ARMOUR Residential REIT, Inc.
Q2 2021 Earnings Call Transcript

Published: 23 Jul 2021

[Operator:]

Good day, and welcome to the ARMOUR Residential REIT Second Quarter 2021 Earnings Conference Call. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Jim Mountain, CFO. Please go ahead.

[Jim Mountain:]

Thank you, Sarah. And thank you all for joining our call to discuss ARMOUR's second quarter 2021 results. This morning, I'm joined by ARMOUR's Co-CEOs Scott Ulm and Jeff Zimmer; and Mark Gruber, our CIO, is also with us this morning. By now, everyone has access to ARMOUR's earnings release, which can be found on ARMOUR's website www.armourreit.com.

[Scott Ulm:]

Thanks, Jim. Crossroads hit financial markets in July, while COVID seemed to be in retreat in the second quarter, rapidly increasing infections driven by the spread of the delta variant in July sparked concerns about renewed business restrictions. In the opposite direction, the pace of the global economic reopening kept on an upswing with an abundance of liquidity from fiscal and monetary policies. A strong rebounding growth created outsized imbalances between demand and supply of labor and materials, pushing producer and consumer prices above historic averages. Dismissive of increases in prices is largely transitory, the Fed has pointed to the low level of labor participation and the existing slack in labor markets is the main reasons to keep its monetary policy accommodative for the foreseeable future. Despite these assurances to the market, the U.S. treasury yield curve flattened significantly, signaling greater uncertainty around the strength of economic growth once monetary accommodation is removed. The outright yields on the ten-year treasury decreased from 1.74% to 1.47% during the second quarter, and dropped as low as 1.19% in July and even lower intraday.

[Operator:]

Thank you. We will now begin the question-and-answer session. First question comes from Doug Harter with Credit Suisse. Please go ahead.

[Doug Harter:]

Thanks. You guys mentioned in your prepared remarks that the returns on new investments are improving. Can you just quantify that? Where you see incremental investment returns today? And just if you could put that in context of where that was three months ago.

[Jeff Zimmer:]

Sure Doug, it’s Jeff. Good morning. So, returns on specified pools have improved by 200 to 450 basis points depending on the coupon. There are specified pools now that have double-digit returns. And that's – the way we look at that is we run a generic eight times leverage, 50% hedged, but to a 0.5 duration. So, using all that criteria we're seeing low double-digits on some TBAs, that's an asset that might be 10.5% or 11% return, now was six, perhaps six to nine weeks ago. So that's kind of moves you see in there. The dollar rolls at one point got crazy, you're getting returns of 20%, 22%, and they're now in the 12% to 16%, depending on the coupon. And we expect over time that you would see those dollar rolls returns probably go down as the Fed quits buying. But that's a little bit about waiting for Godot. That will happen, but probably not in this quarter. Now in terms of marginal cash then, you could actually invest equal or better to your dividend rate, if that's what you're asking.

[Doug Harter:]

Got it. And then just on that comment you just made about eventually, expecting dollar rolls to kind of normalize. I guess, just how do you think about portfolio construction and kind of how to think about that the trade-off of owning pools versus TBAs, in that – with that as a backdrop?

[Jeff Zimmer:]

Yes. So right now, we're approximately 50/50 TBAs and specified. And we would anticipate over time that as the Fed moves out of the TBA market, that also specified prices or returns would improve as well. So, at that period of time, we would morph from some of our dollar roll positions into our specifieds. But let's go back even two years ago, we were 20%, 22%-dollar roll. So, there are and will be always opportunities in the dollar roll market.

[Doug Harter:]

Great. Appreciate it.

[Jeff Zimmer:]

Well, thanks very much for calling in.

[Operator:]

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

[Trevor Cranston:]

Thanks. To follow-up on the questions about the new investment opportunities, where you guys see things today, do you consider the reinvestment opportunity attractive enough that you would start taking your leverage back up towards your more historical average levels? Or do you guys want to continue to hold onto some dry powder anticipating that new investment returns could get even more attractive than where they are currently? Thanks.

[Jeff Zimmer:]

Trevor, good morning, it’s Jeff again. We're going to be very slow about increasing our leverage. So, I'm looking at a chart right now. If I go to the last couple of days of April, LIBOR OAS's on Fannie 2.5s were negative 23. Everybody's model is a little different. Okay. I look at them today, they are about five. Historically, they should be 20 wider than that. Now we weren't trading Fannie 2.5s 10 years ago either. So, we have to look at what the current coupon is. And a number of your broker-dealer brethrens can provide those kinds of charts for you. I look at Fannie 3s and at that same date in April, they were negative 2 to 5 OAS LIBOR, and I got them about 34 and they could probably widen another 15. So, we're not going to be able to catch the wides. And I anticipate and I think our group anticipates that a lot of the Fed tapering's probably just came into the marketplace over the next six weeks. So don't expect to see our leverage go up immediately, but we are studying very closely the reinvestment opportunities as they are now equivalent to what we're paying out in dividends with a number of the coupons. And if we widen further, you'll see us start putting some money to work on. As Scott said in his comments, we’re 1.5 to 2 turns lower than our historic leverage numbers. And if we go back up there that core income is going to be at your dividend rate or perhaps even exceed it.

[Trevor Cranston:]

Got it. Okay. That's helpful. And then looking at the portfolio composition now versus last quarter, it looks like the asset durations are a little bit shorter. And the swap book increased somewhat. Could you just comment on sort of where your duration positioning is that and how that's evolved over the last few months as interest rates come back down? Thanks.

[Jeff Zimmer:]

We've targeted over the last two to three years, maintaining a duration of the whole business of about 0.5, but what happens when you see moves in the marketplace like we've seen that duration increases, so what you're seeing from our portfolio is the rally in the tenure. Scott said, down intraday at 113 at one point. Those mortgage prices quick going up, and they hit a wall, but your hedges don't, right? So, we believe it's temporary. And that duration goes back down, we believe that will equalize, as the market, kind of gets back what we think is normal, perhaps slightly higher rates and a slightly steeper curve. And that duration, which is now closer to zero would work its way back to 0.4 to 0.5 area. So, the only reason you're seeing those assets get shorter durations, is the rally in the marketplace, except for the DUS. The DUS are kind of locked out. And they've maintained their duration quality. Now, on the head side, I'd say the following. We don't anticipate at this point, changing our hedging profile, or the way we run our hedge book, I would note that our average pay rate is 68 basis points right now. You were to put on tenure, OAS. This morning is about 109. We do have 600 million of real short hedges rolling off within the next 10 months. And we will not replace those. But should we put any new assets on, we will hedge them, assuming 8 or 8.5 times leverage to where we get to 0.5 duration. That's our target right now. Is that helpful?

[Trevor Cranston:]

Yes, very helpful. Appreciate the comment. Thank you, guys.

[Jeff Zimmer:]

Well, thanks for calling in.

[Operator:]

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

[Christopher Nolan:]

Hey, guys Jeff, in recent quarters, you articulated that you were changing the investment strategy to protect book value at the cost of EPS. Given the change in the interest rate environment since then, is there any update to the strategy that you can articulate for us?

[Jeff Zimmer:]

No, it's exactly the same despite the book value decrease, if we maintain our historic leverage, you would have seen decreases of similar to what some of the other firms announced, which were 300 to 400 basis points, worse than ours unfortunately. So, we maintain the lower than historic leverage to protect ourselves. And what we saw is a too tight and OAS environment. And turns out we were right. But we can't sell all our mortgages, we're in the business of providing income for our shareholders. So, as they say in that one movie, this is the business that we've chosen. So, we will remain mortgage investors, we are just not investing as much as we normally would in order to protect book value as much as we can, what equalizing and balancing that with the fact that we need to produce a dividend for our investors.

[Christopher Nolan:]

Got it. And then I guess, in Scott prepared comments; he indicated he's seeing an improved investment environment. Could we start seeing guys reenter the non-agency space at all?

[Jeff Zimmer:]

You won't see that, no.

[Christopher Nolan:]

Okay. And final question is, what is your outlook for prepayments going forward? I know they're up a little bit in July, but any…

[Jeff Zimmer:]

We actually expect them to be level for the next couple months? Now, we are getting a refi burnout here. We've been at very low rates. Ever since 2008, we've been at low rates. And now we've been at low rates, obviously, since April of last year, even lower rates. Our models have shown that's equal to what the Wall Street dealers estimate, for example, August they estimate down 4%, we're going to, we're running them at zero, so no change. They're estimating September, unchanged from August, and we're going to maybe make them up a couple percent, because we usually are very conservative in our estimates. And we haven't estimated yet for October or November. It's too early.

[Christopher Nolan:]

Great. Okay. That's it for me. Thank you.

[Jeff Zimmer:]

Thank you very much for calling in.

[Operator:]

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

[Jim Mountain:]

Well, I'd like to thank everyone for joining us this morning. And as always, if there are questions or inquiries in the intervening period between now and when we gather again in another three months, feel free to give us a call at the office or send us a note. Well, as I said earlier, we're still working somewhat remotely through September. So, an e-mail and we'll get right back to you. And speaking of between now and September, August usually is a slightly slower month on the finance business. So, I hope everyone has an opportunity to unplug and recharge for a little while before we get back full speed in September, so until then, stay well.

[Operator:]

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