Q1 2021 ARMOUR Residential REIT Inc Earnings Call

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Greetings and welcome to the armour residential REIT, Inc. First quarter 2021 earnings conference call. During the presentation, all participants will be in a listen only mode. Afterwards, we will conduct the question and answer session at that time. If you of a question. Please press the one followed by the four on your telephone.

If at any time during the conference who need to reach an operator. Please press star Zero as a reminder, this conference is being recorded Thursday April 22nd 2000 of 'twenty one.

Now I'd like to turn the conference over to Jim Mountain Chief Financial Officer. Please go ahead.

Thank you Kelly and thank you all for joining our call today, Scott farmers first quarter 2021 results.

This morning, I am joined the huge all of my Armours co Ceos, Scott Ulm, and Jeff Zimmer and by our CIO Mark Gruber.

By now everyone has access to <unk> earnings release, which can be found on Armours website, www armour REIT 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 1095, 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 impacts 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 of these reports are available on the SEC's website at Www SEC 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 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 measures is included in the earnings release, which can be found on on this website.

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

Farmer continues to concentrate its portfolio activities in agency MBS for the foreseeable future.

Quarter end book value was $12 40 per common share up <unk> <unk> from Q4 of 2020.

As of the close of business. This past Monday, we estimated book value to be approximately $12 15 per common share.

Farmers portfolio consisted exclusively of specified agency mortgage backed securities valued at approximately $4 3 billion.

The agency TBA positions, representing another $3 6 billion and underlying securities.

Armours Q1, GAAP comprehensive income was $29 1 million, which includes $71 $3 million of GAAP net income and represents an annualized return on equity of 12%.

Let me make a brief comment on prepayment of accounting and core income.

We recognize the amortization expense of prepayments as they occur.

Given the recent ramp up in prepayments, we estimate that using the forecast method for this quarter amortization would have been six 7% lower per share or about 29% of core income.

We paid dividends of <unk> 10 per common share for each month in the first quarter for a total of $28 1 million. We've also declared the April and May common dividends at the rate of <unk> 10 per common share.

Series C preferred stock dividend for each month in Q2.

Continuing.

Is that the contractual rate of 14, five eight <unk> per share.

Armours common and series C preferred stock ATM programs were active in Q1 and through Friday April 9th day.

Raised approximately 107 $7 million in total capital.

Common stock represented about two thirds of that total and preferred stock represent of the remaining third we.

We saw no discernible effect on share prices and dilution to common stockholders was negligible a shade over <unk> <unk> per common share for the entire program.

That equates on a per share expense basis to savings that will occur over about 16 months.

Our current projections for 2021 show the 100% of both common and preferred dividends will likely be treated as tax basis adjustments rather than the current taxable income on it.

Gets distributed to our shareholders.

That's due to the tax shield provided by the amortization of hedging costs that were previously deferred for tax purposes.

This is consistent with the results for 2020.

ACM the company's external manager continued to waive a portion of its management fee.

Which was initiated in the second quarter of 2020.

This waiver offset $2 4 million of operating expenses for Q1 2021.

On April 22021, and the company's external manager notified of armour that it intended to adjust this fee waiver to the rate of $2 1 million for the second quarter of 'twenty, one 2021 and continue with the rate of $700000 per month thereafter until further notice.

The annual meeting of armour residential REIT is scheduled for Thursday may 13th at eight a M eastern time.

By now all shareholders of record of armour common stock should have received their notice and access cards on the mail.

They should contact their broker full.

The full proxy statement and annual report are available electronically at the proxy vote dot com or on the SEC website.

Stockholders of record May also request paper copies by following the instructions on their notice on access card.

The annual meeting will be webcast on www, CSP proxy dot com slash armour REIT slash 2021.

And it will be virtual only again this year.

That link is also on the notice and access card, we encourage all of armour common stockholders to log and the proxy vote Dot Com and register their votes in advance I've already voted my IRR shares on the process as painless.

Shareholders, who wish to vote their shares during the annual meeting will need to obtain a legal proxy in advance however.

Now, let me turn the call over to co Chief Executive officers Officer, Scott on.

So the Scott you can discuss armours portfolio position in the current strategy. Thanks, Tim.

The first quarter of 2021.

Please standby the conference call will begin momentarily. We thank you very much for your patience and we ask that you. Please remain on the line.

I will try to get from the line of Mr Mountain back onto the call. Please stay connected.

Okay.

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Okay.

I have resumed the call Sir you May proceed.

Thank you apologies we were disconnected.

Scott on.

Co CEO of armour rate growth continuing on in my remarks the.

The first quarter of 2021 deliver the first rays of the optimism of the nearly year long fight against the pandemic and its impact on the economy.

Positive sentiment was fueled by the largest fiscal stimulus in the U S history of one nine trillion.

And rapid distribution of effective vaccines, the financial markets saw this as a potent fixed to reinflate and reopen the economy ahead of the expected timelines of higher projections for inflation in treasury issuance of quickly repriced the yield on the 10 year Treasury higher by 82 basis points to touch as high as 175%, while the yield spread between Twos, Inc.

<unk> treasuries expanded by 78 basis points.

Despite a rise in treasury yields at a quicker pace than in 2013 mortgage spreads of avoided a repeat of the 2013 taper tantrum due in large parts of the federal reserve's unwavering commitment to keep the mortgage purchase program going well into the economic recovery cycle.

Over the course of the first quarter the option adjusted spreads on the 30 year.

Fannie 2% TBA as of tightened by eight basis points, while the zero volatility OIS tightened as much as 19 basis points from this cohort despite sharply lower treasury bond prices.

<unk> delivered a positive three 1% or 12, 4% annualized economic return on the first quarter illustrating strong risk controls around the portfolio of duration and convexity.

Armour was active in managing of hedge book and exposure on production coupons in a very dynamic market over the course of 2021 armour implied leverage declined from seven six times at the end of the fourth quarter to six nine times as it sits today. This took place through capital raised through our ATM program and sales of assets without the rich valuation.

<unk> or less favorable prepayment profile.

Our lower leverage provides us with ample dry powder to take advantage of market opportunities ahead, we will continue to be very selective in the prices. We will accept for the risks on offer in the current market.

Barbara is duration as of year end was 0.62 and is currently three zero with the negative duration of exposure to the 10 year plus part of the yield curve.

We like the duration profile, which matches our long term bias for higher interest rates in the second half of 2021.

The first quarter prepayments remained elevated as originators were slow to increase mortgage rates in order to protect their market share <unk> portfolio average of $17 four CPR in the first quarter slightly above 17, three CPR from the previous quarter.

Of note that both are still significantly below speeds of more generic MBS cohorts and we expect prepayment pressures to subside in the second quarter of a potential tailwind to earnings.

While we have allocated approximately 45% of our portfolio to dollar rolls in the 15 year on 30 year of TBA is 97% of the remaining portfolio of assets with favorable prepayment protection characteristics, including prepayment penalties lower loan balances and seasoning.

Nominal specified payoffs of declined by nearly 50% quarter over quarter, but still performed well on the duration of adjusted basis.

VA roll Specialness was also notably weaker in the first quarter as origination supply remained robust while investor demand cool relative to the fourth quarter. Today. We are again observing an increase in roll Specialness is higher mortgage rates reduced the available supply to the delivered into the fed portfolio.

Although current MBS QE purchases are clearly favorable to the supply demand balance near term markets are continuously challenging the timing of the fed's eventual exit from MBS something that we see as a key driver to book value of performance this year.

As we've noted before we set our dividend policy based on the medium term outlook on our business. We continue to see our dividend level is appropriate.

So in summary, we are just not comfortable putting our shareholders extensively in the very high price Securities District grades return increases risk and threatens book value long term. This business makes a lot of money, but we clearly have a distortion on the market from the FET delight of they are there, but we need to be a bit cautious.

With that we would be the allowed to take questions.

Okay.

Thank you if you'd like to register a question. Please press the one followed by the four on your telephone you will USB tome prompt with knowledge of your request.

<unk> has been answered all of you would like to withdraw your registration. Please press. The one followed by the spring once again, it's one four if you would like to register for a question.

And the first question comes from Doug Harter with Credit Suisse. You May proceed with your question.

Thanks, I was hoping you could give a little more context to the.

The amortization expense.

I think you said it was kind of the sick around the <unk> drag.

This quarter.

<unk> kind of model prepay speeds can.

How would that kind of <unk> compared to the prior quarter.

Okay.

The prepayment Hey, does Jeff prepayments were up as you can see from the monthly company update that we put up last night as much as 25% over.

A year ago.

The exact difference in amortization I actually don't believe we released those numbers, yes, I need to be careful about releasing non public information. So I'll have Jim double check on that and we will get back to you and if indeed, we haven't.

Go ahead, and we'll release that where everybody could see that but prepayments are up 25% that's the.

The biggest drag on earnings.

Two things.

Higher prepayments, which is greater amortization as Jim said in his comments on I think everybody knows we don't do modeling or forecasting and then do catch ups the catch ups run through book value and actually in some cases make our current core earnings of non-GAAP measure appear to be higher than perhaps they are we take amortization as it occur.

Sure so as prepayments of ramped up here, we are getting.

Larger hit the core earnings even even though if you kind of look at the returns over the quarter of the comprehensive income was quite substantial and honorable the.

Other thing that I think you need to be aware of it in addition to that or what's around the corner and expectations. Most of the street and we have seven firms here on our chart expect may prepayments to be down by 18% and expect the June prepayments to be further down another 11% if interest rates of which of <unk>.

The lead a little bit do stay here then of course, you will see a little catch up and maybe the increase as we get into the late summer now the other element.

Scott on said in his comments is our leverages in the high sixes now we target eight and a half almost two full turns and I can tell you. We had two full turns of the TBA twos right now youre going to have 15 cents a quarter to income so a little bit of reinvestment can add a lot of income that being said also to Scott's point.

Oas's are negative here and Im looking at of chart left or right at the negative 20. Some OIS is on Doosan to NAV, we are not going to do heavy reinvestment of these kind of levels, we're going to be patient. However, as Scott also indicated of highly likely that we have maintained our dividend structure. As it is now we look at dividends in the medium term way out not just the.

On a month to month basis based on our perspective on reinvestment and occurrences of prepayments.

Okay.

Just to drill down on the prepay I.

I guess industry wide prepays were down in the first quarter relative to the fourth quarter can you just talk about kind of what pieces of your portfolio and what kind of drove you to have higher sequential prepays in the first quarter.

Our prepayments are well under our peer group prepayments of prepayment rate for the last month was in the high to mid 18 CPR level of you compare that to the peer groups that are going to be the at least 10 CPR higher.

Our individual securities the prepaid represented our higher coupons are positions at four and four fives.

We own those positions at the very.

Low prices, but they continue to have some.

The higher prepayment levels, but we're going to maintain although securities on our portfolio.

So on that to be exact the CPR in Q1 was $17 four.

18.

Great. Thank you.

Thank you very much.

Our next question comes from Trevor Cranston with JMP Securities. You May proceed with your question.

Alright. Thanks.

Sure.

I was wondering if you could elaborate maybe on sort of the thought process behind the.

The dividend level I know you said, it's sort of based on your medium term view.

But is the way to think about that sort of.

That's where you had the year earnings level. If you were at your target leverage as opposed to.

Running the lower risk lower leverage the strategy in the near term.

Or are there other things at play there as well.

That's exactly correct and as a matter of fact, we could probably earn a little bit more on our dividend rate. If we were fully invested as I just indicated.

Investing long term on core incomes that have per core income with assets that are negative.

<unk> is going to lead to some book value dilution at some point, we're going to be very cautious and I expect for the remainder of this quarter, there will be great opportunities to reenter and we have lots of dry powder.

Okay got it that makes sense.

And then in terms of your rate positioning.

You mentioned I think in the prepared remarks that you had some.

Overall positive duration, but negative duration further out the curve.

Can you kind of comment on how that how that's changed as rates go up.

And if you guys see any value in sort of adding some additional <unk>.

<unk> production into the portfolio as well to protect against.

The large moves in the tenure.

So the DBO on we don't release, our DVD of ones, but as Scott said.

On the whole duration pattern.

As of 0.28 of the duration as of this morning was slightly negative in the tenure and that will defend us against a steepening that has occurred and we as a firm expect more steepening, we feel of the fed will keep the short end of the curve.

Overnight funding rates low.

Don't see an increase for as many potentially as much as another two years and as the economy expands and banks have opportunities to provide credit and other areas Youll see higher 10 year rates and so we're positioned for that at some point. The fed will also reduce the buying of mortgages and that is of hope.

The period, where we can do some more reinvestment I know mark and his team of only reinvested pay downs once of one to full round of the last three months or so on not only under invested in paydowns to maintain the underinvested and of course on a full level of leverage target.

By the way you saw yesterday that Canada announced.

The theyre starting to.

Reduce the amount of purchases that theyre going to make.

Many of the.

People's comments on that as you know at some point, we will be next I think the expectation is that if the fed wants to maintain the same level of purchases they would reduce in the mortgages and put it into treasuries.

Okay.

To follow up on the comment about reinvesting Paydowns I guess.

With Oes is negative here.

Would you guys continue to let leverage.

The lower valuations remain those tighter even potentially get tighter or are you at a level, where you'd like to keep leverage kind of where it was at at the end of the quarter.

I don't think leverage all of it will get much lower what you maybe you could see debt to equity get a little bit lower if we put more money into TBA is I mean, you can do the TBA two of <unk> right now the <unk>.

May June roles at 17% and changed.

The TBA twos or 11, 5%, even 15 year wanted to halves of 11, 5%. So theres areas to put money there, but when we look at the risks associated with that and the potential spread widening of negative 20 OIS.

First of all the opportunities today, we're just being cautious so we will do some reinvestment will do some reinvestment in specified and I would note.

The pay ups for specified interestingly enough of come off quite a bit from their highs and some stuff that was like 80 90 takes over 60 takes over now, but interestingly enough. The OAS as of come in so pay ups over TBA as have come down, but the OAS as or more negative and the dynamics of that market maybe.

You want to speak to that element, because we talk about that in our investment of meetings.

Sure I mean, it's just the fact is as a rates declined the option cost.

The hedge on the mortgage portfolio has gone up.

So even though you see a little bit of maybe some nominal spread widening.

On the option adjusted spread has just continued to decline.

And so that's the reason why we continue to not reinvest a lot of our paydowns back in the mortgage product.

Because we are seeing negative OAS as we're seeing single digit kind of yields mid single digit yields on spec pools.

And the TBA like Jeff said have some specialness on are interesting, but they have a lot of convexity risk and on different spot. So the.

The investment opportunities when we look out on the outlook are not super attractive to reinvest all of our Paydowns. These opportunities come out you very quickly the difference between the investment opportunities on May 10 2000.

<unk> thousand 14, and July 10th 2000, and 2013 were like six points of difference these things come at you.

Trying to set ourselves up so if the marketplace provides an opportunity for a larger reinvestment we can ramp up our leverage very quickly two times otherwise we will continue to reinvest we do want to maintain of dividend.

We have the power to create earnings.

Got it okay.

Okay I appreciate the kind of thank you.

Thank you.

As a reminder, if you would like to register for a question. Please press the one followed by the floor.

Our next question comes from Christopher Nolan with Landenberger Tolman you May proceed with your question.

Hey, guys on the lower waiver does that indicative of more confidence in the.

Earnings momentum outlook.

For 2021.

It's actually probably more reflective of the capital raise in the way that our our fee changes with capital raises.

Got it and by the way to Jim's point on that that entire raise of the equity in the preferred of combined.

Total <unk>.