Q2 2021 ARMOUR Residential REIT Inc Earnings Call

[music].

Good day and welcome to the on the residential REIT second quarter 2021 the earnings conference call.

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I'd now like to turn the conference over to Jim Mountain. The CFO. Please go ahead.

Thank you Sarah.

Thank you all for joining our call to discuss armour second quarter 'twenty 'twenty..1 results. This morning, I am joined by Armours Co Ceos, Scott Ulm, and Jeff Zimmer Mark Gruber, our CIO is also with US this morning.

By now everyone has access to Armours earnings release, which can be found on Armours website, www armour REIT 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 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 at the SEC's website www dot the SEC 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.

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 the most comparable GAAP measure is included in our earnings release, which can also be found on Armours website.

An online replay of this conference call will be available on Armours website, shortly and will continue for 1 year.

Armour continues to concentrate its portfolio activity in agency MBS for the foreseeable future.

Quarter end book value was $11.28 per common share the.

The quarter over quarter decrease reflects spread widening across our MBS portfolio likely as the result of taper discussions and the market's synthesis of the fed talk about future reductions in agency mortgage purchases.

That trend has continued through the close of business. This past Wednesday, when we estimated book book value to be approximately $10.77 per common share.

While the spread widening negatively impacts of the current market values of our existing MBS portfolio. It also reflects increasing current asset yields and improving opportunities for new MBS investments.

Armour continues to enjoy widespread access to repurchase financing funding, our MBS portfolio under attractive terms and pricing both through its affiliate Buckler securities and through our numerous other active lending counterparties.

Farmers portfolio consists exclusively of agency MBS valued at approximately $4.4 billion plus.

Plus to be announced positions representing another $3.8 billion of securities.

Armours Q2 comprehensive loss was $61.3 million, which includes $69.2 million of GAAP net losses.

Core income, which excludes gains and losses from security sales and early termination of derivatives as well as market value in just adjustments, but does include TBA drop income was $18.9 million or 21 per common share.

During Q2, we issued $13 million 200, 9700, 290759 shares of common stock through our at the money programs raising $159.3 million of capital after fees and expenses.

That represents an average price of $11.99 per share, which was accretive to book value and exceeded the volume weighted average price of our share trading for Q2.

Armour capital management, the company's external manager continued to waive a portion of its contractual management fees, which waiver was initiated in the second quarter of 2020.

In Q2, the waiver offset $2.1 million of operating expenses the.

<unk> will remain at that level until further notice by ACM.

Farmer paid dividends of <unk> 10 per common share for each month in the second quarter for.

For a total of $26.2 million.

We've also declared the July and August common dividends at the rate of <unk> 10 per share as well as the stated series C preferred stock dividends through Q3.2021.

The company is remote work environment protocol has allowed us to keep operations fully functional while we worked remotely.

All of Acm's eligible employees are fully vaccinated and we've begun a phased plan to return to working from the company's offices, we expect that to be completed in September of 2021.

Now, let me turn the call over to co Chief Executive Officer, Scott Ulm to discuss Armours portfolio position and current strategy Scott.

Thanks, Jeff.

Questions hit the financial markets in July while Covid seem to be and were treated in the second quarter rapidly increasing infection is driven by the spread of the Delta variant in July of spark concerns about renewed business restrictions in the opposite direction the <unk>.

<unk> of the global economic reopening kept on an upswing with an abundance of liquidity from fiscal and monetary policies.

The strong rebound in growth created outside of imbalances between demand and supply of labor and materials, pushing producer and consumer prices above historic averages.

Specific to the increases in prices is largely transitory. The fed has pointed to the low level of the labor participation and the existing slack in labor markets as the main reasons to keep its monetary policy accommodative for the foreseeable future.

Despite these assurances to the market the U S treasury yield curve flattened significantly the signaling greater uncertainty around the strength of economic growth, whilst monetary accommodation is low.

The outward yields on the 10 year Treasury decreased from 174, 4 percentage of 147% during the second quarter and dropped as low as $1.1 9% in July and EBIT lower inter day <unk>.

Similarly, the yield spreads between the twos tens of $5 <unk> of the treasury curve flattened considerably by approximately 36 basis points of 28 basis points, respectively in the second quarter.

And the mortgage market the option adjusted spreads on Fannie twos widened significantly from the historic types of observed in the first quarter.

As of June 30 of the.

Of the OAS of 30 year, Fannie twos, and Fannie 2 fives widened by 14 basis points and 17 basis points, respectively. Since the end of the first quarter.

For the month of July we've seen the widening of an additional 3 and 4 basis points of those coupons respectively.

While this widening has impacted book value and a significantly improved reinvestment opportunities spreads are going longer deeply negative and we foresee a slow but steady normalization of spreads towards historical averages prior to the end of this latest round of QE.

The improvement in reinvestment opportunities is an extremely positive development for our business model after a year plus of continued tight.

Nominal outright payoffs of specified pools rebounded from their lows of the second quarter the.

The TBA dollar roll Specialness is still quite high is deliverable bonds remain locked away in the fed's portfolio.

We continue to allocate nearly 50% of our assets the dollar rolls in 15, and 30 year TBA markets.

The other half of our assets at favorable prepayment protection characteristics composed primarily of prepayment penalties and dust and lower loan balances of MBS pools.

Second quarter of prepayments slow relative to the prior 2 quarters, providing a tailwind to earnings.

<unk> portfolio averaged $15.3 CPR in the second quarter below the $17.4 CPR from the previous quarter.

We expect spreads to remain at speeds to remain at similar levels in the third quarter.

We used the past quarter to position US portfolio ahead of the potential changes in monetary policies with all eyes on the Jackson hole Symposium in August and the epilepsy meeting later in September.

Our debt to equity ratio of 3.5 times and our implied leverage of 7.2 channel, which includes TBA is 1.5 to 2 terms low our historical leverage levels are lower leverage provides us with ample dry powder to take advantage of future market opportunities.

Average term in overnight repo rates range between 10, and 14 basis points throughout the second quarter.

The feds 5 basis point hike for their overnight reverse repo rate funding markets continue to stick to the historic lows and are projected to remain dormant and of the year end.

Armour is active with 18 different count repo Counterparties and approximately 58% of our principles borrower with our broker dealer affiliate Buckler Securities as I'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.

That we'd like to take any questions.

Thank you.

We will now begin the question and answer session.

To ask a question of DNA Press Star then 1 on your Touchtone phone.

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John from the question queue. Please press Star then Kim.

At this time, we will pause momentarily to assemble our roster.

The first question comes from Doug Harter with Credit Suisse. Please go ahead.

Thanks.

You guys mentioned in your prepared remarks that the.

Returns on new investments are improving can.

Can you just quantify that.

Where you see.

Incremental investment returns today, and just if you could put that in context of of where that was 3 months ago.

Sure Doug This is Jeff good morning.

The returns on our specified pools have improved by 200 to 450 basis points, depending on the coupon. There are specified pools now that have double digit returns and thats. The way we look at that is.

We run of generic 8 times leverage of 50% hedged, but 280.5 duration. So use it all of that criteria, we're seeing low double digits out of some.

The TBA.

And after that it might be 10, 511% return now was 6 perhaps.

6 to 9 weeks ago, so thats kind of moving to sitting there the.

Dollar rolls.

1 point got Crazy Youre getting returns of 2022% and Theyre now in the 12% to 16% depending on the coupon and we expect over time that you would see those dollar rules returns probably go down as the fed quit buying but that.

A little bit about waiting for godot that will happen, but probably not in this quarter now.

In terms of.

Marginal cash then you could actually invest equal or better to your dividend if thats what youre asking.

Got it and then just on that on that comment you just made about eventually.

<unk> dollar rolls to kind of normalize.

Just how do you think about portfolio construction and kind of how to think about the the tradeoff of owning.

Owning pools versus TBA.

And that.

With that as the backdrop.

Yes, so right now we have approximately $50.50, <unk> and <unk>.

Specified.

And we would anticipate over time that as the fed moves out of the TBA market that also specified prices or returns would improve as well. So at that period of time, we would more from some of our dollar roll positions into our specified but let's go back even even 2 years ago, we were 20% 22% dollar of.

So there are and will be always opportunities of the dollar roll market now it's not just the fed the buys in the front most of that helps that out why the mortgage banker activity is very heavy they're oftentimes hedging 60.90, even of 120 days out so that puts pressure on <unk>.

123 months out of <unk>.

Rice's, so and that's what creates the opportunity with the fed buying of the Frontload just exacerbates that makes it even better. So we anticipate exposure to dollar rolls, but wouldnt be surprised if we talk a year from now in its 20% to 25% of portfolio.

Great I appreciate it.

Well, thanks, very much for calling in.

Our next question comes from Trevor Cranston with JMP Securities. Please go ahead.

Alright. Thanks.

To follow up on the questions about the new investment opportunities.

Where do you guys see things today.

Do you consider the reinvestment opportunity attractive enough that you would.

Start taking your leverage back up towards your more historical average levels.

Or do you guys want to continue to hold onto some dry powder anticipating that.

New investment returns could get even more attractive for the.

Currently.

Trevor Good morning, Jeff again, we're going to be very slow about increasing our leverage so I'm looking at the chart right now if I go to the.

For the last couple of days of April.

<unk> OAS as Fannie 2 fives were negative 23 everybody's model is a little different okay. I look at them today. They are about 5% historically, they should be 20 wider than that.

We weren't trading of <unk> 10 years ago, either so we have to look at what the current coupon is.

The number of your broker dealer brother, and it's going to provide those kind of charts for you.

Look at Fannie Threes and at that same date in April they were negative 2 to 5 OAS LIBOR and I got from about 34, and they could probably widen another 15, so we're not going to be able to catch the wides.

Dissipate and I think our group anticipates that a lot of the fed tapering robley just came into the marketplace over the next 6 weeks. So don't expect to see our leverage go up immediately but we are studying very closely the reinvestment opportunities as they are now equivalent to what we're paying out in dividends with a number of the coupons.

If we widen further you'll see us start putting some money to work on as Scott said in his comments. We're wondering if half of the 2 turns lower than our historic leverage numbers and if we go back up there at core income is going to be at your dividend rate of our view, perhaps even exceed it.

Got it okay. That's helpful.

And then looking at the portfolio composition.

Narrow versus last quarter it.

It looks like the asset durations are a little bit shorter.

And the swap book increased somewhat.

Could you just comment on sort of where your duration positioning of that.

And how that's evolved over the last few months as interest rates come back down.

We've targeted over the last 2 to 3 years, maintaining a duration of the whole business of about 0.5, but what happens when you see moves in the marketplace like we've seen that duration increase so what you are saying seeing from our portfolio as the rally in the 10 year as Scott said down of inter data of the 113 at 1 point those mortgage price.

<unk> quick quick going up as they hit a wall, but your hedges don't right. So we believe it's temporary and debt duration goes back down we believe that that will equalize.

As the market.

Kind of gets back to what we think is normal perhaps slightly higher rates at a slightly steeper curve and that duration, which is now closer to zero would work its way back to the <unk>.

Zero point forward of 0.5 area. So the only reason you're seeing those assets get sort of duration is the rally in the marketplace, except for the dust the industrial kind of locked out and they've maintained their duration quality now on the hedge side.

I'd say the following.

We don't anticipate at this point changing our hedging profile or the way we run our hedge book I would note that our average pay rate is 68 basis points right now.

For that tenure OIS. This morning, its about 109.

We do have $600 million of real short hedges rolling off within the next 10 months and we will not replace those but should we put any new assets on we will hedge them.

Moving 8 or 8.5 times leverage to where we get to the 0.5 duration. That's our target right now that's helpful.

Yes very helpful. I appreciate the comments thank you guys.

Well, thanks for calling in.

Again, if you'd like to ask a question. Please press Star then 1 of your next question comes from Christopher Nolan with Ladenburg Thalmann. Please go ahead.

Hey, guys.

Jeff in recent quarters, you articulated that.

You were changing the investment strategy to protect book value at the cost of EPS given the change in the interest rate environment. Since then is there any update to the strategy that you can articulate for us.

No. It's exactly the same despite the book value decrease if we'd maintain our historic leverage you would have seen decreases of similar to what some of the other firms announced which were 3 of 400 basis points.

Worse than ours. Unfortunately, so we maintain the lower than historic leverage to protect ourselves and what we saw is a to tighten OAS environment and turns out we were right, but we can't sell all of our mortgages. We are in the business of providing income for our shareholders. So as they say in that 1 movie. This is the business that we've chosen so.

We will remain mortgage investors, we are just not investing as much as we normally would in order to protect book value as much as we can while equalizing of balancing that with the fact that we need to produce the dividend for our investors.

And then I guess from Scott prepared comments. He indicated he is seeing an improved.

Investment environment could we start seeing you guys reenter the non agency space at all.

You won't see that no.

Okay and final question is what is your outlook for prepayments going forward I know, they're up a little bit in July but.

We actually expect them to be level for the next couple of months now.

We are getting a.

Refi burnout here, we've been at very low rates ever since <unk> been at low rates and that we've been at low rates, obviously since April of <unk>.

The last year or even lower rates.

Our model of show and Thats equal to what the Wall Street dealers estimate for example August day estimate.

Down 4%, we're going to we're running of its zero. So no change the estimating September unchanged from August and we're going to maybe make them up a couple of percent because we usually we're very conservative in our estimates and we haven't estimated yet for October and November it's too early.

Great. Okay. That's it for me thank you.

Thank you very much for calling in.

This concludes our question and answer session.

To turn the conference back over to Jim Mountain for any closing remarks.

Well I'd like to thank everyone for joining us this morning, and as always if there are.

Questions or inquiries in the intervening.

The period between now and when we gather again in another 3 months of field.

Feel free to give us a call at the office or send us an out well.

As I said earlier, we're still working somewhat remotely.

Through September so an email and we'll get right back to you.

And speaking of.

Between now and September August usually is a slightly slower month on the finance business saw help everyone has an opportunity to.

Unplug and recharge for a little while before we get back.

Full speed.

September sell until then stay well.

The conference has now concluded. Thank you for attending today's presentation you may now disconnect.