ARMOUR Residential REIT, Inc. — 2019 Form 10-K
Reporting period: Fiscal year ended December 31, 2019. Unless stated otherwise, dollar figures below are in millions; the filing presents financial statements in thousands. ARMOUR is an externally managed mortgage REIT investing mainly in Agency mortgage-backed securities, funded largely with short-term repurchase agreements and using derivatives to manage interest-rate exposure.
Financial performance and position
| Metric | 2019 | 2018 |
|---|---|---|
| Interest income | $439.6 | $283.1 |
| Net interest income | $151.3 | $128.9 |
| Other income (loss), including derivatives | $(362.8) | $(197.9) |
| Net income (loss) | $(249.9) | $(106.0) |
| Net loss per common share | $(4.59) | $(2.92) |
| Comprehensive income (loss) | $149.4 | $(129.7) |
| Total assets at year-end | $13,272.4 | $8,464.6 |
| Repurchase-agreement debt at year-end | $11,354.5 | $7,037.7 |
| Stockholders’ equity at year-end | $1,436.7 | $1,125.3 |
- Interest spread: Company-reported average portfolio yield was 3.63%, average cost of funds 2.19%, and interest-rate spread 1.44%, versus 3.30%, 1.70%, and 1.60%, respectively, in 2018. Average securities portfolio size grew 30.3% to $12,461.4.
- Leverage and liquidity: Year-end debt-to-equity leverage was 7.90:1, up from 6.25:1. Reported liquidity was $648.7, comprising $181.4 cash and $467.3 unpledged MBS. Average repo haircut was 5.16%, compared with 5.48% in 2018.
- Cash flows: Operating activities used $40.7; investing activities used $4,389.8; financing activities provided $4,471.5. Cash and cash collateral together increased $41.0 during the year. Cash interest paid was $425.7.
- Distributions: Common dividends paid were $124.5 and preferred dividends $16.0. Common dividends declared were $2.16 per share, down from $2.28 in 2018. An estimated 56.8% of 2019 common dividends represented non-taxable return of capital. Estimated REIT taxable income was $69.4.
Changes and notable developments
- Net interest income increased by $22.4, as the larger portfolio and higher asset yield more than offset increased funding costs; the spread narrowed year over year.
- The larger net loss primarily reflected derivative losses, which rose to $350.1 from $1.8 in 2018. Agency-security sales generated a $9.6 realized gain, compared with a $153.0 realized loss in 2018. No Agency-security OTTI was recognized in 2019.
- Despite the GAAP net loss, comprehensive income was $149.4, chiefly reflecting $409.0 of unrealized gains on available-for-sale Agency securities recorded in other comprehensive income.
- Agency securities were 93.1% of non-TBA securities at year-end; their fair value was $11,941.8. The company also reported $883.6 of Credit Risk and Non-Agency securities and $1,006.3 of long TBA positions by fair value.
- Average portfolio CPR rose to 10.41% for 2019 from 5.96% in 2018; management reported a fourth-quarter average CPR of 17.1%, versus 3.9% in the first quarter. Management attributed the late-year increase to the lagged effect of refinancing activity after the third-quarter mortgage-rate decline.
- The company redeemed its Series A preferred stock in July and issued common and Series B preferred shares during 2019. Common shares outstanding rose to 58.877 million at year-end from 43.702 million.
Outlook, risks, and contingencies
- No specific earnings, spread, or dividend guidance is provided. Management said it believed available liquidity, operating cash flow, and portfolio-adjustment capacity would meet anticipated short-term requirements, including financing, investment activity, expenses, and distributions. It cautioned that future dividends remain at the Board’s discretion.
- Management described fourth-quarter funding markets as liquid and said the portfolio was financed continuously as planned. Average repo financing cost was 2.14% in Q4, versus 2.55% in Q3; the Federal Reserve lowered its target range to 1.50%–1.75% in October 2019.
- Key exposures include interest-rate and mortgage-spread movements, prepayments, short-term refinancing and margin calls, counterparty concentration, and the potential mismatch between long-lived assets and short-term repo funding. BUCKLER accounted for 45.0% of repo borrowings at year-end, and its amount at risk was 14.8% of equity.
- In the company’s modeled scenarios, an instantaneous +100 basis-point rate shock was estimated to reduce net interest income 16.52% and shareholders’ equity 14.77%; a +25 basis-point mortgage-spread shock was estimated to reduce equity 11.64%. These are model estimates, not forecasts, and assume specified market conditions.
- ARMOUR relies on the Section 3(c)(5)(C) exclusion from Investment Company Act registration and must maintain REIT qualification. Failure to meet applicable requirements could constrain operations, force asset sales, or create tax and financing consequences.
- Nine putative class-action suits relate to the 2016 JAVELIN tender offer and merger. The court deferred the consolidated matter for six months in September 2019; the company said it could not estimate the outcome. Potential damages and defense costs are not quantified.
- Subsequent events: ARMOUR issued 7.00% Series C preferred shares in January 2020, with gross proceeds of approximately $86.3 million, and announced redemption of all outstanding Series B preferred shares effective February 27, 2020. The filing also reports subsequent Series C sales and common dividends of $0.17 per share for February and March 2020.
- The auditor issued unqualified opinions on the financial statements and internal control over financial reporting. The audit identified securities valuation and management’s intent-to-sell assessment for impairment as a critical audit matter; it was not a modified audit opinion.
Important facts for investors to verify
- Whether derivative results and GAAP earnings are representative of underlying portfolio economics; reconcile derivative losses with available-for-sale gains recorded in equity.
- Whether the 7.90:1 leverage and $648.7 million of reported liquidity provide adequate capacity for repo maturities, collateral calls, and refinancing under stressed markets.
- The durability of the 1.44% annual spread amid higher funding costs, faster prepayments, and the company’s portfolio expansion.
- Dividend sustainability and the extent to which distributions are supported by taxable income, cash generation, or return of capital.
- BUCKLER’s financing role and concentration, related-party arrangements and management fees, and the funding and capital effects of the Series B redemption and Series C issuance.
- Developments in the JAVELIN litigation, GSE policy, and the transition away from LIBOR, which the company said could affect portfolio liquidity and valuation.