ARMOUR Residential REIT, Inc. — FY 2012 Form 10-K
Reporting period: Year ended December 31, 2012; filed February 22, 2013. The filing also reports fourth-quarter results. ARMOUR is an externally managed mortgage REIT investing in agency residential mortgage-backed securities (RMBS); its portfolio was 100% Agency Securities at year-end. It finances assets primarily through short-term repurchase agreements and seeks to earn the spread between asset yields and funding costs, after hedging.
Financial and operating highlights
| Metric | FY 2012 | FY 2011 |
|---|---|---|
| Interest income, net of premium amortization | $389.0 million | $117.6 million |
| Interest expense | $61.2 million | $11.9 million |
| Net interest income | $327.8 million | $105.8 million |
| Net income (loss) | $222.3 million | $(9.4) million |
| Net income (loss) available to common shareholders | $220.3 million; $0.99 basic EPS | $(9.4) million; $(0.15) basic EPS |
| Average portfolio yield / cost of funds / interest-rate spread | 2.73% / 0.96% / 1.76% | 3.00% / 0.94% / 2.05% |
| Return on equity | 9.6% | (2.0)% |
| Common dividends per share | $1.20 | $1.41 |
Year-end balance sheet: Agency Securities were $19.10 billion, versus $5.39 billion a year earlier; repurchase borrowings were $18.37 billion, versus $5.34 billion. Total assets were $20.88 billion and shareholders’ equity was $2.31 billion. Debt-to-equity was 7.96:1, within the company’s stated typical target range of 6–10 times equity. Repurchase agreements had a 34-day weighted-average maturity, 0.49% weighted-average contractual rate, and 4.8% average haircut.
Cash flow and liquidity: Operating cash flow was $343.7 million; investing activities used $14.13 billion and financing activities provided $14.30 billion. Year-end cash and cash equivalents were $771.3 million, with another $265.6 million in restricted cash, primarily collateral for derivatives. Management said available equity, operating cash flow, and borrowing capacity were expected to meet anticipated short-term needs; liquidity remains exposed to collateral calls and financing access.
Fourth quarter: Net interest income was $99.4 million and net income was $115.7 million ($0.37 per common share, basic and diluted). Asset yield was 2.47%, cost of funds 0.92%, and net interest margin 1.55%. Common dividends declared were $0.27 per share, down from $0.33 in Q4 2011.
Material changes versus the prior comparable period
- Rapid balance-sheet expansion followed substantial capital raising: ARMOUR issued 213.5 million common shares and raised about $1.5 billion net common equity in 2012, plus about $48.8 million net from Series A preferred stock. The portfolio and repo financing grew accordingly.
- Annual net income improved from a loss in 2011, largely because of the larger invested portfolio and equity base. Interest income and net interest income rose substantially, while the average portfolio yield and spread narrowed.
- Derivative losses remained significant: total realized and unrealized derivative losses were $121.8 million in 2012, compared with $122.1 million in 2011. The company does not apply cash-flow hedge accounting, so derivative fair-value changes flow through earnings and can make GAAP results volatile.
- The portfolio shifted toward fixed-rate securities: fixed-rate assets were 88.6% of Agency Securities at year-end 2012, versus 47.8% a year earlier. The average annual portfolio repayment rate was 11.9%, down from 13.2%.
- The common dividend declined during 2012, from $0.11 per share early in the year to $0.09 monthly late in the year. The company reported $1.20 per common share paid for the year.
Outlook, risks, and unusual items
- No earnings or dividend guidance was provided. Management described a challenging reinvestment and hedging environment, with Federal Reserve purchases supporting high Agency-security prices and compressing spreads. Management expected continued sensitivity to short-term rates and mortgage prepayments.
- Key operating risks include leverage and short-term repo refinancing, margin calls if collateral values fall or haircuts rise, asset/liability repricing mismatch, prepayment and premium-amortization uncertainty, and imperfect hedge performance. The filing’s modeled rate sensitivities are estimates based on a static portfolio and assumptions, not forecasts.
- Agency guarantees reduce direct mortgage credit exposure, but Fannie Mae and Freddie Mac remain in conservatorship and their guarantees are not backed by the full faith and credit of the U.S. government. Changes to GSE support or housing-finance policy could affect asset values, supply, funding, and spreads.
- ARMOUR relies on the Section 3(c)(5)(C) Investment Company Act exclusion and must maintain REIT qualification and distribution requirements. Regulatory or interpretive changes could constrain its portfolio or leverage. The company reported CFTC staff relief for certain mortgage REIT hedging activity, subject to conditions.
- The external manager’s fee is based on gross equity raised, not investment performance; management and officers also serve or are affiliated with JAVELIN, creating disclosed conflicts. The management agreement has an initial term through June 18, 2022 and termination restrictions and potential fees.
- Unusual items included a repo-counterparty bankruptcy: ARMOUR recorded $1.1 million of losses in connection with the event and $1.0 million of other income from counterparty nonperformance. It also reported $40.6 million of realized gains on Agency-security sales for the year.
- After year-end, ARMOUR announced a first-quarter 2013 common dividend rate of $0.08 per share. It also completed a $135.0 million Series B preferred-stock offering (about $130.5 million net) and a 65 million-share common-stock offering in February 2013; the common offering proceeds are not specified in the supplied filing text.
Most important facts for investors to verify
- Whether net interest margin, dividend coverage, and earnings remain sustainable as asset yields and spreads compress; distinguish GAAP earnings from REIT taxable income and cash available for distribution.
- Current repo maturities, lender concentration, haircuts, unencumbered liquidity, and the ability to meet margin calls under adverse rate or spread moves.
- Portfolio mix, duration and repricing profile, prepayment assumptions, premium amortization, and the assumptions behind management’s interest-rate sensitivity analysis.
- Derivative exposure and collateral needs, including the impact of mark-to-market accounting and the extent to which hedges offset asset and funding risks.
- Post-year-end share issuance, dilution, preferred-stock obligations, and the effect of capital raised on per-share results and distributions.
- Continued eligibility for REIT treatment and the Investment Company Act exclusion, as well as manager-related fees, conflicts, and termination provisions.