Q3 2020 ARMOUR Residential REIT Inc Earnings Call
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[noise], Oh greetings, everyone and welcome to the armour residential REIT Inc. third quarter Twentytwenty earnings call during.
During todays presentation, all participants' lines will remain in a listen only mode. Afterwards, we will conduct a question and answer session with instructions to follow if.
If at any time during today's briefing you need to reach an operator, Please press star zero on your telephone.
Please note as well today's conference is being recorded Thursday October 22nd 2020. It is now with pleasure that I turn todays presentation over to Mr., Jim Mountain Chief Financial Officer. Please go ahead Sir.
Thank you Bridget and thank you all for joining our call to discuss Armours third quarter 2020 result.
This morning, as usual I'm joined by armour as co Ceos, Scott home, and Jeff Zimmer and by our COO Mark Gruber.
By now everyone has access to armour as earnings release, and form 10-Q, which can be found on Armours website, www armour <unk> dot com.
This conference call may contain statements that are not mere recitations of historical fact, and therefore constitute forward looking statements within the meaning of the private Securities Litigation Reform Act of 995.
All such forward looking statements are intended to be subject to the safe Harbor protection provided by the Reform Act.
Actual outcomes and results could differ materially from the outcomes and results expressed or implied by the forward looking statements due to the impact of many factors beyond the control of armour.
Certain factors that could cause actual results to differ materially from those contained in the forward. Looking statements are included in the risk factors 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 todays date and are subject to change without notice we disclaim any obligation to update our forward looking statements unless we are required to do so by law.
Also our discussion today may include references to certain non-GAAP measures. A reconciliation of these measures to our most comparable GAAP measure is included in our earnings release, which can be found on Armours website and.
An online replay of this conference call will be available on our website shortly and will continue for one year.
Quarter end book value for armour was $11.74 per common share up 63 cents from Q2 2020 our.
Armours Q3 comprehensive income was $61.9 million or 91 cents per common share and that includes $58.4 million worth of GAAP net income.
Core income on the other hand was $25.4 million or 35 cents per common share Korean.
Core income includes TV, a drop income and excludes market value adjustments.
A complete definition and reconciliation showing how we compute core income is included in yesterday's press release.
Core income for the quarter represents an annualized return on equity of 12.6% based on per share book value at the beginning of the quarter.
Armours portfolio consists exclusively of agency MBS totaling over $5.5 billion since the beginning of Q2, we have continued to designate any agency MBS purchased as trading securities.
In the fair value changes for these investments are reported in net income.
Commencing with the second quarter of 2020, and continuing until further notice the company's external manager is waiving, 40% of its management fee. This waiver offset $2.95 million of operating expenses in the quarter.
Armour paid dividends of 10 cents per common share for each month in the third quarter.
We have also declared October and November common dividends is continuing at that rate of 10 cents per common share.
And the series C preferred stock dividends for Q4 2020 at their contractual rate of 0.145, a $3 per share.
Now, let me turn the call over to our co Chief Executive Officer, Scott all to discuss Armours portfolio position in further detail and give us an insight on our current strategy.
Thanks, Jim.
Third quarter 2020 saw a return to commerce conditions across the mortgage market and dramatically improve sentiment.
The federal reserve flooded the market with funding and agency and Treasury markets and their outright purchases helped drive the bond markets recovery of stabilization.
We completed the previously announced strategic transition of our investment portfolio to solely agency mortgage backed securities issued or guaranteed by US government sponsored enterprises Treasury securities and the cash.
With Arbor is common equity closing a $9.43 yesterday, a 20 cents, a 20% discount to the third quarter ending book value. The current yield on the common is 12.7%.
Our core income for common share of 35 cents was 16.77, 0.7% higher than the 30 cents in dividends, we paid in the quarter.
The federal Reserve's large footprint in the agency MBS market continued to be a major factor in MBS performance during the third quarter driving oil is tighter volatility lower and greatly improving liquidity. The fed purchased about $330 billion of agency MBS through out the third quarter absorbing almost the entirety of new net.
Agency MBS supply.
Following treasury yields and tightening mortgage spreads drove primary mortgage rates to all time lows during the quarter.
We continue to strategy of focusing investments on prepay protected lower coupon mortgage pass throughs to protect its MBS portfolio from the expected refinance wave triggered by these ultra low rates. In addition to stable income. These specified stores delivered considerable results in book value appreciation for the quarter.
As of September Thirtyth, our were held 94% of its MBS portfolio of securities with favorable prepayment protection characteristics. These include 58% and bonds with loan balances less than or equal to $225000.
22% in agency CMBS, with lockouts, and prepayment penalties, 11% in bonds with loan to value ratios of greater than 95% FICO scores less than 700, and or seasoning of greater than 24 months at 4% in bonds with a 100% of the loans in states that have additional taxes on refinancing.
Cash out transactions, such as Texas, Florida, and New York.
We saw a strong dollar roll performance or the production coupons, where the feds purchases match new supply throughout the quarter. We expect dollar rolls to continue to yield double digit returns over the medium term horizon.
Our average duration as of the end of the third quarter was <unk> 0.86, we're comfortable with the portfolio's interest rate risk in both up and down rate scenarios.
Our portfolios convexity profile is significantly more favorable than that of newly issued MBS.
We manage our net duration gap within a tight range dictated by our team's outlook on the rates Mark it.
It should be noted that a significant portion of the portfolio's duration is in the key rate buckets inside of 3.5 years, where we expect yields to be paid close to zero for the foreseeable future our exposure.
Our exposure to the long end of the curve is considerably less than our overall duration.
While our third quarter ending debt to equity was approximately five times, we maintained our all in leverage which includes the implied leverage of dollar rolls between 7.5 and eight times throughout the quarter. This.
This provides us with ample dry powder should new investment opportunities arise. We expect this leverage range to persist at least through the fall absent some attractive opportunities arise.
The repo market continues as benign course with financing costs that are at all time lows with little to no term premier for longer dated repo and.
Ample year end funding as we see it today reinforces that.
Our broker dealer affiliate Buckler Securities continues to provide us with attractive terms and perhaps more importantly reliable financing.
Our earnings outlook remains constructive despite the rich reinvestment marketing cash securities with attractive convexity characteristics as an.
As noted the high returns available in the TV market are very attractive, but will remain a distinctly smaller portion of our portfolio than specified pool cash securities.
Based on these investment opportunities, we believe that our core earnings will cover our dividend in the fourth quarter.
While third quarter 2020 marked a bright spot in the bleak year armour continues to monitor and planned for what's ahead.
The fed statements suggest a strong commitment to lower rates in the medium term and continued support for the mortgage backed securities market over the.
Over the longer term the timeline and future sizing for the Feds QB program remains in question as does the shorter term uncertainty surrounding nexmo selections prepayment speeds have stabilized, but remain elevated as lenders continue to streamline their technology and grow staff to capture the refinancing business we.
We believe our portfolio is balanced considering these uncertainties.
Hello, protective convexity profile right amount exposure to Q E buying and enough dry powder to take advantage of opportunities ahead.
Operator, we'll now take any questions.
Thank you very much as a reminder to register questions or comments. Please press one four on your telephone.
Our first question comes from the line of Douglas Harter of Credit Suisse. Please proceed with your question.
Hey, guys. This is Josh Bolton on for Doug Good morning.
Appreciate the comments Scott about leverage from the fourth quarter update you gave it looks like leverage was up a little bit from the end of the third quarter.
Is that intentional or is that you know just the result of book value moving around and I guess, how are you thinking about target leverage going forward.
And specifically what would you have to see to to take that level, either up or down. Thanks.
Hey, good morning, it's Jeff Zimmer here, so our leverage is exactly where we want it to be we recently settled some forward purchases.
Had the leverage slightly tick up a book value to days actually almost unchanged.
End of the quarter.
So the leverage is not changed because of book value moving around and matter of fact, the number we published yesterday actually up a little bit since then the opportunities in the marketplace and we talk about this in our morning meeting. So this is kind of important so they are bifurcated right now right zero volatility always some Fannie twos is like 65.
No volatility Oh, yes on Fannie threes, where the fed is not buying anything are up to 93. So when Scott in his comments talked about keeping powder dry for buying opportunities you start seeing some on the run stuff or TB, a non TB stuff, where the pay ups come off a little bit perhaps in a steepener you can see that leverage pop up.
Eight to eight and a half to aid in three quarters, but only because we see good opportunities otherwise our target leverage will stay in the range that it is right now and as you could see from the monthly company update that we published last night. We continue as Scott also said in his comments with the barbell strategy meeting, we bought a lot of specs at low.
Low pay ups in early mid April number those are up two times or even more from what we paid for them and we offset that with about 27% of our portfolio in the TV market where is he also said were seeing returns in the mid teens to even low twentys. So I hope that addresses your question.
Yes, Thanks, Jeff for those comments and I guess my my second question.
Last quarter, you talked on the call about the percentage of repos through bulk glare securities.
Longer term or getting closer to 50% down from what it is.
I'm just curious if that's still a sales.
It's a goal or if theres any update I know, it's running higher than that today, but any comments you can give about the buckler broker dealer. Thanks, yeah.
Yeah, Josh Buckler are running a little a little above the proportion we did over the last few years, mostly because there is a little and utilize capital at Butler and we wanted to make sure. It was it was working.
You know.
I would expect that percentage you may may drift down a bit but.
But you know I think it's a it's still at a reasonable amount basically determined to keep a keeper keep a balance of being able to utilize the advantages we get from Butler, while at the same time staying active with the you know 17 other counterparties that were operating with you know our execution at Butler is now is on the screws with what we're seeing what we're.
Okay, and elsewhere, and we get better terms, you know parts is principally in China and in hair cut and the ability to access some different types of financing there. So.
So you know that's a little it's a little higher than we have been for the last few years.
You know its there just just because you know Buckler has had has had some capital that we want to make sure we use it.
Awesome. Thanks, the comms guys.
Our next question comes from the line of Trevor Cranston JMP Securities. Please proceed with your question.
Hi, Thanks, good morning.
You had mentioned that.
You had mentioned a couple times the return opportunity that's available within the TV market being quite attractive can you say.
Can you say, where you are seeing returns in specified pools compared to TV and.
You know also as part of that can you maybe talk about how.
How much larger you'd be willing to take the TV position as a percentage of the ore portfolio going forward. Thanks.
Hey, Trevor glad to have you dial in so we could see returns as low as 4% in some in some of the specified pools. That's how high these prices have gone up.
Would you know we have purchased anything like that but there are returns also in low double digits. So just exceeding a 10% to 11.5% now that would imply.
And eight times leverage and a duration of between <unk> 0.5, and where we are right now you increase that leverage up to where others in the sector have done which would be nine to nine and a half a those numbers go up.
Proportionately from there.
And so what we were discussing earlier just to repeat on the leverage we get.
We get spreads to widen or pay ups to come down we will use the opportunity to go ahead and make some additional.
No investments in the space, but that is not the case today. So we'll keep the target leverage where it is right now and those opportunities go and I said, we could be up to eight and a half to eight and three quarters, but only you have great opportunities arise as Scott said in his comments as it is right now we estimate that our core income will equal or exceed the dividends up or.
Fourth quarter.
Okay got you that's helpful.
Then.
On the multifamily portion of the portfolio spreads have always be recovered pretty well in that sector.
You know in light of that recovery.
How are you guys thinking about that part of the book is it something that you see.
Still see value in holding as sort of a.
Prepaid diversification or.
Given that spreads have recovered so much is that something you'd potentially look to partially sell and reallocate to.
The agency RMBS market.
So if you go look at monthly updates on a month by month, you can see the positions come down a little bit. It's currently on the.
The information, we published last night 1.19 billion and we did sell some over the last 60 days to take advantage of really tight spreads, but if you refer to page four on that publication you can see that the weighted average net coupon is 369 and the EPS estimated effective duration is seven.
It means that you know most of those are going to have a maturity north of seven and a half to up to like nine years from now great convexity paper burning a lot for our shareholders. So.
So we would very selectively be selling in that asset class in the near future. It has no extension risk market rallies they'll go up in price, it's paying our shareholders a large dividend they financed equally to specified and TV market and once again, there is just a insatiable demand.
For banks for that asset class I don't see that going away. So the answer is we probably won't sell a lot, but occasionally we see opportunities to sell and I would also note one of the reasons. We sold we wanted to make sure we cleaned ourselves out of any potential assets in that asset class that might be subject to forbearance or bankruptcy.
Or some of the negative factors that have occurred since cobot. We believe we've done a really good job of that so far and so that protects the premium in that asset class.
Okay got it I appreciate the comments thank you.
Thanks for calling.
And again as a reminder to register questions or comments. Please press one four on your telephone.
Our next question comes from the line of Christopher Nolan of Ladenburg Thalmann and call. Please proceed with your question.
Hey, guys.
Quarter, the given the GAAP EPS guidance to cover the dividend in the fourth quarter. It seems like your core are always going to be at the higher end of your guidance, which was high single digit to low double digits at least in the fourth quarter I guess.
I guess my question is is.
Should the core or are we guidance be low double digits to mid double digits going forward or are you going to keep it the way it is.
So if you have the publication that I, just referred to a minute ago that we put out last night. If you go to page six and be a monthly portfolio CPR you can see that the October CPR was up 11%.
Over the average of Q3.
Now, we expect CPR for our portfolio to remain relatively flat over the next two months November and December.
From that up 11% level. So is the result of higher Prepays you would expect the core earnings to be off modestly from what they were in Q3 that doesn't mean, they will be but our expectation is to be a little lower but yet to cover certainly our dividend. So the change in earnings base.
On the reinvestment opportunity really two different things to look at with the great convexity in the low amount of actual dollar prepays that we have that month are each month, our exposure to reinvestment risk is quite limited well under $100 million a month. So is that helpful. In your analysis.
Yeah, no very.
Good point, you made S on a different topic any thoughts on buybacks given where your stock is trading.
So we are always looking at buybacks as we discussed on the last two earnings calls.
There are times, where you really need to protect your capital and that benefit shareholders greatly and then there are times when hey, you know we're trading at a really cheap level and is accretive to book value to go ahead and buy we haven't executed that second step yet, but it's clearly a job out there if we want to and need to we're still watching.
Capital, let's get through the election, let's do you have any buying opportunities happen. For example, you get Oh, yes as to widen out here and you get a steepener in the curve, we might be earning so much more money or taking leverage up from you know AJ now operating three quarters that might benefit shareholders more than doing a buyback, but how are those are the things that we looked at every day.
Obviously, we just had our board meeting.
In order to go and publish our Q and these are things that are discussed at the at all levels of the corporation. So I hope that addresses your question great.
Great. Thanks, Jeff.
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And there are no further questions at this time I'll now turn the call back to you. Please continue.
Thank you for your help bridge. It then to all our other friends in the analyst community. Thank you for joining US. This morning, we very much appreciate your time and interest in armor and as always.
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Until next time.
Stay safe.
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