Scott Ulm

Thanks, Gordon. I want to start by sharing our perspective on the current macro environment. In late August, Fed Chair Jerome Powell signaled that after nearly 2.5 years of restrictive monetary policy, the risks around inflation and the labor markets are in balance and that interest rates are set to decline.
The Federal Reserve Committee followed this up with a jumbo 50 basis points interest rate cut in September, prompting a rapid steepening of the US Treasury yield curve. Quarter-over-quarter, the two-year and the 10-year treasuries rallied by 111 and 62 basis points respectively, with the 2s-10s spread reaching a high positive 22 basis points, a drastic turnaround from the negative 35 basis points close to the second quarter.
Over the last three decades, the Fed easing cycles have resulted in curve steepening of 50 basis points to 300 basis points. With this in mind, we anticipate that the curve steepening trend has more room to run in the coming quarters. A scenario of Fed easing without the accompanying volatility of a severe economic recession sets up a particularly constructive environment for potential future book value appreciation and earnings growth at ARMOUR.
We expect both book value and our earnings to benefit from the return of positive carry in production MBS, declining volatility and the still historically wide nominal mortgage spreads of nearly 150 basis points versus the average spread of 106 basis points over the last decade. While the US elections could lead to near-term volatility, we expect monetary easing to remain the primary driver for mortgage spreads once the political uncertainty resolves.
Overall, we believe we're well positioned to benefit from these favorable market trends over the coming months. There are also a number of other specific factors that will benefit us into next year and probably beyond. Our strong liquidity and access to financing, particularly through our securities finance affiliate, BUCKLER, gives us more flexibility to increase leverage to take advantage of this environment.
We are keenly aware of the risks and volatility in today's world, but we have the ability to capitalize on this environment when the time is right. We have the demonstrated capability to raise capital at very low cost. In short, despite some volatility, which is not unexpected, this is shaping up to turn into a great environment overall for our business.
At this point, I'll turn the discussion over to Sergey.

Sergey Losyev

Thank you, Scott. In the third quarter, ARMOUR's portfolio experienced approximately 5 basis points of tightening in nominal spreads, and we progressively increased our portfolio size and leverage, taking advantage of pullbacks in the market. As the markets closed on October 21, our portfolio's duration and implied leverage stood at 0.91 years and 8.6 times, respectively.
We maintain healthy levels of available liquidity at approximately 50% of total capital, and we continue to closely monitor as well as rigorously stress test our liquidity levels to ensure appropriately reflect market conditions and can support our portfolio growth. In anticipation of a Fed cutting cycle and a more positively sloped yield curve, we steadily increased our duration risk exposure to shorter interest rates while limiting duration exposure in the longer part of the curve.
We terminated $1.75 billion of notional swaps with a weighted average maturity of 29 months and $1.8 billion of treasury futures with a weighted average duration of less than four years. Terminating the swaps versus receiving their cash flows carries no economic impact given that the swaps' positive book value is already reflected in their forward pricing. The proactive reduction in our swap position has lowered our ratio of hedges to repo funding to approximately 62%.
We expect this recalibrated profile to be economically beneficial for our investors in an environment with a steepening yield curve. While earnings available for distribution related to swap income may be lower in subsequent quarters, over time, we expect EAD to benefit from lower financing costs, and therefore increasing carry income as the Fed continues its rate cutting cycle.
We continue to run a diversified hedge book composed of interest rate swaps, treasury shorts and futures totaling just over $7.7 billion of notional amount to dampen the volatility of the firm's book value. Our investment portfolio remains very liquid, 100 Agency MBS, and is well diversified across 30 year specified pools ranging from 2.5% to 6.5% coupons. While the largest composition of our holdings is in near par price coupons, we carry strategic exposures to deep discount and premium coupons totaling 30% and 22% of market value, respectively.
This diversification shields the portfolio from prepayment volatility when rates decline. In Q3, constant prepayment rates averaged 7.5% CPR, a slight decrease from 7.7% CPR in Q2 and below 8.2% CPR so far in October. It is worth noting that the September's uptick in the mortgage refi index is expected to show up in the prepayment reports later this fall, and we believe this has already been priced into the market.
With mortgage rates already backing up to 6.5%, the valuations on premium MBS offer very compelling value as the forward-looking prepayments begin to recede. Additionally, higher mortgage rates and weaker winter seasonals set up low net supply of MBS as yet another favorable near-term driver for spreads.
Within the premium coupons, we are focused on specified pools tied with loans to lower credit FICO scores, higher LTV loan characteristics and states with traditionally lower refi response rates to help mitigate the prepayment risk versus more generic pools and TBA.
In discounts, our analysis shows that some of the more seasoned holdings were a substantial contributor to a gradual increase in the portfolio CPR this year, proving that mortgage prepayments can also work to investors' benefit. We expect this benefit to grow in the future when the housing market begins to recover as interest rates decline.
And finally, the repo market remains liquid, albeit some of the funding pressures observed at the end of Q2 have persisted throughout Q3. These pressures are expected to remain throughout the end of the year, with dealers' capacity to intermediate somewhat constrained amid record levels of US treasury issuance.
As Scott had already alluded to earlier, we are funding 40% to 60% of our MBS portfolio with our affiliate BUCKLER Securities while spreading out the remaining repo balances across 15 to 20 other counterparties to provide ARMOUR with the best financing opportunities.
BUCKLER allows flexibility of overnight funding while seeking out value and market collar in term repo markets. Overall, repo funding for Agency MBS remains plentiful and competitively priced across the Board. Back to you, Scott.

Scott Ulm

Thanks, Sergey. I'd also like to mention our preferred stock. We're around where we want to be with preferred as a proportion of our capital structure, so we're less likely to be involved in the preferred market. As you know, our preferreds remain fixed once they enter the call period. We are pleased with this feature, given where today's floating levels would be.
As we look out over the next few quarters, we believe that our current dividend rate is appropriate. Our dividend outlook is based on the portfolio's future earnings power over the medium term, not the current period earnings. Our primary focus remains on generating total economic return on our portfolio and delivering that value to our shareholders.
Thank you for joining today's call and your interest in ARMOUR. We're happy to now answer your questions.

Question and Answer Session

Operator

(Operator Instructions)
Trevor Cranston, Citizens JMP.

Trevor Cranston

With the sell-off in rates we've seen here in October, can you give us an update on what your current duration exposure is? And if you've made any significant changes to either the assets or hedge composition compared to what you disclosed as of September 30?

Desmond Macauley

Yes, Trevor. This is Desmond Macauley. So we did say in our prepared remarks that our duration was 0.9. That's actually as of October 21. Overall, we -- as we mentioned, we positioned for a steepened. Most of that duration is in the front end of the curve. In the back end, we have some duration we're looking to delta hedge.
So we have a program of keeping the back-end duration very close to zero, but we are at 0.91. So we've moved our hedges. We talked about a couple of things we've done so far. But overall, 0.91 duration as of October 21, most of it in the front end of the curve.

Trevor Cranston

Okay. And then in terms of leverage, it looks like it's gone up a little bit since September 30. With the volatility priced into the market coming up on the election, is the 8.6% level kind of what you guys are comfortable running with near term? Or how are you thinking about that?

Desmond Macauley

Yes. So as far as our leverage, we see it more as an output. We have ample levels of liquidity, which is typically what we look at. So we are very comfortable with this environment. We think that the Fed easing cycle is going to be the key driver.
And of course, we have bouts of volatility, which we think are going to be short term. So yes, the presidential elections is one, and we wouldn't be looking to add risk into that. But at the same time, in terms of where we are right now with our leverage, we are pretty comfortable.

Operator

Doug Harter, UBS.

William Nasta

This is actually Will Nasta on for Doug today. And thanks for the book value update you gave, but given the rate volatility this week, is there any chance we get another update on how book has fared so far this week?

Scott Ulm

I don't think we're planning to update the book value more frequently than we do. I think, yes, it's been a volatile week. No question of that. But I don't think we have any plans to move to frequent book value updates.

William Nasta

Okay. That makes sense. And then just one more question. Just given the ATM issuance you had in 3Q, can you just update us on how you're thinking about raising capital going forward?

Scott Ulm

We look at a number of factors on it and probably the most important is the price that we can raise it at. We attempt to raise capital very close to and ideally over book value, which we've been able to achieve, which is not to say that we wouldn't issue at different prices, which goes to the second leg of it, which is looking at investment opportunities and how we view the environment that we'd be putting that capital to work in.
So we carefully eye that, and if we see exceptional opportunities in an environment that we like, we may be more aggressive on getting capital. That's the right answer for shareholders. But generally, we remain pretty conservative at the prices that we're willing to issue it and then keep a very close eye to the returns that we can generate with it.

Operator

Jason Stewart, Janney Montgomery Scott.

Jason Stewart

Could you talk a little bit more in detail about where you see current returns in terms of carry, how that relates to the cost of capital, maybe including the cost to operate? But if you could just break it down one more level in terms of carry versus total return and how you're thinking about those two components as you raise and deploy capital?

Scott Ulm

Desmond, why don't you go -- .

Desmond Macauley

Sure, Scott. So production coupon ROEs, 6%, 6.5% coupons, are in the high teens. Belly coupons like 4%s and 4.5%s are in the mid- to high teens, depending on the specified pools, and lower coupons are trading over a wide range depending on the pool characteristics.
So I think your -- the second part of your question was in terms of our dividend yield. You have to look at the dividend yield plus the preferreds overall. So if our dividend yield is about 15%, you have to adjust that for the preferreds, and then you add operating cost to that, and you can kind of get a sense of what that breakeven is.
But we're very comfortable, as we mentioned, in terms of looking forward, we think that these returns as is are good enough to maintain our dividend. And we also like the environment overall where we can get some spread tightening, which would include our overall economic return there.

Jason Stewart

Okay. That's helpful. And then second, just a macro question. There's -- in terms of prepayments, I mean, what's your view on the servicing capacity in the industry? Obviously, there's been a lot of rate vol that's taken some refi incentive out. But in general, what's your view on, especially for current production coupons, the near-term outlook for prepays given the capacity in the servicing industry?

Desmond Macauley

So let me start, and Sergey could add more to that. So as we mentioned in our prepared remarks, we did see an uptick in refi activity over the summer, and that should play out to faster speeds over the next month or two. But mortgage rates have already backed up to 6.5%. So looking forward beyond that time period, we can expect prepayments to decline.
Now over time, if you look even further into 2025 as the Fed easing cycle deepens, we think rates overall would come down, and that could lead to faster speeds. We are prepared for that. We maintain a diversified portfolio of both lower coupons and higher coupons. And the higher coupons, in terms of their current valuation, has priced in a lot of that prepayment risk already.

Sergey Losyev

Yes. And just to add to that, it's very hard to define current coupon right now when rates are moving as they are this month. So longer term, our view is that interest rates are coming down, but it would take mortgage rates to drop much lower than 5% given the composition of outstanding mortgage universe.
And our portfolio reflects that composition. As we mentioned, we have coupons between 2.5% and 6.5% coupon in 30 years, so it's really easy to mitigate some of the prepayment concerns just by shifting your exposures along the coupon stack.

Operator

Matthew Erdner, JonesTrading.

Matthew Erdner

Could you talk a little bit about how you guys are thinking about tail risk outlook, if the 10 year were to run a little bit higher than where it is now or if it were to contract significantly, and how the recent changes to the hedge portfolio kind of reflect the way that you guys are thinking about it?

Desmond Macauley

Matt, so as I mentioned, we are positioned for a steepener. We dynamically hedge our portfolio, particularly that back end. So the back end has run up a lot already. In terms of outlook, where we do have the elections and there could be some other volatility there, we do expect, though, that as the Fed easing cycle deepens, that back-end rate should come down as well. But in terms of how we're preparing for it, it's about dynamically hedging our duration to meet the profile that we think fits with our macroeconomic views.

Operator

(Operator Instructions)
Christopher Nolan, Ladenburg Thalmann.

Christopher Nolan

Back to the returns question. On the return on equity, given the improved environment that you guys are sort of anticipating, where should we expect equity returns to go?

Desmond Macauley

So Chris, in terms of just looking across -- if we think of it as incremental return based on new purchases, I mentioned earlier we see the higher coupons now in the high teens, so 18% to 20%. Now obviously, we do have -- we try to maintain a diversified portfolio. Some of the value coupons are in the mid-teens and lower coupons trade over a wide range. We try to maintain a diversified portfolio. We also include -- we have those securities as well.
So we're looking at overall returns in terms of how it improves our convexity. So sometimes there's a trade-off. Positive convexity, securities may have lower ROEs, but we try to balance it to maintain a well-diversified portfolio in terms of what those returns are versus the risks that we take.

Sergey Losyev

Yes. And if I may, really quick, we also apply, of course, total return scenarios to all potential investments, not running just to the forwards, but using some assumptions we can have on the market using spreads and rates, given our macro outlook. And given the volatility so far in the month, a lot of these assumptions could start to look more favorable from a total return perspective in addition to ROE numbers that Desmond quoted.

Christopher Nolan

So, if I heard Desmond correctly, I heard 18% to 20% or so in there?

Desmond Macauley

In the higher coupons, yes. 18%, 19%.

Christopher Nolan

Which is pretty much in line with where EPS is for the stock. And so I hear what you're saying in terms of book value appreciation, stronger earnings, but I'm not hearing it in terms of the details you're providing. It sounds like equity returns will be pretty much in line with what the market is expecting. Is that a fair summary?

Desmond Macauley

As Sergey mentioned, those returns just looks at where our current spreads are, right? So if you look at our dividend yield, let's say you take that in the mid-teens and you adjust for operating costs and things like that, the returns as we see today covers that.
We think that in a Fed easing cycle, you can also see OAS is up, so just mortgage spreads tightening by 10 to 15 basis points. Most likely post elections or into next year, that is an additional component of the returns that is baked into those numbers. So that easily gets you into the low 20s for those coupons. --

Christopher Nolan

So you're expecting slightly higher ROE, and that's definitely helpful. Slightly different, when given that you have negative investment spreads, cost of funds relative to investment yields, any handicapping in terms of ideas in terms of when that could turn positive? Or is that sort of dependent on who wins the presidential election and so forth?

Desmond Macauley

It's -- when you say negative investment spreads, we are currently -- I mean, for some coupons, we are already positive, right. It depends. I mean we do have lower coupons that are negative carry. As I mentioned, sometimes we look at just the ability to balance our portfolio in terms of the risks, the convexity. But there are some securities right now, if you just run them currently to where the repo rate is, they are already positive.

Christopher Nolan

Okay. I was just looking at the portfolio as a whole.

Scott Ulm

A lot of that timing depends on the Fed and where the Fed is going, right. And forward curve has one view of it. We've got dot plots, but I think the direction is pretty clear. You can squint at it and see some timing as that sweeps through the coupon stack, gradually making more and more of it see some daylight of positive carry.

Operator

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

Scott Ulm

Thanks all. We appreciate your interest. If questions come up, give us a ring. We're around and always happy to talk with you. Have a great day. Thank you.

Operator

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