Armour Residential REIT, Inc. quarterly report, Q2 FY2020

ARMOUR Residential REIT, Inc. — Q2 2020 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2020. ARMOUR is an externally managed mortgage REIT that invests primarily in Agency mortgage-backed securities (MBS), financed largely with short-term repurchase agreements. Unless otherwise indicated, amounts below are in millions of dollars.

Key financial results and position

Metric	Q2 2020	Q2 2019	Six months 2020	Six months 2019
Interest income	$28.6	$128.4	$121.4	$223.2
Net interest income	$23.1	$40.9	$64.5	$74.7
Total other income (loss)	$36.5	$(214.1)	$(401.6)	$(352.8)
Net income (loss)	$51.7	$(183.3)	$(354.9)	$(297.6)
Net income (loss) per common share, diluted	$0.77	$(3.14)	$(5.87)	$(5.40)

Balance sheet at June 30: Total assets were $5,564 million, down from $13,272 million at December 31, 2019. Agency securities were $5,186 million, compared with $11,942 million; Credit Risk and Non-Agency securities were $66 million, compared with $884 million.
Debt and equity: Repurchase-agreement borrowings were $4,238 million, down from $11,355 million. Stockholders’ equity was $851 million, down from $1,437 million. Repurchase debt-to-equity leverage was 4.98:1, versus 7.90:1 at year-end.
Liquidity: Management reported $540 million of liquidity at June 30, comprising $153 million cash and $387 million of unpledged MBS, including securities received as collateral. Cash and cash collateral posted to counterparties totaled $181 million at period-end.
Cash flows, six months: Operating activities used $348 million; investing activities provided $7,446 million; financing activities used $7,191 million. The large investing and financing movements reflect portfolio sales and purchases and substantial reductions in repo borrowings.
Margin and funding: Q2 asset yield was 2.53%, cost of funds 0.90%, and net interest margin 1.63%, compared with 3.70%, 2.30%, and 1.40%, respectively, in Q2 2019. Repo weighted-average contractual rate was 0.25% at June 30, versus 2.54% at December 31.
Common dividends: Declared dividends were $0.09 per share in Q2 2020 versus $0.57 in Q2 2019; no common dividend was paid for April or May 2020. Subsequent to quarter-end, the company declared $0.10 per share for July and August.

Material changes versus comparable periods

Q2 returned to GAAP net income from a substantial year-earlier loss, chiefly reflecting a $36.0 million realized gain on sales of available-for-sale Agency securities and a $7.9 million gain on trading Agency securities, alongside a much smaller net derivative loss. Q2 derivative loss was $7.2 million, compared with $200.3 million in Q2 2019.
Despite Q2 profitability, the six-month net loss widened to $354.9 million from $297.6 million. Six-month results included $182.9 million of losses on Credit Risk and Non-Agency securities and $376.3 million of net derivative losses.
Average securities portfolio, including TBAs, fell 29.5% year over year for the first half, to $8,804 million. Net interest income declined as the smaller average portfolio outweighed lower funding costs.
The company sharply reduced leverage and sold securities to bolster liquidity amid the March 2020 market disruption. Agency exposure, including TBA securities, was reduced 45% from year-end according to management.
ARMOUR liquidated substantially all Credit Risk Transfer (CRT) positions during Q2 after volatility, reduced liquidity, and less favorable financing terms. At June 30, remaining Credit Risk and Non-Agency securities were $66 million.
Equity actions included issuing 5.8 million common shares through an ATM program for net proceeds of $48.9 million, issuing $129.1 million of Series C preferred stock, and redeeming all $209.6 million of Series B preferred stock. Common shares outstanding rose to 64.7 million from 58.9 million.

Outlook, risks, contingencies, and unusual items

Management outlook: ARMOUR said it believed available liquidity, operating cash flow, and portfolio adjustments would be sufficient for anticipated short-term needs, including financing obligations and distributions. It did not provide earnings or portfolio guidance. Management cautioned that COVID-19’s ultimate effects could not be estimated and could materially affect future results.
Market disruption and risk management: Management said Federal Reserve intervention helped stabilize Agency MBS markets after March spread widening. ARMOUR prioritized liquidity, reduced leverage, and continued to meet repo obligations. It received waivers from certain ISDA counterparties for equity-reduction events that otherwise could have triggered default or termination.
Funding and counterparty concentration: BUCKLER, a related party, represented 68.6% of repo borrowings at June 30; one other counterparty represented about 9.6%. Repo agreements are short-term, collateralized, and subject to margin calls. A decline in collateral values or withdrawal of financing could force additional collateral posting or asset sales.
Hedging and valuation: Interest-rate swaps had $5,112 million notional at a weighted-average rate of 0.29%; TBA positions had $1,900 million notional. ARMOUR does not apply cash-flow hedge accounting, so derivative fair-value changes can materially affect reported earnings. The filing’s sensitivity analysis estimates that a 100-basis-point rate increase would reduce shareholder equity by 7.41%, while a 25-basis-point MBS spread widening would reduce it by 9.51%; these are model-based estimates, not forecasts.
Other risks: Risks include interest-rate and mortgage-spread changes, prepayments, repo liquidity and margin calls, GSE reform, LIBOR transition to SOFR, credit exposure in non-Agency assets, cybersecurity, and maintaining REIT status. The company reported no material change in previously disclosed risk factors.
Contingency and related parties: Putative shareholder litigation concerning the 2016 JAVELIN merger remained unresolved; the company said it could not estimate the outcome. ACM waived $2.9 million of management fees in Q2, a 40% waiver continuing until further notice. On July 21, the management agreement’s base term was extended to June 18, 2027.

Important facts for investors to verify

How much of Q2’s reported profit reflects realized security-sale gains and accounting presentation, versus recurring net interest income and sustainable portfolio economics.
Whether liquidity and repo funding remain adequate under renewed market stress, including margin-call needs and the high concentration of borrowings with BUCKLER.
Whether the reduced portfolio, lower leverage, and revised asset mix can support earnings and dividends; the filing does not guarantee future distributions.
The performance and valuation of remaining CRT and other non-Agency securities, and the impact of derivative positions and interest-rate or spread movements.
Developments in COVID-19 effects, the JAVELIN litigation, LIBOR transition, and the company’s dependence on ACM and related-party financing.