QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 2023
OR
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period fromto
ARMOUR RESIDENTIAL REIT, INC.
(Exact name of registrant as specified in its charter)
Maryland
001-34766
26-1908763
(State or other jurisdiction of incorporation or organization)
(Commission File Number)
(I.R.S. Employer Identification No.)
3001 Ocean Drive, Suite 201, Vero Beach, FL32963
(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
Preferred Stock, 7.00% Series C Cumulative Redeemable
ARR-PRC
New York Stock Exchange
Common Stock, $0.001 par value
ARR
New York Stock Exchange
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.
Large accelerated filer☒ Accelerated filer ☐ Non-accelerated filer ☐ Smaller reporting company ☐ Emerging growth company ☐
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 July 25, 2023 was 228,309,234.
Agency Securities (including pledged securities of $10,172,104 ($5,284,870 with BUCKLER) at June 30, 2023 and $7,249,039 at December 31, 2022 ($3,920,706 with BUCKLER))
11,176,635
8,198,591
Receivable for unsettled sales (including pledged securities of $89,013 at June 30, 2023)
94,825
—
Derivatives, at fair value
1,001,049
984,456
Accrued interest receivable
45,760
28,809
Prepaid and other
4,628
2,101
Subordinated loan to BUCKLER
—
105,000
Total Assets
$
12,539,120
$
9,437,047
Liabilities and Stockholders’ Equity
Liabilities:
Repurchase agreements, net (including $4,412,261 and $3,247,474, respectively with BUCKLER)
$
9,121,329
$
6,463,058
Obligations to return securities received as collateral, at fair value (including $99,438 and $100,531, respectively with BUCKLER)
497,188
502,656
Cash collateral posted by counterparties
963,656
963,591
Payable for unsettled purchases
616,435
353,436
Derivatives, at fair value
11,608
13,016
Accrued interest payable- repurchase agreements (including $6,447 and $9,908, respectively with BUCKLER)
33,994
19,096
Accrued interest payable- U.S. Treasury Securities sold short (including $695 and $684, respectively with BUCKLER)
3,475
3,418
Accounts payable and other accrued expenses
8,446
6,404
Total Liabilities
$
11,256,131
$
8,324,675
Commitments and contingencies (Note 8 and Note 14)
Stockholders’ Equity:
Preferred stock, $0.001 par value, 50,000 shares authorized;
7.00% Series C Cumulative Preferred Stock; 6,847 shares issued and outstanding ($25.00 per share liquidation preference)
7
7
Common stock, $0.001 par value, 450,000 and 300,000 shares authorized;
206,810 shares and 162,911 shares issued and outstanding at June 30, 2023 and December 31, 2022, respectively.
207
163
Additional paid-in capital
4,128,402
3,874,627
Cumulative distributions to stockholders
(2,098,693)
(1,992,361)
Accumulated net loss
(746,934)
(758,537)
Accumulated other comprehensive loss
—
(11,527)
Total Stockholders’ Equity
$
1,282,989
$
1,112,372
Total Liabilities and Stockholders’ Equity
$
12,539,120
$
9,437,047
See financial statement notes (unaudited).
2
ARMOUR Residential REIT, Inc.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) (UNAUDITED)
(in thousands, except per share)
For the Three Months Ended June 30,
For the Six Months Ended June 30,
2023
2022
2023
2022
Interest Income:
Interest Income (including $0 and $157 and $973 and $176, respectively with BUCKLER)
$
134,835
$
48,440
$
253,070
$
81,810
Interest expense (including $58,740 and $6,462 and $108,349 and $7,495, respectively with BUCKLER)
(129,075)
(13,035)
(235,320)
(15,440)
Net Interest Income
$
5,760
$
35,405
$
17,750
$
66,370
Other Income (Loss):
Realized loss on sale of available for sale Agency Securities (reclassified from Comprehensive Income (Loss))
—
(7,501)
(7,471)
(7,501)
Loss on Agency Securities, trading
(157,659)
(249,022)
(37,293)
(503,411)
Gain (Loss) on U.S. Treasury Securities
11,933
(33,983)
79
(112,370)
Gain on derivatives, net (1)
194,190
205,914
59,790
450,518
Total Other Income (Loss)
$
48,464
$
(84,592)
$
15,105
$
(172,764)
Expenses:
Management fees
9,392
8,297
18,636
16,437
Compensation
1,261
1,410
2,420
2,819
Other Operating
2,259
1,647
3,496
3,275
Total Expenses
$
12,912
$
11,354
$
24,552
$
22,531
Less management fees waived
(1,650)
(1,950)
(3,300)
(3,900)
Total Expenses after fees waived
$
11,262
$
9,404
$
21,252
$
18,631
Net Income (Loss)
$
42,962
$
(58,591)
$
11,603
$
(125,025)
Dividends on preferred stock
(2,996)
(2,996)
(5,991)
(5,991)
Net Income (Loss) available (related) to common stockholders
$
39,966
$
(61,587)
$
5,612
$
(131,016)
Net Income (Loss)
$
42,962
$
(58,591)
$
11,603
$
(125,025)
Reclassification adjustment for realized loss on sale of available for sale Agency Securities
—
7,501
7,471
7,501
Net unrealized gain (loss) on available for sale Agency Securities
—
(42,151)
4,056
(120,689)
Other Comprehensive Income (loss)
—
(34,650)
11,527
(113,188)
Comprehensive Income (Loss)
$
42,962
$
(93,241)
$
23,130
$
(238,213)
Dividends on preferred stock
(2,996)
(2,996)
(5,991)
(5,991)
Comprehensive Income (Loss) available (related) to common stockholders
$
39,966
$
(96,237)
$
17,139
$
(244,204)
Net Income (Loss) per share available (related) to common stockholders (Note 11):
Basic
$
0.20
$
(0.58)
$
0.03
$
(1.29)
Diluted
$
0.20
$
(0.58)
$
0.03
$
(1.29)
Dividends declared per common share
$
0.24
$
0.30
$
0.52
$
0.60
Weighted average common shares outstanding:
Basic
198,699
106,514
191,682
101,396
Diluted
200,379
106,514
193,362
101,396
(1) Interest expense related to our interest rate swap contracts is recorded in gain on derivatives, net on the consolidated statements of operations and comprehensive income (loss). For additional information, see financial statement Note 7.
See financial statement notes (unaudited).
3
ARMOUR Residential REIT, Inc.
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY (UNAUDITED)
(in thousands)
Shares
Par
Preferred Stock
Common Stock
Preferred Stock
Common Stock
Additional Paid-in Capital
Cumulative Distributions to Stockholders
Accumulated Net Loss
Accumulated Other Comprehensive Income (Loss)
Total Stockholders'Equity
Balance, March 31, 2022
6,847
100,361
$
7
$
100
$
3,458,492
$
(1,870,058)
$
(595,041)
$
28,435
$
1,021,935
Comprehensive loss
—
—
—
—
—
—
(58,591)
(34,650)
(93,241)
Issuance of common stock, net
—
10,425
—
11
79,691
—
—
—
79,702
Stock based compensation, net of withholding requirements
—
48
—
—
959
—
—
—
959
Common stock repurchased
—
(248)
—
—
(1,544)
—
—
—
(1,544)
Preferred stock dividends
—
—
—
—
—
(2,996)
—
—
(2,996)
Common stock dividends
—
—
—
—
—
(32,157)
—
—
(32,157)
Balance, June 30, 2022
6,847
110,586
$
7
$
111
$
3,537,598
$
(1,905,211)
$
(653,632)
$
(6,215)
$
972,658
Balance, March 31, 2023
6,847
192,003
7
192
4,052,190
(2,047,360)
(789,896)
—
1,215,133
Comprehensive income
—
—
—
—
—
—
42,962
—
42,962
Issuance of common stock, net
—
15,160
—
15
77,463
—
—
—
77,478
Stock based compensation, net of withholding requirements
—
72
—
—
821
—
—
—
821
Common stock repurchased
—
(425)
—
—
(2,072)
—
—
—
(2,072)
Preferred stock dividends
—
—
—
—
—
(2,996)
—
—
(2,996)
Common stock dividends
—
—
—
—
—
(48,337)
—
—
(48,337)
Balance, June 30, 2023
6,847
206,810
$
7
$
207
$
4,128,402
$
(2,098,693)
$
(746,934)
$
—
$
1,282,989
Continued
4
ARMOUR Residential REIT, Inc.
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY (UNAUDITED)
(in thousands)
Shares
Par
Preferred Stock
Common Stock
Preferred Stock
Common Stock
Additional Paid-in Capital
Cumulative Distributions to Stockholders
Accumulated Net Loss
Accumulated Other Comprehensive Income (Loss)
Total Stockholders'Equity
Balance, December 31, 2021
6,847
94,152
$
7
$
94
$
3,403,127
$
(1,837,955)
$
(528,607)
$
106,973
1,143,639
Comprehensive loss
—
—
—
—
—
—
(125,025)
(113,188)
(238,213)
Issuance of common stock, net
—
16,587
—
17
134,121
—
—
—
134,138
Stock based compensation, net of withholding requirements
—
95
—
—
1,894
—
—
—
1,894
Common stock repurchased
—
(248)
—
—
(1,544)
—
—
—
(1,544)
Preferred stock dividends
—
—
—
—
—
(5,991)
—
—
(5,991)
Common stock dividends
—
—
—
—
—
(61,265)
—
—
(61,265)
Balance, June 30, 2022
6,847
110,586
$
7
$
111
$
3,537,598
$
(1,905,211)
$
(653,632)
$
(6,215)
$
972,658
Balance, December 31, 2022
6,847
162,911
$
7
$
163
$
3,874,627
$
(1,992,361)
$
(758,537)
$
(11,527)
$
1,112,372
Comprehensive income
—
—
—
—
—
—
11,603
11,527
23,130
Issuance of common stock, net
—
45,023
—
45
258,638
—
—
—
258,683
Stock based compensation, net of withholding requirements
—
144
—
—
1,513
—
—
—
1,513
Common stock repurchased
—
(1,268)
—
(1)
(6,376)
—
—
—
(6,377)
Preferred stock dividends
—
—
—
—
—
(5,991)
—
—
(5,991)
Common stock dividends
—
—
—
—
—
(100,341)
—
—
(100,341)
Balance, June 30, 2023
6,847
206,810
$
7
$
207
$
4,128,402
$
(2,098,693)
$
(746,934)
$
—
$
1,282,989
See financial statement notes (unaudited).
5
ARMOUR Residential REIT, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(in thousands)
For the Six Months Ended June 30,
2023
2022
Cash Flows From Operating Activities:
Net Income (Loss)
$
11,603
$
(125,025)
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
3,452
13,464
Net accretion of U.S. Treasury Securities
132
(1,176)
Realized loss on sale of Agency Securities, available for sale
7,471
7,501
Loss on Agency Securities, trading
37,293
503,411
Gain (Loss) on U.S. Treasury Securities
(79)
112,370
Stock based compensation
1,513
1,894
Changes in operating assets and liabilities:
Increase in accrued interest receivable
(16,222)
(10,402)
Increase in prepaid and other assets
1,139
(2,012)
Change in derivatives, at fair value
(18,001)
(580,506)
Increase in accrued interest payable- repurchase agreements
14,898
4,438
Increase in accrued interest payable- U.S. Treasury Securities sold short
57
—
Increase in accounts payable and other accrued expenses
2,042
2,284
Net cash and cash collateral posted to counterparties provided by (used in) operating activities
$
45,298
$
(73,759)
Cash Flows From Investing Activities:
Purchases of Agency Securities (includes $247,308 with BUCKLER at June 30, 2023)
(7,259,764)
(5,482,336)
Purchases of U.S. Treasury Securities (includes $155,857 with BUCKLER at June 30, 2023)
(619,373)
(3,441,267)
Principal repayments of Agency Securities
404,010
287,457
Proceeds from sales of Agency Securities
4,008,466
2,197,403
Proceeds from sales of U.S. Treasury Securities (includes $154,875 with BUCKLER at June 30, 2023)
613,852
2,932,385
Disbursements on reverse repurchase agreements, with BUCKLER
(1,057,803)
—
Receipts from reverse repurchase agreements, with BUCKLER
1,249,579
—
Increase in cash collateral posted by counterparties
65
647,786
Proceeds from subordinated loan due from BUCKLER
105,000
—
Net cash and cash collateral posted to counterparties used in investing activities
$
(2,555,968)
$
(2,858,572)
Cash Flows From Financing Activities:
Issuance of common stock, net of expenses
255,017
134,138
Proceeds from repurchase agreements (including $36,419,817 and $19,406,946, respectively with BUCKLER)
57,386,698
34,679,574
Principal repayments on repurchase agreements (including $(35,446,806) and $(17,935,626), respectively with BUCKLER)
(54,920,203)
(31,935,064)
Series C Preferred stock dividends paid
(5,991)
(5,991)
Common stock dividends paid
(100,341)
(61,265)
Common stock repurchased
(6,377)
(1,544)
Net cash and cash collateral posted to counterparties provided by financing activities
$
2,608,803
$
2,809,848
(Continued)
6
ARMOUR Residential REIT, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(in thousands)
For the Six Months Ended June 30,
2023
2022
Net increase in cash and cash collateral posted to counterparties
98,133
(122,483)
Cash and cash collateral posted to counterparties - beginning of period
118,090
356,216
Cash and cash collateral posted to counterparties - end of period
$
216,223
$
233,733
Supplemental Disclosure:
Cash paid during the period for interest
$
269,691
$
33,776
Non-Cash Investing Activities:
Receivable for unsettled sales
$
94,825
$
427,203
Payable for unsettled purchases
$
(616,435)
$
(358,753)
Net unrealized gain (loss) on available for sale Agency Securities
$
4,056
$
(120,689)
Non-Cash Financing Activities:
Amounts receivable for issuance of common stock
$
3,666
$
—
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 10.8% 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. U.S. dollar amounts are presented in thousands, except per share amounts or as otherwise noted.
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 8 - Commitments and Contingencies and Note 14 - Related Party Transactions). 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.
At June 30, 2023 and December 31, 2022, we invested in mortgage backed securities ("MBS"), issued or guaranteed by a United States ("U.S.") Government-sponsored entity ("GSE"), such as the Federal National Mortgage Association ("Fannie Mae"), the Federal Home Loan Mortgage Corporation ("Freddie Mac"), or a government agency such as Government National Mortgage Administration ("Ginnie Mae") (collectively, "Agency Securities"). Our Agency Securities consist primarily of fixed rate loans. The remaining are either backed by hybrid adjustable rate or adjustable rate loans. From time to time we have also invested in Credit Risk and Non-Agency Securities, Interest-Only Securities, U.S. Treasury Securities and money market instruments.
Note 2 - Basis of Presentation and Consolidation
The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States ("GAAP") for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X promulgated by the SEC. Accordingly, the condensed financial statements do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and six months ended June 30, 2023 are not necessarily indicative of the results that may be expected for the calendar year ending December 31, 2023. These unaudited consolidated financial statements should be read in conjunction with the audited financial statements and notes thereto included in our annual report on Form 10-K for the year ended December 31, 2022.
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. Interest earned/paid on cash collateral posted/held on interest rate swap contracts was reclassified from Interest Income to
8
ARMOUR Residential REIT, Inc.
FINANCIAL STATEMENT NOTES (UNAUDITED)
(in thousands, except per share)
Gain (loss) on derivatives, net, in the consolidated financial statements to conform to current presentation. No other reclassifications have been made to previously reported amounts.
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, interest rate swaptions, basis swap contracts, futures contracts,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.
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 and comprehensive income (loss).
Available for Sale Securities represented investments that we intended to hold for extended periods of time and were reported at their estimated fair values with unrealized gains and losses excluded from earnings and reported as part of comprehensive income (loss). During the first quarter of 2023, we sold the remaining balance of our Available for Sale Securities which resulted in a realized loss of $(7,471).
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 and interest on repurchase agreements. At certain times, we may have interest payable on U.S. Treasury Securities sold short.
Repurchase Agreements, net
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 moved in close relationship to the Federal Funds Effective Rate ("Fed Funds Rate") and the Secured Overnight Funding Rate ("SOFR"). 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
9
ARMOUR Residential REIT, Inc.
FINANCIAL STATEMENT NOTES (UNAUDITED)
(in thousands, except per share)
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.
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. At June 30, 2023 and December 31, 2022, we had $512,500 and $704,276, respectively, in reverse repurchase agreements which are recorded in repurchase agreements, net on our consolidated balance sheet.
Obligations to Return Securities Received as Collateral, at Fair Value
We also sell to third parties the U.S. Treasury Securities received as collateral for reverse repurchase agreements and recognize the resulting obligation to return said U.S. Treasury Securities as a liability on our consolidated balance sheet. Interest is recorded on the repurchase agreements, reverse repurchase agreements and U.S. Treasury Securities on an accrual basis and presented as net interest expense. Both parties to the transaction have the right to make daily margin calls based on changes in the fair value of the collateral received and/or pledged. We had obligations to return securities received as collateral associated with our reverse repurchase agreements as of June 30, 2023 and December 31, 2022 of $497,188 ($99,438 of which were with BUCKLER) and $502,656 ($100,531 of which were with BUCKLER), respectively.
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 and comprehensive income (loss). 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 may include interest rate swap contracts, interest rate swaptions, basis swap contracts and futures 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
Impairment of available for sale securities was assessed at least on a quarterly basis and more frequently when economic or market concerns warranted such evaluation. An impairment was considered if we (1) intended to sell the available for sale securities, or (2) believed it was more likely than not that we were required to sell the securities before recovery (for example, because of liquidity requirements or contractual obligations) and a credit impairment existed where
10
ARMOUR Residential REIT, Inc.
FINANCIAL STATEMENT NOTES (UNAUDITED)
(in thousands, except per share)
fair value was less than amortized cost. Impairment losses recognized established a new cost basis for the related available for sale securities.
Revenue Recognition
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 sales of available for sale securities are reclassified into income from Comprehensive Income (Loss) and are determined using the specific identification method.
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 the sum of net income and other comprehensive income (loss). It represents all changes in equity during a period from transactions and other events from non-owner sources. It excludes all changes in equity during a period resulting from investments by owners and distributions to owners.
Note 4 - 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.
11
ARMOUR Residential REIT, Inc.
FINANCIAL STATEMENT NOTES (UNAUDITED)
(in thousands, except per share)
Investments in Securities
Fair value for our investments in 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 swap contracts 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 and are classified as Level 2. We estimate the fair value of TBA Agency Securities based on similar methods used to value our Agency Securities and they are classified as Level 2. Management compares the pricing information received to dealer quotes to ensure that the current market conditions are properly reflected. Futures contracts are traded on the Chicago Mercantile Exchange ("CME") which requires the use of daily mark-to-market collateral and they are classified as Level 1.
The following tables provide a summary of our assets and liabilities that are measured at fair value on a recurring basis at June 30, 2023 and December 31, 2022.
June 30, 2023
Level 1
Level 2
Level 3
Balance
Assets at Fair Value:
Agency Securities
$
—
$
11,176,635
$
—
$
11,176,635
Derivatives
$
11,252
$
989,797
$
—
$
1,001,049
Liabilities at Fair Value:
Derivatives
$
8,166
$
3,442
$
—
$
11,608
December 31, 2022
Level 1
Level 2
Level 3
Balance
Assets at Fair Value:
Agency Securities
$
—
$
8,198,591
$
—
$
8,198,591
Derivatives
$
94
$
984,362
$
—
$
984,456
Liabilities at Fair Value:
Derivatives
$
516
$
12,500
$
—
$
13,016
There were no transfers of assets or liabilities between the levels of the fair value hierarchy during the six months ended June 30, 2023 or for the year ended December 31, 2022.
Excluded from the tables above are financial instruments, including cash, cash collateral posted to/by counterparties, receivables, the Subordinated loan to BUCKLER, payables, borrowings under repurchase agreements, net and obligations to return securities received as collateral, which are presented in our consolidated financial statements at
12
ARMOUR Residential REIT, Inc.
FINANCIAL STATEMENT NOTES (UNAUDITED)
(in thousands, except per share)
cost, which approximates fair value. The estimated fair value of these instruments is measured using "Level 1" or "Level 2" inputs at June 30, 2023 and December 31, 2022.
Note 5 - Investments in Securities
As of June 30, 2023 and December 31, 2022, our securities portfolio consisted of $11,176,635 and $8,198,591 of investment securities, at fair value, respectively. We also had $100,734 and $777,469 of TBA Agency Securities, at fair value, which were reported at net carrying value of $(3,027) and $(11,797), respectively, at June 30, 2023 and December 31, 2022. TBA Securities are reported in Derivatives, at fair value on our consolidated balance sheets (see Note 7 - Derivatives). 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.
During the first quarter of 2023, we sold the remaining balance of our Available for Sale Securities which resulted in a realized loss of $(7,471).
The tables below present the components of the carrying value and the unrealized gain or loss position of our investments in securities at June 30, 2023 and December 31, 2022.
June 30, 2023
Principal Amount
Amortized Cost
Gross Unrealized Loss
Gross Unrealized Gain
Fair Value
Agency Securities:
Trading securities
$
11,489,593
$
11,473,356
$
(297,779)
$
1,058
$
11,176,635
Total Agency Securities
$
11,489,593
$
11,473,356
$
(297,779)
$
1,058
$
11,176,635
December 31, 2022
Principal Amount
Amortized Cost
Gross Unrealized Loss
Gross Unrealized Gain
Fair Value
Agency Securities:
Available for sale securities
$
191,870
$
199,472
$
(11,527)
$
—
$
187,945
Trading securities
8,519,397
8,553,485
(543,207)
368
8,010,646
Total Agency Securities
$
8,711,267
$
8,752,957
$
(554,734)
$
368
$
8,198,591
13
ARMOUR Residential REIT, Inc.
FINANCIAL STATEMENT NOTES (UNAUDITED)
(in thousands, except per share)
The following tables summarize the weighted average lives of our investments in securities at June 30, 2023 and December 31, 2022.
Weighted Average Life
Trading Securities
June 30, 2023
Fair Value
Amortized Cost
≥ 3 years and < 5 years
$
2,877
$
2,918
≥ 5 years
11,173,758
11,470,438
Totals
$
11,176,635
$
11,473,356
Weighted Average Life
Available for Sale Securities
Trading Securities
December 31, 2022
Fair Value
Amortized Cost
Fair Value
Amortized Cost
< 1 year
$
61
$
64
$
—
$
—
≥ 1 year and < 3 years
2,390
2,525
—
—
≥ 3 years and < 5 years
11,541
12,171
—
—
≥ 5 years
173,953
184,712
8,010,646
8,553,485
Totals
$
187,945
$
199,472
$
8,010,646
$
8,553,485
We use a third-party model to calculate the weighted average lives of our investments in securities. Weighted average life is calculated based on expectations for estimated prepayments for the underlying mortgage loans of our investments in 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 investments in securities at June 30, 2023 and December 31, 2022 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 these securities could be longer or shorter than estimated.
Available for Sale Securities
The following table presents the unrealized losses and estimated fair value of our available for sale securities by length of time that such securities were in a continuous unrealized loss position at December 31, 2022. All of the available for sale securities were issued and guaranteed by GSEs (with a long term credit rating of AA+) or Ginnie Mae at December 31, 2022.
Unrealized Loss Position For:
< 12 Months
≥ 12 Months
Total
Agency Securities
Fair Value
Unrealized
Losses
Fair Value
Unrealized
Losses
Fair Value
Unrealized
Losses
December 31, 2022
$
187,397
$
(11,497)
$
548
$
(30)
$
187,945
$
(11,527)
Note 6 - Repurchase Agreements, net
At June 30, 2023, we had active MRAs with 38 counterparties and had $9,121,329 in outstanding borrowings with 18 of those counterparties. At December 31, 2022, we had MRAs with 38 counterparties and had $6,463,058 in outstanding borrowings with 16 counterparties.
The following tables represent the contractual repricing regarding our repurchase agreements to finance MBS purchases at June 30, 2023 and December 31, 2022. Our repurchase agreements require excess collateral, known as a “haircut.” At June 30, 2023, the average haircut percentage was 2.82% compared to 3.85% at December 31, 2022. The
14
ARMOUR Residential REIT, Inc.
FINANCIAL STATEMENT NOTES (UNAUDITED)
(in thousands, except per share)
haircut for our repurchase agreements vary by counterparty and therefore, the changes in the average haircut percentage will vary with the changes in our counterparty repurchase agreement balances.
June 30, 2023
Balance
Weighted Average Contractual Rate
Weighted Average Maturity in days
Agency Securities
≤ 30 days (1)
$
9,121,329
5.23
%
19
Total or Weighted Average
$
9,121,329
5.23
%
19
(1)Net of reverse repurchase agreements of $512,500. Obligations to return securities received as collateral of $497,188 associated with the reverse repurchase agreements are all due within 30 days.
December 31, 2022
Balance
Weighted Average Contractual Rate
Weighted Average Maturity in days
Agency Securities
≤ 30 days (1)
$
5,912,572
4.43
%
15
> 30 days to ≤ 60 days
550,486
4.48
%
34
Total or Weighted Average
$
6,463,058
4.43
%
16
(1)Net of reverse repurchase agreements of $704,276. Obligations to return securities received as collateral of $502,656 associated with the reverse repurchase agreements all matured in January 2023.
The following table presents information about the gross and net securities purchased and sold under our repurchase agreements, net on the accompanying consolidated balance sheets at June 30, 2023 and December 31, 2022.
June 30, 2023
Gross Amounts Not Offset
Gross Amounts
Gross Amounts offset in the Consolidated Balance Sheet
Net Amounts Presented in the Consolidated Balance Sheet
Financial
Instruments (1)
Cash Collateral
Total Net
Assets
Reverse Repurchase Agreements
$
512,500
$
(512,500)
$
—
$
—
$
—
$
—
Totals
$
512,500
$
(512,500)
$
—
$
—
$
—
$
—
Liabilities
Repurchase Agreements
$
(9,633,829)
$
512,500
$
(9,121,329)
$
9,121,329
$
—
$
—
Totals
$
(9,633,829)
$
512,500
$
(9,121,329)
$
9,121,329
$
—
$
—
(1)The fair value of securities pledged against our repurchase agreements was $10,172,104 at June 30, 2023.
15
ARMOUR Residential REIT, Inc.
FINANCIAL STATEMENT NOTES (UNAUDITED)
(in thousands, except per share)
December 31, 2022
Gross Amounts Not Offset
Gross Amounts
Gross Amounts offset in the Consolidated Balance Sheet
Net Amounts Presented in the Consolidated Balance Sheet
Financial
Instruments (1)
Cash Collateral
Total Net
Assets
Reverse Repurchase Agreements
$
704,276
$
(704,276)
$
—
$
—
$
189
$
189
Totals
$
704,276
$
(704,276)
$
—
$
—
$
189
$
189
Liabilities
Repurchase Agreements
$
(7,167,334)
$
704,276
$
(6,463,058)
$
6,463,058
$
—
$
—
Totals
$
(7,167,334)
$
704,276
$
(6,463,058)
$
6,463,058
$
—
$
—
(1)The fair value of securities pledged against our repurchase agreements was $7,249,039 at December 31, 2022.
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 June 30, 2023 and December 31, 2022, BUCKLER accounted for 48.4% and 50.2%, respectively, of our aggregate borrowings and had an amount at risk of 7.8% and 12.9%, respectively, of our total stockholders' equity with a weighted average maturity of 21 days and 15 days, respectively, on repurchase agreements, net (see Note 14 - Related Party Transactions).
At June 30, 2023, we had 3 additional repurchase agreement counterparties that individually accounted for over 5% of our aggregate borrowings. In total, these counterparties accounted for approximately 24.9% of our repurchase agreement borrowings outstanding at June 30, 2023. At December 31, 2022, we had 3 additional repurchase agreement counterparties that individually accounted for over 5% of our aggregate borrowings. In total, these counterparties accounted for 28.1% of our repurchase agreement borrowings at December 31, 2022.
Note 7 - 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
16
ARMOUR Residential REIT, Inc.
FINANCIAL STATEMENT NOTES (UNAUDITED)
(in thousands, except per share)
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.
All of our interest rate contracts have floating leg interest rate indexes of either the Fed Funds Rate or SOFR. The Fed Funds Rate is published daily by the New York Federal Reserve and is a measure of unsecured borrowings by depository institutions from other depository institutions or GSEs. SOFR is published daily by the New York Federal Reserve and is the average overnight rate for borrowings secured by U.S. Treasury securities. We enter into interest rate swap contracts either directly with a counterparty (a “bilateral” contract) or through a centrally-cleared swap contract. In a bilateral contract, we exchange margin collateral with the counterparty and have exposure to counterparty risk. In a centrally-cleared contract, we exchange margin collateral with a Futures Clearing Merchant, with whom we have opened an account. Our counterparty risk is limited to the clearing exchange itself. All of our centrally-cleared swaps are cleared by the CME. In general, centrally-cleared interest rate swap contracts require us to post higher initial margin than bilateral contracts.
Futures contracts are traded on the CME which requires the use of daily mark-to-market collateral and the CME provides substantial credit support. The collateral requirements of the CME require us to pledge assets under a bi-lateral margin arrangement, including either cash or Agency Securities and these requirements may vary and change over time based on the market value, notional amount and remaining term of the futures contracts. In the event we are unable to meet a margin call under one of our futures contracts, the counterparty to such agreement may have the option to terminate or close-out all of the outstanding futures contracts with us. In addition, any close-out amount due to the counterparty upon termination of the counterparty’s transactions would be immediately payable by us pursuant to the applicable agreement.
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 ISDA. 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.
17
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 June 30, 2023 and December 31, 2022.
Gross Amounts Not Offset
Assets
Gross Amounts(1)
Financial Instruments
Cash Collateral
Total Net
June 30, 2023
Interest rate swap contracts (2)
$
989,719
$
(337)
$
(919,153)
$
70,229
Futures contracts
11,252
(8,166)
2,810
5,896
TBA Agency Securities
78
(3,105)
5,164
2,137
Totals
$
1,001,049
$
(11,608)
$
(911,179)
$
78,262
December 31, 2022
Interest rate swap contracts
$
983,659
$
—
$
(955,941)
$
27,718
Futures contracts
94
(516)
9,334
8,912
TBA Agency Securities
703
(12,500)
13,633
1,836
Totals
$
984,456
$
(13,016)
$
(932,974)
$
38,466
(1)See Note 4 - Fair Value of Financial Instruments for additional discussion.
(2)Includes $22,099 of centrally-cleared interest rate swap contracts.
Gross Amounts Not Offset
Liabilities
Gross Amounts(1)
Financial Instruments
Cash Collateral
Total Net
June 30, 2023
Interest rate swap contracts (2)
$
(337)
$
337
$
—
$
—
Futures contracts
(8,166)
8,166
—
—
TBA Agency Securities
(3,105)
3,105
—
—
Totals
$
(11,608)
$
11,608
$
—
$
—
December 31, 2022
Futures contracts
$
(516)
$
516
$
—
$
—
TBA Agency Securities
(12,500)
12,500
—
—
Totals
$
(13,016)
$
13,016
$
—
$
—
(1)See Note 4 - Fair Value of Financial Instruments for additional discussion.
(2)Includes $(337) of centrally-cleared interest rate swap contracts.
The following table represents the information regarding our derivatives which are included in Gain on derivatives, net in the accompanying consolidated statements of operations and comprehensive income (loss) for the three and six months ended June 30, 2023 and June 30, 2022.
18
ARMOUR Residential REIT, Inc.
FINANCIAL STATEMENT NOTES (UNAUDITED)
(in thousands, except per share)
Income (Loss) Recognized
For the Three Months Ended June 30,
For the Six Months Ended June 30,
Derivatives
2023
2022
2023
2022
Interest rate swap contracts (1)
$
199,945
$
221,661
$
73,531
$
565,459
Futures contracts
(2,469)
2,152
(13,298)
2,152
TBA Agency Securities
(3,286)
(17,899)
(443)
(117,093)
Total Gain (Loss) on Derivatives, net
$
194,190
$
205,914
$
59,790
$
450,518
(1)Includes $51,087 and $21,992 of centrally-cleared interest rate swap contracts for the three and six months ended June 30, 2023.
The following tables present information about our derivatives at June 30, 2023 and December 31, 2022.
Interest Rate Swap Contracts (1)
Notional Amount
Weighted Average Remaining Term (Months)
Weighted Average Rate
June 30, 2023
< 3 years
$
3,080,000
23
0.01
%
≥ 3 years and < 5 years
1,429,000
47
0.51
%
≥ 5 years and < 7 years
1,552,000
76
0.49
%
≥ 7 years
2,750,000
95
6.29
%
Total or Weighted Average (2)
$
8,811,000
59
2.14
%
December 31, 2022
< 3 years
$
1,066,000
10
0.10
%
≥ 3 years and < 5 years
1,182,000
50
0.63
%
≥ 5 years and < 7 years
754,000
82
0.62
%
≥ 7 years
3,348,000
99
0.96
%
Total or Weighted Average (3)
$
6,350,000
73
0.72
%
(1)Pay Fixed/Receive Variable.
(2)Of this amount, $3,500,000 notional are SOFR based swaps, the last of which matures in 2032; and $5,311,000 notional are Fed Funds based swaps, the last of which matures in 2032. Of this amount, $3,300,000 notional are centrally-cleared interest rate swap contracts, the last of which matures in 2028.
(3)Of this amount, $803,000 notional are SOFR based swaps, the last of which matures in 2032; and $5,547,000 notional are Fed Funds based swaps, the last of which matures in 2032.
19
ARMOUR Residential REIT, Inc.
FINANCIAL STATEMENT NOTES (UNAUDITED)
(in thousands, except per share)
TBA Agency Securities
Notional Amount
Cost Basis
Fair Value
June 30, 2023
30 Year Short, 3.0%
$
(500,000)
$
(440,199)
$
(440,156)
30 Year Long, 5.0%
550,000
543,960
540,890
Total
$
50,000
$
103,761
$
100,734
December 31, 2022
30 Year Long, 4.5%
$
500,000
$
489,805
$
481,641
30 Year Long, 5.0%
300,000
300,164
295,828
Totals (1)
$
800,000
$
789,969
$
777,469
(1) $400,000 notional were forward settling at December 31, 2022.
Note 8 - Commitments and Contingencies
Management
The Company is managed by ACM, pursuant to a management agreement (see also Note 14 - Related Party Transactions). The management agreement entitles ACM to receive management fees payable monthly in arrears. Currently, the monthly 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. Gross equity raised includes the total amounts of paid in capital relating to both our common and preferred stock, plus brokerage commissions and other costs of capital raising. Amounts paid to shareholders to repurchase stock, before any brokerage commissions and costs, reduces gross equity raised. Dividends specifically designated by the Board as liquidation dividends will reduce the amount of gross equity raised. To date, the Board has not so designated any of the dividends paid by the Company. Realized and unrealized gains and losses do not affect the amount of gross equity raised. At June 30, 2023, the average management fee rate, prior to management fees waived, was 0.94% based on gross equity raised of $4,042,078 and effectively a rate of 2.95% based on total stockholders' equity.
ACM began waiving 40% of its management fee during the second quarter of 2020 and on January 13, 2021, ACM notified ARMOUR that it intended to adjust the fee waiver to the rate of $2,400 for the first quarter of 2021 and $800 per month thereafter. On April 20, 2021, ACM notified ARMOUR that it intended to adjust the fee waiver to the rate of $2,100 for the second quarter of 2021 and $700 per month thereafter. On October 25, 2021, ACM notified ARMOUR that it intended to adjust the fee waiver from the rate of $700 per month to $650 per month, effective November 1, 2021, until further notice. On February 14, 2023, ACM notified ARMOUR that it intended to adjust the fee waiver to the rate of $1,650 for the first quarter of 2023 and $550 per month thereafter until ACM provides further 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 2009 Stock Incentive Plan as amended (the “Plan”).
During the three and six months ended June 30, 2023, and June 30, 2022 ACM waived management fees of $1,650 and $3,300 and $1,950 and $3,900, respectively. The 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 incurs solely on our behalf other than the various overhead expenses specified in the terms of the management agreement.
On February 14, 2023, the Company extended the contractual term of the management agreement through December 31, 2029. Based on the management fee base, gross equity raised, as of June 30, 2023, the Company’s contractual management fee commitments are:
20
ARMOUR Residential REIT, Inc.
FINANCIAL STATEMENT NOTES (UNAUDITED)
(in thousands, except per share)
Year
Contractual Management Fee
Remainder of 2023
$
31,500
2024
37,800
2025
37,800
2026
37,800
2027
37,800
2028
37,800
2029
37,800
Total
$
258,300
The Company cannot voluntarily terminate the management agreement without cause before the expiration of its contractual term. If the management agreement is terminated in connection with a liquidation of the Company or certain business combination transactions, the Company is obliged to pay ACM a termination fee equal to 4 times the contractual management fee (before any waiver) for the preceding 12 months.
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 June 30, 2023 and December 31, 2022.
Nine putative class action lawsuits have been filed in connection with the tender offer (the “Tender Offer”) and merger (the “Merger”) for JAVELIN. The Tender Offer and Merger are collectively defined herein as the “Transactions.” All nine suits 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. The Court has deferred ruling on the Motion to Dismiss several times. On October 25, 2022, the court deferred the Order of Dismissal until May 1, 2023, and if the case was not fully disposed of by that date, the clerk would enter on the docket "dismissed for lack of prosecution without prejudice." To date, no further action has been taken by the court.
21
ARMOUR Residential REIT, Inc.
FINANCIAL STATEMENT NOTES (UNAUDITED)
(in thousands, except per share)
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 of all of these suits, ARMOUR is not able at this time to estimate their outcome.
Note 9 - Stock Based Compensation
We adopted 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 June 30, 2023, there were 867 shares available for future issuance under the Plan.
Transactions related to awards for the six months ended June 30, 2023 are summarized below:
June 30, 2023
Number of
Awards
Weighted Average Grant Date Fair Value per Award
Unvested RSU Awards Outstanding beginning of period
568
$
12.88
Granted (1)
1,300
$
5.93
Vested
(188)
$
9.64
Unvested RSU Awards Outstanding end of period
1,680
$
7.87
(1)During the six months ended June 30, 2023, 980 RSUs were granted to certain officers of ARMOUR and 320 RSUs were granted to the Board.
At June 30, 2023, there was approximately $13,223 of unvested stock based compensation related to the Awards (based on a weighted grant date price of $7.87 per share), which we expect to recognize as an expense as follows: for the remainder of 2023 an expense of $1,881, in 2024 an expense of $3,626, and thereafter an expense of $7,716. Our policy is to account for forfeitures as they occur. We also pay each of our non-executive Board members quarterly fees of $33, which are payable in cash, common stock, RSUs or a combination of common stock, RSUs and cash at the option of the director. Non-executive Board members have the option to participate in the Company's Non-Management Director Compensation and Deferral Program (the "Deferral Program"). The Deferral Program permits non-executive Board members to elect to receive either common stock or RSUs or a combination of common stock and RSUs at the option of the director, instead of all or part of their quarterly cash compensation and/or all or part of their committee and chairperson cash retainers.
Note 10 - Stockholders' Equity
The following table presents the components of cumulative distributions to stockholders at June 30, 2023 and December 31, 2022.
Cumulative Distributions to Stockholders
June 30, 2023
December 31, 2022
Preferred dividends
$
150,818
$
144,827
Common stock dividends
1,947,875
1,847,534
Totals
$
2,098,693
$
1,992,361
22
ARMOUR Residential REIT, Inc.
FINANCIAL STATEMENT NOTES (UNAUDITED)
(in thousands, except per share)
Preferred Stock
At June 30, 2023 and December 31, 2022, 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. At June 30, 2023, 10,000 shares of the Company’s authorized preferred stock, par value $0.001 per share are designated as shares of 7.00% Series C Cumulative Redeemable Preferred Stock ("Series C Preferred Stock") with the powers, designations, preferences and other rights as set forth therein and a total of 40,000 shares of our authorized preferred stock remain available for designation as future series.
At June 30, 2023 and December 31, 2022, we had 6,847 shares of Series C Preferred Stock issued and outstanding with a par value of $0.001 per share and a liquidation preference of $25.00 per share, or $171,175 in the aggregate. At June 30, 2023 and December 31, 2022, there were no accrued or unpaid dividends on the Series C Preferred Stock.
On January 29, 2020, the Company entered into an Equity Sales Agreement (the “Preferred C ATM Sales Agreement”) with B. Riley Securities, Inc. (formerly 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 or more of the Agents, as the Company’s agents, up to 6,550 of Series C Preferred Stock. The Preferred C ATM Sales Agreement relates to a proposed “at-the-market” offering program. Under the Preferred C ATM Sales 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 Preferred C ATM Sales Agreement. We did not sell any shares under the Preferred C ATM Sales Agreement during the six months ended June 30, 2023. Shares designated as Series C Preferred Stock but unissued, which are available under the Preferred C ATM Sales Agreement, totaled 3,153 at June 30, 2023 and December 31, 2022.
Preferred Stock Repurchase Program
On July 26, 2022, the Board authorized a repurchase program of up to an aggregate of 2,000 shares of the Company’s outstanding Series C Preferred Stock ("Series C Preferred Stock Repurchase Program"). Under the Series C Preferred Stock 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, in consultation with the Pricing Committee of the Board, 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 Series C Preferred Stock 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. We did not repurchase any shares under the Series C Preferred Stock Repurchase Program during the six months ended June 30, 2023.
Common Stock
February 14, 2023, we submitted Articles of Amendment with the State of Maryland to increase the number of authorized shares of common stock, from 300,000 shares to 450,000 shares. At June 30, 2023 and December 31, 2022, we were authorized to issue up to 450,000 and 300,000 shares of common stock, respectively, 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 206,810 and 162,911 shares of common stock issued and outstanding at June 30, 2023 and December 31, 2022, respectively.
On May 14, 2021, we entered into an Equity Sales Agreement (the “2021 Common stock ATM Sales Agreement”) with BUCKLER, JMP Securities LLC, Ladenburg Thalmann & Co. Inc. and B. Riley Securities, Inc., as sales agents, relating to the shares of our common stock. In accordance with the terms of the 2021 Common Stock ATM Sales agreement, we may offer and sell over a period of time and from time to time, up to 17,000 shares of our common stock, par value $0.001 per share. On November 12, 2021, the 2021 Common stock ATM Sales Agreement was amended to add JonesTrading Institutional Services LLC, as a sales agent and to offer an additional 25,000 shares available for sale pursuant to the terms of the 2021 Common stock ATM Sales Agreement. On June 9, 2022, the 2021 Common stock ATM Sales Agreement was
23
ARMOUR Residential REIT, Inc.
FINANCIAL STATEMENT NOTES (UNAUDITED)
(in thousands, except per share)
further amended to offer an additional 28,800 shares available for sale. On November 4, 2022, the Common stock ATM Sales Agreement was further amended to offer an additional 35,000 shares available for sale. On January 17, 2023, it was amended to add an additional 48,678 shares pursuant to the terms of the 2021 Common stock ATM Sales Agreement.
The 2021 Common stock ATM Sales Agreement relates to an "at-the-market" offering program. The 2021 Common stock ATM Sales Agreement provides that 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 2021 Common stock ATM Sales Agreement. During the six months ended June 30, 2023, we sold 45,023 shares under this agreement for proceeds of $258,683, net of issuance costs and commissions of approximately $2,675. In July 2023, we sold 21,499 shares under this agreement for proceeds of $109,314, net of issuance costs and commissions of approximately $1,050. These sales fully utilized the shares allocated to the 2021 Common stock ATM Sales Agreement, which has been completed. See Note 14 - Related Party Transactions for discussion of additional transactions with BUCKLER.
On July 26, 2023 we entered into a new Equity Sales Agreement (the “2023 Common stock ATM Sales Agreement”), with BUCKLER, JonesTrading Institutional Services LLC, JMP Securities LLC, Ladenburg Thalmann & Co. Inc. and B. Riley Securities, Inc., as sales agents, relating to the shares of our common stock. In accordance with the terms of the 2023 Common Stock ATM Sales agreement, we may offer and sell over a period of time and from time to time, up to 75,000 shares of our common stock, par value $0.001 per share.
Common Stock Repurchase Program
At June 30, 2023 and December 31, 2022, there were 5,464 and 6,732 authorized shares remaining under the current repurchase authorization. During the six months ended June 30, 2023, we repurchased 1,268 common shares under this authorization for a cost of $6,377. 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 Exchange Act, 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. See Note 14 - Related Party Transactions for discussion of additional transactions with BUCKLER.
Equity Capital Activities
The following tables present our equity transactions for the six months ended June 30, 2023 and for the year ended December 31, 2022.
Transaction Type
Completion Date
Number of Shares
Per Share price (1)
Net Proceeds (costs)
June 30, 2023
2021 Common stock ATM Sales Agreement
January 4, 2023 - June 30, 2023
45,023
$
5.75
$
258,683
Common stock repurchased
March and May
(1,268)
$
(5.03)
$
(6,377)
December 31, 2022
2021 Common stock ATM Sales Agreement
January 11, 2022 - December 21, 2022
70,041
$
6.79
$
475,537
Common stock repurchased
June, September and October
(1,478)
$
5.19
$
(7,664)
(1)Weighted average price
Dividends
On July 27, 2023, a cash dividend of $0.14583 per outstanding share of Series C Preferred Stock, or $998 in the aggregate, will be paid to holders of record on July 15, 2023. We have also declared cash dividends of $0.14583 per
24
ARMOUR Residential REIT, Inc.
FINANCIAL STATEMENT NOTES (UNAUDITED)
(in thousands, except per share)
outstanding share of Series C Preferred Stock payable August 28, 2023 to holders of record on August 15, 2023 and payable September 27, 2023 to holders of record on September 15, 2023.
On July 28, 2023, a cash dividend of $0.08 per outstanding common share, or $18,404 in the aggregate, will be paid to holders of record on July 17, 2023. We have also declared a cash dividend of $0.08 per outstanding common share payable August 30, 2023 to holders of record on August 15, 2023.
The following table presents our Series C Preferred Stock dividend transactions for the six months ended June 30, 2023.
Record Date
Payment Date
Rate per Series C Preferred Share
Aggregate amount paid to holders of record
January 15, 2023
January 27, 2023
$
0.14583
$
998.5
February 15, 2023
February 27, 2023
$
0.14583
998.5
March 15, 2023
March 27, 2023
$
0.14583
998.5
April 15, 2023
April 27, 2023
$
0.14583
998.5
May 15, 2023
May 30, 2023
$
0.14583
998.5
June 15, 2023
June 27, 2023
$
0.14583
998.5
Total dividends paid
$
5,991
The following table presents our common stock dividend transactions for the six months ended June 30, 2023.
Record Date
Payment Date
Rate per common share
Aggregate amount paid to holders of record
January 17, 2023
January 30, 2023
$
0.10
$
17,007
February 15, 2023
February 27, 2023
$
0.10
19,471
March 15, 2023
March 28, 2023
$
0.08
15,526
April 17, 2023
April 27, 2023
$
0.08
15,788
May 15, 2023
May 30, 2023
$
0.08
15,964
June 15, 2023
June 29, 2023
$
0.08
16,585
Total dividends paid
$
100,341
Note 11 - Net Income (Loss) per Common Share
The following table presents a reconciliation of net income (loss) and the shares used in calculating weighted average basic and diluted earnings per common share for the three and six months ended June 30, 2023 and June 30, 2022.
25
ARMOUR Residential REIT, Inc.
FINANCIAL STATEMENT NOTES (UNAUDITED)
(in thousands, except per share)
For the Three Months Ended June 30,
For the Six Months Ended June 30,
2023
2022
2023
2022
Net Income (Loss)
$
42,962
$
(58,591)
$
11,603
$
(125,025)
Less: Preferred dividends
(2,996)
(2,996)
(5,991)
(5,991)
Net Income (Loss) available (related) to common stockholders
$
39,966
$
(61,587)
$
5,612
$
(131,016)
Weighted average common shares outstanding – basic
198,699
106,514
191,682
101,396
Add: Effect of dilutive non-vested awards, assumed vested
1,680
—
1,680
—
Weighted average common shares outstanding – diluted
200,379
106,514
193,362
101,396
For the three and six months ended June 30, 2022, 696 of potentially dilutive non-vested awards outstanding were excluded from the computation of diluted Net Income (Loss) available (related) to common stockholders because to have included them would have been anti-dilutive for the period.
Note 12 - Comprehensive Income (Loss) per Common Share
The following table presents a reconciliation of comprehensive income (loss) and the shares used in calculating weighted average basic and diluted comprehensive income (loss) per common share for the three and six months ended June 30, 2023 and June 30, 2022.
For the Three Months Ended June 30,
For the Six Months Ended June 30,
2023
2022
2023
2022
Comprehensive Income (Loss)
$
42,962
$
(93,241)
$
23,130
$
(238,213)
Less: Preferred dividends
(2,996)
(2,996)
(5,991)
(5,991)
Comprehensive Income (Loss) available (related) to common stockholders
$
39,966
$
(96,237)
$
17,139
$
(244,204)
Comprehensive Income (Loss) per share available (related) to common stockholders:
Basic
$
0.20
$
(0.90)
$
0.09
$
(2.41)
Diluted
$
0.20
$
(0.90)
$
0.09
$
(2.41)
Weighted average common shares outstanding:
Basic
198,699
106,514
191,682
101,396
Add: Effect of dilutive non-vested awards, assumed vested
1,680
—
1,680
—
Diluted
200,379
106,514
193,362
101,396
For the three and six months ended June 30, 2022, 696 of potentially dilutive non-vested awards outstanding were excluded from the computation of diluted Comprehensive Income (Loss) available (related) to common stockholders because to have included them would have been anti-dilutive for the period.
26
ARMOUR Residential REIT, Inc.
FINANCIAL STATEMENT NOTES (UNAUDITED)
(in thousands, except per share)
Note 13 - Income Taxes
The following table reconciles our GAAP net income (loss) to estimated REIT taxable income (loss) for the three and six months ended June 30, 2023 and June 30, 2022.
For the Three Months Ended June 30,
For the Six Months Ended June 30,
2023
2022
2023
2022
GAAP net income (loss)
$
42,962
$
(58,591)
$
11,603
$
(125,025)
Book to tax differences:
TRS (income) loss
20
(6)
3
(7)
Premium amortization expense
—
(36)
(1)
(78)
Agency Securities
44,403
249,022
(238,647)
503,411
U.S. Treasury Securities
(11,934)
33,983
(79)
112,370
Changes in interest rate contracts
(141,321)
(204,744)
40,819
(455,644)
Loss on Security Sales
113,256
7,501
283,412
7,501
Amortization of deferred hedging costs
(26,202)
(36,716)
(56,570)
(76,296)
Amortization of deferred Treasury Future gains
6,062
—
11,877
—
Other
484
610
779
1,160
Estimated REIT taxable income (loss)
$
27,730
$
(8,977)
$
53,196
$
(32,608)
Interest rate contracts and futures 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 and futures contracts terminated before their maturity are deferred and amortized over the remainder of the original term of the contract for REIT taxable income. At June 30, 2023 and December 31, 2022, we had approximately $268,923 and $307,316, respectively, of net deductible expense relating to previously terminated interest rate swap and treasury futures contracts amortizing through the year 2032. At June 30, 2023, we had $257,341 of net operating loss carryforwards available for use indefinitely.
Net capital losses realized
Amount
Available to offset capital gains through
2018
$
(136,388)
2023
2019
$
(13,819)
2024
2021
$
(15,605)
2026
2022
$
(732,478)
2027
The Company's subsidiary, ARMOUR TRS, Inc. has made an election as a taxable REIT subsidiary (“TRS”). As such, the TRS is taxable as a domestic C corporation and subject to federal, state, and local income taxes based upon its taxable income.
The aggregate tax basis of our assets and liabilities was greater than our total Stockholders’ Equity at June 30, 2023 by approximately $132,413, or approximately $0.64 per common share (based on the 206,810 common shares then outstanding). State and federal tax returns for the years 2019 and later remain open and are subject to possible examination.
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 for the three and six months ended June 30, 2023 and June 30, 2022 were $51,333 and $106,332 and $35,153 and $67,256, respectively.
27
ARMOUR Residential REIT, Inc.
FINANCIAL STATEMENT NOTES (UNAUDITED)
(in thousands, except per share)
Our estimated 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.
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 14 - Related Party Transactions
ACM
The Company is managed by ACM, pursuant to a management agreement. 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 management agreement runs through December 31, 2029 and is thereafter automatically renewed for an additional five-year term unless terminated under certain circumstances. Either party must provide 180 days prior written notice of any such termination.
Under the terms of the management agreement, 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.
ACM began waiving 40% of its management fee during the second quarter of 2020 and on January 13, 2021, ACM notified ARMOUR that it intended to adjust the fee waiver to the rate of $2,400 for the first quarter of 2021 and $800 per month thereafter. On April 20, 2021, ACM notified ARMOUR that it intended to adjust the fee waiver to the rate of $2,100 for the second quarter of 2021 and $700 per month thereafter. On October 25, 2021, ACM notified ARMOUR that it intended to adjust the fee waiver from the rate of $700 per month to $650 per month, effective November 1, 2021, until further notice. On February 14, 2023, ACM notified ARMOUR that it intended to adjust the fee waiver to the rate of $1,650 for the first quarter of 2023 and $550 per month thereafter until ACM provides further notice to ARMOUR (see Note 8 - Commitments and Contingencies).
28
ARMOUR Residential REIT, Inc.
FINANCIAL STATEMENT NOTES (UNAUDITED)
(in thousands, except per share)
The following table reconciles the fees incurred in accordance with the management agreement for the three and six months ended June 30, 2023 and June 30, 2022.
For the Three Months Ended June 30,
For the Six Months Ended June 30,
2023
2022
2023
2022
ARMOUR management fees
$
9,377
$
8,282
$
18,605
$
16,407
Less management fees waived
(1,650)
(1,950)
(3,300)
(3,900)
Total management fee expense
$
7,727
$
6,332
$
15,305
$
12,507
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 agreement. For the three and six months ended June 30, 2023 and June 30, 2022, we reimbursed ACM $170 and $405 and $130 and $237, respectively, for other expenses incurred on our behalf. In 2017, 2020, 2021 and 2022, we elected to grant restricted stock unit awards to our executive officers and other ACM employees that generally vest over 5 years. In 2017, 2020, 2021 and 2022, we elected to grant RSUs to the Board. We recognized stock based compensation expense of $118 and $259 and $140 and $302 for the three and six months ended June 30, 2023 and June 30, 2022, respectively.
BUCKLER
At June 30, 2023, we held an ownership interest in BUCKLER of 10.8%, which 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 $466 at June 30, 2023 and $377 at December 31, 2022, 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 each of the three and six months ended June 30, 2023 and June 30, 2022, we earned $0 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, which expired at the end of the first quarter of 2022.
Effective March 20, 2023, the Company committed to provide on demand a subordinated loan agreement to BUCKLER in an amount up to $200,000. The commitment extends through March 20, 2026, and is collateralized by mortgage backed and/or U.S. Treasury Securities owned by the Company and pledged to BUCKLER. The commitment is treated by BUCKLER currently as capital for regulatory purposes and BUCKLER may pledge the securities to secure its own borrowings.
This arrangement replaced the prior $105.0 million subordinated loan, which was to mature on May 1, 2025. In March 2023, BUCKLER, at its option after obtaining regulatory approval, repaid all of the principal amount of the loan. The loan had 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
29
ARMOUR Residential REIT, Inc.
FINANCIAL STATEMENT NOTES (UNAUDITED)
(in thousands, except per share)
three and six months ended June 30, 2023 and June 30, 2022, the Company earned $0 and $973 and $157 and $176, respectively, of interest on this loan.
On February 22, 2021, the Company entered into an uncommitted revolving credit facility and security agreement with BUCKLER. Under the terms of the facility, the Company may, in its sole and absolute discretion, provide drawings to BUCKLER of up to $50,000. Interest on drawings is payable monthly at the Federal Reserve Bank of New York SOFR plus 2% per annum. To date, BUCKLER has not yet used the facility and therefore no interest expense was payable for the six months ended June 30, 2023.
With BUCKLER as the sales agent, under the 2021 Common stock ATM Sales Agreement, we sold 10,910 and 37,013 common shares for proceeds of $55,892 and $215,193, net of issuance costs and commissions of approximately $486 and $2,215 during the three and six months ended June 30, 2023, respectively. We also repurchased 425 and 1,268 common shares under the current repurchase authorization which cost $2,072 and $6,377, including commissions of approximately $18 and $54, respectively, to BUCKLER during the three and six months ended June 30, 2023. In July 2023, we sold 6,117 shares under the 2021 Common stock ATM Sales Agreement for proceeds of $31,354, net of issuance costs and commissions of approximately $269 to BUCKLER (see Note 10 - Stockholders' Equity).
The table below summarizes other transactions with BUCKLER for the six months ended June 30, 2023 and for the year ended December 31, 2022.
Transactions with BUCKLER
June 30, 2023
December 31, 2022
Repurchase agreements, net (1)
$
4,412,261
$
3,247,474
Collateral posted on repurchase agreements
$
5,284,870
$
3,920,706
Agency Securities Purchased
$
247,308
$
203,147
U.S. Treasury Securities Purchased
$
155,857
$
593,162
U.S. Treasury Securities Sold
$
154,875
$
814,265
(1)Interest on repurchase agreements, net was $58,740 and $108,349 and $6,462 and $7,495 for the three and six months ended June 30, 2023 and June 30, 2022, respectively. See also, Note 6 - Repurchase Agreements, net for transactions with BUCKLER.
Note 15 - Subsequent Events
Except as disclosed above, no subsequent events were identified through the date of filing this Quarterly Report of Form 10-Q.
30
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 10.8% 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
We are a Maryland corporation managed by ACM, an investment advisor registered with the SEC (see Note 8 and Note 14 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.
At June 30, 2023 and December 31, 2022, we invested in MBS, 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 of fixed rate loans. From time to time we have also invested in Credit Risk and Non-Agency Securities, 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 currently invest primarily in Agency Securities, for which the principal and interest payments are guaranteed by a GSE or other government agency. We also invest in U.S. Treasury Securities and money market instruments. In the past, we have invested in Credit Risk and Non-Agency Securities and it is possible we may do so in the future. We expect our investments to be subject to risks arising from prepayments resulting from existing home sales, financings, delinquencies and foreclosures. We are exposed to changing mortgage spreads, which could result in declines in the fair value of our investments. Our asset selection, financing and hedging strategies are designed to work together to generate current net interest income while moderating our exposure to market volatility.
31
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.
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. For GAAP purposes, all changes in the fair value of our derivatives currently flow through earnings. Changes in the fair value of our legacy Agency MBS portfolio, that was designated as available for sale historically, were recognized in other comprehensive income. Therefore, historical earnings reported in accordance with GAAP have fluctuated even in situations where our derivatives were operating as intended. Currently, all of our Agency MBS portfolio is designated as trading securities and changes in the fair values of our derivatives and Agency MBS flow through earnings together. Accordingly, our results of operations will not be subject to the additional fluctuations caused by the previous differences in mark-to-market accounting treatments.
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.
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 8 and Note 14 to the consolidated financial statements.
Market and Interest Rate Trends and the Effect on our Securities Portfolio
Federal Reserve Actions
On June 14, 2023, the Fed raised its target range for the Fed Funds Rate to between 5.00% and 5.25%, which they had set on May 3, 2023. The Fed stated that holding the target range steady allowed them to assess additional information and its implications for monetary policy. The Fed further stated that some additional policy firming may be appropriate to return inflation to 2% over time. The Fed also stated that it will continue reducing its holdings of agency mortgage-backed securities and other fixed-income assets as described in its previously announced plans and that it will reinvest into agency MBS the amount of principal payments from the Fed's holdings of agency debt and agency MBS received in each calendar
32
ARMOUR Residential REIT, Inc.
Management’s Discussion and Analysis (continued)
month that exceeds a cap of $35 billion per month. The Fed further indicated that it will roll over at auction the amount of principal payments from its holdings of Treasury securities maturing in each calendar month that exceeds a cap of $60 billion per month.
Financial markets will likely be highly sensitive to the Fed’s interest rate decisions, its bond purchasing and balance sheet holding decisions, as well as its communication. We intend to continue to mitigate risk and maximize liquidity within the scope of our business plan. The agency mortgage-backed securities market remains highly dependent on the future course and timing of the Fed's actions on interest rates as well as its purchases and holdings of our target assets.
Federal Deposit Insurance Corporation ("FDIC") Actions
In March 2023, the FDIC placed into receivership Silicon Valley Bank and Signature Bank, the 16th and 29th largest banks in the U.S., respectively. As a result of the receivership, the FDIC acquired approximately $120 billion in securities, including approximately $60 billion of Agency MBS pass-through securities and $15 billion of Agency CMBS. The FDIC retained BlackRock Financial Market Advisory group to sell some of these assets through a gradual and orderly process, which commenced on April 18, 2023. As of June 30 2023, approximately $40 billion of Agency MBS pass-through securities had been liquidated, comprising 66% of the total acquired. Also as of June 30 2023, approximately $1.5 billion of Agency CMBS had been liquidated, comprising all of the Agency CMBS that the FDIC plans to liquidate. The size and pace of all future sales are subject to market conditions.
We expect these asset sales will create a modest drag on Agency MBS valuations. While some of the Agency MBS among these assets are similar to positions in ARMOUR’s portfolio, a majority consists of coupons and maturities not currently among our holdings. We have no current plans to expand ARMOUR’s portfolio holdings into the other coupons and maturities to be sold unless particularly attractive buying opportunities arise. Accordingly, we do not expect to see material impacts on ARMOUR’s current portfolio.
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.
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 Fed Funds Rate at each Fed meeting where a change was made since June 2022.
33
ARMOUR Residential REIT, Inc.
Management’s Discussion and Analysis (continued)
Meeting Date
Lower Bound
Higher Bound
May 3, 2023
5.00
%
5.25
%
March 22, 2023
4.75
%
5.00
%
February 1, 2023
4.50
%
4.75
%
December 14, 2022
4.25
%
4.50
%
November 2, 2022
3.75
%
4.00
%
September 21, 2022
3.00
%
3.25
%
July 27, 2022
2.25
%
2.50
%
June 15, 2022
1.50
%
1.75
%
Our borrowings in the repurchase market have closely tracked the Fed Funds Rate, and SOFR. Traditionally, a lower Fed 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. Our derivatives are either Fed Funds Rate or SOFR-based interest rate swap contracts (see Note 7 to the consolidated financial statements).
The following graph shows the effective Fed Funds Rate as compared to SOFR on a monthly basis from June 30, 2021 to June 30, 2023.
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, interest rate swaptions, basis swap contracts and futures
34
ARMOUR Residential REIT, Inc.
Management’s Discussion and Analysis (continued)
contracts to economically hedge against changes in the valuation of our securities. We do not use such hedging contracts for speculative purposes.
We may reduce our mortgage spread exposure by entering in to certain TBA Agency Securities short positions. The TBA short positions may represent different securities and maturities than our MBS and 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.
Results of Operations
For the Three Months Ended June 30,
For the Six Months Ended June 30,
2023
2022
2023
2022
Net Interest Income
$
5,760
$
35,405
$
17,750
$
66,370
Total Other Income (Loss)
48,464
(84,592)
15,105
(172,764)
Total Expenses after fees waived
(11,262)
(9,404)
(21,252)
(18,631)
Net Income (Loss)
$
42,962
$
(58,591)
$
11,603
$
(125,025)
Reclassification adjustment for realized loss on sale of available for sale Agency Securities
—
7,501
7,471
7,501
Net unrealized gain (loss) on available for sale Agency Securities
—
(42,151)
4,056
(120,689)
Other Comprehensive Income (Loss)
—
(34,650)
11,527
(113,188)
Comprehensive Income (Loss)
$
42,962
$
(93,241)
$
23,130
$
(238,213)
Net Income (Loss) for the three and six months ended June 30, 2023 compared to the three and six months ended June 30, 2022 reflected interest income from a larger average securities portfolio and lower mark to market losses on our Agency Securities due to changes in interest rates, offset by higher interest rates applicable to repurchase agreements due to higher rates and the larger average securities portfolio, and lower income from our derivatives.
Net interest income is a function of both our securities portfolio size and net interest rate spread.
For the Three Months Ended June 30,
For the Six Months Ended June 30,
2023
2022
2023
2022
Interest Income
$
134,835
$
48,440
$
253,070
$
81,810
Interest Expense
(129,075)
(13,035)
(235,320)
(15,440)
Net Interest Income
$
5,760
$
35,405
$
17,750
$
66,370
•Our average securities portfolio, including TBA Agency Securities, increased 38.2% from $8,158,792 for the six months ended June 30, 2022 to $11,272,925 for the six months ended June 30, 2023 due to the repositioning of our securities portfolio.
•Our average securities portfolio yield increased 1.36% and our cost of funds increased 1.83% quarter over quarter.
•Our net interest rate spread decreased by 0.47% quarter over quarter.
35
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 (1)
Net Cost of Funds (2)
Net Interest Margin
Interest Expense on Repurchase Agreements
June 30, 2023
4.24
%
2.49
%
1.75
%
5.17
%
March 31, 2023
3.77
%
1.80
%
1.97
%
4.71
%
December 31, 2022
3.25
%
0.66
%
2.59
%
3.80
%
September 2022
3.24
%
1.03
%
2.21
%
2.30
%
June 2022
2.88
%
0.66
%
2.22
%
0.83
%
March 2022
2.20
%
0.42
%
1.78
%
0.17
%
December 2021
2.15
%
0.40
%
1.75
%
0.16
%
September 2021
2.15
%
0.45
%
1.70
%
0.17
%
June 2021
1.95
%
0.50
%
1.45
%
0.17
%
March 2021
1.84
%
0.35
%
1.49
%
0.23
%
(1)Asset yield on securities portfolio and cash collateral posted to/by counterparties.
(2)This includes interest expense on repurchase agreements and interest income/expense on interest rate swap contracts and futures contracts.
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.
36
ARMOUR Residential REIT, Inc.
Management’s Discussion and Analysis (continued)
Other Income (Loss)
For the Three Months Ended June 30,
For the Six Months Ended June 30,
2023
2022
2023
2022
Other Income (Loss):
Realized loss on sale of available for sale Agency Securities (reclassified from Comprehensive Income (Loss))
$
—
$
(7,501)
$
(7,471)
$
(7,501)
Loss on Agency Securities, trading
(157,659)
(249,022)
(37,293)
(503,411)
Gain (Loss) on U.S. Treasury Securities
11,933
(33,983)
79
(112,370)
Gain on derivatives, net
194,190
205,914
59,790
450,518
Total Other Income (Loss)
$
48,464
$
(84,592)
$
15,105
$
(172,764)
Three and Six Months Ended June 30, 2023 vs. Three and Six Months Ended June 30, 2022
•During the first quarter of 2023, we sold the remaining balance of our Available for Sale Securities which resulted in a realized loss of $(7,471).
•Loss on Agency Securities, trading, includes changes in fair value of the securities as well as the gain (loss) on sales. For the three and six months ended June 30, 2023, the change in fair value of the securities was $(44,403) and $246,118 compared to $(64,543) and $(318,932) for the three and six months ended June 30, 2022. During the three and six months ended June 30, 2023, we sold $3,050,412 (including $94,825 of receivable for unsettled sales) and $3,818,535 of Agency Securities, trading, resulting in realized losses of $(113,256) and $(283,411). During the three and six months ended June 30, 2022, we sold $1,681,292 of Agency Securities, trading (including $427,203 in receivables for unsettled sales) which resulted in a loss of $(184,479).
•Gain (Loss) on U.S. Treasury Securities resulted from the change in fair value of the securities as well as the loss on sales. For the three and six months ended June 30, 2023, the change in fair value of the securities was $11,933 and $5,468. For the three and six months ended June 30, 2023, we sold $0 and $(613,852) of U.S. Treasury Securities resulting in realized losses of $0 and $(5,389), respectively. For the three and six months ended June 30, 2022, the change in fair value of the securities was $32,928 and $314. For the three and six months ended June 30, 2022, we sold $1,414,547 and $2,932,385 of U.S. Treasury Securities resulting in losses of $(66,911) and $(112,684), respectively.
•Gain on Derivatives resulted from a combination of the following:
◦Changes in fair value due to interest rate movements.
◦Interest rate swap contracts' aggregate notional balance increased from $6,350,000 at December 31, 2022 to $8,811,000 at June 30, 2023.
◦Our total TBA Agency Securities aggregate notional balance was $800,000 at December 31, 2022 and $50,000 at June 30, 2023. The decrease in TBA prices resulted in losses of $(3,286) and $(443) and $(17,899) and $(117,093) for the three and six months ended June 30, 2023 and June 30, 2022, respectively.
37
ARMOUR Residential REIT, Inc.
Management’s Discussion and Analysis (continued)
For the Three Months Ended June 30,
For the Six Months Ended June 30,
2023
2022
2023
2022
Expenses:
Management fees
$
9,392
$
8,297
$
18,636
$
16,437
Compensation
1,261
1,410
2,420
2,819
Other Operating
2,259
1,647
3,496
3,275
Total Expenses
$
12,912
$
11,354
$
24,552
$
22,531
Less management fees waived
(1,650)
(1,950)
(3,300)
(3,900)
Total Expenses after fees waived
$
11,262
$
9,404
$
21,252
$
18,631
Expenses
The Company is managed by ACM, pursuant to a management agreement. The 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 management fee rate decreased to 0.75% per annum for gross equity raised in excess of $1.0 billion pursuant to the management agreement, the effective average management fee rate declines as equity is raised. The cost of repurchased stock and any dividends specifically designated by the Board as liquidation dividends will reduce the amount of gross equity raised used to calculate the monthly management fee. Realized and unrealized gains and losses do not affect the amount of gross equity raised. At June 30, 2023 and June 30, 2022, the effective management fee, prior to management fees waived, was 0.94% and 0.97% based on gross equity raised of $4,042,078 and $3,448,004, respectively. ACM began waiving 40% of its management fee during the second quarter of 2020 and on January 13, 2021, ACM notified ARMOUR that it intended to adjust the fee waiver to the rate of $2,400 for the first quarter of 2021 and $800 per month thereafter. On April 20, 2021, ACM notified ARMOUR that it intended to adjust the fee waiver to the rate of $2,100 for the second quarter of 2021 and $700 per month thereafter. On October 25, 2021, ACM notified ARMOUR that it intended to adjust the fee waiver from the rate of $700 per month to $650 per month, effective November 1, 2021, until further notice. On February 14, 2023, ACM notified ARMOUR that it intended to adjust the fee waiver to the rate of $1,650 for the first quarter of 2023 and $550 per month thereafter until ACM provides further notice to ARMOUR (see Note 8 - Commitments and Contingencies).
Compensation includes non-executive director compensation as well as the restricted stock units awarded to our Board and executive officers through ACM. The fluctuation from year to year is due to the number of awards vesting.
Other Operating 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.
•Professional fees for securities clearing, legal, audit and consulting costs that 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 premiums for both general business and directors and officers liability coverage fluctuate from year to year due to changes in premiums.
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 13 to the consolidated financial statements).
38
ARMOUR Residential REIT, Inc.
Management’s Discussion and Analysis (continued)
Realized gains and losses on interest rate contracts and treasury futures terminated before their maturity are deferred and amortized over the remainder of the original term of the contract for REIT taxable income. At June 30, 2023 and December 31, 2022, we had approximately $268,923 and $307,316, respectively, of net deductible expense relating to previously terminated interest rate swap and treasury futures contracts amortizing through the year 2032. At June 30, 2023, we had $257,341 of net operating loss carryforwards available for use indefinitely. For 2023, we forecast that estimated ordinary REIT taxable income will be positive. This would likely result in Series C Preferred Stock dividends for 2023 being treated as fully taxable ordinary income. Common stock dividends for 2023 are expected to partially be treated as taxable ordinary income.
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 12 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 7 to the consolidated financial statements).
Agency Securities:
Agency 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.
39
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 tables below summarize certain characteristics of our investments in securities at June 30, 2023 and December 31, 2022.
June 30, 2023
Principal Amount
Amortized Cost
Gross Unrealized Gain (Loss)
Fair Value
CPR (1)
Weighted Average Months to Maturity
Percent of Total
Agency Fixed Rates ≥ 181 months
3.0%
610,466
548,705
(10,305)
538,400
2.4
%
338
4.8
%
3.5%
1,215,454
1,197,717
(87,864)
1,109,853
4.1
%
346
9.8
%
4.0%
1,167,121
1,168,772
(71,451)
1,097,321
4.0
%
347
9.7
%
4.5%
1,308,599
1,303,402
(44,103)
1,259,299
4.8
%
349
11.1
%
5.0%
2,077,911
2,072,445
(32,383)
2,040,062
5.0
%
352
18.1
%
5.5%
2,356,908
2,380,018
(28,107)
2,351,911
5.6
%
355
20.9
%
6.0%
2,316,917
2,364,304
(21,808)
2,342,496
9.4
%
355
20.8
%
6.5%
57,099
58,571
228
58,799
15.2
%
354
0.5
%
Other Agency Securities
Agency CMBS
$
379,118
$
379,421
$
(927)
$
378,494
n/a
120
3.4
%
Total Agency Securities
$
11,489,593
$
11,473,355
$
(296,720)
$
11,176,635
99.1
%
TBA Agency Securities (2)
30 Year Short, 3.0%
$
(500,000)
$
(440,199)
$
43
$
(440,156)
n/a
n/a
(3.9)
%
30 Year Long, 5.0%
$
550,000
$
543,960
$
(3,070)
$
540,890
n/a
n/a
4.8
%
Total TBA Agency Securities
$
50,000
$
103,761
$
(3,027)
$
100,734
n/a
n/a
0.9
%
Totals
$
11,539,593
$
11,577,116
$
(299,747)
$
11,277,369
100.0
%
(1)Weighted average CPR during the quarter for the securities owned at June 30, 2023. Negative CPR can occur if payments are not made on the first of the month and the scheduled principal amount is not received.
(2)Our TBA Agency Securities were recorded as derivative instruments in our accompanying consolidated financial statements. Our TBA Agency Securities were reported at net carrying values of $(3,027), at June 30, 2023 and were reported in Derivatives, at fair value on our consolidated balance sheets (see Note 7 to the consolidated financial statements).
40
ARMOUR Residential REIT, Inc.
Management’s Discussion and Analysis (continued)
December 31, 2022
Principal Amount
Amortized Cost
Gross Unrealized Gain (Loss)
Fair Value
CPR (1)
Weighted Average Months to Maturity
Percent of Total
Agency Fixed Rates ≤ 180 months
3.5% to 6.0%
$
14,264
$
14,760
$
(768)
$
13,992
1.3
%
111
0.2
%
Agency Fixed Rates ≥ 181 months
2.0%
390,154
397,483
(74,778)
322,705
7.3
%
336
3.6
%
2.5%
608,261
645,600
(119,925)
525,675
8.3
%
331
5.9
%
3.0%
969,166
973,560
(120,174)
853,386
3.9
%
349
9.5
%
3.5%
1,229,970
1,212,939
(91,395)
1,121,544
3.4
%
352
12.5
%
4.0%
1,217,621
1,219,805
(72,499)
1,147,306
3.8
%
352
12.8
%
4.5%
1,509,102
1,510,336
(52,439)
1,457,897
4.4
%
350
16.2
%
5.0%
1,733,644
1,730,097
(17,792)
1,712,305
4.6
%
356
19.0
%
5.5%
1,039,085
1,048,377
(4,596)
1,043,781
—
%
357
11.6
%
Total Agency Securities
$
8,711,267
$
8,752,957
$
(554,366)
$
8,198,591
4.0
%
351
91.3
%
TBA Agency Securities
30 Year (2)
4.5%
$
500,000
$
489,805
$
(8,164)
$
481,641
n/a
n/a
5.4
%
5.0%
$
300,000
$
300,164
$
(4,336)
$
295,828
n/a
n/a
3.3
%
Total TBA Agency Securities
$
800,000
$
789,969
$
(12,500)
$
777,469
n/a
0
8.7
%
Totals
$
9,511,267
$
9,542,926
$
(566,866)
$
8,976,060
100.0
%
(1)Weighted average CPR during the fourth quarter for the securities owned at December 31, 2022. Negative CPR can occur if payments are not made on the first of the month and the scheduled principal amount is not received.
(2)Our TBA Agency Securities were recorded as derivative instruments in our accompanying consolidated financial statements. Our TBA Agency Securities were reported at net carrying values of $(11,797), at December 31, 2022 and were reported in Derivatives, at fair value on our consolidated balance sheets (see Note 7 to the consolidated financial statements).
The following tables summarize changes in our investments in securities as of June 30, 2023 and December 31, 2022, excluding TBA Agency Securities (see Note 7 to the consolidated financial statements).
41
ARMOUR Residential REIT, Inc.
Management’s Discussion and Analysis (continued)
Available for Sale Securities
Trading Securities
Agency
Agency
U.S. Treasuries
U.S. Treasury Securities Sold Short
June 30, 2023
Balance, December 31, 2022
$
187,944
$
8,010,647
$
—
$
(506,074)
Purchases (1)
—
7,522,034
619,373
—
Proceeds from sales
(189,931)
(3,818,535)
(613,852)
—
Receivable for unsettled sales
—
(94,825)
—
—
Principal repayments
(1,997)
(402,013)
—
—
Current gains (losses)
3,946
(48,112)
(5,394)
5,468
Accrued interest payable
—
—
—
(57)
Amortization:
Prior unrealized (gains) losses
110
10,819
5
—
Purchase (premium) discount
(72)
(3,380)
(132)
—
Balance, June 30, 2023
$
—
$
11,176,635
$
—
(500,663)
Percentage of Portfolio
—
%
100.00
%
—
%
December 31, 2022
Balance, December 31, 2021
$
1,387,845
$
3,018,676
$
198,833
$
—
Purchases (1)
—
11,809,926
4,820,464
—
Proceeds from sales
(988,728)
(5,360,328)
(4,876,767)
(494,797)
Principal repayments
(77,101)
(496,508)
—
—
Current losses
(122,917)
(980,365)
(144,918)
(7,859)
Credit loss expense
(4,183)
—
—
—
Accrued interest payable
—
—
—
(3,418)
Amortization:
Prior unrealized (gains) losses
(3,035)
33,699
509
—
Purchase (premium) discount
(3,937)
(14,453)
1,879
—
Balance, December 31, 2022
$
187,944
$
8,010,647
$
—
$
(506,074)
Percentage of Portfolio
2.29
%
97.71
%
—
%
(1)Purchases include cash paid during the period, plus payable for investment securities purchased during the period as of period end.
Repurchase Agreements, net
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 moved in close relationship to the Fed Funds Rate and SOFR. We have established borrowing relationships with numerous investment banking firms and other lenders, 18 of which had open repurchase agreements with us at June 30, 2023 and December 31, 2022. We had outstanding balances under our repurchase agreements, net at June 30, 2023 and December 31, 2022 of $9,121,329 and $6,463,058, respectively, consistent with the increase in our MBS in our securities portfolio. At June 30, 2023 and December 31, 2022, BUCKLER accounted for 48.4% and 50.2%, respectively, of our aggregate borrowings and had an amount at risk of 7.8% and 12.9%,
42
ARMOUR Residential REIT, Inc.
Management’s Discussion and Analysis (continued)
respectively, of our total stockholders' equity with a weighted average maturity of 21 days and 15 days, respectively, on repurchase agreements (see Note 6 to the consolidated financial statements).
Our repurchase agreements require excess collateral, known as a “haircut.” At June 30, 2023, the average haircut percentage was 2.82% compared to 3.85% at December 31, 2022.
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 Fed Funds Rate or SOFR.
We had contractual commitments under derivatives at June 30, 2023 and December 31, 2022. At June 30, 2023 and December 31, 2022, we had derivatives with a net fair value of $989,441 and $971,440, respectively. 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 June 30, 2023 and December 31, 2022.
Gross Amounts Not Offset
Assets
Gross Amounts(1)
Financial Instruments
Cash Collateral
Total Net
June 30, 2023
Interest rate swap contracts (2)
$
989,719
$
(337)
$
(919,153)
$
70,229
Futures contracts
11,252
(8,166)
2,810
5,896
TBA Agency Securities
78
(3,105)
5,164
2,137
Totals
$
1,001,049
$
(11,608)
$
(911,179)
$
78,262
December 31, 2022
Interest rate swap contracts
$
983,659
$
—
$
(955,941)
$
27,718
Futures contracts
94
(516)
9,334
8,912
TBA Agency Securities
703
(12,500)
13,633
1,836
Totals
$
984,456
$
(13,016)
$
(932,974)
$
38,466
(1)See Note 4 - Fair Value of Financial Instruments for additional discussion.
(2)Includes $22,099 of centrally-cleared interest rate swap contracts.
All of our interest rate contracts have floating leg interest rate indexes of either the Fed Funds Rate or SOFR. The Fed Funds Rate is published daily by the New York Federal Reserve and is a measure of unsecured borrowings by depository institutions from other depository institutions or GSEs. SOFR is published daily by the New York Federal Reserve and is the average overnight rate for borrowings secured by U.S. Treasury securities. We enter into interest rate swap contracts either directly with a counterparty (a “bilateral” contract) or through a centrally-cleared swap contract. In a bilateral contract, we exchange margin collateral with the counterparty and have exposure to counterparty risk. In a centrally-cleared contract, we exchange margin collateral with a Futures Clearing Merchant, with whom we have opened an account. Our counterparty risk is limited to the clearing exchange itself. All of our centrally-cleared swaps are cleared by the CME. In general, centrally-cleared interest rate swap contracts require us to post higher initial margin than bilateral contracts.
43
ARMOUR Residential REIT, Inc.
Management’s Discussion and Analysis (continued)
Gross Amounts Not Offset
Liabilities
Gross Amounts(1)
Financial Instruments
Cash Collateral
Total Net
June 30, 2023
Interest rate swap contracts (2)
$
(337)
$
337
$
—
$
—
Futures contracts
(8,166)
8,166
—
—
TBA Agency Securities
(3,105)
3,105
—
—
Totals
$
(11,608)
$
11,608
$
—
$
—
December 31, 2022
Futures contracts
$
(516)
$
516
$
—
$
—
TBA Agency Securities
(12,500)
12,500
—
—
Totals
$
(13,016)
$
13,016
$
—
$
—
(1)See Note 4 - Fair Value of Financial Instruments for additional discussion.
(2)Includes $(337) of centrally-cleared interest rate swap contracts.
At June 30, 2023, we had interest rate swap contracts with an aggregate notional balance of $8,811,000, a weighted average swap rate of 2.14% and a weighted average term of 59 months. At December 31, 2022, we had interest rate swap contracts with an aggregate notional balance of $6,350,000, a weighted average swap rate of 0.72% and a weighted average term of 73 months. We also had TBA Agency Securities with an aggregate notional balance of $50,000 and $800,000 at June 30, 2023 and December 31, 2022, respectively (see Note 7 to the consolidated financial statements).
The following table details the changes in the fair value of our interest rate swap contracts for the six months ended June 30, 2023 and for the year ended December 31, 2022.
Interest Swap Contracts
Six Months Ended June 30, 2023
For the Year Ended December 31, 2022
Net Balance, beginning of period
$
983,659
$
180,476
Net interest rate swap contract payments paid (received)
(56,511)
17,027
Interest rate swap income accrued
183,019
107,269
Interest rate swap expense accrued
(83,274)
(54,049)
Current unrealized gains (losses)
(123,849)
677,865
Amortization of prior unrealized gains
97,635
122,101
Loss on early terminations
(11,297)
(67,030)
Net, Balance, end of period
$
989,382
$
983,659
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:
44
ARMOUR Residential REIT, Inc.
Management’s Discussion and Analysis (continued)
•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.
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 offset difficult. We recognized net gains related to our derivatives of $194,190 and $59,790 and $205,914 and $450,518, for the three and six months ended June 30, 2023 and June 30, 2022, respectively.
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. Centrally-cleared interest rate swaps may have higher margin requirements than bilateral interest rate swaps. We have established an account with a futures commission merchant for this purpose. During the six months ended June 30, 2023, we entered into $3,300,000 notional amount of centrally-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.
45
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.
46
ARMOUR Residential REIT, Inc.
Management’s Discussion and Analysis (continued)
Liquidity and Capital Resources
At June 30, 2023, our liquidity totaled $644,417, consisting of $163,746 of cash plus $480,671 of unencumbered Agency Securities and U.S. government securities (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 potential sources of liquidity include our automatic shelf registration filed with the SEC, pursuant to which we may offer an unspecified amount of shares of our common stock, preferred stock, warrants, depositary shares and debt securities. During the three and six months ended June 30, 2023, we sold 15,160 and 45,023 shares under the 2021 Common stock ATM Sales Agreement for proceeds of $77,478 and $258,683, net of issuance costs and commissions of approximately $707 and $2,675. During the three and six months ended June 30, 2023, we repurchased 425 and 1,268 common shares under our current repurchase authorization for costs of $2,072 and $6,377 (refer to Note 10 to the consolidated financial statements). See Note 14for additional discussion of transactions with BUCKLER.
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. At June 30, 2023 we had $512,500 in reverse repurchase agreements and obligations to return securities received as collateral associated with our reverse repurchase agreements of $497,188. At December 31, 2022 we had $704,276 in reverse repurchase agreements and obligations to return securities received as collateral associated with our reverse repurchase agreements of $502,656.
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 June 30, 2023 and December 31, 2022, we financed our securities portfolio with $9,121,329 and $6,463,058 of borrowings under repurchase agreements. We generally seek to borrow (on a recourse basis) between six and ten times the amount of our total stockholders’ equity. Our debt to equity ratios at June 30, 2023 and December 31, 2022, were 7.11:1 and 5.81:1, respectively, as we substituted Agency MBS for TBA Agency Securities. Our leverage ratios, including notional on our TBA Agency Securities, were 7.19:1 and 6.51:1 at June 30, 2023 and December 31, 2022, respectively. Implied leverage, including TBA Securities and forward settling sales and unsettled purchases was 7.59:1 and 8.69:1 at June 30, 2023 and December 31, 2022, respectively.
47
ARMOUR Residential REIT, Inc.
Management’s Discussion and Analysis (continued)
Securities Portfolio Matters
For the Six Months Ended June 30,
2023
2022
Securities purchased using proceeds from repurchase agreements and principal repayments
$
8,141,407
$
9,281,740
Average securities portfolio
$
11,272,925
$
8,158,792
Cash received from principal repayments on MBS
$
404,010
$
287,457
Net cash increase from repurchase agreements, net
$
2,658,271
$
2,744,510
Cash interest payments made on liabilities
$
269,691
$
33,776
Cash and cash collateral posted to counterparties provided by (used in) operating activities (1)
$
45,298
$
(73,759)
(1)The increase in cash and cash collateral posted to counterparties related to operating activities from 2022 to 2023 is related to exiting certain MBS positions.
Other Contractual Obligations
The Company is managed by ACM, pursuant to a management agreement (see Note 8 and Note 14 to the consolidated financial statements). The management agreement runs through December 31, 2029 and is thereafter automatically renewed for an additional five-year term unless terminated under certain circumstances.
The following table reconciles the fees incurred in accordance with the management agreement for the three and six months ended June 30, 2023 and June 30, 2022 (see Note 8 to the consolidated financial statements).
For the Three Months Ended June 30,
For the Six Months Ended June 30,
2023
2022
2023
2022
ARMOUR management fees
$
9,377
$
8,282
$
18,605
$
16,407
Less management fees waived
(1,650)
(1,950)
(3,300)
(3,900)
Total management fee expense
$
7,727
$
6,332
$
15,305
$
12,507
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 June 30, 2023, there were 867 shares available for future issuance under the Plan.
At June 30, 2023, there was approximately $13,223 of unvested stock based compensation related to the Awards (based on a weighted grant date price of $7.87 per share), which we expect to recognize as an expense as follows: for the remainder of 2023 an expense of $1,881, in 2024 an expense of $3,626, and thereafter an expense of $7,716. Our policy is to account for forfeitures as they occur. We also pay each of our non-executive Board members quarterly fees, which are payable in cash, common stock, RSUs or a combination of common stock, RSUs and cash at the option of the director. Compensation to be paid to our non-executive Board in the form of cash and common equity is $1,351 annually (see Note 9 to the consolidated financial statements).
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.
48
ARMOUR Residential REIT, Inc.
Management’s Discussion and Analysis (continued)
Repurchase Agreements, net
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 6 and Note 14 to the consolidated financial statements).
49
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.
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 agreement 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 liquidity requirements. As of the date hereof, we have "at-the-market" offering programs with 3,153 shares available under the Preferred C ATM Sales Agreement and 75,000 shares of common stock remain available under the 2023 Common stock ATM Sales Agreement (see Note 10 to the consolidated financial statements). These liquidity requirements include maturing repurchase agreements, settling TBA Agency Security positions and potentially making net payments on our interest rate swap contracts, and in each case, continuing to meet ongoing margin requirements. 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 10 to the consolidated financial statements.
Critical Accounting Policies
Valuation
Fair value is based on valuations obtained from third-party pricing services and/or dealer quotes. The third-party pricing services use common market pricing methods that include valuation models which incorporate such factors as coupons, collateral type, bond structure, historical and projected future prepayment speeds, priority of payments, historical and projected future delinquency rates and default 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.
Valuation modeling is required because each individual MBS pool is a separately identified security with individual combinations of characteristics that influence market pricing. While the Agency Security market is generally very active and liquid within the context of broader classes of MBS, any particular security will likely trade infrequently. Our interest rate contracts are bilateral contracts with individual dealers and counterparties and are not cleared through recognized clearing
50
ARMOUR Residential REIT, Inc.
Management’s Discussion and Analysis (continued)
organizations. Valuation models for these positions rely on information from the active and liquid general interest rate swap market to infer the value of these unique positions.
From time to time, we challenge the information and valuations we receive from third-party pricing services. Occasionally, the third-party pricing services revise their information or valuations as a result of such challenges. While we have concluded that the fair values reflected in the financial statements are appropriate, there is no way to verify that the particular fair value estimated for any individual position represents the price at which it may actually be bought or sold at any given date.
Fair value for our U.S. Treasury Securities is based on obtaining a valuation for each U.S. Treasury Security from third-party pricing services and/or dealer quotes.
We update our fair value estimates at the end of each business day to reflect current market dynamics. During times of high market volatility, it can be difficult to obtain accurate market information timely, and accordingly, the confidence interval around our valuation estimates will increase, potentially significantly. During the three and six months ended June 30, 2023, the largest inter-day movement was the overall estimated values of our investment and hedge positions translated to a change in estimated book value of $(0.19) per common share. Similarly, 95% of inter-day movements in estimated value translated to changes in estimated book value per share of $0.19 or less.
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.
Subsequent Events
See Note 15 to the consolidated financial 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 COVID-19 or a new pandemic on our operations;
•the geopolitical situation as a result of the war in Ukraine may continue to adversely affect the U.S. economy, which may lead the Fed to take actions that may impact our business;
•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;
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ARMOUR Residential REIT, Inc.
Management’s Discussion and Analysis (continued)
•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;
•the potential for BUCKLER's inability to access attractive repurchase financing on our behalf or secure profitable third-party business;
•our management's competing duties to other affiliated entities, which could result in decisions that are not in the best interest of our stockholders;
•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.
52
GLOSSARY OF TERMS
ARMOUR Residential REIT, Inc.
Term
Definition
Agency CMBS
Commercial mortgage backed securities.
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.
Basis swap contracts
Derivative contracts that allow us to exchange one floating interest rate basis for another, for example, 3 month 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.
CME
Chicago Mercantile Exchange.
Co-CEOs
Co-Chief Executive Officers of ARMOUR, Jeffrey Zimmer and Scott Ulm.
Code
The Internal Revenue Code of 1986.
Common Stock Repurchase Program
ARMOUR's common stock repurchase program authorized by our Board.
COVID-19
The Coronavirus pandemic.
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.
Fed Funds Rate
Federal Funds Effective Rate.
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.
53
ARMOUR Residential REIT, Inc.
GLOSSARY OF TERMS (continued)
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.
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.
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.
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.
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.
54
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.
Our borrowings are not subject to similar restrictions and are generally repurchase agreements of limited duration that track the Fed Funds Rate and SOFR 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 and obligations to return securities received as collateral.
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 June 30, 2023 and December 31, 2022. It assumes that the mortgage spread on our MBS remains constant. Actual 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. Interest rates for interest rate swaps and repurchase agreements are assumed to remain positive. The analysis presented utilized assumptions, models and estimates of ACM based on ACM's judgment and experience.
55
ARMOUR Residential REIT, Inc.
Market Risk Disclosures (continued)
Percentage Change in Projected
Change in Interest Rates
Net Interest Income
Portfolio Including Derivatives
Shareholder's Equity
June 30, 2023
1.00%
5.06%
(1.60)%
(14.59)%
0.50%
2.53%
(0.72)%
(6.57)%
(0.50)%
(2.51)%
0.52%
4.77%
(1.00)%
(5.01)%
0.79%
7.14%
December 31, 2022
1.00%
2.81%
(1.60)%
(13.54)%
0.50%
1.41%
(0.76)%
(6.39)%
(0.50)%
(1.42)%
0.60%
5.08%
(1.00)%
(2.87)%
0.98%
8.31%
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 June 30, 2023 and December 31, 2022. 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.
June 30, 2023
December 31, 2022
Percentage Change in Projected
Percentage Change in Projected
Change in MBS spread
Portfolio Value
Shareholders' Equity
Portfolio Value
Shareholders' Equity
+25 BPS
(1.36)%
(11.93)%
(1.54)%
(12.39)%
+10 BPS
(0.54)%
(4.77)%
(0.61)%
(4.96)%
-10 BPS
0.54%
4.77%
0.61%
4.96%
-25 BPS
1.36%
11.93%
1.54%
12.39%
56
ARMOUR Residential REIT, Inc.
Market Risk Disclosures (continued)
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 impairment 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 impairment 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+.
At June 30, 2023 and December 31, 2022, we did not own any Credit Risk and Non-Agency Securities. From time to time we may 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. Credit Risk and Non-Agency Securities are subject to risk of loss with regard to principal and interest payments.
Liquidity Risk
Our primary liquidity risk arises from financing long-maturity MBS with short-term debt. The interest rates on our borrowings adjust frequently while the interest rates on our MBS are fixed. 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.
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 IT Committee to help mitigate technology risks including cybersecurity. One of the roles of the IT 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
57
ARMOUR Residential REIT, Inc.
Market Risk Disclosures (continued)
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.
In addition, our Audit Committee periodically monitors and oversees our information and cybersecurity risks including reviewing and approving any information and cybersecurity policies, procedures and resources, and reviewing our information and cybersecurity risk assessment, detection, protection, and mitigation systems.
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 June 30, 2023. Based on their participation in that evaluation, our Co-CEOs and CFO concluded that our disclosure controls and procedures were effective as of June 30, 2023 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 June 30, 2023. That evaluation did not identify any changes that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
58
PART II. OTHER INFORMATION
ARMOUR Residential REIT, Inc.
(in thousands, except per share)
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, 2022, filed with the SEC on February 15, 2023.
Item 1A. Risk Factors
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, 2022, filed with the SEC on February 15, 2023.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
The following table presents information regarding our repurchases made during the three months ended June 30, 2023 (in thousands, except per share price). In the four business days prior to and after the announcement of our stock repurchase program (the "Common Stock Repurchase Program") there were no purchases or sales by any directors or officers of common stock.
Period
Class of Shares
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)
Total Number of Shares Purchased on the Open Market
April 1, 2023 through April 30, 2023
Common
—
$
—
—
5,889
—
May 1, 2023 through May 31, 2023
Common
(425)
$
(4.88)
(425)
5,464
(425)
June 1, 2023 through June 30, 2023
Common
—
$
—
—
5,464
—
Totals
(425)
(425)
5,464
(425)
(1)All shares were repurchased pursuant to the Common Stock Repurchase Program (see Note 10 to the consolidated financial statements).
(2)Weighted average share price, including fees and commissions.
(3)The Board authorized the Common Stock Repurchase Program to initially authorize the Company to repurchase up to $100 million of its outstanding shares of common stock, which Common Stock Repurchase Program was announced on December 17, 2012. The Board subsequently amended the repurchase authorization on March 5, 2014 to increase the repurchase authorization from $100 million shares to 50,000 shares. On July 28, 2015, the Board increased the repurchase authorization to 9,000 shares effective in connection with the Company’s one-for-eight reverse stock split of its common stock in July 2015. Most recently, the Board increased the repurchase authorization back up to 9,000 shares on June 4, 2019. At June 30, 2023 there were 5,464 authorized shares remaining under the current Common Stock Repurchase Program.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Mine Safety Disclosures
Not applicable.
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ARMOUR Residential REIT, Inc.
Item 6. Exhibits
Item 5. Other Information
On July 26, 2023, the Company entered into a new Equity Sales Agreement, dated July 26, 2023 (the “2023 Common stock ATM Sales Agreement”), with BUCKLER, an affiliate of the Company and member of the Financial Industry Regulatory Authority, JonesTrading Institutional Services LLC (“JonesTrading”), JMP Securities LLC (“JMP Securities”), Ladenburg Thalmann & Co. Inc. (“Ladenburg”) and B. Riley Securities, Inc. (“B. Riley Securities,” and together with BUCKLER, JonesTrading, JMP Securities and Ladenburg, the “Agents”), as sales agents, and ACM, pursuant to which the Company may, from time to time, issue and sell up to 75,000 shares (“Shares”) of the Company’s common stock through or to such designated Agents.
The 2023 Common stock ATM Sales Agreement relates to a proposed “at the market offering” of shares of the Company’s common stock (the “Offering”). The Shares are being offered pursuant to a prospectus supplement (the “ATM Prospectus Supplement”) filed with the SEC on July 26, 2023, in connection with the Company’s effective shelf registration statement on Form S-3 (Registration No. 333-253311). Sales of the Company’s common stock through the Agents, if any, will be made in amounts and at times to be determined by the Company from time to time, but neither the Company nor the Agents have an obligation to sell any of the shares in the Offering. Actual sales will depend on a variety of factors to be determined by the Company from time to time, including (among others) market conditions, the trading price of the Company’s common stock and determinations by the Company of the appropriate sources of funding for the Company. Under the Sales Agreement, the Agents have agreed to use commercially reasonable efforts consistent with their normal trading and sales practices to sell common stock in agency transactions. The 2023 Common stock ATM Sales Agreement provides that the Agents will be entitled to compensation of up to 2.0% of the gross sales price per share for any of the common stock sold under the Sales Agreement in agency transactions.
Sales of the common stock, if any, under the 2023 Common stock ATM Sales Agreement may be made by means of transactions that are deemed to be “at-the-market offerings” as defined in Rule 415 under the Securities Act of 1933, as amended and may include block sales and other privately negotiated transactions to investors. Neither the Company nor the Agents have an obligation to sell any of the common stock in the Offering, and the Company or Agents may at any time suspend solicitation and offers under the Sales Agreement or terminate the Sales Agreement. The Company intends to use the proceeds from any sales to acquire additional MBS and other mortgage-related assets in accordance with its objectives and strategies described in the Company's most recent Annual Report on Form 10-K and other filings with the SEC.
The 2023 Common stock ATM Sales Agreement contains customary representations, warranties and agreements of the Company and ACM and customary conditions to completing future sale transactions, indemnification rights and obligations of the parties and termination provisions.
The 2023 Common stock ATM Sales Agreement is filed as Exhibit 10.1 to this Quarterly Report on Form 10-Q and is incorporated herein by reference. The foregoing description of the 2023 Common stock ATM Sales Agreement and the transactions contemplated thereby is qualified in its entirety by reference to Exhibit 10.1.
Also attached as Exhibit 5.1 to this Quarterly Report on Form 10-Q and incorporated herein by reference is a legal opinion regarding the validity of the shares to be issued and sold in the Offering.
This Item 5 disclosure shall not constitute an offer to sell or a solicitation of an offer to buy any securities, nor shall there be any sale of these securities in any state or jurisdiction in which such an offer, solicitation or sale would be unlawful prior to registration or qualification under the securities laws of any such state or other jurisdiction.
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.
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 Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
July 26, 2023
ARMOUR RESIDENTIAL REIT, INC.
/s/ James R. Mountain
James R. Mountain
Chief Financial Officer, Duly Authorized Officer and Principal Financial Officer
