Armour Residential REIT, Inc. Q3 FY2025 Earnings Call

Good day, and welcome to the ARMOUR Residential REIT Third Quarter 2025 Earnings Conference Call. Please note this event is being recorded. I would now like to turn the conference over to Scott Ulm, Chief Executive Officer. Please go ahead.

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

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. ARMOUR's Q3 GAAP net income available to common stockholders was $156.3 million or $1.49 per common share. Net interest income was $38.5 million. Distributable earnings available to common stockholders was $75.3 million or $0.72 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. Total economic return for the quarter was 7.75%. Quarter-end book value was $17.49 per common share, up 3.5% from June 30 and up 2.8% from August 8, the last date which we have reported book value. Our most recent current available estimate of book value is as of Tuesday, October 21, and was $17.50 per common share, which reflects the accrual of the October common dividend of $0.24 per share payable on October 30. During Q3, ARMOUR raised approximately $99.5 million of capital by issuing approximately 6 million shares of common stock through an after-market offering program. In August, we completed the sale of 18.5 million shares of common stock for proceeds of approximately $298.6 million, net of underwriting discounts and commissions. And in September, we repurchased 700,000 shares of common stock through our common stock repurchase program. 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. On October 30, a cash dividend of $0.24 per outstanding common share will be paid to the holders of record on October 15. We have also declared a cash dividend of $0.24 per outstanding common share payable November 28, to holders of record on November 17, 2025. I'll now turn the call over to Scott Ulm to discuss ARMOUR's portfolio and current strategy.

Thank you, Gordon. The third quarter unfolded against the backdrop of shifting macroeconomic currents. Downward revisions to employment data confirmed that the U.S. labor market had been softer than earlier reports suggested. In response, the Federal Reserve resumed its easing cycle, implementing a 25 basis point cut in September. Chair Powell described the move as a risk management cut, reflecting growing caution around labor conditions. Updated projections now signal two additional cuts by year-end, setting the stage for a constructive environment for Agency MBS as financing conditions continue to improve. Markets responded positively to the Fed's pivot. Treasury yields declined, Agency MBS spreads tightened by roughly 20 basis points and volatility fell to its lowest level since 2022. These dynamics produced a total economic return of 7.75% for the quarter, as previously mentioned by Gordon. Following this strong performance, MBS spreads are now near the tightest levels of the year. Near-term consolidation is possible, valuations remain compelling on a medium-term horizon. As we entered the fourth quarter, macro and political visibility became more clouded. The federal government shutdown that began on October 1 delayed key data releases and introduced incremental uncertainty to growth forecasts. Even so, the market continues to expect an easing bias through year-end that's likely to redirect liquidity from the short end of the rates curve into Agency MBS. Chair Powell's recent comments also indicated that quantitative tightening may conclude in the coming months. Although details are still evolving, the Fed's MBS runoff is likely to continue with paydowns from MBS and treasuries expected to be reinvested in the treasury market. Together with a broader push toward banking deregulation, these shifts are aimed to ease balance sheet constraints and reinforce demand for treasuries and Agency MBS. Notably, SOFR treasury spreads have turned more positive in recent weeks, strengthening the effectiveness of pay fixed SOFR swaps as portfolio hedges. On the policy front, reports suggest that major banks are positioning to lead potential IPOs for Fannie Mae and Freddie Mac, collectively estimated around $30 billion. Although the process has been delayed by the U.S. government shutdown and the absence of a formal roadmap for privatization, administration officials have reiterated support for retaining an implicit government guarantee, an outcome that could transform GSE reform from a potential headwind into a tailwind for MBS investors. An additional and somewhat unexpected source of demand could come from GSEs themselves. After years of balance sheet contraction under conservatorship, Fannie Mae and Freddie Mac now have roughly $250 billion of combined capacity to invest in mortgage loans and MBS should it align with GSE's earnings and valuation objectives. While no formal plan has been announced, recent disclosures point to greater flexibility within their investment mandates, hinting at a more dynamic approach to managing their portfolios than in the prior cycles. I'll now turn it over to Sergey for more detail on our portfolio.

Thank you, Scott, and good morning. ARMOUR's most recent net duration and implied leverage were 0.2 years and 8.1x, respectively, a balanced stance with a bias towards further Fed easing. Roughly 87% of our hedges are in OIS and SOFR pay fixed swaps with the balance in treasury futures. Our liquidity remains robust at approximately 55% of total capital. The portfolio is invested entirely in Agency MBS, Agency CMBS, and U.S. treasuries. Our recent activity has centered on par to slight premium coupon mortgages where levered and hedge ROEs range from 16% to 18%. Higher premium pools continue to offer up to 19% returns, though with greater sensitivity to prepayment risk. Diversification across 30-year coupon stack, Ginnie Mae, and DUS securities whose positive convexity and shorter duration provide relative value remain a key advantage. During the second half of the year, the 30-year mortgage rate briefly reached 6.15%, the lowest level of this year. While rates remain just above 2024 lows, refinancing activity has already exceeded last year's pace, elevating prepayment concerns for TBA and generic premium MBS. This reinforces our long-standing focus on specified pools, which represent over 92% of the portfolio. Aggregate portfolio prepayment rates rose to 9.6 CPR in October compared with the third quarter average of 8.1 CPR, a 19% increase and consistent with our expectations. We anticipate a similar uptick in November before prepayments stabilize towards the year-end as refinance volumes moderate. Should mortgage rates move down below 6%, levels we've not seen since early 2022, the MBS coupon stack offers a deep market of lower-priced coupons as a hedge against higher prepayments. Roughly 40% of our assets are already positioned in prepayment protected Agency CMBS pools and discount MBS. As usual, we financed 40% to 60% of the MBS portfolio through BUCKLER Securities, distributing the balance across 15 to 20 additional repo counterparties. Average gross haircuts stand near 2.75%. Repo market liquidity remains healthy with only a modest 2 to 3 basis points increase in repo SOFR spreads versus the Q3 average. More meaningfully, the spread between SOFR and Fed funds widened from 3 basis points in Q3 to roughly 10 basis points through October, muting the transmission of the Fed's recent cut to funding markets and by extension to the broader economy. An increase in treasury bill issuance and a gradual decline in banking reserves means banks can lend cash at higher prices. This makes repo funding a key area of focus heading into year-end, yet despite a recent bump in SOFR rates, we view funding conditions as stable with standing repo facility to supply liquidity if needed. Looking ahead, we expect structural demand for Agency MBS to continue to strengthen. Regulatory clarity around banking reform and resumed easing cycles have historically been a powerful catalyst for high-quality liquid assets like MBS. While spreads have compressed, underlying fundamentals and market dynamics remain favorable. Back to you, Scott.

Thanks, Sergey. We executed a $300 million overnight underwritten bought deal in August, the first one we've done this decade. While it was somewhat more expensive than our ATM execution, it allowed us to put a significant amount of capital to work at attractive spread levels. In fact, we estimate that the spread tightening from the newly purchased assets alone contributed about 0.6% to our increase in book value this quarter, along with a meaningful reduction in operating expenses per share. We saw some weakness in our stock in mid-August. And as in the past, we repurchased some shares in the open market. We will continue to look at both sides, selling and buying in our equity account. As you know, we determined our dividend based on a medium-term outlook. We view our current dividend as appropriate for this environment and the returns available. 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 are confident in our positioning strategy and ability to deliver value for shareholders. Thank you for joining today's call and your interest in ARMOUR. We're happy to now answer your questions. Please open the line for some questions, please.

Our first question comes from Doug Harter with UBS.

Hoping you could talk a little bit about where you see current returns on incremental investments and kind of the importance of the hedge choice you make in that and how that factors into your view of the attractiveness of the market today?

Yes. Doug. So expected ROEs, hedged ROEs are in the 16% to 18% range. Obviously, a touch lower than where they were at the end of June, given the tightness in mortgage spreads. So over a short-term basis here, you can assume eight tons of leverage and hedge to swaps. So that's also picking up the swap income. Now we are still constructive medium-term, given the resumption of the normalization cycle and also because of spreads, while local types are still attractive over a longer time horizon. So if we see another 10 basis points of tightening, that could add about 4% in return on equity to that base case of 16% to 18% range for production coupon.

I guess how do you think about what the outlook is for swap spreads? And then how do you think about the attractiveness if you looked at mortgage spreads on like an OIS basis?

Doug, this is Sergey. Yes. So swap spreads have also had a big move since the September meeting. We think swap spreads will continue to normalize. If you look at some of the average prior to Liberation Day, we see 10-year swaps somewhere in the mid-30s, currently trading around 44%. So we've gone a long way from minus 60 earlier in Q2, and we feel like this is going to continue to be a tailwind for the portfolio as effective and more effective hedges to hedge MBS. Currently, we have about 87% notional allocated to SOFR and OIS swaps. So that's good positioning. We will probably tailor it if we do get back to those averages, but a lot of things have been lining up to see balance sheet expansion as well as potentially the Fed looking at changing the target policy rate from the Fed funds to SOFR or another repo measure, and that will provide lower volatility to funding rates and potentially wider SOFR spreads as well. So a lot of tailwinds are lining up there.

And the next question comes from Jason Weaver with Jones Trading.

Scott, along with your prepared remarks, if the administration is actively looking for ways to reduce borrower rates via GSE deregulation, do you have any thoughts on what the actual implementation looks like, whether that's GP manipulation, changes in LLPAs, underwriting guidelines?

There are many options available to them, and it seems they are pulling various levers these days, some of which may be unexpected. I believe this aligns with their agenda. The short answer is yes; we could observe a lot of changes here. Specifically, if they are considering a capital raise for the GSEs, they will aim to make them as appealing as possible. This could also hold back certain actions. It's a balancing act, and I can’t provide deeper insights other than to mention that there are two opposing factors at play. On one hand, they would like to see lower mortgage rates, but on the other, they want the GSEs to be seen as an attractive investment option.

Agree. That's helpful. And then noticing the hedge ratio ticked down quite a bit from Q2. Is that more of a timing issue? Or just along with the greater confidence in the pace of easing activity, you can be a bit more directional here?

There are a lot of things going on in that. Sergey, Desmond, maybe you want to give a little more color on that, but there's a lot that goes into the way that that ratio in itself works. Sergey, Desmond, do you want to give a little more color on that?

Yes, Jason. The way we approach hedges is to manage our duration across the entire curve. As we mentioned earlier, our duration is 0.2, and we maintain a balanced perspective with a tendency towards more Fed easing. Most of that 0.2 duration is concentrated at the front end of the curve, while we aim to keep it flat at the back end. Ultimately, we adjust our hedges to meet our duration targets across the curve.

And the next question comes from Trevor Cranston with Citizens JMP.

There was a notable decline in interest rate volatility during the third quarter, which affected MBS. Can you share your thoughts on how you anticipate volatility will change moving forward? Additionally, considering that it is currently priced much lower, how does that influence the possibility of adding swaptions or options to the hedge portfolio?

Sure. In terms of managing volatility, there are two main strategies. One strategy involves using swaptions, which we have employed in the past and still consider, including hedges not reflected on our balance sheet. The second approach is asset selection. We tend to select assets with low optionality, and approximately 40% of our portfolio consists of shorter-term, lower coupon, DUS securities, which exhibit very low optionality. Additionally, some of these securities even have positive convexity, providing a good counterbalance to the negative convexity associated with our production coupons. Regarding volatility, while it has significantly decreased this year, it is important to consider the larger context. For instance, in 2019, when the Federal Reserve began to normalize policy and reduced its purchase of mortgage-backed securities, the volatility levels then were actually lower than current levels. Specifically, if we look at the swaptions from one year to ten years, today’s rate is about 82 basis points, while the average during that earlier period was around 64 basis points, leaving us approximately 18 basis points higher now. If the Fed continues on its path of normalization, we may see reduced tail risks around interest rates, which could lead to a decline in volatility over the medium term. Although we may still experience short-term fluctuations, we anticipate that volatility will overall decrease. Consequently, if you hold options, their value would diminish if volatility continues to lower. We are constantly evaluating our hedges, but for the time being, we believe focusing on low optionality assets is the preferable strategy.

And the next question comes from Timothy D'Agostino with B. Riley Securities.

Just one for me. Regarding economic net interest margin, it seems like it widened about one basis point quarter-over-quarter. Looking forward to year-end and maybe to halfway through 2026, what would we need to see for this trend to kind of continue and if not pick up pace?

It really depends on our portfolio and the impact of continued cuts in the Fed rate on our financing costs. We believe we've built a strong portfolio, and the returns we're generating are reasonable given the circumstances. I’m not sure if Sergey and Desmond have anything else to add about their outlook, but we typically don’t provide too many forward-looking statements about our future earnings. It will largely depend on how quickly the rates are cut and how the market responds. Overall, we believe we have a solid portfolio for the future.

Yes. Yes. So just on that to continue Scott's comment there. Yes, so we kind of typically just look at forward ROEs as well, another way to look at the same way of looking at things. So 16% to 18% in production coupons. Our weighted average dividend yield, both preferred and common plus operational expenses all in is about 18%. So that could be sort of as a hurdle rate. We already have assets that we are buying that are at 18%. There are others that are slightly lower than that. But as we said, we're still constructive medium term here. So just a few more basis points of tightening and those assets would meet or exceed our hurdle rate.

Our next question comes from Eric Hagen with BTIG.

Maybe following up on some of this conversation here. I mean, what do you think is priced into MBS spreads with respect to the Fed cutting rates? Like right now, it looks like there's 125 basis points of cuts priced into the forward curve through the end of next year. Do you feel like spreads would widen if those expectations got walked back for any reason? And do you feel like spreads would actually have room to tighten once they actually deliver those cuts?

Yes, to both. A pause in the rate easing cycle or any factor prompting a revision of their projections could lead to market volatility. However, I believe that delivering cuts will unlock a significant amount of bank demand. Currently, the difference between coupon mortgages and yields on money markets or T-bills has narrowed again over the year, approaching 100 basis points. As we near a 152% spread between mortgage yields and cash, we are likely to see increased interest from other market participants, especially since demand has not met earlier expectations. This addresses both scenarios. We also mentioned in our prepared remarks that spreads have tightened considerably this quarter. While we foresee potential upside, the overall macroeconomic environment and the lack of government economic data have caused some hesitation. Nevertheless, in the medium-term, lower Fed funds rates present a clear advantage.

Yes. Got you. That's good color. The move to raise capital and buy back stock in the quarter, can you kind of share the rough level of your stock valuation when you did those transactions? And like what's the best way to compare the value from having done each of those deals, transactions?

Yes. So Gordon will provide the information on the level where we bought back the stock. We're committed to being active on both sides. When there's a dislocation, we'll buy back some stock, and when we find good valuations, we'll sell stock. Stock buybacks can be challenging because they occur amidst other activities, and it's often costly to reissue the stock. However, we achieved a favorable spread between our buying and selling actions. Gordon, do you have those numbers available?

Yes, I know that when we did the buybacks, it was about a couple of cents accretive on those days, and it was around the $14.40 mark on the days that averaged out. We've since bounced back from those days and have bought back the stock.

Is that useful?

Yes, that was helpful. I appreciate you guys.

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 the call today. We appreciate it. Any further questions occur to you, give a ring at the office, and we'll be back to you as soon as we can. Very good. Thank you, and have a nice day.

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