Good morning. I’d like to welcome everyone to the Arlington Asset Second Quarter 2020 Earnings Call. Please be aware each of your lines is in a listen-only mode. After the company’s remarks, we will open the floor for questions. [Operator Instructions] I would now like to turn the conference over to Richard Konzmann. Mr. Konzmann, you may begin.

Good morning, thank you very much. This is Rich Konzmann, Chief Financial Officer of Arlington Asset. Before we begin this morning’s call, I would like to remind everyone that statements concerning future financial or business performance, market conditions, business strategies or expectations, and any other guidance on present or future periods constitute forward-looking statements that are subject to a number of factors, risks and uncertainties that might cause actual results to differ materially from stated expectations or current circumstances. These forward-looking statements are based on management’s beliefs, assumptions and expectations, which are subject to change, risk and uncertainty as a result of possible events or factors. These and other material risks are described in the company’s Annual Report on Form 10-K and other documents filed by the company with the SEC from time to time, which are available from the company and from the SEC and you should read and understand these risks in evaluating any forward-looking statements. I would now like to turn the call over to Rock Tonkel for his remarks.

Thank you, Rich. Good morning and welcome to the second quarter 2020 earnings call for Arlington Asset. Also joining me on the call today is Brian Bowers, our Chief Investment Officer. Financial market conditions improved significantly during the second quarter, driven by unprecedented support by federal monetary and fiscal stimulus policies. Despite the uncertain path of an economic recovery, risk asset prices rallied during the quarter with equity markets recovering most of their losses from the prior quarter. Most fixed income asset classes also recouped some of their prior quarter losses as credit spreads generally tightened during the second quarter. And the Federal Reserve signaled its intention to keep short-term interest rates at their current level for the foreseeable future, leading to low interest rate volatility and a slight steepening of the yield curve during the quarter. Agency mortgage performance was mixed for the second quarter. Elevated prepayment expectations adversely impacted higher coupon agency MBS, resulting in generic lower coupon bonds outperforming their higher coupon counterparts. Agency MBS backed by specified pools, like those Arlington owns, outperformed generic TBAs as pay-up premiums for specified pools increased significantly during the quarter. As a result of the Federal Reserve rate cuts and ongoing support for repo operations, repo funding for agency MBS remains readily available at lower funding costs. While the current landscape for the levered agency MBS investing has improved from last quarter, certain investment risks have also increased, including the uncertain path of prepayments in a lower interest rate environment and higher pay-up premiums embedded in the current pricing of specified pools. With the improvement in the financial markets during the second quarter, values of most mortgage credit asset classes recovered some of their losses from the prior quarter, reflecting a general tightening of credit spreads. However, there continues to…

[Operator Instructions] We’ll take our first question from Doug Harter with Credit Suisse.

Thanks. Rock, can you just talk about kind of how – obviously, you did buy back some stock during the second quarter, how you’re thinking about additional share repurchase? And how the attractiveness of share repurchase compares to the investment opportunities you just talked about?

Sure. Morning, Doug. I guess I’d take two things. One, obviously, capital is a precious commodity and reducing scale by repurchasing securities on the balance sheet has to be something that we’re very deliberate about, given our scale. So we start with that part of the equation. Having said that, I’d say secondly that as we sit here today, I don’t think we’re really viewing the world much differently, the markets and our stock and our circumstances versus markets much differently than we were during the second quarter. So I’d say, generally, our orientation and our thought process would be reasonably in line with where it was while we were executing that process in the second quarter.

Great. And can you just remind us how much authorization you have remaining on your – under for buybacks?

So at the end of the quarter, I think there was probably, give or take, a million shares left. And we’ve undertaken a new authorization as well, which you’ll see disclosed, I think, later today or – later today.

Okay. Thank you.

And we’ll take our next question from Trevor Cranston with JMP Securities.

Thanks. You guys talked about some of the reasons why you’re somewhat cautious on the agency space at the moment. But can you sort of add some color around how you way the fact that you think assets may be a little bit overpriced with the Fed in the market versus the cost of giving up the carry income associated with relevering that book? And maybe just talk a little bit about sort of what you would be looking for to see to start adding to that portfolio again? Thanks.

Sure. Well, let’s see, I think – I don’t know that I would say our thoughts are terribly outlined with maybe some others. A couple of things. One, obviously, the government is heavily involved in the net supply equation, and that’s had a very powerful effect on stabilizing both sides of the agency equation, prices as well as funding. And I think on the one hand, if one was to contemplate whether you think that bid or that influence is likely to continue to be there for a while, I think we and others would probably conclude that it probably will be around for a while. I don’t think the government has probably indicated any – given any indication that it’s intends to pull that support any time soon. Having said that, all of us who’ve been around this space know that if the government were to give any – even a slightest hint of pulling back, that could have a negative effect on pricing. The other factor here, as I think we’re all aware, is the uncertainty around speed. And so as we sit here today, let’s take the low end of the coupon stack, which we’d probably find appealing in a spec 2 at somewhere around 1.05%, but with a market expectation of maybe an 11% speed or something like that. If it all goes according to plan, maybe you can generate a 1.25%-ish-type yield off of that, which seems like it’s not, though it’s reasonable. But we’ve also all observed that speeds, the path of speeds is – can be pretty uncertain here recently. And so it’s not outside of the room of possibility that, that could double. And if it doubles, then your yield is now probably closer to 1% or even potentially below, but it’s…

Okay, great. Thank you. And then just another question on the mortgage credit portfolio. The two new asset classes you added there, the bigger one being the MSR financing and then also some of the resi MBS, looks like both of those are carried pretty close to par value. Can you talk about what your expected unleveraged yield is on those new assets that you bought during the second quarter? Thanks.

Well, they’re carried at fair value. And just so I’m clear on the question, Trevor. You’re asking about the, give or take, $75 million of incremental assets that were added from quarter-end to quarter-end. Is that what you’re describing?

Yes, exactly.

And you’re asking what the cash carry is or the total expected return on those?

Well, both, I guess, the sort of the yield you’ll be amortizing and, I guess, what your expected total return might be?

Well, it’s a blend, right? Some of them are straight coupon instruments, and those are going to be in the mid-to-high single digits, call it, 6%, 6.5%, maybe some a little higher than that. And then others are going to be a combination of current and upside. And those are going to be a little bit lower currents, maybe. But with the discounts, those are going to be high single digits and some in the teens – so I’m sorry, not teens, double digits. But I’d say the range for those that don’t have a discount upside would be 6.5%, 7% – 6%, 6.5%, 7%, something like that. And the – those assets that do carry discounts will be a little higher than that 7%, 8%, 9%.

Okay, great. And then the last question, just back on the agency book. It looks like you guys have a significantly smaller hedge portfolio relative to the agency book than you have historically. Can you talk about your approach to hedging right now and kind of where your interest rate sensitivity is at?

Right now, we’re at 0.2 positive GAAP. And that’s with all the elements that I described before, it’s slightly positively durated. And most of that is in the long end. That hedge is mostly in the long end. And as you can see – you’ll see it if it’s not in the – if you didn’t see in the release, you’ll see it in the Q. It’s more of a 10-year focus.

Okay, got it. Thank you.

And we’ll take our next question from Jason Stewart with Jones Trading.

Good morning, gentlemen. On the credit side of the investment book, what does current term financing look like? And how is that driving or impacting the opportunities that you evaluate?

Well, I guess first, we’re not really putting financing on the credit side of the book, generally. There may be exceptions to that. But that portfolio is essentially unlevered, except for the one piece of repo on one – on the only commercial mortgage that we have. So, we’re not really focused on layering in a lot of repo financing, external financing, I should say, non-structural financing on the credit side of the portfolio. If we were, I think you’d be looking at financing rates that would be in the 300 basis point range, something like that, maybe 350 on some. And depending on where they are on the credit stack, if they’re really senior like a – take a really senior RPL bond, that’s going to be closer to 2%-ish. And those that are a little bit further down the stack might be 3%, 3.5%. Those are – that would be against assets that are going to carry mid- to high single digits carry. And if you’re going to lever them, you’d be levering them against a 3%, 3.5% cost of funds or something like that. But we’re not doing that. And I don’t think we anticipate doing that soon. We don’t have a need with this level of liquidity on the balance sheet.

Got it. I guess I was just thinking more down the road, if you did apply leverage what the NIM would look like on it, and it sounds like it’s pretty attractive.

As a broad matter, Jason, I think it’d be fair to say, if you assumed a 5% or 6% carry, something like that, it’s just an example against a 3%, 3.5% net cost, that probably would be a fair assumption. We’re not doing that today, but that could be possible down the road.

Okay. Thank you, sir.

Thank you.

We’ll take our next question from Christopher Nolan with Ladenburg Thalmann.

Hey, Chris.

Rock, can you clarify – hey, how are you doing? in your comments, and I appreciate the detailed comments you gave on the new strategy. But when you’re mentioning high single-digit return for RMBS, was that unlevered?

You mean on the credit side, on the obviously non-agencies?

Yes.

Yes.

Okay.

Now, some of those assets, they may have some structural leverage on them. In some cases, but in many cases not. Those would be unlevered, raw, either carry or a combination of carry and discount realized as upside over time.

Okay. And then I guess, I’m trying to get my hands around the strategy, given how the MBS market has evolved in the second quarter, given the decline in repo funding costs. And it seems to me just boiling it down, you’re making a bet that prepayments are going to materially increase so impacting RMBS and that the U.S. economy will recover, which will enable you to keep your credit losses manageable. Is that a reasonable way to look at this?

Yes. I – possibly, meaning, prepay speeds are uncertain. And while one can fund these assets at attractive levels on a repo basis, they still have to be hedged. A 2% asset, 2% spec pool, which today would probably be the asset of choice, either a 2% or 2.5%, but let’s use the 2% for now, given where rates, markets, prices and yields are, that is an asset that’s going to require significant hedge. And so by placing a significant hedge on that, you’re raising the cost of funding and therefore, shrinking the net spread available on that asset. And so if you get that, combined with some potential elevation in expected speeds from the number I used before, which was an 11% to say a 15%, you will realize less spread than you may believe you bargain for upfront. And it could be quite significant. So, the returns there are just less predictable than maybe they appear on the surface and maybe than they have been at points where there’s been a bit wider spread opportunity. Now, others have a different view on it. And obviously, they’re expressing a quite different view in their allocations. But we look at it that the combination of those uncertainties around those speeds and those net resulting spreads and the capital volatility that can occur from that, justifies an allocation that doesn’t require a great deal of leverage in the agency, and at the same time, provides the opportunity to capture comparable returns. And in some cases, maybe higher returns on an unlevered or very low leverage basis on the non-agency side with liquidity, albeit less than the agency side, but some liquidity as these are CUSIPs. Or by entering into opportunities that may not have a CUSIP, may not have the same liquidity, can offer double-digit returns, either in pure carry or in a combination of carry and discount upside. So, those are sort of the three sets of types of alternatives that we’re looking at as well as platform opportunities that I identified in the script. But those are the opportunities that we focus on. And at the same time, we’re focusing on the balance sheet – securities on our own balance sheet as – and balancing each of those day by day.

And also, just as a clarification, you might have mentioned it earlier. What are the – what type of assets are you buying at a discount and hoping to collect on some discount accretion?

Well, they’re principally residential in character. They’re almost exclusively residential in character. But – so I mean they’re common residential assets. We’re not focused right now on the commercial side. Our commercial exposure is very small. And I gave commentary in the script on the one commercial loan that we have that’s performing very well and has a repo facility that extends out almost a year. So our focus is primarily residential and residential-related assets, either CUSIP or non-CUSIP. And then also, we’re focused on platform opportunities that we’ve identified and continue to evaluate in addition to agencies.

Great. Thank you.

Mr. Tonkel, there are no more questions at this time.

Thank you very much.

Thank you, ladies and gentlemen. This concludes today’s teleconference. You may now disconnect.