Business context and reporting period
ARMOUR Residential REIT, Inc. filed this Form 10-K for the fiscal year ended December 31, 2022. The company is an externally managed mortgage REIT investing primarily in agency mortgage-backed securities (MBS), financed mainly with short-term repurchase agreements and hedged with derivatives. Unless stated otherwise, financial amounts below are in millions of U.S. dollars.
Financial performance and position
| Metric | 2022 | 2021 |
|---|---|---|
| Interest income | $228.4 | $80.5 |
| Interest expense | $120.8 | $7.1 |
| Net interest income | $107.6 | $73.4 |
| Total other gain (loss) | $(299.7) | $(23.1) |
| Net income (loss) | $(229.9) | $15.4 |
| Comprehensive income (loss) | $(348.4) | $(56.7) |
| Net income (loss) per common share | $(2.05) | $0.05 |
| Common dividend declared per share | $1.20 | $1.20 |
- Interest spread: Average securities portfolio size, including TBA positions, rose 7.7% to $8,270.8. Average asset yield increased 0.83 percentage points and average funding cost rose 0.26 points, widening the annual net interest rate spread by 0.57 points. In Q4 2022, reported asset yield was 3.25%, cost of funds 0.66%, and net interest margin 2.59%.
- Drivers of GAAP loss: A $810.8 derivative gain was outweighed by losses on trading agency securities ($946.7) and U.S. Treasuries ($152.3), among other items. Trading agency securities had $489.3 of fair-value losses and $457.4 of realized losses on sales.
- Non-GAAP earnings: Distributable Earnings were $147.6, versus total comprehensive loss of $348.4. The company defines Distributable Earnings to exclude portfolio valuation effects; it is not a substitute for GAAP results and is not directly comparable across companies.
- Cash flow: Operating activities provided $124.1, investing activities used $3,895.0, and financing activities provided $3,532.8. Cash and cash collateral posted to counterparties ended the year at $118.1, including $87.3 of cash.
- Balance sheet and leverage: Total assets were $9,437.0, total liabilities $8,324.7, and stockholders’ equity $1,112.4, down from $1,143.6. Repurchase borrowings, net of reverse repos, were $6,463.1 versus $3,948.0. Debt-to-equity was 5.81:1 versus 3.45:1; leverage including TBA notional was 6.51:1 versus 7.39:1.
- Liquidity: Management reported $689.2 of liquidity: $87.3 cash and $601.9 of unencumbered agency and U.S. government securities, including securities received as collateral. Average repo haircut increased to 3.85% from 3.45%.
- Portfolio: At year-end, agency securities at fair value were $8,198.6 and TBA agency securities were $777.5. Agency securities had $554.4 of gross unrealized losses. Common book value per share was $5.78, down from $10.33 at year-end 2021.
- Dividends and capital: The company paid $142.4 in common dividends and $12.0 in preferred dividends. All 2022 common and preferred dividends were treated as return of capital for tax purposes. Common shares issued and outstanding increased to 162.9 million from 94.2 million, principally reflecting ATM issuance.
Material changes versus the prior comparable period
- Net interest income increased 46.7%, but the company moved from $15.4 of net income to a $229.9 net loss, and comprehensive loss widened substantially, mainly reflecting 2022 market-value and realized losses on securities.
- Repo borrowings rose 63.7%, while stockholders’ equity declined 2.7%. The portfolio mix shifted materially: agency securities fair value increased from $4,406.5 to $8,198.6, while TBA securities fell from $4,575.1 to $777.5; the company also sold its U.S. Treasury holdings during 2022.
- Derivative fair value rose to a net asset of $971.4 from $188.2. Interest rate swap notional declined to $6,350.0 from $7,210.0; the swaps’ aggregate fair-value asset was $983.7, exceeding common equity of $941.2.
- Common ATM issuance generated $475.5 net proceeds from 70.0 million shares. The filing reports average net proceeds of about 98% of recently estimated book value and $9.5 of aggregate dollar dilution.
Outlook, management commentary, risks and unusual items
- Management said it believed available liquidity and capital resources were sufficient for anticipated short-term needs, including financing obligations, investment activity and dividends. It also noted that additional financing depends on market conditions and is not assured.
- The filing describes the Federal Reserve’s 2022 rate increases and balance-sheet reduction as contributing to higher funding costs, wider mortgage spreads and lower MBS values. Key exposures include short-term funding against longer-duration assets, spread volatility, prepayments, margin calls, counterparty access and liquidity.
- BUCKLER, an affiliate in which ARMOUR owns 10.8%, provided 50.2% of year-end repo borrowings; its amount at risk was 12.9% of stockholders’ equity. This concentration creates related-party, funding and counterparty risks.
- The company’s $983.7 swap fair-value asset reflects prior rate increases and is expected to decline to zero over time; average remaining swap term was 73 months. The timing and path depend on future rates and other factors.
- ARMOUR forecast positive ordinary REIT taxable income for 2023, which management said would likely make Series C preferred dividends fully taxable as ordinary income and common dividends at least partly taxable as ordinary income. Subsequent common dividends declared were $0.10 per share for January and February 2023 and $0.08 for March 2023.
- On February 14, 2023, ARMOUR extended ACM’s management agreement through December 31, 2029. The filing estimates contractual management fees of $260.9 through 2029 based on the then-current fee base. ACM also reduced its voluntary fee waiver to $1.65 for Q1 2023 and $0.55 monthly thereafter, subject to change.
- A legacy JAVELIN merger-related class action remained unresolved; the company could not estimate its outcome. The court deferred dismissal proceedings to May 1, 2023. The filing reports no other material litigation estimate.
- Deloitte issued unqualified opinions on the financial statements and internal control over financial reporting; no critical audit matters were identified. Management reported effective disclosure controls and internal financial controls.
Important facts for investors to verify
- How much of the GAAP loss and book-value decline reflects realized losses versus unrealized marks, and how should Distributable Earnings be interpreted alongside comprehensive loss?
- Whether net interest income and funding spreads remain resilient as short-term repo rates, mortgage spreads and prepayment behavior change.
- Current liquidity, collateral headroom, repo maturities and the ability to replace or diversify BUCKLER’s 50.2% funding share under stressed markets.
- The sustainability and tax character of common dividends, given the 2022 GAAP and REIT taxable losses, return-of-capital treatment, and subsequent dividend reduction for March 2023.
- The effects of further ATM issuance, common share dilution, and the extended non-performance-based management-fee arrangement on per-share book value and returns.
- The status and potential exposure from the JAVELIN litigation and the expected evolution of the large swap fair-value asset.