Yahoo Finance ARMOUR Residential REIT, Inc. (NYSE:ARR) Q1 2024 Earnings Call Transcript
ARMOUR Residential REIT, Inc. (NYSE:ARR) Q1 2024 Earnings Call Transcript April 26, 2024
ARMOUR Residential REIT, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Good day, and welcome to the ARMOUR Residential REIT’s First Quarter 2024 Earnings Conference Call. Today all participants will be in a listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note that today’s event is being recorded. I would now like to turn the conference over to Mr. Scott Ulm, CEO, ARMOUR Residential REIT. Please go ahead, sir.
Scott Ulm: Good morning. I’d like to welcome you to the ARMOUR Residential REIT first quarter 2024 conference call. This morning I’m pleased to welcome our new CFO, Gordon Harper; as well as our new Co-CIOs, Sergey Losyev and Desmond Macauley, to the call. All are experienced members of the ARMOUR team whom we promoted to their new roles in March, and I have tremendous confidence in them all. Gordon has been with us since 2015, and Sergey and Desmond have been on our portfolio management team since 2016 and 2013 respectively. We’re all excited to lead the business into this next chapter. Our priorities are unchanged and we are all united on our focus on delivering value to shareholders. I’ll now turn the call over to Gordon to run through the financial results. Gordon?
Gordon Harper: Thank you, Scott. 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 protection provided by the Private Securities Litigation Reform Act of 1995. The Risk Factors section of ARMOUR’s periodic reports filed with the Securities and Exchange Commission, describes certain factors beyond ARMOUR’s control that could cause actual results to differ materially from those expressed in 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 for one year. Now, turning to results for the quarter. ARMOUR’S Q1 GAAP net income available to common shareholders was $11.5 million, or $0.24 per common share. Net interest income was $5.3 million. Expenses included $9 million of non-recurring professional fees related to the Special Committee internal investigation. Distributable Earnings available to common stockholders was $40.4 million, or $0.82 per common share. This non-GAAP measure is defined as net interest income plus TBA drop income, adjusted for interest income or expense on our interest rate swaps minus net operating expenses.
ARMOUR Capital Management continues to waive a portion of their management fees, waiving $1.65 million for Q1, which offsets operating expenses. The waiver continues until further notice. ARMOUR paid monthly common stock dividends of $0.24 per common share per month for a total of $0.72 for the quarter. We aim to pay an attractive dividend that is appropriate in context and stable over the medium term. Taken together with the contractual dividends on the preferred stock, ARMOUR has made cumulative distributions to stockholders of $2.3 billion over its history. Quarter end book value was $22.07 per common share. Our most recent current available estimate of book value is as of Tuesday, April 23 and was $20.48 per common share. I will now turn the call over to Scott Ulm to discuss ARMOUR’s portfolio position and current strategy.
Scott Ulm: Thanks, Gordon. I know you have all seen our disclosure in the K and Q about the events of the spring and I would like to address this upfront with some highlights in detail. I, of course, refer you to the K and Q for the company’s definitive disclosure and further detail. A variety of issues were raised just prior to our scheduled 10-K filing related to non-GAAP disclosures, the Board’s internal review processes, potential conflicts of interest and the external manager. The Board followed best practices and formed a special committee of independent directors. The special committee engaged outside counsel and a national accounting firm to review all of these issues. The investigation, which was comprehensive, extended through our customary filing schedule and the 12b-25 Extension, but did conclude in time for the special committee, the broader board and our auditors to review the results and file our 10-K by the March 15 deadline.
The special committee found that our use of earnings available for distribution and NIM were appropriate. You will find in our press release a revised presentation of economic interest income, which makes clear that it includes swap payments as a non-GAAP measure. As to the other matters raised, the investigation found no substantiation of any of the matters raised and found that the independent directors of the board complied with their fiduciary duties. There was a finding that in the course of the investigation there was an issue with tone at the top that constituted material weakness. The tone set by certain individuals during the investigation was insufficient to create the proper environment for effective internal control over financial.
As you have seen, the result of all this was streamlining our management structure to a single CEO and a number of remedial measures, including training on appropriate tone at the top, internal controls, reviewing tone at the top and enhanced whistleblower reporting. As you know, we had a number of personnel changes including the removal of our CFO for matters unrelated to the investigation and the resignation of our CIO. We’re fortunate to have a deep bench and as I said at the beginning of the meeting, our CFO, Gordon Harper has been with us a long time and spent 25 years prior to joining us at Deloitte. Our Co-CIOs both bring extensive experience with our portfolio and deep backgrounds in MBS investment. Now let’s talk a bit about the mortgage business.
Following the sharp decline in the fourth quarter of 2023, treasury yields reversed their path and climbed higher in 2024, despite the Fed’s dovish outlook on inflation to start the year, with seven rate cuts penciled in for 2024 and 2025, recent economic data is signaled otherwise and forced bond investors to once again abandon overly optimistic expectation of Fed’s rates. Following a trend of hotter than expected inflation and labor data releases, the yield on the 10-year treasury climbed above 4.65% by mid April, totally moved more than 75 basis points from a low of 3.88% reported on the last trading day of 2023. The yield spread between two-year and 10-year treasuries remained inverted at an average level of negative 34 basis points in the first quarter, posing a challenge for MBS investors and particularly mortgage REITs and banks.
We expect a wide ranging spread environment with elevated volatility to persist until the yield curve reverts to its upward sloping shape. In the first quarter, newly originated MBS traded within roughly 20 basis points of nominal spread range, closing the quarter roughly flat versus the fourth quarter. The zero volatility OAS on ARMOUR’s portfolio tightened by approximately 7 basis points on the heels of a strong performance in March to contribute to a 1.1% total economic return, 4.4% annualized for the first quarter. April’s strong inflation trend ended the expectations for lower Fed rates in the first half of 2024, causing a sharp widening in mortgage spreads by 10 basis points to 15 basis points and a rise in 10-year treasury yields by 30 basis points.
Reflecting the broad sentiment shift on Fed policy staying higher for longer, ARMOUR executed a series of trades aimed at repositioning the portfolio with a view of higher yields and volatility to dominate the second quarter. First, we sold approximately 50% of our 10-year DUS tools and in turn purchased higher premium coupon conventional MBS with a shorter duration profile. While DUS spreads continue to exhibit favorable positive convexity, lower spread volatility and diversification benefits compared to MBS assets, their outperformance in recent quarters has allows us to capture 10 basis points to 15 basis points of spread return and reinvest proceeds into cheaper mortgage assets. Second, ARMOUR sold over 40% of our deep discount MBS pools with coupons of 3.5% and lower, where faster prepayments fees have never materialized.
We reinvested a portion of these proceeds into higher premium Ginnie Mae TBAs, which stood to benefit from the backup in mortgage rates while still trading at discount to their conventional equivalents. Lastly, ARMOUR sold over 10% of par coupon MBS versus treasury hedges, closing the basis trade that benefited most from the spread rally in March. As the market closed on April 23, the portfolio’s implied leverage and duration stated 6.9 times and 0.5 times respectively – 0.5 years respectively, while maintaining healthy levels of available liquidity. Our book value since the start of the quarter is down 7%. We believe recent spread widening is preceding [ph] more hawkish Fed path and as a result, mortgages now offer compelling upside in a scenario where inflation and growth begin to moderate.
Our mortgage strategy continues to target a well diversified portfolio. About half of ARR’s mortgage assets are higher coupon MBS, which are experiencing slow prepayments due to historically elevated mortgage rates. Around 40% of our current holdings are in coupons of 5%lower, with specified characteristics favoring faster turnover speeds while priced at a discount. ARMOUR’s average prepayment rate for all MBS assets in the first quarter of 2024 was 4.5 CPR and a still low 6.6 CPR for April. The benign prepayment environment continues to favor mortgages that are supported by attractive, fundamental and relative valuations. ARMOUR has increased its allocation to funding with BUCKLER Securities to approximately 60% of its borrowings as of quarter end.
This reflects BUCKLER’s growth as a broker dealer and ARMOUR’s benefit of financing through its affiliate. In the first quarter, REPO markets generally priced around SOFR+ mid to high teens in basis points with a weighted average haircut at under 3%. As our trading activity indicates, we have turned more cautious on mortgage spreads for the remainder of the second quarter. We’ll continue to dynamically adjust our risk profile as we continue to analyze the interest rate, new macroeconomic data, geopolitical risks, and reaction to the evolving environment by market participants and the Fed. Looking further out, we remain constructive on spreads over the longer horizon. We expect that the Fed will eventually start its much anticipated easing cycle later this year, leading banks to increase their share of net MBS purchases on improved net interest margin.
We also expect rate volatility decline as the date of our first Fed cut becomes more certain, attracting more MBS investors, including crossover buyers that may want to increase their allocation to MBS at the expense of tighter corporate spreads. We continue to believe that our dividend level is appropriate for this environment. Thank you for joining today’s call. That wraps up our prepared remarks for the first quarter of 2024, and we’d be happy to take any questions.
Operator: Thank you. We will now begin the question-and-answer session. [Operator Instructions] Today’s first question comes from Jason Weaver with Janney Montgomery Scott. Please go ahead.
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