ARMOUR Residential REIT, Inc. — Q3 2022 Form 10-Q
Reporting period: Three and nine months ended September 30, 2022. ARMOUR is an externally managed mortgage REIT investing primarily in agency mortgage-backed securities (MBS), financed mainly through short-term repurchase agreements. Unless otherwise noted, dollar amounts below are in millions.
Financial results and position
| Metric | Q3 2022 | Q3 2021 | Nine months 2022 | Nine months 2021 |
|---|---|---|---|---|
| Interest income | $69.5 | $22.0 | $150.9 | $58.8 |
| Interest expense | $44.3 | $1.6 | $59.8 | $5.7 |
| Net interest income | $25.1 | $20.4 | $91.1 | $53.2 |
| Net income (loss) | $(144.3) | $34.0 | $(269.3) | $36.1 |
| Net loss per common share | $(1.20) | $0.37 | $(2.56) | $0.37 |
| Comprehensive income (loss) | $(152.7) | $13.3 | $(390.9) | $(18.9) |
- Net interest margin was 2.21% in Q3, versus 2.22% in Q2 2022 and 1.70% in Q3 2021. Q3 asset yield rose to 3.24% from 2.88% in Q2, while cost of funds rose to 1.03% from 0.66%.
- Q3 other loss was $159.9 million: $514.5 million of losses on trading agency securities and $16.0 million on U.S. Treasuries were partly offset by $374.7 million of derivative gains. Nine-month derivative gains were $825.6 million, against trading agency-security losses of $1,017.9 million and Treasury losses of $128.3 million.
- At September 30, total assets were $10.92 billion, including $8.01 billion of agency securities; repurchase-agreement borrowings were $8.25 billion. Stockholders’ equity was $944.1 million, down from $1.14 billion at December 31, 2021.
- Debt-to-equity leverage was 8.74:1, compared with 3.45:1 at year-end 2021. Leverage including TBA securities was 7.76:1, versus 7.39:1. Average repurchase-agreement haircut was 3.32%.
- Reported liquidity was $469.3 million: $290.8 million cash plus $178.5 million of unencumbered agency and U.S. government securities. Operating activities provided $16.7 million of cash and cash collateral for the nine months, compared with $24.4 million in 2021.
- Common dividends declared were $0.30 per share for Q3 and $0.90 for the nine months, unchanged from the comparable 2021 periods. The Series C preferred stock carries a 7.00% annual dividend.
Material changes versus comparable periods
- Net interest income increased year over year, reflecting a larger average securities portfolio and higher asset yield; funding costs also rose sharply as short-term rates increased.
- Large fair-value and realized losses on securities drove the shift to net losses, partly offset by gains on hedges. The nine-month comprehensive loss included $121.6 million of other comprehensive loss, primarily unrealized losses on legacy available-for-sale securities.
- The securities portfolio expanded and changed composition: agency securities at fair value rose from $4.41 billion at December 31, 2021 to $8.01 billion at September 30, 2022, while the portfolio’s TBA position shifted from $4.50 billion long to $1.00 billion short notional.
- Repurchase borrowings increased from $3.95 billion to $8.25 billion. Common shares issued and outstanding grew from 94.2 million at year-end to 132.6 million at quarter-end, largely through ATM issuance. The company raised $301.4 million net through common-stock sales in the first nine months.
Outlook, risks and unusual items
- Management stated it believed available liquidity and capital resources were sufficient for anticipated short-term needs, including financing obligations and dividends. It cautioned that future financing depends on market conditions and is not assured.
- The Federal Reserve raised its target federal funds range to 3.00%–3.25% on September 21, 2022 and signaled further increases and continued balance-sheet reduction. Management noted that higher funding costs, MBS spread widening and market volatility could pressure earnings, asset values and liquidity.
- Management expected estimated ordinary REIT taxable income for 2022 to be negative, so 2022 dividends were expected to be treated as return of capital for federal tax purposes. It forecast positive ordinary REIT taxable income for 2023, with preferred dividends likely fully taxable and common dividends at least partly taxable. These are estimates, not guarantees.
- Interest-rate sensitivity estimates at September 30 indicated a 100-basis-point rate increase could reduce projected net interest income by 2.10% and stockholders’ equity by 6.32%; a 25-basis-point widening in MBS spreads could reduce equity by 12.13%. These are model-based estimates and actual outcomes may differ materially.
- Funding is concentrated: BUCKLER accounted for 45.3% of repurchase borrowings, and its amount at risk was 12.2% of stockholders’ equity. Repurchase agreements are short-term, collateralized and subject to margin calls; collateral declines or lender withdrawal could force asset sales or additional funding.
- Other risks include imperfect hedge performance, prepayment uncertainty, dependence on agency guarantees and the Federal Reserve’s actions, and potential conflicts involving the external manager ACM and BUCKLER. Nine putative class-action suits relating to the 2016 JAVELIN transaction remained unresolved; the company said it could not estimate their outcome.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. No material changes to the prior annual-report risk factors were reported.
Investor verification priorities
- Track book value/equity, securities valuation losses, MBS spreads and the assumptions behind management’s market-risk sensitivity estimates.
- Review repurchase-agreement renewals, collateral and margin requirements, liquidity under stress, and BUCKLER’s large share of funding.
- Assess whether hedge gains, funding costs and asset yields remain aligned as interest rates and mortgage spreads change; GAAP results include derivative mark-to-market volatility.
- Check ATM issuance, share-count dilution, subsequent authorization changes, dividends and the company’s taxable-income estimates. The board authorized an additional 35 million ATM shares on October 25, 2022.
- Monitor the JAVELIN litigation, ACM management-fee arrangements and related-party transactions. The filing also disclosed a $105 million subordinated loan to BUCKLER, maturing in 2025.