Armour Residential REIT, Inc. — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. Unless stated otherwise, dollar amounts below are in millions. ARMOUR is an externally managed mortgage REIT investing primarily in Agency mortgage-backed securities (MBS), funded largely through repurchase agreements and using derivatives to manage interest-rate risk.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Interest income | $65.8 | $60.0 | $134.0 | $118.6 |
| Interest expense on repos | $35.7 | $20.5 | $67.7 | $38.6 |
| Net interest income | $30.1 | $39.5 | $66.2 | $80.0 |
| Net income | $13.6 | $29.7 | $58.3 | $82.4 |
| Net income available to common | $9.3 | $25.8 | $49.8 | $74.6 |
| Diluted EPS | $0.22 | $0.70 | $1.18 | $2.03 |
| Common dividends declared per share | $0.57 | $0.57 | $1.14 | $1.14 |
- Six-month net interest rate spread was 1.56%, down from 1.67%. Management attributed lower net interest income to repo funding costs rising faster than asset yields, despite a larger average portfolio and higher asset yields.
- Derivative results were gains of $30.7 million in Q2 and $89.3 million for the first half, compared with losses of $21.1 million and $9.6 million, respectively, in 2017. These gains partly offset losses and valuation changes elsewhere; derivatives are not designated for GAAP cash-flow hedge accounting.
- Agency security sales generated realized losses of $25.3 million in Q2 and $57.9 million in the first half. The first-half results also included $12.1 million of previously identified Agency-security impairment losses. Q2 had no new other-than-temporary impairment.
Financial position, liquidity and cash flow
- At June 30, 2018, total assets were $8.10 billion, including $6.25 billion of Agency securities and $957.8 million of credit-risk and non-Agency securities. Stockholders’ equity was $1.21 billion, down from $1.33 billion at December 31, 2017.
- Repurchase agreement borrowings were $6.25 billion, down from $7.56 billion at year-end. The weighted-average repo rate rose to 2.31% from 1.71%, while average maturity shortened to 23 days from 51 days. The reported leverage ratio was 5.18:1; including forward-purchased TBAs and excluding debt related to forward-settling sales, it was 6.56:1.
- Reported liquidity was $676.1 million: $335.5 million in cash and $340.6 million of unpledged Agency securities. Management stated it believed available liquidity and capital resources were sufficient for anticipated short-term needs, including financing obligations and dividends.
- First-half operating cash flow was $17.3 million, versus $59.5 million in 2017. Investing activities provided $1.41 billion, while financing activities used $1.36 billion. Cash ended the period at $335.5 million.
- Other balance-sheet items included $462.3 million payable for unsettled purchases, $216.3 million receivable for unsettled sales, and $105 million of subordinated loans to BUCKLER Securities LLC.
Changes, outlook and material risks
- Compared with Q2 2017, Q2 2018 interest income increased, but higher repo interest expense contributed to lower net interest income and earnings. The reported six-month average securities portfolio, including TBAs, increased 11.5% year over year; asset yields rose 0.11 percentage point, while repo expense rose 0.75 percentage point.
- Unrealized losses on available-for-sale Agency securities were $195.0 million for the first half, contributing to a $125.0 million other comprehensive loss. Accumulated other comprehensive loss increased to $145.1 million from $20.1 million at year-end.
- The Federal Reserve raised its target range three times through June 2018, to 1.75%–2.00%. Management warned that short-term rate increases can raise funding costs faster than asset income and reduce net interest income and book value. The filing gives no specific earnings or dividend guidance.
- Key exposures include interest-rate and mortgage-spread changes, prepayments and premium amortization, credit losses on non-Agency holdings, repo refinancing and margin calls, and derivative counterparty and collateral risk. A parallel 100-basis-point rate increase was modeled to raise projected net interest income 8.18% but reduce portfolio value including derivatives 0.69% and shareholder equity including hedges 5.28%; these are scenario estimates, not forecasts.
- BUCKLER accounted for 49.0% of repo borrowings at quarter-end, versus 38.4% at year-end. This concentration is notable alongside the company’s $105 million in subordinated BUCKLER loans and 10% ownership interest.
- Eight Maryland putative class actions concerning the JAVELIN tender offer and merger were consolidated; the court had not ruled on the motion to dismiss. ARMOUR said it could not estimate the outcome or potential loss. Management reported no material changes to previously disclosed risk factors.
- Subsequent to quarter-end, the company declared common dividends of $0.19 per share for July and August 2018. Preferred dividends were also declared; future dividends remain subject to board decisions and REIT requirements.
Important facts for investors to verify
- Whether repo funding costs and the net interest spread continue to pressure earnings, and how the portfolio responds to further rate changes.
- Whether the $676.1 million reported liquidity buffer remains adequate under margin calls, higher haircuts, or reduced repo availability—particularly given short repo maturities and BUCKLER concentration.
- How Agency-security valuation losses, realized sales losses, and the large accumulated other comprehensive loss affect book value and the company’s capacity to maintain distributions.
- Developments in the JAVELIN litigation and the repayment, extension approval, and credit exposure associated with BUCKLER subordinated loans.
- Whether declared dividends remain supported by taxable income and liquidity; first-half estimated REIT taxable income was $9.7 million, while common dividends declared were $1.14 per share.