Armour 住宅房產信托 (ARR) 2015 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the ARMOUR Residential REIT, Inc. first-quarter 2015 conference call. (Operator Instructions). As a reminder, this conference is being recorded Thursday, April 30, 2015. And I would now like to turn the conference over to Jim Mountain, Chief Financial Officer. Please go ahead.

Thank you and thank you all for joining our earnings call this morning.

By now, everyone should have access to ARMOUR's earnings release and Form 10-Q, which can be found on ARMOUR's website.

This conference call may contain statements that are not recitations of historical fact and, therefore, constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All such forward-looking statements are intended to be subject to the Safe Harbor protection provided by the Reform Act.

Actual outcomes and results could differ materially from the outcomes and results expressed or implied by the forward-looking statements due to the impact of many factors beyond the control of ARMOUR. Certain factors that could cause actual results to differ materially from those contained in the forward-looking statements are included in the Risk Factors section of ARMOUR's periodic reports filed with the Securities and Exchange Commission. Copies are available on the SEC's website at www.sec.gov.

All forward-looking statements that are included in this conference call are made only as of today's date and are subject to change without notice. We disclaim any obligation to update our forward-looking statements unless required by law.

Also, our discussions today may include reference to certain non-GAAP measures. A reconciliation of those measures to the most comparable GAAP measures are included in our earnings release, which can also be found on ARMOUR's website.

An online replay of this conference call will be available on ARMOUR's website shortly and will continue for one year.

Now to the substance.

ARMOUR's Q1 core earnings and estimated taxable income were a positive $33.5 million or $0.08 per share. GAAP results were $125.5 million loss or $0.37 per share, mostly as a result of the $216 million unrealized loss on our interest rate derivatives. ARMOUR does not use hedge accounting for its GAAP reporting, so quarterly results will always be influenced or in this case even dominated by fluctuations in fair view of our open interest-rate swaps.

On the other hand, the quarter's $90 million positive market adjustment on our agency securities flows directly into stockholders equity rather than through GAAP P&L.

At March 31, 2015, ARMOUR book value was $4.14 per share or nearly $1.00 above the New York Stock Exchange closing trade price that day. ARMOUR paid cash dividends monthly, up $0.04 per common share in Q1. We've also declared cash dividends of $0.04 per share per month for Q2. That represents a dividend yield on book value of 11.6% per annum. Quarter-end leverage was 8.4 to 1, and our interest rate hedges cover 86.6% of our debt. Repo haircuts and interest rates are heading holding steady, and availability remains strong.

Quarter-end liquidity, consisting of cash and unpledged securities, totaled nearly $900 million.

Now I'll turn the call over to co-Chief Executive Officers' Jeff Zimmer and Scott Ulm to discuss ARMOUR's portfolio position and current strategy. Gentlemen?

Hi. It's Jeff Zimmer here. In addition to the customary SEC filings, we also provide a monthly Company update which is furnished to the SEC and available on our website as well as EDGAR. the Company update contains a considerable amount of information about our portfolio, hedging, and financing on a timely basis.

Beginning with our March monthly company update this year, we included our expectations for core earnings and book value. As shown on our monthly Company updates from 2013 to present, our net achieve duration has ranged from a negative 0.46 to a positive (technical difficulty). As of the close of Tuesday this week, it is now slightly positive at 0.27. Our rates (technical difficulty) is now approximately $436,000, and our spread duration of an [01] in an OAS move is approximately $8.1 million, which (technical difficulty) the fact that swaps could widen with mortgages, making that number smaller.

Book value at the end of Q1 was $4.14, and we have a book value at the close of business of last night, April 28, of approximately $4.10 to $4.16, the middle of which is $0.01 lower than the end of the quarter.

This book value is almost 24% above last night's closing stock price of $3.15. This large gap between stock price and book value during Q4 2014 and Q1 of this year encouraged us to buy back stock in the open market in both periods. However, we did not see anything in our stock price performance from these reports. We will continue to monitor the market and the potential impact of stock repurchases under our authorized stock repurchase program.

Our portfolio today is comprised of five major components. First, 10 years. 36.1% of our 15-year pass-throughs are 80.6% loan balances of $175,000 or less. Number two, 20 years -- 30.6% of all our fixed-rate debts mature in the bucket of [181] (technical difficulty) but a weighted average seasoning of 50 months.

Number three is the DUS bond. 13.4% of our portfolio is Fannie Mae DUS bonds, delegated underwriting and servicing bonds, essentially multifamily agency bonds, which are generally locked out from prepayments for the first 9.5 years of their 10-year expected maturities.

The fourth bucket is our 30-year bucket, and 10.3% of our portfolio has thirty-year maturities with -- of which almost 89% are $175,000 loan balances. The remainder of our portfolio, 8.7%, is Fannie 3.5% on dollar roll.

So, as you can see from the details of each of those buckets of our portfolio, it is a very convex group of assets. We expect that those assets will provide good price performance in a rates rally with a minimal amount of extension in a high rate environment.

We've added a modest amount of higher-yielding assets to the portfolio and slightly restructured the hedge book to increase our earnings. Our estimates for April and May have us earning between $0.036 and $0.039 per share for each of those months. Most of our changes designed to address earnings have been implemented.

While we have changed the composition of the portfolio, we've generally maintained our swap position. Today 86.7% of our repo financing is covered with swaps that have a duration of negative 3.7. $8.6 million or 71.1% of our swaps are current payer swaps with the remainder becoming current payers within nine to 13 months from today. The size and tenor of our hedge book is expensive and part of the trade-off of earnings versus book value protection.

We continue to face spread risk, the variation and the value of MBS versus comparable 10-year treasuries. Changes in spread can move valuation significantly and quickly. The good news is the spreads widen and they tighten. The bad news is that it is difficult and some I guess would say impossible and uneconomic to hedge spread risk. But spread risk is the major part of the risk we bear in order to earn our returns.

The financing environment continues to remain favorable for our business. We've seen continued wide availability of funding and a general improvement in pricing. ARMOUR now has 41 MRAs with counterparties and is currently active with 30 of those. We actively seek to diversify our financing book, and our counterparties range from the big Wall Street firms to large European and Asian banks to regional securities firms and some specialists. The details can be found in our monthly company update month after month after month of who we are borrowing from.

We keep a close eye on our counterparties. While we are a secured creditor to them, they are an unsecured creditor to us for our haircut amounts. We've had also numerous opportunities to extend our maturities to a year and beyond in some cases. So depending on pricing, we have put some of this longer financing on the books, and once again, you can see that in the monthly Company update.

We continue to feel that the US economy is recovering, and that improvement will be reflected in interest rates, despite the dissimilar environment overseas. We have a positive view on the economic environment in the United States, but remain mindful of the multiple factors impeding this more rapid economic expansion.

At the same time, we think the ultimate scale of rate changes both on the short end and on the long end will likely be measured. We believe that the (technical difficulty) in rates we experienced in the past are likely to repeat given the structural and other headwinds facing the US and world economy. Combine that with the measures we hear from the Fed and the continuing issues in Europe, and our overall outlook for the environment remains quite constructive. Nonetheless, potential rate volatility remains a concern, even if the ultimate extent of the rate changes is moderate.

The experience of the second half of 2013 is ample demonstration of the potential volatility of the rates market, even with little ultimate change at the end of the day. And our business -- well, we need to be prepared for a more difficult environment, and that is reflected in our high liquidity and our rate protection profile.

We have long maintained the view that we seek to balance earning and book value protection. In this environment, we put our finger on the scale to provide (technical difficulty) protecting book value from higher rates as a long-term goal, yet while earning an attractive and sustainable dividend.

We are pleased to have you for an audience today. Thank you for calling in, and we will entertain any questions that you have at this point.

If we can open up the lines for questions and tell people how to get their question queued up.

(Operator Instructions). Trevor Cranston, JMP Securities.

Hi, thanks, and thank you very much for the great monthly disclosures you guys give. That is always extremely helpful.

I guess the first question -- can you maybe talk about the dollar roll position and kind of why you guys thought it was attractive to enter into that at this particular point in time, maybe as opposed to adding more specified pools as you were increasing earnings power of the portfolio?

Good morning, Trevor. When you add dollar rolls, you always have the ability to deliver and swap those into specifieds. And although we have not been active in the dollar rolls in the future, we don't know if it's likely that we will be active in any size in the future. We did put a modest amount on at 8.7% of our portfolio. We have it as pick up 70 basis points annually. So if you look at that at 8 or 8.5 times leverage, that's a large component of core earnings that you can adjust. Do not look for us to be extremely large in the dollar roll business, and once again if the dollar roll goes away, we will take delivery and swap into some other assets.

Great. And then on the multifamily side, that's become a meaningful portion of the portfolio. Can you comment on how you are thinking about that bucket currently and how big a percentage of the portfolio you think that has the potential to grow to over time?

We've talked internally that we probably won't see it get much more than 15% or 18% of the portfolio, so that's only 1.5% to [0.5%] away from where we are right now.

So let's talk about DUS. What is DUS? So it doesn't yield as much as 30-year pass-throughs -- maybe 20 basis points less. But it has a defined period of payment. So, in other words, it is more like a corporate bond, and it rolls down the curve.

So if it trades at 52 to the I curve right now -- swap curve -- excuse me. As it rolls down the curve, it should and would as in the past we'll trade tighter and tighter and tighter. So it's a really good total rate of return vehicle, but let's look at the extension risk of it.

We already measured to be a 9.5% bond when you buy it. So if rates go up, it doesn't extend. However, if rates go down, it continues -- it doesn't get the negative convexes that most pass-through mortgages get, so it's a good vehicle for both ways. I think we have the durations in the mid-7s on that asset class. So we hedge it accordingly. We really like it a lot.

There's also some structural things that could be done down the road as well. You might decide to keep it I/O and sell part of it off, which will provide long-term financing, and we discussed that with some of our Wall Street dealers.

Great. That's helpful color. And then last thing, the added disclosures you guys have provided the last couple of months, is that something that we can expect to be provided continually going forward, or is that just kind of a supplemental bit of information as you guys were making a lot of changes in the portfolio?

As long as we are comfortable with our estimates, we will continue to provide that kind of information to you on a monthly basis. Originally we had not done that, as you well know, and we got some color from people when we went negative on our duration, and the profile didn't look good in the rally. And we said let's provide investors and analysts with as much information as we can, and we've gotten really good feedback from that. So it's highly likely that we will continue in more or less the format that we have now. We may even go to a charting format where you can look back on the comments, and you'll see here is what duration was last month and the previous month and that kind of thing. So you may look for just a change to make it a little easier to read.

Great. Well, we appreciate that, and thanks a lot for the color.

Brock Vandervliet, Nomura Securities International.

Thanks for taking my question. You mentioned the spread risk, and if you could just spend a moment speaking about that with respect to your book value decline year to date? And if you were to bucket the drivers of book value decline, what would fall into spread risk versus other factors? Thanks.

For our board meetings, we do a component of what happens quarter by quarter to book value, and there's four different components of that. Volatility and spread risk during the first quarter were the majority of the reason that the value was down. I would note since the end of the quarter, as I just quoted, book value is essentially unchanged since then, although rates are higher on the 10 year by 11 or 12 basis points. So spreads have actually tightened since then even with our slightly positive duration.

Somebody brought up earlier yesterday, what happens when the Fed decides to go ahead and not reinvest or the Fed decides to sell some of their mortgages? That spread risk is way down the road, and although when and if it happens and comes, we will deal with it. It's not something that is comprised in our day-to-day exposure and the way that we look at our key rates right now.

So in the future, that's what we see as the most overriding issue. Otherwise, mortgages seem to be on an OAS basis actually slightly above fair value here.

Okay. And just a big picture question here, and you are continuing to earn below your dividend. What confidence can you give us here that we are close to a bottom in earnings or not? Just trying to get a sense of some go forward earnings power here. Thanks.

Yes. Thank you. We declared $0.04 for quarter two and, as I said in the comments, we are close to $0.039, we believe, for May and $0.036 for April within that average range, so it's just a little bit under. And part of it is, when you readjust your portfolio and your hedges, it takes a couple of months for things to get fully up to speed. So we'd like to say that we will earn $0.04 in June. We won't know that for another month or so.

If the curve doesn't shift and the world doesn't change, the kind of earnings that we are describing right now to you seem feasible, I would ask you to take note that we are providing earnings guidance in advance. So when you see the majority of the other firms in our space, they are looking in the rearview mirror. So they are declaring dividends now for what we already declared 90 days ago. So please be thoughtful when you give that comparison.

If the curve flattens into some Fed movement and the 10 year stays where it is, the entire sector is going to see some NIM compression.

Okay. Thanks, Jeff.

David Walrod, Ladenburg.

Good morning, everyone. Jeff -- you kind of broke up a bit -- but you said the book value range now is $4.10 to --

$4.10 to $4.16, so the middle of which is $4.13, which is $0.01 off where it was at the end of the quarter. So we do give a range because without having it audited, we want to be a little cautious about presenting ourselves.

Sure. And then also, you started talking about share buybacks. Did you say you bought back stock in the first quarter?

Yes, we bought back 875,000 shares. I cleaned 100,000 out myself in addition, and then maybe some other insiders did as well. And, as you may have heard from our comments, every time we bought we saw no response. As a matter of fact, many days the price was down, but we continue to monitor it, and we understand it's an important component of value to our shareholders, as well as a good structure for the whole balance of our balance sheet.

Okay. Great. And then my last question is a lot of your peers have been looking at the FHLB, the captive insurance subsidiary. Is that something you guys have explored?

David, this is Scott. We are active in discussions with the FHLB and have been so for over a year now. So watch that space.

Okay. Great. That's all I need. Thank you.

(Operator Instructions). Mike Widner, KBW.

Good morning, guys. You've covered most of the stuff I think that I had questions about. But let me just -- I was looking at your duration estimate and the most recent monthly commentary, and it actually came down while -- even though you guys added a bunch of -- the 1.4 billion of 30-year TDAs. And so I was curious about that. It didn't seem like rates moved up that much. So I was just curious how you added that much longer-duration stuff and yet the estimate came down. Actually [it was] huge, but.

I don't have all three reports in front of me, but we were slightly negative duration three reports ago, and we've gone slightly positive. So I actually think it's gone slightly up here. I've got Mark bringing it up on the screen.

I meant just the pure asset duration, putting aside -- because I know you did the swap side, too. It's just the asset duration you mentioned came down to 3.9 to from 3.96. And, again, not that that's huge, I was just curious.

You did have a little bit of a rally during that period, and it just shortened up. It's modeled duration driven. So you have the 1.4 billion of the DUS, and their duration just doesn't change. Our 15 years don't change that much either because so much of it is low loan balance or $175,000s and under, but you do get on the 20-year and the 30-year bucket, you do get some duration drift. So that's what the changes are right there -- just literally modeling.

As you know, or most of the people know that cover us, we do use BlackRock Solutions. We had their whole senior team in here earlier this week, and we were discussing how the modeling works and the changes, and we are very comfortable with the way their model is right now. But sometimes because they are mortgages, you just get some modest changes that almost can't be accounted for.

Yes, I certainly know how that goes. So your net duration still -- you guys reported still seeing pretty short in aggregate. Is that the place to be right now? Because, again, you did a lot of rebalancing over the last month or two. Is that still in motion at all, or do you kind of like it here right now the way it is?

One of the other analysts right before you or two analysts ago asked about our earnings stream. We could go up to a 0.4 duration and probably be earning your $0.041 very, very quickly. We are going to keep it right in the zip code that we are -- up 0.2 to 0.4 for the foreseeable future. We have Board meetings this week, as well as the aforementioned meetings with BlackRock, and that's kind of our goal.

Scott?

We also -- duration is not the ultimate measure here. We also spend a lot of time on key rates throughout the portfolio, and that's something that's kind of always in motion, particularly as we make portfolio changes. So I'd just sort of throw a word of caution on duration as the ultimate measure of rate sensitivity.

There's a lot more going on there. So, yes, generally we are in the zip code, but there can always be some variation, and even variation doesn't necessarily imply a different risk profile one way or the other.

Right. So our DV01 risk -- rate risk is $436,000 right now, and we are a little overhedged in the 10-year component of the key rates and maybe a little less hedged in the three-year to four-year area. So we might move a little bit of that around, and that's one of the things we were working on this week, which you might see duration go up 0.1, but our DV01 might be exactly the same. So I hope that clarifies that.

And by the way, I read your very thoughtful commentary and report very early this morning, and I thought you were right on with a lot of that. I appreciate your thoughtfulness in your reporting.

Thank you. I appreciate that, too. One of the things we mentioned is it looked like you actually had the 10-year part of the curve. Your sensitivity there came down quite a bit, and I guess I was just wondering if your view on sort of -- I don't want to put words in your mouth, but you had been positioned at least the way we look at it in a way that your book value would benefit from the 10-year rising or the curve steepening. That seems to be a little bit shifted now. So just wondering if your view of how the curve seems most likely to move has changed. Specifically -- the 10 year has obviously been coming down rather than up in general -- obviously a lot of volatility, but everyone seems to think the Fed is determined to raise in the back half of the year anyway. So just, does that converge with your views, or do you think the world is still a horrible place and the Fed ain't moving or whatever?

So for six years of roadshows here, people have asked, well, what's important? Earnings or book value? And we did focus on book value last year, and the market rallied, and book value went down as so many analysts obviously stated.

So our position now is that we want to earn a good rate of return for the sector, and we are doing that based on book value with our $0.0375 kind of average per month, but we also want to protect book value. For example, yesterday rates were up considerably, but our book value went up a little bit because mortgages tightened. But in order to earn the dividend rate and the earnings rate that is expected by this space, we do have to have a slightly positive duration. But it can be positive -- we still can't protect you for increases. So don't expect us to go back to a negative duration for ARMOUR right away. We don't see that in the near future. We are quite happy earning a proper rate of return on our equity, as well as protecting as best we can the book value, but not going negative duration for that enterprise.

All right. Well, thanks for the comments as always, guys. I'll also I think echo what some other people say. I love the monthly disclosures, and as you guys put more stuff in there, that is even more helpful. So very nice and appreciate all that stuff as well.

Doug Harter, Credit Suisse.

Thanks. I was hoping you could give a little more color on kind of the return profile of the DUS bonds versus kind of the 15s or 30s and sort of how you got there with leverage? How does the leverage profile look?

Sure. With the DUS, the haircuts are the same as they are for any Fannie Mae or Freddie Mac product. It's generally a 5% haircut on the financing. So that's generally what most of our -- I think our average haircut on our agency portfolio is like 4.7% or something. So it's very liquid, and it's trading at 52 to the Z curve right now, which puts -- swap curve -- which puts it at about 20 basis points less yield than you might expect an average TBA Fannie 30-year 3.5% to trade. That, once again, is going to be about 40 to 50 more than a 15-year pass-through.

So there's not much modeling that has to go on with the DUS. It is what it is because it's like a lockout corporate bond. The only reason we wouldn't own more than 20% or 25%, and as I said earlier, we will probably keep it in the 15% to 18% range, is that it is not quite as liquid. You could go ahead and sell 1 billion Fannie 3.5%s pretty quickly, but with the DUS bonds, they are all individual CUSIPs. You have to line up with a dealer to move them.

So we are going to be very respectful of the importance of liquidity and keep that position to a relatively manageable size, although we really like it a lot.

Got it. And you had mentioned before that you guys might be slightly over-hedged to the 10 year on the queue rate duration. Is there any way you could help us think about book value sensitivity to if we have more flattening of the curve?

That is exactly what we were discussing with the last analyst. You might expect us to be -- we are a little negative on the 10-year key rate, which means we are slightly over-hedged there, and we are a little positive in the three- to four-year key rates.

So we are going to do some subtle things to flatten that out over the next couple of weeks.

I think our perspective right now, Doug, is that we see a bear flattener, which means the short income is up a little bit, and the 10 year doesn't go up as much as the short year. So you might have a bear flattener, and it might not be like 2007 or 2006 where the 10 year just kind of stayed in mud. The whole curve might shift up 25, 30, 40 basis points but with the short end going up further. And in those kind of circumstances, we definitely want to have some key rate protection in the shorter end and take a little bit off the 10 year.

Is that helpful?

Got it. So that would be if you are looking to do kind of anything else in the portfolio repositioning, that would kind of be the area to focus on?

To date we have not shown our key rates in our monthly Company update. We talked about it in a meeting the other day and yet to be determined if we will. At some point, we are providing extreme disclosure here. And if we do, but you are always welcome to call, and we will provide as much public information as we can and guidance as to how you might look at it. But based on what I just discussed, we are a little more negative on the 10 year and a little more positive in the shorter end.

I should give you a situation that if we did a big bear flattener today, that book value we go down a little bit. However, I think as we adjust that and depending on mortgage spreads, it could have the opposite effect.

And, as I also said earlier, for example, book value was up yesterday. With the rates up, I think we were up like $0.02 or $0.03 yesterday.

Great. That's very helpful. Thank you.

Brock Vandervliet, Nomura Securities.

Thanks. Could you just touch on CPR rates throughout the quarter and any look ahead that you may be able to offer? Thanks.

We expect CPRs. If you get our monthly Company update, you can see that CPRs have been up a little bit, but the relative CPR rates that range from the last four months from 8.7% to 6.5%, our amortization expense, as you can see in our Q, is pretty low.

For example, you have $1.4 billion of our assets, which are the DUSs, which have just a straight line amortization rate because they can't prepay. Based on analyst expectations from Wall Street firms such as yourself, we expect people payments to be down slightly for the next month or two, and that's based on applications and refis.

So if you think about what I talked about in my comments, so much of our portfolio has convexity in it -- just to repeat those numbers. Of our 15-year pass-throughs, 80.6% of them have loan balances under $175,000. Of our 20-year pass-throughs, the weighted average maturity is 50 months.

So when you get really big seasoning like that, your housing turnover -- the seasoned payer pays slow. The DUS bonds, of course, have no turnover, and of our 30-year bucket -- our 10% -- 88.7% have loan balances of $175,000 or less.

So unlike 2006, 2007, and 2008 where you had all these high prepayment circumstances appear, we have a portfolio that we think where prepayments are the least of our concerns right now. So we are focusing our concerns on how do we balance our key rates and our hedges to make sure that if we get some extreme volatility in rates that we don't have any book value to lose.

Is that helpful for you?

Thank you.

Thank you. And at this time, there are no further questions. I'll now turn the call back over to you, Mr. Zimmer. Please go ahead.

Thank you, everybody, for listening in today. We will speak to you at the end of the second quarter. Once again, we encourage any analyst that has any questions, Mark, Jim Mountain, Scott Ulm, or myself are here to answer questions. There are a various number of firms doing some things in New York over the next few months, and we will be attending a number of those and doing some 101s and making some presentations.

So thank you, once again, and have a good day.

Thank you, ladies and gentlemen. That does conclude today's conference call. We thank you for your participation and ask that you please disconnect. Have a great day.