SEC Company Response from Arlington Asset Investment Corp. (CIK 0001209028) — Jul 20, 2022
Arlington Asset Investment Corp. (CIK 0001209028)
Date: July 20, 2022 · CIK: 0001209028 · Accession: 0000950170-22-012812
AI Filing Summary & Sentiment
File numbers found in text: 001-34374
Referenced dates: June 21, 2022
Letter
VIA EDGAR Division of Corporation Finance Office of Real Estate & Construction United States Securities and Exchange Commission Arlington Asset Investment Corp. Form 10-K for fiscal year ended December 31, 2021 Filed March 10, 2022 File No. 001-34374
Dear Mr. McPhee:
This letter is submitted in response to the comments of the Staff of the Division of Corporation Finance (the “Staff”) of the United States Securities and Exchange Commission (the “Commission”) contained in your letter dated June 21, 2022 with respect to the Form 10‑K (File No. 001-34374) for the fiscal year ended December 31, 2021 of Arlington Asset Investment Corp. (the “Company”), which was filed with the Commission on March 10, 2022 (the “Form 10‑K”).
For convenience of reference, the Staff’s comments contained in your June 21 letter are reprinted below in italics, numbered to correspond with the paragraph number assigned in your letter, and are followed by the corresponding response of the Company.
Form 10-K for the year ended December 31, 2021
Economic Net Interest Income from Financial Assets, page 48
1.We note that your non-GAAP measure 'Economic net interest income from financial assets' is reconciled to 'Net operating income from financial assets determined in accordance with GAAP,' which also appears to be a non-GAAP measure. Please tell us how your presentation is consistent with Item 10(e) of Regulation S-K; specifically, tell us how you determined that you have reconciled 'Economic net interest income from financial assets' to the most directly comparable GAAP measure.
RESPONSE:
The Company respectfully believes that its reconciliation of “economic net interest income from financial assets” to “net operating income from financial assets determined in accordance with GAAP” meets the requirements of Item 10(e) of Regulation S-K. Specifically, “net operating
July 20, 2022
Page 2
income from financial assets determined in accordance with GAAP” is reconciled to “net operating income,” which is pulled directly from the Company’s GAAP income statement and is prominently disclosed on page 46 in close proximity to the non-GAAP measure “economic net interest income from financial assets.” However, the Company acknowledges the Staff’s comment and will not include the measure “economic net interest income from financial assets” in future filings.
2.It appears that 'Economic net interest income from financial assets' excludes interest expense for long-term unsecured debt. Please tell us how you determined it was appropriate to exclude this component of interest expense from this measure. Reference is made to Item 10(e) of Regulation S-K.
RESPONSE:
The Company determined it was appropriate to exclude interest expense from the Company’s long-term unsecured debt from the non-GAAP measure “economic net interest income from financial assets” primarily because the Company does not deploy capital from its long-term unsecured debt solely to fund investments in financial assets (rather, the Company uses such capital to fund all of its investment classes and/or for general corporate purposes). In this regard, the Company respectfully believes that its presentation of “economic net interest income from financial assets” meets the requirements of Item 10(e) of Regulation S-K. However, the Company acknowledges the Staff’s comment and will not include the measure “economic net interest income from financial assets” in future filings.
Non-GAAP Core Operating Income, page 52
3.We note your disclosure of Non-GAAP Core Operating Income. This non-GAAP measure include an adjustment for various realized and unrealized gains and losses. In light of this adjustment, please tell us how you determined it was appropriate to title this measure as core operating income.
RESPONSE:
In response to the Staff’s comment, the Company will revise its title of its non-GAAP measure “core operating income” to “earnings available for distribution” in future filings.
4.We note your table on page 52. It appears this presentation may be a non-GAAP income statement. Please tell us how you considered the guidance in Question 102.10 of the Division’s Compliance and Disclosure Interpretations for Non- GAAP Financial Measures in determining that your presentation was appropriate.
RESPONSE:
July 20, 2022
Page 3
The Company respectfully believes that its table presenting “non-GAAP core operating income” is not a full non-GAAP income statement as contemplated by Question 102.10, primarily because such table (i) does not include all of the components of the Company’s income statement and (ii) is not presented nearly as prominently as the Company’s GAAP measures. However, the Company acknowledges the Staff’s comment and will not include this table in future filings.
Notes to Consolidated Financial Statements
Note 7. Investments in MSR Financing Receivables, page F-12
5.We note your investments in MSR Financing Receivables. Please provide us with a detailed analysis describing your accounting for these investments and your basis in U.S. GAAP for such accounting. Your response should address, but not be limited to the following:
a.Please tell us who is the mortgage servicing counterparty and if they are an affiliate
of your company.
b.It appears that you bear the risk related to demands from the counterparty's lender for additional collateral to meet margin calls and you have the ability to utilize approximately 83% of its available capacity under its credit facility. Please clarify for us the nature of these and any other risks and rewards related to your investments in the MSR Financing Receivables. In addition, please tell us what consideration you gave to consolidating the counterparty. Your response should address your ability to direct the activities of the entity and your obligation to absorb losses.
c.In light of your requirement to provide the mortgage servicing counterparty with additional funds to meet a margin call, please tell us what consideration was given to recording the counterparty's debt as a liability within your financial statements.
d.We note that you have elected to allow the mortgage servicing counterparty to leverage the MSR financing receivables, and that as of December 31, 2021, the counterparty had obtained approximately $40.4 million of financing secured by the MSRs to which the Company's MSR financing receivables are referenced. Please clarify how you have accounted for this transaction and reference the authoritative accounting literature management relied upon.
RESPONSE:
As noted in its Form 10-K, the Company does not hold the requisite licenses to acquire or hold mortgage servicing rights (“MSRs”) directly. In order to garner the economic return of an investment in MSRs, the Company entered into a contractual financing arrangement with Seneca Mortgage Investments LP, which wholly owns a fully licensed, residential mortgage loan servicer, Seneca Mortgage Servicing LLC (herein referred to collectively along with Seneca Mortgage Investments LP as “Seneca”) that was founded in 2008 and approved by the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”) (collectively, the “government-sponsored enterprises” or “GSEs”), as well as the U.S. Department of Housing and Urban Development and the U.S. Department of Veterans affairs. Seneca is not an affiliate of the Company. The Company had no prior involvement with Seneca until its current contractual financing relationship was established on December 31, 2020.
July 20, 2022
Page 4
Under its contractual financing arrangement, the Company provides financing to Seneca which Seneca uses to acquire and hold MSRs for GSE-held residential mortgage loans. The Company’s return on its financing receivable is based upon the performance of a reference pool of MSRs acquired and held by Seneca.
Consolidation Analysis
In evaluating the appropriate accounting model for investments made pursuant to its contractual financing arrangement with Seneca, the Company first considered the consolidation guidance in Accounting Standards Codification (“ASC”) Topic 810, Consolidation. The Company notes that Seneca (directly) is the legal entity that serves as the Company’s counterparty within the contractual arrangement. No special purpose vehicles were created to facilitate the Company’s contractual financing arrangement with Seneca. Accordingly, the purpose of the Company’s consolidation analysis was to determine if the contractual financing arrangement provides the Company with a controlling financial interest in its counterparty, Seneca.
In sequentially performing the consolidation analysis prescribed by ASC Subtopic 810-10, the Company determined that none of the scope exceptions from the consolidation guidance or the variable interest entity (“VIE”) Subsection described in ASC 810-10-15-12 and ASC 810-10-15-17, respectively, were applicable in its fact pattern. Next, the Company determined that its contractual financing arrangement provides it with a variable interest in Seneca as the Company’s return on the financing provided is based upon the performance of a pool of reference MSRs held by Seneca. The Company then evaluated whether Seneca is a VIE. ASC 810-10-05-8 defines VIEs as follows:
“…certain legal entities in which equity investors do not have sufficient equity at risk for the legal entity to finance its activities without additional subordinated financial support or, as a group, the holders of the equity investment at risk lack any one of the following three characteristics:
a.The power, through voting rights or similar rights, to direct the activities of a legal entity that most significantly impact the entity’s economic performance
b.The obligation to absorb the expected losses of the legal entity
c.The right to receive the expected residual returns of the legal entity.”
The Company concluded that Seneca is not a VIE on the basis of the following:
▪Seneca was designed such that the entity’s equity holders have sufficient equity at risk to finance its activities without additional subordinated financial support.
Seneca’s wholly owned servicing entity was designed by its equity holders to operate as a fully licensed, national, GSE approved residential mortgage loan servicer and has done so since its formation in 2008. The entity was designed with sufficient equity at risk to finance its activities without the need for additional subordinated financial support. If the Company were to terminate its contractual financing arrangement with Seneca, Seneca would continue to have sufficient equity at risk to finance its activities in the same manner it demonstrated for 12 years prior to the existence of the arrangement.
July 20, 2022
Page 5
▪Seneca’s equity holders have the power to direct the activities that most significantly impact its economic performance.
The economic performance of Seneca is most significantly impacted by the performance of its assets, including its MSRs. The economic performance of Seneca’s assets are most significantly impacted (i) by the procurement (that is, the evaluation, selection, purchase price negotiation and acquisition) of its assets and (ii) the servicing and management of those assets, which includes Seneca’s efforts to secure itself as the servicer of new loans to the borrowers of existing serviced loans who may be exploring refinancing options as well as improve the payment performance of, and mitigate potential losses from, delinquent or otherwise troubled loans. Seneca’s management is accountable solely to Seneca’s equity holders, providing its equity holders with the power to oversee and direct the entity’s asset procurement processes as well as the servicing and management of those assets. No parties beyond the equity holders of Seneca have the power to direct the activities that most significantly impact the performance of Seneca’s assets.
Subsequent to the Company’s establishment of its contractual financing arrangement with Seneca, Seneca sought out, negotiated the terms of and procured on April 30, 2021 a secured credit facility with a third-party lender under which it may pledge its MSRs as collateral for additional financing advances. The Company did not participate in the selection of the third-party lender or in the negotiation of the terms of the secured credit facility. Pursuant to the secured credit facility, Seneca may obtain financing advances at an amount up to 60 percent of the fair value of the MSRs pledged as collateral. While Seneca’s utilization and management of financial leverage through its secured credit facility does, indeed, impact the entity’s economic performance, it does not do so to the same degree as the procurement, servicing and management of its assets which are, as previously discussed, the activities that most significantly impact Seneca’s economic performance.
At the Company’s request, Seneca may, but is not required to, pledge the MSRs to which the Company’s financing receivable is refenced as collateral under its secured credit facility in order obtain incremental financing for Seneca’s acquisition of additional MSRs to be added to the Company’s financing receivable reference pool of assets as a means to increase potential investment returns. The Company notes that, while, through its non-binding requests, it may exercise some degree of influence over Seneca’s utilization and management of a portion of its financial leverage obtained through its secured credit facility, it does not possess the full power to direct such activities. In addition, as previously noted, Seneca’s utilization and management of financial leverage through its secured credit facility does not impact the entity’s economic performance to the same degree as the procurement, servicing and management of its assets.
▪Seneca’s equity holders have the obligation to absorb expected losses and the right to receive expected residual returns of the entity.
After reaching the conclusion that Seneca is not a VIE, the Company then evaluated Seneca for consolidation under the voting interest model within ASC Subtopic 810-10. In its evaluation, the Company noted that Seneca’s voting interests are held solely by its equity holders. As a provider
July 20, 2022
Page 6
of financing, the Company does not hold any voting interests in Seneca nor does it hold any participation rights (substantive or otherwise). Accordingly, the Company concluded that it should not consolidate the financial statements of Seneca. In response to one of the Staff’s comments, in reaching the conclusion that the Company should not consolidate the financial statements of Seneca, the Company determined that it should not record Seneca’s debt obtained from the third-party secured credit facility as a liability within the Company’s financial statements.
Determination of the Appropriate Accounting Model Applicable to the Company’s MSR Financing Receivables
In determining the appropriate accounting model applicable to the Company’s MSR financing receivables, the Company first determined whether such investments should be accounted for as a derivative instrument within the scope of ASC Topic 815, Derivatives and Hedging. ASC 815-10-15-83 defines a derivative instrument as a financial instrument that has all of the following characteristics:
(i)has an underlying and a notional amount or payment provision
(ii)requires little or no initial net investment
(iii)provides for net settlement
The Company determined that its MSR financing receivables, in their entirety, do not meet th
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July 20, 2022
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July 20, 2022
VIA EDGAR
Eric McPhee
Division of Corporation Finance
Office of Real Estate & Construction
United States Securities and Exchange Commission
100 F Street, N.E.
Washington, D.C. 20549
RE:
Arlington Asset Investment Corp.
Form 10-K for fiscal year ended December 31, 2021
Filed March 10, 2022
File No. 001-34374
Dear Mr. McPhee:
This letter is submitted in response to the comments of the Staff of the Division of Corporation Finance (the “Staff”) of the United States Securities and Exchange Commission (the “Commission”) contained in your letter dated June 21, 2022 with respect to the Form 10‑K (File No. 001-34374) for the fiscal year ended December 31, 2021 of Arlington Asset Investment Corp. (the “Company”), which was filed with the Commission on March 10, 2022 (the “Form 10‑K”).
For convenience of reference, the Staff’s comments contained in your June 21 letter are reprinted below in italics, numbered to correspond with the paragraph number assigned in your letter, and are followed by the corresponding response of the Company.
Form 10-K for the year ended December 31, 2021
Economic Net Interest Income from Financial Assets, page 48
1.We note that your non-GAAP measure 'Economic net interest income from financial assets' is reconciled to 'Net operating income from financial assets determined in accordance with GAAP,' which also appears to be a non-GAAP measure. Please tell us how your presentation is consistent with Item 10(e) of Regulation S-K; specifically, tell us how you determined that you have reconciled 'Economic net interest income from financial assets' to the most directly comparable GAAP measure.
RESPONSE:
The Company respectfully believes that its reconciliation of “economic net interest income from financial assets” to “net operating income from financial assets determined in accordance with GAAP” meets the requirements of Item 10(e) of Regulation S-K. Specifically, “net operating
July 20, 2022
Page 2
income from financial assets determined in accordance with GAAP” is reconciled to “net operating income,” which is pulled directly from the Company’s GAAP income statement and is prominently disclosed on page 46 in close proximity to the non-GAAP measure “economic net interest income from financial assets.” However, the Company acknowledges the Staff’s comment and will not include the measure “economic net interest income from financial assets” in future filings.
2.It appears that 'Economic net interest income from financial assets' excludes interest expense for long-term unsecured debt. Please tell us how you determined it was appropriate to exclude this component of interest expense from this measure. Reference is made to Item 10(e) of Regulation S-K.
RESPONSE:
The Company determined it was appropriate to exclude interest expense from the Company’s long-term unsecured debt from the non-GAAP measure “economic net interest income from financial assets” primarily because the Company does not deploy capital from its long-term unsecured debt solely to fund investments in financial assets (rather, the Company uses such capital to fund all of its investment classes and/or for general corporate purposes). In this regard, the Company respectfully believes that its presentation of “economic net interest income from financial assets” meets the requirements of Item 10(e) of Regulation S-K. However, the Company acknowledges the Staff’s comment and will not include the measure “economic net interest income from financial assets” in future filings.
Non-GAAP Core Operating Income, page 52
3.We note your disclosure of Non-GAAP Core Operating Income. This non-GAAP measure include an adjustment for various realized and unrealized gains and losses. In light of this adjustment, please tell us how you determined it was appropriate to title this measure as core operating income.
RESPONSE:
In response to the Staff’s comment, the Company will revise its title of its non-GAAP measure “core operating income” to “earnings available for distribution” in future filings.
4.We note your table on page 52. It appears this presentation may be a non-GAAP income statement. Please tell us how you considered the guidance in Question 102.10 of the Division’s Compliance and Disclosure Interpretations for Non- GAAP Financial Measures in determining that your presentation was appropriate.
RESPONSE:
July 20, 2022
Page 3
The Company respectfully believes that its table presenting “non-GAAP core operating income” is not a full non-GAAP income statement as contemplated by Question 102.10, primarily because such table (i) does not include all of the components of the Company’s income statement and (ii) is not presented nearly as prominently as the Company’s GAAP measures. However, the Company acknowledges the Staff’s comment and will not include this table in future filings.
Notes to Consolidated Financial Statements
Note 7. Investments in MSR Financing Receivables, page F-12
5.We note your investments in MSR Financing Receivables. Please provide us with a detailed analysis describing your accounting for these investments and your basis in U.S. GAAP for such accounting. Your response should address, but not be limited to the following:
a.Please tell us who is the mortgage servicing counterparty and if they are an affiliate
of your company.
b.It appears that you bear the risk related to demands from the counterparty's lender for additional collateral to meet margin calls and you have the ability to utilize approximately 83% of its available capacity under its credit facility. Please clarify for us the nature of these and any other risks and rewards related to your investments in the MSR Financing Receivables. In addition, please tell us what consideration you gave to consolidating the counterparty. Your response should address your ability to direct the activities of the entity and your obligation to absorb losses.
c.In light of your requirement to provide the mortgage servicing counterparty with additional funds to meet a margin call, please tell us what consideration was given to recording the counterparty's debt as a liability within your financial statements.
d.We note that you have elected to allow the mortgage servicing counterparty to leverage the MSR financing receivables, and that as of December 31, 2021, the counterparty had obtained approximately $40.4 million of financing secured by the MSRs to which the Company's MSR financing receivables are referenced. Please clarify how you have accounted for this transaction and reference the authoritative accounting literature management relied upon.
RESPONSE:
As noted in its Form 10-K, the Company does not hold the requisite licenses to acquire or hold mortgage servicing rights (“MSRs”) directly. In order to garner the economic return of an investment in MSRs, the Company entered into a contractual financing arrangement with Seneca Mortgage Investments LP, which wholly owns a fully licensed, residential mortgage loan servicer, Seneca Mortgage Servicing LLC (herein referred to collectively along with Seneca Mortgage Investments LP as “Seneca”) that was founded in 2008 and approved by the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”) (collectively, the “government-sponsored enterprises” or “GSEs”), as well as the U.S. Department of Housing and Urban Development and the U.S. Department of Veterans affairs. Seneca is not an affiliate of the Company. The Company had no prior involvement with Seneca until its current contractual financing relationship was established on December 31, 2020.
July 20, 2022
Page 4
Under its contractual financing arrangement, the Company provides financing to Seneca which Seneca uses to acquire and hold MSRs for GSE-held residential mortgage loans. The Company’s return on its financing receivable is based upon the performance of a reference pool of MSRs acquired and held by Seneca.
Consolidation Analysis
In evaluating the appropriate accounting model for investments made pursuant to its contractual financing arrangement with Seneca, the Company first considered the consolidation guidance in Accounting Standards Codification (“ASC”) Topic 810, Consolidation. The Company notes that Seneca (directly) is the legal entity that serves as the Company’s counterparty within the contractual arrangement. No special purpose vehicles were created to facilitate the Company’s contractual financing arrangement with Seneca. Accordingly, the purpose of the Company’s consolidation analysis was to determine if the contractual financing arrangement provides the Company with a controlling financial interest in its counterparty, Seneca.
In sequentially performing the consolidation analysis prescribed by ASC Subtopic 810-10, the Company determined that none of the scope exceptions from the consolidation guidance or the variable interest entity (“VIE”) Subsection described in ASC 810-10-15-12 and ASC 810-10-15-17, respectively, were applicable in its fact pattern. Next, the Company determined that its contractual financing arrangement provides it with a variable interest in Seneca as the Company’s return on the financing provided is based upon the performance of a pool of reference MSRs held by Seneca. The Company then evaluated whether Seneca is a VIE. ASC 810-10-05-8 defines VIEs as follows:
“…certain legal entities in which equity investors do not have sufficient equity at risk for the legal entity to finance its activities without additional subordinated financial support or, as a group, the holders of the equity investment at risk lack any one of the following three characteristics:
a.The power, through voting rights or similar rights, to direct the activities of a legal entity that most significantly impact the entity’s economic performance
b.The obligation to absorb the expected losses of the legal entity
c.The right to receive the expected residual returns of the legal entity.”
The Company concluded that Seneca is not a VIE on the basis of the following:
▪Seneca was designed such that the entity’s equity holders have sufficient equity at risk to finance its activities without additional subordinated financial support.
Seneca’s wholly owned servicing entity was designed by its equity holders to operate as a fully licensed, national, GSE approved residential mortgage loan servicer and has done so since its formation in 2008. The entity was designed with sufficient equity at risk to finance its activities without the need for additional subordinated financial support. If the Company were to terminate its contractual financing arrangement with Seneca, Seneca would continue to have sufficient equity at risk to finance its activities in the same manner it demonstrated for 12 years prior to the existence of the arrangement.
July 20, 2022
Page 5
▪Seneca’s equity holders have the power to direct the activities that most significantly impact its economic performance.
The economic performance of Seneca is most significantly impacted by the performance of its assets, including its MSRs. The economic performance of Seneca’s assets are most significantly impacted (i) by the procurement (that is, the evaluation, selection, purchase price negotiation and acquisition) of its assets and (ii) the servicing and management of those assets, which includes Seneca’s efforts to secure itself as the servicer of new loans to the borrowers of existing serviced loans who may be exploring refinancing options as well as improve the payment performance of, and mitigate potential losses from, delinquent or otherwise troubled loans. Seneca’s management is accountable solely to Seneca’s equity holders, providing its equity holders with the power to oversee and direct the entity’s asset procurement processes as well as the servicing and management of those assets. No parties beyond the equity holders of Seneca have the power to direct the activities that most significantly impact the performance of Seneca’s assets.
Subsequent to the Company’s establishment of its contractual financing arrangement with Seneca, Seneca sought out, negotiated the terms of and procured on April 30, 2021 a secured credit facility with a third-party lender under which it may pledge its MSRs as collateral for additional financing advances. The Company did not participate in the selection of the third-party lender or in the negotiation of the terms of the secured credit facility. Pursuant to the secured credit facility, Seneca may obtain financing advances at an amount up to 60 percent of the fair value of the MSRs pledged as collateral. While Seneca’s utilization and management of financial leverage through its secured credit facility does, indeed, impact the entity’s economic performance, it does not do so to the same degree as the procurement, servicing and management of its assets which are, as previously discussed, the activities that most significantly impact Seneca’s economic performance.
At the Company’s request, Seneca may, but is not required to, pledge the MSRs to which the Company’s financing receivable is refenced as collateral under its secured credit facility in order obtain incremental financing for Seneca’s acquisition of additional MSRs to be added to the Company’s financing receivable reference pool of assets as a means to increase potential investment returns. The Company notes that, while, through its non-binding requests, it may exercise some degree of influence over Seneca’s utilization and management of a portion of its financial leverage obtained through its secured credit facility, it does not possess the full power to direct such activities. In addition, as previously noted, Seneca’s utilization and management of financial leverage through its secured credit facility does not impact the entity’s economic performance to the same degree as the procurement, servicing and management of its assets.
▪Seneca’s equity holders have the obligation to absorb expected losses and the right to receive expected residual returns of the entity.
After reaching the conclusion that Seneca is not a VIE, the Company then evaluated Seneca for consolidation under the voting interest model within ASC Subtopic 810-10. In its evaluation, the Company noted that Seneca’s voting interests are held solely by its equity holders. As a provider
July 20, 2022
Page 6
of financing, the Company does not hold any voting interests in Seneca nor does it hold any participation rights (substantive or otherwise). Accordingly, the Company concluded that it should not consolidate the financial statements of Seneca. In response to one of the Staff’s comments, in reaching the conclusion that the Company should not consolidate the financial statements of Seneca, the Company determined that it should not record Seneca’s debt obtained from the third-party secured credit facility as a liability within the Company’s financial statements.
Determination of the Appropriate Accounting Model Applicable to the Company’s MSR Financing Receivables
In determining the appropriate accounting model applicable to the Company’s MSR financing receivables, the Company first determined whether such investments should be accounted for as a derivative instrument within the scope of ASC Topic 815, Derivatives and Hedging. ASC 815-10-15-83 defines a derivative instrument as a financial instrument that has all of the following characteristics:
(i)has an underlying and a notional amount or payment provision
(ii)requires little or no initial net investment
(iii)provides for net settlement
The Company determined that its MSR financing receivables, in their entirety, do not meet th