Q1 2022 ARMOUR Residential REIT Inc Earnings Call

Good morning, and welcome to the armour residential REIT first quarter 2022 earnings conference call. All participants will be in listen only mode should you need assistance. Please signal a conference specialist by pressing Star then zero on your telephone keypad after today's.

Presentation, there will be an opportunity to ask questions to ask a question you May Press Star then one on your telephone keypad to withdraw your question. Please press Star then two please note. This event is being recorded.

I would now like to turn the conference over to Jim Mountain Chief Financial Officer. Please go ahead.

Thank you Andrew.

Thank you all for joining our call today to discuss Armours first quarter 2022 result.

This morning as usual I am joined by Armours Co Ceos, Scott, Ulm, and Jeff Zimmer and Mark Gruber, our Chief investment Officer.

By now everyone has access to Armours earnings release, which can be found on the armor 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 1095.

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 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, which have been filed with the securities and Exchange Commission copies.

Copies 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 there are subject to change without notice we disclaim any obligation to update our forward looking statements unless we're 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 be found on Armours website.

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

Net interest margin for the quarter was $1, 78% an increase of 18 basis points over the 2021 year average and a three basis point increase compared with Q4 of 2021.

Armours Q1 comprehensive loss related to common stockholders was $148 million.

Which includes $66 $4 million of GAAP net loss.

Distributable earnings available to common shareholders, which excludes gains or losses from security sales and early termination of derivatives as well as market value adjustments, but includes TBA drop income was $26 $7 million or 28 per common share.

Because of armor users pay fixed interest rate swaps for hedging distributable earnings includes the monthly running cash coupon cost or benefit of our hedging activities.

This effect makes distributable earnings more stable as movements in repo funding cost and swap net coupon payments will tend to offset one another.

Armour paid monthly common stock dividends of <unk> 10 per share during the quarter and has announced dividends at that rate for April and May of 2022 taken together with the contractual dividends on preferred stock Armours made cumulative distributions to stockholders of $1 $87 billion over its history.

ACM the company's external manager continues to waive a portion of its management fee, which was initiated in the second quarter of 2020.

This waiver offset $195 million worth of operating expenses in the first quarter of 2022.

Quarter end book value was $8 48 per common share down $1, 85% from December 31, 2021 as of the close of business on Tuesday, the 26th we estimated book value to be approximately $7 63 per common share.

At March 31, <unk> portfolio consisted of $6 $4 billion of agency Securities plus TBA positions, representing another $750 million.

One 3 billion of U S treasuries.

Now, let me turn the call over to Scott on one of our co Chief Executive officers Scott take it away.

Jim.

The first quarter of 2022 was one of the worst quarters for bonds in nearly 50 years as investors grappled with the scope and magnitude of the monetary policy response necessary to hold rapidly rising inflation, while also worrying about its impact on economic growth.

Over the course of the first quarter of 2022, two year Treasury yields rose 160 basis points.

10 year yields rose over 80 basis points and the two tenths difference briefly dipped below zero.

Ominous sign of economic turbulence ahead.

<unk> entered 2022 with a defensive posture.

As risk parameters and leverage we're below historical averages in anticipation of increased volatility as the fed declared at the end of their QE program.

Our net duration gap heading into year end was three <unk>.

The leverage seven five times and liquidity was at a very healthy level of $840 million.

<unk> allocated roughly 50% $4 5 billion par of the portfolio to the production TBA contracts with superior market liquidity compared to the specified pool market, which struggled to trade in line with its fair value in times of heightened market volatility early first quarter.

Rapidly rising rates and quickly deteriorated market liquidity in early January flash warning signals for mortgage spreads, prompting a response from AMR to quickly and efficiently sell our entire TBA position on swap for duration matched treasuries.

Remove which greatly reduced mortgage spread risk in the portfolio.

In the first seven weeks of the quarter a.

Decreased its agency MBS spread exposure by over 30%.

By late February when mortgage spreads and yields approached levels last seen in four years armour began to steadily deploy its available leverage and newly purchase mortgage bonds back in the par coupon MBS.

Since the end of February we have purchased $1 $8 billion of production pools, and $1 2 billion of TBA as well selling $1 8 billion of longer duration treasuries.

During the same period, we're actively rotating into production MBS and out of our lower coupons 15 year and 30 year pools as those make up the majority of the fed's MBS portfolio that are most at risk of spread widening due to potential active sales by the fed.

As of mid April 2022.

We replace the vast majority of our former treasury positions with newly acquired MBS with Levered yields between 12 and 15%.

While the near term there remains at elevated levels of uncertainty ahead of US we will be watching very carefully to invest with a longer time horizon.

With about 116% of our repo book hedged with current and forward starting swaps. We believe we are adequately hedged for the nearly 275 basis point fed funds rate increase is currently being priced into the market.

Also note that our distributable earnings contains all of the cost of our hedging and financing.

<unk> continues to monitor the term structure of the repo market in light of the aggressive fed but for now we prefer to keep our remaining average repo term short currently at 21 days our average repo rate today is just about 50 days.

We continue to believe that our current dividend rate is appropriate for current conditions against further support from the investment opportunities available.

Thank you now I'd like to open for questions.

Andrew do we have questions.

Yes. So we will now begin the question and answer session to ask a question you May Press Star then one on your telephone keypad, if youre using a speakerphone. Please pick up your handset before pressing the keys if at any time. Your question has been addressed and you would like to withdraw your question. Please press Star then.

<unk>.

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.

Given the size of the book value decline in the first quarter and so far in April how do you think about what the right size of the balance sheet is and how much more capacity you have to to increase that if you see the opportunity.

Hey, good morning, Doug and thanks for calling in so when you do have a book value decline the leverage goes up naturally.

We started the quarter at $6, one times leverage and it has crept up to the mid to high Sevens.

We do own a number of treasuries still and we have not reinvested April .

Expected may pay downs, so we do have.

On the table that amount of reinvestment opportunity into mortgages, which obviously as Scott center, yielding between 12% to 15% it would be unlikely at this point unless the opportunities.

Became extraordinarily good and I'm talking like 18% or so for us to be.

8586 times leverage so look at it that way and I think that.

It gives you a good tablet for how we're looking at things.

Got it and then just on the on the dividend comment.

If I take the current dividend divided by your updated April book value that gives me.

Kind of a number north of 15% required return to kind of <unk>.

Generally at that and that would be kind of after expenses.

You're talking 12% to 15%.

Returns that youre seeing in the market.

Just curious as to kind of your commentary around the comfort in that dividend level.

So based on the historic assets that we own and based on the current investment opportunities. We definitely can support that dividend. We have not had a longer term discussion with the board in terms of third or fourth quarter, yet, but we currently feel very comfortable with what we're paying and that support Scott's comments.

Okay. Thank you.

Thank you very much.

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

Okay.

Alright. Thanks.

There is obviously a lot of volatility in.

Spread widening in the first quarter.

Can you guys talk about kind of where are you where you see things today.

How much risk you see if additional.

Widening in the MBS market and whats.

Or what's your thoughts around the potential for continued great volatility in.

Good policy going forward over the rest of year.

So you wouldn't have thought looking at February 15th 2020 that wed be looking at investment opportunities.

26 months later in the 12% to 15% area, because thats about 500 basis points better than what we're looking at that.

And I think that those changes highlight the risks that are inherent in the current environment.

Geopolitical risks, we can't do anything about their there we respect them, we're being cautious about them and we understand that they could be X essential we just don't know how crazy they could get however in the mortgage spread widening.

We look back.

Through the subprime crisis, which I think highlights how bad things can get and we're within a standard deviation or so.

Being normal on that so we are not fully invested but we are adequately invested and as Scott said in his comments and as we've said in our monthly company update we took more than $2 billion of treasuries and reinvested them into mortgages, but we did it over a 10 or 12 week period, and we caught some of the wider spreads.

<unk>.

Also lots of assets a little tighter than we wanted to we've left some.

Cash on the table to reinvest if we do get it widen there, but as I said, we are very respectful of the risks that are out there and we're cautiously.

Watching those and we're probably not.

Investing that last of opportunities of cash that we have.

As I said, we're being respectful of that in terms of.

The second question that U S.

I don't think that the.

Capital markets.

Mortgage spreads get crazy wide for a long period of time, so if they get too levered returns of 18% to 20% it would probably be very short lift.

Even the high yield indices have not.

Gone out like 110 basis points or so.

No.

So.

That's our thoughts on that I hope that answers your question.

Yes, that's helpful.

And then in terms of the coupon positioning of the portfolio.

Hey, guys.

They've been moving up in coupon somewhat.

Can you maybe just talk about kind of what the pace you would expect that rotation to continue.

You know, if you're or if you're comfortable continuing to own.

Larger discount bonds that you guys currently have in the portfolio.

Sure Trevor this is mark.

I believe we're probably almost done with kind of rotating out of some of the lower coupons in the upper coupons.

And mainly thats because.

The lower coupons are pretty much fully extended they have good convexity and they're good assets.

So when you look at our portfolio at our next update Youll, probably see us maintain most of those lower coupons.

All the Reinvestments are going to go on the upper coupons.

What we've done for the most part all the rotation out maybe some there'd be some low things on the end.

We really like the assets and the lower coupon just because of extended so much already and it can vaccines are great.

Sure.

Okay. That's helpful. Thank you.

The next question comes from Christopher Nolan with Ladenburg Thalmann. Please go ahead.

Guys.

Just a quick question for Jim net interest income in the quarter.

Seem to go up a bit quarter over quarter I'm just trying to.

Okay clarification why.

Well I'll pitch that mark.

Net interest income between Q4, and Q1 is that what Youre asking yes.

It's just going to be some rotation into some different bonds, but also amortization expenses slowed.

Great and then just I was checking out the Q and I just saw that Youre haircuts plenty of repo funding has actually gone down in the quarter.

I found surprising given all the turbulence going on MBS market was that related about buckler or is there any color you can provide on that.

No that is.

Clearing marketing repo haircuts has declined as I think more and more of our counterparties are getting comfortable with what's the risk in owning MBS agency MBS. So we've actually got our counterparties to lower haircuts.

And as a result of some actual outreach and conversation trying to make sure everybody was.

Meeting the market leader and we are sort of most favored nation positions with all of our Counterparties Christopher.

Christopher I would note that in the treasury market many of the dealers have no haircuts at all and.

If you go back to the subprime crisis is interesting haircuts went from 3% to 4% up to 6% to 7%, 8% or 3% to six months and we haven't seen that right. Now. So we would suggest that the banks are characterizing the current environment is not being as risky as that unless haircuts.

Andy.

Despite the widening thats happened in mortgages.

Volatility theyre very comfortable with and I think thats actually makes us somewhat comfortable with our increased investment in MBS.

Okay. So it sounds like there is a disconnect between how the banks are viewing the MBS market.

With the credit spreads aside.

Well I think they've gotten more comfortable with the fact that over time, how often have mortgages dropped.

Three or four points in a day.

Because remember they have our collateral so they can sell at anytime its bankruptcy remote.

And so I think there are just more comfortable that they're not going to see it.

Greater than three point drop in a day on the collateral honed it's very liquid.

Well, perhaps a little bit to that.

As repo rates are.

Gone up from 56789 basis points to 50 basis points, we've seen new entrants in the market and so the attractiveness of repo as an asset to them.

To be increasing in haircuts, just one of the terms upon which they can compete for balances.

Got it okay. Thanks, guys.

Thank you.

Again, if you have a question. Please press Star then one.

The next question comes from Matthew Howlett with Nomura. Please go ahead.

Oh, Hey, guys. Just a question on historical context, where MBS spreads are on a nominal OAS basis slipped to here.

Where they are today versus different points in time paper Tantrum financial crisis.

Yes, so couple of pulp a chart here.

But we think when we look at.

Our analytics.

Z spread basis, Fannie fours are about 110.

OAS as obviously, we are lower than that just because of the way the metric works.

Does spreads are probably in the mid fifties.

And so we would say that dust is tighter.

In agency MBS.

Definitely wider.

On a treasury OAS basis, one of the trucks, we look at it as Treasury OAS.

<unk> basis.

In general the coupon stack is on the average of where.

The fed has been buying.

But its below long term average of when they are not buying.

So that's why we do think there is still some widening when the fed decides to really stop and maybe actually sell tenors.

10, or 15 basis points.

So but in general.

Mortgages are much much wider than they were just a few months ago.

So thats why Jeff said earlier, there are attractive and we've been slowly buying some over time.

So we run a number of different charts.

And the charts.

Breakeven still when the fed is buying when they are not buying and then when we look at the crisis.

There was a period of about.

Eight or 12 business days ago, where we were actually OAS spreads.

Well north of that mortgages has actually performed well net of one day over the last week. So we're just inside the.

Net average non fed buying over the last 12 years. So hopefully that's helpful to you and one of our largest counterparts is actually put out a chart of current coupons and we follow that started I think thats the best way to look at it.

So I think about the current environment if they stay at these levels or they go wire that's got to be good for spread.

Core Roe and that they tightened.

That up.

Book value, how do I think about sort of the risk.

Return trade off if we just stay at this kind of environment or are they widened.

Good for reinvestment and good for shareholders or if things do tighten we'll see the big rebound in the book.

So if things tighten.

Generally you would expect book value to go up it doesn't always work that way because of the other events, but we would expect that to be the case.

We think the vast majority of widening has taken place here, okay, everybody knows the fed's out and everybody expects the fed to go ahead and sell some assets and I believe that thats priced into mortgage OAS right now, but as I said earlier in my comments, we are extremely respectful of the fact that they could widen.

A little bit more and we are ready if and when that happens to reinvest.

That being said when they do widen book value generally as a proclivity to go down a bit they tightened book value generally as a proclivity to go up but the investment opportunities now and if things widen or better that is correct.

Great and then last question I mean, it looks like you've got the liability side.

Much termed out with I think you said, 116% and Youre good all the way up to the $2 75 to go through that.

As Gerry you mentioned long dated repo, maybe like you said is there anything else you're looking to do on the liability side of the balance sheet as you enter the.

It could be a rate hiking cycle or do you feel like you pretty much done everything and.

And you're sort of well positioned for it.

So as Scott said in his comments and as well as our press release, we have more than 100% of our repo balances swapped out right now so what that means is as repo rates go up we.

Pay fixed on our swaps and our fixed rate is locked in generally at lower rates than the market is right now and then the receiver side would generally go up as well with repo rates, so that definitely offset each other so we look at that as very comforting in terms of our liability balance.

As we increase our assets and as we said also at this point, we're not generally increasing our leverage until we see some great opportunities, we would put more swaps on the book to offset that risk.

Great. Thanks, Jeff.

Thank you good to hear from you.

Been a while.

This concludes our question and answer session I would like to turn the conference back over to Jim Mountain for any closing remarks.

Let me end, where we began and thanking you all for joining US this morning and for your interest in armour residential REIT.

We're always interested in conversations with shareholders and analysts and so.

If anything comes up between now and the next time, we're together in this forum don't hesitate to reach out.

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

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