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

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended March 31, 2022

OR

For the transition period from              to             

Commission File Number: 001-34374

ARLINGTON ASSET INVESTMENT CORP.

(Exact name of Registrant as specified in its charter)

(703) 373-0200

(Registrant’s Telephone Number, Including Area Code)

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

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.

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 April 29, 2022:

ARLINGTON ASSET INVESTMENT CORP.

FORM 10-Q

FOR THE QUARTER ENDED MARCH 31, 2022

INDEX

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PART I

FINANCIAL INFORMATION

Item 1. Financial Statements

ARLINGTON ASSET INVESTMENT CORP.

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands)

(Unaudited)

See notes to consolidated financial statements.

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ARLINGTON ASSET INVESTMENT CORP.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Dollars in thousands, except per share data)

(Unaudited)

See notes to consolidated financial statements.

2

ARLINGTON ASSET INVESTMENT CORP.

CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

(Dollars in thousands)

(Unaudited)

See notes to consolidated financial statements.

3

ARLINGTON ASSET INVESTMENT CORP.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

(Unaudited)

See notes to consolidated financial statements.

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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 March 31, 2022 and December 31, 2021, approximately 81% 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.

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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 and Mortgage Loans of Consolidated VIEs

The Company recognizes interest income for its investments in agency MBS and mortgage loans of consolidated variable interest entities (“VIEs”) 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 Credit Securities and MSR Financing Receivables

The Company recognizes interest income for its investments in credit securities 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.  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:

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Other Significant Accounting Policies

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

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:

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 March 31, 2022 and December 31, 2021, the fair value of the Company’s investments in agency MBS was $292,318 and $483,927, respectively. As of March 31, 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:

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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 March 31, 2022 and December 31, 2021, the fair value of the Company’s investments in credit securities was $25,360 and $26,222, respectively.  As of March 31, 2022, the Company’s investments in credit securities primarily consist of non-agency MBS collateralized by pools of business purpose residential 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:

Note 5. Loans Held for Investment

As of March 31, 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 $29,592 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 March 31, 2022 and December 31, 2021, the Company’s investment was $29,592 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 March 31, 2022 and December 31, 2021, was equal to the contractual note rate of the loan.

As of March 31, 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 one-month LIBOR plus 3.75% with a LIBOR 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 March 31, 2022 and December 31, 2021, the Company’s unfunded commitment was $30,000.

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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.

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 March 31, 2022 and December 31, 2021, the Company had provided funds of $2,587 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, the mortgage servicing counterparty can utilize leverage on the MSRs to which the Company’s MSR financing receivables are referenced to finance the purchase of additional MSRs.   As of March 31, 2022 and December 31, 2021, the Company’s counterparty had drawn $43,948 and $40,398, respectively, of financing secured by the MSRs to which the Company’s MSR financing receivables are referenced.

Under GAAP, 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 March 31, 2022 and December 31, 2021, the fair value of the Company’s investments in MSR financing receivables was $139,225 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:

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.  

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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.

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, insurance and interest expense incurred in financing secured by SFR properties.

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 March 31, 2022 and December 31, 2021, the Company had not recognized any impairment losses for its investments in SFR properties.

As of March 31, 2022 and December 31, 2021, the Company had investments in 405 and 214 SFR properties, respectively, for a total cost of $121,962 and $61,188, respectively.  During the three months ended March 31, 2022, the Company recognized $715 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 the dates indicated:

As of March 31, 2022, the Company had commitments to acquire 49 SFR properties for an aggregate purchase price of $14,616.

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On May 10, 2022, the Company entered into an agreement under which it made a binding commitment to sell 378 SFR properties for $132,750.  The 378 SFR properties have an estimated all-in-cost of $114,874, which includes the purchase price of the properties, closing costs and initial rehabilitation costs.  Prior to settlement, the buyer can remove up to 5% of the SFR properties from the sale transaction.  Pursuant to the agreement, the buyer may, for any reason or no reason at all, and in its sole and absolute discretion, terminate the agreement within 20 days of contract signing.  If ultimately consummated, the sale is expected to settle late in the second quarter.  As of March 31, 2022, the requirements for held-for-sale classification of the SFR properties had not been met.

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 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:

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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 $5,930 and $329, respectively, as of March 31, 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 March 31, 2022, the weighted average net note rate to which the VIE was entitled was 6.00%.

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 March 31, 2022, the aggregate unfunded construction draw balance commitment attributable to the Company’s subordinate debt security investment was $127.

Consolidated VIE of Residential Mortgage Loans

The pool of mortgage loans and the third-party held debt obligations of the consolidated VIE had aggregate unpaid principal balances of $251,008 and $257,612, respectively, as of March 31, 2022.  As of March 31, 2022, the weighted average contractual interest rates of the loans and consolidated debt held by third parties were 4.86% and 1.36%, 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

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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 March 31, 2022:

The following table presents information about the accrual status of the loans of the Company’s consolidated VIE of residential mortgage loans as of March 31, 2022:

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 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.

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As of March 31, 2022 and December 31, 2021, the Company had no amount at risk with a single repurchase agreement counterparty or lender greater than 10% of equity. The following table provides information regarding the Company’s outstanding repurchase agreement borrowings as of the dates indicated:

The following table provides information regarding the Company’s outstanding repurchase agreement borrowings during the three months ended March 31, 2022 and 2021:

Long-Term Unsecured Debt

As of March 31, 2022 and December 31, 2021, the Company had $86,096 and $85,994, respectively, of outstanding long-term unsecured debentures, net of unamortized debt issuance costs of $1,585 and $1,687, respectively. The Company’s long-term unsecured debentures consisted of the following as of the dates indicated:

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    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%.  As of March 31, 2022 and December 31, 2021, the outstanding balance was $77,824 and $39,178, respectively, net of unamortized debt issuance costs of $251 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.

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

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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.

The Company’s agency MBS investment portfolio includes 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.

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Derivative Instrument Population and Fair Value

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

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 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 March 31, 2022:

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

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 March 31, 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

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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 March 31, 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:

TBA Commitments

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

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Derivative Instrument Gains and Losses

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