Armour Residential REIT, Inc. — Q1 2013 Form 10-Q
Reporting period: Quarter ended March 31, 2013. Unaudited financial statements; dollar amounts below are in millions unless noted. Armour is an externally managed mortgage REIT whose portfolio consisted entirely of Agency residential mortgage-backed securities.
Key financial results and position
| Metric | Q1 2013 | Q1 2012 or prior period |
|---|---|---|
| Interest income | $130.6 | $62.8 |
| Net interest income | $105.2 | $55.8 |
| Other income | $5.8 | $14.2 |
| Net income | $102.3 | $65.2 |
| Net income available to common stockholders | $99.8 | $65.2 |
| Basic / diluted EPS | $0.30 / $0.29 | $0.48 / $0.48 |
| Common dividend declared per share | $0.24 | $0.32 |
| Asset yield / cost of funds / net interest margin | 2.33% / 0.98% / 1.35% | 3.04% / 0.81% / 2.23% |
| Operating cash flow | $95.0 | $35.6 |
- At March 31, assets were $27.75 billion, including $24.34 billion of Agency securities; repurchase agreements were $24.83 billion. Stockholders’ equity was $2.71 billion.
- Cash and cash equivalents were $836.5 million; cash collateral posted was $230.5 million. Repo weighted-average maturity was 36 days, contractual rate 0.43%, and haircut 4.8%.
- Leverage was approximately 9.17:1, compared with 7.96:1 at December 31, 2012. The company generally seeks leverage of six to ten times equity.
- Q1 investing cash use was $6.99 billion and financing cash provided was $6.96 billion; net cash increased $65.2 million. These cash-flow figures reflect substantial portfolio purchases and repo financing activity.
Material changes and drivers
- Net interest income rose 88% year over year as equity raises funded a larger portfolio. However, common EPS declined from $0.48 to $0.30, reflecting a much larger weighted-average share count and preferred dividends.
- The portfolio grew from $19.10 billion at year-end to $24.34 billion. Common shares outstanding increased from 309.0 million to 374.1 million.
- Q1 capital raising included approximately $438.5 million net from a common-stock offering and $141.0 million net from Series A and Series B preferred issuance.
- Higher prepayments—15.7% CPR versus 11.4% in Q1 2012—contributed to greater premium amortization. Asset yield and net interest margin contracted, while cost of funds increased.
- Net realized and unrealized derivative results were a loss of $12.8 million, compared with a gain of $7.9 million in Q1 2012. Armour reported a $198.6 million comprehensive loss, principally reflecting a $180.1 million unrealized decline in Agency securities recorded in other comprehensive income.
- Management reported no other-than-temporary impairment of Agency securities and attributed unrealized losses to market conditions, not asset credit quality.
Outlook, risks and unusual items
- No earnings or dividend guidance was provided. Management said it believed equity, operating cash flow and available borrowing capacity would meet anticipated short-term liquidity needs and support investment activity and distributions.
- Management identified interest-rate and prepayment risk as central exposures. Rising rates could increase short-term funding costs faster than asset yields and reduce asset values; falling rates may accelerate prepayments and premium amortization. The company does not hedge all exposure.
- Funding depends heavily on short-term, collateralized repurchase agreements. Falling collateral values or higher haircuts can trigger margin calls, and lenders may terminate or decline to renew financing. Management noted it could be forced to sell assets at unfavorable prices if financing or liquidity became inadequate.
- Derivative fair-value changes flow through GAAP earnings because Armour does not apply cash-flow hedge accounting, potentially increasing reported earnings volatility. Derivatives also carry basis, counterparty, collateral and margin-call risks.
- Agency securities depend on GSE guarantees; Fannie Mae and Freddie Mac remained in federal conservatorship. Potential housing-finance reform, government mortgage programs, regulatory changes and LIBOR-related developments could affect the portfolio or funding markets.
- The external manager’s fee is based on gross equity raised rather than portfolio performance and may not decline when earnings fall. Management fees were $6.6 million versus $3.5 million in Q1 2012. The company disclosed no pending litigation and no material changes to previously reported risk factors.
- After quarter-end, Armour paid a $0.07 common dividend per share and announced quarterly preferred dividends. These subsequent payments do not constitute a stated forward dividend commitment beyond those announcements.
Most important facts for investors to verify
- Whether asset yield and net interest margin can stabilize as funding costs, prepayments and premium amortization change.
- Whether the high leverage and short repo maturities remain supportable, including the availability of counterparties and liquidity to meet margin calls.
- How Agency-security fair values and book value respond to rate and spread movements; confirm assumptions behind management’s sensitivity analysis and prepayment estimates.
- Whether common dividends are supported by REIT taxable income and cash generation, considering preferred dividends and the company’s capital needs.
- The dilution and potential share supply from equity issuance and the 32.5 million warrants outstanding, exercisable at $11.00 and expiring in November 2013.