Q1 2024 ARMOUR Residential REIT Inc Earnings Call

Participants

Scott Ulm; Co-Chief Executive Officer, Co-Vice Chairman, Chief Investment Officer and Head of Risk Management; ARMOUR Residential REIT Inc

Gordon Harper; Chief Financial Officer, Controller, Company Secretary; ARMOUR Residential REIT Inc

Jason Weaver; Analyst; Janney Montgomery Scott

Doug Parker; Analyst; UBS

Trevor Cranston; Analyst; JMP Securities

Christopher Nolan; Analyst; Ladenburg Thalmann

Presentation

Operator

Good day, and welcome to the ARMOUR Residential REIT first-quarter 2024 earnings conference. (Operator Instructions) Please note that today's call is being recorded.
I would now like to turn the conference over to Mr. Scott Ulm, CEO, ARMOUR Residential. Please go ahead, sir.

Scott Ulm

Warner, 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-CEOs, Sergey Losyev and Desmond Macauley, to the call all are experienced members of our team who we promoted to their new roles in March, and I have tremendous confidence in them. All Gordon has been with us since 2015, and Sergei 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 we can, which can be found on our website, w. w. armory.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 our periodic reports filed with the US Securities Exchange Commission describes certain factors beyond our control that could cause actual results to differ materially from those expressed in or implied by these forward-looking. Those periodic filings can be found on the SEC's website at w. w. dot 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. Although today's discussion refers to certain non-GAAP measures. These measures are reconciled with comparable GAAP measures in our earnings release and online replay of this conference call will be available on our website shortly and will continue for one year.
Now turning to results for the quarter, our 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 nonrecurring professional fees related to the special committee internal investigation. Distributed earnings available to common stockholders was $40.4 million or $0.32 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.
Our capital management continues to waive a portion of the amendment fees waiving $1.65 million for Q1, which offsets operating expenses for 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 as appropriate in the 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 $22.7 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. I'll discuss Armour's portfolio position and current strategy.

Scott Ulm

Thanks, Jordan. I know you've all seen our disclosure in the K and Q about the events of this spring, and I'd 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, but the Board followed best practices and formed a special committee of independent directors special committee engaged outside counsel at a national accounting firm to review all of these 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 for 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 him were appropriate. You'll find in our press release a revised presentation of economic interest income to make clear that includes swap payments as a non-GAAP measure as to the otherwise 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 a material weakness.
The tone set by certain individuals during the investigation was insufficient to create the proper environment for effective internal control over financial. And as you've 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 review and tone at the top and enhance whistleblower reported. 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 RCIL. 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 the Lloyd, our co-CEOs 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 reverse their path and climb higher in 2024, despite intense dovish outlook on inflation to start the year with seven rate cuts penciled in for 2024 and 2025. Recent economic base of data has signaled otherwise and forced bond investors to once again abandoned overly optimistic expectation of Fed rates following a trend of hotter than expected inflation and labor data 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 remain inverted at an average level of negative 34 basis points in the first quarter, posing a challenge for MBS investors and particularly mortgage rates 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 our MS portfolio tightened by approximately seven basis points on the heels of a strong performance in March to contribute to a 1.1% total economic return of 4.4% annualized for the first quarter April strong inflation print ended the expectations for lower Fed rates in the first half of 2020 for causing a sharp widening in mortgage spreads by 10 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 armor, execute 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 tenure does tools and in turn purchase higher premium to bond conventional MBS with a shorter duration profile, while dark spreads continue to exhibit favorable positive equity, lower spread volatility and diversification benefits compared to our MBS assets, their outperformance in recent quarters as allows us to capture 10 to 15 basis points of spread return and reinvest proceeds into cheaper mortgage assets.
Second, our missile over 40% of our deep discount MBS pools with coupons of 3.5% and lower were faster. Prepayment speeds 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, armor sold over 10% of par coupon MBS versus treasury hedges closing the basis trade that benefit most from the spread rally in March as the market close on April 23rd, the portfolio's implied leverage and duration stood at 6.9 times and 0.5 times, respectively. Or five 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 priced in a 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 our 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% and lower specified characteristics favoring faster turnover speeds while priced at a discount farmers 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 of funding with Butler securities to approximately 60% of its borrowings as of quarter end. This reflects sluggish growth as a broker dealer and our mix benefit of financing through its affiliate in the first quarter, repo markets generally priced around so for plus mid to high 10s in basis points with a weighted average haircut at under 3%. As our trading activity indicates, we are 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, but 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 as much anticipated easing cycle later this year, leading banks to increase their share of and net MBS purchases on improved net interest margin. We also expect rate volatility declining as the date of a first Fed cut becomes more certain attracting more MBS investors, including crossover buyers that may want to increase their allocation 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 or That wraps up our prepared remarks for the first quarter of 2024, and we'd be happy to take any questions.

Question and Answer Session

Operator

(Operator Instructions) Jason Weaver, Janney Montgomery Scott.

Jason Weaver

I good morning. Actually on with JonesTrading. I wanted to ask Scott regarding your prepared remarks on Butler. If you were detecting any change in the availability of general repo credit out there given the volatility over the last month, you know, repo has been just fine. It's a obviously we monitor that extremely carefully and we are we are active with with a whole bunch of counterparties as well as being sort of on the inside with Butler. But repo has been well behaved.
Okay. Fair enough. And then on the expense side, I was curious how long you plan to continue waiving the management fee as well as if there's any lingering and sort of enhanced compliance off coming from the results of the the internal investigation. First of all, on the waiver, we expect to continue that. Obviously, it's a function of scale of portfolio dynamics here, but we've added we've added since COVID and expect to continue today as to as to enhance compliance?

Scott Ulm

Yes. As I mentioned, the focus on talent at the top is very real and is part of our internal controls now. So yes, that is a that is certainly an area of focus. But other than that, it's the and some of it, some of the some of the other things I mentioned with regard to a to a to NIM. and its new formulation and economic interest income being we remain in the same place we've always been, which is could take great care with this stuff.

Jason Weaver

All right. Thanks for that. I appreciate you taking the questions.

Operator

Doug Parker, UBS.

Doug Parker

Thanks. Good morning. Paul, hoping you could talk through a little bit more of the decision to reduce the portfolio size and April as you're kind of balancing kind of the near term volatility that you might said with kind of the longer term optimism now on current spread levels?

Scott Ulm

I'm sorry, I'm going to turn it over to say okay.

Gordon Harper

Yes, good morning, Doug, and thank you for your question? Yes. So we took a series of trades that we discussed in our earnings script that early Q2. We felt like mortgage markets were pricing in very well and dovish Fed path and the high inflation trend that we saw early April on really kind of triggered a wide portfolio rebalancing to reflect kind of a pushback on the future path of the Fed rates.
Now we are looking at this as only a Q2 event or really quarter quarter by quarter. We do still see some easing cycle beginning at sometime later this year. So we're just kind of seeing this as a grand theme of second quarter as elevated volatility. We have geopolitical risks as well as the strong economic data really kind of moving the market to a little bit. So we felt it was prudent to reduce our leverage below seven target duration of about 0.5 year and then be able to go and then deploy the dry powder when we feel the time is right.
I guess just on the leverage, how are you thinking about the right level of leverage over time? And what's kind of the on the ability appetite to kind of we allow leverage to move higher when you have these pockets of volatility?
Yes. So just kind of goes in line with the previous answer, we have about at least a turn of leverage to deploy are currently on. But we do still see some residual uncertainty in the market until we confirm with a few more data points on inflation and labor markets to determine whether this is just a blip or a change in the change in the C. So I think you can see us being aggressively buying into the market once we figure out the Horizon past the second quarter.

Doug Parker

All right. Thank you.

Operator

(Operator Instructions) Trevor Cranston, JMP Securities.

Trevor Cranston

Thanks. A follow-up on the question about the expenses. Just to clarify, are the weather would you expect to see any more of the sort of onetime expenses and coming through April? Or was that exclusively in the first quarter?

Scott Ulm

I think we've accrued pretty pretty well for it. But you know how these things go. There's always something that dribbles in, but I don't think it will have anything. And even if there is some some drilling later on. I don't I don't expect it to be significant.

Trevor Cranston

Okay, got it. And then given the on the reduction in the MBS portfolio here in April, can you also maybe comment on any changes you've made to the hedge book, either either swaps or treasuries in the early part of April? Thanks.

Scott Ulm

To the launch of Dublin, Ireland, can say, Trevor, on in line with some of our asset sales. We've also adjusted our hedge book as well. We've been trying to and 4.5 duration about half the duration. So our hedge book is we dynamically allocate on treasuries and swap hedges along those lines. So yes, we've been making adjustments as we do our asset sales, adjusting our out our hedges as well to keep our duration. We've seen a framework that we feel comfortable with given the environment that we are in.

Trevor Cranston

Okay. That's helpful. Thank you.

Operator

Christopher Nolan, Ladenburg Thalmann.

Christopher Nolan

Effects related to the special committee investigation from the ones you mentioned that you hired outside counsel and accounting firms, the same accounting firm does your audit go where they were a national accounting firm and not delay?

Scott Ulm

All right. So it is a reflection on your confidence and delight and it all the way these things you always I always hire somebody or somebody independent to serve to help them to their best practices, but you just wouldn't use your regular your regular account for this sort of like, okay. You repeatedly mentioned tone at the top and then you also mentioned conflict of interest. Is the tone at the top financial related to conflicts of interest or other, but it's other and this is this is all bound up with the the co-CEO framework, which is that we cannot control a framework that we use and the way it works is that the tone at the top, which is a which is a broad measure, but you know and recognize, but recognize as a critical part of effective effective controls, it leads into a whole network of financial controls as part of that.
So that's that's the that's where that goes is pretty clearly laid out in the in the K and the Q, you see the broader co, so framework and then how this fits in as part of a flood. But it's unrelated to conflict of interest factor on which there were down which there were no findings, there were no findings from the conflict of interest, correct.

Christopher Nolan

Okay. And then final question on given that the Q mentioned on parallel, give of all material Yes.

Scott Ulm

Doug clean bill of health for the financials, is it fair to say that we're not we should not expect a restatement of past results?

Gordon Harper

Correct.

Christopher Nolan

Okay. That's it for me. Thanks.

Operator

At this time, we are showing no further questions in the queue. And this does conclude our question-and-answer session. I would now like to turn the conference back over to Scott Ulm for any closing remarks.

Scott Ulm

Thanks all. Appreciate your participating in the call. And as always, if you have encouraged, you try and give us a range or higher. Thank you.

Operator

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