ARMOUR Residential REIT, Inc.
Q3 2020 Earnings Call Transcript

Published: 22 Oct 2020

[Operator:]

Greetings and welcome to the ARMOUR Residential REIT Inc. Third Quarter 2020 Earnings Call. During the presentation, all the participants will remain in a listen-only mode. Afterwards, we will conduct a question-and-answer session with instruction to follow. Please note as well, today's conference is being recorded, Thursday, October 22, 2020. It is now with pleasure that I turn today's presentation over to Mr. Jim Mountain, Chief Financial Officer. Please go ahead, sir.

[Jim Mountain:]

Thank you, Bridgette, And thank you all for joining our call to discuss ARMOUR’s third quarter 2020 results. This morning, as usual I’m joined by ARMOUR’s co-CEOs, Scott Ulm and Jeff Zimmer; and by our CIO, Mark Gruber.

[Scott Ulm:]

Thanks Jim. Third quarter of 2020, so I returned the ARMOUR conditions across the mortgage market and dramatically improved sentiment. The Federal Reserve flooded the market with funding and agency and treasury markets and their outright purchases help drive the bond markets recovery and stabilization. We completed the previously announced strategic transition of our investment portfolio to solely agency mortgage backed securities issued or guaranteed by U.S. government sponsored enterprises, treasury securities, and cash. With ARMOUR's common equity closing at $9.43 yesterday, a 20% discount to the third quarter ending book value, the current yield on the common is 12.7%. Our core income for common share of $0.35 was 16.7% higher than the $0.30 in dividends we paid in the quarter. The Federal Reserve's large footprint in the agency MBS markets continue to be a major factor in MBS performance during the third quarter, driving OAS tighter, volatility lower and greatly improving liquidity. The Fed purchased about $330 billion of agency MBS throughout the third quarter, absorbing almost the entirety of new net agency MBS supply. Following treasury yields and tightening mortgage spreads grow primary mortgage rates to all time lows during the quarter. ARMOUR continued strategy of focusing its investments on prepaid protected, lower coupon mortgage pastors to protect its MBS portfolio from we expected refinance wave treated by results with lower rates. In addition to stable income, these specified stories delivered considerable results in book value appreciation for the quarter. As of September 30, ARMOUR held 94% of its MBS portfolio securities with favorable prepayment protection characteristics. These include 58% in bonds with loan balances less than or equal to $225,000, 22% in agencies CMBS with lockouts and prepayment penalties, 11% in bonds with loan to value ratios of greater than 95%, FICO score is less than 700 and are seasoning of greater than 24 months, and 4% in bonds with 100% of the loans and states have additional taxes on refinancing and cash out transactions such as Texas, Florida and New York.

[Operator:]

Thank you very much. Our first question comes from the line of Douglas Harter of Credit Suisse. Please proceed with your question.

[Josh Bolton:]

Hey, guys. This is Josh Bolton on for Doug. Good morning. Appreciate the comments, Scott, about leverage from the fourth quarter update you gave. It looks like leverage was up a little bit from the end of the third quarter. Is that intentional or is that just the result of book value moving around? And I guess how are you thinking about target leverage going forward? And specifically, what would you have to see to take that level either up or down?

[Jeff Zimmer:]

Good morning. It's a Jeff Zimmer here. So, our leverage is exactly where we want it to be. We recently settled some forward purchases, which had the leverage slightly tick up. The book value today is actually almost unchanged since the end of the quarter. So, the leverage has not changed because the book value is moving around, and matter of fact the number we published yesterday is actually up a little bit since then. The opportunities in the marketplace and we talked about this in our morning meeting, so it's kind of important. So, they're bifurcated right now, right? Zero volatility OAS or Fannie 2s is like 65, zero volatility OAS on Fannie 3s where the Fed is not buying anything or up to 93. So when Scott in his comments talked about keeping powder dry for buying opportunities, you start seeing some on the run stuff or TBA, non-TBA stuff where the payoffs come off a little bit, perhaps going to steepener. You can see that leverage pop up from 8 to 8.5 to 8.75, but only because we see good opportunities. Otherwise, our target leverage will stay in the range that it is right now. And as you could see from the month the Company update that we published last night, we continue, as Scott also said in his comments with the barbell strategy, meaning we bought a lot of specs at low pay ups in early mid-April. Number those are up two times or even more from what we paid for them, and we offset that with about 27% of our portfolio in the TBA market where as he also said we're seeing returns in mid-teens to even low 20s. So hope that addresses your question.

[Josh Bolton:]

Yes, thanks, Jeff, for those comments. And I guess my second question. Last quarter, you talked on the call about the percentage of repos through BUCKLER Securities longer term getting closer to 50% down from what it is. Just curious, if that's still a goal or if there's any update? I know it's running higher than that today, but any comments you can give about the BUCKLER brokerage deal? Thanks.

[Jeff Zimmer:]

Yes. Josh, BUCKLER running a little above the proportion we did over the last few years, mostly because there's a little unutilized capital at BUCKLER and we want to make sure it was working. I would expect that percentage may drift down a bit, but I think it's still at a reasonable amount basically determined to go keep a balance of, being able to utilize the advantages we get from BUCKLER, while at the same time staying active with the 17 other counterparties that we're operating with. Our execution at BUCKLER is on the screws with what we're seeing elsewhere, and we get better terms principally in haircut and the ability to access some different types of financing there. So, that's a little higher than we have been for last few years. It's there just because BUCKLER has had some capital we want to make sure we use it.

[Operator:]

Our next question comes from the line of Trevor Cranston of JMP Securities. Please proceed with your question.

[Trevor Cranston:]

You guys mentioned a couple of times the return opportunity that's available within the TBA market being quite attractive. Can you say where you're seeing returns in specified pools compared to TBAs? And also as part of that, can you maybe talk about how much larger you'd be willing to take the TBA position as a percentage of the overall portfolio going forward?

[Jeff Zimmer:]

Hey, Trevor, glad to have you dialed in. So, we can see returns as low as 4% in some of the specified pools, that's how high these prices have gone, which we have purchased anything like that, but there are returns also in low-double-digit, so just exceeding 10% to 11.5%. Now, that would imply an 8 times leverage and duration of between 0.5 and where we are right now. You increased that leverage to where others in the sector have done, which would be 9 to 9.5, those numbers go up proportionally from there. And so what we were discussing earlier, just to repeat on the leverage. We get spreads to widen or pay us to come down, we will use the opportunity to go ahead and make some additional investments in the space, but that is not the case today. So, we'll keep that target leverage where it is right now and that's opportunities go. And as I said, we could be up to 8.5 to 8.75 in quarters, but only if great opportunities arise. As Scott said in his comments, as it is right now, we estimate that our core income will equal or exceed the dividends for the fourth quarter.

[Trevor Cranston:]

And then, on the multifamily portion of the portfolio spreads have obviously covered pretty well in that sector. In light of that recovery, are you guys thinking about that part of the book? Is this something that you still see value in holding and sort of a prepaid diversification? Or given the spreads have recovered so much, is this something you'd potentially look to partially sell and reallocate to the agency RMBS market?

[Jeff Zimmer:]

So if you go look at monthly updates month-by-month, you can see the positions come down a little bit, it's currently on the information we published last night, 1.19 billion. And we did sell some over the last 60 days to take advantage of really tight spreads. But if you refer to Page 4 on that publication, you can see that the weighted average net coupon is 369. And the estimated effective duration is 7, which means that most of those are going to have a maturity north of 7.5 to up to like 9 years from now, great convexity paper, earning a lot for our shareholders. So, we would very selectively be selling in that asset class in the near future. It has no extension risk, market rallies to go up in price. It's paying our shareholders a large dividend. They finance equally to specify in TBA market. And once again, there is just insatiable demand for banks for that asset class I don't see that goes away. So, the answer is, we probably won't sell a lot, but occasionally, we see opportunities to sell. And I would also note, one of the reasons we sold we wanted to make sure we cleaned ourselves out of any potential assets in that asset class that might be subject to forbearance or bankruptcy, or some of the negative factors that have occurred since COVID. We believe we've done a really good job of that so far, and so that protects the premium in that asset class.

[Operator:]

Our next question comes from the line of Christopher Nolan of Ladenburg Thalmann & Co. Please proceed with you question.

[Christopher Nolan:]

Given the EPS guidance to cover the dividend in the fourth quarter, it seems like your core ROE is going to be the higher end of your guidance, which was high single digits or low double digits, at least in the fourth quarter. I guess my question is, should the core ROE guidance be low double digits to mid double digits going forward? Or are you going to keep it the way it is?

[Jeff Zimmer:]

So if you have the publication that I just referred to a minute ago that we put out last night, you go to Page 6, the monthly portfolio CPR. You can see that the October CPR was up 11% over the average of Q3. Now, we expect CPR for our portfolio to remain relatively flat over the next two months in November and December, from that up 11% level. So as a result of higher prepays, you would expect the core earnings to be up modestly from what they were in Q3. That doesn't mean they will be but our expectations to be a little lower, but yet to cover, certainly our dividends. So, the change in earnings based on the reinvestment opportunities really two different things to look at. With the great convexity and the low amount of actual dollar prepays that we have that month are each month, our exposure to reinvestment risk is quite limited and well under $100 million a month. So is that helpful in your analysis?

[Christopher Nolan:]

Yes, very good point you made. As on a different topic, any thoughts on buybacks given where your stock is trading?

[Jeff Zimmer:]

So, we are always looking at buybacks. As we discussed on the last two earnings calls, there are times where you really need to protect your capital and that benefits shareholders greatly. And then there are times when, hey, we're trading at a really cheap level and that's accretive to book value to go ahead and buy. We haven't executed that that second step yet but it's clearly out there if we want to and need to. We're still watching capital. Let's get through the election, let's see if any buying opportunities happen. For example, you get OAS is to widen out here and you get steepener in the curve. We might be earning so much more money taking leverage up from 8 to 8.5 or 8.75 that might benefit shareholders more than doing a buyback. But how are those the things that we look at every day, and obviously, we just had our board meeting in order to go and publish our Qs, and these are things that are discussed at all levels of the corporation. So, I hope that addresses your question.

[Operator:]

And there don't appear to be any further questions in the queue. And there are no further questions. At this time, I'll now turn the call back to you. Please continue.

[Jeff Zimmer:]

Thank you for your help Bridgette and to all our friends in the analyst community, thank you for joining us this morning. We very much appreciate your time and interest in ARMOUR. And as always, you know where we live. So, if there are any questions that come up between these calls, feel free to reach out. Give us a call, send us an email, and we'll try and get back to you before the sunsets, if we can. And until next time, stay safe.

[Operator:]

And that does conclude today's presentation. We do thank you for your participation and ask that you please disconnect your lines. Have a great rest of the day, everyone.