Armour Residential REIT, Inc. — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019. Unless otherwise noted, dollar amounts are in millions; the filing reports financial statements in thousands. Armour is an externally managed mortgage REIT investing primarily in Agency mortgage-backed securities (MBS), financed largely through short-term repurchase agreements.
Financial performance and position
| Metric | Q1 2019 | Q1 2018 / prior period |
|---|---|---|
| Interest income | $94.8 | $68.2 |
| Net interest income | $33.8 | $36.2 |
| Total other income (loss) | $(138.7) | $18.1 |
| Net income (loss) | $(114.4) | $44.7 |
| Net loss available to common stockholders | $(118.6); $(2.21) per share | $40.5; $0.97 basic earnings per share |
| Comprehensive income (loss) | $72.8 | $(56.0) |
| Common dividend declared per share | $0.57 | $0.57 |
Net interest income fell 6.5% year over year: higher average portfolio size and asset yields did not offset increased repurchase-agreement interest expense. Management reported a net interest rate spread of 1.62% at March 31, 2019, versus 1.52% at March 31, 2018. The $135.2 million net derivative loss, including a $113.1 million unrealized loss, was the principal driver of the quarterly GAAP loss. In contrast, unrealized gains on available-for-sale Agency securities contributed $184.2 million to other comprehensive income. These accounting effects make net income and comprehensive income move differently.
At March 31, total assets were $13.97 billion, liabilities $12.49 billion, and stockholders’ equity $1.49 billion. Agency securities were $12.71 billion, up from $7.05 billion at year-end; total repurchase-agreement borrowings rose to $12.14 billion from $7.04 billion. Reported leverage increased to 8.17:1 from 6.25:1. The Agency portfolio’s weighted-average coupon was 3.91%.
Cash and cash collateral posted to counterparties totaled $226.4 million at quarter-end. Management reported liquidity of $713.1 million, comprising $167.4 million cash and $545.7 million of unpledged Agency securities. Operating activities used $11.3 million; investing activities used $5.39 billion; financing activities provided $5.39 billion. Cash interest paid was $98.6 million. The company raised $322.0 million net from common-stock issuance, including public offerings and ATM sales.
Material changes and management commentary
- Agency securities increased substantially, while their share of the securities portfolio rose to 93.8% from 88.2% at year-end. Credit-risk and non-Agency securities declined to 6.0% of the portfolio from 10.3%.
- Common shares outstanding increased from 43.7 million at December 31, 2018 to 59.8 million at March 31, 2019, primarily reflecting 16.1 million shares issued during the quarter.
- Average securities portfolio size increased 5.82% year over year. Average asset yield increased 0.60 percentage points, while the effective repurchase financing rate increased 0.9 percentage points, according to management.
- Management stated that it believes available liquidity and capital resources are sufficient for anticipated short-term needs, including investment activity, debt repayments, expenses, and dividends. It gave no specific earnings, spread, or dividend guidance.
- Management’s modeled sensitivity at March 31 estimated that an immediate 100-basis-point rate increase would reduce net interest income 2.89% and shareholder equity including derivatives 6.78%; a 100-basis-point decrease was estimated to reduce them 5.67% and 11.87%, respectively. These are model-based estimates, not forecasts.
Risks, contingencies, and unusual items
- Funding and liquidity risks are significant: most assets are financed with short-term, generally repricing repurchase agreements. A decline in collateral values or increased haircuts can trigger margin calls, forced sales, or termination of financing. The weighted-average repo maturity was 12 days and the average haircut was 4.73%.
- BUCKLER, a broker-dealer controlled by ACM and certain Armour executives, represented 49.2% of repo borrowings. Armour had $5.97 billion borrowed through BUCKLER and a $105 million subordinated loan to it. This creates financing concentration and related-party considerations.
- Interest-rate, mortgage-spread, prepayment, and derivative risks can affect earnings, book value, and liquidity. Derivatives are not designated as cash-flow hedges for GAAP, so fair-value changes flow through earnings. A 25-basis-point widening in MBS spreads was modeled to reduce portfolio book value 11.62%.
- Credit-risk and non-Agency securities expose the company to defaults, delinquencies, and loss severity. Agency securities depend on GSE and government guarantees and on future policy concerning Fannie Mae and Freddie Mac.
- Nine putative class-action suits relating to the JAVELIN tender offer and merger remain unresolved. The court had not ruled on the motion to dismiss; Armour said it could not estimate the outcome. An adverse result or defense costs could be material.
- The company continued to qualify and intended to operate as a REIT. Estimated REIT taxable income was $18.5 million for the quarter, compared with $5.8 million a year earlier. Subsequent to quarter-end, it declared common dividends of $0.19 per share for April and May payments.
- The filing reported no material changes to the risk factors in the 2018 Form 10-K. Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting.
Most important facts for investors to verify
- Whether repo funding remains available on acceptable terms and whether liquidity can withstand margin calls, given 8.17:1 leverage, short repo maturities, and BUCKLER’s 49.2% funding share.
- How much of the reported GAAP loss reflects derivative mark-to-market movements versus recurring net interest economics, and how subsequent results compare with the 1.62% reported spread.
- Whether the larger Agency portfolio and expanded share count support sustainable per-share earnings and dividends; the quarter’s common dividend was $0.19 monthly despite a GAAP loss.
- Whether interest-rate and MBS-spread outcomes differ materially from management’s model sensitivities, which rely on assumptions about rates, prepayments, and portfolio behavior.
- Developments in the JAVELIN litigation and any changes in related-party financing, management arrangements, or BUCKLER exposure.