Q3 2022 ARMOUR Residential REIT Inc Earnings Call

Good morning, and welcome to the armour industrial REIT third 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.

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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 drew and thank you all for joining our call to discuss armour residential REIT third quarter 2022 result.

This morning, I'm joined by Armours Co Ceos, Scott, Ulm, and Jeff Zimmer and by Mark Gruber, our CIO.

By now everyone has access to Armours earnings release, which can be found on Armours website, Www armory Dot com.

This conference call includes forward looking statements, which are intended to be subject to the safe Harbor protection provided by the private Securities Litigation Reform Act of 1995.

The risk factors section of Armours periodic reports filed with the Securities and Exchange Commission describe certain factors beyond <unk> control that could cause actual results to differ materially from those expressed or implied in these forward looking statements.

Arctic filings can be found on the SEC's website at Www FCC Dot Gov.

All of today's forward looking statements are subject to change without notice, we disclaim any obligation to update them unless required by law.

Also today's discussion refers to certain non-GAAP measures. These measures are reconciled with comparable GAAP measures in our earnings release.

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 1% the decrease of one basis point compared to Q2 'twenty two.

Armours Q3 comprehensive loss related to common shareholders was $155 $7 million, which includes a $144 3 million GAAP net loss.

Distributable earnings available to common shareholders was $38 8 million or <unk> 32 per common share.

This non-GAAP measure is based on historical cost and excludes gains or losses from security sales and early terminations of derivatives as well as market value adjustments. It does include TBA drop income.

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

The outlook for dividends appears to be stable based on current conditions. However, we will keep a keen eye on economic conditions, which could change rapidly in this environment.

Taken together with the contractual dividends on preferred stock armor has made cumulative distributions to stockholders of $919 billion throughout our history.

ACM the company's external manager continues to voluntarily waive $195 million of its management fee, which offsets Q3 operating expenses.

Armour was proactive in managing its common share capital base in Q3, resulting in positive accretion to stockholders of <unk> 14 per share.

During the quarter, we issued over 22.733 million shares.

Common stock through our ATM programs that raised $167 $2 million of capital after fees and expenses.

That represents an average price of $7 36 per common share.

In September we repurchased 780000 shares of common stock at an average cost of $4 96 per share.

For context, Q3 volume weighted average price was $6 89 per common share.

Quarter end book value was $5 83 per common share as of last night. The 26th we estimate that book value per common share was between $5 26, and $5.31 per common share again between $5 26 and $5 31.

As we finalize our tax projections for calendar 2022, we expect that all common stock dividends and series C preferred stock dividends will be treated for federal income tax purposes as returns of capital and not currently taxable to our shareholders.

This is comparable to last year's tax results.

Looking forward to 2023, and we forecast the series C preferred stock dividends for 2023 will likely be treated as fully taxable ordinary income to those shareholders.

Common dividends for 2023 will also likely be treated at least partially as taxable ordinary income.

Now I want to turn the call over to our co Chief Executive Officer, Scott Ulm to discuss Armours portfolio.

Alright strategy in more detail Scott.

Thanks Kim.

And as you try to normalize high inflation. The fed has delivered the fastest pace of tightening since the 19 eighties when former fed chair Paul Volcker raise the fed funds rate to nearly 20% during the third quarter. The fed fund rate rose by 150 basis points to 325% the two year Treasury yield rose by 132 basis point.

To a $4 two 8% and the 10 year Treasury yield rose by 91 basis points to 383% the historic upsurge in risk free borrowing rates combined with the start of quantitative tightening of $95 billion per month.

2022 total returns on U S treasury bonds to negative 13, 1% its worst on record.

The UK pension industry, which six weeks of US go most of US are very limited knowledge of emerge as a catalyst for a major risk off trade and interest rates around the globe such as the market we're in.

Our March 2020 experience served as a valuable tool to stay ahead of the increased volatility by proactively managing our dollar liquidity and MBS portfolio risks in September and October we reduced our mortgage portfolio by $2 9 billion.

Of MBS pools, with three five to four and a half coupons raising the overall liquidity to $591 million and trimming our implied leverage down to seven times as of 10 25 since.

Since the beginning of September we've decreased our spread duration by 32% and our net duration gap was <unk> 79.

Despite dialing down the overall risk levels, we still maintain a healthy exposure to the MBS market, which in our view is approaching levels of incredible value seen prior only during the great financial crisis, a decade and a half ago.

With MBS spreads just 20 to 30 basis points lower than the widest levels of 2008, we believe the risk reward ratio now firmly favors the investor.

To further improve our resilience to rising turbulence of the market armour raised $167 million of new capital in the third quarter through our ATM share issuance program that was accretive to our shareholders by 14 sets.

An insurer to healthy levels of cash liquidity, even under the harshest stress test scenarios.

Repo financing remains another strong pillar of our business in these markets.

<unk> from greater volatility observed in nearly all financial markets funding of our high quality MBS assets remained liquid and plentiful.

Armour is active with 20 different repo counterparties and approximately 50% of our borrower balances funded funded through our broker dealer affiliate Buckler Securities.

Our business relationship with Buckler provides us with a particular advantage in the mortgage REIT sector, securing our lifeline to the funding markets even in times of great distress.

We have very limited dependence on third party repo providers that are dependent on the cc, 104% of our repo book is hedged with Kurt fixed to floating.

And so for index swaps absorbing the impact of the fed hiking cycle on overall funding rates due to the daily floating receive leg of a swap. If we include the notional amount of all of our interest rate hedges.

I'm wondering if you know our funding is covered by a 125%.

Armours vastly reduced its exposure to premiums paid on specified pools and has high excess liquidity as a percentage of total capital both of which better position the balance sheet to weather the unexpected turns that the ryzen market volatility can break.

We believe the expected slowdown in the pace of interest rate hikes. In 2023, we will provide a catalyst to lower volatility and reward agency MBS investors, who have stayed the course with outstanding returns. We expect our all agency MBS strategy will deliver compelling returns in the future without the risk of credit.

We view our current dividend of 10 cents is appropriate in this volatile environment that is particularly affected book value. We will as always continue to evaluate the level of the dividend. We're also mindful that this environment could deliver upside provides surprises as well that can move our metrics substantially.

We'll now open the line to questions.

We will now begin the question and answer session.

To ask a question you May press Star then one on your telephone keypad.

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

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

Yeah.

Thanks, just hoping to get a little more clarity around your comments.

Can you describe the environment for the dividend as stable to me it feels like the current environment is.

Have been anything but stable, so just hoping to kind of get a little bit more detail around that that comment.

Hey, Doug Good morning, Jeff Zimmer here.

So most of our portfolio was constructed.

Essentially all of the constructed before the wild swings in.

Prices in almost every asset class started in late August .

So the comment is that we have constructed a portfolio under stable environment. These subsequent environment is not stable, but right now the dividend that we're paying out based on the investments.

Investments in swaps put on a while ago is very stable as Scott also noted conditions could change that could change to the upside just like you lose a dollar and a half to $2 of book value very quickly. If you stay the course like we have we still invested.

Very much so in agency mortgage backed securities you can get book value back up which would then mean dividend yields would that look like they would look like today.

Got it.

I guess given the further decline in book value in October any updates on what what's the portfolio size looks like today.

Yeah.

As you've reacted to the environment.

I do know the liquidity as of last night was 525 million cash of $2 50 in the box of $2 75, net liquidity has increased because some of our transactions from them earlier in September finally settled in the month of October I think I'll hand, it over to Mark Gruber market that could be okay to note the size of it.

The portfolio at this point in time.

Yeah sure Doug it's the portfolio is about $6 5 billion in size right now.

Yeah.

So our leverage is.

I think we mentioned that earlier, but it's $6 5 billion and that includes that includes some of the treasuries.

<unk> Leverages. This morning is six nine that would be implied leverage an actual leverage we only have a $100 million outstanding forward settles Doug. So your implied in your actual was about $6 nine with the duration of the zero.

0.6 to 0.7 range.

Okay. Thank you.

Alright, thanks for calling in.

Yeah.

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

Hey, Thanks, good morning.

A follow up on the question about the.

Our current leverage and portfolio size.

So the portfolio size has obviously been declining somewhat in September and October .

And you also mentioned the spreads are obviously very wide and there's some potential for them to tighten at some point.

So I guess can you talk about how you're sort of balancing.

The potential for spread tightening and get some book value back versus selling.

Selling assets and kind of keeping leverage at a <unk>.

Conservative level in order to manage through the current market volatility.

Yes, Trevor it's Jeff again, I just did you actually say what your exact question is I'm not clear what you needed to address.

So I guess the question is sort of you mentioned that there's potential for spreads to tighten back in but at the same time you guys are.

Yeah, obviously, reducing the portfolio size.

So I guess the question is like how you were kind of how you are coming up with a leverage target in today's market and.

Kind of what you view as the near term upside.

Versus downside risk to spreads.

Yeah. So.

We believe that would be highly unlikely to see spreads widen much more than 20 OAS from here that would reach the worst levels seen in the OE period.

It can happen to drop could be a bomb could be dropped in Ukraine. There could be some other events that are out of our control. So we are keeping our risk profile reduced but yet have the optionality to increase it very rapidly for example, we.

We own hundreds of million dollars of treasuries and Mark can tell you how much in a moment we own today those can quickly be sold to be exchanged into mortgage backed securities at today's widespread but we want to maintain this liquidity for a while longer.

You don't know until you look in the rearview mirror that exact moment in time too.

Address the risk profile and start increasing it but at this point, we're going to keep it reduced and overtime and when the mountain seemed a little secret of Skean. We'll go ahead and start increasing our exposure again into the MBS world and to Scott's point. The investments are very good right here, but we do want to maintain our high.

Level of risk management profile right here, and we're going to maintain a lot of cash and a lot of liquidity Mark do you want to talk about the treasury portfolio, and where leverage could possibly build from here.

Sure. So we have about $450 million of treasuries. So obviously that can be swapped into to MBS.

We also have the ability historically right we've had leverage up to nine so we have probably two turns of leverage we could add here.

And to your question.

When we get back and we have some metrics we were.

We are using.

Internally things like volatility in spreads and such.

So we're looking for.

Those metrics to hit targets, that's when we would step back in.

We're just not there yet.

Okay got it I appreciate the comments thank you.

Thank you.

The next question comes from Jason Stewart with Jones trading.

Please go ahead.

Hey, good morning, Thanks for taking the question wanted to follow up on Doug's question about the dividend and how you view them.

I mean, I guess the yield on the stock versus the current economic environment, which it sounds like you feel pretty good about.

Covering that dividend, but do you feel like you'll get credit for that.

But anytime you look at a stock dividend yields are north of 20% Youre going to just take a deeper look and say hi that seems off market, but you cant compare us to an industrial company can't compare it to any other company, but a financial company and.

When markets change very rapidly as they did for the last week in August really.

Today, Okay metrics change quickly what you do is have to go back and look at what I.

How I answered Doug we put together a portfolio over a number of quarters that hasn't really changed that much except for a few sales that took place in September and early October . So the portfolio is supporting our current dividend yield right now also to Scott's point.

Market conditions could improve so you get 30 40 OAS of.

Tightening, which would be a normalized oes over the last decade, or so all of a sudden book values back up and Youre looking at the returns you're saying gosh, that's a 15% return so that's not kind of off market, but what this sector has had over the years, but we take a look at it every week, we make decisions in every quarter, we talk to the board and actually as you know we announced.

The dividend monthly and if you want to go back a number of years, we actually took a leadership role in that regard we were the first REIT to start paying monthly. So that also gives us the ability to go ahead, and say hey, we're not going to wait till the end of the quarter things have changed we're going to lower the dividend, we're going to raise the dividend based on what conditions are but for the last four or five quarters.

Scott has been very clear that we look at up to the medium term and we set the dividend based on what we see over a period of time not just what's happening today. So if any changes are made it is because we believe as a group and the board agrees that conditions have changed such that over the medium term.

Xyz should be at a given level does that helpful too.

Yes. Thank you.

Last question from me are you expecting any meaningful changes at FHFA with regard to credit policies.

You know the way they look at.

You know the market liquidity credit et cetera.

I'll ask mark to finish off on this but we have particularly good inside now because we have buchler the broker dealer.

And our new seat yogurt Buckler has.

<unk> have experience with the different agencies, and we'll talk to them directly.

We don't see anything, particularly if you want you can talk about the F. ICC any changes right there regarding the FHA I'll hand, it over to Mark to see if you'd noted any changes there.

No I wouldn't say that we have any particular insight into what we think theyre going to do.

At this time.

Okay.

Thank you appreciate it.

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

Hey, guys just.

Just a couple of questions.

The 14th accretion from both repurchases and share issuances.

Yes.

Yes, it was.

There's a big difference in the size, we were on both sides of the market.

We're always we always look at both sides of the market.

And when it when it just just.

It gets too cheap or buy some.

But we were fortunate to be able to execute.

Some of our sales.

Difficultly above where we ended up.

Great and then the net interest income declined quarter over quarter despite relatively.

A relatively stable net interest margin and higher earning asset volumes what was the reason for the decline.

Jim Mountain will address that.

Okay.

Dan.

The net interest income declined in the quarter, despite a larger portfolio and stable margins just trying to see what was the catalyst for the decline.

Yeah.

Repo cost of funds.

Ended up running up just a little bit and there.

There is a little bit of friction and mismatch in the <unk>.

Index and reset timing of the swaps versus.

Actual tenor of the repos that we that we roll so that's as much frictional.

Noise is anything.

Great and then the third question I have is sort of a follow up to what Trevor was I think I'm, leading up to is right now given where your stock price is and given the amount of liquidity that you have in terms of cash Unlevered securities, but my estimate your cash Unlevered securities is $3.56, a share or roughly 70% of your share price.

Yeah.

And I guess the risk reward question is you know why not take that in the portfolio are way down I'll take the leverage way off.

Given the risks in this environment I'm just trying to.

I'm not criticizing I'm, just really trying to get a I deal with the thought processes.

Six nine times leverage implied an actual debt to equity, which it is this morning is about the lowest we've been since inception I think in 2020, we got under that for a cup of coffee like things got a little crazy, but the environment and our liquidity supports exactly where we are right now.

And if we wanted to be lower we would be but we don't want to be lower and we actually want to.

<unk> continued to have exposure to an asset class that has cheapened up considerably and if we start selling all of that asset class you have no opportunity to take advantage of it when things normalize. So we have enough exposure to be able to appreciate our book value and opportunities when things normalize we have liquidity based on our <unk>.

Treasuries on our cash position to be able to move and shake a little bit in case things.

Do you get more volatile for a short period of time. So we are where we want to be and we're opportunistic but we're also being very considerate of the volatility in the marketplace I hope that's helpful.

That is.

Market timing and certainly there have been some.

Some days when we wish we we wish we were not a long mortgage backed securities, but that's the business we're in.

And I think we are.

We recognize that we are unlikely to be able to call market timing precisely.

Maybe generally we can sense as Mark said.

Through a variety of metrics, we follow when when timing is more propitious than others, but to take the portfolio are way down and take it way back up and to get all that right.

<unk> is a that's a heavy lift so I think our investors expect us by the name of the company would be long mortgage backed securities.

We very that we try to be judicious about it and we try to be safe about it.

But at the end of the day, that's the business we're in.

Great. Thank you for the clarification.

Great Thanks for calling in.

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

Good morning, guys. Thanks for taking my question just to follow up on that.

Jeff just got one asset selection collateral session become important I mean at some point do you feel like speeds now look like they're at five.

Five CPR at some point do you feel like you may have to move our portfolio to focus on slower potentially slower paying pools at rates do decline next year.

So one thing that.

We discussed in previous calls is what is the company's exposure to specified premiums and we'll talk about that for a second here.

A year ago, we may have had $150 million exposure to specified premiums and that means the amount you paid over TBA prices to buy assets with characteristics, whose prepays will be very stable and by the way then maybe stable at a fast rate, which is okay. Okay. Well, then maybe stable to slow rate, but at least you have a.

Better idea of where theyre going to be so we have reduced that exposure to I believe close to around $30 million, so very little bit of our balance sheet, but yet our portfolio still exhibits.

I think it's and Mark correct me, if I'm wrong, 70% to 80% of our portfolio still has specified pools that exhibit characteristics that are <unk>.

Stabilizing factors in understanding what the prepayments will be in the future and we have a diversified portfolio from two and a half as all the way up to five and as we may have purchased some sixes Mark do you want to enhance on those comments.

Yeah.

Sure. So yes, we are very aware of the type of collateral purchasing we.

We do look for stores that will be slow in environments. When rates go lower and you can buy some of those stories cheap these days.

But what the coupon stack moving up so fast.

That hasnt been basically.

The primary investment metric.

But it is a concern we know as we moved up in coupon, we're adding convexity of the portfolio in an environment when.

<unk> could rapidly decrease who knows when the fed turns an image.

But if there is a catalyst where they have to do that.

We're making sure the portfolio is set up for that too.

And so what youre, saying that you still feel like you're in a declining rate scenario. If it happened today or tomorrow that your your your book, which still pre pay slower than generic you still have those characteristics.

Correct, because those those pay ups don't cost a lot these days.

Yes.

No great good to hear that and then Jeff I'd Love to hear your just last time, we talked about essentially what you thought the fed would do next year I think you look at the macro environment. I think you had two variables were deferred or they stop it will it may potentially ease and then what do you think they do with potentially outright selling Mds do you think that.

At some point will become viable.

Well, here's what our firm believes our firm believes that will increase by 75 basis points in November .

And I would've said a month ago, we would've said, 75% in December I think as a group that we're more like 50, and then we believe theyre going to watch and wait for a while and let the data go ahead and catch up with.

The rest of the world right and that takes a quarter or two okay. We do not believe at this point theyre going to make asset sales and the mortgage backed securities Arena and look at as we said in the last call that certainly could change, but the regular mortgage rates Fannie rate right. Now is 715% the housing market is going.

And reverse very very quickly and the fed wants that but they also don't want to make it so upsetting that.

The metrics of everyday life or sorry to get ruined for people. They just wanted to slow down. So we don't expect right now that theyre going to make any sales. There is research out there that would suggest they're going to make some treasury sales. However, you may have treasury sales going on right now by China, you may have them going out through Japan, certainly going out to Japan to go ahead and support.

Their currencies.

And to the extent that we think that they will go ahead and start selling mortgages, we will talk about it in the next earnings call, but right now that's kind of where we stand Mark do you want to improve on any of that.

No I think you got it right from.

The portfolio team's perspective, no I just wanted to I guess reiterate we really don't think theyre going to sell MBS anytime soon but that definitely is in the cards at a later date.

But it's with the housing market, where it is and where rates are where they are right. Now we just don't see that in the foreseeable future.

I would agree I really appreciate the comments thank you.

Thanks for calling.

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

Thank you for joining us for the third quarter 2022 conference calls a residential REIT, we are always available.

On the fly if you guys want to call into the office.

And wish you a good day. Thank you.

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

Okay.

Alright.

Do you guys still here.

We're still here or listening to the muzak.

Like a good elevator.

Thank you.

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Yeah.

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