Armour Residential REIT, Inc. quarterly report, Q2 FY2023

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ARMOUR Residential REIT, Inc. — Q2 2023 Form 10-Q

Reporting period: Three and six months ended June 30, 2023. Amounts are in U.S. dollars; financial statement amounts are in thousands unless otherwise stated. ARMOUR is an externally managed mortgage REIT whose portfolio is primarily Agency mortgage-backed securities (MBS), financed largely with short-term repurchase agreements.

Key financial results and position

  • Q2 net income: $43.0 million, compared with a $58.6 million net loss in Q2 2022. Net income available to common stockholders was $40.0 million, or $0.20 per diluted share, versus a $61.6 million loss, or $0.58 per share.
  • First-half net income: $11.6 million versus a $125.0 million net loss in the first half of 2022; common-stockholder earnings were $5.6 million, or $0.03 per diluted share, versus a $131.0 million loss, or $1.29 per share.
  • Net interest income: Q2 was $5.8 million, down from $35.4 million a year earlier; first-half net interest income was $17.8 million versus $66.4 million. Q2 interest income rose to $134.8 million from $48.4 million, but interest expense increased to $129.1 million from $13.0 million.
  • Other income: Q2 other income was $48.5 million, versus an $84.6 million loss in Q2 2022. It included a $157.7 million trading-MBS loss and a $194.2 million derivative gain. First-half other income was $15.1 million, compared with a $172.8 million loss.
  • Costs and distributions: Q2 expenses after management-fee waivers were $11.3 million, up from $9.4 million. Common dividends declared were $0.24 per share in Q2 and $0.52 for the first half, compared with $0.30 and $0.60, respectively, in 2022.
  • Assets, debt and equity: At June 30, Agency securities were $11.18 billion, repurchase borrowings net were $9.12 billion, and stockholders’ equity was $1.28 billion. Repurchase debt-to-equity was 7.11:1, versus 5.81:1 at year-end 2022; leverage including TBA positions was 7.19:1.
  • Liquidity and cash flow: Management reported $644.4 million of liquidity, comprising $163.7 million cash and $480.7 million of unencumbered Agency and U.S. government securities. First-half operating activities provided $45.3 million; cash and cash collateral increased by $98.1 million.

Changes versus comparable periods

  • The larger average securities portfolio—up 38.2% year over year in the first half—supported higher interest income, but rising funding costs more than offset that benefit. Management reported Q2 asset yield of 4.24%, net cost of funds of 2.49%, and net interest margin of 1.75%, down from 1.97% in Q1 2023.
  • The portfolio expanded: Agency securities fair value rose from $8.20 billion at December 31, 2022 to $11.18 billion at June 30, 2023. Repurchase borrowings also increased, from $6.46 billion to $9.12 billion.
  • ARMOUR sold its remaining available-for-sale securities in Q1 and classified its Agency MBS portfolio as trading. Fair-value changes in both securities and derivatives now flow through earnings, contributing to reported earnings volatility.
  • Common shares outstanding increased from 162.9 million at year-end 2022 to 206.8 million at June 30, 2023, primarily reflecting ATM issuance. First-half issuance generated $258.7 million net proceeds.

Outlook, risks and notable items

  • Management said it expects current cash flow, portfolio adjustments and borrowing arrangements to meet anticipated short-term liquidity needs, including financing obligations and distributions. There is no specific earnings or dividend guidance in the filing.
  • Management forecast positive 2023 ordinary REIT taxable income; it expected Series C preferred dividends to be fully taxable as ordinary income and common dividends to be partly taxable as ordinary income.
  • Interest-rate, mortgage-spread, prepayment and liquidity risks are central. Short-term repo funding costs may rise faster than yields on longer-term fixed-rate MBS; falling MBS values can trigger margin calls or forced sales. At June 30, 48.4% of repo borrowings were with BUCKLER, an affiliate in which ARMOUR owns 10.8%.
  • ARMOUR’s modeled sensitivity to an instantaneous 100-basis-point rate increase indicated a 14.59% decline in projected shareholder equity; a 25-basis-point widening in MBS spreads indicated an 11.93% equity decline. These estimates rely on assumptions and may not predict actual outcomes.
  • On July 26, 2023, ARMOUR established a new common-stock ATM program for up to 75 million shares. In July, it also sold 21.5 million shares under the prior program for $109.3 million net; the prior program was then fully utilized. These offerings may dilute existing holders.
  • The management agreement runs through December 31, 2029. Contractual management-fee commitments were $258.3 million as of June 30, 2023, before any fee waivers. The agreement is externally managed and fees are not based on asset performance.
  • The filing describes longstanding putative class-action litigation related to the 2016 JAVELIN transaction. ARMOUR says it cannot estimate the outcome; it intends to defend the claims. The court had not taken further action as described in the filing.

Important facts for investors to verify

  • Whether MBS yields and portfolio returns can keep pace with short-term funding costs, and how net interest margin and book value respond to rates and mortgage spreads.
  • Repo financing availability, collateral haircuts, margin requirements, refinancing terms and concentration with BUCKLER and other counterparties.
  • Actual ATM share issuance, associated dilution, and how proceeds are invested relative to per-share value and distributions.
  • Dividend sustainability relative to REIT taxable income and cash needs; GAAP earnings and taxable income differ materially.
  • Developments in the JAVELIN litigation, the BUCKLER loan commitment of up to $200 million, and potential conflicts or costs under the long-term management agreement.