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ARMOUR Residential REIT (NYSE:ARR)
Q1 2020 Earnings Call
May 01, 2020, 8:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Operator

Greetings and welcome to the ARMOUR Residential REIT first-quarter 2020 earnings conference call. [Operator instructions] 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 Nelson, and thank you all for joining ARMOUR's first-quarter 2020 conference call. We hope that all of you have been able to remain safe and healthy. This morning, I'm joined by ARMOUR's co-CEOs, Scott Ulm and Jeff Zimmer; and our chief investment officer, Mark Gruber. By now, everyone has access to ARMOUR's earnings release 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 of those reports 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 to do so. 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 it will continue to be there for one year. Like other firms in our sector and across the economy, ARMOUR was impacted negatively by the sudden and historic levels of market volatility in March resulting from the COVID-19 pandemic. On March 31, 2020, ARMOUR's total assets stood at approximately $5.1 billion, down nearly 62% from the $13.3 billion level at the beginning of the quarter.

This reflects ARMOUR's successful results and actions to aggressively prune the investment portfolio, reduce risk and preserve liquidity. By comparison, ARMOUR's total comprehensive loss for the quarter of $537 million represents only 37% of stockholders' equity at the beginning of the quarter. Total equity was also reduced by $113.5 million by the company's January decision to replace its outstanding 7.875% preferred stock with a new 7% Series as well as the payment of previously declared dividends. Having weathered with what we expect to be the worst weeks of this emergency, ARMOUR ended Q1 with book value per common share of $11.10, corresponding to total stockholders' equity of $786 million.

That included cash and unpledged liquid securities of $360 million. Today, ARMOUR's liquidity stands at approximately $470 million. Since March 31, ARMOUR has done a number of things. ARMOUR's issued approximately 5.7 million shares of common stock through its aftermarket offering program, raising approximately $8.4 million of additional capital.

We continue to enjoy sufficient access to repurchase funding and interest rate swaps with a diversified group of counterparties. ARMOUR's affiliate, BUCKLER Securities, continues to play a major role in the company's funding strategy. ARMOUR has also taken advantage of relatively attractive opportunities to sell certain of its credit risk transfer and other non-agency positions. The company is also selectively rebuilding its agency pass-through portfolio and is refreshing its swap book.

We expect to continue on this course for the rest of Q2. As of yesterday evening, the ARMOUR portfolio stood at $5.6 billion which includes $1.3 billion of TBAs and $308 million market value of CRT positions. They have a weighted average mark above 76% and 37% of those positions have investment-grade ratings. The $4 billion of agency securities in portfolio is a nice mix of legacy, higher coupon 30-year and DUS positions, combined with newer 15-year and 30-year products.

When the last few legacy swaps run off in July, our hedge book will stand at $3.7 billion with a average pay rate of 22 basis points based on our current positioning. In addition to anticipated improvements in portfolio composition and lower hedging costs, we expect future net interest margin will also be positively affected by favorable repo financing rates as term transactions roll off and are replaced at substantially lower current rates. For example, three months term repos for agency collateral, we're pricing just under 180 basis points in early March. Today, we are seeing 1-month repo prices inside of 30 basis points and less for overnight.

Contractual management fee expense for Q2 will be reduced by 40% as further described in the company's Form 10-Q which will be filed with the SEC shortly. Earlier this week, ARMOUR paid the April cash dividend on the Series C preferred stock and declared the May cash dividend at the rate of $0.14583 per share the holders of record on the 15th of May 2020. That dividend will be payable on May 27, 2020. As previously announced, ARMOUR is moving to a quarterly dividend on its common stock for the second quarter.

Expect a further announcement on the amount and timing of Q2 common dividends in the latter part of June. Now let me turn the call over to Scott, Jeff and Mark to discuss further ARMOUR's portfolio position, strategy and view toward the future. Scott?

Scott Ulm -- Co-Chief Executive Officer

Thanks Jim. Good morning. The world has changed significantly from our last earnings call in February. Our team has been working remotely since early March, and our business continuity plan has worked well for us.

While we'll be talking today about the pandemic's financial impact on us, we are mindful of personal costs to so many of our peers and colleagues. We hope everyone joining us today stays healthy. March was a profoundly bad month for the mortgage investment industry. As a senior management team with each professional having 35 years or so of average experience in the capital markets, March was the worst environment we have had to deal within our careers.

The market movement was more sudden and violent than 2008. Our results were driven by several phenomena that occurred simultaneously. Interest rates on 10-year treasury bonds weeps off from 1.16% at the beginning of March down to the new historic lows of 0.54% and back up to 1.2% in a matter of days. Despite the historic risk off rally in treasuries, mortgage-backed security and TBA prices declined.

This resulted in the widest MBS spreads since the financial crisis. ARMOUR as well as many others in our investment sector, experienced a double shock of both interest rate hedges and asset prices moving against us. Premiums on best criteria specified pools evaporated as force selling by leverage investors, mutual funds and REITs quickly drowned out all available balance sheet of banks, lack of which was further exacerbated by quarter end pressures. In the Fannie Mae DUS 10 9.5 market, spreads exploded from approximately [Inaudible] Many transfer bonds fell from par or 100 price levels to as high as 110 price levels to as low as 60 to 80 points on the dollar price levels, if a bit could be found at all.

Repo terms in the agency asset class were very stable, and in particular, ARMOUR's always found very sound funding through its broker-dealer affiliate BUCKLER Securities. However, outside of the agency business, funding propositions degraded dramatically as haircuts and financing rates doubled or tripled on CRTs. Amidst the non-agency funding cash, one large money center bank abruptly ended its financing of CRTs altogether, causing further turmoil as many investors were forced to sell at the same time into a tumultuous market, further lower prices. Liquidity, in many respects, simply disappeared.

Off the run treasuries sharply underperformed on the runs indicated bid offer spreads on current production TBAs widened by multiples. 30-day commercial paper oustside of between 0.95% and 1.81%, even as Fed funds went to 0.05%. FX swap funding all the dried up in the middle of March. To reduce risk, leverage and free up available cash, we acted early by selling $1.7 billion of agency securities in the first two weeks of March.

In the last two weeks of March, we sold another $7.4 billion of primarily agency securities. If we have not acted promptly and decisively, there's little question that we might have found ourselves in the midst of forbearance discussions with creditors, like many others in our sector face today and with the most uncertain future. The Fed's announcement of unlimited support for agency mortgages on March 23 caused prices to stabilize and increase. In order to increase liquidity for an uncertain future, we have sold many agency mortgage assets who were not able to fully participate in the subsequent agency mortgage price fell recovery.

Standing here today, we see a changed landscape from prior years. We believe the substantial uncertainties will surround mortgage credit for the remainder of the year and perhaps longer. Agency securities are again a bright investment spot, but require careful selection. The Fed buying program has given definitive support to the market, but has also caused substantial increases in prices that are exacerbated by the low rate environment.

We believe close attention to credit characteristics in agency securities will be rewarded with superior performance. We believe elevated prepayments will return as a concern later in the year, not in the immediate future. And focused portfolio selection now can mitigate that medium-term risk. Currently, 85% of our agency specified pools have some kind of prepaid protection.

We are methodically investing and expect our leverage to increase over the coming few weeks with our emphasis on liquid agency securities that offer attractive risk return profiles. We previously announced that we will declare a dividend for the second quarter in late June, and we believe our ongoing dividend policy should be stable as possible and reflect our medium-term view of our net profitability. We believe our dividend should not chase period-to-period net profitability. At this point in the investment cycle, we're very constructive on our business for the following reasons.

As we move through the pandemic and the economy revise, we expect to see the yield curve modestly steepen, providing improved opportunities for investment. At the same time, we believe the Fed will keep short-term rates low in order to nurture a nascent recovery which will keep our funding rates low. The Fed has already begun to taper its MBS purchases, and we expect will continue to do so as the agency market normalizes. Some spreads feel are naturally tight today and Fed pay for tapering should allow more conventional pricing relationship.

Prepayments will likely remain subdued until staffing and financial conditions are much closer to normal. This is a great tailwind for new investments. Financing for agencies is abundant and at its most attractive levels in years. We are highly confident of our access to financing in excellent terms through our affiliate BUCKLER Securities as well as the almost three dozen other relationships we maintain with other repo counterparties.

There's clearly uncertainty in the timing and realization of all these factors. That said, we believe that the medium-term net yield expectation should be in the high single digit to low double-digit range. We are delighted to be through the month of March and standing here with great liquidity, solid financing and dry powder to continue to design our portfolio for the present environment. We'll now be happy to take any questions.

Jim Mountain -- Chief Financial Officer

Nelson, can you now open up the line for questions?

Questions & Answers:


Operator

[Operator instructions] Our first question comes from the line of Douglas Harter with Crédit Suisse. Please proceed.

Unknown speaker

Hey guys. This is actually Josh on for Doug. Good morning. We saw the large drop in leverage in the quarter, and you mentioned on the call that we should expect that to tick up going forward.

Curious if you could talk a little bit about how you're thinking about target leverage at this point? And if we should expect it to get back to where it was in 2019? Thanks.

Jeff Zimmer -- Co-Chief Executive Officer

Our target leverage at this point is around eight, give or take half a turn depending on the opportunities and how fast we can deploy our capital based on those opportunities.

Unknown speaker

Got it. That makes sense. And then one on funding. Can you update us on how much of the agency repo is currently funded through BUCKLER and the average maturities -- the average maturity of that funding?

Jeff Zimmer -- Co-Chief Executive Officer

So approximately three-quarters of the agency book is with BUCKLER. And I suspect as we regrow our agency portfolio, that number will come down a little bit but we want to make sure that the capital at Buckler is completely utilized. And quite frankly, the rates that we get from BUCKLER and the terms we get from BUCKLER are fantastic at particularly better haircuts than the Street.

Unknown speaker

Got it. Are you able to quantify how much better those terms are versus Street repo?

Jeff Zimmer -- Co-Chief Executive Officer

Well, sometimes it's a couple of basis points better. Sometimes it's a couple of basis points worse. But if you add that with the factor that we have surety on overnight funding, I'm not going to do overnight funding with XYZ Bank because you're not sure if they're going to be there the next day. We know that BUCKLER is going to be there the next day.

And as you heard from some of the other participants in the sector, the overnight funding can be half the rate that some of the term funding is. So we have a trust and an ability to know that they're going to be there every day. And sometimes you can't actually quantify that.

Unknown speaker

Got it. Thanks for taking the question guys.

Jeff Zimmer -- Co-Chief Executive Officer

Thank you.

Operator

Thank you. Our next question comes from the line of Trevor Cranston with JMP Securities. Please proceed with your question.

Trevor Cranston -- JMP Securities -- Analyst

Hey. Thanks. I apologize if I missed this in the prepared remarks, but with the credit portfolio, can you talk about sort of how you're thinking about that going forward? If your intention is to hang on to that portfolio or as prices have started to recover some in April, are you going to be looking to sell down that book? And as the second part of that question, can you give some additional detail around where the financing market is for credit securities now in terms of haircuts and the cost of repo? Thank you.

Jeff Zimmer -- Co-Chief Executive Officer

Sure. Good morning. So the credit book, CRTs let's say had approximately, in early March, $900 million market value. The value of the remaining securities on our balance sheet today of non-agencies are only CRTs, everything that's not a CRT has been sold.

And the CRT valuation is $308 million. So we've reduced that by two-thirds. It is our intention over the next two to three months to sell the rest of that. And we're doing it surgically.

As opportunities and buyers come into the market and people have a better perspective on recoveries, we're selling into strength and not selling into weakness. There are some companies and mutual funds, particularly, who had withdrawals that were force sellers during March and the first two or three weeks of April and there are opportunities for us to move out of that product who are not as profound. And yesterday, actually, we made a number of very nice sales and we're above marks, and we'll continue to look and do that. You should look at us by the time we get into the third quarter to be almost, if not all, agency assets, and that will be our portfolio platform in the future.

Now funding for the non agencies is -- and seems to be very secure today, but did not feel that way even as of two weeks ago. As Scott said in his comments, Trevor, one major center bank, one of the top five banks in the country, all of a sudden, in third week of March, decides to pull out of all of their CRT funding which meant that everybody that was funding with them had to sell bonds because very few other lenders were taking on new CRTs at the time. And it created a real-world win of down pricing for a while. So we refrain from selling there for a period.

But today, haircuts are as low as 17 and a half percent.. Our average haircut on our CRT portfolio is right around 25% today.

Trevor Cranston -- JMP Securities -- Analyst

OK. Great. That's very helpful. And as you're deploying capital back into the agency trade, can you talk about specifically kind of what sector of the market you like and kind of what coupons the portfolio is in today? And what coupons you're mainly looking to buy? And maybe specifically, some color on whether or not you find roles attractive enough to be buying TBAs or if you're really going to be focused mostly on buying spec pools? Thanks.

Mark Gruber -- Chief Investment Officer

Hey. Trevor, it's Mark. So we've been looking at both 15-year sector and a variety of coupons there. Also, the 30-year sector, more of the higher coupons.

So three and a halves -- like Jim had said earlier, most of our book is still four and four and a halves. The higher coupon stuff we had bought earlier last few years. So we're sticking to those sectors. We're looking for more stable bonds that have good convexity profiles.

We do like TBA rolls and certain coupons, certain sectors, and we're watching those carefully, have invested some of that. So -- but you'll continue to see us do a variety of different sectors. We still like DUS. We like those profiles.

So in the same sector, as we've always been in agency, but probably on the 30-year sector, more higher coupons than lower coupons.

Jeff Zimmer -- Co-Chief Executive Officer

And one of the reasons there is the Fed has now changed. If you look at the Fed report over the last few days, they've changed what they're buying. For a long time they were buying a lot of three and halves, four and four and a halves. They're going to refrain from buying those now.

And they're going to start buying a lower coupons which means those are going to continue to be rich. May not get richer, but they can continue to be rich. Whereas there could be some ongoing buying opportunities in above threes and areas, particularly ones that have some specialty, like 1.25 kind of loan balances, those kind of things. Is that helpful?

Trevor Cranston -- JMP Securities -- Analyst

Yes, very helpful. Thank you for that. And last question. It looks like there was some issuance through the ATM plan in April.

Can you just provide some additional color around sort of the rationale for that issuance, given where the stock was trading and kind of where you're at today in terms of the likelihood of any continued issuance of the con? Thanks.

Jeff Zimmer -- Co-Chief Executive Officer

Sure. So as you know, our traditional approach to capital raising was kind of threefold, basically how can shareholders benefit based on a variety of factors. So is it accretive? Is it accretive to earnings? Can it be a good deal? However, as we entered April, there was not clarity on how the world is going to turn out. Liquidity was at a premium.

And we thought a modest amount of dilution was a very deal for our shareholders to go ahead and raise up to $50 million, and we raised $48 million. The actual dilution was just around $0.2 all in, to be clear. So we felt that was a very modest amount to increase the assurety and survival factor of the firm during a period of time where some of our brethren were doing for forbearance issues. We feel very good about what we did for our shareholders.

I don't anticipate right now turning that program back on. We'll see how the future develops.

Trevor Cranston -- JMP Securities -- Analyst

OK. Great. Thank you for that.

Jeff Zimmer -- Co-Chief Executive Officer

You're very welcome.

Operator

[Operator instructions] Our next question comes from the line of Christopher Nolan with Landenburg Thalmann & Company. Please proceed with your question.

Christopher Nolan -- Ladenburg Thalmann and Company -- Analyst

Hey guys. Hey Scott, in your comments, you mentioned that net yields could be high single, low double digits. What do you mean by net yields? Is that core income relative to equity? Can you define that a little bit, please?

Scott Ulm -- Co-Chief Executive Officer

Yeah. Correct, that's correct. Current income relative to equity -- core income.

Jeff Zimmer -- Co-Chief Executive Officer

Net to shareholder. That's correct.

Christopher Nolan -- Ladenburg Thalmann and Company -- Analyst

OK. Great. And then the -- I mean, from what I can gather from the press release, it looks like the investment spreads widened quite a bit this quarter. What's sort of your anticipation for investment spreads going forward? I mean, is that just sort of an anomaly for 1Q or are we in a new world?

Jeff Zimmer -- Co-Chief Executive Officer

Just define investment spreads? Are you talking investment opportunities, as we said, low double digits. Or are you talking NIM or is there some other criteria?

Christopher Nolan -- Ladenburg Thalmann and Company -- Analyst

NIM would be great.

Scott Ulm -- Co-Chief Executive Officer

No. NIM is going to be in the -- on an asset basis. I guess I have to think about how I would define -- it's going to be higher than it was in Q1 because spreads are going to be a little wider than we're investing. I don't have a -- I can't give you a good concrete number for NIM, but I can say it's going to be higher than it was in the past.

Mark Gruber -- Chief Investment Officer

And Jim also mentioned a couple of other factors. We've got term financing that's rolling off, and we've got higher rate swaps that are rolling off too, both of which are going to give a little tailwind here to NIM.

Jeff Zimmer -- Co-Chief Executive Officer

Yeah. But I look at it this way, Christopher. Jim said that our swap book is going to be at 22 basis points going forward by July 1 because all the old stuff is rolling off. Repo is in high single digits.

For -- let's say, overnights are anywhere from 10 to 20. And let's say, term is anywhere from 25 to 30. So take your 22 and add 20 to that is 42. You can earn assets here in the mid to high 1s.

So you can kind of do the math and figure out where you could be. And frankly, as Mark said earlier, we think prepayments are going to be kind of slower for the next few months. So NIM should be pretty good. And I've heard other people that we deal with on the broker side are kind of looking at it the same way we are.

I hope that's helpful.

Christopher Nolan -- Ladenburg Thalmann and Company -- Analyst

Yeah. No, it is. Great. And then I guess final question is, when should we expect the Q to be released?

Mark Gruber -- Chief Investment Officer

We should be getting that out shortly. Ideally that the on EDGAR before it closes tonight, but in any event, we ought to be able to see it Monday morning.

Christopher Nolan -- Ladenburg Thalmann and Company -- Analyst

Great. Final question is, given the changes in interest rates, how does -- do you guys change your thinking about preferred stock at all? I mean is the consideration to pay that down further and go with more repo funding? Yes please go ahead.

Jeff Zimmer -- Co-Chief Executive Officer

So we have $132 million of our 7% out there, OK? Based on the investment opportunities today, that is accretive to the overall proposition of investing. However, you don't ever want to have preferred to be too large a portion of your total capital structure. And currently, the firm is very comfortable with the capital structure amount of our regular equity versus our preferred. Also, there was a very large buyer of our preferred yesterday.

Apparently, over 200,000 shares in the market at the close. But that's still only trading at $22 a share. And we would not be interested at least any consideration that we've been approached with now of selling it under $25 a share.

Scott Ulm -- Co-Chief Executive Officer

Yeah. Just let me amplify a little bit. In retrospect, the January decision to swap out $200 million, I don't know, $40 million or $50 million, whatever it was, of 7% and 8% for Series B with slightly on appreciable smaller amount of lower coupon, 7% Series C. In retrospect in mind, that looks like a really smart decision the way things have worked out.

Christopher Nolan -- Ladenburg Thalmann and Company -- Analyst

All right. That's it for me. Good show guys. Thanks.

Scott Ulm -- Co-Chief Executive Officer

Thank you.

Jim Mountain -- Chief Financial Officer

Nelson, do we have any more questions?

Operator

I am showing no further questions at this time.

Jim Mountain -- Chief Financial Officer

Well, thank you all for joining us. We continue to work largely remotely, but are completely connected. So if anybody has additional questions, you've got our emails, call the office and we'll get reconnected. And until next time, stay safe.

Operator

[Operator signoff]

Duration: 29 minutes

Call participants:

Jim Mountain -- Chief Financial Officer

Scott Ulm -- Co-Chief Executive Officer

Unknown speaker

Jeff Zimmer -- Co-Chief Executive Officer

Trevor Cranston -- JMP Securities -- Analyst

Mark Gruber -- Chief Investment Officer

Christopher Nolan -- Ladenburg Thalmann and Company -- Analyst

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