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Q1 2019 Earnings Call
May. 2, 2019 8:30 a.m. ET


  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Greetings, and welcome to the ARMOUR Residential REIT, Inc. first-quarter 2019 earnings conference call. [Operator instructions] As a reminder, this conference is being recorded Thursday, April 25, 2019. I would now like to turn the conference over to Jim Mountain, chief financial officer.

Please go ahead.

Jim Mountain -- Chief Financial Officer

Thank you, Kelly, and thank you all for joining our call today to discuss ARMOUR's first-quarter 2019 results. This morning, I am also joined by ARMOUR's co-CEOs, Scott Ulm and Jeff Zimmer; and Mark Gruber, our chief operating and chief investment officer. By now, everyone has access to ARMOUR's earnings release and Form 10-Q, which can be found on ARMOUR's 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 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 included in this conference call are made only as of today's date and are subject to change without notice. We disclaim any responsibility 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 measures 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 continue for one year. ARMOUR's Q1 2019 GAAP net loss was $114.4 million or $2.21 per common share. The net loss was driven primarily by mark-to-market losses on our interest rate swaps. Core income, which excludes mark-to-market items and includes TBA Dropped Income, was $37 million or $0.61 per common share.

For the last 11 quarters, our core earnings have consistently exceeded dividends. Through March 31st, that access totaled $36.4 million, which represents about $0.61 per common share outstanding at quarter end. Based on stockholders' equity at the beginning of the quarter, core income represents an annualized ROE of 13.2%. We were active in the equity market this quarter raising approximately $322 million in the first three months of the year.

We promptly invested that money to acquire additional target assets on a leverage basis, along with related hedges. We issued approximately 16.1 million common shares through these common offerings. Now we have 59,791,877 shares of common stock outstanding as of quarter end. The increased share base reduced our overall administrative expense per share by over 20% on a pro forma basis or about $0.05 per quarter running.

ARMOUR's quarter-end agency portfolio consisted of over $12.7 billion of mortgage-backed securities and about $800 million of TBA positions. Our continuing tactical bias away from TBA contracts and toward cash bonds reflects the relative softening we have seen in the TBA bid throughout Q1 and so far into April. Quarter-end book value was $21.29 per common share, up 2.1% for the quarter, reflecting our strong investment gains net of hedging and the excess of core income over dividends paid. Yesterday's press release also shows an immediate dilutive effect on book value of our Q1 stock offerings of $0.28 per common share.

However, $0.08 per common share of the reported net investment gains come directly from the additional assets we were able to acquire with the equity proceeds net of hedging. Considering the effect of the per-share expense reduction I mentioned earlier, we expect to recover the net per share dilution in just over one year. GAAP book value at April 22, 2019, was estimated at $21.10 per common share outstanding. Remember that we include recent book value estimates in our updated presentations available on our website or EDGAR usually around the middle of the following month.

We paid dividends of $0.19 per common share during each month of the first quarter and that represents a total of $29.8 million or $0.57 per common share. We've announced monthly common dividends for April and May, continuing that steady rate of dividend at $0.19 per common share. Now let me turn the call over to our Co-Chief executive officer, Scott Ulm, to discuss ARMOUR's portfolio position and another look at our current strategy.

Scott Ulm -- Co-Chief Executive Officer

Thanks, Jim. Good morning. December's market events did not follow the script for a soft landing that the Fed officials had in mind. In an attempt to reverse some of this rapid tightening of financial conditions, Fed Chair Jerome Powell set a contrastingly dovish tone early in 2019.

It was a sea change moment for the rates market and we believe for our business as well. A significantly more dovish Fed and oversold risk indicators left mortgages at some of the cheapest valuations since early 2016. ARMOUR seized this opportunity by raising equity as the outlook for volatility and bond markets improved drastically. Responding to the sharp turnaround in officials' appetite for further rate increases in 2019, yields on 10-year treasuries continued their decline from 2018 highs of 3.24% down to 2.37% by the end of March.

The significance of such a large move was reflected not just in lower absolute yields but also in an inversion of yields on longer-tenor treasuries versus the rate on overnight and three-month funding tenors and, historically, recessionary signal in predicting the shifts in economic cycles. National mortgage refinance rates followed the move in the treasury market, dropping by nearly half of a percentage point in the first quarter from the highs of 4.51% down to a low of 4.06% as reported by Freddie Mac survey index. Despite the large decline in mortgage rates and the pickup in refinancing activity from historical lows, the MBA financing index remains muted, well below average levels in the 2010 to 2016 period of ultralow rates. While we expect some increase in prepayments in our MBS portfolio, we feel we're well-positioned due to our significant proportion of prepayment-protected securities.

We do not foresee the scale or duration of refinancing activity to be enough to alter our current positioning. The rapid declines in treasury yields fueled a grab for duration and lower-coupon MBS and positive convexity bonds like 10-year DUS pools, where spreads rallied the most. The MBS index posted a 2.17% three-month total return, its highest since the second quarter of 2014. Mortgages bested treasuries by 28 basis points, a sharp turnaround from the fourth-quarter underperformance of negative 59 basis points.

The agency CMBS total return equaled 2.8% or 73 basis points better than duration-equivalent treasury hedges as reported by the Bloomberg Barclays Indices as of March 29. The dovish pivot in the official policy and lower mortgage rates should be a near-term positive for housing credit. Spreads for on-the-run CRT last cash flow bonds rallied by 75 basis points in the first quarter, a total return of 2.9%. Newer vintages outperformed more seasoned M2 cohorts by as much as 20 to 30 basis points, reversing their relative underperformance from the fourth quarter.

As we noticed in our last conference call, we view the new issue CRT market as nearly fully priced, but acknowledge that strong participation and a supportive housing market may provide strong tailwinds to valuations for a while. You can view our first-quarter 2019 portfolio on our 10-Q, but the highlights of ARMOUR's positioning as of March 31 were as follows. We maintained a hedge book of pay-fixed, receive-floating swaps of $9.8 billion notional. We are a net receiver overall.

Our agency fixed rate asset repo position was covered 83.4% by swaps. Our net duration was negative 0.18 basis points, an increase from negative 0.49 at the end of the year. This number does not include any negative duration effects from our repurchase liabilities. Our spread DV01 as of March 31st was $6.9 million.

And we expect the core earnings will cover our dividends during the second quarter of 2019. As of March 31st, our funded leverage ratio, or debt to equity, was approximately 8.2 times in the the leverage effect of unfunded TBA dollar roll positions and forward settling transactions resulted in implied leverage of approximately 8.5 times as of March 31. While TBA dollar rolls are no longer trading at the levels of specialness observed over the past few years, we continue to find pockets of opportunities where dollar roll financing is more favorable than the general collateral repo market. The average prepayment rate on our agency assets decreased from 4.7% CPR in the fourth quarter to 3.9% CPR in the first quarter of 2019.

Our April CPR increased to 5.5%, and we expect prepays to pick up in May and June as refinances ramp up from a rate rally. Approximately 76% of our agency portfolio is composed of assets with prepayment protection through lower loan balances or contractual prepayment lockouts as in our DUS paper. Repo financing remains consistent and reasonably priced for our business model. ARMOUR is currently active with 23 repo counter parties and, in addition, has signed MRAs with another 26.

The total repo financing was $12.1 billion at the end of March 2019. Importantly, our affiliate BUCKLER Securities is financing approximately 49% of our entire repo position and 51% of our agency portfolio liabilities. Financings from BUCKLER provides us with greater control over our liabilities. Our investment in credit risk transfer securities were valued at $727 million at the end of March 2019 and represented 89% of our credit risk in non-agency portfolio.

In the CRT transactions, we take the credit risk of Fannie and Freddie underwriting in return for an uncapped floating-rate coupon. The credit quality of our CRT bonds has continued to be reliable due in large part to strong GSE underwriting standards on the 2013 to 2016 vintages that we own. In addition, these securities benefit from increasing credit enhancement over time that can lead to credit rating upgrades. 59% of our CRT portfolio has been upgraded to investment grade.

Rating upgrades result in better financing terms and possible price appreciation. At the end of March, ARMOUR owned 70.6 million of non-agency legacy RMBS. Currently, we see very few opportunities for investment in this asset class. However, our existing holdings from that period continue to perform well.

Although the jumbo and non-QM market issuance is again projected to double versus 2018, non-agency mortgage issuance remains very low on a historical scale, keeping spreads tight. Given the tight credit valuations in the non-agency markets, we mostly see better opportunities in agency collateral. As we enter the second quarter, we see a market trading at relatively tight spreads in many sectors. The continued accommodative stance of the Fed provides us with a tailwind.

In this environment, we're comfortable with a modest increase in leverage beyond our unusually low levels of the past few years. We continue to maintain the capability to capitalize on opportunities as they may appear. While volatility seems subdued, we will continue to maintain our modest duration through our asset selection and hedge fund. Operator, that concludes our prepared remarks.

We'll now take any questions. 

Questions and Answers:


[Operator instructions] Our first question comes from Douglas Harter with Credit Suisse. You may proceed with your question.

Doug Harter -- Credit Suisse -- Analyst

Thanks. I was hoping you could talk about kind of where your average leverage was during the quarter kind of given the amount of capital you raised during the quarter, kind of just how to think about the average leverage versus kind of your ending period leverage as we think about earnings power going into the second quarter?

Jeff Zimmer -- Co-Chief Executive Officer

I would use low eights as a number. Remember, we raised capital, but we put the money to work oftentimes within two to three business days. Unfortunately, some of the bonds don't settle for a couple weeks and some of them settle T plus two, T plus three.

Doug Harter -- Credit Suisse -- Analyst

Got it. And just on that settlement question, when you're putting out your monthly portfolio update, I guess, at what point do you kind of include it in the portfolio just so that we can kind of try to figure out what that average balance was?

Jeff Zimmer -- Co-Chief Executive Officer

So if we have done a transaction or a sale, it is out of the portfolio. If we have bought bonds, but they haven't settled yet, it is in the portfolio. So if we sell something for May delivery, it's out of our portfolio. If we buy something for May delivery, it is in our portfolio.

Doug Harter -- Credit Suisse -- Analyst

All right. And then just thinking about the net interest spread that you're earning and kind of where that would sit today versus kind of the average you had for the quarter.

Jeff Zimmer -- Co-Chief Executive Officer

So the funding rates were up in the quarter. And quite frankly, we think funding rates may improve over a little bit. So we don't expect a big change in the NIM over the immediate period except for May and June are going to experience some higher prepays, and that's going to put a little bit pressure on NIM. As we said earlier, however, our estimates at this point is that we will earn dividends payable as we've been sustainable over the last 11 quarters.

I want to make one note here before we move on, one of your peer analysts, David Walrod from JonesTrading, did pass away a month ago. He was well-respected and well-liked. I just wanted to make a note to everybody while we're on.

Scott Ulm -- Co-Chief Executive Officer

We miss him.

Jeff Zimmer -- Co-Chief Executive Officer

And we miss him. So here's to you, David. And the next question, please.


[Operator instructions] Our next question comes from Christopher Nolan with Ladenburg Thalmann & Company. You may proceed with your question.

Christopher Nolan -- Ladenburg Thalmann and Company -- Analyst

I echo your sentiments on Dave Walrod. He was a good guy. Scott, on your comments on leverage, should we read into that where you guys are sort of at a higher -- your leverage limit or you can possibly go up to nine turns? What's the thoughts there?

Jeff Zimmer -- Co-Chief Executive Officer

Yes, this is Jeffrey. We possibly can come up to nine. What we haven't talked about so far, and Scott mentioned it in his prepared remarks, is that zero OAS spreads are way tighter over the quarter, even though nominal spreads are not. And when spreads are tighter, we normally wouldn't want to use that opportunity to increase our leverage.

If we see a little widening and we see some buying opportunities, you might see us go from this 8.2 to 8.5 level up to 9.

Christopher Nolan -- Ladenburg Thalmann and Company -- Analyst

Great. And then I noticed on the haircuts for your repos, the rate went down slightly. Should we read anything into that? Or what's the driver for that?

Jeff Zimmer -- Co-Chief Executive Officer

Well, BUCKLER Securities provides ARMOUR with generally better haircuts than the rest of the firms that we deal with, and we have a larger amount with BUCKLER now. And also, we have taken CRTs. You may note in our monthly updates and, hopefully, you noticed it in our Q end materials that we have a large amount of liquidity. And we've taken some of that cash down and maintaining around $100 million now, and we brought in a lot of our CRTs.

So they used to be 20% kind of haircuts, even 25%. So if you take off $500 million or $600 million of CRTs and put them in the box, that's really going to bring the average down a little bit. So use the increase in BUCKLER and the CRTs in the box to get to the number you want to be.

Christopher Nolan -- Ladenburg Thalmann and Company -- Analyst

Great. Jeff, final question. On your comments on the CRT being fully priced, whatever, should we anticipate more CRT sales from the portfolio? Or --

Jeff Zimmer -- Co-Chief Executive Officer

In the immediate future, I don't think we're selling. We did sell some before because we wanted to just see what the liquidity was like in the marketplace and take 13 points of profit on some assets. In the immediate future, we don't anticipate selling any CRTs. If we add it to the portfolio, it would most likely have to be seasoned paper because the new paper, that is the reference pool, has some of the characteristics that we think could be problematic down the road and affect those potential spreads negatively in the future.

Christopher Nolan -- Ladenburg Thalmann and Company -- Analyst

Great. OK. Great. Thank you for taking my questions.


We have no further phone questions at this time, sir.

Jim Mountain -- Chief Financial Officer

Well, Kelly, thank you very much for moderating. Thank you all for joining our earnings call. And as always, if you have sidebar questions, call us in the office, and we'll pick up or get back to you promptly. That offer stands throughout the quarter.

And until next time, take care.


[Operator signoff]

Duration: 20 minutes

Call Participants:

Jim Mountain -- Chief Financial Officer

Scott Ulm -- Co-Chief Executive Officer

Doug Harter -- Credit Suisse -- Analyst

Jeff Zimmer -- Co-Chief Executive Officer

Christopher Nolan -- Ladenburg Thalmann and Company -- Analyst

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