ARMOUR Residential REIT, Inc. — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016. ARMOUR is a leveraged mortgage REIT managed by ACM, investing primarily in agency mortgage-backed securities (MBS). Figures below are in millions of dollars except per-share amounts and ratios.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Interest income | $58.4 | $85.6 | $202.7 | $276.9 |
| Net interest income | $41.3 | $71.2 | $148.3 | $234.4 |
| Total other income (loss) | $86.5 | $(283.4) | $(259.0) | $(355.6) |
| Expenses | $9.1 | $9.4 | $28.9 | $27.7 |
| Net income (loss) | $118.7 | $(221.6) | $(139.6) | $(149.0) |
| Net income (loss) per common share, diluted | $3.12 | $(5.18) | $(4.12) | $(3.68) |
| Common dividends declared per share | $0.66 | $0.98 | $2.36 | $2.90 |
Q3 earnings included $39.5 million of gains on Non-Agency Securities and $45.6 million of net derivative gains. For the nine-month period, derivative losses were $335.9 million, partly offset by $53.8 million of Non-Agency gains, $18.9 million of realized Agency-security gains, and a $6.5 million bargain-purchase gain from JAVELIN. Results are therefore sensitive to fair-value movements and should not be read as recurring earnings alone.
Net interest income declined 42% in Q3 and 37% year to date versus 2015. Management attributed the decline mainly to a smaller MBS portfolio and higher repurchase-agreement interest expense. The nine-month average MBS portfolio was $11.0 billion, down 21.4% from $14.0 billion. The nine-month net interest-rate spread increased to 1.39% from 1.33%; Q3 asset yield was 2.69%, cost of funds 1.25%, and net interest margin 1.44%.
Financial position, cash flow and liquidity
- At September 30, total assets were $8.86 billion, total liabilities $7.63 billion, and stockholders’ equity $1.22 billion. Cash was $401.8 million; Agency Securities were $7.04 billion and Non-Agency Securities $1.00 billion.
- Repurchase-agreement borrowings were $7.36 billion, down from $11.57 billion at December 31, 2015. The weighted average borrowing rate was 0.88%, with a 21-day weighted average maturity and 6.68% average haircut. Agency financing averaged 0.73%; Non-Agency financing averaged 2.21%.
- Reported leverage was 6.03:1; including forward-purchased TBA Agency Securities, it was 8.28:1. Liquidity was reported at $625.9 million, consisting of $401.8 million cash and $224.1 million unpledged Agency Securities, including securities received as collateral.
- Nine-month operating cash flow was negative $171.7 million, investing cash flow positive $5.18 billion, and financing cash flow negative $4.90 billion. Cash increased $111.9 million to $401.8 million. Investing cash flow included substantial Agency-security sale proceeds; financing cash flows reflected large repurchase-agreement turnover and $86.8 million of common dividends paid.
- Other comprehensive income was $232.6 million for the nine months, primarily reflecting unrealized gains on available-for-sale Agency Securities. Agency MBS fair-value changes flow through comprehensive income, while Non-Agency and interest-only security and derivative fair-value changes affect reported earnings.
Material changes, outlook and risks
- Portfolio and acquisition: ARMOUR acquired JAVELIN on April 6, 2016, for $85.2 million cash. The acquisition broadened exposure to Non-Agency MBS; at quarter-end the MBS portfolio was 86.5% Agency, 12.3% Non-Agency, and 1.2% interest-only securities. Non-Agency securities are Level 3 valuations based on management cash-flow and discount-rate assumptions.
- Dividends: Common monthly dividends declined from $0.33 per share early in 2016 to $0.22 from May onward. The filing reports subsequent $0.22 common dividends paid and declared. Preferred dividends continued at stated rates of 8.25% for Series A and 7.875% for Series B.
- Management outlook: ARMOUR said it believed available liquidity and capital were sufficient for anticipated near-term needs, including financing obligations and distributions. It provided no quantified earnings or dividend guidance and cautioned that actual results may differ materially.
- Market and funding risks: Short-term borrowing costs can rise faster than income on longer-duration MBS; prepayments can accelerate premium amortization; and interest-rate, mortgage-spread, credit, and valuation changes can reduce earnings or book value. Daily margin calls, higher haircuts, counterparty withdrawal, or inability to refinance short-term repos could force asset sales. Management’s rate sensitivity estimates show a parallel 100-basis-point increase would reduce projected net interest income 5.14% and portfolio value including derivatives 1.18%; these are model estimates, not forecasts.
- Other notable items: Nine putative class actions challenge the JAVELIN tender offer and merger, alleging fiduciary-duty and related claims. Defendants’ motion to dismiss was fully briefed; ARMOUR said it could not estimate the outcome or potential exposure. A regulatory change bars new advances or renewal of a $100 million FHLB advance maturing in December 2016. Management reported effective disclosure controls and no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether Q3 gains on Non-Agency securities and derivatives are sustainable, and how much reported earnings depend on fair-value changes.
- Current repo funding rates, maturities, haircuts, counterparty concentration, margin-call capacity, and leverage including TBA positions.
- Whether reported liquidity remains adequate under adverse rate, spread, collateral, and prepayment scenarios; confirm the assumptions behind rate-sensitivity estimates.
- Valuation assumptions and performance of the Level 3 Non-Agency portfolio, including defaults, loss severities, delinquencies, and discount rates.
- Developments in the JAVELIN litigation, the maturing FHLB advance, and the company’s ability to support common dividends from REIT taxable income and available liquidity.