Armour Residential REIT, Inc. — Q3 2013 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2013. Armour is an externally managed REIT investing primarily in leveraged portfolios of U.S. agency mortgage-backed securities (Agency Securities); these represented 100% of its securities portfolio at quarter-end.
Financial performance and position
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Net interest income | $94.5 million | $97.5 million | $317.2 million | $228.4 million |
| Net income (loss) available to common | $(233.8) million | $54.1 million | $343.4 million | $105.6 million |
| Basic earnings (loss) per share | $(0.63) | $0.20 | $1.28 | $0.54 |
| Common dividends declared per share | $0.21 | $0.30 | $0.66 | $0.92 |
| Net interest margin | 1.24% | 1.82% | 1.33% | 1.87% |
- Q3 loss primarily reflected a $301.0 million realized loss on sales of Agency Securities, following portfolio sales amid market volatility. Net derivative losses were $49.1 million; gains on U.S. Treasury positions were $35.3 million.
- For the nine months, net income included $311.5 million of net derivative gains, largely reflecting unrealized fair-value gains. Agency-security sales generated a realized loss of $261.6 million.
- Q3 asset yield was 2.60% and cost of funds 1.36%; for the nine months they were 2.47% and 1.15%, respectively. Management cited lower asset yields and higher funding costs versus 2012 as factors in the narrower margins.
- At September 30, total assets were $17.63 billion, including $16.66 billion of Agency Securities; stockholders’ equity was $2.15 billion. Cash was $496.5 million. Nine-month operating cash flow was $300.2 million.
- Repurchase-agreement debt was $14.92 billion, down from $18.37 billion at December 31, 2012. Leverage was 6.93:1 versus 7.96:1 at year-end 2012. Management reported total liquidity of approximately $1.3 billion, including cash and unpledged Agency Securities.
- Accumulated other comprehensive loss was $590.9 million at quarter-end, versus income of $230.6 million at year-end 2012, reflecting substantial unrealized declines in Agency Securities. The filing reports an approximate $0.75-per-common-share excess of aggregate tax basis over stockholders’ equity; it does not state book value per share as a reported metric.
Material changes and capital
- In Q3, Armour sold $6.0 billion of Agency Securities at a $301.0 million realized loss to reduce exposure to volatility. Debt-to-equity leverage fell from 9.77:1 at June 30 to 6.93:1 at September 30.
- Agency Securities fair value declined to $16.66 billion from $19.10 billion at December 31, 2012. The portfolio shifted further toward fixed-rate securities: 98.4% of principal at quarter-end versus 88.6% at year-end.
- Capital raised during the first nine months included $438.5 million net from common stock and $140.9 million from preferred stock. Common shares outstanding increased to 370.9 million from 309.0 million at year-end. The company also repurchased 3.4 million common shares for $20.3 million.
- New Series B preferred shares carry a 7.875% annual dividend; Series A preferred shares carry an 8.250% annual dividend. Both rank senior to common stock.
Outlook, risks and unusual items
- Management described Q3 as a period of disruptive volatility, associated in part with uncertainty about Federal Reserve bond purchases. After the Fed maintained its purchase pace in September, markets recovered; management nevertheless expected continued volatility and said it would take a conservative approach to reinvestment, leverage and hedging until medium-term risks subsided. No specific earnings or dividend guidance was provided.
- Management said it believed liquidity and capital resources were sufficient for anticipated near-term needs, including financing obligations and dividends. This outlook depends on continued access to short-term repo funding and the ability to meet potentially frequent margin calls.
- Interest-rate, spread, prepayment and funding risks are significant. Repo financing is short-term and collateralized; a decline in Agency-security values or higher haircuts could trigger margin calls, force asset sales, raise borrowing costs or reduce liquidity. Repurchase agreements had a 0.40% weighted-average contractual rate, 39-day weighted-average maturity and 5.0% average haircut at quarter-end.
- Interest-rate swaps, swaptions and futures had $14.14 billion aggregate notional at quarter-end. Hedges covered approximately 84.4% of non-adjustable-rate mortgages. Derivatives are not designated as GAAP cash-flow hedges, so fair-value movements can cause earnings volatility and may not offset asset-value changes.
- Further risks include possible reform or winding down of Fannie Mae and Freddie Mac, changes in government support or mortgage programs, regulatory changes affecting REIT or Investment Company Act status, and conflicts or fees associated with external management. The management fee is not performance-based. The filing reports no pending, threatened or contemplated litigation and no material change to previously disclosed risk factors beyond the referenced prior-quarter filing.
- After quarter-end, the company paid a $0.05 common dividend in October and announced $0.05 monthly common dividends for November and December 2013; preferred dividends were also paid and announced for those months.
Important facts for investors to verify
- Whether reported earnings, taxable income and cash available for distributions support the common dividend: Q3 GAAP loss contrasted with estimated REIT taxable income of $3.8 million; nine-month taxable income was $181.2 million.
- How Agency-security prices, interest-rate spreads, prepayments and hedge performance affect book value, net interest margin and realized or unrealized results.
- Liquidity and repo-funding capacity, including collateral haircuts, margin-call exposure, counterparty concentration and the short maturities of borrowings.
- The effects of equity issuance and dilution, preferred dividend obligations, and the external manager’s fee structure on returns to common shareholders.
- Potential GSE, Federal Reserve and regulatory changes that could affect the portfolio’s pricing, liquidity, financing or business model.