ARR - NYSE

Good morning, and welcome to ARMOUR Residential REIT's First 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.

Thank you, Andrew, and thank you all for joining our call to discuss ARMOUR's first quarter 2023 results. This morning, I'm joined by ARMOUR's Co-CEOs, Scott Ulm and Jeff

Thanks, Jim. In January 2023, the Agency MBS index delivered the third best monthly total return since 1989, reflecting the value proposition mortgage spreads after their worst 1-year performance on record in 2022. Despite positive fund inflows back into MBS and the broader fixed income markets in the first quarter of this year, the elevated levels of volatility and deep conversion along the treasury yield curve are keeping many investors on the sidelines. This is evidenced by the significant increase in the sizes of money market bonds and the Federal Reserve's reverse repo program. Moreover, the failure of Silicon Valley Bank and Signature Bank, this spring resulted in an FDIC portfolio with more than $100 billion of MBS to be liquidated over the course of the next 10 months. As of this week, the sales of the bank bonds and FDIC receivership of [indiscernible] plans course gradual and orderly. However, Tuesday's headline that First Republic may sell up to $100 billion in assets to raise liquidity stoked additional fear of a lingering banking contingent. While most of these assets are presumed to be non-agency mortgage loans, the headlines caused MBS spreads to widen approximately 5 to 10 basis points. This has left investors demanding an additional discount to absorb the unanticipated supply. Despite all these challenges, the spreads on MBS have remained tighter versus the wide seen last fall, implying that there is a significant appetite for mortgage assets near their current valuations. We're confident that highly liquid U.S. government-sponsored mortgage-backed securities, trading at multi-decade widespreads with muted refinance activity will grow increasingly attractive to the investor base in 2023. ARMOUR continues to pursue favorable investment opportunities while growing the portfolio, adding $3 billion of mortgage-backed securities since year-end, bringing total portfolio size to just over $11.9 billion. Visual and tight valuations and relative richness and deep discount coupons, ARMOUR sold the remainder of our Fannie 2 and 2.5 coupon positions early in the first quarter. Proceeds were reinvested into new higher-yielding current coupon mortgages. Sales proved to be well timed as lower coupon MBS accounting for most of the securities transferred into FDIC receivership from the 2 failed bags. ARMOUR continue to hedge our exposure to FDIC held assets by decreasing our 30-year 3% MBS bucket from 7.1%, down to just about 1% of total portfolio value. We are closely monitoring the ongoing FDIC liquidation for the opportunity to buy back lower coupons once spreads are for a discount versus that in the higher coupon production MBS. Our leverage flows the quarter at 8.7x and currently sits at 9x. A number of attractive valuations, yet is prudent enough to stand still elevated in the highly unpredictable levels of daily market volatility. A Additionally, ARMOUR maintains healthy levels of available liquidity at $590 million, which includes cash, unleveraged securities and principal and interest as of the 24th of April. Our purchased MBS are concentrated in the most liquid, low premium bank service production coupon pools featuring more favorable geographics, LTVs, FICO scores and loan balance characteristics versus generic production cohorts. We continue to favor these lower payoff premium specified stories, which we believe will perform best when volatility reverts to its historical norms. These investments also reflect historically low prepayment risk as the MBA Finance Index has remained at suppressed levels. ARMOUR's average prepayment rate for all MBS assets in the first quarter of 2023 was 4.7 CPR and still a very low 6.7 CPR for April. Although mortgage rates have already declined from the highs of 7.2% in early November last year, to 6.5% in mid-April 2023, a substantial refinancing wave would require mortgage rates to fall below 5%. ARMOUR continues to fund just over 50% of our borrowers through our broker-dealer affiliate BUCKLER Securities. Despite margin's precipitous drop in liquidity within the interbank lending community itself, Agency repo funding remained on a strong footing throughout the quarter, with spreads ranging from 10 to 20 basis points above the several benchmark. The enormous supply of cash for money market funds combined with a growing shortage of [indiscernible] 2 bills have created incredibly liquid conditions for overnight agency repo and term agency repo funding that benefit ARMOUR. The weighted average haircut on our repo book remained exceptionally low at 2.6% as of the 24th of April. As we've always noted, we set our dividend to be appropriate for the medium term. We will, as always, continue to evaluate the level of dividend. We are also mindful that this environment can deliver upside surprises as well that can move our metrics. So thanks for that, and over to you, Jim.

Let's take some questions. Andrew?

[Operator Instructions] The first question comes from Trevor Cranston with JMP Securities.

You guys talked a little bit about the pending sales of the failed bank portfolios. And you briefly mentioned the prospect of another bank selling assets. Can you comment in general on how you guys are thinking about the potential risk of maybe some other banks needing to sell MBS as a risk on top of the sales that we already know about happening.

It's Jeff

Okay. Got it. And then it looks like you guys added some swaps during the quarter. Can you just give the details on kind of what the maturity of the newly added swaps?

Sure. And this is Jeff. It's interesting because we're talking about this in our Board meeting the other day. So two things going there. The average weighted maturity of our OTC swaps is 75 months right now. But we have been managing off of OTC swaps over to exchange trade swaps and they're a little shorter that we've been putting on, apparently because they're much lower haircuts. And Mark you could perhaps provide some detail on the recent exchange rate swaps that we put on the books.

Sure. So the cleared swaps are 1- to 3-year swaps you put on really to protect the front end of the curve. The bilateral swaps, the existing book is mainly longer term.

The next question comes from Doug Harter with Credit Suisse.

You just mentioned keeping dry powder. I guess how would you size the amount of dry powder in terms of leverage that you think you could add? And what would be the conditions that would cause you to want to deploy some of that dry powder?

Thank you. And thanks for continuing to write about ARMOUR. We appreciate that, and we wish you the best of luck with the Credit Suisse merger. A couple of things -- you're very welcome. A couple of things here. We have probably another full turn of capabilities to invest in mortgage-backed securities. I think our team would rather see it slightly tighter, and that would indicate that the market in general is now willing to or have accepted the fact many of the securities that are for sale have been absorbed into the pricing structure of the MBS market. So if it widens a little bit more, we'll be there to watch and perhaps invest at that point. But we want to see others invest. It is our belief that we're not going to see large bank investing, Doug, the investing is going to come from a privately managed funds or hedge funds but not banks. So we're going to be aware. We talk to our counterparties on the street. We get a general feeling of who's now involved in the market, where things are and then we'll deploy some money. I suspect that that's not this month. It is a longer-term perspective than it will be over the next couple of quarters. So I hope that answers your question.

Yes, absolutely. And then just on the funding market, what are you seeing around debt feeling debate, anything around those maturities? And how does BUCKLER help kind of in that context?

BUCKLER helps a lot, and that's why we went ahead and started in 2016 of putting together the BUCKLER structure. And we are very fortunate to have direct access into that whole system. And we also get very, very good color of from BUCKLER. Now I'll hand it over to Mark to talk about specific rates and where they are out in the curve. But generally, we feel very comfortable doing a lot of overnight with BUCKLER we wouldn't feel as comfortable doing it with our other 20 some other counterparties in the repo market because the will and changes probably may approach the markets could happen in any single day. So we have great security and the fact that we can go through the banking system with BUCKLER. And then Mark, perhaps just talk a little bit about different maturities and where we are there and the cost of those maturities and the access to it.

Yes, sure. So we don’t see any issue with repo both overnight or term. Obviously, we do a lot more overnight with BUCKLER than we would with anybody else just because of our relationship, but that funding has been great. There – I haven’t heard really any talk on – from our repo counterparties about the debt ceiling and its impact. I think because of the debt ceiling because of the banks, a lot of people want to be in repo. So it’s actually helped us. And like Scott said in his remarks, SOFR plus 10% to 15% is kind of what we’re seeing across maturities it widened a little bit at one point when we were kind of in the middle of the SVB and Signature Banking crisis, but it came back with no issue. So we see plenty of liquidity in the repo and financing markets.

The next question comes from Christopher Nolan with Ladenburg Thalman.

What is -- if you guys can give an update in terms of where you're seeing the investment spreads, particularly funding costs in the second quarter to date?

Sure, Mark. You want to detail that?

You said funding cost?

Funding cost.

So low 5s is where we're seeing repo. So somewhere 5.15, 5. 10, somewhere just depends on the surety in counterparty for about a 30-day term.

Okay, then. Given that, I mean, how should we think about the earnings power for the company in terms of sustaining the current $0.28 dividend -- excuse me, $0.24 dividend.

Good morning. So right, as Jim said in his comments and quite frankly, as we’ve said in the last 10 to 12 earnings calls, we set the dividend based on the medium term. And right now, we think that the $0.08 dividend on a monthly basis suits the investment opportunities on the medium term. Now as actually, Doug Harter reflected in an earlier report on ARMOUR some of the earnings and quite a bit of it actually comes from our well-managed swap position that we put on in April and May of 2020 when rates were very low. As a matter of fact, it was noted in the Board meeting on Tuesday that we actually had a swap where they had paid us on both sides that just rolled off who were starting to see that go. But Fannie 6s are trading around par. So they’re yielding 6%. Funding is at 5%. So it gives you 100 basis points times 8, there’s only 8% right there, and then you have some overhead costs as well, correct? So where does that funding power comes from that large swap position. But 75 months left on that swap position, as I noted earlier, on the over-the-counter swaps. So it does provide earnings power. And the reason you set up those swap positions exactly for situations like this, okay? If we sense that rates for some reason, we’re going to go dramatically lower both on the short end or even on the 10-year, we might actually unwind some of those swaps. But right now, we put on those positions 3-plus years ago. Exactly where we want to be, and we’re getting the benefit of it today. So I hope that answers your question.

The next question comes from Matthew Howlett with B. Riley.

Jeff. On the prepayments outlook, I just things already ticked up, obviously off a very, very low rate in the winter. Is it seasonal in nature? And then what's the outlook for speeds. It just seems like the housing market much stronger than I think people would have imagined at this point in the cycle. Any sort of update on where speeds to go for 5 or 6 coupon?

Sure. We as a company -- Mark, please go ahead.

Sure. So we expect prepayments to increase over the next 2 months, probably up 20%, that's for our portfolio. That's what we're expecting based on where rates are today, the pull-through of rates versus over time. So again, we plan for that. It still won't be a surprise. But rates are -- mortgage rates are lower than they were at peak.

Is there [indiscernible] when you -- I see a lot of this is going to be dependent on the Fed, but there were some changes recently at the FHFA GP. And just curious, what do you think of those, first of all, in terms of investment in selection? And then, are you still focused on sort of the specified pool or credit impaired nature? And how are you approaching investing higher up in the coupon today given obviously they could be cutting rates here the back half of the year and mortgage rates could be a lot lower at some point.

So we have structured the portfolio and higher coupons because of the wider spreads, but it's the other reason why we -- our duration is higher than we probably would have been in a normal environment where the rate -- the Fed has been continuing to raise rates. And that's to balance that effect of if rates do rally and we do get prepayments to increase more than we expect, we have duration on to protect us against that. So it is a balance we try to maintain.

And you can get you can get that duration on your balance sheet by also using treasuries in the future. So you have your mortgage core position, you have your hedge core position, then you can manage it with very liquid other products. I believe your duration today, Mark, is 0.82 to 0.88 area. So that's the benefit that he's talking about that.

Right. You guys have been very active with that. And then just any comments on the changes with the g-fee.

Mark?

Would say, we’re taking into account when we look at asset selection. But we are, for the most part, looking at bonds that have low pay-ups because that’s where we like to play because we don’t want that additional risk of having big pay-ups that could evaporate in different scenarios. And again, it’s part of our liquidity management. If you remember back in 2020, pay-ups on liquid MBS basically evaporated. They went to zero or negative in some cases. So that’s one of our risk management techniques is to keep in lower pay-ups and to find bonds that have characteristics that we like where we’re not paying up a lot for it.

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

Thank you, Andrew, and thanks to everyone who’s joined us this morning and one final shout out to all the shareholders that have dialed in on the internet or hear this shortly on replay. We look forward to having you join us this time next week for our annual meeting. Until then, stay safe.