UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the Quarterly Period Ended March 31, 2020
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the transition period from to
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of incorporation or organization) | (Commission File Number) | (I.R.S. Employer Identification No.) |
(Address of principal executive offices)(zip code)
(772 ) 617-4340
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class | Trading symbols | Name of Exchange on which registered | ||
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer" "smaller reporting company" and "emerging growth company" in Rule 12b-2 of the Exchange Act.
If an emerging growth company, indicate by a check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
The number of outstanding shares of the Registrant’s common stock as of April 30, 2020 was 64,586,296 .
ARMOUR Residential REIT, Inc.
TABLE OF CONTENTS
1
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
ARMOUR Residential REIT, Inc.
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(in thousands, except per share)
March 31, 2020 | December 31, 2019 | |||||||
Assets | ||||||||
Cash | $ | $ | ||||||
Cash collateral posted to counterparties | ||||||||
Investments in securities, at fair value | ||||||||
Agency Securities (including pledged securities of $2,764,806 at March 31, 2020 and $11,188,502 at December 31, 2019, net of allowance for credit losses of $1,012 at March 31, 2020) | ||||||||
Credit Risk and Non-Agency Securities (including pledged securities of $761,537 at March 31, 2020 and $810,549 at December 31, 2019) | ||||||||
Receivable for unsettled sales (including pledged securities of $220,543 at March 31, 2020) | ||||||||
Derivatives, at fair value | ||||||||
Accrued interest receivable | ||||||||
Prepaid and other | ||||||||
Subordinated loan to BUCKLER | ||||||||
Total Assets | $ | $ | ||||||
Liabilities and Stockholders’ Equity | ||||||||
Liabilities: | ||||||||
Repurchase agreements | $ | $ | ||||||
Cash collateral posted by counterparties | ||||||||
Payable for unsettled purchases | ||||||||
Derivatives, at fair value | ||||||||
Accrued interest payable- repurchase agreements | ||||||||
Accounts payable and other accrued expenses | ||||||||
Total Liabilities | $ | $ | ||||||
Commitments and contingencies (Note 9) | ||||||||
Stockholders’ Equity: | ||||||||
Preferred stock, $0.001 par value, 50,000 shares authorized; | ||||||||
7.875% Series B Cumulative Preferred Stock; 8,383 shares issued and outstanding ($209,583 aggregate liquidation preference) at December 31, 2019 | ||||||||
7.00% Series C Cumulative Preferred Stock; 5,303 shares issued and outstanding ($132,588 aggregate liquidation preference) at March 31, 2020 | ||||||||
Common stock, $0.001 par value, 125,000 shares authorized, 58,881 and 58,877 shares issued and outstanding at March 31, 2020 and December 31, 2019, respectively | ||||||||
Additional paid-in capital | ||||||||
Accumulated deficit | ( | ) | ( | ) | ||||
Accumulated other comprehensive income | ||||||||
Total Stockholders’ Equity | $ | $ | ||||||
Total Liabilities and Stockholders’ Equity | $ | $ | ||||||
See financial statement notes (unaudited).
2
ARMOUR Residential REIT, Inc.
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(in thousands, except per share)
For the Three Months Ended March 31, | ||||||||
2020 | 2019 | |||||||
Interest Income: | ||||||||
Agency Securities, net of amortization of premium and fees | $ | $ | ||||||
Credit Risk and Non-Agency Securities, including discount accretion | ||||||||
Interest-Only Securities | ||||||||
U.S. Treasury Securities | ||||||||
BUCKLER Subordinated loan | ||||||||
Total Interest Income | $ | $ | ||||||
Interest expense- repurchase agreements | ( | ) | ( | ) | ||||
Net Interest Income | $ | $ | ||||||
Other Income (Loss): | ||||||||
Realized gain (loss) on sale of Agency Securities (reclassified from Other comprehensive income (loss)) | ( | ) | ||||||
Credit loss expense | ( | ) | ||||||
Gain (loss) on Credit Risk and Non-Agency Securities | ( | ) | ||||||
Loss on Interest-Only Securities | ( | ) | ||||||
Gain (loss) on U.S. Treasury Securities | ( | ) | ||||||
Subtotal | $ | ( | ) | $ | ( | ) | ||
Realized loss on derivatives (1) | ( | ) | ( | ) | ||||
Unrealized loss on derivatives | ( | ) | ( | ) | ||||
Subtotal | $ | ( | ) | $ | ( | ) | ||
Total Other Loss | $ | ( | ) | $ | ( | ) | ||
Expenses: | ||||||||
Management fees | ||||||||
Professional fees | ||||||||
Insurance | ||||||||
Compensation | ||||||||
Other | ( | ) | ||||||
Total Expenses | $ | $ | ||||||
Net Loss | $ | ( | ) | $ | ( | ) | ||
Dividends on preferred stock | ( | ) | ( | ) | ||||
Net Loss related to common stockholders | $ | ( | ) | $ | ( | ) | ||
Net Loss per share related to common stockholders (Note 12): | ||||||||
Basic | $ | ( | ) | $ | ( | ) | ||
Diluted | $ | ( | ) | $ | ( | ) | ||
Dividends declared per common share | $ | $ | ||||||
Weighted average common shares outstanding: | ||||||||
Basic | ||||||||
Diluted | ||||||||
(1) Interest expense related to our interest rate swap contracts is recorded in realized loss on derivatives on the consolidated statements of operations. For additional information, see financial statement Note 8.
See financial statement notes (unaudited).
3
ARMOUR Residential REIT, Inc.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (UNAUDITED)
(in thousands)
For the Three Months Ended March 31, | ||||||||
2020 | 2019 | |||||||
Net Loss | $ | ( | ) | $ | ( | ) | ||
Other comprehensive income (loss): | ||||||||
Reclassification adjustment for realized (gain) loss on sale of available for sale Agency Securities | ( | ) | ||||||
Reclassification adjustment for credit loss expense on available for sale Agency Securities | ||||||||
Net unrealized gain (loss) on available for sale Agency Securities | ( | ) | ||||||
Other comprehensive income (loss) | $ | ( | ) | $ | ||||
Comprehensive Income (Loss) | $ | ( | ) | $ | ||||
See financial statement notes (unaudited).
4
ARMOUR Residential REIT, Inc.
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY (UNAUDITED)
(in thousands)
Preferred Stock | Common Stock | |||||||||||||||||||||||||||||||||||
7.875% Series B | 7.00% Series C | |||||||||||||||||||||||||||||||||||
Shares | Par | Shares | Par | Shares | Par | Total Additional Paid-in Capital | Accumulated Deficit | Accumulated Other Comprehensive Income (Loss) | Total | |||||||||||||||||||||||||||
Balance, December 31, 2019 | $ | $ | $ | $ | $ | ( | ) | $ | $ | |||||||||||||||||||||||||||
Series B Preferred dividends | — | — | — | — | — | — | — | ( | ) | — | ( | ) | ||||||||||||||||||||||||
Series C Preferred dividends | — | — | — | — | — | — | — | ( | ) | — | ( | ) | ||||||||||||||||||||||||
Common stock dividends | — | — | — | — | — | — | — | ( | ) | — | ( | ) | ||||||||||||||||||||||||
Series B Preferred stock, called for redemption | ( | ) | ( | ) | — | — | — | — | ( | ) | — | — | ( | ) | ||||||||||||||||||||||
Issuance of Series C Preferred stock, net of expenses | — | — | — | — | — | — | ||||||||||||||||||||||||||||||
Stock based compensation, net of withholding requirements | — | — | — | — | — | — | ||||||||||||||||||||||||||||||
Common stock repurchased, net | — | — | — | — | ( | ) | — | ( | ) | — | — | ( | ) | |||||||||||||||||||||||
Net Loss | — | — | — | — | — | — | — | ( | ) | — | ( | ) | ||||||||||||||||||||||||
Other comprehensive loss | — | — | — | — | — | — | — | — | ( | ) | ( | ) | ||||||||||||||||||||||||
Balance, March 31, 2020 | $ | $ | $ | $ | $ | ( | ) | $ | $ | |||||||||||||||||||||||||||
See financial statement notes (unaudited).
5
ARMOUR Residential REIT, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(in thousands)
For the Three Months Ended March 31, | ||||||||
2020 | 2019 | |||||||
Cash Flows From Operating Activities: | ||||||||
Net Loss | $ | ( | ) | $ | ( | ) | ||
Adjustments to reconcile net income (loss) to net cash and cash collateral posted to counterparties provided by (used in) operating activities: | ||||||||
Net amortization of premium on Agency Securities | ||||||||
Accretion of net discount on Credit Risk and Non-Agency Securities | ( | ) | ( | ) | ||||
Net amortization of Interest-Only Securities | ||||||||
Net amortization of U.S. Treasury Securities | ( | ) | ||||||
Realized (gain) loss on sale of Agency Securities | ( | ) | ||||||
Credit loss expense | ||||||||
(Gain) loss on Credit Risk and Non-Agency Securities | ( | ) | ||||||
Loss on Interest-Only Securities | ||||||||
(Gain) loss on U.S. Treasury Securities | ( | ) | ||||||
Stock based compensation | ||||||||
Changes in operating assets and liabilities: | ||||||||
Increase (decrease) in accrued interest receivable | ( | ) | ||||||
Increase in prepaid and other assets | ||||||||
Change in derivatives, at fair value | ||||||||
Increase (Decrease) in accrued interest payable- repurchase agreements | ( | ) | ||||||
Increase in accounts payable and other accrued expenses | ||||||||
Net cash and cash collateral posted to counterparties used in operating activities | $ | ( | ) | $ | ( | ) | ||
Cash Flows From Investing Activities: | ||||||||
Purchases of Agency Securities | ( | ) | ( | ) | ||||
Purchases of Credit Risk and Non-Agency Securities | ( | ) | ||||||
Purchases of U.S. Treasury Securities | ( | ) | ( | ) | ||||
Principal repayments of Agency Securities | ||||||||
Principal repayments of Credit Risk and Non-Agency Securities | ||||||||
Proceeds from sales of Agency Securities | ||||||||
Proceeds from sales of Credit Risk and Non-Agency Securities | ||||||||
Proceeds from sales of U.S. Treasury Securities | ||||||||
(Decrease) increase in cash collateral posted by counterparties | ( | ) | ||||||
Net cash and cash collateral posted to counterparties provided by (used in) investing activities | $ | $ | ( | ) | ||||
(Continued) | ||||||||
6
ARMOUR Residential REIT, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(in thousands)
Cash Flows From Financing Activities: | ||||||||
Redemption of Series B Preferred stock, net of expenses | ( | ) | ||||||
Issuance of Series C Preferred stock, net of expenses | ||||||||
Issuance of common stock, net of expenses | ||||||||
Proceeds from repurchase agreements | ||||||||
Principal repayments on repurchase agreements | ( | ) | ( | ) | ||||
Series A Preferred stock dividends paid | ( | ) | ||||||
Series B Preferred stock dividends paid | ( | ) | ( | ) | ||||
Series C Preferred stock dividends paid | ( | ) | ||||||
Common stock dividends paid | ( | ) | ( | ) | ||||
Common stock repurchased, net | ( | ) | ||||||
Net cash and cash collateral posted to counterparties provided by (used in) financing activities | $ | ( | ) | $ | ||||
Net Increase (decrease) in cash and cash collateral posted to counterparties | ( | ) | ||||||
Cash and cash collateral posted to counterparties - beginning of period | ||||||||
Cash and cash collateral posted to counterparties - end of period | $ | |||||||
Supplemental Disclosure: | ||||||||
Cash paid during the period for interest | $ | |||||||
Non-Cash Investing Activities: | ||||||||
Receivable for unsettled sales | $ | |||||||
Payable for unsettled purchases | $ | |||||||
Net unrealized gain (loss) on available for sale Agency Securities | $ | ( | ) | |||||
See financial statement notes (unaudited).
7
ARMOUR Residential REIT, Inc.
FINANCIAL STATEMENT NOTES (UNAUDITED)
(in thousands, except per share)
Note 1 - Organization and Nature of Business Operations
References to "we," "us," "our," or the "Company" are to ARMOUR Residential REIT, Inc. ("ARMOUR") and its subsidiaries. References to "ACM" are to ARMOUR Capital Management LP, a Delaware limited partnership. ARMOUR owns a 10 % equity interest in BUCKLER Securities, LLC ("BUCKLER"). BUCKLER is a Delaware limited liability company and a FINRA-regulated broker-dealer, controlled by ACM and certain executive officers of ARMOUR. Refer to the Glossary of Terms for definitions of capitalized terms and abbreviations used in this report.
ARMOUR is an externally managed Maryland corporation incorporated in 2008. The Company is managed by ACM, an investment advisor registered with the Securities and Exchange Commission (the "SEC"), (see Note 9 - Commitments and Contingencies and Note 15 - Related Party Transactions for additional discussion). We have elected to be taxed as a real estate investment trust ("REIT") under the Internal Revenue Code of 1986, as amended (the "Code"). Our qualification as a REIT depends on our ability to meet, on a continuing basis, various complex requirements under the Code relating to, among other things, the sources of our gross income, the composition and values of our assets, our distribution levels and the concentration of ownership of our capital stock. We believe that we are organized in conformity with the requirements for qualification as a REIT under the Code and our manner of operations enables us to meet the requirements for taxation as a REIT for federal income tax purposes. As a REIT, we will generally not be subject to federal income tax on the REIT taxable income that we currently distribute to our stockholders. If we fail to qualify as a REIT in any taxable year and do not qualify for certain statutory relief provisions, we will be subject to federal income tax at regular corporate rates. Even if we qualify as a REIT for U.S. federal income tax purposes, we may still be subject to some federal, state and local taxes on our income.
Note 2 - Basis of Presentation and Consolidation
The unaudited consolidated financial statements include the accounts of ARMOUR Residential REIT, Inc. and its subsidiaries. All intercompany accounts and transactions have been eliminated. The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates affecting the accompanying condensed consolidated financial statements include the valuation of MBS, including an assessment of the allowance for credit losses, and derivative instruments.
8
ARMOUR Residential REIT, Inc.
FINANCIAL STATEMENT NOTES (UNAUDITED)
(in thousands, except per share)
Note 3 - Summary of Significant Accounting Policies
Cash
Cash includes cash on deposit with financial institutions. We may maintain deposits in federally insured financial institutions in excess of federally insured limits. However, management believes we are not exposed to significant credit risk due to the financial position and creditworthiness of the depository institutions in which those deposits are held.
Cash Collateral Posted To/By Counterparties
Cash collateral posted to/by counterparties represents cash posted by us to counterparties or posted by counterparties to us as collateral. Cash collateral posted to/by counterparties may include collateral for interest rate swap contracts (including swaptions and basis swap contracts), and repurchase agreements on our MBS and our Agency Securities purchased or sold on a to-be-announced basis ("TBA Agency Securities").
Investments in Securities, at Fair Value
Our investments in securities are generally classified as either available for sale or trading securities. Management determines the appropriate classifications of the securities at the time they are acquired and evaluates the appropriateness of such classifications at each balance sheet date.
Available for Sale Securities represent investments that we intend to hold for extended periods of time and are reported at their estimated fair values with unrealized gains and losses excluded from earnings and reported as part of the consolidated statements of comprehensive income (loss).
Trading Securities are reported at their estimated fair values with gains and losses included in Other Income (Loss) as a component of the consolidated statements of operations.
Receivables and Payables for Unsettled Sales and Purchases
We account for purchases and sales of securities on the trade date, including purchases and sales for forward settlement. Receivables and payables for unsettled trades represent the agreed trade price multiplied by the outstanding balance of the securities at the balance sheet date.
Accrued Interest Receivable and Payable
Accrued interest receivable includes interest accrued between payment dates on securities and interest on unsettled sales of securities. Accrued interest payable includes interest on unsettled purchases of securities, interest on repurchase agreements and may, at certain times, contain interest payable on U.S. Treasury Securities sold short.
Repurchase Agreements
We finance the acquisition of the majority of our MBS through the use of repurchase agreements. Our repurchase agreements are secured by our MBS and bear interest rates that have historically moved in close relationship to the Federal Funds Rate and short-term London Interbank Offered Rate ("LIBOR"). Under these repurchase agreements, we sell MBS to a lender and agree to repurchase the same MBS in the future for a price that is higher than the original sales price. The difference between the sales price that we receive and the repurchase price that we pay represents interest paid to the lender, which accrues over the life of the repurchase agreement. A repurchase agreement operates as a financing arrangement under which we pledge our MBS as collateral to secure a loan which is equal in value to a specified percentage of the estimated fair value of the pledged collateral. We retain beneficial ownership of the pledged collateral. At the maturity of a repurchase agreement, we are required to repay the loan and concurrently receive back our pledged collateral from the lender or, with the consent of the lender, we may renew such agreement at the then prevailing interest rate. The repurchase agreements may require us to pledge additional assets to the lender in the event the estimated fair value of the existing pledged collateral declines.
9
ARMOUR Residential REIT, Inc.
FINANCIAL STATEMENT NOTES (UNAUDITED)
(in thousands, except per share)
In addition to the repurchase agreement financing discussed above, at certain times we have entered into reverse repurchase agreements with certain of our repurchase agreement counterparties. Under a typical reverse repurchase agreement, we purchase U.S. Treasury Securities from a borrower in exchange for cash and agree to sell the same securities in the future in exchange for a price that is higher than the original purchase price. The difference between the purchase price originally paid and the sale price represents interest received from the borrower. Reverse repurchase agreement receivables and repurchase agreement liabilities are presented net when they meet certain criteria, including being with the same counterparty, being governed by the same master repurchase agreement ("MRA"), settlement through the same brokerage or clearing account and maturing on the same day. We did not have any reverse repurchase agreements outstanding at March 31, 2020 and December 31, 2019.
Derivatives, at Fair Value
We recognize all derivatives individually as either assets or liabilities at fair value on our consolidated balance sheets. All changes in the fair values of our derivatives are reflected in our consolidated statements of operations. We designate derivatives as hedges for tax purposes and any unrealized derivative gains or losses would not affect our distributable net taxable income. These transactions include interest rate swap contracts, interest rate swaptions and basis swap contracts.
We also may utilize forward contracts for the purchase or sale of TBA Agency Securities. We account for TBA Agency Securities as derivative instruments if it is reasonably possible that we will not take or make physical delivery of the Agency Security upon settlement of the contract. We account for TBA dollar roll transactions as a series of derivative transactions. We may also purchase and sell TBA Agency Securities as a means of investing in and financing Agency Securities (thereby increasing our “at risk” leverage) or as a means of disposing of or reducing our exposure to Agency Securities (thereby reducing our “at risk” leverage). We agree to purchase or sell, for future delivery, Agency Securities with certain principal and interest terms and certain types of collateral, but the particular Agency Securities to be delivered are not identified until shortly before the TBA settlement date. We may also choose, prior to settlement, to move the settlement of these securities out to a later date by entering into an offsetting short or long position (referred to as a “pair off”), net settling the paired off positions for cash, and simultaneously purchasing or selling a similar TBA Agency Security for a later settlement date. This transaction is commonly referred to as a “dollar roll.” When it is reasonably possible that we will pair off a TBA Agency Security, we account for that contract as a derivative.
Impairment of Assets
We assess impairment of available for sale securities at least on a quarterly basis and more frequently when economic or market concerns warrant such evaluation. We consider an impairment if we (1) intend to sell the available for sale securities, or (2) believe it is more likely than not that we will be required to sell the securities before recovery (for example, because of liquidity requirements or contractual obligations) and a credit impairment exists where fair value is greater than amortized cost. Impairment losses recognized establish a new cost basis for the related available for sale securities.
Revenue Recognition
Available for Sale Securities - Interest income is earned and recognized on Agency Securities based on their unpaid principal amounts and their contractual terms. Recognition of interest income commences on the settlement date of the purchase transaction and continues through the settlement date of the sale transaction. Premiums and discounts associated with the purchase of Multi-Family MBS, which are generally not subject to prepayment, are amortized or accreted into interest income over the contractual lives of the securities using a level yield method. Premiums and discounts associated with the purchase of other Agency Securities are amortized or accreted into interest income over the actual lives of the securities, reflecting actual prepayments as they occur. Purchase and sale transactions (including TBA Agency Securities) are recorded on the trade date to the extent it is probable that we will take or make timely physical delivery of the related securities. Gains or losses realized from the sale of securities are reclassified into income from other comprehensive income and are determined using the specific identification method.
10
ARMOUR Residential REIT, Inc.
FINANCIAL STATEMENT NOTES (UNAUDITED)
(in thousands, except per share)
Trading Securities - Interest income on Credit Risk and Non-Agency Securities and Interest-Only Securities is recognized using the effective yield method over the life of the securities based on the future cash flows expected to be received. Future cash flow projections and related effective yields are determined for each security and updated quarterly. Impairment losses establish a new cost basis in the security for purposes of calculating effective yields, recognized when the fair value of a security is less than its cost basis and there has been an adverse change in the future cash flows expected to be received. Other changes in future cash flows expected to be received are recognized prospectively over the remaining life of the security. Interest income on U.S. Treasury Securities is recognized based on their unpaid principal amounts and their contractual terms. Recognition of interest income commences on the settlement date of the purchase transaction and continues through the settlement date of the sale transaction.
Comprehensive Income (Loss)
Comprehensive income (loss) refers to changes in equity during a period from transactions and other events and circumstances from non-owner sources. It includes all changes in equity during a period, except those resulting from investments by owners and distributions to owners.
Note 4 - Recent Accounting Pronouncements
We consider the applicability and impact of all Accounting Standards Updates ("ASU") issued by the Financial Accounting Standards Board. Those not listed below were deemed to be either not applicable, are not expected to have a significant impact on our consolidated financial statements when adopted, or did not have a significant impact on our consolidated financial statements upon adoption.
Accounting Standard | Description | |
ASU 2018–07, Improvements to Non-employee Share –Based Payment Accounting (Topic 718) | The standard is effective for fiscal years beginning after December 15, 2018, including interim periods within that fiscal year. The standard largely aligns the accounting for share-based payment awards issued to employees and non-employees. Equity-classified share-based payment awards issued to non-employees are measured on the grant date, instead of being remeasured through the performance completion date (generally the vesting date). The standard was applied on a modified retrospective basis through a cumulative effect adjustment to retained earnings as of the beginning of the fiscal year when adopted. The cumulative effective adjustment was recorded in our consolidated statement of stockholders' equity as of January 1, 2019, and did not have a material impact on the Company's financial condition or results of operations. | |
ASU 2016-13, Financial Instruments–Credit Losses (Topic 326) | The standard introduces a new model for recognizing credit losses on financial instruments based on an estimate of current expected credit losses. The standard applies to (1) loans, accounts receivable, trade receivables, and other financial assets measured at amortized cost, (2) loan commitments and certain other off–balance sheet credit exposures, (3) debt securities and other financial assets measured at fair value through other comprehensive income, and (4) beneficial interests in securitized financial assets. The standard was effective for fiscal years beginning after December 15, 2019. The adoption of the standard on January 1, 2020 did not have a significant impact on the Company, since at that time we did not intend to sell our investments in available for sale Agency Securities. The Company determined that it was not more likely than not that we would be required to sell the investments before recovery of their amortized cost bases as the contractual cash flows of these federal agency mortgage backed securities are guaranteed by an agency of the U.S. government and we expected that all securities would not be settled at a price less than their amortized cost. | |
11
ARMOUR Residential REIT, Inc.
FINANCIAL STATEMENT NOTES (UNAUDITED)
(in thousands, except per share)
Note 5 - Fair Value of Financial Instruments
Our valuation techniques for financial instruments use observable and unobservable inputs. Observable inputs reflect readily obtainable data from third party sources, while unobservable inputs reflect management’s market assumptions. The Accounting Standards Codification Topic No. 820, "Fair Value Measurement," classifies these inputs into the following hierarchy:
Level 1 Inputs - Quoted prices for identical instruments in active markets.
Level 2 Inputs - Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable.
Level 3 Inputs - Prices determined using significant unobservable inputs. Unobservable inputs may be used in situations where quoted prices or observable inputs are unavailable (for example, when there is little or no market activity for an investment at the end of the period). Unobservable inputs reflect management’s assumptions about the factors that market participants would use in pricing an asset or liability, and would be based on the best information available.
At the beginning of each quarter, we assess the assets and liabilities that are measured at fair value on a recurring basis to determine if any transfers between levels in the fair value hierarchy are needed.
The following describes the valuation methodologies used for our assets and liabilities measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy. Any transfers between levels are assumed to occur at the beginning of the reporting period.
Agency Securities, Credit Risk and Non-Agency Securities, Interest-Only Securities and U.S. Treasury Securities:
Fair value for these securities are based on obtaining a valuation for each security from third party pricing services and/or dealer quotes. The third party pricing services use common market pricing methods that may include pricing models that may incorporate such factors as coupons, prepayment speeds, spread to the Treasury curves and interest rate swap curves, duration, periodic and life caps and credit enhancement. If the fair value of a security is not available from the third party pricing services or such data appears unreliable, we obtain pricing indications from up to three dealers who make markets in similar securities. Management reviews pricing used to ensure that current market conditions are properly reflected. This review includes, but is not limited to, comparisons of similar market transactions or alternative third party pricing services, dealer pricing indications and comparisons to a third party pricing model. Fair values obtained from the third party pricing services for similar instruments are classified as Level 2 securities if the inputs to the pricing models used are consistent with the Level 2 definition. If quoted prices for a security are not reasonably available from the third party pricing service, but dealer pricing indications are, the security will be classified as a Level 2 security. If neither is available, management will determine the fair value based on characteristics of the security that we receive from the issuer and based on available market information and classify it as a Level 3 security. U.S. Treasury Securities are classified as Level 1, as quoted unadjusted prices are available in active markets for identical assets.
Derivatives:
The fair values of our interest rate swap contracts, interest rate swaptions and basis swaps are valued using information provided by third party pricing services that incorporate common market pricing methods that may include current interest rate curves, forward interest rate curves and market spreads to interest rate curves. We estimate the fair value of TBA Agency Securities based on similar methods used to value our Agency Securities. Management compares the pricing information received to dealer quotes to ensure that the current market conditions are properly reflected. The fair values of our derivatives are classified as Level 2.
12
ARMOUR Residential REIT, Inc.
FINANCIAL STATEMENT NOTES (UNAUDITED)
(in thousands, except per share)
The following tables provide a summary of our assets and liabilities that are measured at fair value on a recurring basis at March 31, 2020 and December 31, 2019.
March 31, 2020 | (Level 1) | (Level 2) | (Level 3) | Balance | ||||||||||||
Assets at Fair Value: | ||||||||||||||||
Agency Securities | $ | $ | $ | $ | ||||||||||||
Credit Risk and Non-Agency Securities | $ | $ | $ | $ | ||||||||||||
Derivatives | $ | $ | $ | $ | ||||||||||||
Liabilities at Fair Value: | ||||||||||||||||
Derivatives | $ | $ | $ | $ | ||||||||||||
December 31, 2019 | (Level 1) | (Level 2) | (Level 3) | Balance | ||||||||||||
Assets at Fair Value: | ||||||||||||||||
Agency Securities | $ | $ | $ | $ | ||||||||||||
Credit Risk and Non-Agency Securities | $ | $ | $ | $ | ||||||||||||
Derivatives | $ | $ | $ | $ | ||||||||||||
Liabilities at Fair Value: | ||||||||||||||||
Derivatives | $ | $ | $ | $ | ||||||||||||
There were no transfers of assets or liabilities between the levels of the fair value hierarchy during the three months ended March 31, 2020 or for the year ended December 31, 2019.
Excluded from the tables above are financial instruments, including cash, cash collateral posted to/by counterparties, receivables, the Subordinated loan to BUCKLER, payables and borrowings under repurchase agreements, which are presented in our consolidated financial statements at cost which approximates fair value. The estimated fair value of these instruments is measured using "Level 1" or "Level 2" inputs at March 31, 2020 and December 31, 2019.
Note 6 - Investments in Securities
As of March 31, 2020 and December 31, 2019, our securities portfolio consisted of $3,552,515 and $12,825,367 of investment securities, at fair value, respectively, and $1,292,462 and $1,006,280 of TBA Agency Securities, at fair value, respectively. Our TBA Agency Securities are reported at net carrying value of $22,044 and $(592 ), at March 31, 2020 and December 31, 2019, respectively, and are reported in Derivatives, at fair value on our consolidated balance sheets (see Note 8 - Derivatives for additional information). The net carrying value of our TBA Agency Securities represents the difference between the fair value of the underlying Agency Security in the TBA contract and the cost basis or the forward price to be paid or received for the underlying Agency Security.
13
ARMOUR Residential REIT, Inc.
FINANCIAL STATEMENT NOTES (UNAUDITED)
(in thousands, except per share)
The following table summarizes our investments in securities as of March 31, 2020 and December 31, 2019, excluding TBA Agency Securities (see Note 8 - Derivatives for additional information).
Available for Sale Securities | Trading Securities | |||||||||||||||||||
Agency | Credit Risk and Non-Agency | Interest-Only | U.S. Treasuries | Totals | ||||||||||||||||
March 31, 2020 | ||||||||||||||||||||
Beginning balance | $ | $ | $ | $ | $ | |||||||||||||||
Purchases (1) | ||||||||||||||||||||
Proceeds from sales | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||||||
Receivable for unsettled sales | ( | ) | ( | ) | ( | ) | ||||||||||||||
Principal repayments | ( | ) | ( | ) | ( | ) | ||||||||||||||
Gains (losses) | ( | ) | ( | ) | ( | ) | ||||||||||||||
Credit loss expense | ( | ) | — | — | — | ( | ) | |||||||||||||
Amortization/accretion | ( | ) | ( | ) | ( | ) | ||||||||||||||
Ending balance | $ | $ | $ | $ | $ | |||||||||||||||
Percentage of Portfolio | % | % | % | % | % | |||||||||||||||
December 31, 2019 | ||||||||||||||||||||
Beginning balance | $ | $ | $ | $ | $ | |||||||||||||||
Purchases (1) | $ | |||||||||||||||||||
Sales | ( | ) | ( | ) | ( | ) | $ | ( | ) | |||||||||||
Principal Repayments | ( | ) | ( | ) | $ | ( | ) | |||||||||||||
Gains (losses) | ( | ) | $ | |||||||||||||||||
Amortization/accretion | ( | ) | ( | ) | $ | ( | ) | |||||||||||||
Ending balance | $ | $ | $ | $ | $ | |||||||||||||||
Percentage of Portfolio | % | % | % | % | % | |||||||||||||||
(1) | Purchases include cash paid during the period, plus payable for investment securities purchased during the period as of period end. At March 31, 2020 and December 31, 2019, we had investment related payables with respect to unsettled purchases of Agency Securities of $ |
Available for Sale Securities:
At March 31, 2020, we evaluated our available sale securities to determine if an allowance for credit losses was required for securities which were in an unrealized loss position and determined that, as we may be be required to sell these securities in the near future we recognized an impairment of $1,012 in our consolidated statements of operations.
At March 31, 2019 and December 31, 2019, we evaluated our available for sale securities with unrealized losses to determine whether there was an OTTI. At those dates, we also considered whether we intended to sell available for sale securities and whether it was more likely than not that we could meet our liquidity requirements and contractual obligations without selling available for sale securities. No OTTI was recognized for the three months ended March 31, 2019 or for the year ended December 31, 2019.
14
ARMOUR Residential REIT, Inc.
FINANCIAL STATEMENT NOTES (UNAUDITED)
(in thousands, except per share)
The table below presents the components of the carrying value and the unrealized gain or loss position of our Agency Securities at March 31, 2020 and December 31, 2019. Our Agency Securities had a weighted average coupon of 3.98 % and 3.76 % at March 31, 2020 and December 31, 2019.
Principal Amount | Amortized Cost | Gross Unrealized Loss | Gross Unrealized Gain | Fair Value | ||||||||||||||||
March 31, 2020 | ||||||||||||||||||||
Total Fannie Mae | $ | $ | $ | $ | $ | |||||||||||||||
Total Freddie Mac | ||||||||||||||||||||
Total Ginnie Mae | ||||||||||||||||||||
Total | $ | $ | $ | $ | $ | |||||||||||||||
December 31, 2019 | ||||||||||||||||||||
Total Fannie Mae | $ | $ | $ | ( | ) | $ | $ | |||||||||||||
Total Freddie Mac | ( | ) | ||||||||||||||||||
Total Ginnie Mae | ( | ) | ||||||||||||||||||
Total | $ | $ | $ | ( | ) | $ | $ | |||||||||||||
The following table presents the unrealized losses and estimated fair value of our Agency Securities by length of time that such securities have been in a continuous unrealized loss position at March 31, 2020 and December 31, 2019. All of our Agency Securities are issued and guaranteed by GSEs or Ginnie Mae. The GSEs have a long term credit rating of AA+.
Unrealized Loss Position For: | ||||||||||||||||||||||||
< 12 Months | ≥ 12 Months | Total | ||||||||||||||||||||||
Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | |||||||||||||||||||
March 31, 2020 | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
December 31, 2019 | $ | $ | ( | ) | $ | $ | ( | ) | $ | $ | ( | ) | ||||||||||||
Actual maturities of Agency Securities are generally shorter than stated contractual maturities because actual maturities of Agency Securities are affected by the contractual lives of the underlying mortgages, periodic payments of principal and prepayments of principal. The following table summarizes the weighted average lives of our Agency Securities at March 31, 2020 and December 31, 2019.
March 31, 2020 | December 31, 2019 | |||||||||||||||
Weighted Average Life of all Agency Securities | Fair Value | Amortized Cost | Fair Value | Amortized Cost | ||||||||||||
< 1 year | $ | $ | $ | $ | ||||||||||||
≥ 1 year and < 3 years | ||||||||||||||||
≥ 3 years and < 5 years | ||||||||||||||||
≥ 5 years | ||||||||||||||||
Total Agency Securities | $ | $ | $ | $ | ||||||||||||
15
ARMOUR Residential REIT, Inc.
FINANCIAL STATEMENT NOTES (UNAUDITED)
(in thousands, except per share)
We use a third party model to calculate the weighted average lives of our Agency Securities. Weighted average life is calculated based on expectations for estimated prepayments for the underlying mortgage loans of our Agency Securities. These estimated prepayments are based on assumptions such as interest rates, current and future home prices, housing policy and borrower incentives. The weighted average lives of our Agency Securities at March 31, 2020 and December 31, 2019 in the table above are based upon market factors, assumptions, models and estimates from the third party model and also incorporate management’s judgment and experience. The actual weighted average lives of our Agency Securities could be longer or shorter than estimated.
Trading Securities:
Our Credit Risk Transfer securities are collateralized by residential mortgage loans meeting agency criteria. However, our securities principal and interest are not guaranteed by the agencies. Credit Risk Transfer securities include tranches issued since 2014. Our Non-Agency Securities are collateralized by residential mortgage loans not guaranteed by any agency and include legacy securities issued between 2005 and 2007.
The components of the carrying value of our Trading Securities at March 31, 2020 and December 31, 2019 are presented in the table below. We did not have any U.S. Treasury Securities or Interest-Only Securities at March 31, 2020 and December 31, 2019.
Principal Amount | Amortized Cost | Gross Unrealized Loss | Gross Unrealized Gain | Fair Value | ||||||||||||||||
March 31, 2020 | ||||||||||||||||||||
Credit Risk Transfer | $ | $ | $ | ( | ) | $ | $ | |||||||||||||
Non-Agency Securities | ( | ) | ||||||||||||||||||
Total Credit Risk and Non-Agency Securities | $ | $ | $ | ( | ) | $ | $ | |||||||||||||
December 31, 2019 | ||||||||||||||||||||
Credit Risk Transfer | $ | $ | $ | $ | $ | |||||||||||||||
Non-Agency Securities | ( | ) | ||||||||||||||||||
Total Credit Risk and Non-Agency Securities | $ | $ | $ | ( | ) | $ | $ | |||||||||||||
16
ARMOUR Residential REIT, Inc.
FINANCIAL STATEMENT NOTES (UNAUDITED)
(in thousands, except per share)
The following table presents the unrealized losses and estimated fair value of our Trading Securities by length of time that such securities have been in a continuous unrealized loss position at March 31, 2020 and December 31, 2019. Our Credit Risk and Non-Agency Securities are subject to risk of loss with regard to principal and interest payments. We evaluate each investment based on the characteristics of the underlying collateral and securitization structure, rather than relying on the ratings assigned by rating agencies.
Unrealized Loss Position For: | ||||||||||||||||||||||||
< 12 Months | ≥ 12 Months | Total | ||||||||||||||||||||||
Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | |||||||||||||||||||
March 31, 2020 | ||||||||||||||||||||||||
Credit Risk and Non-Agency Securities | $ | $ | ( | ) | $ | $ | $ | $ | ( | ) | ||||||||||||||
December 31, 2019 | ||||||||||||||||||||||||
Credit Risk and Non-Agency Securities | $ | $ | ( | ) | $ | $ | $ | $ | ( | ) | ||||||||||||||
The following table summarizes the weighted average lives of our Trading Securities at March 31, 2020 and December 31, 2019.
March 31, 2020 | December 31, 2019 | |||||||||||||||
Estimated Weighted Average Life of Trading Securities | Fair Value | Amortized Cost | Fair Value | Amortized Cost | ||||||||||||
< 1 year | $ | $ | $ | $ | ||||||||||||
≥ 1 year and < 3 years | ||||||||||||||||
≥ 3 years and < 5 years | ||||||||||||||||
≥ 5 years | ||||||||||||||||
Total | $ | $ | $ | $ | ||||||||||||
We use a third party model to calculate the weighted average lives of our Credit Risk and Non-Agency Securities. Weighted average life is calculated based on expectations for estimated prepayments for the underlying mortgage loans of our Credit Risk and Non-Agency Securities. These estimated prepayments are based on assumptions such as interest rates, current and future home prices, housing policy and borrower incentives. The weighted average lives of our Credit Risk and Non-Agency Securities at March 31, 2020 and December 31, 2019 in the tables above are based upon market factors, assumptions, models and estimates from the third party model and also incorporate management’s judgment and experience. The actual weighted average lives of our Credit Risk and Non-Agency Securities could be longer or shorter than estimated.
Note 7 - Repurchase Agreements
At March 31, 2020, we had MRAs with 49 counterparties and had $3,465,472 in outstanding borrowings with 18 of those counterparties. At December 31, 2019, we had MRAs with 49 counterparties and had $11,354,547 in outstanding borrowings with 25 of those counterparties.
17
ARMOUR Residential REIT, Inc.
FINANCIAL STATEMENT NOTES (UNAUDITED)
(in thousands, except per share)
The following table represents the contractual repricing regarding our repurchase agreements to finance MBS purchases at March 31, 2020 and December 31, 2019. No amounts below are subject to offsetting.
Balance | Weighted Average Contractual Rate | Weighted Average Maturity in days | Haircut (1) | |||||||||
March 31, 2020 | ||||||||||||
Agency Securities | ||||||||||||
≤ 30 days | $ | % | % | |||||||||
> 30 days to ≤ 60 days | % | % | ||||||||||
Total or Weighted Average | $ | % | % | |||||||||
Credit Risk and Non-Agency Securities | ||||||||||||
≤ 30 days | % | % | ||||||||||
Total or Weighted Average | $ | % | % | |||||||||
December 31, 2019 | ||||||||||||
Agency Securities | ||||||||||||
≤ 30 days | $ | % | % | |||||||||
> 30 days to ≤ 60 days | % | % | ||||||||||
Total or Weighted Average | $ | % | % | |||||||||
Credit Risk and Non-Agency Securities | ||||||||||||
≤ 30 days | % | % | ||||||||||
Total or Weighted Average | $ | % | % | |||||||||
(1) | The Haircut represents the weighted average margin requirement, or the percentage amount by which the collateral value must exceed the loan amount. |
Our repurchase agreements require that we maintain adequate pledged collateral. A decline in the value of the MBS pledged as collateral for borrowings under repurchase agreements could result in the counterparties demanding additional collateral pledges or liquidation of some of the existing collateral to reduce borrowing levels. We manage this risk by maintaining an adequate balance of available cash and unpledged securities. An event of default or termination event under the standard MRA would give our counterparty the option to terminate all repurchase transactions existing with us and require any amount due to be payable immediately. In addition, certain of our MRAs contain a restriction that prohibits our leverage from exceeding twelve times our stockholders’ equity as well as termination events in the case of significant reductions in equity capital. We also may receive cash or securities as collateral from our derivative counterparties which we may use as additional collateral for repurchase agreements. Certain interest rate swap contracts provide for cross collateralization and cross default with repurchase agreements and other contracts with the same counterparty.
At March 31, 2020 and December 31, 2019, BUCKLER accounted for 56.2 % and 45.0 %, respectively, of our aggregate borrowings and had an amount at risk of 7.7 % and 14.8 %, respectively, of our total stockholders' equity with a weighted average maturity of 27 days and 7 days, respectively, on repurchase agreements (see Note 15 - Related Party Transactions for additional information).
In addition, at March 31, 2020, we had 1 repurchase agreement counterparty that individually accounted for over 5 % of our aggregate borrowings. In total, this counterparty accounted for approximately 11.8 % of our repurchase agreement borrowings outstanding at March 31, 2020. At March 31, 2020, we also had 1 repurchase counterparty with an amount at risk of 5.62 % of our total stockholders' equity with a weighted average maturity of 10 days on repurchase agreements. At December
18
ARMOUR Residential REIT, Inc.
FINANCIAL STATEMENT NOTES (UNAUDITED)
(in thousands, except per share)
31, 2019, we had 2 repurchase agreement counterparties that individually accounted for between 5 % and 10 % of our aggregate borrowings. In total, these counterparties accounted for 12.7 % of our repurchase agreement borrowings at December 31, 2019.
Note 8 - Derivatives
We enter into derivative transactions to manage our interest rate risk and agency mortgage rate exposures. We have agreements with our derivative counterparties that provide for the posting of collateral based on the fair values of our derivatives. Through this margin process, either we or our counterparties may be required to pledge cash or securities as collateral. Collateral requirements vary by counterparty and change over time based on the fair value, notional amount and remaining term of the contracts. Certain contracts provide for cross collateralization and cross default with repurchase agreements and other contracts with the same counterparty.
Interest rate swap contracts are designed to lock in funding costs for repurchase agreements associated with our assets in such a way to help assure the realization of net interest margins. Such transactions are based on assumptions about prepayments which, if not realized, will cause transaction results to differ from expectations. Interest rate swaptions generally provide us the option to enter into an interest rate swap agreement at a certain point of time in the future with a predetermined notional amount, stated term and stated rate of interest in the fixed leg and interest rate index on the floating leg. Basis swap contracts allow us to exchange one floating interest rate basis for another, thereby allowing us to diversify our floating rate basis exposures.
TBA Agency Securities are forward contracts for the purchase (“long position”) or sale (“short position”) of Agency Securities at a predetermined price, face amount, issuer, coupon and stated maturity on an agreed-upon future date. The specific Agency Securities delivered into the contract upon the settlement date, published each month by the Securities Industry and Financial Markets Association, are not known at the time of the transaction. We may enter into TBA Agency Securities as a means of hedging against short-term changes in interest rates. We may also enter into TBA Agency Securities as a means of acquiring or disposing of Agency Securities and we may from time to time utilize TBA dollar roll transactions to finance Agency Security purchases. We estimate the fair value of TBA Agency Securities based on similar methods used to value our Agency Securities.
We have netting arrangements in place with all derivative counterparties pursuant to standard documentation developed by the International Swap and Derivatives Association. We are also required to post or hold cash collateral based upon the net underlying market value of our open positions with the counterparty. A decline in the value of the open positions with the counterparty could result in the counterparties demanding additional collateral pledges or liquidation of some of the existing collateral to reduce borrowing levels. We manage this risk by maintaining an adequate balance of available cash and unpledged securities. An event of default or termination event under the standard ISDA would give our counterparty the option to terminate all repurchase transactions existing with us and require any amount due to be payable immediately. In addition, certain of our ISDAs contain a restriction that prohibits our leverage from exceeding twelve times our stockholders’ equity as well as termination events in the case of significant reductions in equity capital. At March 31, 2020, we received waivers from certain ISDA counterparties related to significant reductions in equity capital that would have otherwise caused a default or termination event.
19
ARMOUR Residential REIT, Inc.
FINANCIAL STATEMENT NOTES (UNAUDITED)
(in thousands, except per share)
The following tables present information about the potential effects of netting our derivatives if we were to offset the assets and liabilities on the accompanying consolidated balance sheets. We currently present these financial instruments at their gross amounts and they are included in derivatives, at fair value on the accompanying consolidated balance sheets at March 31, 2020 and December 31, 2019.
Gross Amounts Not Offset | ||||||||||||||||
Assets | Gross Amounts(1) | Financial Instruments | Cash Collateral | Total Net | ||||||||||||
March 31, 2020 | ||||||||||||||||
Interest rate swap contracts | $ | $ | ( | ) | $ | $ | ||||||||||
TBA Agency Securities | ( | ) | ( | ) | ||||||||||||
Totals | $ | $ | ( | ) | $ | ( | ) | $ | ||||||||
December 31, 2019 | ||||||||||||||||
Interest rate swap contracts | $ | $ | ( | ) | $ | $ | ||||||||||
TBA Agency Securities | ( | ) | ||||||||||||||
Totals | $ | $ | ( | ) | $ | $ | ||||||||||
(1) | See Note 5 - Fair Value of Financial Instruments for additional discussion. |
Gross Amounts Not Offset | ||||||||||||||||
Liabilities | Gross Amounts(1) | Financial Instruments | Cash Collateral | Total Net | ||||||||||||
March 31, 2020 | ||||||||||||||||
Interest rate swap contracts | $ | ( | ) | $ | $ | $ | ( | ) | ||||||||
TBA Agency Securities | ( | ) | ||||||||||||||
Totals | $ | ( | ) | $ | $ | $ | ( | ) | ||||||||
December 31, 2019 | ||||||||||||||||
Interest rate swap contracts | $ | ( | ) | $ | $ | $ | ||||||||||
TBA Agency Securities | ( | ) | $ | ( | ) | |||||||||||
Totals | $ | ( | ) | $ | $ | $ | ( | ) | ||||||||
(1) | See Note 5 - Fair Value of Financial Instruments for additional discussion. |
20
ARMOUR Residential REIT, Inc.
FINANCIAL STATEMENT NOTES (UNAUDITED)
(in thousands, except per share)
The following table represents the location and information regarding our derivatives which are included in Other Income (Loss) in the accompanying consolidated statements of operations for the three months ended March 31, 2020 and March 31, 2019.
Income (Loss) Recognized | ||||||||||
For the Three Months Ended March 31, | ||||||||||
Derivatives | Location on consolidated statements of operations | 2020 | 2019 | |||||||
Interest rate swap contracts: | ||||||||||
Realized loss | Realized loss on derivatives | $ | ( | ) | $ | ( | ) | |||
Interest income | Realized loss on derivatives | |||||||||
Interest expense | Realized loss on derivatives | ( | ) | ( | ) | |||||
Changes in fair value | Unrealized loss on derivatives | ( | ) | ( | ) | |||||
$ | ( | ) | ( | ) | ||||||
TBA Agency Securities: | ||||||||||
Realized gain | Realized loss on derivatives | |||||||||
Changes in fair value | Unrealized loss on derivatives | ( | ) | |||||||
$ | ||||||||||
Totals | $ | ( | ) | ( | ) | |||||
Interest Rate Swaps (1) | Notional Amount | Weighted Average Remaining Term (Months) | Weighted Average Rate | ||||||
March 31, 2020 | |||||||||
< 3 years | $ | % | |||||||
≥ 3 years and < 5 years | % | ||||||||
≥ 5 years and < 7 years | % | ||||||||
< 7 years | % | ||||||||
Total or Weighted Average (2) | $ | % | |||||||
December 31, 2019 | |||||||||
< 3 years | $ | % | |||||||
≥ 3 years and < 5 years | % | ||||||||
≥ 5 years and < 7 years | % | ||||||||
< 7 years | % | ||||||||
Total or Weighted Average (3) | $ | % | |||||||
(1) | Pay Fixed/Receive Variable. |
(2) | Of this amount, $ |
21
ARMOUR Residential REIT, Inc.
FINANCIAL STATEMENT NOTES (UNAUDITED)
(in thousands, except per share)
(3) | Of this amount, |
TBA Agency Securities | Notional Amount | Cost Basis | Fair Value | |||||||||
March 31, 2020 | ||||||||||||
15 Year Long | ||||||||||||
2.0% | ||||||||||||
30 Year Long | ||||||||||||
2.5% | ||||||||||||
3.0% | ||||||||||||
Total (1) | $ | $ | $ | |||||||||
December 31, 2019 | ||||||||||||
15 Year Long | ||||||||||||
3.0% | ||||||||||||
30 Year Long | ||||||||||||
2.5% | ||||||||||||
Total (1) | $ | $ | $ | |||||||||
(1) |
Note 9 - Commitments and Contingencies
Management
The Company is managed by ACM, pursuant to management agreements with ARMOUR and JAVELIN (see also Note 15, “Related Party Transactions”). The management agreements entitle ACM to receive management fees payable monthly in arrears. Currently, the monthly ARMOUR management fee is 1/12th of the sum of (a) 1.5 % of gross equity raised up to $1.0 billion plus (b) 0.75 % of gross equity raised in excess of $1.0 billion. The cost of repurchased stock and any dividend representing a return of capital for tax purposes will reduce the amount of gross equity raised used to calculate the monthly management fee. At March 31, 2020 and March 31, 2019, the effective ARMOUR management fee was 1.00 % and 1.00 % based on gross equity raised of $2,887,586 and $2,986,934 , respectively. The ACM monthly management fees are not calculated based on the performance of our assets. Accordingly, the payment of our monthly management fees may not decline in the event of a decline in our earnings and may cause us to incur losses. We are also responsible for any costs and expenses that ACM incurred solely on behalf of ARMOUR or JAVELIN other than the various overhead expenses specified in the terms of the management agreements. ACM is further entitled to receive termination fees from ARMOUR and JAVELIN under certain circumstances.
Indemnifications and Litigation
We enter into certain contracts that contain a variety of indemnifications, principally with ACM and underwriters, against third party claims for errors and omissions in connection with their services to us. We have not incurred any costs to defend lawsuits or settle claims related to these indemnification agreements. As a result, the estimated fair value of these agreements, as well as the maximum amount attributable to past events, is not material. Accordingly, we have no liabilities recorded for these agreements at March 31, 2020 and December 31, 2019.
22
ARMOUR Residential REIT, Inc.
FINANCIAL STATEMENT NOTES (UNAUDITED)
(in thousands, except per share)
name ARMOUR, the previous members of JAVELIN’s board of directors prior to the Merger (of which eight are current members of ARMOUR’s board of directors) (the “Individual Defendants”) and JMI Acquisition Corporation (“Acquisition”) as defendants. Certain cases also name ACM and JAVELIN as additional defendants. The lawsuits were brought by purported holders of JAVELIN’s common stock, both individually and on behalf of a putative class of JAVELIN’s stockholders, alleging that the Individual Defendants breached their fiduciary duties owed to the plaintiffs and the putative class of JAVELIN stockholders, including claims that the Individual Defendants failed to properly value JAVELIN; failed to take steps to maximize the value of JAVELIN to its stockholders; ignored or failed to protect against conflicts of interest; failed to disclose material information about the Transactions; took steps to avoid competitive bidding and to give ARMOUR an unfair advantage by failing to adequately solicit other potential acquirors or alternative transactions; and erected unreasonable barriers to other third-party bidders. The suits also allege that ARMOUR, JAVELIN, ACM and Acquisition aided and abetted the alleged breaches of fiduciary duties by the Individual Defendants. The lawsuits seek equitable relief, including, among other relief, to enjoin consummation of the Transactions, or rescind or unwind the Transactions if already consummated, and award costs and disbursements, including reasonable attorneys’ fees and expenses. The sole Florida lawsuit was never served on the defendants, and that case was voluntarily dismissed and closed on January 20, 2017. On April 25, 2016, the Maryland court issued an order consolidating the eight Maryland cases into one action, captioned In re JAVELIN Mortgage Investment Corp. Shareholder Litigation (Case No. 24-C-16-001542), and designated counsel for one of the Maryland cases as interim lead co-counsel. On May 26, 2016, interim lead counsel filed the Consolidated Amended Class Action Complaint for Breach of Fiduciary Duty asserting consolidated claims of breach of fiduciary duty, aiding and abetting the breaches of fiduciary duty, and waste. On June 27, 2016, defendants filed a Motion to Dismiss the Consolidated Amended Class Action Complaint for failing to state a claim upon which relief can be granted. A hearing was held on the Motion to Dismiss on March 3, 2017, and the Court reserved ruling. On September 27, 2019 the court further deferred the matter for six months. No further action has been taken.
Each of ARMOUR, JAVELIN, ACM and the Individual Defendants intends to defend the claims made in these lawsuits vigorously; however, there can be no assurance that any of ARMOUR, JAVELIN, ACM or the Individual Defendants will prevail in its defense of any of these lawsuits to which it is a party. An unfavorable resolution of any such litigation surrounding the Transactions may result in monetary damages being awarded to the plaintiffs and the putative class of former stockholders of JAVELIN and the cost of defending the litigation, even if resolved favorably, could be substantial. Due to the preliminary nature all of these suits, ARMOUR is not able at this time to estimate their outcome.
Note 10 - Stock Based Compensation
We adopted the 2009 Stock Incentive Plan as amended (the “Plan”) to attract, retain and reward directors and other persons who provide services to us in the course of operations. The Plan authorizes the Board to grant awards including common stock, restricted shares of common stock (“RSUs”), stock options, performance shares, performance units, stock appreciation rights and other equity and cash-based awards (collectively, “Awards”), subject to terms as provided in the Plan. At March 31, 2020, there were 677 shares available for future issuance under the Plan.
Transactions related to awards for the three months ended March 31, 2020 are summarized below:
March 31, 2020 | |||||||
Number of Awards | Weighted Average Grant Date Fair Value per Award | ||||||
Unvested RSU Awards Outstanding beginning of period | $ | ||||||
Granted (1) | $ | ||||||
Vested | ( | ) | $ | ||||
Unvested RSU Awards Outstanding end of period | $ | ||||||
(1) | In January 2020, we granted |
23
ARMOUR Residential REIT, Inc.
FINANCIAL STATEMENT NOTES (UNAUDITED)
(in thousands, except per share)
Note 11 - Stockholders' Equity
Changes in Stockholders' Equity
The following table presents the changes in Stockholders' Equity for the following interim periods.
Stockholders' Equity | March 31, 2020 | March 31, 2019 | |||||
Balance, beginning of quarter | $ | $ | |||||
Series B Preferred dividends ($0.1640625 per share) | ( | ) | ( | ) | |||
Series C Preferred dividends ($0.14583 per share) | ( | ) | ( | ) | |||
Common stock dividends (1) | ( | ) | ( | ) | |||
Series B Preferred Stock, called for redemption | ( | ) | |||||
Issuance of Series C Preferred Stock | |||||||
Issuance of Common stock, net | |||||||
Stock based compensation, net of withholding requirements | |||||||
Common Stock repurchased, net | ( | ) | |||||
Net loss | ( | ) | ( | ) | |||
Other comprehensive income (loss) | ( | ) | |||||
Balance, end of quarter | $ | $ | |||||
(1) | See the below table for common stock dividends per share for the three months ended March 31, 2020. Common stock dividends were $ |
Preferred Stock
At March 31, 2020 and December 31, 2019, we were authorized to issue up to 50,000 shares of preferred stock, par value $0.001 per share, with such designations, voting and other rights and preferences as may be determined from time to time by our Board of Directors (“Board”) or a committee thereof. On June 24, 2019, we filed Articles Supplementary with the State Department of Assessments and Taxation of the State of Maryland to designate 10,320 shares of the Company’s authorized preferred stock, par value $0.001 per share, as additional shares of 7.875 % Series B Preferred Stock, thereby increasing the aggregate number of shares of preferred stock designated as Series B Preferred Stock to 17,970 shares. On January 28, 2020, we filed Articles Supplementary with the Department to designate 10,000 shares of the Company’s authorized preferred stock, par value $0.001 per share, as shares of 7.00 % Series C Preferred Stock with the powers, designations, preferences and other rights as set forth therein. At March 31, 2020, a total of 22,030 shares of our authorized preferred stock remain available for designation as future series.
24
ARMOUR Residential REIT, Inc.
FINANCIAL STATEMENT NOTES (UNAUDITED)
(in thousands, except per share)
Series B Cumulative Preferred Stock - Called for redemption, (February 27, 2020) “Series B Preferred Stock”
On January 24, 2020, the Company mailed a notice of full redemption (the “Notice”) of all 8,383 issued and outstanding shares of its 7.875 % Series B Preferred Stock ($25.00 per share, $209,583 in the aggregate liquidation preference) to the holders of record of its Series B Preferred Stock as of January 13, 2020. Pursuant to this redemption, each share of Series B Preferred Stock was canceled and represented solely the right to receive cash in the amount of $25.00 per share of Series B Preferred Stock on February 27, 2020. Pursuant to the terms of the Series B Preferred Stock, holders of record of the Series B Preferred Stock on February 15, 2020 received the full monthly dividend for February. The final dividend amount of $1,375 was paid on February 27, 2020 and was recorded as other expense in our consolidated statements of operations.
At December 31, 2019, we had 8,383 shares of Series B Preferred Stock issued and outstanding with a par value of $0.001 per share and a liquidation preference of $25.00 per share, or $209,583 , in the aggregate. Shares designated as Series B Preferred Stock but unissued totaled 9,587 at December 31, 2019. At December 31, 2019, there were no accrued or unpaid dividends on the Series B Preferred Stock. The Series B Preferred Stock was entitled to a dividend at a rate of 7.875 % per year based on the $25.00 per share liquidation preference before the common stock was entitled to receive any dividends.
On March 2, 2020, we terminated the Equity Sales Agreement (the “Preferred B ATM Sales Agreement”) with BUCKLER and B. Riley FBR, Inc., as sales agents, relating to an "at-the-market" offering program for our Series B Preferred Stock, dated as of June 24, 2019. The Preferred B ATM Sales Agreement, allowed us to offer and sell, over a period of time and from time to time, up to 9,000 shares of our Series B Preferred Stock. At the date of termination, we sold 1,914 shares under this agreement for proceeds of $47,306 , net of issuance costs and commissions of approximately $689 . We did not incur any termination penalties as a result of this termination.
On March 4, 2020, we terminated the 2019 Series B Preferred Stock Dividend Reinvestment and Stock Purchase Plan (the “2019 Plan”) relating to the offer and sale of up to 2,500 shares of our Series B Preferred Stock pursuant to the terms of the 2019 Plan (the “DRIP Offering”) dated June 24, 2019. The 2019 Plan permitted (i) current holders of our Series B Preferred Stock to reinvest all or a portion of the cash dividends on their shares of Series B Preferred Stock into shares of Series B Preferred Stock and to separately purchase additional shares of Series B Preferred Stock and (ii) other interested investors to purchase shares of Series B Preferred Stock. At the date of termination, we issued sixteen shares under the DRIP Offering.
Series C Cumulative Redeemable Preferred Stock "Series C Preferred Stock"
On January 23, 2020, the Company and ACM, entered into an Underwriting Agreement (the “Underwriting Agreement”) with B. Riley FBR, Inc., as representative of the several underwriters named therein (collectively, the “Underwriters”), including, but not limited to, BUCKLER, with respect to (i) the sale by the Company of 3,000 shares (the “Firm Shares”) of the Company’s new 7.00 % Series C Preferred Stock ($25.00 liquidation preference per share), $0.001 par value, to the Underwriters with an offering price to the public of $25.00 per share, and (ii) the grant by the Company to the Underwriters of an option to purchase all or part of 450 additional shares of the Series C Preferred Stock during the 30-day period following the execution of the Underwriting Agreement with the same offering price per share to the public to cover over-allotments. On January 24, 2020, the Underwriters exercised the option to purchase all 450 additional shares of the Series C Preferred Stock. On January 28, 2020, the Company completed the sale of 3,450 total shares for proceeds of $83,322 , net of issuance costs and commissions of $2,928 .
On January 29, 2020, the Company entered into an Equity Sales Agreement with B. Riley FBR, Inc. and BUCKLER, as sales agents (individually and collectively, the “Agents’), and ACM, pursuant to which the Company may offer and sell, over a period of time and from time to time, through one of more of the Agents, as the Company’s agents, up to 6,550 of Series C Preferred Stock. The Equity Sales Agreement relates to a proposed “at-the-market” offering. The Company used the net proceeds from the offering as a portion of the funds to redeem 100 % of the outstanding Series B Preferred Stock as described above. During the three months ended March 31, 2020, we sold 1,853 shares under this agreement for proceeds of $45,899 , net of issuance costs and commissions of approximately $630 .
25
ARMOUR Residential REIT, Inc.
FINANCIAL STATEMENT NOTES (UNAUDITED)
(in thousands, except per share)
Common Stock
At March 31, 2020 and December 31, 2019, we were authorized to issue up to 125,000 shares of common stock, par value $0.001 per share, with such designations, voting and other rights and preferences as may be determined from time to time by our Board. We had 58,881 shares of common stock issued and outstanding at March 31, 2020 and 58,877 shares of common stock issued and outstanding at December 31, 2019.
On February 15, 2019, we entered into an Equity Sales Agreement (the “Common stock ATM Sales Agreement”) with BUCKLER, JMP Securities LLC and Ladenburg Thalmann & Co. Inc., as sales agents, relating to the shares of our common stock. On April 3, 2020, the Common stock ATM Sales Agreement was amended to add B. Riley, FBR, Inc. as a sales agent. In accordance with the terms of the Common stock ATM Sales Agreement, we may offer and sell over a period of time and from time to time, up to 7,000 shares of our common stock par value $0.001 per share. The Common stock ATM Sales Agreement relates to an "at-the-market" offering program. Under the agreement, we will pay the agent designated to sell our shares, an aggregate commission of up to 2.0 % of the gross sales price per share of our common stock sold through the designated agent, under the agreement. We did not sell any shares or pay any fees under this agreement during the three months ended March 31, 2020.
See Note 15 - Related Party Transactions for discussion of additional transactions with BUCKLER.
Common Stock Repurchased
At March 31, 2020 and December 31, 2019, there were 8,210 and 8,250 authorized shares remaining under the current repurchase authorization. Under the Repurchase Program, shares may be purchased in the open market, including block trades, through privately negotiated transactions, or pursuant to a trading plan separately adopted in the future. The timing, manner, price and amount of any repurchases will be at our discretion, subject to the requirements of the Securities Exchange Act of 1934, as amended, and related rules. We are not required to repurchase any shares under the Repurchase Program and it may be modified, suspended or terminated at any time for any reason. We do not intend to purchase shares from our Board or other affiliates. Under Maryland law, such repurchased shares are treated as authorized but unissued.
Equity Capital Raising Activities
The following tables present our equity transactions for the three months ended March 31, 2020 and for the year ended December 31, 2019.
Transaction Type | Completion Date | Number of Shares | Per Share price (1) | Net Proceeds | |||||||||
March 31, 2020 | |||||||||||||
Preferred C Underwritten Offering | January 28, 2020 | $ | $ | ||||||||||
Preferred C ATM Sales Agreement | January 30, 2020-March 31, 2020 | $ | $ | ||||||||||
Common stock repurchases, net | February 26, 2020-March 3, 2020 | ( | ) | $ | $ | ( | ) | ||||||
December 31, 2019 | |||||||||||||
Preferred B ATM Sales Agreement | June 6, 2019-June 19, 2019 | $ | $ | ||||||||||
Preferred B ATM Sales Agreement | June 25, 2019-December 31, 2019 | $ | $ | ||||||||||
Common Stock ATM Sales Agreement | January 4, 2019-January 11, 2019 | $ | $ | ||||||||||
January Public Offering | January 17, 2019 | $ | $ | ||||||||||
February Public Offering | February 22, 2019-February 27, 2019 | $ | $ | ||||||||||
Common stock repurchases | May 31, 2019-December 31, 2019 | ( | ) | $ | $ | ( | ) | ||||||
(1) | Weighted average price |
26
ARMOUR Residential REIT, Inc.
FINANCIAL STATEMENT NOTES (UNAUDITED)
(in thousands, except per share)
Dividends
The following table presents our Series B Preferred Stock dividend transactions prior to full redemption. The table below does not include the final dividend amount of $1,375 that was paid on February 27, 2020 to holders of record on February 15, 2020. This amount is recorded in other expense in our consolidated statements of operations.
Record Date | Payment Date | Rate per Series B Preferred Share | Aggregate amount paid to holders of record | |||||||
January 15, 2020 | January 27, 2020 | $ | $ | |||||||
The following table presents our Series C Preferred Stock dividend transactions for the three months ended March 31, 2020.
Record Date | Payment Date | Rate per Series C Preferred Share | Aggregate amount paid to holders of record | |||||||
February 15, 2020 | February 27, 2020 | $ | $ | |||||||
March 15, 2020 | March 27, 2020 | $ | ||||||||
Total dividends paid | $ | |||||||||
The following table presents our common stock dividend transactions for the three months ended March 31, 2020.
Record Date | Payment Date | Rate per common share | Aggregate amount paid to holders of record | |||||||
January 15, 2020 | January 30, 2020 | $ | $ | |||||||
February 14, 2020 | February 27, 2020 | $ | ||||||||
March 16, 2020 | March 27, 2020 | $ | ||||||||
Total dividends paid | $ | |||||||||
27
ARMOUR Residential REIT, Inc.
FINANCIAL STATEMENT NOTES (UNAUDITED)
(in thousands, except per share)
Note 12 - Net Loss per Common Share
The following table presents a reconciliation of net loss and the shares used in calculating weighted average basic and diluted earnings per common share for the three months ended March 31, 2020 and March 31, 2019.
For the Three Months Ended March 31, | ||||||||
2020 | 2019 | |||||||
Net Loss | $ | ( | ) | $ | ( | ) | ||
Less: Preferred dividends | ( | ) | ( | ) | ||||
Net Loss related to common stockholders | $ | ( | ) | $ | ( | ) | ||
Weighted average common shares outstanding – basic | ||||||||
Add: Effect of dilutive non-vested awards, assumed vested | ||||||||
Weighted average common shares outstanding – diluted | ||||||||
Note 13 - Comprehensive Income (Loss) per Common Share
The following table presents a reconciliation of comprehensive net income (loss) and the shares used in calculating weighted average basic and diluted comprehensive income (loss) per common share for the three months ended March 31, 2020 and March 31, 2019.
For the Three Months Ended March 31, | ||||||||
2020 | 2019 | |||||||
Comprehensive Income (Loss) | $ | ( | ) | $ | ||||
Less: Preferred dividends | ( | ) | ( | ) | ||||
Comprehensive Income (Loss) available (related) to common stockholders | $ | ( | ) | $ | ||||
Net Comprehensive Income (Loss) per share available (related) to common stockholders: | ||||||||
Basic | $ | ( | ) | $ | ||||
Diluted | $ | ( | ) | $ | ||||
Weighted average common shares outstanding: | ||||||||
Basic | ||||||||
Add: Effect of dilutive non-vested awards, assumed vested | ||||||||
Diluted | ||||||||
28
ARMOUR Residential REIT, Inc.
FINANCIAL STATEMENT NOTES (UNAUDITED)
(in thousands, except per share)
Note 14 - Income Taxes
The following table reconciles our GAAP net loss to estimated REIT taxable income for the three months ended March 31, 2020 and March 31, 2019.
For the Three Months Ended March 31, | ||||||||
2020 | 2019 | |||||||
GAAP net loss | $ | ( | ) | $ | ( | ) | ||
Book to tax differences: | ||||||||
TRS (income) loss | ( | ) | ||||||
Credit Risk and Non-Agency Securities | ( | ) | ||||||
Interest-Only Securities | ||||||||
U.S. Treasury Securities | ( | ) | ||||||
Changes in interest rate contracts | ||||||||
Credit loss expense | ||||||||
(Gain) loss on Security Sales | ( | ) | ||||||
Amortization of deferred hedging costs | ( | ) | ( | ) | ||||
Series B Cumulative Preferred Stock dividend - Called for redemption | ||||||||
Other | ||||||||
Estimated REIT taxable income | $ | $ | ||||||
Interest rate contracts are treated as hedging transactions for U. S. federal income tax purposes. Unrealized gains and losses on open interest rate contracts are not included in the determination of REIT taxable income. Realized gains and losses on interest rate contracts terminated before their maturity are deferred and amortized over the remainder of the original term of the contract for REIT taxable income.
Net capital losses realized | Amount | Available to offset capital gains through | ||||
2015 | $ | ( | ) | 2020 | ||
2016 | $ | ( | ) | 2021 | ||
2017 | $ | ( | ) | 2022 | ||
2018 | $ | ( | ) | 2023 | ||
The aggregate tax basis of our assets and liabilities was greater than our total Stockholders’ Equity at March 31, 2020 by approximately $661,300 , or approximately $11.23 per common share (based on the 58,881 common shares then outstanding).
We are required and intend to timely distribute substantially all of our REIT taxable income in order to maintain our REIT status under the Code. Total dividend payments to stockholders were $34,579 (including the final dividend on the Series B Preferred Stock, called for redemption of $1,375 paid on February 27, 2020 to holders of record on February 15, 2020) and $34,073 for the three months ended March 31, 2020 and March 31, 2019, respectively. Our estimated REIT taxable income available for distribution as dividends was $6,337 and $18,459 for the three months ended March 31, 2020 and March 31, 2019, respectively. Our REIT taxable income and dividend requirements to maintain our REIT status are determined on an annual basis. Dividends paid in excess of current tax earnings and profits for the year will generally not be taxable to common stockholders.
29
ARMOUR Residential REIT, Inc.
FINANCIAL STATEMENT NOTES (UNAUDITED)
(in thousands, except per share)
Our management is responsible for determining whether tax positions taken by us are more likely than not to be sustained on their merits. We have no material unrecognized tax benefits or material uncertain tax positions.
Note 15 - Related Party Transactions
ACM
Management:
The Company is managed by ACM, pursuant to management agreements with ARMOUR and JAVELIN. All of our executive officers are also employees of ACM. ACM manages our day-to-day operations, subject to the direction and oversight of the Board. The ARMOUR management agreement runs through June 18, 2024 and is thereafter automatically renewed for an additional five-year term unless terminated under certain circumstances. The JAVELIN management agreement renewed on October 5, 2017, for a one-year period, with the base management fee thereunder reduced to one dollar for the entirety of the renewal term.It will automatically renew for successive one-year terms unless terminated under certain circumstances. Either party must provide 180 days prior written notice of any such termination.
Under the terms of the management agreements, ACM is responsible for costs incident to the performance of its duties, such as compensation of its employees and various overhead expenses. ACM is responsible for the following primary roles:
• | Advising us with respect to, arranging for and managing the acquisition, financing, management and disposition of, elements of our investment portfolio; |
• | Evaluating the duration risk and prepayment risk within the investment portfolio and arranging borrowing and hedging strategies; |
• | Coordinating capital raising activities; |
• | Advising us on the formulation and implementation of operating strategies and policies, arranging for the acquisition of assets, monitoring the performance of those assets and providing administrative and managerial services in connection with our day-to-day operations; and |
• | Providing executive and administrative personnel, office space and other appropriate services required in rendering management services to us. |
In accordance with the ARMOUR management agreement, we incurred $7,444 and $7,244 in management fees for the three months ended March 31, 2020 and March 31, 2019, respectively. Commencing with the second quarter of 2020 and continuing until further notice, ACM is waiving 40 % of its management fee.
We are required to take actions as may be reasonably required to permit and enable ACM to carry out its duties and obligations. We are also responsible for any costs and expenses that ACM incurred solely on our behalf other than the various overhead expenses specified in the terms of the management agreements. For the three months ended March 31, 2020 and March 31, 2019, we reimbursed ACM $117 and $27 for other expenses incurred on our behalf. In 2013, 2017 and January 2020, we elected to grant restricted stock unit awards to our executive officers and other ACM employees through ACM that vest over 5 years. In November 2017 and January 2020, we elected to grant restricted stock unit awards to the Board. We recognized stock based compensation expense of $186 and $97 for the three months ended March 31, 2020 and March 31, 2019, respectively.
30
ARMOUR Residential REIT, Inc.
FINANCIAL STATEMENT NOTES (UNAUDITED)
(in thousands, except per share)
BUCKLER
In March 2017, we contributed $352 for a 10 % ownership interest in BUCKLER. The investment is included in prepaid and other assets in our consolidated balance sheet and is accounted for using the equity method as BUCKLER maintains specific ownership accounts. The value of the investment was $465 at March 31, 2020 and $381 at December 31, 2019, reflecting our total investment plus our share of BUCKLER’s operating results, in accordance with the terms of the operating agreement of BUCKLER that our independent directors negotiated. The primary purpose of our investment in BUCKLER is to facilitate our access to repurchase financing on potentially attractive terms (considering rate, term, size, haircut, relationship and funding commitment) compared to other suitable repurchase financing counterparties.
Our operating agreement with BUCKLER contains certain provisions to benefit and protect the Company, including (1) sharing in any (a) defined profits realized by BUCKLER from the anticipated financing spreads resulting from repurchase financing facilitated by BUCKLER, and (b) distributions from BUCKLER to its members of net cash receipts, and (2) the realization of anticipated savings from reduced clearing, brokerage, trading and administrative fees. In addition, the independent directors of the Company must approve, in their sole discretion, any third-party business engaged by BUCKLER and may cause BUCKLER to wind up and dissolve and promptly return certain subordinated loans we provide to BUCKLER as regulatory capital (as described more fully below) if the independent directors reasonably determine that BUCKLER’s ability to provide attractive securities transactions for the Company is materially adversely affected. For the three months ended March 31, 2020, we have earned $363 from BUCKLER as an allocated share of Financing Gross Profit for a reduction of interest on repurchase agreements charged to the Company. Financing Gross Profit is defined in the operating agreement, subject to a contractually required reduction in our share of the Financing Gross Profit of $306 per annum until the end of the first quarter of 2020. See Note 11 - Stockholders' Equity for discussion of equity transactions with BUCKLER.
We previously entered into three subordinated loan agreements with BUCKLER, totaling $105.0 million. On March 18, 2019, these three subordinated loan agreements were consolidated into one loan of $105.0 million, maturing on April 1, 2022. Subsequent to March 31, 2020, we agreed to extend the maturity of the loan to May 1, 2025. BUCKLER may at its option after obtaining regulatory approval repay all or a portion of the principal amount of the loan. The loan has a stated interest rate of zero , plus additional interest payable to the Company in an amount equal to the amount of interest earned by BUCKLER on the investment of the loan proceeds, generally in government securities funds. For the three months ended March 31, 2020 and March 31, 2019, the Company earned $258 and $539 respectively, of interest.
The table below summarizes other transactions with BUCKLER at March 31, 2020 and December 31, 2019.
Transactions with BUCKLER | March 31, 2020 | December 31, 2019 | ||||||
Repurchase agreements (1) | $ | $ | ||||||
Interest on repurchase agreements | $ | $ | ||||||
Collateral posted on repurchase agreements | $ | $ | ||||||
(1) |
Note 16 - Subsequent Events
Coronavirus ("COVID-19") pandemic
The novel COVID-19 pandemic has been unprecedented and continues to have a real-time impact on all business sectors. The extent of the ultimate impact of the COVID-19 pandemic on the Company's operational and financial performance will depend on various developments, including the duration of the outbreak and the spread of the virus and the federal government's and states' responses to the virus, which cannot be reasonably predicted at this time. While the Company is not able to estimate the future impact of the COVID-19 pandemic at this time, it could continue to materially affect the Company’s future financial and operational results.
31
ARMOUR Residential REIT, Inc.
FINANCIAL STATEMENT NOTES (UNAUDITED)
(in thousands, except per share)
Portfolio Purchases and Sales
Subsequent to March 31, 2020, we purchased Agency Securities and reduced our Credit Risk Transfer securities. Accordingly, as of April 30, 2020, our securities portfolio was valued at approximately $5,600,000 consisting primarily of approximately $5,300,000 of Agency Securities (including approximately $1,300,000 of TBA Agency Securities).
Common Stock
On April 2, 2020, we announced that we will move to a quarterly dividend on our common stock for the second quarter of 2020. We expect to announce our decision regarding the amount of second quarter dividends on common stock in the latter part of June 2020 as well as whether we will return to our prior monthly dividend policy.
Between April 7, 2020 and April 24, 2020, we issued 5,704 shares under our Common stock ATM Sales Agreement for proceeds of $48,393 , net of issuance costs and commissions of approximately $738 .
Series C Preferred Stock
A cash dividend of $0.15 per outstanding share of Series C Preferred Stock, or $773 in the aggregate, was paid on April 27, 2020 to holders of record on April 15, 2020. We have also declared cash dividends of $0.15 per outstanding share of Series C Preferred Stock payable May 27, 2020 to holders of record on May 15, 2020.
32
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
ARMOUR Residential REIT, Inc.
References to “we,” “us,” “our,” or the “Company” are to ARMOUR Residential REIT, Inc. (“ARMOUR”) and its subsidiaries. References to “ACM” are to ARMOUR Capital Management LP, a Delaware limited partnership. ARMOUR owns a 10% equity interest in BUCKLER Securities LLC ("BUCKLER"), a Delaware limited liability company and a FINRA-regulated broker-dealer, controlled by ACM and certain executive officers of ARMOUR. Refer to the Glossary of Terms for definitions of capitalized terms and abbreviations used in this report.
The following discussion of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this report. U.S. dollar amounts are presented in thousands, except per share amounts or as otherwise noted.
Overview
ARMOUR is a Maryland corporation formed in 2008 and managed by ACM, an investment advisor registered with the SEC (see Note 9 and Note 15 to the consolidated financial statements). We have elected to be taxed as a REIT under the Code. We believe that we are organized in conformity with the requirements for qualification as a REIT under the Code and our manner of operations enables us to meet the requirements for taxation as a REIT for federal income tax purposes.
Our strategy is to create shareholder value through thoughtful investment and risk management that produces current yield and superior risk adjusted returns over the long term. Our focus on residential real estate finance supports home ownership for a broad and diverse spectrum of Americans by bringing private capital into the mortgage markets. We are deeply committed to implementing sustainable environmental, responsible social, and prudent governance practices that improve our work and our world.
We strive to contribute to a healthy, sustainable environment by utilizing resources efficiently. As an organization, we create a relatively small environmental footprint. Still, we are focused on minimizing the environmental impact of our business where possible.
We invest in MBS. Some MBS are issued or guaranteed by a U.S. GSE, such as Fannie Mae, Freddie Mac, or a government agency such as Ginnie Mae (collectively, "Agency Securities"). Our Agency Securities consist primarily of fixed rate loans. The remaining MBS in which we invest are either backed by hybrid adjustable rate or adjustable rate loans. Other MBS in which we invest, for which the payment of principal and interest is not guaranteed by a GSE or government agency, may benefit from credit enhancement derived from structural elements such as subordination, over collateralization or insurance (collectively, "Credit Risk and Non-Agency Securities"). From time to time, we may also invest in Interest-Only Securities, U.S. Treasury Securities and money market instruments.
We earn returns on the spread between the yield on our assets and our costs, including the interest cost of the funds we borrow, after giving effect to our hedges. We identify and acquire MBS, finance our acquisitions with borrowings under a series of short-term repurchase agreements and then hedge certain risks based on our entire portfolio of assets and liabilities and our management’s view of the market.
Factors that Affect our Results of Operations and Financial Condition
Our results of operations and financial condition are affected by various factors, many of which are beyond our control, including, among other things, our net interest income, the market value of our assets and the supply of and demand for such assets. Recent events, such as those discussed below, can affect our business in ways that are difficult to predict and may produce results outside of typical operating variances. Our net interest income varies primarily as a result of changes in interest rates, borrowing costs and prepayment speeds, the behavior of which involves various risks and uncertainties. We look to invest across the spectrum of mortgage investments, from Agency Securities, for which the principal and interest payments are guaranteed by a GSE, to Credit Risk and Non-Agency Securities and non-prime mortgage loans. As such, we expect our investments to be subject to risks arising from delinquencies and foreclosures, thereby exposing our investment portfolio to potential losses. We are exposed to changing credit spreads, which could result in declines in the fair value of our investments. We believe ACM’s in-depth investment expertise across multiple sectors of the mortgage market, prudent asset selection and our hedging strategy enable us to minimize our credit losses, our market value losses and financing costs.
33
ARMOUR Residential REIT, Inc.
Management’s Discussion and Analysis (continued)
Interest Rates - Changes in interest rates, particularly short-term interest rates, may significantly influence our net interest income. With the maturities of our assets, generally of a longer term than those of our liabilities, interest rate increases will tend to decrease our net interest income and the market value of our assets (and therefore our book value). Such rate increases could possibly result in operating losses or adversely affect our ability to make distributions to our stockholders. Our operating results depend, in large part, upon our ability to manage interest rate risks effectively while maintaining our status as a REIT.
Prepayment Rates - Prepayments on MBS and the underlying mortgage loans may be influenced by changes in market interest rates and a variety of economic and geographic factors, policy decisions by regulators, as well as other factors beyond our control. To the extent we hold MBS acquired at a premium or discount to par, or face value, changes in prepayment rates may impact our anticipated yield. In periods of declining interest rates, prepayments on our MBS will likely increase. If we are unable to reinvest the proceeds of such prepayments at comparable yields, our net interest income may decline. Our operating results depend, in large part, upon our ability to manage prepayment risks effectively while maintaining our status as a REIT.
While we use strategies to economically hedge some of our interest rate risk, we do not hedge all of our exposure to changes in interest rates and prepayment rates, as there are practical limitations on our ability to insulate our securities portfolio from all potential negative consequences associated with changes in short-term interest rates in a manner that will allow us to seek attractive net spreads on our securities portfolio. Also, since we have not elected to use cash flow hedge accounting, earnings reported in accordance with GAAP will fluctuate even in situations where our derivatives are operating as intended. As a result of this mark-to-market accounting treatment, our results of operations are likely to fluctuate far more than if we were to designate our derivative activities as cash flow hedges. Comparisons with companies that use cash flow hedge accounting for all or part of their derivative activities may not be meaningful. For these and other reasons more fully described under the section captioned “Derivative Instruments” below, no assurance can be given that our derivatives will have the desired beneficial impact on our results of operations or financial condition.
In addition to the use of derivatives to hedge interest rate risk, a variety of other factors relating to our business may also impact our financial condition and operating performance; these factors include
• | our degree of leverage; |
• | our access to funding and borrowing capacity; |
• | the REIT requirements under the Code; and |
• | the requirements to qualify for an exclusion under the 1940 Act and other regulatory and accounting policies related to our business. |
Management
See Note 9 and Note 15 to the consolidated financial statements.
Market and Interest Rate Trends and the Effect on our Securities Portfolio:
First Quarter 2020 Trends
The novel Coronavirus ("COVID-19") pandemic has been unprecedented and continues to have a real-time impact on all business sectors. The strong intervention by the Federal Reserve helped stabilize the agency residential and commercial mortgage-backed securities and recover a large amount of the spread widening that took place during the month of March. ARMOUR has acted aggressively to mitigate risk, moderate leverage and maximize liquidity and activated its remote work environment protocol to minimize health and operational risks. The Company's remote work environment protocol has allowed our operations to remain fully functional while we work remotely. The Company remains focused on prioritizing liquidity through this period of increased market volatility and financial risks. The rapid spread of COVID-19 around the globe has set off an immediate flight to cash and cash-equivalent products, causing turmoil to the U.S. Treasuries and the U.S. Agency MBS markets. The Company has met all of its obligations to repurchase agreement counterparties in a timely manner, while prudently
34
ARMOUR Residential REIT, Inc.
Management’s Discussion and Analysis (continued)
managing the risk of its assets and hedges portfolios. Trading activity in agency Credit Risk Transfer securities has resumed and prices are stabilizing. See Item 1A. "Risk Factors" for further discussion of the possible impact of COVID-19 pandemic on our business.
Developments at Fannie Mae and Freddie Mac
The payments we receive on the Agency Securities in which we invest depend upon a steady stream of payments by borrowers on the underlying mortgages and the fulfillment of guarantees by GSEs. There can be no assurance that the U.S. Government's intervention in Fannie Mae and Freddie Mac will continue to be adequate or assured for the longer-term viability of these GSEs. These uncertainties may lead to concerns about the availability of and market for Agency Securities in the long term. Accordingly, if the GSEs defaulted on their guaranteed obligations, suffered losses or ceased to exist, the value of our Agency Securities and our business, operations and financial condition could be materially and adversely affected.
The passage of any new federal legislation affecting Fannie Mae and Freddie Mac may create market uncertainty and reduce the actual or perceived credit quality of securities issued or guaranteed by them. If Fannie Mae and Freddie Mac were reformed or wound down, it is unclear what effect, if any, this would have on the value of the existing Fannie Mae and Freddie Mac Agency Securities. The foregoing could materially adversely affect the pricing, supply, liquidity and value of the Agency Securities in which we invest and otherwise materially adversely affect our business, operations and financial condition.
On June 3, 2019, Fannie Mae and Freddie Mac started issuing a new common security, the Uniform MBS, in place of their previous offerings of MBS. The new Uniform MBS was issued using a new Common Securitization Platform ("CSP"). The Uniform MBS more closely resembles the previous Fannie Mae MBS and has become the basis for the TBA MBS market place. Previously existing Freddie Mac MBS are eligible for exchange into the new Uniform MBS. The introduction of the new Uniform MBS did not have a material impact on our existing MBS and we do not expect our securities portfolio to be materially impacted in the future.
Short-term Interest Rates and Funding Costs
Changes in Fed policy affect our financial results, since our cost of funds is largely dependent on short-term rates. An increase in our cost of funds without a corresponding increase in interest income earned on our MBS would cause our net income to decline. Below is the Fed's target range for the Federal Funds Rate at each Fed meeting where a change was made from March 2018 to March 2020.
Meeting Date | Lower Bound | Higher Bound | ||||
March 15, 2020 | 0.00 | % | 0.25 | % | ||
March 3, 2020 | 1.00 | % | 1.25 | % | ||
December 2019 | 1.50 | % | 1.75 | % | ||
October 2019 | 1.50 | % | 1.75 | % | ||
September 2019 | 1.75 | % | 2.00 | % | ||
July 2019 | 2.00 | % | 2.25 | % | ||
December 2018 | 2.25 | % | 2.50 | % | ||
September 2018 | 2.00 | % | 2.25 | % | ||
June 2018 | 1.75 | % | 2.00 | % | ||
March 2018 | 1.50 | % | 1.75 | % | ||
Our borrowings in the repurchase market have historically closely tracked the Federal Funds Rate and LIBOR. Traditionally, a lower Federal Funds Rate has indicated a time of increased net interest margin and higher asset values. Volatility in these rates and divergence from the historical relationship among these rates could negatively impact our ability to manage our securities portfolio. If rates were to increase as a result, our net interest margin and the value of our securities portfolio might suffer as a result. The expected discontinuation of LIBOR in 2021 may impact our liquidity and the value of our MBS.
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ARMOUR Residential REIT, Inc.
Management’s Discussion and Analysis (continued)
SOFR is currently scheduled to replace LIBOR as a reference rate. We are currently assessing the impact on our securities portfolio and will continue to do so until 2021.
The following graph shows 30-day LIBOR as compared to the Effective Federal Funds Rate on a monthly average from March 31, 2018 to March 31, 2020.
Long-term Interest Rates and Mortgage Spreads
Our securities are valued at an interest rate spread versus long-term interest rates (mortgage spread). This mortgage spread varies over time and can be above or below long-term averages, depending upon market participants' current desire to own MBS over other investment alternatives. When the mortgage spread gets smaller (or negative) versus long-term interest rates, our book value will be positively affected. When this spread gets larger (or positive), our book value will be negatively affected.
Mortgage spreads can vary due to movements in securities valuations, movements in long-term interest rates or a combination of both. We mainly use interest rate swap contracts (including swaptions) to economically hedge against changes in the valuation of our securities. We do not use such hedging contracts for speculative purposes.
We reduce our net TBA Agency Securities exposure by entering in to certain TBA short positions. The TBA short positions represent different securities and maturities than our TBA Agency Security long positions, and accordingly, may perform somewhat differently. While we expect our TBA Agency Securities short positions to perform well compared to our related mortgage securities, there can be no assurance as to their relative performance.
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ARMOUR Residential REIT, Inc.
Management’s Discussion and Analysis (continued)
Results of Operations
Net Income (Loss) Summary
The following is a summary of our consolidated results of operations for the periods presented:
Our results for the quarter were significantly impacted by the novel Coronavirus outbreak that occurred in the second and third week of March 2020. To increase liquidity in March, we significantly reduced our portfolio of Agency Securities (including TBA Agency Securities) by 68% from December 31, 2019. We also terminated $3,975,000 in notional interest rate swaps. The net loss for the quarter reflected realized and unrealized losses on our interest rate swaps due to declines in interest rates in the quarter and exiting notional positions as well as fair value losses on our Credit Risk Transfer securities.
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ARMOUR Residential REIT, Inc.
Management’s Discussion and Analysis (continued)
Net Interest Income
Net interest income is a function of both our securities portfolio size and net interest rate spread.
2020 vs. 2019
• | Our average securities portfolio increased 10.5% from $10,909,345 for the three months ended March 31, 2019 to $12,056,794 for the three months ended March 31, 2020. |
• | Our average securities portfolio yield decreased 0.47% and our cost of funds decreased 0.08% quarter over quarter. |
• | Net interest income increased from 2019 to 2020 due to a higher average securities portfolio balance for the first two months of the quarter. This was partially offset by the decrease in our portfolio yield. Our net interest rate spread was 1.23% and 1.62% at March 31, 2020 and March 31, 2019, respectively. |
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ARMOUR Residential REIT, Inc.
Management’s Discussion and Analysis (continued)
The following table presents the components of the yield earned on our securities portfolio for the quarterly periods ended on the dates shown below:
Asset Yield | Cost of Funds | Net Interest Margin | Interest Expense on Repurchase Agreements | |||||||||
March 2020 | 3.18 | % | 1.95 | % | 1.23 | % | 1.94 | % | ||||
December 2019 | 3.63 | % | 2.14 | % | 1.49 | % | 2.14 | % | ||||
September 2019 | 3.56 | % | 2.25 | % | 1.31 | % | 2.55 | % | ||||
June 2019 | 3.70 | % | 2.30 | % | 1.40 | % | 2.69 | % | ||||
March 2019 | 3.65 | % | 2.03 | % | 1.62 | % | 2.71 | % | ||||
December 2018 | 3.59 | % | 1.92 | % | 1.67 | % | 2.55 | % | ||||
September 2018 | 3.46 | % | 1.82 | % | 1.64 | % | 2.30 | % | ||||
June 2018 | 3.13 | % | 1.57 | % | 1.56 | % | 2.10 | % | ||||
March 2018 | 3.05 | % | 1.53 | % | 1.52 | % | 1.77 | % | ||||
The yield on our assets is most significantly affected by the rate of repayments on our Agency Securities. The following graph shows the annualized CPR on a monthly basis for the quarterly periods ended on the dates shown below.
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ARMOUR Residential REIT, Inc.
Management’s Discussion and Analysis (continued)
Other Income (Loss)
2020 vs. 2019
• | Gains (losses) on Agency Securities resulted from the sales of Agency Securities during the three months ended March 31, 2020 of $10,395,454 (including $618,081 receivable for unsettled sales) compared to $1,017,396 during the three months ended March 31, 2019. |
• | At March 31, 2020, we evaluated our available sale securities to determine if an allowance for credit losses was required for securities which were in an unrealized loss position and determined that, as we may be required to sell these securities in the near future we recognized an impairment of $1,012 in our consolidated statements of operations. No OTTI was recognized for the three months ended March 31, 2019. |
• | Gain (loss) on Credit Risk and Non-Agency Securities results from the the change in fair value of the securities as well as sales of Credit Risk and Non-Agency Securities. The change in the fair value of the securities was $(181,879) for the three months ended March 31, 2020. We did not sell any Credit Risk and Non-Agency Securities for the three months ended March 31, 2019. For the three months ended March 31, 2020, we sold $142,539 (including $70,102 receivable for unsettled sales) of Credit Risk and Non-Agency Securities, which resulted in losses of $(1,232). |
• | Loss on Interest-Only Securities for the three months ended March 31, 2019 resulted from the change in the fair value of these securities. We did not have Interest-Only Securities at March 31, 2020. |
• | Sales of U.S. Treasury Securities of $3,785,248, resulted in a realized gain of $21,771 for the three months ended March 31, 2020. Sales of U.S. Treasury Securities of $199,445 during the three months ended March 31, 2019 resulted |
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ARMOUR Residential REIT, Inc.
Management’s Discussion and Analysis (continued)
in a realized loss of $(750). The change in fair value of the securities was $57 for the three months ended March 31, 2019.
• | Losses on Derivatives resulted from a combination of the following: |
◦ | Changes in interest rates and TBA prices. |
◦ | The decrease in our total interest rate swap contracts' aggregate notional balance from $7,975,000 at December 31, 2019 to $4,000,000 at March 31, 2020. |
◦ | The increase in our total TBA Agency Securities aggregate notional balance from $1,000,000 at December 31, 2019 to $1,250,000 at March 31, 2020. |
Expenses
The Company is managed by ACM, pursuant to management agreements with ARMOUR and JAVELIN. The ARMOUR management fees are determined based on gross equity raised. Therefore, management fees increase when we raise capital and decline when we repurchase previously issued stock and liquidate distributions as approved and so designated by a majority of the Board. However, because the ARMOUR management fee rate decreased to 0.75% per annum for gross equity raised in excess of $1.0 billion pursuant to the ARMOUR management agreement, the effective average management fee rate declines as equity is raised. Gross equity raised was $2,887,586 at March 31, 2020, compared to $2,986,934 at March 31, 2019, respectively. Commencing with the second quarter of 2020 and continuing until further notice, ACM is waiving 40% of its management fee.
Professional fees include securities clearing, legal, audit and consulting costs and are generally driven by the size and complexity of our securities portfolio, the volume of transactions we execute and the extent of research and due diligence activities we undertake on potential transactions.
Insurance includes premiums for both general business and directors and officers liability coverage. The fluctuation from year to year is due to changes in premiums.
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ARMOUR Residential REIT, Inc.
Management’s Discussion and Analysis (continued)
Compensation includes both non-executive director compensation as well as the restricted stock units awarded to our executive officers and other ACM employees through ACM. The fluctuation from year to year is due to a combination of the change in our stock price and the number of awards vesting to our executive officers and other ACM employees.
Other expenses include fees for market and pricing data, analytics and risk management systems and portfolio related data processing costs as well as stock exchange listing fees and similar stockholder related expenses, net of other miscellaneous income.
Taxable Income
As a REIT that regularly distributes all of its taxable income, we are generally not required to pay federal income tax (see Note 14 to the consolidated financial statements).
Comprehensive Income (Loss)
Comprehensive income (loss) includes all changes in equity during a period, except those resulting from investments by owners and distributions to owners (see Note 13 to the consolidated financial statements).
Financial Condition
Investments In Securities
Our securities portfolio consists primarily of Agency Securities backed by fixed rate home loans. From time to time, a portion of our Agency Securities may be backed by hybrid adjustable rate and adjustable rate home loans as well as unsecured notes and bonds issued by GSEs, U.S. Treasuries and money market instruments, subject to certain income tests we must satisfy for our qualification as a REIT. Our charter permits us to invest in MBS. Our TBA Agency Securities are reported at net carrying value and are reported in Derivatives, at fair value on our consolidated balance sheets (see Note 8 to the consolidated financial statements).
The charts below present our investments in securities by percentage of our total investments in securities, at fair value as of the dates indicated.
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ARMOUR Residential REIT, Inc.
Management’s Discussion and Analysis (continued)
Available for Sale Securities:
Agency Securities
Security purchase and sale transactions, including purchases and sales for forward settlement, are recorded on the trade date to the extent it is probable that we will take or make timely physical delivery of the related securities. Gains or losses realized from the sale of securities are included in income and are determined using the specific identification method. We typically purchase Agency Securities at premium prices. The premium price paid over par value on those assets is expensed as the underlying mortgages experience repayment or prepayment. The lower the prepayment rate, the lower the amount of amortization expense for a particular period. Accordingly, the yield on an asset and earnings are higher. If prepayment rates increase, the amount of amortization expense for a particular period will go up. These increased prepayment rates would act to decrease the yield on an asset and would decrease earnings.
Our net interest income is primarily a function of the difference between the yield on our assets and the financing (borrowing and hedging) cost of owning those assets. Since we tend to purchase Agency Securities at a premium to par, the main item that can affect the yield on our Agency Securities after they are purchased is the rate at which the mortgage borrowers repay the loan. While the scheduled repayments, which are the principal portion of the homeowners’ regular monthly payments, are fairly predictable, the unscheduled repayments, which are generally refinancing of the mortgage but can also result from repurchases of delinquent, defaulted, or modified loans, are less so. Being able to accurately estimate and manage these repayment rates is a critical portion of the management of our securities portfolio, not only for estimating current yield but also for considering the rate of reinvestment of those proceeds into new securities, the yields on those new securities and the impact of the repayments on our hedging strategy.
Adjustable and hybrid adjustable rate mortgage loans underlying some of our Agency Securities have fixed-interest rates after which time the interest rates reset and become adjustable. After a reset date, interest rates on our adjustable and hybrid adjustable Agency Securities float based on spreads over various indices, typically LIBOR or the one-year constant maturity treasury rate. These interest rates are subject to caps that limit the amount the applicable interest rate can increase during any year, known as an annual cap and through the maturity of the security, known as a lifetime cap.
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ARMOUR Residential REIT, Inc.
Management’s Discussion and Analysis (continued)
TBA Agency Securities:
We account for TBA Agency Securities as derivative instruments if it is reasonably possible that we will not take or make physical delivery of the Agency Security upon settlement of the contract. TBA Agency Securities are forward contracts for the purchase (“long position”) or sale (“short position”) of Agency Securities at a predetermined price, face amount, issuer, coupon and stated maturity on an agreed-upon future date. The specific Agency Securities delivered pursuant to the contract upon the settlement date, published each month by the Securities Industry and Financial Markets Association, are not known at the time of the transaction. We estimate the fair value of TBA Agency Securities based on similar methods used to value our Agency Securities. TBA Agency Securities are included in the table below on a gross basis as they can be used to establish and finance portfolio positions in Agency Securities.
The table below summarizes certain characteristics of our Agency Securities and TBA Agency Securities at March 31, 2020 and December 31, 2019.
Asset Type | Principal Amount | Fair Value | Weighted Average Coupon | CPR (1) | Weighted Average Months to Maturity | Percent of Total | |||||||||||||
March 31, 2020 | |||||||||||||||||||
Agency Securities: | |||||||||||||||||||
Total Fannie Mae | $ | 1,930,475 | $ | 2,184,964 | 3.9 | % | 6.7 | % | 168 | 53.6 | % | ||||||||
Total Freddie Mac | 536,387 | 580,027 | 4.3 | % | 20.3 | % | 333 | 14.2 | |||||||||||
Total Ginnie Mae | 21,418 | 21,971 | 3.4 | % | 10.8 | % | 230 | 0.5 | |||||||||||
Total Agency Securities | $ | 2,488,280 | $ | 2,786,962 | 4.0 | % | 9.6 | % | 203 | 68.3 | % | ||||||||
TBA Agency Securities: | |||||||||||||||||||
15 Year Long (2) | 500,000 | 513,310 | 2.0 | % | n/a | n/a | 12.6 | ||||||||||||
30 Year Long (2) | 750,000 | 779,152 | 2.7 | % | n/a | n/a | 19.1 | ||||||||||||
Total TBA Agency Securities | $ | 1,250,000 | $ | 1,292,462 | 2.4 | % | n/a | n/a | 31.7 | % | |||||||||
Total | $ | 3,738,280 | $ | 4,079,424 | 100.0 | % | |||||||||||||
December 31, 2019 | |||||||||||||||||||
Agency Securities: | |||||||||||||||||||
Total Fannie Mae | $ | 8,779,331 | $ | 9,269,786 | 3.7 | % | 14.4 | % | 239 | 71.6 | % | ||||||||
Total Freddie Mac | 2,522,870 | 2,648,795 | 3.9 | % | 20.7 | % | 329 | 20.5 | |||||||||||
Total Ginnie Mae | 22,504 | 23,185 | 3.7 | % | 11.6 | % | 233 | 0.1 | |||||||||||
Total Agency Securities | $ | 11,324,705 | $ | 11,941,766 | 3.8 | % | 15.8 | % | 259 | 92.2 | % | ||||||||
TBA Agency Securities: | |||||||||||||||||||
15 Year Long (2) | 500,000 | 511,885 | 3.0 | % | n/a | n/a | 4.0 | % | |||||||||||
30 Year Long (2) | 500,000 | 494,395 | 2.5 | % | n/a | n/a | 3.8 | % | |||||||||||
Total TBA Agency Securities | $ | 1,000,000 | $ | 1,006,280 | 2.8 | % | n/a | n/a | 7.8 | % | |||||||||
Total | $ | 12,324,705 | $ | 12,948,046 | 100.0 | % | |||||||||||||
(1) | Weighted average CPR during the quarter for the securities owned at March 31, 2020 and December 31, 2019. |
(2) | Our TBA Agency Securities are recorded as derivative instruments in our accompanying consolidated financial statements. Our TBA Agency Securities are reported at net carrying value of $22,044 and $(592), at March 31, 2020 and December 31, 2019, respectively, and are reported in Derivatives, at fair value on our consolidated balance sheets (see Note 8 to the consolidated financial statements). |
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ARMOUR Residential REIT, Inc.
Management’s Discussion and Analysis (continued)
Trading Securities:
Credit Risk and Non-Agency Securities
We purchase Credit Risk and Non-Agency Securities at prices which incorporate our expectations for prepayment speeds, defaults, delinquencies and severities. These expectations determine the yields we receive on our assets. If actual prepayment speeds, defaults, delinquencies and severities are different from our expectations, our actual yields could be higher or lower. Our Credit Risk and Non-Agency Securities are subject to risk of loss with regard to principal and interest payments. We evaluate each investment based on the characteristics of the underlying collateral and securitization structure, rather than relying on the ratings assigned by rating agencies.
The table below summarizes the credit ratings of our Credit Risk and Non-Agency Securities.
Investment Grade | Non-Investment Grade | Non-Rated | Total | |||||||||||||
March 31, 2020 | $ | 448,186 | $ | 166,389 | $ | 150,978 | $ | 765,553 | ||||||||
December 31, 2019 | $ | 570,332 | $ | 233,418 | $ | 79,851 | $ | 883,601 | ||||||||
Interest-Only Securities
From time to time we may purchase Interest-Only Securities to tailor the overall risk characteristics of our investment securities portfolio. We did not have any Interest-Only Securities at March 31, 2020 or December 31, 2019.
U.S. Treasury Securities
From time to time we may purchase U.S. Treasury Securities to tailor the overall risk characteristics of our investment securities portfolio. While U.S. Treasury Securities provide overall interest rate exposure, they are generally not sensitive to the other risks inherent in MBS. We did not have any U.S. Treasury Securities at March 31, 2020 or December 31, 2019.
The table below summarizes certain characteristics of our Trading Securities at March 31, 2020 and December 31, 2019. We did not have any Interest-Only Securities or U.S. Treasury Securities at March 31, 2020 or December 31, 2019.
Asset Type | Principal Amount | Fair Value | Weighted Average Coupon | Weighted Average Months to Maturity | Percent of Total | |||||||||||
March 31, 2020 | ||||||||||||||||
Credit Risk Transfer | $ | 821,060 | $ | 696,041 | 4.7 | % | 162 | 90.9 | % | |||||||
Non-Agency Securities | 90,721 | 69,512 | 5.2 | % | 224 | 9.1 | ||||||||||
Total for Credit Risk and Non-Agency Securities | $ | 911,781 | $ | 765,553 | 4.8 | % | 167 | 100.0 | % | |||||||
December 31, 2019 | ||||||||||||||||
Credit Risk Transfer | $ | 754,729 | $ | 803,964 | 5.9 | % | 114 | 91.0 | % | |||||||
Non-Agency Securities | 93,723 | 79,637 | 5.2 | % | 226 | 9.0 | ||||||||||
Total for Credit Risk and Non-Agency Securities | $ | 848,452 | $ | 883,601 | 5.8 | % | 124 | 100.0 | % | |||||||
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ARMOUR Residential REIT, Inc.
Management’s Discussion and Analysis (continued)
Repurchase Agreements
We have entered into repurchase agreements to finance the majority of our MBS. Our repurchase agreements are secured by our MBS and bear interest at rates that have historically moved in close relationship to the Federal Funds Rate and LIBOR. We have established borrowing relationships with numerous investment banking firms and other lenders, 18 of which had open repurchase agreements with us at March 31, 2020 and 25 of which had open repurchases agreements with us at December 31, 2019. We had outstanding balances under our repurchase agreements at March 31, 2020 and December 31, 2019 of $3,465,472 and $11,354,547, respectively, consistent with the increase in our MBS in our securities portfolio.
Our repurchase agreements require excess collateral, known as a “haircut.” At March 31, 2020, the average haircut percentage was 7.34% compared to 5.16% at December 31, 2019. The change in the average haircut percentage is a reflection of the response by our repurchase agreement counterparties to increase collateralization haircut levels on our portfolio of Credit Risk and Non-Agency Securities due to the impact of the COVID-19 pandemic.
Derivative Instruments
We use various contracts to manage our interest rate risk as we deem prudent in light of market conditions and the associated costs with counterparties that have a high quality credit rating and with futures exchanges. We generally pay a fixed rate and receive a floating rate with the objective of fixing a portion of our borrowing costs and hedging the change in our book value to some degree. The floating rate we receive is generally the Federal Funds Rate, SOFR or LIBOR. Our policies do not contain specific requirements as to the percentages or amount of interest rate risk that we are required to hedge. No assurance can be given that our derivatives will have the desired beneficial impact on our results of operations or financial condition. We have not elected cash flow hedge accounting treatment as allowed by GAAP. Since we do not designate our derivative activities as cash flow hedges, realized as well as unrealized gains/losses from these transactions will impact our GAAP earnings.
Use of derivative instruments may fail to protect or could adversely affect us because, among other things:
• | available derivatives may not correspond directly with the interest rate risk for which protection is sought (e.g., the difference in interest rate movements for long-term U.S. Treasury Securities compared to Agency Securities); |
• | the duration of the derivatives may not match the duration of the related liability; |
• | the counterparty to a derivative agreement with us may default on its obligation to pay or not perform under the terms of the agreement and the collateral posted may not be sufficient to protect against any consequent loss; |
• | we may lose collateral we have pledged to secure our obligations under a derivative agreement if the associated counterparty becomes insolvent or files for bankruptcy; |
• | we may experience a termination event under one or more of our derivative agreements related to our REIT status, equity levels and performance, which could result in a payout to the associated counterparty and a taxable loss to us; |
• | the credit-quality of the party owing money on the derivatives may be downgraded to such an extent that it impairs our ability to sell or assign our side of the hedging transaction; and |
• | the value of derivatives may be adjusted from time to time in accordance with GAAP to reflect changes in fair value; downward adjustments, or “mark-to-market losses,” would reduce our net income or increase any net loss. |
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ARMOUR Residential REIT, Inc.
Management’s Discussion and Analysis (continued)
The following graphs present the notional and weighted average interest rate of our interest rate swap contracts by year of maturity.
At March 31, 2020 and December 31, 2019, we had derivatives with a net fair value of $(176,176) and $(47,223), respectively. At March 31, 2020 and December 31, 2019, we had interest rate swap contracts with an aggregate notional balance
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ARMOUR Residential REIT, Inc.
Management’s Discussion and Analysis (continued)
of $4,000,000 and $7,975,000, respectively. Counterparty risk of derivatives are limited to some degree because of daily mark-to-market and collateral requirements. These derivative transactions are designed to; (1) lock in a portion of funding costs for financing activities associated with our assets in such a way as to help assure the realization of attractive net interest margins and (2) vary inversely in value with our MBS. Such contracts are based on assumptions about prepayments which, if not realized, will cause results to differ from expectations.
We also had TBA Agency Securities with an aggregate notional balance of $1,250,000 and 1,000,000 at March 31, 2020 and December 31, 2019, respectively.
Although we attempt to structure our derivatives to offset the changes in asset prices, the complexity of the actual and expected prepayment characteristics of the underlying mortgages as well as the volatility in mortgage interest rates relative to U.S. Treasury and interest rate swap contract rates makes achieving high levels of off-set difficult. We recognized net losses of $(369,035) and $(135,198), for the three months ended March 31, 2020 and March 31, 2019, respectively, related to our derivatives.
As required by the Dodd-Frank Act, the Commodity Futures Trading Commission has adopted rules requiring certain interest rate swap contracts to be cleared through a derivatives clearing organization. We are required to clear certain new interest rate swap contracts. Cleared interest rate swaps may have higher margin requirements than un-cleared interest rate swaps we previously had. We have established an account with a futures commission merchant for this purpose. To date, we have not entered into any cleared interest rate swap contracts.
We are required to account for our TBA Agency Securities as derivatives when it is reasonably possible that we will not take or make timely physical delivery of the related securities. However, from time to time, we use TBA Agency Securities primarily to effectively establish portfolio positions. See the section, "TBA Agency Securities" above.
Contractual Obligations and Commitments
We had the following contractual obligations at March 31, 2020:
Payments Due By Period | ||||||||||||||||||||
Obligations | Total | < 1 Year | ≥ 1 and ≤ 3 Years | > 3 and ≤ 5 Years | > 5 Years | |||||||||||||||
Repurchase agreements (1) | $ | 3,465,472 | $ | 3,465,472 | $ | — | $ | — | $ | — | ||||||||||
Interest expense on repurchase agreements | 6,706 | 6,706 | — | — | — | |||||||||||||||
Related Party Fees (2) | 204,099 | 29,157 | 58,314 | 58,314 | 58,314 | |||||||||||||||
Board of Directors fees (3) | 9,457 | 1,351 | 2,702 | 2,702 | 2,702 | |||||||||||||||
Total | $ | 3,685,734 | $ | 3,502,686 | $ | 61,016 | $ | 61,016 | $ | 61,016 | ||||||||||
(1) | At March 31, 2020, BUCKLER accounted for 56.2% of our aggregate borrowings and had an amount at risk of 7.7% of our total stockholders' equity with a weighted average maturity of 27 days on repurchase agreements (refer to Note 7 to the consolidated financial statements). |
(2) | Represents fees to be paid to ACM under the terms of the management agreements (refer to Note 9 and Note 15 to the consolidated financial statements). |
(3) | Represents compensation to be paid to the Board in the form of cash and common equity. |
We had contractual commitments under derivatives at March 31, 2020. We had interest rate swap contracts with an aggregate notional balance of $4,000,000, a weighted average swap rate of 1.75% and a weighted average term of 46 months at March 31, 2020. We also entered into $1,250,000 notional of TBA Agency Securities during the three months ended March 31, 2020.
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ARMOUR Residential REIT, Inc.
Management’s Discussion and Analysis (continued)
Liquidity and Capital Resources
At March 31, 2020, our liquidity totaled $360,056, consisting of $333,884 of cash plus $26,172 of unpledged MBS (including securities received as collateral). Our primary sources of funds are borrowings under repurchase arrangements, monthly principal and interest payments on our MBS and cash generated from our operating results. Other sources of funds may include proceeds from equity and debt offerings and asset sales (refer to Note 11 to the consolidated financial statements). We generally maintain liquidity to pay down borrowings under repurchase arrangements to reduce borrowing costs and otherwise efficiently manage our long-term investment capital. Because the level of our borrowings can be adjusted on a daily basis, the level of cash carried on our consolidated balance sheet is significantly less important than our potential liquidity available under our borrowing arrangements. We continue to pursue additional lending counterparties in order to help increase our financial flexibility and ability to withstand periods of contracting liquidity in the credit markets.
In addition to the repurchase agreement financing discussed above, from time to time we have entered into reverse repurchase agreements with certain of our repurchase agreement counterparties. Under a typical reverse repurchase agreement, we purchase U.S. Treasury Securities from a borrower in exchange for cash and agree to sell the same securities back in the future. We then sell such U.S. Treasury Securities to third parties and recognize a liability to return the securities to the original borrower. Reverse repurchase agreement receivables and repurchase agreement liabilities are presented net when they meet certain criteria, including being with the same counterparty, being governed by the same MRA, settlement through the same brokerage or clearing account and maturing on the same day. The practical effect of these transactions is to replace a portion of our repurchase agreement financing of our MBS in our securities portfolio with short positions in U.S. Treasury Securities. We believe that this helps to reduce interest rate risk, and therefore counterparty credit and liquidity risk. Both parties to the repurchase and reverse repurchase transactions have the right to make daily margin calls based on changes in the value of the collateral obtained and/or pledged. We did not have any reverse repurchase agreements outstanding at March 31, 2020 and December 31, 2019.
Our primary uses of cash are to purchase MBS, pay interest and principal on our borrowings, fund our operations and pay dividends. From time to time, we purchase or sell assets for forward settlement up to 90 days in the future to lock in purchase prices or sales proceeds. At March 31, 2020 and December 31, 2019, we financed our securities portfolio with $3,465,472 and $11,354,547 of borrowings under repurchase agreements. Our leverage ratios at March 31, 2020 and December 31, 2019, were 4.41:1 and 7.90:1, respectively. Our leverage ratio is calculated by dividing the amount outstanding under our repurchase agreements at period end by total stockholders’ equity at period end.
During the three months ended March 31, 2020, we purchased $6,129,078 of securities using proceeds from repurchase agreements and principal repayments. During the three months ended March 31, 2020, we received cash of $507,170 from principal payments on our MBS. We had a net cash decrease from our repurchase agreements of $7,889,075 for the three months ended March 31, 2020 and made cash interest payments of approximately $139,313 on our liabilities for the three months ended March 31, 2020.
During the three months ended March 31, 2019, we purchased $6,907,777 of securities using proceeds from repurchase agreements and principal repayments. During the three months ended March 31, 2019, we received cash of $152,112 from principal payments on our MBS. We had a net cash decrease from our repurchase agreements of $5,105,623 for the three months ended March 31, 2019 and made cash interest payments of approximately $98,627 on our liabilities for the three months ended March 31, 2019.
Cash and cash collateral posted to counterparties provided by (used in) operating activities was $(184,446) and $(11,334), respectively, for the three months ended March 31, 2020 and March 31, 2019. The decrease in cash and cash collateral posted to counterparties related to operating activities is related to the realized loss on our derivatives. Our average securities portfolio was $12,056,794 and $10,909,345 for the three months ended March 31, 2020 and March 31, 2019, respectively. During the three months ended March 31, 2020, we sold 5,303 of Series C Preferred stock under our Preferred C Underwritten Offering and our Preferred C ATM Sales Agreement, for an increase in equity of $129,221. During the three months ended March 31, 2020 we also fully redeemed all 8,383 issued and outstanding shares of our Series B Preferred Stock ($25.00 per share, $209,583 in the aggregate liquidation preference).
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ARMOUR Residential REIT, Inc.
Management’s Discussion and Analysis (continued)
We currently believe that we have sufficient liquidity and capital resources available for the acquisition of additional investments, repayments on repurchase borrowings, reacquisition of securities to be returned to borrowers and the payment of cash dividends as required for continued qualification as a REIT.
Repurchase Agreements
Declines in the value of our Agency Securities portfolio can trigger margin calls by our lenders under our repurchase agreements. An event of default or termination event under the standard MRA would give our counterparty the option to terminate all repurchase transactions existing with us and require any amount due to be payable immediately.
Changing capital or other financial market regulatory requirements may cause our lenders to exit the repurchase market, increase financing rates, tighten lending standards or increase the amount of required equity capital or haircut we post, any of which could make it more difficult or costly for us to obtain financing.
The following graph represents the outstanding balances of our repurchase agreements (before the effect of netting reverse repurchase agreements), which finance most of our MBS. Our repurchase agreements balance will fluctuate based on our change in capital, leverage targets and the market prices of our assets (including the effects of principal paydowns) and the level and timing of investment and reinvestment activity.
See Note 7 and Note 15 to the consolidated financial statements for additional information.
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ARMOUR Residential REIT, Inc.
Management’s Discussion and Analysis (continued)
Effects of Margin Requirements, Leverage and Credit Spreads
Our MBS have values that fluctuate according to market conditions and, as discussed above, the market value of our MBS will decrease as prevailing interest rates or credit spreads increase. When the value of the securities pledged to secure a repurchase agreement decreases to the point where the positive difference between the collateral value and the loan amount is less than the haircut, our lenders may issue a margin call, which requires us to pay the difference in cash or pledge additional collateral to meet the obligations under our repurchase agreements. Under our repurchase facilities, our lenders have full discretion to determine the value of the MBS we pledge to them. Most of our lenders will value securities based on recent trades in the market. Lenders also issue margin calls as the published current principal balance factors change on the pool of mortgages underlying the securities pledged as collateral when scheduled and unscheduled principal repayments are announced monthly. At March 31, 2020, we received waivers from certain ISDA counterparties related to significant reductions in equity capital that would have otherwise caused a default or termination event.
We generally seek to borrow (on a recourse basis) between six and ten times the amount of our total stockholders’ equity. At March 31, 2020 and December 31, 2019, we financed our securities portfolio with $3,465,472 and $11,354,547 of borrowings under repurchase agreements. Our leverage ratios at March 31, 2020 and December 31, 2019, were 4.41:1 and 7.90:1, respectively. Our leverage ratio is calculated by dividing the amount outstanding under our repurchase agreements at period end by total stockholders’ equity at period end.
Forward-Looking Statements Regarding Liquidity
Based on our current portfolio, leverage rate and available borrowing arrangements, we believe that our cash flow from operations and our ability to make timely portfolio adjustments will be sufficient to enable us to meet anticipated short-term (one year or less) liquidity requirements such as to fund our investment activities, meet our financing obligations, pay fees under the management agreements and fund our distributions to stockholders and pay general corporate expenses.
We may increase our capital resources by obtaining long-term credit facilities or making public or private offerings of equity or debt securities, including classes of preferred stock, common stock and senior or subordinated notes to meet our long-term (greater than one year) liquidity. Such financing will depend on market conditions for capital raises and for the investment of any proceeds and there can be no assurances that we will successfully obtain any such financing.
Stockholders’ Equity
See Note 11 to the consolidated financial statements.
Off-Balance Sheet Arrangements
At March 31, 2020 and December 31, 2019, we had not maintained any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance, or special purpose or variable interest entities, established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Furthermore, at March 31, 2020 and December 31, 2019, we had not guaranteed any obligations of any unconsolidated entities or entered into any commitment or intent to provide funding to any such entities. All of our transactions with BUCKLER are reflected in our consolidated balance sheets.
Critical Accounting Policies
See Note 3 to the consolidated financial statements for our significant accounting policies.
Valuation
The unrealized changes in fair value on our available for sale securities are reflected in total stockholders' equity as accumulated other comprehensive income or loss. Changes in fair value of our trading securities are reported in the consolidated statements of operations as income or loss. We do not use hedge accounting for our derivatives for financial reporting purposes
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ARMOUR Residential REIT, Inc.
Management’s Discussion and Analysis (continued)
and therefore changes in fair value are reflected in net income as other gain or loss. To the extent that fair value changes on derivatives offset fair value changes in our MBS, the fluctuation in our stockholders’ equity will be lower. For example, rising interest rates may tend to result in an overall increase in our reported net income even while our total stockholders’ equity declines.
Fair value for our MBS and derivatives are based on obtaining a valuation for each from third party pricing services and/or dealer quotes. The third party pricing services use common market pricing methods that may include pricing models that may incorporate such factors as coupons, collateral type, bond structure, prepayment speeds, priority of payments, defaults, delinquencies and severities, spread to the Treasury curve and interest rate swap curves, duration, periodic and life caps and credit enhancement. If the fair value of the MBS is not available from the third party pricing services or such data appears unreliable, we obtain pricing indications from up to three dealers who make markets in similar MBS. Management reviews pricing used to ensure that current market conditions are properly reflected. This review includes, but is not limited to, comparisons of similar market transactions or alternative third party pricing services, dealer pricing indications and comparisons to a third party pricing model.
Fair value for our U.S. Treasury Securities is based on obtaining a valuation for each U.S. Treasury Securities from third party pricing services and/or dealer quotes.
Realized Gains and Losses
Security purchase and sale transactions, including purchases and sales for forward settlement, are recorded on the trade date to the extent it is probable that we will take or make timely physical delivery of the related securities.
Available for Sale Securities
We realize gains and losses on our available for sale securities upon their sale. At that time, previously unrealized amounts included in accumulated other comprehensive income are reclassified and reported in net income as other gain or loss. To the extent that we sell available for sale securities in later periods after changes in the fair value of those available for sale securities have occurred, we may report significant net income or net loss without a corresponding change in our total stockholders' equity.
Declines in the fair values of our available for sale securities that represent credit impairments are also treated as realized losses and reported in net income as other loss. We evaluate available for sale securities for impairment at least on a quarterly basis and more frequently when economic or market concerns warrant such evaluation. We consider available for sale securities impaired if we (1) intend to sell the available for sale securities, (2) believe it is more likely than not that we will be required to sell the securities before recovery (for example, because of liquidity requirements or contractual obligations), and a credit loss exists. Impairment losses recognized establish a new cost basis for the related available for sale securities. Gains or losses on subsequent sales are determined by reference to such new cost basis.
Trading Securities
We carry our trading securities at fair value and reflect changes in those fair values in net income as other gains and losses.
Inflation
Virtually all of our assets and liabilities are interest rate-sensitive in nature. As a result, interest rates and other factors influence our performance far more than inflation. Changes in interest rates do not necessarily correlate with inflation rates or changes in inflation rates. Our financial statements are prepared in accordance with GAAP and any distributions we may make will be determined by our Board based in part on our REIT taxable income as calculated according to the requirements of the Code; in each case, our activities and balance sheet are measured with reference to fair value without considering inflation.
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ARMOUR Residential REIT, Inc.
Management’s Discussion and Analysis (continued)
Subsequent Events
See Note 16 to the consolidated financial statements.
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
The forward-looking statements in this report are based on our beliefs, assumptions and expectations of our future performance, taking into account all information currently available to us. These beliefs, assumptions and expectations are subject to risks and uncertainties and can change as a result of many possible events or factors, not all of which are known to us. If a change occurs, our business, financial condition, liquidity and results of operations may vary materially from those expressed in our forward-looking statements. See Part I, Item 1A. "Risk Factors" of our most recent Annual Report on Form 10-K. You should carefully consider these risks before you make an investment decision with respect to our stock, along with the following factors that could cause actual results to vary from our forward-looking statements:
• | the impact of the COVID-19 pandemic on our operations; |
• | the impact of the federal conservatorship of Fannie Mae and Freddie Mac and related efforts, along with any changes in laws and regulations affecting the relationship between Fannie Mae and Freddie Mac and the federal government and the Fed system; |
• | the possible material adverse effect on our business if the U.S. Congress passed legislation reforming or winding down Fannie Mae or Freddie Mac; |
• | mortgage loan modification programs and future legislative action; |
• | actions by the Fed which could cause a change of the yield curve, which could materially adversely affect our business, financial condition and results of operations and our ability to pay distributions to our stockholders; |
• | the impact of a delay or failure of the U.S. Government in reaching an agreement on the national debt ceiling; |
• | availability, terms and deployment of capital; |
• | extended trade disputes with foreign countries. |
• | changes in economic conditions generally; |
• | changes in interest rates, interest rate spreads and the yield curve or prepayment rates; |
• | general volatility of the financial markets, including markets for mortgage securities; |
• | a downgrade of the U.S. Government's or certain European countries' credit ratings and future downgrades of the U.S. Government's or certain European countries' credit ratings may materially adversely affect our business, financial condition and results of operations; |
• | our inability to maintain the level of non-taxable returns of capital through the payment of dividends to our stockholders or to pay dividends to our stockholders at all; |
• | inflation or deflation; |
• | the impact of a shutdown of the U.S. Government; |
• | availability of suitable investment opportunities; |
• | the degree and nature of our competition, including competition for MBS; |
• | changes in our business and investment strategy; |
• | our failure to maintain our qualification as a REIT; |
• | our failure to maintain an exemption from being regulated as a commodity pool operator; |
• | our dependence on ACM and ability to find a suitable replacement if ACM was to terminate its management relationship with us; |
• | the existence of conflicts of interest in our relationship with ACM, BUCKLER, certain of our directors and our officers, which could result in decisions that are not in the best interest of our stockholders; |
• | our management's competing duties to other affiliated entities, which could result in decisions that are not in the best interest of our stockholders; |
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ARMOUR Residential REIT, Inc.
Management’s Discussion and Analysis (continued)
• | changes in personnel at ACM or the availability of qualified personnel at ACM; |
• | limitations imposed on our business by our status as a REIT under the Code; |
• | the potential burdens on our business of maintaining our exclusion from the 1940 Act and possible consequences of losing that exclusion; |
• | changes in GAAP, including interpretations thereof; and |
• | changes in applicable laws and regulations. |
We cannot guarantee future results, levels of activity, performance or achievements. You should not place undue reliance on forward-looking statements, which apply only as of the date of this report. We do not intend and disclaim any duty or obligation to update or revise any industry information or forward-looking statements set forth in this report to reflect new information, future events or otherwise, except as required under the U.S. federal securities laws.
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GLOSSARY OF TERMS
ARMOUR Residential REIT, Inc.
Term | Definition | |
Agency Securities | Securities issued or guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae; interests in or obligations backed by pools of fixed rate, hybrid adjustable rate and adjustable rate mortgage loans. | |
ARMs | Adjustable Rate Mortgage backed securities. | |
Basis swap contracts | Derivative contracts that allow us to exchange one floating interest rate basis for another, for example, 3 month LIBOR and Fed Funds Rates, thereby allowing us to diversify our floating rate basis exposures. | |
Board | ARMOUR’s Board of Directors. | |
BUCKLER | A Delaware limited liability company, and a FINRA-regulated broker-dealer. The primary purpose of our investment in BUCKLER is to facilitate our access to repurchase financing, on potentially more attractive terms (considering rate, term, size, haircut, relationship and funding commitment) compared to other suitable repurchase financing counterparties. | |
CFO | Chief Financial Officer of ARMOUR, James Mountain. | |
Co-CEOs | Co-Chief Executive Officers of ARMOUR, Jeffrey Zimmer and Scott Ulm. | |
Code | The Internal Revenue Code of 1986. | |
CPR | Constant prepayment rate. | |
Credit Risk and Non-Agency Securities | Securities backed by residential mortgages in which we may invest, which are not issued or guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae. | |
Dodd-Frank Act | The Dodd-Frank Wall Street Reform and Consumer Protection Act. | |
Exchange Act | Securities Exchange Act of 1934. | |
Fannie Mae | The Federal National Mortgage Association. | |
Fed | The U.S. Federal Reserve. | |
FINRA | The Financial Industry Regulatory Authority. A private corporation that acts as a self-regulatory organization. | |
Freddie Mac | The Federal Home Loan Mortgage Corporation. | |
GAAP | Accounting principles generally accepted in the United States of America. | |
Ginnie Mae | the Government National Mortgage Administration. | |
GSE | A U.S. Government Sponsored Entity. Obligations of agencies originally established or chartered by the U.S. government to serve public purposes as specified by the U.S. Congress; these obligations are not explicitly guaranteed as to the timely payment of principal and interest by the full faith and credit of the U.S. government. | |
Haircut | The weighted average margin requirement, or the percentage amount by which the collateral value must exceed the loan amount. Among other things, it is a measure of our unsecured credit risk to our lenders. | |
Hybrid | A mortgage that has a fixed rate for an initial term after which the rate becomes adjustable according to a specific schedule. | |
Interest-Only Securities | The interest portion of Agency Securities, which is separated and sold individually from the principal portion of the same payment. | |
ISDA | International Swaps and Derivatives Association. | |
JAVELIN | JAVELIN Mortgage Investment Corp., formerly a publicly-traded REIT. Since its acquisition on April 6, 2016, JAVELIN became a wholly-owned, qualified REIT subsidiary of ARMOUR and continues to be managed by ACM pursuant to the pre-existing management agreement between JAVELIN and ACM. | |
LIBOR | The London Interbank Offered Rate. | |
MBS | Mortgage backed securities. A security representing a direct interest in a pool of mortgage loans. The pass-through issuer or servicer collects the payments on the loans in the pool and “passes through” the principal and interest to the security holders on a pro rata basis. | |
Merger | The merger of JMI Acquisition Corporation with and into JAVELIN on April 6, 2016. | |
MGCL | Maryland General Corporation Law | |
ARMOUR Residential REIT, Inc.
GLOSSARY OF TERMS (continued)
MRA | Master repurchase agreement. A document that outlines standard terms between the Company and counterparties for repurchase agreement transactions | |
Multi-Family MBS | MBS issued under Fannie Mae's Delegated Underwriting System (DUS) program. | |
NYSE | New York Stock Exchange. | |
OTTI | Other than temporary impairment. | |
REIT | Real Estate Investment Trust. A special purpose investment vehicle that provides investors with the ability to participate directly in the ownership or financing of real-estate related assets by pooling their capital to purchase and manage mortgage loans and/or income property. | |
Repurchase Program | ARMOUR's common stock repurchase program authorized by our Board. | |
Sarbanes-Oxley Act | A U.S. federal law that set new or enhanced standards for all U.S. public company boards, management and public accounting firms. Section 302 requires senior management to certify the accuracy of the financial statements. Section 404 requires that management and auditors establish internal controls and reporting methods on the adequacy of those controls. | |
SEC | The Securities and Exchange Commission. | |
SOFR | Secured overnight funding rate. A measure of the cost of borrowing cash overnight collateralized by U.S. Treasury Securities. | |
TBA Agency Securities | Forward contracts for the purchase (“long position”) or sale (“short position”) of Agency Securities at a predetermined price, face amount, issuer, coupon and stated maturity on an agreed-upon future date. | |
TBA Drop Income | The discount associated with TBA Agency Securities contracts which reflects the expected interest income on the underlying deliverable Agency Securities, net of an implied financing cost, which would have been earned by the buyer if the TBA Agency Securities contract had settled on the next regular settlement date instead of the forward settlement date specified. TBA Drop Income is calculated as the difference between the forward settlement price of the TBA Agency Securities contract and the spot price of similar TBA Agency Securities contracts for regular settlement. The Company generally accounts for TBA Agency Securities contracts as derivatives and TBA Drop Income is included as part of the periodic changes in fair value of the TBA Agency Securities that the Company recognizes in the Other Income (Loss) section of its Consolidated Statement of Operations. | |
TRS | Taxable REIT subsidiary. | |
U.S. | United States. | |
1940 Act | The Investment Company Act of 1940. | |
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Item 3. Quantitative and Qualitative Disclosures about Market Risk
ARMOUR Residential REIT, Inc.
We seek to manage our risks related to the credit-quality of our assets, interest rates, liquidity, prepayment speeds and market value while, at the same time, seeking to provide an opportunity to stockholders to realize attractive risk adjusted returns through ownership of our capital stock. While we do not seek to avoid risk completely, we believe the risk can be quantified from historical experience and seek to actively manage that risk, to earn sufficient compensation to justify taking those risks and to maintain capital levels consistent with the risks we undertake.
Interest Rate Risk
Our primary market risk is interest rate risk. Interest rates are highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors beyond our control. Changes in the general level of interest rates can affect net interest income, which is the difference between the interest income earned on our assets and the interest expense incurred in connection with our liabilities, by affecting the spread between the interest-earning assets and interest-bearing liabilities. Changes in the level of interest rates also can affect the value of MBS and our ability to realize gains from the sale of these assets. A decline in the value of the MBS pledged as collateral for borrowings under repurchase agreements could result in the counterparties demanding additional collateral pledges or liquidation of some of the existing collateral to reduce borrowing levels.
A portion of our securities portfolio consists of hybrid adjustable rate and adjustable rate MBS. Hybrid mortgages are ARMs that have a fixed-interest rate for an initial period of time (typically three years or greater) and then convert to an adjustable rate for the remaining loan term. ARMs are typically subject to periodic and lifetime interest rate caps that limit the amount the interest rate can change during any given period. Furthermore, some ARMs may be subject to periodic payment caps that result in some portion of the interest being deferred and added to the principal outstanding. ARMs are also typically subject to a minimum interest rate payable. Most of our adjustable rate assets are based on the one-year constant maturity treasury rate and the one-year LIBOR rate. Our fixed rate MBS have interest rates that are not variable and are constant for the entire loan term.
Our borrowings are not subject to similar restrictions and are generally repurchase agreements of limited duration that track the Federal Funds Rate and LIBOR and are periodically refinanced at current market rates. Therefore, on average, our cost of funds may rise or fall more quickly than our earnings rate on our assets. Hence, in a period of increasing interest rates, interest rates on our borrowings could increase without limitation, while the changes in the interest rates on our mortgage related assets could be limited. These factors could lower our net interest income or cause a net loss during periods of rising interest rates, which would negatively impact our liquidity, net income and our ability to make distributions to stockholders.
We anticipate that in most cases the interest rates, interest rate indices and repricing terms of our mortgage assets and our funding sources will not be identical, thereby creating an interest rate mismatch between assets and liabilities. These indices generally move in the same direction, but there can be no assurance that this will continue to occur. Furthermore, our net income may vary somewhat as the spread between one-month interest rates, the typical term for our repurchase agreements, and the interest rates on our mortgage assets varies. During periods of changing interest rates, such interest rate mismatches could negatively impact our net interest income, dividend yield and the market price of our stock.
Another component of interest rate risk is the effect changes in interest rates will have on the market value of our MBS. We face the risk that the market value of our MBS will increase or decrease at different rates than that of our liabilities, including our derivative instruments.
We primarily assess our interest rate risk by estimating the effective duration of our assets and the effective duration of our liabilities and by estimating the time difference between the interest rate adjustment of our assets and the interest rate adjustment of our liabilities. Effective duration essentially measures the market price volatility of financial instruments as interest rates change. We generally estimate effective duration using various financial models and empirical data. Different models and methodologies can produce different effective duration estimates for the same securities.
The sensitivity analysis tables presented below reflect the estimated impact of an instantaneous parallel shift in the yield curve, up and down 50 and 100 basis points, on the market value of our interest rate-sensitive investments and net interest income, at March 31, 2020 and December 31, 2019. It assumes that the mortgage spread on our MBS remains constant. Actual
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ARMOUR Residential REIT, Inc.
Market Risk Disclosures (continued)
interest rate movements over time will likely be different, and such differences may be material. When evaluating the impact of changes in interest rates, prepayment assumptions and principal reinvestment rates are adjusted based on ACM’s expectations. The analysis presented utilized assumptions, models and estimates of ACM based on ACM's judgment and experience.
Percentage Change in Projected | ||||||
Change in Interest Rates | Net Interest Income | Portfolio Including Derivatives | Shareholder's Equity | |||
March 31, 2020 (1) | ||||||
1.00% | 180.15% | (1.36)% | (8.03)% | |||
0.50% | 91.97% | (0.56)% | (3.33)% | |||
(0.50)% | (94.39)% | 0.27% | 1.61% | |||
(1.00)% | (191.58)% | 0.33% | 1.92% | |||
December 31, 2019 | ||||||
1.00% | (16.52)% | (1.54)% | (14.77)% | |||
0.50% | (7.87)% | (0.59)% | (5.63)% | |||
(0.50)% | 3.58% | 0.07% | 0.62% | |||
(1.00)% | (10.16)% | (0.53)% | (5.12)% | |||
(1) | The March 31, 2020 balance sheet has been impacted by the events surrounding the COVID-19 pandemic and is the result of management's efforts and desire to preserve liquidity and manage risk rather than focus on income generation. |
While the tables above reflect the estimated immediate impact of interest rate increases and decreases on a static securities portfolio, we rebalance our securities portfolio from time to time either to seek to take advantage of or reduce the impact of changes in interest rates. It is important to note that the impact of changing interest rates on market value and net interest income can change significantly when interest rates change beyond 100 basis points from current levels. Therefore, the volatility in the market value of our assets could increase significantly when interest rates change beyond amounts shown in the tables above. In addition, other factors impact the market value of and net interest income from our interest rate-sensitive investments and derivative instruments, such as the shape of the yield curve, market expectations as to future interest rate changes and other market conditions. Accordingly, interest income would likely differ from that shown above and such difference might be material and adverse to our stockholders.
Mortgage Spread Risk
Weakness in the mortgage market may adversely affect the performance and market value of our investments. This could negatively impact our book value. Furthermore, if our lenders are unwilling or unable to provide additional financing, we could be forced to sell our MBS at an inopportune time when prices are depressed.
The table below quantifies the estimated changes in the fair value of our securities portfolio and in our shareholders' equity as of March 31, 2020 and December 31, 2019. The estimated impact of changes in spreads is in addition to our interest rate sensitivity presented above. Our securities portfolio's sensitivity to mortgage spread changes will vary with changes in interest rates and in the size and composition of our securities portfolio. Therefore, actual results could differ materially from our estimates.
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ARMOUR Residential REIT, Inc.
Market Risk Disclosures (continued)
March 31, 2020 | December 31, 2019 | |||||||
Percentage Change in Projected | Percentage Change in Projected | |||||||
Change in MBS spread | Portfolio Value | Shareholders' Equity | Portfolio Value | Shareholders' Equity | ||||
+25 BPS | (1.23)% | (7.58)% | (1.21)% | (11.64)% | ||||
+10 BPS | (0.49)% | (3.03)% | (0.48)% | (4.65)% | ||||
-10 BPS | 0.49% | 3.03% | 0.48% | 4.65% | ||||
-25 BPS | 1.23% | 7.58% | 1.21% | 11.64% | ||||
Prepayment Risk
As we receive payments of principal on our MBS, premiums paid on such securities are amortized against interest income and discounts are accreted to interest income as realized. Premiums arise when we acquire MBS at prices in excess of the principal balance of the mortgage loans underlying such MBS. Conversely, discounts arise when we acquire MBS at prices below the principal balance, adjusted for expected credit losses, of the mortgage loans underlying such MBS. Volatility in actual prepayment speeds will create volatility in the amount of premium amortization we recognize. Higher speeds will reduce our interest income and lower speeds will increase our interest income.
Credit Risk
We have limited our exposure to credit losses on our securities portfolio of Agency Securities. The payment of principal and interest on the Freddie Mac and Fannie Mae Agency Securities are guaranteed by those respective agencies and the payment of principal and interest on the Agency Securities guaranteed by Ginnie Mae are backed by the full faith and credit of the U.S. Government. Fannie Mae and Freddie Mac remain in conservatorship of the U.S. Government. There can be no assurances as to how or when the U.S. Government will end these conservatorships or how the future profitability of Fannie Mae and Freddie Mac and any future credit rating actions may impact the credit risk associated with Agency Securities and, therefore, the value of the Agency Securities. All of our Agency Securities are issued and guaranteed by GSEs or Ginnie Mae. The GSEs have a long term credit rating of AA+.
We purchase Credit Risk and Non-Agency Securities at prices which incorporate our expectations for prepayment speeds, defaults, delinquencies and severities. These expectations determine the yields we receive on our assets. If actual prepayment speeds, defaults, delinquencies and severities are different from our expectations, our actual yields could be higher or lower. We evaluate each investment based on the characteristics of the underlying collateral and securitization structure, rather than relying on the ratings assigned by rating agencies. Our Credit Risk and Non-Agency Securities are subject to risk of loss with regard to principal and interest payments. At March 31, 2020, 58.5% of our Credit Risk and Non-Agency Securities were assigned an investment grade rating and 41.5%, were assigned below an investment grade rating, or were not rated. At December 31, 2019, 64.5% of our Credit Risk and Non-Agency Securities were assigned an investment grade rating and 35.5% were assigned below an investment grade rating or were not rated.
Liquidity Risk
Our primary liquidity risk arises from financing long-maturity MBS with short-term debt. The interest rates on our borrowings generally adjust more frequently than the interest rates on our ARMs. Accordingly, in a period of rising interest rates, our borrowing costs will usually increase faster than our interest earnings from MBS. Our repurchase agreements require that we maintain adequate pledged collateral. A decline in the value of the MBS pledged as collateral for borrowings under repurchase agreements could result in the counterparties demanding additional collateral pledges or liquidation of some of the existing collateral to reduce borrowing levels.
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ARMOUR Residential REIT, Inc.
Market Risk Disclosures (continued)
Operational Risk
We rely on our financial, accounting and other data processing systems. Computer malware, viruses, computer hacking and phishing attacks have become more prevalent in our industry and may occur on our systems. Although we have not detected a material cybersecurity breach to date, other financial services institutions have reported material breaches of their systems, some of which have been significant. Even with all reasonable security efforts, not every breach can be prevented or even detected. It is possible that we have experienced an undetected breach. There is no assurance that we, or the third parties that facilitate our business activities, have not or will not experience a breach. It is difficult to determine what, if any, negative impact may directly result from any specific interruption or cyber-attacks or security breaches of our networks or systems (or the networks or systems of third parties that facilitate our business activities) or any failure to maintain performance.
ACM has established an Information Technology Steering Committee (“the Committee”) to help mitigate technology risks including cybersecurity. One of the roles of the Committee is to oversee cyber risk assessments, monitor applicable key risk indicators, review cybersecurity training procedures, oversee the Company’s Cybersecurity Incident Response Plan and engage third parties to conduct periodic penetration testing. Our cybersecurity risk assessment includes an evaluation of cyber risk related to sensitive data held by third parties on their systems. There is no assurance that these efforts will effectively mitigate cybersecurity risk and mitigation efforts are not an assurance that no cybersecurity incidents will occur.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Our Co-Chief Executive Officers (“Co-CEOs”) and Chief Financial Officer (“CFO”) participated in an evaluation by our management of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of our fiscal quarter that ended on March 31, 2020. Based on their participation in that evaluation, our Co-CEOs and CFO concluded that our disclosure controls and procedures were effective as of March 31, 2020 to ensure that information required to be disclosed in our reports filed or submitted under the Exchange Act, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and to ensure that information required to be disclosed in our reports filed or furnished under the Exchange Act, is accumulated and communicated to our management, including our Co-CEOs and CFO, as appropriate, to allow timely decisions regarding required disclosures.
Internal Control Over Financial Reporting
Our Co-CEOs and CFO also participated in an evaluation by our management of any changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the quarter ended March 31, 2020. That evaluation did not identify any changes that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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PART II. OTHER INFORMATION
ARMOUR Residential REIT, Inc.
Item 1. Legal Proceedings
There have been no material changes to the legal proceedings disclosed in our Annual Report on Form 10–K for the year ended December 31, 2019, filed with the SEC on February 19, 2020.
Item 1A. Risk Factors
Except as set forth below, there have been no material changes to the risk factors disclosed in our Annual Report on Form 10-K for the year ended December 31, 2019, filed with the SEC on February 19, 2020.
We expect the novel COVID-19 pandemic to have a significant effect on our results of operations. In addition, it has resulted in significant financial market volatility, and its impact on the global economy appears to be significant. A continuation or worsening of the pandemic will have a material adverse impact on our business, results of operations and financial condition and on the market price of our common stock.
On March 12, 2020, the World Health Organization declared COVID-19 to be a pandemic. In an effort to contain and mitigate the spread of COVID-19, many countries, including the United States, Canada and China, have imposed unprecedented restrictions on travel, and there have been business closures and a substantial reduction in economic activity in countries that have had significant outbreaks of COVID-19. Significant uncertainty remains as to the potential impact of the COVID-19 pandemic on our continuing operations and on the global economy as a whole. It is currently not possible to predict how long the pandemic will last or the time that it will take for economic activity to return to prior levels. The COVID-19 pandemic has resulted in significant financial market volatility and uncertainty. A continuation or worsening of the levels of market disruption and volatility seen in the recent past could have an adverse effect on our ability to access capital, on our business, results of operations and financial condition, and on the market price of our common stock. We expect that our results of operations will reflect a negative impact from, among other things, the global pandemic. Depending upon the duration and severity of the pandemic, the continuing effect on our results over the long term is uncertain.
Responding to the COVID-19 pandemic, both Fannie Mae and Freddie Mac have announced mortgage forbearance policies that will allow borrowers to delay their mortgage payments for up to one year. Individual states also have adopted or may adopt forbearance policies addressing loan payments, rent payments, foreclosures and evictions. These policies may impact our investments in many ways, some that are foreseeable, others that are not. The impact of high levels of forbearance on our securities portfolio could range from immaterial to significant depending upon not only actual losses incurred on underlying loans but also future public policy choices and actions by the GSEs, their regulator the Federal Housing Finance Authority ("FHFA"), the Fed, and federal and state governments. The nature and timing of any such future public policy choices and actions are unpredictable. We expect prepayment speeds on Agency Securities to be affected and scenarios suggesting both slowing and increasing prepayment speeds are plausible. Certain classes of our Credit Risk Transfer securities, in our securities portfolio contain contractual provisions that allow the issuing GSE to declare a credit event based solely on payment delays, including forbearance (even if the issuing GSE ultimately sustains no loss on the underlying loans). While similar forbearance during prior natural disasters did not result in CRT credit events, there can be no assurance as to what stance the GSEs and the FHFA will take on this issue regarding the COVID-19 pandemic forbearance.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
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ARMOUR Residential REIT, Inc.
Issuer Purchases of Equity Securities
The following table presents information regarding our net common stock repurchases made during the three months ended March 31, 2020 (in thousands, except per share price).
Total Number of Shares Purchased (1) | Average Price Paid Per Share (2) | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | Maximum Number of Shares That May Yet Be Purchased Under the Publicly Announced Plans or Programs (3) | |||||||||
January 1, 2020 through January 31, 2020 | — | $ | — | — | 8,250 | |||||||
February 1, 2020 through February 29, 2020 | 10 | $ | 20.02 | 10 | 8,260 | |||||||
March 1, 2020 through March 31, 2020 | (50 | ) | $ | 19.47 | (50 | ) | 8,210 | |||||
Total | (40 | ) | (40 | ) | 8,210 | |||||||
(1) | All shares were repurchased pursuant to our stock repurchase program (the "Repurchase Program") (see Note 11 to the consolidated financial statements). |
(2) | Weighted average share price |
(3) | On June 4, 2019, the Board increased the repurchase authorization under the Repurchase Program to 9,000 shares. At December 31, 2019, there were 8,250 authorized shares remaining under the current Repurchase Program. |
Item 3. Defaults Upon Senior Securities
None.
Item 4. Mine Safety Disclosures
Not applicable.
Item 5. Other Information
On April 30, 2020, ARMOUR Capital Management LP ("ACM”) waived 40% of the Base Management Fee due from ARMOUR Residential REIT, Inc. (“ARMOUR”) and payable to ACM pursuant to the Sixth Amended and Restated Management Agreement, effective as of November 17, 2017 (the “Agreement”), between the ACM and ARMOUR, beginning with amounts becoming due and payable on or after May 1, 2020. The waiver will continue from month to month until ACM provides notice to ARMOUR. ACM may terminate this waiver for any month by providing notice to ARMOUR on or before the 25th day of the preceding month. This waiver does not constitute a waiver of any other amounts due to ACM from ARMOUR under the Agreement or otherwise, including but not limited to any expense reimbursements, any amounts calculated by reference to the contractual Base Management Fee, or any awards under the Second Amended and Restated 2009 Stock Incentive Plan.
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ARMOUR Residential REIT, Inc.
Item 6. Exhibits
EXHIBIT INDEX | ||
Exhibit Number | Description | |
3.1 | ||
4.1 | ||
31.1 | ||
31.2 | ||
31.3 | ||
32.1 | ||
32.2 | ||
32.3 | ||
101.INS | XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document. | |
101.SCH | XBRL Taxonomy Extension Schema Document (1) | |
101.CAL | XBRL Taxonomy Extension Calculation Linkbase Document (1) | |
101.DEF | XBRL Taxonomy Extension Definition Linkbase Document (1) | |
101.LAB | XBRL Taxonomy Extension Label Linkbase Document (1) | |
101.PRE | XBRL Taxonomy Extension Presentation Linkbase Document (1) | |
104 | Cover Page Interactive Data (formatted as Inline XBRL and contained in Exhibit 101) | |
(1) | Filed herewith. | |
(2) | Furnished herewith. | |
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SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
May 1, 2020 | ARMOUR RESIDENTIAL REIT, INC. |
/s/ James R. Mountain | |
James R. Mountain | |
Chief Financial Officer, Duly Authorized Officer and Principal Financial Officer | |