Armour Residential REIT, Inc. Q2 FY2025 Earnings Call

Good morning, and welcome to ARMOUR Residential REIT's Second Quarter 2025 Earnings Conference Call. Please note, this event is being recorded. I would now like to turn the conference over to Scott Ulm. Please go ahead.

Good morning, and welcome to ARMOUR Residential REIT's Second Quarter 2025 Conference Call. This morning, I'm joined by our CFO, Gordon Harper, as well as our co-CIOs, Sergey Losyev and Desmond Macauley. I'll now turn the call over to Gordon to run through the financial results. Gordon?

Thanks, Scott. By now, everyone has access to ARMOUR's earnings release, which can be found on ARMOUR's website. This conference call includes forward-looking statements that 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 describe 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. 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. ARMOUR's Q2 GAAP net loss related to common stockholders was $78.6 million, or $0.94 per common share. Net interest income was $33.1 million. Distributable earnings available to common stockholders was $64.9 million, or $0.77 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 and futures contracts minus net operating expenses. ARMOUR Capital Management waived a portion of their management fees, waiving $1.65 million for the quarter, which offsets operating expenses. During Q2, ARMOUR raised approximately $104.6 million of capital by issuing approximately 6.3 million shares of common stock through an at-the-market offering program. Since June 30, we have raised approximately $58.8 million of capital by issuing approximately 3.5 million shares of common stock through an at-the-market offering program. We currently have outstanding 91.5 million common shares. ARMOUR paid monthly common stock dividends per share 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. On July 30, 2025, a cash dividend of $0.24 per outstanding common share will be paid to holders of record on July 15, 2025. We have also declared a cash dividend of $0.24 per outstanding common share payable August 29 to the holders of record on August 15, 2025. Quarter ending book value was $16.90 per common share. Our estimate of book value as of Monday, July 21, was $16.81 per common share, reflective of the accrual of the July common dividend. I will now turn the call over to Chief Executive Officer, Scott Ulm, to discuss ARMOUR's portfolio position and current strategy.

Thanks, Gordon. Just a note to the team. I had a connectivity problem a second ago. So if I disappear, just continue with what we have to say here, but we should be just fine. Well, thanks all. As we entered the second half of 2025, the debate around U.S. fiscal sustainability, Fed independence, and trade dynamics continues to weigh on the macro landscape. While we don't expect these issues to be resolved quickly, markets appear to have digested much of the initial shock as rates and spreads have settled into stable ranges and volatility has drifted lower. On the monetary policy front, incoming U.S. economic data indicates solid economic growth that's supportive of the Fed's wait-and-see approach. While Fed policy rates remain on hold, elevated short-term yields are absorbing investor liquidity. However, we believe that a resumption of the Fed cutting cycle this year should reignite the flow of liquidity into Agency MBS. Current coupon MBS spreads have retraced from April's historically distressed levels, supported by declining volatility. The MBS to SOFR spreads have consolidated back towards an average of the spread levels observed in 2025. They widened by approximately 10 basis points quarter-over-quarter and remain historically cheap. The 30-year fixed mortgage rate was near 6.75% through late June and early July, effectively dampening refinancing activity and keeping net mortgage supply muted. This tightening backdrop, while a challenge for borrowers, continues to create compelling opportunities for investors in high carry production Agency MBS. At the policy level, the U.S. housing finance system remains a central topic in D.C. The FHFA Director, Bill Pulte, has begun to implement reforms aimed at streamlining the GSEs, Fannie Mae and Freddie Mac, with administration officials signaling support for retaining an implicit government guarantee for the GSEs. While public rhetoric hints at an eventual need to end conservatorship, we view these developments as constructive yet not imminent. I'll now turn it over to Desmond for more detail on our portfolio.

Thank you, Scott. ARMOUR's estimated net portfolio duration and implied leverage are closely managed at 0.46 years and 8 turns, respectively. Our total liquidity is strong at approximately 52% of the total capital as of July 21. Our hedge book reflects a balanced view of duration with a bias for further Fed easing. Hedges are composed of about 33% in treasury shorts and futures with the remainder in OIS and SOFR swaps as measured on a DVO1 basis. While SOFR swaps are cheaper hedges, treasuries have proven to be a more effective hedge instrument for mortgages as of late. ARMOUR is invested 100% in Agency MBS, Agency CMBS, and U.S. treasuries. Our MBS portfolio remains concentrated in production MBS with ROEs in the 18% to 20% range. The portfolio remains well diversified across the 30-year coupon stack, Ginnie Mae's, and in DUS whose positive convexity and short duration attributes offer better value over comparable 15-year MBS pools. Portfolio MBS prepayment rates have averaged 7.7 CPR in Q2 and are trending at around 8.3 CPR so far in Q3. We see no signs of material acceleration unless mortgage rates drop significantly. We continue to favor higher loan balance and credit specified pools with favorable convexity and prepayment profiles to TBA and generic collateral. Our TBA exposure is light at $300 million and remains a tactical tool to manage MBS coupon positioning. ARMOUR forms 40% to 60% of our MBS portfolio with our affiliate BUCKLER Securities, while spreading out the remaining repo balances across 15 to 20 other counterparties to provide ARMOUR with the best financing opportunities at an average gross haircut of 2.75%. Overall, MBS repo funding remains ample and competitively priced, ranging at around SOFR plus 15 to 17 basis points. We are increasingly optimistic that structural demand for MBS may improve later this year. Evolving regulatory clarity around banking reform and a resumption of the Fed easing policy could act as meaningful catalysts for increasing banking demand. This, combined with constrained mortgage supply, sets up a highly constructive technical backdrop for Agency MBS, while historically wide spreads signal strong risk to reward incentive to own mortgage assets. I'll turn it back over to you, Scott.

Thanks, Desmond. ARMOUR's approach remains unchanged: grow and deploy capital thoughtfully during spread dislocations, maintain robust liquidity, and dynamically adjust hedges for disciplined risk management. We're confident in our positioning, strategy, and ability to deliver value for shareholders. As you know, we determine our dividend based on a medium-term outlook. We view our current dividend as appropriate for this environment and the returns available. Thank you for joining today's call and your interest in ARMOUR. We're happy to now answer your questions.

The first question comes from Doug Harter with UBS.

I was hoping you could just talk about your philosophy for managing spread duration risk as you go through a volatile period like you did in April and the second quarter in total and kind of just give us a little more on the thought process.

Yes, Doug. So on spread risk, I can start with just our leverage, which we are very comfortable with at this point. We think that spreads remain historically attractive. And for that reason, we could potentially look to even modestly increase our leverage here. Currently, we are around just a little bit below the average over the last 6 to 12 months, our own average over the last 6 to 12 months. In terms of duration, we manage it dynamically. We've recently increased our hedges in longer duration assets, longer duration beyond the 10-year point to adjust for what we saw in Q2 where there was steepness of the curve in 10-year maturities and beyond.

The next question comes from the line of Trevor Cranston with JMP Securities.

Looking at the portfolio data, it looks like the allocation to higher coupons like 6s and above declined during the second quarter. Can you guys just comment on where you're seeing the best value in the coupon stack and kind of where you guys are deploying marginal dollars as you raise capital?

Trevor, this is Sergey. Yes, so I think we might have talked about it on the last earnings call, there was a volatility during the first half of April. That is probably where the sizes might have been reduced. But overall, we remain favorable of 5.5 and 6 coupons. These are the highest ROE coupons that we are currently modeling. So with the prepayment environment remaining very benign, this remains our focal point for the portfolio. We don't really expect large changes in the near term.

Got it. Okay. And I guess the other notable thing there was the new line item for the long treasury position. Can you just comment on kind of the role of that within the portfolio?

Yes. So as you know, we view the 5-year point on the yield curve as a very important pivotal point for managing overall portfolio duration risk and just responding to the monetary policy across the yield curve. So a 5-year treasury serves as part of that hedging strategy, but it also is used as a proxy for our Agency CMBS position. As we know, we hold slightly just below maybe 5% of our portfolio. And we are very tactical about that market. We tend to go in when spreads widen and reduce our allocations when we see spreads on the more richer side. And 5-year treasuries help us hedge that position and be able to rotate among those asset classes.

The next question comes from the line of Randy Binner with B. Riley.

I just have one on the model and total expenses after fees waived reported in the quarter was $14.3 million. That was just a little bit higher than what trend was and what we were looking for. Was there anything unusual in that line item this quarter or seasonal? Or is that a level we would expect going forward?

I wouldn't say it's a level we'd expect going forward. We had a bit more professional fees than we had probably in the first quarter, just on things that we were working on. So that – as we explained in the 10-Q, some of that can just vary quarter-to-quarter, but not expecting sort of the same run rate on expenses.

And that's helpful. Just to clarify, if there were higher hedge costs or volatility due to interest rate fluctuations in April, that would not appear in that line item but would be recorded elsewhere, correct?

Yes. That's up in the derivatives.

The next question comes from the line of Jason Stewart with Janney.

Just big picture, as you think about constructing the hedge portfolio and the coupon stack, how do you balance total return versus carry as we start to see some of these dislocations in swaps versus treasuries?

Jason, so in terms of our portfolio, on the hedge side, we mentioned our duration. We are positioned for a bullish steepener, and we adjust our hedges appropriately. And it's pretty dynamic. It's our view of the macroeconomic environment. We like to stay diversified across the coupon stack. The lower coupons would benefit if we do see rate rally. We expect that a rally could take place when the Fed resumes normalization, which we are expecting later on this year, in the fall or later. The higher coupons could benefit in a steepener where, in any steepness scenario, the CPRs, projected CPRs could be slower and those could benefit the higher coupons. We're looking to reinvest muscle in production coupon 5.5 and 6s. These are specified pools. They have the prepayment characteristics that we talked about in our prepared remarks. And that is supposed to improve the overall convexity of our portfolio. And last, of course, we also have those securities with even positive convexity. So best to stay diversified across the coupon stack and looking to add more in production coupons in terms of reinvesting paydowns and also reinvesting any equity capital raises.

Yes. And just to add on the hedge book side, Desmond mentioned, on DV01 basis, we're about 33% in treasuries. On a notional basis, it's closer to 20-80. We still like to use interest rate swaps as the main hedge instrument. It's a cheaper hedge. Obviously, from a total return, treasuries have been a more effective hedge as of late. So we're keeping the balance of the hedge book right where we feel like it provides both the carry and the total return opportunity from both sides.

Okay. So does the 18% to 20% range keep the hedge book with the same composition that you have right now in 20-80 notional?

So an 18% to 20% return would apply to our production coupons of 5.5 and 6. From a total return perspective, if we use swap hedges and convert them to forwards, the total return would be approximately zero in that scenario. Therefore, a 20% return on production coupons is nearly indifferent to whether we opt for swaps or treasury futures. It's important to note that this 18% to 20% range reflects our base case. We find the current spreads quite appealing. For instance, should we experience a 10 basis points tightening in OAS, that could contribute an additional 4% to this figure. Additionally, the repo rate has remained stable throughout the year, with the Fed not implementing any cuts. If normalization resumes, we anticipate those returns could become even more appealing, at least under the current conditions, as they either meet or surpass our hurdle rate. This is one of the factors contributing to our optimism about the existing environment.

Okay. That's helpful color. And then just on the ATM program quarter-to-date in 3Q, could you give us an idea of how that was raised relative to book and where book was today?

I don't have book value for you as of today, but book is, as we said, was $16.81 as of Monday. And the issuances were just mildly dilutive, just a couple of cents per share.

The next question comes from the line of Matthew Erdner with Jones Trading.

Just a quick one for me. You guys talked on leverage a little bit with it running back up quarter-to-date, still below those historical levels. What exactly are you looking for to take leverage up? Is it more clarity from the Fed? Is it kind of a little more stability on the long end of the curve? I would just like your thoughts there.

Go ahead, Desmond.

Our leverage strategy is very flexible and is meant to align with our perspective on the attractiveness of spreads, market volatility, and our desired liquidity position. We have tactically reduced our leverage so far this quarter since spreads have tightened locally and volatility has increased significantly since early April. Additionally, the headlines regarding Fed independence have subsided. Given that spreads remain near historically wide levels and liquidity conditions are now stable, we feel comfortable with a modest increase in our leverage from its current level. Does that answer your question?

Yes, a little bit. But I guess going forward over the next three months, when you guys are expecting the Fed cut, are you going to put leverage on in front of that as you go into that event?

We are optimistic...

Yes, I'd just say we think about all this stuff and – but are generally not in the – try not to be in the business of putting big bets on. What's behind your question is exactly right. It's a view that there's more stability across all the axes that we look at. And to the degree that – and of course, that's a reflection of how stable we feel liquidity is going to be, which is really the driver behind what leverage you're comfortable with. And we'll react accordingly. I think you can probably expect us not to take a big bet. But as you see elements of greater stability come into the market across those axes, there may well be a pretty good case for going up a little bit. Remember, historically, leverage in this sort of business model, if you go back decades, was a lot higher. And generally, people have been keeping their head down, which has served everybody pretty well, frankly. But less volatility, more stability means that the model can take a little more leverage. Sorry, go ahead.

Just – and as a catalyst, of course, the big elephant in the room is bank demand so far year-to-date, and it has probably disappointed most industry investors, and we are closely watching developments on the regulation front. Just yesterday, there was the first Fed capital framework conference that a lot of color came out of that industry-wide participants are looking to speed up and agree that currently capital framework is too confusing and too stringent. Banks are sitting on record excess capital. So we feel like it's just a question of if not when we start to see greater participation from the banks, and this will be the tailwind that we outlined in our script as well.

Yes, I definitely agree.

The next question comes from the line of Eric Hagen with BTIG.

Sticking on this conversation around hedging. I mean, do you think there's any value at this point in hedging the short end of the yield curve? I mean how attractive do you think it is to buy swaptions at this point, just considering volatility has come down a little bit?

Eric, yes. So I mean, look, the 2-year yield has been extremely stable over the last year. Obviously, the talk of hikes are not on the table at this point. But we express that in our bull steepener bias of our yield curve hedging. Whatever front-end hedges we have on, they're there for kind of the risk management to express that exposure. We currently don't play in the swaptions market. We always evaluate it. But from where mortgages are trading and how wide the spreads are, we feel like the better trade-off is to express the view on volatility through the current coupon basis, for example.

Yes. That's helpful. I mean maybe continuing on that theme, I mean, you guys offer good information and color on your duration gap. I mean just looking at these current coupons specifically, do you maybe have an estimate for what your duration gap would extend to if mortgage rates backed up, let's call it like 50 basis points. And in that extension scenario, would you be more likely at this point to let your leverage run a little higher? Or would you look to sell assets in that scenario?

Yes, that's a good question. We obviously run risk stress test scenarios. We can get some numbers for you. And do you mean selloff on the long end or on the front end since that was the initial question?

Yes, maybe more on the long end, right, like that curve steepener you guys are positioned for.

Yes, I believe we manage our current exposure in a dynamic way. We won't allow duration to extend beyond certain levels where it would necessitate a rebalancing of duration. From this perspective, we maintain strict discipline. Our risk metrics under stress scenarios do not indicate any significant extension that would jeopardize liquidity.

Ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the conference back over to Scott Ulm for any closing remarks.

Thanks for joining us this morning. Please feel free to give us a ring at the office. Happy to catch up if other things occur as you're thinking about what's going on in mortgage land. Thank you for joining us this morning, and good morning to you.

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