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, 2019

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.)

 

1001 Nineteenth Street North

Arlington, VA

 

22209

(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

 

Number of shares outstanding of each of the registrant’s classes of common stock, as of April 30, 2019:

 

Title

 

Outstanding

Class A Common Stock

 

36,572,617 shares

 

 


 

ARLINGTON ASSET INVESTMENT CORP.

FORM 10-Q

FOR THE QUARTER ENDED MARCH 31, 2019

INDEX

 

 

 

 

 

 

 

Page

PART I — FINANCIAL INFORMATION

 

 

 

 

Item 1.

 

Consolidated Financial Statements and Notes  — (unaudited)

 

1

 

 

 

 

Consolidated Balance Sheets — March 31, 2019 and December 31, 2018

 

1

 

 

 

 

Consolidated Statements of Comprehensive Income — Three Months Ended March 31, 2019 and 2018

 

2

 

 

 

 

Consolidated Statements of Changes in Equity — Three Months Ended March 31, 2019 and 2018

 

3

 

 

 

 

Consolidated Statements of Cash Flows — Three Months Ended March 31, 2019 and 2018

 

4

 

 

 

 

Notes to Consolidated Financial Statements

 

5

 

 

Item 2.

 

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

 

22

 

 

Item 3.

 

Quantitative and Qualitative Disclosures about Market Risk

 

39

 

 

Item 4.

 

Controls and Procedures

 

43

PART II — OTHER INFORMATION

 

 

 

 

Item 1.

 

Legal Proceedings

 

44

 

 

Item 1A.

 

Risk Factors

 

44

 

 

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

44

 

 

Item 3.

 

Defaults Upon Senior Securities

 

44

 

 

Item 4.

 

Mine Safety Disclosures

 

44

 

 

Item 5.

 

Other Information

 

44

 

 

Item 6.

 

Exhibits

 

44

 

 

 

 

Signatures

 

47

 

 

 

i


 

PART I

FINANCIAL INFORMATION

Item 1. Financial Statements

ARLINGTON ASSET INVESTMENT CORP.

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands)

(Unaudited)

 

 

 

March 31, 2019

 

 

December 31, 2018

 

ASSETS

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

37,547

 

 

$

26,713

 

Interest receivable

 

 

14,128

 

 

 

13,349

 

Sold securities receivable

 

 

341,798

 

 

 

 

Mortgage-backed securities, at fair value

 

 

 

 

 

 

 

 

Agency

 

 

4,192,327

 

 

 

3,982,106

 

Private-label

 

 

28

 

 

 

24

 

Derivative assets, at fair value

 

 

15,248

 

 

 

438

 

Deposits

 

 

53,446

 

 

 

61,052

 

Other assets

 

 

18,636

 

 

 

15,768

 

Total assets

 

$

4,673,158

 

 

$

4,099,450

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

Repurchase agreements

 

$

3,964,127

 

 

$

3,721,629

 

Interest payable

 

 

5,063

 

 

 

4,646

 

Accrued compensation and benefits

 

 

1,420

 

 

 

3,732

 

Dividend payable

 

 

14,190

 

 

 

11,736

 

Derivative liabilities, at fair value

 

 

2,346

 

 

 

6,959

 

Purchased securities payable

 

 

251,144

 

 

 

 

Other liabilities

 

 

4,297

 

 

 

2,200

 

Long-term unsecured debt

 

 

74,160

 

 

 

74,104

 

Total liabilities

 

 

4,316,747

 

 

 

3,825,006

 

Commitments and contingencies

 

 

 

 

 

 

 

 

Stockholders’ Equity:

 

 

 

 

 

 

 

 

Series B Preferred stock, $0.01 par value, 352,630 and 350,595 shares issued and

   outstanding, respectively (liquidation preference of $8,816 and $8,765,

   respectively)

 

 

8,290

 

 

 

8,245

 

Series C Preferred stock, $0.01 par value, 1,200,000 and -0- shares issued and

   outstanding, respectively (liquidation preference of $30,000 and $-0-,

   respectively)

 

 

28,880

 

 

 

 

Class A common stock, $0.01 par value, 450,000,000 shares authorized, 36,572,617

   and 30,497,998 shares issued and outstanding, respectively

 

 

366

 

 

 

305

 

Additional paid-in capital

 

 

2,047,398

 

 

 

1,997,876

 

Accumulated deficit

 

 

(1,728,523

)

 

 

(1,731,982

)

Total stockholders’ equity

 

 

356,411

 

 

 

274,444

 

Total liabilities and stockholders’ equity

 

$

4,673,158

 

 

$

4,099,450

 

 

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,

 

 

 

2019

 

 

2018

 

Interest income

 

 

 

 

 

 

 

 

Agency mortgage-backed securities

 

$

33,570

 

 

$

30,725

 

Private-label mortgage-backed securities

 

 

1

 

 

 

4

 

Other

 

 

261

 

 

 

131

 

Total interest income

 

 

33,832

 

 

 

30,860

 

Interest expense

 

 

 

 

 

 

 

 

Short-term secured debt

 

 

24,643

 

 

 

15,325

 

Long-term unsecured debt

 

 

1,272

 

 

 

1,231

 

Total interest expense

 

 

25,915

 

 

 

16,556

 

Net interest income

 

 

7,917

 

 

 

14,304

 

Investment advisory fee income

 

 

250

 

 

 

 

Investment gain (loss), net

 

 

 

 

 

 

 

 

Gain (loss) on trading investments, net

 

 

69,168

 

 

 

(88,343

)

(Loss) gain from derivative instruments, net

 

 

(55,205

)

 

 

40,154

 

Other, net

 

 

(160

)

 

 

50

 

Total investment gain (loss), net

 

 

13,803

 

 

 

(48,139

)

General and administrative expenses

 

 

 

 

 

 

 

 

Compensation and benefits

 

 

3,116

 

 

 

3,040

 

Other general and administrative expenses

 

 

1,260

 

 

 

1,257

 

Total general and administrative expenses

 

 

4,376

 

 

 

4,297

 

Income (loss) before income taxes

 

 

17,594

 

 

 

(38,132

)

Income tax provision

 

 

 

 

 

18,251

 

Net income (loss)

 

 

17,594

 

 

 

(56,383

)

Dividend on preferred stock

 

 

(278

)

 

 

(137

)

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

 

$

17,316

 

 

$

(56,520

)

Basic earnings (loss) per common share

 

$

0.52

 

 

$

(2.00

)

Diluted earnings (loss) per common share

 

$

0.52

 

 

$

(2.00

)

Weighted-average common shares outstanding (in thousands)

 

 

 

 

 

 

 

 

Basic

 

 

33,053

 

 

 

28,197

 

Diluted

 

 

33,139

 

 

 

28,197

 

 

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, 2017

 

 

303,291

 

 

$

7,108

 

 

 

 

 

$

 

 

 

28,140,721

 

 

$

281

 

 

$

1,974,941

 

 

$

(1,596,013

)

 

$

386,317

 

Net loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(56,383

)

 

 

(56,383

)

Issuance of Class A common

  stock

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(23

)

 

 

 

 

 

(23

)

Issuance of preferred stock

 

 

19,431

 

 

 

459

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

459

 

Cumulative-effect of accounting

  change (see Note 7)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

4,059

 

 

 

4,059

 

Stock-based compensation

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

451

 

 

 

 

 

 

451

 

Dividends declared (1)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(15,875

)

 

 

(15,875

)

Balances, March 31, 2018

 

 

322,722

 

 

$

7,567

 

 

 

 

 

$

 

 

 

28,140,721

 

 

$

281

 

 

$

1,975,369

 

 

$

(1,664,212

)

 

$

319,005

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 (1)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(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

 

 

 

(1)

The Board of Directors approved and the Company declared and paid dividends of $0.375 and $0.55 per common share for the three months ended March 31, 2019 and 2018, respectively. The Board of Directors approved and the Company declared and paid dividends of $0.4375 per Series B preferred share for the three months ended March 31, 2019 and 2018. For the three months ended March 31, 2019, includes a dividend accrual of $0.103125 per Series C preferred share that has not been declared.

 

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,

 

 

 

2019

 

 

2018

 

Cash flows from operating activities:

 

 

 

 

 

 

 

 

Net income (loss)

 

$

17,594

 

 

$

(56,383

)

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

 

 

 

 

 

 

 

 

Investment (gain) loss, net

 

 

(13,803

)

 

 

48,139

 

Net premium amortization on mortgage-backed securities

 

 

5,943

 

 

 

7,925

 

Deferred tax provision

 

 

 

 

 

18,251

 

Other

 

 

833

 

 

 

511

 

Changes in operating assets

 

 

 

 

 

 

 

 

Interest receivable

 

 

(779

)

 

 

(116

)

Other assets

 

 

(493

)

 

 

(399

)

Changes in operating liabilities

 

 

 

 

 

 

 

 

Interest payable and other liabilities

 

 

689

 

 

 

(1,147

)

Accrued compensation and benefits

 

 

(2,312

)

 

 

(3,394

)

Net cash provided by operating activities

 

 

7,672

 

 

 

13,387

 

Cash flows from investing activities:

 

 

 

 

 

 

 

 

Purchases of agency mortgage-backed securities

 

 

(793,278

)

 

 

(907,468

)

Proceeds from sales of agency mortgage-backed securities

 

 

461,558

 

 

 

842,741

 

Receipt of principal payments on agency mortgage-backed securities

 

 

94,067

 

 

 

109,323

 

(Payments for) proceeds from derivatives and deposits, net

 

 

(67,803

)

 

 

34,619

 

Other

 

 

71

 

 

 

(18

)

Net cash (used in) provided by investing activities

 

 

(305,385

)

 

 

79,197

 

Cash flows from financing activities:

 

 

 

 

 

 

 

 

Proceeds from (repayments of) repurchase agreements, net

 

 

242,498

 

 

 

(83,823

)

Proceeds from (payments for) issuance of common stock

 

 

48,810

 

 

 

(23

)

Proceeds from issuance of preferred stock

 

 

28,925

 

 

 

459

 

Dividends paid

 

 

(11,686

)

 

 

(15,592

)

Net cash provided by (used in) financing activities

 

 

308,547

 

 

 

(98,979

)

Net increase (decrease) in cash and cash equivalents

 

 

10,834

 

 

 

(6,395

)

Cash and cash equivalents, beginning of period

 

 

26,713

 

 

 

21,614

 

Cash and cash equivalents, end of period

 

$

37,547

 

 

$

15,219

 

Supplemental cash flow information:

 

 

 

 

 

 

 

 

Cash payments for interest

 

$

25,442

 

 

$

17,434

 

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 residential mortgage-backed securities (“MBS”), consisting of “agency MBS” and “private-label MBS.” 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”). Private-label MBS, or “non-agency MBS,” include residential MBS that are not guaranteed by a GSE or the U.S. government. Arlington Asset is a Virginia corporation that is internally managed.

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. Commencing with its taxable year ending December 31, 2019, the Company intends to elect to be taxed as a REIT under the Internal Revenue Code of 1986, as amended (the “Internal Revenue Code”).  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.

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, 2018.

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, 2019 and December 31, 2018, approximately 99% 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 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

5


 

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.

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

Borrowings

Note 4

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

Note 5

Derivative instruments

Note 5

Balance sheet offsetting

Note 6

Fair value measurements

Note 7

 

Refer to the Company’s 2018 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

Accounting Standards Update (“ASU”) No. 2016-02, Leases (Topic 842)

This amendment replaces the existing lease accounting model with a revised model.  The primary change effectuated by the revised lease accounting model is the recognition of lease assets and lease liabilities by lessees for those leases classified as operating leases.

January 1, 2019

The primary impact of the adoption of ASU No. 2016-02 was the recognition of lease liabilities and associated right-of-use assets, as a component of “Other liabilities” and “Other assets,” respectively, on the Company’s consolidated balance sheets as of March 31, 2019.  The adoption of ASU No. 2016-02 did not have an effect on the timing or amount of periodic lease expense recognized in net income.  The adoption of ASU No. 2016-02 did not have a material effect on the Company’s consolidated financial statements.

 

 

 

 

6


 

Standard

Description

Date of

Adoption

Effect on the Consolidated

Financial Statements

ASU No. 2017-08, Premium Amortization of

Purchased Callable Debt Securities (Subtopic 310-20)

This amendment requires purchase premiums for investments in debt securities that are noncontingently callable by the issuer (at a fixed price and preset date) to be amortized to the earliest call date. Previously, purchase premiums for such investments were permitted to be amortized to the instrument’s maturity date.

 

January 1, 2019

 

 

Investments in prepayable financial assets, such as residential MBS, for which the embedded call options are not held by the issuer are not within the scope of ASU No. 2017-08. Accordingly, the adoption of ASU No. 2017-08 did not have an effect on the Company’s consolidated financial statements.

 

 

 

 

ASU No. 2017-12, Targeted Improvements to Accounting for Hedging Activities (Topic 815)

This update made several targeted amendments to existing GAAP with the objectives of facilitating (i) financial reporting that more closely reflects entities’ risk management strategies and (ii) greater ease of understanding and interpreting the effects of hedge accounting on an entities’ reported results.

January 1, 2019

Hedge accounting pursuant to GAAP is an elective, rather than a required, accounting model.  The Company does not elect to apply hedge accounting.  The adoption of ASU No. 2017-12 did have an effect on the Company’s consolidated financial statements.

 

 

 

 

Recently Issued Accounting Guidance Not Yet Adopted

 

 

 

 

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 currently 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 will not affect the accounting for investments in debt securities that are classified as trading securities.

January 1, 2020

As of March 31, 2019, all of the Company’s investments in debt securities are classified as trading securities. Accordingly, the Company does not expect ASU No. 2016-13 to have a material impact on its consolidated financial statements.

 

 

Note 3. Investments in Agency MBS

The Company’s investments in agency MBS are reported in the accompanying consolidated balance sheets at fair value. As of March 31, 2019 and December 31, 2018, the Company had $4,192,327 and $3,982,106, respectively, of fair value in agency MBS classified as trading securities. As of March 31, 2019, all the Company’s investments in agency MBS represent undivided (or “pass-through”) beneficial interests in specified pools of fixed-rate mortgage loans.

 

7


 

All periodic changes in the fair value of trading 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 in come. 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 inves tments in agency MBS classified as trading securities:

 

 

 

Three Months Ended March 31,

 

 

 

2019

 

 

2018

 

Net gains (losses) recognized in earnings for:

 

 

 

 

 

 

 

 

Agency MBS still held at period end

 

$

62,109

 

 

$

(61,825

)

Agency MBS sold during the period

 

 

7,056

 

 

 

(26,520

)

Total

 

$

69,165

 

 

$

(88,345

)

 

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

 

 

Note 4. Borrowings

Repurchase Agreements

The Company finances the purchase of MBS through repurchase agreements, which are accounted for as collateralized borrowing arrangements. In a repurchase transaction, the Company sells MBS to a counterparty under a master repurchase agreement in exchange for cash and concurrently agrees to repurchase the same security at a future date in an amount equal to the cash initially exchanged plus an agreed-upon amount of interest. MBS sold under agreements to repurchase remain on the Company’s consolidated balance sheets because the Company maintains effective control over such securities 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 MBS. The difference between the proceeds received by the Company upon the initial transfer of the MBS 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.

As of March 31, 2019 and December 31, 2018, 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, 2019

 

 

December 31, 2018

 

Pledged with agency MBS:

 

 

 

 

 

 

 

 

Repurchase agreements outstanding

 

$

3,964,127

 

 

$

3,721,629

 

Agency MBS collateral, at fair value (1)

 

 

4,197,580

 

 

 

3,931,232

 

Net amount (2)

 

 

233,453

 

 

 

209,603

 

Weighted-average rate

 

 

2.73

%

 

 

2.72

%

Weighted-average term to maturity

 

20.9 days

 

 

17.3 days

 

 

(1)

As of March 31, 2019, includes $323,156 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.

 

8


 

The following table provides information regarding the Company’s outstanding repurchase agreement borrowings during the three months ended March 31, 2019 and 2018 :

 

 

 

March 31, 2019

 

 

March 31, 2018

 

Weighted-average outstanding balance during the three months ended

 

$

3,680,429

 

 

$

3,730,619

 

Weighted-average rate during the three months ended

 

 

2.68

%

 

 

1.64

%

Long-Term Unsecured Debt

As of March 31, 2019 and December 31, 2018, the Company had $74,160 and $74,104, respectively, of outstanding long-term unsecured debentures, net of unamortized debt issuance costs of $1,140 and $1,196, respectively. The Company’s long-term debentures consisted of the following as of the dates indicated:

 

 

 

March 31, 2019

 

 

December 31, 2018

 

 

 

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

%

 

 

5.54

%

 

 

6.75

%

 

 

6.625

%

 

 

5.19

%

Maturity

 

March 15, 2025

 

 

May 1, 2023

 

 

2033 - 2035

 

 

March 15, 2025

 

 

May 1, 2023

 

 

2033 - 2035

 

Early Redemption Date

 

March 15, 2018

 

 

May 1, 2016

 

 

2008 - 2010

 

 

March 15, 2018

 

 

May 1, 2016

 

 

2008 - 2010

 

 

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 and Senior Notes due 2025 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 these 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 5. 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.

9


 

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 acco unts 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 fut ures 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 fa ir 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 derivatives 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.

Under the terms of these forward commitments, the daily exchange of variation margin may occur based on changes in the fair value of the agency MBS commitments if a party to the transaction demands it. Receivables recognized for the right to reclaim cash collateral posted by the Company in respect of TBA transactions 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 TBA transactions is included in the line item “other liabilities” in the accompanying consolidated balance sheets.

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.

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, 2019

 

 

December 31, 2018

 

 

 

Assets

 

 

Liabilities

 

 

Assets

 

 

Liabilities

 

Interest rate swaps

 

$

5,143

 

 

$

 

 

$

 

 

$

(5,709

)

10-year U.S. Treasury note futures

 

 

605

 

 

 

 

 

 

 

 

 

(1,250

)

TBA commitments

 

 

9,500

 

 

 

(2,346

)

 

 

438

 

 

 

 

Total

 

$

15,248

 

 

$

(2,346

)

 

$

438

 

 

$

(6,959

)

10


 

 

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, 2019:

 

 

 

 

 

 

 

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

 

$

1,175,000

 

 

 

1.59

%

 

 

2.70

%

 

 

1.11

%

 

 

1.4

 

 

$

714

 

3 to less than 7 years

 

 

100,000

 

 

 

1.77

%

 

 

2.63

%

 

 

0.86

%

 

 

3.4

 

 

 

181

 

7 to less than 10 years

 

 

1,550,000

 

 

 

2.51

%

 

 

2.64

%

 

 

0.13

%

 

 

8.7

 

 

 

4,142

 

10 or more years

 

 

25,000

 

 

 

2.96

%

 

 

2.63

%

 

 

(0.33

)%

 

 

29.0

 

 

 

106

 

Total / weighted-average

 

$

2,850,000

 

 

 

2.11

%

 

 

2.66

%

 

 

0.55

%

 

 

5.7

 

 

$

5,143

 

 

The following table presents information about the Company’s interest rate swap agreements that were in effect as of December 31, 2018:

 

 

 

 

 

 

 

Weighted-average:

 

 

 

 

 

 

 

Notional Amount

 

 

Fixed Pay Rate

 

 

Variable Receive Rate

 

 

Net Receive

(Pay) Rate

 

 

Remaining Life (Years)

 

 

Fair Value

 

Years to maturity: