ARMOUR Residential REIT, Inc. (NYSE: ARR) is a Maryland-based real estate investment trust (REIT) that specializes in investing in mortgage-backed securities (MBS) issued or guaranteed by U.S. government agencies or government-sponsored entities. The company has demonstrated its ability to navigate the complex and ever-changing mortgage market, delivering consistent returns to its shareholders.

Financials

For the fiscal year ended December 31, 2023, ARMOUR reported annual net income of -$67,923,000, annual revenue of $449,674,000, annual operating cash flow of $132,816,000, and annual free cash flow of $132,816,000. In the second quarter of 2024, the company reported a GAAP net loss available to common stockholders of $51.3 million, or $1.05 per common share. Net interest income for the quarter was $7 million. Distributable earnings available to common stockholders, a non-GAAP measure, was $52.5 million, or $1.08 per common share.

ARMOUR's book value per common share as of June 30, 2024, was $20.30, and the most recent available estimate as of July 22, 2024, was $20.37 per common share. The company paid monthly common stock dividends of $0.24 per share for a total of $0.72 per share for the second quarter of 2024. Cumulatively, ARMOUR has made distributions to stockholders of approximately $2.3 billion over its history.

Navigating the Shifting Mortgage Landscape

The second quarter of 2024 marked a potential turning point in the Federal Reserve's fight against inflation. As the disinflationary trend gained momentum, the market began pricing in the expectation of interest rate cuts, with the market currently anticipating 2.5 cuts this year and an additional 4.5 cuts by the end of 2025. While ARMOUR remains cautious about the depth of the cutting cycle, the company believes that the Fed's actions will have a profound impact on the mortgage-backed securities (MBS) market, the mortgage REIT sector, and ARMOUR specifically.

ARMOUR's Mortgage Strategy

ARMOUR's mortgage strategy continues to target a well-diversified portfolio, with approximately 10% market value exposures across each of the discount coupons from 3% and up, while maintaining an overweight to 5.5% and 6% coupon MBS for their wide option-adjusted spread and carry. The company's average prepayment rate on MBS assets in the second quarter of 2024 was 7.7 CPR, up from 4.6 CPR in the first quarter, driven largely by speeds in discount coupons.

ARMOUR is also seeing an uptick in the mortgage refinance index, signaling that prepayment speeds should continue to rise gradually into the year-end. To mitigate prepayment risk, the company is focusing on lower premium specified pools tied to geographic, credit, and loan-to-value characteristics. Additionally, ARMOUR maintains around 12% of its portfolio in forward TBA contracts for the attractive dollar roll carry in premium coupon Ginnie MBS and for better market liquidity versus specified pools in lower coupon conventional MBS.

Funding and Leverage

ARMOUR continues to fund 50% to 60% of its MBS portfolio with BUCKLER Securities, a related party, and the remainder is diversified among 14 other counterparties, with a weighted average haircut of just under 3%. The company's leverage has increased towards the end of the second quarter, reaching 7.7 turns, as it saw confirmation in economic data that the Fed is on the path to begin cutting rates later this year.

Outlook

Looking ahead, ARMOUR remains constructive on the medium to longer-term outlook for the MBS market, the mortgage REIT sector, and the company itself. The expected start of the Fed's easing cycle and the potential end of the quantitative tightening program are seen as significant tailwinds that could drive mortgage spreads 10 to 15 basis points tighter by the end of the year. However, the path to this outcome is not expected to be a straight line, and the company remains disciplined in its approach to leverage and deploying capital.

ARMOUR's earnings available for distribution sufficiently covered its dividend for the second quarter, and the company believes its current dividend is appropriate and expects earnings to cover the dividend rate into the year-end. The company's primary focus remains on generating total economic return on its portfolio to deliver to its shareholders.

Capital Raising and Dividend Policy

ARMOUR has not been actively raising capital this year due to an equity valuation that was considered too low. The company's thinking on raising equity remains the same, as it will look to raise equity if there are good investment opportunities and it can achieve a fair price, all factors considered, including whether it would lower per-share expenses and minimize a negative impact on its stock price.

The company continues to believe that its dividend is appropriate for the current environment and expects to maintain the fee rebate it has had in place. ARMOUR looks at its dividend over the intermediate term rather than focusing on short-term market fluctuations.

Risks and Challenges

Like any investment, ARMOUR faces a variety of risks and challenges, including interest rate risk, prepayment risk, credit risk, and operational risk. The company's ability to manage these risks effectively will be crucial to its long-term success. ARMOUR must navigate potential changes in monetary policy, fluctuations in the housing market, and shifts in investor sentiment towards REITs.

Conclusion

ARMOUR Residential REIT has demonstrated its ability to navigate the complex and ever-changing mortgage market, delivering consistent returns to its shareholders. The company's disciplined investment strategies, prudent risk management, and focus on generating total economic return have positioned it well to capitalize on the shifting landscape in the mortgage industry. As the Federal Reserve's actions unfold, ARMOUR is poised to benefit from the expected tailwinds in the MBS market, further strengthening its position as a leading player in the mortgage REIT sector.