreements declines and such lenders demand additional collateral (commonly referred to as a “margin call”), which may take the form of additional securities or cash. Margin calls on repurchase agreements collateralized by our mortgage investments primarily result from events such as declines in the value of the underlying mortgage collateral caused by factors such as rising interest rates, higher prepayments or higher actual or expected credit losses. Our repurchase agreements generally provide that valuations for mortgage investments securing our repurchase agreements are to be obtained from a generally recognized source agreed to by both parties. However, in certain circumstances and under certain of our repurchase agreements, our lenders have the sole discretion to determine the value of the mortgage investments securing our repurchase agreements. In such instances, our lenders are required to act in good faith in making determinations of value. Our repurchase agreements generally provide that in the event of a margin call, we must provide cash or additional securities on the same business day that the margin call is made if the lender provides us notice prior to the margin notice deadline on such day.

To date, we have not had any margin calls on our repurchase agreements that we were not able to satisfy with either cash or additional pledged collateral. However, should we encounter increases in interest rates, prepayments or expected credit losses, margin calls on our repurchase agreements could result in a material adverse change in our liquidity position.

Our repurchase agreement counterparties apply a “haircut” to the value of the pledged collateral, which means the collateral is valued, for the purposes of the repurchase agreement transaction, at less than fair value. Upon the renewal of a repurchase agreement financing at maturity, a lender could increase the “haircut” percentage applied to the value of the pledged collateral, thus reducing our liquidity.

Our repurchase agreements generally mature within 30 to 60 days, but may have maturities as short as one day and as long as one year. In the event that market conditions are such that we are unable to continue to obtain repurchase agreement financing for our mortgage investments in amounts and at interest rates consistent with our financing objectives, we may liquidate such investments and may incur significant losses on any such sales of mortgage investments.

51


 

The following table provides information regarding our outstanding repurchase agreement borrowings as of the date and period indicated (dollars in thousands):

 

 

 

June 30, 2022

 

 Agency MBS repurchase financing:

 

 

 

Repurchase agreements outstanding

 

$

224,566

 

Agency MBS collateral, at fair value

 

 

237,373

 

Net amount (1)

 

 

12,807

 

Weighted-average rate

 

 

1.48

%

Weighted-average term to maturity

 

14.0 days

 

Non-agency MBS repurchase financing:

 

 

 

Repurchase agreements outstanding

 

$

84,788

 

MBS collateral, at fair value

 

 

99,901

 

Net amount (1)

 

 

15,113

 

Weighted-average rate

 

 

2.81

%

Weighted-average term to maturity

 

17.0 days

 

Mortgage loans repurchase financing:

 

 

 

Repurchase agreements outstanding

 

$

20,640

 

Mortgage loans collateral, at fair value

 

 

29,484

 

Net amount (1)

 

 

8,844

 

Weighted-average rate

 

 

3.77

%

Weighted-average term to maturity

 

260.0 days

 

Total mortgage investments repurchase financing:

 

 

 

Repurchase agreements outstanding

 

$

329,994

 

Mortgage investments collateral, at fair value

 

 

366,758

 

Net amount (1)

 

 

36,764

 

Weighted-average rate

 

 

1.96

%

Weighted-average term to maturity

 

30.2 days

 

Maximum amount outstanding at any month-end during the period

 

$

340,286

 

 

(1)
Net amount represents the value of collateral in excess of corresponding repurchase obligation. The amount of collateral at-risk is limited to the outstanding repurchase obligation and not the entire collateral balance.

To limit our exposure to counterparty risk, we diversify our repurchase agreement funding across multiple counterparties. As of June 30, 2022, we had outstanding repurchase agreement balances with seven counterparties and have master repurchase agreements in place with a total of 14 counterparties located throughout North America, Europe and Asia. As of June 30, 2022, no more than 11.2% of our stockholders’ equity was at risk with any one counterparty, with the top five counterparties representing approximately 16.7% of our stockholders’ equity.

52


 

Long-term Debt Secured by SFR Properties

McLean SFR Investment, LLC (“McLean SFR”), a wholly-owned subsidiary of Arlington Asset, is party to a loan agreement with a third-party lender to fund McLean SFR’s purchases of SFR properties. Under the terms of the loan agreement, loan advances may be drawn up to 74% of the fair value of eligible SFR properties up to a maximum loan amount of $150 million. Advances under the loan agreement may be drawn during the advance period, which ends on the earlier of the date the outstanding principal balance equals the maximum loan amount or March 28, 2023. The outstanding principal balance is due on October 9, 2026 and advances under the loan agreement bear interest at a fixed rate of 2.76%. During the advance period, McLean SFR is subject to a commitment fee on the unfunded commitment if the outstanding loan balance is below certain thresholds. As of June 30, 2022, the outstanding principal balance was $123.0 million.

Through September 28, 2024, the outstanding principal balance may be prepaid in an amount equal to the excess of (i) the sum of the present value of all remaining scheduled payments of principal and interest on the principal amount of the loan being prepaid discounted using a U.S. Treasury rate over (ii) the outstanding principal balance of the loan. Subsequent to September 28, 2024, the outstanding principal balance may be prepaid in an amount equal to the outstanding principal balance plus accrued interest. On March 25, 2022, McLean SFR entered into a waiver agreement with the lender that would waive any prepayment fee determined in accordance with the prior sentence on the portion of outstanding loan balance prepaid with the sale proceeds from the potential sale of 376 SFR properties if the sale transaction is consummated by August 22, 2022 in exchange for a one-time waiver fee of 0.80% of the outstanding principal balance prepaid.

The loan is secured by a first priority interest in all the assets of McLean SFR and a first priority pledge of the equity interest of McLean SFR. If the outstanding principal balance of the loan is greater than 74% of the fair value of the eligible collateral, McLean SFR is required to either pledge additional collateral or prepay the loan in an amount so that the outstanding principal balance does not exceed 74% of the fair value of the eligible collateral. Under the terms of the loan agreement, if McLean SFR does not maintain a minimum debt service coverage ratio for a specified time period, then all available cash of McLean SFR will be held as additional collateral for the loan amount until the minimum debt service coverage ratio is met. The obligations under the loan agreement may become recourse to Arlington Asset upon the occurrence of certain enumerated acts committed by McLean SFR or Arlington Asset. The loan agreement contains a minimum net worth financial covenant of Arlington Asset.

Long-Term Unsecured Debt

As of June 30, 2022, we had $86.2 million of total long-term unsecured debt, net of unamortized debt issuance costs of $1.5 million. Our 6.75% Senior Notes due 2025 with a principal amount of $34.9 million outstanding as of June 30, 2022 accrue and require payment of interest quarterly at an annual rate of 6.75% and mature on March 15, 2025. Our 6.00% Senior Notes due 2026 with a principal amount of $37.8 million outstanding as of June 30, 2022 accrue and require payment of interest quarterly at an annual rate of 6.00% and mature on August 1, 2026. Our trust preferred debt with a principal amount of $15.0 million outstanding as of June 30, 2022 accrue and require the payment of interest quarterly at three-month LIBOR plus 2.25% to 3.00% and mature between 2033 and 2035. Our Senior Notes due 2025 and trust preferred debt may be redeemed in whole or part at any time and from time to time at our option at a redemption price equal to the principal amount plus accrued and unpaid interest. Our Senior Notes due 2026 may be redeemed in whole or in part at any time and from time to time at our option on or after August 1, 2023 at a redemption price equal to the principal amount plus accrued and unpaid interest.

53


 

Derivative Instruments

In the normal course of our operations, we are a party to financial instruments that are accounted for as derivative financial instruments including (i) interest rate hedging instruments such as interest rate swaps, U.S. Treasury note futures, put and call options on U.S. Treasury note futures, Eurodollar futures, interest rate swap futures and options on agency MBS, and (ii) derivative instruments that economically serve as investments such as TBA purchase and sale commitments.

Interest Rate Hedging Instruments

We exchange cash variation margin with the counterparties to our interest rate hedging instruments at least on a daily basis based upon daily changes in fair value as measured by the central clearinghouse through which those derivatives are cleared. In addition, the central clearinghouse requires market participants to deposit and maintain an “initial margin” amount which is determined by the clearinghouse and is generally intended to be set at a level sufficient to protect the clearinghouse from the maximum estimated single-day price movement in that market participant’s contracts. However, the futures commission merchants (“FCMs”) through which we conduct trading of our cleared and exchanged-traded hedging instruments may require incremental initial margin in excess of the clearinghouse’s requirement. The clearing exchanges have the sole discretion to determine the value of our hedging instruments for the purpose of setting initial and variation margin requirements or otherwise. In the event of a margin call, we must generally provide additional collateral on the same business day. To date, we have not had any margin calls on our hedging agreements that we were not able to satisfy. However, if we encounter significant decreases in long-term interest rates, margin calls on our hedging agreements could result in a material adverse change in our liquidity position.

As of June 30, 2022, we had outstanding interest rate swaps with the following aggregate notional amount and corresponding initial margin held in collateral deposit with the FCM (dollars in thousands):

 

 

 

June 30, 2022

 

 

 

Notional

 

 

Collateral

 

 

 

Amount

 

 

Deposit

 

Interest rate swaps

 

$

230,000

 

 

$

4,084

 

The FCMs through which we conduct trading of our hedging instruments may limit their exposure to us (due to an inherent one business day lag in the variation margin exchange process) by applying a maximum “ceiling” on their level of risk, either overall and/or by instrument type. The FCMs generally use the amount of initial margin that we have posted with them as a measure of their level of risk exposure to us. We currently have FCM relationships with two large financial institutions. To date, among our two FCM arrangements, we have had sufficient excess capacity above and beyond what we believe to be a sufficient and appropriate hedge position. However, if our FCMs substantially lowered their risk exposure thresholds, we could experience a material adverse change in our liquidity position and our ability to hedge appropriately.

TBA Dollar Roll Transactions

TBA dollar roll transactions represent a form of off-balance sheet financing accounted for as derivative instruments. In a TBA dollar roll transaction, we do not intend to take physical delivery of the underlying agency MBS and will generally enter into an offsetting position and net settle the paired-off positions in cash. However, under certain market conditions, it may be uneconomical for us to roll our TBA contracts into future months and we may need to take or make physical delivery of the underlying securities. If we were required to take physical delivery to settle a long TBA contract, we would have to fund our total purchase commitment with cash or other financing sources and our liquidity position could be negatively impacted.

Margin Requirements for Agency MBS Purchase and Sale Commitments

Our commitments to purchase and sell agency MBS, including TBA commitments, are subject to master securities forward transaction agreements published by SIFMA as well as supplemental terms and conditions with each counterparty. Under the terms of these agreements, we may be required to pledge collateral to our counterparty in the event the fair value of the agency MBS underlying our purchase and sale commitments change and such counterparty demands collateral through a margin call. Margin calls on agency MBS commitments are generally caused by factors such as rising interest rates or prepayments. Our agency MBS commitments provide that valuations for our commitments and any pledged collateral are to be obtained from a generally recognized source agreed to by both parties. However, in certain circumstances, our counterparties have the sole discretion to determine the value of the agency MBS commitment and any pledged collateral. In such instances, our counterparties are required to act in good faith in making determinations of value. In the event of a margin call, we must generally provide additional collateral on the same business day.

MSR Financing Receivable Commitments

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We are party to agreements with a licensed, GSE approved residential mortgage loan servicer that enables us to garner the economic return of an investment in an MSR purchased by the mortgage servicing counterparty through an MSR financing transaction. We have committed to invest a total minimum of $50 million of capital with the counterparty with $25 million of the minimum commitment expiring on December 31, 2023 and $25 million of the minimum commitment expiring on April 1, 2024. As of June 30, 2022, we have fully funded the total minimum commitment. At any time prior to the minimum commitment expiration dates, we have the option to request the mortgage servicing counterparty to sell the related MSR investments and repay us amounts owed to us under the MSR financing transaction less a minimum fee the mortgage servicing counterparty would have earned over the remaining original commitment periods.

At our election, we can request the mortgage servicing counterparty utilize leverage on the MSRs to which our MSR financing receivables are referenced to finance the purchase of additional MSRs to increase potential returns to us. As of June 30, 2022, our mortgage servicing counterparty has a $75 million credit facility that is secured by its MSRs including MSRs to which our MSR financing receivables are referenced. As of June 30, 2022, we had the ability to utilize approximately 81% of our mortgage servicing counterparty’s available capacity under its credit facility. In general, our mortgage servicing counterparty can obtain advances of up to 60% of the fair value of the MSR collateral value pledged. Under our mortgage servicing counterparty’s credit facility, if the fair value of the pledged MSR collateral declines and the lender demands additional collateral from our mortgage servicing counterparty through a margin call, we would be required to provide the mortgage servicing counterparty with additional funds to meet such margin call. If we were unable to satisfy such margin call, the lender could liquidate the MSR collateral position to which our MSR financing receivables are referenced to satisfy the loan obligation, thereby reducing the value of our MSR financing receivables. Draws under the facility bear interest at term SOFR plus 2.90% with a SOFR floor of 1.60% and a maturity date of April 28, 2023 with a one-year borrower extension option.

Our mortgage servicing counterparty may also pledge MSRs subject to other similar MSR financing receivable relationships with other third parties as collateral under the same credit facility that have a pledge of the MSRs to which our MSR financing receivables are referenced. If such third party to another MSR financing receivable were unable to satisfy a margin call on its referenced pool of MSRs and the value of such MSRs were insufficient to satisfy the corresponding debt obligation to the lender, the lender would have recourse to the MSRs to which our MSR financing receivables are referenced. In such case, if the mortgage servicing counterparty to our MSR financing receivables fails to satisfy such third party’s shortfall, the lender could liquidate the MSRs to which our MSR financing receivables are referenced if we did not fund such remaining margin deficiency. As a result of this cross collateralization of our mortgage servicing counterparty’s credit facility, the value of our MSR financing receivables may be adversely impacted by the inability of our mortgage servicing counterparty’s other contracted parties to meet their margin calls.

Under the arrangement, we are obligated to provide funds to the mortgage servicing counterparty to fund its advances of payments on the serviced pool of mortgage loans within the referenced MSR. The mortgage servicing counterparty is required to return to us any subsequent servicing advances collected or reimbursed by the GSEs. At our option, we could request the mortgage servicing counterparty to fund any servicing advances with draws under its credit facility, subject to available borrowing capacity, while we would be required to fund such financing costs.

As of June 30, 2022, our mortgage servicing counterparty has drawn $73.6 million of financing under its credit facility, including $60.9 million attributable to us, collateralized by an estimated $131.2 million of MSRs, including $108.4 million attributable to us, and $1.3 million of servicer advances, including $1.1 million attributable to us.

Investment Commitments

We are party to an investment management agreement with a third party to invest up to a minimum $65 million of capital in SFR properties. Our commitment to fund up to $65 million of capital may be reduced to $55 million to the extent we utilize debt financing to fund certain acquisitions of SFR properties. As of June 30, 2022, we have fully funded the $65 million of the capital commitment. Under the terms of the investment management agreement, if we were to terminate the commitment, we would have to pay a termination fee equal to a fixed amount less inception to date fees paid.

As of June 30, 2022, we had commitments to acquire 25 SFR properties for an aggregate purchase price of $9.0 million.

As of June 30, 2022, we are a party to a participation agreement pursuant to which we have committed to fund up to $30 million of a $130 million revolving credit facility that matures on July 7, 2024. Under the terms of the participation agreement, we are obligated to fund the last $30 million of advances under the revolving credit facility. As of June 30, 2022, our unfunded commitment was $29.7 million.

Equity Capital

Common Equity Distribution Agreements

We are party to separate common equity distribution agreements with equity sales agents JMP Securities LLC, B. Riley FBR, Inc., JonesTrading Institutional Services LLC and Ladenburg Thalmann & Co. Inc. pursuant to which we may offer and sell, from

55


 

time to time, shares of our common stock. Pursuant to the common equity distribution agreements, shares of our common stock may be offered and sold through the equity sales agents in transactions that are deemed to be “at the market” offerings as defined in Rule 415 under the Securities Act of 1933, including sales made directly on the NYSE or sales made to or through a market maker other than on an exchange or, subject to the terms of a written notice from us, in privately negotiated transactions. As of June 30, 2022, we had 11,302,160 shares of Class A common stock available for sale under the common equity distribution agreements.

Preferred Stock

As of June 30, 2022, we had Series B Preferred Stock outstanding with a liquidation preference of $9.5 million. The Series B Preferred Stock is publicly traded on the New York Stock Exchange under the ticker symbol “AAIC PrB.” The Series B Preferred Stock has no stated maturity, is not subject to any sinking fund and will remain outstanding indefinitely unless repurchased or redeemed by us. Holders of Series B Preferred Stock have no voting rights, except under limited conditions and are entitled to receive a cumulative cash dividend at a rate of 7.00% per annum of their $25.00 per share liquidation preference (equivalent to $1.75 per annum per share). Shares of Series B Preferred Stock are redeemable at $25.00 per share, plus accumulated and unpaid dividends (whether or not authorized or declared) exclusively at our option. Dividends are payable quarterly in arrears on the 30th day of each December, March, June and September, when and as declared. We have declared and paid all required quarterly dividends on our Series B Preferred Stock to date.

As of June 30, 2022, we had Series C Preferred Stock outstanding with a liquidation preference of $26.1 million. The Series C Preferred Stock is publicly traded on the New York Stock Exchange under the ticker symbol “AAIC PrC.” The Series C Preferred Stock has no stated maturity, is not subject to any sinking fund and will remain outstanding indefinitely unless repurchased or redeemed by us. Holders of Series C Preferred Stock have no voting rights except under limited conditions and will be entitled to receive cumulative cash dividends (i) from and including the original issue date to, but excluding, March 30, 2024 at a fixed rate equal to 8.250% per annum of the $25.00 per share liquidation preference (equivalent to $2.0625 per annum per share) and (ii) from and including March 30, 2024, at a floating rate equal to three-month LIBOR plus a spread of 5.664% per annum. Shares of Series C Preferred Stock are redeemable at $25.00 per share, plus accumulated and unpaid dividends (whether or not authorized or declared) exclusively at our option commencing on March 30, 2024 or earlier upon the occurrence of a change in control or under circumstances where it is necessary to preserve our qualification as a REIT. Under certain circumstances upon a change of control, the Series C Preferred Stock is convertible into shares of our common stock. Dividends are payable quarterly in arrears on the 30th day of March, June, September and December of each year, when and as declared. We have declared and paid all required quarterly dividends on our Series C Preferred Stock to date.

Preferred Equity Distribution Agreement

We are party to an amended and restated equity distribution agreement with JonesTrading Institutional Services LLC and Ladenburg Thalmann & Co. Inc., pursuant to which we may offer and sell, from time to time, shares of our Series B Preferred Stock. Pursuant to the Series B preferred equity distribution agreement, shares of our Series B Preferred Stock may be offered and sold through the preferred equity sales agents in transactions that are deemed to be “at the market” offerings as defined in Rule 415 under the Securities Act of 1933, including sales made directly on the NYSE or sales made to or through a market maker other than on an exchange or, subject to the terms of a written notice from us, in privately negotiated transactions.

During the six months ended June 30, 2022, we issued 6,058 shares of Series B preferred stock for proceeds net of selling commissions and expenses of $0.1 million under the Series B preferred equity distribution agreement. As of June 30, 2022, we had 1,602,566 shares of Series B Preferred stock available for sale under the Series B preferred equity distribution agreement.

REIT Distribution Requirements

We have elected to be taxed as a REIT under the Internal Revenue Code. As a REIT, we are required to distribute annually 90% of our REIT taxable income (subject to certain adjustments) to our shareholders. So long as we continue to qualify as a REIT, we will generally not be subject to U.S. federal or state corporate income taxes on our taxable income that we distribute to our shareholders on a timely basis. At present, it is our intention to distribute 100% of our taxable income, although we will not be required to do so. We intend to make distributions of our taxable income within the time limits prescribed by the Internal Revenue Code, which may extend into the subsequent taxable year.

As of June 30, 2022, we had estimated NOL carryforwards of $167.5 million that can be used to offset future taxable ordinary income and reduce our future distribution requirements. As of June 30, 2022, we also had estimated NCL carryforwards of $171.8 million that can be used to offset future net capital gains.

 

Off-Balance Sheet Arrangements and Other Commitments

As of June 30, 2022 and December 31, 2021, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance, or special purpose entities or VIEs, established for the purpose of

56


 

facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Our economic interests held in unconsolidated VIEs are generally limited in nature to those of a passive holder of beneficial interests in securitized financial assets. As of June 30, 2022 and December 31, 2021, we had consolidated for financial reporting purposes two and one, respectively, securitization trusts for which we determined that our investments provided us with both (i) the power to direct the activities that most significantly impact the economic performance of the VIE and (ii) the obligation to absorb losses or the right to receive benefits that could potentially be significant to the VIE. We were not required to consolidate for financial reporting purposes any other VIEs as of June 30, 2022 and December 31, 2021, as we did not have the power to direct the activities that most significantly impact the economic performance of such entities.

As of June 30, 2022 and December 31, 2021, we had not guaranteed any obligations of unconsolidated entities. As of June 30, 2022 and December 31, 2021, we had not entered into any commitment or intent to provide funding to unconsolidated entities other than the aforementioned asset-backed revolving credit facility funding commitment.

 

Critical Accounting Estimates

Refer to the heading titled “Critical Accounting Estimates” in our Annual Report on Form 10-K for the year ended December 31, 2021 for a discussion of our critical accounting estimates.

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Market risk is the exposure to loss resulting from changes in market factors such as interest rates, foreign currency exchange rates, commodity prices, equity prices and other market changes that affect market risk sensitive instruments. The primary market risks that we are exposed to are interest rate risk, prepayment risk, extension risk, spread risk, credit risk, liquidity risk and regulatory risk. See “Item 1 — Business” in our Annual Report on Form 10-K for the year ended December 31, 2021 for discussion of our risk management strategies related to these market risks. The following is additional information regarding certain of these market risks.

Interest Rate Risk

We are exposed to interest rate risk in our agency MBS, MSR related asset and SFR investments. Our investments in mortgage investments are also financed with short-term borrowing facilities, such as repurchase agreements, which are interest rate sensitive financial instruments. Our exposure to interest rate risk fluctuates based upon changes in the level and volatility of interest rates, mortgage prepayments, and in the shape and slope of the yield curve, among other factors. Through the use of interest rate hedging instruments, we attempt to economically hedge a portion of our exposure to changes, attributable to changes in benchmark interest rates, in agency MBS fair values and future interest cash flows on our short-term financing arrangements. Our primary interest rate hedging instruments include interest rate swaps as well as U.S. Treasury note futures, options on U.S. Treasury note futures, and options on agency MBS.

Changes in both short- and long-term interest rates affect us in several ways, including our financial position. As interest rates rise, the value of fixed-rate agency MBS may be expected to decline, prepayment rates may be expected to decrease and duration may be expected to extend, while the values of our interest rate hedging instruments and MSR financing receivables are generally expected to increase due to lower expectations of prepayments in the referenced pools of mortgage loans. Increases in interest rates may also have an adverse impact on our SFR investments if we are unable to increase rents or acquire SFR homes with rates high enough to offset the increase in interest rates on our borrowings. In addition, an increase in interest rates could also negatively impact the value of our SFR investments as the affordability to individual home buyers would likely decrease. Conversely, if interest rates decline, the value of fixed-rate agency MBS is generally expected to increase while the value of our interest rate hedging instruments and MSR related assets are expected to decline. In addition, decreases in interest rates may lead to additional competition for the acquisition of SFR homes, which may lead to future acquisitions being more costly and resulting in lower yields. Also, our ability to obtain favorable interest rates on our financing structures may affect our SFR investment strategy. We manage our interest rate risk through investment allocation between our agency MBS and MSR related assets and the utilization of interest rate hedging instruments.

The tables that follow illustrate the estimated change in fair value for our current investments in agency MBS, MSR financing receivable and derivative instruments under several hypothetical scenarios of interest rate movements. For the purposes of this illustration, interest rates are defined by the U.S. Treasury yield curve. Changes in fair value are measured as percentage changes from their respective fair values presented in the column labeled “Value.” Our estimate of the change in the fair value of agency MBS is based upon the same assumptions we use to manage the impact of interest rates on the portfolio. The interest rate sensitivity of our agency MBS and TBA commitments is derived from The Yield Book, a third-party model. The interest rate sensitivity of our MSR financing receivable is derived from an internal model. Actual results could differ significantly from these estimates. The effective durations are based on observed fair value changes, as well as our own estimate of the effect of interest rate changes on the fair value of the investments, including assumptions regarding prepayments based, in part, on age and interest rate of the mortgages underlying

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the agency MBS, prior exposure to refinancing opportunities, and an overall analysis of historical prepayment patterns under a variety of historical interest rate conditions.

The interest rate sensitivity analyses illustrated by the tables that follow have certain limitations, most notably the following:

The 50 and 100 basis point upward and downward shocks to interest rates that are applied in the analyses represent parallel shocks to the forward yield curve. The analyses do not consider the sensitivity of stockholders’ equity to changes in the shape or slope of the forward yield curve.
The analyses assume that spreads remain constant and, therefore, do not reflect an estimate of the impact that changes in spreads would have on the value of our MBS investments or our LIBOR- or SOFR-based derivative instruments, such as our interest rate swap agreements.
The analyses assume a static portfolio and do not reflect activities and strategic actions that management may take in the future to manage interest rate risk in response to significant changes in interest rates or other market conditions.
The yield curve that results from applying an instantaneous parallel decrease in interest rates may reflect an interest rate of less than 0% in certain points of the curve. The results of the analyses included in the tables below reflect the effect of these negative interest rates.
The analyses do not reflect an estimated changes in our income tax provision.
The analyses do not reflect any estimated changes in the fair value of our credit investments or SFR properties.

These analyses are not intended to provide a precise forecast. Actual results could differ materially from these estimates (dollars in thousands, except per share amounts):

 

 

 

June 30, 2022

 

 

 

 

 

 

Value

 

 

Value

 

 

 

 

 

 

with 50

 

 

with 50

 

 

 

 

 

 

Basis Point

 

 

Basis Point

 

 

 

 

 

 

Increase in

 

 

Decrease in

 

 

 

Value

 

 

Interest Rates

 

 

Interest Rates

 

Agency MBS

 

$

382,357

 

 

$

373,539

 

 

$

389,927

 

TBA commitments

 

 

337

 

 

 

4,690

 

 

 

(3,660

)

MSR financing receivables

 

 

120,260

 

 

 

122,446

 

 

 

116,918

 

Interest rate swaps

 

 

(1,008

)

 

 

2,298

 

 

 

(4,314

)

Equity available to common stock (1)

 

 

179,704

 

 

 

180,732

 

 

 

176,629

 

Equity available to common stock percent change

 

 

 

 

 

0.57

%

 

 

(1.71

)%

 

 

 

June 30, 2022

 

 

 

 

 

 

Value

 

 

Value

 

 

 

 

 

 

with 100

 

 

with 100

 

 

 

 

 

 

Basis Point

 

 

Basis Point

 

 

 

 

 

 

Increase in

 

 

Decrease in

 

 

 

Value

 

 

Interest Rates

 

 

Interest Rates

 

Agency MBS

 

$

382,357

 

 

$

363,653

 

 

$

396,100

 

TBA commitments

 

 

337

 

 

 

9,388

 

 

 

(7,055

)

MSR financing receivables

 

 

120,260

 

 

 

124,971

 

 

 

113,021

 

Interest rate swaps

 

 

(1,008

)

 

 

5,603

 

 

 

(7,619

)

Equity available to common stock (1)

 

 

179,704

 

 

 

181,373

 

 

 

172,204

 

Equity available to common stock percent change

 

 

 

 

 

0.93

%

 

 

(4.17

)%

 

(1)
Equity available to common stock is calculated as total equity plus accumulated depreciation of single-family residential real estate less the preferred stock liquidation preference.

 

Spread Risk

Our mortgage investments expose us to “spread risk.” Spread risk, also known as “basis risk,” is the risk of an increase in the spread between market participants’ required rate of return (or “market yield”) on our mortgage investments and prevailing benchmark interest rates, such as the U.S. Treasury or interest rate swap rates.

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The spread risk inherent to our investments in agency MBS and the resulting fluctuations in fair value of these securities can occur independent of changes in prevailing benchmark interest rates and may relate to other factors impacting the mortgage and fixed income markets, such as actual or anticipated monetary policy actions by the U. S. Federal Reserve, liquidity, or changes in market participants’ required rates of return on different assets. While we use interest rate hedging instruments to attempt to mitigate the sensitivity of our net book value to changes in prevailing benchmark interest rates, such instruments are generally not designed to mitigate spread risk inherent to our investment in agency MBS. Consequently, the value of our agency MBS and, in turn, our net book value, could decline independent of changes in interest rates.

The tables that follow illustrate the estimated change in fair value for our investments in agency MBS and TBA commitments under several hypothetical scenarios of agency MBS spread movements. Changes in fair value are measured as percentage changes from their respective fair values presented in the column labeled “Value.” The sensitivity of our agency MBS and TBA commitments to changes in MBS spreads is derived from The Yield Book, a third-party model. The analysis to follow reflects an assumed spread duration for our investment in agency MBS of 4.9 years, which is a model-based assumption that is dependent upon the size and composition of our investment portfolio as well as economic conditions present as of June 30, 2022.

These analyses are not intended to provide a precise forecast. Actual results could differ materially from these estimates (dollars in thousands, except per share amounts):

 

 

 

June 30, 2022

 

 

 

 

 

 

Value with

 

 

Value with

 

 

 

 

 

 

10 Basis Point

 

 

10 Basis Point

 

 

 

 

 

 

Increase in

 

 

Decrease In

 

 

 

 

 

 

Agency MBS

 

 

Agency MBS

 

 

 

Value

 

 

Spreads

 

 

Spreads

 

Agency MBS

 

$

382,357

 

 

$

380,184

 

 

$

384,530

 

TBA commitments

 

 

337

 

 

 

1,365

 

 

 

(690

)

Equity available to common stock (1)

 

 

179,704

 

 

 

178,558

 

 

 

180,850

 

Equity available to common stock percent change

 

 

 

 

 

(0.64

)%

 

 

0.64

%

 

 

 

June 30, 2022

 

 

 

 

 

 

Value with

 

 

Value with

 

 

 

 

 

 

25 Basis Point

 

 

25 Basis Point

 

 

 

 

 

 

Increase in

 

 

Decrease In

 

 

 

 

 

 

Agency MBS

 

 

Agency MBS

 

 

 

Value

 

 

Spreads

 

 

Spreads

 

Agency MBS

 

$

382,357

 

 

$

376,923

 

 

$

387,791

 

TBA commitments

 

 

337

 

 

 

2,906

 

 

 

(2,231

)

Equity available to common stock (1)

 

 

179,704

 

 

 

176,839

 

 

 

182,569

 

Equity available to common stock percent change

 

 

 

 

 

(1.59

)%

 

 

1.59

%

 

(1)
Equity available to common stock is calculated as total equity plus accumulated depreciation of single-family residential real estate less the preferred stock liquidation preference.

 

Credit Risk

Unlike our agency MBS investments, our credit investments do not carry a credit guarantee from a GSE or government agency. Accordingly, our credit investments expose us to credit risk. Credit risk, sometimes referred to as non-performance or non-payment risk, is the risk that we will not receive, in full, the contractually required principal or interest cash flows stemming from our investments due to an underlying borrower’s or issuer’s default on their obligation. Upon a mortgage loan borrower’s default, a foreclosure sale or other liquidation of the underlying mortgaged property will result in a credit loss if the liquidation proceeds fall short of the mortgage loan’s unpaid principal balance and unpaid accrued interest.

 

Some of our credit investments have credit enhancements that mitigate our exposure to the credit risk of the underlying mortgage loans. Credit losses incurred on the underlying mortgage loans collateralizing our investments in non-agency MBS are allocated on a “reverse sequential” basis. Accordingly, any credit losses realized on the underlying mortgage loans are first absorbed by the beneficial interests subordinate to our non-agency MBS, if any, to the extent of their respective principal balance, prior to being allocated to our investments.

 

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Other of our non-agency MBS investments represent “first loss” positions. Accordingly, for such investments, credit losses realized on the underlying pool of mortgage loans are first allocated to our security, to the extent of its principal balance, prior to being allocated to the respective securitization’s more senior credit positions.

 

We accept exposure to credit risk at levels we deem prudent within our overall investment strategy and our evaluation of the potential risk-adjusted returns. We attempt to manage our exposure to credit risk through prudent asset selection resulting from pre-acquisition due diligence, on-going performance monitoring subsequent to acquisition, and the disposition of assets for which we identify negative credit trends.

 

There is no guarantee that our attempts to manage our credit risk will be successful. We could experience substantial losses if the credit performance of the mortgage loans to which we are exposed falls short of our expectations.

 

Cautionary Statement About Forward-Looking Information

When used in this Quarterly Report on Form 10-Q, in future filings with the SEC or in press releases or other written or oral communications, statements which are not historical in nature, including those containing words such as “believe,” “expect,” “anticipate,” “estimate,” “plan,” “continue,” “intend,” “should,” “may” or similar expressions, are intended to identify “forward-looking statements” within the meaning of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and, as such, may involve known and unknown risks, uncertainties and assumptions. The forward-looking statements we make in this Quarterly Report on Form 10-Q include, but are not limited to, statements about the following:

the availability and terms of, and our ability to deploy, capital and our ability to grow our business through our current strategy focused on acquiring either (i) residential MBS that are either issued by U.S. government agencies or guaranteed as to principal and interest by U.S. government agencies or U.S. government sponsored agencies (“agency MBS”), or (ii) mortgage servicing right (“MSR”) related assets, (iii) credit investments that generally consist of mortgage loans secured by either residential or commercial real property or MBS collateralized by such mortgage loans, or (iv) SFR homes as rental properties;
the uncertainty and economic impact of the ongoing COVID-19 pandemic and the measures taken by the government to address it, including the impact on our business, financial condition, liquidity and results of operations due to a significant decrease in economic activity and disruptions in our financing operations, among other factors;
our ability to qualify and maintain our qualification as a REIT;
our ability to forecast our tax attributes, which are based upon various facts and assumptions, and our ability to protect and use our net operating losses (“NOLs”) and net capital losses (“NCLs”) to offset future taxable income, including whether our shareholder rights plan, as amended (“Rights Plan”) will be effective in preventing an ownership change that would significantly limit our ability to utilize such losses;
our business, acquisition, leverage, asset allocation, operational, investment, hedging and financing strategies and the success of, or changes in, these strategies;
credit risks underlying our assets, including changes in the default rates and management’s assumptions regarding default rates on the mortgage loans securing our non-agency MBS;
the effect of changes in prepayment rates, interest rates and default rates on our portfolio;
our evaluation of SFR homes and the costs to operate SFR homes;
the effect of governmental regulation and actions on our business, including, without limitation, changes to monetary and fiscal policy and tax laws;
our ability to quantify and manage risk;
our ability to roll our repurchase agreements on favorable terms, if at all;
our liquidity;
our asset valuation policies;
our decisions with respect to, and ability to make, future dividends;

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investing in assets other than mortgage investments or pursuing business activities other than investing in mortgage investments;
our ability to successfully operate our business as a REIT;
our ability to maintain our exclusion from the definition of “investment company” under the Investment Company Act of 1940, as amended; and
the effect of general economic conditions on our business.

Forward-looking statements are based on our beliefs, assumptions and expectations of our future performance, taking into account information currently in our possession. These beliefs, assumptions and expectations may change as a result of many possible events or factors, not all of which are known to us or are within our control. If a change occurs, the performance of our portfolio and our business, financial condition, liquidity and results of operations may vary materially from those expressed, anticipated or contemplated in our forward-looking statements. You should carefully consider these risks, along with the following factors that could cause actual results to vary from our forward-looking statements, before making an investment in our securities:

the overall environment for interest rates, changes in interest rates, interest rate spreads, the yield curve and prepayment rates, including the timing of changes in the Federal Funds rate by the U.S. Federal Reserve;
the effect of any changes to the London Interbank Offered Rate (“LIBOR”) and the Secured Overnight Financing Rate (“SOFR”) and establishment of alternative reference rates;
current conditions and further adverse developments in the residential mortgage market and the overall economy;
potential risk attributable to our mortgage-related portfolios, including changes in fair value;
our use of leverage and our dependence on repurchase agreements and other short-term borrowings to finance our mortgage-related holdings;
the availability of certain short-term liquidity sources;
the sale of our SFR properties;
competition for investment opportunities;
U.S. Federal Reserve monetary policy;
the federal conservatorship of Fannie Mae and Freddie Mac and related efforts, along with any changes in laws and regulations affecting the relationship between Fannie Mae and Freddie Mac and the federal government;
mortgage loan prepayment activity, modification programs and future legislative action;
changes in, and success of, our acquisition, hedging and leverage strategies, changes in our asset allocation and changes in our operational policies, all of which may be changed by us without shareholder approval;
failure of sovereign or municipal entities to meet their debt obligations;
fluctuations of the value of our hedge instruments;
fluctuating quarterly operating results;
changes in laws and regulations and industry practices that may adversely affect our business;
volatility of the securities markets and activity in the secondary securities markets in the United States and elsewhere;
our ability to qualify and maintain our qualification as a REIT for federal income tax purposes;
our ability to successfully expand our business into areas other than investing in MBS and our expectations of the returns of expanding into any such areas; and
the other important factors identified in our Quarterly Reports on Form 10-Q and our Annual Report on Form 10-K for the year ended December 31, 2021 under the caption “Item 1A — Risk Factors.”

These and other risks, uncertainties and factors, including those described elsewhere in this Quarterly Report on Form 10-Q, could cause our actual results to differ materially from those projected in any forward-looking statements we make. All forward-looking statements speak only as of the date on which they are made. New risks and uncertainties arise over time and it is not possible to predict those events or how they may affect us. Except as required by law, we are not obligated to, and do not intend to, update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

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Item 4. Controls and Procedures

Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures

As of the end of the period covered by this Quarterly Report on Form 10-Q, our management, with the participation of our Chief Executive Officer, J. Rock Tonkel, Jr., and our Chief Financial Officer, Richard E. Konzmann, carried out an evaluation of the effectiveness of our disclosure controls and procedures (as defined under Rule 13a-15(e) under the Exchange Act) pursuant to Rule 13a-15(b) of the Exchange Act. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding disclosure.

Changes in Internal Control Over Financial Reporting

There have been no changes in our internal control over financial reporting that occurred during the quarter ended June 30, 2022 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II

OTHER INFORMATION

We are from time to time involved in civil lawsuits, legal proceedings and arbitration matters that we consider to be in the ordinary course of our business. There can be no assurance that these matters individually or in the aggregate will not have a material adverse effect on our financial condition or results of operations in a future period. We are also subject to the risk of litigation, including litigation that may be without merit. As we intend to actively defend such litigation, significant legal expenses could be incurred. An adverse resolution of any future litigation against us could materially affect our financial condition, results of operations and liquidity. Furthermore, we operate in highly-regulated markets that currently are under intense regulatory scrutiny, and we have received, and we expect in the future that we may receive, inquiries and requests for documents and information from various federal, state and foreign regulators. In addition, one or more of our subsidiaries have received requests to repurchase loans from various parties in connection with the former securitization business conducted by a subsidiary. We believe that the continued scrutiny of MBS, structured finance, and derivative market participants increases the risk of additional inquiries and requests from regulatory or enforcement agencies and other parties. We cannot provide any assurance that these inquiries and requests will not result in further investigation of or the initiation of a proceeding against us or that, if any such investigation or proceeding were to arise, it would not materially adversely affect our Company.

Item 1A. Risk Factors

 

Other than the following risk factor relating to the announced sale of up to 376 SFR properties, there have been no material changes to the risk factors disclosed in Item 1A. “Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2021. The materialization of any risks and uncertainties identified in our Cautionary Statement About Forward-Looking Information contained in this report together with those previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2021 or those that are presently unforeseen could result in significant adverse effects on our financial condition, results of operations and cash flows. See “Cautionary Statement About Forward-Looking Information” in Part I, Item 3 of this report or our Annual Report on Form 10-K for the year ended December 31, 2021.

 

We may not consummate the announced sale of up to 376 SFR properties on a timely basis, on its current terms or at all, and even if consummated, we may not fully realize the anticipated benefits of the sale.

 

As disclosed in our Notes to Consolidated Financial Statements, we have entered into a definitive agreement to sell 376 SFR properties. While the sale is expected to be completed in August 2022, there can be no assurance that the sale will be completed in a timely manner, on its current terms or at all, as the completion of the sale is dependent on a number of factors, including customary closing conditions. If we are unable to consummate the sale, then we will not derive the expected benefits to our business. Further, even if we do consummate the sale, we nonetheless may not fully realize the anticipated benefits of the transaction.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Purchases of Equity Securities by the Issuer

On July 31, 2020, we announced that our Board of Directors authorized an increase to our share repurchase program (the “Repurchase Program”) pursuant to which we may purchase up to 18,000,000 shares of our common stock. As of June 30, 2022, we had repurchased 6,966,858 shares of our common stock and there remain available for repurchase 11,033,142 shares of our common stock under the Repurchase Program.

The following table presents information with respect to our purchases of our common stock during the three months ended June 30, 2022 by us or any “affiliated purchaser” affiliated with us, as defined in Rule 10b-18(a)(3) under the Exchange Act:

 

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Settlement Date

 

Total Number of Shares Purchased

 

 

Average Net Price Paid Per Share

 

 

Total Number of Shares Repurchased as Part of Repurchase Program

 

 

Maximum Number of Shares that May Yet be Purchased Under the Repurchase Program

 

April 1, 2022 - April 30, 2022

 

 

397,432

 

 

$

3.52

 

 

 

397,432

 

 

 

11,583,280

 

May 1, 2022 - May 31, 2022

 

 

370,152

 

 

 

3.24

 

 

 

370,152

 

 

 

11,213,128

 

June 1, 2022 - June 30, 2022

 

 

179,986

 

 

 

3.46

 

 

 

179,986

 

 

 

11,033,142

 

Total

 

 

947,570

 

 

$

3.40

 

 

 

947,570

 

 

 

11,033,142

 

 

On March 20, 2020, our Board of Directors authorized us to repurchase up to $25 million in the aggregate of our Series B Preferred Stock, Series C Preferred Stock, Senior Notes due 2023 and Senior Notes due 2025. As of June 30, 2022, we had repurchased an aggregate of $5.9 million of Preferred Stock and Senior Notes and had remaining authorization to repurchase up to $19.1 million of such securities.

The following table presents information with respect to our purchases of our Series C Preferred Stock during the three months ended June 30, 2022 by us or any “affiliated purchaser” affiliated with us, as defined in Rule 10b-18(a)(3) under the Exchange Act:

 

Settlement Date

 

Total Number of Shares Purchased

 

 

Average Net Price Paid Per Share

 

 

Total Number of Shares Repurchased as Part of Repurchase Program

 

 

Maximum Number of Shares that May Yet be Purchased Under the Repurchase Program

April 1, 2022 - April 30, 2022

 

 

23,003

 

 

$

24.57

 

 

 

23,003

 

 

N/A

May 1, 2022 - May 31, 2022

 

 

34,809

 

 

 

24.38

 

 

 

34,809

 

 

N/A

June 1, 2022 - June 30, 2022

 

 

14,551

 

 

 

23.03

 

 

 

14,551

 

 

N/A

Total

 

 

72,363

 

 

$

24.17

 

 

 

72,363

 

 

N/A

Item 3. Defaults Upon Senior Securities

None.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

 

None.

Item 6. Exhibits

 

Exhibit
Number

 

Exhibit Title

 

 

 

3.01

 

Amended and Restated Articles of Incorporation, as amended (incorporated by reference to Exhibit 3.1 to the Company’s Quarterly Report on Form 10-Q filed on November 9, 2009).

 

 

 

3.02

 

Articles of Amendment to the Amended and Restated Articles of Incorporation designating the shares of 7.00% Series B Cumulative Perpetual Redeemable Preferred Stock, $0.01 par value per share (incorporated by reference to Exhibit 3.2 to the Company’s Registration Statement on Form 8-A filed on May 9, 2017).

 

 

 

 

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3.03

 

Articles of Amendment to the Amended and Restated Articles of Incorporation of Arlington Asset Investment Corp. designating the Company’s 8.250% Series C Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock, par value $0.01 per share (incorporated by reference to Exhibit 3.3 to the Company’s Registration Statement on Form 8-A filed on March 11, 2019).

 

 

 

3.04

 

Articles of Amendment to the Amended and Restated Articles of Incorporation of Arlington Asset Investment Corp. (incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed on June 25, 2019).

 

 

 

3.05

 

Amended and Restated Bylaws, as amended (incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed on July 28, 2011).

 

 

 

3.06

 

Amendment No. 1 to the Amended and Restated Bylaws (incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed on February 4, 2015).

 

 

 

3.07

 

Amendment No. 2 to the Amended and Restated Bylaws (incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed on October 26, 2016).

 

 

 

3.08

 

Amendment No. 3 to the Amended and Restated Bylaws (incorporated by reference to Exhibit 3.1 to the Registrant’s Current Report on Form 8-K filed on January 17, 2019).

 

 

 

3.09

 

Amendment No. 4 to the Amended and Restated Bylaws (incorporated by reference to Exhibit 3.1 to the Registrant’s Current Report on Form 8-K filed on December 13, 2019).

 

 

 

4.01

 

Indenture governing the Senior Debt Securities by and between the Company and The Bank of New York Mellon, as Trustee (incorporated by reference to Exhibit 4.1 to the Company’s Registration Statement on Form S-3 (File No. 333-235885) filed on January 10, 2020).

 

 

 

4.02

 

Indenture governing the Subordinated Debt Securities by and between the Company and The Bank of New York Mellon, as Trustee (incorporated by reference to Exhibit 4.2 to the Company’s Registration Statement on Form S-3 (File No. 333-235885) filed on January 10, 2020).

 

 

 

4.03

 

Indenture dated as of May 1, 2013 between the Company and Wells Fargo Bank, National Association, as trustee (incorporated by reference to Exhibit 4.1 of the Company’s Current Report on Form 8-K filed on May 1, 2013).

 

 

 

4.04

 

First Supplemental Indenture dated as of May 1, 2013 between the Company and Wells Fargo Bank, National Association, as trustee (incorporated by reference to Exhibit 4.2 of the Company’s Current Report on Form 8-K filed on May 1, 2013).

 

 

 

4.05

 

Form of Senior Note. (incorporated by reference to Exhibit 4.6 to the Company’s Registration Statement on Form S-3 (File No. 333-235885) filed on January 10, 2020).

 

 

 

4.06

 

Form of Subordinated Note. (incorporated by reference to Exhibit 4.7 to the Company’s Registration Statement on Form S-3 (File No. 333-235885) filed on January 10, 2020).

 

 

 

4.07

 

Form of 6.625% Senior Notes due 2023 (incorporated by reference to Exhibit 4.3 to Current Report on Form 8-K filed by the Company on May 1, 2013).

 

 

 

4.08

 

Form of Certificate for Class A common stock (incorporated by reference to Exhibit 4.01 of the Annual Report on Form 10-K filed with the SEC on February 24, 2010).

 

 

 

4.09

 

Shareholder Rights Agreement, dated June 5, 2009 (incorporated by reference to Exhibit 4.1 of the Current Report on Form 8-K filed with the SEC on June 5, 2009).

 

 

 

4.10

 

First Amendment to Shareholder Rights Agreement, dated as of April 13, 2018 (incorporated by reference to Exhibit 4.2 to the Registrant’s Current Report on Form 8-K filed on April 13, 2018).

 

 

 

4.11

 

Second Supplemental Indenture, dated as of March 18, 2015, between the Company, Wells Fargo Bank, National Association, as Trustee and The Bank of New York Mellon, as Series Trustee (incorporated by reference to Exhibit 4.3 to the Company’s Form 8-A filed on March 18, 2015).

 

 

 

4.12

 

Form of 6.750% Notes due 2025 (incorporated by reference to Exhibit 4.3 to the Current Report on Form 8-K filed by the Company on March 17, 2015).

 

 

 

4.13

 

Form of specimen certificate representing the shares of 7.00% Series B Perpetual Redeemable Preferred Stock (incorporated by reference to Exhibit 4.1 to the Company’s Registration Statement on Form 8-A filed on May 9, 2017).

 

 

 

 

65


 

4.14

 

Form of specimen certificate representing the shares of 8.250% Series C Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock (incorporated by reference to Exhibit 4.1 to the Company’s Registration Statement on Form 8-A filed on March 11, 2019).

 

 

 

4.15

 

First Supplemental Indenture dated as of July 15, 2021 between the Company and The Bank of New York Mellon, as trustee (incorporated by reference to Exhibit 4.5 to the Company’s Registration Statement on Form 8-A filed on July 15, 2021).

 

 

 

4.16

 

Form of 6.000% Senior Notes Due 2026 (incorporated by reference to Exhibit 4.6 to the Company’s Registration Statement on Form 8-A filed on July 15, 2021).

 

 

 

4.17

 

Second Amendment to Shareholder Rights Agreement, dated as of April 11, 2022 (incorporated by reference to Exhibit 4.3 to the Registrant’s Current Report on Form 8-K filed on April 12, 2022).

 

 

 

10.01

 

Purchase and Sale Agreement dated as of May 10, 2022, by and between McLean SFR Investment, LLC and HomeSource Acquisitions, LLC (incorporated by reference to Exhibit 10.01 to the Registrant's Quarterly Report on Form 10-Q filed on May 16, 2022).

 

 

 

10.02

 

Amendment No. 1 to Purchase and Sale Agreement dated as of May 27, 2022, by and between McLean SFR Investment, LLC and HomeSource Acquisitions, LLC.*

 

 

 

10.03

 

Amendment No. 2 to Purchase and Sale Agreement dated as of June 20, 2022, by and between McLean SFR Investment, LLC and HomeSource Acquisitions, LLC. (incorporated by reference to Exhibit 10.01 to the Registrant’s Current Report on Form 8-K filed on June 21, 2022).

 

 

 

31.01

 

Certification of Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*

 

 

 

31.02

 

Certification of Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*

 

 

 

32.01

 

Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.**

 

 

 

32.02

 

Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.**

 

 

 

101.INS

 

Inline XBRL Instance Document – the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.***

 

 

 

101.SCH

 

Inline XBRL Taxonomy Extension Schema Document***

 

 

 

101.CAL

 

Inline XBRL Taxonomy Extension Calculation Linkbase Document***

 

 

 

101.DEF

 

Inline XBRL Taxonomy Extension Definition Linkbase Document***

 

 

 

101.LAB

 

Inline XBRL Taxonomy Extension Label Linkbase Document***

 

 

 

101.PRE

 

Inline XBRL Taxonomy Extension Presentation Linkbase Document***

 

 

 

104

 

The cover page from the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2022, has been formatted in Inline XBRL.

 

 

 

 

 

 

 

 

 

 

 

 

 

* Filed herewith.

** Furnished herewith.

*** Submitted electronically herewith. Attached as Exhibit 101 are the following materials from the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2022, formatted in XBRL (eXtensible Business Reporting Language): (i) Consolidated Balance Sheets at June 30, 2022 and December 31, 2021; (ii) Consolidated Statements of Comprehensive Income for the Three and Six Months Ended June 30, 2022 and 2021; (iii) Consolidated Statements of Changes in Equity for the Three Months Ended March 31, 2022 and 2021 and for the Three Months Ended June 30, 2022 and 2021; and (iv) Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2022 and 2021.

66


 

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

ARLINGTON ASSET INVESTMENT CORP.

 

By:

 

/s/ RICHARD E. KONZMANN

 

 

 

Richard E. Konzmann

 

 

 

Executive Vice President, Chief Financial Officer and Treasurer

 

 

 

(Principal Financial Officer)

Date: August 15, 2022

 

 

 

 

67