ARMOUR Residential REIT, Inc.

and welcome to the Armour Residential REIT Inc. 4th Quarter 2020 Earnings Conference Call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. If you would like to register at this time, you may do so by pressing the 1 followed by the 4 on your telephone. If you require operator assistance, please press star 0 and an operator will assist you. As a reminder, this conference is being recorded today, Thursday, February 18, 2021. It is now my pleasure to turn the conference over to Jim Mountain, Chief Financial Officer. Please go ahead, sir.

Thank you, France. And thank you all for joining our call to discuss Armour's fourth quarter 2020 results. This morning, I am joined by Armour's co-CEOs, Scott Allman, Jeff Zimmer, and Armour's 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, along with our Form 10-K and most recent company update. 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 protections 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 armor. 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 these 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 we are required to do so by law. Also, our discussion today may include reference to certain non-GAAP measures. A reconciliation of these measures to our 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 will continue for one year. U.S. financial markets continued to stabilize and improve during the fourth quarter, and Armour continues to concentrate its portfolio activity in agency MBS, which we will do for the foreseeable future. Quarter-end book value was $12.32 per common share, up 58 cents from Q3 2020. As of the close of business last Friday, February 12th, we estimate book value to be approximately $12.90 per common share, ex-dividend. Armour's Q4 comprehensive income was $60.2 million, or $0.89 per common share. We paid dividends of $0.10 per common share for each month in the fourth quarter, for a total of $19.6 million. We've also declared February and March common dividends at the rate of 10 cents per share, and Series C preferred stock dividends for Q1 at the rate of 14.583 cents per share. Now let me turn the call over to Co-Chief Executive Officer Scott Ulm to discuss Armour's portfolio position and current strategy in a bit more detail. Scott?

Thanks, Jim, and good morning. The fourth quarter of 2020 provided favorable conditions for mortgage investors and Armoury. A one-two punch of fiscal action from Washington and all-out commitment from the Fed to the U.S. Treasury and mortgage-backed securities markets created a wave of liquidity that drove asset spreads significantly tighter in the fourth quarter. The trends have continued into the first quarter of 2021, as markets anticipate a new wave of fiscal stimulus from Congress in the near future. Demand for yield from private investors combined with the official QE purchases delivered a strong MBS performance during a period when longer-term Treasury yields rose significantly off their 2020 lows. Echoing the positive market sentiment, repo financing also improved over the quarter, dropping from 20 to 25 basis points in the third quarter for 30-day tenors down to 15 to 20 basis points currently. The flip side of all the good news is that historically low mortgage rates helped create the largest wave of home loan refinancing since 2003. Faster prepayments at higher prices tampered down new yield opportunities in the market. The TVA dollar role market remains the most attractive proposition as the Fed's growing footprint in the sector generates significantly higher returns versus those on agency CMBS or specified MBS pools. And we expect the Fed's presence to persist at least for the first half of 2021, if not longer. While we do allocate approximately 36% of our portfolio to dollar rolls in 30-year and 15-year TVAs, 94% of the remaining portfolio are assets with favorable prepayment protection characteristics, including prepayment penalties, lower loan balances, and seasoning. Such pools held up very well as expected. The average CPR in our portfolio was 17.3% as of the fourth quarter versus 16% in the third quarter, which were both significantly below the aggregate speeds on more generic MBS. Year-to-date, the portfolio is averaging 17.9% CPR. Our response to the tighter spread, higher prepayment mortgage environment has been to exercise caution. This is reflected in our implied leverage ratio of 7.7 at the end of the fourth quarter and 6.9 implied leverage ratio currently. These numbers are considerably lower than our historical leverage levels and provide two or more terms of that additional dry powder to take advantage of market opportunities. Armour's duration as of year end was 0.62 and is currently 0.76. As a result of our early investment in specified pools, the portfolio's convexity profile remains significantly more favorable than that of newly issued MBS. Armour continuously monitors its hedge book and manages the net duration gap within a tight range dictated by the team's outlook on the rates market. It should be noted that a significant portion of the portfolio's duration is in the key rate buckets of inside three years, where we expect yields to be pegged close to zero for the foreseeable future. Our exposure to the long end of the curve is considerably less than our overall duration. While we accept the apparent market consensus that the Fed's presence and support for the market is here to stay for a prolonged period, we also have a keen appreciation for the unexpected. We will continue to shape our portfolio to protect book value and will not reach for yield at the expense of much higher risk. This means that metrics like core earnings may trend a bit lower, but should work to optimize total economic return. As we've noted before, we set our dividend policy based on the medium-term outlook on our business. We continue to see our dividend level as appropriate. We'd be delighted to take any questions.

Thank you. If you would like to register for a question, please press the 1 followed by the 4 on your telephone. You will hear a three-tone prompt to acknowledge your request. If your question has been answered and you would like to withdraw, You may press the one followed by the three. And our first question will be from the line of Doug Harder with Credit Suisse. You may go ahead.

Thanks, and good morning. You mentioned that you kind of brought down leverage to take advantage of potential, you know, better opportunities. You know, it seems like the mortgage market this week, you know, is starting to give you some of that opportunity I guess if you could just talk about, you know, I guess how you view the opportunity today and, you know, is that enough to start kind of building back the position, or would you be looking for more volatility and still potentially better entry points?

So, Doug, this is Jeff. Good morning. In middle August, Fannie Two's, for example, had OAS of 83, zero volatility OAS of 83. On our last earnings call, they had come into 65. when we last spoke to you, and they're at 31 today. I listened to Leon Cooperman this morning being interviewed on Bloomberg News, and Leon said about stocks, I like what I own, but I don't want to buy anymore here. And I think that's the way we feel as well. We like what we own. We've done some selective selling. Dust, you may have heard, got as wide as 250 off Z's. And swaps, excuse me, in March. Now we're trading in the mid-20s. We've done a little pruning there. We've done a little pruning of our 3.5 position where prepayment speeds had gone so wild that the yields on those assets were actually negative. And we've done some pruning in the lower coupon assets as well. We're not in a position to say that we will increase our exposure or our leverage quite yet. We are watching very carefully, and we do think the opportunities will come, and we're going to be patient.

And I guess just philosophically, you know, I guess how do you kind of weigh the tradeoff of, you know, potential lost carry by, you know, by being lower levered versus, you know, kind of the potential for book value volatility?

So between the beginning of the second quarter of 2013 and the end of the second quarter of 2013, many of the firms in this space lost between 10% and 25% of their book value. And Those numbers and reflections of OASs and tightness and demand during that period of time are too dissimilar than what we're seeing today. So I look at Armour and we sit down in our meetings and we go, gosh, book value is up 4.5% so far this quarter. And mortgages are really tight. And this looks like another party that got a little sloppy at the end of it. And we're just going to be patient and watch. And we think we'll be better off long term looking at your book value this period.

I'd also add that it's relatively often that we find opportunities to create earnings. It may come with some risk that we may or may not like, but opportunities to find earnings are usually there. Opportunities to create book value are more difficult to achieve.

Understood. Thank you.

Our next question is from the line of Trevor Cranston with JMT Securities. Please proceed.

Hey, thanks. Good morning. Follow up on the on the question about leverage. Would you would you guys say at this point that you're finding opportunities to reinvest pay downs or given your views on the market? Are you sort of letting portfolio runoff not be replaced at this point, and which would imply that leverage may continue to tick down a little bit going forward.

Morning, Trevor. It's Jeffrey. We can invest in two and two-and-a-half dollar rolls and get mid-double-digit returns, you know, 12%, 13%, 14% double-digit returns, but that comes with a price, and the prices, these assets are becoming increasingly expensive. poor convexity assets. And that's why the TBA market trades at way lower levels than the specified market. Their specified assets now trading at four or five points over TBA's number, about 100 years of experience sitting at this table. And these are new levels stretching that out. So we will selectively add, we have added some dollar rolls over the last quarter, When we see some opportunities, but we want to be very cautious of the convexity, and that gets back to our point to Doug Harder, that you can blow up a lot of book value by just reaching for a little bit of extra earnings. And at the end of the day, we're better off not reaching and protecting book value, and that's how we will do it in the immediate future. Those earnings opportunities will come. And it's pretty easy to buy one or two billion of them when their opportunities are there. But as Scott just, you know, boldly stated, very hard to find those opportunities to increase book value.

Got it. Okay. Then actually my second question is related to, you know, you just commented on the convexity of some investments. You know, how do you guys think about, you know, the extension risk within the portfolio? You know, obviously we've seen the 10-year move higher over the last, you know, in the fourth quarter and again in the first quarter. So I was curious how you guys think about extension risk in your book and how you're approaching that on the hedge side as well.

So 94%, as Scott said in his comments, of our non-TBA position are assets that have qualities that have improved convexity, and as a result, improved convexity means improved Extension characteristics. And, I mean, that's like almost 100%, right? So when rates go up, we don't extend. I would also say that model-wise, most of the DVO-1 exposure we have is in the very short end of the curve. And the Fed was very clear in their minutes yesterday that's not going anywhere. So our exposure out to the 10-year area, well, let's look at this. When we last spoke, what was the 10-year? 45 basis points, 50 basis points lower in yield than it is now. But, yes, since we last spoke, our book value is up like 8%. So pretty good performance. Mortgages haven't extended yet. They will get out that term, the S-curve. You get like a 160 kind of 10-year note. Mortgage banker pipelines are going to get very bloated. and all of a sudden they're going to need to sell, and then you're going to have other people that need to sell. And you're going to see some extension, but those are going to be reflected on the TBAs and the 2s where we've generally, as I said, reduced our exposure and we're being very cautious. Hope that's helpful.

Yeah, that is very helpful. Appreciate the comments. Thank you. Great.

Once again, as a reminder, to register for questions, you may press the 1 followed by the 4 on your telephone. And our next question from the line of Christopher Nolan with Leidenberg Thalmann. Please proceed.

Hey, guys. Based on Scott's comments and Jeff's follow-ups in terms of not reaching for earnings and protecting book value, in the past you guys indicated that you're targeting high single-digit, low double-digit core ROE. How would you characterize the target now?

So we're paying a dividend of, 10 cents a month based on our stock prices, about 10% dividend yield, right? And we'll continue to pay that dividend. And we would hope that at the end of the year, the total 2021, you know, earnings and book value will exceed the dividends paid. And that's our goal. Comprehensive income.

Got it. That's it for me. Thanks.

Thank you.

And speakers, it appears we have no further questions at this time. I'll return the call back to you.

Again, I'd like to thank everybody for joining us. We look forward to continuing our conversations with you individually over the rest of the quarter. So as always, if there's anything that comes up that you want to talk about in more depth, we're here. Give us a call. And until next time. Stay warm, stay safe.

Thank you. This does conclude the conference call for today. We thank you all for your participation and kindly ask that you please disconnect your lines. Have a great day, everyone.