Armour Residential REIT, Inc. — Q1 2015 Form 10-Q
Reporting period: Three months ended March 31, 2015. The company is an externally managed mortgage REIT investing primarily in leveraged portfolios of agency mortgage-backed securities (Agency Securities). Amounts below are in U.S. dollars; financial statement amounts are in millions unless stated otherwise.
Financial performance and position
| Metric | Q1 2015 / March 31, 2015 | Comparable period / prior year-end |
|---|---|---|
| Interest income, net of premium amortization | $99.6 million | $123.1 million in Q1 2014 |
| Interest expense; net interest income | $14.2 million; $85.4 million | $14.7 million; $108.3 million in Q1 2014 |
| Net loss; loss attributable to common stockholders | $(125.5) million; $(129.4) million | $(19.8) million; $(23.7) million in Q1 2014 |
| Basic and diluted loss per common share | $(0.37) | $(0.07) in Q1 2014 |
| Net interest margin | 1.20% | 1.82% in Q1 2014 |
| Total assets; stockholders’ equity | $15,879.8 million; $1,658.1 million | $16,285.8 million; $1,749.3 million at December 31, 2014 |
| Repurchase agreement borrowings | $13,904.8 million | $13,881.9 million at December 31, 2014 |
| Cash and reported liquidity | $473.8 million cash; $897.7 million total liquidity | Total liquidity includes $423.8 million of unpledged Agency Securities |
| Cash flows | $73.1 million operating; $(67.5) million investing; $(26.3) million financing; cash decreased $20.7 million | Operating $76.7 million; investing $(1,935.9) million; financing $1,951.6 million in Q1 2014 |
- Management reported leverage of 8.39:1 at March 31, 2015, versus 7.94:1 at year-end. The stated borrowing target is generally six to ten times stockholders’ equity.
- The portfolio was 100% Agency Securities, with a $15,050.4 million fair value and a 3.47% weighted-average coupon. Agency Securities were carried at a net premium to par; weighted-average amortized cost was 105.05% of par.
- Q1 2015 total other loss was $201.7 million, including $216.3 million of unrealized derivative losses, partly offset by $6.5 million of realized gains on Agency Security sales and $8.1 million of realized derivative gains. Total expenses were $9.1 million, including a $6.9 million management fee.
- Other comprehensive income was $83.2 million, primarily reflecting unrealized gains on Agency Securities, and comprehensive loss was $42.3 million.
- Common dividends declared were $0.12 per share in Q1, down from $0.15 in Q1 2014. Estimated Q1 REIT taxable income was $33.5 million; total dividends paid to common and preferred holders were $46.4 million. Taxable income and REIT distribution requirements are assessed annually.
Material changes and management commentary
- Net interest income fell 21.2% year over year. Management attributed the decline to a smaller average securities portfolio and narrower net interest spread: average portfolio value decreased from $15,399.957 million to $14,634.391 million, while the spread narrowed from 1.82% to 1.20%. Asset yield declined 0.47 percentage points and cost of funds increased 0.15 percentage points year over year.
- Net loss attributable to common stockholders increased to $129.4 million from $23.7 million in Q1 2014. Management cited larger unrealized derivative losses, lower net interest income, and lower realized gains on security sales. Falling interest rates contributed to derivative losses; the company reported no other-than-temporary impairment of Agency Securities.
- At March 31, derivative liabilities were $272.3 million, compared with $137.4 million at December 31, 2014. Derivative notional was approximately $12.0 billion, and derivative fair-value changes flow through earnings because the company does not use cash-flow hedge accounting.
- Repo financing had a 0.38% weighted-average contractual rate and a 4.79% weighted-average haircut. The company had 30 repo counterparties; seven each represented 5%–10% of borrowings and together represented approximately 46.91%.
- Management stated that available liquidity and expected operating cash flows should meet anticipated short-term needs, including financing obligations and distributions. It gave no quantified earnings or margin guidance. Management said it positioned the portfolio for higher rates, although rates had trended lower, and expected continued interest-rate volatility.
Outlook, risks, contingencies and unusual items
- Key exposures include short-term funding costs rising faster than returns on longer-duration assets, changing yield curves and spreads, mortgage prepayments and premium amortization, and imperfect hedging. Margin calls could require additional collateral or asset sales; repo counterparties may tighten terms or withdraw financing.
- Interest-rate sensitivity estimates for an instantaneous parallel shift showed projected net interest income changes of +8.57% for a 100-basis-point increase and +2.97% for a 100-basis-point decrease. Estimated portfolio value including derivatives changed by −0.29% and −0.79%, respectively. These are model-based estimates, not forecasts, and management cautioned that actual outcomes may differ materially.
- Further risks include changes to Fannie Mae and Freddie Mac or their conservatorships, dependence on external manager ACM, potential conflicts of interest, and maintaining REIT qualification. The filing said there were no material changes to the risk factors in the 2014 Form 10-K.
- The management agreement fee is based on gross equity raised rather than portfolio performance; the effective fee rate was 1.03% at quarter-end. The filing notes that fees may not decline when earnings decline. ACM-related arrangements and conflicts merit review.
- The company reported no pending, threatened or contemplated litigation, no material unrecognized tax benefits, and no off-balance-sheet arrangements of the described type. Disclosure controls were concluded to be effective; no material change in internal control over financial reporting was identified.
- After quarter-end, common dividends of $0.04 per share and preferred dividends of $0.17 per Series A share and $0.16 per Series B share were paid or declared for subsequent monthly dates.
Important facts for investors to verify
- Whether reported liquidity remains adequate under stressed collateral values, increased repo haircuts, or reduced counterparty availability.
- How net interest spread, prepayment speeds, premium amortization and derivative mark-to-market changes affect recurring earnings and book value.
- Whether dividend levels are supported by annual REIT taxable income and liquidity, rather than GAAP earnings alone.
- The scale and terms of ACM management and sub-management arrangements, including fee calculation and potential conflicts.
- Assumptions underlying the interest-rate sensitivity analysis and the concentration of repo funding among counterparties.