Good morning, and welcome to the ARMOUR Residential REIT's third quarter 2022 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 Jim Mountain, Chief Financial Officer. Please go ahead.
Thank you, Drew, and thank you all for joining our call to discuss ARMOUR Residential REIT's third quarter 2022 results. This morning, I'm joined by ARMOUR's co-CEOs, Scott Ulm and Jeffrey Zimmer, and by Mark Gruber, our CIO. By now, everyone has access to ARMOUR's earnings release, which can be found on ARMOUR's website, www.armorreit.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 or implied in 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. Net interest margin for the quarter was 2.21%, a decrease of one basis point compared to Q2 2022. ARMOUR's Q3 comprehensive loss related to common shareholders was $155.7 million, which includes $144.3 million of GAAP net loss. Distributable earnings available to common shareholders was $38.8 million or $0.32 per common share. This non-GAAP measure is based on historical cost and excludes gains or losses from security sales and early terminations of derivatives, as well as market value adjustments.
It does include TBA drop income. ARMOUR paid monthly common dividends of $0.10 per common share during the quarter and has announced dividends at that rate for October and November 2022. The outlook for dividends appears to be stable based on current conditions. However, we will keep a keen eye on economic conditions which could change rapidly in this environment. Taken together with the contractual dividends on preferred stock, ARMOUR has made cumulative distributions to stockholders of over $1.9 billion throughout our history. ACM, the company's external manager, continues to voluntarily waive $1.95 million of its management fee, which offsets Q3 operating expenses. ARMOUR was proactive in managing its common share capital base in Q3, resulting in positive accretion to stockholders of $0.14 per share.
During the quarter, we issued over 22,733,000 shares of common stock through our ATM programs. That raised $167.2 million of capital after fees and expenses. That represents an average price of $7.36 per common share. In September, we repurchased 780,000 shares of common stock at an average cost of $4.96 per share. For context, Q3 volume-weighted average price was $6.89 per common share. Quarter end book value was $5.83 per common share. As of last night, the twenty-sixth, we estimate that book value per common share was between $5.26 and $5.31 per common share. Again, between $5.26 and $5.31.
As we finalize our tax projections for calendar 2022, we expect that all common stock dividends and Series C preferred stock dividends will be treated for federal income tax purposes as returns of capital and not currently taxable to our shareholders. This is comparable to last year's tax results. Looking forward to 2023, we forecast that Series C preferred stock dividends for 2023 will likely be treated as fully taxable ordinary income to those shareholders. Common dividends for 2023 will also likely be treated at least partially as taxable ordinary income. Now I want to turn the call over to Co-Chief Executive Officer Scott Ulm to discuss ARMOUR's portfolio and current strategy in more detail. Scott?
Thanks, Jim. In its fight to normalize high inflation, the Fed has delivered the fastest pace of tightening since the 1980s, when former Fed Chair Paul Volcker raised the Fed funds rate to nearly 20%. During the third quarter, the Fed funds rate rose by 150 basis points to 3.25%. The two-year treasury yield rose by 132 basis points to 4.28%, and the ten-year treasury yield rose by 91 basis points to 3.83%. The historic upsurge in risk-free borrowing rates, combined with the start of quantitative tightening of $95 billion per month, sent 2022 total returns on U.S. Treasury bonds to -13.1%. It's worst on record.
The U.K. pension industry, which six weeks ago most of us had very limited knowledge of, emerged as a catalyst for a major risk-off trade in interest rates around the globe. Such is the market we're in. Our March 2020 experience served as a valuable tool to stay ahead of the increased volatility by proactively managing our dollar liquidity and MBS portfolio risks. In September and October, we reduced our mortgage portfolio by $2.9 billion of MBS pools with 3.5-4.5 coupons, raising the overall liquidity to $591 million and trimming our implied leverage down to 7x as of 10/25. Since the beginning of September, we have decreased our spread duration by 32%, and our net duration gap was 0.79.
Despite dialing down the overall risk levels, we still maintain a healthy exposure to the MBS market, which in our view, is approaching levels of incredible value seen prior only during the great financial crisis a decade and a half ago. With MBS spreads just 20-30 basis points lower than the widest levels of 2008, we believe the risk reward ratio now firmly favors the investor. To further improve our resilience to rising turbulence in the market, ARMOUR raised $167 million of new capital in the third quarter through our ATM share issuance program that was accretive to our shareholders by $0.14, and ensured healthy levels of cash liquidity even under the harshest stress test scenarios. Repo financing remains another strong pillar of our business in these markets.
Shielded from greater volatility observed in nearly all financial markets, funding of our high-quality MBS assets remained liquid and plentiful. ARMOUR is active with 20 different repo counterparties and approximately 50% of our borrower balance is funded through our broker-dealer affiliate, BUCKLER Securities. Our business relationship with Buckler provides us with a particular advantage in the mortgage REIT sector, securing our lifeline to the funding markets even in times of great distress. We have very limited dependence on third-party repo providers that are dependent on the FICC. 104% of our repo book is hedged with current fixed to floating OIS and SOFR index swaps, absorbing the impact of the Fed hiking cycle on overall funding rates due to the daily floating receive leg of the swap.
If we include the notional amount of all of our interest rate hedges, our funding is covered by 125%. ARMOUR has vastly reduced its exposure to premiums paid on specified pools and has high excess liquidity as a percentage of total capital, both of which better position the balance sheet to weather the unexpected turns that the rise in market volatility can bring. We believe the expected slowdown in the pace of interest rate hikes in 2023 will provide a catalyst to lower volatility and reward agency MBS investors who have stayed the course with outstanding returns. We expect our all-agency MBS strategy will deliver compelling returns in the future without the risk of credit. We view our current dividend of $0.10 as appropriate.
In this volatile environment that has particularly affected book value, we will, as always, continue to evaluate the level of the dividend. We're also mindful that this environment could deliver upside surprises as well that can move our metrics substantially. We'll now open the line to questions.
We will now begin the question and answer session. To ask a question, you may press Star, then one on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you'd like to withdraw your question, please press Star then two. At this time, we will pause momentarily to assemble our roster. The first question comes from Douglas Harter with Credit Suisse. Please go ahead.
Thanks. Just hoping to get a little more clarity around your comment. You described the environment for the dividend as stable. To me, it feels like the current environment is, you know, has kind of been anything but stable. Just hoping to kind of get a little bit more detail around that comment.
Hey, Doug. Good morning. Jeffrey Zimmer here. Most of our portfolio was constructed, essentially all of it constructed before the wild swings in prices in almost every asset class started in late August. The comment is that we have constructed a portfolio under a stable environment. The subsequent environment is not stable. Right now, the dividend that we're paying out, based on investments and swaps put on a while ago is very stable. As Scott also noted, conditions could change. They could change to the upside. Just like you lose $1.50-$2 of book value very quickly.
If you stay the course like we have, and we still invested, you know, very much so in agency mortgage-backed securities, you can get book value back up, which would then mean that dividend yields would not look like they would look like today.
Got it. You know, I guess given the further decline in book value in October, you know, any updates on what the portfolio size looks like today? You know, just as you've reacted to the environment.
I do know the liquidity as of last night was $525 million, cash of $250 million and the box of $275 million. Net liquidity has increased because some of our transactions from earlier in September finally settled in the month of October. I think I'll hand it over to Mark Gruber. Mark, I think it'd be okay to note the size of the portfolio at this point in time.
Yeah, sure, Doug. It's the portfolio is about $6.5 billion in size right now. Our leverage is, you know, I think we mentioned that earlier, but it's $6.5 billion, and that includes some of the treasuries.
Leverage this morning is 6.9. That would be implied leverage and actual leverage. We only have $100 million of outstanding forward settle stock. So your implied and your actual is about 6.9, with a duration of, you know, 0.6-0.7 range.
Okay, thank you.
All right. Thanks for calling in.
The next question comes from Trevor Cranston with JMP Securities. Please go ahead.
Hey, thanks. Good morning. A follow-up on the question about the current leverage and portfolio size. The portfolio size has obviously been declining somewhat in September and October. You also mentioned, you know, the spreads are obviously very wide and there's some potential for them to tighten at some point. I guess, can you talk about how you're sort of balancing, you know, the potential for spreads to tighten and get some book value back versus, you know, selling assets and kind of keeping leverage at a conservative level in order to, you know, manage through the current market volatility.
Yeah, Trevor, hi, it's Jeff again. Can you actually say what your exact question is? I'm not clear what you need us to address.
I guess the question is sort of, you know, you mentioned there's potential for spreads to tighten back in, but at the same time, you guys are, you know, obviously reducing the portfolio size. I guess the question is like kinda how you're coming up with the leverage target in today's market and, you know, kind of what you view as the near term upside versus downside risk to spreads.
Yeah. We believe that it'd be highly unlikely to see spreads widen much more than 20 OAS from here. That would reach the worst level seen in the 2008 period. Anything can happen. A bomb could be dropped in Ukraine. There could be some, you know, other events that are out of our control. We are, you know, keeping our risk profile reduced, but yet have the optionality to increase it very rapidly. For example, we own $hundreds of millions of treasuries, and Mark can tell you how much in a moment we own today. Those can quickly be sold to be exchanged into mortgage-backed securities at today's wide spreads. We wanna maintain this liquidity for a while longer.
You know, you don't know until you look in the rear view mirror that exact moment in time to address the risk profile and start increasing it. At this point, we're gonna keep it reduced. Over time, when the mountain seems a little safer to ski on, we'll go ahead and start increasing our exposure again into the MBS world. To Scott's point, the investments are very good right here, but we do want to maintain our high level of, you know, risk management profile right here, and we're gonna maintain a lot of cash and a lot of liquidity. Mark, you wanna talk about the Treasury portfolio and where leverage could possibly go from here?
Sure. We have about $450 million of treasuries. Obviously that can be swapped into MBS. We also have the ability, you know, historically, right, we've had leverage up to nine. You know, we have probably two turns of leverage we could add here. You know, to your question of, you know, well, when will we get back in? You know, we have some metrics we've, you know, we're using internally, things like volatility and spreads and such. We're looking for, you know, those metrics to hit targets. That's when we would step back in. We're just not there yet.
Okay. Got it. I appreciate the comments. Thank you.
Thank you.
The next question comes from Jason Stewart with Jones Trading. Please go ahead.
Hey, good morning. Thanks for taking the question. Wanted to follow up on Doug's question about the dividend and how you view, I mean, I guess the yield on the stock versus the current economic environment, which sounds like you feel pretty good about covering that dividend, but do you feel like you get credit for that?
Anytime you look at a stock and your dividend yields are north of 20%, you're gonna just take a deeper look and say, "Hi, that seems off-market." You can't compare us to an industrial company. You can't compare us to any other company but a financial company. When markets change very rapidly as they did from the last week in August, really, you know, through today, okay, metrics change quickly. What you do is have to go back and look at what I, how I answered Doug. We put together a portfolio over a number of quarters, that hasn't really changed that much except for a few sales that took place in September and early October. The portfolio is supporting the current dividend yield right now. Also, to Scott's point, market conditions could improve.
You get 30, 40 OAS of tightening, which would be a normalized OAS over the last decade or so. All of a sudden book value is back up and you're looking at the returns and you're saying, "Gosh, that's a 15% return." That's not kind of off-market for what this sector's had over the years. We take a look at it every week. You know, we make decisions and every quarter we talk to the board. Actually, as you know, we announce the dividend monthly. If you want to go back a number of years, we actually took a leadership role in that regard. We were the first REIT to start paying monthly. That also gives us the ability to go ahead and say, "Hey, we're not gonna wait till the end of the quarter. Things have changed.
We're gonna lower the dividend, or we're gonna raise the dividend based on what conditions are." For the last 4 or 5 quarters, Scott has been very clear that we look out to the medium term, and we set that dividend based on what we see over a period of time, not just what's happening today. If any changes are made, it's because we believe as a group, and the board agrees that conditions have changed such that over the medium term, X, Y, Z should be the given level. Is that helpful to you?
Yes. Thank you. Last question from me. Are you expecting any meaningful changes out of FHFA with regard to credit policies? You know, the way they look at, you know, the market liquidity, the credit, et cetera.
I'll ask Mark to finish off on this, but we have particularly good insight now because we have BUCKLER, the broker-dealer, and our new CEO over at BUCKLER has a litany of experience with the different agencies, and talks to them directly. We don't see anything, particularly if you want to even talk about the FICC, any changes right there. Regarding the FHFA, I'll hand it over to Mark to see if he's noted any changes there.
No, I wouldn't say that we have any particular insight into what we think they're gonna do at this time.
Okay. Thank you. Appreciate it.
The next question comes from Christopher Nolan with Ladenburg Thalmann. Please go ahead.
Hey, guys. Just a couple of questions. Was the $0.14 accretion from both repurchases and share issuances?
Yes.
Yes. Yes, it was. Though, you know, there's a big difference in the size. You know, we're on both sides of the market. You know, we always look at both sides of the market. You know, when it just, you know, gets too cheap, we'll buy some. But we were, you know, fortunate to be able to execute some of our sales, you know, significantly above where we ended up.
Great. Then the net interest income declined quarter-over-quarter despite, you know, relatively stable net interest margin and higher earning asset volumes. What was the reason for the decline?
Jim might as well address that.
Say again.
The net interest income declined in the quarter despite a larger portfolio and stable margins. Just trying to see what was the catalyst for the decline?
Repo cost of funds ended up running up just a little bit, and there's a little bit of friction and mismatch in the index and reset timing of the swaps versus the actual tenor of the repos that we roll. That's as much frictional noise as anything.
Great. Then the third question I have is sort of a follow-up to what Trevor was, I think, leading up to. Right now, given where your stock price is and given the amount of liquidity that you have in terms of cash and unlevered securities, by my estimate, your cash unlevered securities is $3.56 a share or roughly 70% of your share price. I guess the risk reward question is, you know, why not take down in the portfolio way down, take the leverage way off, given, you know, the risk in this environment. I'm just trying to. I'm not criticizing. I'm just really trying to get a idea what the thought process is.
6.9 times of leverage implied and actual debt to equity, which it is this morning, is about the lowest we've been since inception. I think in 2020, we got under that for a cup of coffee while things got a little crazy. The environment and our liquidity supports exactly where we are right now. If we wanted to be lower, we would be. We don't wanna be lower, and we actually wanna continue to have exposure to an asset class that has cheapened up considerably. If we start selling all that asset class, you have no opportunity to take advantage of it when things normalize.
We have enough exposure to be able to appreciate, book value and opportunities when things normalize, yet we have liquidity, based on our treasuries and our cash position to be able to move and shake a little bit in case things, do get more volatile for a short period of time. We are where we wanna be, and we're opportunistic, but we're also being, you know, very considerate of the volatility in the marketplace. I hope that's helpful.
Yeah.
Yeah.
Part of that is, you know, market timing. You know, certainly there have been some days when we wish we were not long mortgage-backed securities, but that's the business we're in. You know, I think we recognize that we are unlikely to be able to call market timing precisely. Maybe generally, we can sense, as Mark said, through a variety of metrics we follow when, you know, when timing is more propitious than others. You know, to take the portfolio way down, take it way back up, and to get all that right, that's a heavy lift. I think our, you know, our investors expect us, you know, by the name of the company, to be long mortgage-backed securities.
We vary that. You know, we try to be judicious about it, and we try to be safe about it. At the end of the day, that's the business we're in.
Great. Thank you for the clarification.
Great. Thanks for calling in.
The next question comes from Matthew Howlett with B. Riley. Please go ahead.
Good morning, guys. Thanks for taking my question. Just to follow up on that. You know, Jeff or Scott, when does asset selection and collateral selection become important? At some point, do you feel like, you know, speeds now look like they're at, you know, 5 CPR. At some point, do you feel like you may have to move the portfolio to focus on, you know, slower, potentially slower paying pools if rates do decline next year?
One thing that, you know, we discussed in previous calls is what is the company's exposure to specified premiums? We'll talk about that for a second here. A year ago, we may have had $150 million exposure to specified premiums, and that means the amount you paid over TBA prices to buy assets with characteristics whose prepays will be very stable. By the way, they may be stable at a fast rate, which is okay. Or they may be stable at a slow rate, but at least you have a better idea of where they're going to be. We have reduced that exposure to, I believe, close to around $30 million.
Very little bit of our balance sheet, but yet our portfolio still exhibits, I think it's, and Mark, correct me if I'm wrong, 70%-80% of our portfolio still has specified pools that exhibit characteristics that are stabilizing factors in understanding what the prepayments will be in the future. We have a diversified portfolio from 2.5s all the way up to 5.5s. We may have purchased some 6s. Mark, you wanna enhance on those comments?
Sure. Yeah, we are very aware of the type of collateral we're purchasing. We do look for stories that will be slow in environments when rates go lower. You can buy some of those stories cheap these days. But with the coupon stack moving up so fast, you know, that hasn't been basically, you know, the primary, you know, investment metric. But it is a concern. We know as we moved up in coupon, we're adding convexity to the portfolio in an environment, you know, when rates could, you know, rapidly decrease. Who knows when the Fed turns and pivots. But if there is a catalyst where they have to do that, you know, we're making sure the portfolio is set up for that too.
What you're saying is you still feel that you're under a declining rate scenario if it happened, you know, today or tomorrow, that your book would still prepay slower than generics, and you still have those characteristics in there.
Correct. 'Cause those payups don't really cost a lot these days.
Right. No, great. No, it's good to hear that. Jeff, I'd love to hear you just, you know, last time we talked about, you know, potentially what you thought the Fed would do next year. I think you look at the macro environment, I think you have two variables with the Fed. Will they stop, and will they potentially ease? What do you think they do with potentially outright selling MBS? Do you think that at some point will become viable?
Here's what our firm believes. Our firm believes that we'll increase by 75 basis points in November. I would have said a month ago, we would have said 75 in December. I think as a group now we're more like 50. Then we believe they're gonna watch and wait for a while and let the data go ahead and catch up with, you know, the rest of the world, right? That takes a quarter or two. Okay? We do not believe at this point that they're gonna make asset sales in the mortgage-backed securities arena. Look at, as we said in the last call, that certainly could change. The regular mortgage rate, Fannie rate right now is 7.15%.
The housing market is going in reverse very, very quickly, and the Fed wants that, but they also don't wanna make it so upsetting that the metrics of everyday life are starting to get ruined for people. They just want it to slow down. We don't expect right now that they're gonna make any sales. There's research out there that would suggest they're gonna make some Treasury sales. However, you may have Treasury sales going on right now by China. You may have them going out through Japan, certainly going out through Japan to go ahead and support their currencies. To the extent that we think that they will go ahead and start selling mortgages, we'll talk about it in the next earnings call. Right now that's kinda where we stand.
Mark, you wanna improve on any of that?
No, I think you got it right from, you know, the portfolio team's perspective. No, I just wanna, you know, I guess reiterate, we really don't think they're gonna sell MBS anytime soon, but that definitely is in the cards, you know, at a later date. You know, it's with the housing market where it is and where rates are where they are right now, we just don't see that in the foreseeable future.
I would agree. I really appreciate the comment. Thank you.
Thanks for calling.
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 for joining us for the third quarter 2022 conference call of ARMOUR Residential REIT. We are always available on the fly if you guys wanna call into the office, and wish you a good day. Thank you.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.