Q2 2022 ARMOUR Residential REIT Inc Earnings Call

Good morning, everyone and welcome to the armour residential REIT second quarter 2022 earnings conference call.

All participants will be in a listen only mode.

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Please also note today's event is being recorded and at this time I'd like to turn the floor over to Jim Mountain Chief Financial Officer, Sir. Please go ahead.

Thank you Jamie and thank you all for joining our call to discuss <unk> second quarter 2022 results. This morning, I'm joined by Armours Co Ceos, Scott Ulm, and Jeff Zimmer, and our Chief investment Officer, Mark Gruber.

By now everyone has access to Armours earnings release, which can be found on <unk> website, www <unk> 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 $19 95.

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.

That would be 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 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 required to do so by law.

Also our discussion today may include reference to certain non-GAAP measures. A reconciliation of these measures. The most comparable GAAP measure is included in our earnings release, which can be found on our website.

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

Net interest margin for the quarter was $2 two 2% an increase of 44 basis points compared to Q1 2022.

Armours Q2 comprehensive loss related to common stockholders was $96 $2 million, which includes $58 6 million.

GAAP net loss distributable earnings available to common shareholders was $31 $2 million, that's up 16, 8% from Q1.

On a per share basis that represents 29 per common share.

That non-GAAP measure excludes gains or losses from security sales and early termination of derivatives as well as market value adjustments, but it does include TBA drop income.

ACM the company's external manager continues to voluntarily waive $195 million of its management fee, which offsets Q2 operating expenses.

Armour paid monthly common dividends of <unk> 10 per common share during the quarter and has announced dividends at that rate for July and August of 2022.

Taken together with contractual dividends on the preferred stock of armor has made cumulative distributions to stockholders over $1 $9 billion throughout its history.

On the capital markets front armor took advantage of the brief selloff in Q2 to repurchase 248000 shares of common stock at an average cost of $6 23 per share the existing repurchase authority stands at just under 8 million shares which will allow us to take advantage when Andy yes.

Future market dislocations present, similarly compelling opportunities.

The company also raised approximately $80 million worth of equity capital in Q2 by issuing 10 4 million shares of common stock at an average price of $7 65 per share through its at the money at the market program.

In July the company raised an additional $28 $5 million worth of equity capital with the issuance of about 4 million shares of common stock.

Quarter end book value was $7 25 per common share down 10, 7%.

From Q1 2022 through the close of business on Tuesday, the 26th we estimate that armor has picked up a nickel on book value at approximately $7 30 per common share liquidity remained strong at more than $650 million.

At June 32022, Armours portfolio consisted of $6 $7 billion of <unk>.

Agency Securities plus TBA positions, representing another $700 million, or so and $600 million plus or minus of U S Treasury Securities.

With the sale of our dusk portfolio Armours legacy available for sale portfolio now represents less than 4% of <unk>.

Total specified pool positions.

Now, let me turn the call over to co Chief Executive Officer, Scott, Ulm, who will discuss armours portfolio position and current strategy in further detail Scott.

Thanks, Jim.

Circle Selloff and bond markets continue through the second quarter of 2014 to as global Central banks.

Aggressive tightening of financial conditions like rising rates of inflation.

The 10 year Treasury yield reached $3 four 5%.

Highest level since 2007 and up from just 20 basis points a.

A year ago.

The 10 year benchmark yield rose to just under three 5% surpassing 2018.

A three 5% to break out of a multi decade trend lower yields.

Rapid tightening financial conditions did not avoid the housing sector professional mortgage rate search, 6% driving mortgage refinancing activity to the lowest level since the early two thousands.

Historically, while agency MBS spreads discount coupon nearly all existing mortgages presented are exceptionally attractive environment for our agency MBS portfolio strategy.

Continuing with our Q1 strategy to redeploy risk back into the market.

During the second quarter are sold in U S treasury bonds at lower yielding assets totaling almost $4 billion to purchase newly issued MBS specified pools with levered yields ranging between 15 and 18%.

The asset sales included our entire dusk portfolio of just under $1 billion, which were sold at risk levels in the face of a widening of credit spreads and rising worries of a recession.

<unk> also included $1 billion in lower coupon MBS pools was particularly slow prepay characteristics to take advantage of tight spreads and to pair down the portfolio reservoir potential fed states.

Coupons.

We believe the fed will exhibit a particular care and caution in approaching the question of portfolio of MBS sales. Both in terms of the announcement timing and the size of those vessels potential sales astronaut produce an outsized impact on the mortgage market.

We hold approximately 20% of the total portfolio by market value in 2% to 3% coupon pools with faster turnover prepayment speeds collateral very low negative convexity.

At approximately 44% market value our core portfolio holdings are in three five and 4% coupon pools, which are shielded from both the risk of the selling in of new origination supply.

The remaining exposure is in MBS was $4 five 5% coupons were nominal spreads offer a value proposition we haven't seen since the 2010 2011 environment.

As of the end of June our net portfolio duration was <unk> 48, and our convexity was negative <unk> nine.

This is indeed, a great time to be an agency mortgage investor.

Our overall reallocation of capital is reflected in our quarter on quarter increase in NIM by 44 basis points.

Still historically low leverage of seven six times as of the end of June and distributable earnings just slightly below our stated dividend.

We estimate our earnings capacity to exceed the dividend of <unk> 30 for the third quarter and persistent leased into the year and we anticipate that high volatility will produce many additional opportunities ahead.

Armour maintains a healthy amount of dry powder of over $700 million of U S Treasury notes.

Capacity for at least one turn of additional leverage and ample excess liquidity.

Despite rapidly rising rates of 104% of our repo book as of the end of June is hedged with current and forward, starting swaps, which reset daily.

This allows us to be relatively agnostic to sizing and timing of fed moves which have been extremely unpredictable this year.

Armour continues to monitor the term structure of the repo market, but for now we prefer to keep our MBS term repo.

Or shorter as of 630 it stood at 22 days with an average rate of 137 basis points.

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

Thank you very much we would now like to open up for questions.

Ladies and gentlemen at this time well begin the question and answer session to ask a question you May Press Star and then one if you are using a speaker phone. We do ask you. Please pick up your handset prior to pressing the keys.

So all your questions you May press star into once again that is star and then wanted to join the question queue.

Our first question today comes from Doug Harter from Credit Suisse. Please go ahead with your question.

Thanks.

You talk about where you see incremental returns.

On new investments today and then.

You are truly mark to market kind of the entire portfolio from a return perspective.

The returns do you kind of comparable to that.

Sure ill defer to Mark Gruber, Chief investment Officer Mark.

Sure. Thanks, Doug.

So right now we see asset yields levered yields somewhere in the mid teens, so 14% to 16% yields.

On new investment opportunities.

And like you said and Scott had said, we turned out of the portfolio pretty quite a bit over the last few months.

And we think.

The return profile of the the whole company the whole portfolio is going to be somewhere in the low to mid teens also like.

Like Scott also said in his remarks.

Our earnings capacity is higher than where it's been over the last.

Six to nine months.

I mean, I guess just on the on the dividend with that construct right. If I take the current dividend over the current book value now.

So that gets me something in the 16% range or if you're saying that.

That's okay.

Oh, yeah yeah.

You have to earn that sort of after expenses.

If you're saying the returns are in the 14 range just curious around the commentary that.

Around the sustainability of the dividend.

Hi, This is jeffrey so the dividend is very sustainable here make special note of the fact that.

The amortization expense that we currently have.

Very low prepay.

Prepayments.

Portfolios exhibited now are the lowest it's been since we started the company.

Particularly.

Two reasons higher mortgage rates are near 6% music prepayments.

Existing portfolio attributes are very low and it also means because over 90% of our portfolio is specified assets that we pay a premium over TBA to identify characteristics that will keep prepayments slow. So if you get faster prepayments than you could have a situation where you are not being able to support the 30 cent dividend.

I'll, let me Scott was very clear in his comments that we feel the foreseeable future.

The portfolio after expenses will support a 30% dividend per quarter.

Sure. Thank you.

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

Alright. Thanks.

Can you talk about how you guys are thinking about.

The risk of any potential further spread widening from here and.

Kind of what's your what you guys are looking forward to maybe be a little more aggressive in terms of taking leverage up to a higher level.

So once again Scott also commented.

As our prepared remarks.

We believe that low likelihood at this point that the federal reserve is going to sell mortgages and create a big spread widening that we've protected ourselves specifically by reducing exposure to those coupons at the federal reserve owns so should they be selling.

We have very little exposure to that spread widening risk now however, if the season the ocean tide goes down.

All of those go down a little bit we do understand it so for right now we have one turn underwear, our actual historical mid eights leverage had been and when we see assets that we think have good longer term attributes. We will go ahead and buy that we do.

A big slug of treasuries and the Treasury position is well can be turned into mortgages. So we have two ways to go ahead and increase our exposure to spread but we're just being very cautious and careful here understanding of course that we are supporting and we expect to be supporting our dividend for at least the foreseeable couple of quarters. So we.

We will not see a reason to go ahead and extend ourselves hope.

That answered your question.

Okay, Yeah. It does.

And in terms of the as you guys are buying new securities.

And the spec market can you talk about how much.

Premium you're paying for.

Prepay protected pools at this point.

Sure I'll hand, it back over to Mark to give you some details on that.

Before he starts I will tell you, we're being very cautious about that because in March and April 2020, a lot of those premiums disappeared and painful for owners of mortgages. So mark I want to give a little more specifics on some of those attributes.

Yes, so most of the spec pools, we buy have pay ups by half a point or under.

And specifically that the reason is because of what Jeff just said is that.

Prepay volatility was kind of extreme a few years ago.

So we've kept our pay ups pretty low.

Now, where Charles was trying to find assets that have the right convexity characteristics. So there are cases won't pay more than that.

For a really good assets, but we will.

I would say I have appointed under where we tried to keep it.

Okay got it thank you.

Thank you and our next IND.

Our next question comes from Matthew Howlett from B Riley. Please go ahead with your question.

Oh, Hey, guys. Thanks for taking my question just on hedging I mean, we've got the with the curve inverted.

<unk> seen a lot of flattened.

<unk> converted yield curves over time.

Think about taking out the hedging longer and then theres been some talk or some forecasted possibly the fed cutting next year, just talk a little bit about how you how you look at hedging today.

So if we get to a point, where we actually think the fed is going to be cutting or even perhaps a little bit before that we may adjust but let's let's walk through there's still about close to 100% of our portfolio is hedged with pay fixed receive floating a lot of that paid fixed is low single digits that we put on in 2020.

We're paying low amounts and we're receiving in the two hundreds now rights as the federal reserve raises short term rates for the foreseeable future we could see.

Short term rates federal funds rate going up another 150 basis points before they take a deep breath and take a look at things and we'd be a net receiver of those against the increase that we look equally half on our repo book. So for right now we're going to keep that as positioning it. It helps earnings at the way, we havent setup is across the curve.

Little inversion or little Steepening doesn't really play around book value as much as it might think.

In that regard we're doing some work early.

Earlier in the year. So think about this the two year note in Q2, moving average basis daily basis points up seven basis points. So every single day on average has moved seven basis points. The last 20 years. It moved three four on average so you got a lot of moving around Thats, what mark and his team have been very good about.

Hedging across the curve and that same respect the tenure during the second quarter moving average of seven one basis points in yield but over the last 20 years. It was $4 four so once again not quite double but certainly near that so.

That was the mountain that we were fighting that battle against them.

A very very good job about that so I hope that addresses your question.

It does thank you and then I guess last question on just on the topic of capital I mean.

<unk> held up I mean, it's above book here and you look at <unk>.

<unk> markets.

You don't have a crystal ball, but what do you think that's.

All of the preferreds in the mortgage REIT, you're trading below it.

To me that he outlined on your statements. It's one of the best environments, you've seen in a while any sense on when the preferred market would open up and would you access that it looks like your capital you have room to add some preferred in the capital structure.

So we spent every quarter on this.

This very subject, let's take a look at it right now when the tenure note was trading at one and a quarter or.

2% it would make sense that.

657 to seven and a quarter coupon preferreds would be trading at around $25 par.

Working its way up to $2 75 to $3 50, you can see that just nominally that return is not enough to compete with risk refresh rates. So in our opinion, the preferreds are trading more or less where they make sense now there's two ways to look at what you could do with your preferreds at this point that you could buy some back at $21 a share and I believe the flow for.

All of our peers.

It's a <unk> coupon they all seem to be traded 20% what you wanted to add.

It's not as accretive to book value as you would think now the real yields on those are like eight in the quarter to 875 trading under par, but mark and his team can invested 12, 14, 16, maybe even 18% right now so we have better investment opportunities.

Our primary asset class of agency mortgages, rather than buying back the preferreds.

So what you've commented on was that you thought we had a good balance between preferred currently in the amount of common equity that we have outstanding we agree with that 100%.

Preferred stock trading above par again.

Our.

Common equity is larger we might look at issuing notes, but that's not something that we're interested in doing right now for all the reasons I just mentioned.

Right.

7% I think on the current preferred would you be with the returns available today with the Asia at 758% if that was to tighten a little bit and open up when it makes sense. So it looks like it would be accretive where where you mentioned the returns our free agency.

I think it's unlikely at this point, we'd be issuing any coupons above where our current outstanding issue is once again, if we traded up toward target and we felt we wanted to access the capital markets in that fashion, we probably increased the size of that issue.

Remind you twice in our history, we bought issues out we bought all the HVAC, but all the issues.

But all of these back and so we'll see what the future presents itself, but were actively used that class.

Equity structure actively as part of the way, we run our company and yesterday I really appreciate the question because not enough people understand the value in having that optionality.

Yeah. It just looks like you had incredible discounts today, but yeah. Thanks, Scott that's.

That really helps take care.

Thank you.

And once again, if you would like to ask a question. Please press star and then one.

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

Hey, Jeff most of my questions have been asked.

On your just a clarification on your earlier comments in terms of the earnings run rate given the shift into the.

Higher yielding.

Agencies.

Should we be expecting the management fee waiver to decline in the second half of the year.

So that I havent discussed that with the board of directors. This week, but our opinion I think globally would be that it would more or less stay where it is right now.

Great and then.

I guess I missed it.

What is the leverage level of the.

Portfolio.

As of July 26.

I think we can release that information Mark can you take that off the recent report and there's two ways to look at it there is absolute debt.

Debt to equity and then Theres imply we do have a small three or $400 million rollout Mark can you help on that.

Yes, I mean, it's going to be in the mid Sevens right now.

Great. Okay. Thank you guys.

Thank you very much.

And ladies and gentlemen at this point in showing no additional questions I'd like to turn the floor back over to management for any closing remarks.

Well, we thank you thanks for joining us here today.

Yes.

Thank you Scott.

Thanks for joining us today, we appreciate your time and we're always available.

<unk>.

Guys.

Thanks.

And ladies and gentlemen, with that we'll conclude today's conference call and presentation. We do thank you for joining you may now disconnect your lines.