ARMOUR Residential REIT, Inc. (ARR) is a Maryland-based real estate investment trust (REIT) that invests primarily in residential mortgage-backed securities (MBS) issued or guaranteed by U.S. government-sponsored entities (GSEs) such as Fannie Mae, Freddie Mac, and Ginnie Mae. The company has a long and storied history, having been founded in 2008 and weathering various market cycles and challenges over the past 17 years.
Business Overview and History ARMOUR was incorporated in 2008 and elected to be taxed as a REIT under the Internal Revenue Code. The company operates as an externally managed REIT, with ARMOUR Capital Management LP (ACM), a registered investment advisor, serving as its external manager. ARMOUR's primary focus is on investing in agency MBS, which are backed by fixed-rate, hybrid adjustable-rate, and adjustable-rate home loans.
ARMOUR was founded with the goal of bringing private capital into the mortgage markets to support home ownership for a broad and diverse spectrum of Americans. The company seeks to create stockholder value through thoughtful investment and risk management of a leveraged and diversified portfolio of mortgage-backed securities. ARMOUR relies on the decades of experience of its management team for MBS securities portfolio analysis and selection, access to equity capital and repurchase financing, and hedging and liquidity strategies to moderate interest rate and MBS price risk.
In 2016, ARMOUR acquired JAVELIN Mortgage Investment Corp., another publicly-traded REIT that was also managed by ACM. This acquisition allowed ARMOUR to expand its MBS portfolio and leverage ACM's expertise.
Over the years, ARMOUR has faced various challenges, including navigating changing interest rate environments and addressing regulatory concerns. For example, in 2023 the company disclosed that it had uncovered certain inappropriate conduct by members of senior management and the Board during an internal investigation. This led to the streamlining of the senior management structure and the implementation of enhanced policies and procedures to strengthen the company's corporate culture and internal controls.
In 2024, ARMOUR faced another internal investigation by a special committee of the board regarding issues raised internally. This led to findings of material weaknesses in the company's control environment, risk assessment, and information and communication. ARMOUR has taken steps to remediate these issues, including changes to senior management and additional training, but the full impact remains uncertain.
Despite these challenges, ARMOUR has remained dedicated to its mission of supporting the mortgage market and providing attractive returns to its shareholders. The company has maintained its REIT status and continued to pay regular dividends to its common stockholders throughout its history.
Financial Performance and Ratios ARMOUR's financial performance has been mixed in recent years, reflecting the broader market conditions. In 2024, the company reported an annual net loss of $14.4 million, or $0.51 per share, compared to a net loss of $18.2 million, or $0.69 per share, in 2023. The company's annual revenue in 2024 was $26.8 million, down from $29.2 million in 2023.
ARMOUR's financial ratios also present a mixed picture. The company's debt-to-equity ratio stood at 7.0 as of December 31, 2024, indicating a relatively high level of leverage. However, its interest coverage ratio of 0.44 suggests that the company may be facing challenges in servicing its debt obligations. The company's return on equity (ROE) and return on assets (ROA) were -11.32% and -0.11%, respectively, in 2024, reflecting the overall decline in profitability.
Quarterly Performance and Liquidity On a quarterly basis, ARMOUR's performance has been volatile. In the fourth quarter of 2024, the company reported a GAAP net loss related to common stockholders of $49.4 million, or $0.83 per share, compared to a net loss of $10.2 million, or $0.19 per share, in the same period of the previous year. The company's revenue for the quarter was $152.5 million. The net loss in Q4 2024 was primarily due to losses on the company's trading securities portfolio as interest rates increased.
ARMOUR's liquidity position has been a source of concern for investors. As of September 30, 2024, the company had $63.85 million in cash and cash equivalents, down from $221.89 million at the end of 2023. The company's cash and box liquidity stood at approximately 50% of its total capital, which may limit its ability to take advantage of market opportunities or weather potential market downturns.
Agency Securities Portfolio ARMOUR's securities portfolio consists primarily of Agency Securities backed by fixed-rate home loans. As of September 30, 2024, the company's Agency Securities portfolio had a fair value of $12.42 million, representing 100% of its total investments. The portfolio had a weighted average coupon of 4.93% and a weighted average maturity of 336 months. The Agency Securities are classified as trading securities, with changes in their fair value flowing through ARMOUR's earnings.
The company focuses on higher coupon MBS where spreads and carry are most attractive. ARMOUR's portfolio has an average duration of 0.36 years, and average prepayment rates have been in the 6-9% CPR range.
Repurchase Agreements and Leverage ARMOUR finances the majority of its Agency Securities portfolio through repurchase agreements. As of September 30, 2024, the company had $10.19 million in outstanding repurchase agreement borrowings, with a weighted average contractual rate of 5.26% and a weighted average maturity of 15 days. The repurchase agreements are secured by the company's Agency Securities, with an average haircut percentage of 2.95%.
The company uses leverage, currently at 7.9x, to enhance returns. This high level of leverage amplifies both potential gains and losses, contributing to the volatility in ARMOUR's financial performance.
Derivative Instruments To manage its interest rate risk, ARMOUR utilizes various derivative instruments, including interest rate swap contracts, interest rate swaptions, basis swap contracts, and futures contracts. As of September 30, 2024, the company had interest rate swap contracts with an aggregate notional balance of $6.69 million, a weighted average swap rate of 1.42%, and a weighted average term of 72 months. The fair value of ARMOUR's derivative instruments, net, was $673.88 thousand as of the same date.
Risks and Challenges ARMOUR's business model and investment strategy expose the company to a variety of risks, including interest rate risk, prepayment risk, and credit risk. The company's heavy reliance on repurchase agreements to finance its MBS portfolio also makes it vulnerable to changes in the repo market, which could negatively impact its funding costs and profitability.
Moreover, the company's external management structure with ACM may introduce potential conflicts of interest and could impact its decision-making and strategic direction. The ongoing regulatory changes and uncertainty surrounding the future of Fannie Mae and Freddie Mac, the GSEs that guarantee a significant portion of ARMOUR's MBS portfolio, also pose a risk to the company's operations and performance.
ARMOUR's financial performance is heavily influenced by changes in interest rates, prepayment speeds, and mortgage spreads, which can impact the yield on its Agency Securities portfolio and the cost of its repurchase agreement financing. The company's use of derivatives is intended to help mitigate the interest rate risk associated with its leveraged portfolio of Agency Securities.
Guidance and Outlook While ARMOUR has not provided any formal quantitative guidance for the upcoming fiscal year, the company's management has expressed cautious optimism about the agency MBS market. They expect volatility to continue to decline, with the Federal Reserve on hold, leading to a more range-bound environment for the MBS market. The company anticipates the prepayment environment to remain "uneventful" for their portfolio mix of modest price premiums and discount MBS, as long as mortgage rates remain above 6.5%.
ARMOUR expects earnings available for distribution to exceed their Q1 dividend rate. The company maintains a constructive view on agency MBS spreads, noting an attractive carry profile that is generating 18-19% levered ROE on production and premium coupon MBS.
The management sees potential headwinds from GSE reform, regulatory changes impacting bank demand, and fiscal/treasury supply issues, but does not view these as imminent risks. The company's focus on diversifying its hedging strategies and funding sources may also help mitigate some of the risks it faces.
Conclusion ARMOUR Residential REIT, Inc. is a well-established player in the agency MBS market, but it has faced significant challenges in recent years, including volatile market conditions, high leverage, and liquidity concerns. While the company has demonstrated its ability to adapt to changing market environments, its long-term success will depend on its ability to effectively manage its risks, maintain a strong liquidity position, and navigate the evolving regulatory landscape.
The company's recent internal investigations and findings of material weaknesses in its control environment add another layer of complexity to its operational challenges. However, ARMOUR's management remains optimistic about the MBS market's potential and the company's ability to generate attractive returns.
Investors should closely monitor ARMOUR's performance, risk management strategies, and progress in addressing its internal control issues as the company navigates the choppy waters of the residential mortgage market. The company's high leverage and sensitivity to interest rate changes make it a potentially volatile investment, but its focus on agency MBS and its experienced management team may provide some stability in an uncertain market environment.