Armour Residential REIT, Inc. — Q3 2018 Form 10-Q
Business context and reporting period
ARMOUR is an externally managed mortgage REIT investing primarily in agency residential mortgage-backed securities (MBS), financed mainly through short-term repurchase agreements. This unaudited report covers the quarter and nine months ended September 30, 2018; comparisons are with the corresponding 2017 periods unless otherwise indicated. Dollar amounts below are in millions except per-share data.
Financial performance and position
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Interest income | $72.6 | $66.8 | $206.6 | $185.4 |
| Net interest income | $32.3 | $39.6 | $98.5 | $119.7 |
| Net income | $47.7 | $27.7 | $106.0 | $110.1 |
| Net income available to common | $43.4 | $23.8 | $93.2 | $98.4 |
| Diluted earnings per common share | $1.02 | $0.58 | $2.20 | $2.57 |
| Common dividend per share | $0.57 | $0.57 | $1.71 | $1.71 |
- Q3 net income included $57.9 million of derivative gains, including $54.2 million of unrealized gains. For the nine months, derivative gains were $147.2 million. These earnings gains coincided with a $152.1 million nine-month other comprehensive loss, primarily reflecting unrealized losses on agency MBS.
- Nine-month net interest income fell 17.7% year over year: higher asset yields and a 4.9% larger average securities portfolio did not offset higher repo funding costs. Management reported the net interest rate spread decreased from 1.66% to 1.57% (9 basis points).
- At September 30, total assets were $8.68 billion, including $6.96 billion of agency securities and $947.3 million of credit-risk and non-agency securities. Total liabilities were $7.47 billion, including $7.22 billion of repo borrowings. Stockholders’ equity was $1.21 billion, down from $1.33 billion at year-end 2017.
- Cash was $266.7 million. Reported liquidity was $639.3 million, comprising cash and $372.6 million of unpledged agency securities. Leverage was 5.97:1, or 7.01:1 including purchased-forward TBA securities under the company’s stated calculation.
- Repo borrowings declined from $7.56 billion at year-end 2017; their weighted average rate rose from 1.71% to 2.38%, while weighted average maturity shortened from 51 to 16 days. BUCKLER accounted for 46.8% of borrowings.
- Nine-month operating cash flow was $47.4 million, versus $96.8 million in 2017; investing activities provided $364.9 million, while financing activities used $410.8 million. Cash ended at $266.7 million, up $1.5 million from year-end.
Changes, outlook, and risks
- Agency securities declined to $6.96 billion from $7.48 billion. Their weighted-average coupon rose to 3.91% from 3.68%, but gross unrealized losses increased to $172.3 million from $39.4 million. Management reported no agency-security impairment for Q3; the nine-month results included $12.1 million of impairment losses identified previously.
- The company says it believes liquidity and capital resources are sufficient for anticipated short-term needs, including financing obligations and dividends. It gives no earnings or dividend-growth guidance; future results remain dependent on rates, spreads, prepayments, funding access, and portfolio decisions.
- Interest-rate risk remains central. In the company’s modeled instantaneous +100-basis-point scenario, net interest income increased 6.93%, while shareholder equity including hedges declined 7.49%. A 25-basis-point widening in MBS spreads was estimated to reduce portfolio book value 10.30%. Management cautions that actual outcomes may differ materially from these models.
- Repo financing exposes the company to frequent margin calls, collateral demands, refinancing and counterparty risks. A decline in MBS values, higher haircuts, or reduced lender availability could pressure liquidity or force asset sales. The short repo maturity and concentration with BUCKLER are notable exposures.
- Nine putative class-action suits related to the JAVELIN tender offer and merger remained unresolved; the court had not ruled on the motion to dismiss, and the company could not estimate the outcome. Management states it intends to defend the claims.
- ACM manages the company and receives fees based on gross equity raised, not portfolio performance. The company also has a 10% interest in BUCKLER and $105 million of subordinated loans to it; BUCKLER is also a major repo counterparty. These are related-party arrangements.
- After quarter-end, the company declared a $0.19-per-common-share dividend payable in October and November 2018. Preferred dividends were also declared for subsequent payment dates through December.
Important facts for investors to verify
- Whether derivative gains and their volatility meaningfully offset MBS valuation losses and higher funding costs over time.
- How repo repricing, the 16-day average maturity, collateral haircuts, and BUCKLER’s 46.8% share of borrowings affect refinancing and margin-call resilience.
- Whether reported liquidity remains adequate under adverse rate and spread moves, including the modeled equity sensitivity and actual collateral requirements.
- Whether the common dividend is supported by recurring taxable income and cash generation; GAAP earnings include substantial mark-to-market effects.
- Developments in the JAVELIN litigation and any resulting costs or liabilities; the filing provides no clear estimate of potential exposure.