ARMOUR Residential REIT [ARR] Conference call transcript for 2023 q3
2023-10-27 15:01:07
Fiscal: 2023 q3
Operator: Good morning, and welcome to ARMOUR Residential REIT's Third Quarter 2023 Earnings Conference Call. [Operator Instructions] 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.
James Mountain: Thank you, Drew, and thank you to all of you for joining us this morning to discuss ARMOUR's third quarter 2023 results. Today, I'm joined by ARMOUR's co-CEOs, Scott Ulm and Jeff Zimmer; and our CIO, Mark Gruber. By now, everyone has access to ARMOUR's earnings release, which can be found on our website, www.armourreit.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 ARMOUR's periodic reports filed with the Securities and Exchange Commission, describes certain factors beyond ARMOUR's control that could cause actual results to differ materially from those expressed in 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 our website shortly and will continue for one year. On September 29, 2023, ARMOUR completed the previously announced One-For-Five Reverse Stock Split. All of the common share and per share amounts reflect the reverse stock split. ARMOUR's Q3 GAAP net loss was $179.2 million. Net interest income was $3.6 million. Distributable earnings available to common stockholders was $50.2 million or $1.08 per common share. This non-GAAP measure is defined as net interest income plus TBA drop income, adjusted for the net coupon effective interest rate swaps and futures contracts, minus operating expenses, net of management fee waivers. Asset yield of 4.65% less cost of funds of 2.92% resulted in a net interest margin of 1.73% for the quarter. ARMOUR Capital Management is continuing to waive a portion of their management fees. They waived $1.65 million for Q3, which offsets operating expenses. The waiver will continue until further notice. ARMOUR paid monthly common stock dividends per share of $0.40 for a total of $1.20 per share for the quarter. We previously announced that we will maintain the $0.40 per share common monthly dividend rate for the remainder of 2023. We prioritize maintaining a common share dividend appropriate for the intermediate term rather than focusing on short-term market fluctuations. We expect to provide dividend guidance in late December, which will reflect our best understanding of current market conditions and outlooks at that time. Taken together with contractual dividends on preferred stock, ARMOUR has made cumulative distributions to stockholders approaching $2.2 billion over our history. During the third quarter, we issued 7,628,578 shares under our common stock ATM program. That raised $191.4 million in capital after fees and expenses. This represents an average net proceeds of $25.09 per share. We also repurchased fractional shares for $233,000 in connection with the reverse stock split. We have historically been active repurchasing ARMOUR common shares in the open market when trading price dislocation opportunities present themselves. ARMOUR's Board of Directors has increased the company's stock repurchase authority to 2.5 million common shares effective Monday, October 30, when our current blackout period ends. Quarter end book value was $21.73 per common share. The treasury and mortgage markets have continued to be highly volatile since then. As of Tuesday night, October 24, we estimated our book value to be approximately $17.95 per common share. Now let me turn the call over to Co-Chief Executive Officer, Scott Ulm. Scott?
Scott Ulm: Thanks, Jim. At the end of the third quarter and beginning of the fourth quarter presented some of the most difficult conditions for mortgage-backed securities since the onset of COVID-19 in March of 2020. We've seen a significant decline in MBS prices primarily because of the nearly 125 basis point increase in 10-year treasury yields trough to peak since June 30. The widening in OAS caused mortgage assets to underperform similar duration treasuries even further. As a result, there have been broader investment -- investor redemptions in various bond funds, adding to the significant price pressures in the agency MBS market. We believe that much of this selling is driven by investors' existing overweight exposure to mortgage allocations relative to other investments. Our current book value of $17.95 as of October 24, fully reflects this decline in agency mortgage prices. However, the market value decline of ARMOUR REIT common shares seems to have substantially overshot this book value movement. It's important to note against this backdrop that the market is offering once-in-a-decade opportunities to invest in Agency MBS with compelling returns and no appreciable credit risk. Despite the tough market conditions recently, we remain very constructive on the MPS market and its potential as we move towards the end of the Fed tightening cycle. We continue to assess share repurchases when we trade significantly below book value. We've increased our authorized repurchase authority effective next week. As always, we need to balance the value in historically cheap MBS against the accretion available from below book stock repurchases, as well as liquidity on balance sheet. In response to the increased market volatility, ARMOUR took measured steps towards a more conservative portfolio risk profile in order to safeguard our capital in this turbulent environment. These steps included a 25% reduction of our Agency CMBS DUS position. We've long valued how our DUS allocation bolsters both the convexity and the diversification of our Agency MBS portfolio. While we acknowledge DUS spreads are at recent wide, we execute these trades due to DUS outperformance versus MBS pools over the last two months. We sold a lower coupon TBA position against our conventional seasoned loan balance pools to rotate into higher coupon Ginnie Mae II TBAs and pools. Improving the profile of the portfolio through the shorter cash flows of Ginnie Collateral. The explicit U.S. government guarantee gives this pools a 0% risk weighting on par with U.S. treasuries and makes them particularly attractive to banks and overseas investors. This trade brought our overall exposure to the Ginnie II sector to $1.5 billion or 16% of the total portfolio market value as of 10.4%. We also sold 4%, 4.5% and 5% coupon TBAs and pools. These are shielded from supply by the FDIC and organic new mortgage issuance. These belly coupons have outperformed on a relative basis. We plan to eventually reinvest these proceeds into more attractive higher coupons with higher yields and wider spread characteristics. We rebalanced nearly all of our cleared short duration swaps and treasury futures in the 10-year SOFR swap hedges. This shifted negative duration to longer tenors at a time when the 2/10 spread was inverted by more than negative 100 basis points. We also added $700 million in 10-year treasury short positions. This timely strategic shift enhanced our portfolio resilience to rise in treasury yields and MBS duration extension, while improving our liquidity. All in, these trades allowed our portfolio to be more flexible in the face of a less predictable market environment. The portfolio's implied leverage and duration currently sit at 7.9x and 0.9 years, respectively. We expect selling pressures to begin to subside, and this risk profile should benefit from even a modest improvement in current market conditions. Additionally, ARMOUR maintains healthy levels of available liquidity. Despite seasonal effects driving CPR is marginally higher, the overall mortgage refinancing activity remains at historically low prepayment loans. ARMOUR's average prepayment rate for all MBS assets in the third quarter was 5.3 CPR and a still very low 4.2 CPR in October. With our assets now priced on average 7 to 9 points below par, any prepayment activity in the portfolio is accretive to book value and is welcome to current prices. ARMOUR continues to fund just over 50% of its borrowings through our broker-dealer affiliate, BUCKLER Securities with REPO generally priced around SOFR plus 15 basis points. In late August, prior to most of the negative price action, ARMOUR gave guidance that we intended to maintain the same $0.40 per common share monthly dividend through the fourth quarter. The company followed through by declaring common dividends for October, November and December on October 3. The resulting dividend rate is extremely high for conditions today, a level beyond what can be earned with reasonable risk. We are committed to paying the previously announced Q4 dividends. We will also be carefully considering market conditions and outlook through the remainder of the fourth quarter. We expect to provide guidance on future dividends in late December, which will reflect the company's best assessment for the intermediate term at that time. That concludes my remarks. Drew, do we have any questions from people on the line?
Operator: [Operator Instructions] The first question comes from Trevor Cranston with JMP Securities. Please go ahead.
Trevor Cranston: Hi, thanks. Good morning. Can you guys talk about how you're thinking about the interest rate market and specifically the risk of 10-year yields continuing to rise. And if we weren't to see that scenario, generally, how do you think we see MBS perform in that backdrop? Thanks.
Jeffrey Zimmer: So, good morning. We have reduced our exposure to DV01, at a dollar value of a 1 basis point move in rates considerably from where it was four to five months ago. On the long end, as Scott said in his statement. Our exposure on the short end is greater than on the long end such that if you have a steepener in a bear market, meaning the 10-year rates go up, we are in a better position than we would have been on the first day of the third quarter. The mortgages are in an interesting place here because we are seeing fund redemptions. It's something we haven't experienced or talked about, I mean, in a decade, the last time I talked about that was 2008, '09, '10. And on redemptions are without regard to the value of mortgage-backed securities, it's usually the large money management houses that run these funds, people redeem and they have to sell. So until fund redemptions stop, we imagine that mortgages are going to be fairly flat to even perhaps a little wider. However, there will be a point that would fund reductions will slow down. And at that point, we don't know who the sellers would be of mortgages. And on the margin, there would likely be buyers. So our perspective on mortgages, while we thought at the end of the second quarter, they were exceedingly attractive. They are exceedingly more attractive today. We are a levered bond portfolio. We intend to continue to be a levered mortgage-backed agency security bond portfolio, but we are cognizant that the risks are out there. However, Trevor, we think they're less than perhaps what they were four to six weeks ago. I hope that addresses your question, and if not, come back with a follow-up.
Trevor Cranston: No, yes, that was very helpful. And I guess one more. So as you guys are thinking about the appropriate dividend level heading into the end of the year, can you just comment sort of generally on where you see ROEs on new capital deployments today at the leverage levels you're comfortable with?
Mark Gruber: Trevor, it's Mark. So we see large returns in MBS somewhere in the mid-teens, and that's even before you add the hedges, which are going to be positive carry based on the inverted yield curve, which could add another 500 basis points of cases. So mid-teens where we see current opportunities.
Jeffrey Zimmer: And that would be on a leverage of approximately 8x and hedged to duration of 0.5 to one area. So that's deliverable, and frankly, if you wanted to raise your number from 8 to 9 on the leverage, it increases it by probably another 150 basis points. So there are opportunities out there. But as I said in my comments a minute ago, we continue to be cognizant of the downside. And Mark has his team leverage just under 8 right now, to match a stick around that area for a while until we see clear skies.
Trevor Cranston: Okay. That's helpful. Thank you.
Jeffrey Zimmer: Thank you.
Operator: The next question comes from Matthew Erdner with JonesTrading. Please go ahead.
Matthew Erdner: Hi, good morning, guys. Thanks for taking the question. You said into redemption stop mortgage spreads will kind of be flat to a little bit wider. Are you guys waiting for the money managers to kind of come back in for spreads to tighten? Or what other catalysts do you think could bring those spreads in?
Jeffrey Zimmer: So eventually, mortgages are going to be so attractive versus other places where funds can be invested that you're going to see buyers come in. And this is why Mark and his team exposed -- increased their exposure, excuse me, to the Ginnie Mae sector to almost $1.5 billion right now. Because we know banks are going to be more interested in buying Ginnie Mae's. And we know that the convexity features of mortgages when they have way lower dollar prices. So I mean even 6.5 are well below par right now. So these are going to have interest to investors. You just have to wait out bear markets, and that's what we're doing. Mark, do you want to improve on that?
Mark Gruber: Yes. When we see -- start to see banks and money measures come back in and banks are going to be the biggest player. I think that's going to drive spreads in. When loan growth and deposit growth go in better directions for security purchases, that's when we'll start to see things tighten.
Matthew Erdner: Got it. Thank you.
Operator: The next question comes from Christopher Nolan with Ladenburg Thalmann. Please go ahead.
Christopher Nolan: Hi, guys, thanks for taking my question. Given on the capital management front, I know you have not issued stock quarter-to-date, but have you repurchased any shares?
Jeffrey Zimmer: At the point we wanted to repurchase, we were in a blackout period. So the answer is we've not repurchased any to date. Jim Mountain was very explicit in his comments, though, that blackout ends on Monday and the Board authority has increased our ability to repurchase shares. So we will be considering that, but take note of what Scott said as well, if you would, please. So there's three things you have to think about. Number one, we're always thinking about liquidity. And our liquidity is quite good right now. So that would enable us on the margin to repurchase shares. Then we balance the use of that capital versus where Mark and his team could invest money and they modeled, they decide what is the best use of capital.
Christopher Nolan: Great. And then on leverage, where are you thinking about taking leverage forward? It looks fairly flat quarter-to-date relative to September 30. But given everything you have been discussing, it sounds like you want to be in a more defensive posture. Just trying to understand where you think leverage might go.
Mark Gruber: So leverage for us, we have to balance the fact that we still see so much volatility going forward. And we don't want to get over our skis and have to force to sell assets because our leverage gets too high. So we're trying to balance this. And as Scott said in his remarks, we did several trades in Q3, as the things we're selling off and our leverage was increasing to decrease leverage and decrease risk. But we still want to have enough risk on when things turn, we are in a position that we could take advantage of that. So we want to have enough dry powder that we can withstand rates continuing to rise and spreads continue to widen, but enough leverage on that when things go the other way, we are able to take that advantage and see the increase in book value.
Jeffrey Zimmer: But as I noted earlier, go ahead. Please.
Christopher Nolan: No, no please go ahead, please.
Jeffrey Zimmer: As I noted earlier, we're at 7.9 right now. I doubt you would see us getting much over 8 in the current environment.
Christopher Nolan: Great. Final question. Reason for the decline in net interest income quarter-over-quarter given investment margins were relatively flat and your agency volumes went up since last quarter. Is that a timing issue?
Mark Gruber: I think that is just a timing issue. I'd have to look at that a little harder. I don't know off the top of my head what the driver was there. But towards the end of the quarter, we did do a lot of selling, as we said. So we'll take a look.
Christopher Nolan: Okay. Thank you, guys.
Operator: [Operator Instructions] This concludes our question-and-answer session. I would like to turn the conference back over to Jim Mountain for any closing remarks.
James Mountain: Thank you for joining us this morning. We appreciate your interest in ARMOUR Residential REIT. And as always, if questions or concerns arise between now and the next time we do this in three months or so, please give us a call at the office. And in the meantime, stay safe.
Operator: The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
