Business Context and Reporting Period
Company: Armour Residential REIT, Inc. (ARMOUR)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: March 31, 2011
Business Overview: ARMOUR is an externally-managed Maryland corporation organized as a Real Estate Investment Trust (REIT). It invests primarily in hybrid adjustable-rate, adjustable-rate, and fixed-rate residential mortgage-backed securities (Agency Securities) issued or guaranteed by Fannie Mae, Freddie Mac, or Ginnie Mae. The company finances its portfolio primarily through short-term repurchase agreements.
Key Financial Metrics
| Metric | Q1 2011 | Q1 2010 |
|---|---|---|
| Net Interest Income | $10,358,089 | $987,492 |
| Total Net Revenues | $9,975,707 | $592,112 |
| Net Income | $8,596,073 | $305,833 |
| Diluted EPS | $0.33 | $0.13 |
| Total Assets | $2,345,673,563 | $1,209,223,950 (Dec 31, 2010) |
| Agency Securities (Fair Value) | $2,273,914,732 | $1,161,850,680 (Dec 31, 2010) |
| Repurchase Agreements (Debt) | $2,099,366,245 | $971,675,658 (Dec 31, 2010) |
| Stockholders' Equity | $220,612,375 | $108,708,577 (Dec 31, 2010) |
| Cash & Restricted Cash | $60,887,383 | $40,024,510 (Dec 31, 2010) |
| Net Cash Provided by Operating Activities | $11,247,195 | $776,562 |
| Net Cash Used in Investing Activities | ($1,221,297,276) | ($125,796,997) |
| Net Cash Provided by Financing Activities | $1,221,880,335 | $121,148,860 |
Additional Metrics:
- Book Value Per Share: $6.84 (March 31, 2011) vs. $6.61 (Dec 31, 2010).
- Weighted Average Cost of Funds: 0.29% (Q1 2011).
- Asset Yield: 3.20% (Q1 2011).
- Net Interest Margin: 2.40% (Q1 2011).
- Leverage Ratio: Approximately 9.52:1 (Debt to Equity).
Material Changes vs. Prior Period
- Portfolio Expansion: The Agency Securities portfolio more than doubled in fair value, increasing from $1.16 billion at December 31, 2010, to $2.27 billion at March 31, 2011. This was funded by a significant increase in repurchase agreements, which rose from $972 million to $2.10 billion.
- Equity Capital Raises: The company completed two underwritten secondary public offerings in Q1 2011, issuing 15,812,500 shares and raising approximately $113 million in net proceeds. Outstanding shares increased from 16.4 million to 32.3 million.
- Profitability Surge: Net income increased to $8.6 million from $0.3 million in the prior year quarter, driven by the larger asset base and capital deployment. Net interest income grew from $1.0 million to $10.4 million.
- Expense Growth: Total operating expenses increased to $1.4 million from $0.3 million, primarily due to higher management fees calculated on the increased gross equity raised.
- Prepayment Rates: The average quarterly principal repayment rate (CPR) was 11.7% in Q1 2011, down from 14.5% in Q1 2010.
Guidance, Outlook, Risks, and Unusual Items
Management Commentary & Outlook:
Management notes that earnings per share may take time to reach a full run-rate as capital from recent offerings is deployed. The company intends to maintain a leverage ratio between 6x and 10x equity. Dividends of $0.12 per share were declared and paid in January, February, and March 2011.
Subsequent Events:
- On April 13, 2011, the company completed a secondary offering of 17 million shares at $7.40 per share, raising $121.4 million net.
- On April 28, 2011, a dividend of $0.12 per share was paid.
Risks and Contingencies:
- Interest Rate Risk: The company faces mismatch risk as assets (longer duration) reprice slower than liabilities (short-term repurchase agreements). Rising rates could compress net interest margins and reduce asset values.
- Liquidity & Financing: Reliance on short-term repurchase agreements exposes the company to margin calls if asset values decline. The weighted average margin requirement (haircut) was 5.2% as of March 31, 2011.
- Prepayment Risk: Accelerated prepayments (due to refinancing or agency repurchases of delinquent loans) increase premium amortization, reducing yields on assets purchased at a premium.
- Derivative Risk: The company uses interest rate swaps and Eurodollar futures to hedge. Unrealized losses on these contracts ($0.3 million in Q1 2011) impact GAAP earnings but do not affect REIT taxable income.
Investor Verification Checklist
- Capital Deployment Speed: Verify the rate at which the $113 million raised in Q1 and $121 million raised in April 2011 is being invested to generate yield.
- Net Interest Margin Stability: Monitor the spread between asset yields (3.20%) and cost of funds (0.29%) against potential increases in LIBOR and prepayment rates.
- Liquidity Coverage: Assess the adequacy of unpledged assets and cash ($60.9 million total) to meet potential margin calls given the 9.52:1 leverage ratio.
- Dividend Sustainability: Confirm that REIT taxable income (estimated at $8.9 million for Q1) continues to support the $0.12 quarterly dividend policy, noting the divergence between GAAP net income and taxable income due to unrealized derivative losses.
- Counterparty Concentration: Review the top 14 repurchase agreement counterparties, noting that the top 5 lenders account for approximately 52% of total borrowings.