UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
☒
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2022
OR
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 001-34374
ARLINGTON ASSET INVESTMENT CORP.
(Exact name of registrant as specified in its charter)
Virginia
54-1873198
(State or Other Jurisdiction of
Incorporation or Organization)
(I.R.S. Employer
Identification No.)
6862 Elm Street, Suite 320
McLean, VA 22101
(Address of Principal Executive Offices) (Zip Code)
(703) 373-0200
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class
Trading Symbol(s)
Name of Each Exchange on Which Registered
Class A Common Stock
AAIC
NYSE
7.00% Series B Cumulative Perpetual Redeemable Preferred Stock
AAIC PrB
NYSE
8.250% Series C Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock
AAIC PrC
NYSE
6.000% Senior Notes due 2026
AAIN
NYSE
6.75% Senior Notes due 2025
AIC
NYSE
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act: Yes ☐ No ☒
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act: Yes ☐ No ☒
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 (§232.405 of this chapter) during the
preceding 12 months (or for such shorter period that the registrant was required to submit such files): Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the 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 has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the
Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☐
If securities are registered pursuant to Section 12(b) of the Act, indicate by check mark whether the financial statements of the registrant included in the filing reflect the correction of an error to previously issued
financial statements. ☐
Indicate by check mark whether any of those error corrections are restatements that required a recovery analysis of incentive-based compensation received by any of the registrant’s executive officers during the
relevant recovery period pursuant to §240.10D-1(b). ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act): Yes ☐ No ☒
The aggregate market value of the registrant’s Class A common stock held by non-affiliates computed by reference to the last reported price at which the registrant’s Class A common stock was sold on the New
York Stock Exchange on June 30, 2022 was $90.5 million.
As of February 28, 2023, there were 28,360,447 shares of the registrant’s Class A common stock outstanding and no shares of the registrant’s Class B common stock outstanding.
Documents incorporated by reference: Portions of the registrant’s Definitive Proxy Statement for the 2023 Annual Meeting of Shareholders (to be filed with the Securities and Exchange Commission no later
than 120 days after the end of the registrant’s fiscal year end) are incorporated by reference in this Annual Report on Form 10-K in response to Part II, Item 5 and Part III, Items 10, 11, 12, 13 and 14.
Auditor Firm Id:
238
Auditor Name:
PricewaterhouseCoopers LLP
Auditor Location:
Washington DC, DC, USA
i
TABLE OF CONTENTS
Page
Cautionary Statement About Forward-Looking Information
iii
PART I
ITEM 1.
Business
1
ITEM 1A.
Risk Factors
9
ITEM 1B.
Unresolved Staff Comments
33
ITEM 2.
Properties
34
ITEM 3.
Legal Proceedings
34
ITEM 4.
Mine Safety Disclosures
34
PART II
ITEM 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
35
ITEM 6.
Reserved
36
ITEM 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
37
ITEM 7A.
Quantitative and Qualitative Disclosures About Market Risk
55
ITEM 8.
Financial Statements and Supplementary Data
58
ITEM 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
58
ITEM 9A.
Controls and Procedures
58
ITEM 9B.
Other Information
59
ITEM 9C.
Disclosure Regarding Foreign Jurisdictions That Prevent Inspections
59
PART III
ITEM 10.
Directors, Executive Officers and Corporate Governance
60
ITEM 11.
Executive Compensation
60
ITEM 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
60
ITEM 13.
Certain Relationships and Related Transactions, and Director Independence
60
ITEM 14.
Principal Accountant Fees and Services
60
PART IV
ITEM 15.
Exhibits and Financial Statement Schedules
60
ITEM 16.
Form 10-K Summary
63
Signatures
64
Index to Consolidated Financial Statements of Arlington Asset Investment Corp.
F-1
ii
CAUTIONARY STATEMENT ABOUT FORWARD-LOOKING INFORMATION
When used in this Annual Report on Form 10-K, in future filings with the Securities and Exchange Commission (“SEC”) or in press releases or
other written or oral communications, statements which are not historical in nature, including those containing words such as “believe,” “expect,”
“anticipate,” “estimate,” “plan,” “continue,” “intend,” “should,” “may” or similar expressions, are intended to identify “forward-looking statements” within
the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as
amended (the “Exchange Act”), and, as such, may involve known and unknown risks, uncertainties and assumptions. The forward-looking statements we
make in this Annual Report on Form 10-K include, but are not limited to, statements about the following:
•
the availability and terms of, and our ability to deploy, capital and our ability to grow our business through our current strategy focused on
acquiring either (i) residential mortgage-backed securities (“MBS”) that are either issued by U.S. government agencies or guaranteed as to
principal and interest by U.S. government agencies or U.S. government sponsored agencies (“agency MBS”), (ii) mortgage servicing right
(“MSR”) related assets, or (iii) credit investments that generally consist of mortgage loans secured by either residential or commercial real
property or MBS collateralized by such mortgage loans;
•
risks related to a resurgence of the coronavirus (“COVID-19”), including the impact on our business, financial condition, liquidity and results
of operations due to a significant decrease in economic activity and disruptions in our financing operations, among other factors;
•
our ability to qualify and maintain our qualification as a real estate investment trust (“REIT”);
•
our ability to forecast our tax attributes, which are based upon various facts and assumptions, and our ability to protect and use our net
operating losses (“NOLs”) and net capital losses (“NCLs”) to offset future taxable income, including whether our shareholder rights plan, as
amended (“Rights Plan”) will be effective in preventing an ownership change that would significantly limit our ability to utilize such losses;
•
our business, acquisition, leverage, asset allocation, operational, investment, hedging and financing strategies and the success of, or changes
in, these strategies;
•
credit risks underlying our assets, including changes in the default rates and management’s assumptions regarding default rates on the
mortgage loans securing our non-agency MBS;
•
the effect of changes in inflation, prepayment rates, interest rates and default rates on our portfolio;
•
the effect of governmental regulation and actions on our business, including, without limitation, changes to monetary and fiscal policy and
tax laws;
•
our ability to quantify and manage risk;
•
our ability to roll our repurchase agreements on favorable terms, if at all;
•
our liquidity;
•
our asset valuation policies;
•
our decisions with respect to, and ability to make, future dividends;
•
investing in assets other than mortgage investments or pursuing business activities other than investing in mortgage investments;
•
our ability to successfully operate our business as a REIT;
•
our ability to maintain our exclusion from the definition of “investment company” under the Investment Company Act of 1940, as amended
(the “1940 Act”);
•
the uncertainty and economic impact of a resurgence of the coronavirus (“COVID-19”) pandemic; and
•
the effect of general economic conditions including the impact of a potential recessionary environment on our business.
Forward-looking statements are based on our beliefs, assumptions and expectations of our future performance, taking into account information
currently in our possession. These beliefs, assumptions and expectations may change as a result of many possible events or factors, not all of which are
known to us or are within our control. If a change occurs, the performance of our portfolio and our business, financial condition, liquidity and results of
operations may vary materially from those expressed, anticipated or
iii
contemplated in our forward-looking statements. You should carefully consider these risks, along with the following factors that could cause actual results
to vary from our forward-looking statements, before making an investment in our securities:
•
the overall environment for interest rates, changes in interest rates, interest rate spreads, the yield curve and prepayment rates, including the
timing of changes in the Federal Funds rate by the U.S. Federal Reserve;
•
the effect of any changes to the London Interbank Offered Rate (“LIBOR”) and the Secured Overnight Financing Rate (“SOFR”) and
establishment of alternative reference rates;
•
current conditions and further adverse developments in the residential mortgage market and the overall economy;
•
potential risk attributable to our mortgage-related portfolios, including changes in fair value;
•
our use of leverage and our dependence on repurchase agreements and other short-term borrowings to finance our mortgage-related holdings;
•
the availability of certain short-term liquidity sources;
•
competition for investment opportunities;
•
U.S. Federal Reserve monetary policy;
•
the federal conservatorship of the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation
(“Freddie Mac”) and related efforts, along with any changes in laws and regulations affecting the relationship between Fannie Mae and
Freddie Mac and the federal government;
•
mortgage loan prepayment activity, modification programs and future legislative action;
•
changes in, and success of, our acquisition, hedging and leverage strategies, changes in our asset allocation and changes in our operational
policies, all of which may be changed by us without shareholder approval;
•
failure of sovereign or municipal entities to meet their debt obligations;
•
fluctuations of the value of our hedge instruments;
•
fluctuating quarterly operating results;
•
changes in laws and regulations and industry practices that may adversely affect our business;
•
volatility of the securities markets and activity in the secondary securities markets in the United States and elsewhere;
•
our ability to qualify and maintain our qualification as a REIT for federal income tax purposes;
•
our ability to successfully expand our business into areas other than investing in MBS and our expectations of the returns of expanding into
any such areas; and
•
the other important factors identified in this Annual Report on Form 10-K under the caption “Item 1A - Risk Factors.”
These and other risks, uncertainties and factors, including those described elsewhere in this Annual Report on Form 10-K, could cause our actual
results to differ materially from those projected in any forward-looking statements we make. All forward-looking statements speak only as of the date on
which they are made. New risks and uncertainties arise over time and it is not possible to predict those events or how they may affect us. Except as required
by law, we are not obligated to, and do not intend to, update or revise any forward-looking statements, whether as a result of new information, future events
or otherwise.
iv
PART I
ITEM 1. BUSINESS
Unless the context otherwise requires or indicates, all references in this Annual Report on Form 10-K to “Arlington Asset” refer to Arlington Asset
Investment Corp., and all references to “we,” “us,” “our,” and the “Company,” refer to Arlington Asset Investment Corp. and its consolidated subsidiaries.
Our Company
We are an investment firm that focuses primarily on investing in mortgage related assets. Our investment capital is currently allocated between the
following asset classes:
•
mortgage servicing right (“MSR”) related assets
•
credit investments
•
agency mortgage-backed securities (“MBS”)
Our MSR related assets represent investments for which the return is based on the economic performance of a pool of specific MSRs. Our credit
investments generally include investments in mortgage loans secured by either residential or commercial real property or MBS collateralized by residential
or commercial mortgage loans (“non-agency MBS”). Our agency MBS consist of residential mortgage pass-through certificates for which the principal and
interest payments are guaranteed by a U.S. government sponsored enterprise (“GSE”), such as Fannie Mae and Freddie Mac.
We also previously allocated investment capital to a strategy of investing in single-family residential ("SFR") properties that consisted of acquiring,
leasing and operating single-family residential homes as rental properties. During 2022, we sold our portfolio of SFR properties and are currently no longer
anticipating allocating capital to our SFR investment strategy.
We are a Virginia corporation that was incorporated on November 10, 1997. We are internally managed and do not have an external investment
advisor. We have elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended (the “Internal Revenue Code”). As a REIT, we are
required to distribute annually 90% of our REIT taxable income (subject to certain adjustments). So long as we continue to qualify as a REIT, we will
generally not be subject to U.S. federal or state corporate income taxes on our taxable income that we distribute to our shareholders on a timely basis. At
present, it is our intention to distribute 100% of our taxable income, although we will not be required to do so. We intend to make distributions of our
taxable income within the time limits prescribed by the Internal Revenue Code, which may extend into the subsequent taxable year.
Investment Portfolio
We manage our investment portfolio with the goal of obtaining a high risk-adjusted return on capital. We evaluate the rates of return that can be
achieved in each asset class and for each individual investment within an asset class in which we invest. We then evaluate opportunities against the returns
available in each of our investment alternatives and attempt to allocate our assets and capital with an emphasis toward what we believe to be the highest
risk-adjusted return available. We expect this strategy will cause us to have different allocations of capital and leverage in different market environments.
In addition, we also may pursue other business activities that would utilize our experience in analyzing investment opportunities and applying similar
portfolio management skills. However, investing in other asset classes or pursuing other business activities may be limited by our desire to continue to
qualify as a REIT. We may change our investment strategy at any time without the consent of our shareholders; accordingly, in the future, we could make
investments or enter into hedging transactions that are different from, and possibly riskier than, the investments and associated hedging transactions
described in this Annual Report on Form 10-K.
The following tables summarize our asset and capital allocation of our investment strategies as of December 31, 2022 and 2021, respectively
(dollars in thousands):
December 31, 2022
Assets
Invested Capital
Allocation
Invested Capital
Allocation (%)
Leverage
MSR financing receivables
$
180,365 $
180,365
63%
—
Credit investments
167,519
58,485
21%
1.9
Agency MBS
43,722
45,566
16%
—
Total invested capital
$
391,606
284,416
100%
Cash and other corporate capital, net
19,329
Total investable capital
$
303,745
0.3
1
(1)
(2)
(3)
(5)
December 31, 2021
Assets
Invested Capital
Allocation
Invested Capital
Allocation (%)
Leverage
MSR financing receivables
$
125,018 $
125,018
43%
0.3
Credit investments
65,626
44,946
16%
0.5
Agency MBS
483,927
91,763
32%
4.3
Single-family residential properties
60,889
26,407
9%
1.5
Total invested capital
$
735,460
288,134
100%
Cash and other corporate capital, net
21,987
Total investable capital
$
310,121
1.5
Our investable capital is calculated as the sum of our shareholders’ equity capital plus accumulated depreciation of our single-family residential
properties and long-term unsecured debt.
Our leverage is measured as the ratio of the sum of our repurchase agreement financing, long-term debt secured by SFR properties, net payable
or receivable for unsettled securities, net contractual forward purchase or sale price of our to-be-announced ("TBA") commitments and
leverage within our MSR financing receivables less our cash and cash equivalents compared to our investable capital.
Includes our net investment of $28,904 in variable interest entities with gross assets and liabilities of $198,511 and $169,607, respectively, that
is consolidated for GAAP financial reporting purposes.
Includes our net investment of $9,708 in a variable interest entity with gross assets and liabilities of $10,218 and $510, respectively, that is
consolidated for GAAP financial reporting purposes.
Agency MBS assets include the fair value of the agency MBS which underlie our TBA forward purchase and sale commitments. In accordance
with GAAP, our TBA forward commitments are reflected on the consolidated balance sheets as derivative assets and liabilities at fair value in
the financial statement line items "other assets" and "other liabilities". As of December 31, 2022 and 2021, the fair value of the underlying
agency MBS that underlie our net long (short) positions in TBA commitments had a fair value of $(399,818) and $0 with a carrying value of
$5,630 and $109, respectively.
Mortgage Servicing Right Related Assets
An MSR provides a mortgage servicer with the right to service a pool of residential mortgage loans in exchange for a portion of the interest
payments made on the underlying residential mortgage loans. This amount typically ranges from 25 to 50 basis points times the unpaid principal balance
(“UPB”) of the residential mortgage loans, plus ancillary income and custodial interest. An MSR is made up of two components: a basic fee and an excess
servicing spread. The basic fee is the amount of compensation for the performance of servicing duties (including advance obligations), and the excess
servicing spread is the amount that exceeds the basic fee. Ownership of an MSR requires the owner to be a licensed mortgage servicer. An owner of an
excess servicing spread is not required to be licensed, and is not required to assume any servicing duties, advance obligations or liabilities associated with
the loan pool underlying the MSR unless otherwise specified through agreement.
We do not hold the requisite licenses to purchase or hold MSRs directly. However, we have entered into agreements with a licensed, GSE approved
residential mortgage loan servicer that enable us to garner the economic return of an investment in an MSR purchased by the mortgage servicing
counterparty through an MSR financing transaction. Under the terms of the arrangement, for an MSR acquired by the mortgage servicing counterparty, (i)
we purchase the excess servicing spread from the mortgage servicer counterparty, entitling us to monthly distributions of the servicing fees collected by the
mortgage servicing counterparty in excess of 12.5 basis points per annum (and to distributions of corresponding proceeds of sale of the MSRs), and (ii) we
fund the balance of the MSR purchase price to the parent company of the mortgage servicing counterparty and, in exchange, have an unsecured right to
payment of certain amounts determined by reference to the MSR, generally equal to the servicing fee revenue less the excess servicing spread and the costs
of servicing (and to distributions of corresponding proceeds of sale of the MSRs), net of fees earned by the mortgage servicing counterparty and its
affiliates including an incentive fee equal to a percentage of the total return of the MSR in excess of a hurdle rate of return. Under the arrangement, we are
obligated to provide funds to the mortgage servicing counterparty to fund the counterparty’s advances of payments on the serviced pool of mortgage loans.
The mortgage servicing counterparty is required to return to us subsequent servicing advances collected from the underlying borrowers or reimbursed by
the GSEs. The mortgage servicing counterparty is entitled to reimbursement from the GSEs of any servicing advances that are not subsequently collected
from the underlying borrowers.
Our investments in the excess servicing spread component of an MSR are considered mortgages on real property for REIT qualification purposes.
However, our investments in the basic fee component of an MSR are not considered mortgages on real property for REIT qualification purposes.
Accordingly, we invest in the basic fee component of an MSR in our taxable REIT
2
(1)
(2)
(4)
(5)
(1)
(2)
(3)
(4)
(5)
subsidiary ("TRS"). As a result, any income we earn on the basic fee component of an MSR would be subject to corporate income tax.
The MSRs that underly our MSR related assets are comprised solely of residential mortgage loans guaranteed by Fannie Mae or Freddie Mac. We
target pools of loans that are recently originated or have a low coupon that will generally exhibit a lower propensity for prepayment in a rising rate
environment. The MSRs underlying our MSR related assets are purchased by our mortgage servicing counterparty in either bulk purchases in the
secondary market or through flow agreements with various loan originators.
Credit Investments
Our targeted credit investments generally include the following:
•
mortgage loans secured by residential real property
•
mortgage loans secured by commercial real property
•
non-agency MBS collateralized by residential mortgage loans
•
non-agency MBS collateralized by commercial mortgage loans
•
asset-backed securities ("ABS") collateralized by solar panel loans
The principal and interest of such credit investments are not guaranteed by a GSE or a U.S government agency. Accordingly, these investments
carry a significantly higher level of credit exposure relative to the credit exposure of agency MBS. The credit investments in which we may invest may be
non-investment grade or not rated by major rating agencies.
Residential Mortgage Loans
Residential mortgage loans are secured by one to four family residential properties and are generally classified as being either a qualified or non-
qualified mortgage. A qualified mortgage is a mortgage that meets certain requirements for lender protection and secondary trading under the Dodd-Frank
Wall Street Reform and Consumer Protection Act (“the Dodd-Frank Act”). In general, a qualified mortgage (i) contains less risky loan features, such as
interest-only periods, negative amortization or balloon payments, (ii) has debt-to-income ratio limits, (iii) has limits on origination points and fees, and (iv)
has certain legal protections for lenders. Qualified mortgages may or may not meet the underwriting standards of a U.S. government agency or GSE. In
general, non-qualified mortgage loans carry a higher credit risk than qualified mortgage loans.
Residential mortgage loans may also consist of either performing or distressed loans. Performing residential mortgage loans are loans that are
generally current and may consist of GSE eligible mortgage loans, non-qualified mortgage loans, or loans originally underwritten to GSE or another
program’s guidelines but are either undeliverable to a GSE or ineligible for a program due to certain underwriting or compliance errors. Distressed
residential mortgage loans may include seasoned re-performing, non-performing and other delinquent mortgage loans that would generally be purchased at
a discount to the principal amount outstanding.
Residential Business Purpose Loans
Residential business purpose loans (“BPL”) are mortgage loans made to professional real estate investors secured by first lien positions in non-
owner occupied residential real estate. Residential business purpose loans are used by the borrower to fund the acquisition, renovation, rehabilitation,
development and/or improvement of a residential property for investment or sale. 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
loans generally consist of fixed-rate, short-term, interest-only mortgage loans with the full amount of principal due at maturity. Residential BPLs are also
used to fund investments in single-family rental properties. The repayment of loans for single-family rental properties are generally based upon the rental
income received by the borrower or upon the sale of the property.
Commercial Mortgage Loans
Commercial mortgage loans are secured by commercial real property such as office, retail, multifamily, industrial, hospitality or healthcare facilities.
The commercial mortgage loans in which we invest typically have a first lien in the underlying real property; however, we may also invest in loans that
have a second lien or that are considered mezzanine loans. Commercial mortgage loans generally require the payment of interest monthly at a fixed-rate or
floating rate based on a benchmark such as LIBOR, SOFR or the prime rate plus a spread and generally mature between three and ten years and may
require periodic principal amortization with a balloon principal payment at maturity. Commercial mortgage loans typically have various covenants
including financial covenants based on the performance of the property securing the loan.
Non-agency MBS
3
Our credit investments also include investments in securitization trusts not issued or guaranteed by a U.S. government agency or GSE that are
collateralized by a pool of either residential or commercial mortgage loans, which we refer to as non-agency MBS. In some instances, non-agency
commercial MBS may be backed by a single mortgage loan secured by one or more commercial real properties. In addition, non-agency MBS also may
include a re-securitization of MBS.
Non-agency MBS are generally issued by a securitization trust referred to as either a Real Estate Mortgage Investment Conduit (“REMIC”) or a
grantor trust. The securitization trust will generally issue both senior and subordinated interests. Senior securities are those interests in a securitization that
have the first right to cash flows and are last in line to absorb losses, and, therefore, have the least amount of credit risk in a securitization transaction. In
general, most, if not all, principal collected from the underlying mortgage loan pool is used to pay down the senior securities until certain performance tests
are satisfied. If certain performance tests are satisfied, principal payments are allocated, generally on a pro rata basis, between the senior securities and the
subordinated securities. Conversely, the most subordinate securities are those interests in a securitization that have the last right to cash flows and are first
in line to absorb losses. Subordinate securities absorb the initial credit losses from a securitization structure, thus protecting the senior securities.
Subordinate securities generally receive interest payments even if they do not receive principal payments. Our non-agency MBS may also include interest-
only ("I/O") or principal-only ("P/O") strips issued by a securitization trusts. Holders of the I/O strips are entitled to only receive the interest payments of
the underlying mortgages loans in the securitization trust while holders of the P/O strips are entitled to only receive the principal payments of the
underlying mortgage loans in the securitization trust.
Non-agency MBS may be supported by one or more forms of private (i.e., non-governmental) credit enhancement. These credit enhancements
provide an extra layer of loss coverage in the event that losses are incurred upon foreclosure sales or other liquidations of underlying mortgaged properties
in amounts that exceed the equity holder’s equity interest in the property. Forms of credit enhancement include limited issuer guarantees, reserve funds,
private mortgage guaranty pool insurance, overcollateralization and subordination. Subordination is a form of credit enhancement frequently used and
involves the issuance of classes of MBS that are subordinate to senior class MBS and, accordingly, are the first to absorb credit losses realized on the
underlying mortgage loans. In addition, non-agency MBS are generally purchased at a discount to par value, which may provide further protection to credit
losses of the underlying mortgage loan collateral.
Solar Panel Loans or ABS Collateralized by Solar Panel Loans
Solar panel loans are sustainable home improvement loans primarily used to finance the acquisition and installation of solar panels and related
energy storage systems and equipment in residential homes. The loans are an obligation of the homeowner and are secured by the solar panels and related
energy storage systems and equipment. The loans generally bear interest at fixed rates and have maturities of up to 25 years. The borrower may qualify for
solar income tax credits for which the borrower is typically incentivized to use any proceeds towards the repayment of the outstanding principal balance of
the solar panel loans. Our investments in solar panel loans generally would not qualify as investments in real property or mortgages on real property.
Accordingly, our ability to invest in solar panel loans would be limited by our desire to qualify as a REIT.
Agency MBS
Agency MBS consist of residential pass-through certificates that are securities representing undivided interests in “pools” of mortgage loans secured
by residential real property. The monthly payments of both principal and interest of the securities are guaranteed by a U.S. government agency or GSE to
holders of the securities, in effect “passing through” the monthly payments made by the individual borrowers on the mortgage loans that underlie the
securities plus “guarantee payments” made in the event of any defaults on such mortgage loans, net of fees paid to the issuer/guarantor and servicers of the
underlying mortgage loans, to the holders of the securities. Mortgage pass-through certificates distribute cash flows from the underlying collateral on a pro
rata basis among the holders of the securities. Although the principal and interest payments are guaranteed by a U.S. government agency or GSE to the
security holder, the market value of the agency MBS is not guaranteed by a U.S. government agency or GSE.
The agency MBS in which we primarily invest are issued by Fannie Mae and Freddie Mac. Fannie Mae and Freddie Mac are stockholder-owned
corporations chartered by Congress with a public mission to provide liquidity, stability, and affordability to the U.S. housing market. Fannie Mae and
Freddie Mac are currently regulated by the Federal Housing Finance Agency (“FHFA”), the U.S. Department of Housing and Urban Development
(“HUD”), the SEC, and the U.S. Department of the Treasury (“U.S. Treasury”) and are currently operating under the conservatorship of the FHFA. The
U.S. Treasury has agreed to support the continuing operations of Fannie Mae and Freddie Mac with any necessary capital contributions while in
conservatorship. However, the U.S. government does not guarantee the securities, or other obligations, of Fannie Mae or Freddie Mac.
We also may invest in agency MBS issued by the Government National Mortgage Association (“Ginnie Mae”). Ginnie Mae is a wholly-owned
corporate instrumentality of the United States within HUD. Ginnie Mae guarantees the timely payment of the principal and interest on certificates that
represent an interest in a pool of mortgages insured by the Federal Housing Administration ("FHA"), or partially guaranteed by the Department of Veterans
Affairs and other loans eligible for inclusion in mortgage pools underlying Ginnie Mae certificates. Section 306(g) of the Housing Act provides that the full
faith and credit of the United States is pledged to the payment of all amounts which may be required to be paid under any guaranty by Ginnie Mae.
4
Fannie Mae, Freddie Mac and Ginnie Mae operate in the secondary mortgage market. They provide funds to the mortgage market by purchasing
residential mortgages from primary mortgage market institutions, such as commercial banks, savings and loan associations, mortgage banking companies,
seller/servicers, securities dealers and other investors. Through the mortgage securitization process, they package mortgage loans into guaranteed MBS for
sale to investors, such as us, in the form of pass-through certificates and guarantee the payment of principal and interest on the securities or on the
underlying loans held within the securitization trust in exchange for guarantee fees. The underlying loans of Fannie Mae and Freddie Mac agency MBS
must meet certain underwriting standards established by Fannie Mae and Freddie Mac (referred to as “conforming loans”) and may be fixed or adjustable
rate loans with original terms to maturity generally up to 30 years.
Agency MBS differ from other forms of traditional fixed-income securities which normally provide for periodic payments of interest in fixed
amounts with principal payments at maturity. Instead, agency MBS provide for a monthly payment that consists of both interest and principal. In addition,
outstanding principal on the agency MBS may be prepaid, without penalty, at par at any time due to prepayments on the underlying mortgage loans. These
differences can result in significantly greater price and yield volatility than is the case with more traditional fixed-income securities.
As of December 31, 2022, our agency MBS portfolio was comprised of securities collateralized by pools of fixed-rate mortgages that have original
terms to maturity of 30 years. In the future, we may also invest in agency MBS collateralized by adjustable-rate mortgage loans (“ARMs”), hybrid ARMs,
or loans with original terms to maturity of 15 or 20 years.
We purchase and sell agency MBS either in initial offerings or in the secondary market through broker-dealers or similar entities. We may also
utilize to-be-announced (“TBA”) forward contracts in order to invest in agency MBS or to hedge our investments. A TBA security is a forward contract for
the purchase or the sale of agency securities at a predetermined price, face amount, issuer, coupon and stated maturity on an agreed-upon future date, but
the particular agency securities to be delivered are not identified until shortly before the TBA settlement date. We may also choose, prior to settlement, to
move the settlement of these securities out to a later date by entering into an offsetting position (referred to as a “pair off”), net settling the paired off
positions for cash, and simultaneously entering into a similar TBA contract for a later settlement date, which is commonly collectively referred to as a
“dollar roll” transaction.
Financing Strategy
We use leverage to finance a portion of our investment portfolio and to seek to increase potential returns to our shareholders. To the extent that
revenue derived from our investment portfolio exceeds our interest expense and other costs of the financing, our net income will be greater than if we had
not borrowed funds and had not invested in the assets. Conversely, if the revenue from our investment portfolio does not sufficiently cover the interest
expense and other costs of the financing, our net income will be less or our net loss will be greater than if we had not borrowed funds.
We closely monitor the leverage (debt-to-equity ratio) of our investment portfolio. Our leverage may vary from time to time depending upon several
factors, including changes in the value of the underlying investment and hedge portfolio, changes in investment allocation between our investment
strategies, the timing and amount of investment purchases or sales, and our assessment of risk and returns.
For our investments in MSR related assets, at our election and direction, we could have our mortgage servicing counterparty utilize leverage on the
MSRs that are subject to our MSR financing receivables to finance the purchase of additional MSRs to increase potential returns to us through a credit
facility that our mortgage servicing counterparty has with a third-party lender. Any draws under the credit facility would be secured by the MSRs subject to
our MSR financing receivables. Under its credit facility, our mortgage servicing counterparty can obtain advances up to a fixed percentage of the fair value
of the MSR collateral value. In general, if the fair value of the pledged MSR collateral declines and the lender demands additional collateral from our
mortgage servicing counterparty through a margin call, we would be required to provide additional funds to meet such margin call. Accordingly, our MSR
financing receivables can have embedded leverage to the extent we request our mortgage servicing counterparty to utilize leverage.
We may finance our agency MBS and credit investments using short-term secured borrowings structured as repurchase agreements. Under our
repurchase agreements, we are subject to daily margin calls in the event the estimated fair value of existing pledged collateral declines and such lenders
demand additional collateral. To mitigate our risk associated with daily margin calls on less liquid credit investments, we generally seek to limit the
amount of our use of repurchase agreement financing secured by credit investments.
When we engage in a repurchase transaction, we initially sell securities to the counterparty under a master repurchase agreement in exchange for
cash from the counterparty. The counterparty is obligated to resell the same securities back to us at the end of the term of the repurchase agreement, which
typically is 30 to 60 days, but may have maturities as short as one day or as long as one year. Amounts available to be borrowed under our repurchase
agreements are dependent upon lender collateral requirements and the lender’s determination of the fair value of the securities pledged as collateral, which
fluctuates with changes in interest rates, credit quality and liquidity conditions within the investment banking, mortgage finance and real estate industries.
In addition, our
5
counterparties apply a “haircut” to our pledged collateral, which means our collateral is valued, for the purposes of the repurchase transaction, at less than
market value. Under our repurchase agreements, we typically pay a fixed interest rate. These transactions are accounted for as secured financings, and we
present the investment securities and related funding on our consolidated balance sheets.
We may also finance the acquisition of agency MBS by entering into TBA dollar roll transactions in which we would sell a TBA contract for current
month settlement and simultaneously purchase from the same counterparty a similar TBA contract for a forward settlement date. Prior to the forward
settlement date, we may choose to roll the position out to a later date by entering into an offsetting TBA position, net settling the paired off positions for
cash, and simultaneously entering into a similar TBA contract for a later settlement date. In such transactions, the TBA contract purchased for a forward
settlement date is priced at a discount to the TBA contract sold for settlement/pair-off in the current month. This difference (or discount) is referred to as the
“price drop.” As discussed in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations— “Non-GAAP Core
Operating Income,” we believe this price drop is the economic equivalent of net interest carry income (interest income less implied financing cost) earned
from the underlying agency MBS over the roll period, which is commonly referred to as “dollar roll income.” Consequently, dollar roll transactions
represent a form of off-balance sheet financing. In evaluating our overall leverage at risk, we consider both our on-balance and off-balance sheet financing.
In general, we seek term securitization debt financing for our targeted investments in residential or commercial mortgage loans within our credit
investment strategy for which the financing obligation is non-recourse to us and for which we are not obligated to pledge additional margin. Our
investments in non-agency MBS carry implicit financing leverage through the securitized debt that is issued by the underlying trust. In certain of our
investments in non-agency MBS, we may be deemed to be the primary beneficiary of a securitization trust that is a variable interest entity (“VIE”) through
our ownership interest in the trust requiring us to consolidate the trust’s asset and liabilities for financial reporting purposes. In such a situation, the debt
issued by the securitization trust is non-recourse to us and our risk of loss is limited to our investment in the trust.
We have also issued, and may issue in the future, long-term unsecured notes as an additional source of financing.
Risk Management Strategy
In conducting our business, we are exposed to market risks, including interest rate, prepayment, extension, spread, credit, liquidity and regulatory
risks. We attempt to manage these risks through the use of interest rate hedging instruments, investment allocation, asset selection and monitoring our
overall leverage levels. We use a variety of strategies to manage a portion of our exposure to these risks to the extent we believe to be prudent, taking into
account our investment strategy, the cost of any hedging transactions and our intention to qualify as a REIT. As a result, we may not hedge certain risks if
we believe that bearing such risks enhances our return relative to our risk/return profile.
Competition
Our success depends, in large part, on our ability to acquire our targeted investments at favorable returns. In acquiring these assets, we compete with
mortgage finance and specialty finance companies, real estate funds, savings and loan associations, banks, mortgage bankers, insurance companies, mutual
funds, institutional investors, REITs, investment banking firms, other lenders, the U.S. Treasury, Fannie Mae, Freddie Mac, other governmental bodies and
other entities. In addition, there are numerous entities with similar asset acquisition objectives and others may be organized in the future which may
increase competition for the available supply of our targeted mortgage investments that meet our investment objectives. Additionally, our investment
strategy is dependent on the amount of financing available to us, which may also be impacted by competing borrowers. Our investment strategy will be
adversely impacted if we are not able to secure financing on favorable terms, if at all. In addition, competition is intense for the recruitment and retention of
qualified professionals. Our ability to continue to compete effectively in our businesses will depend upon our continued ability to attract new professionals
and retain and motivate our existing professionals. For a further discussion of the competitive factors affecting our business, see “Item 1A - Risk Factors”
in this Annual Report on Form 10-K.
Our Tax Status
We have elected to be taxed as a REIT under the Internal Revenue Code. As a REIT, we are required to distribute annually 90% of our REIT taxable
income (subject to certain adjustments). So long as we continue to qualify as a REIT, we will generally not be subject to U.S. federal or state corporate
income taxes on our taxable income that we distribute to our shareholders on a timely basis. Any amounts not distributed are subject to U.S. federal and
state corporate taxes. At present, it is our intention to distribute 100% of our taxable income, although we will not be required to do so. We intend to make
distributions of our taxable income within the time limits prescribed by the Internal Revenue Code, which may extend into the subsequent taxable year.
Qualification and taxation as a REIT depends upon our ability to continually meet requirements imposed upon REITs by the Internal Revenue Code,
including satisfying certain organizational requirements, an annual distribution requirement and quarterly asset and annual income tests. The REIT asset
and income tests are significant to our operations as they restrict the extent to which we can invest in certain types of securities and conduct certain hedging
activities within the REIT.
6
Income Tests
To qualify as a REIT, we must satisfy two gross income requirements on an annual basis:
1.
At least 75% of our gross income for each taxable year generally must be derived from investments in real property or mortgages on real
property.
2.
At least 95% of our gross income for each taxable year generally must be derived from some combination of income that qualifies under the
75% gross income test described above, as well as other dividends, interest, gains from the sale or disposition of stock or securities, which need
not have any relation to real property.
Interest income and gains from the disposition of obligations secured by mortgages on real property, such as agency MBS, constitute qualifying
income for purposes of the 75% gross income test described above. There is no direct authority with respect to the qualification of income or gains from
TBAs for the 75% gross income test; however, we treat income and gains from commitments to purchase TBAs as qualifying income under the 75% gross
income test based on an opinion of legal counsel.
Income earned by a TRS is not attributable to the REIT. As a result, income that might not be qualifying income for the purpose of the income tests
applicable to a REIT could be earned by a TRS without affecting our status as a REIT. A TRS is an entity that is taxable as a corporation in which we
directly or indirectly own the stock and that elects with us to be treated as a TRS.
Income and gains from instruments that we use to hedge the interest rate risk associated with our borrowings incurred, or to be incurred, to acquire
real estate assets will generally be excluded from both gross income tests, provided that specified requirements are met. To the extent that we enter into
hedging instruments that are not a hedge of our interest rate risk associated with our borrowings incurred to acquire real estate assets or are not properly
designated as such, the gross income and gains from such hedging transactions will likely be treated as nonqualifying income for purposes of the 75% gross
income test and may also be treated as nonqualifying income for purposes of the 95% gross income test. However, we may conduct such hedging activities
through a TRS, the income of which may be subject to income tax rather than participating in the arrangements directly through the REIT.
Asset Tests
At the close of each calendar quarter, we must satisfy five gross asset tests relating to the nature of our assets:
1.
At least 75% of the value of our assets must be represented by some combination of real estate assets, cash, cash items, U.S. Government
securities, stock in other REITs and debt instruments of publicly offered REITs, and, under some circumstances, temporary investments in
stock or debt instruments purchased with new capital. For this purpose, interests in mortgage loans secured by real property such as agency
MBS are treated as real estate assets. Assets that do not qualify for purposes of the 75% asset test are subject to the additional tests described
below.
2.
The value of any one issuer’s securities that we own may not exceed 5% of the value of our total assets.
3.
We may not own more than 10% of any issuer’s outstanding securities, as measured by either voting power or value. The 5% and 10% asset
tests do not apply to securities of TRSs and qualified REIT subsidiaries and the 10% test does not apply to “straight debt” having specified
characteristics and to certain other securities.
4.
The aggregate value of all securities of all TRSs that we hold may not exceed 20% of the value of our total assets.
5.
No more than 25% of the total value of our assets may be represented by certain non-mortgage debt instruments issued by publicly offered
REITs.
If we should fail to satisfy the income or asset tests, such a failure would not cause us to lose our REIT qualification if we were able to eliminate the
discrepancy within a specified cure period, in the case of the asset tests, satisfy certain relief provisions and pay any applicable penalty taxes and other
fines. Please refer to the “Risks Related to Taxation” in “Item 1A - Risk Factors” of this Form 10-K for further discussion of REIT qualification
requirements and related items.
Net Operating Loss and Net Capital Loss Carryforwards
As of December 31, 2022, we had estimated NOL carryforwards of $162.5 million that can be used to offset future taxable ordinary income and
reduce our future distribution requirements. NOL carryforwards totaling $14.6 million expire in 2028 and NOL carryforwards totaling $147.9 million have
no expiration period. As of December 31, 2022, we also had estimated NCL carryforwards of $155.7 million that can be used to offset future net capital
gains. The scheduled expirations of our NCL carryforwards are $110.3 million in 2023, $14.2 million in 2026 and $31.2 million in 2027. Our estimated
NOL and NCL carryforwards as of December 31, 2022 are subject to potential adjustments up to the time of filing our income tax returns.
Our ability to use our NOLs, NCLs and built-in losses would be limited if we experienced an “ownership change” under Section 382 of the Internal
Revenue Code. In general, an “ownership change” would occur if there is a cumulative change in the ownership of our Class A Common Stock (our
“common stock”) of more than 50% by one or more “5% shareholders” during a three-year period.
7
Our Board of Directors adopted and our shareholders approved a shareholder rights agreement and the first amendment thereto, in an effort to protect
against a possible limitation on our ability to use our NOL carryforwards, NCL carryforwards, and built-in losses under Sections 382 and 383 of the
Internal Revenue Code. The Rights Plan was adopted to dissuade any person or group from acquiring 4.9% or more of our outstanding common stock
without the approval of our Board of Directors and triggering an “ownership change” as defined by Section 382.
Government Regulation
We intend to operate so as to be excluded from regulation under the 1940 Act. We rely on Section 3(c)(5)(C) of the 1940 Act, which provides an
exclusion for entities that are “primarily engaged in purchasing or otherwise acquiring . . . interests in real estate.” Section 3(c)(5)(C) as interpreted by the
staff of the SEC provides an exclusion from registration for a company if at least 55% of its assets, on an unconsolidated basis, consist of qualified assets
such as whole loans and whole pool agency certificates, and if at least 80% of its assets, on an unconsolidated basis, are real estate related assets. We will
need to ensure not only that we qualify for an exclusion or exemption from regulation under the 1940 Act, but also that each of our subsidiaries qualifies for
such an exclusion or exemption. We intend to maintain our exclusion by monitoring the value of our interests in our subsidiaries. We may not be successful
in this regard.
If we fail to maintain our exclusion or secure a different exclusion or exemption if necessary, we may be required to register as an investment
company, or we may be required to acquire or dispose of assets in order to meet our exemption. Any such asset acquisitions or dispositions may include
assets that we would not acquire or dispose of in the ordinary course of business, may be at unfavorable prices and result in a decline in the price of our
common stock. If we are required to register under the 1940 Act, we would become subject to substantial regulation with respect to our capital structure
(including our ability to use leverage), management, operations, transactions with affiliated persons (as defined in the 1940 Act), and portfolio composition,
including restrictions with respect to diversification and industry concentration and other matters. Accordingly, registration under the 1940 Act could limit
our ability to follow our current investment and financing strategies and result in a decline in the price of our common stock.
Available Information
Our SEC filings are available to the public from commercial document retrieval services and at the internet website maintained by the SEC at
http://www.sec.gov and on our website at http://www.arlingtonasset.com under “Investor Relations.”
Our website address is http://www.arlingtonasset.com. We make available free of charge through our website this Annual Report on Form 10-K,
quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the
Exchange Act, as well as the annual report to shareholders and Section 16 reports on Forms 3, 4 and 5 as soon as reasonably practicable after such
documents are electronically filed with, or furnished to, the SEC. In addition, our Bylaws, Statement of Business Principles (our code of ethics), Corporate
Governance Guidelines, and the charters of our Audit, Compensation, and Nominating and Governance Committees are available on our website and are
available in print, without charge, to any shareholder upon written request in writing c/o our Secretary at 6862 Elm Street, Suite 320, McLean, Virginia
22101. Information on our website should not be deemed to be a part of this report or incorporated into any other filings we make with the SEC.
Human Capital Resources
As of December 31, 2022, we had nine employees. We endeavor to maintain workplaces that are free from discrimination or harassment on the basis
of color, race, sex, national origin, ethnicity, religion, age, disability, sexual orientation, gender identification or expression or any other status protected by
applicable law. Our basis for recruitment, hiring, development, training, compensation and advancement is qualifications, performance, skills and
experience. Our employees are fairly compensated, without regard to gender, race and ethnicity and are routinely recognized for outstanding performance.
Our compensation program is designed to attract and retain talent.
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ITEM 1A. RISK FACTORS
Summary of Risk Factors
Risks Related to our Investing and Financing Activities
•
Risks related to changes in interest rates.
•
Risks related to hedging.
•
Risks related to declines in the market values of our investment portfolio.
•
Risks related to the significant leverage involved in our investing.
•
Risks related to increases in borrowing costs.
•
Risks related to the maturity of our fixed-rate assets and short-term borrowings.
•
Risks related to the need for additional collateral and increased margin requirements.
•
Risks related to the potential lack of adequate financing through repurchase agreements.
•
Risks related to underperforming yields on new assets.
•
Risks related to our agency MBS investments, Fannie Mae and Freddie Mac.
•
Risks related to the volatility of the value of our MSR related assets.
•
Risks related to the relationship between interest rate changes and prepayment.
•
Risks related to changes in prepayment rates.
•
Risks related to TBA dollar roll transactions.
•
Risks related to our use of repurchase agreements.
•
Risks related to potential default on obligations under our repurchase agreements.
•
Risks related to current indebtedness levels.
•
Risks related to the elimination of LIBOR.
•
Risks related to limitations on our access to capital.
•
Risks related to due diligence of potential investments.
•
Risks related to our credit investments.
•
Risks related to servicers and third-party service providers.
•
Risks related to concentration of credit risk.
•
Risks related to subordinated tranches of non-agency MBS.
•
Risks related to mortgage loan investments secured by healthcare properties.
•
Risks related to MSR related assets.
•
Risks related to the subjectivity of fair value assumptions.
•
Risks related to potential changes in strategies, asset allocation and operation policies.
•
Risks related to entering into new lines of business.
•
Risks related to the involvement of our Board in our investment, financing and hedging decisions.
•
Risks related to a highly-competitive market for investment opportunities.
Risks Related to our Business and Structure
•
Risks related to our Rights Plan.
•
Risks related to ownership limits in our charter.
•
Risks related to the trading price of our securities.
•
Risks related to fluctuations in quarterly operating results.
•
Risks related to lack of minimum dividend payment levels.
•
Risks related to indemnification obligations.
•
Risks related to the 1940 Act and potential regulations as an investment company.
•
Risks related to potential regulation as a commodity pool operator.
•
Risks related to competition for personnel.
•
Risks related to communications and information systems operated by third parties.
•
Risks related to cybersecurity attacks.
•
Risks related to future issuances of additional debt securities or other equity securities.
•
Risks related to future sales of common stock.
•
Risks related to a resurgence of COVID-19.
•
Risks related to future cash dividends on our common stock.
Risks Related to Taxation
•
Risks related to potential failure to qualify as a REIT.
9
•
Risks related to complying with REIT requirements.
•
Risks related to REIT distribution requirements.
•
Risks related to net capital losses.
•
Risks related to additional tax liabilities.
•
Risks related to liquidation of assets.
•
Risks related to potential failure of assets subject to repurchase agreements to be treated as owned.
•
Risks related to the treatment of our TBAs.
•
Risks related to prohibited transactions.
•
Risks related to distributions to tax-exempt investors.
•
Risks related to certain financing activities and their negative tax consequences.
•
Risks related to stock ownership limits.
•
Risks related to our TRSs.
•
Risks related to new legislation or administrative or judicial action.
•
Risks related to our ability to deduct interest expense.
•
Risks related to our utilization of NOL and NCL carryforwards.
•
Risks related to our potential to elect to no longer be taxed as a REIT.
•
Risks related to ownership change.
•
Risks related to preserving the ability to use our NOLs and NCLs.
Investing in our company involves various risks, including the risk that you might lose your entire investment. Our results of operations depend upon many
factors including our ability to implement our business strategy, the availability of opportunities to acquire assets, the level and volatility of interest rates,
the cost and availability of short- and long-term credit, financial market conditions and general economic conditions.
The following discussion concerns the material risks associated with our business. These risks are interrelated, and you should consider them as a whole.
Additional risks and uncertainties not presently known to us may also materially and adversely affect the value of our capital stock and our ability to pay
dividends to our shareholders. In connection with the forward-looking statements that appear in this Annual Report on Form 10-K, including these risk
factors and elsewhere, you should carefully review the section entitled “Cautionary Statement About Forward-Looking Information.”
Risks Related to our Investing and Financing Activities
We may change our investment strategy, hedging strategy, asset allocation and operational policies without shareholder consent, which may result in
riskier investments and may adversely affect our results of operations and the market value of our securities.
We may change our investment strategy, hedging strategy, asset allocation and operational policies at any time without the consent of our
shareholders, which could result in our making investment or hedge decisions that are different from, and possibly riskier than, the investments and hedges
described in this Annual Report on Form 10-K. A change in our investment or hedging strategy may increase our exposure to interest rate and real estate
market fluctuations. A change in our asset allocation could result in us making investments in securities, assets or business different from those described in
this Annual Report on Form 10-K. Our Board of Directors oversees our operational policies, including those with respect to our acquisitions, growth,
operations, indebtedness, capitalization and distributions and approves transactions that deviate from these policies without a vote of, or notice to, our
shareholders. Operational policy changes could adversely affect the market value of our securities and our ability to make distributions to our shareholders.
Investing in assets or businesses other than our historical investment strategies may not be successful and could adversely affect our results of operations
and the market value of our securities.
We may enter into new lines of business, acquire other companies or engage in other strategic initiatives, each of which may result in additional risks
and uncertainties in our businesses.
We may pursue growth through acquisitions of other companies or other strategic initiatives that may require approval by our Board of Directors,
stockholders, or both. To the extent we pursue strategic investments or acquisitions, undertake other strategic initiatives or consider new lines of business,
we will face numerous risks and uncertainties, including risks associated with:
10
•
the availability of suitable opportunities;
•
the level of competition from other companies that may have greater financial resources;
•
our ability to value potential acquisition opportunities accurately and negotiate acceptable terms for those opportunities;
•
the required investment of capital and other resources;
•
the lack of availability of financing and, if available, the terms of any financings;
•
the possibility that we have insufficient expertise to engage in such activities profitably or without incurring inappropriate amounts of
risk;
•
the diversion of management’s attention from our core businesses;
•
assumption of liabilities in any acquired business;
•
the disruption of our ongoing businesses;
•
the increasing demands on or issues related to combining or integrating operational and management systems and controls;
•
compliance with additional regulatory requirements; and
•
costs associated with integrating and overseeing the operations of the new businesses.
Entry into certain lines of business may subject us to new laws and regulations with which we are not familiar, or from which we are currently
exempt, and may lead to increased litigation and regulatory risk. In addition, if a new business generates insufficient revenues or if we are unable to
efficiently manage our expanded operations, our results of operations will be adversely affected. Our strategic initiatives may include joint ventures, in
which case we will be subject to additional risks and uncertainties in that we may be dependent upon, and subject to liability, losses or reputational damage
relating to, systems, controls and personnel that are not under our control.
Our Board of Directors does not approve each of our investment, financing and hedging decisions.
Our Board of Directors oversees our operational policies and periodically reviews our investment guidelines and our investment portfolio. However,
our Board of Directors does not review all of our proposed investments. In addition, in conducting periodic reviews, our Board of Directors may rely
primarily on information provided to them by our management. Furthermore, transactions entered into or structured for us by our management may be
difficult or impossible to unwind by the time they are reviewed by our Board of Directors.
Changes in interest rates and adverse market conditions could negatively affect the value of our investments and increase the cost of our borrowings,
which may adversely affect our results of operations.
Our investment portfolio includes fixed-rate agency MBS with long-term maturities. The majority of our funding is in the form of repurchase
agreements with short-term maturities with an interest rate that resets upon maturity and rolling the repurchase agreement financing to a new maturity date.
We are exposed to interest rate risk that fluctuates based on changes in the level or volatility of interest rates and in the shape and slope of the yield curve.
Under a normal yield curve, long-term interest rates are higher relative to short-term interest rates. In certain instances, the yield curve can become inverted
when the short-term interest rates are higher than the long-term interest rates.
A significant risk associated with our portfolio of mortgage-related assets is the risk that both long-term and short-term interest rates will increase
significantly. If long-term rates were to increase significantly, the market value of fixed-rate agency MBS would decline and the duration and weighted
average life of these MBS would increase. We could realize a loss in the future if the agency MBS in our portfolio are sold. If short-term interest rates were
to increase, the financing costs on the repurchase agreements we enter into in order to finance the purchase of MBS would increase, thereby decreasing net
interest margin if all other factors remain constant.
Hedging against interest rate exposure may not completely insulate us from interest rate risk and may adversely affect our earnings.
We engage in certain hedging transactions to limit our exposure from the adverse effects of changes in interest rates on the borrowing costs of our
short-term financing agreements and the value of our fixed-rate agency MBS investment portfolio, and
11
therefore may expose our company to the risks associated with such transactions. We have historically entered into and may enter into interest rate swap
agreements, U.S. Treasury note futures, Eurodollar futures, interest rate swap futures, options on U.S. Treasury note futures, options on agency MBS, TBAs
or may pursue other hedging strategies. Our hedging activities are generally designed to limit certain exposures and not to eliminate them. Hedging against
a decline in the values of our portfolio positions does not eliminate the possibility of fluctuations in the values of such positions or prevent losses if the
values of such positions decline. Such hedging transactions may also limit the opportunity for gain if the values of the portfolio positions should increase.
Moreover, it may not be possible to hedge against an interest rate fluctuation that is so generally anticipated that we are not able to enter into a hedging
transaction at an acceptable price.
There are no perfect hedging strategies, and interest rate hedging may fail to protect us from loss. The success of our hedging transactions depends
on our ability to accurately predict movements of interest rates and credit spreads. In addition, the degree of correlation between price movements of the
instruments used in a hedging strategy and price movements in the portfolio positions being hedged may vary. Moreover, for a variety of reasons, we may
not seek to establish a perfect correlation between such hedging instruments and the portfolio holdings being hedged. Any such imperfect correlation may
prevent us from achieving the intended hedge and expose us to risk of loss. Furthermore, our hedging strategies may adversely affect us because hedging
activities involve costs that we incur regardless of the effectiveness of the hedging activity, which may decrease our net interest margin. Our hedging
activity will vary in scope based on the level and volatility of interest rates and principal prepayments, the amount of leverage, the type of MBS held, the
form and tenor of financing arrangements, and other changing market conditions.
Interest rate hedging may fail to protect or could adversely affect us because, among other things:
•
interest rate hedging can be expensive, particularly during periods of rising and volatile interest rates;
•
available interest rate hedging may not correspond directly with the interest rate risk for which protection is sought;
•
the duration of the hedge may not match the duration of the related asset or liability;
•
the amount of income that a REIT may earn from hedging transactions other than hedging transactions that satisfy certain requirements of the
Internal Revenue Code or that are done through a TRS is limited by federal tax provisions governing REITs;
•
the value of our interest rate hedges declines due to interest rate fluctuations, lapse of time or other factors; and
•
the party owing money in the hedging transaction may default on its obligation to pay.
Our hedging activity may adversely affect our earnings and result in volatile fluctuations in the fair value of our hedges, net income and book value
per share.
Our hedging strategies are generally not designed to mitigate spread risk.
When the market spread widens between the yield on our mortgage assets and benchmark interest rates, our net book value could decline if the fair
value of our mortgage assets falls by more than the offsetting fair value increases on our hedging instruments tied to the underlying benchmark interest
rates or if the fair value of our mortgage assets do not increase as much as the fair value decreases on our hedging instruments. We refer to this scenario as
an example of “spread risk” or “basis risk.” The spread risk associated with our mortgage assets and the resulting fluctuations in fair value of these
securities can occur independently of changes in benchmark interest rates and may relate to other factors impacting the mortgage and fixed income markets,
such as actual or anticipated monetary policy actions by the Federal Reserve, market liquidity, changes in expected prepayments, or changes in required
rates of return on different assets. Consequently, while we use various interest rate hedging instruments to attempt to protect against moves in interest rates,
such instruments typically will not protect our net book value against spread risk, which could adversely affect our financial condition and results of
operations.
Declines in the market values of our investment portfolio may adversely affect our financial condition, results of operations, and market price of your
investments in our securities.
Certain of our investments are recorded at fair value with changes in fair value reported in net income. As a result, a decline in the fair value of our
investments would reduce our net income and book value per share. Fair values for our investments can be volatile. The fair values can change rapidly and
significantly, and changes can result from various factors, including changes in interest rates, actual and perceived risk, supply, demand, expected
prepayment rates, and actual and projected credit performance. Declines in the market values of our investment portfolio would adversely affect our
financial condition, results of operations, and market price of your investments in our securities.
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Our investment strategy involves significant leverage, which could adversely affect our financial condition and results of operations.
We may increase our investment exposure by funding a portion of new investments with repurchase agreements or other borrowing arrangements.
To the extent that revenue derived from such levered assets exceeds our interest expense, hedging expense and other costs of the financing, our net income
will be greater than if we had not borrowed funds and had not invested in such assets on a leveraged basis. Conversely, if the revenue from our investment
do not sufficiently cover the interest expense, hedging expense and other costs of the financing, our net income will be less or our net loss will be greater
than if we had not borrowed funds. Because of the credit and interest rate risks inherent in our investment strategies, we closely monitor the leverage of our
investment portfolio. From time to time, our leverage ratio may increase or decrease due to several factors, including changes in the value of the underlying
portfolio, changes in investment allocations and the timing and amount of acquisitions.
An increase in our borrowing costs relative to the interest we receive on our assets may adversely affect our profitability.
As our repurchase agreements and other short-term borrowings mature, we must either enter into new borrowings or liquidate certain of our
investments at times when we might not otherwise choose to do so. Lenders may also seek to use a maturity date as an opportune time to demand additional
terms or increased collateral requirements that could be adverse to us and harm our operations. Due to the short-term nature of our repurchase agreements
used to finance our investments, our borrowing costs are particularly sensitive to changes in short-term interest rates. An increase in short-term interest
rates when we seek new borrowings would reduce the spread between our returns on our assets and the cost of our borrowings and may adversely affect our
liquidity position, business, financial condition and results of operations.
Differences in the stated maturity of our fixed-rate assets and short-term borrowings may adversely affect our profitability.
We rely primarily on short-term borrowings to acquire fixed-rate securities with long-term maturities. The relationship between short-term and
longer-term interest rates is often referred to as the “yield curve.” Ordinarily, short-term interest rates are lower than longer-term interest rates. If short-term
interest rates rise disproportionately relative to longer-term interest rates, resulting in a “flattening” of the yield curve, our borrowing costs may increase
more rapidly than the interest income earned on our assets. Because our investments generally bear interest at longer-term rates than we pay on our
borrowings under our repurchase agreements, a flattening of the yield curve would tend to decrease our net interest income and the market value of our
investment portfolio. Additionally, to the extent cash flows from investments that return principal are reinvested, the spread between the yields on the new
investments and available borrowing rates may decline, which would likely decrease our net income. It is also possible that short-term interest rates may
exceed longer-term interest rates (a yield curve “inversion”), in which event, our borrowing costs may exceed our interest income and we could incur
operating losses and our ability to make distributions to our shareholders could be hindered.
Our lenders may require us to provide additional collateral, especially when the market values for our investments decline, which may restrict us from
leveraging our assets as fully as desired, and reduce or eliminate our liquidity and adversely affect our results of operations and financial condition.
We currently use repurchase agreements to finance our investments in agency MBS and other mortgage assets. Our repurchase agreements allow the
lenders, to varying degrees, to determine a new market value of the collateral to reflect current market conditions. If the market value of the securities
pledged or sold by us to a funding source declines in value, as occurred with great regularity during the onset of the COVID-19 pandemic, we may be
required by the lender to provide additional collateral or pay down a portion of the funds advanced on minimal notice, which is known as a margin call.
Posting additional collateral will reduce our liquidity and limit our ability to leverage our assets, which could adversely affect our business. Additionally, in
order to satisfy a margin call, we may be required to liquidate assets at a disadvantageous time, which could cause us to incur further losses and adversely
affect our results of operations and financial condition. In the event we do not have sufficient liquidity to satisfy these margin calls, lending institutions can
accelerate our indebtedness, increase our borrowing rates, liquidate our collateral and terminate our ability to borrow. Such a situation would likely result in
a rapid deterioration of our financial condition and possibly necessitate a filing for protection under the bankruptcy code.
Clearing facilities or exchanges upon which some of our hedging instruments are traded may increase margin requirements on our hedging
instruments in the event of adverse economic developments.
Our interest rate hedging agreements typically require that we pledge collateral on such agreements. We exchange collateral with the counterparties
to our interest rate hedging instruments at least on a daily basis based upon daily changes in fair value (also known as “variation margin”) as measured by
the central clearinghouse through which those instruments are cleared. In addition, the central clearinghouse requires market participants to deposit and
maintain an “initial margin” amount which is determined by the clearinghouse and is generally intended to be set at a level sufficient to protect the
clearinghouse from the maximum estimated
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single-day price movement in that market participant’s contracts. The clearing exchanges have the sole discretion to determine the value of the instruments.
In the event of a margin call, we must generally provide additional collateral on the same business day. In response to events having or expected to have
adverse economic consequences or which create market uncertainty, clearing facilities or exchanges upon which our hedging instruments are traded may
require us to pledge additional collateral against our hedging instruments. In the event that future adverse economic developments or market uncertainty
result in increased margin requirements for our hedging instruments, it could materially adversely affect our liquidity position, business, financial condition
and results of operations.
If we fail to maintain adequate financing or to renew or replace existing borrowings upon maturity, we will be limited in our ability to implement our
investing activities, which will adversely affect our results of operations and may, in turn, negatively affect the market value of your investment in our
securities.
We depend upon repurchase agreement financing to purchase agency MBS and other mortgage assets and reach our target leverage ratio. We cannot
assure you that sufficient repurchase agreement financing will be available to us in the future on terms that are acceptable to us. Our lenders also may revise
their eligibility requirements for the types of assets they are willing to finance or the terms of such financings based on, among other factors, the regulatory
environment and their perceived risk. If we fail to obtain adequate funding or to renew or replace existing funding upon maturity, we will be limited in our
ability to implement our business strategy, which will adversely affect our results of operations and may, in turn, negatively affect the market value of your
investments in our securities.
New assets we acquire may not generate yields as attractive as yields on our current assets, resulting in a decline in our earnings over time.
We receive monthly cash flows consisting of principal and interest payments from many of our assets. Principal payments reduce the size of our
current portfolio (i.e., reduce the amount of our long-term assets) and generate cash for us. We may also sell assets from time to time as part of our portfolio
management and capital reallocation strategies. In order to maintain or grow our portfolio size and our earnings, we must reinvest in new assets a portion of
the cash flows we receive from principal repayments and asset sales. New investment opportunities may not generate the same investment returns as our
current investment portfolio. If the assets we acquire in the future earn lower returns than the assets we currently own, our reported earnings will likely
decline over time as the older assets pay down, are called, or are sold.
Our agency MBS investments that are guaranteed by Fannie Mae and Freddie Mac are subject to the risk that these GSEs may not be fully able to
satisfy their guarantee obligations or that these guarantee obligations may be repudiated, which would adversely affect the value of our investment
portfolio and our ability to sell or finance these securities.
All of the agency MBS in which we invest depend on a steady stream of payments on the mortgages underlying the MBS. The interest and principal
payments we receive on agency MBS issued by Fannie Mae or Freddie Mac are guaranteed by these GSEs, but are not guaranteed by the U.S. government.
To the extent these GSEs are not able to fully satisfy their guarantee obligations or that these guarantee obligations are repudiated or otherwise defaulted
upon, the value of our investment portfolio and our ability to sell or finance these securities would be adversely affected.
The conservatorship of Fannie Mae and Freddie Mac and related efforts, along with any changes in laws and regulations affecting the relationship
between Fannie Mae and Freddie Mac and the federal government, may adversely affect our business.
The interest and principal payments we receive on agency MBS issued by Fannie Mae or Freddie Mac are guaranteed by these GSEs and not
guaranteed by the full faith and credit of the U.S. government. Fannie Mae and Freddie Mac are currently regulated by the FHFA, HUD, SEC and U.S.
Treasury, and are currently operating under the conservatorship of the FHFA, which is a statutory process pursuant to which the FHFA operates Fannie Mae
and Freddie Mac in an effort to stabilize the entities. As part of these actions, the U.S. Treasury has agreed to support the continuing operations of Fannie
Mae and Freddie Mac with any necessary capital contributions up to a maximum capital commitment to each GSE while in conservatorship. Although the
U.S. Treasury has committed to support the positive net worth of Fannie Mae and Freddie Mac, the two GSEs could default on their guarantee obligations,
which would materially and adversely affect the value of our agency MBS.
In addition, the future roles of Fannie Mae and Freddie Mac could be significantly reduced or eliminated and the nature of their guarantees could be
eliminated or considerably limited relative to historical measurements. Any changes to the nature of the guarantees provided by Fannie Mae and Freddie
Mac could redefine what constitutes agency MBS, have broad adverse market implications and negatively impact us. The FHFA and both houses of
Congress have each discussed and considered separate measures intended to restructure the U.S. housing finance system and the operations of Fannie Mae
and Freddie Mac. The passage of any additional new legislation affecting Fannie Mae and Freddie Mac may create market uncertainty and reduce the actual
or perceived credit quality of securities issued or guaranteed by the U.S. government through a new or existing successor entity to Fannie
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Mae and Freddie Mac. If the charters of Fannie Mae and Freddie Mac were revoked, it is unclear what effect, if any, this would have on the value of the
existing Fannie Mae and Freddie Mac agency MBS. We anticipate debate and discussion on residential housing and mortgage reform to continue; however,
we cannot be certain if any housing and/or mortgage-related legislation will emerge from committee, be approved by Congress, or be affected by any
executive actions and, if so, what the effect will be on our business.
The value of our MSR related assets may vary substantially with changes in interest rates.
The values of our MSR related assets are highly sensitive to changes in interest rates. The value of MSRs typically increases when interest rates rise
and decreases when interest rates decline due to the effect those changes in interest rates have on prepayment estimates. Subject to qualifying and
maintaining our qualification as a REIT, we may pursue various hedging strategies to seek to reduce our exposure to adverse changes in interest rates. Our
hedging activity will vary in scope based on the level and volatility of interest rates, the type of assets held and other changing market conditions. Interest
rate hedging may fail to protect or could adversely affect us. To the extent we do not utilize hedging instruments to hedge against changes in the fair value
of our MSR related assets, our balance sheet, results of operations and cash flows would be susceptible to significant volatility due to changes in the fair
value of, or cash flows from, those assets as interest rates change.
Changes in prepayment rates may adversely affect our profitability and are difficult to predict.
Our investment portfolio includes securities backed by pools of residential mortgage loans. For securities backed by pools of residential mortgage
loans, we receive income, generally, from the payments that are made by the borrowers of the underlying mortgage loans. When borrowers prepay their
mortgage loans at rates that are faster or slower than expected, it results in prepayments that are faster or slower than expected on our investments. These
faster or slower than expected payments may adversely affect our profitability.
We may purchase securities that have a higher interest rate than the then-prevailing market interest rate. In exchange for this higher interest rate, we
may pay a premium to par value to acquire such securities. In accordance with GAAP, we amortize this premium as a reduction to interest income under
the contractual interest method so that a proportional amount of the unamortized premium is amortized as principal prepayments occur. If a security is
prepaid in whole or in part at a faster rate than originally expected, we will amortize the purchased premium at a faster pace resulting in a lower effective
return on our investment than originally expected.
We also may purchase securities that have a lower interest rate than the then-prevailing market interest rate. In exchange for this lower interest rate,
we may pay a discount to par value to acquire such securities. In accordance with GAAP, we accrete this discount as an increase to interest income under
the contractual interest method so that a proportional amount of the unamortized discount is accreted as principal prepayments occur. If a security is prepaid
in whole or in part at a slower rate than originally expected, we will accrete the purchased discount at a slower pace resulting in a lower effective return on
our investment than originally expected.
Moreover, if prepayment rates decrease due to a rising interest rate environment, the average life or duration of our fixed-rate assets will generally
be extended. This could have a negative impact on our results from operations, as the maturities of our interest rate hedges are fixed and will, therefore,
cover a smaller percentage of our funding exposure on our MBS assets to the extent that the average lives of the mortgages underlying such MBS increase
due to slower prepayments.
Prepayments also significantly affect the value of MSRs. An MSR entitles the holder to receive a servicing fee equal to a percentage of the unpaid
principal balance of the mortgage loans with the value of an MSR based on expected future cash flows expected to be received from servicing the loans
including expected future servicing fees. To the extent the underlying mortgage loan principal balances are prepaid or expected to be prepaid at a faster
rate, the expected future cash flows from servicing would be expected to be lower and the value of the MSR would be expected to decline. The value of
our MSR financing receivables are based on the value of a related MSR. Accordingly, an increase in prepayments can result in a reduction in the value and
income we may earn of our MSR financing receivables and negatively affect our profitability.
Homeowners tend to prepay mortgage loans more quickly when interest rates decline. Although prepayment rates generally increase when interest
rates fall and decrease when interest rates rise, changes in prepayment rates are difficult to predict. Prepayments may also occur as the result of an
improvement in the borrower’s ability to refinance the loan as a result of home price appreciation or wage growth. Prepayments can also occur when
borrowers sell the property and use the sale proceeds to prepay the mortgage as part of a physical relocation or when borrowers default on their mortgages
and the mortgages are prepaid from the proceeds of a foreclosure sale of the property. Fannie Mae and Freddie Mac will generally, among other conditions,
purchase mortgages that are 120 days or more delinquent from holders of such mortgages when the cost of guarantee payments to such holders, including
advances of interest at the loan coupon rate, exceeds the cost of holding the nonperforming loans in their portfolios. Consequently, prepayment rates also
may be affected by conditions in the housing and financial markets, which may result in increased delinquencies on mortgage loans, the GSEs’ cost of
capital, general economic conditions and the relative interest rates on fixed and adjustable rate
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loans, which could lead to an acceleration of the payment of the related principal. Furthermore, changes in the GSEs’ policies regarding the repurchase of
delinquent loans can materially impact prepayment rates. In addition, the introduction of new government programs could increase the availability of
mortgage credit to a large number of homeowners in the United States, which could impact the prepayment rates for the entire residential mortgage MBS
market. Any new programs or changes to existing programs could cause substantial uncertainty around the magnitude of changes in prepayment speeds.
Faster or slower than expected prepayments may adversely affect our profitability and cash available for distribution to our shareholders and are
difficult to predict.
Market conditions may disrupt the historical relationship between interest rate changes and prepayment trends, which would make it more difficult for
us to analyze our investment portfolio.
Our success depends on our ability to analyze the relationship of changing interest rates on prepayments of the mortgage loans that underlie our
agency MBS and our MSR related investments. Changes in interest rates and prepayments affect the market price of agency MBS and MSR related
investments that we intend to purchase and any MBS or MSR related investments that we hold at a given time. As part of our overall portfolio risk
management, we analyze interest rate changes and prepayment trends separately and collectively to assess their effects on our investment portfolio. In
conducting our analysis, we depend on certain assumptions based upon historical trends with respect to the relationship between interest rates and
prepayments under normal market conditions. Dislocations in the residential mortgage market and other developments may change the way that
prepayment trends have historically responded to interest rate changes and, consequently, may negatively impact our ability to (i) assess the impact of
future changes in interest rates and prepayments on the market value of our investment portfolio, (ii) implement our hedging strategies, and (iii) implement
techniques to reduce our prepayment rate volatility would be significantly affected. If we are unable to accurately forecast interest and prepayment rates,
our financial position and results of operations could be materially adversely affected.
It may be uneconomical to “roll” our TBA dollar roll transactions or we may be unable to meet margin calls on our TBA commitments, which could
negatively affect our financial condition and results of operations.
We may utilize TBA dollar roll transactions as a means of investing in and financing agency MBS. TBA contracts enable us to purchase or sell, for
future delivery, agency MBS with certain principal and interest terms and certain types of collateral, but the particular agency MBS to be delivered are not
identified until shortly before the TBA settlement date. Prior to settlement of the TBA commitment, we may choose to move the settlement of the securities
out to a later date by entering into an offsetting position (referred to as a “pair off”), net settling the paired off positions for cash, and simultaneously
purchasing a similar TBA for a later settlement date, collectively referred to as a “dollar roll.” The agency MBS purchased for a forward settlement date
under the TBA commitment are typically priced at a discount to agency MBS for settlement in the current month. This difference (or discount) is referred
to as the “price drop.” As discussed under Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations— “Non-GAAP
Core Operating Income,” we believe this price drop is the economic equivalent of net interest carry income on the underlying agency MBS over the roll
period (interest income less implied financing cost), which is commonly referred to as “dollar roll income.” Consequently, dollar roll transactions and such
forward purchases of agency MBS represent a form of off-balance sheet financing.
Under certain market conditions, TBA dollar roll transactions may result in negative carry income whereby the agency MBS purchased for a
forward settlement date under the TBA commitment are priced at a premium to agency MBS for settlement in the current month. Under such conditions, it
may be uneconomical to roll our TBA positions prior to the settlement date and we could have to take physical delivery of the underlying securities and
settle our obligations for cash. We may not have sufficient funds or alternative financing sources available to settle such obligations.
In addition, our TBA commitments are subject to master securities forward transaction agreements published by SIFMA as well as supplemental
terms and conditions with each counterparty. Under the terms of these agreements, we may be required to pledge collateral to our counterparty in the event
the fair value of our agency MBS commitments decline and such counterparty demands collateral through a margin call.
Negative carry income on TBA dollar roll transactions or failure to procure adequate financing to settle our obligations or meet margin calls under
our TBA commitments could result in defaults or force us to sell assets under adverse market conditions or through foreclosure and adversely affect our
financial condition and results of operations.
Our use of repurchase agreements may give our lenders greater rights in the event that either we or any of our lenders file for bankruptcy, which may
make it difficult for us to recover our collateral.
Our borrowings under repurchase agreements may qualify for special treatment under the bankruptcy code, giving our lenders the ability to avoid
the automatic stay provisions of the bankruptcy code and take possession of and liquidate our collateral under the repurchase agreements without delay if
we file for bankruptcy. Furthermore, the special treatment of repurchase agreements under the
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bankruptcy code may make it difficult for us to recover our pledged assets in the event that any of our lenders file for bankruptcy. Thus, the use of
repurchase agreements exposes our pledged assets to risk in the event of a bankruptcy filing by either our lenders or us. In addition, if the lender is a broker
or dealer subject to the Securities Investor Protection Act of 1970 or an insured depository institution subject to the Federal Deposit Insurance Act, our
ability to exercise our rights to recover our investment under a repurchase agreement or to be compensated for any damages resulting from the lender’s
insolvency may be further limited by those statutes.
If the lending institution under one or more of our repurchase agreements defaults on its obligation to resell the underlying security back to us at the
end of the agreement term, we will lose money on our repurchase transactions.
When we engage in a repurchase transaction, we initially sell securities to a counterparty under a master repurchase agreement in exchange for cash
from the counterparty. The counterparty is obligated to resell the same securities back to us at the end of the term of the repurchase agreement, which
typically is 30 to 60 days, but may have terms from one day to up to one year or more. The cash we receive when we initially sell the collateral is less than
the value of the collateral, which is referred to as the “haircut.” If the counterparty in a repurchase transaction defaults on its obligation to resell the
securities back to us, we will incur a loss on the transaction equal to the amount of the haircut (assuming no change in the value of the securities). Losses
incurred on our repurchase transactions would adversely affect our operating results and the market price of our securities.
If we default on our obligations under our repurchase agreements, we may be unable to establish a suitable replacement facility on acceptable terms or
at all.
If we default on one of our obligations under a repurchase agreement, the counterparty may terminate the agreement and cease entering into any
other repurchase agreements with us. In that case, we would likely need to establish a replacement repurchase facility with another financial institution in
order to continue to leverage the assets in our investment portfolio and to carry out our investment strategy. We may be unable to establish a suitable
replacement repurchase facility on acceptable terms or at all.
Despite current indebtedness levels, we may still be able to incur substantially more debt, which could have important consequences to you.
As of December 31, 2022, we had total unsecured indebtedness (excluding payables, derivative liabilities and repurchase agreement financing) of
$87.7 million, which includes $34.9 million in principal amount of our 6.75% Senior Notes due 2025 (the “Senior Notes due 2025”), $37.8 million in
principal amount of our 6.00% Senior Notes due 2026 (the “Senior Notes due 2026” and, collectively with the Senior Notes due 2025, the “Senior Notes”)
and $15.0 million in principal amount of subordinated unsecured long-term debentures due between 2033 and 2035. Our level of indebtedness could have
important consequences to you, because:
•
it could affect our ability to satisfy our financial obligations;
•
a substantial portion of our cash flows from operations will have to be dedicated to interest and principal payments and may not be
available for operations, expansion, acquisitions or general corporate or other purposes;
•
it may impair our ability to obtain additional debt or equity financing in the future;
•
it may limit our ability to refinance all or a portion of our indebtedness on or before maturity;
•
it may limit our flexibility in planning for, or reacting to, changes in our business and industry;
•
it may make it more difficult to meet REIT distribution requirements; and
•
it may make us more vulnerable to downturns in our business, our industry or the economy in general.
Our operations may not generate sufficient cash to enable us to service our debt. If we fail to make payment on the Senior Notes, we could default
on the Senior Notes.
The elimination of LIBOR may affect our financial results.
On March 5, 2021, the FCA, which regulates LIBOR, announced that all LIBOR tenors relevant to us will cease to be published or will no longer be
representative after June 30, 2023. The FCA's announcement coincides with the March 5, 2021 announcement of LIBOR's administrator, the IBA,
indicating that, as a result of not having access to input data necessary to calculate LIBOR tenors relevant to us on a representative basis after June 30,
2023, IBA would have to cease publication of such LIBOR tenors immediately after the last publication on June 30, 2023. These announcements mean that
any of our LIBOR-based financial instruments that extend beyond June 30, 2023 will need to be converted to a replacement rate.
The U.S. Federal Reserve and the Federal Reserve Bank of New York jointly convened the ARRC, a steering committee comprised of private sector
entities, each with an important presence in markets effected by LIBOR, and official-sector entities,
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including banking and financial sector regulators. The ARCC’s initial objectives were to identify risk-free alternative reference rates for USD LIBOR,
identify best practices for contract robustness and create an implementation plan. The ARRC has recommended SOFR and, in some cases, the forward-
looking term rate based on SOFR published by CME Group Benchmark Administration Limited ("CME Term SOFR") plus, in each case, a recommended
spread adjustment, as LIBOR's replacement.
The U.S. federal government enacted the Adjustable Interest Rate (LIBOR) Act ("LIBOR Act") to provide for uniform nationwide solution for
certain contracts that do not have clear and practical provisions for replacing LIBOR after June 30, 2023. On December 16, 2022, the Federal Reserve
Board implemented a final rule that implements the LIBOR Act and identifies replacement benchmark rates based on SOFR to replace overnight, one-
month, three-month, six-month and 12-month LIBOR in U.S. contracts that do not mature before LIBOR ends and that lack adequate fallback provisions
that would replace LIBOR with a practicable replacement benchmark rate. The final rule also restates the safe harbor protections contained in the LIBOR
Act for selection or use of the replacement benchmark rate selected by the Federal Reserve Board and clarifies who would be considered a determining
person able to choose to use the replacement benchmark rate selected by the Federal Reserve Board for certain LIBOR contracts.
Any of our LIBOR-based borrowings that extend beyond June 30, 2023 will need to be converted to a replacement rate. There are significant
differences between LIBOR and SOFR, such as LIBOR being an unsecured lending rate while SOFR is a secured lending rate, and SOFR is an overnight
rate while LIBOR reflects term rates at different maturities. If our LIBOR-based borrowings are converted to SOFR, the differences between LIBOR and
SOFR, plus the recommended spread adjustment, could result in interest costs that are higher than if LIBOR remained available, which could have a
material adverse effect on our operating results. Although SOFR is the ARRC's recommended replacement rate, it is also possible that lenders may instead
choose alternative replacement rates that may differ from LIBOR in ways similar to SOFR or in other ways that would result in higher interest costs for us.
Furthermore, lenders may select alternative rates sooner than June 30, 2023, either in amendments to existing facilities or as we decide to enter into new
facilities. It is possible that not all of our assets and liabilities will transition away from LIBOR at the same time, and it is possible that not all of our assets
and liabilities will transition to the same alternative reference rate, in each case increasing the difficulty of hedging. We and other market participants have
less experience understanding and modeling SOFR-based assets and liabilities than LIBOR-based assets and liabilities, increasing the difficulty of
investing, hedging, and risk management. The process of transition involves operational risks. We are still evaluating the potential effect of LIBOR's end on
our borrowing costs and other operations, which remains uncertain given the varying replacement rates and timing.
We are party to various financial instruments which include LIBOR as a reference rate that mature or expire after June 30, 2023. As of December
31, 2022, these financial instruments include preferred stock and unsecured notes issued by us.
At this time, it is not possible to predict the effect of any such changes, any establishment of alternative reference rates or any other reforms to
LIBOR that may be implemented in the U.K. or elsewhere. While we expect one- and three-month LIBOR to be available in substantially their current
form through June 2023, if sufficient banks decline to make submissions to IBA, it is possible that these LIBOR tenors will become unavailable prior to
that point. Uncertainty as to the nature of such potential changes, alternative reference rates or other reforms may adversely affect the market for, or value
of, any securities, loans, derivatives and other financial obligations on which the interest or dividend is determined by reference to LIBOR, which could
negatively impact our overall financial condition or results of operations. More generally, any of the above changes or any other consequential changes to
LIBOR or any other “benchmark” as a result of international, national or other proposals for reform or other initiatives or investigations, or any further
uncertainty in relation to the timing and manner of implementation of such changes, could have a material adverse effect on the value of and return on any
securities based on or linked to a “benchmark.”
Limitations on our access to capital could impair our liquidity and our ability to conduct our business.
Liquidity, or ready access to funds, is essential to our business. Failures of similar businesses have often been attributable in large part to insufficient
liquidity. Liquidity is of particular importance to our business and perceived liquidity issues may affect our counterparties’ willingness to engage in
transactions with us. Our liquidity could be impaired due to circumstances that we may be unable to control, such as a general market disruption, the
payment of significant legal defense and indemnification costs, expenses, damages or settlement amounts, or an operational problem that affects us or third
parties. Further, our ability to sell assets may be impaired if other market participants are seeking to sell similar assets at the same time or the market is
experiencing significant volatility. Our inability to maintain adequate liquidity would materially harm our business and operations.
Our due diligence of potential investments may not reveal all of the liabilities associated with those investments and may not reveal aspects of the
investments which could lead to lower expected investment returns or investment losses.
Before making certain investments, we may undertake due diligence efforts with respect to various aspects of the acquisition, including investigating
the strengths and weaknesses of the originator or issuer of the asset and verifying certain aspects of the underlying securities, loans or properties themselves
as well as other factors and characteristics that may be material to the performance of the investment. In making the assessment and otherwise conducting
due diligence, we rely on resources available to us
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and, in some cases, third party information. There can be no assurance that any due diligence process that we conduct will uncover relevant facts that could
be determinative of whether or not an investment will be successful.
Our credit investments subject us to a potential high risk of loss.
Investments in mortgage-related assets where repayment of principal and interest is not guaranteed by a U.S. government agency or GSE subject us
to the potential risk of loss of principal and/or interest due to delinquency, foreclosure and related losses on the underlying mortgage loans.
Residential mortgage loans underlying non-agency residential MBS are secured by residential property and are subject to risks of delinquency,
foreclosure and loss. The ability of a borrower to repay a loan secured by residential property is dependent upon the income or assets of the borrower. A
number of factors may impair a borrower's ability to repay the loan, including: loss of employment; divorce; illness; acts of God; acts of war or terrorism;
adverse changes in national and local economic and market conditions; changes in laws and regulations, fiscal policies and zoning ordinances and the
related costs of complying with such laws and regulations, fiscal policies and ordinances; costs of remediation and liabilities associated with environmental
conditions such as mold; and the potential for uninsured or under-insured property losses.
Business purpose residential mortgage loans are loans to professional real estate investors secured by non-owner occupied residential property that
are also subject to risks of delinquency, foreclosure and loss. The properties that secure these mortgage loans often require construction, repair, or
rehabilitation and are not income producing. 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 risks of delinquency and foreclosure
on these residential properties may be greater than similar risks associated with loans made on the security of single-family, owner-occupied, residential
property. The borrower’s ability to repay our mortgage loans will depend, to a great extent, on the borrower’s ability to complete the construction, repair or
rehabilitation of the property in a timely and cost efficient manner as well as the value of the property at the maturity date of the loan. In the event of any
default under a mortgage loan held by us, we will bear a risk of loss to the extent of any deficiency between the value of the collateral and the outstanding
principal and accrued interest of the mortgage loan, and any such losses could have a material adverse effect on our cash flow from operations and our
ability to make distributions to our shareholders.
Commercial mortgage loans are secured by commercial property and are subject to risks of delinquency and foreclosure, and risks of loss that are
greater than similar risks associated with loans made on the security of residential property. The ability of a borrower to repay a loan secured by an income-
producing property typically is dependent primarily upon the successful operation of such property rather than upon the existence of independent income or
assets of the borrower. If the net operating income of the property is reduced, the borrower's ability to repay the loan may be impaired. Net operating
income of an income producing property can be affected by, among other things: tenant mix; success of tenant businesses; property management decisions;
property location and condition; competition from comparable types of properties; changes in laws that increase operating expense or limit rents that may
be charged; any need to address environmental contamination at the property; the occurrence of any uninsured casualty at the property; changes in national,
regional or local economic conditions or specific industry segments; declines in regional or local real estate values; declines in regional or local rental or
occupancy rates; increases in interest rates; real estate tax rates and other operating expenses; changes in governmental rules, regulations and fiscal policies,
including environmental legislation; acts of God, acts of war or terrorism, a pandemic, social unrest and civil disturbances. These risks may be more
pronounced during times of market volatility and negative economic conditions.
We depend on third-party service providers, including mortgage servicers, for a variety of services related to our non-agency MBS, mortgage loan
investments and MSR related assets. We are, therefore, subject to the risks associated with third-party service providers.
We depend on a variety of third-party service providers related to our non-agency MBS, mortgage loan investments and MSR related assets. We rely
on the mortgage servicers who service the mortgage loans backing our non-agency MBS to, among other things, collect principal and interest payments on
the underlying mortgages and perform loss mitigation services. We also rely on administrative agents who service the mortgage loans that we may directly
invest in. Mortgage servicers and other service providers to our MBS, such as trustees, bond insurance providers and custodians, may not perform in a
manner that promotes our interests.
Our MSR related assets are dependent upon the mortgage servicer counterparty performing the actual servicing of the mortgage loans. The duties
and obligations of the mortgage servicer are defined through contractual agreements, which generally provide for the possibility of termination of the
mortgage servicer in the absolute discretion of Fannie Mae or Freddie Mac. Our MSR related assets could also be materially and adversely affected if the
mortgage servicer is unable to service the underlying mortgage loans due to a failure to comply with applicable laws and regulations, failure to perform its
loss mitigation duties, a downgrade in its servicer rating, the failure to perform adequately in its external audits, or a failure in or performance of its
operational systems or infrastructure.
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Economic disruptions may result in liquidity pressures on servicers and other third-party vendors that we rely upon. For instance, as a result of an
increase in mortgagors requesting relief in the form of forbearance plans and/or other loss mitigation, servicers and other parties responsible in capital
markets securitization transactions for funding advances with respect to delinquent mortgagor payments of principal and interest may begin to experience
financial difficulties if mortgagors do not make monthly payments. The negative impact of an economic disruption on the business and operations of such
servicers or other parties responsible for funding such advances could be significant.
The failure of servicers to effectively service the mortgage loans underlying the non-agency MBS in our investment portfolio could materially and
adversely affect us.
Most securitizations of mortgage loans require a servicer to manage collections on each of the underlying loans. Both default frequency and default
severity of loans may depend upon the quality of the servicer. If servicers are not vigilant in encouraging borrowers to make their monthly payments, the
borrowers may be far less likely to make these payments, which could result in a higher frequency of default. If servicers take longer to liquidate non-
performing assets, loss severities may tend to be higher than originally anticipated. Additionally, servicers can perform loan modifications, which could
potentially impact the value of our securities. The failure of servicers to effectively service the mortgage loans underlying the non-agency MBS in our
investment portfolio could negatively impact the value of our investments and our performance. Servicer quality is of prime importance in the default
performance of non-agency MBS. If a servicer goes out of business, the transfer of servicing takes time and loans may become delinquent because of
confusion or lack of attention. When servicing is transferred, previously advanced principal and interest is often recaptured rapidly by the new servicer,
which may have an adverse effect on non-agency MBS credit support. In the case of pools of securitized loans, servicers may be required to advance
interest on delinquent loans to the extent the servicer deems those advances recoverable. In the event the servicer does not advance funds, interest may be
interrupted, even on more senior securities. Servicers may also advance more than is in fact recoverable once a defaulted loan is disposed, and the loss to
the trust may be greater than the outstanding principal balance of that loan (greater than 100% loss severity).
Our investment portfolio may be concentrated in terms of credit risk.
Our investment portfolio may at times be concentrated in certain property types that are subject to higher risk of foreclosure, or secured by
properties concentrated in a limited number of geographic locations. To the extent that our portfolio is concentrated in any one region or type of asset,
downturns relating generally to such region or type of asset may result in defaults on a number of our assets within a short time period, which may reduce
our net income and the value of our shares and accordingly reduce our ability to pay dividends to our stockholders. Our portfolio may contain other
concentrations of risk, and we may fail to identify, detect or hedge against those risks, resulting in large or unexpected losses. This risk may be more
pronounced during times of market volatility and negative economic conditions.
Our investments may include subordinated tranches of non-agency MBS, which are subordinate in right of payment to more senior securities.
Our investments may include subordinated tranches of non-agency MBS, which are subordinated classes of securities in a structure collateralized by
a pool of mortgage loans and, accordingly, are among the first to bear the loss upon a restructuring or liquidation of the underlying collateral and the last to
receive payment of interest and principal. Additionally, estimated fair values of these subordinated interests tend to be more sensitive to changes in
economic conditions than more senior securities. As a result, such subordinated interests generally are less actively traded and may not provide holders
thereof with liquid investments. When we invest in securities that are illiquid, are unrated, have a higher risk of default or are difficult to value, such
securities may be considered speculative, and their capacity to pay principal and interest in accordance with the terms of their issue is not certain.
Our mortgage loan investments secured by healthcare properties exposes us to additional risk of loss.
We have a mortgage loan investment that is secured by the real property of healthcare facilities and guaranteed by the operator of the facilities. The
revenues of the operators are primarily driven by occupancy, private pay rates and Medicare and Medicaid reimbursements. Expenses of these facilities are
primarily driven by the costs of labor, food, utilities, taxes, insurance and rent. To the extent that any decrease in revenue or increase in operating expenses
result in the facilities not generating enough cash to make payments to us, we would have to rely on the creditworthiness of the guarantor and the value of
the collateral. To the extent the value of the property is reduced, we may need to reduce the fair value of our mortgage loan investment and we could incur
a realized loss upon the disposition of the investment.
The healthcare industry is highly competitive. The operators of the facilities securing our mortgage loan investments compete on a local and
regional basis with other properties and healthcare providers that provide comparable services. We cannot be certain
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that the operators of the facilities securing our investments will be able to achieve and maintain occupancy levels and rates that will enable them to meet
our borrower’s obligations to us.
The operators and healthcare facilities securing our investments may also face litigation and may experience rising liability and insurance costs.
Litigation brought by individual patients and advocacy groups against operators of facilities can result in large damage awards of alleged abuses and may
result in material increases in the costs incurred by operators, including increases to their costs of liability and medical malpractice insurance.
The operators and healthcare facilities are also subject to varying levels of federal, state, local and industry-regulated licensures, certification and
inspection laws, regulations and standards. The failure to comply with any of these laws, regulations, or standards could result in loss of accreditation,
denial of reimbursements, imposition of fines, suspension, decertification or exclusion from federal and state healthcare programs, loss of licensure or
closure of the facility. The operators and healthcare facilities rely on reimbursement from third-party payors, including Medicare and Medicaid programs,
for their revenues. Changes in the reimbursement rates or methods of payment of insurance companies and Medicare and Medicaid programs could have a
material adverse effect on the operators and healthcare facilities securing our mortgage loan investment.
Our investments in MSR related assets expose us to additional risk of loss if our counterparty were unable to satisfy its obligation to us.
We have investments in MSR related assets that expose us to additional risk of loss. We do not hold the requisite licenses to purchase or hold MSRs
directly. However, we have entered into agreements with a licensed, GSE approved residential mortgage loan servicer that enable us to garner the
economic return of an investment in an MSR purchased by the mortgage servicing counterparty through an MSR financing transaction. Under the terms of
the arrangement, for an MSR acquired by the mortgage servicing counterparty (i) we purchase the “excess servicing spread” from the mortgage servicer
counterparty, entitling us to monthly distributions of the servicing fees collected by the mortgage servicing counterparty in excess of 12.5 basis points per
annum (and to distributions of corresponding proceeds of sale of the MSRs), and (ii) we fund the balance of the MSR purchase price to the parent company
of the mortgage servicing counterparty (the “basic fee”) and, in exchange, have an unsecured right to payment of certain amounts determined by reference
to the MSR, generally equal to the servicing fee revenue less the excess servicing spread and the costs of servicing (and to distributions of corresponding
proceeds of sale of the MSRs), net of fees earned by the mortgage servicing counterparty and its affiliates including an incentive fee. Under GAAP, we
account for transactions executed under this arrangement as financing transactions and reflect the associated financing receivables in the line item “MSR
financing receivables” on our consolidated balance sheets.
The counterparty to our agreements has the approvals from Fannie Mae and Freddie Mac and the requisite state licenses to hold and manage MSRs.
While we are the owner of the “excess servicing spread” of the MSR, the mortgage servicing counterparty is the legal owner of the MSR and our right to
receive proceeds on our MSR financing receivable from the basic fee component part of the transaction is an unsecured obligation of the mortgage
servicing counterparty. If the counterparty were to default under its obligation to return any of the proceeds from the MSR financing receivable to us, we
could realize a loss on our mortgage servicing related asset that could adversely affect our financial condition and results of operations.
The underlying mortgage loans related to the MSRs the counterparty purchases are subject and subordinate in all respects to the interests of Fannie
Mae and Freddie Mac, which includes the right of the applicable agency to terminate the mortgage servicing counterparty with or without cause, the right to
sell, retain or have transferred the related MSRs, and the right to direct the sale or transfer process of the related MSRs. A default by the mortgage
servicing counterparty in its capacity as servicer relating to its obligations under any acknowledge agreement with an agency, pooling and servicing
agreement, agency requirements and/or failure of the servicer to perform its obligations related to any MSR could result in a loss of value of our excess
servicing spread of the MSR and a loss in value of our MSR financing receivable that references the MSR. In addition to being subject to regulations by
the related agency, mortgage servicers are also subject to extensive federal, state and local laws, regulations and administrative decisions that failure to
comply with expose the servicer to fines, damages and losses. In its capacity as servicer, the mortgage servicing counterparty also operates in a highly
litigious industry that subject it to potential lawsuits related to billing and collections practices, modification protocols or foreclosure practices. If the
MSRs that are referenced to our contractual arrangements are terminated or transferred or if our counterparty incurred significant losses, such mortgage
servicing counterparty to our MSR financing receivables may not be able to satisfy its obligation to us which could adversely affect our financial condition
and results of operations.
Our investments in MSR related assets may expose us to additional risk of leverage that could adversely affect our financial condition, liquidity and
results of operations.
Pursuant to our MSR financing receivables, we are entitled to an unsecured right of payment determined by reference to a pool of specific MSRs
owned by the mortgage servicing counterparty. At our election and direction, the mortgage servicing counterparty could utilize leverage on the MSRs that
are subject to our MSR financing receivables to finance the purchase of additional MSRs to increase potential returns to us. The lender providing the
leverage to our mortgage servicing counterparty would have a secured
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interest in the MSRs pledged under a credit facility between the lender and our mortgage servicing counterparty. Under the credit facility, if the fair value
of the pledged MSR collateral declines and the lender demands additional collateral from our mortgage servicing counterparty through a margin call, we
would be required to provide the mortgage servicing counterparty with additional funds to meet such margin call. If we were unable to satisfy such margin
call, the lender could liquidate the MSR collateral position that are referenced to our MSR financing receivable to satisfy the loan obligation which would
adversely affect our financial condition, liquidity and results of operations.
We may have to fund servicing advances under our MSR related assets that could adversely affect our liquidity and financial condition.
An owner of an MSR is obligated to fund servicing advances for the payment of principal and interest due to the third-party owners of the loans,
property taxes and insurance premiums, legal expenses and other protective advances that have not yet been received from the individual borrowers. Under
the arrangements of our MSR financing receivables, we are required to fund to the mortgage servicing counterparty any servicing advances that it is
required to fund as the owner of the referenced MSR. These advances may be subject to delays in recovery and may not be recoverable under certain
circumstances. During periods of economic disruption, there is a greater possibility that mortgage loan borrowers could request forbearance of their
monthly mortgage payments. In addition, agencies and other federal and state regulators may require servicers to grant forbearance under these
circumstances. If a borrower is granted forbearance, the owner of the MSR would be required to fund the servicing advances. If we had to fund servicing
advances under our mortgage servicing related assets, our liquidity and financial condition could be adversely affected.
Our investments are recorded at fair value based upon assumptions that are inherently subjective, and our results of operations and financial condition
could be adversely affected if our determinations regarding the fair value of our investments are materially higher than the values that we ultimately
realize upon their disposal.
We measure the fair value of certain of our investments quarterly, in accordance with guidance set forth in FASB Accounting Standards Codification
(“ASC”) Topic 820, Fair Value Measurements and Disclosures. Ultimate realization of the value of an asset depends to a great extent on economic and
other conditions that are beyond our control. Further, fair value is only an estimate based on good faith judgment of the price at which an investment can be
sold because market prices of investments can only be determined by negotiation between a willing buyer and seller. If we were to liquidate a particular
asset, the realized value may be more than or less than the amount at which such asset is valued. Accordingly, the value of our securities could be adversely
affected by our determinations regarding the fair value of our investments, whether in the applicable period or in the future. Additionally, such valuations
may fluctuate over short periods of time.
Our determination of the fair value of our investments includes prices based on estimates provided by third-party pricing sources including pricing
services and dealers. In general, these pricing sources heavily disclaim their valuations. Our credit and MSR related investments trade infrequently and may
be considered illiquid. Our determination of the fair value of certain of our credit and MSR related investments are based on significant unobservable inputs
based on various assumptions made by our management or third-party pricing services. These significant unobservable inputs may include assumptions
regarding future interest rates, prepayment rates, discount rates, costs of servicing, default rates, loss-given-default rates and the timing of credit losses.
These assumptions are inherently subjective and involve a high degree of management judgment, and our determinations of fair value may differ materially
from the values that would have been used if a public market for these investments existed. Depending on the complexity and liquidity of an investment,
valuations of the same investment can vary substantially from one pricing service to another. Our results of operations for a given period could be adversely
affected if our determinations regarding the fair market value of these investments are materially different than the values that we ultimately realize upon
their disposal.
We operate in a highly-competitive market for investment opportunities, which could make it difficult for us to purchase or originate investments at
attractive yields and thus have an adverse effect on our business, results of operations and financial condition.
We gain access to investment opportunities only to the extent that they become known to us. Gaining access to investment opportunities is highly
competitive. Many of our competitors are substantially larger than us and have considerably greater financial, technical and marketing resources, more
long-standing relationships, broader product offerings and other advantages. Some of our competitors may have a lower cost of funds and access to funding
sources that are not available to us. As a result of this competition, we may not be able to purchase or originate our target investments at attractive yields,
which could have an adverse effect on our business, results of operations and financial condition.
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Risks Related to our Business and Structure
Our Rights Plan could inhibit a change in our control.
We have a Rights Plan designed to protect against a possible limitation on our ability to use our NOLs, NCLs and built-in losses by dissuading
investors from aggregating ownership of our common stock and triggering an “ownership change” for purposes of Sections 382 and 383 of the Internal
Revenue Code. Under the terms of the Rights Plan, in general, if a person or group acquires or commences a tender or exchange offer for beneficial
ownership of 4.9% or more of the outstanding shares of our common stock upon a determination by our Board of Directors (an “Acquiring Person”), all of
our other Class A common shareholders will have the right to purchase securities from us at a discount to such securities’ fair market value, thus causing
substantial dilution to the Acquiring Person. The Rights Plan and any outstanding rights will expire at the earliest of (i) June 4, 2025, (ii) the time at which
the rights are redeemed or exchanged pursuant to the Rights Plan, (iii) the repeal of Section 382 and 383 of the Internal Revenue Code or any successor
statute if the Board of Directors determines that the Rights Plan is no longer necessary for the preservation of the applicable tax benefits, or (iv) the
beginning of a taxable year to which the Board of Directors determines that no applicable tax benefits may be carried forward. Our Board of Directors and
shareholders may in the future approve an amendment to extend the expiration period of the Rights Plan.
The Rights Plan may have the effect of inhibiting or impeding a change in control not approved by our Board of Directors and, notwithstanding its
purpose, could adversely affect our shareholders’ ability to realize a premium over the then-prevailing market price for our common stock in connection
with such a transaction. In addition, because our Board of Directors can prevent the Rights Plan from operating, in the event our Board of Directors
approves of an Acquiring Person, the Rights Plan gives our Board of Directors significant discretion over whether a potential acquirer’s efforts to acquire a
large interest in us will be successful. Consequently, the Rights Plan could impede transactions that would otherwise benefit our shareholders.
The ownership limits in our charter may discourage a takeover or business combination that may benefit our shareholders.
To assist us in qualifying as a REIT, among other purposes, our Articles of Incorporation generally limits, unless waived by our board of directors,
the beneficial or constructive ownership of any class of our stock by any person to no more than 9.9% in value or the number of shares, whichever is more
restrictive, of the outstanding shares of any class or series of our stock. This and other restrictions on ownership and transfer of our shares of stock
contained in our Articles of Incorporation may discourage a change of control of us and may deter individuals or entities from making tender offers for our
common stock on terms that might be financially attractive to you or which may cause a change in our management. In addition to deterring potential
transactions that may be favorable to our stockholders, these provisions may also decrease your ability to sell our common stock because they make
purchases of our common stock less attractive.
The trading price of our securities may be adversely affected by factors outside of our control.
Any negative changes in the public’s perception of the prospects for our business or the types of assets in which we invest could depress our stock
price regardless of our results. The following factors, among others, could contribute to the volatility of the price of our capital stock:
•
actual or unanticipated variations in our quarterly results;
•
changes in our financial estimates by securities analysts;
•
conditions or trends affecting companies that make investments similar to ours;
•
changes in interest rate environments and the mortgage market that cause our borrowing costs to increase, our reported yields on our
investment portfolio to decrease or that cause the value of our investment portfolio to decrease;
•
changes in the residential real estate market;
•
changes in the market valuations of our investments;
•
negative changes in the public’s perception of the prospects of investment or financial services companies;
•
changes in the regulatory environment in which our business operates or changes in federal fiscal or monetary policies;
•
dilution resulting from new equity issuances;
•
general economic conditions such as a recession, or interest rate or currency rate fluctuations; and
•
additions or departures of our key personnel.
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Many of these factors are beyond our control.
We have not established a minimum dividend payment level and we cannot assure you of our ability to pay dividends in the future.
The declaration, amount and payment of any future dividends on shares of common stock will be at the sole discretion of our Board of Directors.
As a REIT, we are required to distribute annually 90% of our REIT taxable income (subject to certain adjustments). So long as we continue to
qualify as a REIT, we will generally not be subject to U.S. federal or state corporate income taxes on our REIT taxable income that we distribute to our
shareholders on a timely basis. At present, it is our intention to distribute 100% of our REIT taxable income, although we will not be required to do so. We
intend to make distributions of our REIT taxable income within the time limits prescribed by the Internal Revenue Code, which may extend into the
subsequent taxable year. As of December 31, 2022, we had estimated NOL carryforwards of $162.5 million that can be used to offset future REIT taxable
income and reduce our future distribution requirements. As of December 31, 2022, we also had estimated NCL carryforwards of $155.7 million that can be
used to offset future net capital gains.
We have not established a minimum dividend payment level and the amount of future dividends, if any, may fluctuate. Our ability to pay dividends
may be adversely affected by the risk factors described herein. All distributions will be made at the discretion of our Board of Directors. Our Board of
Directors’ determination to declare a dividend is based upon multiple factors, including REIT distribution requirements, current financial results, overall
economic and market conditions, ongoing liquidity needs, opportunities to return capital to shareholders through accretive stock repurchases, available
returns on new investments, and such other factors as our Board of Directors deems relevant from time to time. Our Board of Directors did not declare a
dividend on our common stock for any quarter during 2022, and it is uncertain when our Board of Directors will determine to declare future dividends, if
any, on our common stock. Accordingly, the timing and amount, if any, of future cash distributions to common stock shareholders is uncertain which may
also negatively impact the market price of our common stock.
Indemnification obligations to certain of our current and former directors and officers may increase the costs to us of legal proceedings involving our
company.
Our charter contains a provision that limits the liability of our directors and officers to us and our shareholders for money damages, except for
liability resulting from willful misconduct or a knowing violation of the criminal law or any federal or state securities law. Our charter also requires us to
indemnify our directors and officers in connection with any liability incurred by them in connection with any action or proceeding (including any action by
us or in our right) to which they are or may be made a party by reason of their service in those or other capacities if the conduct in question was in our best
interests and the person was acting on our behalf or performing services for us, unless the person engaged in willful misconduct or a knowing violation of
the criminal law. The Virginia Stock Corporation Act requires a Virginia corporation (unless its charter provides otherwise, which our charter does not) to
indemnify a director or officer who has been successful, on the merits or otherwise, in the defense of any proceeding to which he is made a party by reason
of his service in that capacity.
In addition, we have entered into indemnification agreements with certain of our current and former directors and officers under which we are
generally required to indemnify them against liability incurred by them in connection with any action or proceeding to which they are or may be made a
party by reason of their service in those or other capacities, if the conduct in question was in our best interests and the person was conducting themselves in
good faith (subject to certain exceptions, including liabilities arising from willful misconduct, a knowing violation of the criminal law or receipt of an
improper benefit).
In the future, we may be the subject of indemnification assertions under our charter, Virginia law or these indemnification agreements by our current
and former directors and officers who are or may become party to any action or proceeding. We maintain directors’ and officers’ insurance policies that
may limit our exposure and enable us to recover a portion of any amounts paid with respect to such obligations. However, if our coverage under these
policies is reduced, denied, eliminated or otherwise not available to us, our potential financial exposure would be increased. The maximum potential
amount of future payments we could be required to make under these indemnification obligations could be significant. Amounts paid pursuant to our
indemnification obligations could adversely affect our financial results and the amount of cash available for distribution to our shareholders.
Loss of our exclusion from regulation as an investment company under the 1940 Act would adversely affect us and may reduce the market price of our
securities.
We currently rely on Section 3(c)(5)(C) of the 1940 Act for our exclusion from the registration requirements of the 1940 Act. This provision requires
that 55% of our assets, on an unconsolidated basis, consist of qualifying assets, such as agency whole pool certificates, and 80% of our assets, on an
unconsolidated basis, consist of qualifying assets or real estate-related assets. We will need to ensure not only that we qualify for an exclusion or exemption
from regulation under the 1940 Act, but also that each of our
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subsidiaries qualifies for such an exclusion or exemption. We intend to maintain our exclusion by monitoring the value of our interests in our subsidiaries.
We may not be successful in this regard.
If we fail to maintain our exclusion and another exclusion or exemption is not available, we may be required to register as an investment company,
or we may be required to acquire or dispose of assets in order to meet our exemption. Any such asset acquisitions or dispositions may include assets that we
would not acquire or dispose of in the ordinary course of business, may be at unfavorable prices and result in a decline in the price of our securities. If we
are required to register as an investment company under the 1940 Act, we would become subject to substantial regulation with respect to our capital
structure (including our ability to use leverage), management, operations, transactions with affiliated persons (as defined in the 1940 Act), and portfolio
composition, including restrictions with respect to diversification and industry concentration and other matters. Accordingly, registration under the 1940
Act could limit our ability to follow our current investment and financing strategies and result in a decline in the price of our securities.
Failure to obtain and maintain an exemption from being regulated as a commodity pool operator could subject us to additional regulation and
compliance requirements and may result in fines and other penalties which could materially adversely affect our business, financial condition and
results of operations.
The Dodd-Frank Act established a comprehensive new regulatory framework for derivative contracts commonly referred to as “swaps.” As a result,
any investment fund that trades in swaps or other derivatives may be considered a “commodity pool,” which would cause its operators (in some cases the
fund’s directors) to be regulated as “commodity pool operators,” or CPOs. Under rules adopted by the U.S. Commodity Futures Trading Commission
(“CFTC”) for which the compliance date generally was December 31, 2012 as to those funds that become commodity pools solely because of their use of
swaps, CPOs must by then have filed an application for registration with the National Futures Association (“NFA”) and have commenced and sustained
good faith efforts to comply with the Commodity Exchange Act and CFTC’s regulations with respect to capital raising, disclosure, reporting, recordkeeping
and other business conduct applicable for their activities as CPOs as if the CPOs were in fact registered in such capacity (which also requires compliance
with applicable NFA rules). However, the CFTC’s Division of Swap Dealer and Intermediary Oversight issued a no-action letter saying, although it
believes that mortgage REITs are properly considered commodity pools, it would not recommend that the CFTC take enforcement action against the
operator of a mortgage REIT who does not register as a CPO if, among other things, the mortgage REIT limits the initial margin and premiums required to
establish its swaps, futures and other commodity interest positions to not more than five percent (5%) of its total assets, the mortgage REIT limits the net
income derived annually from those commodity interest positions which are not qualifying hedging transactions to less than five percent (5%) of its gross
income, and interests in the mortgage REIT are not marketed to the public as or in a commodity pool or otherwise as or in a vehicle for trading in the
commodity futures, commodity options or swaps markets.
We use hedging instruments in conjunction with our investment portfolio and related borrowings to reduce or mitigate risks associated with changes
in interest rates, yield curve shapes and market volatility. These hedging instruments may include interest rate swaps, interest rate swap futures, Eurodollar
futures, U.S. Treasury note futures and options on futures. We do not currently engage in any speculative derivatives activities or other non-hedging
transactions using swaps, futures or options on futures. We do not use these instruments for the purpose of trading in commodity interests, and we do not
consider our company or its operations to be a commodity pool as to which CPO registration or compliance is required. We have claimed the relief afforded
by the above-described no-action letter. Consequently, we will be restricted to operating within the parameters discussed in the no-action letter and will not
enter into hedging transactions covered by the no-action letter if they would cause us to exceed the limits set forth in the no-action letter. However, there
can be no assurance that the CFTC will agree that we are entitled to the no-action letter relief claimed.
The CFTC has substantial enforcement power with respect to violations of the laws over which it has jurisdiction, including their anti-fraud and anti-
manipulation provisions. For example, the CFTC may suspend or revoke the registration of or the no-action relief afforded to a person who fails to comply
with commodities laws and regulations, prohibit such a person from trading or doing business with registered entities, impose civil money penalties, require
restitution and seek fines or imprisonment for criminal violations. In the event that the CFTC staff does not provide the no action letter relief we requested
or if the CFTC otherwise determines that CPO registration and compliance is required of us, we may be obligated to furnish additional disclosures and
reports, among other things. Further, a private right of action exists against those who violate the laws over which the CFTC has jurisdiction or who
willfully aid, abet, counsel, induce or procure a violation of those laws. In the event that we fail to comply with statutory requirements relating to
derivatives or with the CFTC’s rules thereunder, including the mortgage REIT no-action letter described above, we may be subject to significant fines,
penalties and other civil or governmental actions or proceedings, any of which could have a materially adverse effect on our business, financial condition
and results of operations.
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We face competition for personnel, which could adversely affect our business and in turn negatively affect our operating results and the market price of
our securities.
We are dependent on the highly-skilled, and often highly-specialized, individuals we employ. Retention of specialists to manage our portfolio is
particularly important to our prospects. Competition for the recruiting and retention of employees may increase elements of our compensation costs. We
may not be able to recruit and hire new employees with our desired qualifications in a timely manner. Our incentives may be insufficient to recruit and
retain our employees. We currently do not have employment agreements with any of our senior officers and other key professionals. We cannot guarantee
that we will continue to have access to members of our senior management team or other key professionals. Increased compensation costs or failure to
recruit and retain qualified employees could materially and adversely affect our operating results and the market price of our securities.
We are highly dependent upon communications and information systems operated by third parties, and systems failures could significantly disrupt our
business, which may, in turn, negatively affect our operating results and the market price of our securities.
Our business is highly dependent upon communications and information systems that allow us to monitor, value, buy, sell, finance and hedge our
investments. Many of these systems are primarily operated by third parties and, as a result, we have limited ability to ensure their continued operation.
Furthermore, in the event of systems failure or interruption, we will have limited ability to affect the timing and success of systems restoration. Any failure
or interruption of our systems or third-party trading or information systems could cause delays or other problems in our securities trading activities, which
could have a material adverse effect on our operating results and negatively affect the market price of our securities and our ability to pay dividends to our
shareholders.
We face risks relating to cybersecurity attacks that could cause loss of confidential information and other business disruptions.
We rely extensively on computer systems to process transactions and manage our business, and our business is at risk from, and may be impacted by,
third-party action including cybersecurity attacks, service provider or vendor error, or malfeasance or other intentional or unintentional acts by third parties
and bad actors, including third-party providers. These could include attempts to gain unauthorized access to our data and computer systems. Attacks can be
both individual and/or highly organized attempts by sophisticated hacking organizations. Due to the greater use of remote working environments as a result
of the COVID-19 pandemic, there is an elevated risk of such events occurring. We employ a number of measures to prevent, detect and mitigate these
threats, which include password encryption, frequent password change events, firewall detection systems, anti-virus software and frequent backups;
however, there can be no guarantee that such efforts will be successful in preventing a cybersecurity attack. A cybersecurity attack could compromise the
confidential information of our employees, borrowers and vendors. A successful attack could disrupt and otherwise adversely affect our business operations
and financial prospects, damage our reputation and involve significant legal and/or financial liabilities and penalties, including through lawsuits by third-
parties.
If we issue additional debt securities or other equity securities that rank senior to our common stock, our operations may be restricted and we will be
exposed to additional risk and the market price of our securities could be adversely affected.
If we decide to issue additional debt securities in the future, it is likely that such securities will be governed by an indenture or other instrument
containing covenants restricting our operating flexibility and inhibit our ability to make required distributions. Additionally, any convertible or
exchangeable or other securities registered pursuant to our shelf registration statement that we issue in the future may have rights, preferences and
privileges more favorable than those of our common stock. Also, additional shares of preferred stock, if issued, could have a preference on liquidating
distributions or a preference on dividend payments that could limit our ability to make a dividend distribution to the holders of our common stock. We, and
indirectly our shareholders, will bear the cost of issuing and servicing such securities. Holders of debt securities may be granted specific rights, including
but not limited to, the right to hold a perfected security interest in certain of our assets, the right to accelerate payments due under the indenture, rights to
restrict dividend payments, and rights to approve the sale of assets. Such additional restrictive covenants, operating restrictions and preferential dividends
could have a material adverse effect on our operating results and negatively affect the market price of our securities and our ability to pay distributions to
our shareholders.
Future sales of shares of our common stock may depress the price of our shares.
We cannot predict the effect, if any, of future sales of our common stock or the availability of shares for future sales on the market price of our
common stock. Any sales of a substantial number of our shares in the public market, or the perception that sales might occur, may cause the market price of
our shares to decline.
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We may experience significant fluctuations in quarterly operating results.
Our revenues and operating results may fluctuate from quarter to quarter and from year to year due to a combination of factors, many of which are
beyond our control, including the market value of the investments we acquire, the performance of our hedging instruments, prepayment rates, credit
performance of our investments, current events and changes in interest rates. As a result, we may fail to meet profitability or dividend expectations, which
could negatively affect the market price of our securities and our ability to pay dividends to our shareholders.
A resurgence of COVID-19 or similar pandemic could cause severe disruptions in the U.S. and global economies that could adversely affect our
business, financial conditions, liquidity and results of operations.
The COVID-19 outbreak caused significant volatility and disruption in the global financial markets that negatively affected our business. Although
global efforts to contain the spread of COVID-19 have reduced the impact of the pandemic on global economies and financial markets, new COVID-19
variants or another highly infectious or contagious disease could emerge that could once again cause significant volatility and disruption to financial
markets that could adversely affect our business, financial conditions, liquidity and results of operations. The extent of such effects will depend on future
developments which are highly uncertain and cannot be predicted, including the geographic spread of the virus, the overall severity of the disease, the
duration of the outbreak, mutations and new variants of the virus, the measures that may be taken by various governmental authorities in response to the
outbreak and the possible further impacts on the global economy.
In particular, the resurgence of COVID-19 or similar pandemic presents the following risks and uncertainties to our business:
•
A significant decrease in economic activity and/or resulting decline in the real estate market could have an adverse effect on the value
of our investments in mortgages. Mortgage borrowers may experience difficulties meeting their obligations or seek to forbear payment
on or refinance their mortgage loans to avail themselves of lower rates. Elevated levels of delinquency or default would have an
adverse impact on the value of our mortgage investments.
•
We may also experience more difficulty in our financing operations. COVID-19 caused mortgage REITs to experience severe
disruptions in financing operations (including the cost, attractiveness and availability of financing), in particular the ability to utilize
repurchase financing and the margin requirements related to such financing. We could experience an unwillingness or inability of our
potential lenders to provide us with or to renew financing, increased margin calls, and/or additional capital requirements. These
conditions could force us to sell our assets at inopportune times or otherwise cause us to potentially revise our strategic business
initiatives, which could adversely affect our business.
•
The availability of key personnel necessary to conduct our business.
•
Governments have adopted, and may continue to adopt, policies, laws and plans intended to address the COVID-19 pandemic and
adverse developments in the credit, financial, mortgage and rental markets. We cannot assure you that these programs will be effective,
sufficient or otherwise have a positive impact on our business and could potentially have a negative impact on our business.
•
The analytical models and data we use to value our investments may be more prone to inaccuracies in light of unprecedented
conditions created by a resurgence of COVID-19 or similar pandemic.
Risks Related to Taxation
Our failure to qualify as a REIT would result in higher taxes and reduced cash available for distribution to our stockholders.
We have elected to be taxed as a REIT for U.S. federal income tax purposes, and we intend to operate so that we will qualify as a REIT. U.S. federal
income tax laws governing REITs are complex, and interpretations of the U.S. federal income tax laws governing qualification as a REIT are limited.
Qualifying as a REIT requires us to meet various tests regarding the nature of our assets and our income, the ownership of our outstanding stock, and the
amount of our distributions on an ongoing basis.
Our ability to satisfy the asset tests depends upon the characterization and fair market values of our assets, some of which are not susceptible to a
precise determination, and for which we will not obtain independent appraisals. Our compliance with the REIT income and quarterly asset requirements
also depends upon our ability to successfully manage the composition of our income and assets on an ongoing basis. Although we intend to operate so that
we will qualify as a REIT, given the highly complex nature of the rules governing REITs, the ongoing importance of factual determinations, and the
possibility of future changes in our circumstances, no assurance can be given that we will so qualify for any particular year.
If we fail to qualify as a REIT in any calendar year, we would be required to pay U.S. federal income tax on our REIT taxable income at regular
corporate rates, and dividends paid to our stockholders would not be deductible by us in computing our taxable
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income. Further, if we fail to qualify as a REIT, we might need to borrow money or sell assets in order to pay any resulting tax. Our payment of income tax
would decrease the amount of our income available for distribution to our stockholders. Furthermore, if we fail to qualify or maintain our qualification as a
REIT, we no longer would be required to distribute substantially all of our REIT taxable income to our stockholders. Unless our failure to qualify as a REIT
was subject to relief under U.S. federal tax laws, we could not re-elect to qualify as a REIT for four taxable years following the year in which we failed to
qualify.
Complying with the REIT requirements can be difficult and may cause us to forgo otherwise attractive opportunities.
To qualify as a REIT for U.S. federal income tax purposes, we must continually satisfy tests concerning, among other things, the sources of our
income, the nature and diversification of our assets, the amounts we distribute to our stockholders and the ownership of our shares. We may be required to
make distributions to our stockholders at disadvantageous times or when we do not have funds readily available for distribution, and may be unable to
pursue otherwise attractive investments in order to satisfy the source-of-income or asset-diversification requirements for qualifying as a REIT. Thus,
compliance with the REIT requirements may hinder our ability to operate solely on the basis of maximizing profits.
The REIT distribution requirements could adversely affect our ability to execute our business strategies.
We generally must distribute annually at least 90% of our REIT taxable income, excluding any net capital gain. We may use our net operating loss
carryforward to reduce our REIT distribution requirement. To the extent that we satisfy the 90% distribution requirement, but distribute less than 100% of
our taxable income, we will be subject to U.S. federal corporate income tax, and may be subject to state and local income tax, on our undistributed taxable
income. In addition, we will be subject to a 4% nondeductible excise tax if the actual amount that we pay out to our stockholders in a calendar year is less
than a minimum amount specified under U.S. federal income tax laws. We intend to make distributions to our stockholders to comply with the
requirements of the Internal Revenue Code and to avoid paying corporate income tax. However, differences in timing between the recognition of taxable
income and the actual receipt of cash could require us to sell assets or borrow funds on a short-term or long-term basis to meet the distribution requirements
of the Internal Revenue Code.
From time to time, we may be required to recognize taxable income from our assets in advance of our receipt of cash flow on or proceeds from
disposition of such assets. Also, our ability, or the ability of our subsidiaries, to deduct interest may be limited under Section 163(j) of the Internal Revenue
Code. For example, if we purchase MBS at a discount, we generally are required to accrete the discount into taxable income prior to receiving the cash
proceeds of the accreted discount at maturity. In addition, we may be required under the terms of indebtedness that we incur to use cash received from
interest payments to make principal payments on that indebtedness, with the effect of recognizing income but not having a corresponding amount of cash
available for distribution to our stockholders. Additionally, if we incur capital losses in excess of capital gains, such net capital losses are not allowed to
reduce our taxable income for purposes of determining our distribution requirement. They may be carried forward for a period of up to five years and
applied against future capital gains subject to the limitation of our ability to generate sufficient capital gains, which cannot be assured.
If we do not have other funds available, we could be required to (i) sell assets in adverse market conditions, (ii) borrow on unfavorable terms, (iii)
distribute amounts that would otherwise be invested in future acquisitions, capital expenditures or repayment of debt, or (iv) distribute taxable dividends
that are payable in cash or shares of our common stock at the election of each stockholder, to make distributions sufficient to enable us to pay out enough of
our taxable income to satisfy the REIT distribution requirement and to avoid the corporate income tax and 4% excess tax in a particular year. Thus,
compliance with the REIT requirements may hinder our ability to grow, which could adversely affect the value of our common stock.
Net capital losses do not reduce our REIT distribution requirements, which may result in distribution requirements in excess of economic earnings.
As a REIT, we generally must distribute annually at least 90% of our REIT taxable income, excluding any net capital gain. If we incur capital losses in
excess of capital gains, such net capital losses are not allowed to reduce our taxable income for purposes of determining our distribution requirement. They
may be carried forward for a period of up to five years and applied against future capital gains subject to the limitation of our ability to generate sufficient
capital gains, which cannot be assured. Accordingly, if we generate a net capital loss during the year, the minimum amount of our REIT taxable income that
we are required to distribute could exceed our net earnings for the year resulting in a reduction of our shareholders’ equity capital.
The difference in character between our gains and losses on our agency MBS and our interest rate hedging transactions could make this situation more
likely to occur. The gains and losses on the sale of our agency MBS generally are characterized as capital for U.S. federal income tax purposes. However,
our income and losses from interest rate hedging transactions that are designated as hedges generally are characterized as ordinary for U.S. federal income
tax purposes. In general, to the extent that interest rates rise, the value of our interest rate hedging instruments increase in value while the value of our
fixed-rate agency MBS decrease in value.
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As a result, we could realize annual ordinary income from our interest rate hedges that would not be offset, for purposes of the REIT distribution
requirements, by annual net capital losses on our fixed-rate agency MBS. This could lead to a required distribution to our shareholders in excess of our net
earnings, which could result in a reduction in our shareholders’ equity.
Even if we qualify as a REIT, we may face tax liabilities that reduce our cash flow.
Even if we qualify for taxation as a REIT, we may be subject to certain U.S. federal, state and local taxes on our income and assets, including taxes on
any undistributed income, tax on income from certain activities conducted as a result of a foreclosure, and state or local income, property and transfer taxes,
such as mortgage recording taxes, and other taxes. In addition, in order to meet the REIT qualification requirements, or to avoid the imposition of a 100%
tax that applies to certain gains derived by a REIT from dealer property or inventory, we may hold certain assets through, and derive a significant portion of
our taxable income and gains in, TRSs. Such subsidiaries are subject to corporate level income tax at regular rates. Any of these taxes would decrease cash
available for distribution to our stockholders.
Liquidation of assets may jeopardize our REIT qualification.
To qualify as a REIT, we must comply with requirements regarding our assets and our sources of income. If we are compelled to liquidate our
investments to repay obligations to our lenders, we may be unable to comply with these requirements, ultimately jeopardizing our qualification as a REIT,
or we may be subject to a 100% tax on any resultant gain if we sell assets that are treated as dealer property or inventory.
The failure of assets subject to repurchase agreements to be treated as owned by us for U.S. federal income tax purposes could adversely affect our
ability to qualify as a REIT.
We have entered and may in the future enter into repurchase agreements that are structured as sale and repurchase agreements pursuant to which we
nominally sell certain of our assets to a counterparty and simultaneously enter into an agreement to repurchase these assets at a later date in exchange for a
purchase price. Economically, these agreements are financings that are secured by the assets sold pursuant thereto. We believe that we are treated for REIT
asset and income test purposes as the owner of the assets that are the subject of any such sale and repurchase agreement notwithstanding that such
agreements may transfer record ownership of the assets to the counterparty during the term of the agreement. It is possible, however, that the IRS could
assert that we did not own the assets during the term of the sale and repurchase agreement, in which case we could fail to qualify as a REIT.
Complying with the REIT requirements may limit our ability to hedge effectively.
The REIT provisions of the Internal Revenue Code could substantially limit our ability to hedge our assets and operations. Under current law, any
income that we generate from transactions intended to hedge our interest rate or currency risks will be excluded from gross income for purposes of the
REIT 75% and 95% gross income tests if (i) the instrument hedges risk of interest rate or currency fluctuations on indebtedness incurred or to be incurred to
carry or acquire real estate assets, (ii) the instrument hedges risk of currency fluctuations with respect to any item of income or gain that would be
qualifying income under the REIT 75% or 95% gross income tests, or (iii) the instrument was entered into to “offset” certain instruments described in
clauses (i) or (ii) of this sentence and certain other requirements are satisfied and such instrument is properly identified under applicable Treasury
Regulations. Income from hedging transactions that do not meet these requirements is likely to constitute nonqualifying income for purposes of both the
REIT 75% and 95% gross income tests. As a result of these rules, we may have to limit our use of hedging techniques that might otherwise be
advantageous to us or implement those hedges through a TRS. This could increase the cost of our hedging activities because a TRS would be subject to tax
on gains or expose us to greater risks associated with interest rate fluctuations or other changes than we would otherwise want to bear.
Uncertainty exists with respect to the treatment of our TBAs for purposes of the REIT asset and income tests.
We purchase and sell agency MBS through TBAs and recognize income or gains from the disposition of those TBAs, through dollar roll transactions
or otherwise, and may continue to do so in the future. While there is no direct authority with respect to the qualification of TBAs as real estate assets or
U.S. Government securities for purposes of the REIT 75% asset test or the qualification of income or gains from dispositions of TBAs as gains from the
sale of real property or other qualifying income for purposes of the REIT 75% gross income test, we treat our TBAs under which we contract to purchase a
TBA agency MBS ( “long TBAs”) as qualifying assets for purposes of the REIT 75% asset test, and we treat income and gains from our long TBAs as
qualifying income for purposes of the REIT 75% gross income test, based on an opinion of counsel substantially to the effect that (i) for purposes of the
REIT asset tests, our ownership of a long TBA should be treated as ownership of real estate assets, and (ii) for purposes of the REIT 75% gross income test,
any gain recognized by us in connection with the settlement of our long TBAs should be treated as gain from the sale or disposition of an interest in
mortgages on real property. Opinions of counsel are not binding on the IRS, and no assurance
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can be given that the IRS will not successfully challenge the conclusions set forth in such opinions. In addition, it must be emphasized that the opinion of
counsel is based on various assumptions relating to our TBAs and is conditioned upon fact-based representations and covenants made by our management
regarding our TBAs. No assurance can be given that the IRS would not assert that such assets or income are not qualifying assets or income. If the IRS
were to successfully challenge the opinion of counsel, we could be subject to a penalty tax or we could fail to remain qualified as a REIT if a sufficient
portion of our assets consists of TBAs or a sufficient portion of our income consists of income or gains from the disposition of TBAs.
The tax on prohibited transactions will limit our ability to engage in transactions, including certain methods of securitizing MBS, that would be treated
as sales for U.S. federal income tax purposes.
A REIT’s net income from prohibited transactions is subject to a 100% tax with no offset for losses. In general, prohibited transactions are sales or
other dispositions of property, other than foreclosure property, but including mortgage loans, held primarily for sale to customers in the ordinary course of
business. We might be subject to this tax if we dispose of or securitize MBS in a manner that was treated as dealer activity for U.S. federal income tax
purposes. Therefore, in order to avoid the prohibited transactions tax, we may choose not to engage in certain sales or securitization structures or to
implement such transactions through a TRS, even though the transactions might otherwise be beneficial to us.
Distributions to tax-exempt investors, or gains on sale of our common stock by tax-exempt investors, may be classified as unrelated business taxable
income.
Neither ordinary nor capital gain distributions with respect to our common stock nor gain from the sale of our common stock are anticipated to
constitute unrelated business taxable income to a tax-exempt investor. However, there are certain exceptions to this rule. For example, if (i) all or a portion
of our assets are subject to the rules relating to "taxable mortgage pools" or we hold residual interests in a REMIC; (ii) we are a "pension held REIT;" (iii) a
tax-exempt stockholder has incurred debt to purchase or hold our common stock; or (iv) a tax-exempt stockholder is classified as a social club, voluntary
employee benefit association, supplemental unemployment benefit trust or a qualified group legal services plan, then a portion of our distributions to tax-
exempt stockholders and, in the case of stockholders described in clauses (iii) and (iv), gains realized on the sale of our common stock by tax-exempt
stockholders may be subject to U.S. federal income tax as unrelated business taxable income under the Internal Revenue Code.
Certain financing activities may subject us to U.S. federal income tax and could have negative tax consequences for our shareholders.
We currently do not intend to enter into any transactions that could result in our, or a portion of our assets, being treated as a taxable mortgage pool for
U.S. federal income tax purposes. If we enter into such a transaction in the future we will be taxable at the highest corporate income tax rate on a portion of
the income arising from a taxable mortgage pool, referred to as "excess inclusion income," that is allocable to the percentage of our shares held in record
name by disqualified organizations (generally tax-exempt entities that are exempt from the tax on unrelated business taxable income, such as state pension
plans and charitable remainder trusts and government entities).
If we were to realize excess inclusion income, IRS guidance indicates that the excess inclusion income would be allocated among our shareholders in
proportion to our dividends paid. Excess inclusion income cannot be offset by losses of our shareholders. If the shareholder is a tax-exempt entity and not a
disqualified organization, then this income would be fully taxable as unrelated business taxable income under Section 512 of the Internal Revenue Code. If
the shareholder is a foreign person, it would be subject to U.S. federal income tax at the maximum tax rate and withholding will be required on this income
without reduction or exemption pursuant to any otherwise applicable income tax treaty.
The stock ownership limits applicable to us that are imposed by the Internal Revenue Code for REITs may restrict our business combination
opportunities.
In order for us to maintain our qualification as a REIT under the Internal Revenue Code, not more than 50% in value of our outstanding shares may be
owned, directly or indirectly, by five or fewer individuals (as defined in the Internal Revenue Code to include certain entities) at any time during the last
half of each taxable year after our first taxable year.
In addition to the limitations on ownership under our Rights Plan, our Amended and Restated Articles of Incorporation contain customary
“ownership limitation” provisions that are designed to protect our ability to qualify as a REIT. Pursuant to our Amended and Restated Articles of
Incorporation, no person may own, or deemed to own by virtue of the attribution provisions of the Internal Revenue Code, in excess of (i) 9.9% of the
number of the outstanding shares of our common stock, (ii) 9.9% in number of the outstanding shares of any class or series of our preferred stock, and (iii)
9.9% of the aggregate value of the outstanding shares of our equity stock. Our Board of Directors may, in its sole discretion, with respect to any person, (i)
grant an exemption from this 9.9% stock ownership limitation, and (ii) establish different ownership limitations for any such person.
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Such stock ownership limits might delay or prevent a transaction or a change in our control that might involve a premium price for our common
stock or otherwise be in the best interests of our stockholders.
A REIT cannot invest more than 20% of its total assets in the stock or securities of one or more TRS.
A TRS is a corporation, other than a REIT or a qualified REIT subsidiary, in which a REIT owns the stock and with which the REIT jointly elects TRS
status. The term also includes a corporate subsidiary in which the TRS owns more than a 35% interest.
A REIT may own up to 100% of the stock of one or more TRSs. A TRS may earn income that would not be qualifying income if it was earned directly
by the parent REIT. Overall, at the close of any calendar quarter, no more than 20% of the value of a REIT’s assets may consist of stock or securities of one
or more TRSs.
The stock and securities of our TRSs are expected to represent less than 20% of the value of our total assets. Furthermore, we intend to monitor the
value of our investments in the stock and securities of our TRSs to ensure compliance with the above-described limitation. We cannot assure you, however,
that we will always be able to comply with the limitation so as to maintain REIT status.
TRSs are subject to tax at the regular corporate rates, are not required to distribute dividends, and the amount of dividends a TRS can pay to its parent
REIT may be limited by REIT gross income tests.
A TRS must pay income tax at regular corporate rates on any income that it earns. Our TRSs will pay corporate income tax on their taxable income,
and their after-tax net income will be available for distribution to us. In certain circumstances, the ability of our TRSs to deduct interest expense for federal
income tax may be limited. Such income, however, is not required to be distributed.
Moreover, the annual gross income tests that must be satisfied to ensure REIT qualification may limit the amount of dividends that we can receive
from our TRSs and still maintain our REIT status. Generally, not more than 25% of our gross income can be derived from non-real estate related sources,
such as dividends from a TRS. If, for any taxable year, the dividends we received from our TRSs, when added to our other items of non-real estate related
income, represented more than 25% of our total gross income for the year, we could be denied REIT status, unless we were able to demonstrate, among
other things, that our failure of the gross income test was due to reasonable cause and not willful neglect.
The limitations imposed by the REIT gross income tests may impede our ability to distribute assets from our TRSs to us in the form of dividends.
Certain asset transfers may, therefore, have to be structured as purchase and sale transactions upon which our TRSs recognize a taxable gain.
If interest accrues on indebtedness owed by a TRS to its parent REIT at a rate in excess of a commercially reasonable rate, or if transactions between a
REIT and a TRS are entered into on other than arm’s-length terms, the REIT may be subject to a penalty tax.
If interest accrues on an indebtedness owed by a TRS to its parent REIT at a rate in excess of a commercially reasonable rate, the REIT is subject to
tax at a rate of 100% on the excess of (i) interest payments made by a TRS to its parent REIT over (ii) the amount of interest that would have been payable
had interest accrued on the indebtedness at a commercially reasonable rate. A tax at a rate of 100% is also imposed on any transaction between a TRS and
its parent REIT to the extent the transaction gives rise to deductions to the TRS that are in excess of the deductions that would have been allowable had the
transaction been entered into on arm’s-length terms. While we will scrutinize all of our transactions with our TRSs in an effort to ensure that we do not
become subject to these taxes, there is no assurance that we will be successful. We may not be able to avoid application of these taxes.
New legislation or administrative or judicial action, in each instance potentially with retroactive effect, could make it more difficult or impossible for us
to qualify as a REIT.
The present U.S. federal income tax treatment of REITs may be modified, possibly with retroactive effect, by legislative, judicial or administrative
action at any time, which could affect the U.S. federal income tax treatment of an investment in our common stock. The U.S. federal tax rules that affect
REITs are under review constantly by persons involved in the legislative process, the IRS and the U.S. Treasury Department, which results in statutory
changes as well as frequent revisions to Treasury regulations and interpretations. Revisions in U.S. federal tax laws and interpretations thereof could cause
us to change our investments and commitments, which could also affect the tax considerations of an investment in our stock. We cannot predict the long-
term effect of any recent law changes or any future law changes on REITs and their stockholders. Any such changes could have an adverse effect on the
market value of our securities or our ability to make dividends to our shareholders.
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The ability of our Board of Directors to revoke or otherwise terminate our REIT election without stockholder approval may cause adverse
consequences to our stockholders.
Our charter provides that our Board of Directors may revoke or otherwise terminate our REIT election, without the approval of our stockholders,
upon the requisite vote of our Board of Directors. If we cease to qualify as a REIT, we would become subject to U.S. federal income tax on our net taxable
income and we generally would no longer be required to distribute any of our net taxable income to our stockholders, which may have adverse
consequences on the total return to our stockholders.
We may not be able to generate future taxable income to fully utilize NOL and NCL carryforwards.
As of December 31, 2022, we had an estimated NOL carryforward of $162.5 million that can be used to offset future taxable ordinary income and
reduce our future distribution requirements. Estimated NOL carryforwards totaling $14.6 million expire in 2028 and NOL carryforwards totaling $147.9
million have no expiration period. As of December 31, 2022, we also had NCL carryforwards of $155.7 million that can be used to offset future net capital
gains. The scheduled expirations of our NCL carryforwards are $110.3 million in 2023, $14.2 million in 2026 and $31.2 million in 2027. We can utilize
our NCL carryforward to reduce our net capital gain income that would be subject to income taxes to the extent it is not distributed to our shareholders.
Utilizing our NOL and NCL carryforwards may allow us to reduce our required distributions to shareholders or income tax liability which would allow us
to retain future taxable income as capital. However, we may not generate sufficient taxable income of the appropriate tax character to fully utilize these
carryforwards prior to their expiration. To the extent that our NOL or NCL carryforwards expire unutilized, we may not fully realize the benefit of these tax
attributes which could lead to higher annual distribution requirements or tax liabilities.
Our ability to use our tax benefits could be substantially limited if we experience an “ownership change.”
Our NOL and NCL carryforwards and certain recognized built-in losses may be limited by Sections 382 and 383 of the Internal Revenue Code if we
experience an “ownership change.” In general, an “ownership change” occurs if 5% shareholders increase their collective ownership of the aggregate
amount of the outstanding shares of our company by more than 50 percentage points looking back over the relevant testing period. If an ownership change
occurs, our ability to use our NOLs, NCLs and certain recognized built-in losses to reduce our REIT distribution requirement or taxable income in a future
year would be limited to a Section 382 limitation equal to the fair market value of our stock immediately prior to the ownership change multiplied by the
long-term tax-exempt interest rate in effect for the month of the ownership change. In the event of an ownership change, NOLs and NCLs that exceed the
Section 382 limitation in any year will continue to be allowed as carryforwards for the remainder of the carryforward period and such losses can be used to
offset taxable income for years within the carryforward period subject to the Section 382 limitation in each year. However, if the carryforward period for
any NOL or NCL were to expire before that loss had been fully utilized, the unused portion of that loss would be lost. Our use of new NOLs or NCLs
arising after the date of an ownership change would not be affected by the Section 382 limitation (unless there were another ownership change after those
new losses arose).
We have a Rights Plan designed to protect against the occurrence of an ownership change. The Rights Plan is intended to act as a deterrent to any
person or group acquiring 4.9% or more of our outstanding common stock without the approval of our Board of Directors. See “Risks Related to our
Business and Structure - Our Rights Plan could inhibit a change in our control” for information on our Rights Plan. The Rights Plan and any outstanding
rights will expire at the earliest of (i) June 4, 2025, (ii) the time at which the rights are redeemed or exchanged pursuant to the Rights Plan, (iii) the repeal of
Section 382 and 383 of the Internal Revenue Code or any successor statute if the Board of Directors determines that the Rights Plan is no longer necessary
for the preservation of the applicable tax benefits, or (iv) the beginning of a taxable year to which the Board of Directors determines that no applicable tax
benefits may be carried forward.
In addition, the Rights Plan does not protect against all transactions that could cause an ownership change, such as public issuances and repurchases
of shares of our common stock. The Rights Plan may not be successful in preventing an ownership change within the meaning of Sections 382 and 383 of
the Internal Revenue Code, and we may lose all or most of the anticipated tax benefits associated with our prior losses.
Based on our knowledge of our stock ownership, we do not believe that an ownership change has occurred since our losses were generated.
Accordingly, we believe that at the current time there is no annual limitation imposed on our use of our NOLs and NCLs to reduce future taxable income.
The determination of whether an ownership change has occurred or will occur is complicated and depends on changes in percentage stock ownership
among shareholders. Other than the Rights Plan, there are currently no restrictions on the transfer of our stock that would discourage or prevent transactions
that could cause an ownership change, although we may adopt such restrictions in the future. As discussed above, the Rights Plan is intended to discourage
transactions that could cause an ownership change. In addition, we have not obtained, and currently do not plan to obtain, a ruling from the Internal
Revenue Service, regarding our conclusion as to whether our losses are subject to any such limitations. Furthermore, we may decide in the future that it is
necessary or in our interest to take certain actions that could result in an ownership change. Therefore, no assurance can be provided as to whether an
ownership change has occurred or will occur in the future.
32
Preserving the ability to use our NOLs and NCLs may cause us to forgo otherwise attractive opportunities.
Limitations imposed by Sections 382 and 383 of the Internal Revenue Code may discourage us from, among other things, repurchasing our stock or
issuing additional stock to raise capital or to acquire businesses or assets. Accordingly, our desire to preserve our NOLs and NCLs may cause us to forgo
otherwise attractive opportunities.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
33
ITEM 2. PROPERTIES
As of December 31, 2022, we do not own any property. Our executive and administrative office is located at 6862 Elm Street, Suite 320, McLean,
Virginia 22101. We lease our office space.
ITEM 3. LEGAL PROCEEDINGS
We are from time to time involved in civil lawsuits, legal proceedings and arbitration matters that we consider to be in the ordinary course of our
business. There can be no assurance that these matters individually or in the aggregate will not have a material adverse effect on our financial condition or
results of operations in a future period. We are also subject to the risk of litigation, including litigation that may be without merit. As we intend to actively
defend such litigation, significant legal expenses could be incurred. An adverse resolution of any future litigation against us could materially affect our
financial condition, results of operations and liquidity. Furthermore, we operate in highly-regulated markets that currently are under intense regulatory
scrutiny, and we have received, and we expect in the future that we may receive, inquiries and requests for documents and information from various federal,
state and foreign regulators. We believe that the continued scrutiny of MBS, structured finance, and derivative market participants increases the risk of
additional inquiries and requests from regulatory or enforcement agencies and other parties. We cannot provide any assurance that these inquiries and
requests will not result in further investigation of or the initiation of a proceeding against us or that, if any such investigation or proceeding were to arise, it
would not materially adversely affect our Company.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
34
PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF
EQUITY SECURITIES
Our common stock is listed on the NYSE under the symbol “AAIC.” As of January 31, 2023, there were approximately 100 record holders of our
common stock. However, most of the shares of our common stock are held by brokers and other institutions on behalf of shareholders.
We have elected to be taxed as a REIT under the Internal Revenue Code. As a REIT, we are required to distribute annually 90% of our REIT taxable
income (subject to certain adjustments). So long as we continue to qualify as a REIT, we will generally not be subject to U.S. federal or state corporate
income taxes on our taxable income that we distribute to our shareholders on a timely basis. At present, it is our intention to distribute 100% of our taxable
income, although we will not be required to do so. We intend to make distributions of our taxable income within the time limits prescribed by the Internal
Revenue Code, which may extend into the subsequent taxable year. We have not established a minimum dividend payment level and our ability to pay
dividends may be adversely affected for the reasons described in “Item 1A Risk Factors.” All distributions to shareholders will be made at the discretion of
our Board of Directors and will depend upon our earnings, financial condition, maintenance of our REIT status and other factors as our Board of Directors
may deem relevant from time to time.
In addition, holders of our Series B Preferred Stock and Series C Preferred Stock are entitled to receive cumulative cash dividends at a specified
rate of each of their liquidation preference before holders of our common stock are entitled to receive any dividends.
Securities Authorized for Issuance Under Equity Compensation Plans
Information about securities authorized for issuance under our equity compensation plans is incorporated by reference from our Definitive Proxy
Statement for the 2023 Annual Meeting of Shareholders.
Purchases of Equity Securities by the Issuer
On July 31, 2020, we announced that our Board of Directors authorized an increase to our share repurchase program (the “Repurchase Program”)
pursuant to which we may repurchase up to 18,000,000 shares of our common stock. As of December 31, 2022, we had repurchased 7,804,296 shares of
our common stock and there remain available for repurchase 10,195,704 shares of our common stock under the Repurchase Program.
The following table presents information with respect to our purchases of our common stock during the three months ended December 31, 2022, by
us or any “affiliated purchaser” affiliated with us, as defined in Rule 10b-18(a)(3) under the Exchange Act:
Settlement Date
Total Number of
Shares Purchased
Average Net Price
Paid Per Share
Total Number of
Shares Repurchased
as Part of
Repurchase
Program
Maximum Number
of Shares that May
Yet be Purchased
Under the
Repurchase
Program
October 1, 2022 - October 31, 2022
225,700
$
2.86
225,700
10,335,085
November 1, 2022 - November 30, 2022
139,381
3.09
139,381
10,195,704
December 1, 2022 - December 31, 2022
—
—
—
10,195,704
Total
365,081
$
2.95
365,081
10,195,704
On March 20, 2020, our Board of Directors authorized us to repurchase up to $25 million in the aggregate of our Series B Preferred Stock, Series C
Preferred Stock, Senior Notes due 2023 and Senior Notes due 2025. As of December 31, 2022, we had repurchased an aggregate of $8.0 million of
Preferred Stock and Senior Notes and had remaining authorization to repurchase up to $17.0 million of such securities.
The following table presents information with respect to our purchases of our Series C Preferred Stock during the three months ended December 31,
2022 by us or any “affiliated purchaser” affiliated with us, as defined in Rule 10b-18(a)(3) under the Exchange Act:
35
Settlement Date
Total Number of
Shares Purchased
Average Net Price
Paid Per Share
Total Number of
Shares Repurchased
as Part of
Repurchase Program
Maximum Number of
Shares that May Yet be
Purchased Under the
Repurchase Program
October 1, 2022 - October 31, 2022
5,690
$
18.25
5,690
N/A
November 1, 2022 - November 30, 2022
—
—
—
N/A
December 1, 2022 - December 31, 2022
2,000
21.27
2,000
N/A
Total
7,690
$
19.04
7,690
N/A
ITEM 6. RESERVED
Reserved.
36
(1)
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
We are an investment firm that currently focuses primarily on investing in mortgage related assets. Our investment capital is currently allocated
between the following asset classes:
•
mortgage servicing right (“MSR”) related assets
•
credit investments
•
agency mortgage-backed securities (“MBS”)
Our MSR related assets represent investments for which the return is based on the economic performance of a pool of specific MSRs. Our credit
investments generally include investments in mortgage loans secured by either residential or commercial real property or MBS collateralized by residential
or commercial mortgage loans (“non-agency MBS”). Our agency MBS consist of residential mortgage pass-through certificates for which the principal and
interest payments are guaranteed by a U.S. government sponsored enterprise (“GSE”), such as the Federal National Mortgage Association (“Fannie Mae”)
and the Federal Home Loan Mortgage Corporation (“Freddie Mac”).
We also previously allocated investment capital to a strategy of investing in single-family residential ("SFR") properties that consisted of acquiring,
leasing and operating single-family residential homes as rental properties. During 2022, we sold our portfolio of SFR properties and are currently no longer
anticipating allocating capital to our SFR investment strategy.
We may also invest in other asset classes that our management team believes may offer attractive risk adjusted returns outside the real estate or
mortgage asset classes.
We are internally managed and do not have an external investment advisor.
Factors that Affect our Results of Operations and Financial Condition
Our business is materially affected by a variety of industry and economic factors, including:
•
conditions in the global financial markets and economic conditions generally;
•
changes in interest rates and prepayment rates;
•
conditions in the real estate and mortgage markets;
•
actions taken by the U.S. government, U.S. Federal Reserve, the U.S. Treasury and foreign central banks;
•
changes in laws and regulations and industry practices; and
•
other market developments.
Current Market Conditions and Trends
The 10-year U.S. Treasury rate was 3.87% as of December 31, 2022, a 236 basis point increase from the prior year end. The interest rate curve,
measured as the spread between the 2-year and 10-year U.S. Treasury, inverted to a negative 56 basis points as of December 31, 2022 as the increases in the
short-term interest rates have outpaced the rise in long-term interest rates. With the rise in the 10-year U.S. Treasury rate, residential mortgage rates
increased significantly evidenced by the Fannie Mae average primary mortgage rate increasing by 331 basis points during 2022 to 6.42% as of December
31, 2022. The spread between the current coupon agency MBS and the 10-year swap rate widened 106 basis points during 2022. The rate of inflation
continued to increase significantly during 2022 with the Consumer Price Index rising to a peak of 9.1% for the twelve month period ending June 30, 2022,
one of the largest increases in over 40 years, before falling to 6.5% for the twelve month period ending December 31, 2022.
In order to address the persistently high inflation, the U.S. Federal Reserve has continued to take actions with the objective of lowering inflation by
significantly raising interest rates. During 2022, the Federal Open Market Committee (“FOMC”) raised its target range for the federal funds rate at each of
its scheduled meetings for a total increase of 425 basis points to a target range of 4.25% to 4.50% at its last meeting on December 14, 2022. In addition, the
FOMC announced that it will continue reducing its holdings of Treasury securities and agency debt and agency MBS. As of December 31, 2022, the
market is expecting additional hikes totaling approximately 50 basis points in the next six months followed by rate cuts of approximately 25 basis points in
the latter half of 2023 based on federal funds futures.
Prepayment speeds in the fixed-rate residential mortgage market decreased during 2022 primarily due to the rise in the primary mortgage rate driven
by the increase in the 10-year U.S. Treasury rate. Pay-up premiums on agency MBS, which represent the price premium of agency MBS backed by
specified pools over a TBA security, decreased during 2022 as a result of declining prepayment
37
concerns. The spread between the market yield on agency MBS and benchmark interest rates widened during 2022 resulting in agency MBS
underperforming relative to interest rate hedges. Conversely, valuation multiples of MSRs increased during 2022 driven primarily by declining prepayment
speed expectations.
Housing price gains continue to remain historically high although they have begun to decelerate as evidenced by the Standard & Poor’s CoreLogic
Case-Shiller U.S. National Home Price NSA index reporting a 7.7% annual gain in November 2022, the fifth consecutive month of declining home prices.
As the Federal Reserve continues to likely increase interest rates, more expensive mortgage financing along with a challenging macroeconomic
environment may cause housing prices to continue to decelerate in the near future.
The following table presents certain key market data as of the dates indicated:
December 31,
2021
March 31,
2022
June 30,
2022
September 30,
2022
December 31,
2022
Change - 2021 to
2022
30-Year FNMA Fixed Rate MBS
2.0%
$
102.09
$
95.20
$
89.89 $
83.80 $
84.63 $
(17.46 )
3.0%
103.64
97.55
93.11
86.81
87.71
(15.93 )
3.5%
105.32
99.75
96.17
89.83
90.82
(14.50 )
4.0%
106.41
101.58
98.62
92.68
93.77
(12.64 )
4.5%
107.22
103.25
100.39
95.18
96.31
(10.91 )
5.0%
109.06
105.16
102.07
97.34
98.52
(10.55 )
Investment Spreads
FNMA Current Coupon vs.
10-year Swap Rate
49 bps
108 bps
129 bps
180 bps
155 bps
106 bps
30 Year Fixed Mortgage Rate
Freddie Mac Average Primary
Mortgage Rate
3.11 %
4.67 %
5.70 %
6.70 %
6.42 %
331 bps
U.S. Treasury Rates ("UST")
2-year UST
0.73 %
2.33 %
2.95 %
4.28 %
4.43 %
370 bps
5-year UST
1.26 %
2.46 %
3.04 %
4.09 %
4.00 %
274 bps
10-year UST
1.51 %
2.34 %
3.01 %
3.83 %
3.87 %
236 bps
2-year to 10-year UST Spread
78 bps
1 bps
6 bps
-45 bps
-56 bps
-134 bps
Interest Rate Swap Rates
2-year Swap
0.94 %
2.55 %
3.28 %
4.55 %
4.71 %
377 bps
5-year Swap
1.37 %
2.52 %
3.08 %
4.14 %
4.02 %
265 bps
10-year Swap
1.58 %
2.41 %
3.09 %
3.88 %
3.84 %
226 bps
2-year Swap to 2-year UST Spread
21 bps
22 bps
33 bps
27 bps
28 bps
7 bps
10-year Swap to 10-year UST Spread
7 bps
7 bps
8 bps
5 bps
-3 bps
-10 bps
London Interbank Offered Rates ("LIBOR") and Secured Overnight Financing Rate ("SOFR")
1-month LIBOR
0.10 %
0.45 %
1.79 %
3.14 %
4.39 %
429 bps
3-month LIBOR
0.21 %
0.96 %
2.29 %
3.75 %
4.77 %
456 bps
1-month Term SOFR
0.05 %
0.30 %
1.69 %
3.04 %
4.36 %
431 bps
Twelve Month Percent Change in Consumer Price Index ("CPI")
Consumer Price Index for All Urban
Consumers
7.00 %
8.50 %
9.10 %
8.20 %
6.50 %
-50 bps
Generic 30-year FNMA TBA price information, sourced from Bloomberg, is provided for illustrative purposes only and is not meant to be reflective
of the fair value of securities held by the Company.
Recent Regulatory Activity
Elimination of LIBOR
On March 5, 2021, the FCA, which regulates LIBOR, announced that all LIBOR tenors relevant to us will cease to be published or will no longer be
representative after June 30, 2023. The FCA's announcement coincides with the March 5, 2021 announcement of LIBOR's administrator, the IBA,
indicating that, as a result of not having access to input data necessary to calculate LIBOR tenors relevant to us on a representative basis after June 30,
2023, IBA would have to cease publication of such LIBOR tenors immediately after the last publication on June 30, 2023. These announcements mean that
any of our LIBOR-based financial instruments that extend beyond June 30, 2023 will need to be converted to a replacement rate.
The U.S. Federal Reserve and the Federal Reserve Bank of New York jointly convened the ARRC, a steering committee comprised of private sector
entities, each with an important presence in markets effected by LIBOR, and official-sector entities, including banking and financial sector regulators. The
ARCC’s initial objectives were to identify risk-free alternative reference rates for USD LIBOR, identify best practices for contract robustness and create an
implementation plan. The ARRC has recommended
38
(1)
(1)
SOFR and, in some cases, the forward-looking term rate based on SOFR published by CME Group Benchmark Administration Limited ("CME Term
SOFR") plus, in each case, a recommended spread adjustment, as LIBOR's replacement.
The U.S. federal government enacted the Adjustable Interest Rate (LIBOR) Act ("LIBOR Act") to provide for uniform nationwide solution for
certain contracts that do not have clear and practical provisions for replacing LIBOR after June 30, 2023. On December 16, 2022, the Federal Reserve
Board implemented a final rule that implements the LIBOR Act and identifies replacement benchmark rates based on SOFR to replace overnight, one-
month, three-month, six-month and 12-month LIBOR in U.S. contracts that do not mature before LIBOR ends and that lack adequate fallback provisions
that would replace LIBOR with a practicable replacement benchmark rate. The final rule also restates the safe harbor protections contained in the LIBOR
Act for selection or use of the replacement benchmark rate selected by the Federal Reserve Board and clarifies who would be considered a determining
person able to choose to use the replacement benchmark rate selected by the Federal Reserve Board for certain LIBOR contracts.
Any of our LIBOR-based borrowings that extend beyond June 30, 2023 will need to be converted to a replacement rate. We are party to various
financial instruments which include LIBOR as a reference rate that mature or expire after June 30, 2023. As of December 31, 2022, these financial
instruments include preferred stock and unsecured notes issued by us.
As of December 31, 2022, we had $15.0 million of junior subordinated debt outstanding that require quarterly interest payments at three-month
LIBOR plus a spread of 2.25% to 3.00% and matures between 2033 and 2035. Under the terms of the indenture agreement for the notes, if the publication
of LIBOR is not available, the current fallback is for the independent calculation agent to obtain quotations for what LIBOR should be from major banks in
the interbank market. If the calculation agent is unable to obtain such quotations, then the LIBOR in effect for future interest payments would be LIBOR in
effect for the immediately preceding interest payment period. We expect the LIBOR Act to automatically invalidate such polling provisions and provide a
safe harbor for those, like the calculation agent, who are contractually responsible for determining LIBOR replacements if the agent replaces LIBOR with
the SOFR-based rate selected by the Federal Reserve. Accordingly, we expect that the calculation agent will select the SOFR-based rate selected by
Federal Reserve in its final rule.
As of December 31, 2022, we had 957,133 shares of Series C Preferred Stock outstanding with a liquidation preference of $23.9 million. The Series
C Preferred Stock is entitled to receive a cumulative cash dividend (i) from and including the original issue to, but excluding, March 30, 2024 at a fixed rate
of 8.250% per annum of the $25.00 per share liquidation preference, and (ii) from and including March 30, 2024, at a floating rate equal to three-month
LIBOR plus a spread of 5.664% per annum of the $25.00 liquidation preference. Under the terms of our Articles of Incorporation, if the publication of
LIBOR is not available, the current fallback is for us to obtain quotations for what LIBOR should be from major banks in the interbank market. If we are
unable to obtain such quotations, we are required to appoint an independent calculation agent, which will determine LIBOR based on sources it deems
reasonable in its sole discretion. If the calculation agent is unable or unwilling to determine LIBOR, then the LIBOR in effect for future dividend payments
would be LIBOR in effect for the immediately preceding dividend payment period. We expect all of these provisions to be invalidated by the LIBOR Act.
We expect to appoint an independent calculation agent to determine whether there is an industry accepted substitute or successor base rate to three-month
LIBOR. If the calculation agent determines that there is an industry accepted substitute or successor base rate, the calculation agent shall use such substitute
or successor base rate. We expect that the calculation agent will select the SOFR-based rate selected by Federal Reserve in its final rule.
Portfolio Overview
The following table summarizes our asset and capital allocation of our investment strategies as of December 31, 2022 (dollars in thousands):
December 31, 2022
Assets
Invested Capital
Allocation
Invested Capital
Allocation (%)
Leverage
MSR financing receivables
$
180,365 $
180,365
63%
—
Credit investments
167,519
58,485
21%
1.9
Agency MBS
43,722
45,566
16%
—
Total invested capital
$
391,606
284,416
100%
Cash and other corporate capital, net
19,329
Total investable capital
$
303,745
0.3
Our investable capital is calculated as the sum of our shareholders’ equity capital and long-term unsecured debt.
Our leverage is measured as the ratio of the sum of our repurchase agreement financing, net payable or receivable for unsettled securities, net
contractual forward purchase or sale price of our TBA commitments and leverage within our MSR financing receivables less our cash and cash
equivalents compared to our investable capital.
Includes our net investment of $28,904 in VIEs with gross assets and liabilities of $198,511 and $169,607, respectively, that is consolidated for
GAAP financial reporting purposes.
39
(1)
(2)
(3)
(4)
(1)
(2)
(3)
Agency MBS assets include the fair value of the agency MBS which underlie our TBA forward purchase and sale commitments. In accordance with
GAAP, our TBA forward commitments are reflected on the consolidated balance sheets as derivative assets and liabilities at fair value in the
financial statement line items "other assets" and "other liabilities". As of December 31, 2022, the fair value of the underlying agency MBS that
underlie our net short position in TBA commitments had a fair value of $(399,818) with a net carrying value of $5,630.
MSR Financing Receivables
As of December 31, 2022, we had $180.4 million of MSR financing receivable investments at fair value. We are party to agreements with a
licensed, GSE approved residential mortgage loan servicer that enable us to garner the economic return of an investment in an MSR purchased by the
mortgage servicing counterparty. The arrangement allows us to participate in the economic benefits of investing in an MSR without holding the requisite
licenses to purchase or hold MSRs directly. The transactions are accounted for as a financing receivable in our consolidated financial statements. The
following tables present further information about our MSR financing receivable investments as of December 31, 2022 (dollars in thousands):
Amortized Cost Basis
Unrealized Gain
Fair Value
$
134,469
$
45,896
$
180,365
Represents capital investments plus accretion of interest income net of cash distributions.
MSR Financing Receivable Underlying Reference Amounts:
MSRs
Financing
Advances Receivable
Cash and Other Net
Receivables
Counterparty
Incentive Fee Accrual
MSR Financing
Receivables
Implicit
Leverage
$
184,107 $
(7,863) $
6,046 $
10,643 $
(12,568) $
180,365
0.04
Underlying Reference MSRs:
Holder of Loans
Unpaid Principal
Balance
Weighted-
Average Note
Rate
Weighted-
Average
Servicing Fee
Weighted-
Average Loan
Age
Price
Multiple
Fair Value
Fannie Mae
$
12,547,523
3.09%
0.25%
24 months
1.35%
5.41 $
169,839
Freddie Mac
1,023,446
3.72%
0.25%
22 months
1.39%
5.58
14,268
Total/weighted-average
$
13,570,969
3.14%
0.25%
24 months
1.36%
5.42 $
184,107
Calculated as the underlying MSR price divided by the weighted-average servicing fee.
Credit Investment Portfolio
The following table presents information about our credit investments as of December 31, 2022 (dollars in thousands):
Market Price
Fair Value
Financing
Invested Capital
Leverage
Commercial MBS
$
98.93 $
98,933 $
88,953 $
10,188
8.7
Commercial mortgage loan
100.00
29,264
20,485
8,931
2.3
Residential MBS - interest-only
10.76
24,036
—
24,036
—
Residential MBS
64.66
1,048
—
1,048
—
Business purpose residential MBS
91.75
7,244
—
7,244
—
Corporate asset-backed loan
100.00
4,914
—
4,958
—
Solar ABS
41.10
2,080
—
2,080
—
Total/weighted-average
$
167,519 $
109,438 $
58,485
1.9
For non-commercial credit investments in securities, includes contractual accrued interest receivable.
Invested capital includes investment accrued interest receivable and financing accrued interest payable.
Residential MBS – interest-only and residential MBS, in combination, reflect our net investment at fair value of $25,084 in a VIE with gross assets
and liabilities of $194,490 and $169,406, respectively, that is consolidated for GAAP financial reporting purposes.
Includes our net investment of $3,820 in a VIE with gross assets and liabilities of $4,021 and $201, respectively, that is consolidated for GAAP
financial reporting purposes.
The corporate asset-backed loan was repaid in full on January 17, 2023.
40
(4)
(1)
(1)
(1)
(1)
(1)
(2)
(3)
(3)
(4)
(5)
(1)
(2)
(3)
(4)
(5)
Our classes of credit investments as of December 31, 2022 are summarized as follows:
Commercial MBS - We hold two AAA rated senior position commercial MBS which are summarized as follows:
•
A senior position commercial MBS with a fair value of $49.6 million and an unpaid principal balance of $50.0 million. The
investment has 30.9% in subordinated credit support and is secured primarily by a first lien mortgage loan on a 153 room full-service
hotel ("The Mark Hotel") located in New York, New York. The security carries a variable coupon rate of one-month term SOFR plus
2.70%.
•
A senior position commercial MBS with a fair value of $49.3 million and an unpaid principal balance of $50.0 million. The
investment has 43.7% in subordinated credit support and is secured primarily by a first lien mortgage loan on a super-regional mall
("The Streets at Southpoint") located in Durham, North Carolina. The security carries a variable coupon rate of one-month term
SOFR plus 3.00%.
Commercial mortgage loan - Our commercial mortgage loan investment is a $29.3 million participation in an unrated $86.6 million first lien
mortgage loan secured by 42 midwestern health care facilities. The mortgage loan is guaranteed by the parent operating company. The loan carries
a variable note rate of one-month term SOFR plus 5.61% and matures on March 23, 2023.
Residential MBS - Our residential MBS investments are an excess interest-only strip and a small first loss position in a securitized pool of
performing non-qualified mortgage loans. The underlying collateral pool is comprised of 512 first lien mortgage loans with an original weighted
average loan-to-value ratio of 69.2%. The weighted average note rate of the underlying mortgage loans was 4.77% as of December 31, 2022. At
initial issuance, 64% of the underlying mortgage loans carried a fixed note rate. The delinquency rate of the underlying mortgage loans was 1.3% as
of December 31, 2022.
Business purpose residential MBS - We hold residual interests in two securitized pools of business purpose residential mortgage loans with a
combined fair value of $7.2 million. As of December 31, 2022, the underlying collateral pools are comprised of 28 first lien mortgage loans or
foreclosed real estate with an unpaid principal balance of $7.5 million. The underlying collateral pools as of December 31, 2022 represented less
than 5% of the original collateral pools. We expect substantial realization of the remaining value to occur within the next several quarters.
Corporate asset-backed loan - As of December 31, 2022, we held a $4.9 million loan stemming from a corporate asset-backed line of credit.
The $4.9 million loan was repaid in full on January 17, 2023.
Solar ABS - We hold a first loss position in a securitized pool of loans for the purchase and installation of solar panels on residential real
estate with a fair value of $2.1 million and unpaid principal balance of $5.1 million. As of December 31, 2022, the underlying collateral pool was
comprised of 9,557 loans with an unpaid principal balance of $355 million and a delinquency rate of 1.8%.
Agency MBS Investment Portfolio
Our agency MBS investment portfolio consisted of the following as of December 31, 2022 (dollars in thousands):
Fair Value
Agency MBS
$
443,540
Net short TBA Position
(399,818)
Total agency MBS investment portfolio
$
43,722
Our agency MBS consisted of the following as of December 31, 2022 (dollars in thousands):
Unpaid
Principal
Balance
Net
Unamortized
Purchase
Premiums
(Discounts)
Amortized
Cost Basis
Net Unrealized
Gain (Loss)
Fair Value
Market
Price
Coupon
Weighted
Average
Expected
Remaining
Life
30-year fixed rate:
3.0%
$
69,223 $
(2,492 ) $
66,731 $
(5,651 ) $
61,080 $
88.24
3.00 %
10.0
4.0%
194,587
1,165
195,752
(12,568 )
183,184
94.14
4.00 %
9.1
4.5%
206,509
(3,937 )
202,572
(3,303 )
199,269
96.49
4.50 %
9.5
5.5%
7
—
7
—
7
103.53
5.50 %
6.1
Total/weighted-average
$
470,326 $
(5,264 ) $
465,062 $
(21,522 ) $
443,540 $
94.30
4.07 %
9.4
41
Unpaid
Principal
Balance
Net
Unamortized
Purchase
Premiums
(Discounts)
Amortized Cost
Basis
Net Unrealized
Gain (Loss)
Fair Value
Market
Price
Coupon
Weighted
Average
Expected
Remaining
Life
Fannie Mae
$
253,120 $
(3,813 ) $
249,307 $
(10,294 ) $
239,013 $
94.43
4.09 %
9.2
Freddie Mac
217,206
(1,451 )
215,755
(11,228 )
204,527
94.16
4.06 %
9.6
Total/weighted-average
$
470,326 $
(5,264 ) $
465,062 $
(21,522 ) $
443,540 $
94.30
4.07 %
9.4
The actual annualized prepayment rate for our agency MBS was 6.81% for the year ended December 31, 2022 compared to 6.87% for the year
ended December 31, 2021. As of December 31, 2022, our agency MBS was comprised of securities specifically selected for their relatively lower
propensity for prepayment, which includes approximately 29% and 18% in specified pools of high loan-to-value and low balance loans, respectively, while
the remainder includes specified pools of loans originated in certain geographical areas. Weighted average pay-up premiums on our agency MBS portfolio,
which represent the estimated price premium of agency MBS backed by specified pools over a TBA agency MBS, were approximately 0.28 percentage
point as of December 31, 2022.
As of December 31, 2022, our agency MBS investment portfolio also included a net short TBA position. In accordance with GAAP, we account for
our TBA positions as derivative instruments. Information about our net short TBA positions as of December 31, 2022 is as follows (dollars in thousands):
Notional Amount:
Long (Short)
Position
Implied
Cost Basis
Implied
Fair Value
Net Carrying
Amount
3.0% 30-year MBS sale commitments
$
(70,000) $
(62,828) $
(61,516) $
1,312
4.0% 30-year MBS sale commitments
(150,000)
(142,255)
(140,830)
1,425
4.5% 30-year MBS sale commitments
(205,000)
(200,365)
(197,472)
2,893
Total net long (short) agency TBA positions
$
(425,000) $
(405,448) $
(399,818) $
5,630
Notional amount represents the unpaid principal balance of the underlying agency MBS.
Implied cost basis represents the contractual forward price for the underlying agency MBS.
Implied fair value represents the current fair value of the underlying agency MBS.
Net carrying amount represents the difference between the implied cost basis and the implied fair value of the underlying agency MBS. This
amount is reflected on the Company's consolidated balance sheets as a component of "other assets" and "other liabilities".
Results of Operations
Net Operating Income
Net operating income primarily represents the interest and other income recognized from our investments in financial assets and rent revenues
recognized from SFR properties net of the interest expense incurred from repurchase agreement financing arrangements or other short and long-term
borrowing transactions and SFR property operating expenses.
Net operating income does not include TBA agency MBS dollar roll income (expense), which we believe represents the economic equivalent of net
interest income (expense) earned (incurred) from our investments in non-specified fixed-rate agency MBS, nor does it include the net interest income or
expense of our interest rate swap agreements, which are not designated as hedging instruments for financial reporting purposes. In our consolidated
statements of comprehensive income, TBA agency MBS dollar roll income (expense) and the net interest income or expense from our interest rate swap
agreements are reported as a component of the overall periodic change in the fair value of derivative instruments within the line item “investment and
derivative gain (loss), net.”
Investment and Derivative Gain (Loss), Net
“Investment and derivative gain (loss), net” primarily consists of periodic changes in the fair value (whether realized or unrealized) of our
investments in financial assets, periodic changes in the fair value (whether realized or unrealized) of derivative instruments and realized gain on sale of SFR
properties.
42
(1)
(2)
(3)
(4)
(1)
(2)
(3)
(4)
General and Administrative Expenses
“Compensation and benefits expense” includes base salaries, annual cash incentive compensation, and non-cash stock-based compensation. Annual
cash incentive compensation is based on meeting estimated annual performance measures and discretionary components. Non-cash stock-based
compensation includes expenses associated with stock-based awards granted to employees, including performance share units that are earned only upon the
attainment of Company performance measures over the relevant measurement period.
“Other general and administrative expenses” primarily consists of the following:
•
professional services expenses, including accounting, legal, and consulting fees;
•
insurance expenses, including liability and property insurance;
•
occupancy and equipment expense, including rental costs for our facilities, and depreciation and amortization of equipment and software;
•
Board of Director fees; and
•
other operating expenses, including information technology expenses, business development costs, public company reporting expenses, proxy
solicitation expenses, corporate registration fees, banking fees, fees and commissions on interest rate derivative instruments, local license
taxes, office supplies and other miscellaneous expenses.
Comparison of the years ended December 31, 2022 and 2021
The following table presents summary financial information for the years ended December 31, 2022 and 2021, respectively (dollars in thousands,
except per share amounts):
Year Ended December 31,
2022
2021
Interest and other income
$
43,283 $
25,530
Rent revenues from single-family residential properties
6,173
259
Interest expense
(21,511)
(8,206)
Single-family residential property operating expenses
(6,073)
(629)
Net operating income
21,872
16,954
Investment and derivative gain (loss), net
2,587
(13,199)
General and administrative expenses
(14,915)
(11,704)
Income (loss) before income taxes
9,544
(7,949)
Income tax provision
4,118
1,566
Net income (loss)
5,426
(9,515)
Dividend on preferred stock
(2,784)
(2,916)
Net income (loss) available (attributable) to common stock
2,642
(12,431)
Diluted earnings (loss) per common share
$
0.09 $
(0.38)
Weighted-average diluted common shares outstanding
29,243
32,312
Interest and Other Income
Interest and other income increased $17.8 million, or 69.8%, from $25.5 million for the year ended December 31, 2021 to $43.3 million for the year
ended December 31, 2022. The increase from the comparative periods is primarily the result of a higher average investment balance in higher yielding
MSR financing receivables as well as a higher average investment balance in mortgage loans of consolidated VIEs.
43
The components of interest and other income are summarized in the following tables for the periods indicated (dollars in thousands):
Year Ended December 31,
2022
2021
Average
Balance
Interest &
Other
Income
Yield
Average
Balance
Interest &
Other
Income
Yield
Agency MBS
$
373,193 $
11,920
3.19% $
682,291 $
10,634
1.56%
Credit investments
101,432
7,512
7.41%
69,345
5,058
7.29%
Mortgage loans of consolidated VIEs
236,591
7,570
3.20%
44,811
2,908
6.49%
MSR financing receivables
105,438
15,419
14.62%
65,754
6,282
9.55%
Other
2,113
862
4,739
648
Total
$
818,767 $
43,283
5.29% $
866,940 $
25,530
2.94%
The effects of changes in the composition of our investments in financial assets on interest and other income are summarized below (dollars in
thousands):
Year Ended December 31, 2022
vs.
Year Ended December 31, 2021
Rate
Volume
Total Change
Agency MBS
$
6,104 $
(4,818) $
1,286
Credit investments
(1,296)
3,750
2,454
Mortgage loans of consolidated VIEs
(7,779)
12,441
4,662
MSR financing receivables
5,346
3,791
9,137
Other
573
(359)
214
Total
$
2,948 $
14,805 $
17,753
Rent Revenues from SFR Properties
We began to acquire SFR properties pursuant to our SFR property rental investment strategy in September 2021. The homes we purchased may have
required minor refurbishment prior to a tenant occupying the property. In addition, there was typically a lease marketing period prior to a new tenant
occupying the home. In general, the time period between the date of settlement of the home purchase and the date the house was occupied by a tenant
averaged between 30 to 60 days. Accordingly, the timing of the earnings benefit to us was dictated by the pace of home purchases, the level of any property
level refurbishments and the length of the lease marketing period.
During the year ended December 31, 2022, we sold all our SFR rental properties in two separate transactions in August 2022 and December 2022.
Going forward, we do not anticipate allocating capital to our SFR investment strategy.
For the years ended December 31, 2022 and 2021, we had rental income of $6.2 million and $0.3 million, respectively.
Interest Expense
Interest expense increased $13.3 million, or 162.2%, from $8.2 million for the year ended December 31, 2021 to $21.5 million for the year ended
December 31, 2022. The increase from the comparative periods is primarily the result of higher interest rates on repurchase agreement financings, the
addition of long-term debt secured by SFR properties and a higher average balance in secured debt of consolidated VIEs, partially offset by lower interest
rates on secured debt of consolidated VIEs.
The components of interest expense are summarized in the following tables for the periods indicated (dollars in thousands):
Year Ended December 31,
2022
2021
Average
Balance
Interest
Expense
Cost
Average
Balance
Interest
Expense
Cost
Repurchase agreements
$
388,890 $
8,983
2.28% $
575,615 $
1,483
0.25%
Long-term debt secured by SFR properties
73,179
2,202
2.97%
4,843
151
3.08%
Long-term unsecured debt
86,204
5,742
6.66%
81,486
5,112
6.27%
Secured debt of consolidated VIEs
220,315
4,584
2.08%
31,552
1,460
4.63%
Total
$
768,588 $
21,511
2.78% $
693,496 $
8,206
1.18%
44
The effects of changes in the composition of our debt obligations on interest expense are summarized below (dollars in thousands):
Year Ended December 31, 2022
vs.
Year Ended December 31, 2021
Rate
Volume
Total Change
Repurchase agreements
$
7,969 $
(469) $
7,500
Long-term debt secured by SFR properties
(70)
2,121
2,051
Long-term unsecured debt
334
296
630
Secured debt of consolidated VIEs
(5,616)
8,740
3,124
Total
$
2,617 $
10,688 $
13,305
SFR Properties Operating Expenses
We began to acquire SFR properties pursuant to our SFR property rental investment strategy in September 2021. During the period prior to a lease
commencement date as well as subsequently, we incurred property costs such as real estate taxes, insurance, homeowner association fees and depreciation.
For the year ended December 31, 2022, we had property operating expenses of $6.1 million, including $2.2 million of depreciation expense. For the year
ended December 31, 2021, we had property operating expenses of $0.6 million, including $0.3 million of depreciation expense.
Investment and Derivative Gain (Loss), Net
As prevailing longer-term interest rates increase (decrease), the fair value of and MSR financing receivables and TBA sale commitments generally
increase (decrease). Conversely, the fair value of our investments in fixed-rate agency MBS and TBA purchase commitments generally decreases
(increases) in response to increases (decreases) in prevailing interest rates. We may enter into interest rate derivative hedging instruments intended to
economically hedge changes attributable to changes in benchmark interest rates to either our agency MBS or MSR financing receivables. While our
interest rate derivative hedging instruments are designed to mitigate the sensitivity of the fair value of either our agency MBS or MSR financing receivables
to fluctuations in interest rates, they are not generally designed to mitigate the sensitivity of our net book value to spread risk, which is the risk of an
increase of the market spread between the market yield on our agency MBS and MSR financing receivables and the benchmark yield on U.S. Treasury
securities or interest rate swaps. Accordingly, changes in the spread between the market yields of agency MBS or MSR financing receivables and
benchmark interest rates may result in a net gain or loss in the fair value of our investments and interest rate hedging instruments.
During the year ended December 31, 2022, we sold all of our SFR properties in two separate transactions for a total net gain of $16.2 million.
The following table presents information about the gains and losses recognized due to the changes in the fair value of our investments and interest
rate hedging instruments for the periods indicated (dollars in thousands):
Year Ended December 31,
2022
2021
Loss on agency MBS investments, net
$
(53,887) $
(28,365)
Gain on credit investments, net
3,898
2,762
Gain on sale of SFR properties, net
16,211
—
Gain on MSR financing receivables, net
31,712
14,183
TBA commitments, net:
TBA dollar roll income
253
4,143
Other loss from TBA commitments, net
(7,509)
(11,586)
Total loss on TBA commitments, net
(7,256)
(7,443)
Interest rate derivatives:
Net interest expense on interest rate swaps
(103)
(2,929)
Other gain from interest rate derivative instruments, net
12,846
8,318
Total gain on interest rate derivatives, net
12,743
5,389
Other investments, net
(834)
275
Investment and derivative gain (loss), net
$
2,587 $
(13,199)
45
General and Administrative Expenses
General and administrative expenses increased by $3.2 million from $11.7 million for the year ended December 31, 2021 to $14.9 million for the
year ended December 31, 2022. The increase from the comparative periods is primarily due to an increase in compensation and benefits expense primarily
as a result of an increase in performance based management incentive compensation.
Income Tax Provision
Our TRSs are subject to U.S. federal and state corporate income taxes. As a result, for the years ended December 31, 2022 and 2021, we recognized
a provision for income taxes of $4.1 million and $1.6 million, respectively, on the pre-tax net income of our TRSs. As noted in “Non-GAAP Earnings
Available for Distribution” below, our computation of non-GAAP earnings available for distribution includes a provision for income taxes on the earnings
available for distribution of our TRSs. TRS earnings available for distribution is comprised of net interest income generated by TRSs net of the TRSs’
general and administrative expenses. In our consolidated financial consolidated statements of comprehensive income prepared in accordance with GAAP,
the “income tax provision (benefit)” includes (i) the income tax provision for TRS earnings available for distribution and (ii) an income tax provision for
(or benefit from) periodic increases (or decreases) in the fair value of the investments of our TRSs, which are recognized in net income as a component of
“investment and derivative gain (loss) net.” Below is a reconciliation of the income tax provision for TRS earnings available for distribution, a non-GAAP
financial measure, to the income tax provision determined in accordance with GAAP for the periods indicated (dollars in thousands):
For the Year Ended December 31,
2022
2021
Income tax provision for TRS earnings available for distribution
$
1,502 $
286
Income tax provision for TRS investment gain, net
2,616
1,280
GAAP income tax provision
$
4,118 $
1,566
Non-GAAP Earnings Available for Distribution
In addition to the results of operations determined in accordance with GAAP, we also report a non-GAAP financial measure "earnings available for
distribution" (formerly core operating income). We define earnings available for distribution as net income available to common stock determined in
accordance with GAAP adjusted for the following items:
•
Plus (less) realized and unrealized losses (gains) on investments and derivatives
•
Plus (less) income tax provision (benefit) for TRS realized and unrealized gains and losses on investments and derivatives
•
Plus TBA dollar roll income
•
Plus (less) interest rate swap net interest income (expense)
•
Plus depreciation of single-family residential properties
•
Plus stock-based compensation
Realized and unrealized gains and losses recognized with respect to our mortgage related investments and economic hedging instruments, which are
reported in line item “investment and derivative gain (loss), net” of our consolidated statements of comprehensive income, other than TBA dollar roll
income and interest rate swap net interest income or expense, are excluded from the computation of earnings available for distribution as such gains on
losses are not reflective of the economic interest income earned or interest expense incurred from our interest-bearing financial assets and liabilities during
the indicated reporting period. Because our long-term-focused investment strategy for our mortgage related investment portfolio is to generate a net spread
on the leveraged assets while prudently hedging periodic changes in the fair value of those assets attributable to changes in benchmark interest rates, we
generally expect the fluctuations in the fair value of our mortgage related investments and economic hedging instruments to largely offset one another over
time. In addition, certain of our investments are held by our TRS which is subject to U.S. federal and state corporate income taxes. In calculating earnings
available for distribution, any income tax provision or benefit associated with gains or losses on our mortgage related investments and economic hedging
instruments are also excluded from earnings available for distribution.
TBA dollar roll income (expense) represents the economic equivalent of net interest income (expense) generated from our transactions in non-
specified fixed-rate agency MBS, executed through sequential series of forward-settling purchase and sale transactions that are settled on a net basis
(known as “dollar roll” transactions). Dollar roll income (expense) is generated (incurred) as a result of delaying, or “rolling,” the settlement of a forward-
settling purchase (sale) of a TBA agency MBS by entering into an offsetting “spot” sale (purchase) with the same counterparty prior to the settlement date,
net settling the “paired-off” positions in cash, and contemporaneously entering another forward-settling purchase (sale) with the same counterparty of a
TBA agency MBS of the same essential characteristics for a later settlement date at a price discount relative to the spot sale (purchase). The price discount
of
46
the forward-settling purchase (sale) relative to the contemporaneously executed spot sale (purchase) reflects compensation to the seller for the interest
income (inclusive of expected prepayments) that, at the time of sale, is expected to be foregone as a result of relinquishing beneficial ownership of the MBS
from the settlement date of the spot sale until the settlement date of the forward purchase, net of implied repurchase financing costs. We calculate dollar roll
income (expense) as the excess of the spot sale (purchase) price over the forward-settling purchase (sale) price and recognize this amount ratably over the
period beginning on the settlement date of the sale (purchase) and ending on the settlement date of the forward purchase (sale). In our consolidated
statements of comprehensive income prepared in accordance with GAAP, TBA agency MBS dollar roll income (expense) is reported as a component of the
overall periodic change in the fair value of TBA forward commitments within the line item “investment and derivative gain (loss), net."
We utilize interest rate swap agreements to economically hedge a portion of our exposure to variability in future interest cash flows, attributable to
changes in benchmark interest rates, associated with future roll-overs of our short-term repurchase agreement financing arrangements. Accordingly, the net
interest income earned or expense incurred (commonly referred to as “net interest carry”) from our interest rate swap agreements in combination with
repurchase agreement interest expense recognized in accordance with GAAP represents our effective “economic interest expense.” In our consolidated
statements of comprehensive income prepared in accordance with GAAP, the net interest income earned or expense incurred from interest rate swap
agreements is reported as a component of the overall periodic change in the fair value of derivative instruments within the line item “investment and
derivative gain (loss), net."
The following table provides a reconciliation of GAAP net income (loss) available (attributable) to common stock to non-GAAP earnings available
for distribution for the periods indicated (amounts in thousands):
For the Year Ended December 31,
2022
2021
Net income (loss) available (attributable) to common stock
$
2,642 $
(12,431)
Add (less):
Investment and derivative (gain) loss, net
(2,587)
13,199
Income tax provision for TRS investment gain
2,616
1,280
Depreciation of single-family residential properties
2,176
299
Stock-based compensation expense
3,537
2,083
Add back:
TBA dollar roll income
253
4,143
Interest rate swap net interest expense
(103)
(2,929)
Non-GAAP earnings available for distribution
$
8,534 $
5,644
Non-GAAP earnings available for distribution per diluted common share
$
0.29 $
0.17
Weighted average diluted common shares outstanding
29,243
32,626
Earnings available for distribution is used by management to evaluate the financial performance of our long-term-focused, net interest spread-based
investment strategy and core business activities over periods of time as well as assist with the determination of the appropriate level of periodic dividends to
common stockholders. In addition, we believe that earnings available for distribution assists investors in understanding and evaluating the financial
performance of our long-term-focused, net interest spread-based investment strategy and core business activities over periods of time as well as our
earnings capacity.
A limitation of utilizing this non-GAAP financial measure is that the effect of accounting for all 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. In
addition, our calculation of earnings available for distribution may not be comparable to other similarly titled measures of other companies. Therefore, we
believe that earnings available for distribution should be considered as a supplement to, and in conjunction with, net income and comprehensive income
determined in accordance with GAAP. Furthermore, there may be differences between earnings available for distribution and taxable income determined in
accordance with the Internal Revenue Code. As a REIT, we are required to distribute at least 90% of our REIT taxable income (subject to certain
adjustments) to qualify as a REIT and all of our taxable income in order to not be subject to any U.S. federal or state corporate income taxes. Accordingly,
earnings available for distribution may not equal our distribution requirements as a REIT.
47
Liquidity and Capital Resources
Liquidity is a measurement of our ability to meet potential cash requirements including ongoing commitments to repay borrowings, fund
investments, meet margin calls on our short-term borrowings and hedging instruments, and for other general business purposes. Our primary sources of
funds for liquidity consist of existing cash balances, short-term borrowings (for example, repurchase agreements), principal and interest payments from our
mortgage investments and proceeds from sales of mortgage investments. Other sources of liquidity include proceeds from the offering of common stock,
preferred stock, debt securities, or other securities registered pursuant to our effective shelf registration statement filed with the Securities and Exchange
Commission (“SEC”).
Liquidity, or ready access to funds, is essential to our business. Perceived liquidity issues may affect our counterparties’ willingness to engage in
transactions with us. Our liquidity could be impaired due to circumstances that we may be unable to control, such as a general market disruption or an
operational problem that affects us or third parties. Further, our ability to sell assets may be impaired if other market participants are seeking to sell similar
assets at the same time. If we cannot obtain funding from third parties our results of operations could be negatively impacted.
As of December 31, 2022, our debt-to-equity leverage ratio was 3.5 to 1 measured as the ratio of the sum of our total debt to our stockholders’
equity as reported on our consolidated balance sheet. In evaluating our liquidity and leverage ratios, we also monitor our “at risk” leverage ratio. Our “at
risk” leverage ratio is measured as the ratio of the sum of our repurchase agreement financing, net payable or receivable for unsettled securities, net
contractual forward price of our TBA commitments, leverage within our MSR financing receivable less our cash and cash equivalents compared to our
investable capital. Our investable capital is calculated as the sum of our stockholders’ equity and long-term unsecured debt. As of December 31, 2022, our
“at risk” leverage ratio was 0.3 to 1.
As of December 31, 2022, our liquid assets totaled $46.5 million consisting of cash and cash equivalents of $28.0 million and settled unencumbered
agency MBS of $18.5 million at fair value.
Sources of Funding
We believe that our existing cash balances, net investments in mortgage investments, cash flows from operations, borrowing capacity, and other
sources of liquidity will be sufficient to meet our cash requirements for at least the next twelve months. We may, however, seek debt or equity financings, in
public or private transactions, to provide capital for corporate purposes and/or strategic business opportunities, including possible acquisitions, joint
ventures, alliances or other business arrangements which could require substantial capital outlays. Our policy is to evaluate strategic business opportunities,
including acquisitions and divestitures, as they arise. There can be no assurance that we will be able to generate sufficient funds from future operations, or
raise sufficient debt or equity on acceptable terms, to take advantage of investment opportunities that become available. Should our needs ever exceed these
sources of liquidity, we believe that most of our investments could be sold, in most circumstances, to provide cash. However, we may be required to sell our
assets in such instances at depressed prices.
Cash Flows
As of December 31, 2022, our cash totaled $30.2 million, which included cash and cash equivalents of $28.0 million and restricted cash of
consolidated VIEs of $2.2 million, representing a net increase of $8.4 million from $21.8 million as of December 31, 2021. Cash used in operating
activities of $1.4 million during 2022 was attributable primarily to net interest income less our general and administrative expenses. Cash used in investing
activities of $17.5 million during 2022 was primarily from purchases of new agency MBS, credit securities, MSR financing receivables and SFR properties,
partially offset by proceeds generated by sales of agency MBS, credit securities, and SFR properties and receipt of principal payments from agency MBS,
loans and mortgage loans of consolidated VIEs and distributions from MSR financing receivables. Cash provided by financing activities of $27.3 million
during 2022 was primarily generated from proceeds from repurchase agreements and long-term unsecured debt secured by SFR properties, partially offset
by net repayments of secured debt of consolidated VIEs, repurchases of our common and preferred stock, and repayments of long-term debt secured by
SFR properties.
Debt Capital
Repurchase Agreements
We have short-term financing facilities that are structured as repurchase agreements with various financial institutions to fund our mortgage
investments. We have obtained, and believe we will be able to continue to obtain, short-term financing in amounts and at interest rates consistent with our
financing objectives. Funding for mortgage investments through repurchase agreements continues to be available to us at rates we consider to be attractive
from multiple counterparties.
Our repurchase agreements to finance our acquisition of MBS include provisions contained in the standard master repurchase agreement as
published by the Securities Industry and Financial Markets Association (“SIFMA”) and may be amended and supplemented in accordance with industry
standards for repurchase facilities. Certain of our repurchase agreements include financial
48
covenants, with which the failure to comply would constitute an event of default. Similarly, each repurchase agreement includes events of insolvency and
events of default on other indebtedness as similar financial covenants. As provided in the standard master repurchase agreement as typically amended, upon
the occurrence of an event of default or termination, the applicable counterparty has the option to terminate all repurchase transactions under such
counterparty’s repurchase agreement and to demand immediate payment of any amount due from us.
Our repurchase agreement to finance our acquisition of mortgage loans is subject to a master repurchase agreement between our wholly-owned
subsidiary, for which we provide a full guarantee of performance, and a third party lender. The agreement contains financial covenants including our
maintenance of a minimum level of net worth, liquidity and profitability, with which the failure to comply would constitute an event of default. Similarly,
the agreement includes events of insolvency and events of default on other indebtedness as similar financial covenants. Upon the occurrence of an event of
default or termination, the counterparty has the option to terminate all other indebtedness arrangements with us and to demand immediate payment of any
amount due from us.
Under our repurchase agreements, we may be required to pledge additional assets to our repurchase agreement counterparties in the event the
estimated fair value of the existing pledged collateral under such agreements declines and such lenders demand additional collateral (commonly referred to
as a “margin call”), which may take the form of additional securities or cash. Margin calls on repurchase agreements collateralized by our mortgage
investments primarily result from events such as declines in the value of the underlying mortgage collateral caused by factors such as rising interest rates,
higher prepayments or higher actual or expected credit losses. Our repurchase agreements generally provide that valuations for mortgage investments
securing our repurchase agreements are to be obtained from a generally recognized source agreed to by both parties. However, in certain circumstances and
under certain of our repurchase agreements, our lenders have the sole discretion to determine the value of the mortgage investments securing our
repurchase agreements. In such instances, our lenders are required to act in good faith in making determinations of value. Our repurchase agreements
generally provide that in the event of a margin call, we must provide cash or additional securities on the same business day that the margin call is made if
the lender provides us notice prior to the margin notice deadline on such day.
To date, we have not had any margin calls on our repurchase agreements that we were not able to satisfy with either cash or additional pledged
collateral. However, should we encounter increases in interest rates, prepayments or expected credit losses, margin calls on our repurchase agreements
could result in a material adverse change in our liquidity position.
Our repurchase agreement counterparties apply a “haircut” to the value of the pledged collateral, which means the collateral is valued, for the
purposes of the repurchase agreement transaction, at less than fair value. Upon the renewal of a repurchase agreement financing at maturity, a lender could
increase the “haircut” percentage applied to the value of the pledged collateral, thus reducing our liquidity.
Our repurchase agreements generally mature within 30 to 60 days, but may have maturities as short as one day and as long as one year. In the event
that market conditions are such that we are unable to continue to obtain repurchase agreement financing for our mortgage investments in amounts and at
interest rates consistent with our financing objectives, we may liquidate such investments and may incur significant losses on any such sales of mortgage
investments.
The following table provides information regarding our outstanding repurchase agreement borrowings as of date and period indicated (dollars in
thousands):
49
December 31, 2022
Agency MBS repurchase financing:
Repurchase agreements outstanding
$
406,072
Agency MBS collateral, at fair value
425,023
Net amount
18,951
Weighted-average rate
4.47%
Weighted-average term to maturity
12.0 days
Non-agency MBS repurchase financing:
Repurchase agreements outstanding
$
88,953
MBS collateral, at fair value
98,933
Net amount
9,980
Weighted-average rate
5.02%
Weighted-average term to maturity
20.0 days
Mortgage loans repurchase financing:
Repurchase agreements outstanding
$
20,485
Mortgage loans collateral, at fair value
29,264
Net amount
8,779
Weighted-average rate
6.84%
Weighted-average term to maturity
235.0 days
Total mortgage investments repurchase financing:
Repurchase agreements outstanding
$
515,510
Mortgage investments collateral, at fair value
553,220
Net amount
37,710
Weighted-average rate
4.66%
Weighted-average term to maturity
22.2 days
Maximum amount outstanding at any month-end during the period
$
515,510
Net amount represents the value of collateral in excess of corresponding repurchase obligation. The amount of collateral at-risk is limited to the
outstanding repurchase obligation and not the entire collateral balance.
To limit our exposure to counterparty risk, we diversify our repurchase agreement funding across multiple counterparties and by counterparty region.
As of December 31, 2022, we had outstanding repurchase agreement balances with 8 counterparties and have master repurchase agreements in place with a
total of 14 counterparties located throughout North America, Europe and Asia. As of December 31, 2022, no more than 4.6% of our stockholders’ equity
was at risk with any one counterparty, with the top five counterparties representing approximately 15.0% of our stockholders’ equity.
Long-Term Unsecured Debt
As of December 31, 2022, we had $86.4 million of total long-term debt, net of unamortized debt issuance costs of $1.3 million. Our Senior
Notes due 2025 with a principal amount of $34.9 million outstanding as of December 31, 2022 accrue and require payment of interest quarterly at an
annual rate of 6.75% and mature on March 15, 2025. Our Senior Notes due 2026 with a principal amount of $37.8 million outstanding as of December 31,
2022 accrue and require payment of interest quarterly at an annual rate of 6.00% and mature on August 1, 2026. Our trust preferred debt with a principal
amount of $15.0 million outstanding as of December 31, 2022 accrue and require the payment of interest quarterly at three-month LIBOR plus 2.25% to
3.00% and mature between 2033 and 2035. Our Senior Notes due 2025 and trust preferred debt may be redeemed in whole or part at any time and from
time to time at our option at a redemption price equal to the principal amount plus accrued and unpaid interest. Our Senior Notes due 2026 may be
redeemed in whole or in part at any time and from time to time at our option on or after August 1, 2023 at a redemption price equal to the principal amount
plus accrued and unpaid interest.
Derivative Instruments
In the normal course of our operations, we are a party to financial instruments that are accounted for as derivative financial instruments including (i)
interest rate hedging instruments such as interest rate swaps, U.S. Treasury note futures, put and call options on U.S. Treasury note futures, Eurodollar
futures, interest rate swap futures, options on agency MBS, and TBA sale commitments and (ii) derivative instruments that economically serve as
investments such as TBA purchase sale commitments.
Interest Rate Hedging Instruments
We exchange cash variation margin with the counterparties to our interest rate hedging instruments at least on a daily basis based upon daily changes
in fair value as measured by the central clearinghouse through which those derivatives are cleared. In addition, the central clearinghouse requires market
participants to deposit and maintain an “initial margin” amount which is
50
(1)
(1)
(1)
(1)
(1)
determined by the clearinghouse and is generally intended to be set at a level sufficient to protect the clearinghouse from the maximum estimated single-
day price movement in that market participant’s contracts. However, the futures commission merchants (“FCMs”) through which we conduct trading of our
cleared and exchanged-traded hedging instruments may require incremental initial margin in excess of the clearinghouse’s requirement. The clearing
exchanges have the sole discretion to determine the value of our hedging instruments for the purpose of setting initial and variation margin requirements or
otherwise. In the event of a margin call, we must generally provide additional collateral on the same business day. To date, we have not had any margin
calls on our hedging agreements that we were not able to satisfy. However, if we encounter significant decreases in long-term interest rates, margin calls on
our hedging agreements could result in a material adverse change in our liquidity position.
As of December 31, 2022, we had outstanding interest rate swaps with the following aggregate notional amount and corresponding initial margin
held in collateral deposit with the FCM (in thousands):
December 31, 2022
Notional Amount
Collateral Deposit
Interest rate swaps
$
60,000 $
1,823
The FCMs through which we conduct trading of our hedging instruments may limit their exposure to us (due to an inherent one business day lag in
the variation margin exchange process) by applying a maximum “ceiling” on their level of risk, either overall and/or by instrument type. The FCMs
generally use the amount of initial margin that we have posted with them as a measure of their level of risk exposure to us. We currently have FCM
relationships with two large financial institutions. To date, among our two FCM arrangements, we have had sufficient excess capacity above and beyond
what we believe to be a sufficient and appropriate hedge position. However, if our FCMs substantially lowered their risk exposure thresholds, we could
experience a material adverse change in our liquidity position and our ability to hedge appropriately.
TBA Dollar Roll Transactions
TBA dollar roll transactions represent a form of off-balance sheet financing accounted for as derivative instruments. In a TBA dollar roll
transaction, we do not intend to take physical delivery of the underlying agency MBS and will generally enter into an offsetting position and net settle the
paired-off positions in cash. However, under certain market conditions, it may be uneconomical for us to roll our TBA contracts into future months and we
may need to take or make physical delivery of the underlying securities. If we were required to take physical delivery to settle a long TBA contract, we
would have to fund our total purchase commitment with cash or other financing sources and our liquidity position could be negatively impacted.
Margin Requirements for Agency MBS Purchase and Sale Commitments
Our commitments to purchase and sell agency MBS, including TBA commitments, are subject to master securities forward transaction agreements
published by SIFMA as well as supplemental terms and conditions with each counterparty. Under the terms of these agreements, we may be required to
pledge collateral to our counterparty in the event the fair value of the agency MBS underlying our purchase and sale commitments change and such
counterparty demands collateral through a margin call. Margin calls on agency MBS commitments are generally caused by factors such as rising interest
rates or prepayments. Our agency MBS commitments provide that valuations for our commitments and any pledged collateral are to be obtained from a
generally recognized source agreed to by both parties. However, in certain circumstances, our counterparties have the sole discretion to determine the value
of the agency MBS commitment and any pledged collateral. In such instances, our counterparties are required to act in good faith in making determinations
of value. In the event of a margin call, we must generally provide additional collateral on the same business day.
MSR Financing Receivable Commitments
We are party to agreements with a licensed, GSE approved residential mortgage loan servicer that enables us to garner the economic return of an
investment in an MSR purchased by the mortgage servicing counterparty through an MSR financing transaction. We have committed to invest a total
minimum of $50 million of capital with the counterparty with $25 million of the minimum commitment expiring on December 31, 2023 and $25 million of
the minimum commitment expiring on April 1, 2024. As of December 31, 2022, we have fully funded the total minimum commitment. At any time prior
to the minimum commitment expiration dates, we have the option to request the mortgage servicing counterparty to sell the related MSR investments and
repay us amounts owed to us under the MSR financing transaction less a minimum fee the mortgage servicing counterparty would have earned over the
remaining original commitment periods.
At our election, we can request the mortgage servicing counterparty utilize leverage on the MSRs to which our MSR financing receivables are
referenced to finance the purchase of additional MSRs to increase potential returns to us. As of December 31, 2022, our mortgage servicing counterparty
has a $100 million credit facility that is secured by its MSRs including MSRs to which our MSR financing receivables are referenced. As of December 31,
2022, our mortgage servicing counterparty had drawn $33.9
51
million and had $66.1 million of availability under its credit facility. As of December 31, 2022, we had the ability to utilize approximately 73% of our
mortgage servicing counterparty’s available undrawn capacity under its credit facility. In general, our mortgage servicing counterparty can obtain advances
of up to 60% of the fair value of the MSR collateral value pledged. Under our mortgage servicing counterparty’s credit facility, if the fair value of the
pledged MSR collateral declines and the lender demands additional collateral from our mortgage servicing counterparty through a margin call, we would be
required to provide the mortgage servicing counterparty with additional funds to meet such margin call. If we were unable to satisfy such margin call, the
lender could liquidate the MSR collateral position to which our MSR financing receivables are referenced to satisfy the loan obligation, thereby reducing
the value of our MSR financing receivables. Draws under the facility bear interest at term SOFR plus 2.90% with a SOFR floor of 1.60% and a maturity
date of April 28, 2023 with a one-year borrower extension option.
Under the arrangement, we are obligated to provide funds to the mortgage servicing counterparty to fund its advances of payments on the serviced
pool of mortgage loans within the referenced MSR. The mortgage servicing counterparty is required to return to us any subsequent servicing advances
collected or reimbursed by the GSEs. At our option, we could request the mortgage servicing counterparty to fund any servicing advances with draws
under its credit facility, subject to available borrowing capacity, while we would be required to fund such financing costs.
As of December 31, 2022, our mortgage servicing counterparty has drawn $33.9 million of financing under its credit facility, including $7.9 million
attributable to us, collateralized by an estimated $301.3 million of MSRs, including $20.4 million attributable to us, and $7.9 million of servicer advances,
including $0.7 million attributable to us.
Investment Commitments
As of December 31, 2022, we are a party to a participation agreement pursuant to which we have committed to fund up to $30 million of a $130
million revolving credit facility that matures on July 7, 2024. Under the terms of the participation agreement, we are obligated to fund the last $30 million
of advances under the revolving credit facility. As of December 31, 2022, our unfunded commitment was $25.1 million. On February 27, 2023, our $30
million commitment was terminated.
Equity Capital
Common Equity Distribution Agreements
We are party to separate common equity distribution agreements with equity sales agents JMP Securities LLC, B. Riley FBR, Inc., JonesTrading
Institutional Services LLC and Ladenburg Thalmann & Co. Inc. pursuant to which we may offer and sell, from time to time, shares of our common stock.
Pursuant to the common equity distribution agreements, shares of our common stock may be offered and sold through the equity sales agents in transactions
that are deemed to be “at the market” offerings as defined in Rule 415 under the Securities Act of 1933, including sales made directly on the NYSE or sales
made to or through a market maker other than on an exchange or, subject to the terms of a written notice from us, in privately negotiated transactions. As
of December 31, 2022, we had 11,302,160 shares of common stock available for sale under the common equity distribution agreements.
Preferred Stock
As of December 31, 2022, we had Series B Preferred Stock outstanding with a liquidation preference of $9.5 million. The Series B Preferred Stock
is publicly traded on the New York Stock Exchange under the ticker symbol “AAIC PrB.” The Series B Preferred Stock has no stated maturity, is not
subject to any sinking fund and will remain outstanding indefinitely unless repurchased or redeemed by us. Holders of Series B Preferred Stock have no
voting rights, except under limited conditions and are entitled to receive a cumulative cash dividend at a rate of 7.00% per annum of their $25.00 per share
liquidation preference (equivalent to $1.75 per annum per share). Shares of Series B Preferred Stock are redeemable at $25.00 per share, plus accumulated
and unpaid dividends (whether or not authorized or declared) exclusively at our option. Dividends are payable quarterly in arrears on the 30th day of each
December, March, June and September, when and as declared. We have declared and paid all required quarterly dividends on our Series B Preferred Stock
to date.
As of December 31, 2022, we had Series C Preferred Stock outstanding with a liquidation preference of $23.9 million. The Series C Preferred Stock
is publicly traded on the New York Stock Exchange under the ticker symbol “AAIC PrC.” The Series C Preferred Stock has no stated maturity, is not
subject to any sinking fund and will remain outstanding indefinitely unless repurchased or redeemed by us. Holders of Series C Preferred Stock have no
voting rights except under limited conditions and will be entitled to receive cumulative cash dividends (i) from and including the original issue date to, but
excluding, March 30, 2024 at a fixed rate equal to 8.250% per annum of the $25.00 per share liquidation preference (equivalent to $2.0625 per annum per
share) and (ii) from and including March 30, 2024, at a floating rate equal to three-month LIBOR plus a spread of 5.664% per annum. Shares of Series C
Preferred Stock are redeemable at $25.00 per share, plus accumulated and unpaid dividends (whether or not authorized or declared) exclusively at our
option commencing on March 30, 2024 or earlier upon the occurrence of a change in control or under circumstances where it is necessary to preserve our
qualification as a REIT. Under certain circumstances upon a change of control, the Series C Preferred Stock is convertible into shares of our common
stock. Dividends are payable quarterly in arrears on the 30th day of March,
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June, September and December of each year, when and as declared. We have declared and paid all required quarterly dividends on our Series C Preferred
Stock to date.
Preferred Equity Distribution Agreement
We are party to an amended and restated equity distribution agreement with JonesTrading Institutional Services LLC and Ladenburg Thalmann &
Co. Inc., pursuant to which we may offer and sell, from time to time, shares of our Series B Preferred Stock. Pursuant to the Series B preferred equity
distribution agreement, shares of our Series B Preferred Stock may be offered and sold through the preferred equity sales agents in transactions that are
deemed to be “at the market” offerings as defined in Rule 415 under the Securities Act of 1933, including sales made directly on the NYSE or sales made to
or through a market maker other than on an exchange or, subject to the terms of a written notice from us, in privately negotiated transactions.
As of December 31, 2022, we had 1,602,566 shares of Series B Preferred Stock available for sale under the Series B preferred equity distribution
agreement.
REIT Distribution Requirements
We have elected to be taxed as a REIT under the Internal Revenue Code. As a REIT, we are required to distribute annually 90% of our REIT taxable
income (subject to certain adjustments) to our shareholders. So long as we continue to qualify as a REIT, we will generally not be subject to U.S. federal or
state corporate income taxes on our taxable income that we distribute to our shareholders on a timely basis. At present, it is our intention to distribute
100% of our taxable income, although we will not be required to do so. We intend to make distributions of our taxable income within the time limits
prescribed by the Internal Revenue Code, which may extend into the subsequent taxable year.
As of December 31, 2022, we had estimated NOL carryforwards of $162.5 million that can be used to offset future taxable ordinary income and
reduce our future distribution requirements. As of December 31, 2022, we also had estimated NCL carryforwards of $155.7 million that can be used to
offset future net capital gains.
Off-Balance Sheet Arrangements and Other Commitments
As of December 31, 2022 and 2021, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often
referred to as structured finance, or special purpose entities or VIEs, established for the purpose of facilitating off-balance sheet arrangements or other
contractually narrow or limited purposes that have, or are reasonably likely to have, a material current or future effect on our financial condition. Our
economic interests held in unconsolidated VIEs are generally limited in nature to those of a passive holder of beneficial interests in securitized financial
assets. As of December 31, 2022 and 2021, we had consolidated for financial reporting purposes two and one, respectively, securitization trusts for which
we determined that our investments provided us with both (i) the power to direct the activities that most significantly impact the economic performance of
the VIE and (ii) the obligation to absorb losses or the right to receive benefits that could potentially be significant to the VIE. We were not required to
consolidate for financial reporting purposes any other VIEs as of December 31, 2022 and 2021, as we did not have the power to direct the activities that
most significantly impact the economic performance of such entities. For further information about our consolidated VIE, see “Note 9. Consolidation of
Variable Interest Entities” to our consolidated financial statements under “Item 8 - Financial Statements and Supplementary Data.”
As of December 31, 2022 and 2021, we had not guaranteed any obligations of unconsolidated entities. As of December 31, 2022 and 2021, we had
not entered into any commitment or intent to provide funding to unconsolidated entities other than the aforementioned asset-backed revolving credit facility
funding commitment.
Critical Accounting Estimates
The preparation of financial statements in accordance with GAAP requires us to make estimates and assumptions that affect amounts reported in the
consolidated financial statements. Although we base these estimates and assumptions on historical experience and all other information available as of the
time that the financial statements are prepared, such estimates frequently require management to exercise significant subjective judgment about matters that
are inherently uncertain. Actual results may differ from these estimates, which could have a significant and potentially adverse effect on our financial
condition, results of operations and cash flows. A summary of our significant accounting policies is included in “Note 3. Summary of Significant
Accounting Policies” in the Notes to Consolidated Financial Statements.
Our most critical accounting estimates, which are those accounting estimates that require the highest degree of management judgment due to the
inherent level of estimation uncertainty, relate to the fair value measurement and interest income recognition for our investments in credit securities and
MSR financing receivables.
Fair Value Measurement of Certain Credit Investments and MSR Financing Receivables
53
Credit investments – Our investments in non-agency MBS secured by pools of business-purpose residential mortgage loans trade infrequently and,
therefore, the measurement of their fair value requires the use of significant unobservable inputs. To measure the fair value of the non-agency MBS
secured by pools of business-purpose residential mortgage loans, we exercise significant judgment to develop assumptions about the future performance of
each loan, which includes determining loan-level probabilities of default and loss-given-default. We use our best efforts to corroborate these assumptions
with evidence such as historical collateral performance data, our evaluation of historical collateral performance data for other loans with similar risk
characteristics, available information about the fair value of the underlying properties and observed completed or pending transactions in similar loans or
real estate foreclosure sales, to the extent reasonably available. The following tables present the significant assumptions about the future performance of
the business-purpose residential mortgage loans underlying our non-agency MBS investments, including our net investment in a VIE that is consolidated
for external reporting purposes, as of December 31, 2022:
Weighted-average
Range
Annualized default rate
36.0%
0.0% - 100.0%
Loss-given-default
14.7%
0.0% - 18.4%
Our investments in the subordinate and excess interest-only positions in a securitized pool of non-qualified residential mortgage loans trade
infrequently and, therefore, the measurement of their fair value requires the use of significant unobservable inputs. To measure the fair value of these
investments, the Company uses an income approach by preparing an estimate of the present value of the amount and timing of the cash flows expected to
be collected from each security over its expected remaining life. To prepare the estimate of cash flows expected to be collected, the Company uses
significant judgment to develop assumptions about the future performance of the pool of residential mortgage loans that serve as collateral, including
assumptions about the timing and amount of credit losses and prepayments. The significant unobservable inputs to the fair value measurement include the
estimated rate of prepayment, rate of default and loss-given-default for the underlying pool of mortgage loans as well as the discount rate, which represents
a market participant’s current required rate of return for a similar instrument. The following table presents the weighted-average of the significant inputs to
the fair value measurement of the subordinate and excess interest-only debt obligations of its consolidated VIE of residential mortgage loans as of
December 31, 2022:
Subordinate Debt Obligation
Excess Interest-Only Debt
Obligations
Annualized voluntary prepayment rate
10.0%
10.0%
Annualized default rate
0.5%
0.5%
Loss-given-default
17.5%
17.5%
Discount rate
7.8%
17.7%
In general, significant increases (decreases) in default, loss severity, prepayment or discount rate assumptions, in isolation, would result in a
significantly lower (higher) fair value measurement. However, it is often difficult to generalize the interrelationships between these significant inputs and
the actual results could differ considerably on an individual security basis. Each significant input is closely analyzed to ascertain its reasonableness in light
of reasonably available corroborating evidence. The assumptions that we apply are specific to each individual asset. Although we rely on our internal
calculations to estimate the fair value of these assets, we consider indications of value from actual sales of similar securities, to the extent available, to assist
in the valuation process and calibrate our models.
To measure the fair value of our commercial mortgage loan investment, we use an income approach by preparing an estimate of the present value of
the expected future cash flows of the loan over its expected remaining life, discounted at a current market rate. The significant unobservable inputs to the
fair value measurement of our mortgage loan investment are the estimated probability of default and the discount rate, which is based on current market
yields and interest rate spreads for a similar loan. As of December 31, 2022, the estimated probability of default and discount rate for our mortgage loan
investment was 0% and 10.0%, respectively.
MSR financing receivables – Our MSR financing receivables primarily derive their value from the MSRs to which they are referenced. While
trades of MSRs occur regularly, MSRs trade relatively less frequently than other highly liquid assets such as agency MBS. Accordingly, significant
judgment is required in measuring the fair value of MSRs, including the development of the significant assumptions used in performing that measurement.
To assist in our measurement of our MSR financing receivables, we use a nationally recognized, independent third-party mortgage analytics and valuation
firm to estimate the fair value of the underlying MSRs from which our MSR financing receivables primarily derive their value. The third-party valuation
firm estimates the fair value of the underlying MSRs using a discounted cash flow analysis using their proprietary prepayment models and market analysis.
We
54
corroborate the third-party valuation firm’s estimate of the fair value of the underlying MSRs and evaluate the estimate for reasonableness. The significant
unobservable inputs to the fair value measurement of the underlying MSRs include the following:
•
the discount rate, which represents a market participant’s current required rate of return for similar MSRs;
•
expected rates of prepayment within the serviced pools of mortgage loans; and
•
annual per-loan cost of servicing.
The following table presents the significant unobservable inputs to the fair value measurement of the MSRs underlying our MSR financing
receivables as of December 31, 2022:
December 31, 2022
Discount rate
8.5%
Annualized prepayment rate
7.0%
Annual per-loan cost of servicing (current loans)
$
65.00
Pursuant to our MSR financing receivable arrangements, upon the consummation of three-year performance periods ending December 31, 2023 and
April 1, 2024, our mortgage servicing counterparty is entitled to an incentive fee payment equal to a percentage of the total return of the underlying MSRs
in excess of a hurdle rate of return. Accordingly, the fair value of our MSR financing receivables reflects the present value of any expected incentive fee
payment that would be owed to our counterparty. The present value of the expected incentive fee payment is estimated based upon the timing and amount
of capital contributions from (and cash distributions to) us to (from) our mortgage servicing counterparty to date as well as the future expected cash flows
from the MSR financing receivables over the remaining performance periods, which is derived from the current fair value of the underlying reference
MSRs. Given the significant management judgment required to estimate the fair value of our MSR financing receivables and their underlying components,
our return from such investments may, ultimately, differ materially from these estimates.
Interest Income Recognition for Investments in Certain Credit Securities and MSR Financing Receivables
We recognize interest income for certain of our investments in credit securities and MSR financing receivables by applying the prospective level-
yield methodology required by GAAP for financial assets that are either not of high credit quality at the time of acquisition or can be contractually prepaid
or otherwise settled in such a way that we would not recover substantially all of our recorded investment. The amount of periodic interest income
recognized is determined by applying the investment’s effective interest rate to its amortized cost basis (or “reference amount”). At the time of acquisition,
the investment’s effective interest rate is calculated by solving for the single discount rate that equates the present value of our best estimate of the amount
and timing of the cash flows expected to be collected from the investment to our purchase cost. To prepare our best estimate of cash flows expected to be
collected, we exercise significant judgment with consideration of current information and events to develop a number of assumptions about the future
performance of the pool of mortgage loans that serve as collateral or as a reference asset for our investment, including assumptions about the timing and
amount of prepayments and credit losses. These assumptions require a high degree of management judgment as they represent forecasts about future
events for which the ultimate outcome is inherently uncertain. If our periodic estimate of future cash flows is higher than those actually received in future
periods, we may recognize non-cash interest income over certain portions of the security’s holding period that exceeds the level of effective interest income
that will ultimately be realized. We use our best efforts to corroborate the significant assumptions underlying our estimates of futures cash flows with
evidence such as historical collateral performance data for the specific pool of assets collateralizing our investments as well as our evaluation of historical
collateral performance data for other assets collateralized or referenced to asset pools with similar risk characteristics, to the extent reasonably available.
Recently Issued Accounting Pronouncements
Refer to “Note 3. Summary of Significant Accounting Policies” in the Notes to Consolidated Financial Statements for a summary of recently issued
accounting pronouncements and their effect on our consolidated financial statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the exposure to loss resulting from changes in market factors such as interest rates, foreign currency exchange rates, commodity
prices, equity prices and other market changes that affect market risk sensitive instruments. The primary market risks that we are exposed to are interest rate
risk, prepayment risk, extension risk, spread risk, credit risk, liquidity risk and regulatory risk.
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Interest Rate Risk
We are exposed to interest rate risk in our agency MBS and MSR related assets. Our investments in mortgage investments are also financed with
short-term borrowing facilities, such as repurchase agreements, which are interest rate sensitive financial instruments. Our exposure to interest rate risk
fluctuates based upon changes in the level and volatility of interest rates, mortgage prepayments, and in the shape and slope of the yield curve, among other
factors. Through the use of interest rate hedging instruments, we attempt to economically hedge a portion of our exposure to changes, attributable to
changes in benchmark interest rates, in agency MBS fair values and future interest cash flows on our short-term financing arrangements. Our primary
interest rate hedging instruments include interest rate swaps as well as U.S. Treasury note futures, options on U.S. Treasury note futures, options on agency
MBS and TBA sale commitments.
Changes in both short- and long-term interest rates affect us in several ways, including our financial position. As interest rates rise, the value of
fixed-rate agency MBS may be expected to decline, prepayment rates may be expected to decrease and duration may be expected to extend, while the
values of our interest rate hedging instruments and MSR financing receivables are generally expected to increase due to lower expectations of prepayments
in the referenced pools of mortgage loans. Conversely, if interest rates decline, the value of fixed-rate agency MBS is generally expected to increase while
the value of our interest rate hedging instruments and MSR related assets are expected to decline. We manage our interest rate risk through investment
allocation between our agency MBS and MSR related assets and the utilization of interest rate hedging instruments.
The tables that follow illustrate the estimated change in fair value for our current investments in agency MBS, MSR financing receivable and
derivative instruments under several hypothetical scenarios of interest rate movements. For the purposes of this illustration, interest rates are defined by the
U.S. Treasury yield curve. Changes in fair value are measured as percentage changes from their respective fair values presented in the column labeled
“Value.” Our estimate of the change in the fair value of agency MBS is based upon the same assumptions we use to manage the impact of interest rates on
the portfolio. The interest rate sensitivity of our agency MBS and TBA commitments is derived from The Yield Book, a third-party model. The interest rate
sensitivity of our MSR financing receivable is derived from an internal model. Actual results could differ significantly from these estimates. The effective
durations are based on observed fair value changes, as well as our own estimate of the effect of interest rate changes on the fair value of the investments,
including assumptions regarding prepayments based, in part, on age and interest rate of the mortgages underlying the agency MBS, prior exposure to
refinancing opportunities, and an overall analysis of historical prepayment patterns under a variety of historical interest rate conditions.
The interest rate sensitivity analyses illustrated by the tables that follow have certain limitations, most notably the following:
•
The 50 and 100 basis point upward and downward shocks to interest rates that are applied in the analyses represent parallel shocks to the
forward yield curve. The analyses do not consider the sensitivity of stockholders’ equity to changes in the shape or slope of the forward yield
curve.
•
The analyses assume that spreads remain constant and, therefore, do not reflect an estimate of the impact that changes in spreads would have on
the value of our MBS investments or our LIBOR- or SOFR-based derivative instruments, such as our interest rate swap agreements.
•
The analyses assume a static portfolio and do not reflect activities and strategic actions that management may take in the future to manage
interest rate risk in response to significant changes in interest rates or other market conditions.
•
The yield curve that results from applying an instantaneous parallel decrease in interest rates may reflect an interest rate of less than 0% in
certain points of the curve. The results of the analyses included in the tables below reflect the effect of these negative interest rates.
•
The analyses do not reflect an estimated changes in our income tax provision.
•
The analyses do not reflect any estimated changes in the fair value of our credit investments.
56
These analyses are not intended to provide a precise forecast. Actual results could differ materially from these estimates (dollars in thousands, except
per share amounts).
December 31, 2022
Value
Value with 50
Basis Point
Increase in
Interest Rates
Value with 50
Basis Point
Decrease in
Interest Rates
Agency MBS
$
443,540 $
432,852 $
453,192
TBA commitments
5,630
15,262
(2,911)
MSR financing receivables
180,365
183,526
177,422
Interest rate swaps
8
(1,371)
1,387
Equity available to common stock
183,920
184,646
183,467
Equity available to common stock percent change
0.39%
(0.25%)
December 31, 2022
Value
Value with 100
Basis Point
Increase in
Interest Rates
Value with 100
Basis Point
Decrease in
Interest Rates
Agency MBS
$
443,540 $
421,404 $
461,688
TBA commitments
5,630
25,741
(10,242)
MSR financing receivables
180,365
186,438
173,925
Interest rate swaps
8
(2,750)
2,766
Equity available to common stock
183,920
185,210
182,514
Equity available to common stock percent change
0.70%
(0.76%)
Equity available to common stock is calculated as total equity less the preferred stock liquidation preference.
Spread Risk
Our mortgage investments expose us to “spread risk.” Spread risk, also known as “basis risk,” is the risk of an increase in the spread between
market participants’ required rate of return (or “market yield”) on our mortgage investments and prevailing benchmark interest rates, such as the U.S.
Treasury or interest rate swap rates.
The spread risk inherent to our investments in agency MBS and the resulting fluctuations in fair value of these securities can occur independent of
changes in prevailing benchmark interest rates and may relate to other factors impacting the mortgage and fixed income markets, such as actual or
anticipated monetary policy actions by the U. S. Federal Reserve, liquidity, or changes in market participants’ required rates of return on different assets.
While we use interest rate hedging instruments to attempt to mitigate the sensitivity of our net book value to changes in prevailing benchmark interest rates,
such instruments are generally not designed to mitigate spread risk inherent to our investment in agency MBS. Consequently, the value of our agency MBS
and, in turn, our net book value, could decline independent of changes in interest rates.
The tables that follow illustrate the estimated change in fair value for our investments in agency MBS and TBA commitments under several
hypothetical scenarios of agency MBS spread movements. Changes in fair value are measured as percentage changes from their respective fair values
presented in the column labeled “Value.” The sensitivity of our agency MBS and TBA commitments to changes in MBS spreads is derived from The Yield
Book, a third-party model. The analysis to follow reflects an assumed spread duration for our investment in agency MBS of 4.6 years, which is a model-
based assumption that is dependent upon the size and composition of our investment portfolio as well as economic conditions present as of December 31,
2022.
These analyses are not intended to provide a precise forecast. Actual results could differ materially from these estimates (dollars in thousands, except
per share amounts).
December 31, 2022
Value
Value with 10
Basis Point
Increase in Agency
MBS Spreads
Value with 10
Basis Point
Decrease in Agency
MBS Spreads
Agency MBS
$
443,540 $
441,034 $
446,046
TBA commitments
5,630
7,921
3,338
Equity available to common stock
183,920
183,705
184,134
Equity available to common stock percent change
(0.12)%
0.12%
57
(1)
(1)
(1)
(1)
December 31, 2022
Value
Value with 25
Basis Point
Increase in Agency
MBS Spreads
Value with 25
Basis Point
Decrease in Agency
MBS Spreads
Agency MBS
$
443,540 $
437,275 $
449,805
TBA commitments
5,630
11,359
(99)
Equity available to common stock
183,920
183,384
184,456
Equity available to common stock percent change
(0.29)%
0.29%
Equity available to common stock is calculated as total equity less the preferred stock liquidation preference.
Credit Risk
Unlike our agency MBS investments, our credit investments do not carry a credit guarantee from a GSE or government agency. Accordingly, our
credit investments expose us to credit risk. Credit risk, sometimes referred to as non-performance or non-payment risk, is the risk that we will not receive,
in full, the contractually required principal or interest cash flows stemming from our investments due to an underlying borrower’s or issuer’s default on
their obligation. Upon a mortgage loan borrower’s default, a foreclosure sale or other liquidation of the underlying mortgaged property will result in a
credit loss if the liquidation proceeds fall short of the mortgage loan’s unpaid principal balance and unpaid accrued interest.
Some of our credit investments have credit enhancements that mitigate our exposure to the credit risk of the underlying mortgage loans. Credit
losses incurred on the underlying mortgage loans collateralizing our investments in non-agency MBS are allocated on a “reverse sequential” basis.
Accordingly, any credit losses realized on the underlying mortgage loans are first absorbed by the beneficial interests subordinate to our non-agency MBS,
if any, to the extent of their respective principal balance, prior to being allocated to our investments.
Other of our non-agency MBS investments represent “first loss” positions. Accordingly, for such investments, credit losses realized on the
underlying pool of mortgage loans are first allocated to our security, to the extent of its principal balance, prior to being allocated to the respective
securitization’s more senior credit positions.
We accept exposure to credit risk at levels we deem prudent within our overall investment strategy and our evaluation of the potential risk-adjusted
returns. We attempt to manage our exposure to credit risk through prudent asset selection resulting from pre-acquisition due diligence, on-going
performance monitoring subsequent to acquisition, and the disposition of assets for which we identify negative credit trends.
There is no guarantee that our attempts to manage our credit risk will be successful. We could experience substantial losses if the credit performance
of the mortgage loans to which we are exposed falls short of our expectations.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this item appears in a subsequent section of this report. See “Index to Arlington Asset Investment Corp. Consolidated
Financial Statements” on page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
Our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), evaluated the effectiveness of the design
and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended)
as of the end of the period covered by this report. Based on that evaluation, our CEO and CFO have concluded that as of December 31, 2022, our disclosure
controls and procedures, as designed and implemented, (i) were effective in ensuring that information is made known to our management, including our
CEO and CFO, by our officers and employees, as appropriate to allow timely decisions regarding required disclosure and (ii) were effective in ensuring that
information the Company must disclose in its reports under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and
reported within the time periods prescribed by the SEC’s rules and forms.
58
(1)
(1)
Management’s Report on Internal Control over Financial Reporting
Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over
financial reporting is defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended, as a process designed by, or under
the supervision of, the Company’s principal executive and principal financial officers and effected by the Company’s Board of Directors, management and
other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external
purposes in accordance with GAAP and includes those policies and procedures that:
•
pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the
Company;
•
provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with
GAAP, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and
directors of the Company; and
•
provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets
that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risks that controls may become inadequate because of changes in conditions or that the
degree of compliance with the policies or procedures may deteriorate.
The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2022. In
making this assessment, the Company’s management used criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission
(“COSO”) in Internal Control-Integrated Framework (2013 version). Based on management’s assessment, the Company’s management has concluded that
the Company’s internal control over financial reporting was effective as of December 31, 2022.
Changes in Internal Control over Financial Reporting
There have been no changes in our internal control over financial reporting that occurred during the year ended December 31, 2022 that have
materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B. OTHER INFORMATION
None.
ITEM 9C. DISCLOSURE REGARDING FOREIGN JURISDICTIONS THAT PREVENT INSPECTIONS
None.
59
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by Part III, Item 10 of this Annual Report on Form 10-K will be provided in the Definitive Proxy Statement relating to our
2023 Annual Meeting of Shareholders (our 2023 Proxy Statement) and is hereby incorporated by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information required by Part III, Item 11 of this Annual Report on Form 10-K will be provided in our 2023 Proxy Statement and is hereby
incorporated by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER
MATTERS
The information required by Part III, Item 12 of this Annual Report on Form 10-K will be provided in our 2023 Proxy Statement and is hereby
incorporated by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by Part III, Item 13 of this Annual Report on Form 10-K will be provided in our 2023 Proxy Statement and is hereby
incorporated by reference.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by Part III, Item 14 of this Annual Report on Form 10-K will be provided in our 2023 Proxy Statement and is hereby
incorporated by reference.
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) (1) Financial Statements. The Arlington Asset Investment Corp. consolidated financial statements for the year ended December 31, 2022,
included in “Item 8 - Financial Statements and Supplementary Data”, of this Annual Report on Form 10-K, are incorporated by reference into this Part IV,
Item 15:
•
Report of Independent Registered Public Accounting Firm (page F-2)
•
Consolidated Balance Sheets as of December 31, 2022 and 2021 (page F-4)
•
Consolidated Statements of Comprehensive Income for the years ended December 31, 2022 and 2021 (page F-5)
•
Consolidated Statements of Changes in Equity for the years ended December 31, 2022 and 2021 (page F-6)
•
Consolidated Statements of Cash Flows for the years ended December 31, 2022 and 2021 (page F-7)
•
Notes to Consolidated Financial Statements (page F-8)
(2) Financial Statement Schedules. All schedules are omitted because they are not required or because the information is shown in the financial
statements or notes thereto.
(3) Exhibits
Exhibit
Number
Exhibit Title
3.01
Amended and Restated Articles of Incorporation, as amended (incorporated by reference to Exhibit 3.1 to the Company’s Quarterly Report
on Form 10-Q filed on November 9, 2009).
3.02
Articles of Amendment to the Amended and Restated Articles of Incorporation designating the shares of 7.00% Series B Cumulative
Perpetual Redeemable Preferred Stock, $0.01 par value per share (incorporated by reference to Exhibit 3.2 to the Company’s Registration
Statement on Form 8-A filed on May 9, 2017).
3.03
Articles of Amendment to the Amended and Restated Articles of Incorporation of Arlington Asset Investment Corp. designating the
Company’s 8.250% Series C Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock, par value
60
Exhibit
Number
Exhibit Title
$0.01 per share (incorporated by reference to Exhibit 3.3 to the Company’s Registration Statement on Form 8-A filed on March 11, 2019).
3.04
Articles of Amendment to the Amended and Restated Articles of Incorporation of Arlington Asset Investment Corp. (incorporated by
reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed on June 25, 2019).
3.05
Amended and Restated Bylaws, as amended (incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed on
July 28, 2011).
3.06
Amendment No. 1 to the Amended and Restated Bylaws (incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form
8-K filed on February 4, 2015).
3.07
Amendment No. 2 to the Amended and Restated Bylaws (incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form
8-K filed on October 26, 2016).
3.08
Amendment No. 3 to the Amended and Restated Bylaws (incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form
8-K filed on January 17, 2019).
3.09
Amendment No. 4 to the Amended and Restated Bylaws (incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form
8-K filed on December 13, 2019).
4.01
Indenture governing the Senior Debt Securities by and between the Company and The Bank of New York Mellon, as Trustee (incorporated
by reference to Exhibit 4.1 to the Company’s Registration Statement on Form S-3 (File No. 333-235885) filed on January 10, 2020).
4.02
Indenture governing the Subordinated Debt Securities by and between the Company and The Bank of New York Mellon, as Trustee
(incorporated by reference to Exhibit 4.2 to the Company’s Registration Statement on Form S-3 (File No. 333-235885) filed on January 10,
2020).
4.03
Indenture dated as of May 1, 2013 between the Company and Wells Fargo Bank, National Association, as trustee (incorporated by reference
to Exhibit 4.1 of the Company’s Current Report on Form 8-K filed on May 1, 2013).
4.04
First Supplemental Indenture dated as of May 1, 2013 between the Company and Wells Fargo Bank, National Association, as trustee
(incorporated by reference to Exhibit 4.2 of the Company’s Current Report on Form 8-K filed on May 1, 2013).
4.05
Form of Senior Note. (incorporated by reference to Exhibit 4.6 to the Company’s Registration Statement on Form S-3 (File No. 333-235885)
filed on January 10, 2020).
4.06
Form of Subordinated Note. (incorporated by reference to Exhibit 4.7 to the Company’s Registration Statement on Form S-3 (File No. 333-
235885) filed on January 10, 2020).
4.07
Form of Certificate for Class A common stock (incorporated by reference to Exhibit 4.01 of the Annual Report on Form 10-K filed on
February 24, 2010).
4.08
Shareholder Rights Agreement, dated June 5, 2009 (incorporated by reference to Exhibit 4.1 of the Company’s Current Report on Form 8-K
filed on June 5, 2009).
4.09
First Amendment to Shareholder Rights Agreement, dated as of April 13, 2018 (incorporated by reference to Exhibit 4.2 to the Company’s
Current Report on Form 8-K filed on April 13, 2018).
4.10
Second Supplemental Indenture, dated as of March 18, 2015, between the Company, Wells Fargo Bank, National Association, as Trustee and
The Bank of New York Mellon, as Series Trustee (incorporated by reference to Exhibit 4.3 to the Company’s Form 8-A filed on March 18,
2015).
4.11
Form of 6.750% Notes due 2025 (incorporated by reference to Exhibit 4.3 to the Company’s Current Report on Form 8-K filed on March 17,
2015).
4.12
Form of specimen certificate representing the shares of 7.00% Series B Perpetual Redeemable Preferred Stock (incorporated by reference to
Exhibit 4.1 to the Company’s Registration Statement on Form 8-A filed on May 9, 2017).
4.13
Form of specimen certificate representing the shares of 8.250% Series C Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock
(incorporated by reference to Exhibit 4.1 to the Company’s Registration Statement on Form 8-A filed on March 11, 2019).
4.14
Description of Registrant’s Securities (incorporated by reference to Exhibit 4.15 to the Company’s Annual Report on Form 10-K filed on
February 24, 2020).
4.15
First Supplemental Indenture dated as of July 15, 2021 between the Company and The Bank of New York Mellon, as trustee (incorporated by
reference to Exhibit 4.5 to the Company’s Registration Statement on Form 8-A filed on July 15, 2021).
4.16
Form of 6.000% Senior Notes Due 2026 (incorporated by reference to Exhibit 4.6 to the Company’s Registration Statement on Form 8-A
filed on July 15, 2021).
4.17
Second Amendment to Shareholder Rights Agreement, dated as of April 11, 2022 (incorporated by reference to Exhibit 4.3 to the
Registrant’s Current Report on Form 8-K filed on April 12, 2022).
10.01
Friedman, Billings, Ramsey Group, Inc. 2004 Long-Term Incentive Plan (incorporated by reference to Appendix A to the Company’s
Definitive Proxy Statement on Schedule 14A filed on April 29, 2004).*
61
Exhibit
Number
Exhibit Title
10.02
Friedman, Billings, Ramsey Group, Inc. 1997 Stock and Annual Incentive Plan (incorporated by reference to Exhibit 10.06 to Amendment
No. 2 to the Registration Statement on Form S-1 (File No. 333-39107) filed by Friedman, Billings, Ramsey Group, Inc. on December 19,
1997).*
10.03
Friedman, Billings, Ramsey Group, Inc. Non-Employee Director Stock Compensation Plan (incorporated by reference to Exhibit 10.07 to
Amendment No. 2 to the Registration Statement on Form S-1 (File No. 333-39107) filed by Friedman, Billings, Ramsey Group, Inc. on
December 19, 1997).*
10.04
Friedman, Billings, Ramsey Group, Inc. Amended and Restated Non-Employee Director Stock Compensation Plan (incorporated by
reference to Exhibit 10.04 to the Company’s Annual Report on Form 10-K filed on February 23, 2012).*
10.05
Arlington Asset Investment Corp. 2011 Long-Term Incentive Plan (incorporated by reference to Exhibit 10.1 to the Company’s Current
Report on Form 8-K filed on June 6, 2011).*
10.06
Arlington Asset Investment Corp. 2014 Long-Term Incentive Plan (incorporated by reference to the Company’s Registration Statement on
Form S-8 filed on July 15, 2014).*
10.07
Arlington Asset Investment Corp. 2021 Long-Term Incentive Plan (incorporated by reference to Annex A of the Company’s Definitive Proxy
Statement on Schedule 14A filed on April 29, 2021).*
10.08
Form of Restricted Stock Award Agreement under Arlington Asset Investment Corp. 2021 Long-Term Incentive Plan (incorporated by
reference to Exhibit 10.2 of the Company’s Current Report on Form 8-K filed on June 17, 2021).*
10.09
Form of Deferred Stock Unit Award Agreement under Arlington Asset Investment Corp. 2021 Long-Term Incentive Plan (incorporated by
reference to Exhibit 10.3 of the Company’s Current Report on Form 8-K filed on June 17, 2021).*
10.10
Form of Performance Restricted Stock Unit Award Agreement under Arlington Asset Investment Corp. 2021 Long-Term Incentive Plan
(incorporated by reference to the Company’s Current Report on Form 8-K filed on June 17, 2021).*
10.11
Form of Change in Control Continuity Agreement (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K
filed on January 27, 2017).*
10.12
Form of Indemnification Agreement (incorporated by reference to Exhibit 10.08 to the Company’s Annual Report on Form 10-K, filed on
February 23, 2012).*
10.13
Equity Distribution Agreement, dated February 22, 2017, by and between the Company and JMP Securities LLC (incorporated by reference
to Exhibit 1.1 to the Company’s Current Report on Form 8-K filed on February 22, 2017).
10.14
Equity Distribution Agreement, dated February 22, 2017, by and between the Company and FBR Capital Markets & Co. (incorporated by
reference to Exhibit 1.2 to the Company’s Current Report on Form 8-K filed on February 22, 2017).
10.15
Equity Distribution Agreement, dated February 22, 2017, by and between the Company and JonesTrading Institutional Services LLC
(incorporated by reference to Exhibit 1.3 to the Company’s Current Report on Form 8-K filed on February 22, 2017).
10.16
Equity Distribution Agreement, dated February 22, 2017, by and between the Company and Ladenburg Thalmann & Co. Inc. (incorporated
by reference to Exhibit 1.4 to the Company’s Current Report on Form 8-K filed on February 22, 2017).
10.17
Amendment No. 1 to the Equity Distribution Agreement, dated August 10, 2018, by and between the Company and JMP Securities LLC
(incorporated by reference to Exhibit 1.5 to the Company’s Current Report on Form 8-K filed on August 10, 2018).
10.18
Amendment No. 1 to the Equity Distribution Agreement, dated August 10, 2018, by and between the Company and B. Riley FBR, Inc.
(incorporated by reference to Exhibit 1.6 to the Company’s Current Report on Form 8-K filed on August 10, 2018).
10.19
Amendment No. 1 to the Equity Distribution Agreement, dated August 10, 2018, by and between the Company and JonesTrading
Institutional Services LLC (incorporated by reference to Exhibit 1.7 to the Company’s Current Report on Form 8-K filed on August 10,
2018).
10.20
Amendment No. 1 to the Equity Distribution Agreement, dated August 10, 2018, by and between the Company and Ladenburg Thalmann &
Co. Inc. (incorporated by reference to Exhibit 1.8 to the Company’s Current Report on Form 8-K filed on August 10, 2018).
10.21
Amended and Restated Equity Distribution Agreement, dated March 21, 2019, by and among the Company and JonesTrading Institutional
Services LLC, B. Riley FBR, Inc., Compass Point Research & Trading, LLC and Ladenburg Thalmann & Co. Inc. (incorporated by reference
to Exhibit 1.1 to the Company’s Current Report on Form 8-K filed on March 21, 2019).
10.22
Amendment No. 1 to the Amended and Restated Equity Distribution Agreement, dated as of July 21, 2021, by and among Arlington Asset
Investment Corp. and JonesTrading Institutional Services LLC and Ladenburg Thalmann & Co. Inc. (incorporated by reference to Exhibit 1.2
to the Company’s Current Report on Form 8-K filed on July 21, 2021).
10.23
Retirement and Consulting Agreement dated June 6, 2019, by and between Arlington Asset Investment Corp. and Eric F. Billings
(incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on June 6, 2019).
21.01
List of Subsidiaries of the Registrant.†
23.01
Consent of PricewaterhouseCoopers LLP.†
62
Exhibit
Number
Exhibit Title
24.01
Power of Attorney (included on the signature page to this Annual Report on Form 10-K and incorporated by reference herein).†
31.01
Certification of Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002.†
31.02
Certification of Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002.†
32.01
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002.†
32.02
Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.†
101.INS
Inline XBRL Instance Document – the instance document does not appear in the Interactive Data File because its XBRL tags are embedded
within the Inline XBRL document**
101.SCH
Inline XBRL Taxonomy Extension Schema Document**
101.CAL
Inline XBRL Taxonomy Extension Calculation Linkbase Document**
101.DEF
Inline XBRL Taxonomy Extension Definition Linkbase Document**
101.LAB
Inline XBRL Taxonomy Extension Label Linkbase Document**
101.PRE
Inline XBRL Taxonomy Extension Presentation Linkbase Document**
104
The cover page from the Company’s Annual Report on Form 10-K for the year ended December 31, 2022, has been formatted in Inline
XBRL.
† Filed herewith.
* Compensatory plan or arrangement.
** Submitted electronically herewith. Attached as Exhibit 101 are the following materials from the Company’s Annual Report on Form 10-K for the fiscal
year ended December 31, 2022, formatted in XBRL (eXtensible Business Reporting Language): (i) Consolidated Balance Sheets at December 31, 2022 and
December 31, 2021; (ii) Consolidated Statements of Comprehensive Income for the years ended December 31, 2022 and 2021; (iii) Consolidated
Statements of Changes in Equity for the years ended December 31, 2022 and 2021; and (iv) Consolidated Statements of Cash Flows for the years ended
December 31, 2022 and 2021.
ITEM 16. FORM 10-K SUMMARY
Not applicable.
63
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
ARLINGTON ASSET INVESTMENT CORP.
Date: March 31, 2023
By: /s/ RICHARD E. KONZMANN
Richard E. Konzmann
Executive Vice President, Chief Financial Officer and
Treasurer
POWER OF ATTORNEY
KNOW ALL BY THESE PRESENTS, that each person whose signature appears below hereby constitutes and appoints J. Rock Tonkel, Jr. and
Richard E. Konzmann and each of them as their true and lawful attorney-in-fact and agent, with full power of substitution and resubstitution, for them and
in their name, place and stead, in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K for the fiscal year ended
December 31, 2022, and to file the same, with all exhibits thereto, and any other documents in connection therewith, with the Securities and Exchange
Commission, granting unto said attorneys-in-fact and agents full power and authority to do and perform each and every act and thing requisite and
necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all
that said attorneys-in-fact and agents or any of them, or their substitute or substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signature
Title
Date
/s/ J. ROCK TONKEL, JR.
President, Chief Executive Officer and Director
March 31, 2023
J. ROCK TONKEL, JR.
(Principal Executive Officer)
/s/ RICHARD E. KONZMANN
Executive Vice President, Chief Financial Officer and Treasurer
March 31, 2023
RICHARD E. KONZMANN
(Principal Financial Officer)
/s/ BENJAMIN J. STRICKLER
Vice President, Chief Accounting Officer and Controller
March 31, 2023
BENJAMIN J. STRICKLER
(Principal Accounting Officer)
/s/ DANIEL E. BERCE
Chairman of the Board
March 31, 2023
DANIEL E. BERCE
/s/ DAVID W. FAEDER
Director
March 31, 2023
DAVID W. FAEDER
/s/ MELINDA H. MCCLURE
Director
March 31, 2023
MELINDA H. MCCLURE
/s/ RALPH S. MICHAEL III
Director
March 31, 2023
RALPH S. MICHAEL III
/s/ ANTHONY P. NADER III
Director
March 31, 2023
ANTHONY P. NADER III
64
FINANCIAL STATEMENTS OF ARLINGTON ASSET INVESTMENT CORP.
Index to Arlington Asset Investment Corp. Consolidated Financial Statements
Page
Report of Independent Registered Public Accounting Firm
F-2
Consolidated Balance Sheets as of December 31, 2022 and 2021
F-4
Consolidated Statements of Comprehensive Income for the years ended December 31, 2022 and 2021
F-5
Consolidated Statements of Changes in Equity for the years ended December 31, 2022 and 2021
F-6
Consolidated Statements of Cash Flows for the years ended December 31, 2022 and 2021
F-7
Notes to Consolidated Financial Statements
F-8
F-1
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of Arlington Asset Investment Corp.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Arlington Asset Investment Corp. and its subsidiaries (the “Company”) as of December
31, 2022 and 2021, and the related consolidated statements of comprehensive income, of changes in equity and of cash flows for the years then ended,
including the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present
fairly, in all material respects, the financial position of the Company as of December 31, 2022 and 2021, and the results of its operations and its cash flows
for the years then ended in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s
consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board
(United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the
applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits of these consolidated financial statements in accordance with the standards of the PCAOB. Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to
error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our
audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the
effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or
fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and
disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by
management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis
for our opinion.
Critical Audit Matters
The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was
communicated or required to be communicated to the audit committee and that (i) relates to accounts or disclosures that are material to the consolidated
financial statements and (ii) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not
alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below,
providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Fair Value of the Mortgage Servicing Rights used to value the MSR Financing Receivables
As described in Notes 7 and 13 to the consolidated financial statements, the Company elected to account for its MSR financing receivables at fair value.
The Company’s MSR financing receivables are classified within Level 3 of the fair value hierarchy. The Company uses a nationally recognized,
independent third-party mortgage analytics and valuation firm to estimate the fair value of the underlying MSRs from which the Company’s MSR
financing receivables primarily derive their value of $180.4 million as of December 31, 2022. The third-party valuation firm estimates the fair value of
the underlying MSRs using a discounted cash flow analysis using their proprietary prepayment models and market analysis. The Company corroborates
the third-party valuation firm’s estimate of the fair value of the underlying MSRs and evaluates the estimate for reasonableness. The significant
unobservable inputs to the fair value measurement of the underlying MSRs include the discount rate, expected rates of prepayment and annual per-loan
cost of servicing.
The principal considerations for our determination that performing procedures relating to the fair value of the mortgage servicing rights used to value the
MSR financing receivables is a critical audit matter are (i) the significant judgment by management, including the use of a specialist, in estimating the
fair value of MSRs used to value the MSR financing receivables, which in turn led to a high degree of auditor judgment, subjectivity and effort in
performing procedures and evaluating audit evidence related to the
F-2
fair value of MSRs and the assumptions related to the discount rate, expected rates of prepayment and annual per-loan cost of servicing used by
management and its specialist and (ii) the audit effort involved the use of professionals with specialized skill and knowledge.
Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated
financial statements. The work of management’s specialist was used in performing the procedures to evaluate the reasonableness of the estimate of the
fair value of MSRs. As a basis for using this work, the specialist’s qualifications were understood and the Company’s relationship with the specialist was
assessed. The procedures performed also included evaluation of the methods and assumptions used by the specialist, tests of the data used by the
specialist, and an evaluation of the specialist’s findings. These procedures also included, among others, the involvement of professionals with specialized
skill and knowledge to assist in evaluating the methods and assumptions related to the discount rate, expected rates of prepayment and annual per-loan
cost of servicing used by the specialist.
/s/ PricewaterhouseCoopers LLP
Washington, DC
March 31, 2023
We have served as the Company’s auditor since 2002.
F-3
ARLINGTON ASSET INVESTMENT CORP.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except share amounts)
December 31,
2022
2021
ASSETS
Cash and cash equivalents (includes $296 and $2,118, respectively, from consolidated VIEs)
$
28,021 $
20,543
Restricted cash
—
1,132
Restricted cash of consolidated VIEs
2,191
111
Sold securities receivable
—
28,219
Agency mortgage-backed securities, at fair value
443,540
483,927
MSR financing receivables, at fair value
180,365
125,018
Credit securities, at fair value
104,437
26,222
Mortgage loans, at fair value
29,264
29,697
Mortgage loans of consolidated VIEs, at fair value
193,957
7,442
Single-family residential real estate (net of $-0- and $299, respectively, of accumulated
depreciation)
—
60,889
Deposits
1,823
4,549
Other assets (includes $2,067 and $547, respectively, from consolidated VIEs)
18,720
15,287
Total assets
$
1,002,318 $
803,036
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
Repurchase agreements
$
515,510 $
446,624
Secured debt of consolidated VIEs, at fair value
169,345
508
Long-term unsecured debt
86,405
85,994
Long-term debt secured by single-family properties
—
39,178
Other liabilities (includes $262 and $2, respectively, from consolidated VIEs)
13,718
6,605
Total liabilities
784,978
578,909
Commitments and contingencies (Note 15)
Stockholders’ Equity:
Series B Preferred stock, $0.01 par value, 379,668 and 373,610 shares issued and
outstanding, respectively (liquidation preference of $9,492 and $9,340,
respectively)
9,001
8,852
Series C Preferred stock, $0.01 par value, 957,133 and 1,117,034 shares issued and
outstanding, respectively (liquidation preference of $23,928 and $27,926,
respectively)
23,820
27,356
Class A common stock, $0.01 par value, 450,000,000 shares authorized, 28,186,827
and 30,676,931 shares issued and outstanding, respectively
282
307
Additional paid-in capital
2,024,298
2,030,315
Accumulated deficit
(1,840,061 )
(1,842,703 )
Total stockholders’ equity
217,340
224,127
Total liabilities and stockholders’ equity
$
1,002,318 $
803,036
December 31, 2022
December 31, 2021
Assets and liabilities of consolidated VIEs:
Cash and restricted cash
$
2,487 $
2,229
Mortgage loans, at fair value
193,957
7,442
Other assets
2,067
547
Secured debt, at fair value
(169,345 )
(508 )
Other liabilities
(262 )
(2 )
Net investment in consolidated VIEs
$
28,904 $
9,708
The accompanying notes are an integral part of these consolidated financial statements.
F-4
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Dollars in thousands except per share amounts)
Year Ended December 31,
2022
2021
Interest income
MSR financing receivables
$
15,419 $
6,282
Agency mortgage-backed securities
11,920
10,634
Credit securities and loans
7,512
5,058
Mortgage loans of consolidated VIEs
7,570
2,908
Other
862
648
Total interest and other income
43,283
25,530
Rent revenues from single-family properties
6,173
259
Interest expense
Repurchase agreements
8,983
1,483
Long-term debt secured by single-family properties
2,202
151
Long-term unsecured debt
5,742
5,112
Secured debt of consolidated VIEs
4,584
1,460
Total interest expense
21,511
8,206
Single-family property operating expenses
6,073
629
Net operating income
21,872
16,954
Investment and derivative gain (loss), net
2,587
(13,199)
General and administrative expenses
Compensation and benefits
9,845
6,979
Other general and administrative expenses
5,070
4,725
Total general and administrative expenses
14,915
11,704
Income (loss) before income taxes
9,544
(7,949)
Income tax provision
4,118
1,566
Net income (loss)
5,426
(9,515)
Dividend on preferred stock
(2,784)
(2,916)
Net income (loss) available (attributable) to common stock
$
2,642 $
(12,431)
Basic earnings (loss) per common share
$
0.09 $
(0.38)
Diluted earnings (loss) per common share
$
0.09 $
(0.38)
Weighted-average common shares outstanding (in
thousands)
Basic
28,717
32,312
Diluted
29,243
32,312
The accompanying notes are an integral part of these consolidated financial statements.
F-5
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
(Dollars in thousands)
Series B
Preferred
Stock (#)
Series B
Preferred
Amount ($)
Series C
Preferred
Stock (#)
Series C
Preferred
Amount ($)
Class A
Common
Stock (#)
Class A
Amount
($)
Additional
Paid-In
Capital
Accumulated
Deficit
Total
Balances, December 31, 2020
336,273 $
7,933
1,117,034 $
27,356
33,517,018 $
335 $
2,040,918 $
(1,830,272 ) $
246,270
Net loss
—
—
—
—
—
—
—
(9,515 )
(9,515 )
Issuance of Class A common
stock under stock-based
compensation plans
—
—
—
—
487,104
4
(4 )
—
—
Forfeiture of Class A common
stock under stock-based
compensation plans
—
—
—
—
(22,000 )
—
—
—
—
Repurchase of Class A
common stock
—
—
—
—
(3,242,371 )
(32 )
(12,443 )
—
(12,475 )
Repurchase of Class A
common stock under
stock-based
compensation plans
—
—
—
—
(62,820 )
—
(239 )
—
(239 )
Issuance of preferred stock
37,337
919
—
—
—
—
—
—
919
Stock-based compensation
—
—
—
—
—
—
2,083
—
2,083
Dividends declared
—
—
—
—
—
—
—
(2,916 )
(2,916 )
Balances, December 31, 2021
373,610 $
8,852
1,117,034 $
27,356
30,676,931 $
307 $
2,030,315 $
(1,842,703 ) $
224,127
Series B
Preferred
Stock (#)
Series B
Preferred
Amount
($)
Series C
Preferred
Stock (#)
Series C
Preferred
Amount ($)
Class A
Common
Stock (#)
Class A
Amount
($)
Additional
Paid-In
Capital
Accumulated
Deficit
Total
Balances, December 31, 2021
373,610 $
8,852
1,117,034 $
27,356
30,676,931 $
307 $
2,030,315 $
(1,842,703 ) $
224,127
Net income
—
—
—
—
—
—
—
5,426
5,426
Issuance of Class A common
stock under stock-based
compensation plans
—
—
—
—
404,746
4
(4 )
—
—
Forfeiture of Class A common
stock under stock-based
compensation plans
—
—
—
—
(12,167 )
—
—
—
—
Repurchase of Class A
common stock
—
—
—
—
(2,794,574 )
(29 )
(9,287 )
—
(9,316 )
Repurchase of Class A
common stock under
stock-based
compensation plans
—
—
—
—
(88,109 )
—
(263 )
—
(263 )
Issuance of preferred stock
6,058
149
—
—
—
—
—
—
149
Repurchase of preferred stock
—
—
(159,901 )
(3,536 )
—
—
—
—
(3,536 )
Stock-based compensation
—
—
—
—
—
—
3,537
—
3,537
Dividends declared
—
—
—
—
—
—
—
(2,784 )
(2,784 )
Balances, December 31, 2022
379,668 $
9,001
957,133 $
23,820
28,186,827 $
282 $
2,024,298 $
(1,840,061 ) $
217,340
The accompanying notes are an integral part of these consolidated financial statements.
F-6
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
Year Ended December 31,
2022
2021
Cash flows from operating activities
Net income (loss)
$
5,426 $
(9,515 )
Adjustments to reconcile net income (loss) to net cash (used in) provided by operating
activities
Investment and derivative (gain) loss, net
(2,587 )
13,199
Net discount accretion
(11,747 )
(4,791 )
Other
5,932
2,472
Changes in operating assets
Interest receivable
(957 )
1,145
Other assets
37
(47 )
Changes in operating liabilities
Interest payable and other liabilities
1,562
2,163
Accrued compensation and benefits
959
65
Net cash (used in) provided by operating activities
(1,375 )
4,691
Cash flows from investing activities
Purchases of agency mortgage-backed securities
(674,581 )
(607,659 )
Purchases of credit securities
(128,779 )
(51,934 )
Purchases of MSR financing receivables
(83,393 )
(101,808 )
Purchases of single-family residential real estate
(135,997 )
(61,188 )
Purchases of loans
(4,914 )
(29,967 )
Proceeds from sales of agency mortgage-backed securities
654,294
830,524
Proceeds from sales of credit securities
18,788
54,545
Proceeds from sales of single-family residential real estate
157,857
—
Receipt of principal payments on agency mortgage-backed securities
34,230
64,982
Receipt of principal payments on credit securities
8,179
367
Receipt of principal payments on loans
433
45,271
Receipt of principal payments on mortgage loans of consolidated VIEs
40,453
87,746
Receipt of distributions on MSR financing receivables
75,177
5,667
Restricted cash balance of VIE upon consolidation
9,637
—
Proceeds from (payments for) derivatives and deposits, net
2,523
(204 )
Other
8,623
5,526
Net cash (used in) provided by investing activities
(17,470 )
241,868
Cash flows from financing activities
Proceeds from (repayments of) repurchase agreements, net
68,886
(208,588 )
Repayments of secured debt of consolidated VIEs
(43,711 )
(93,319 )
Repurchase of common stock
(9,316 )
(12,475 )
Repurchase of preferred stock
(3,535 )
—
Proceeds from issuance of preferred stock
149
919
Proceeds from long-term debt secured by single-family properties
99,371
39,164
Issuance of long-term unsecured debt
—
36,305
Redemption of long-term unsecured debt
—
(23,821 )
Repayments of long-term debt secured by single-family properties
(81,790 )
—
Repurchase of long-term unsecured debt
—
(7 )
Dividends paid
(2,783 )
(2,916 )
Net cash provided by (used in) financing activities
27,271
(264,738 )
Net increase (decrease) in cash, cash equivalents and restricted cash
8,426
(18,179 )
Cash, cash equivalents and restricted cash, beginning of year
21,786
39,965
Cash, cash equivalents and restricted cash, end of year
$
30,212 $
21,786
Supplemental cash flow information
Cash payments for interest
$
19,162 $
7,907
Cash payments for income taxes
$
2,604 $
—
Non-cash investing activity
Assets of VIE upon consolidation
$
287,282 $
—
Third-party assumption of long-term debt secured by single-family properties sold
$
56,810 $
—
Non-cash financing activity
Liabilities of VIE upon consolidation
$
266,697 $
—
The accompanying notes are an integral part of these consolidated financial statements.
F-7
ARLINGTON ASSET INVESTMENT CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except per share amounts)
Note 1. Organization and Nature of Operations
Arlington Asset Investment Corp. (“Arlington Asset”) and its consolidated subsidiaries (unless the context otherwise provides, collectively, the
“Company”) is an investment firm that focuses primarily on investing in mortgage related assets and residential real estate. The Company’s investment
capital is currently allocated between mortgage servicing rights (“MSR”) related assets, credit investments and agency mortgage-backed securities
(“MBS”).
The Company’s MSR related assets represent investments for which the return is based on the economic performance of a pool of specific MSRs.
The Company’s credit investments generally include investments in mortgage loans secured by either residential or commercial real property or MBS
collateralized by residential or commercial mortgage loans (“non-agency MBS”) or asset-backed securities (“ABS”) collateralized by residential solar panel
loans. The Company’s agency MBS consist of residential mortgage pass-through certificates for which the principal and interest payments are guaranteed
by a U.S. government sponsored enterprise (“GSE”), such as the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan
Mortgage Corporation (“Freddie Mac”).
The Company also previously allocated investment capital to a strategy of investing in single-family residential ("SFR") properties that consisted of
acquiring, leasing and operating single-family residential homes as rental properties. During 2022, the Company sold its portfolio of SFR properties and is
currently no longer anticipating allocating capital to its SFR investment strategy.
The Company is a Virginia corporation. The Company is internally managed and does not have an external investment advisor.
The Company has elected to be taxed as a real estate investment trust (“REIT”) under the Internal Revenue Code of 1986, as amended (the “Internal
Revenue Code”). As a REIT, the Company is required to distribute annually 90% of its REIT taxable income (subject to certain adjustments). So long as
the Company continues to qualify as a REIT, it will generally not be subject to U.S. Federal or state corporate income taxes on its taxable income that it
distributes to its shareholders on a timely basis. At present, it is the Company’s intention to distribute 100% of its taxable income, although the Company
will not be required to do so. The Company intends to make distributions of its taxable income within the time limits prescribed by the Internal Revenue
Code, which may extend into the subsequent taxable year.
Note 2. Basis of Presentation
The consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) and
include the accounts of Arlington Asset and all other entities in which the Company has a controlling financial interest. All intercompany accounts and
transactions have been eliminated in consolidation.
The preparation of financial statements in conformity with GAAP requires the Company to make estimates and assumptions that affect amounts
reported in the consolidated financial statements. Although the Company bases these estimates and assumptions on historical experience and all other
reasonably available information that the Company believes to be relevant under the circumstances, such estimates frequently require management to
exercise significant subjective judgment about matters that are inherently uncertain. Actual results may differ materially from these estimates.
Certain prior period amounts in the consolidated financial statements and the accompanying notes may have been reclassified to conform to the
current year’s presentation. These reclassifications had no impact on the previously reported net income, total assets or total liabilities.
Note 3. 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 December 31, 2022 and 2021, approximately 84% and 67%, respectively, of the Company’s cash equivalents were invested in money
market funds that invest primarily in U.S. Treasuries and other securities backed by the U.S. government.
F-8
Investment Security Purchases and Sales
Purchases and sales of investment securities are recorded on the settlement date of the transfer unless the trade qualifies as a “regular-way” trade and
the associated commitment qualifies for an exemption from the accounting guidance applicable to derivative instruments. A regular-way trade is an
investment security purchase or sale transaction that is expected to settle within the period of time following the trade date that is prevalent or traditional for
that specific type of security. Any amounts payable or receivable for unsettled security trades are recorded as “sold securities receivable” or “purchased
securities payable” in the consolidated balance sheets.
Interest Income Recognition for Investments in Agency MBS, Mortgage Loans of Consolidated VIEs and Credit Securities of High Credit Quality
The Company recognizes interest income for its investments in agency MBS, mortgage loans of consolidated variable interest entities (“VIEs”) and
credit securities that are considered to be of high credit quality (that is, those with a Standard & Poor's rating of AA or higher or an equivalent rating from
another rating agency) by applying the “interest method” permitted by GAAP, whereby purchase premiums and discounts are amortized and accreted,
respectively, as an adjustment to contractual interest income accrued at each investment’s stated interest rate. The interest method is applied at the
individual instrument level based upon each instrument’s effective interest rate. The Company calculates each instrument’s effective interest rate at the time
of purchase or initial recognition by solving for the discount rate that equates the present value of that instrument's remaining contractual cash flows
(assuming no principal prepayments) to its purchase cost. Because each instrument’s effective interest rate does not reflect an estimate of future
prepayments, the Company refers to this manner of applying the interest method as the “contractual effective interest method.” When applying the
contractual effective interest method, as principal prepayments occur, a proportional amount of the unamortized premium or unaccreted discount is
recognized in interest income such that the contractual effective interest rate on any remaining security or loan balance is unaffected.
For mortgage loans of consolidated VIEs, the Company ceases the accrual of interest income (i.e., places the loan in non-accrual status) when it
believes collectability of principal and interest in full is not reasonably assured, which generally occurs when a loan is three or more monthly payments past
due, unless the loan is well secured and in the process of collection based upon an individual loan assessment. Upon placing a loan in non-accrual status,
any previously accrued but uncollected interest is derecognized and a corresponding reduction to current period interest income is recorded. While a loan is
in non-accrual status, the Company recognizes interest income only when interest payments occur.
Interest Income Recognition for Investments in Other Credit Securities and MSR Financing Receivables
The Company recognizes interest income for its investments in credit securities (other than those considered to be of high credit quality) and MSR
financing receivables by applying the prospective level-yield methodology required by GAAP for financial assets that are either not of high credit quality at
the time of acquisition or can be contractually prepaid or otherwise settled in such a way that the Company would not recover substantially all of its
recorded investment. The amount of periodic interest income recognized is determined by applying the investment’s effective interest rate to its amortized
cost basis (or “reference amount”). At the time of acquisition, the investment’s effective interest rate is calculated by solving for the single discount rate that
equates the present value of the Company’s best estimate of the amount and timing of the cash flows expected to be collected from the investment to its
purchase cost. To prepare its best estimate of cash flows expected to be collected, the Company develops a number of assumptions about the future
performance of the pool of loans that serve as collateral for its investment, including assumptions about the timing and amount of prepayments and credit
losses. For investments in MSR financing receivables, the Company's estimate of cash flows expected to be collected reflects all components of its
mortgage servicing counterparty's payment obligation, which is comprised of cash flows referenced to the monthly net cash flows of the underlying
reference pool of MSRs net of (i) the counterparty's periodic interest payments and principal repayments related to advances obtained via its third-party
secured financing facility collateralized by MSRs to which the Company's MSR financing receivables are referenced and (ii) fees payable to the
counterparty. In each subsequent quarterly reporting period, the amount and timing of cash flows expected to be collected from the investment are re-
estimated based upon current information and events. The following table provides a description of how periodic changes in the estimate of cash flows
expected to be collected affect interest income recognition prospectively for investments in credit securities and MSR financing receivables:
Scenario:
Effect on Interest Income Recognition for Investments
in Credit Securities and MSR Financing Receivables:
F-9
A positive change in cash flows occurs.
Actual cash flows exceed prior estimates and/or a
positive change occurs in the estimate of expected
remaining cash flows.
A revised effective interest rate is calculated and applied prospectively such that the positive
change in cash flows is recognized as incremental interest income over the remaining life of the
investment.
The amount of periodic interest income recognized over the remaining life of the investment will
be reduced accordingly. Generally, the investment’s effective interest rate is reduced accordingly
and applied on a prospective basis. However, if the revised effective interest rate is negative, the
investment’s existing effective interest rate is retained while the reference amount to which the
existing effective interest rate will be prospectively applied is reduced to the present value of cash
flows expected to be collected, discounted at the investment’s existing effective interest rate.
An adverse change in cash flows occurs.
Actual cash flows fall short of prior estimates
and/or an adverse change occurs in the estimate of
expected remaining cash flows.
Earnings (Loss) Per Share
Basic earnings (loss) per share includes no dilution and is computed by dividing net income or loss applicable to common stock by the weighted-
average number of common shares outstanding for the respective period. Diluted earnings per share includes the impact of dilutive securities such as
unvested shares of restricted stock, restricted stock units, and performance share units. The following table presents the computations of basic and diluted
earnings (loss) per share for the periods indicated:
Year Ended December 31,
(Shares in thousands)
2022
2021
Basic weighted-average common shares outstanding
28,717
32,312
Performance share units, unvested restricted stock units,
and unvested restricted stock
526
—
Diluted weighted-average common shares outstanding
29,243
32,312
Net income (loss) available (attributable) to common stock
$
2,642 $
(12,431)
Basic earnings (loss) per common share
$
0.09 $
(0.38)
Diluted earnings (loss) per common share
$
0.09 $
(0.38)
The diluted loss per share for the year ended December 31, 2021 did not include the antidilutive effect of 314,376 shares of unvested shares of
restricted stock, restricted stock units, and performance share units.
Other Significant Accounting Policies
The Company’s other significant accounting policies are described in the following notes:
Investments in agency MBS, subsequent measurement
Note 4
Investments in credit securities, subsequent measurement
Note 5
Loans held for investment, subsequent measurement
Note 6
Investments in MSR financing receivables, subsequent measurement
Note 7
Investments in single-family residential properties
Note 8
Consolidation of variable interest entities
Note 9
Borrowings
Note 10
To-be-announced agency MBS transactions, including “dollar rolls”
Note 11
Derivative instruments
Note 11
Balance sheet offsetting
Note 12
Fair value measurements
Note 13
Income taxes
Note 14
Stock-based compensation
Note 17
F-10
Recent Accounting Pronouncements
The following table provides a brief description of recently issued accounting pronouncements and their actual or expected effect on the Company’s
consolidated financial statements:
Standard
Description
Date of
Adoption
Effect on the Consolidated
Financial Statements
Recently Issued Accounting Guidance Not Yet Adopted
ASU Nos. 2020-04, 2021-01,
and 2022-06, Reference Rate
Reform (Topic 848)
The amendments in these updates provide optional practical
expedients and exceptions for applying GAAP to the
modification of receivables, debt or lease contracts as well
as cash flow and fair value hedge accounting relationships
that reference a rate, such as the London Interbank Offered
Rate (“LIBOR”), that is expected to be discontinued because
of reference rate reform.
The practical expedients and exceptions provided by these
updates are effective from March 12, 2020 through
December 31, 2024.
Not yet adopted.
To date, any modifications due to
reference rate reform have not had a
material impact to the Company.
The Company has not elected to
apply hedge accounting for financial
reporting purposes.
The Company does not currently
expect the adoption of ASU Nos.
2020-04, 2021-01 and 2022-06 to
have a material effect on its
consolidated financial statements.
Note 4. 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 December 31, 2022 and 2021, the fair value of the Company’s
investments in agency MBS was $443,540 and $483,927, respectively. As of December 31, 2022 and 2021, all of the Company’s investments in agency
MBS represent undivided (or “pass-through”) beneficial interests in specified pools of fixed-rate mortgage loans.
All periodic changes in the fair value of agency MBS that are not attributed to interest income are recognized as a component of “investment and
derivative gain (loss), net” in the accompanying consolidated statements of comprehensive income. The following table provides additional information
about the gains and losses recognized as a component of “investment and derivative gain (loss), net” in the Company’s consolidated statements of
comprehensive income for the periods indicated with respect to investments in agency MBS:
Year Ended December 31,
2022
2021
Net gains (losses) recognized in earnings for:
Agency MBS still held at period end
$
(21,522) $
(15,116)
Agency MBS sold during the period
(32,365)
(13,249)
Total
$
(53,887) $
(28,365)
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 11.
Derivative Instruments” for further information about dollar rolls.
Note 5. Investments in Credit Securities
The Company has elected to classify its investments in credit securities as trading securities. Accordingly, the Company’s investments in credit
securities are reported in the accompanying consolidated balance sheets at fair value. As of December 31, 2022 and 2021, the fair value of the Company’s
investments in credit securities was $104,437 and $26,222, respectively. As of December 31, 2022, the Company’s investments in credit securities
primarily consist of non-agency MBS collateralized by pools of business purpose residential mortgage loans or commercial mortgage loans and ABS
collateralized by pools of residential solar panel loans.
All periodic changes in the fair value of credit securities that are not attributed to interest income are recognized as a component of “investment and
derivative gain (loss), net” in the accompanying consolidated statements of comprehensive income. The following
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table provides additional information about the gains and losses recognized as a component of “investment and derivative gain (loss), net” in the
Company’s consolidated statements of comprehensive income for the periods indicated with respect to investments in credit securities:
Year Ended December 31,
2022
2021
Net gains (losses) recognized in earnings for:
Credit securities still held at period end
$
(3,383) $
(375)
Credit securities sold during the period
(1,036)
1,511
Total
$
(4,419) $
1,136
Note 6. Loans Held for Investment
As of December 31, 2022 and 2021, the Company held a loan secured by a first lien position in healthcare facilities and guaranteed by the operator
of the facilities with an outstanding principal balance of $29,264 and $29,697, respectively. The loan bears interest at a floating note rate equal to SOFR
plus 5.61%. The original maturity date of the loan was March 23, 2022 with a one-year extension available at the option of the borrower. On March 23,
2022, the borrower exercised its one-year extension option resulting in a new maturity date of March 23, 2023. The loan has monthly principal
amortization based upon a 30-year amortization schedule with the remaining principal balance due at loan maturity.
As of December 31, 2022 and 2021, the Company was party to a participation agreement pursuant to which the Company has committed to fund up
to $30,000 of a $130,000 revolving credit facility that matures on July 7, 2024. Under the terms of the participation agreement, the Company funds the last
$30,000 of advances under the revolving credit facility. Any draws under the revolving credit facility bear interest at SOFR plus 3.86% with a SOFR floor
of 1.00% and are secured by a first lien on all accounts receivable and a second lien on all other assets of the borrower. The borrower is also required to
pay an unused commitment fee of 0.50%. As of December 31, 2022 and 2021, the Company’s funded loan advances were $4,914 and $0, respectively,
which are included in the line item "other assets" in the accompanying consolidated balance sheets. As of December 31, 2022 and 2021, the Company's
unfunded commitment was $25,086 and $30,000, respectively. Subsequent to December 31, 2022, the Company's loan advances were repaid in full.
The Company has elected to account for its loans held for investment at fair value on a recurring basis with periodic changes in fair value recognized
as a component of “investment and derivative gain (loss), net” in the accompanying consolidated statements of comprehensive income. As of December
31, 2022 and 2021, the Company’s loans held for investment were $34,178 and $29,697, respectively, at fair value. The Company recognizes interest
income on its loans held for investment based upon the effective interest rate of the loans which is equal to the contractual note rate of each loan.
Note 7. Investments in MSR Financing Receivables
The Company does not hold the requisite licenses to purchase or hold MSRs directly. However, the Company has entered into agreements with a
licensed, GSE approved residential mortgage loan servicer that enable the Company to garner the economic return of an investment in an MSR purchased
by the mortgage servicing counterparty through an MSR financing transaction. Under the terms of the arrangement, for an MSR acquired by the mortgage
servicing counterparty (i) the Company purchases the “excess servicing spread” from the mortgage servicer counterparty, entitling the Company to monthly
distributions of the servicing fees collected by the mortgage servicing counterparty in excess of 12.5 basis points per annum (and to distributions of
corresponding proceeds of sale of the MSRs), and (ii) the Company funds the balance of the MSR purchase price to the parent company of the mortgage
servicing counterparty and, in exchange, has an unsecured right to payment of certain amounts determined by reference to the MSR, generally equal to the
servicing fee revenue less the excess servicing spread and the costs of servicing (and to distributions of corresponding proceeds of sale of the MSRs), net of
fees earned by the mortgage servicing counterparty and its affiliates including an incentive fee equal to a percentage of the total return of the MSR in excess
of a hurdle rate of return. The Company has committed to invest a total minimum of $50,000 in capital with the counterparty with $25,000 of the minimum
commitment expiring on December 31, 2023 and $25,000 of the minimum commitment expiring on April 1, 2024. As of December 31, 2022, the
Company has fully funded its minimum capital commitment.
Under the arrangement, the Company is obligated to provide funds to the mortgage servicing counterparty to fund the counterparty’s advances of
payments on the serviced pool of mortgage loans. The mortgage servicing counterparty is required to return to the Company subsequent servicing advances
collected from the underlying borrowers. The mortgage servicing counterparty is entitled to reimbursement from the GSEs of any servicing advances that
are not subsequently collected from the underlying borrowers. As of December 31, 2022 and 2021, the Company had provided funds of $6,046 and $3,731,
respectively, to its mortgage servicing counterparty related to the counterparty’s servicing advances made pursuant to the MSRs to which the Company’s
MSR financing receivables are referenced.
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As a means to increase potential returns to the Company, at the Company’s election, it can request the mortgage servicing counterparty utilize
leverage on the MSRs to which the Company’s MSR financing receivables are referenced to finance the purchase of additional MSRs. As of December 31,
2022 and 2021, the Company’s counterparty had drawn $7,863 and $40,398, respectively, of financing secured by the MSRs to which the Company’s MSR
financing receivables are referenced.
The Company accounts for transactions executed under its arrangement with the mortgage servicing counterparty as financing transactions and
reflects the associated financing receivables in the line item “MSR financing receivables” on its consolidated balance sheets. The Company has elected to
account for its MSR financing receivables at fair value with changes in fair value that are not attributed to interest income recognized as a component of
“investment and derivative gain (loss), net” in the accompanying consolidated statements of comprehensive income. As described in further detail in “Note
3. Summary of Significant Accounting Policies,” the Company recognizes interest income for MSR financing receivables by applying the prospective
level-yield methodology required by GAAP for financial assets that are either not of high credit quality at the time of acquisition or can be contractually
prepaid or otherwise settled in such a way that the Company would not recover substantially all of its recorded investment.
As of December 31, 2022 and 2021, the fair value of the Company’s investments in MSR financing receivables was $180,365 and $125,018,
respectively. The following table presents activity related to the carrying value of the Company’s investments in MSR financing receivables for the periods
indicated:
Year Ended December 31,
2022
2021
Balance at period beginning
$
125,018 $
9,346
Capital investments
83,392
100,873
Capital distributions
(75,176)
(5,666)
Accretion of interest income
15,419
6,282
Changes in valuation inputs and assumptions
31,712
14,183
Balance at period end
$
180,365 $
125,018
Note 8. Investments in Single-Family Residential Properties
The Company previously allocated investment capital to a strategy of investing in SFR properties that consisted of acquiring, leasing and operating
single-family residential homes as rental properties. During 2022, the Company sold its portfolio of SFR properties and is currently no longer anticipating
allocating capital to its SFR investment strategy. The Company conducted its SFR investment strategy through a wholly-owned subsidiary, McLean SFR
Investment, LLC ("McLean SFR").
To execute its strategy of investing in SFR properties, the Company entered into an agreement with a third-party investment advisory firm to
identify, acquire and manage investments in SFR properties on behalf of the Company. Under the terms of the agreement, the Company had committed to
fund up to $55,000 of capital to fund the acquisition of SFR properties. On January 18, 2023, the Company's capital commitment amount was reduced to
zero as a result of its sale of its remaining portfolio of SFR properties on December 1, 2022. Under the terms of its agreement, the Company is obligated to
pay the third-party firm a minimum fee plus an incentive fee equal to a percentage of the total investment return in excess of a hurdle rate of return. If the
Company were to terminate the agreement with the third-party investment firm, the Company would incur a termination fee equal to a fixed amount less
inception to date minimum fees paid to the third-party firm. As of December 31, 2022, the Company expects to terminate its agreement with the third-party
investment firm. Accordingly, the Company accrued a termination fee as of December 31, 2022.
The Company’s investments in SFR properties were initially recognized on the settlement date of their acquisition at cost. The Company allocated
the initial acquisition cost of each property to land and building on the basis of their relative fair values at the time of acquisition. To determine the relative
fair value of land and building at the time of acquisition, the Company used available market data, such as property specific county tax assessment records.
Subsequent to the acquisition of a property, expenditures which improved or extended the life of the property were capitalized as a component of the
property’s cost basis. Expenditures for ordinary maintenance and repairs were recognized as an expense as incurred and were reported as a component of
“single-family property operating expenses” in the Company’s consolidated statements of comprehensive income.
The Company subsequently recognized depreciation of each property’s buildings and capitalized improvements over the expected useful lives of
those assets. The Company calculated depreciation on a straight-line basis over a useful life of 27.5 years for buildings and useful lives ranging from five
to 27.5 years for capitalized improvements. The Company reported depreciation expense as a component of “single-family property operating expenses” in
the Company’s consolidated statements of comprehensive income.
Pursuant to its SFR investment strategy, the Company leased its SFR properties to tenants who occupied the properties. The leases generally had
terms of one year or more and were classified as operating leases. Rental revenue, net of any concessions, was
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recognized over the term of each lease on a straight-line basis. If the Company determined that collectability of lease payments was not probable, any lease
receivables previously recognized were reversed and rental revenue was limited to cash received.
Costs directly associated with the origination of a lease, such as a commission paid to a property manager when a lease agreement was obtained,
were deferred at the commencement of the lease and subsequently recognized ratably as an expense over the lease term, consistent with the recognition of
rental revenue from the lease. The ratable expense recognition of lease direct costs was reported as a component of “single-family property operating
expenses” in the Company’s consolidated statements of comprehensive income. In addition to the expense items previously mentioned, “single-family
property operating expenses” also included accruals for, but not limited to, third-party property management fees, local real estate tax assessments, utilities,
homeowners’ association dues and property insurance.
The Company evaluated its SFR properties for impairment whenever circumstances indicated that their carrying amounts may not be recoverable.
Significant indicators of potential impairment included, but were not limited to, declines in home values, adverse changes in rental or occupancy rates and
relevant unfavorable changes in the broader economy. If indicators of potential impairment existed, the Company performed a recoverability test by
comparing the property’s net carrying amount to its estimate of the undiscounted future net cash flows expected to be obtained from the use and eventual
disposition of the property. If the property’s carrying amount exceeded the Company’s estimate of the undiscounted future net cash flows expected to be
obtained from the property, the Company would have recognized an impairment loss equal to the amount that the property’s net carrying amount exceeded
the property’s estimated fair value.
From time to time, the Company identified SFR properties to be sold. At the time that any such properties were identified, the Company performed
an evaluation to determine whether or not such properties should be classified as held for sale. Factors considered as part of the Company's held for sale
evaluation process included whether the following conditions had been met: (i) the Company had committed to a plan to sell a property; (ii) the property
was immediately available for sale in its present condition; (iii) an active program to locate a buyer and other actions required to complete the plan to sell a
property had been initiated; (iv) the sale of a property was probable within one year (generally determined based upon listing for sale); (v) the property was
being actively marketed for sale at a price that was reasonable in relation to its current fair value; and (vi) actions required to complete the plan indicated
that it is unlikely that significant changes to the plan would be made or that the plan would be withdrawn. To the extent that these factors were all present,
the Company ceased depreciating the property, measured the property at the lower of its carrying amount or its fair value less estimated costs to sell, and
presented the property separately on its consolidated balance sheets.
On August 19, 2022, the Company completed a sale of 371 SFR properties for a gross sale price of $130,026 for a gain of $14,391 that is net of
accrued incentive fees to the Company's third-party investment firm.
On December 1, 2022, the Company completed a sale of McLean SFR, which included all of the Company's remaining investments in SFR
properties and its long-term debt facility secured by SFR properties, for a gross sale price of $87,050, including the assumption of the debt liability (see
Note 10 "Borrowings"), for a gain of $1,789 that is net of accrued incentive fees and termination fees to the Company's third-party investment advisory
firm.
During the year ended December 31, 2022 and 2021, the Company recognized $2,176 and $299, respectively, of depreciation expense related to its
SFR properties. The following table summarizes the Company’s net carrying amount of its SFR properties by component as of the dates indicated:
December 31, 2022
December 31, 2021
Investments in single-family residential real estate:
Land
$
— $
10,128
Buildings and improvements
—
51,060
Investments in single-family residential real estate, at cost
—
61,188
Less: accumulated depreciation
—
(299)
Investments in single-family residential real estate, net
$
— $
60,889
Note 9. Consolidation of Variable Interest Entities
The vehicles that issue the Company’s investments in securitized mortgage assets are considered VIEs. The Company is required to consolidate any
VIE in which it holds a variable interest if it determines that it holds a controlling financial interest in the VIE and is, therefore, determined to be the
primary beneficiary of the VIE. The Company is determined to be the primary beneficiary of a VIE in which it holds a variable interest if it both (i) holds
the power to direct the activities that most significantly impact the VIE’s economic performance and (ii) has the obligation to absorb losses or the right to
receive benefits that could potentially be significant to the VIE. The economic performance of the trusts that issue the Company’s investments in
securitized mortgage assets is most significantly impacted by the performance of the mortgage loans that are held by the trusts. The party that is
determined to have the most power to direct the loss mitigation actions that are taken with respect to delinquent or otherwise troubled mortgage loans held
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by the trust is, therefore, deemed to hold the most power to direct the activities that most significantly impact the trust’s economic performance. As a
passive investor, the Company does not have the power to direct the loss mitigation activities of most of the trusts that have issued its securitized mortgage
assets.
On September 30, 2020, the Company acquired for $10,693 an investment that represents a majority interest in the first loss position of a securitized
pool of business purpose residential mortgage loans. As majority holder of the first loss position, the Company is required to approve any material loss
mitigation action proposed by the servicer with respect to a troubled loan. The Company also has the option (but not the obligation) to purchase delinquent
loans from the trust. As a result of these contractual rights, the Company determined that it is the party with the most power to direct the loss mitigation
activities and, therefore, the economic performance of the trust. As holder of the majority of the first loss position issued by the trust, the Company has the
obligation to absorb losses or the right to receive benefits that could potentially be significant to the trust. Accordingly, the Company determined that it is
the primary beneficiary of the trust and consolidated the trust’s assets and liabilities owed to third parties onto its consolidated balance sheets.
On February 3, 2022, the Company acquired for $20,585 investments in the first loss position and the excess interest-only strip of a securitized pool
of recently originated, performing “non-qualified” residential mortgage loans. The Company’s investment in the excess interest-only strip provides it with
the option (but not the obligation) to purchase delinquent loans from the trust. As a result of this contractual right, the Company determined that it has the
power to circumvent the loss mitigation activities that would otherwise be performed by the servicer and, therefore, is the party with the most power to
impact the economic performance of the trust. As a result of its investments, the Company also has the obligation to absorb losses or the right to receive
benefits that could potentially be significant to the trust. Accordingly, the Company determined that it is the primary beneficiary of the trust and
consolidated the trust’s assets and liabilities owed to third parties onto its consolidated balance sheets.
The carrying values of the assets and liabilities of the consolidated VIEs, net of elimination entries, are as follows as of the dates indicated:
December 31, 2022
VIE of Business Purpose
Residential Mortgage
Loans
VIE of Residential
Mortgage Loans
Total
Cash of consolidated VIEs
$
296 $
— $
296
Restricted cash of consolidated VIEs
16
2,175
2,191
Mortgage loans of consolidated VIEs, at fair value
2,320
191,637
193,957
Other assets of consolidated VIEs
1,389
678
2,067
Secured debt of consolidated VIEs, at fair value
(200)
(169,145)
(169,345)
Other liabilities of consolidated VIEs
(1)
(261)
(262)
Net investment in consolidated VIEs
$
3,820 $
25,084 $
28,904
Restricted cash represents cash collected by the trust that must be used solely to satisfy the liabilities of the VIE owed to third-parties in the
month following collection.
December 31, 2021
VIE of Business Purpose
Residential Mortgage
Loans
VIE of Residential
Mortgage Loans
Total
Cash of consolidated VIEs
$
2,118 $
— $
2,118
Restricted cash of consolidated VIEs
111
—
111
Mortgage loans of consolidated VIEs, at fair value
7,442
—
7,442
Other assets of consolidated VIEs
547
—
547
Secured debt of consolidated VIEs, at fair value
(508)
—
(508)
Other liabilities of consolidated VIEs
(2)
—
(2)
Net investment in consolidated VIEs
$
9,708 $
— $
9,708
Restricted cash represents cash collected by the trust that must be used solely to satisfy the liabilities of the VIE owed to third-parties in the
month following collection.
The debt of the Company’s consolidated VIEs have recourse solely to the assets of the respective VIE; it has no recourse to the general credit of the
Company.
Consolidated VIE of Business Purpose Residential Mortgage Loans
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(1)
(1)
(1)
(1)
The pool of business purpose residential mortgage loans and the third-party held debt obligations of the consolidated VIE had aggregate unpaid
principal balances of $2,462 and $210, respectively, as of December 31, 2022. The pool of business purpose residential mortgage loans and the third-party
held debt obligations of the consolidated VIE had aggregate unpaid principal balances of $7,687 and $520, respectively, as of December 31, 2021. The
trust is contractually entitled to receive monthly interest payments on each underlying mortgage loan net of a loan-specific servicing and asset management
fee that is not remitted to the trust but is, rather, retained by the servicer. As of December 31, 2022 and 2021, the weighted average net note rate to which
the VIE was entitled was 6.02% and 6.05%, respectively.
The pool of business purpose residential mortgage loans held by the consolidated VIE consists of fixed-rate, short-term, interest-only mortgage
loans (with the full amount of principal due at maturity) made to professional real estate investors and are secured by first lien positions in non-owner
occupied residential real estate. The properties that secure these mortgage loans often require construction, repair or rehabilitation. The repayment of the
mortgage loans is often largely based on the ability of the borrower to sell the mortgaged property or to convert the property for rental purposes and obtain
refinancing in the form of a longer-term loan.
Consolidated VIE of Residential Mortgage Loans
The pool of mortgage loans and the third-party held debt obligations of the consolidated VIE had aggregate unpaid principal balances of $227,901
and $227,596, respectively, as of December 31, 2022. As of December 31, 2022, the weighted average contractual interest rates of the loans and
consolidated debt held by third parties were 4.77% and 1.38%, respectively.
The pool of mortgage loans of the consolidated VIE consists of performing, first lien “non-qualified” residential mortgage loans. “Non-qualified”
residential mortgage loans are loans that do not fully comply with the “ability-to-repay” rule and related guidelines of the Truth-in-Lending Act established
by the Consumer Finance Protection Bureau pursuant to the authority granted under the Dodd-Frank Act. A “qualified” residential mortgage loan (i.e., a
residential mortgage loan that fully complies with the “ability-to-repay” rule of the Truth-in-Lending Act) must meet certain debt-to-income ratio
requirements and cannot have certain features, such as an interest-only period, negative amortization, balloon payments or terms longer than 30 years.
Qualified mortgage loans have limited upfront fees and points and, generally, cannot have prepayment penalties except for limited circumstances. Lenders
of qualified mortgage loans are afforded certain legal protections not available to non-qualified mortgage loan lenders.
Accounting for Consolidated VIEs
The Company has elected to account for the mortgage loans and debt of its consolidated VIEs at fair value with changes in fair value that are not
attributed to interest income or interest expense, respectively, recognized as a component of “investment and derivative gain (loss), net” in the
accompanying consolidated statements of comprehensive income.
As described in further detail in “Note 3. Summary of Significant Accounting Policies,” the Company recognizes interest income for the mortgage
loans of its consolidated VIEs by applying the “interest method” permitted by GAAP, whereby the premium or discount recognized at the initial recognition
of each loan is amortized or accreted as an adjustment to contractual interest income accrued at the loan’s contractual interest rate. The Company ceases the
accrual of interest income for a mortgage loan (i.e., places the loan in non-accrual status) when it believes collectability of principal and interest in full is
not reasonably assured, which generally occurs when a loan is three or more monthly payments past due, unless the loan is well secured and in the process
of collection based upon an individual loan assessment. Upon placing a loan in non-accrual status, any previously accrued but uncollected interest is
derecognized and a corresponding reduction to current period interest income is recorded.
The following table presents information about the accrual status of the loans of the Company’s consolidated VIE of business purpose residential
mortgage loans as of December 31, 2022:
Aggregate Fair Value
Aggregate Unpaid
Principal Balance
Difference
Less than 90 days past due and in accrual status
$
— $
— $
—
90 days or more past due and in non-accrual status
2,320
2,462
(142)
Total mortgage loans of consolidated VIE
$
2,320 $
2,462 $
(142)
The following table presents information about the accrual status of the loans of the Company’s consolidated VIE of residential mortgage loans as of
December 31, 2022:
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Aggregate Fair Value
Aggregate Unpaid
Principal Balance
Difference
Less than 90 days past due and in accrual status
$
190,842 $
226,955 $
(36,113)
90 days or more past due and in non-accrual status
795
946
(151)
Total mortgage loans of consolidated VIE
$
191,637 $
227,901 $
(36,264)
Note 10. Borrowings
Repurchase Agreements
The Company finances the purchase of mortgage investments through repurchase agreements, which are accounted for as collateralized borrowing
arrangements. In a repurchase transaction, the Company sells a mortgage investment to a counterparty under a master repurchase agreement in exchange
for cash and concurrently agrees to repurchase the same asset at a future date in an amount equal to the cash initially exchanged plus an agreed-upon
amount of interest. Mortgage investments sold under agreements to repurchase remain on the Company’s consolidated balance sheets because the Company
maintains effective control over such assets throughout the duration of the arrangement. Throughout the contractual term of a repurchase agreement, the
Company recognizes a “repurchase agreement” liability on its consolidated balance sheets to reflect the obligation to repay to the counterparty the proceeds
received upon the initial transfer of the mortgage investment. The difference between the proceeds received by the Company upon the initial transfer of the
mortgage investment and the contractually agreed-upon repurchase price is recognized as interest expense ratably over the term of the repurchase
arrangement.
Amounts borrowed pursuant to repurchase agreements are equal in value to a specified percentage of the fair value of the pledged collateral. The
Company retains beneficial ownership of the pledged collateral throughout the term of the repurchase agreement. The counterparty to the repurchase
agreements may require that the Company pledge additional securities or cash as additional collateral to secure borrowings when the value of the collateral
declines.
The Company’s MBS repurchase agreement arrangements generally carry a fixed rate of interest and are short-term in nature with contract durations
generally ranging from 30 to 60 days, but may be as short as one day or as long as one year. The Company’s mortgage loan repurchase agreement
arrangement has a maturity date of August 23, 2023 and an interest rate that resets monthly at a rate equal to SOFR plus 2.61%. Under the terms of the
Company’s mortgage loan repurchase agreement, the Company may request extensions of the maturity date of the agreement for up to 364 days, subject to
the lender’s approval.
As of December 31, 2022 and 2021, the Company had no amount at risk with a single repurchase agreement counterparty or lender greater than 10%
of equity. The following table provides information regarding the Company’s outstanding repurchase agreement borrowings as of the dates indicated:
December 31, 2022
December 31, 2021
Agency MBS repurchase financing:
Repurchase agreements outstanding
$
406,072 $
425,836
Agency MBS collateral, at fair value
425,023
447,979
Net amount
18,951
22,143
Weighted-average rate
4.47%
0.14%
Weighted-average term to maturity
12.0 days
13.0 days
Non-agency MBS repurchase financing:
Repurchase agreements outstanding
$
88,953 $
—
MBS collateral, at fair value
98,933
—
Net amount
9,980
—
Weighted-average rate
5.02%
Weighted-average term to maturity
20.0 days
Mortgage loans repurchase financing:
Repurchase agreements outstanding
$
20,485 $
20,788
Mortgage loans collateral, at fair value
29,264
29,697
Net amount
8,779
8,909
Weighted-average rate
6.84%
2.60%
Weighted-average term to maturity
235.0 days
319.0 days
Total mortgage investments repurchase financing:
Repurchase agreements outstanding
$
515,510 $
446,624
Mortgage investments collateral, at fair value
553,220
477,676
Net amount
37,710
31,052
Weighted-average rate
4.66%
0.25%
Weighted-average term to maturity
22.2 days
27.2 days
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(1)
(2)
(2)
(2)
(1)
(2)
As of December 31, 2021, includes $28,219 at sale price of unsettled agency MBS sale commitments which is included in the line item “sold
securities receivable” in the accompanying consolidated balance sheets.
Net amount represents the value of collateral in excess of corresponding repurchase obligation. The amount of collateral at-risk is limited to the
outstanding repurchase obligation and not the entire collateral balance.
The following table provides information regarding the Company’s outstanding repurchase agreement borrowings during the years ended December
31, 2022 and 2021:
December 31, 2022
December 31, 2021
Weighted-average outstanding balance
$
388,890 $
575,615
Weighted-average rate
2.28%
0.25%
Long-Term Unsecured Debt
As of December 31, 2022 and 2021, the Company had $86,405 and $85,994, respectively, of outstanding long-term unsecured debentures, net of
unamortized debt issuance costs of $1,276 and $1,687, respectively. The Company’s long-term unsecured debentures consisted of the following as of the
dates indicated:
December 31, 2022
December 31, 2021
Senior
Notes Due 2025
Senior
Notes Due 2026
Trust
Preferred Debt
Senior
Notes Due 2025
Senior
Notes Due 2026
Trust
Preferred Debt
Outstanding
Principal
$
34,931 $
37,750 $
15,000 $
34,931 $
37,750 $
15,000
Annual Interest
Rate
6.75 %
6.000 %
LIBOR+
2.25 - 3.00 %
6.75 %
6.000 %
LIBOR+
2.25 - 3.00 %
Interest Payment
Frequency
Quarterly
Quarterly
Quarterly
Quarterly
Quarterly
Quarterly
Weighted-Average
Interest Rate
6.75 %
6.000 %
6.83 %
6.75 %
6.000 %
2.87 %
Maturity
March 15, 2025
August 1, 2026
2033 - 2035
March 15, 2025
August 1, 2026
2033 - 2035
During the year ended December 31, 2021, the Company repurchased $7 in principal balance of Senior Notes due 2023 for a purchase price of $7.
There were no repurchases of Senior Notes due 2025 and Senior Notes due 2026 during the years ended December 31, 2022 and 2021.
On July 15, 2021, the Company completed a public offering of $37,750 of 6.00% Senior Notes due 2026 and received net proceeds of $36,570 after
deducting underwriter discounts. On August 6, 2021, the Company redeemed all $23,821 in principal amount of its outstanding Senior Notes due 2023 at a
redemption price of 100% of the principal amount plus unpaid interest thereon.
The Senior Notes due 2025 and the Senior Notes due 2026 are publicly traded on the New York Stock Exchange under the ticker symbols “AIC”
and “AAIN,” respectively. The Senior Notes due 2025 and Trust Preferred Debt may be redeemed in whole or in part at any time and from time to time at
the Company’s option at a redemption price equal to the principal amount plus accrued and unpaid interest. The Senior Notes due 2026 may be redeemed in
whole or in part at any time and from time to time at the Company’s option on or after August 1, 2023 at a redemption price equal to the principal amount
plus accrued and unpaid interest. The indenture governing the Senior Notes contains certain covenants, including limitations on the Company’s ability to
merge or consolidate with other entities or sell or otherwise dispose of all or substantially all of the Company’s assets.
Long-Term Debt Secured by Single-family Residential Real Estate
On September 28, 2021, McLean SFR, a wholly-owned subsidiary of Arlington Asset, entered into a loan agreement with a third-party lender to
fund McLean SFR’s purchases of SFR properties. As a result of the sale of McLean SFR on December 1, 2022, the obligations under the loan agreement
were assumed by the acquiror of McLean SFR (see Note 8 "Investments in Single-Family Residential Properties").
Under the terms of the loan agreement, loan advances were available to be drawn up to 74% of the fair value of eligible SFR properties up to a
maximum loan amount of $150,000. Advances under the loan agreement were able to be drawn during the advance period, which would end on the earlier
of the date the outstanding principal balance equals the maximum loan amount or March 28, 2023. The outstanding principal balance was due on October
9, 2026 and advances under the loan agreement bore interest at a fixed rate of 2.76%. The loan was secured by a first priority interest in all the assets of
McLean SFR and a first priority pledge of the equity interest of McLean SFR. As of December 31, 2021, the outstanding balance was $39,178, net of
unamortized debt issuance costs of $264.
F-18
(1)
(2)
Note 11. Derivative Instruments
In the normal course of its operations, the Company is a party to financial instruments that are accounted for as derivative instruments. Derivative
instruments are recorded at fair value as either “other assets” or “other liabilities” in the consolidated balance sheets, with all periodic changes in fair value
reflected as a component of “investment and derivative gain (loss), net” in the consolidated statements of comprehensive income. Cash receipts or
payments related to derivative instruments are classified as investing activities within the consolidated statements of cash flows.
Types and Uses of Derivative Instruments
Interest Rate Hedging Instruments
The Company is party to interest rate hedging instruments that are intended to economically hedge changes, attributable to changes in benchmark
interest rates, in agency MBS and MSR financing receivable fair values and future interest cash flows on the Company’s short-term financing
arrangements. Interest rate hedging instruments may include centrally cleared interest rate swaps, exchange-traded instruments, such as U.S. Treasury note
futures, Eurodollar futures, interest rate swap futures and options on futures, and non-exchange-traded instruments such as options on agency MBS. While
the Company uses its interest rate hedging instruments to economically hedge a portion of its interest rate risk, it has not designated such contracts as
hedging instruments for financial reporting purposes.
The Company exchanges cash “variation margin” with the counterparties to its interest rate hedging instruments 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 on a one-day lag, the unsettled fair value of such instruments generally represents the change in fair
value that occurred on the last trading 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 may include 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 economically 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
F-19
statements. Accordingly, dollar roll income is recognized as a component of “investment and derivative gain (loss), net” along with all other periodic
changes in the fair value of TBA commitments.
In addition to transacting in net long positions in TBA securities for investment purposes, the Company may also, from time to time, transact in net
sale (or “net short”) positions in TBA securities for the purpose of economically hedging a portion of the sensitivity of the fair value of the Company’s
investments in agency MBS to changes in interest rates.
In addition to TBA transactions, the Company may, from time to time, enter into commitments to purchase or sell specified agency MBS that do not
qualify as regular-way security trades. Such commitments are also accounted for as derivative instruments.
Under the terms of commitments to purchase or sell TBAs or specified agency MBS, the daily exchange of variation margin may occur based on
changes in the fair value of the underlying agency MBS if a party to the transaction demands it. Receivables recognized for the right to reclaim cash
collateral posted by the Company in respect of agency MBS purchase or sale commitments is included in the line item “deposits” in the accompanying
consolidated balance sheets. Liabilities recognized for the obligation to return cash collateral received by the Company in respect of agency MBS purchase
or sale commitments is included in the line item “other liabilities” in the accompanying consolidated balance sheets.
Derivative Instrument Population and Fair Value
The following table presents the fair value of the Company’s derivative instruments as of the dates indicated:
December 31, 2022
December 31, 2021
Assets
Liabilities
Assets
Liabilities
Interest rate swaps
$
8 $
— $
— $
(107)
10-year U.S. Treasury note futures
—
—
16
—
Options on U.S. Treasury note futures
—
—
4
—
TBA commitments
5,652
(22)
230
(121)
Total
$
5,660 $
(22) $
250 $
(228)
Interest Rate Swaps
The Company’s LIBOR based interest rate swap agreements represent agreements to make semiannual interest payments based upon a fixed interest
rate and receive quarterly variable interest payments based upon the prevailing three-month LIBOR as of the preceding reset date. The Company’s Secured
Overnight Financing Rate (“SOFR”) based interest rate swap agreements represent agreements to make (or receive) annual interest payments based upon a
fixed interest rate and receive (or make) annual variable interest payments based upon the daily SOFR over the preceding annual period. As of December
31, 2022, all of the Company's interest rate swap agreements were SOFR based.
The following table presents information about the Company’s interest rate swap agreements that were in effect as of December 31, 2022:
Weighted-average:
Notional
Amount
Fixed
Receive Rate
Variable
Pay Rate
Net (Pay)
Receive Rate
Remaining
Life (Years)
Fair Value
Years to maturity:
Less than 5 years
$
60,000
3.58%
4.30%
(0.72)%
4.9 $
8
The following table presents information about the Company’s interest rate swap agreements that were in effect as of December 31, 2021:
Weighted-average:
Notional
Amount
Fixed
Pay Rate
Variable
Receive Rate
Net Receive
(Pay) Rate
Remaining
Life (Years)
Fair Value
Years to maturity:
Less than 3 years
$
50,000
0.71%
0.13%
(0.58)%
1.8 $
(5)
3 to less than 10 years
100,000
0.90%
0.13%
(0.77)%
6.6
(102)
Total / weighted-average
$
150,000
0.84%
0.13%
(0.71)%
5.0 $
(107)
F-20
U.S. Treasury Note Futures
The Company may purchase (“long”) or sell (“short”) exchange-traded U.S. Treasury note futures with the objective of economically hedging a
portion of its interest rate risk. Upon the maturity date of these futures contracts, the Company has the option to either net settle each contract in cash in an
amount equal to the difference between the then-current fair value of the underlying U.S. Treasury note and the contractual sale price inherent to the futures
contract, or to physically settle the contract by purchasing or delivering the underlying U.S. Treasury note.
As of December 31, 2022, the Company had no outstanding positions of U.S. Treasury note futures. As of December 31, 2021, the Company held
long positions of 10-year U.S. Treasury note futures with an aggregate notional amount of $25,000 with a maturity date in March 2022.
Options on U.S. Treasury Note Futures
The Company may purchase or sell exchange-traded options on U.S. Treasury note futures contracts with the objective of economically hedging a
portion of the sensitivity of its investments in agency MBS to significant changes in interest rates. The Company may purchase put or call options which
provide the Company with the right to sell to a counterparty or purchase from a counterparty U.S. Treasury note futures, and the Company may also write
put or call options that provide a counterparty with the option to sell to the Company or buy from the Company U.S. Treasury note futures. The options
may be exercised at any time prior to their expiry, and if exercised, may be net settled in cash or through physical receipt or delivery of the underlying
futures contracts.
As of December 31, 2022, the Company had no outstanding options on U.S. Treasury note futures contracts.
Information about the Company’s outstanding options on 10-year U.S. Treasury note futures contracts as of December 31, 2021 is as follows:
Notional
Amount
Long/(Short)
Weighted-
average
Strike Price
Implied Strike
Rate
Net Fair Value
Purchased call options:
January 2022 expiration
$
25,000
134.5
1.00%
$
4
The implied strike rate is estimated based upon the weighted average strike price per contract and the price of an equivalent 10-year U.S. Treasury
note futures contract.
TBA Commitments
The following tables present information about the Company’s TBA commitments as of the date indicated:
December 31, 2022
Notional Amount:
Net Purchase (Sale)
Commitment
Contractual
Forward Price
Market Price
Fair Value
3.0% 30-year MBS sale commitments
$
(70,000) $
(62,828) $
(61,516) $
1,312
4.0% 30-year MBS sale commitments
(150,000)
(142,255)
(140,830)
1,425
4.5% 30-year MBS sale commitments
(205,000)
(200,365)
(197,472)
2,893
Total TBA commitments, net
$
(425,000) $
(405,448) $
(399,818) $
5,630
December 31, 2021
Notional Amount:
Net Purchase (Sale)
Commitment
Contractual
Forward Price
Market Price
Fair Value
2.5% 30-year MBS purchase commitments
$
225,000 $
229,043 $
229,148 $
105
2.5% 30-year MBS sale commitments
(225,000)
(229,152)
(229,148)
4
Total TBA commitments, net
$
— $
(109) $
— $
109
F-21
(1)
(1)
Derivative Instrument Gains and Losses
The following table provides information about the derivative gains and losses recognized within the periods indicated:
For the Year Ended December 31,
2022
2021
Interest rate derivatives:
Interest rate swaps:
Net interest expense
$
(103) $
(2,929)
Unrealized (losses) gains, net
(4,383)
3,129
Gains realized upon early termination, net
18,015
1,960
Total interest rate swap gains, net
13,529
2,160
U.S. Treasury note futures, net
(782)
3,215
Options on U.S. Treasury note futures, net
(4)
14
Total interest rate derivatives gains, net
12,743
5,389
TBA commitments:
TBA dollar roll income
253
4,143
Other losses on TBA commitments, net
(7,509)
(11,586)
Total losses on TBA commitments, net
(7,256)
(7,443)
Total derivative gains (losses), net
$
5,487 $
(2,054)
Represents the periodic net interest settlement incurred during the period (often referred to as “net interest carry”). Also includes “price alignment
interest” income earned or expense incurred on cumulative variation margin paid or received, respectively, associated with centrally cleared interest
rate swap agreements.
Represents the price discount of forward-settling TBA purchases (sales) relative to a contemporaneously executed “spot” TBA sale (purchase),
which economically equates to net interest income (expense) that is earned (incurred) ratably over the period beginning on the settlement date of the
sale (purchase) and ending on the settlement date of the forward-settling purchase (sale).
Derivative Instrument Activity
The following tables summarize the volume of activity, in terms of notional amount, related to derivative instruments for the periods indicated:
For the Year Ended December 31, 2022
Beginning of
Period
Additions
Scheduled
Settlements
Early
Terminations
End of Period
Interest rate swaps
$
150,000 $
295,000 $
— $
(385,000) $
60,000
10-year U.S. Treasury note futures
25,000
50,000
(50,000)
(25,000)
—
Purchased call options on 10-year U.S.
Treasury note futures
25,000
—
(25,000)
—
—
TBA commitments, net
—
2,335,000
(1,910,000)
—
425,000
For the Year Ended December 31, 2021
Beginning of
Period
Additions
Scheduled
Settlements
Early
Terminations
End of Period
Interest rate swaps
$
275,000 $
750,000 $
— $
(875,000) $
150,000
2-year U.S. Treasury note futures
—
50,000
(50,000)
—
—
10-year U.S. Treasury note futures
—
590,100
(365,000)
(200,100)
25,000
Purchased call options on 10-year U.S.
Treasury note futures
—
165,200
(65,200)
(75,000)
25,000
TBA commitments, net
—
2,965,000
(2,965,000)
—
—
F-22
(1)
(2)
(1)
(2)
Cash Collateral Posted and Received for Derivative and Other Financial Instruments
The following table presents information about the cash collateral posted by the Company in respect of its derivative and other financial instruments,
which is included in the line item “deposits” in the accompanying consolidated balance sheets, for the dates indicated:
December 31, 2022
December 31, 2021
Cash collateral posted for:
Interest rate swaps (cash initial margin)
$
1,823 $
4,174
U.S. Treasury note futures (cash initial margin)
—
375
Total cash collateral posted, net
$
1,823 $
4,549
Note 12. Offsetting of Financial Assets and Liabilities
The agreements that govern certain of the Company’s derivative instruments and collateralized short-term financing arrangements provide for a right
of setoff in the event of default or bankruptcy with respect to either party to such transactions. The Company presents derivative assets and liabilities as
well as collateralized short-term financing arrangements on a gross basis.
Receivables recognized for the right to reclaim cash initial margin posted in respect of interest rate derivative instruments are included in the line
item “deposits” in the accompanying consolidated balance sheets.
The daily exchange of variation margin associated with a centrally cleared or exchange-traded derivative instrument is legally characterized as the
daily settlement of the derivative instrument itself, as opposed to a pledge of collateral. Accordingly, the Company accounts for the daily receipt or payment
of variation margin associated with its interest rate swaps and futures as a direct reduction to the carrying value of derivative asset or liability, respectively.
The carrying amount of interest rate swaps and futures reflected in the Company’s consolidated balance sheets is equal to the unsettled fair value of such
instruments; because variation margin is exchanged on a one-day lag, the unsettled fair value of such instruments generally represents the change in fair
value that occurred on the last day of the reporting period.
The following tables present information, as of the dates indicated, about the Company’s derivative instruments, short-term borrowing arrangements,
and associated collateral, including those subject to master netting (or similar) arrangements:
As of December 31, 2022
Gross Amount
Recognized
Amount
Offset
in the
Consolidated
Balance
Sheets
Net Amount
Presented in
the
Consolidated
Balance Sheets
Gross Amount Not Offset in the
Consolidated Balance Sheets
Net
Amount
Financial
Instruments
Cash
Collateral
Assets:
Derivative instruments:
TBA commitments
$
5,652 $
— $
5,652 $
(22 ) $
— $
5,630
Interest rate swaps
8
—
8
—
—
8
Total derivative instruments
5,660
—
5,660
(22 )
—
5,638
Total assets
$
5,660 $
— $
5,660 $
(22 ) $
— $
5,638
Liabilities:
Derivative instruments:
TBA commitments
$
22 $
— $
22 $
(22 ) $
— $
—
Total derivative instruments
22
—
22
(22 )
—
—
Repurchase agreements
515,510
—
515,510
(515,510 )
—
—
Total liabilities
$
515,532 $
— $
515,532 $
(515,532 ) $
— $
—
F-23
(1)
(2)
As of December 31, 2021
Gross Amount
Recognized
Amount
Offset
in the
Consolidated
Balance
Sheets
Net Amount
Presented in
the
Consolidated
Balance Sheets
Gross Amount Not Offset in the
Consolidated Balance Sheets
Net
Amount
Financial
Instruments
Cash
Collateral
Assets:
Derivative instruments:
TBA commitments
$
230 $
— $
230 $
(105 ) $
— $
125
10-year U.S. Treasury note futures
16
—
16
—
—
16
Options on U.S. Treasury note futures
4
—
4
—
—
4
Total derivative instruments
250
—
250
(105 )
—
145
Total assets
$
250 $
— $
250 $
(105 ) $
— $
145
Liabilities:
Derivative instruments:
Interest rate swaps
$
107 $
— $
107 $
— $
(107 ) $
—
TBA commitments
121
—
121
(105 )
—
16
Total derivative instruments
228
—
228
(105 )
(107 )
16
Repurchase agreements
446,624
—
446,624
(446,624 )
—
—
Total liabilities
$
446,852 $
— $
446,852 $
(446,729 ) $
(107 ) $
16
Does not include the fair value amount of financial instrument collateral pledged in respect of repurchase agreements that exceeds the associated
liability presented in the consolidated balance sheets.
Does not include the amount of cash collateral pledged in respect of derivative instruments and repurchase agreements that exceeds the associated
liability presented in the consolidated balance sheets.
Note 13. Fair Value Measurements
Fair Value of Financial Instruments
The accounting principles related to fair value measurements define fair value as the price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants at the measurement date. Financial Accounting Standards Board Accounting Standards
Codification Topic 820, Fair Value Measurements and Disclosures, establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used
to measure fair value into three broad levels, giving the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the
lowest priority to unobservable inputs (Level 3) as described below:
Level 1 Inputs - Unadjusted quoted prices in active markets for identical assets or liabilities that are accessible by the Company at the measurement
date;
Level 2 Inputs - Quoted prices in markets that are not active or financial instruments for which all significant inputs are observable, either directly or
indirectly; and
Level 3 Inputs - Unobservable inputs for the asset or liability, including significant judgments made by the Company about the assumptions that a
market participant would use.
The Company measures the fair value of the following assets and liabilities:
Investments in Financial Assets
Agency MBS – The Company’s investments in agency MBS are classified within Level 2 of the fair value hierarchy. Inputs to fair value
measurements of the Company’s investments in agency MBS include price estimates obtained from third-party pricing services. In determining fair value,
third-party pricing services use a market approach. The inputs used in the fair value measurements performed by the third-party pricing services are based
upon readily observable transactions for securities with similar characteristics (such as issuer/guarantor, coupon rate, stated maturity, and collateral pool
characteristics) occurring on the measurement date. The Company makes inquiries of the third-party pricing sources and reviews their documented
valuation methodologies to understand the significant inputs and assumptions used to determine prices. The Company reviews the various third-party fair
value estimates and performs procedures to validate their reasonableness, including comparison to recent trading activity for similar securities and an
overall review for consistency with market conditions observed as of the measurement date.
Credit securities – The Company's investments in commercial MBS are classified within Level 2 of the fair value hierarchy. Inputs to fair value
measurements of the Company's investments in commercial MBS include quoted prices for similar assets in recent market transactions and estimates
obtained from third-party sources including pricing services and dealers. In determining fair value, third-party pricing sources use a market approach. The
inputs used in the fair value measurements performed by third-party pricing sources are based upon observable transactions for securities with similar
characteristics. The Company reviews the third-party fair
F-24
(1)
(2)
(1)
(2)
value estimates and performs procedures to validate their reasonableness, including comparisons to recent trading activity observed for similar securities as
well as an internally derived discounted future cash flow measurement. The Company’s investments in a non-agency MBS collateralized by a pool of
business purpose residential mortgage loans and ABS collateralized by residential solar panel loans are classified within Level 3 of the fair value hierarchy.
To measure the fair value of the Company’s non-agency MBS investment secured by a pool of business purpose residential mortgage loans, the
Company uses an income approach by preparing an estimate of the present value of the amount and timing of the cash flows expected to be collected from
the security over its expected remaining life. To prepare the estimate of cash flows expected to be collected, the Company uses significant judgment to
develop assumptions about the future performance of the pool of business purpose residential mortgage loans that serve as collateral, including loan-level
probabilities of default and loss-given-default. As of December 31, 2022 and 2021, the remaining population of business purpose residential mortgage
loans serving as collateral to the Company's non-agency MBS investment represented less than 5% and 10% of the original collateral pool, respectively.
Because the repayment of business purpose residential 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, relatively high delinquency and default rates are
common and expected attributes of this asset class. The following table presents the weighted-average of the significant inputs to the fair value
measurement of the Company’s non-agency MBS secured by business purpose residential mortgage loans as of dates indicated:
December 31, 2022
December 31, 2021
Probability of default
27.8%
77.7%
Loss-given-default
18.3%
15.8%
Inputs to fair value measurements of the Company’s investments in ABS collateralized by residential solar panel loans includes quoted prices
obtained from dealers and, when available, observable market information for the same or similar securities. In determining fair value, dealers may use a
market approach or an income approach, depending upon the type and level of relevant market information available as of the measurement date. The
significant inputs used in the fair value measurements performed by dealers are often unobservable as ABS collateralized by residential solar panel loans
trade infrequently. The Company reviews the fair value estimates obtained from dealers and performs procedures to validate their reasonableness, including
comparisons to an internally derived discounted future cash flow measurement and, when available, recent trading activity observed for similar securities.
Loans – The Company’s commercial mortgage loan investment is classified within Level 3 of the fair value hierarchy. To measure the fair value of
its mortgage loan investment, the Company uses an income approach by preparing an estimate of the present value of the expected future cash flows of the
loan over its expected remaining life, discounted at a current market rate. The significant unobservable inputs to the fair value measurement of the
Company’s mortgage loan investment are the estimated probability of default and the discount rate, which is based on current market yields and interest
rate spreads for a similar loan. As of December 31, 2022, the estimated probability of default and discount rate for the Company’s mortgage loan
investment were 0% and 10.0%, respectively. As of December 31, 2021, the estimated probability of default and discount rate for the Company’s mortgage
loan investment were 0% and 5.6%, respectively.
Mortgage loans and secured debt of consolidated VIEs – The Company has elected to apply a fair value measurement practical expedient permitted
by GAAP to measure the fair value of the mortgage loans and debt obligations of its consolidated VIEs. The fair value measurement practical expedient is
permitted to be applied to consolidated “collateralized financing entities,” which are VIEs for which the financial liabilities of the VIE have contractual
recourse solely to the financial assets of the VIE.
As of December 31, 2022 and 2021, pursuant to the practical expedient, the Company measured the fair value of both the mortgage loans and the
debt obligations of its consolidated VIE of business purpose residential mortgage loans based upon the fair value of the mortgage loans of the VIE. As of
December 31, 2021, the senior debt obligations of the consolidated VIE had been fully extinguished and only the subordinate debt obligation of the
consolidated VIE remained. The business purpose residential mortgage loans and subordinate debt obligation of the consolidated VIE are classified within
Level 3 of the fair value hierarchy. To measure the fair value of the business purpose residential mortgage loans of the consolidated VIE as of December
31, 2022 and 2021, the Company used significant judgment to develop assumptions about the future performance of each business purpose residential
mortgage loan, which included determining loan-level probabilities of default and loss-given-default. As of December 31, 2022 and December 31, 2021,
the remaining population of business purpose residential mortgage loans represented less than 5% and 10% of the original collateral pool, respectively.
Because the repayment of business purpose residential 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, relatively high delinquency and default rates are
common and expected attributes of this asset class. The following table presents the weighted-average of the significant inputs to the fair value
measurement of the business purpose residential mortgage loans of the Company’s consolidated VIE as of the periods indicated:
F-25
December 31, 2022
December 31, 2021
Probability of default
44.1%
66.2%
Loss-given-default
11.3%
8.6%
As of December 31, 2022, the Company measured the fair value of both the residential mortgage loans and the debt obligations of its consolidated
VIE of residential mortgage loans based upon the fair value of the debt obligations as the fair value of the debt securities issued by the VIE were more
observable to the Company than the fair value of the underlying mortgage loans.
The senior and mezzanine debt obligations of the consolidated VIE of residential mortgage loans are classified within Level 2 of the fair value
hierarchy. Inputs to the fair value measurements of the senior and mezzanine debt obligations of the consolidated VIE include quoted prices for similar
assets in recent market transactions and estimates obtained from third-party pricing sources, including pricing services and dealers. In determining fair
value, third-party pricing sources use a market approach. The inputs used in the fair value measurements performed by third-party pricing sources were
based upon observable transactions for securities with similar characteristics.
The residential mortgage loans and the subordinate and excess interest-only debt obligations of the consolidated VIE of residential mortgage loans
(held by the Company as investments and eliminated against the associated debt of the VIE in consolidation) are classified within Level 3 of the fair value
hierarchy. To measure the fair value of the subordinate and excess interest-only debt obligations of the consolidated VIE of residential mortgage loans, the
Company uses an income approach by preparing an estimate of the present value of the amount and timing of the cash flows expected to be collected from
each security over its expected remaining life. To prepare the estimate of cash flows expected to be collected, the Company uses significant judgment to
develop assumptions about the future performance of the pool of residential mortgage loans that serve as collateral, including assumptions about the timing
and amount of credit losses and prepayments. The significant unobservable inputs to the fair value measurement include the estimated rate of prepayment,
rate of default and loss-given-default for the underlying pool of mortgage loans as well as the discount rate, which represents a market participant’s current
required rate of return for a similar instrument. The following table presents the weighted-average of the significant inputs to the fair value measurement of
the subordinate and excess interest-only debt obligations of its consolidated VIE of residential mortgage loans as of December 31, 2022:
Subordinate Debt Obligation
Excess Interest-Only Debt
Obligations
Annualized voluntary prepayment rate
10.0%
10.0%
Annualized default rate
0.5%
0.5%
Loss-given-default
17.5%
17.5%
Discount rate
7.8%
17.7%
MSR financing receivables – The Company’s MSR financing receivables are classified within Level 3 of the fair value hierarchy. The Company
uses a nationally recognized, independent third-party mortgage analytics and valuation firm to estimate the fair value of the underlying MSRs from which
the Company’s MSR financing receivables primarily derive their value. The third-party valuation firm estimates the fair value of the underlying MSRs
using a discounted cash flow analysis using their proprietary prepayment models and market analysis. The Company corroborates the third-party valuation
firm’s estimate of the fair value of the underlying MSRs and evaluates the estimate for reasonableness. The significant unobservable inputs to the fair value
measurement of the underlying MSRs include the following:
•
the discount rate, which represents a market participant’s current required rate of return for similar MSRs;
•
expected rates of prepayment within the serviced pools of mortgage loans; and
•
annual per-loan cost of servicing.
The following table presents the significant unobservable inputs to the fair value measurement of the MSRs underlying the Company’s MSR
financing receivables as of the periods indicated:
December 31, 2022
December 31, 2021
Discount rate
8.5%
9.0%
Annualized prepayment rate
7.0%
10.1%
Annual per-loan cost of servicing (current loans)
$
65.00 $
65.00
Pursuant to the Company’s MSR financing receivable arrangements, upon the consummation of three-year performance periods ending December
31, 2023 and April 1, 2024, the Company’s mortgage servicing counterparty is entitled to an incentive fee payment equal to a percentage of the total return
of the underlying MSRs in excess of a hurdle rate of return. Accordingly, the fair value of the
F-26
Company’s MSR financing receivables reflects the present value of any expected incentive fee payment that would be owed to its counterparty. The
present value of the expected incentive fee payment is estimated based upon the timing and amount of capital contributions from (and cash distributions to)
the Company to (from) its mortgage servicing counterparty to date as well as the future expected cash flows from the MSR financing receivables over the
remaining performance periods, which is derived from the current fair value of the underlying reference MSRs. As of December 31, 2022 and 2021, the
present value of the expected incentive fee payment reflected in the fair value of the Company’s MSR financing receivables was $12,568 and $3,820,
respectively.
Derivative instruments
Exchange-traded derivative instruments - Exchange-traded derivative instruments, which include U.S. Treasury note futures, Eurodollar futures,
interest rate swap futures, and options on futures, are classified within Level 1 of the fair value hierarchy as they are measured using quoted prices for
identical instruments in liquid markets.
Interest rate swaps - Interest rate swaps are classified within Level 2 of the fair value hierarchy. The fair values of the Company’s centrally cleared
interest rate swaps are measured using the daily valuations reported by the clearinghouse through which the instrument was cleared. In performing its end-
of-day valuations, the clearinghouse constructs forward interest rate curves (for example, three-month LIBOR or SOFR forward rates) from its specific
observations of that day’s trading activity. The clearinghouse uses the applicable forward interest rate curve to develop a market-based forecast of future
remaining contractually required cash flows for each interest rate swap. Each market-based cash flow forecast is then discounted using the SOFR curve
(sourced from the Federal Reserve Bank of New York) to determine a net present value amount which represents the instrument’s fair value.
Forward-settling purchases and sales of TBA securities – Forward-settling purchases and sales of TBA securities are classified within Level 2 of the
fair value hierarchy. The fair value of each forward-settling TBA contract is measured using price estimates obtained from a third-party pricing service,
which are based upon readily observable transaction prices occurring on the measurement date for forward-settling contracts to buy or sell TBA securities
with the same guarantor, contractual maturity, and coupon rate for delivery on the same forward settlement date as the commitment under measurement.
Other
Long-term unsecured debt - As of December 31, 2022 and 2021, the carrying value of the Company’s long-term unsecured debt was $86,405 and
$85,994, respectively, net of unamortized debt issuance costs, and consists of Senior Notes and trust preferred debt issued by the Company. The Company’s
estimate of the fair value of long-term unsecured debt is $79,900 and $84,821 as of December 31, 2022 and 2021, respectively. The Company’s Senior
Notes, which are publicly traded on the New York Stock Exchange, are classified within Level 1 of the fair value hierarchy. Trust preferred debt is
classified within Level 2 of the fair value hierarchy as the fair value is estimated based on the quoted prices of the Company’s publicly traded Senior Notes.
Long-term debt secured by single-family properties - As of December 31, 2021, the carrying value of the Company’s long-term debt secured by
single-family properties was $39,178, net of unamortized debt issuance costs. As of December 31, 2021, the Company’s estimate of the fair value of its
long-term debt secured by single-family properties was $38,562. The Company’s long-term debt secured by single-family properties is classified within
Level 3 of the fair value hierarchy.
Investments in equity securities of publicly-traded companies - As of December 31, 2022 and 2021, the Company had investments in equity
securities of publicly-traded companies at fair value of $234 and $5,267, respectively, which are included in the line item “other assets” in the
accompanying consolidated balance sheets. Investments in publicly traded stock are classified within Level 1 of the fair value hierarchy as their fair value
is measured based on unadjusted quoted prices in active exchange markets for identical assets.
Investments in equity securities of non-public companies and investment funds - As of December 31, 2022 and 2021, the Company had investments
in equity securities of non-public companies and investment funds measured at fair value of $2,964 and $7,388, respectively, which are included in the line
item “other assets” in the accompanying consolidated balance sheets.
Investments in equity securities of non-public companies and investment funds are classified within Level 3 of the fair value hierarchy. The fair
values of the Company’s investments in equity securities of non-public companies and investment funds are not readily determinable. Accordingly, the
Company estimates fair value by estimating the enterprise value of the investee which it then allocates to the investee’s securities in the order of their
preference relative to one another. To estimate the enterprise value of the investee, the Company uses traditional valuation methodologies based on income
and market approaches, including the consideration of recent investments in, or tender offers for, the equity securities of the investee, a discounted cash
flow analysis and a comparable guideline public company valuation. The primary unobservable inputs used in estimating the fair value of an equity security
of a non-public company include (i) a stock price to net asset multiple for similar public companies that is applied to the entity’s net assets, (ii) a discount
factor for lack of marketability and control, and (iii) a cost of equity discount rate, used to discount to present value the equity cash flows available for
distribution and the terminal value of the entity. As of December 31, 2022, the stock price to net asset multiple for similar public companies, the discount
factor for lack of marketability and control, and the cost of equity discount rate used as inputs were 97 percent, 15 percent, and 16 percent, respectively. As
of December 31, 2021, the stock price to net asset
F-27
multiple for similar public companies, the discount factor for lack of marketability and control, and the cost of equity discount rate used as inputs were 95
percent, 15 percent, and 16 percent, respectively. For its investments in investment funds, the Company estimates fair value based upon the investee’s net
asset value per share.
Financial assets and liabilities for which carrying value approximates fair value - Cash and cash equivalents, restricted cash, deposits, receivables,
repurchase agreements, payables, and other assets (aside from those previously discussed) and liabilities are generally reflected in the consolidated balance
sheets at their cost, which, due to the short-term nature of these instruments and their limited inherent credit risk, approximates fair value.
Fair Value Hierarchy
Financial Instruments Measured at Fair Value on a Recurring Basis
The following tables set forth financial instruments measured at fair value by level within the fair value hierarchy as of December 31, 2022 and
2021. Assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.
December 31, 2022
Total
Level 1
Level 2
Level 3
Financial assets:
Agency MBS
$
443,540 $
— $
443,540 $
—
MSR financing receivables
180,365
—
—
180,365
Loans
29,264
—
—
29,264
Credit securities
104,437
—
98,933
5,504
Mortgage loans of consolidated VIEs
193,957
—
—
193,957
Derivative assets
5,660
—
5,660
—
Other assets
3,198
234
—
2,964
Financial liabilities:
Secured debt of consolidated VIEs
169,345
—
159,464
9,881
Derivative liabilities
22
—
22
—
December 31, 2021
Total
Level 1
Level 2
Level 3
Financial assets:
Agency MBS
$
483,927 $
— $
483,927 $
—
MSR financing receivables
125,018
—
—
125,018
Loans
29,697
—
—
29,697
Credit securities
26,222
—
—
26,222
Mortgage loans of consolidated VIE
7,442
—
—
7,442
Derivative assets
250
20
230
—
Other assets
12,655
5,267
—
7,388
Financial liabilities:
Secured debt of consolidated VIE
508
—
—
508
Derivative liabilities
228
—
228
—
F-28
Level 3 Financial Assets and Liabilities
The table below sets forth an attribution of the change in the fair value of the Company’s Level 3 financial assets that are measured at fair value on a
recurring basis for the periods indicated:
Year Ended December 31,
2022
2021
Beginning balance
$
195,767 $
166,428
Net (loss) gain included in "Investment and derivative gain (loss), net"
(17,812)
16,166
Additions from consolidation of VIEs
276,594
—
Transfers to real estate owned by consolidated VIEs
(1,060)
(534)
Purchases
83,392
157,842
Sales
(14,624)
(13,263)
Payments, net
(124,999)
(139,501)
Accretion of discount
14,796
8,629
Ending balance
$
412,054 $
195,767
Net unrealized (losses) gains included in earnings for the
period for Level 3 assets still held at the reporting date
$
(16,926) $
16,304
The table below sets forth an attribution of the change in the fair value of the Company’s Level 3 financial liabilities that are measured at fair value
on a recurring basis for the periods indicated:
Year Ended December 31,
2022
2021
Beginning balance
$
508 $
576
Net (gain) loss included in "Investment and derivative gain (loss), net"
(2,259)
16
Additions from consolidation of VIEs
14,278
—
Payments, net
(2,480)
(158)
(Amortization) accretion of (premium) discount, net
(166)
74
Ending balance
$
9,881 $
508
Net unrealized (gains) losses included in earnings for the
period for Level 3 liabilities still held at the reporting date
$
(2,259) $
16
Note 14. Income Taxes
The Company has elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended (the “Internal Revenue Code”) commencing
upon filing its tax return for its taxable year ended December 31, 2019. As a REIT, the Company is required to distribute annually 90% of its REIT taxable
income. So long as the Company continues to qualify as a REIT, it will generally not be subject to U.S. federal or state corporate income taxes on its
taxable income to the extent that it distributes all of its annual taxable income to its shareholders on a timely basis. At present, it is the Company’s intention
to distribute 100% of its taxable income, although the Company will not be required to do so. The Company intends to make distributions of its REIT
taxable income within the time limits prescribed by the Internal Revenue Code, which may extend into the subsequent taxable year. Accordingly, the
Company does not expect to incur an income tax liability on its REIT taxable income.
For the year ended December 31, 2022, the Company did not have any REIT taxable income after a dividend paid deduction for its preferred stock.
For the year ended December 31, 2021, the Company had a REIT taxable loss and did not have a distribution requirement. As of December 31, 2022, the
Company had estimated net operating loss (“NOL”) carryforwards of $162,463 that can be used to offset future taxable ordinary income and reduce its
REIT distribution requirements. NOL carryforwards totaling $14,588 expire in 2028 and NOL carryforwards totaling $147,875 have no expiration period.
For the NOL carryforwards that have no expiration period, the Company is limited to utilizing NOL carryforwards to 80% of the REIT taxable income in
any one year. As of December 31, 2022, the Company had estimated net capital loss (“NCL”) carryforwards of $155,740 that can be used to offset future
net capital gains. The scheduled expirations of the Company’s NCL carryforwards are $110,323 in 2023, $14,187 in 2026 and $31,230 in 2027. The
Company’s estimated NOL and NCL carryforwards as of December 31, 2022 are subject to potential adjustments up to the time of filing of the Company’s
income tax returns.
The Company and subsidiaries have made joint elections to treat certain subsidiaries as taxable REIT subsidiaries (“TRSs”). In general, a TRS may
hold assets and engage in activities that the Company cannot hold or engage in directly and generally may engage in any real estate or non-real estate
related business. As such, each of these TRSs is taxable as a C corporation and subject to federal, state and local income taxes based upon their taxable
income. For the years ended December 31, 2022 and 2021, the Company recognized a provision for income taxes of $4,118 and $1,566, respectively, on the
pre-tax net income of its TRSs.
F-29
The Company recognizes uncertain tax positions in the financial statements only when it is more-likely-than-not that the position will be sustained
upon examination by the relevant taxing authority based on the technical merits of the position. A position that meets this standard is measured at the
largest amount of benefit that will more-likely-than-not be realized upon settlement. A liability is established for differences between positions taken in a
tax return and the financial statements. As of December 31, 2022 and 2021, the Company assessed the need for recording a provision for any uncertain tax
position and has made the determination that such provision is not necessary. If the Company were to incur income tax related interest and penalties, the
Company’s policy is to classify them as a component of provision for income taxes.
The Company is subject to examination by the Internal Revenue Service (“IRS”) and state and local authorities in jurisdictions where the Company
has significant business operations. The Company’s federal tax returns for 2019 and forward remain subject to examination by the IRS.
Note 15. Commitments and Contingencies
Contractual Obligations
The Company has contractual obligations to make future payments in connection with long-term debt and non-cancelable lease agreements. The
following table sets forth these contractual obligations by fiscal year as of December 31, 2022:
2023
2024
2025
2026
2027
Thereafter
Total
Long-term unsecured debt maturities
$
— $
— $
34,931 $
37,750 $
— $
15,000 $
87,681
Minimum rental commitments
100
85
—
—
—
—
185
$
100 $
85 $
34,931 $
37,750 $
— $
15,000 $
87,866
Note 16. Shareholders’ Equity
Common Stock
The Company has authorized common share capital of 450,000,000 shares of Class A common stock, par value $0.01 per share, and 100,000,000
shares of Class B common stock, par value $0.01 per share. Holders of the Class A and Class B common stock are entitled to one vote and three votes per
share, respectively, on all matters voted upon by the shareholders. Shares of Class B common stock are convertible into shares of Class A common stock on
a one-for-one basis at the option of the Company in certain circumstances including either (i) upon sale or other transfer, or (ii) at the time the holder of
such shares of Class B common stock ceases to be employed by the Company. As of December 31, 2022 and 2021, there were no outstanding shares of
Class B common stock. The Class A common stock is publicly traded on the New York Stock Exchange under the ticker symbol “AAIC.”
Common Equity Distribution Agreements
On August 10, 2018, the Company entered into separate common equity distribution agreements with equity sales agents JMP Securities LLC, B.
Riley FBR, Inc., JonesTrading Institutional Services LLC and Ladenburg Thalmann & Co. Inc. pursuant to which the Company may offer and sell, from
time to time, up to 12,597,423 shares of the Company’s Class A common stock.
Pursuant to the common equity distribution agreements, shares of the Company’s common stock may be offered and sold through the equity sales
agents in transactions that are deemed to be “at the market” offerings as defined in Rule 415 under the Securities Act of 1933, including sales made directly
on the NYSE or sales made to or through a market maker other than on an exchange or, subject to the terms of a written notice from the Company, in
privately negotiated transactions.
During the years ended December 31, 2022 and 2021, there were no issuances of common stock under the common equity distribution agreements.
As of December 31, 2022, the Company had 11,302,160 shares of Class A common stock available for sale under the common equity distribution
agreements.
Common Share Repurchase Program
On July 31, 2020, the Company announced that its Board of Directors authorized a share repurchase program pursuant to which the Company may
repurchase up to 18,000,000 shares of Class A common stock (the "Repurchase Program"). Repurchases under the Repurchase Program may be made from
time to time on the open market and in private transactions at management’s discretion in accordance with applicable federal securities laws. The timing of
repurchases and the exact number of shares of Class A common stock to be repurchased will depend upon market conditions and other factors. The
Repurchase Program is funded using the Company’s cash on hand and cash generated from operations. The Repurchase Program has no expiration date and
may be suspended or terminated at any time without prior notice.
F-30
During the years ended December 31, 2022 and 2021, the Company repurchased 2,794,574 and 3,242,371 shares, respectively, of Class A common
stock for a total purchase price of $9,316 and $12,475, respectively. As of December 31, 2022, there remain available for repurchase 10,195,704 shares of
Class A common stock under the Repurchase Program.
Preferred Stock
The Company has authorized preferred share capital of (i) 100,000 shares designated as Series A Preferred Stock that is unissued; (ii) 2,000,000
shares designated as 7.00% Series B Cumulative Perpetual Redeemable Preferred Stock (the “Series B Preferred Stock”), par value of $0.01 per share; (iii)
2,500,000 shares designated as 8.250% Series C Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock (the “Series C Preferred Stock”), par
value of $0.01 per share; and (iv) 20,400,000 shares of undesignated preferred stock. The Company’s Board of Directors has the authority, without further
action by the shareholders, to issue additional preferred stock in one or more series and to fix the terms and rights of the preferred stock. The Company’s
preferred stock ranks senior to its common stock with respect to the payment of dividends and the distribution of assets upon a voluntary or involuntary
liquidation, dissolution, or winding up of the Company. The Company’s preferred stock ranks on parity with each other. The Series B Preferred Stock and
Series C Preferred Stock are publicly traded on the New York Stock Exchange under the ticker symbols “AAIC PrB” and “AAIC PrC,” respectively.
The Series B Preferred Stock has no stated maturity, is not subject to any sinking fund and will remain outstanding indefinitely unless repurchased or
redeemed by the Company. Holders of Series B Preferred Stock have no voting rights, except under limited conditions, and are entitled to receive a
cumulative cash dividend at a rate of 7.00% per annum of their $25.00 per share liquidation preference (equivalent to $1.75 per annum per share). Shares of
Series B Preferred Stock are redeemable at $25.00 per share, plus accumulated and unpaid dividends (whether or not authorized or declared), exclusively at
the Company’s option. Dividends are payable quarterly in arrears on the 30th day of March, June, September and December of each year, when and as
declared. The Company has declared and paid all required quarterly dividends on the Company’s Series B Preferred Stock to date in 2022.
The Series C Preferred Stock has no stated maturity, is not subject to any sinking fund and will remain outstanding indefinitely unless repurchased or
redeemed by the Company. Holders of Series C Preferred Stock have no voting rights, except under limited conditions, and are entitled to receive a
cumulative cash dividend (i) from and including the original issue date to, but excluding, March 30, 2024 at a fixed rate equal to 8.250% per annum of the
$25.00 per share liquidation preference (equivalent to $2.0625 per annum per share) and (ii) from and including March 30, 2024, at a floating rate equal to
three-month LIBOR plus a spread of 5.664% per annum of the $25.00 per share liquidation preference. Shares of Series C Preferred Stock are redeemable
at $25.00 per share, plus accumulated and unpaid dividends (whether or not authorized or declared), exclusively at the Company’s option commencing on
March 30, 2024 or earlier upon the occurrence of a change in control or under circumstances where it is necessary to preserve the Company’s qualification
as a REIT. Dividends are payable quarterly in arrears on the 30th day of March, June, September and December of each year, when and as declared. The
Company has declared and paid all required quarterly dividends on the Company’s Series C Preferred Stock to date in 2022.
During the year ended December 31, 2022, the Company repurchased 159,901 shares of Series C Preferred Stock for a total purchase price of
$3,536. There were no shares of Series C Preferred stock repurchased by the Company during the year ended December 31, 2021.
Preferred Equity Distribution Agreement
The Company is party to an amended and restated equity distribution agreement with JonesTrading Institutional Services LLC and Ladenburg
Thalmann & Co. Inc., pursuant to which the Company may offer and sell, from time to time, up to 1,647,370 shares of the Company’s Series B Preferred
Stock. Pursuant to the Series B preferred equity distribution agreement, shares of the Company’s Series B Preferred stock may be offered and sold through
the preferred equity sales agents in transactions that are deemed to be “at the market” offerings as defined in Rule 415 under the Securities Act of 1933,
including sales made directly on the NYSE or sales made to or through a market maker other than on an exchange or, subject to the terms of a written
notice from the Company, in privately negotiated transactions.
During the years ended December 31, 2022 and 2021, the Company issued 6,058 and 37,337 shares of Series B Preferred Stock at a weighted
average public offering price of $24.87 per share and $24.99 per share for proceeds net of selling commissions and expenses of $149 and $919,
respectively, under the Series B preferred equity distribution agreement. As of December 31, 2022, the Company had 1,602,566 shares of Series B
Preferred stock available for sale under the Series B preferred equity distribution agreement.
Shareholder Rights Agreement
On June 1, 2009, the Board of Directors approved a shareholder rights agreement (“Rights Plan”) and the Company’s shareholders approved the
Rights Plan at its annual meeting of shareholders on June 2, 2010. On April 9, 2018, the Board of Directors approved a first amendment to the Rights Plan
(“First Amendment”) to extend the term for an additional three years and the
F-31
Company’s shareholders approved the First Amendment at its annual meeting of shareholders on June 14, 2018. On April 11, 2022, the Board of Directors
approved a second amendment to the Rights Plan (“Second Amendment”) to further extend the term until June 4, 2025 and the Company's shareholders
approved the Second Amendment at its annual meeting of shareholders on June 16, 2022. The Second Amendment also decreased the Purchase Price (as
defined under the Rights Plan) from $70.00 to $21.30.
Under the terms of the Rights Plan, in general, if a person or group acquires or commences a tender or exchange offer for beneficial ownership of
4.9% or more of the outstanding shares of our Class A common stock upon a determination by our Board of Directors (an “Acquiring Person”), all of our
other Class A and Class B common shareholders will have the right to purchase securities from us at a discount to such securities’ fair market value, thus
causing substantial dilution to the Acquiring Person.
The Board of Directors adopted the Rights Plan in an effort to protect against a possible limitation on the Company’s ability to use its NOL
carryforwards, NCL carryforwards, and built-in losses under Sections 382 and 383 of the Internal Revenue Code. The Company’s ability to use its NOLs,
NCLs and built-in losses would be limited if it experienced an “ownership change” under Section 382 of the Internal Revenue Code. In general, an
“ownership change” would occur if there is a cumulative change in the ownership of the Company’s common stock of more than 50% by one or more “5%
shareholders” during a three-year period. The Rights Plan was adopted to dissuade any person or group from acquiring 4.9% or more of the Company’s
outstanding Class A common stock, each, an Acquiring Person, without the approval of the Board of Directors and triggering an “ownership change” as
defined by Section 382.
The Rights Plan, as amended by the Second Amendment, and any outstanding rights will expire at the earliest of (i) June 4, 2025, (ii) the time at
which the rights are redeemed or exchanged pursuant to the Rights Plan, (iii) the repeal of Section 382 and 383 of the Internal Revenue Code or any
successor statute if the Board of Directors determines that the Rights Plan is no longer necessary for the preservation of the applicable tax benefits, or (iv)
the beginning of a taxable year to which the Board of Directors determines that no applicable tax benefits may be carried forward.
Note 17. Long-Term Incentive Plan
The Company provides its employees and its non-employee directors with long-term incentive compensation in the form of stock-based awards. On
April 29, 2021, the Board of Directors adopted the Arlington Asset Investment Corp. 2021 Long-Term Incentive Plan (the “2021 Plan”), which was
approved by the Company’s shareholders and became effective on July 15, 2021. The 2021 Plan replaced the Arlington Asset Investment Corp. 2014
Long-Term Incentive Plan (the “2014 Plan”). No additional grants will be made under the 2014 Plan. However, previous grants under the 2014 Plan and
any long-term incentive plans prior to the 2014 Plan (collectively, the “Prior Plans”) will remain in effect subject to the terms of the Prior Plans and the
applicable award agreement.
Under the 2021 Plan, a maximum number of 5,256,076 shares of Class A common stock of the Company, subject to adjustment as set forth in the
2021 Plan, were authorized for issuance and may be issued to employees, directors, consultants, advisors and independent contractors who provide bona
fide services to the Company and its affiliates. If an award under the 2021 Plan or Prior Plans is canceled, terminated, forfeited or otherwise settled without
the issuance of shares subject to such award, those shares will be available for future grants under the 2021 Plan. In addition, shares delivered or withheld
for tax obligations arising from an award, other than a stock option or stock appreciation right (“SAR”), will be available for future grants under the 2021
Plan. As of December 31, 2022, 4,397,394 shares remained available for issuance under the 2021 Plan; however, the shares remaining available for
issuance would be reduced by the potential future issuance of shares of common stock for the settlement of outstanding performance-based stock awards
and dividend equivalents for such awards. If these outstanding performance-based stock awards are earned at “target” level performance, an additional
1,658,973 shares would be issued resulting in 2,738,421 shares remaining available for issuance under the 2021 Plan as of December 31, 2022.
Under the 2021 Plan, the Compensation Committee of the Company’s Board of Directors may grant restricted stock, restricted stock units (“RSUs”),
stock options, SARs and/or other stock-based awards. Under the 2021 Plan, shares issued upon the exercise of a stock option or SAR or shares subject to a
restricted stock award and any shares issued in settlement of restricted stock unit award, reduced by the number of any shares withheld to satisfy
withholding taxes, may not be sold or transferred before the earlier of (i) the first anniversary of the exercise of the option or SAR or vesting of the
restricted stock award or the settlement of restricted stock unit award, or (ii) the date the participant is no longer employed by or providing services to the
Company or an affiliate. Non-employee members of the Board of Directors may not be granted awards under the 2021 Plan during any twelve-month
period with respect to the number of shares that have a fair market value on the date of grant that exceeds $160. The 2021 Plan will terminate on the tenth
anniversary of its effective date unless sooner terminated by the Board of Directors.
Stock-based compensation costs are initially measured at the estimated fair value of the awards on the grant date developed using appropriate
valuation methodologies, as adjusted for estimates of future award forfeitures. Valuation methodologies used and subsequent expense recognition is
dependent upon each award’s service and performance conditions.
F-32
Performance-based Stock Awards
The Company has granted performance-based RSUs and performance stock units (collectively, “Performance-based Stock Awards”) to employees of
the Company that are convertible into shares of Class A common stock following the achievement of performance goals over the applicable performance
periods. Compensation costs for Performance-based Stock Awards subject to nonmarket-based performance conditions (i.e., performance not predicated on
changes in the Company’s stock price) are measured at the closing stock price on the dates of grant, adjusted for the probability of achieving certain
benchmarks included in the performance metrics. These initial cost estimates are recognized as expense over the requisite performance periods, as adjusted
for changes in estimated, and ultimately actual, performance and forfeitures. Compensation costs for components of Performance-based Stock Awards
subject to market-based performance conditions (i.e., performance predicated on changes in the Company’s stock price) are measured at the dates of grant
using a Monte Carlo simulation model which incorporates into the valuation the inherent uncertainty regarding the achievement of the market-based
performance metrics. These initial valuation amounts are recognized as expense over the requisite performance periods, subject only to adjustments for
changes in estimated, and ultimately actual, forfeitures.
During the years ended December 31, 2022 and 2021, the Compensation Committee granted Performance-based Stock Awards with performance
goals based on (i) the compound annualized total shareholder return (i.e., share price change plus dividends on a reinvested basis) during the applicable
performance period (“Absolute TSR Awards”), (ii) the compound annualized total shareholder return relative to a peer index during the applicable
performance period (“Relative TSR Awards”), (iii) the compound annualized growth in the Company’s book value per share (i.e., book value change with
such adjustments as determined and approved by the Compensation Committee plus dividends on a reinvested basis) during the applicable performance
period (“Book Value Awards”), and (iv) the share price of the Company's common stock during the applicable performance period ("Stock Price Awards").
In addition, the Compensation Committee granted Performance-based Stock Awards in prior years with performance goals based on annual return on equity
during the applicable performance period ("ROE Awards").
The Compensation Committee of the Board of Directors of the Company approved the following Performance-based Stock Award grants for the
periods indicated:
Year Ended December 31,
2022
2021
Absolute TSR Awards granted
174,581
90,711
Absolute TSR Award grant date fair value per share
$
6.03 $
6.89
Relative TSR Awards granted
87,291
47,710
Relative TSR Award grant date fair value per share
$
5.83 $
6.55
Book Value Awards granted
103,000
—
Book Value Award grant date fair value per share
$
3.37 $
—
Stock Price Awards granted
1,225,490
—
Stock Price Award grant date fair value per share
$
1.72 $
—
For the Company’s Book Value Awards and ROE Awards, the grant date fair value per share is based on the close price on the date of grant. For the
Company’s Absolute TSR Awards, Relative TSR Awards and Stock Price Awards, the grant date fair value per share is based on a Monte Carlo simulation
model. The following assumptions, determined as of the date of grant, were used in the Monte Carlo simulation model to measure the grant date fair value
per share of the Company’s Absolute TSR Awards, Relative TSR Awards and Stock Price Awards for the periods indicated:
Absolute TSR Awards
Granted in:
Relative TSR Awards
Granted in:
Stock Price Awards
Granted in:
2022
2021
2022
2021
2022
2021
Closing stock price on date of grant
$
3.58 $
4.08 $
3.58 $
4.08 $
3.06 $
—
Beginning average stock price on
date of grant
$
3.60 $
4.07 $
3.60 $
4.07
N/A $
—
Expected volatility
69.20%
69.27%
69.20%
69.27%
51.17%
—
Dividend yield
0.00%
0.00%
0.00%
0.00%
0.00%
—
Risk-free rate
1.01%
0.34%
1.01%
0.34%
2.97%
—
Discount for illiquidity
0.00%
0.00%
0.00%
0.00%
8.42%
—
(1) Based upon the 30 trading days prior to and including the date of grant.
(2) Based upon the most recent three-year volatility as of the date of grant.
(3) Dividend equivalents are accrued during the performance period and deemed reinvested in additional stock units, which are to be paid out at the end of
the performance period to the extent the underlying Performance-based Stock Award is earned. Applying dividend yield assumption of 0.00% in the
Monte Carlo simulation is mathematically equivalent to reinvesting dividends on a continuous basis and including the value of the dividends in the
final payout.
F-33
(1)
(2)
(3)
(4)
(5)
(4) Based upon the yield of a U.S. Treasury bond with a term commensurate with the average vesting period of the stock grant.
(5) Based on restriction on ability to sell vested awards for one year after vesting.
The vesting of the Performance-based Stock Awards is subject to both continued employment under the terms of the award agreement and the
achievement of the Company performance goals established by the Compensation Committee.
For Absolute TSR Awards and Relative TSR Awards granted during the years ended December 31, 2022 and 2021, the Compensation Committee
established a three-year performance period. The actual number of shares of Class A common stock that will be issued to each participant at the end of the
applicable performance period will vary between 0% and 250% of the number of the Absolute TSR Awards and Relative TSR Awards granted, depending
on performance results. If the minimum threshold level of performance goals is not achieved, no awards are earned. To the extent the performance results
are between the minimum threshold level and maximum level of performance goals, between 50% to 250% of the number of Absolute TSR Awards and
Relative TSR Awards are earned. Upon settlement, vested Absolute TSR Awards and Relative TSR Awards are converted into shares of the Company’s
Class A common stock on a one-for-one basis.
For Book Value Awards granted during the year ended December 31, 2022, the Compensation Committee established a one-year performance period
that ended on December 31, 2022. The actual number of shares of Class A common stock that could be issued to each participant at the end of the
performance period varied between 0% and 100% of the number of Book Value Awards granted, depending on performance results. Based on the actual
performance measurements, 41,410 shares of the 103,000 Book Value Awards granted were earned and were converted into an equal number of shares of
restricted stock in February 2023 that will vest on the third anniversary of the original Book Value Award grant date subject to continued employment under
the terms of the award agreement.
For Stock Price Awards granted during the year ended December 31, 2022, the Compensation Committee established a three-year performance
period. If the market price of the Company's common stock is equal to or greater than a stock price performance goal for 45 consecutive trading days at
any time during the performance period, between 75% to 300% of the number of Stock Price Awards are earned and become restricted stock units that will
vest ratably over a three-year period beginning on the third anniversary of the date of grant subject to continued employment under the terms of the award
agreement. If the minimum threshold level of stock price performance goals are never achieved, no awards are earned. As of December 31, 2022, the
market price of the Company's common stock had not met any of the price performance goals for 45 consecutive trading days.
For the ROE Awards granted in prior years, the Compensation Committee established a one-year performance period. Any ROE Awards earned at
the end of the one-year performance period were converted into an equal number of shares of restricted stock that will vest on the third anniversary of the
original ROE Award grant date subject to continued employment under the terms of the award agreement.
Performance-based Stock Awards do not have any voting rights. No dividends are paid on outstanding Performance-based Stock Awards during the
applicable performance period. Instead, dividend equivalents are accrued on outstanding Performance-based Stock Awards during the applicable
performance period, deemed invested in shares of Class A common stock and are paid out in shares of Class A common stock at the end of the performance
period to the extent that the underlying Performance-based Stock Awards vest.
For the years ended December 31, 2022 and 2021, the Company recognized $1,281 and $415, respectively, of compensation expense related to
Performance-based Stock Awards. As of December 31, 2022, the Company had 1,658,973 Performance-based stock awards outstanding, excluding 41,410
shares of Book Value Awards that were earned and were converted into an equal number of shares of restricted stock in February 2023. As disclosed
above, the actual number of shares of common stock that could be issued for settlement of the Performance-based shares can be greater or less than the
amount of Performance-based shares outstanding depending upon the actual results compared to the performance goals. As of December 31, 2022 and
2021, the Company had unrecognized compensation expense related to Performance-based Stock Awards of $3,314 and $878, respectively. The
unrecognized compensation expense as of December 31, 2022 is expected to be recognized over a weighted average period of 3.23 years. For Absolute
TSR Awards, Relative TSR Awards and certain of the Book Value Awards that had performance measurement periods ending during the years ended
December 31, 2022 and 2021, none of the performance measures were met and therefore no awards were earned or vested during those periods. For the
years ended December 31, 2022 and 2021, there were 0 and 82,124 ROE Awards, respectively, including dividend equivalents, that were earned and
converted into an equal number of shares of restricted stock that will vest on the third anniversary of the original ROE Award grant date. For the year
ended December 31, 2022, there were 41,410 Book Value Awards that were earned and converted into an equal number of shares of restricted stock in
February 2023 that will vest on the third anniversary of the original Book Value Award grant date.
Employee Restricted Stock Awards
Compensation costs for restricted stock awards subject only to service conditions are measured at the closing stock price on the dates of grant and
are recognized as expense on a straight-line basis over the requisite service periods for the awards, as adjusted for changes in estimated, and ultimately
actual, forfeitures.
F-34
The Company grants restricted common shares to employees that either vest ratably over a three-year period or cliff vest at the end of a three-year
period based on continued employment over these specified periods. A summary of these unvested restricted stock awards is presented below:
Number of Shares
Weighted-average
Grant-date Fair
Value
Weighted-
average Remaining
Vested Period
Share Balance as of December 31, 2020
547,688 $
4.89
1.5
Granted
365,592
3.89
—
Conversion of ROE Awards
82,124
5.65
—
Forfeitures
(22,000)
6.54
—
Vestitures
(214,369)
5.89
—
Share Balance as of December 31, 2021
759,035
4.16
1.5
Granted
384,291
3.42
—
Forfeitures
(12,167)
3.57
—
Vestitures
(300,317)
4.44
—
Share Balance as of December 31, 2022
830,842 $
3.72
1.2
For the years ended December 31, 2022 and 2021, the Company recognized $1,856 and $1,190, respectively, of compensation expense related to
restricted stock awards. As of December 31, 2022 and 2021, the Company had unrecognized compensation expense related to restricted stock awards of
$1,262 and $1,847, respectively. The unrecognized compensation expense as of December 31, 2022 is expected to be recognized over a weighted average
period of 1.2 years. For the years ended December 31, 2022 and 2021, the intrinsic value of restricted stock awards that vested were $909 and $828,
respectively.
In addition, as part of the Company’s satisfaction of incentive compensation earned for past service under the Company’s variable compensation
programs, employees may receive restricted Class A common stock in lieu of cash payments. These restricted Class A common stock shares are issued to
an irrevocable trust and are not returnable to the Company. No such shares were issued in 2022 and 2021. As of December 31, 2022 and 2021, the
Company had 9,155 vested shares of the undistributed restricted stock issued to the trust.
Employee Restricted Stock Units
In connection with the announcement in June 2019 that the Company’s Executive Chairman would retire on December 31, 2019 from all positions
with the Company, including its Board of Directors, the Company and its Executive Chairman entered into a consulting agreement to provide consulting
services through January 1, 2022. Pursuant to the consulting agreement, the Company granted the Executive Chairman 87,847 RSUs with a grant date fair
value of $6.83 per share. The grant date fair value of the award was based on the closing price of the Class A common stock on the New York Stock
Exchange on the date of grant. The RSUs vested equally on each of January 1, 2020, July 1, 2020, January 1, 2021, July 1, 2021 and January 1, 2022, and
were subject to the individual’s continued employment through December 31, 2019 and providing consulting services through January 1, 2022. Upon
vesting, the RSUs were converted into shares of Class A common stock. The RSUs did not have any voting rights, and no dividends were paid on
outstanding RSUs. Instead, dividend equivalents were accrued on outstanding RSUs, deemed invested in shares of Class A common stock and were paid
out in shares of Class A common stock on the vesting date.
For the years ended December 31, 2022 and 2021, the Company recognized $0 and $78, respectively, of compensation expense related to employee
restricted stock units. For the years ended December 31, 2022 and 2021, the intrinsic value of RSUs that were converted into shares of Class A common
stock were $73 and $154, respectively. As of December 31, 2022, the Company had no employee restricted stock units outstanding.
Director Restricted Stock Units
Compensation costs for RSU awards subject only to service conditions are measured at the closing stock price on the dates of grant and are
recognized as expense on a straight-line basis over the requisite service periods for the awards, as adjusted for changes in estimated, and ultimately actual,
forfeitures. Compensation costs for RSUs that do not require future service conditions are expensed immediately.
The Company’s non-employee directors are compensated in both cash and RSUs. RSUs awarded to non-employee directors vest immediately on the
award grant date and are convertible into shares of Class A common stock. For RSUs granted under the Company’s 2021 Plan, 2014 Plan, and certain of
the Prior Plans, the RSUs are convertible into shares of Class A common stock at the later of the date the non-employee director ceases to be a member of
the Company’s Board or the first anniversary of the grant date. For RSUs granted under certain Prior Plans, the RSUs are convertible into shares of Class A
common stock one year after the non-employee director ceases to be a member of the Company’s Board. The non-employee director RSUs do not have any
voting rights
F-35
but are entitled to cash dividend equivalent payments. As of December 31, 2022, the Company had 548,272 of non-employee director RSUs outstanding. A
summary of the non-employee director RSUs grants is presented below for the periods indicated:
Year Ended December 31,
2022
2021
RSUs granted
132,450
98,035
Grant date fair value
$
3.02 $
4.08
The grant date fair value is based on the closing price of the Class A common stock on the New York Stock Exchange on the date of grant. For the
years ended December 31, 2022 and 2021, the Company recognized $400 and $400, respectively, of director fees related to these RSUs. There were no
non-employee director RSUs converted into shares of Class A common stock for the years ended December 31, 2022 and 2021.
Note 18. Financial Instruments with Off-Balance-Sheet Risk and Credit Risk
As of December 31, 2022 and 2021, the Company did not have any relationships with unconsolidated entities or financial partnerships, such as
entities often referred to as structured finance, or special purpose entities or VIEs, established for the purpose of facilitating off-balance sheet arrangements
or other contractually narrow or limited purposes. The Company’s economic interests held in unconsolidated VIEs are generally limited in nature to those
of a passive holder of beneficial interests in securitized financial assets. As described in Note 9 to the Company’s consolidated financial statements, as of
December 31, 2022 and 2021, the Company had consolidated for financial reporting purposes two and one, respectively, securitization trusts for which the
Company determined that its investments provided the Company with both (i) the power to direct the activities that most significantly impact the economic
performance of the VIE and (ii) the obligation to absorb losses or the right to receive benefits that could potentially be significant to the VIE. The
Company was not required to consolidate for financial reporting purposes any other VIEs as of December 31, 2022 and 2021, as the Company did not have
the power to direct the activities that most significantly impact the economic performance of such entities.
As of December 31, 2022 and 2021, the Company had not guaranteed any obligations of unconsolidated entities. As of December 31, 2022 and
2021, the Company had not entered into any commitment or intent to provide funding to unconsolidated entities other than the aforementioned asset-back
revolving credit facility funding commitment.
F-36
Exhibit 21.01
List of Significant Subsidiaries of the Registrant
Name
State of Incorporation
Arlington Asset Investment Holdings, LLC
Arlington Asset TRS Holdings, LLC
McLean Mortgage Investment, LLC
McLean MSR Investment, LLC
McLean SFR Holdings, LLC
McLean Solar Investment, LLC
Virginia
Delaware
Delaware
Delaware
Delaware
Delaware
Exhibit 23.01
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (Nos. 333-104475, 333-174669, 333-197442 and
333-257110) of Arlington Asset Investment Corp. of our report dated March 31, 2023 relating to the financial statements, which appears in this Annual
Report on Form 10-K.
/s/ PRICEWATERHOUSECOOPERS LLP
Washington, DC
March 31, 2023
Exhibit 31.01
CERTIFICATION
I, J. Rock Tonkel, Jr., certify that:
1.
I have reviewed this Annual Report on Form 10-K of Arlington Asset Investment Corp.;
2.
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered
by this report;
3.
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.
The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-
15(f) and 15d-15(f)) for the registrant and have:
(a)
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the period in which this report is being prepared;
(b)
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under
our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted accounting principles;
(c)
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation;
and
(d)
Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s
most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5.
The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial
reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent
functions):
(a)
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b)
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s
internal control over financial reporting.
March 31, 2023
/s/ J. ROCK TONKEL, JR.
J. Rock Tonkel, Jr.
President and Chief Executive Officer
(Principal Executive Officer)
Exhibit 31.02
CERTIFICATION
I, Richard E. Konzmann, certify that:
1.
I have reviewed this Annual Report on Form 10-K of Arlington Asset Investment Corp.;
2.
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered
by this report;
3.
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.
The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-
15(f) and 15d-15(f)) for the registrant and have:
(a)
Designed such disclosure controls and procedures or caused such disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the period in which this report is being prepared;
(b)
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under
our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted accounting principles;
(c)
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation;
and
(d)
Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s
most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5.
The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial
reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent
functions):
(a)
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b)
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s
internal control over financial reporting.
March 31, 2023
/s/ RICHARD E. KONZMANN
Richard E. Konzmann
Executive Vice President,
Chief Financial Officer, and Treasurer
(Principal Financial Officer)
Exhibit 32.01
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report on Form 10-K of Arlington Asset Investment Corp. (the Company) for the year ended December 31, 2022, as
filed with the Securities and Exchange Commission on the date hereof (the Report), I, J. Rock Tonkel, Jr., Chief Executive Officer of the Company, certify,
pursuant to 18 U.S.C. §1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002, that:
(1)
the Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2)
the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the
Company.
March 31, 2023
/s/ J. ROCK TONKEL, JR.
J. Rock Tonkel, Jr.
President and Chief Executive Officer
(Principal Executive Officer)
Exhibit 32.02
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report on Form 10-K of Arlington Asset Investment Corp. (the Company) for the year ended December 31, 2022, as
filed with the Securities and Exchange Commission on the date hereof (the Report), I, Richard E. Konzmann, Chief Financial Officer of the Company,
certify, pursuant to 18 U.S.C. §1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002, that:
(1)
the Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2)
the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the
Company.
March 31, 2023
/s/ RICHARD E. KONZMANN
Richard E. Konzmann
Executive Vice President,
Chief Financial Officer and Treasurer
(Principal Financial Officer)