Q2 2020 ARMOUR Residential REIT Inc Earnings Call

Mhm mhm.

Uh huh.

Oh Boy Maria.

[music].

Greetings and welcome to the armor residential lead.

Second quarter 2020 earnings conference call to presentation, all participants will be no listen only mode. Afterwards, we'll conduct a question answer session. I time, if you have a question expressed a one so by the four on your telephone.

And having to Congress to reach not predict the process start <unk> followed by this year.

As a reminder, today's call is being recorded Thursday July 20, Threerd 2020.

No I would love to turn the call. So if that Jim Shelton Chief Financial Officer armor residential Reid. Please go ahead.

Thank you Tommy.

Thank you all for joining our call today to discuss armor second quarter 2020 results. This morning, I'm joined by Armours Co Ceos, Scott on and Jeff Simmer and by Mark Gruber, Our CIO.

By now everyone has access to Armours earnings release, which can be found on Armours website, Www armory Dot com.

This conference call may contain statements that are not recitations of historical fact, and therefore constitute forward looking statements within the meaning of the private Securities Litigation Reform Act of 1995.

All such forward looking statements are intended to be subject to the safe Harbor protections provided by the Reform Act.

Actual outcomes and results could differ materially from me outcomes and results expressed or implied by the forward looking statements due to the impact of many factors beyond the control of armor.

Certain factors that could cause actual results to differ materially from those contained in the forward. Looking statements are included in the risk factor section of Armours periodic reports filed with the Securities and Exchange Commission.

Copies are available on the Fccs website at Www FCC Dot Gov.

All forward looking statements included in this conference call are made only as of today's date and are subject to change without notice.

We disclaim any obligation to update our forward looking statements unless required by law.

Also our discussion today may include references to certain non-GAAP measures. A reconciliation of these measures to our most comparable GAAP measures are included in the earnings release, which can be found on Armours website.

An online replay of this conference call will be available on Armours website, shortly and will continue for one year.

The second quarter, what period of transition for armor April began with significant levels of uncertainty as U.S. financial markets began stabilizing towards the end of the month and into May we rebuilt farmers investment portfolio acquiring $2.4 billion of agency MBS and 650 million.

$1 of TV subs securities.

While substantially disposing of our positions in non agency and CRT securities for the foreseeable future, we will focus exclusively on agency MBS.

Quarter end book value was $11.11 per common share up a penny from Q1 2020.

Armours Q2 comprehensive income was $23.4 million.

Core income, which is made up of net interest income and TV, a drop income minus hedging costs and net operating expenses was $14.8 million or 19 cents per common share.

Core income excludes gains and losses from security sales and early terminations of derivatives as well as mark to market value adjustments.

Core income for the quarter represents an annualized return on equity of 7.5%.

Armours MBS portfolio consisted of $5.25 billion of securities substantially all of which our agency MBS.

We are designating agency MBS purchased on or after April 1st 2020, as trading securities for financial reporting purposes. Consequently fair value changes for these investments are reported in GAAP net income.

The company's legacy agency MBS continued to be classified as available for sale and fair value changes for these securities will be reported in other comprehensive income for the rest of their lives in our portfolio.

Commencing with the second quarter 2020, and continuing until further notice.

The Companys external manager is waving 40% of its management fee.

This waiver offset $2.9 million of operating expenses in the quarter.

Armor pay dividends of nine cents per common share for June 2020.

That totaled $5.9 million.

We previously announced guidance on monthly common stock dividends for Q3, 2020, raising the dividend rate to 10 cents per common share.

We've also announced the series C preferred stock dividend for Q3 2020 at the rate of 0.14 $583 per share.

Now, let me turn the call over to co Chief Executive Officer, Scott on to discuss Armours portfolio position and current strategy and a little further detail Scott.

Thanks, Jim.

The second quarter marked a period of stabilization and turnaround for the bond markets as well as for Armory.

In the first part of the quarter, we maintain focused on risk and liquidity management, we kept leveraged lower than normal and emphasize liquidity as announced in our last call. We began reallocating cash to only agency securities, particularly prepay protected down in coupons 15, and 30 year paper simultaneously, we substantially reduced our.

Exposure to mortgage credit.

Our sole remaining credit position as of 630 is 66 million market value of season credit risk transfer securities.

We believe our portfolio shift to agency only securities is well suited to the current environment for many reasons as the key elements are likely to persist for a long time.

Pricing in the agency MBS market has stabilized and liquidity is increased due to the supported the federal reserve, which has described this commitment is unlimited.

We believe the current us and international economic situation suggests that interest rates are likely to remain low for a prolonged period.

In addition, the yield curve today makes hedging over the long term very inexpensive so.

Financing remains widely available and our affiliate Buckler Securities has been able to Thunder said historically low rates prepayments, while elevated have been manageable.

And our composition of the portfolio is approximately 91% of Armours agency portfolio positions, excluding DVA positions benefit from favorable prepayment characteristics, including 24% that have prepayment penalties. That's agency multifamily securities, 55% that have loan balances less than or equal to two.

Hundred $25000, 12% of loan to value ratios greater than 95% and FICO scores on less than 700 or seasoning of greater than 24 months.

Our multifamily agency securities have long principal lockouts that provide excellent convexity characteristics the balance of the portfolio away from the small remaining CRT position is comprised of TD securities, which compensate us for their increased convexity risk with very high yields.

All of this adds up to an environment, which we believe we can earn our expected dividend of 10 cents a month during the third quarter, we've set our dividend policy based on a medium term outlook.

As always we still bear risks mitigated as they may be in this environment.

Our duration is relatively short at 0.3, while we're comfortable with the rate risk both up and down we will continue to maintain our hedge book to keep those risks within bounds. We also wary of a possible move in a negative rates as we have had some shorter swaps executed a negative rates over the last quarter.

While negative medium term and longer term rates seem unlikely we still continue to guard against developing a negative duration in the portfolio.

Despite the returns stability in the market, particularly for agency securities the potential for further disruptions or per long recovery still exists we continue to maintain leverage towards the lower end of our historical levels and liquidity at the higher Ed.

We expect the total leverage will remain between seven and eight times, including our $2 billion of TV positions.

We're very constructive on the opportunities for an agency focused strategy, we've seen perhaps some of the best opportunities in the last seven plus years.

Policy, the macroeconomic environment financing and the cost of risk management are all tailwinds restore out there, but we believe there currently containable, we look forward to taking your questions.

Tommy can we start with questions now.

Absolutely. Thank you very much.

And if you like to register question just crossed the one for by the floor on your telephone.

Here are three tone prompt technology requests.

Good question Hasnt been answered.

Draw your restoration compressor one for better three.

Once again the phones for any questions or comments you may have for today. It is still one for our new telephone keypad.

One moment, please our first question.

And we'll get our first question on the line from Douglas Harter with credit Suisse Red hat.

Thanks, I was hoping we could talk a little bit more about buckler.

Just.

You could give us an update as to what percentage of the funding is there today and how that compared to kind of three months ago and what the relative funding advantage is versus kind of strict repo.

[noise] Buckler today's running I'd say, approximately 70%, which has touch higher than it was before we were around 50%.

I think thats, primarily a result of both the lower amount we're financing as well as buckler is other customers are financing, leaving Butler with.

Well, a little capital that needs to be utilized.

I'd expect that to revert more towards the 50% levels as as things as things normalize, but thats, probably going to be a little ways yet.

In funding advantage.

Repo repo is a is it is a highly efficient market. So it's less that we see we see absolute dollar advantages in funding rates.

We often get a little benefit on hair on haircut, which is.

Moving especially valuable.

And we also we also enjoy.

You know a level a level of insight into what's going on in the repo market that we never really enjoyed as.

As simply a customer there.

We also are able to keep keep us.

Some portion of the book on open which is something overnight funding, which is something we wouldn't do with a with a non affiliates of which contains an interesting implicit option to it which means that we can when an opportunity develops in the markets. We can jump out at immediately which if we were all turned out for 30 days or 90 days.

We wouldn't really be able to.

So that's where the economic advantage derives from from Butler. In addition to the reason why we have buckler, which is of the safety and security of having an affiliate that we are confident can finance us even in difficult periods, which was approved in spades in March.

She can you just put a little more color around the hair cut differential just to kind of size slides that benefit.

We can see haircuts of 1% to 2% lower than we would see in normal market conditions I.

I would also know Doug a couple of weeks ago, we were studying what the company look like five years ago, and it's interesting on our repo book you only one of the top 10 people are the same today that they were five years ago and that's the power of Buckler now and this obviously excludes buckler, but having them around when other market participants.

Moving and you know changing their approach to the funding market makes us very stable situation and the funding side.

And then with the one to two points of lower haircut does that change how you think about what the kind of long term or steady state leverage is or.

Did you know I guess, just how does that factor into kind of what kind of where you think the appropriate leverage level is.

Elaborate leverage is in independent discussion in many ways sort of an output to output to the the mix that we're seeing on the portfolio of the haircuts primarily relevant to liquidity.

Yes, and we just keep it in excess liquidity I mean, if you look over the last two or three months at some points. The actual cash an unlevered securities. We had were larger than our market cap.

Okay, that's going to you know, we're going to keep our liquidity very hot.

Great. Thank you for the answers.

Okay. Thank you.

And we'll proceed current next question on the line from the line of Trevor Cranston, It with GE MP Securities go ahead.

Hey, thanks.

Looking at the portfolio mix today. It looks like you guys are more weighted towards 15 your securities than you had been for a while.

Can you talk about the sort of trade off between fifteens and Thirtys today.

And you know why why you guys have been taking that allocation relatively hurdle right.

The 15 year Securities have great convexity now the price you pay is lower levered yields, but if you look at our portfolio that we put out as of 630 of 15% of the portfolios at 15 years or however, you may be reflecting on the 18.7% of the 15 years in the dollars.

All positions solutions securities that were buying in the forward markets very unlikely Trevor that we will take a delivery those but they just got great convexity, we pay the price for it but should the market increase in volatility or should the longer and move up a little bit we won't have very much extension on those assets at all.

Okay got it.

And can you also provide some color on how you guys are seeing your dollar roll funding a relative to two repo and how attractive you see tbds versus spec pools on the market.

Sure.

I mean, there's some extraordinary return opportunities in the dollar roll market and as I looked at the August Sep rules right now 15 in 30 years, we're seeing numbers from a 17% to 22% depending on the security that there is there are some securities that dollar roll even higher.

Returns versus buying assets and putting them in the repo market. However, those have other risk characteristics to them and so we don't know the on those securities.

Okay got it and then last question on the the waiver of the management fee or the portion of the management fee.

Can you talk about sort of how you guys are thinking about that in terms of what type of conditions.

You know might leave it might lead to the that were being.

Reinstated in the future. Thanks.

Growth, though the equity of the company would change that.

Okay fair enough. Thank you.

Thank you very much.

Thank you.

And before we proceed turn next question once again I was reminded to register any questions or comments you may have it is still one oh by the floor on your telephone keypad.

And I'll get to our next question on the line from Christopher Nolan from Ladenburg Thalmann and company go right ahead with your question.

Hey, guys, Hey, Scott on the management fee waiver did you mentioned in your comments that that was going to become continuing in coming quarters.

I think you can expect that to can continue we got to have a have a reasonable a management fee and I think we're sort of down the middle of the fairway right. Now. So you can expect that to continue.

Great and then given that the housing market nationwide has seen a jump in terms of people buying houses just generally I mean, and given that you're seeing a rising C.P. ours I mean can you.

Give a little color in terms of where you think your portfolio positioning is gonna be.

Coming in the second half of the year given changes going on.

Well take the number of things to talk about right now okay.

And let's talk about our July prepayments, they were up 10% from a little bit less than 10% from the previous month, we expected that we expect August to be up another 5%.

But I'm looking at a chart that shows what the monthly growth isn't issuance of agency MBS was in June. It was 250 billion. So that was that's a record high okay and you may be familiar was the primary secondary spread I know, it's a very topical right now.

People are talking about it so think about this and then have a big will answer your question. So there's been a 225 basis point reduction in the fed funds since 2019, but mortgage rates are only down 125 basis points right. So the primary secondary spread has increased dramatically and why because originators parts. So.

Busy okay. They have capacity constraints. So over time those capacity constraints will probably helped lower the primary secondary spread which will increase prepayments one of the reason that Scott discussed the assets that we choose the loan balances and the other great characteristics, So if and when.

When that happens and we do expect that to happen. Okay that we will have assets that will be less likely to have heavy prepayments now up at the end of the day a change in prepayments for us by 5% is not even worth a third of the pending ethic approximately.

So you can think about that is your modeling.

You know out into the future, but when we changed our dividend to 10 cents a month, we changed it because we feel that we are earning it and we're actually quite positive on NIM. If you. If you look at the NIM because quoted is a 163 basis points I believe for the second quarter. You remember we were very under invested for April right, we add.

Ended.

Q1, with only $2.8 billion of agency Securities and now we have 6.6 billion. So the NIM that we reported does not reflect the boat at full speed right. So you would expect the NIM to be reported higher for Q3, and that's why we feel we can earn that 10 cents each month.

And I Wonder is really good conditions Ooh, maybe we are in a little bit more than that that's not get to your point.

Yes. It does I guess also to cut to the quick Jeff is last quarter, you guys mentioned that on a core EPS basis, you're targeting a high single digit low double digit or are we are.

Are you guys still targeting that or is there sort changes.

Well, if we're if we say that we hope to make $1.20 a year and you know you're a $11 change of book value. That's you know 10, plus after expenses are always that's kind of where we are right now.

Yeah fair enough.

That's what I can go ahead im sorry, not please continue.

Well the stock at a discount to book value or you have an even greater return opportunities my point.

Yeah, and then I'll final question ATM races.

The guys are pretty active on the ATM is that continuing into third quarter.

Oh, no we've not done any ATM, we talked on the last earnings call about the $48.5 million of ATM with it we did I think substantially in April and that was just solely to increase liquidity and I believe I said on the call is about 2020, plus sense, a a dilutive to book value. Indeed, it was but that cap.

Capital is very dear at the time and it was important to have that great liquidity. Our liquidity position is very very sound and good right now and we have not anticipated or a engage in any recent ATM activities.

Great. Thanks for Jeff.

Hi, Thank you very much.

Thank you and we have no further questions on the way, it's continue with the presentation or any closing remarks.

Well. Thank you Tommy Thank you all for joining us a this morning as always if you have questioned a protocol onto the office everybody is working remotely, but I will get the message and can get back to you promptly and throughout the quarter if there's anything.

That you want to talk about please don't hesitate to reach out until next time they thing.

Thank you that does conclude the conference call for today, we thank you for your participation speed disconnect your lines.

Everyone.

[music].