ARLINGTON ASSET INVESTMENT AI
October 22, 2009 - 7:50am EST by
heffer504
2009 2010
Price: 14.05 EPS nm $2.00
Shares Out. (in M): 8 P/E nm 7.0x
Market Cap (in $M): 111 P/FCF nm 7.0x
Net Debt (in $M): 0 EBIT 0 18
TEV ($): 111 TEV/EBIT nm nm

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Description

 

Arlington Asset is the old FBR mortgage REIT that has been cleaned up.  The story lies in an understated clean book value, as well as a few other sources of potential value.  I believe the stock is worth at least $18, with potential upside from this value.  First, the book value:

        fbcm pf pf mbs
    2q09 q 8/10 update mk to mkt debt repo mk to mkt
agency mbs              120.0                120.0                120.0             120.0             120.0
non-agency mbs                30.0                  49.3                  49.3                49.3                60.0
   note: face value                   115.8               115.8             115.8             115.8
other assets                12.0                  12.0                  12.0                12.0                12.0
cash                36.8                    9.4                    9.4                  4.4                  5.7
fbcm share value                71.3                  69.1                  77.6                77.6                77.6
  note: shares owned                15.1                 14.7                 14.7               14.7               14.7
  note: price - 12%    $         4.70  $             4.70  $             5.28  $           5.28  $           5.28
  total assets              270.1                259.8                268.3             263.3             275.4
             
repos                94.7                  94.7                  94.7                94.7                94.7
a/p etc                31.4                  31.4                  31.4                31.4                31.4
lt debt                51.8                  26.8                  26.8                  1.8                  1.8
  total liabilities              177.9                152.9                152.9             127.9             127.9
             
calculated equity                92.2                106.9                115.4             135.4             147.5
shares                   8.0                    8.0                    8.0                  8.0                  8.0
per share    $        11.60  $           13.45  $           14.52  $         17.03  $         18.55

 

This is the adjustment from stated book as of 6/30 through my estimate of current economic book value.  The adjustments are as follows (right to left):

1) Bought non-agency MBS and retired $25m of trust preferred debt for $5m, as reported in 8/10 press release

 

2) Mark to market 14.7 million share holding of FBCM from $4.70 price as of 6/30 to current price, less 7% fees and 5% offering discount

 

3) Repurchase remaining $25m of trust preferred debt at .20, as per management guidance, and similar to repurchase done in August

 

4) Mark non-agency MBS to market, assuming a 20% increase in price in the last 2-4 months.  These are all "busted" AAA tranches, likely of alt-a paper, so per my checks this seems like a reasonable assumption of appreciation.

 

This, I believe that the current book value is around $19.  In addition, I believe you are getting the following potential sources of upside:

 

1) Other assets are mostly private equity holdings and have been marked down to extremely conservative valuations.

 

2) FBCM stock could trade up from its recently-depressed price before the offering occurs as they tell their story on the roadshow.  FBR has been the lead underwriter in a few FDIC-assisted bank recapitalization transactions (most recently for a $1.2 billion blind pool), and I believe the number of these transactions will increase dramatically in the next 12 months due to the increasing pace of bank failures and the compelling economics offered to investors.

 

3) There are roughly $1 billion of gross net operating and capital loss carry-forwards that are not carried at any value on the balance sheet.  With 8 million shares outstanding, this works out to over $40 (net, undiscounted) per share in NOL value.  As a result, though, there is a poison pill in place to prevent any section 382 limitation issues.

 

What is the most likely outcome here?  The management will sell the FBCM stock and be left with book value of around $150 million.  Then assume they are able to lever up modestly and create a 12% pre-tax ROE (seems like the average over a cycle for mortgage REITs), of which 85% is paid out.  This should allow a dividend of roughly $1.75 a share, which at an 8% yield would give you a $20-22 stock.

Catalyst

FBCM shares sold

quarter reported and new book value discussed

capital invested into interest-bearing assets

    sort by   Expand   New

    Description

     

    Arlington Asset is the old FBR mortgage REIT that has been cleaned up.  The story lies in an understated clean book value, as well as a few other sources of potential value.  I believe the stock is worth at least $18, with potential upside from this value.  First, the book value:

            fbcm pf pf mbs
        2q09 q 8/10 update mk to mkt debt repo mk to mkt
    agency mbs              120.0                120.0                120.0             120.0             120.0
    non-agency mbs                30.0                  49.3                  49.3                49.3                60.0
       note: face value                   115.8               115.8             115.8             115.8
    other assets                12.0                  12.0                  12.0                12.0                12.0
    cash                36.8                    9.4                    9.4                  4.4                  5.7
    fbcm share value                71.3                  69.1                  77.6                77.6                77.6
      note: shares owned                15.1                 14.7                 14.7               14.7               14.7
      note: price - 12%    $         4.70  $             4.70  $             5.28  $           5.28  $           5.28
      total assets              270.1                259.8                268.3             263.3             275.4
                 
    repos                94.7                  94.7                  94.7                94.7                94.7
    a/p etc                31.4                  31.4                  31.4                31.4                31.4
    lt debt                51.8                  26.8                  26.8                  1.8                  1.8
      total liabilities              177.9                152.9                152.9             127.9             127.9
                 
    calculated equity                92.2                106.9                115.4             135.4             147.5
    shares                   8.0                    8.0                    8.0                  8.0                  8.0
    per share    $        11.60  $           13.45  $           14.52  $         17.03  $         18.55

     

    This is the adjustment from stated book as of 6/30 through my estimate of current economic book value.  The adjustments are as follows (right to left):

    1) Bought non-agency MBS and retired $25m of trust preferred debt for $5m, as reported in 8/10 press release

     

    2) Mark to market 14.7 million share holding of FBCM from $4.70 price as of 6/30 to current price, less 7% fees and 5% offering discount

     

    3) Repurchase remaining $25m of trust preferred debt at .20, as per management guidance, and similar to repurchase done in August

     

    4) Mark non-agency MBS to market, assuming a 20% increase in price in the last 2-4 months.  These are all "busted" AAA tranches, likely of alt-a paper, so per my checks this seems like a reasonable assumption of appreciation.

     

    This, I believe that the current book value is around $19.  In addition, I believe you are getting the following potential sources of upside:

     

    1) Other assets are mostly private equity holdings and have been marked down to extremely conservative valuations.

     

    2) FBCM stock could trade up from its recently-depressed price before the offering occurs as they tell their story on the roadshow.  FBR has been the lead underwriter in a few FDIC-assisted bank recapitalization transactions (most recently for a $1.2 billion blind pool), and I believe the number of these transactions will increase dramatically in the next 12 months due to the increasing pace of bank failures and the compelling economics offered to investors.

     

    3) There are roughly $1 billion of gross net operating and capital loss carry-forwards that are not carried at any value on the balance sheet.  With 8 million shares outstanding, this works out to over $40 (net, undiscounted) per share in NOL value.  As a result, though, there is a poison pill in place to prevent any section 382 limitation issues.

     

    What is the most likely outcome here?  The management will sell the FBCM stock and be left with book value of around $150 million.  Then assume they are able to lever up modestly and create a 12% pre-tax ROE (seems like the average over a cycle for mortgage REITs), of which 85% is paid out.  This should allow a dividend of roughly $1.75 a share, which at an 8% yield would give you a $20-22 stock.

    Catalyst

    FBCM shares sold

    quarter reported and new book value discussed

    capital invested into interest-bearing assets

    Messages


    SubjectQuestions
    Entry10/22/2009 10:36 AM
    Memberdavid101

    Heffer,

    Any thoughts on why Passport was selling this past summer at lower prices, even factoring in the reverse 1 for 20 stock split?

     

    Right now, they are losing money, a lot of money. Adjusting for the split, they lost $4.20/sh last quarter. What is going to change so that they start earning money and paying dividends?

     

    Related to earnings, can you provide some color on the earning power of the MBS? They have $149 mm of MBS marked at fair value and earned $1.3 mm of interest in the last quarter. That implies less than a 4% yield on marked down bonds. I would have expected a much higher yield.

     

    Thanks,

     

    David


    Subjecttrust preferred debt
    Entry10/22/2009 11:39 AM
    Memberbroncos727

    Great write up.  I own this one.  I must have missed the guidance that they were going to repurchase the other block of trust preferred debt at .20.  Question, any thoughts on who sells that debt at .20 on the dollar?  Why would anybody sell that at those prices?  .205 bid here. 


    SubjectRE: Questions
    Entry10/22/2009 01:02 PM
    Memberheffer504

    a) illiquid, tax loss, same reason every other .50 stock was mispriced this summer i assume, but no idea really

    b and c) there is a leap of faith here.  the agency mbs have a 5.6% coupon so there is clearly some disconnect- i assume writedowns on the other mbs that offset the interest.  this company has been restructuring, selling stuff at a loss, firing people and taking charges, etc etc.  generically speaking, you need to assume that this is no different than any other reit, and once everything settles down they can make a reasonable return on equity.  i think this is a fair assumption...


    SubjectRE: trust preferred debt
    Entry10/22/2009 01:05 PM
    Memberheffer504

    i agree it is a little strange.  but, this is 30 year debt, 3% coupon, with no collateral value, so mgmt claims that .20 is a generous bid... in any event, they clearly bought this back 2 months ago at .20, and as i said the cfo is confident the last block will be repurchased at that price...


    Subjectquick update
    Entry10/22/2009 01:38 PM
    Memberheffer504

    the fbcm deal looks like it will come close to $6 and the underwriter's fee will be 5% not 7%, so this adds around $.50 to my estimate. 


    SubjectDoes the trust preferred trade?
    Entry10/22/2009 03:05 PM
    Memberdoggy835

    I can't seem to track it down anywhere. Thanks.


    SubjectRE: Does the trust preferred trade?
    Entry10/22/2009 04:16 PM
    Memberbroncos727
    They were able to buy back the debt through a busted asset backed 
    security selling at distressed level, they dont trade anywhere, is my understanding.

    SubjectRE: update
    Entry11/13/2009 04:50 PM
    Memberheffer504

    all as expected.  book adjusted to market is over $20...


    SubjectRE: RE: update
    Entry11/13/2009 09:53 PM
    Memberhb190

    Heffer, what are your thoughts on likely sources, costs, and levels of leverage going forward?  how do you reconcile the target 8% yield with the higher yields on existing clean m-reits?  thanks.


    SubjectRE: Non-agency MBS
    Entry11/19/2009 01:37 PM
    Memberheffer504

    no they don't give that transparency


    SubjectRE: RE: RE: update
    Entry11/19/2009 01:40 PM
    Memberheffer504

    i think they will hold non-agency mbs unlevered as long as they can get 15%+ yields.  they will lever the agency stuff on repos... so the leverage will depend on the portfolio i guess.  8% is at an 85% payout and a conservative roe estimate (hopefully), and basically just gets you back to book value (without any value for the NOL)...

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