Armour Residential REIT, Inc. — Q1 2017 Form 10-Q
Reporting period: Quarter ended March 31, 2017. Figures below are unaudited; dollar amounts are in millions unless stated otherwise. Armour is an externally managed mortgage REIT investing primarily in Agency mortgage-backed securities (MBS), financed largely with short-term repurchase agreements. Results include JAVELIN, acquired in April 2016, so the prior-year comparison does not include a full comparable period of JAVELIN operations.
Key financial results
| Metric | Q1 2017 | Q1 2016 |
|---|---|---|
| Interest income | $58.6 | $79.0 |
| Interest expense on repurchase agreements | $18.1 | $19.1 |
| Net interest income | $40.5 | $59.8 |
| Other income (loss), including derivatives | $20.9 | $(329.2) |
| Net income (loss) | $52.7 | $(279.5) |
| Net income (loss) attributable to common stockholders | $48.8 | $(283.4) |
| Basic and diluted earnings (loss) per common share | $1.33 | $(7.73) |
| Comprehensive income (loss) | $70.0 | $(89.5) |
| Common dividends declared per share | $0.57 | $0.99 |
| Net cash used in operating activities | $5.0 | $208.7 |
The company reported a 1.61% net interest rate spread, compared with 1.37% in Q1 2016. Management said the improvement was offset by a smaller average MBS portfolio, down 20.1% year over year to $9,148.7 million. The filing reports no conventional revenue or operating-margin measure.
Balance sheet, debt and liquidity
- Total assets were $8,142.4 million at March 31, 2017, versus $7,978.2 million at December 31, 2016. Stockholders’ equity was $1,137.4 million, up from $1,092.1 million.
- Repurchase-agreement borrowings were $6,514.4 million, down from $6,818.5 million. The average contractual rate was 1.17%, versus 1.07%, and the weighted-average maturity was 19 days. The reported leverage ratio was 5.73:1; it was 6.34:1 including purchased-forward TBA securities and excluding debt related to forward-settling sales.
- Cash was $194.5 million, compared with $271.8 million at year-end. Reported liquidity was $559.1 million, comprising cash and $364.6 million of unpledged Agency securities, including securities received as collateral.
- At quarter-end, the balance sheet included $649.3 million receivable for unsettled securities sales and $467.6 million payable for unsettled purchases.
Material changes and notable items
- Net interest income fell to $40.5 million from $59.8 million, reflecting lower Agency interest income and a smaller average portfolio. Asset yields rose 0.2 percentage points year over year, while repurchase-agreement expense rates rose 0.4 percentage points, according to management.
- Derivative results improved substantially: net gains were $11.5 million versus net losses of $335.2 million in Q1 2016. Results include mark-to-market changes; Armour does not use cash-flow hedge accounting, so derivative fair-value movements affect GAAP earnings.
- Agency securities at fair value declined to $6,135.1 million from $6,511.2 million at year-end. The company sold $1,387.4 million of Agency securities during the quarter and recorded an $11.2 million realized loss. Non-Agency securities rose to $1,069.4 million from $1,052.2 million, with a reported $24.3 million gain; these holdings are Level 3 fair-value assets relying on significant unobservable assumptions.
- Armour’s common dividend declined from $0.99 per share in Q1 2016 to $0.57 in Q1 2017. Estimated REIT taxable income was $4.9 million, compared with $21.1 million a year earlier; total dividends paid across common and preferred shares were $24.9 million in Q1 2017. Taxable income and GAAP earnings are different measures.
- At March 31, Agency securities represented 84.82% and Non-Agency securities 14.79% of the MBS portfolio. Agency securities had a 3.68% weighted-average coupon; Non-Agency securities had a 5.25% weighted-average coupon.
Outlook, risks and contingencies
- No quantified earnings or portfolio guidance is provided. Management stated it believed available liquidity and capital resources were sufficient for anticipated short-term needs, including investment activity, financing obligations, expenses and REIT distributions. It cautioned that additional longer-term financing could depend on market conditions and might not be available.
- The Federal Reserve raised its target federal funds range to 0.75%–1.00% on March 15, 2017. Management identified rising short-term funding costs, interest-rate and mortgage-spread changes, prepayments, credit performance, leverage and access to repo financing as material risks.
- Armour estimated that an immediate 100-basis-point rate increase would reduce projected net interest income by 6.59% and projected shareholder equity, including hedges, by 7.46%; a 25-basis-point widening in MBS spreads was estimated to reduce portfolio book value by 9.64%. These are model-based scenarios, not forecasts.
- Repo financing is short-term and collateralized. Falling MBS values or higher haircuts could trigger margin calls, require additional collateral or force asset sales. At quarter-end, the average haircut was 7.56%; Agency collateral haircuts averaged 4.72% and Non-Agency haircuts 23.82%.
- Nine putative shareholder class actions related to the JAVELIN acquisition were consolidated into one Maryland action. The court had reserved its ruling on defendants’ motion to dismiss; Armour said it could not estimate the outcome, and an adverse resolution could involve damages and substantial defense costs. The filing reports no material changes to the risk factors in the 2016 Form 10-K.
- Armour and affiliates established BUCKLER Securities, a related-party broker-dealer venture intended to support repo financing. FINRA registration was obtained in April 2017; FICC membership was pending, and full operation was expected during Q3 2017, with no assurance of success. The disclosed subordinated-loan commitments total $105 million; the filing says $25 million had been funded in April. The venture involves related-party interests and execution, regulatory and funding risks.
- Disclosure controls and procedures were reported effective as of March 31, 2017; management reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether the improved derivative result and reported GAAP profit are representative of ongoing spread income; separate recurring net interest income from fair-value and realized gains or losses.
- The leverage figures’ differing treatment of TBA positions and unsettled sales, and the company’s ability to meet margin calls using reported liquidity.
- How the lower common dividend compares with sustainable REIT taxable income and future distribution requirements.
- The valuation assumptions and sensitivity of Level 3 Non-Agency securities to defaults, loss severities, delinquencies, prepayments and discount rates.
- Developments in the JAVELIN litigation and BUCKLER’s FICC approval, remaining capital funding, related-party safeguards and actual financing benefits.