Q2 2023 ARMOUR Residential REIT Inc Earnings Call

Good morning, and welcome to armour residential REIT second quarter 2023 earnings conference call all participants will be in listen only mode.

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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 drew.

Thank you to all of you for joining us on our call. This morning to discuss <unk> second quarter 2023 results with me today are Armours co Ceos, Scott Ulm, and Jeff Zimmer and our CIO Mark Gruber.

By now everyone has access to Armours earnings release, which can be found on <unk> website, www armour REIT 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 1095.

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

Those periodic filings can be found on the SEC's website at Www SEC 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 <unk> website, shortly and it will continue for one year.

Armours Q2 earnings available to common shareholders was $40 million, which includes $43 million of GAAP net income.

We sold the last of our legacy of available for sale mortgage backed securities in Q1 going forward there will be no mark to market items excluded from GAAP net income we will continue to report total comprehensive income for comparable prior periods as long as they remain relevant.

Net interest income was $5 $8 million distributable earnings available to common stockholders was $45 $4 million or 23 per common share.

This non-GAAP measure is defined as net interest income plus TBA dropped income adjusted for the net coupon effective interest rate swaps less net operating expenses.

Our asset yield of $4, two 4% less net cost of funds of $2, 49% gave us net interest margin of 175% for the quarter.

Armour capital management continues to waive a portion of their management fees.

Waived $165 million for Q2, which offset operating expenses. This waiver will continue until further notice.

Armour paid monthly common stock dividends of <unk> <unk> per common share.

That total of 24 cents per common share for the quarter.

We've maintained the eight <unk> per share common dividend rate for July and August .

We've discussed on our previous calls.

Our aim is to pay an attractive dividend that is appropriate and context and stable over the medium term.

Together with the contractual dividends on preferred stock farmers made cumulative distribution to stockholders of $2 $1 billion over its history.

During the second quarter, we issued $15 million 160000 shares under our common stock ATM program, raising $77 $5 million of capital after fees and expenses.

During the second quarter, we also repurchased 425000 shares of common stock at an average cost of $4 88 per share that was under our existing standing repurchase authorization.

For the first half of the year, our capital activities have been accretive to book value per common share and reducing per share running costs. So.

Far in Q3, we've issued another $21 million 499175 common shares raising net capital of $109 3 million.

That completes our current ATM program.

This brings our common share count 28, with 228.309 million 234 common shares.

Recently, we've approved a new ATM program offering up to 75 million shares through our affiliate Buckler and for other agents.

Quarter end book value was $5 38 per common share. Our most recent available book value estimate as of Monday Night July 24th was estimated to be $5 25 per common share.

Now, let me turn the call over to co Chief Executive Officer, Scott Ulm, Scott, if you'd like to discuss in more detail our portfolio position and current strategy. Please go ahead. Thanks Jim.

Market conditions in the second quarter continue to support our thesis that we are entering into a compelling period for investment in agency MBS.

<unk> remained near historic highs.

Funding and hedging are widely available with the fed nearing the end of a tightening cycle. We believe MTS will offer significant returns through carry spread tightening or bowl.

Throughout this hiking cycle U S. Treasuries have had a persistent trend of extreme fluctuations for two year treasury yield surged by 112 basis points from its low of $3, 78% for the quarter simultaneously. The 10 year treasury yield experienced a gain of over 50 basis points, reaching a quarter high of 384%.

Notably the spread between these two tenants also made history closing the week below negative 100 basis points for the first time since 1981.

In response to portfolio team rebalance the hedge book to favor a steeper yield curve environment, which we expect will begin later this year.

In early May armour sold $1 8 billion of our lowest premium specified pools as the looming fight over the debt ceiling greatly increase the likelihood of more volatility in the market armour decreased its net portfolio leverage and duration from eight nine times at 1.15, respectively down to six eight times and <unk> 87.

To address this increasing risks.

Production coupon MBS underperformed significantly into this event, which presented a good opportunity to buyback exposure to five 5% and 6% pools. Shortly after the debt ceiling resolution occurred.

Other widely anticipated event was the liquidation of the FDIC portfolio.

Hip sales of agency mortgage passes have now surpassed 75% and what has been a remarkably orderly affair.

The fear of a major market disruption is fated with demand stronger than initially thought and we do not expect the remaining liquidation of the Fdic's MBS portfolio to have a material impact on valuations. Despite this we view the relative valuation of FDIC coupons as two rigs versus the opportunities up the coupon stack, where we own over.

60% of our mortgage assets.

We are maintaining our short position of negative $500 million Fannie 33% TBA is.

And have reallocated capital towards agency MBS, Thus 10 95 pools.

Thus falls are trading at over a 100 basis points wide to sulfur swaps, which is almost double the <unk> Oh, yes.

Sure coupon pools, coupled this with favorable financing like pools armour lexis trade from a total return perspective.

Although spreads may remain at these valuations for a while we see long term value of the positive convexity desktops.

Additionally, we've recently allocated over one $3 billion of recently issued capital and 5% and five 5% Ginnie Mae pools, they're zero percent risk weighting and wider spreads favor domestic and foreign bank demand in the second half of the year, we feel that the newly proposed banking regulations should provide a greater boost to the Ginnie Mae MBS.

Second longer term.

Our luggage closed the quarter at seven six times and currently sits at seven eight times as of the 20th of July .

That reflects attractive valuations, it's prudent enough to withstand still elevated and highly unpredictable levels of daily market volatility.

Additionally, armour maintains healthy levels of available liquidity at $714 million, which includes cash Unlevered securities and principal and interest receivables as of the 20th of July .

Our current portfolio is concentrated in the most liquid low premium production coupon pools, featuring more favorable demographic geographics ltvs FICO scores and loan balance characteristics versus generic production cohorts.

We continue to favor specified pools over TBA.

As we expect no improvement in the deliverable collateral and the implied funding of dollar rolls lag current repo rates.

These lower pay up premiums specified stories should perform strongly as demand for agency MBS remains.

Despite seasonal driving up Cpr's marginally these.

These investments reflect a historically low prepayment risks and still a significant amount of borrowers are out of the money.

Armours average prepayment rate for all MBS assets in the second quarter of 2023 was $6 three CPR and still a very low six CPR for July .

Although mortgage rates have already declined from the highs of seven 2% in early November of 2022 to six 8% in mid July 2023, a substantial refinancing were able to acquire mortgage rates to fall below 5% in our view.

Armour continues to fund just over 50% of its borrowings through our broker dealer affiliate Buckler securities since the debt ceiling resolution the rebuilding of the Treasury General account has been orderly and agency MBS repo funding has been stable.

Weighted average haircut on our repo book remains exceptionally low at two 7% as of the 18th of July .

As we've already noted we set our dividend to be appropriate for the medium term, we will as always continue to evaluate the level of the dividend. We're also mindful that this environment can deliver upside price surprises or they can move our metrics substantially.

Thank you very much and with that we will open for questions.

We will now begin the question and answer session.

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If at any time. Your question has been addressed and you would like to withdraw your question. Please press Star then two.

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

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

Hey, thanks.

It looks like you guys you mentioned that you added to the portfolio.

I don't think that ceiling in June and it looks like you've continued to add to it to some extent in July .

Can you talk about how your how you guys are approaching leverage overall, right now and kind.

Kind of how high Youre willing to go on leverage.

Given the seemingly favorable backdrop her embryos.

Hi, Trevor its mark.

We view leverage here as appropriate and that there is still some volatility out there with both rates and spreads. So we feel comfortable where we're at we think it's appropriate we do like mortgages a lot.

You have some dry powder and we think that volatility is going to subside here and rates are basically topped out.

Okay.

And could you talk about how you guys are thinking about sort of the supply demand picture over the rest of the year and if you think theres any potentials potential catalysts for spread tightening up there, particularly.

After the FDIC portfolios have cleared the market.

So in jeopardy.

Good morning, and Scott's comments you'd mentioned specifically.

Increased exposure to the Ginnie Mae sector.

So everyone knows mortgages on a historical basis are cheap to treasuries.

There are investors in all sorts of asset classes that are going to be looking at this are looking at this and they're going to say Wow mortgages are really good alternative to corporates or some other assets that they may have particularly in an environment, where you may experience some credit deterioration down the road.

Now the reason we increased our exposure to journeys is because the banking rules.

Positively effect.

Banks ability to purchase there, but they won't be the only ones journeys are particularly cheap right now to historically to the Fannie Mae Freddie Mac Counterparties, so catalysts come from buyers from other asset classes catalyst, Virginia, specifically come from banks and other buyers being achieved.

We have a coupon stack is such that we're not one on one affected negatively by.

The liquidations from the FDIC and Mark said earlier that I think Scott comment to still maintain a short position in one of the coupons that.

There'll be sell them. So we're very comfortable where we are and we have a optimistic outlook on spreads for the rest of the year.

Got it okay I appreciate the comments thank you.

Thank you.

The next question comes from Matthew <unk> with Jones trading please.

Please go ahead.

Good morning, guys. Thanks for taking the question you mentioned getting into see MBS at dusk pools.

What kind of other opportunistic opportunities are you seeing there and how large are you.

Willing to increase that see MBS position as a percentage of the portfolio.

So as of this morning, I believe we have 551 million of Das which represents four 5% of the portfolio. We are targeting a number that's larger than that.

I think that generally spreads got as wide as 111 112 to the <unk> curve.

105 today, we've made purchases as low as 100 kind of area. So we are still selectively looking to buy could we take it to 10% we feasibly good if they.

Come in quickly we will stop buying so we our opportunity opportunistically looking to add to this sector were going to be very happy down. The road that we have that added convexity at really good spreads Marc you wanted to expand on that just if you look at our history.

Our disposition has been I think a little north of 20% of the portfolio.

Pre COVID-19.

We just have to balance the fact that there is no liquid TBA market.

<unk> does so there is some spread risk there that's a little more magnified in an agency pools. So we're just balancing that versus where the spreads are today.

That's helpful. Thank you.

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

Hey, guys. So on the follow up to that question on the C. M B S.

You guys sort of warming up to go back into CRT types of securities.

The commercial real estate market develops.

We are warming up to continue our exposure to dust and we're not warming up to increase our exposure to <unk>.

Okay.

And on the commercial real estate front.

If that turns into a large issue for the commercial banking sector. How do you anticipate that could impact on residential mortgage backed securities.

When the tide goes up when the tide goes down all ships move up and down in the harbor Okay.

And that's why Mark commented to the fact that there could be.

There is spread risk in the das sector that may be different than there are on fatty five and a half passengers were cognizant of that and that's why although we intend to potentially increase our exposure at 10% or more of the portfolio highly unlikely that we'd be up at 20% again like we were in the spring of 2020 in the winter of 2019.

Mark.

Do you think the margin is you had duration could you know in the higher coupons improve your and what's the outlook for the rest of the year.

[laughter] so [laughter].

Okay. So you are you use your question more about where do we think spreads and harder coupons are gonna go.

What's that 175 net interest Mark and we're looking at sort of you know.

Sort of adjusted income that you know that.

Really the core earnings power the company that you're also you repose going up and it you know.

[noise] repricing, but you have the hedges in place and then the coupons or arising sorta.

We model of that margin that adjusted margin any sort of.

Guidance on on where where that could go towards the end of the year.

Right so.

Just stay there you'll steeper curve is going to help us on earnings power.

Because we can always take off hedges and beforehand or are repositioning portfolio in the hedges, but Ah steeper curve is wherever you Wanna be you Wanna borrow short and long and.

Are modeling shows that as the fed does increase 25 basis points in September by the way the work page I'm Bloomberg's Alexa, there's a 90% chance of that right now.

Right.

Seem to affect their income very much we have.

76% of a rebuild balance hedged right now and you know 67 per cent of our assets hedged right now.

We don't want our heads more than that because we believe we're at or very near the end of the cycle would think that'd be inappropriate so where the name is going to end up at the end of Q3.

It should be within a short kick of where we are right now, but there can be technical things that could change the law. The exact number comes down, but I think Scott and I've been very clear that were very positive on mortgages over the course of the year. So you may experience total return not just from them, but you may experience it from the.

Asset class improving versus treasuries in versus as Heche counterparties in terms of spread for the rest of the year. So the various ways.

That you could see improvement and the company's outcome that helpful.

Absolutely and Jeff you entertainment in through all the cycles. When do you I mean, it sounds like you were saying <unk> terrific of environment do you think there's gonna be a <unk>.

That's gonna stop it when you when you when you when do you really.

Put the.

Pedal to the metal so to speak and really really good this is it.

F. T can we're gonna start taking library job and you know we're going to see <unk> come in that class come down what are you what are you waiting for the C.

To really start being more aggressive.

I think we'd like to see a little more deterioration in credit and the deterioration credit will be the leading indicator.

That the world needs to stop raising rates and probably you're gonna see some cutting at some point and.

You don't know exactly when at what point in time, you're Gonna say, let's take a half a billion to swap software will undo but right. When you walk in and we're going to smell it and we're going to figure it out and so there's a number of things that could happen as you well know and we're in the business of assessing those in making those decisions.

Look forward to that thanks for taking my question. Thank.

Thank you.

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

Well, we'd like to thank you all for joining US. This morning, we look forward to speaking with you again in about 90 days until then.

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

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