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```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 March 31, 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 April 29, 2022:

 

Title

 

Outstanding

Class A Common Stock

 

29,662,512 shares

 

 

 

 

ARLINGTON ASSET INVESTMENT CORP.

FORM 10-Q

FOR THE QUARTER ENDED MARCH 31, 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

 

30

 

 

Item 3.

 

Quantitative and Qualitative Disclosures about Market Risk

 

53

 

 

Item 4.

 

Controls and Procedures

 

58

PART II — OTHER INFORMATION

 

 

 

 

Item 1.

 

Legal Proceedings

 

59

 

 

Item 1A.

 

Risk Factors

 

59

 

 

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

59

 

 

Item 3.

 

Defaults Upon Senior Securities

 

60

 

 

Item 4.

 

Mine Safety Disclosures

 

60

 

 

Item 5.

 

Other Information

 

60

 

 

Item 6.

 

Exhibits

 

60

 

 

 

 

Signatures

 

63

 

 

 

i

 

 

PART I

FINANCIAL INFORMATION

Item 1. Financial Statements

ARLINGTON ASSET INVESTMENT CORP.

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands)

(Unaudited)

 

 

 

March 31, 2022

 

 

December 31, 2021

 

ASSETS

 

 

 

 

 

 

 

 

Cash and cash equivalents (includes $73 and $2,118, respectively, from

  consolidated VIEs)

 

$

21,715

 

 

$

20,543

 

Restricted cash

 

 

851

 

 

 

1,132

 

Restricted cash of consolidated VIEs

 

 

9,292

 

 

 

111

 

Sold securities receivable

 

 

—

 

 

 

28,219

 

Agency mortgage-backed securities, at fair value

 

 

292,318

 

 

 

483,927

 

MSR financing receivables, at fair value

 

 

139,225

 

 

 

125,018

 

Credit securities, at fair value

 

 

25,360

 

 

 

26,222

 

Mortgage loans, at fair value

 

 

29,592

 

 

 

29,697

 

Mortgage loans of consolidated VIEs, at fair value

 

 

261,976

 

 

 

7,442

 

Single-family residential real estate (net of $1,010 and $299, respectively, of

  accumulated depreciation)

 

 

120,952

 

 

 

60,889

 

Deposits

 

 

4,607

 

 

 

4,549

 

Other assets (includes $1,461 and $547, respectively, from consolidated VIEs)

 

 

14,995

 

 

 

15,287

 

Total assets

 

$

920,883

 

 

$

803,036

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

Repurchase agreements

 

$

284,862

 

 

$

446,624

 

Secured debt of consolidated VIEs, at fair value

 

 

244,365

 

 

 

508

 

Long-term unsecured debt

 

 

86,096

 

 

 

85,994

 

Long-term debt secured by single-family properties

 

 

77,824

 

 

 

39,178

 

Other liabilities (includes $293 and $2, respectively, from consolidated VIEs)

 

 

9,639

 

 

 

6,605

 

Total liabilities

 

 

702,786

 

 

 

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, 1,117,034 shares issued

   and outstanding (liquidation preference of $27,926)

 

 

27,356

 

 

 

27,356

 

Class A common stock, $0.01 par value, 450,000,000 shares authorized, 30,059,944

   and 30,676,931 shares issued and outstanding, respectively

 

 

301

 

 

 

307

 

Additional paid-in capital

 

 

2,027,585

 

 

 

2,030,315

 

Accumulated deficit

 

 

(1,846,146

)

 

 

(1,842,703

)

Total stockholders’ equity

 

 

218,097

 

 

 

224,127

 

Total liabilities and stockholders’ equity

 

$

920,883

 

 

$

803,036

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2022

 

 

December 31, 2021

 

Assets and liabilities of consolidated VIEs

 

 

 

 

 

 

 

 

Cash and restricted cash

 

$

9,365

 

 

$

2,229

 

Mortgage loans, at fair value

 

 

261,976

 

 

 

7,442

 

Other assets

 

 

1,461

 

 

 

547

 

Secured debt, at fair value

 

 

(244,365

)

 

 

(508

)

Other liabilities

 

 

(293

)

 

 

(2

)

Net investment in consolidated VIEs

 

$

28,144

 

 

$

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 March 31,

 

 

 

2022

 

 

2021

 

Interest income

 

 

 

 

 

 

 

 

Agency mortgage-backed securities

 

$

1,492

 

 

$

2,784

 

MSR financing receivables

 

 

3,382

 

 

 

358

 

Credit securities and loans

 

 

853

 

 

 

1,269

 

Mortgage loans of consolidated VIEs

 

 

1,354

 

 

 

1,687

 

Other

 

 

325

 

 

 

161

 

Total interest and other income

 

 

7,406

 

 

 

6,259

 

Rent revenues from single-family properties

 

 

1,064

 

 

 

—

 

Interest expense

 

 

 

 

 

 

 

 

Repurchase agreements

 

 

276

 

 

 

488

 

Long-term debt secured by single-family properties

 

 

408

 

 

 

—

 

Long-term unsecured debt

 

 

1,370

 

 

 

1,151

 

Secured debt of consolidated VIEs

 

 

1,188

 

 

 

862

 

Total interest expense

 

 

3,242

 

 

 

2,501

 

Single-family property operating expenses

 

 

1,531

 

 

 

—

 

Net operating income

 

 

3,697

 

 

 

3,758

 

Investment and derivative loss, net

 

 

(827

)

 

 

(6,763

)

General and administrative expenses

 

 

 

 

 

 

 

 

Compensation and benefits

 

 

2,065

 

 

 

1,395

 

Other general and administrative expenses

 

 

1,219

 

 

 

1,242

 

Total general and administrative expenses

 

 

3,284

 

 

 

2,637

 

Loss before income taxes

 

 

(414

)

 

 

(5,642

)

Income tax provision

 

 

2,287

 

 

 

398

 

Net loss

 

 

(2,701

)

 

 

(6,040

)

Dividend on preferred stock

 

 

(742

)

 

 

(723

)

Net loss attributable to common stock

 

$

(3,443

)

 

$

(6,763

)

Basic loss per common share

 

$

(0.12

)

 

$

(0.20

)

Diluted loss per common share

 

$

(0.12

)

 

$

(0.20

)

Weighted-average common shares outstanding

  (in thousands)

 

 

 

 

 

 

 

 

Basic

 

 

29,832

 

 

 

33,181

 

Diluted

 

 

29,832

 

 

 

33,181

 

 

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

 

 

 

 

 

 

 

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

 

 

See notes to consolidated financial statements.

 

 

3

 

 

ARLINGTON ASSET INVESTMENT CORP.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

(Unaudited)

 

 

 

Three Months Ended March 31,

 

 

 

2022

 

 

2021

 

Cash flows from operating activities:

 

 

 

 

 

 

 

 

Net loss

 

$

(2,701

)

 

$

(6,040

)

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

 

 

 

 

 

 

 

 

Investment and derivative loss, net

 

 

827

 

 

 

6,763

 

Net (discount) premium (accretion) amortization

 

 

(1,820

)

 

 

(357

)

Other

 

 

1,598

 

 

 

564

 

Changes in operating assets

 

 

 

 

 

 

 

 

Interest receivable

 

 

372

 

 

 

510

 

Other assets

 

 

(1,016

)

 

 

(90

)

Changes in operating liabilities

 

 

 

 

 

 

 

 

Interest payable and other liabilities

 

 

2,444

 

 

 

1,091

 

Accrued compensation and benefits

 

 

(1,977

)

 

 

(1,754

)

Net cash (used in) provided by operating activities

 

 

(2,273

)

 

 

687

 

Cash flows from investing activities:

 

 

 

 

 

 

 

 

Purchases of agency mortgage-backed securities

 

 

(78,874

)

 

 

(354,417

)

Purchases of credit securities

 

 

(20,585

)

 

 

—

 

Purchases of MSR financing receivables

 

 

(3,187

)

 

 

(21,279

)

Purchases of single-family residential real estate

 

 

(61,098

)

 

 

—

 

Proceeds from sales of agency mortgage-backed securities

 

 

259,415

 

 

 

517,200

 

Proceeds from sales of credit securities

 

 

—

 

 

 

11,978

 

Proceeds from sales of single-family residential real estate

 

 

351

 

 

 

—

 

Receipt of principal payments on agency mortgage-backed securities

 

 

12,717

 

 

 

14,305

 

Receipt of principal payments on credit securities

 

 

308

 

 

 

—

 

Receipt of principal payments on loans

 

 

105

 

 

 

85

 

Receipt of principal payments on mortgage loans of consolidated VIE

 

 

14,855

 

 

 

36,529

 

Receipt of distributions on MSR financing receivables

 

 

15,119

 

 

 

—

 

Restricted cash balance of VIE upon consolidation

 

 

9,637

 

 

 

—

 

Proceeds from (payments for) derivatives and deposits, net

 

 

3,026

 

 

 

(2,543

)

Other

 

 

1,351

 

 

 

4,154

 

Net cash provided by investing activities

 

 

153,140

 

 

 

206,012

 

Cash flows from financing activities:

 

 

 

 

 

 

 

 

Repayments of repurchase agreements, net

 

 

(161,761

)

 

 

(149,662

)

Repayments of secured debt of consolidated VIE

 

 

(13,576

)

 

 

(34,994

)

Repurchase of common stock

 

 

(3,497

)

 

 

(523

)

Proceeds from issuance of preferred stock

 

 

149

 

 

 

—

 

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

 

 

38,632

 

 

 

—

 

Repurchase of long-term unsecured debt

 

 

—

 

 

 

(7

)

Dividends paid

 

 

(742

)

 

 

(723

)

Other

 

 

—

 

 

 

—

 

Net cash used in financing activities

 

 

(140,795

)

 

 

(185,909

)

Net increase in cash, cash equivalents and restricted cash

 

 

10,072

 

 

 

20,790

 

Cash, cash equivalents and restricted cash, beginning of period

 

 

21,786

 

 

 

39,965

 

Cash, cash equivalents and restricted cash, end of period

 

$

31,858

 

 

$

60,755

 

Supplemental cash flow information:

 

 

 

 

 

 

 

 

Cash payments for interest

 

$

3,278

 

 

$

2,434

 

Cash payments for taxes

 

$

—

 

 

$

—

 

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 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.

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 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:

 

 Scenario:

 

 

Effect on Interest Income Recognition for Investments

in Credit Securities and MSR Financing Receivables:

 

 

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.

 

 

6

 

 

 

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

 

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, the Company has not made any modifications to contracts due to reference rate reform.

 

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 an 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 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:

7

 

 

 

 

 

Three Months Ended March 31,

 

 

 

2022

 

 

2021

 

Net gains (losses) recognized in earnings for:

 

 

 

 

 

 

 

 

Agency MBS still held at period end

 

$

(17,414

)

 

$

(19,035

)

Agency MBS sold during the period

 

 

(8,543

)

 

 

(10,180

)

Total

 

$

(25,957

)

 

$

(29,215

)

 

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:

 

 

 

Three Months Ended March 31,

 

 

 

2022

 

 

2021

 

Net gains (losses) recognized in earnings for:

 

 

 

 

 

 

 

 

Credit securities still held at period end

 

$

(842

)

 

$

551

 

Credit securities sold during the period

 

 

—

 

 

 

840

 

Total

 

$

(842

)

 

$

1,391

 

 

 

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.

8

 

 

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:

 

 

 

Three Months Ended March 31,

 

 

 

2022

 

 

2021

 

Balance at period beginning

 

$

125,018

 

 

$

9,346

 

Capital investments

 

 

3,187

 

 

 

20,344

 

Capital distributions

 

 

(15,120

)

 

 

—

 

Accretion of interest income

 

 

3,382

 

 

 

358

 

Changes in valuation inputs and assumptions

 

 

22,758

 

 

 

5,957

 

Balance at period end

 

$

139,225

 

 

$

36,005

 

 

 

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.  

9

 

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:

 

 

 

March 31, 2022

 

 

December 31, 2021

 

Investments in single-family residential real estate:

 

 

 

 

 

 

 

 

Land

 

$

20,317

 

 

$

10,128

 

Buildings and improvements

 

 

101,645

 

 

 

51,060

 

Investments in single-family residential real estate, at cost

 

 

121,962

 

 

 

61,188

 

Less: accumulated depreciation

 

 

(1,010

)

 

 

(299

)

Investments in single-family residential real estate, net

 

$

120,952

 

 

$

60,889

 

 

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

10

 

 

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:

 

 

 

March 31, 2022

 

 

 

VIE of Business Purpose Residential Mortgage Loans

 

 

VIE of Residential Mortgage Loans

 

 

Total

 

Cash of consolidated VIEs

 

$

73

 

 

$

—

 

 

$

73

 

Restricted cash of consolidated VIEs (1)

 

 

4

 

 

 

9,288

 

 

 

9,292

 

Mortgage loans of consolidated VIEs, at fair value

 

 

5,684

 

 

 

256,292

 

 

 

261,976

 

Other assets of consolidated VIEs

 

 

506

 

 

 

955

 

 

 

1,461

 

Secured debt of consolidated VIEs, at fair value

 

 

(312

)

 

 

(244,053

)

 

 

(244,365

)

Other liabilities of consolidated VIEs

 

 

(2

)

 

 

(291

)

 

 

(293

)

Net investment in consolidated VIEs

 

$

5,953

 

 

$

22,191

 

 

$

28,144

 

 

 

(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.

 

11

 

 

 

 

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 $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

 

12

 

 

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:

 

 

 

Aggregate Fair Value

 

 

Aggregate Unpaid Principal Balance

 

 

Difference

 

Less than 90 days past due and in accrual status

 

$

1,076

 

 

$

1,093

 

 

$

(17

)

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

 

 

4,608

 

 

 

4,837

 

 

 

(229

)

Total mortgage loans of consolidated VIE

 

$

5,684

 

 

$

5,930

 

 

$

(246

)

 

 

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:

 

 

 

Aggregate Fair Value

 

 

Aggregate Unpaid Principal Balance

 

 

Difference

 

Less than 90 days past due and in accrual status

 

$

255,065

 

 

$

249,781

 

 

$

5,284

 

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

 

 

1,227

 

 

 

1,227

 

 

 

—

 

Total mortgage loans of consolidated VIE

 

$

256,292

 

 

$

251,008

 

 

$

5,284

 

 

 

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.

13

 

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:

 

 

 

March 31, 2022

 

 

December 31, 2021

 

Agency MBS repurchase financing:

 

 

 

 

 

 

 

 

Repurchase agreements outstanding

 

$

264,148

 

 

$

425,836

 

Agency MBS collateral, at fair value (1)

 

 

279,874

 

 

 

447,979

 

Net amount (2)

 

 

15,726

 

 

 

22,143

 

Weighted-average rate

 

 

0.36

%

 

 

0.14

%

Weighted-average term to maturity

 

13.0 days

 

 

13.0 days

 

Mortgage loans repurchase financing:

 

 

 

 

 

 

 

 

Repurchase agreements outstanding

 

$

20,714

 

 

$

20,788

 

Mortgage loans collateral, at fair value

 

 

29,592

 

 

 

29,697

 

Net amount (2)

 

 

8,878

 

 

 

8,909

 

Weighted-average rate

 

 

2.86

%

 

 

2.60

%

Weighted-average term to maturity

 

351.0 days

 

 

319.0 days

 

Total mortgage investments repurchase financing:

 

 

 

 

 

 

 

 

Repurchase agreements outstanding

 

$

284,862

 

 

$

446,624

 

Mortgage investments collateral, at fair value (1)

 

 

309,466

 

 

 

477,676

 

Net amount (2)

 

 

24,604

 

 

 

31,052

 

Weighted-average rate

 

 

0.54

%

 

 

0.25

%

Weighted-average term to maturity

 

37.6 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 months ended March 31, 2022 and 2021:

 

 

 

March 31, 2022

 

 

March 31, 2021

 

Weighted-average outstanding balance during the three months ended

 

$

342,364

 

 

$

553,842

 

Weighted-average rate during the three months ended

 

 

0.32

%

 

 

0.35

%

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:

 

 

 

March 31, 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

%

 

 

2.99

%

 

 

6.75

%

 

 

6.000

%

 

 

2.87

%

Maturity

 

March 15, 2025

 

 

August 1, 2026

 

 

2033 - 2035

 

 

March 15, 2025

 

 

August 1, 2026

 

 

2033 - 2035

 

 

14

 

 

    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

15

 

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.

16

 

Derivative Instrument Population and Fair Value

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

 

 

 

March 31, 2022

 

 

December 31, 2021

 

 

 

Assets

 

 

Liabilities

 

 

Assets

 

 

Liabilities

 

Interest rate swaps

 

$

—

 

 

$

(239

)

 

$

—

 

 

$

(107

)

10-year U.S. Treasury note futures

 

 

—

 

 

 

—

 

 

 

16

 

 

 

—

 

Options on U.S. Treasury note futures

 

 

—

 

 

 

—

 

 

 

4

 

 

 

—

 

TBA commitments

 

 

271

 

 

 

(1,502

)

 

 

230

 

 

 

(121

)

Total

 

$

271

 

 

$

(1,741

)

 

$

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 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:

 

 

 

 

 

 

 

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

 

$

100,000

 

 

 

0.90

%

 

 

0.27

%

 

 

(0.63

)%

 

 

1.7

 

 

$

(56

)

3 to less than 10 years

 

 

75,000

 

 

 

1.33

%

 

 

0.45

%

 

 

(0.88

)%

 

 

5.8

 

 

 

(183

)

Total / weighted-average

 

$

175,000

 

 

 

1.08

%

 

 

0.35

%

 

 

(0.73

)%

 

 

3.5

 

 

$

(239

)

 

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 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

17

 

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:

 

 

 

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.

 

TBA Commitments

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

 

 

 

March 31, 2022

 

 

 

Notional Amount:

Net Purchase (Sale)

Commitment

 

 

Contractual Forward Price

 

 

Market Price

 

 

Fair Value

 

2.0% 30-year MBS purchase commitments

 

$

50,000

 

 

$

47,344

 

 

$

46,398

 

 

$

(946

)

2.0% 30-year MBS sale commitments

 

 

(50,000

)

 

 

(46,531

)

 

 

(46,398

)

 

 

133

 

2.5% 30-year MBS purchase commitments

 

 

25,000

 

 

 

24,391

 

 

 

23,850

 

 

 

(541

)

2.5% 30-year MBS sale commitments

 

 

(25,000

)

 

 

(23,973

)

 

 

(23,850

)

 

 

123

 

Total TBA commitments, net

 

$

—

 

 

$

1,231

 

 

$

—

 

 

$

(1,231

)

 

 

 

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

 

 

18

 

 

Derivative Instrument Gains and Losses

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

 

 

Three Months Ended March 31,

 

 

2022

 

 

2021

 

Interest rate derivatives:

 

 

 

 

 

 

 

Interest rate swaps:

 

 

 

 

 

 

 

Net interest expense (1)

$

(291

)

 

$

(710

)

Unrealized gains, net

 

3,466

 

 

 

21,065

 

Gains (losses) realized upon early termination, net

 

3,161

 

 

 

(13

)

Total interest rate swap gains, net

 

6,336

 

 

 

20,342

 

U.S. Treasury note futures, net

 

(782

)

 

 

2,619

 

Options on U.S. Treasury note futures, net

 

(4

)

 

 

(20

)

Total interest rate derivative gains, net

 

5,550

 

 

 

22,941

 

TBA commitments:

 

 

 

 

 

 

 

TBA dollar roll income (2)

 

823

 

 

 

836

 

Other losses on TBA commitments, net

 

(4,706

)

 

 

(9,232

)

Total losses on TBA commitments, net

 

(3,883

)

 

 

(8,396

)

Total derivative gains, net

$

1,667

 

 

$

14,545

 

 

 

(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.

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 March 31, 2022

 

 

 

Beginning of

Period

 

 

Additions

 

 

Scheduled

Settlements

 

 

Early

Terminations

 

 

End of Period

 

Interest rate swaps

 

$

150,000

 

 

$

70,000

 

 

$

—

 

 

$

(45,000

)

 

$

175,000

 

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 purchase (sale) commitments, net

 

 

—

 

 

 

325,000

 

 

 

(325,000

)

 

 

—

 

 

 

—

 

 

 

 

For the Three Months Ended March 31, 2021

 

 

 

Beginning of

Period

 

 

Additions

 

 

Scheduled Settlements

 

 

Early

Terminations

 

 

End of Period

 

Interest rate swaps

 

$

275,000

 

 

$

450,000

 

 

$

—

 

 

$

(50,000

)

 

$

675,000

 

2-year U.S. Treasury note futures

 

 

—

 

 

 

50,000

 

 

 

(50,000

)

 

 

—

 

 

 

—

 

10-year U.S. Treasury note futures

 

 

—

 

 

 

375,100

 

 

 

(200,000

)

 

 

(175,100

)

 

 

—

 

Purchased call options on 10-year U.S.

  Treasury note futures

 

 

—

 

 

 

65,200

 

 

 

—

 

 

 

—

 

 

 

65,200

 

TBA purchase (sale) commitments, net

 

 

—

 

 

 

915,000

 

 

 

(815,000

)

 

 

—

 

 

 

100,000

 

19

 

 

 

 

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:

 

 

 

March 31, 2022

 

 

December 31, 2021

 

Cash collateral posted for:

 

 

 

 

 

 

 

 

Interest rate swaps (cash initial margin)

 

$

3,432

 

 

$

4,174

 

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

 

 

—

 

 

 

375

 

TBA commitments, net

 

 

1,175

 

 

 

—

 

Total cash collateral posted, net

 

$

4,607

 

 

$

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 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 March 31, 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

 

$

271

 

 

$

—

 

 

$

271

 

 

$

(271

)

 

$

—

 

 

$

—

 

Total derivative instruments

 

 

271

 

 

 

—

 

 

 

271

 

 

 

(271

)

 

 

—

 

 

 

—

 

Total assets

 

$

271

 

 

$

—

 

 

$

271

 

 

$

(271

)

 

$

—

 

 

$

—

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivative instruments:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate swaps

 

$

239

 

 

$

—

 

 

$

239

 

 

$

—

 

 

$

(239

)

 

$

—

 

TBA commitments

 

 

1,502

 

 

 

—

 

 

 

1,502

 

 

 

(271

)

 

 

(1,175

)

 

 

56

 

Total derivative instruments

 

 

1,741

 

 

 

—

 

 

 

1,741

 

 

 

(271

)

 

 

(1,414

)

 

 

56

 

Repurchase agreements

 

 

284,862

 

 

 

—

 

 

 

284,862

 

 

 

(284,862

)

 

 

—

 

 

 

—

 

Total liabilities

 

$

286,603

 

 

$

—

 

 

$

286,603

 

 

$

(285,133

)

 

$

(1,414

)

 

$

56

 

20

 

 

 

 

 

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 that exceeds the associated derivative 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 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.

21

 

 

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 – As of March 31, 2022 and December 31, 2021, the Company’s investments in credit securities consisted of a non-agency MBS collateralized by a pool of residential business-purpose mortgage loans and ABS collateralized by residential solar panel loans, all of which 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 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 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 Company’s non-agency MBS secured by business-purpose residential mortgage loans as of dates indicated:

 

 

March 31, 2022

 

 

December 31, 2021

 

Annualized default rate

 

39.5

%

 

 

77.7

%

Loss-given-default

 

15.2

%

 

 

15.8

%

Discount rate

 

13.0

%

 

 

13.0

%

 

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.

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 March 31, 2022 and 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 March 31, 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 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 mortgage loans of the consolidated VIE as of March 31, 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

22

 

of default and loss-given-default.  The following table presents the weighted-average of the significant inputs to the fair value measurement of the mortgage loans of the Company’s consolidated VIE as of the periods indicated:

 

 

March 31, 2022

 

 

December 31, 2021

 

Probability of default

 

45.1

%

 

 

66.2

%

Loss-given-default

 

9.8

%

 

 

8.6

%

 

As of March 31, 2022, the Company measured the fair value of both the 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 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 March 31, 2022:

 

 

Subordinate Debt Obligation

 

 

Excess Interest-Only Debt Obligations

 

Annualized voluntary prepayment rate

 

18.6

%

 

 

18.6

%

Annualized default rate

 

0.5

%

 

 

0.5

%

Loss-given-default

 

17.5

%

 

 

17.5

%

Discount rate

 

6.6

%

 

 

17.0

%

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:

 

 

 

March 31, 2022

 

 

December 31, 2021

 

Discount rate

 

 

8.0

%

 

 

9.0

%

Annualized prepayment rate

 

 

8.2

%

 

 

10.1

%

Annual per-loan cost of servicing (current loans)

 

$

60.00

 

 

$

65.00

 

23

 

 

 

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 March 31, 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 $9,223 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.

Other

Long-term unsecured debt - As of March 31, 2022 and December 31, 2021, the carrying value of the Company’s long-term unsecured debt was $86,096 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 $83,661 and $84,821 as of March 31, 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 March 31, 2022 and December 31, 2021, the carrying value of the Company’s long-term debt secured by single-family properties was $77,824 and $39,178, respectively, net of unamortized debt issuance costs. As of March 31, 2022 and December 31, 2021, the Company’s estimate of the fair value of its long-term debt secured by single-family properties was $72,314 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 March 31, 2022 and December 31, 2021, the Company had investments in equity securities of publicly-traded companies at fair value of $3,525 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 March 31, 2022 and December 31, 2021, the Company investments in equity securities of non-public companies and investment funds measured at fair value of $7,165 and $7,388, respectively, which are included in the line item “other assets” in the accompanying consolidated balance sheets.

24

 

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 March 31, 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 95 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.

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 March 31, 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.

 

 

 

March 31, 2022

 

 

 

Total

 

 

Level 1

 

 

Level 2

 

 

Level 3

 

Financial assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Agency MBS

 

$

292,318

 

 

$

—

 

 

$

292,318

 

 

$

—

 

MSR financing receivables

 

 

139,225

 

 

 

—

 

 

 

—

 

 

 

139,225

 

Loans

 

 

29,592

 

 

 

—

 

 

 

—

 

 

 

29,592

 

Credit securities

 

 

25,360

 

 

 

—

 

 

 

—

 

 

 

25,360

 

Mortgage loans of consolidated VIEs

 

 

261,976

 

 

 

—

 

 

 

—

 

 

 

261,976

 

Derivative assets

 

 

271

 

 

 

—

 

 

 

271

 

 

 

—

 

Other assets

 

 

10,690

 

 

 

3,525

 

 

 

—

 

 

 

7,165

 

Financial liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Secured debt of consolidated VIEs

 

 

244,365

 

 

 

—

 

 

 

230,750

 

 

 

13,615

 

Derivative liabilities

 

 

1,741

 

 

 

—

 

 

 

1,741

 

 

 

—

 

 

 

 

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

 

 

 

—

 

 

25

 

 

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 March 31,

 

 

2022

 

 

2021

 

Beginning balance

$

195,767

 

 

$

166,428

 

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

 

15,215

 

 

 

6,318

 

Additions from consolidation of VIEs

 

276,594

 

 

 

—

 

Purchases

 

3,187

 

 

 

20,344

 

Sales

 

—

 

 

 

—

 

Payments, net

 

(30,618

)

 

 

(36,776

)

Accretion (amortization) of discount (premium), net

 

3,173

 

 

 

1,400

 

Ending balance

$

463,318

 

 

$

157,714

 

Net unrealized gains (losses) included in earnings for the

   period for Level 3 assets still held at the reporting date

$

15,215

 

 

$

6,318

 

 

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 March 31,

 

 

2022

 

 

2021

 

Beginning balance

$

508

 

 

$

576

 

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

 

(251

)

 

 

(39

)

Additions from consolidation of VIEs

 

14,278

 

 

 

—

 

Payments, net

 

(860

)

 

 

—

 

(Amortization) accretion of (premium) discount, net

 

(60

)

 

 

74

 

Ending balance

$

13,615

 

 

$

611

 

Net unrealized losses (gains) included in earnings for the

   period for Level 3 liabilities still held at the reporting date

$

(251

)

 

$

(39

)

 

 

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 March 31, 2022, the Company had estimated net operating loss (“NOL”) carryforwards of $165,410 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 $150,822 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 March 31, 2022, the Company had estimated net capital loss (“NCL”) carryforwards of $145,960 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 $18,838 in 2027.  The Company’s estimated NOL and NCL carryforwards as of March 31, 2022 are subject to potential adjustments up to the time of filing of the Company’s income tax returns.

26

 

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 March 31, 2022 and 2021, the Company recognized a provision for income taxes of $2,287 and $398, respectively, on the pre-tax net 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 March 31, 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

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 March 31,

 

(Shares in thousands)

2022

 

 

2021

 

Basic weighted-average common shares outstanding

 

29,832

 

 

 

33,181

 

Performance share units, unvested restricted stock units,

   and unvested restricted stock

 

—

 

 

 

—

 

Diluted weighted-average common shares outstanding

 

29,832

 

 

 

33,181

 

Net loss attributable to common stock

$

(3,443

)

 

$

(6,763

)

Basic loss per common share

$

(0.12

)

 

$

(0.20

)

Diluted loss per common share

$

(0.12

)

 

$

(0.20

)

 

 The diluted loss per share for the three months ended March 31, 2022 and 2021 did not include the antidilutive effect of 482,445 and 263,410 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 March 31, 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 Stock Dividends

The Board of Directors evaluates common stock dividends on a quarterly basis and, in its sole discretion, approves the payment of dividends. The Company’s common stock dividend payments, if any, may vary significantly from quarter to quarter. For the three months ended March 31, 2022 and the year ended December 31, 2021, the Board of Directors determined that the Company would not declare a dividend on its common stock.

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.

27

 

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 months ended March 31, 2022 and the year ended December 31, 2021, there were no issuances of common stock under the common equity distribution agreements.

As of March 31, 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 October 26, 2015, the Company announced that its Board of Directors authorized a share repurchase program pursuant to which the Company may repurchase up to 2,000,000 shares of Class A common stock (the “Repurchase Program”). On July 31, 2020, the Company announced that its Board of Directors authorized an increase in the Repurchase Program pursuant to which the Company may repurchase up to 18,000,000 shares of Class A common stock, inclusive of 56,090 shares previously available to be repurchased under the prior authorization.  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.  

 

During the three months ended March 31, 2022, the Company repurchased 1,009,566 shares of Class A common stock for a total purchase price of $3,497. 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 March 31, 2022, there remain available for repurchase 11,980,712 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 commencing on May 12, 2022 or earlier upon the occurrence of a change in control. 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.  

28

 

 

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 three months ended March 31, 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. 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 March 31, 2022, the Company had 1,602,566 shares of Series B Preferred stock available for sale under the preferred equity distribution agreement.

 

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. The Second Amendment also decreases the Purchase Price (as defined under the Rights Plan) from $70.00 to $21.30.  No shareholder approval was required for adoption of the Second Amendment; however, the Company has submitted the Second Amendment to its shareholders for approval at the 2022 annual meeting of shareholders.  

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 First Amendment, and any outstanding rights will expire at the earliest of (i) June 4, 2022, (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.  If the Second Amendment is approved by our shareholders at the 2022 annual meeting, the Rights Plan, as further amended, 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.

29

 

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.

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 2.34% as of March 31, 2022, an 83 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 rate, flattened 77 basis points to only one basis point as of March 31, 2022 as the short end of the curve increased significantly from the prior quarter end.  The spread between the current coupon agency MBS and the 10-year swap rate widened meaningfully by 59 basis points during the first quarter of 2022.  The rate of inflation increased significantly during the first quarter of 2022 with the Consumer Price Index rising 1.2% with the index for gasoline, shelter and food being the largest contributors.  For the twelve month period ending March 31, 2022, the Consumer Price Index increased 8.5%.

30

 

At its March 16, 2022 meeting, the Federal Open Market Committee (“FOMC”) decided to raise its target range for the federal funds rate by 25 basis points to a range of 0.25% to 0.50% and that it anticipates ongoing increases in the target range will be appropriate.  In addition, the FOMC expects to begin reducing its holdings of Treasury securities and agency MBS at a coming meeting.  The market is currently expecting multiple rate hikes totaling approximately 225 basis points in the next twelve months based on federal funds futures.

Prepayment speeds in the fixed-rate residential mortgage market decreased during the first 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 first quarter of 2022 as a result of declining prepayment concerns. The spread between the market yield on agency MBS and benchmark interest rates widened significantly during the first quarter of 2022 resulting in agency MBS underperforming relative to interest rate hedges.  Conversely, valuation multiples of MSRs increased meaningfully during the first 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 19.8% annual gain in February 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.

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

 

 

 

 

March 31,

2021

 

 

June 30,

2021

 

 

September 30,

2021

 

 

December 31,

2021

 

 

March 31,

2022

 

 

Change - First Quarter 2022

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

30-Year FNMA Fixed Rate MBS (1)

 

2.0%

 

$

99.67

 

 

$

100.98

 

 

$

100.38

 

 

$

99.72

 

 

$

92.63

 

 

$

(7.09

)

2.5%

 

 

102.51

 

 

 

103.41

 

 

 

103.22

 

 

 

102.09

 

 

 

95.20

 

 

 

(6.89

)

3.0%

 

 

104.13

 

 

 

104.22

 

 

 

104.67

 

 

 

103.64

 

 

 

97.55

 

 

 

(6.09

)

3.5%

 

 

105.61

 

 

 

105.27

 

 

 

105.83

 

 

 

105.32

 

 

 

99.75

 

 

 

(5.57

)

4.0%

 

 

107.32

 

 

 

106.54

 

 

 

107.17

 

 

 

106.41

 

 

 

101.58

 

 

 

(4.83

)

4.5%

 

 

108.87

 

 

 

107.63

 

 

 

108.16

 

 

 

107.22

 

 

 

103.25

 

 

 

(3.97

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investment Spreads

 

FNMA Current Coupon vs.

   10-year Swap Rate

 

26 bps

 

 

39 bps

 

 

46 bps

 

 

49 bps

 

 

108 bps

 

 

59 bps

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Treasury Rates ("UST")

 

2-year UST

 

 

0.16

%

 

 

0.25

%

 

 

0.28

%

 

 

0.73

%

 

 

2.33

%

 

160 bps

 

5-year UST

 

 

0.94

%

 

 

0.89

%

 

 

0.96

%

 

 

1.26

%

 

 

2.46

%

 

120 bps

 

10-year UST

 

 

1.74

%

 

 

1.47

%

 

 

1.49

%

 

 

1.51

%

 

 

2.34

%

 

83 bps

 

2-year UST to 10-year UST spread

 

158 bps

 

 

122 bps

 

 

121 bps

 

 

78 bps

 

 

1 bps

 

 

-77 bps

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest Rate Swap Rates

 

2-year swap

 

 

0.29

%

 

 

0.33

%

 

 

0.38

%

 

 

0.94

%

 

 

2.55

%

 

161 bps

 

5-year swap

 

 

1.06

%

 

 

0.96

%

 

 

1.05

%

 

 

1.37

%

 

 

2.52

%

 

115 bps

 

10-year swap

 

 

1.78

%

 

 

1.44

%

 

 

1.51

%

 

 

1.58

%

 

 

2.41

%

 

83 bps

 

2-year swap to 2-year UST spread

 

13 bps

 

 

8 bps

 

 

10 bps

 

 

21 bps

 

 

22 bps

 

 

1 bps

 

10-year swap to 10-year UST spread

 

4 bps

 

 

-3 bps

 

 

2 bps

 

 

7 bps

 

 

7 bps

 

 

0 bps

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

1-month LIBOR

 

 

0.11

%

 

 

0.10

%

 

 

0.08

%

 

 

0.10

%

 

 

0.45

%

 

35 bps

 

3-month LIBOR

 

 

0.19

%

 

 

0.15

%

 

 

0.13

%

 

 

0.21

%

 

 

0.96

%

 

75 bps

 

SOFR

 

 

0.01

%

 

 

0.05

%

 

 

0.05

%

 

 

0.05

%

 

 

0.29

%

 

24 bps

 

 

(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.

31

 

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 borrowings 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 March 31, 2022, these financial instruments include interest rate swap agreements and preferred stock and unsecured notes issued by us.

As of March 31, 2022, we had $175 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 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.

32

 

As of March 31, 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 March 31, 2022, we had 1,117,034 shares of Series C Preferred Stock outstanding with a liquidation preference of $27.9 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 March 31, 2022 (dollars in thousands):

 

 

 

March 31, 2022

 

 

 

Assets

 

 

Invested Capital

Allocation (1)

 

 

Invested Capital

Allocation (%)

 

 

Leverage (2)

 

MSR financing receivables

 

$

139,225

 

 

$

139,225

 

 

 

50

%

 

 

0.3

 

Credit investments (3)

 

 

83,096

 

 

 

62,485

 

 

 

22

%

 

 

0.3

 

Single-family residential properties

 

 

121,962

 

 

 

48,036

 

 

 

17

%

 

 

1.6

 

Agency MBS

 

 

292,318

 

 

 

31,900

 

 

 

11

%

 

 

8.3

 

Total invested capital

 

$

636,601

 

 

 

281,646

 

 

 

100

%

 

 

 

 

Cash and other corporate capital

 

 

 

 

 

 

23,557

 

 

 

 

 

 

 

 

 

Total investable capital

 

 

 

 

 

$

305,203

 

 

 

 

 

 

1.3

 

 

 

(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.

 

(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 price of our TBA commitments and leverage within our MSR financing receivables less our cash and cash equivalents compared to our investable capital.

33

 

 

(3)

Includes our net investment of $28,144 in VIEs with gross assets and liabilities of $272,802 and $244,658, respectively, that is consolidated for GAAP financial reporting purposes.

MSR Financing Receivables

As of March 31, 2022, we had $139.2 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 March 31, 2022 (dollars in thousands):

 

 

Amortized Cost Basis (1)

 

 

Unrealized Gain

 

 

Fair Value

 

$

102,284

 

 

$

36,941

 

 

$

139,225

 

 

 

(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

 

$

179,987

 

 

$

(43,948

)

 

$

2,587

 

 

$

9,822

 

 

$

(9,223

)

 

$

139,225

 

 

 

0.32

 

 

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

 

$

13,450,698

 

 

 

2.94

%

 

 

0.25

%

 

13 months

 

 

1.31

%

 

 

5.21

 

 

$

176,026

 

Freddie Mac

 

 

298,226

 

 

 

3.06

%

 

 

0.25

%

 

9 months

 

 

1.33

%

 

 

5.31

 

 

 

3,961

 

Total/weighted-average

 

$

13,748,924

 

 

 

2.94

%

 

 

0.25

%

 

13 months

 

 

1.31

%

 

 

5.21

 

 

$

179,987

 

 

 

(1)

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

Credit Investment Portfolio

As of March 31, 2022, our credit investment portfolio was primarily comprised of a $29.6 million commercial mortgage loan secured by a first lien position in healthcare facilities and $53.5 million in non-agency MBS or ABS investments collateralized by pools of business purpose residential mortgage loans, residential mortgage loans and residential solar panel loans, including a $28.1 million net investment in VIEs consolidated for GAAP financial reporting purposes.  The following table presents further information about our credit investments as of March 31, 2022 (dollars in thousands):

 

 

Fair Value (1)

 

 

Market Price

 

 

Leverage

 

 

Cumulative Total Return on Capital (2)

 

Commercial mortgage loan

$

29,592

 

 

$

100.00

 

 

 

2.3

 

 

 

11.15

%

Residential MBS - interest-only (3)

 

20,910

 

 

 

8.20

 

 

 

—

 

 

 

124.14

%

Residential MBS (3)

 

1,281

 

 

 

79.13

 

 

 

—

 

 

 

(54.26

)%

Business purpose residential MBS (4)

 

17,002

 

 

 

94.42

 

 

 

—

 

 

 

9.27

%

Residential solar panel loan ABS

 

14,311

 

 

 

78.19

 

 

 

—

 

 

 

(4.55

)%

Total/weighted-average

$

83,096

 

 

 

 

 

 

 

0.3

 

 

 

11.53

%

 

34

 

 

 

(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 $22,191 in a VIE with gross assets and liabilities of $266,535 and $244,344, respectively, that is consolidated for GAAP financial reporting purposes.

 

(4)

Includes our net investment of $5,953 in a VIE with gross assets and liabilities of $6,267 and $314, 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 March 31, 2022 (dollars in thousands):

 

Market

 

Number of

Properties

 

 

Gross Book

Value

 

 

Average Gross

Book Value

 

 

Average

Square Feet

 

 

Average

Year Built

 

Tulsa, OK

 

 

78

 

 

$

19,780

 

 

$

254

 

 

 

1,735

 

 

 

2016

 

Dallas, TX

 

 

57

 

 

 

19,592

 

 

 

344

 

 

 

1,969

 

 

 

2014

 

Atlanta, GA

 

 

61

 

 

 

19,449

 

 

 

319

 

 

 

2,284

 

 

 

2010

 

Huntsville, AL

 

 

47

 

 

 

15,105

 

 

 

321

 

 

 

2,356

 

 

 

2013

 

Memphis, TN

 

 

45

 

 

 

13,209

 

 

 

294

 

 

 

1,910

 

 

 

2007

 

Charlotte, NC

 

 

34

 

 

 

11,905

 

 

 

350

 

 

 

1,921

 

 

 

2011

 

Kansas City, MO

 

 

40

 

 

 

11,738

 

 

 

293

 

 

 

1,947

 

 

 

2006

 

Birmingham, AL

 

 

43

 

 

 

11,184

 

 

 

260

 

 

 

1,691

 

 

 

2018

 

Total/weighted average

 

 

405

 

 

$

121,962

 

 

$

301

 

 

 

1,974

 

 

 

2012

 

 

 

Status of Property

 

Number of

Properties

 

 

Gross Book

Value

 

In rehabilitation

 

 

47

 

 

$

14,517

 

In marketing

 

 

69

 

 

 

21,124

 

Leased not yet occupied

 

 

20

 

 

 

6,291

 

Leased and occupied

 

 

269

 

 

 

80,030

 

Total

 

 

405

 

 

$

121,962

 

 

 

As of March 31, 2022, we also had commitments to acquire 49 properties for an aggregate purchase price of $14,616.  On May 10, 2022, we entered into a definitive agreement to sell 378 SFR properties. Refer to Part II, Item 5. “Other Information” for further information.

Agency MBS Investment Portfolio

Our agency MBS consisted of the following as of March 31, 2022 (dollars in thousands):

 

 

 

Unpaid Principal Balance

 

 

Net Unamortized Purchase Premiums

 

 

Amortized Cost Basis

 

 

Net Unrealized (Loss) Gain

 

 

Fair Value

 

 

Market Price

 

 

Coupon

 

 

Weighted

Average

Expected

Remaining

Life

 

30-year fixed rate:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2.0%

 

$

98,035

 

 

$

2,264

 

 

$

100,299

 

 

$

(8,867

)

 

$

91,432

 

 

$

93.26

 

 

 

2.00

%

 

 

9.0

 

2.5%

 

 

129,057

 

 

 

6,750

 

 

 

135,807

 

 

 

(11,896

)

 

 

123,911

 

 

 

96.01

 

 

 

2.50

%

 

 

7.9

 

3.0%

 

 

45,092

 

 

 

450

 

 

 

45,542

 

 

 

(1,183

)

 

 

44,359

 

 

 

98.37

 

 

 

3.00

%

 

 

8.2

 

3.5%

 

 

32,474

 

 

 

855

 

 

 

33,329

 

 

 

(721

)

 

 

32,608

 

 

 

100.41

 

 

 

3.50

%

 

 

7.8

 

5.5%

 

 

8

 

 

 

—

 

 

 

8

 

 

 

—

 

 

 

8

 

 

 

109.57

 

 

 

5.50

%

 

 

5.4

 

Total/weighted-average

 

$

304,666

 

 

$

10,319

 

 

$

314,985

 

 

$

(22,667

)

 

$

292,318

 

 

$

95.95

 

 

 

2.52

%

 

 

8.3

 

 

35

 

 

 

 

Unpaid Principal Balance

 

 

Net Unamortized Purchase Premiums

 

 

Amortized Cost Basis

 

 

Net Unrealized (Loss) Gain

 

 

Fair Value

 

 

Market

Price

 

 

Coupon

 

 

Weighted

Average

Expected

Remaining

Life

 

Fannie Mae

 

$

240,399

 

 

$

7,710

 

 

$

248,109

 

 

$

(18,914

)

 

$

229,195

 

 

$

95.34

 

 

 

2.39

%

 

 

8.4

 

Freddie Mac

 

 

64,267

 

 

 

2,609

 

 

 

66,876

 

 

 

(3,753

)

 

 

63,123

 

 

 

98.22

 

 

 

3.01

%

 

 

7.7

 

Total/weighted-average

 

$

304,666

 

 

$

10,319

 

 

$

314,985

 

 

$

(22,667

)

 

$

292,318

 

 

$

95.95

 

 

 

2.52

%

 

 

8.3

 

 

The annualized prepayment rate for our agency MBS was 9.01% for the three months ended March 31, 2022. As of March 31, 2022, our agency MBS was comprised of securities specifically selected for their relatively lower propensity for prepayment, which includes approximately 79% in specified pools of low balance loans 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 0.44 of a percentage point as of March 31, 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 accordance with GAAP, we account for our net long TBA positions as derivative instruments. As of March 31, 2022, we did not have any long TBA agency positions.

 

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 short-term financing arrangements. As of March 31, 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 March 31, 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

 

$

100,000

 

 

 

0.90

%

 

 

0.27

%

 

 

(0.63

)%

 

 

1.7

 

3 to less than 10 years

 

 

75,000

 

 

 

1.33

%

 

 

0.45

%

 

 

(0.88

)%

 

 

5.8

 

Total / weighted-average

 

$

175,000

 

 

 

1.08

%

 

 

0.35

%

 

 

(0.73

)%

 

 

3.5

 

 

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 March 31, 2022, we had no outstanding U.S. Treasury note futures.

 

Results of Operations

Net Operating Income

Net operating income determined in accordance with GAAP 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. 

36

 

Net operating income determined in accordance with GAAP 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 prepared in accordance with GAAP, 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;

 

•

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.

 

37

 

 

Three months ended March 31, 2022 compared to the three months ended March 31, 2021

The following table presents the net income (loss) available (attributable) to common stock reported for the three months ended March 31, 2022 and 2021, respectively (dollars in thousands, except per share amounts):

 

 

 

Three Months Ended March 31,

 

 

 

2022

 

 

2021

 

Interest and other income

 

$

7,406

 

 

$

6,259

 

Rent revenues from single-family properties

 

 

1,064

 

 

 

—

 

Interest expense

 

 

3,242

 

 

 

2,501

 

Single-family property operating expenses

 

 

1,531

 

 

 

—

 

Net operating income

 

 

3,697

 

 

 

3,758

 

Investment and derivative loss, net

 

 

(827

)

 

 

(6,763

)

General and administrative expenses

 

 

(3,284

)

 

 

(2,637

)

Loss before income taxes

 

 

(414

)

 

 

(5,642

)

Income tax provision

 

 

2,287

 

 

 

398

 

Net loss

 

 

(2,701

)

 

 

(6,040

)

Dividend on preferred stock

 

 

(742

)

 

 

(723

)

Net loss attributable to common stock

 

$

(3,443

)

 

$

(6,763

)

Diluted loss per common share

 

$

(0.12

)

 

$

(0.20

)

Weighted-average diluted common shares

  outstanding

 

 

29,832

 

 

 

33,181

 

 

The following tables present our net income before general and administrative expenses and income tax provision 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 March 31, 2022

 

 

 

Investments in Financial Assets

 

 

Investments in SFR Properties

 

 

Corporate and Other

 

 

Total

 

Interest and other income

 

$

7,406

 

 

$

—

 

 

$

—

 

 

$

7,406

 

Rent revenues from single-family properties

 

 

—

 

 

 

1,064

 

 

 

—

 

 

 

1,064

 

Interest expense

 

 

1,464

 

 

 

408

 

 

 

1,370

 

 

 

3,242

 

Single-family property operating expenses

 

 

—

 

 

 

1,531

 

 

 

—

 

 

 

1,531

 

Net operating income (loss)

 

 

5,942

 

 

 

(875

)

 

 

(1,370

)

 

 

3,697

 

Investment and derivative (loss) gain, net

 

 

(723

)

 

 

32

 

 

 

(136

)

 

 

(827

)

Net income (loss) before general and administrative

  expenses and income taxes

 

$

5,219

 

 

$

(843

)

 

$

(1,506

)

 

$

2,870

 

 

 

 

 

Three Months Ended March 31, 2021

 

 

 

Investments in Financial Assets

 

 

Investments in SFR Properties

 

 

Corporate and Other

 

 

Total

 

Interest and other income

 

$

6,259

 

 

$

—

 

 

$

—

 

 

$

6,259

 

Rent revenues from single-family properties

 

 

—

 

 

 

—

 

 

 

—

 

 

 

—

 

Interest expense

 

 

1,350

 

 

 

—

 

 

 

1,151

 

 

 

2,501

 

Single-family property operating expenses

 

 

—

 

 

 

—

 

 

 

—

 

 

 

—

 

Net operating income (loss)

 

 

4,909

 

 

 

—

 

 

 

(1,151

)

 

 

3,758

 

Investment and derivative (loss) gain, net

 

 

(6,780

)

 

 

—

 

 

 

17

 

 

 

(6,763

)

Net loss before general and administrative

  expenses and income taxes

 

$

(1,871

)

 

$

—

 

 

$

(1,134

)

 

$

(3,005

)

 

GAAP Net Operating Income from Investments in Financial Assets

Net operating income from our investments in financial assets determined in accordance with GAAP increased $1.0 million, or 20.4%, from $4.9 million for the three months ended March 31, 2021 to $5.9 million for the three months ended March 31, 2022. The

38

 

increase from the comparative period is primarily the result of a higher average investment balance in higher yielding MSR financing receivables.  

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

 

 

 

Three Months Ended March 31,

 

 

 

2022

 

 

2021

 

 

 

Average

 

 

Income

 

 

Yield

 

 

Average

 

 

Income

 

 

Yield

 

 

 

Balance

 

 

(Expense)

 

 

(Cost)

 

 

Balance

 

 

(Expense)

 

 

(Cost)

 

Agency MBS

 

$

392,218

 

 

$

1,492

 

 

 

1.52

%

 

$

717,089

 

 

$

2,784

 

 

 

1.55

%

Credit investments

 

 

56,196

 

 

 

853

 

 

 

6.07

%

 

 

64,541

 

 

 

1,269

 

 

 

7.86

%

Mortgage loans of consolidated VIEs

 

 

190,142

 

 

 

1,354

 

 

 

2.85

%

 

 

83,261

 

 

 

1,687

 

 

 

8.10

%

MSR financing receivables

 

 

108,275

 

 

 

3,382

 

 

 

12.49

%

 

 

15,433

 

 

 

358

 

 

 

9.28

%

Other

 

 

4,794

 

 

 

325

 

 

 

 

 

 

 

6,242

 

 

 

161

 

 

 

 

 

 

 

$

751,625

 

 

 

7,406

 

 

 

3.94

%

 

$

886,566

 

 

 

6,259

 

 

 

2.82

%

Repurchase agreements

 

$

342,364

 

 

 

(276

)

 

 

(0.32

)%

 

$

553,842

 

 

 

(488

)

 

 

(0.35

)%

Secured debt of consolidated VIEs

 

 

174,763

 

 

 

(1,188

)

 

 

(2.72

)%

 

 

69,726

 

 

 

(862

)

 

 

(4.95

)%

 

 

$

517,127

 

 

 

(1,464

)

 

 

(1.13

)%

 

$

623,568

 

 

 

(1,350

)

 

 

(0.86

)%

Net interest income/spread

 

 

 

 

 

$

5,942

 

 

 

2.81

%

 

 

 

 

 

$

4,909

 

 

 

1.96

%

Levered net interest return (1)

 

 

 

 

 

 

 

 

 

 

10.14

%

 

 

 

 

 

 

 

 

 

 

7.47

%

 

 

(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 our GAAP net operating income are summarized below (dollars in thousands):

 

 

 

Three Months Ended March 31, 2022

 

 

 

vs.

 

 

 

Three Months Ended March 31, 2021

 

 

 

Rate

 

 

Volume

 

 

Total Change

 

Agency MBS

 

$

(30

)

 

$

(1,262

)

 

$

(1,292

)

Credit investments

 

 

(376

)

 

 

(40

)

 

 

(416

)

Mortgage loans of consolidated VIEs

 

 

(2,499

)

 

 

2,166

 

 

 

(333

)

MSR financing receivables

 

 

871

 

 

 

2,153

 

 

 

3,024

 

Other

 

 

201

 

 

 

(37

)

 

 

164

 

Repurchase agreements

 

 

26

 

 

 

186

 

 

 

212

 

Secured debt of consolidated VIEs

 

 

973

 

 

 

(1,299

)

 

 

(326

)

 

 

$

(834

)

 

$

1,867

 

 

$

1,033

 

 

 

Economic Net Interest Income from Financial Assets

Economic net interest income from financial assets, a non-GAAP financial measure, is comprised of the following: (i) net operating income from our investments in financial assets determined in accordance with GAAP, (ii) TBA agency MBS “dollar roll” income and (iii) net interest income earned or expense incurred from interest rate swap agreements. We believe that economic net interest income from financial assets assists investors in understanding and evaluating the financial performance of our long-term-focused, net interest spread-based investment strategy, prior to the deduction of general and administrative expenses, the costs of corporate financing and provision for income taxes. For a full description of the components of economic net interest income from financial assets, see “Non-GAAP Core Operating Income” below.

Below is a reconciliation of economic net interest income from financial assets, a non-GAAP financial measure, to net operating income from financial assets determined in accordance with GAAP (dollars in thousands):

 

39

 

 

 

 

Three Months Ended March 31,

 

 

 

2022

 

 

2021

 

Economic net interest income from financial assets

 

$

6,474

 

 

$

5,035

 

TBA dollar roll income

 

 

(823

)

 

 

(836

)

Interest rate swap net interest expense

 

 

291

 

 

 

710

 

Net operating income from financial assets

  determined in accordance with GAAP

 

$

5,942

 

 

$

4,909

 

The components of our economic net interest income from financial assets are summarized in the following table for the periods indicated (dollars in thousands):

 

 

 

Three Months Ended March 31,

 

 

 

2022

 

 

2021

 

 

 

Average

 

 

Income

 

 

Yield

 

 

Average

 

 

Income

 

 

Yield

 

 

 

Balance

 

 

(Expense)

 

 

(Cost)

 

 

Balance

 

 

(Expense)

 

 

(Cost)

 

Agency MBS

 

$

392,218

 

 

$

1,492

 

 

 

1.52

%

 

$

717,089

 

 

$

2,784

 

 

 

1.55

%

Credit investments

 

 

56,196

 

 

 

853

 

 

 

6.07

%

 

 

64,541

 

 

 

1,269

 

 

 

7.86

%

Mortgage loans of consolidated VIE

 

 

190,142

 

 

 

1,354

 

 

 

2.85

%

 

 

83,261

 

 

 

1,687

 

 

 

8.10

%

MSR financing receivables

 

 

108,275

 

 

 

3,382

 

 

 

12.49

%

 

 

15,433

 

 

 

358

 

 

 

9.28

%

TBA dollar rolls (1)

 

 

125,202

 

 

 

823

 

 

 

2.63

%

 

 

123,401

 

 

 

836

 

 

 

2.71

%

Other

 

 

4,794

 

 

 

325

 

 

 

 

 

 

 

6,242

 

 

 

161

 

 

 

 

 

 

 

$

876,827

 

 

 

8,229

 

 

 

3.75

%

 

$

1,009,967

 

 

 

7,095

 

 

 

2.81

%

Repurchase agreements

 

$

342,364

 

 

 

(276

)

 

 

(0.32

)%

 

$

553,842

 

 

 

(488

)

 

 

(0.35

)%

Secured debt of consolidated VIE

 

 

174,763

 

 

 

(1,188

)

 

 

(2.72

)%

 

 

69,726

 

 

 

(862

)

 

 

(4.95

)%

Interest rate swaps (2)

 

 

 

 

 

 

(291

)

 

 

 

 

 

 

 

 

 

 

(710

)

 

 

 

 

 

 

$

517,127

 

 

 

(1,755

)

 

 

(1.36

)%

 

$

623,568

 

 

 

(2,060

)

 

 

(1.32

)%

Economic net interest income/spread

 

 

 

 

 

$

6,474

 

 

 

2.39

%

 

 

 

 

 

$

5,035

 

 

 

1.49

%

Levered net interest return (3)

 

 

 

 

 

 

 

 

 

 

11.04

%

 

 

 

 

 

 

 

 

 

 

7.66

%

 

 

 

(1)

TBA dollar roll average balance (average cost basis) is based upon the contractual price of the initial TBA purchase trade of each individual series of dollar roll transactions. TBA dollar roll income is net of implied financing costs.

 

(2)

Interest rate swap cost represents the weighted average net receive (pay) rate in effect for the period, adjusted for “price alignment interest” income earned or expense incurred on cumulative variation margin paid or received, respectively. During the three months ended March 31, 2022, the interest rate swaps had a weighted average notional amount of $173,469 and a net pay rate of 0.68%. During the three months ended March 31, 2021, the interest rate swaps had a weighted average notional amount of $505,799 and a net pay rate of 0.64%.

 

(3)

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

 

40

 

 

The effects of changes in the composition of our investments in financial assets and related funding and hedging activities on our economic net interest income are summarized below (dollars in thousands):

 

 

 

Three Months Ended March 31, 2022

 

 

 

vs.

 

 

 

Three Months Ended March 31, 2021

 

 

 

Rate

 

 

Volume

 

 

Total Change

 

Agency MBS

 

$

(30

)

 

$

(1,262

)

 

$

(1,292

)

Credit investments

 

 

(376

)

 

 

(40

)

 

 

(416

)

Mortgage loans of consolidated VIEs

 

 

(2,499

)

 

 

2,166

 

 

 

(333

)

MSR financing receivables

 

 

871

 

 

 

2,153

 

 

 

3,024

 

TBA dollar rolls

 

 

(25

)

 

 

12

 

 

 

(13

)

Other

 

 

201

 

 

 

(37

)

 

 

164

 

Repurchase agreements

 

 

26

 

 

 

186

 

 

 

212

 

Interest rate swaps

 

 

(47

)

 

 

466

 

 

 

419

 

Secured debt of consolidated VIEs

 

 

973

 

 

 

(1,299

)

 

 

(326

)

 

 

$

(906

)

 

$

2,345

 

 

$

1,439

 

 

Economic net interest income from financial assets for the three months ended March 31, 2022 increased relative to the comparative period from the prior year primarily as a result of a higher average investment balance in higher yielding MSR financing receivables.

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 March 31, 2022, we had rental income of $1.1 million, interest expense from long-term debt secured by the properties of $0.4 million and property operating expenses of $1.5 million, including $0.7 million of depreciation expense, for a net operating loss of $0.8 million.  The net operating loss for the period is attributable to property costs incurred prior to the commencement of the leases for the newly acquired homes.

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):

41

 

 

 

 

Three Months Ended March 31,

 

 

 

2022

 

 

2021

 

Loss on agency MBS investments, net

 

$

(25,957

)

 

$

(29,215

)

Gain on credit investments, net

 

 

1,289

 

 

 

1,593

 

Gain on MSR financing receivables

 

 

22,758

 

 

 

5,957

 

TBA commitments, net:

 

 

 

 

 

 

 

 

TBA dollar roll income

 

 

823

 

 

 

836

 

Other loss from TBA commitments, net

 

 

(4,706

)

 

 

(9,232

)

Total loss on TBA commitments, net

 

 

(3,883

)

 

 

(8,396

)

Interest rate derivatives:

 

 

 

 

 

 

 

 

Net interest expense on interest rate swaps

 

 

(291

)

 

 

(710

)

Other gain from interest rate derivative

  instruments, net

 

 

5,841

 

 

 

23,651

 

Total gain on interest rate derivatives, net

 

 

5,550

 

 

 

22,941

 

Other investments, net

 

 

(584

)

 

 

357

 

Investment and derivative loss, net

 

$

(827

)

 

$

(6,763

)

 

General and Administrative Expenses

General and administrative expenses increased by $0.7 million from $2.6 million for the three months ended March 31, 2021 to $3.3 million for the three months ended March 31, 2022. General and administrative expenses for the three months ended March 31, 2021 reflects the reversal of the estimated employee annual cash incentive compensation expense accrued during 2020 which exceeded the actual amount paid during the first quarter of 2021.

Income Tax Provision

Our TRSs are subject to U.S. federal and state corporate income taxes.  As a result, for the three months ended March 31, 2022 and 2021, we recognized a provision for income taxes of $2.3 million and $0.4 million, respectively, on the pre-tax net income of our TRSs.  As noted in “Non-GAAP Core Operating Income” below, our computation of non-GAAP core operating income includes a provision for income taxes on the core operating income of our TRSs.  TRS core operating income 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 core operating income 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 core operating income, a non-GAAP financial measure, to the income tax provision determined in accordance with GAAP (dollars in thousands):

 

 

 

Three Months Ended March 31,

 

 

 

2022

 

 

2021

 

Income tax provision for TRS core operating income

 

$

229

 

 

$

11

 

Income tax provision for TRS investment gains, net

 

 

2,058

 

 

 

387

 

GAAP income tax provision

 

$

2,287

 

 

$

398

 

 

 

 

Non-GAAP Core Operating Income

 

In addition to the results of operations determined in accordance with GAAP, we also report “non-GAAP core operating income.” We define core operating income as “economic net interest income from financial assets” and “net operating income from SFR properties” less “core general and administrative expenses,” long-term unsecured debt interest expense, preferred stock dividends and an “income tax provision for TRS core operating income.”

Economic Net Interest Income from Financial Assets

 

Economic net interest income from financial assets, a non-GAAP financial measure, is comprised of the following:

42

 

 

•

total interest and other income from our investments in interest-bearing securities, loans and other financial assets determined in accordance with GAAP;

 

•

TBA dollar roll income, which represents the implied net interest income earned from the agency MBS which underlie, and are implicitly financed through, our TBA dollar roll transactions; net of

 

•

interest expense incurred from repurchase agreements or other financing arrangements secured by our investments in interest-bearing financial assets; and

 

•

net interest income earned or expense incurred from interest rate swap agreements.

 

We believe that economic net interest income from financial assets assists investors in understanding and evaluating the financial performance of our long-term-focused, net interest spread-based investment strategy, prior to the deduction of general and administrative expenses, the costs of corporate financing and provision for income taxes.

 

 

•

Total interest and other income determined in accordance with GAAP.  Interest and other income determined in accordance with GAAP primarily represents the interest income recognized from our investments in specified agency MBS, MSR financing receivables, credit securities and loans (including the amortization of purchase premiums and accretion of purchase discounts).

 

 

•

TBA dollar roll income.  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.”

 

From time to time, we may enter into forward-settling TBA agency MBS sale commitments (known as a “net short” TBA position) as a means of economically hedging a portion of the interest rate sensitivity of our agency MBS investment portfolio.  When we delay (or “roll”) the settlement of a net short TBA position, the price discount of the forward-settling sale relative to the contemporaneously executed spot purchase results in an implied net interest expense (i.e., “dollar roll expense”).  In our presentation of non-GAAP core operating income, we present TBA dollar roll income net of any implied net interest expense that resulted from rolling the settlement of net short TBA positions.

 

 

•

Net interest income earned or expense incurred from interest rate swap agreements. 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 component of the overall periodic change in the fair value of derivative instruments within the line item “investment and derivative gain (loss), net.”

Net Operating Income (Loss) from SFR Properties, Excluding Depreciation

 

Net operating income (loss) from SFR properties, excluding depreciation, represents the operating profit of our SFR properties determined in accordance with GAAP plus the depreciation and amortization of the SFR properties.  Net operating income (loss) from SFR properties, excluding depreciation is comprised of the following:

 

•

rent revenues from single-family properties; net of

43

 

 

 

•

single-family property operating expenses, excluding depreciation; and

 

•

interest expense incurred from long-term debt secured by single-family properties.

Core General and Administrative Expenses

 

Core general and administrative expenses are non-interest expenses reported within the line item “total general and administrative expenses” of the consolidated statements of comprehensive income less stock-based compensation expense.  

Income Tax Provision for TRS Core Operating Income

 

Our TRSs are subject to U.S. federal and state corporate income taxes.  Our computation of core operating income includes a provision for income taxes on the core operating income of our TRSs.  The core operating income of our TRSs is comprised of net interest income generated by our TRSs net of our TRSs’ general and administrative expenses.  In our consolidated statements of comprehensive income prepared in accordance with GAAP, the “income tax provision (benefit)” includes (i) the income tax provision for TRS core operating income 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.”  

Non-GAAP Core Operating Income

 

The following table presents our computation of non-GAAP core operating income for the three months ended March 31, 2022 and 2021 (amounts in thousands, except per share amounts):

 

 

Three Months Ended March 31,

 

 

2022

 

 

2021

 

Investments in financial assets

 

 

 

 

 

 

 

Interest and other income

$

7,406

 

 

$

6,259

 

TBA dollar roll income

 

823

 

 

 

836

 

Interest expense

 

(1,464

)

 

 

(1,350

)

Interest rate swap net interest expense

 

(291

)

 

 

(710

)

Economic net interest income

 

6,474

 

 

 

5,035

 

Investments in SFR properties

 

 

 

 

 

 

 

Rent revenues

 

1,064

 

 

 

—

 

Property operating expenses, excluding depreciation

 

(816

)

 

 

—

 

Interest expense

 

(408

)

 

 

—

 

Net operating loss from SFR properties, excluding depreciation

 

(160

)

 

 

—

 

Core general and administrative expenses

 

(2,523

)

 

 

(2,134

)

Long-term unsecured debt interest expense

 

(1,370

)

 

 

(1,151

)

Preferred stock dividend

 

(742

)

 

 

(723

)

Income tax provision for TRS core operating income

 

(229

)

 

 

(11

)

Non-GAAP core operating income

$

1,450

 

 

$

1,016

 

Non-GAAP core operating income per diluted

   common share

$

0.05

 

 

$

0.03

 

Weighted average diluted common shares

   outstanding

 

30,315

 

 

 

33,444

 

44

 

 

The following table provides a reconciliation of GAAP net income (loss) to non-GAAP core operating income for the three months ended March 31, 2022 and 2021 (amounts in thousands):

 

 

Three Months Ended March 31,

 

 

2022

 

 

2021

 

Net loss attributable to common stock

$

(3,443

)

 

$

(6,763

)

Add (less):

 

 

 

 

 

 

 

Investment and derivative loss, net

 

827

 

 

 

6,763

 

Stock-based compensation expense

 

761

 

 

 

503

 

Income tax provision for TRS investment gain

 

2,058

 

 

 

387

 

Depreciation of single-family residential properties

 

715

 

 

 

—

 

Add back:

 

 

 

 

 

 

 

TBA dollar roll income

 

823

 

 

 

836

 

Interest rate swap net interest expense

 

(291

)

 

 

(710

)

Non-GAAP core operating income

$

1,450

 

 

$

1,016

 

 

 

Non-GAAP core operating income 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 non-GAAP core operating income 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.

 

Periodic fair value gains and losses recognized with respect to our mortgage investments and economic hedging instruments, which are reported in line item “investment and derivative gain (loss), net” of our consolidated statements of comprehensive income, are excluded from the computation of non-GAAP core operating income 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 investment portfolio is to generate a net interest 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 investments and economic hedging instruments to largely offset one another over time.

 

A limitation of utilizing this non-GAAP financial measure is that the effect of accounting for “non-core” 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. For example, the economic cost or benefit of hedging instruments other than interest rate swap agreements, such as U.S. Treasury note futures or options, do not affect the computation of non-GAAP core operating income.  In addition, our calculation of non-GAAP core operating income may not be comparable to other similarly titled measures of other companies.  Therefore, we believe that non-GAAP core operating income 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 non-GAAP core operating income 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, non-GAAP core operating income 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”).

45

 

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.

As of March 31, 2022, our debt-to-equity leverage ratio was 3.2 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 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 March 31, 2022, our “at risk” leverage ratio was 1.3 to 1.  

As of March 31, 2022, our liquid assets totaled $34.1 million consisting of cash and cash equivalents of $21.7 million and unencumbered agency MBS of $12.4 million at fair value. Cash equivalents consist primarily of money market funds invested in debt obligations of the U.S. government.

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 March 31, 2022, our cash totaled $31.9 million, which included cash and cash equivalents of $21.7 million, restricted cash of $0.9 million, and restricted cash of consolidated VIEs of $9.3 million, representing a net increase of $10.1 million from $21.8 million as of December 31, 2021. Cash used in operating activities of $2.2 million during the three months ended March 31, 2022 was attributable primarily to net interest income less our general and administrative expenses. Cash provided by investing activities of $153.1 million during the three months ended March 31, 2022 was primarily generated by sales of agency MBS, distributions received on our MSR financing receivables, receipt of principal payments from agency MBS 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 $140.8 million during the three months ended March 31, 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.


46

 

 

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.

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 or prepayments, 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.

47

 

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

 

 

 

March 31, 2022

 

Agency MBS repurchase financing:

 

 

 

 

Repurchase agreements outstanding

 

$

264,148

 

Agency MBS collateral, at fair value

 

 

279,874

 

Net amount (1)

 

 

15,726

 

Weighted-average rate

 

 

0.36

%

Weighted-average term to maturity

 

13.0 days

 

Mortgage loans repurchase financing:

 

 

 

 

Repurchase agreements outstanding

 

$

20,714

 

Mortgage loans collateral, at fair value

 

 

29,592

 

Net amount (1)

 

 

8,878

 

Weighted-average rate

 

 

2.86

%

Weighted-average term to maturity

 

351.0 days

 

Total mortgage investments repurchase financing:

 

 

 

 

Repurchase agreements outstanding

 

$

284,862

 

Mortgage investments collateral, at fair value

 

 

309,466

 

Net amount (1)

 

 

24,604

 

Weighted-average rate

 

 

0.54

%

Weighted-average term to maturity

 

37.6 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 March 31, 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 March 31, 2022, no more than 4.1% of our stockholders’ equity was at risk with any one counterparty, with the top five counterparties representing approximately 10.7% of our stockholders’ equity.

48

 

Long-term Debt Secured by Single-family Propertiest

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%. As of March 31, 2022, the outstanding principal balance was $78.1 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.

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 March 31, 2022, we had $86.1 million of total long-term unsecured debt, net of unamortized debt issuance costs of $1.6 million. Our 6.75% Senior Notes due 2025 with a principal amount of $34.9 million outstanding as of March 31, 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 March 31, 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 March 31, 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.  

49

 

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 March 31, 2022, we had outstanding interest rate swaps with the following aggregate notional amount and corresponding initial margin held in collateral deposit with the custodian (dollars in thousands):

 

 

 

March 31, 2022

 

 

 

Notional

 

 

Collateral

 

 

 

Amount

 

 

Deposit

 

Interest rate swaps

 

$

175,000

 

 

$

3,432

 

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

50

 

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 March 31, 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, the mortgage servicing counterparty could 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 March 31, 2022, our mortgage servicing counterparty has a $75 million credit facility that would be secured by its MSRs including the MSRs to which our MSR financing receivables are referenced.  As of March 31, 2022, we had the ability to utilize approximately 80% 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.  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 instruct 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 March 31, 2022, our mortgage servicing counterparty has drawn $52.6 million of financing under its credit facility, including $43.9 million attributable to us, collateralized by $207.7 million of MSRs, including $180.0 million attributable to us, and $3.1 million of servicer advances, including $2.6 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 March 31, 2022, we have funded $48.5 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 March 31, 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 March 31, 2022, our unfunded commitment was $30 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 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

51

 

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 March 31, 2022, we had 11,302,160 shares of Class A common stock available for sale under the common equity distribution agreements.

Common Share Repurchase Program

Our Board of Directors has authorized a share repurchase program pursuant to which we may repurchase shares of common stock (the “Repurchase Program”). During the three months ended March 31, 2022, we repurchased 1,009,566 shares of our common stock for a total purchase price of $3.5 million. As of March 31, 2022, we had remaining availability of 11,980,712 shares of Class A common stock under the Repurchase Program.

Preferred Stock

As of March 31, 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 commencing on May 12, 2022 or earlier upon the occurrence of a change in control. 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 March 31, 2022, we had Series C Preferred Stock outstanding with a liquidation preference of $27.9 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 three months ended March 31, 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 March 31, 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 March 31, 2022, we had estimated NOL carryforwards of $165.4 million that can be used to offset future taxable ordinary income and reduce our future distribution requirements. As of March 31, 2022, we also had estimated NCL carryforwards of $146.0 million that can be used to offset future net capital gains.

52

 

 

Off-Balance Sheet Arrangements and Other Commitments

As of March 31, 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 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 March 31, 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 March 31, 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 March 31, 2022 and December 31, 2021, we had not guaranteed any obligations of unconsolidated entities.  As of March 31, 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 agency MBS 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.  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

53

 

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 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 reflects 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):

 

 

 

March 31, 2022

 

 

 

 

 

 

 

Value

 

 

Value

 

 

 

 

 

 

 

with 50

 

 

with 50

 

 

 

 

 

 

 

Basis Point

 

 

Basis Point

 

 

 

 

 

 

 

Increase in

 

 

Decrease in

 

 

 

Value

 

 

Interest Rates

 

 

Interest Rates

 

Agency MBS

 

$

292,318

 

 

$

284,130

 

 

$

299,801

 

TBA commitments

 

 

(1,231

)

 

 

(1,231

)

 

 

(1,231

)

MSR financing receivables

 

 

139,225

 

 

 

143,890

 

 

 

136,365

 

Interest rate swaps

 

 

(239

)

 

 

2,502

 

 

 

(2,980

)

Equity available to common stock (1)

 

 

181,689

 

 

 

180,907

 

 

 

183,570

 

Book value per common share (2)

 

$

6.19

 

 

$

6.16

 

 

$

6.26

 

Book value per common share percent change

 

 

 

 

 

 

(0.43

)%

 

 

1.04

%

 

 

 

March 31, 2022

 

 

 

 

 

 

 

Value

 

 

Value

 

 

 

 

 

 

 

with 100

 

 

with 100

 

 

 

 

 

 

 

Basis Point

 

 

Basis Point

 

 

 

 

 

 

 

Increase in

 

 

Decrease in

 

 

 

Value

 

 

Interest Rates

 

 

Interest Rates

 

Agency MBS

 

$

292,318

 

 

$

275,338

 

 

$

306,190

 

TBA commitments

 

 

(1,231

)

 

 

(1,231

)

 

 

(1,231

)

MSR financing receivables

 

 

139,225

 

 

 

146,479

 

 

 

126,144

 

Interest rate swaps

 

 

(239

)

 

 

5,243

 

 

 

(5,721

)

Equity available to common stock (1)

 

 

181,689

 

 

 

177,444

 

 

 

176,998

 

Book value per common share (2)

 

$

6.19

 

 

$

6.05

 

 

$

6.03

 

Book value per common share percentage change

 

 

 

 

 

 

(2.34

)%

 

 

(2.58

)%

 

(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.

54

 

(2)

Book value per common share is calculated as the equity available to common stock divided by common shares outstanding.

 

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.

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 6.2 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 March 31, 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):

 

 

 

March 31, 2022

 

 

 

 

 

 

 

Value with

 

 

Value with

 

 

 

 

 

 

 

10 Basis Point

 

 

10 Basis Point

 

 

 

 

 

 

 

Increase in

 

 

Decrease In

 

 

 

 

 

 

 

Agency MBS

 

 

Agency MBS

 

 

 

Value

 

 

Spreads

 

 

Spreads

 

Agency MBS

 

$

292,318

 

 

$

290,504

 

 

$

294,132

 

TBA commitments

 

 

(1,231

)

 

 

(1,231

)

 

 

(1,231

)

Equity available to common stock (1)

 

 

181,689

 

 

 

179,875

 

 

 

183,503

 

Book value per common share (2)

 

$

6.19

 

 

$

6.13

 

 

$

6.25

 

Book value per common share percent change

 

 

 

 

 

 

(1.00

)%

 

 

1.00

%

 

 

 

March 31, 2022

 

 

 

 

 

 

 

Value with

 

 

Value with

 

 

 

 

 

 

 

25 Basis Point

 

 

25 Basis Point

 

 

 

 

 

 

 

Increase in

 

 

Decrease In

 

 

 

 

 

 

 

Agency MBS

 

 

Agency MBS

 

 

 

Value

 

 

Spreads

 

 

Spreads

 

Agency MBS

 

$

292,318

 

 

$

287,783

 

 

$

296,853

 

TBA commitments

 

 

(1,231

)

 

 

(1,231

)

 

 

(1,231

)

Equity available to common stock (1)

 

 

181,689

 

 

 

177,154

 

 

 

186,224

 

Book value per common share (2)

 

$

6.19

 

 

$

6.04

 

 

$

6.35

 

Book value per common share percent change

 

 

 

 

 

 

(2.50

)%

 

 

2.50

%

 

(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.

(2)

Book value per common share is calculated as the equity available to common stock divided by common shares outstanding.

 

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

55

 

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.

 

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;

56

 

 

•

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;

 

•

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

57

 

 

•

the other important factors identified in this Quarterly Report 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.

 

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 March 31, 2022 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

 

58

 

 

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 378 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 378 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 discussed under “Item 5. Other Information," we have entered into a definitive agreement to sell up to 378 SFR properties. While the sale is expected to be completed by the end of the second quarter of 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 termination by the purchasing counterparty and 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 March 31, 2022, we had repurchased 6,019,288 shares of our common stock and there remain available for repurchase 11,980,712 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 March 31, 2022 by us or any “affiliated purchaser” affiliated with us, as defined in Rule 10b-18(a)(3) under the Exchange Act:

 

59

 

 

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

 

January 1, 2022 - January 31, 2022

 

 

334,423

 

 

$

3.49

 

 

 

334,423

 

 

 

12,655,855

 

February 1, 2022 - February 28, 2022

 

 

349,505

 

 

 

3.39

 

 

 

349,505

 

 

 

12,306,350

 

March 1, 2022 - March 31, 2022

 

 

325,638

 

 

 

3.46

 

 

 

325,638

 

 

 

11,980,712

 

Total

 

 

1,009,566

 

 

$

3.44

 

 

 

1,009,566

 

 

 

11,980,712

 

 

Item 3. Defaults Upon Senior Securities

None.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

 

On May 10, 2022, we entered into an agreement (the “Purchase and Sale Agreement”) under which we 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.  The foregoing description of the Purchase and Sale Agreement does not purport to be complete and is qualified in its entirety by reference to a copy of the Purchase and Sale Agreement filed as Exhibit 10.01 to this Quarterly Report on Form 10-Q, which is incorporated by reference herein.

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).

 

 

 

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).

 

 

 

60

 

Exhibit
Number

 

Exhibit Title

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).

 

 

 

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.*

61

 

Exhibit
Number

 

Exhibit Title

 

 

 

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 March 31, 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 March 31, 2022, formatted in XBRL (eXtensible Business Reporting Language): (i) Consolidated Balance Sheets at March 31, 2022 and December 31, 2021; (ii) Consolidated Statements of Comprehensive Income for the Three Months Ended March 31, 2022 and 2021; (iii) Consolidated Statements of Changes in Equity for the Three Months Ended March 31, 2022 and 2021; and (iv) Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2022 and 2021.

62

 

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: May 16, 2022

 

 

 

 

63
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