Armour Residential REIT, Inc. — Q1 2012 Form 10-Q
Reporting period: Three months ended March 31, 2012; unaudited interim results. Armour is an externally managed REIT investing primarily in agency residential mortgage-backed securities, financed mainly through short-term repurchase agreements.
Key financial results and position
| Metric | Q1 2012 / March 31, 2012 | Comparable period / December 31, 2011 |
|---|---|---|
| Interest income | $62.8 million | $13.5 million in Q1 2011 |
| Net interest income | $55.8 million | $12.2 million in Q1 2011 |
| Net income | $65.2 million | $8.6 million in Q1 2011 |
| GAAP earnings per share | $0.48 | $0.33 in Q1 2011 |
| Dividends per share | $0.32 | $0.34 in Q1 2011 |
| Agency securities, fair value | $12.14 billion | $5.39 billion at December 31, 2011 |
| Repurchase agreements | $11.10 billion | $5.34 billion at December 31, 2011 |
| Total assets / stockholders’ equity | $12.81 billion / $1.21 billion | $6.21 billion / $626.6 million at December 31, 2011 |
| Cash / restricted cash | $264.8 million / $138.6 million | $252.4 million / $147.2 million at December 31, 2011 |
| Book value per share | $6.79 | $6.57 at December 31, 2011 |
Asset yield was 3.04%, reported cost of funds 0.81%, and net interest margin 2.23% for Q1. The separately disclosed interest expense rate on repurchase agreements was 0.34%. Operating cash flow was $35.6 million, versus $11.2 million in Q1 2011; cash increased $12.4 million during the quarter. The company reported estimated REIT taxable income of approximately $47.6 million, which differs from GAAP net income.
Material changes versus prior periods
- Net interest income rose to $55.8 million from $12.2 million year over year, primarily because equity raised since 2011 funded a substantially larger investment portfolio.
- Three follow-on offerings and equity distribution sales contributed to approximately $555.9 million of net common equity raised in Q1. Shares outstanding increased to 177.6 million from 95.4 million at year-end 2011.
- Agency securities and repurchase borrowings more than doubled from year-end. Reported leverage was approximately 9.20:1, compared with 8.52:1 at year-end, measured as borrowings to stockholders’ equity.
- Interest rate swap notional increased to $5.44 billion from $2.77 billion. Total expenses increased to $4.8 million from $1.4 million in Q1 2011, including management fees of $3.5 million versus $0.8 million.
- Net income included $6.3 million of realized gains from security sales and $17.6 million of unrealized derivative gains; derivative results can make GAAP earnings volatile. Comprehensive income was $70.5 million.
- The portfolio mix shifted toward fixed-rate securities: fixed-rate assets were 78.2% of the portfolio at March 31, versus 47.8% at year-end 2011. The quarterly dividend declined to $0.32 per share from $0.34 a year earlier.
Outlook, risks, and other notable items
- Management said it believed available equity, operating cash flow, and borrowing capacity would meet anticipated short-term liquidity needs, including investments, expenses, and distributions. It provided no quantified earnings or dividend guidance.
- The business depends on short-term, largely uncommitted repo financing against longer-term securities. Most repo balances reprice within 30 days; weighted-average maturity was 13 days. Higher haircuts, collateral declines, margin calls, lender withdrawal, or inability to refinance could pressure liquidity or force asset sales. Management reported a 4.8% weighted-average repo haircut and a 9.20:1 leverage ratio.
- Interest-rate and prepayment risk are central. Management noted that short-term funding costs may rise faster than asset yields, while higher prepayments can accelerate premium amortization and reduce yields. The portfolio’s amortized cost was 104.61% of principal.
- At March 31, the company’s modeled parallel-rate scenarios estimated that a 100-basis-point increase would reduce projected net interest income by 18.67% and portfolio value, including derivatives, by 2.63%. These are model estimates based on a static portfolio and stated assumptions, not forecasts.
- Derivatives are not designated as GAAP cash-flow hedges, so fair-value changes flow through earnings. Swap collateral requirements and imperfect hedging may add liquidity and earnings volatility.
- Management cited uncertainty around GSE reform, mortgage-market intervention, refinancing programs, regulation of mortgage-investment companies, and the continuing availability and pricing of agency securities. The company said it remained committed to agency securities while retaining charter flexibility to invest in non-agency securities.
- A $0.10-per-share cash dividend, totaling $17.8 million, was paid on April 27, 2012. The company reported no pending, threatened, or contemplated litigation and no material changes to the risk factors in its 2011 Form 10-K.
Important facts for investors to verify
- Whether the rapid equity-funded growth in assets can sustain net interest income and per-share returns, given the substantial increase in shares outstanding.
- Repo financing terms, counterparty concentration, refinancing access, haircut changes, and liquidity available for collateral calls.
- Actual versus modeled interest-rate, spread, and prepayment exposure; the effectiveness and collateral demands of the enlarged swap position.
- The composition and valuation of the agency portfolio, including premium amortization, fixed-rate concentration, and realized or unrealized gains.
- REIT taxable income, distribution requirements, and the sustainability of dividends; GAAP earnings per share should not be treated as equivalent to taxable income or distributable cash.
- Management-fee terms and related-party expense growth under the external management agreement.