ARMOUR Residential REIT, Inc.

Good morning and welcome to Armour Residential REIT fourth quarter 2024 earnings conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing star then zero on your telephone keypad. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Scott Ulm, CEO. Please go ahead.

Good morning and welcome to our fourth quarter 2024 conference call. This morning I'm joined by our CFO, Gordon Harper, as well as our co-CIOs, Sergey Lazarev and Desmond McCauley. I'll now turn the call over to Gordon to run through the financial results.

Thank you, Scott. By now, everyone has access to Armour's earnings release, which can be found on Armour's website, www.armourleague.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 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 at www.sec.gov. All of today's forward-looking statements are subject to change without notice. We just claim 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. Turning to results. Armour's Q4 gap net loss related to common stockholders was $49.4 million or $0.83 per common share. Net interest income was $12.7 million. Distributable earnings available to common stockholders was $46.5 million or $0.78 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 continues to waive a portion of their management fees, waiving $1.65 million for Q4, which offsets operating expenses. The waiver continues until further notice. During Q4, ARMA raised approximately $136.2 million of capital by issuing approximately 7.2 million shares of common stock through an at-the-market offering program. These issuances were mildly diluted to bulk value at $0.02 per share. Since December 31st, we have continued to be active in our ATM programs, issuing approximately 14 million common shares and 17,364 preferred C shares through February 4th 2025, raising approximately $259 million of total net capital, which again, were mildly dilutive. 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. As we stated previously, we aim to pay an attractive dividend in this appropriated context and stable over the median term. Taken together with contractual dividends on the current stock, Armour has made cumulative distributions to stockholders of $2.4 billion over its history. Quarter end book value was $19.07 per common share. Our most current available estimate of book value is as of Monday, February the 10th, was $19.18 per common share. Now I will turn the call over to our Chief Executive Officer, Scott Holm, to discuss Armour's portfolio position and current strategy.

Thank you, Gordon. 2024 was a year of transition for Fed policy as the FOMC reduced the Fed funds rate by 50 basis points in September after keeping it unchanged at 5.25% since July of 2023. The Fed stated that weakness in the labor markets prompted the larger than typical 25 basis point rate cut. Yet the U.S. economy remained resilient in the fourth quarter, and as economic data continued to improve, Investors reduced the number of expected rate cuts and extended their timing, leading to increased bond yields and wider spreads. The outcome of the U.S. presidential elections with a supportive pro-growth agenda and a potentially larger fiscal spending program added another layer of concern for the Treasury. Lastly, a hawkish rate cut at the December FOMC meeting injected another round of volatility in a month that has been historically favorable for bond investors. Despite the four-quarters swings in MBS valuations, Armour maintains a constructive view on agency MBS spreads. Our positively steeper yield curve and historically attractive MBS spreads are currently generating approximately 150 basis points positive versus cash. Moreover, a duration-edged levered ROE measure produces some of the most attractive yields in Armour's history at 18% to 19% on the production and premium coupon MBS. Although macroeconomic and geopolitical themes continue to prevail, such an attractive carry profile leads us as buyers of MBS during episodes of spread weakness or volatility. Our view is supported by less volatile spreads in 2025, as well as the growing diversification of the mortgage investor base, which has steadily grown from money managers to continued overseas buying and bank demand turning net positive in 2024. With monetary policy on hold, we expect rates to trade in a range-bound environment over the earlier part of the year, a tailwind for consistent MBS returns. Of course, it is just as important to recognize potential headwinds facing MBS investors this year. The recent reemergence of headlines around GSE reform adds to the already busy list of macro drivers that could keep investors in cash for longer than expected. Due to bureaucratic and regulatory complexity and the GSE's outsized role in the housing market, We do not see reforms as an imminent risk, but acknowledge that the new administration, including Scott Bessner as head of the U.S. Treasury Department and Bill Pulte as the head of the FHFA, could begin to introduce details and steps needed for their eventual exit. Our exposure to GINI MBS helps mitigate some of the reform risk in conventional MBS for now. But until we see more concrete proposals, the current situation leaves us looking to fade headline-driven volatility. Secondly, we believe that banks seemingly slower than expected deployment in agency MBS assets could be driven by lack of clarity in the proposed regulatory changes, which though appearing to turn more favorable in recent months, lacks certainty of details and timing. Thus, this is a when, not an if issue, which we will see more transaction if Michelle Bowman, a strong proponent of banking regulations, gets nominated and confirmed as new vice chair for banking supervision. Similarly, We've been encouraged by Treasury Secretary Best's plans to keep future coupon treasuries steady and tackle the budget deficit, steps that strengthen investors' confidence and incentivize banks to allocate their reserves into Treasury and MBS markets. Let me turn it over to Desmond for more detail on our portfolio. Desmond? Thank you, Scott.

In Q4, our agency portfolio experienced approximately four basis points of widening in nominal spreads, versus approximately five basis points of widening in production MBR treasury basis. Year to date, portfolio assets have tightened approximately three basis points, and our book value stands at approximately $19.18 per share as of market close on February 10th. Net portfolio duration and implied leverage, we are at 0.36 years, and 7.9 turns, respectively, while cash and box liquidity is at approximately 50% of the total capital. The hedge book is composed of approximately 25% Treasury-based hedges and the remainder in OIS and SOFRO pay swaps. This allocation benefits us if swap spreads continue to appreciate and help diversify some of the risk its concerns around term funding premium resurface. We maintain healthy levels of available capital liquidity with room to grow leverage in the appropriate market conditions. We are successful in bolstering our capital base through issuance of common and preferred equity in late 2024 and in the first quarter of this year. Given our favorable outlook for MBS Carry, we deployed newly raised capital to purchase approximately $2 billion of mortgage assets and PBAs year-to-date, which earn at or above our hurdle rate after accounting for costs and expenses. We expect earnings available for distribution to exceed our Q1 dividend rate. The overall investment portfolio remains liquid with 100% agency MBS and well diversified across the 30-year coupon stack ranging from 2.5% to 6.5% with particular overweight to 5.5% and 6% coupons where spreads and carry are most attractive. Portfolio MBS prepayment rates have averaged 8.7 CPR in Q4 and trending at around 6.4 average CPR so far in Q1. We expect the prepayment environment to remain uneventful for our portfolio mix of modest price premiums and discount MBS, and while mortgage rates remain above 6.5%. Despite the slow prepayment environment, we continue to favor specified pools which exhibit better convexity over TBA and are less exposed to refinancings should mortgage rates rally to 2024 lows of 6%. Having said that, we have increased our exposure to TBA role in coupons where we see some return in role specialness since the start of the year. While these are not core long-term positions, they help enhance market liquidity and flexibility of the portfolio. The repo market experienced some rising pressures at the year end, as expected, but has since returned to a more typical SOFRA plus 15 basis points repo spread. We found 40 to 60% of our MBS portfolio with our affiliate Buckeler Securities, while spreading out the remaining repo balances across 15 to 20 other counterparties to provide Irma with the best financing opportunities. Overall, repo funding for agency MBS remains plentiful and competitively priced across the board. And Fair Chairman Powell continues to reiterate that banking reserves remain abundant. Back to you, Scott.

Thank you very much. At this point, I think we'd like to open up for any questions.

Yes, sir. We will now begin the question and answer session. To ask a question, you may press star then 1 on your telephone keypad. If you're using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star then 2. At this time, we will pause momentarily to assemble our roster. The first question comes from Doug Harter with UBS. Please go ahead.

Thanks. First, just a clarification on the book value update. How does that factor in February's dividend?

It does not. As we know, X dividend by the end of this week.

Okay. I appreciate that. And then... You know, just, I guess, how are you thinking about the outlook for volatility, you know, and the potential costs of volatility on your returns?

Yes, good morning, Doug. This is Sergey. How are you? Thank you for your question. You know, we've seen volatility decline here, both in rates and spread. And I think this has been the kind of really the tailwind for the MBS market to earn consistent ROE without the volatility that we've seen over the last two years. We expect this volatility to continue to grind lower. With the Fed on hold, we feel like this will be a more range-bound environment than we've seen in prior years. At the same time, we do feel like there's more cuts on the table. The question is going to be their timing, Overall, the volatility aspect of the market looks very favorable.

Great. Appreciate that, Sergey.

The next question comes from Jason Weaver with Jones Trading. Please go ahead.

Hey, good morning. Thanks for taking my question. Scott, I think in your initial comments you mentioned you expect something like 18, 19% ROE on generics concurrently. How does that compare with your actual deployment, the 2 billion of actual deployments here today? What are you expecting there?

We've been able to deploy at those expected numbers. What tomorrow brings... Oh, okay.

That's fair. I just wanted to clarify.

Yeah. I can't tell you what tomorrow brings, but we've been pretty encouraged by what we've been able to achieve with capital.

Got it. Thank you for that. What we're seeing on the screen, at least year-to-date, is mirroring your expectation of somewhat tighter spreads, even in the face of some of these hotter inflationary prints. I was curious You know, and Tony, what are the biggest sort of risk factors you're concerned about for spread widening going forward?

There's all this stuff to worry about, as you know, right? You know, it starts with geopolitical stuff that's out there. It, you know, follows through. We've got, yeah, GSE reforms have been a wild card. You know, as we said, you know, look up. I think that's going to be a heavy lift. It's been on the agenda for past Trump administrations and didn't quite get there. And there is certainly headline risk there, comments on what could happen. But there's a lot of wood to chop on that one. But that could introduce some headline stuff there. We've got ongoing fiscal issues. Treasury supply that might be there and you know obviously we've got you know these this inflation story which continues to evolve probably probably another couple pages of things that we come up with there's always a lot to worry about something going bump in the night got it thanks for that color the next question comes from Jason Stewart with Janie Montgomery Scott please go ahead

Hey, good morning. Thank you. I wanted to follow up on the GST reform topic. Thanks for the color and the comments there. Maybe you could put a finer point on how much you think is priced into the mortgage basis right now. And, you know, as we go through that process and at least see headlines, you know, what kind of widening you would expect to see in terms of basis points and how you would position the portfolio and risk for that environment?

That's a tough one. You know, look, I saw some research that said if the agencies stood on their own, they'd be single-A rated and, you know, cuff that at, you know, 70 basis points or a point of additional spread required. You know, that's a big number. On the other hand, I think it's a – It's a little beyond the pale to think that after the better part of a century of enjoying an implicit government guarantee, and obviously there are issues making it explicit in law, but we've got preferred purchase stuff and five treasury secretaries that say they back the agencies, that we're going to walk away from the implicit support that we've got. My bet is that we'll see efforts to exit conservancy and probably tie that with substantial private capital tied to the front bumper to protect the taxpayer, but still leaving some version of what's been in place for a long time. How much is priced in today? I don't know, a lot. I wouldn't say none because it's hard to say none, but I don't think there's a whole lot of price to it right now.

Yeah, a good measuring tool for that are G&E Fannie swaps, which haven't really reacted to many of the headlines that you see in the equity markets. So that kind of underlines what Scott just mentioned. The steady growth of retained earnings could put them on the path to eventual exit. So the new FHFA director could, look to increase their profitability through certain ways, like increasing the risk premiums on loans and things like that. So this could reshape the footprint of GSEs going forward, but we don't see an abrupt exit as the base case scenario.

Okay. That's helpful. So net takeaway for ARR would be debt to equity probably doesn't change much unless we get a material shift in terms of the The path forward?

I agree with that.

Okay. Okay. That was it for me. Thank you.

Thanks.

The next question comes from Mikael Goberman with Citizens JMP. Please go ahead.

Hey, good morning, guys. Thanks for taking the question, sitting in for Trevor today. Just curious, what would you guys need to see to either increase or decrease leverage from this point on?

Yes, hi, Michal. So we are very comfortable with the current leverage. The last time we checked, we were somewhat above the average of our peers. So we like the leverage where it is today, given the compelling returns, our profile of assets that we purchase. Yet, as we mentioned in our prepared remarks, there are some questions that we're looking to have answered in order for us to increase our leverage. That is the GSE reforms, QT, the timing of any potential tapering of QT. These are the things that we're kind of looking for more clarity on in order to increase leverage from here. In terms of potentially decreasing leverage, we don't see that in our base case, but if, for example, we see the curve flattening for some reason, maybe more Fed hikes get priced in. Those could be the areas of concern that may cause us to reduce our leverage. But those are tail risks. We don't see that as base cash.

Got it. Thank you. And what is your outlook on swap spreads for this year and the tradeoff of using swaps versus treasuries for hedges?

Yes, so Swaps Press have had quite a move this year. I think we moved more than 10 basis points from the tight late December. This was all driven by the fact that, you know, Treasury Secretary Besant's commentary and commitment to bringing term premium lower, as well as some of the banking deregulation proposals by the Fed and potentially new Vice Chair Michelle Bowman. So a lot has been priced in behind those comments already. I think the next pricing point is going to be what actions are actually going to be taking. So we use our swap position of 75% versus 25% in treasuries. That's kind of a very base case, a comfortable position where we are well positioned for the further widening appreciation of swap spreads. But if things... turn around, we do have a treasury position to diversify some of that risk.

Great. Thank you for that, Collar. And just to confirm on current book value, that's $19.1818?

Correct. $19.18.

Great. Thanks a lot. Best of luck going forward, guys. Thank you.

The next question comes from Christopher Nolan with Landberg-Dahlman. Please go ahead.

Hey, guys. First, on the ATM, 136.2, is that gross or net?

Net.

Okay. And then, as memory serves, last quarter, you guys basically were increasing your portfolio, weighting it to lower coupon, shorter-term MBS, on the expectations of further Fed rate cuts. Now, Fast forward to the fourth quarter, has your expectations of rate cuts changed with the outcome of the presidential election? And are you positioning the portfolio more for a higher long end? Or if you could give a little color in terms of how your portfolio position has changed.

Yes, thank you. So we followed the motto, don't fight the Fed. In December meeting, they've indicated that rates are still well-restricted territory and that's well above the neutral rate. Now, you know, since then, we did have new economic data releases, including unemployment and CPI. So a lot of these things will continue to move the timing of further cuts, but we still firmly believe that there's more cuts on the table, you know, and we're positioned for it. on duration and coupon stack positioning. Now, you know, what the guy said in terms of ROE, you know, the most attractive part in a coupon stack is in 5.5 and 6 higher coupon positioning. So we've been particularly active there.

Great. Okay. Thank you.

Again, if you have a question, please press star then 1. The next question comes from Eric Hagan with BTIG. Please go ahead.

Hey, thanks. Good morning. Another follow-up on the asset selection. I mean, I think you mentioned liking higher coupon specified pools. How are the pay-ups right now relative to pay-ups in the current coupon, you know, historically? And do you feel like pay-ups maybe have as much value as they have historically, just given how aggressive the originators are in targeting borrowers for a refi?

Yeah, that's a good question, Eric. A lot of the spec payoffs have appreciated over the last few months. We're seeing the theoretical breakeven on the payoffs versus the model, you know, approaching close to 100%. So this is why we've increased our positioning in TBA dollar rolls as well to kind of diversify away from full payoff premiums. But, you know, so... That's been the strategy to wait out in some of the TBA positions to be able to swap back into spec pools when we see them more attractive.

OK, interesting. Going over to repo market conditions, do you feel like the steeper yield curve is supportive for spreads and liquidity in the repo market? And how much demand do you guys see to extend repo pick up term repo right now. Thank you.

Yeah. So, um, the repo curve, um, and specifically look at one to two months is relatively flat. So, you know, it's really more depends on, uh, kind of what the, what the initiatives out of the treasury department are coming in terms of their funding and their financing and how that affects the calendar, uh, rates. but overall repo market has been extremely well-behaved since the year end. I think we're seeing kind of software plus mid-teens type of spread, and, you know, that part of the market is very beneficial to the agency MBS.

Okay. Thank you guys so much.

This concludes our question and answer session. I would like to turn the conference back over to Scott Ulm for any closing remarks.

Thank you so much for joining us this morning, and we look forward to speaking with you. Feel free to call us with any follow-ups you have. Thank you.

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