ARMOUR Residential REIT, Inc. — 2013 Form 10-K
Reporting period: Fiscal year ended December 31, 2013. The filing also reports fourth-quarter results and subsequent events through February 25, 2014. ARMOUR is an externally managed mortgage REIT investing primarily in Agency mortgage-backed securities, financed mainly with short-term repurchase agreements. Agency securities represented 100% of its securities portfolio at year-end.
Financial performance and position
| Metric | 2013 | 2012 |
|---|---|---|
| Interest income | $505.4 million | $389.0 million |
| Net interest income | $422.2 million | $327.8 million |
| Net income (loss) | $(187.0) million | $222.3 million |
| Net income (loss) available to common | $(201.3) million; $(0.55) per share | $220.3 million; $0.99 basic per share |
| Average portfolio yield / cost of funds / spread | 2.58% / 1.19% / 1.39% | 2.73% / 0.96% / 1.76% |
| Agency securities at fair value, year-end | $14.65 billion | $19.10 billion |
| Repurchase agreements, year-end | $13.15 billion | $18.37 billion |
| Stockholders’ equity, year-end | $1.90 billion | $2.31 billion |
| Debt-to-equity ratio, year-end | 6.92:1 | 7.96:1 |
| Common dividends per share | $0.81 | $1.20 |
- Operating cash flow was $370.4 million. Cash and cash equivalents declined $274.8 million to $496.5 million. Year-end reported liquidity was approximately $1.2 billion, comprising cash and cash equivalents plus $656.8 million of unpledged Agency securities; this is not equivalent to cash alone.
- Other comprehensive loss was $421.0 million, largely reflecting a $1.42 billion decline in unrealized value of available-for-sale Agency securities, partly offset by reclassifications to earnings.
- Year-end repurchase borrowing had a 45-day weighted-average maturity, a 0.42% weighted-average contractual rate and a 5.0% weighted-average haircut.
Material changes and unusual items
- Common-stockholder results swung from $220.3 million income in 2012 to a $201.3 million loss in 2013. ARMOUR attributed the decline principally to realized losses during portfolio reduction, impairment charges and changes in portfolio size and leverage.
- ARMOUR sold $15.0 billion of Agency securities in 2013, recognizing a $593.5 million realized loss. It also recorded $401.5 million of other-than-temporary impairment on certain 25- and 30-year fixed-rate securities, based on anticipated sales. The filing says the value declines reflected market conditions, not deterioration in the securities’ credit quality.
- Derivatives produced a net recognized gain of $408.7 million, including $544.6 million of unrealized gains and $135.9 million of realized losses. Because ARMOUR did not use cash-flow hedge accounting, derivative fair-value changes affected reported earnings and could contribute to volatility.
- ARMOUR reduced its portfolio and leverage amid 2013 market volatility. Fixed-rate securities rose to 98.6% of the portfolio from 88.6% at year-end 2012, while adjustable and hybrid adjustable securities fell to 1.4% from 11.4%.
- Common dividends declined during 2013, from $0.08 per share monthly early in the year to $0.05 monthly by year-end. Total 2013 dividends paid to common and preferred stockholders were $306.8 million, compared with estimated REIT taxable income of $240.4 million and $10.4 million of prior-year undistributed taxable income.
- ARMOUR raised approximately $438.6 million net from common-stock issuance and $140.9 million net from preferred-stock issuance, and repurchased 16.8 million common shares for $72.7 million.
Outlook, risks and contingencies
- Management stated it believed available liquidity and capital resources were sufficient for anticipated short-term needs, including financing obligations and distributions needed for REIT qualification. No quantified earnings, spread or dividend guidance was provided.
- Through February 25, 2014, ARMOUR had sold $5.5 billion of 25- and 30-year fixed-rate securities, had $1.3 billion of 30-year securities remaining to sell, and had purchased $3.7 billion of 15-year securities. Management intended this repositioning to reduce interest-rate risk and expected it to continue into the second quarter of 2014. It reported recovering $69.4 million of the impairment charge through that date.
- Key exposures include interest-rate and yield-curve movements, prepayment speeds, securities-price declines and margin calls. Short-term repo financing must be rolled over frequently; lenders can demand additional collateral or terminate financing. A 5.0% year-end haircut and $13.2 billion of repo debt underscore liquidity sensitivity.
- Management highlighted uncertainty around Federal Reserve asset-purchase reductions, GSE reform, and changes to the role or support of Fannie Mae and Freddie Mac. These could affect Agency-security prices, spreads, financing availability and liquidity.
- External-manager and related-party risks include fees based on gross equity raised rather than portfolio performance, overlapping responsibilities with JAVELIN, and a potential $35.4 million payment under the sub-management arrangement if terminated on the stated terms. The management agreement also provides for a termination fee in specified circumstances.
- ARMOUR reported no pending, threatened or contemplated litigation in the financial-statement notes. The independent auditor issued unqualified opinions on the financial statements and internal control over financial reporting.
Important facts for investors to verify
- Whether the 2014 portfolio repositioning, realized sale prices and impairment recovery proceeded as described, and how the remaining long-duration securities affected book value.
- Current repo borrowing, maturity concentration, collateral haircuts, counterparty access and liquidity available to meet margin calls.
- Whether net interest spread and common dividends are sustainable after the decline in average spread and reduction in the monthly dividend.
- The distinction between GAAP earnings, taxable income, cash available for distribution and dividends paid; confirm the tax treatment of distributions and use of capital-loss carryforwards.
- The economic effect of derivative positions and margin requirements, including the impact of mark-to-market accounting on reported results.
- The management-fee and termination provisions, related-party conflicts, and any changes made under the February 25, 2014 amended management agreement.