Good morning. I'd like to welcome everyone to the Arlington Asset Third Quarter Earnings Call. [Operator Instructions] I would now like to turn the conference over to Kurt Harrington. Mr. Harrington, you may begin.

Thank you very much. Good morning. This is Kurt Harrington, Chief Financial Officer of Arlington Asset. Before we begin this morning's call, I would like to remind everyone that statements concerning future financial and business performance, marketing 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 the 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 and factors. These and other material risks are described in the company's annual report on Form 10-K for the year ended December 31, 2012, the quarterly report on Form 10-Q for the quarter ended June 30, 2013, 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 when evaluating any forward-looking statement. I would now like to turn call over to Eric Billings for his remarks.

Thank you, Kurt. Good morning, and welcome to the third quarter earnings call for Arlington Asset. I'm Eric Billings, Chief Executive Officer of Arlington Asset. And joining me on the call today are Rock Tonkel, President and Chief Operating Officer; and Brian Bowers, our Chief Investment Officer. Yesterday, we reported core operating income of $1.03 per share for the third quarter, which equates to a 16% return on book value available for investment. While interest rates and market volatility have experienced sharp swings over the last 2 quarters, including a 90-basis-point range in 10-year U.S. Treasury yields in the third quarter, our complementary portfolio of private-label and agency mortgage-backed securities have exhibited durable spread income with limited change in book value. Net interest income and cash noninterest expenses remained essentially flat to the prior quarter. Year to date, in 2013, annualized cash G&A expense is down by approximately 14% versus 2012, primarily due to reduced cash compensation expense. Capital allocated to private-label MBS at quarter end was approximately $277 million, representing approximately 64% of investable capital. Capital allocated to agency MBS was approximately $170 million. During the third quarter, we reduced our agency MBS portfolio balances modestly given market volatility, resulting from political uncertainty around the U.S. government shutdown, debt ceiling and U.S. Federal Reserve tapering policy. We have maintained an overall hedged provision approximately equal to the market value of the company's agency MBS portfolio. The Eurodollar futures contracts we utilize to hedge our agency MBS portfolio run consecutively on a quarterly basis beginning in December 2014 and extend out to September 2018. They have an average notional amount of approximately $1 billion and a mark-to-market rate of 2.11%. At September 30, 2013, the average mark-to-market cost of those hedges over the 5-year period through 2018 was 1.54%. At…

[Operator Instructions] Our first question comes from Trevor Cranston with JMP Securities.

I just have a question to make sure I understand the accounting that's going to happen as the credit enhancement of your private-label portfolio kind of goes away and principal losses start to be realized on the bonds. Is that going to have any impact on the reported GAAP yield or kind of how you guys think about the near-term income available to distribute as dividends?

Yes, Trevor, Kurt Harrington. Our valuation is based on your expected cash flows. And so the losses that are anticipated in the future are built into those cash flows. So that's how our value is determined. The face value of the security is just a factor in determining what your percentage of value to that face is. So we expect that it is -- our projections on cash flows, if those remain stable, that there won't be any effect on value. If you do have some deterioration in the stated face of the security, it will just create that percentage of value to the remaining face to increase.

Got it. That makes sense. Okay. And then I also more conceptually wanted to follow up on the comments about kind of evaluating some alternative investment opportunities as kind of legacy non-agency space dwindles away. Can you maybe talk a little bit about the kind of things you're looking at and whether you see any near-term opportunities in either the new GFC risk-sharing deals or the kind of private-label markets that exist today?

Well, Trevor, we look at things always, all the time. And obviously, in the environment we're in today where we can be invested in non-agency securities that, well, we say that we think the appreciation in our non-agency securities will take place over 1 to 3 years, the activity in that asset class right now continues to be very strong. And it is entirely possible that, that result could happen considerably quicker than 1 year in reality. In any case, the clear returns that we expect to generate there are very, very high and on a risk-adjusted basis as attractive as anything I've ever seen in my investment career in these areas. So obviously, that's going to be virtually impossible to compete against. But that doesn't mean we're not looking for the time when we fully realize those gains and then reallocate our capital. And now in the agency structure, simultaneously I think it's really important, at least in my experience, going back to really the beginning of this business, this asset class structure, back in the mid-90s, the uniqueness of this time is that we not only are achieving mid- to high-teens returns on a cash basis in the agency portfolio, but we can do it while we are completely hedged. And this is extremely important because it means that this hedge structure, when we are in a position as we are where we are functionally 4x leveraged, so our liquidity position by any definition can be made to be extremely high. Now that means that the hedge structure of our agency portfolio is, as a funding cost, as you understand, were to go down. If the yield curve functionally steepens, then we can have a mark-to-market negative effect on the portfolio. But that means our funding cost simply…

Our next question comes from Jason Stewart with Compass Point.

On the agency portfolio, a couple of quick questions. From a high level, it looks like Mel Watt is back in the potential driver seat at the FHFA, and I was wondering if you have any thoughts about what the potential impact would be to the agency MBS market if he were to be nominated and become Director of the FHFA?

I don't think, Jason, we have any better or more informed thoughts than anybody else. I mean, to the extent that there was a concern as it relates to Arlington that somehow, that might have some effect on the pay-ups in the spec pool assets. They're basically down to near 0 already. So there's no -- but we don't see sort of some negative -- some negative effect there. Other than that, I don't think we'd probably add a lot to that discussion.

Okay. Well, that obviously dovetails into my second question, I mean, whether you've seen any improvement in pricing since quarter end in some of the spec pools. I mean, you have a lot of prepayment protection in your portfolio, and I'm wondering if the market is starting to realize any more value there or if those have been pretty flat.

A little bit, not a lot. I wouldn't put a lot of emphasis on it. For what reason, whether people sort of don't believe in the rally completely or for whatever other reason, we've seen a little bit, but not a lot.

Okay. And then on the private-label side, I mean, the metrics look great in terms of performance. But there are obviously big moves in terms of delinquency, the decline there, the severity declined in the fair market, percentage increased, which are all good things. But I was wondering if you could give us some more color as to what drove that, if you had a servicing transfer underlying and there's a lot of modifications in the portfolio. Any color you could give would be helpful.

No. I think what you're seeing there, Jason, is just you're seeing sort of a little bit of the lag effect of the improvement in housing market conditions and the underlying borrower conditions. You're seeing more people being able to pay and cure. And you're seeing assets come out of these pools even in sort of maybe more extreme situations. For example, and I'm not saying this is necessarily prevalent, but you're seeing these kinds of things where you have assets that are in foreclosure and they're getting pulled out at par. So you have these examples. We all have anecdotal examples, but I think as a broad matter, you're seeing the lag effect of the positive movement in housing, the sort of shift in psychology that goes on among buyers, homeowners and buyers and rent -- excuse me, and borrowers in that context, and we're seeing that flow through on a lag basis. It just takes a while to work through the servicing cycle, and so you're starting to see that come through. And we all have -- we can all have our different views of what we expect house prices to do over the next 12 months or so. We continue to be constructive, although we don't -- we have what we've said and we've said before, we don't necessarily believe that the house prices are going to hold above 10% appreciation. We don't believe that, that's likely to be the case. But we are very constructive on the supply, demand dynamic in housing for a whole host of reasons. And therefore, we're constructive about the development for credit in these assets over the next, certainly, 12 but really over the next several years. And as a consequence, that is driving -- that really drives our expectations for the terminal par in these assets. And then it's just a question, as Eric said, of the timeline to get at that sort of, give or take, 20-point appreciation potential between our price today and that terminal par on those assets.

But it is occurring in real time. Let me be very clear about that.

Oh, yes.

Yes, we can see the numbers here.

Our next question comes from David Walrod with Ladenburg.

I wanted to just clarify a couple of things. The capital allocation now at 64% into the private label, how long are you willing to let that float up?

I don't think we'll see a lot of difference from here, Dave. I don't think we'll see it higher. We still view the -- I mean, Eric described the return potential on both sides of the book. We feel like the way we're sitting here at this point is a pretty comfortable allocation of capital. I think it wouldn't surprise us if agency exposure was a little higher in the fourth quarter and maybe drew a few dollars of capital, a few dollars of incremental capital in the fourth quarter. But I think we sort of -- as long as this return potential is available on both sides of the portfolio, then I think we feel pretty comfortable here.

Yes. And I mean, one thing I'll add to that, David, is as you, I hope, can tell from our description, clearly, we expect to migrate the residual -- all of the capital, $277 million of capital and plus what we expect to be a significant gain over time in that portfolio to the agency portfolio. The truth is that the pricing change of the market is dynamic enough right now and strong enough right now that this is actually occurring in real time. And in that context, we're constantly migrating the assets that have gone from whatever purchase price we may have made in the past, 50, 50 or 60 or whatever. We have asset that we're selling in the 80s now. And so as we do that in the non-agency portfolio, to the degree we can't reallocate securities, in other words, capital in those, find them attractively priced such that the returns are better than the agency. Of course, we migrate it to the agency, and you are seeing that. So I think on a -- we would expect to the degree that things occur this way on a steady-state basis, you're going to actually start -- you are seeing and you will continue to see a migration to the agency portfolio from a non-agency capital simply because the dynamic that's taking place now in that portfolio is quite powerful and these prices are starting to realize what has been our anticipation of the true value. And as that occurs, you'll see the migration.

Okay, great. You mentioned that the fair value on the private labels was up about 300 basis points or so. Is that primarily just due to changes in the market value or are you -- as you're making additional purchases, are they at a higher price? Is that's what's driving up the average fair value?

It's a little bit of both. New purchases are at a slightly higher basis. So there's a little bit of that in there. But it's also the valuation increase.

Okay. And then the last question I had was there was a slight decline in book value. I'm just curious, what drove that?

It's important, David, and again, as we said in the agency portfolio to the degree we do have marks depending on rate movement on either side of that portfolio, it can result in a -- and move down in book value on a steady basis or move up. The key thing to recognize, because we are completely hedged assets to liabilities on that in the structure, as long as we have the liquidity to stay in the structure, then we are going to receive cash flows to us such that those gains, if book values reduce, we would get it back in the excess spread that would last a longer period of time. And if rates move up, definitely the yield curve in our structure to us flattens, then we would actually have gains and then we would either choose to realize that or the spread technically would be lower on that basis. But that's only because we have already received the cash from the movement rates. But because we're hedged completely in the structure, really these movements around book value on that in this regard really are not important because we have the liquidity to stay in the structure for the duration.

[Operator Instructions] We have a question from Steve Delaney with JMP Securities.

I was wondering, there's been a lot of chatter in the market recently about repo availability in pricing. You were still -- you were 37 basis points at September 30. I'm just wondering if you could give us some comments on kind of what you saw in the market around the debt ceiling debate and how things have settled now, now as we approach year end both in terms of like pricing and sort of liquidity conditions generally in the repo market.

So we really saw no change, Steve. We didn't see any significant change in pricing. There might have been a couple of people who moved their prices around by a couple of basis points. But for the most part, we saw no change in either appetite, availability or really on the cost side.

And you're not getting any sense that going into year end, sometimes we get a little stressed and this year may be a little worse with -- we're going to be facing this debt thing again in January, February. Everything seems -- in terms of the chatter with the repo desk, everybody seems to be fairly copacetic going into year end?

We haven't seen anything to the contrary. We haven't heard anything to the contrary. We actually have a lot of flexibility in our repo program and people who -- a lot of people who want to do business with us, and we have a lot of untapped appetite in our program. So I think you -- in past years, from time to time, we've sort of -- we've done more extended -- in a more extended role over the end of the year. We may do that this year. Again, we may not. But we might not. And that might imply a little bit higher cost since you're going out a little bit longer to go over year end. But other than that, normal economic sort of equation that we've -- that we typically experience over year end. We don't -- we're not hearing of anything that would suggest issues at this stage.

All right. Good to hear. And Eric mentioned the allocation of equity at the agency portfolio was $170 million. So if we do the reverse math, it works out, it looks likes about a 8.4, 8.5 leverage ratio there. We did see in a report last night -- we're seeing -- well, in several. We're seeing some people bring some leverage down below the 8 level, 7, 7.5. Do you think there's -- is there any pressure building there by the dealers or maybe with the Fed behind the dealers? I mean, are you hearing anything that's suggesting that people want to see leverage at -- below 8 at this time? Or are your guys telling you your 8.4 is fine?

We have received no feedback, whatsoever. As far as I'm aware, we've received no feedback on that.

And then again, Steve, we have so much excess capital away from the agency, which is substantially unleveraged debt.

Exactly. And overall, only 3.0x. I mean, I think when we look at the entirety, we consider you fairly low levered certainly on a relative basis.

We've heard no concerns there, Steve.

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

Thanks very much, everybody. Appreciate you joining us. And we look forward to speaking with you next quarter.

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