Armour 住宅房產信托 (ARR) 2016 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the ARMOUR Residential REIT, Inc. second quarter 2016 conference call. During the presentation, all participants will be in a listen-only mode. Afterwards we will conduct a question-and-answer session. (Operator Instructions) As a reminder, this conference is being recorded Wednesday, August 3, 2016. I would now like to turn the conference over to James Mountain, Chief Financial Officer. Please go ahead, sir.

Thank you, Denise, and thank you all for joining ARMOUR's second quarter 2016 earnings call. By now, everyone has access to ARMOUR's earnings release and Form 10-Q and July monthly Company update, 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 protections 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 sections 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 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 discussion today may include references to certain non-GAAP measures. A reconciliation of these measures to the most comparable GAAP measure is included in our earnings release, which can 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.

ARMOUR's Q2 GAAP net income was $21.2 million or $0.47 per common share. Those figures include the one-time gain on ARMOUR's previously announced acquisition of JAVELIN of $6.5 million or $0.18 per share. Core earnings were $27.1 million or $0.63 per common share, which represents an annualized return on equity of 9.9% based on book value at the beginning of the quarter. We paid monthly common dividends of $0.27 per share for April and $0.22 per share for May and June for a total of $0.71 per common share. We've continued the monthly common dividends at $0.22 per share through September. The June 30, 2016 ARMOUR book value was $25.67 per common share, up 4.86% over the quarter. As a reminder, we've been including updated estimates of book value per share in our monthly company updates.

ARMOUR's quarter-end portfolio consists of over $7.7 billion of Agency securities plus another $2.3 billion of Agency TBA positions. At the close of the quarter, we began adding a small portfolio allocation to Agency interest-only securities. As we mentioned last quarter, we've been adding Non-Agency securities to the ARMOUR portfolio while the JAVELIN tender offer was underway. We've continued ramping up and diversifying these Non-Agency positions to just over $900 million at June 30. A majority of the purchases have been credit risk transfer securities and NPL/RPL deals. We've trimmed ARMOUR's interest rate hedge position to $5.4 billion of notional coverage at the end of June as the borrowings under repurchase agreements have come down.

The decline in repo balances is a natural consequence of diversifying the portfolio with Non-Agency securities, which have haircuts 4 times to 5 times the haircuts of Agency securities. A number of our repo counterparties have been aggressive recently in their efforts to finance our Non-Agency securities and financing for our Agency positions remains available and attractive. Now let me turn the call over to Co-Chief Executive Officer, Scott Ulm and Jeff Zimmer, to discuss ARMOUR's portfolio position and current strategy. Scott?

Good morning. In addition to the customary SEC filings, we also provide a 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. As a result of the update along with the comments we made during our last earnings call, the Q2 financial report that we filed last night should contain no surprises for any of our equity analysts or shareholders. During the second quarter, we had strong earnings and book value performance. Our book value of $25.67 was an increase of 4.9% for the second quarter and is an estimated $26.94 or 5% higher as of July 29.

We also closed the accretive tender offer for JAVELIN Mortgage Corporation and added almost $1 billion of Non-Agency assets to ARMOUR's portfolio both from the JAVELIN portfolio and direct purchase by ARMOUR. We believe our investment in Non-Agency assets will provide attractive stable returns going forward, will limit our interest rate exposure and swap risk, and lower leverage. There are several drivers of our economic performance this quarter. First, our entry into credit assets, primarily Agency credit risk transfer or CRT securities as well as non-performing/reperforming NPL/RPL securitizations, was well rewarded by significant spread tightening, more than 100 basis points in some cases as well as the attractive carry we are able to achieve in the space.

In the CRT transactions we take the credit risk of recent Fannie and Freddie underwriting, which we feel is quite good, in return for very attractive spreads and an uncapped floating coupon. NPL/RPL transactions have relatively short maturity fixed rate issues that are driven by the improving housing market. We continue to believe that housing trends and strong mortgage underwriting will give a robust underpinning to the credit quality of these assets. We remain focused on these sectors and expect our commitment to grow commensurate with REIT asset restrictions. The prepayment rate on our Agency assets rose modestly during the quarter from 7.82% CPR to 9.85% CPR. We anticipate that CPR rates will rise somewhat in the third quarter as well.

But it's important to note that 80% of our portfolio is composed of assets with either prepayment protection through low loan balances and other characteristics do not have prepayments at all or in the case of assets like legacy bonds and CRP securities, actually benefit from prepayments. We also extended our portfolio duration and maintained a positive duration into the spring's large rate rally. As of July 29, our duration stands at 0.6 compared to negative durations we've had at many points in the recent past. We also successfully completed the merger with JAVELIN Mortgage Investment Corporation. The JAVELIN merger provides some book value accretion for ARMOUR shareholders and represented a substantial price premium prior to the merger announcement for JAVELIN shareholders.

In the merger we acquired Agency assets that fit perfectly with ARMOUR's existing book as well as Non-Agency assets in the legacy, NPL/RPL, and CRT areas. Most importantly, the JAVELIN merger was the impetus for ARMOUR's move into Non-Agency MBS. We see relatively little new to do in the areas of legacy MBS from 2008 and prior years although our existing assets continue to perform well as they run off. ARMOUR owns $104 million of legacy MBS. Like many market participants, we continue to hope for a revival in the jumbo securitization market, but see plenty of opportunities elsewhere while we wait. While we've owned more significant amounts in the past, our new issue jumbo MBS exposure is only $11 million.

On the Agency side, the portfolio is comprised of six major components. 25% of our portfolio is comprised of 15-year passthroughs, of which 83% of those have loan balances less than $175,000 making them pretty convex assets. 13% of our portfolio is comprised of 20-year fixed rate assets maturing between 181 months and 240 months with a weighted average seasoning of 70 months, the seasoning also provides great complexity to those asset classes. 16% of our portfolio is comprised of Fannie Mae multi-family bonds or DUS, which is a delegated underwriting and servicing bond, which are generally locked up from prepayments for the first 9.5 years of their 10-year expected maturity. Currently that portfolio has an 8.1 year average weighted maturity to the balloon date.

The lack of amortization causes these assets to roll down the curve particularly as they approach benchmark areas like the seven-year and that provides great potential to trade higher. 11% of our portfolio is comprised of 30-year maturity fixed rates, of which 95% of those have $175,000 loan balance or less. We continue to see certain TBA dollar rolls at attractive levels versus owning and financing bonds. We have dollar rolls with a notional value of $2.25 billion. We actively monitor the attractiveness of risk and return in dollar rolls and may increase or decrease depending on market conditions. Our $92 million hybrid ARM position has a weighted average 12 months to reset. We've also initiated a modest position in interest-only securities. These IO positions deliver positive returns as well as an interest rate hedging characteristic.

We may add here as time goes by. Our current dividend of $0.22 a share is a return of 9.8% on today's estimated equity. This is very competitive with our peer group we believe and we feel is sustainable in the current environment. Our notional swap positions were reduced from $6.6 billion at March 31, 2016 to $5.4 billion today driven by smaller Agency book requiring less rate protection in addition to assets such as the CRTs which do not require rate hedging. We have zero forward starting swaps. Financing remains consistent for us and reasonably priced for our business plan. ARMOUR maintains MRAs with 41 counterparties and is currently active with 28 of those for a total financing of $7.7 billion. We have $100 million advance from the Des Moine FHLB that does not mature until December of 2016.

We frequently analyze opportunities for financing for periods of a year and longer and will add this to our book when attractive. New counterparties and new structures under review hold promise for additional compelling sources of portfolio funding. Our overall outlook for our business remains constructive. The addition of non-agency assets provides us an attractive yield that lowers rates sensitivity, swap exposure, and leverage. We subscribe broadly to the theme of lower for longer with the longer end of the curve trading within a relatively firmly bounded range. The backdrop of the US economy making painfully slow but relatively steady progress bodes well for credit exposure in the residential sector. The extremely slow pace of domestic economic expansion combined with international headwinds we believe lowers the ultimate scale of rate risk.

Nonetheless, we remain wary of volatility and will continue to carry substantial protection against interest rate risk. We currently see our equity allocation of Non-Agencies as approximately 19% of our capital base. We define that equity allocation as a percentage of our equity tied up in haircuts for repo. We expect that this allocation will grow over the long term. While gross portfolio allocations will show a much larger quantum of agencies on our balance sheet, we think the purest way to think about capital allocation is by equity committed to financing haircuts in each sector. Non-Agencies have substantially higher haircuts, but equivalent or better equity yields which lowers leverage. Equity is not tied up in financing haircuts is our liquidity and that liquidity is available to any part of the portfolio. Hence our focus on equity and financing haircuts is the real bright line showing capital allocation.

Operator, that concludes our prepared remarks, we'll now take any questions. Thank you.

(Operator Instructions) Douglas Harter, Credit Suisse.

Can you talk about whether you think you've taken all the portfolio actions for this new rate environment or you think there is more to do on the hedging side?

This is Jeff Zimmer. There's nothing to do on the hedging side right now except for the following. If we grow the Non-Agency sector a little bit more so say we bought another $100 million CRTs, then we look at our collateral versus four times or five times that amount. So for example if we did buy another $100 million CRTs, we would either let paydowns go down by $400 million or $500 million of Agency collateral or we'd have to sell some, that would imply the necessity to go ahead and unwind some of the hedges that much support those Agency assets.

Okay. And can you give us a sense as to where sort of your all-in hedged cost might be today relative to the second quarter and should that result in a better spread outlook for the third quarter?

I'm going to defer to Jim and Mark for actual numbers on that if they have those ready. Jim or Mark?

This is Mark. I would say our hedge costs or the financing costs really haven't changed much. Over the last 30 to 60 days, repo has been pretty steady and we haven't really made any changes on the hedge side.

Chris Testa, National Securities Corp.

Just wondering if you can give some detail on the pace of dispositions of the Agency MBS so far in the third quarter and whether you're kind of unloading these at a quick pace given where Agency prices are and where rates are or if this is more measured?

So if you look at the monthly Company update, which came out last week dated July 20, you can see that the Agency portfolio at the time was $7.4 billion. You go back and compare that to the month before and it's down really only due to two components, the natural prepayments that we have which are running at let's say $120 million a month give or take and the fact that we are selling some as we buy the CRTs as I just explained to Doug Harter. We won't be selling any Agency assets here unless we find Non-Agency assets to fill the gap on the other side. We're fully invested as we are right now and actually exactly where we want to be.

Okay. And I just noticed on the Agency side, there was some are longer duration Freddie Mac securities added. Was that just simply from the JAVELIN purchase or is that something you're kind of seeing opportunity in and we should expect maybe more composition in that?

The only longer duration assets that I can see on our books right here would be the dollar rolls of the 30-year 3%s. So, we have those at about a 3.0 duration now and we do have the multi-families, which are about a 6.7 duration on our book. They have been and will continue to be the longest duration assets that we have. The other assets that are long duration actually take it down into the 2%s or so. So, I think you might be referring to the Fannie Mae or the Freddie Mac delegated underwriting securities or perhaps the dollar roll securities and I don't expect any changes there at all in the near future.

Okay. And just with the TBA, should we expect that to be an ongoing part of the strategy as that remains attractive here through the third quarter or is it something that you see as kind of a just quick opportunistic move?

It's a really good question. So as we looked yesterday morning at these dwarfed 2.5% roll, it was pick almost 70 basis points over buying the asset and financing it so take that seven times leverage and that's a very large pick. So as long as it's a good pick over buying and financing it, we'll continue to dollar roll it. We look at the 30-year Fannie 3%s in the mid to high 40s basis points as a pick so we'll continue to do that. At some point if that goes away, we'll take delivery and then perhaps sell them.

Trevor Cranston, JMP Securities.

A question on the new position in the IO securities. Can you say if you are still finding valuations in the IO market attractive and if you're still looking to add those to the portfolio? And then as a second part to that, to the extent you do, would that impact your decision on whether or not to incrementally take off more swaps? Thanks.

So in the IO position, we're not even $90 million as it is right now, but you have a negative duration of 9 and change and we have positive carry on those assets. The majority of the assets have I think the average as I look at this chart right now, Trevor, you have a weighted average net coupon of 5.12% and a gross of 5.63%. These are very, very seasoned assets. So, any of the changes in the prepayment environment wouldn't affect these securities because their wallets are so large. We will only add to that space as the opportunities are at least as good as they are right now. If they tighten up, we just won't add any more. And I wouldn't anticipate us selling them right away either. They'd have to really tighten up a lot for us to sell them. We anticipate because this is a new area for us to keep the exposure in some respects de minimis, I wouldn't expect it to get much over $100 million at least in the near future. So, I hope that answers your question.

Yes, that does. And second question, can you just give us an update on your outlook for prepaid speeds over the next two or three months given the drop in rates we had right at the end of June there? Thanks.

So, our prepayment for our portfolio went up 30% of what the float went up last month. And as Scott said in his comments, 80% of our entire portfolio, that's Agency and Non-Agency combined excluding the TBAs, have some prepayment protection; either $175,000 balances or less or they're DUS bonds or they're CRT bonds. So, you wouldn't expect the ARMOUR portfolios to have prepayment increases that are anywhere close to what the national float would look like. That being said, prepayments will increase. Internally we like to model increases are like 5% to 10% to be conservative in terms of our expectations, but in no way should you as an analyst think that those are a direct response from management saying that that's what they'll be.

(Operator Instructions) Brock Vandervliet, Nomura Securities.

I just wanted to circle back on some of the first questions on leverage and maybe I missed this earlier, but are we there yet in terms of the decline in leverage? It sounded like we may be, but I wanted to confirm that.

Leverage could come down if we are able to increase our exposure to the Non-Agency side a little bit, Brock, because as I had said earlier to Doug Harter, we look at the CRT bonds as about 4 times to 5 times to 1 time versus our Agency assets depending on which Agency assets they are so say it's 4 times. So if you were to buy $100 million CRTs, that would mean that would be $400 million less Agency bonds so that would reduce leverage appropriately. And one thing that nobody's asked is why aren't you buying more CRTs? When we started buying, they were in the low 600s to high 500s. We watched the whole shenanigans from late January and February when the markets were very volatile and unstable. We started to buy not too much longer after that when we announced the JAVELIN deal. So now that the CRTs are priced inside a [4.25%], they are not as perfect for our portfolio as they might be at [5.25%]. So, our reduction of leverage will be in sole response to our exposure increase in the Non-Agency area.

Okay. And separately if I look at your hedge ratio or just hedge swaps divided by repo, it looked like that had increased in the quarter. Is that mainly driven by little activity there and lower balances or some other factor?

Complete lower balances on the Agency side, that's as simple as that. But we've kept some of our exposure in the 10-year sector as we added the Fannie 3% dollar roll. So, we're right where we want to be with our hedges, very comfortable with it.

And do you think post Brexit second half we are more bounded in terms of the macro rate environment and that would allow you to drop that ratio further?

We're not hedging our CRTs or most of our Non-Agency assets, they don't need to be hedged. They are either uncapped floating or the durations as a result of that are very, very low so we don't need. So as we increase if we are able to increase our exposure to the Non-Agency assets, you would see the hedge ratio versus the entire book go down. I might focus on as an analyst what the hedge ratio is versus the Agency portfolio and so that's kind of what we do. As I just said, $7.5 billion there and you have a good portion of that hedge about 75% of it. So, that's how I would look at it.

David Walrod, Ladenburg.

Just wanted to clarify something. Scott, at the end of your prepared remarks, what did you say the capital allocation breakdown was between Agency and Non-Agency?

I noticed in your comments that you put out this morning, we look at it a little differently. So, what we do is we look how much of our equity is tied up in haircuts and currently 19% of our equity is tied up in haircuts for Non-Agency assets and so that's how we look at the allocation.

Okay. The numbers that I used in my note were from your monthly Company update dated as of July 18 which says 37.6%. So, can you help me understand the differences there?

I'm looking at the monthly Company update, what page is it?

Page 5.

That's a really good question and page 5 is accurate and the 19% is accurate. So, the 19% reflects all of our equity and the 37% represents the equities that's tied up in haircuts and excludes the liquidity position. So at the bottom of the page you can see we have $564 million in liquidity, that 37% excludes that. So to your point and this was brought up in another private call that we had recently, I think we'll be more explicit as we present that in the future. So a good pickup, David, thank you.

(Operator Instructions) Kenneth Bruce, Bank of America Merrill Lynch.

This is This is Sean Tillman on for Ken. Just following up on Dave's question. For modeling purposes, which number should we try to think about, the 19% that you guys gave us or the 37.6% in the Company's monthly update?

So, the 19% represents all of our capital and includes the function of the fact that we have a lot of liquidity sitting on the balance sheet. So, I think for modeling purposes if you want to look at our income producing assets, maybe if you look at the 37.6% might be a simpler way to model that meaning that you're excluding the liquidity function. If you want to include the liquidity function, you got to put the 19%. And really anybody in this business is going to have to look at it both ways. We consider liquidity to be just as important if not more important than the assets that we're picking in some respects because if you look at all the volatility in the markets since January 3 or January 4, without that liquidity a lot of those assets might have to have been sold. So I'm giving you two answer to your question, but I hope you can choose one that fits your perspective best and choose it.

Little clarity then, last quarter you guys said you U&A is about 25% of Non-Agency equity over the near term. What number new presentation should we be thinking about that, the 19% going 25% or are you over your threshold at that point based on your last quarter's commentary? Just a little clarity around that.

We hope to take the 19% number up toward 25%. So, that's still our goal and a lot of it depends on where spreads are in the marketplace. I was pretty explicit a couple of minutes ago about how the CRTs have come in so much. The non-performers have come in almost 100 basis points as well. So at some point, and maybe this morning might be a good time to explain that, the Agency assets levered business model 8 times actually is going to produce a little bit more than the NPLs on a levered basis if you want to lever those 3.5 times to 4 times. So, for us to get to 19% to 25% is going to be dependent on the attractiveness of the spreads in the Non-Agency environment.

And one final question and changing gears a bit. You guys are trading about 80% of book value and you have been one of our prolific share repurchasers in the group. Have you thought about buybacks or is that kind of not on the table given your new strategy of targeting Non-Agency?

Buybacks always have to be part of something that we discuss at every single Board meeting and we also have monthly Board calls and it's part of every single conversation. What we're looking at right now is the following. We're including our preferreds about $1.150 billion at market cap although if there weren't great opportunities to invest in, we might be considering more heavily buying back shares. However, the investment opportunities have been really, really good recently. Our returns in the second quarter, income returns with the book values returns because we were able to find assets that offered a lot of value. So the answer is if there is no longer assets that offer great value and we're still trading at a large discount, you would look to see us buy some more shares back.

Brock Vandervliet, Nomura Securities.

I just wondered if you could give us some sense of the RPL/NPL portfolio, some of the characteristics of that whether it's more weighted to one or the other?

I'm going to let Mark give you a little color on that. The one thing I'll say before I hand it over to Mark is we like that asset class a lot and we purchased as much as we could when spreads were wide and they've come in so darn much that they just don't make sense anymore. But Mark, maybe you can be a little more definitive on what the percentage of NPLs is and RPLs in the portfolio and where we stand there?

It's going to be mainly NPLs in the portfolio. They're structured securities senior pieces off of deals over the last year or so, but the majority of it is NPLs in there. There are some RPLs, but it's a funny transactions for the sponsors is really what it is.

Mostly BOLTs.

Would you consider buying more RPLs if the NPL spreads are pretty tight?

We have. The difference would be RPLs are usually longer securities and they are a little different. We like these [BOLT] transactions because they are shorter with some better characteristics that we like. But we definitely have been looking at RPLs over the last year or so. Just we thought these are better securities for us.

(Operator Instructions) And there are no further questions at this time, sir.

Thank you very much for tuning into our second quarter earnings call. Please feel free if you have questions at any point in time to call Mark, Jim Mountain, Scott, or myself at the office and we'll get back to you immediately . Thank you very much and have a good day.

Ladies and gentlemen, this does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.