Armour Residential REIT, Inc. — Q3 2020 Form 10-Q
Reporting period: Three and nine months ended September 30, 2020. Amounts below are in U.S. dollars; financial statement amounts are generally converted from thousands to millions. ARMOUR is an externally managed mortgage REIT investing primarily in agency mortgage-backed securities (MBS), financed largely with short-term repurchase agreements and using derivatives to manage interest-rate risk.
Financial results and position
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Interest income | $25.7m | $115.9m | $147.1m | $339.1m |
| Net interest income | $22.8m | $35.6m | $87.2m | $110.3m |
| Other income (loss) | $42.7m | ($86.2m) | ($358.9m) | ($439.0m) |
| Net income (loss) | $58.4m | ($61.0m) | ($296.5m) | ($358.6m) |
| Net income (loss) available to common | $56.1m | ($64.4m) | ($304.0m) | ($370.5m) |
| Basic earnings (loss) per share | $0.87 | ($1.09) | ($4.87) | ($6.45) |
| Common dividends declared per share | $0.30 | $0.51 | $0.90 | $1.65 |
- Balance sheet, September 30: Total assets were $5.94bn, versus $13.27bn at December 31, 2019; repurchase borrowings were $4.51bn versus $11.35bn; stockholders’ equity was $892.3m versus $1.44bn.
- Leverage and liquidity: Repo debt-to-equity leverage was 5.06:1, down from 7.90:1 at year-end 2019. Reported liquidity was $570.8m, consisting of $250.9m cash and $319.9m unpledged MBS, including securities received as collateral.
- Portfolio: ARMOUR had $5.55bn of agency securities and $2.08bn of TBA agency positions at fair value. It had completed the sale of its remaining credit-risk and non-agency securities and described its portfolio as exclusively agency securities. New agency MBS purchases were classified as trading securities; legacy holdings remained available for sale.
- Margins: Q3 asset yield was 2.21%, cost of funds 0.26%, and net interest margin 1.95%, compared with a 1.31% net interest margin in Q3 2019. The filing attributes lower net interest income versus 2019 principally to a smaller average securities portfolio.
- Cash flows, nine months: Operating activities used $294.9m; investing activities provided $7.23bn; financing activities used $6.94bn. Cash and cash collateral ended at $267.6m, down $5.5m from the start of the period. Investing and financing totals reflect substantial securities and repo turnover.
- Funding: Repo agreements had a weighted-average contractual rate of 0.23% and weighted-average maturity of 20 days. BUCKLER, an affiliate in which ARMOUR owns 10%, accounted for 67% of repo borrowings.
Material changes and notable items
- ARMOUR substantially reduced its portfolio and leverage amid the COVID-19-related market disruption, prioritizing liquidity. Management reported that it continued meeting repo obligations on time.
- Q3 earnings turned positive versus the prior-year quarter, with $42.7m of other income, including $27.7m of net derivative gains and $12.1m of gains on trading agency securities. For the first nine months, other losses remained substantial, including $348.5m of derivative losses and $189.6m of losses on credit-risk and non-agency securities; these were partly offset by $138.8m of realized gains on available-for-sale agency sales.
- Management began waiving 40% of its management fee in Q2 and continued the waiver through Q3; total waived fees through September were $5.9m. Q3 total expenses after waivers were $7.1m, compared with $10.3m a year earlier.
- ARMOUR redeemed all $209.6m of its 7.875% Series B preferred stock and issued 7.00% Series C preferred stock. It also issued 5.77m common shares through its ATM program for net proceeds of $48.9m.
- Common dividends were reduced during 2020: no common dividend transactions were reported for April and May, followed by $0.09 per share in June and $0.10 monthly in July through September. The company subsequently declared $0.10 common dividends for October and November.
Outlook, risks and contingencies
- Management said it believed available liquidity and capital resources were sufficient for near-term investment, financing, operating and dividend needs. It did not provide earnings or margin guidance, and said the future financial impact of COVID-19 could not be estimated and could be material.
- Key exposures include interest-rate and mortgage-spread changes, prepayment speeds, short-term repo refinancing, collateral calls, and the risk that hedges do not offset MBS value changes. The filing’s model estimates show that a 25-basis-point increase in MBS spreads could reduce projected shareholder equity by 10.10% at September 30, 2020; actual outcomes may differ materially.
- Repo financing is short-term and collateralized; falling collateral values can prompt margin calls or forced sales. Certain ISDA counterparties granted waivers for equity-reduction events that otherwise could have triggered default or termination provisions. BUCKLER’s 67% share of repo borrowings creates funding concentration and related-party exposure.
- ARMOUR cited uncertainty about the pandemic, Federal Reserve policy, LIBOR’s expected discontinuation and transition to SOFR, and the future of Fannie Mae and Freddie Mac. It also noted that the 2020 nine-month estimated REIT taxable result was a $57.7m loss; REIT distribution requirements are determined annually.
- Nine putative class actions relating to the 2016 JAVELIN tender offer and merger remain unresolved. ARMOUR said it could not estimate the outcome; an adverse result could involve damages and defense costs.
Important facts for investors to verify
- Whether reported liquidity, unpledged collateral and lender access remain adequate against repo margin calls and the short average financing maturity.
- How much recurring earnings and dividend capacity depend on net interest income versus realized and mark-to-market gains or losses on securities and derivatives.
- The sustainability of the reduced common dividend, considering taxable income, cash flows, portfolio size and REIT distribution requirements.
- The extent of financing concentration with BUCKLER and the terms, waivers and potential triggers in repo and derivative agreements.
- Developments in the JAVELIN litigation, COVID-19 effects, and the agency and mortgage-market risks identified by management.