Greetings, and welcome to the ARMOUR Residential REIT Second Quarter 2020 Earnings Conference Call. [Operator Instructions] As a reminder, today's call is being recorded Thursday, July 23, 2020. Now I would like to turn the conference over to Jim Mountain, Chief Financial Officer of ARMOUR Residential REIT. Please go right ahead.

Thank you, Tommy. And thank you all for joining our call today to discuss ARMOUR's Second Quarter 2020 Results. This morning, I'm joined by ARMOUR's Co-CEOs, Scott Ulm and Jeff 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.armourreit.com. 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 ARMOUR. 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 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 required by law. Also, our discussion today may include reference to certain non-GAAP measures. A reconciliation of these measures to our most comparable GAAP measures are included in the 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 1 year. The second quarter was a period of transition for ARMOUR. April began with significant levels of uncertainty. As U.S. financial markets began stabilizing towards the end of the month and into May,…

Thanks, Jim. The second quarter marked a period of stabilization and turnaround for the bond markets as well as for ARMOUR REIT. In the first part of the quarter, we maintained focus on risk and liquidity management. We kept leverage lower than normal and emphasized liquidity. As announced in our last call, we began reallocating cash to only agency securities, particularly prepay protected, down in coupon 15- and 30-year paper. Simultaneously, we substantially reduced our exposure to mortgage credit. Our sole remaining credit position as of 6/30 is $66 million market value of seasoned credit risk transfer securities. We believe our portfolio shift to agency only securities is well suited to the current environment for many reasons as the key elements are likely to persist for a long time. Pricing in the Agency MBS market has stabilized and liquidity has increased due to the support of the Federal Reserve, which is described as commitment as unlimited. We believe the current U.S. and international economic situation suggests that interest rates are likely to remain low for a prolonged period. In addition, the yield curve today makes hedging over the long term, very inexpensive. Financing remains widely available, and our affiliate BUCKLER Securities, has been able to fund us at historically low rates. Prepayments, while elevated, have been manageable. And our composition of the portfolio is approximately 91% of ARMOUR's agency portfolio positions, excluding TBA positions, benefit from favorable prepayment characteristics, including 24% that have prepayment penalties, that's agency multifamily securities; 55% that have loan balances less than or equal to $225,000; 12% have loan-to-value ratios greater than 95%; and FICO scores of less than 700 or seizing of greater than 24 months. Our multifamily agency securities have long principal lockouts that provide excellent convexity characteristics. The balance of the portfolio, away…

Tommy, can we start with questions now?

[Operator Instructions] And we'll get to our first question on the line from Douglas Harter with Crédit Suisse.

I was hoping we could talk a little bit more about BUCKLER. Just if you could give us an update as to what percentage of the funding is there today and how that compared to kind of 3 months ago? And what the relative funding advantage is versus kind of Street repo?

BUCKLER today is running, I'd say, approximately 70%, which is a touch higher than it was before, we were around 50%. I think that's primarily a result of the lower amount we are financing as well as the BUCKLER's other customers are financing, leaving BUCKLER with a little capital that needed to be utilized. I'd expect that to revert more towards the 50% level as things normalize. But that's probably going to be a little ways yet. In funding advantage, repo is a highly efficient market. So it's less that we see absolute dollar advantages in funding rates. We often get a little benefit on haircut, which has proved especially valuable. And we also enjoy a level of insight into what's going on in the repo market that we never really enjoyed as simply a customer there. We also are able to keep some portion of the book on open, which is something overnight funding, which is something we wouldn't do with a nonaffiliate. Which contains an interesting implicit option to it, which means that we can -- when an opportunity develops in the market, we can jump on it immediately, which if we were all termed out for 30 days or 90 days, we wouldn't really be able to. So that's where the economic advantage derives from BUCKLER. In addition, to the reason why we have BUCKLER, which is the safety and security of having an affiliate that we are confident can finance us, even in difficult periods, which was proved in spades in March.

Can you just put a little more color around the haircut differential just to kind of size that benefit?

We can see haircuts of 1% to 2% lower than we would see in normal market conditions. I would also note, Doug, a couple of weeks ago, we were studying what the company looked like 5 years ago. And it's interesting on our repo book, only one of the top 10 people are the same today than they were 5 years ago. And that's the power of BUCKLER now. And this obviously excludes BUCKLER, but having them around when other market participants are moving and changing their approach to the funding market makes us, I think, a very stable situation on the funding side.

And then with the 1 to 2 points of lower haircut, does that change how you think about what the kind of long term or steady state leverage is? Or I guess just how does that factor into kind of kind of where you think the appropriate leverage level is?

Leverage is an independent discussion in many ways, sort of an output to the mix that we're seeing on the portfolio. The haircut is primarily relevant to liquidity.

Yes. And we just keep it in excess liquidity. I mean if you look over the last 2 or 3 months, at some point, the actual cash and unlevered securities we had were larger than our market cap. Okay? That's going to -- we're going to keep our liquidity very high.

And we'll proceed to our next question on the line from the line of Trevor Cranston with JMP Securities.

All right. Looking at the portfolio mix today, it looks like you guys are more weighted towards 15-year securities than you have been for a while. Can you talk about the sort of trade-off between 15s and 30s today? And why you guys have been taking that allocation relatively higher?

The 15-year securities have great convexity, now the price you pay is lower levered yields. But if you looked at our portfolio that we put out as of 6/30, you have 15% of the portfolio's 15 years. However, you may be reflecting on the 18.7% of the 15 years in the dollar roll positions. So those are securities that we're buying in the forward market. It's very unlikely, Trevor, that we will take delivery of those, but they've just got great convexity. We pay the price for it, but should the markets increase in volatility or should the longer end move up a little bit, we won't have very much extension on those assets at all.

Okay. Got it. And can you also provide some color on how you guys are seeing dollar roll funding relative to repo? And how attractive you see TBAs versus spec pools on the margin?

Sure. I mean there's some extraordinary return opportunities in the dollar roll market. As I looked at the August, [ SEP ] rolls right now, in 15 and 30 years, we're seeing numbers from 17% to 22%, depending on the security that they're in. There are some securities that dollar roll even higher returns versus buying assets and putting them in the repo market. However, those have other risk characteristics to them. And so we don't own those securities.

Okay. Got it. And then last question on the waiver of the management fee or the portion of the management fee. Can you talk about sort of how you guys are thinking about that in terms of what type of conditions might lead to that waiver being reinstated in the future?

Growth of the equity of the company would change that.

[Operator Instructions] And we'll get to our next question on the line from Christopher Nolan from Ladenburg Thalmann & Co.

Scott, on the management fee waiver, did you mention in your comments that, that was going to be continuing in coming quarters?

I think you can expect that to continue. We got to have a reasonable management fee, and I think we're sort of down in the middle of the fairway right now. So you can expect that to continue.

Great. And then given that the housing market nationwide has seen a jump in terms of people buying houses just generally. I mean -- and given that you're seeing a rising CPRs, I mean can you give a little color in terms of where you think your portfolio positioning is going to be coming in the second half of the year, given all the changes going on?

Okay, there are a number of things to talk about right now. Okay? And let's talk about our July prepayments. They were up 10% from -- a little bit less than 10% from the previous month. We expected that. We expect August to be up another 5%. But I'm looking at a chart that shows what the monthly growth issuance of Agency MBS was in June, it was $250 billion. So that was -- that's a record high, okay? And you may be familiar with the primary, secondary spread. I know it's very topical right now. People are talking about it. So think about this, and then I think we'll answer your question. So there's been a 225 basis point reduction in the Fed funds since 2019, but mortgage rates are only down 125 basis points, right? So the primary, secondary spread has increased dramatically. And why? Because originators are so busy. Okay? They have capacity constraints. So over time, those capacity constraints will probably help lower the primary secondary spread, which will increase prepayments. One of the reasons that Scott discussed the assets that we choose, the low loan balances and the other great characteristics. So if and when that happens, and we do expect that to happen, okay, that we will have assets that will be less likely to have heavy prepayments. Now at the end of the day, a change in prepayments for us by 5% is not even worth 1/3 of $0.01, I think, approximately. So you could think about that as your modeling out into the future. But when we changed our dividend to $0.10 a month, we changed it because we feel that we are earning it. And we're actually quite positive on NIM. If you look at the NIM that's quoted as 163 basis points, I believe, for the second quarter. Remember, we were very under-invested for April, right? We ended Q1 with only $2.8 billion of agency securities, and now we have $6.6 billion. So the NIM that we reported does not reflect the boat at full speed, right? So you would expect the NIM to be reported higher for Q3. And that's why we feel we can earn that $0.10 each month. And under really good conditions, and maybe we earn a little bit more than that. Does that get to your point?

Yes, it does. I guess also to cut to the quick, Jeff, is last quarter, you guys mentioned that on a core EPS basis, you're targeting a high single digit, low double-digit ROE. Are you guys still targeting that? Or is there sort of changes?

Well, if we say that we hope to make $1.20 a year and your $11 and change of book value, that's $10-plus after expenses ROEs, so that's kind of where we are right now.

Yes, fair enough. Okay…

But you know, but the stock -- go ahead, I'm sorry.

Yes, no, please continue.

I was going to say with the stock at a discount to book value, you have an even greater return opportunity, is my point.

Yes. And then final question. ATM raises, you saw -- you guys are pretty active on the ATM. Is that continuing into the third quarter?

No, we have not done any ATM. We talked on the last earnings call about the $48.5 million of ATM that we did, I think, substantially in April. And that was just solely to increase liquidity. And I believe I said on the call was about $0.20, $0.20-plus dilutive to book value and indeed it was. But that capital was very dear at the time. And it was important to have that great liquidity. Our liquidity position is very, very sound and good right now. And we have not anticipated or engaged in any recent ATM activities.

And we have no further questions on the way. Please continue with the presentation or any closing remarks.

Well, thank you, Tommy. Thank you all for joining us this morning. As always, if you have questions, put a call into the office. Everybody's working remotely, but we'll get the message and can get back to you promptly. And throughout the quarter, if there's ever anything that you want to talk about, please don't hesitate to reach out. Until next time, stay safe.

Thank you. That does conclude the conference call for today. We thank you for your participation as we disconnect your lines. Have a good day, everyone.