Armour 住宅房產信托 (ARR) 2018 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the ARMOUR Residential REIT Inc. Fiscal First Quarter 2018 Conference Call. (Operator Instructions) As a reminder, this conference is being recorded, Thursday, April 26, 2018. Now I'd like to turn the conference over to Jim Mountain, Chief Financial Officer. Please go ahead, sir.

Thank you, Tommy, and thank you, all, for joining our call to discuss ARMOUR's first quarter 2018 results. This morning, I'm joined by Armour's co-CEOs, Scott Ulm and Jeff Zimmer; and our Chief Operating Officer, Mark Gruber. By now, everyone has access to ARMOUR's earnings release and Form 10-Q, which can be found on ARMOUR website, www.armourreit.com. 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 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 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 to do so by law. Also, our discussion today may include reference 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 1 year.

ARMOUR's first quarter GAAP net income was $44.7 million or $0.96 per common share. Core earnings were $32 million or $0.66 per common share, which comparably exceeded our dividends paid. Based on stockholder's equity at the beginning of the year, core earnings represent a 9.7% ROE annualized. Differences between GAAP and core income are mostly due to the treatment of TBA drop income and unrealized gains on our interest rate contracts. We paid dividends of $0.19 per common share for the first quarter of 2018 for a total of $24.1 million or $0.57 per common share for the quarter. We have announced April and May common dividends of $0.19 per share to shareholders of record on April 13, 2018, and May 15, 2018, payable on April 27 and May 30, respectively.

Quarter-end book value was $24.61 per common share, down $2.01 for the quarter, due primarily to rate increases, and a lesser extent, to the spread widening. Adjusted for dividend, that represents a total economic return of a negative $1.44 or a negative 5.4%. As a reminder, we include updated estimates of book value per share in company updates available on our website. Book value at April 24, 2018, was estimated to be around $23.69 per common share outstanding.

ARMOUR's quarter end portfolio consisted of over $6.2 billion of agency securities, plus another $4.3 billion of Agency TBA positions. Our credit risk and non-agency positions totaled $1 billion at March 31. In addition, we added $700,000 -- $700 million approximately of U.S. Treasury Securities as of March 31. Now let me turn the call over to co- Chief Executive Officers, Scott Ulm and Jeff Zimmer, to discuss in more detail ARMOUR's portfolio position and current strategy.

Thanks, Jim. The beginning of 2018 saw a sharp reversal from 2017, a year marked by low volatility and strong returns across fixed income products. The volatility in the stocks -- stock and bond markets, as measured by the VIX and MOVE indices has rebounded sharply, while the yields on 10-year treasuries reached their highest level since January of 2014. With such a turbulent backdrop, the agency MBS index boasted negative 1.2% returns, its worst first quarter total return performance over the past 20 years. Because of higher durations, 30-year MBS underperformed the 15-year sector, while lower coupons fared worse than higher coupons. Similarly, agency CMBS index posted a negative 1.2% total return, while outperforming a 7-year to 10-year U.S. treasury benchmark return of negative 1.9%. Despite such unfavorable market tone, our credit risk transfer bonds, CRTs, issued by Freddie and Fannie, returned a positive 1.1% to 1.4% in the first quarter. It seems unlikely, as we study the credit worthiness of our CRT portfolio, that we should experience any meaningful degradation of quality, given strong U.S. housing fundamentals. A relatively small non-agency legacy portfolio remained a positive contributor to the results, with an average of 1% of total return for the first quarter.

As of April 24, our funded leverage ratio or debt to equity is approximately 6.1x, a somewhat higher number from the 5.8x ratio observed at the end of 2017. During a period where rates increased in the first quarter, we added 5-year and 7-year treasury notes at what we believe were good risk-adjusted yields versus lower coupon mortgages at the time.

Additionally, we faced no mortgage basis risk or widening on those treasuries. Adding in the leverage effect of unfunded TBA dollar roll positions, results an implied leverage of 8.3 as of April 24. While TBA dollar rolls do not have the extreme levels of specialness observed prior to the beginning of Fed taper program. Most TBA coupons continue to imply lower financing rates than those obtained through the general collateral repo market. This funding advantage existed long before the QE programs, and we expect it to remain an important component of our agency MBS strategy. We expect the Federal Reserve to announce 3 more federal funds rate increases in 2018, and we've taken steps to limit our sensitivity to these hikes and heightened market volatility.

As of March 31, 2018, we maintained a hedge book of pay fixed received floating swaps of $6.8 billion notional. Our agency fixed-rate asset repo position is a covered 110.8% by swaps. Our net duration is 0.54, a decrease from 0.80 on December 31, 2017. This number does not include any negative duration effects from our repurchase liabilities. Our spread DV01 is $4.87 million, a decrease from $5.35 million on December 31, 2017. Despite lower risk exposures, we anticipate that core earnings will cover our dividends during the second quarter of 2018. The average prepayment rate on our agency assets has decreased for the third consecutive quarter to 6.3 CPR. This rate is our lowest quarterly rate since the second quarter of 2014, and the 6.9 CPR level for April remains well below the 2017 average of 7.3%. Prepayment risk is clearly faded with the increase in treasury rates. It's important to note that a good portion of our agency portfolio, excluding TBAs, is composed of assets with prepayment protection through seasoning, lower loan balances or contractual prepayment lockouts in our DUS paper. As such, as rates go up, the average life of these assets do not extend like typical MBS.

Repo financing remains consistent and reasonably priced for our business model. ARMOUR maintains MRAs with 46 counter-parties and is currently active with 27 of those for a total financing of $6.85 billion at the end of the first quarter. Most importantly, our affiliate, BUCKLER Securities, which became operational during the early part of the fourth quarter of 2017, is financing approximately 50% of our portfolio liabilities. Financing through BUCKLER provides us a greater security of financing, flexibility on terms, attractive rates, and therefore, an overall greater control over our liabilities. Lower haircuts from financing with BUCKLER also reduce our liquidity requirements.

Our investment in credit risk transfer securities was valued at $866.7 million at the end of the first quarter and represented 89.5% of our credit risk in non-agency portfolio. The performance of this sector has been exceptional since ARMOUR began investing in the first quarter of 2016. We've been rewarded both by the spread tightening that has occurred in this sector and by the attractive carry.

Our weighted average CRT coupon as of the end of the first quarter was 6.37%, with a weighted average discount margin of 4.5%. In the CRT transactions, we take the credit risk of recent Fannie and Freddie underwriting in return for an uncapped floating rate coupon. The combination of strong mortgage underwriting standards of the GSEs and increasing housing prices have provided a robust underpinning to the credit quality of the CRT bonds. In addition, these securities benefit from increasing credit enhancement over time that can lead to credit rating upgrades, and we expect several securities in our portfolio are potential candidates for future upgrades. These upgrades result in price appreciation and better financing terms. While our value and gains above par will amortize over time, the effect is relatively modest, about 1% of our CRT book value over the next 2 years, and that's likely to be further reduced by lower prepayments in a higher rate environment.

While gross portfolio allocations will show a much larger quantum of agencies on our balance sheet, we believe the purest way to think about capital allocation is equity committed to financing haircuts in each sector. Our allocation to credit assets, as a percent of all haircuts in repo at the end of the first quarter, was approximately 43%. Equity that's not tied up in financing haircuts is our liquidity, and that liquidity is available to support any part of the portfolio. At the end of the first quarter, ARMOUR owned $84 million of non-agency legacy RMBS. At the moment, we see very few opportunities for investment in the 2008 and prior non-agency MBS asset class. However, existing assets from that period continue to perform well as they run off. Like many market participants, we continue to hope for a revival in the jumbo securitization market. Our principal concern for the balance of 2018 is a turbulent geopolitical backdrop. If this becomes more prevalent, strong economic growth expectations will be hampered and stock market and bond volatility will increase. In the midst of the current rate hiking cycle, such developments raise the risk of a flatter or even an inverted yield curve and higher risk premiums. At this point, we believe those factors to be somewhat transient, and we expect strong economic growth expectations to reemerge to the forefront of investment guidance for the markets. We have positioned the portfolio and our hedging needs to reflect these potential hurdles ahead, while still allowing us to earn an attractive risk-adjusted return.

Operator, that concludes our prepared remarks. We will now take the questions.

(Operator Instructions) And we'll get to our first question on the line from Douglas Harter with Crédit Suisse.

This is actually Josh Bolton, on for Doug. Just one question about leverage. With the increase you guys saw in the quarter, how are you thinking about current leverage? Are you comfortable running in the 8s? Or should we expect some repositioning and some unwinding to moderate leverage back down?

Hey, Josh, it's Jeff. So leverage is where we want it to be, and we are quite comfortable with it right there. When the book value does go down, as it did in the first quarter, you will get a natural, obviously, increase in leverage. But at a 3% 10-year note, there are interesting opportunities to buy assets. I would not expect us to have any meaningful increase in leverage from here. But within a half a turn, you can see us at the end of the quarter either way. Notable, in terms of investment opportunities, as I just noted, dollar rolls are low to mid-teens right now. Specified premium balance assets are low to mid-teens. If you look at about a 7.5x leverage, it nets to like a 1 duration. So those are the kind of returns you're getting. Our leverage is a little higher than that.

Great, makes sense. And then just one quick one on funding cost, can you remind us the cost benefit you guys get funding through BUCKLER rather than street repo?

So I talked about that in the last 2 earnings calls that we had targeted initially the 5 to 7 basis point range. The competition in the repo market, as you may be aware, has actually limited our direct savings from BUCKLER, but this is a really good thing for ARMOUR REIT. You might be aware that there's been a backlog of companies trying to get approved by FINRA and the FICC, and as we were approved last fall, so were 6 to 7 other companies have come through. So they're all trying to get balances into their new corporate enterprises. So the aggressiveness in the repo market has benefited ARMOUR considerably. I would note that down the road is that -- that market stabilizes and the group isn't quite as aggressive that you'll actually be able to identify some larger direct savings from BUCKLER. But on the balance, we are very pleased with BUCKLER's performance.

(Operator Instructions) And our next question on the line is from the line of Christopher Nolan from Ladenburg Thalmann & Co.

You mentioned in the call that BUCKLER is handling roughly 50% of liabilities if I heard correctly. How much higher can we expect that to go?

I would think, right now, we're exactly where we want to be, and that's what we've targeted originally. So the only reason you would see that change a little bit, if for example, we sold some actually hard assets that we have repo-ed out and go into some dollar rolls, we won't necessarily adjust BUCKLER or one of our other repo counter-parties. We'll just let that roll off. But within a given range of where it is right now, we would expect to see it, at least, over the next couple of quarters.

Great. And Jeff, just a follow-up on the prior question, if I understood you correctly, you are expecting 5 to 7 basis points of funding advantage, which you did mention on earlier calls, so you're coming in a little bit lower than that. Is that correct?

Yes, we are. But it's a really good thing because the reason that we are is because the competition in the repo market has made pricing so much better than it had been prior to these 6 or 7 companies getting accepted by the FICC. So just to be clear, the business model is for those that have outside clients. BUCKLER, currently, the vast, vast majority of what is does is for ARMOUR REIT. The business model is you need to build up your book. And typically, if you maintain fair pricing, you don't see people move their repo from you very much. So these companies are all out trying to build up $5 billion to $10 billion books, and so they've been very aggressive in pricing. So it's benefited ARMOUR REIT considerably.

Great. Thank you for the clarification. Also, in the TBAs, you have $4.3 billion from TBAs, which is roughly 50% or so of your balance sheet assets. How high can we expect the TBA volumes to go, given the size of your balance sheet? Or is that not the right way to look at it?

Actually, I have TBAs right now currently on March 31 as 24.9% of our portfolio. Are you -- and that's kind of what we've been targeting. Are you referencing some numbers that I'm not familiar with or you don't know?

Just looking at the total assets in the balance sheet, the $8.4 billion.

Well, I'm looking at the March 31...

Jeff, let me answer. It's Mark Gruber. What you're seeing on the balance sheet, because the TBAs are classified as derivates, any forward sales don't get put on the balance sheet. So the net position is actually, I think, $2.3 billion as of the end of the quarter when you net-out some forward sales that happened in April.

Okay, okay. So $2.3 billion is really the correct number, not $4.3 billion in this respect?

I think it's $2.3 billion. I have to go check when you net it, but I think there is another disclosure, I think, in the MD&A that has the net.

You don't have to do that. I'm just trying to get a clarification. So roughly, you guys are up -- the TBA is roughly 25% or so of total balance sheet assets, which is normally the limit, I would think?

There is no limit, but we're targeting that or less right now. I wouldn't anticipate us seeing that go much higher. The opportunities in the bottles over there surprisingly very, very good, and we had anticipated after the move of the Fed from being so involved over the last 7 years, that those opportunities would exist. Well, indeed, they are. So we've been utilizing them, and when you see a reduction, if you do see it in our dollar roll position, it will mean just because the opportunities aren't there.

Got you. Final question is from the comments that you're talking about in terms of the outlook for 2018, should we infer from that you're sort of anticipating a steeper yield curve? Or I'm trying to get a clarification in terms of how you think the interest rate environment will evolve and how you're trying to position the balance sheet from that?

Our corporate position right now is that we’re going to see more of a flattener, but it might be at slightly higher rates than we are right here. Because if the Fed does increase 2 more times or 3 more times, very hard to see a [steepen-er] unless you see the 10-year note get up to 3.75 or 4. And we personally don’t expect the 10-year note to -- our next target range would be 3 to 3.25, which -- if we move from here. So expect a little bit more of a flattener. However, we’re at 48 basis points, as when I last looked, 2s to 10s, and we’re still making opportunities in the 12% and 13% range for specified pools in dollars rolls. So thus far, the flattener has not hurt our business model.

Actually, Ms. Mountain, we have no further questions on the line. I'll turn it back to you.

Well, thank you, Tommy. And again, thank you, all, for joining the ARMOUR's first quarter 2018 conference call. As always, if you have questions coming up in the intervening period, give us a call at the office. We will try and get back to you as quickly as possible, and until next time. Have a great day.

Thank you very much, and ladies and gentlemen, this conclude the conference call for today. We thank you for your participation. We ask you to disconnect your lines. Have a good day, everyone.