Armour 住宅房產信托 (ARR) 2022 Q4 法說會逐字稿

Good morning, and welcome to ARMOUR Residential REIT's Fourth Quarter 2022 Earnings Conference Call. (Operator Instructions) Please note, this event is being recorded.

I'd now like to turn the conference over to ARMOUR's Chief Financial Officer, Jim Mountain. Please go ahead.

Thank you, Anthony, and thank you all for joining our call to discuss ARMOUR's Fourth Quarter 2022 Results. This morning, I'm joined by ARMOUR's Co-CEOs, Scott Ulm and Jeff Zimmer; and Mark Gruber, our CIO.

By now, everyone has access to ARMOUR's earnings release, which can be found on ARMOUR's website, www.armourreit.com.

This conference call includes forward-looking statements, which are intended to be subject to the safe harbor protections provided by the Private Securities Litigation Reform Act of 1995. The Risk Factors section of ARMOUR's public reports filed with the Securities and Exchange Commission describe certain factors beyond ARMOUR's control that could cause actual results to differ materially from those expressed 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 ARMOUR's website shortly and will continue there for 1 year.

ARMOUR's Q4 comprehensive income available to common stockholders was $39.5 million. That includes $39.4 million of GAAP net income. Net interest income was $11.6 million and net interest margin for the quarter improved 38 basis points to 2.59%.

Distributable earnings available to common stockholders was $38.8 million or $0.27 per common share. This non-GAAP measure is defined as net interest income plus TBA drop income adjusted for the net coupon effect of our interest rate swaps, minus net operating expenses. ARMOUR paid monthly common dividend of $0.10 per common share during the quarter and has paid dividends at that rate since January -- and has announced dividends at that rate for January 2023 and February 2023.

Yesterday, we announced an adjustment to our dividend rate to $0.08 per common share monthly. As we have discussed in our previous calls, our aim is to pay an attractive dividend that is appropriate in context and stable over the medium term. We keep a keen eye on economic conditions and the ARMOUR Board believes that this dividend rate achieves those objectives. With this dividend declaration, lifetime cumulative common and preferred dividends are approaching $2.1 billion.

During the fourth quarter, we purchased 449,700 shares of our common stock at an average cost of $5.01 per share under our standing repurchase authorization. On the sales side, our common stock ATM program has been very successful. During the fourth quarter, we issued 30,721,405 shares raising $174.2 million of capital after fees and expenses. That represents an average net landed price of $5.67 per share.

So far in Q1 2023, we've issued approximately 29,863,000 shares, raising net capital of $181.3 million. This represents an average price of $6.07 per share. This brings our common share count to 192,774,581 shares, representing a common share market capitalization of over $1.1 billion based on last night's closing market prices.

In addition to providing capital to take advantage of appealing current investment opportunities, share issuances build a larger base over which to spread our mostly fixed running costs. Our book value at quarter end was $5.78 per common share. Our most current available estimate of book value is as of Monday night, February 13. We estimate that our book value was $6.04 per share after providing for the February dividends.

We finalized our tax projections for calendar 2022. And as expected, all common stock dividends and Series C preferred dividends were treated for Federal income tax purposes as a return of capital and are not currently taxable. This is comparable to 2021's tax results.

Looking forward to 2023, we expect that Series C preferred stock dividends will likely be treated as fully taxable ordinary income to those shareholders. We also expect common dividends for 2023 will likely be treated at least partially as taxable ordinary income.

Now let me turn the call over to Co-Chief Executive Officer, Scott Ulm, to discuss ARMOUR's portfolio position and current strategy in more detail. Scott?

Thanks, Jim. While 2022 marked an all-time worst year for total returns on U.S. treasuries and agency mortgages since their inclusion in fixed income indices, several trends beginning in the fourth quarter and extending into the new year give us optimism that 2023 will see a very constructive environment for MBS and our investment strategy. MBS volatility, which was exceptionally high in 2022, is declining. While the Fed seems by no means to be at the end of rate increases, the size is moderating and we should eventually see a more stable rate environment.

We also expect the economic and rate environment to continue to moderate the supply on mortgages. Most importantly, the unprecedented decline in bond prices generated incredible values as measured by 0 volatility adjusted MBS spreads reaching just shy of 150 basis points. Spread levels not observed since the great financial crisis of 2008, '09. While spreads have tightened driving our book value gain, we continue to see an attractive investment environment.

Responding to new investment opportunities, ARMOUR purchased over $3 billion of MBS pools and TBA positions in the fourth quarter of 2022, split $2.2 billion in MBS and $800 million in TBA. ARMOUR continued to grow its portfolio in 2023 with the addition of $5.9 billion of MBS, divided $4.9 billion of MBS and $1 billion of TBA.

As of February 13, ARMOUR's portfolio size is over $12.3 billion. ARMOUR supported the new purchases through our ATM share issuance program, raising over $345 million in capital since the third quarter of 2022. The MBS assets we purchased are concentrated in the most liquid, low premium bank service production coupon MBS pools. We believe these pools will benefit the most as volatility eases from its recent highs and reverts to historical norms. These investments also reflect historically low prepayment risks as the MBA refinance index has fallen to its lowest level since the 1990s.

ARMOUR's average prepayment rate for all MBS assets in the fourth quarter of 2022 was 4.3 CPR and just 3.7 CPR so far in 2023. Although mortgage rates have already declined from the recent highs of 7.2% in early November 2022 to 6.3% in mid-February 2023, a substantial refinance wave would require mortgage rates well below the 4.5% to provide approximately 20% of existing borrowers with enough incentive to prepay [early].

ARMOUR maintains very healthy levels of available liquidity. Our total leverage closed the year at 6.8x and currently sits at 8x, providing us with room to increase our investment portfolio size as future opportunities come along. ARMOUR continues to fund just over 50% of borrowings through our broker-dealer affiliate, BUCKLER Securities.

Despite the overall increase in market volatility, agency repo funding remained on a strong footing throughout the quarter, with spreads ranging 10 to 20 basis points above the SOFR benchmark. The weighted average haircut on our repo book remained exceptionally low at 3.6% of years (inaudible) numbers.

We see leveraged and hedged returns in the current market in the low to mid-teens. For prospective investments as well as the current book, a substantial amount of yield is provided by hedges. Nonetheless, we've always viewed our investment book as holistically comprised of MBS and related hedging. As we've always noted, we set our dividend to be appropriate for the medium term. Earnings available for distribution have moderated, and we feel it is appropriate to reduce our dividend by $0.02 to $0.08 per month.

We will, as always, continue to evaluate the level of the dividend. We're also mindful that this environment could deliver upside surprises as well that can move our metrics substantially.

We'll now open the line to questions.

We will now begin the question-and-answer session. (Operator Instructions) Our first question will come from Doug Harter with Credit Suisse.

I was hoping you could talk about where you see available returns on incremental investments and just help put the new dividend in the context of those returns rather than an EAD perspective.

Doug, it's Jeff here. Thanks for calling in. Available returns are in the 14% to 16% area. Some of that's supported by the new marginal investments, of course, supported by swaps are still positive. [You've done a] swap you're actually getting paid. So back -- looking back 2 years ago, you paid on a swap and maybe detrimental to your earnings capability as well now the swaps that we have and swaps we put on are incremental to the earnings and that's a benefit to shareholders.

So we pay that out, $6 a share, you got about a 16% payout right now. We think that's appropriate based on the book that we have and where we've been able to invest. I think as Scott stated 150 basis points, just the nominal spread is almost as good as it gets. And I think in October, we might spike out to 175, 180 for a very short period of time. But these are the best investment opportunities that we've seen in a long time, and we're making the investments with our new capital and paying that benefit out to shareholders.

Okay. And then just on expenses. You talked about one of the rationales for using the ATM being to kind of spread the expense base. I guess if I look at the operating expense as a percentage of equity, it's actually been going up over the course of the year since the management fee is...

Doug, you there. Yes. we lost you.

Let me try and jump in and look -- did we get you back, Doug?

His line has gone silent.

If you're listening or we'll pick up the answer on replay. Sort of the way we look at expense and the ATM, when we look at the sort of the dollar difference between net landed proceeds and recent book value that we actually use to guide the ATM program for the full year, that dollar difference that we disclosed in the 10-K is about $9.5 million. If you divide that by ending share count at the end of the year of about 163 million shares, you get $0.06 a share or $6 ending share price, that's kind of 1%-ish.

But if you look at running costs for 2021 divided by ending shares, that's $0.37 a share ending -- the running cost for 2022 divided by ending share of $0.23 a share, so $0.14 per share pickup. If it costs you $0.06 a share to pick up $0.14 annually, that's a payback of -- seems to us less than 6 months, good deal.

So Doug, thank you for calling in. If you'd like to call back, I'm sure the operator can put you in. Otherwise, operator, if there's another question available, we're here to answer.

Our next question will come from Trevor Cranston with JMP Securities.

Looking at the portfolio over the last few months as you guys have added MBS and moved up in coupon, it looks like the hedge positions haven't changed all that much. So I guess, there's 2 questions. First, can you say what the treasury hedges that you show in the slide deck, could you detail what those are? And can you more generally just talk about how you guys are approaching hedging rate risk as you make incremental investments here?

Sure. Mark, why don't you get into that, please? Chief Investment Officer, Mark Gruber.

Thanks, Jeff. So Trevor, so the first answer is the treasuries are going to be a mix of futures and cash treasuries and it's going to be across the curve. So 2, 5, 7 cents, so it's just a mix of that. And yes, as we've added assets, we have moved up in coupon, so the duration of the asset side has shortened, and we didn't add a lot of hedges also because we took our duration up a little bit. We were a little more comfortable as rates were higher to not add hedges and extend the portfolio duration just a little bit. So that's what's going on there.

Okay. Got it. That makes sense. And then in terms of leverage, obviously, the portfolio has been growing, and it looks like leverage is up to around 8x or so currently. Is that kind of where you guys are targeting for the near term? Or could we expect some additional portfolio growth over the next month or so?

Historically, Trevor. Go ahead, Mark. Either way.

I was going to say, we're targeting somewhere between 8x and 9x. So we have a little bit of dry powder. Historically, we've been closer to 9x. So you'll probably see it drift up a little bit from here, but not much from where we are today.

(Operator Instructions) Our next question will come from Matthew Howlett with B. Riley.

On the topic of leverage, I mean obviously, you've had great success, the access from the equity capital markets. When I look at the preferred markets here, and there's been some recent activity in this space and look at your Series C is trading at (inaudible) on a 7% coupon. What's the outlook? I mean your equity, your common equity base is increased to the extent that you look that you do have room to do another preferred series. What sort of -- you looked at that market? Is it open? Would you look at it here in '23?

Good morning, Matt. Jeff Zimmer here. So if you look at our preferred last night, I believe it closed at [22.5], okay? So it's a current strip yield of something like [778], okay? The reason that we issued a fixed, fixed, and we are the only company whose primary issuance over the last 3 years have been fixed, fixed because we did not want to subject our balance sheet and our income statement in the future to the possibility of rates going up and rates are higher.

And the most recent issuance by other firms in our broader space have been at higher coupons and the existing issues that they have outstanding that were fixed for 5 years and go to floating will mean their coupons are going to go to 9% and 10%. So in the environment that we have today, we're able to raise common equity right around par, right around book value, as Jim Mountain stated.

We think that, that's a better way to run the company right now. We can access mortgages at some of the wider spreads they've been in a decade. We access capital around book value and the costs go down. You would not see us in the near future going back to the preferred market. It's just too expensive right now. I hope that answers your question.

No, it does. And it's -- look, I certainly acknowledge that you don't have that -- those 5-year switching to floating. So that was a good move on your part. And it certainly looks at the balance sheet has room, but if you choose to wait for the market to come back, that would make sense.

And then, Jeff, just on the macro question, it looks like the Fed -- I'd love to hear your thoughts, and it looks like markets thinking 25 in March, 25 in June and then pausing. I'd love to hear if you think the next rate -- next move after that would be a cut.

And then on the Fed, obviously, the balance sheet, I think Powell said it'll take a couple of years to shrink the MBS. Just your thoughts on the impact on MBS spreads. Would they -- do you think that they'll eventually start selling? Or what could surprise us, I guess?

So I'll address that, and then I'll see if Mark or Scott want to improve. We do expect an increase at the next 2 meetings of 25 basis points. Our firm does not anticipate the Fed cutting rates in 2023. If they cut, it would be in 2024. The economic numbers that are coming out are just showing that the employment picture is very strong. And that's not going to go away. It's going to take some time. They may internally have to change their target from 2% to like 3% to 4% without announcing it to ease off the pedal a little bit.

On the other hand, we did see an announcement yesterday that already we're seeing commercial credit defaults. Without saying companies names, there were 2 defaults just announced for office buildings in New York and L.A. So even though you have a very strong employment situation, as you see credit defaults and we're sure the Federal Reserve expects these credit defaults, you'll see that will spread to the employment sector. It just takes a while. So that's where we are now.

Now we also believe mortgages, as I said a number of times on today's call, are historically very well priced and attractive. We would expect in the near future for mortgage spreads to stay where they are or even perhaps tighten a little bit. We are not nervous about the Fed selling mortgages down the road.

As a matter of fact, most of what they would have to sell, they're not in our portfolio, frankly. We've got a mid- to higher coupon matrix right now that Mark and his team have put together, and Fed just doesn't own that stuff. So they want to go ahead and sell their 2 and 2.5, which are areas that others may be invested in, that's fine. But there's no other supply other than them, and there's no originations in that sector.

So we're always going to be aware of it and we're acutely aware, I guess, is to say, of the possibility of them selling, but it shouldn't have an awful direct effect. Now look, when the tide goes out, all ships go down, okay? And we understand that. But we will not have a direct impact on the assets we own from them selling the coupons in our portfolio. So does that answer your question?

No, absolutely. And it's always good to hear your insight on that. And I guess the last topic, the CPRs, I mean, I think you said 4.7. And these are the lowest numbers I've ever seen in my career. And I look at -- and I asked the question on the last call about [convexing]. It looks like you're buying step close to par now here. I mean, just you think you said any sense on if there'll be a pickup in CPRs. I mean what you're looking at when you put on your new MBS at these higher coupons?

I'm going to hand that over to Mark because he and his team spend a lot of time working on that. Mark?

Yes. We would expect in our portfolio CPR to pick up a little bit. We're adding newer bonds, so they're going to start at 0 and they're going to slowly ramp up. And it really is going to depend on rates. If rates decline -- mortgage rates decline, we'll see a pickup. But we don't see anything systemic where we go back to 15, 20 CPR right now.

And the premium you're adding, is it just sort of minimal in terms of what you're putting on that you're booking?

It's minimal. The pay-ups in general, like we said earlier, are usually single digits, maybe 0.5 point, but when you look at 5.5 or 6 coupons, it's 2 points or so.

Our next question will come from Christopher Nolan with Ladenburg Thalmann.

I think I'll try to take up from the -- I think, the line of questioning Doug Harter was pursuing. On the dividend, I'm hearing mixed signals from the standpoint that you're saying that the environment is good and you're going to get low to mid-teen returns and then we're cutting the dividend. And I guess my question really centers, is the dividend cutting just expectations of a dramatically growing share count going forward? Or can you give some clarification on that, please?

Sure. In all cases, when we increase our share count, it's to benefit existing shareholders and not just new shareholders. So as I said before, we look at it very holistically. Repo rates have gone from 25 basis points to 4.5% and 4.7% right now. So as those repo rates go up and the 10-year remains inverted to those rates, it's generally going to put a stress on your earnings rate.

So whether we had raised 0 or $300 million, we would be cutting the dividend right now. So please look at that as the holistic approach and as separate things. I hope that's helpful.

Yes, it's helpful. It's just -- I thought I heard your comments where you're going to have low to mid-teen equity returns, which is pretty consistent with what you've been saying in recent quarters. I might have misheard it, but trying to get a clarification.

Returns available are in the 14% to 16% range, and we're currently paying approximately 16%. But what I also said, and I wanted to be crystal clear on that, so we have a very large swap that was put on at very low rates. And that still covers about 65% of our repo book. So that is a real big driver and benefit that we're passing along to shareholders in terms of earnings. So that's a trailing aspect and some of that has quite a ways to go.

It appears there are no further questions. This concludes our question-and-answer session. I would like to turn the conference back over to Jim Mountain for any closing remarks.

Well, we'd like to thank you all for joining us this morning for the attention that you give to our firm and our stock and our shareholders. And I look forward to speaking again in April. Until then.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.