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| AI > SEC Filings for AI > Form 10-Q on 10-Aug-2009 | All Recent SEC Filings |
10-Aug-2009
Quarterly Report
The following analysis of the unaudited condensed consolidated financial condition and results of operations of Arlington Asset Investment Corp. (Arlington Asset), formerly known as Friedman Billings Ramsey Group, Inc. (FBR Group) and its subsidiaries, including FBR Capital Markets Corporation (FBR Capital Markets) (unless the context otherwise provides, collectively, "we", "us", "our" or the "Company"), should be read in conjunction with (i) the Company's audited consolidated financial statements and notes thereto included in Annual Report on Form 10-K for the year ended December 31, 2008; (ii) FBR Capital Markets' unaudited condensed consolidated financial statements and notes thereto included in its Quarterly Report on Form 10-Q for the quarter ended June 30, 2009; and (iii) FBR Capital Markets' audited consolidated financial statements and notes thereto included in its Annual Report on Form 10-K for the year ended December 31, 2008.
The Company's unaudited condensed consolidated financial statements include the results of its former subsidiary, FBR Capital Markets through May 20, 2009. Prior to May 20, 2009, the Company's wholly-owned subsidiary, FBR TRS Holdings, Inc. (FBR TRS Holdings), owned approximately 56% of the outstanding shares of FBR Capital Markets. The Company liquidated 16,667,000 and 1,500,000 shares of FBR Capital Markets common stock on May 20 and June 19, 2009, respectively, resulting in remaining holdings representing an approximately 39% and 24% interest in FBR Capital Markets, respectively. The sale of 16,667,000 shares on May 20, 2009 was to FBR Capital Markets. As a result, effective May 20, 2009, the Company no longer had majority control of FBR Capital Markets and therefore, deconsolidated the results of FBR Capital Markets' activities in preparing the Company's consolidated financial statements.
The discussion of the Company's consolidated financial condition and results of operations below may contain forward-looking statements. These statements, which reflect management's beliefs and expectations, are subject to risks and uncertainties that may cause actual results to differ materially. For a discussion of the risks and uncertainties that may affect the Company's future results, please see "Forward-Looking Statements" immediately following Item 4 of this report on Form 10-Q.
Business Strategy
The sale of FBR Capital Markets stock is in furtherance of the strategic shift the Company has initiated to focus on a principal investing strategy by monetizing our investment in FBR Capital Markets. Given current dislocations in the capital markets, the Company seeks to benefit from potential high current cash returns available on mortgage investments. The Company plans to deploy the net cash proceeds for investments that offer current income as well as capital appreciation potential, and which may utilize the Company's net operating loss carry-forwards (NOLs) and net capital loss carry-forwards (NCLs). The Company expects future investments to include non-agency residential MBS and residential MBS guaranteed by a U.S. Government agency or U.S. Government-sponsored entity, among others. The Company may also consider opportunities for financial service operating businesses potentially in the form of a bank charter, and will seek to continue strengthening its balance sheet by converting long-term debt to equity through the extinguishment of the remaining Trust Preferred securities at a discount to face value.
Executive Summary
As discussed above, on May 20 and June 19, 2009, we liquidated 16,667,000 and 1,500,000 shares of FBR Capital Markets common stock, respectively, resulting in remaining holdings representing an approximately 39% and 24% interest in FBR Capital Markets, respectively. As a result, effective May 20, 2009, we deconsolidated the results of FBR Capital Markets' activities in preparing the Company's consolidated financial statements. The Company recorded $9.8 million of losses related to the sales of FBR Capital Markets stock and $4.0 million of losses related to the fair value measurement of the remaining shares during the quarter ended June 30, 2009. With the sale of FBR Capital Markets stock on May 20, 2009 and resulting deconsolidation, the Company elected to adopt the provisions of SFAS 159 to apply fair value accounting for the remaining shares of its FBR Capital
The sale of 16,667,000 shares on May 20, 2009 was to FBR Capital Markets in accordance with the terms of a Stock Repurchase Agreement entered into in May 2009. In connection with the Stock Repurchase Agreement, the Company and FBR Capital Markets have also agreed that FBR Capital Markets has no additional payment obligations with respect to the FBR Open Golf Tournament (FBR Open). Accordingly, the Company recorded $5.5 million related to the remaining obligations on the FBR Open during the three months ended June 30, 2009.
The results of the Company's operations, without the results of FBR Capital Markets' operations, as compared to the results of consolidated operations as reported, for the three and six months ended June 30, 2009 are as follows (dollars in thousands):
Pro-Forma Results of Operations, Excluding FBR Capital Markets' Operations
Three Months Ended Six Months Ended
June 30, 2009 June 30, 2009
Pro-forma As Reported Pro-forma As Reported
Revenues:
Capital markets $ - $ 31,171 $ - $ 81,075
Principal investment:
Interest 1,282 1,282 3,881 3,881
Net investment loss (3,989 ) (3,989 ) (3,983 ) (3,983 )
Dividends 108 108 108 108
Total revenues (2,599 ) 28,572 6 81,081
Interest expense 582 582 3,095 3,346
Revenues, net of interest expense (3,181 ) 27,990 (3,089 ) 77,735
Non-Interest Expenses:
Compensation and benefits 2,363 25,594 10,502 70,731
Professional services 4,892 7,224 5,120 11,993
Business development 5,534 7,142 7,884 13,123
Clearing and brokerage fees - 2,653 - 5,950
Occupancy and equipment 175 5,374 322 13,479
Communications 82 3,637 148 8,864
Other operating expenses 994 3,611 2,694 8,936
Total non-interest expenses 14,040 55,235 26,670 133,076
Operating loss (17,221 ) (27,245 ) (29,759 ) (55,341 )
Other Income (Loss):
Loss on subsidiary share
transactions (9,776 ) (9,776 ) (9,912 ) (9,912 )
Gain on extinguishment of long-term
debt - - 132,453 132,453
Other loss (4 ) (4 ) (7 ) (7 )
(Loss) income before income taxes
and noncontrolling interest (27,001 ) (37,025 ) 92,775 67,193
Income tax (benefit) provision (501 ) (310 ) 8,445 9,245
Net (loss) income $ (26,500 ) $ (36,715 ) $ 84,330 $ 57,948
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During the quarter ended June 30, 2009, we began our efforts to re-build our mortgage-backed securities (MBS) portfolio. Our strategy is to be selective in identifying non-agency senior MBSs that could provide attractive loss-adjusted yield on an unlevered basis. As of June 30, 2009, the Company had $29.9 million in unlevered non-agency MBS. We are also continuing to invest in agency MBS on a leveraged basis as we believe that these investments will provide attractive risk-adjusted returns given the current environment. As of June 30, 2009, the Company had $119.4 million in its agency MBS portfolio. We will continue to evaluate investment opportunities against the returns available in each of our investment alternatives and endeavor to allocate our assets and capital with an emphasis toward the highest risk-adjusted return available. This strategy may cause us to have different allocations of capital in different environments.
Principal Investing
Mortgage-Backed Securities
The Company recorded net interest income of $1.2 million and $8.5 million from MBS held in its principal investment portfolio for the three months ended June 30, 2009 and 2008, respectively. The Company recorded net interest income of $3.6 million and $14.9 million from MBS held in its principal investment portfolio for the six months ended June 30, 2009 and 2008, respectively. The decrease in net interest income during the three and six months ended June 30, 2009 is due mainly to the decrease in the average balance of MBS investments held in our portfolio offset by the increase in the average yield.
Merchant Banking and Other Investments
The total value of our merchant banking portfolio and other investments was $75.4 million as of June 30, 2009. Of this total, $71.3 million represents an investment in FBR Capital Markets, $2.6 million was held in the merchant banking portfolio and $1.5 million was held in alternative asset funds. Net unrealized losses in the merchant banking portfolio included in accumulated other comprehensive income (AOCI) totaled $0.1 million as of June 30, 2009.
During the three and six months ended June 30, 2009, we recorded $0.5 million and $1.5 million, respectively, in other-than-temporary impairment write-downs as part of the Company's quarterly assessments of unrealized losses in its portfolio.
Results of Operations
Three months ended June 30, 2009 compared to three months ended June 30, 2008
The Company had a net loss of $32.2 million in the second quarter of 2009 versus
a net loss of $25.1 million in the second quarter of 2008. Net loss included the
following results of operations by segment (dollars in thousands):
For the quarter ended
June 30,
2009 2008
Capital markets $ (10,025 ) $ (35,223 )
Principal investing (17,220 ) (11,272 )
Other - (592 )
Operating loss (27,245 ) (47,087 )
Net loss on subsidiary share transactions and other (9,780 ) (192 )
Loss before income taxes and noncontrolling interest (37,025 ) (47,279 )
Income tax benefit (310 ) (9,974 )
Noncontrolling interest in losses of consolidated subsidiary (4,558 ) (12,254 )
Net loss attributable to Arlington Asset shareholders $ (32,157 ) $ (25,051 )
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The increase in net loss attributable to Arlington Asset shareholders is primarily due to losses recorded from the sales of FBR Capital Markets common stock during the second quarter of 2009 and the valuation loss on the remaining shares of FBR Capital Markets stock.
The Company's revenues, net of interest expense, decreased to $28.0 million in the second quarter of 2009 from $49.5 million in the second quarter of 2008 due to the changes in revenues and interest expense described below.
Revenues from our principal investment activities, net of related interest expense, totaled $(2.7) million in the second quarter of 2009 as compared to $3.4 million in the second quarter of 2008. The decrease in net revenues is primarily the result of a decrease in MBS interest income resulting from lower average MBS balances and a decrease in investment losses offset by the losses incurred as a result of fair value changes in our investment in FBR Capital Markets stock. Revenues from our principal investment activities included the following (dollars in thousands):
For the quarter ended
June 30,
2009 2008
Net interest income $ 1,203 $ 8,854
Net investment loss-principal investing (3,989 ) (5,542 )
Dividend income 108 133
$ (2,678 ) $ 3,445
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Three months ended Three months ended
June 30, 2009 June 30, 2008
Average Income / Yield / Average Income / Yield /
Balance (Expense) (Cost) Balance (Expense) (Cost)
Mortgage-backed securities(1) $ 75,101 $ 1,280 6.82 % $ 2,274,713 $ 22,532 3.96 %
Other(2) 2 310
1,282 22,842
Repurchase agreements $ 55,514 (79 ) (0.57 )% $ 1,961,642 (13,358 ) (2.69 )%
Derivative contracts(3) - - - (630 )
$ 55,514 (79 ) (0.57 )% $ 1,961,642 (13,988 ) (2.85 )%
Net interest income/spread $ 1,203 6.25 % $ 8,854 1.11 %
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(1) The average balance and the yield/cost are calculated based upon the adjusted par value which includes the effects of any other-than-temporary impairments recorded by the Company. The yield based on unadjusted par value was 4.25% and 3.92% for the three months ended June 30, 2009 and 2008, respectively.
(2) Includes interest income on cash and other miscellaneous interest-earning assets.
(3) Includes the effect of derivative instruments accounted for as cash flow hedges.
As shown in the table above, net interest income decreased by $7.7 million to $1.2 million during the three months ended June 30, 2009 compared to $8.9 million during the three months ended June 30, 2008. This decrease in interest income was primarily due to a lower average balance on the MBS portfolio.
The Company recognized net investment loss of $4.0 million during the second quarter 2009 compared to net investment loss of $5.5 million in the second quarter 2008. The following table summarizes the components of net investment loss (dollars in thousands):
Three months ended
June 30,
2009 2008
Available for sale and cost method
securities-other-than-temporary impairments $ - $ (3,304 )
Fair value change in investment in FBR Capital Markets stock (4,026 ) -
Losses from investments funds (547 ) (326 )
Realized (losses) gains on sale of available for sale
investments, net (83 ) 737
Residual interest in a securitization-other-than-temporary
impairments - (1,611 )
Other net investment income (loss) 667 (1,038 )
$ (3,989 ) $ (5,542 )
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Fair value change in investment in FBR Capital Markets stock reflects the change in fair value of FBR Capital Markets stock subsequent to the May 20, 2009 deconsolidation.
Loss from investment funds reflects the earnings from and valuation adjustment of investments in proprietary investment partnerships and other managed investments.
Other net investment income primarily includes net gains and losses from the changes in the fair value of investments in our MBS portfolio and derivative transactions.
Capital markets' revenues, generated through FBR Capital Markets and its subsidiaries and consolidated through May 20, 2009, decreased 41.1% to $31.2 million in the quarter ended June 30, 2009 from $53.0 million
Principal investing interest revenue decreased 94.3% to $1.3 million in the second quarter of 2009 from $22.8 million in the second quarter of 2008. Net investment loss decreased to $4.0 million in the second quarter of 2009 from $5.5 million in the second quarter of 2008. The decrease in interest income year over year was a result of the lower average balance in the MBS portfolio as a result of the downsizing effort to reduce exposure to deteriorating market conditions while at the same time generating additional cash to fund the extinguishment of long-term debt in the first quarter of 2009. The decrease in net investment loss was a result of other-than-temporary impairment losses on MBS and a residual interest in securitizations recorded in the second quarter of 2008 with no comparable losses recorded in the second quarter of 2009 offset by fair value losses recorded on our investment in FBR Capital Markets stock and change in derivative activities.
Interest expense, related primarily to long-term debt issued through FBR TRS Holdings, decreased 97.3% to $0.6 million in the second quarter 2009 from $21.9 million in the second quarter 2008 as a result of a decrease in outstanding principal balances due to the extinguishment during the first quarter of 2009 and lower LIBOR based interest rates associated with these floating rate borrowings.
Total non-interest expenses decreased 42.9% to $55.2 million in the second quarter 2009 from $96.6 million in the second quarter 2008. This decrease was caused by the fluctuations in non-interest expenses discussed below.
Compensation and benefits expense decreased 52.6% to $25.6 million in the second quarter 2009 from $54.0 million in the second quarter 2008. The decrease was primarily attributable to the deconsolidation of FBR Capital Markets' activities during the second quarter of 2009 and the cost reduction efforts during the last year.
Professional services expense decreased 31.4% to $7.2 million in the second quarter 2009 from $10.5 million in the second quarter 2008 primarily due to the deconsolidation of FBR Capital Markets' activities during the second quarter of 2009.
Business development expenses increased 4.4% to $7.1 million in the second quarter 2009 from $6.8 million in the second quarter 2008. The increase was primarily due to an increase in expenses associated with costs for the PGA Tour's FBR Open.
Clearing and brokerage fees decreased 20.6% to $2.7 million in the second quarter 2009 from $3.4 million in the second quarter 2008. The decrease reflects the effects of the deconsolidation of FBR Capital Markets' activities during the second quarter of 2009.
Occupancy and equipment expense decreased 37.2% to $5.4 million in the second quarter 2009 from $8.6 million in the second quarter 2008. The decrease in expenses is attributable to the effects of cost reduction initiatives over the past year including decreased costs associated with technology upgrades and the deconsolidation of FBR Capital Markets' activities during the second quarter of 2009.
Communications expense decreased 42.9% to $3.6 million in the second quarter 2009 from $6.3 million in the second quarter 2008. The decrease in expenses is primarily due to the effects of cost reduction initiatives over the past year including decreased costs related to market data and customer trading services and the deconsolidation of FBR Capital Markets' activities during the second quarter of 2009.
The total income tax benefit decreased 97.0% to $0.3 million in the second quarter 2009 from $10.0 million in the second quarter 2008. The decrease is due primarily to the recording of the tax provision due to the discrete period reporting of the tax effects of the gain recognized from the extinguishment of debt during the first quarter of 2009. Our effective tax rate was 0.7% in the second quarter 2009 as compared to 27.0% in the second quarter
Net loss attributable to the noncontrolling interest of consolidated subsidiary of $4.6 million represents minority interest holders' share of losses of FBR Capital Markets for the second quarter 2009 as compared to $12.3 million for the second quarter 2008.
Results of Operations
Six months ended June 30, 2009 compared to six months ended June 30, 2008
Net income increased to $69.4 million in the six months ended June 30, 2009 from
$20.1 million in the six months ended June 30, 2008. Net income included the
following results of operations by segment (dollars in thousands):
Six Months Ended
June 30,
2009 2008
Capital Markets $ (25,584 ) $ (46,204 )
Principal Investment (29,757 ) (31,422 )
Other - (3,115 )
Operating loss (55,341 ) (80,741 )
Net income from extinguishment of debt, subsidiary share
transactions and other 122,534 72,845
Income (loss) before taxes and noncontrolling interest 67,193 (7,896 )
Income tax provision (benefit) 9,245 (10,780 )
Noncontrolling interest in losses of consolidated
subsidiary (11,459 ) (17,167 )
Net income attributable to Arlington Asset shareholders $ 69,407 $ 20,051
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The increase in net income is primarily attributable to the $132.5 million gain on extinguishment of long-term debt in the first quarter of 2009.
The Company's revenues, net of interest expense, decreased to $77.7 million in the first six months of 2009 from $141.8 million in the first six months of 2008 due to the changes in revenues and interest expense described below.
Revenues from our principal investment activities, net of related interest expense, totaled $(0.3) million in the first six months of 2009 as compared to $(2.9) million in the first six months of 2008. The change in net revenues is primarily the result of the recognition of other-than-temporary impairment losses related to the Company's MBS portfolio and a residual interest in a securitization of non-prime mortgage loans during the first half of 2008. No other-than-temporary impairments were recognized in the first half of 2009 related to MBS. This decrease in other-than-temporary impairment losses were offset by losses incurred from our equity investment in FBR Capital Markets. Revenues from our principal investment activities included the following (dollars in thousands):
Six Months Ended
June 30,
2009 2008
Net interest income $ 3,581 $ 16,976
Net investment loss-principal investing (3,983 ) (20,201 )
Dividend income 108 339
$ (294 ) $ (2,886 )
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Six Months Ended June 30,
2009 2008
Average Income / Yield / Average Income / Yield /
Balance (Expense) (Cost) Balance (Expense) (Cost)
Mortgage-backed securities(1) $ 91,830 $ 3,861 8.41 % $ 2,107,574 $ 45,629 4.33 %
Other(2) 20 2,065
3,881 47,694
Repurchase agreements $ 67,663 (300 ) (0.89 )% $ 1,861,188 (29,764 ) (3.16 )%
Derivative contracts(3) - - - (954 )
$ 67,663 (300 ) (0.89 )% $ 1,861,188 (30,718 ) (3.30 )%
Net interest income/spread $ 3,581 7.52 % $ 16,976 1.03 %
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