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, 2020

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)

 

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, 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 

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

 

AI

 

NYSE

7.00% Series B Cumulative Perpetual Redeemable Preferred Stock

 

AI PrB

 

NYSE

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

 

AI PrC

 

NYSE

6.625% Senior Notes due 2023

 

AIW

 

NYSE

6.75% Senior Notes due 2025

 

AIC

 

NYSE

 

Number of shares outstanding of each of the registrant’s classes of common stock, as of April 30, 2020:

 

Title

 

Outstanding

Class A Common Stock

 

36,815,761 shares

 

 


 

ARLINGTON ASSET INVESTMENT CORP.

FORM 10-Q

FOR THE QUARTER ENDED MARCH 31, 2020

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

 

24

 

 

Item 3.

 

Quantitative and Qualitative Disclosures about Market Risk

 

43

 

 

Item 4.

 

Controls and Procedures

 

48

PART II — OTHER INFORMATION

 

 

 

 

Item 1.

 

Legal Proceedings

 

49

 

 

Item 1A.

 

Risk Factors

 

49

 

 

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

50

 

 

Item 3.

 

Defaults Upon Senior Securities

 

50

 

 

Item 4.

 

Mine Safety Disclosures

 

50

 

 

Item 5.

 

Other Information

 

50

 

 

Item 6.

 

Exhibits

 

50

 

 

 

 

Signatures

 

53

 

 

 

i


 

PART I

FINANCIAL INFORMATION

Item 1. Financial Statements

ARLINGTON ASSET INVESTMENT CORP.

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands)

(Unaudited)

 

 

 

March 31, 2020

 

 

December 31, 2019

 

ASSETS

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

89,376

 

 

$

19,636

 

Interest receivable

 

 

6,126

 

 

 

10,663

 

Sold securities receivable

 

 

1,479,396

 

 

 

71,199

 

Agency mortgage-backed securities, at fair value

 

 

645,001

 

 

 

3,768,496

 

Non-agency mortgage-backed securities, at fair value

 

 

32,623

 

 

 

33,501

 

Mortgage loans, at fair value

 

 

44,614

 

 

 

45,000

 

Derivative assets, at fair value

 

 

16,963

 

 

 

1,417

 

Deposits

 

 

33,008

 

 

 

37,123

 

Other assets

 

 

11,200

 

 

 

13,079

 

Total assets

 

$

2,358,307

 

 

$

4,000,114

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

Repurchase agreements

 

$

2,036,466

 

 

$

3,581,237

 

Interest payable

 

 

1,199

 

 

 

4,666

 

Accrued compensation and benefits

 

 

832

 

 

 

3,626

 

Dividend payable

 

 

37

 

 

 

8,494

 

Derivative liabilities, at fair value

 

 

11,828

 

 

 

8

 

Other liabilities

 

 

753

 

 

 

507

 

Long-term unsecured debt

 

 

74,383

 

 

 

74,328

 

Total liabilities

 

 

2,125,498

 

 

 

3,672,866

 

Commitments and contingencies

 

 

 

 

 

 

 

 

Stockholders’ Equity:

 

 

 

 

 

 

 

 

Series B Preferred stock, $0.01 par value, 354,039 shares issued and

   outstanding (liquidation preference of $8,851)

 

 

8,264

 

 

 

8,270

 

Series C Preferred stock, $0.01 par value, 1,200,000 shares issued and

   outstanding (liquidation preference of $30,000)

 

 

28,934

 

 

 

28,944

 

Class A common stock, $0.01 par value, 450,000,000 shares authorized, 36,815,761

   and 36,755,387 shares issued and outstanding, respectively

 

 

368

 

 

 

368

 

Additional paid-in capital

 

 

2,049,741

 

 

 

2,049,292

 

Accumulated deficit

 

 

(1,854,498

)

 

 

(1,759,626

)

Total stockholders’ equity

 

 

232,809

 

 

 

327,248

 

Total liabilities and stockholders’ equity

 

$

2,358,307

 

 

$

4,000,114

 

 

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,

 

 

 

2020

 

 

2019

 

Interest income

 

 

 

 

 

 

 

 

Agency mortgage-backed securities

 

$

23,388

 

 

$

33,570

 

Non-agency mortgage-backed securities

 

 

731

 

 

 

1

 

Mortgage loans

 

 

711

 

 

 

 

Other

 

 

143

 

 

 

261

 

Total interest income

 

 

24,973

 

 

 

33,832

 

Interest expense

 

 

 

 

 

 

 

 

Short-term secured debt

 

 

14,592

 

 

 

24,643

 

Long-term unsecured debt

 

 

1,240

 

 

 

1,272

 

Total interest expense

 

 

15,832

 

 

 

25,915

 

Net interest income

 

 

9,141

 

 

 

7,917

 

Investment advisory fee income

 

 

 

 

 

250

 

Investment (loss) gain, net

 

 

 

 

 

 

 

 

Gain on trading investments, net

 

 

3,094

 

 

 

69,168

 

Loss from derivative instruments, net

 

 

(102,600

)

 

 

(55,205

)

Other, net

 

 

(562

)

 

 

(160

)

Total investment (loss) gain, net

 

 

(100,068

)

 

 

13,803

 

General and administrative expenses

 

 

 

 

 

 

 

 

Compensation and benefits

 

 

1,858

 

 

 

3,116

 

Other general and administrative expenses

 

 

1,385

 

 

 

1,260

 

Total general and administrative expenses

 

 

3,243

 

 

 

4,376

 

Net (loss) income

 

 

(94,170

)

 

 

17,594

 

Dividend on preferred stock

 

 

(774

)

 

 

(278

)

Net (loss) income (attributable) available to common stock

 

$

(94,944

)

 

$

17,316

 

Basic (loss) earnings per common share

 

$

(2.59

)

 

$

0.52

 

Diluted (loss) earnings per common share

 

$

(2.59

)

 

$

0.52

 

Weighted-average common shares outstanding

  (in thousands)

 

 

 

 

 

 

 

 

Basic

 

 

36,711

 

 

 

33,053

 

Diluted

 

 

36,711

 

 

 

33,139

 

 

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, 2018

 

 

350,595

 

 

$

8,245

 

 

 

 

 

$

 

 

 

30,497,998

 

 

$

305

 

 

$

1,997,876

 

 

$

(1,731,982

)

 

$

274,444

 

Net income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

17,594

 

 

 

17,594

 

Issuance of Class A common

  stock

 

 

 

 

 

 

 

 

 

 

 

 

 

 

6,000,000

 

 

 

60

 

 

 

48,750

 

 

 

 

 

 

48,810

 

Issuance of Class A common

  stock under stock-based

  compensation plans

 

 

 

 

 

 

 

 

 

 

 

 

 

 

74,619

 

 

 

1

 

 

 

(1

)

 

 

 

 

 

 

Issuance of preferred stock

 

 

2,035

 

 

 

45

 

 

 

1,200,000

 

 

 

28,880

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

28,925

 

Stock-based compensation

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

773

 

 

 

 

 

 

773

 

Dividends declared

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(14,135

)

 

 

(14,135

)

Balances, March 31, 2019

 

 

352,630

 

 

$

8,290

 

 

 

1,200,000

 

 

$

28,880

 

 

 

36,572,617

 

 

$

366

 

 

$

2,047,398

 

 

$

(1,728,523

)

 

$

356,411

 

 

Balances, December 31, 2019

 

 

354,039

 

 

$

8,270

 

 

 

1,200,000

 

 

$

28,944

 

 

 

36,755,387

 

 

$

368

 

 

$

2,049,292

 

 

$

(1,759,626

)

 

$

327,248

 

Net loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(94,170

)

 

 

(94,170

)

Issuance of Class A common

  stock

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(6

)

 

 

 

 

 

(6

)

Issuance of Class A common

  stock under stock-based

  compensation plans

 

 

 

 

 

 

 

 

 

 

 

 

 

 

60,374

 

 

 

 

 

 

62

 

 

 

 

 

 

62

 

Issuance of preferred stock

 

 

 

 

 

(6

)

 

 

 

 

 

(10

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(16

)

Stock-based compensation

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

393

 

 

 

 

 

 

393

 

Dividends declared

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(702

)

 

 

(702

)

Balances, March 31, 2020

 

 

354,039

 

 

$

8,264

 

 

 

1,200,000

 

 

$

28,934

 

 

 

36,815,761

 

 

$

368

 

 

$

2,049,741

 

 

$

(1,854,498

)

 

$

232,809

 

 

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,

 

 

 

2020

 

 

2019

 

Cash flows from operating activities:

 

 

 

 

 

 

 

 

Net (loss) income

 

$

(94,170

)

 

$

17,594

 

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

 

 

 

 

 

 

 

 

Investment loss (gain), net

 

 

100,068

 

 

 

(13,803

)

Net premium amortization on mortgage-backed securities

 

 

4,587

 

 

 

5,943

 

Other

 

 

521

 

 

 

833

 

Changes in operating assets

 

 

 

 

 

 

 

 

Interest receivable

 

 

4,536

 

 

 

(779

)

Other assets

 

 

(86

)

 

 

(493

)

Changes in operating liabilities

 

 

 

 

 

 

 

 

Interest payable and other liabilities

 

 

(3,282

)

 

 

689

 

Accrued compensation and benefits

 

 

(2,794

)

 

 

(2,312

)

Net cash provided by operating activities

 

 

9,380

 

 

 

7,672

 

Cash flows from investing activities:

 

 

 

 

 

 

 

 

Purchases of agency mortgage-backed securities

 

 

(149,781

)

 

 

(793,278

)

Purchases of non-agency mortgage-backed securities

 

 

(49,353

)

 

 

 

Proceeds from sales of agency mortgage-backed securities

 

 

1,762,433

 

 

 

461,558

 

Proceeds from sales of non-agency mortgage-backed securities

 

 

30,054

 

 

 

 

Receipt of principal payments on agency mortgage-backed securities

 

 

121,715

 

 

 

94,067

 

Receipt of principal payments on non-agency mortgage-backed securities

 

 

1

 

 

 

 

Payments for derivatives and deposits, net

 

 

(100,818

)

 

 

(67,803

)

Other

 

 

 

 

 

71

 

Net cash provided by (used in) investing activities

 

 

1,614,251

 

 

 

(305,385

)

Cash flows from financing activities:

 

 

 

 

 

 

 

 

(Repayments of) proceeds from repurchase agreements, net

 

 

(1,544,771

)

 

 

242,498

 

(Payments for) proceeds from issuance of common stock

 

 

(6

)

 

 

48,810

 

(Payments for) proceeds from issuance of preferred stock

 

 

(16

)

 

 

28,925

 

Dividends paid

 

 

(9,098

)

 

 

(11,686

)

Net cash (used in) provided by financing activities

 

 

(1,553,891

)

 

 

308,547

 

Net increase in cash and cash equivalents

 

 

69,740

 

 

 

10,834

 

Cash and cash equivalents, beginning of period

 

 

19,636

 

 

 

26,713

 

Cash and cash equivalents, end of period

 

$

89,376

 

 

$

37,547

 

Supplemental cash flow information:

 

 

 

 

 

 

 

 

Cash payments for interest

 

$

19,243

 

 

$

25,442

 

Cash payments for taxes

 

$

 

 

$

 

 

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 on acquiring and holding a levered portfolio of mortgage investments generally consisting of agency mortgage-backed securities (“MBS”) and mortgage credit investments.  The Company’s agency MBS include residential mortgage pass-through certificates for which the principal and interest payments are guaranteed by either 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”), or by a U.S. government agency, such as the Government National Mortgage Association (“Ginnie Mae”).  The Company’s mortgage credit investments may include investments in mortgage loans secured by either residential or commercial real property or MBS collateralized by such mortgage loans, which the Company refers to as non-agency MBS. The principal and interest of the Company’s mortgage credit investments are not guaranteed by a GSE or a U.S. government agency.  Arlington Asset is a Virginia corporation that is internally managed and does not have an external investment advisor.

We intend to elect to be taxed as a real estate investment trust (“REIT”) under the Internal Revenue Code of 1986, as amended (the “Internal Revenue Code”) upon filing our tax return for our taxable year ended December 31, 2019. As a REIT, the Company will be 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. For the Company’s tax years ended December 31, 2018 and earlier, the Company was taxed as a C corporation for U.S. federal tax purposes.

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, 2019.

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 from these estimates materially.

Certain amounts in the consolidated financial statements and notes for prior periods 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, 2020 and December 31, 2019, approximately 99% and 97%, 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.

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

5


 

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

The Company recognizes interest income for its investments in agency MBS 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 security’s stated coupon rate. The interest method is applied at the individual security level based upon each security’s effective interest rate. The Company calculates each security’s effective interest rate at the time of purchase by solving for the discount rate that equates the present value of that security's remaining contractual cash flows (assuming no principal prepayments) to its purchase price. Because each security’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 to its investments in agency MBS, as principal prepayments occur, a proportional amount of the unamortized premium or discount is recognized in interest income such that the contractual effective interest rate on the remaining security balance is unaffected.

Interest Income Recognition for Investments in Non-Agency MBS

The Company recognizes interest income for its investments in non-agency MBS by applying the prospective level-yield methodology required by GAAP for securitized 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 security’s effective interest rate to its amortized cost basis (or “reference amount”). At the time of acquisition, the security’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 security to its purchase price. 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 mortgage 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 security 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 non-agency MBS:

 

 Scenario:

 

 

Effect on Interest Income Recognition for Investments

in Non-Agency MBS:

 

 

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 security.

 

 

 

 

 

The amount of periodic interest income recognized over the remaining life of the security will be reduced accordingly. Specifically, if an adverse change in cash flows occurs for a security that is impaired (that is, its fair value is less than its reference amount), the reference amount to which the security’s existing effective interest rate will be prospectively applied will be reduced to the present value of cash flows expected to be collected, discounted at the security’s existing effective interest rate. If an adverse change in cash flows occurs for a security that is not impaired, the security’s effective interest rate will be reduced accordingly and applied on a prospective basis.

An adverse change in cash flows occurs.

 

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

 

 

 

Other Significant Accounting Policies

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

 

Investments in agency MBS, subsequent measurement

Note 3

6


 

Investments in non-agency MBS, subsequent measurement

Investments in mortgage loans, subsequent measurement

Borrowings

Note 4

Note 5

Note 6

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

Note 7

Derivative instruments

Note 7

Balance sheet offsetting

Note 8

Fair value measurements

Note 9

 

Refer to the Company’s 2019 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 Adopted Accounting Guidance

ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 606)

The amendments in this update require financial assets measured at amortized cost as well as available-for-sale debt securities to be measured for impairment on the basis of the net amount expected to be collected.  Credit losses are to be recognized through an allowance for credit losses, which differs from the direct write-down of the amortized cost basis previously required for other-than-temporary impairments of investments in debt securities.  This update also makes substantial changes to the manner in which interest income is to be recognized for financial assets acquired with a more-than-insignificant amount of credit deterioration since origination.

 

This update does not affect the accounting for investments in debt securities that are classified as trading securities.

January 1, 2020

All of the Company’s investments in debt securities are classified as trading securities. Accordingly, the adoption of ASU No. 2016-13 did not have an effect on the Company’s consolidated financial statements.

 

 

 

 

Recently Issued Accounting Guidance Not Yet Adopted

 

 

 

 

ASU No. 2020-04, Reference Rate Reform (Topic 848) - Facilitation of the Effects of Reference Rate Reform on Financial Reporting

 

 

The amendments in this update 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 LIBOR, that is expected to be discontinued because of reference rate reform.

 

The practical expedients and exceptions provided by the update 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.

 

 

7


 

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, 2020 and December 31, 2019, the fair value of the Company’s investments in agency MBS was $645,001 and $3,768,496, respectively. As of March 31, 2020, 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 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 gain (loss), net” in the Company’s consolidated statements of comprehensive income for the periods indicated with respect to investments in agency MBS:

 

 

 

Three Months Ended March 31,

 

 

 

2020

 

 

2019

 

Net gains (losses) recognized in earnings for:

 

 

 

 

 

 

 

 

Agency MBS still held at period end

 

$

12,127

 

 

$

62,109

 

Agency MBS sold during the period

 

 

11,391

 

 

 

7,056

 

Total

 

$

23,518

 

 

$

69,165

 

 

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 7. Derivative Instruments” for further information about dollar rolls.

 

Note 4. Investments in Non-Agency MBS

The Company has elected to classify its investments in non-agency MBS as trading securities.  Accordingly, the Company’s investments in non-agency MBS are reported in the accompanying consolidated balance sheets at fair value.  As of March 31, 2020 and December 31, 2019, the fair value of the Company’s investments in non-agency MBS was $32,623 and $33,501, respectively.  As of March 31, 2020, the Company’s investments in non-agency MBS represent beneficial interests in mortgages secured by commercial real property (commercial MBS or “CMBS”) and residential real property (residential MBS or “RMBS”).

The Company’s investments in non-agency CMBS represent beneficial interests in underlying pools of smaller balance commercial mortgage loans or a single, large balance commercial mortgage loan. Credit losses incurred on the underlying mortgage loans collateralizing the Company’s investments in non-agency CMBS 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 the Company’s non-agency CMBS, to the extent of their respective principal balance, prior to being allocated to Company’s investments. Periodic interest accrues on each security’s outstanding principal balance at its contractual coupon rate.

The Company’s non-agency RMBS investment represents a first loss position in a pool of business-purpose residential mortgage loans.  The pool of underlying mortgage loans 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.  The Company’s non-agency RMBS investment is entitled to any excess of the monthly interest payments from the underlying pool of mortgage loans (net of loan servicing and trust administrative fees) over the interest payments made to the trust’s senior note holders.  Credit losses realized on the underlying pool of mortgage loans are first allocated to the Company’s non-agency RMBS, to the extent of its principal balance, prior to being allocated to the trust’s senior noteholders.

 

All periodic changes in the fair value of non-agency MBS that are not attributed to interest income are recognized as a component of “investment 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 gain (loss), net” in the Company’s consolidated statements of comprehensive income for the periods indicated with respect to investments in non-agency MBS:

 

8


 

 

 

Three Months Ended March 31,

 

 

 

2020

 

 

2019

 

Net gains (losses) recognized in earnings for:

 

 

 

 

 

 

 

 

Non-agency MBS still held at period end

 

$

(15,618

)

 

$

3

 

Non-agency MBS sold during the period

 

 

(4,420

)

 

 

 

Total

 

$

(20,038

)

 

$

3

 

 

Note 5. Investments in Mortgage Loans

On December 31, 2019, the Company acquired a $45,000 mortgage loan secured by a first lien position in healthcare facilities.   The mortgage loan bears interest at a floating note rate equal to one-month LIBOR plus 4.25% with a note rate floor of 6.25%.  The maturity date of the loan is December 31, 2021 with a one-year extension available at the option of the borrower.  The mortgage loan has an initial interest-only period of one year followed by principal amortization based upon a 30-year amortization schedule beginning in 2021 with the remaining principal balance due at loan maturity.  As of March 31, 2020 and December 31, 2019, the fair value of the Company’s investments in mortgage loans were $44,614 and $45,000, respectively.

The Company recognizes interest income on its mortgage loan investment based upon the contractual note rate of the loan.  The Company has elected to account for its mortgage loan investment at fair value on a recurring basis with periodic changes in fair value recognized as a component of “investment gain (loss), net” in the accompanying consolidated statements of comprehensive income.

 

 

 

Note 6. 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.

9


 

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 February 9, 2021 and an interest rate that resets monthly at a rate equal to one-month LIBOR plus 2.00% with an interest rate floor of 3.00%.  Under the terms of the Company’s mortgage loan repurchase agreement, the Company may request extensions of the maturity date of the agreement by up to 364 days, subject to the lender’s approval.

As of March 31, 2020 and December 31, 2019, 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, 2020

 

 

December 31, 2019

 

Agency MBS repurchase financing:

 

 

 

 

 

 

 

 

Repurchase agreements outstanding

 

$

1,977,095

 

 

$

3,560,139

 

Agency MBS collateral, at fair value (1)

 

 

2,094,164

 

 

 

3,741,399

 

Net amount (2)

 

 

117,069

 

 

 

181,260

 

Weighted-average rate

 

 

0.92

%

 

 

2.10

%

Weighted-average term to maturity

 

15.0 days

 

 

23.7 days

 

Non-agency MBS repurchase financing:

 

 

 

 

 

 

 

 

Repurchase agreements outstanding

 

$

27,871

 

 

$

21,098

 

MBS collateral, at fair value (3)

 

 

41,230

 

 

 

30,747

 

Net amount (2)

 

 

13,359

 

 

 

9,649

 

Weighted-average rate

 

 

3.13

%

 

 

3.11

%

Weighted-average term to maturity

 

5.3 days

 

 

8.1 days

 

Mortgage loans repurchase financing:

 

 

 

 

 

 

 

 

Repurchase agreements outstanding

 

$

31,500

 

 

$

 

Mortgage loans collateral, at fair value

 

 

44,614

 

 

 

 

Net amount (2)

 

 

13,114

 

 

 

 

Weighted-average rate

 

 

3.00

%

 

 

 

Weighted-average term to maturity

 

315.0 days

 

 

 

 

Total mortgage investments repurchase financing:

 

 

 

 

 

 

 

 

Repurchase agreements outstanding

 

$

2,036,466

 

 

$

3,581,237

 

Mortgage investments collateral, at fair value

 

 

2,180,008

 

 

 

3,772,146

 

Net amount (2)

 

 

143,542

 

 

 

190,909

 

Weighted-average rate

 

 

0.98

%

 

 

2.11

%

Weighted-average term to maturity

 

19.5 days

 

 

23.6 days

 

 

(1)

As of March 31, 2020 and December 31, 2019, includes $1,455,136 and $71,284, respectively, at sale price of unsettled agency MBS sale commitments which are 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.

(3)

As of March 31, 2020, includes $32,607 and $8,623 at fair value of non-agency and agency MBS collateral, respectively.  As of December 31, 2019, includes $30,747 at fair value of non-agency MBS collateral.

 

The following table provides information regarding the Company’s outstanding repurchase agreement borrowings during the three months ended March 31, 2020 and 2019:

 

 

 

March 31, 2020

 

 

March 31, 2019

 

Weighted-average outstanding balance during the three months ended

 

$

3,162,340

 

 

$

3,680,429

 

Weighted-average rate during the three months ended

 

 

1.83

%

 

 

2.68

%

10


 

Long-Term Unsecured Debt

As of March 31, 2020 and December 31, 2019, the Company had $74,383 and $74,328, respectively, of outstanding long-term unsecured debentures, net of unamortized debt issuance costs of $917 and $972, respectively. The Company’s long-term debentures consisted of the following as of the dates indicated:

 

 

 

March 31, 2020

 

 

December 31, 2019

 

 

 

Senior

Notes Due 2025

 

 

Senior

Notes Due 2023

 

 

Trust

Preferred Debt

 

 

Senior

Notes Due 2025

 

 

Senior

Notes Due 2023

 

 

Trust

Preferred Debt

 

Outstanding Principal

 

$

35,300

 

 

$

25,000

 

 

$

15,000

 

 

$

35,300

 

 

$

25,000

 

 

$

15,000

 

Annual Interest Rate

 

 

6.75

%

 

 

6.625

%

 

LIBOR+

2.25 - 3.00 %

 

 

 

6.75

%

 

 

6.625

%

 

LIBOR+

2.25 - 3.00 %

 

Interest Payment Frequency

 

Quarterly

 

 

Quarterly

 

 

Quarterly

 

 

Quarterly

 

 

Quarterly

 

 

Quarterly

 

Weighted-Average Interest Rate

 

 

6.75

%

 

 

6.625

%

 

 

4.58

%

 

 

6.75

%

 

 

6.625

%

 

 

4.74

%

Maturity

 

March 15, 2025

 

 

May 1, 2023

 

 

2033 - 2035

 

 

March 15, 2025

 

 

May 1, 2023

 

 

2033 - 2035

 

 

The Senior Notes due 2023 and the Senior Notes due 2025 are publicly traded on the New York Stock Exchange under the ticker symbols “AIW” and “AIC,” respectively. The Senior Notes due 2023, 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 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.

 

 

Note 7. 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 “derivative assets” or “derivative liabilities” in the consolidated balance sheets, with all periodic changes in fair value reflected as a component of “investment 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 include centrally cleared interest rate swaps, exchange-traded instruments, such as U.S. Treasury note futures, Eurodollar futures, interest rate swap futures and options on futures, and non-exchange-traded instruments such as options on agency MBS. While the Company uses its interest rate hedging instruments to economically hedge a portion of its interest rate risk, it has not designated such contracts as hedging instruments for financial reporting purposes.

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

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

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

11


 

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

Derivative Instrument Population and Fair Value

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

 

 

 

March 31, 2020

 

 

December 31, 2019

 

 

 

Assets

 

 

Liabilities

 

 

Assets

 

 

Liabilities

 

Interest rate swaps

 

$

26

 

 

$

(55

)

 

$

1,417

 

 

$

(8

)

TBA commitments

 

 

16,937

 

 

 

(11,773

)

 

 

 

 

 

 

Total

 

$

16,963

 

 

$

(11,828

)

 

$

1,417

 

 

$

(8

)

 

12


 

Interest Rate Swaps

The Company’s 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 on the date of reset.

 

The following table presents information about the Company’s interest rate swap agreements that were in effect as of March 31, 2020:

 

 

 

 

 

 

 

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

 

$

500,000

 

 

 

1.78

%

 

 

1.65

%

 

 

(0.13

)%

 

 

1.0

 

 

$

(49

)

3 to less than 5 years

 

 

100,000

 

 

 

1.52

%

 

 

0.77

%

 

 

(0.75

)%

 

 

4.7

 

 

 

20

 

Total / weighted-average

 

$

600,000

 

 

 

1.73

%

 

 

1.50

%

 

 

(0.23

)%

 

 

1.6

 

 

$

(29

)

 

The following table presents information about the Company’s interest rate swap agreements that were in effect as of December 31, 2019: