Business Context and Reporting Period
Company: Armour Residential REIT, Inc. (ARMOUR)
Reporting Period: Fiscal Year Ended December 31, 2009
Business Overview: ARMOUR is an externally-managed Maryland corporation organized in 2008, managed by ARMOUR Residential Management LLC (ARRM). The company 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 intends to qualify as a Real Estate Investment Trust (REIT).
Corporate Structure Change: On November 6, 2009, ARMOUR completed a business combination with Enterprise Acquisition Corp. (a SPAC). Enterprise shareholders received ARMOUR securities, and approximately $226.5 million was returned to shareholders who exercised redemption rights. ARMOUR commenced investment operations in November 2009.
Key Financial Metrics
| Metric | 2009 | 2008 |
|---|---|---|
| Total Assets | $126.7 million | $250.2 million |
| Agency Securities (Fair Value) | $118.6 million | $0 |
| Repurchase Agreements (Debt) | $46.4 million | $0 |
| Net Interest Income | $0.43 million | $5.43 million |
| Total Operating Expenses | $2.03 million | $2.31 million |
| Net Loss | $(1.15) million | $1.07 million (Income) |
| Net Loss Attributable to Common Stock | $(2.35) million | $0.49 million (Income) |
| Book Value Per Share | $9.33 | N/A (Pre-merger) |
| Dividends Declared Per Share | $0.13 | $0.00 |
Portfolio Statistics (2009):
- Average Portfolio Yield: 4.59%
- Average Cost of Funds: 0.72%
- Interest Rate Spread: 3.87%
- Debt-to-Equity Ratio (Period End): 2.16:1 (Target range is 6:1 to 10:1)
- Weighted Average Haircut: 5.4%
Material Changes Versus Prior Period
The financial results for 2009 are not directly comparable to 2008 due to the business combination with Enterprise Acquisition Corp. in November 2009.
- Shift in Operations: In 2008, the company (as Enterprise) held cash in a trust account earning interest. In 2009, following the merger, the company deployed capital into Agency Securities and incurred leverage costs.
- Net Income to Net Loss: The company reported a net loss of $1.15 million in 2009 compared to net income of $1.07 million in 2008. The 2009 loss was driven by $1.61 million in non-recurring merger expenses and the transition from a cash-holding vehicle to an operating REIT.
- Asset Composition: Total assets decreased from $250.2 million in 2008 (primarily cash in trust) to $126.7 million in 2009. This decrease reflects the return of $226.5 million to redeeming shareholders and the deployment of remaining capital into Agency Securities ($118.6 million) and cash.
- Leverage: The company initiated borrowing in 2009, with $46.4 million in repurchase agreements outstanding at year-end, compared to zero in 2008.
Guidance, Outlook, Risks, and Unusual Items
Outlook and Subsequent Events:
- Investment Deployment: As of January 26, 2010, the company had substantially completed the investment of its initial equity, owning approximately $183.7 million of Agency Securities with $169.6 million in repurchase agreements.
- Dividends: On March 5, 2010, the Board declared a first-quarter 2010 dividend of $0.40 per share.
- Leverage Target: Management expects to increase leverage in 2010 to its normal expected range of 6:1 to 10:1 debt-to-equity.
Key Risks:
- REIT Qualification: As of December 31, 2009, the company did not meet the "5/50 test" (ownership concentration) required for REIT status. Management intends to issue more common stock to new shareholders by the end of 2010 to comply.
- Interest Rate and Prepayment Risk: The company's income is sensitive to changes in interest rates and prepayment speeds. Rising rates could decrease asset values, while falling rates could accelerate prepayments of premium-priced securities, reducing yields.
- Liquidity and Financing: The company relies on short-term repurchase agreements. Adverse market conditions could lead to margin calls, increased haircuts, or an inability to refinance debt.
- Government Intervention: Risks related to the federal conservatorship of Fannie Mae and Freddie Mac, including potential changes to their guarantee structures or the termination of Federal Reserve purchase programs.
Unusual Items:
- Merger Expenses: $1.61 million in expenses related to the merger with Enterprise were incurred in 2009.
- Hedging: The company does not qualify for hedge accounting under GAAP, leading to potential volatility in earnings as gains/losses on hedges are recognized immediately.
Investor Verification Checklist
- REIT Status Compliance: Verify if the company has successfully issued new equity to satisfy the 5/50 ownership test required for REIT qualification in 2010.
- Leverage Execution: Confirm if the company has increased its debt-to-equity ratio to the target range of 6:1 to 10:1 as planned for 2010.
- Dividend Sustainability: Assess whether the declared $0.40 dividend is supported by taxable income or if it includes a return of capital, given the net loss in 2009.
- Financing Terms: Monitor the weighted average haircut and cost of funds on repurchase agreements to ensure they remain within manageable levels amidst market volatility.
- Portfolio Yield vs. Cost: Track the net interest spread as the portfolio matures and premium amortization increases, which may compress the 3.87% spread achieved in the partial 2009 period.