Arlington Asset Investment Corp. Reports Third Quarter 2016 Financial Results

ARLINGTON, Va., Oct. 25, 2016 /PRNewswire/ -- Arlington Asset Investment Corp. (NYSE: AI) (the "Company" or "Arlington") today reported net income of $18.8 million, or $0.81 per diluted share, and non-GAAP core operating income of $14.8 million, or $0.64 per diluted share, for the quarter ended September 30, 2016.  A reconciliation of non-GAAP core operating income to GAAP income (loss) before income taxes appears at the end of this press release.

Third Quarter 2016 Financial Highlights

• $0.81 per diluted share of GAAP net income
• $0.64 per diluted share of non-GAAP core operating income
• $18.83 per share of book value
• $14.63 per share of tangible book value
• $0.625 per share dividend

"During the third quarter, the Company's tangible book value experienced a recovery of capital through the outperformance of its interest rate hedges relative to its agency MBS portfolio, benefiting from rising interest rates, lower volatility and a narrowing of investment spreads," said J. Rock Tonkel, Jr., the Company's President and Chief Executive Officer.  "Ongoing low rates and steady home price appreciation continued to drive high mortgage refinancing volumes, resulting in elevated prepayment speeds and lower asset yields during the third quarter on the Company's agency MBS portfolio.  Despite the impact of elevated prepayment speeds, the Company generated non-GAAP core operating income of $0.64 per diluted share and delivered a $0.625 per share dividend to shareholders.  During the third quarter, the Company increased its agency investment allocation of TBA securities to take advantage of higher risk adjusted returns in the TBA dollar roll income market compared to specified agency MBS funded with repurchase agreement financing.  In addition, as the Company's private-label MBS investments have generally reached their expected investment returns and performance has plateaued, the Company has continued to redeploy its appreciated private-label MBS into agency MBS at expected higher relative returns."

Other Third Quarter Highlights

As of September 30, 2016, the Company's agency investment portfolio totaled $4,839 million, consisting of $3,669 million of agency mortgage-backed securities ("MBS") and $1,170 million of net long to-be-announced ("TBA") agency securities.  As of September 30, 2016, the Company's $4,839 million agency portfolio was comprised primarily of the following:

• $1,170 million of 3.0% 30-year agency TBA securities
• $1,757 million of 3.5% 30-year specified agency MBS
• $1,907 million of 4.0% 30-year specified agency MBS

As of September 30, 2016, the Company's $3,669 million specified agency MBS portfolio had a weighted average amortized cost basis of $105.60 and a weighted average market price of $107.51.  The Company's fixed-rate agency MBS are comprised of securities backed by specified pools of mortgage loans selected for their lower propensity for prepayment.  Weighted average pay-up premiums on the Company's agency MBS portfolio, which represent the estimated price premium of agency MBS backed by specified pools over a generic TBA agency security, were approximately one percentage point as of September 30, 2016, relatively unchanged compared to weighted average pay-up premiums as of June 30, 2016. 

As of September 30, 2016, the Company's net long TBA securities had a purchase price of $1,164 million and market value of $1,170 million, resulting in a net GAAP carrying fair value of $6 million.  Under GAAP, the Company accounts for its TBA securities as derivative instruments. 

The Company enters into various hedging transactions to mitigate the interest rate sensitivity of its cost of borrowing and the value of its agency MBS portfolio including interest rate swap agreements and put and call options on 10-year U.S. Treasury note futures. 

Under the terms of the Company's interest rate swap agreements, the Company pays semiannual interest payments based on a fixed rate and receives quarterly variable interest payments based upon the prevailing three-month London Interbank Offered Rate ("LIBOR") on the date of reset. As of September 30, 2016, the Company had $750 million in notional amount of two-year interest rate swap agreements with a weighted average pay fixed rate of 1.04% and a remaining weighted average maturity of 1.2 years, $500 million in notional amount of three-year interest rate swap agreements with a weighted average pay fixed rate of 1.08% and weighted average maturity of 3.0 years, and $1,500 million in notional amount of ten-year interest rate swap agreements with a weighted average pay fixed rate of 1.89% and a remaining weighted average maturity of 9.4 years.  In addition, the Company had $375 million in notional amount of forward starting two-year interest rate swap agreements that become effective in approximately one year with a weighted average pay fixed rate of 1.13%.  

The Company receives a payment on its interest rate swap agreements based on the prevailing three-month LIBOR on the date of reset while the Company makes a payment on its repurchase agreements that is based on a rate that is generally reset monthly.  As of September 30, 2016, the weighted average receive rate on its interest rate swap agreements was 0.84%, an increase of 19 basis points from the prior quarter end.  As of September 30, 2016, the weighted average interest rate on its agency repurchase agreement financing was 0.74%, an increase of 8 basis points from the prior quarter end.  The Company benefits from this spread differential on the notional amount of its interest rate swap agreements to the extent the spread difference remains unchanged.  

In addition to interest rate swap agreements, the Company also had a series of contracts whereby the Company either purchased or sold put and call options on 10-year U.S. Treasury note futures to mitigate the interest rate sensitivity of the value of its agency MBS portfolio.  As of September 30, 2016, the Company purchased contracts that provide the Company with the option to put 10-year U.S. Treasury note futures to a counterparty with an equivalent notional amount of $600 million that were struck at a weighted average strike price per contract that equates to a 10-year U.S. Treasury rate of approximately 1.71%, and sold contracts that provide a counterparty the option to call 10-year U.S. Treasury note futures from the Company with an equivalent notional amount of $600 million that were struck at a weighted average strike price per contract that equates to a 10-year U.S. Treasury rate of approximately 1.39%.  In order to limit its exposure on the sold call options from a significant fall in long-term interest rates, the Company also purchased contracts that provide the Company with the option to call 10-year U.S. Treasury note futures from a counterparty with an equivalent notional amount of $300 million as of September 30, 2016 that were struck at a weighted average strike price per contract that equates to a 10-year U.S. Treasury rate of approximately 1.07%.

Interest income less interest expense on short-term financing on the Company's agency MBS portfolio for the third quarter of 2016 and 2015 was $17.9 million and $24.2 million, respectively.  For the quarters ended September 30, 2016 and 2015, the amortization of the Company's net premium on its agency MBS was $8.9 million and $9.3 million, respectively, and its weighted average yield on its agency MBS was 2.60% and 2.81%, respectively. The actual weighted-average constant prepayment rate ("CPR") for the Company's agency MBS was 12.64% and 10.30% for the third quarters of 2016 and 2015, respectively.  

For the quarters ended September 30, 2016 and 2015, the Company reported TBA dollar roll income of $5.3 million and $1.9 million, respectively.  TBA dollar roll income is considered the economic equivalent of investing in agency MBS financed with a repurchase agreement and is calculated as the price discount of a forward-settling purchase of a TBA agency MBS relative to the "spot" sale of the same security.   Under GAAP, the Company accounts for its TBA securities as derivative instruments and recognizes income from TBA dollar rolls as a component of net investment gains and losses in the Company's financial statements. 

During the third quarter of 2016, the Company recorded net investment gains on its agency investment portfolio of $9.3 million and net investment gains on its related interest rate derivative hedging instruments of $8.4 million for a net investment gain on its hedged agency portfolio of $17.7 million.  Excluding TBA dollar roll income and interest rate swap net interest expense included in non-GAAP core operating income, the Company had net investment gains on its agency investment portfolio of $4.0 million and net investment gains on its related interest rate derivative hedging instruments of $13.5 million for a net investment gain on its hedged agency portfolio of $17.5 million, or $0.76 per share.

As of September 30, 2016, the Company's private-label MBS portfolio consisted of $26.8 million in face value with an amortized cost basis of $17.3 million and a fair value of $21.3 million.  Interest income less interest expense on short-term financing on the Company's private-label MBS portfolio for the third quarter of 2016 and 2015 was $1.5 million and $3.0 million, respectively, including non-cash accretion of $0.9 million and $1.8 million, respectively.  During the third quarter of 2016, the Company sold private-label MBS for sale proceeds of $67.8 million, which was $0.3 million less than the prior quarter fair value.  Subsequent to September 30, 2016, the Company sold additional private-label MBS for sale proceeds of $13.5 million.

As of September 30, 2016, the Company had $3,371 million of repurchase agreements outstanding with a weighted average rate of 74 basis points secured by an aggregate of $3,555 million of agency MBS at fair value.  As of September 30, 2016, the Company also had $6 million of repurchase agreements outstanding with a weighted average rate of 238 basis points secured by $13 million of private-label MBS at fair value.

Corporate Tax Structure

The Company is subject to taxation as a corporation under Subchapter C of the Internal Revenue Code of 1986, as amended.  As of September 30, 2016, the Company's estimated net operating loss carry-forwards were $91.7 million that begin to expire in 2027 and its estimated net capital loss carry-forwards were $272.2 million that begin to expire in 2019.  The Company's estimated net operating and net capital loss carry-forwards as of September 30, 2016 are subject to potential adjustments up to the time of filing the Company's income tax returns.  For GAAP accounting purposes, as of September 30, 2016 the Company had a deferred tax asset of $96.9 million, or $4.20 per share, which reflects a substantial valuation allowance against its net capital loss carry-forwards.  During the third quarter of 2016, the Company recorded an increase in the valuation allowance of $2.7 million.

Distributions to Shareholders

The Company's Board of Directors approved a distribution to common shareholders of $0.625 per share for the third quarter of 2016.  The distribution will be paid on October 31, 2016 to shareholders of record as of September 30, 2016.

The tax characterization of the Company's distributions to shareholders is determined annually and reported to shareholders on Form 1099-DIV after the end of the calendar year.  As a C-corporation, distributions to shareholders of current or accumulated earnings and profits are qualified dividends eligible for the 23.8% federal income tax rate whereas similar distributions to shareholders by a REIT of current or accumulated earnings and profits are nonqualified dividends subject to the higher 43.4% tax rate, inclusive of the 3.8% Medicare tax rate, on ordinary income.  Any distributions in excess of current or accumulated earnings and profits would be reported as returns of capital instead of qualified dividends.  Distributions that are classified as returns of capital are nontaxable to the extent they do not exceed a shareholder's adjusted tax basis in the Company's stock, or as a capital gain to the extent that the amount of the distribution exceeds a shareholder's adjusted tax basis in the Company's stock. 

Conference Call

The Company will hold a conference call for investors at 9:00 A.M. Eastern Time on Wednesday, October 26, 2016 to discuss the Company's third quarter of 2016 results.

Investors may listen to the earnings call via the internet at: http://www.arlingtonasset.com/index.php?s=19.  Replays of the earnings call will be available for 60 days via webcast at the Internet address provided above, beginning two hours after the call ends.

Additional Information

The Company will make available additional quarterly information for the benefit of its shareholders through a supplemental presentation that will be available at the Company's website, www.arlingtonasset.com.  The presentation will be available on the Webcasts and Presentations section located under the Updates & Events tab of the Company's website.

About the Company

Arlington Asset Investment Corp. (NYSE: AI) is a principal investment firm that currently invests primarily in mortgage-related and other assets.  The Company is headquartered in the Washington, D.C. metropolitan area.  For more information, please visit www.arlingtonasset.com.

Statements concerning interest rates, portfolio allocation, financing costs, portfolio hedging, prepayments, dividends, book value, and any other guidance on present or future periods constitute forward-looking statements that are subject to a number of factors, risks and uncertainties that might cause actual results to differ materially from stated expectations or current circumstances.  These factors include, but are not limited to, changes in interest rates, increased costs of borrowing, decreased interest spreads, changes in political and monetary policies, changes in default rates, changes in prepayment rates, changes in the Company's returns, changes in the use of the Company's tax benefits, changes in the agency MBS asset yield, changes in the Company's monetization of net operating loss carry-forwards, changes in the Company's ability to generate cash earnings and dividends, preservation and utilization of the Company's net operating loss and net capital loss carry-forwards, impacts of changes to and changes by Fannie Mae and Freddie Mac, actions taken by the U.S. Federal Reserve, the Federal Housing Finance Agency and the U.S. Treasury, availability of opportunities that meet or exceed the Company's risk adjusted return expectations, ability and willingness to make future dividends, ability to generate sufficient cash through retained earnings to satisfy capital needs, and general economic, political, regulatory and market conditions.  These and other material risks are described in the Company's Annual Report on Form 10-K for the year ended December 31, 2015 and any other documents filed by the Company with the SEC from time to time, which are available from the Company and from the SEC, and you should read and understand these risks when evaluating any forward-looking statement.

Financial data to follow

The following tables present information on the Company's investment and hedge portfolio as of September 30, 2016 (unaudited, dollars in thousands):

Non-GAAP Core Operating Income

In addition to the Company's results of operations determined in accordance with generally accepted accounting principles as consistently applied in the United States ("GAAP"), the Company also reports "non-GAAP core operating income".  The Company defines core operating income as "economic net interest income" less "core general and administrative expenses."

Economic Net Interest Income

Economic net interest income is comprised of the following:

• net interest income determined in accordance with GAAP;
• TBA agency MBS dollar roll income, which is calculated as the price discount of a forward-settling purchase of a TBA agency MBS relative to the "spot" sale of the same security, earned ratably over the period beginning on the settlement date of the sale and ending on the settlement date of the forward-settling purchase; and
• net interest income or expense incurred from interest rate swap agreements.

In the Company's consolidated statements of comprehensive income prepared in accordance with GAAP, TBA agency MBS dollar roll income and the net interest income or expense incurred from 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 "gain (loss) from derivative instruments, net" of the "investment gain (loss), net" section.

Core General and Administrative Expenses

Core general and administrative expenses are non-interest expenses reported within the line item "total other expenses" of the consolidated statements of comprehensive income less stock-based compensation expense. For the three months ended June 30, 2016, core general and administrative expenses also exclude non-recurring expenses related to the 2016 proxy contest that are in excess of those normally incurred for an annual meeting of shareholders.

Non-GAAP Core Operating Income for the Three Months Ended September 30, 2016 and June 30, 2016

The following table presents the Company's computation of core operating income for the third and second quarters of 2016, respectively (unaudited, amounts in thousands, except per share amounts):

The following table provides a reconciliation of GAAP pre-tax net income to non-GAAP core operating income for the third and second quarters of 2016, respectively (unaudited, amounts in thousands):

Non-GAAP core operating income is used by management to evaluate the financial performance of the Company's long-term 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 stockholders.  The Company believes that non-GAAP core operating income assists investors in understanding and evaluating the financial performance of the Company's long-term investment strategy and core business activities over periods of time as well as its earnings capacity.  A limitation of utilizing this non-GAAP financial measure is that the effect of accounting for "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 on U.S. Treasury note futures, do not affect the computation of non-GAAP core operating income.  In addition, the Company's calculation of non-GAAP core operating income may not be comparable to other similarly titled measures of other companies.  Therefore, the Company believes that net income and comprehensive income determined in accordance with GAAP should be considered in conjunction with non-GAAP core operating income.

Non-GAAP Core Operating Income for Fiscal Year 2015

Beginning in the first quarter of 2016, the Company retrospectively applied its revised definition of core operating income to the quarterly and annual periods of fiscal year 2015.  The Company notes, however, that the non-GAAP core operating income measures computed for prior year periods are not directly comparable to the results computed for the three month periods ended September 30, 2016 and June 30, 2016, as the Company solely utilized hedging instruments other than interest rate swap agreements prior to November 2015.  The economic costs or benefits of hedging instruments other than interest rate swap agreements do not affect the computation of non-GAAP core operating income.  The results of the Company's retrospective application of its revised definition of core operating income to fiscal year 2015 are presented in the following table (unaudited, amounts in thousands, except per share amounts):

The following table provides a reconciliation of GAAP pre-tax net income to non-GAAP core operating income for fiscal year 2015 (amounts in thousands):

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SOURCE Arlington Asset Investment Corp.