Armour Residential REIT, Inc. — Q2 2013 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2013. ARMOUR is an externally managed REIT investing primarily in Agency residential mortgage-backed securities, financed largely with short-term repurchase agreements. Amounts below are in U.S. dollars; financial statement amounts are converted from thousands to millions or billions where indicated.
Financial results and key metrics
| Metric | Q2 2013 | Q2 2012 |
|---|---|---|
| Net interest income | $117.6 million | $75.1 million |
| Net income (loss) | $481.4 million | ($13.6 million) |
| Net income (loss) available to common stockholders | $477.5 million | ($13.8 million) |
| Basic and diluted earnings (loss) per common share | $1.28 | ($0.08) |
| Common dividend declared per share | $0.21 | $0.30 |
| Asset yield / cost of funds / net interest margin | 2.53% / 1.14% / 1.38% | 2.97% / 0.82% / 2.15% |
Q2 reported earnings were strongly influenced by a $412.2 million unrealized derivative gain, alongside $38.9 million of realized derivative losses. These fair-value changes can make GAAP earnings volatile and do not necessarily represent current-period cash earnings. Comprehensive loss was $390.6 million for Q2, primarily reflecting an $851.2 million unrealized loss on available-for-sale Agency securities.
For the six months ended June 30, net interest income was $222.7 million (versus $130.9 million in 2012); net income was $583.7 million (versus $51.6 million); and net income available to common stockholders was $577.3 million (versus $51.5 million). Basic EPS was $1.62 versus $0.33. Six-month operating cash flow was $213.9 million; investing cash outflow was $5.7 billion and financing cash inflow was $5.5 billion. Cash and cash equivalents at period end were $802.9 million.
At June 30, total assets were $24.17 billion, including $22.61 billion of Agency securities. Net repurchase-agreement borrowings were $19.76 billion; reported leverage was approximately 9.77:1, compared with 7.96:1 at December 31, 2012. Stockholders’ equity was $2.22 billion. Securities had $862.9 million of gross unrealized losses at quarter-end; accumulated other comprehensive loss was $840.0 million. The company reported no other-than-temporary impairment.
Material changes versus comparable periods
- Net interest income increased year over year, which management attributed principally to a larger investment portfolio funded by equity issuance. However, asset yield and net interest margin declined, while cost of funds rose.
- The portfolio’s fair value increased to $22.61 billion from $19.10 billion at December 31, 2012, while market losses on Agency securities contributed to the sharp decline in accumulated other comprehensive income.
- Net interest-bearing repurchase borrowings rose to $19.76 billion from $18.37 billion; weighted-average repo maturity was 38 days and weighted-average contractual rate was 0.40% at June 30.
- ARMOUR issued approximately $438.4 million net from a common-stock offering and $136.6 million net from Series B preferred stock during the first half. Common shares outstanding increased to about 370.7 million from 309.0 million at year-end. It also repurchased 3.4 million common shares for $20.3 million.
- The monthly common dividend declined from $0.08 per share in Q1 to $0.07 in Q2; the reported quarterly declared dividend was $0.21 per share, versus $0.30 a year earlier.
Outlook, risks and unusual items
No numerical earnings or net-interest-margin guidance is provided. Management said it believed available liquidity and capital resources were sufficient for anticipated short-term needs, including financing, investment activity and distributions, but future financing through equity or debt offerings depends on market conditions. The filing reports no pending, threatened or contemplated litigation and no material change to previously disclosed risk factors other than proposed legislation to wind down Fannie Mae and Freddie Mac.
- Post-quarter market response: In response to increased interest-rate and spread volatility after June 30, ARMOUR sold approximately $4.2 billion of Agency securities, realizing approximately $200 million of losses, and realized approximately $13.5 million of capital gains on short sales of U.S. Treasury securities. The filing states these capital losses generally may offset capital gains realized from 2013 through 2018; they do not reduce ordinary taxable income used for REIT distribution requirements.
- Rate and funding risk: The company finances long-maturity assets with short-term repos. Rising rates or wider spreads can reduce asset values, increase margin calls and borrowing costs, and pressure book value, liquidity and net interest income. A 100-basis-point rate increase was estimated to reduce projected net interest income by 12.05% and portfolio value including derivatives by 2.56%, under the filing’s modeled assumptions.
- Leverage and liquidity: Repo financing is collateralized and subject to daily margin calls; counterparties may demand additional collateral or terminate financing. Most repo balances reprice within 60 days. Management cautions that there is no assurance liquidity will be sufficient under stressed conditions.
- Hedging and accounting: Derivatives are not designated as GAAP cash-flow hedges, so their fair-value movements flow through earnings and may not offset asset or funding changes in the same period. The company’s hedge positions do not eliminate interest-rate, basis, duration or counterparty risk.
- Other exposures: Prepayment speeds affect premium amortization and asset yields. Proposed GSE reform, changes in government support, regulatory developments and the company’s REIT status could also affect its business and distributions. The external manager’s fee is not performance-based and may not decline when earnings fall.
After quarter-end, the company paid and announced common dividends of $0.07 per share monthly for July through September 2013. It also announced monthly preferred dividends of $0.17 per Series A share and $0.16 per Series B share for August and September.
Important facts for investors to verify
- How much of reported GAAP earnings reflects derivative marks rather than recurring net interest income, and how the post-quarter securities sales affect subsequent results and book value.
- Current book value per common share, which is not stated clearly in the supplied filing text, and the effect of the $840.0 million accumulated other comprehensive loss and subsequent realized losses.
- Repo leverage, margin-call capacity, collateral availability and refinancing terms, especially given short weighted-average maturities and higher leverage.
- Whether the lower net interest margin and common dividend level are sustainable, and how taxable income and required REIT distributions compare with declared dividends.
- The effects of rate changes, prepayments and proposed GSE reform on asset values, hedging effectiveness, funding access and distributions.