Item 1. Financial Statements
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2016
|
|
December 31, 2015
|
Assets
|
|
|
|
|
Cash
|
|
$
|
401,825
|
|
|
$
|
289,925
|
|
Cash collateral posted to counterparties
|
|
281,397
|
|
|
263,799
|
|
Agency Securities, available for sale, at fair value (including pledged securities of $6,913,094 at September 30, 2016 and $12,109,868 at December 31, 2015)
|
|
7,041,228
|
|
|
12,461,556
|
|
Non-Agency Securities, trading, at fair value (including pledged securities of $1,001,319 at September 30, 2016 and $0 at December 31, 2015)
|
|
1,001,319
|
|
|
—
|
|
Interest-Only Securities, trading, at fair value
|
|
95,918
|
|
|
—
|
|
Derivatives, at fair value
|
|
10,194
|
|
|
999
|
|
Principal payments receivable
|
|
—
|
|
|
37
|
|
Accrued interest receivable
|
|
19,271
|
|
|
34,500
|
|
Prepaid and other
|
|
3,850
|
|
|
4,461
|
|
Total Assets
|
|
$
|
8,855,002
|
|
|
$
|
13,055,277
|
|
Liabilities and Stockholders’ Equity
|
|
|
|
|
Liabilities:
|
|
|
|
|
Repurchase agreements
|
|
$
|
7,360,670
|
|
|
$
|
11,570,481
|
|
Cash collateral posted by counterparties
|
|
15,496
|
|
|
—
|
|
Derivatives, at fair value
|
|
243,223
|
|
|
233,301
|
|
Accrued interest payable- repurchase agreements
|
|
6,025
|
|
|
7,724
|
|
Accounts payable and other accrued expenses
|
|
9,271
|
|
|
18,605
|
|
Total Liabilities
|
|
$
|
7,634,685
|
|
|
$
|
11,830,111
|
|
|
|
|
|
|
Commitments and contingencies (Note 10)
|
|
|
|
|
|
|
|
|
|
Stockholders’ Equity:
|
|
|
|
|
Preferred stock, $0.001 par value, 50,000 shares authorized;
|
|
|
|
|
8.250% Series A Cumulative Preferred Stock; 2,181 issued and outstanding ($54,514 aggregate liquidation preference)
|
|
2
|
|
|
2
|
|
7.875% Series B Cumulative Preferred Stock; 5,650 issued and outstanding ($141,250 aggregate liquidation preference)
|
|
6
|
|
|
6
|
|
Common stock, $0.001 par value, 125,000 shares authorized, 36,713 and 36,682 shares issued and outstanding at September 30, 2016 and December 31, 2015
|
|
37
|
|
|
37
|
|
Additional paid-in capital
|
|
2,560,021
|
|
|
2,559,361
|
|
Accumulated deficit
|
|
(1,505,020
|
)
|
|
(1,266,938
|
)
|
Accumulated other comprehensive income (loss)
|
|
165,271
|
|
|
(67,302
|
)
|
Total Stockholders’ Equity
|
|
$
|
1,220,317
|
|
|
$
|
1,225,166
|
|
Total Liabilities and Stockholders’ Equity
|
|
$
|
8,855,002
|
|
|
$
|
13,055,277
|
|
See notes to condensed consolidated financial statements.
ARMOUR Residential REIT, Inc. and Subsidiaries
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Quarter
Ended
|
|
For the Nine Months Ended
|
|
|
September 30, 2016
|
|
September 30, 2015
|
|
September 30, 2016
|
|
September 30, 2015
|
Interest Income:
|
|
|
|
|
|
|
|
|
Agency Securities, net of amortization of premium and fees
|
|
$
|
44,544
|
|
|
$
|
85,643
|
|
|
$
|
178,733
|
|
|
$
|
276,896
|
|
Non-Agency Securities, including discount accretion
|
|
12,969
|
|
|
—
|
|
|
23,148
|
|
|
—
|
|
Interest-Only Securities
|
|
852
|
|
|
—
|
|
|
855
|
|
|
—
|
|
Total Interest Income
|
|
$
|
58,365
|
|
|
$
|
85,643
|
|
|
$
|
202,736
|
|
|
$
|
276,896
|
|
Interest expense- repurchase agreements
|
|
(17,040
|
)
|
|
(14,431
|
)
|
|
(54,464
|
)
|
|
(42,539
|
)
|
Net Interest Income
|
|
$
|
41,325
|
|
|
$
|
71,212
|
|
|
$
|
148,272
|
|
|
$
|
234,357
|
|
Other Income (Loss):
|
|
|
|
|
|
|
|
|
Realized gain on sale of Agency Securities (reclassified from Other comprehensive income (loss))
|
|
2,421
|
|
|
69
|
|
|
18,937
|
|
|
1,562
|
|
Gain on Non-Agency Securities
|
|
39,522
|
|
|
—
|
|
|
53,795
|
|
|
—
|
|
Loss on Interest-Only Securities
|
|
(1,105
|
)
|
|
—
|
|
|
(2,348
|
)
|
|
—
|
|
Bargain purchase price on acquisition of JAVELIN
|
|
—
|
|
|
—
|
|
|
6,484
|
|
|
—
|
|
Subtotal
|
|
$
|
40,838
|
|
|
$
|
69
|
|
|
$
|
76,868
|
|
|
$
|
1,562
|
|
Realized gain (loss) on derivatives
(1)
|
|
19,816
|
|
|
(17,400
|
)
|
|
(338,804
|
)
|
|
(69,280
|
)
|
Unrealized gain (loss) on derivatives
|
|
25,824
|
|
|
(266,074
|
)
|
|
2,907
|
|
|
(287,905
|
)
|
Subtotal
|
|
$
|
45,640
|
|
|
$
|
(283,474
|
)
|
|
$
|
(335,897
|
)
|
|
$
|
(357,185
|
)
|
Total Other Income (Loss)
|
|
$
|
86,478
|
|
|
$
|
(283,405
|
)
|
|
$
|
(259,029
|
)
|
|
$
|
(355,623
|
)
|
Expenses:
|
|
|
|
|
|
|
|
|
Management fees
|
|
6,521
|
|
|
6,851
|
|
|
19,549
|
|
|
20,595
|
|
Professional fees
|
|
1,090
|
|
|
878
|
|
|
4,756
|
|
|
2,329
|
|
Insurance
|
|
283
|
|
|
174
|
|
|
727
|
|
|
516
|
|
Compensation
|
|
530
|
|
|
543
|
|
|
1,636
|
|
|
1,731
|
|
Other
|
|
691
|
|
|
914
|
|
|
2,188
|
|
|
2,566
|
|
Total Expenses
|
|
$
|
9,115
|
|
|
$
|
9,360
|
|
|
$
|
28,856
|
|
|
$
|
27,737
|
|
Net Income (Loss)
|
|
$
|
118,688
|
|
|
$
|
(221,553
|
)
|
|
$
|
(139,613
|
)
|
|
$
|
(149,003
|
)
|
Dividends on preferred stock
|
|
(3,905
|
)
|
|
(3,905
|
)
|
|
(11,716
|
)
|
|
(11,716
|
)
|
Net Income (Loss) related to common stockholders
|
|
$
|
114,783
|
|
|
$
|
(225,458
|
)
|
|
$
|
(151,329
|
)
|
|
$
|
(160,719
|
)
|
Net Income (Loss) per share related to common stockholders
(Note 13):
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
3.13
|
|
|
$
|
(5.18
|
)
|
|
$
|
(4.12
|
)
|
|
$
|
(3.68
|
)
|
Diluted
|
|
$
|
3.12
|
|
|
$
|
(5.18
|
)
|
|
$
|
(4.12
|
)
|
|
$
|
(3.68
|
)
|
Dividends declared per common share
|
|
$
|
0.66
|
|
|
$
|
0.98
|
|
|
$
|
2.36
|
|
|
$
|
2.90
|
|
Weighted average common shares outstanding:
|
|
|
|
|
|
|
|
|
Basic
|
|
36,703
|
|
|
43,561
|
|
|
36,693
|
|
|
43,709
|
|
Diluted
|
|
36,746
|
|
|
43,561
|
|
|
36,693
|
|
|
43,709
|
|
(1) Interest expense related to our interest rate swap contracts is recorded as realized loss on derivatives on the condensed consolidated statements of operations. For additional information, see
Note 9
to the condensed consolidated financial statements.
See notes to condensed consolidated financial statements.
ARMOUR Residential REIT, Inc. and Subsidiaries
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in thousands)
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Quarter
Ended
|
|
For the Nine Months Ended
|
|
|
September 30, 2016
|
|
September 30, 2015
|
|
September 30, 2016
|
|
September 30, 2015
|
Net Income (Loss)
|
|
$
|
118,688
|
|
|
$
|
(221,553
|
)
|
|
$
|
(139,613
|
)
|
|
$
|
(149,003
|
)
|
Other comprehensive income (loss):
|
|
|
|
|
|
|
|
|
Reclassification adjustment for realized gain on sale of available for sale Agency Securities
|
|
(2,421
|
)
|
|
(69
|
)
|
|
(18,937
|
)
|
|
(1,562
|
)
|
Net unrealized gain (loss) on available for sale Agency Securities
|
|
(7,526
|
)
|
|
137,312
|
|
|
251,510
|
|
|
5,241
|
|
Other comprehensive income (loss)
|
|
$
|
(9,947
|
)
|
|
$
|
137,243
|
|
|
$
|
232,573
|
|
|
$
|
3,679
|
|
Comprehensive Income (Loss)
|
|
$
|
108,741
|
|
|
$
|
(84,310
|
)
|
|
$
|
92,960
|
|
|
$
|
(145,324
|
)
|
See notes to the condensed consolidated financial statements.
ARMOUR Residential REIT, Inc. and Subsidiaries
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
(in thousands, except per share amounts)
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Preferred Stock
|
|
Common Stock
|
|
|
|
|
|
|
|
|
|
8.250% Series A
|
|
7.875% Series B
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares
|
|
Par Amount
|
|
Additional Paid-in Capital
|
|
Shares
|
|
Par Amount
|
|
Additional Paid-in Capital
|
|
Shares
|
|
Par Amount
|
|
Additional Paid-in Capital
|
|
Total
Additional Paid-in
Capital
|
|
Accumulated
Deficit
|
|
Accumulated
Other
Comprehensive Income (Loss)
|
|
Total
|
Balance, January 1, 2016
|
2,181
|
|
|
$
|
2
|
|
|
$
|
53,172
|
|
|
5,650
|
|
|
$
|
6
|
|
|
$
|
136,547
|
|
|
36,682
|
|
|
$
|
37
|
|
|
$
|
2,369,642
|
|
|
$
|
2,559,361
|
|
|
$
|
(1,266,938
|
)
|
|
$
|
(67,302
|
)
|
|
$
|
1,225,166
|
|
Series A Preferred dividends
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(3,373
|
)
|
|
—
|
|
|
(3,373
|
)
|
Series B Preferred dividends
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(8,343
|
)
|
|
—
|
|
|
(8,343
|
)
|
Common stock dividends
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(86,753
|
)
|
|
—
|
|
|
(86,753
|
)
|
Stock based compensation, net of withholding requirements
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
31
|
|
|
—
|
|
|
660
|
|
|
660
|
|
|
—
|
|
|
—
|
|
|
660
|
|
Net Loss
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(139,613
|
)
|
|
—
|
|
|
(139,613
|
)
|
Other comprehensive income
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
232,573
|
|
|
232,573
|
|
Balance, September 30, 2016
|
2,181
|
|
|
$
|
2
|
|
|
$
|
53,172
|
|
|
5,650
|
|
|
$
|
6
|
|
|
$
|
136,547
|
|
|
36,713
|
|
|
$
|
37
|
|
|
$
|
2,370,302
|
|
|
$
|
2,560,021
|
|
|
$
|
(1,505,020
|
)
|
|
$
|
165,271
|
|
|
$
|
1,220,317
|
|
See notes to condensed consolidated financial statements.
ARMOUR Residential REIT, Inc. and Subsidiaries
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
For the Nine Months Ended
|
|
|
September 30, 2016
|
|
September 30, 2015
|
Cash Flows From Operating Activities:
|
|
|
|
|
Net Loss
|
|
$
|
(139,613
|
)
|
|
$
|
(149,003
|
)
|
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
|
|
|
|
|
Net amortization of premium on Agency Securities
|
|
60,127
|
|
|
85,203
|
|
Accretion of net discount on Non-Agency Securities
|
|
(1,336
|
)
|
|
—
|
|
Net amortization of Interest-Only Securities
|
|
3,682
|
|
|
—
|
|
Realized gain on sale of Agency Securities
|
|
(18,937
|
)
|
|
(1,562
|
)
|
Gain on Non-Agency Securities
|
|
(53,795
|
)
|
|
—
|
|
Loss on Interest-Only Securities
|
|
2,348
|
|
|
—
|
|
Stock based compensation
|
|
660
|
|
|
717
|
|
Bargain purchase price on acquisition of JAVELIN
|
|
(6,484
|
)
|
|
—
|
|
Changes in operating assets and liabilities:
|
|
|
|
|
Decrease in accrued interest receivable
|
|
16,597
|
|
|
4,348
|
|
(Increase) decrease in prepaid and other assets
|
|
1,440
|
|
|
(3,195
|
)
|
(Increase) decrease in derivatives, at fair value
|
|
(16,825
|
)
|
|
260,340
|
|
Decrease in accrued interest payable- repurchase agreements
|
|
(2,612
|
)
|
|
(3,082
|
)
|
Decrease in accounts payable and other accrued expenses
|
|
(16,951
|
)
|
|
(13,278
|
)
|
Net cash provided by (used in) operating activities
|
|
$
|
(171,699
|
)
|
|
$
|
180,488
|
|
Cash Flows From Investing Activities:
|
|
|
|
|
Purchases of Agency Securities
|
|
(391,277
|
)
|
|
(3,485,806
|
)
|
Purchases of Non-Agency Securities
|
|
(760,666
|
)
|
|
—
|
|
Purchases of Interest-Only Securities
|
|
(101,947
|
)
|
|
—
|
|
Principal repayments of Agency Securities
|
|
1,020,179
|
|
|
1,486,497
|
|
Principal repayments of Non-Agency Securities
|
|
37,698
|
|
|
—
|
|
Proceeds from sales of Agency Securities
|
|
5,428,174
|
|
|
3,395,902
|
|
Increase (decrease) in cash collateral
|
|
22,499
|
|
|
(333,103
|
)
|
Net cash used in the acquisition of JAVELIN
|
|
(73,174
|
)
|
|
—
|
|
Net cash provided by investing activities
|
|
$
|
5,181,486
|
|
|
$
|
1,063,490
|
|
Cash Flows From Financing Activities:
|
|
|
|
|
Issuance of common stock, net of expenses
|
|
—
|
|
|
124
|
|
Proceeds from repurchase agreements
|
|
108,505,750
|
|
|
64,947,629
|
|
Principal repayments on repurchase agreements
|
|
(113,305,168
|
)
|
|
(66,233,977
|
)
|
Series A Preferred stock dividends paid
|
|
(3,373
|
)
|
|
(3,373
|
)
|
Series B Preferred stock dividends paid
|
|
(8,343
|
)
|
|
(8,343
|
)
|
Common stock dividends paid
|
|
(86,753
|
)
|
|
(127,669
|
)
|
Common stock repurchased
|
|
—
|
|
|
(36,441
|
)
|
Net cash used in financing activities
|
|
$
|
(4,897,887
|
)
|
|
$
|
(1,462,050
|
)
|
Net increase (decrease) in cash
|
|
111,900
|
|
|
(218,072
|
)
|
Cash - beginning of period
|
|
289,925
|
|
|
494,561
|
|
Cash - end of period
|
|
$
|
401,825
|
|
|
$
|
276,489
|
|
Supplemental Disclosure:
|
|
|
|
|
Cash paid during the period for interest
|
|
$
|
130,758
|
|
|
$
|
184,928
|
|
Non-Cash Investing and Financing Activities:
|
|
|
|
|
Net unrealized gain on available for sale Agency Securities
|
|
$
|
251,510
|
|
|
$
|
5,241
|
|
Amounts payable for common stock repurchased
|
|
$
|
—
|
|
|
$
|
(9,530
|
)
|
See notes to condensed consolidated financial statements
ARMOUR Residential REIT, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share amounts)
(UNAUDITED)
Note 1 -Basis of Presentation
The accompanying condensed 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 Securities and Exchange Commission (the “SEC”). Accordingly, they 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. Certain prior year amounts have been reclassified to conform to the current year's presentation. All per share amounts, common shares outstanding and stock-based compensation amounts for all periods presented reflect our one-for-eight reverse stock split (the “Reverse Stock Split”), which was effective July 31, 2015. Operating results for the
quarter and nine months
ended
September 30, 2016
are not necessarily indicative of the results that may be expected for the calendar year ending
December 31, 2016
. These unaudited 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, 2015
.
The condensed consolidated financial statements include the accounts of ARMOUR Residential REIT, Inc. and its subsidiaries including the results of JAVELIN Mortgage Investment Corp. ("JAVELIN") since its acquisition on April 6, 2016. All intercompany accounts and transactions have been eliminated. The preparation of the condensed 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 (as defined below), including an assessment of whether other-than-temporary impairment (“OTTI”) exists, and derivative instruments.
Note 2 -Organization and Nature of Business Operations
References to “we,” “us,” “our,” “ARMOUR” or the “Company” are to ARMOUR Residential REIT, Inc. References to “ACM” are to ARMOUR Capital Management LP, a Delaware limited partnership.
We are a Maryland corporation incorporated in 2008. ARMOUR and its subsidiaries, including JAVELIN are managed by ACM, an investment advisor registered with the SEC (see
Note 10 -Commitments and Contingencies
and
Note 15 -Related Party Transactions
for additional discussion). We invest in residential mortgage backed securities issued or guaranteed by a United States (“U.S.”) Government-sponsored entity (“GSE”), such as the Federal National Mortgage Association (Fannie Mae) or the Federal Home Loan Mortgage Corporation (Freddie Mac), or a government agency such as Government National Mortgage Administration (Ginnie Mae) (collectively, “Agency Securities”). Interest-only Securities are the interest portion of Agency Securities, which is separated and sold individually from the principal portion of the same payment. Other securities backed by residential mortgages in which we invest, for which the payment of principal and interest is not guaranteed by a GSE or government agency may benefit from credit enhancement derived from structural elements such as subordination, over collateralization or insurance (collectively, “Non-Agency Securities”). Agency Securities, Non-Agency Securities and Interest-only Securities are collectively referred to as “MBS”.
At
September 30, 2016
and
December 31, 2015
, investments in Agency Securities accounted for
86.5%
and
100.0%
of our MBS portfolio, respectively. During the first quarter of 2016, we began to invest in Non-Agency Securities. At
September 30, 2016
, investments in Non-Agency Securities accounted for
12.3%
of our MBS portfolio. During the second quarter of 2016, we began to invest in Interest-only Securities. At
September 30, 2016
, investments in Interest-only Securities accounted for
1.2%
of our MBS portfolio.
Our charter permits us to invest in Agency Securities, Non-Agency Securities and Interest-only Securities. Our MBS portfolio consists primarily of Agency Securities backed by fixed rate home loans. From time to time, a portion of our assets may be invested in Agency Securities 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 real estate investment trust (“REIT”).
We have elected to be taxed as a REIT under the Internal Revenue Code, 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
ARMOUR Residential REIT, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share amounts)
(UNAUDITED)
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 federal income tax purposes, we may still be subject to some federal, state and local taxes on our income.
Note 3 -Summary of Significant Accounting Policies
Cash
Cash includes cash on deposit with financial institutions. We may maintain deposits in federally insured financial institutions in excess of federally insured limits. However, management believes we are not exposed to significant credit risk due to the financial position and creditworthiness of the depository institutions in which those deposits are held.
Cash Collateral Posted To/By Counterparties
Cash collateral posted to/by counterparties represents cash posted by us to counterparties or posted by counterparties to us as collateral. Cash collateral posted to/by counterparties may include collateral for interest rate swap contracts (including swaptions and basis swap contracts), Eurodollar Futures Contracts (“Futures Contracts”) and repurchase agreements on our MBS and our Agency Securities purchased or sold on a to-be-announced basis (“TBA Agency Securities”).
MBS, at Fair Value
We generally intend to hold most of our MBS for extended periods of time. We may, from time to time, sell any of our MBS as part of the overall management of our MBS portfolio. 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. Purchases and sales of our MBS are recorded on the trade date.
Agency Securities, Available For Sale -
At
September 30, 2016
and
December 31, 2015
, all of our Agency Securities were classified as available for sale securities. Agency Securities classified as available for sale are reported at their estimated fair values with unrealized gains and losses excluded from earnings and reported as part of the condensed consolidated statements of comprehensive income (loss).
Non-Agency Securities, Trading -
At
September 30, 2016
, all of our Non-Agency Securities were classified as trading securities. Non-Agency Securities classified as trading are reported at their estimated fair values with unrealized gains and losses included in Other Income (Loss) as a component of the condensed consolidated statements of operations. We estimate future cash flows for each Non-Agency Security and then discount those cash flows based on our estimates of current market yield for each individual security. We then compare our calculated price with our pricing services and/or dealer marks. Our estimates for future cash flows and current market yields incorporate such factors as coupons, prepayment speeds, defaults, delinquencies and severities.
Interest-only Securities, Trading
- At
September 30, 2016
, all of our Interest-only Securities were classified as trading securities. Interest-only Securities represent the right to receive a specified proportion of the contractual interest flows of specific Agency MBS. Interest-only Securities classified as trading are reported at their estimated fair values with unrealized gains and losses included in Other Income (Loss) as a component of the condensed consolidated statements of operations.
Receivables and Payables for Unsettled Sales and Purchases
We account for purchases and sales of securities on the trade date, including purchases and sales for forward settlement. Receivables and payables for unsettled trades represent the agreed trade price multiplied by the outstanding balance of the securities at the balance sheet date.
ARMOUR Residential REIT, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share amounts)
(UNAUDITED)
Accrued Interest Receivable and Payable
Accrued interest receivable includes interest accrued between payment dates on MBS. Accrued interest payable includes interest payable on our repurchase agreements and may, at certain times, contain interest payable on U.S. Treasury Securities sold short.
Repurchase Agreements
We finance the acquisition of our MBS through the use of repurchase agreements. Our repurchase agreements are secured by our MBS and bear interest rates that have historically moved in close relationship to the Federal Funds Rate and the London Interbank Offered Rate (“LIBOR”). Under these repurchase agreements, we sell MBS to a lender and agree to repurchase the same MBS in the future for a price that is higher than the original sales price. The difference between the sales price that we receive and the repurchase price that we pay represents interest paid to the lender. A repurchase agreement operates as a financing arrangement under which we pledge our MBS as collateral to secure a loan which is equal in value to a specified percentage of the estimated fair value of the pledged collateral. We retain beneficial ownership of the pledged collateral. At the maturity of a repurchase agreement, we are required to repay the loan and concurrently receive back our pledged collateral from the lender or, with the consent of the lender, we may renew such agreement at the then prevailing interest rate. The repurchase agreements may require us to pledge additional assets to the lender in the event the estimated fair value of the existing pledged collateral declines.
In addition to the repurchase agreement financing discussed above, at certain times we have entered into reverse repurchase agreements with certain of our repurchase agreement counterparties. Under a typical reverse repurchase agreement, we purchase U.S. Treasury Securities from a borrower in exchange for cash and agree to sell the same securities in the future in exchange for a price that is higher than the original purchase price. The difference between the purchase price originally paid and the sale price represents interest received from the borrower. Reverse repurchase agreement receivables and repurchase agreement liabilities are presented net when they meet certain criteria, including being with the same counterparty, being governed by the same master repurchase agreement (“MRA”), settlement through the same brokerage or clearing account and maturing on the same day. We did not have any reverse repurchase agreements outstanding at
September 30, 2016
and
December 31, 2015
.
Obligations to Return Securities Received as Collateral, at Fair Value
At certain times, 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 condensed consolidated balance sheets. Interest is recorded on the repurchase agreements, reverse repurchase agreements and U.S. Treasury Securities sold short on an accrual basis and presented as 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 did not have any obligations to return securities received as collateral at
September 30, 2016
and
December 31, 2015
.
Derivatives, at Fair Value
We recognize all derivatives as either assets or liabilities at fair value on our condensed consolidated balance sheets. All changes in the fair values of our derivatives are reflected in our condensed consolidated statements of operations. We designate derivatives as hedges for tax purposes and any unrealized derivative gains or losses would not affect our distributable net taxable income. These transactions include interest rate swap contracts, interest rate swaptions and basis swap contracts. We also may utilize forward contracts for the purchase or sale of TBA Agency Securities. We account for TBA Agency Securities as derivative instruments if it is reasonably possible that we will not take or make physical delivery of the Agency Security upon settlement of the contract. We account for TBA dollar roll transactions as a series of derivative transactions.
We may also purchase and sell TBA Agency Securities as a means of investing in and financing Agency Securities (thereby increasing our “at risk” leverage) or as a means of disposing of or reducing our exposure to Agency Securities (thereby reducing our “at risk” leverage). Pursuant to TBA Agency Securities, 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.
ARMOUR Residential REIT, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share amounts)
(UNAUDITED)
Revenue Recognition
Agency Securities, Available For Sale -
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.
Fair Value of Agency Securities: We invest in Agency Securities representing interests in or obligations backed by pools of fixed rate, hybrid adjustable rate and adjustable rate mortgage loans. GAAP requires us to classify our investments as either trading, available for sale or held to maturity 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. We currently classify all of our Agency Securities as available for sale. Agency Securities classified as available for sale are reported at their estimated fair values with unrealized gains and losses excluded from earnings and reported as part of the statements of comprehensive income (loss).
Security purchase and sale transactions, including purchase of TBA Agency Securities, are recorded on the trade date to the extent it is probable that we will take or make timely physical delivery of the related securities. Gains or losses realized from the sale of securities are included in income and are determined using the specific identification method.
Impairment of Assets: We evaluate Agency Securities for other than temporary impairment at least on a quarterly basis and more frequently when economic or market concerns warrant such evaluation. We consider an impairment to be other than temporary if we (1) have the intent to sell the Agency Securities, (2) believe it is more likely than not that we will be required to sell the securities before recovery (for example, because of liquidity requirements or contractual obligations) or (3) a credit loss exists. Impairment losses recognized establish a new cost basis for the related Agency Securities.
Non-Agency Securities and Interest-only Securities, Trading -
Interest income on Non-Agency Securities and Interest-only Securities is recognized using the effective yield method over the life of the securities based on the future cash flows expected to be received. Future cash flow projections and related effective yields are determined for each security and updated quarterly. Other than temporary impairments, which establish a new cost basis in the security for purposes of calculating effective yields, are recognized when the fair value of a security is less than its cost basis and there has been an adverse change in the future cash flows expected to be received. Other changes in future cash flows expected to be received are recognized prospectively over the remaining life of the security.
Comprehensive Income (Loss)
Comprehensive income (loss) refers to changes in equity during a period from transactions and other events and circumstances from non-owner sources. It includes all changes in equity during a period, except those resulting from investments by owners and distributions to owners.
Reclassification
Certain amounts included in other expenses in the first and second quarters of 2016 have been reclassified to Interest Income Agency Securities. All per share amounts, common shares outstanding and stock-based compensation amounts for all periods presented reflect the Reverse Stock Split, which was effective July 31, 2015. No other reclassifications have been made to previously reported amounts.
ARMOUR Residential REIT, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share amounts)
(UNAUDITED)
Note 4 -Recent Accounting Pronouncements
In September 2015, the Financial Accounting Standards Board issued ASU 2015-16,
Business Combinations Simplifying the Accounting for Measurement-Period Adjustments (Topic 805).
The amendment simplifies the accounting for measurement-period adjustments. An acquirer is required to recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The amendment also requires acquirers to present separately on the face of the income statement or disclose in the notes, the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustments to the provisional amounts had been recognized as of the acquisition date. The amendment is effective for fiscal years beginning after December 15, 2015 and has not had a significant impact on the consolidated financial statements for the quarter.
In February 2016, the Financial Accounting Standards Board issued ASU 2016-02,
Leases (Topic 842).
The standard introduces a new lessee model that will require most leases to be recorded on the balance sheet recognizing a right-of-use lease asset and a liability to make lease payments. The standard will be effective for annual periods beginning after December 15, 2018. The Company is assessing the impact of this standard but does not expect it to have a significant impact on the consolidated financial statements.
In July 2016 the Financial Accounting Standards Board issued ASU 2016-13,
Financial Instruments–Credit Losses (Topic 326)
. The standard introduces a new model for recognizing credit losses on financial instruments based on an estimate of current expected credit losses. The standard will apply to (1) loans, accounts receivable, trade receivables, and other financial assets measured at amortized cost, (2) loan commitments and certain other off–balance sheet credit, exposures, (3) debt securities and other financial assets measured at fair value through other comprehensive income, and (4) beneficial interests in securitized financial assets. The standard is effective for fiscal years beginning after December 15, 2019. The Company is assessing the impact of this standard but does not expect it to have significant impact on the consolidated financial statements.
Note 5 -Fair Value of Financial Instruments
Our valuation techniques for financial instruments use observable and unobservable inputs. Observable inputs reflect readily obtainable data from third party sources, while unobservable inputs reflect management’s market assumptions. The Accounting Standards Codification Topic No. 820,
“Fair Value Measurement,”
classifies these inputs into the following hierarchy:
Level 1
Input
s - 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.
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.
Cash
- Cash includes cash on deposit with financial institutions. The carrying amount of cash is deemed to be its fair value and is classified as Level 1. Cash balances posted by us to counterparties or posted by counterparties to us as collateral are classified as Level 2 because they are integrally related to the Company's repurchase financing and interest rate swap agreements, which are classified as Level 2.
Agency Securities, Available for Sale
- Fair value for the Agency Securities in our MBS portfolio is based on obtaining a valuation for each Agency 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 an Agency Security is not available from the third party pricing services or such data appears unreliable, we obtain
ARMOUR Residential REIT, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share amounts)
(UNAUDITED)
pricing indications from up to
three
dealers who make markets in similar Agency 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. At
September 30, 2016
and
December 31, 2015
, all of our Agency Security fair values are classified as Level 2 based on the inputs used by our third party pricing services and dealer quotes.
Non-Agency Securities Trading -
The fair value for the Non-Agency Securities in our MBS portfolio is based on estimates prepared by our Portfolio Management group, which organizationally reports to our Chief Investment Officer. In preparing the estimates, our Portfolio Management group uses commercially available and proprietary models and data as well as market intelligence gained from discussions with, and transactions by, other market participants. We estimate the fair value of our Non-Agency Securities by estimating the future cash flows for each Non-Agency Security and then discounting those cash flows based on our estimates of current market yield for each individual security. Our estimates for future cash flows and current market yields incorporate such factors as collateral type, bond structure and priority of payments, coupons, prepayment speeds, defaults, delinquencies and severities. Quarterly, we compare our estimates of fair value of our Non-Agency Securities with pricing from third party pricing services, dealer marks received and recent purchase and financing transaction history to validate our assumptions of cash flow and market yield and calibrate our models. Fair values calculated in this manner are considered Level 3. At
September 30, 2016
, all of our Non-Agency Security fair values are calculated in this manner and therefore were classified as Level 3.
Interest-Only Securities Trading
- The fair value for the Interest-Only Securities in our MBS portfolio is based on obtaining a valuation for each Interest-Only 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 consistent with those models used to price Agency Securities underlying the Interest-Only Securities 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 an Interest-Only 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 Interest-Only 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. At
September 30, 2016
, all of our Interest-Only Security fair values are classified as Level 2 based on the inputs used by our third party pricing services and dealer quotes.
Receivables and Payables for Unsettled Sales and Purchases
- The carrying amount is generally deemed to be fair value because of the relatively short time to settlement. Such receivables and payables are classified as Level 2 because they are effectively secured by the related securities and could potentially be subject to counterparty credit considerations.
Repurchase Agreements -
The fair value of repurchase agreements reflects the present value of the contractual cash flows discounted at the estimated LIBOR based market interest rates at the valuation date for repurchase agreements with a term equivalent to the remaining term to interest rate repricing, which may be at maturity, of our repurchase agreements. The fair value of the repurchase agreements approximates their carrying amount due to the short-term nature of these financial instruments. Our repurchase agreements are classified as Level 2.
Obligations to Return Securities Received as Collateral -
The fair value of the obligations to return securities received as collateral are based upon the prices of the related U.S. Treasury Securities obtained from a third party pricing service. Such obligations are classified as Level 1.
Derivative Transactions
-
Our Futures Contracts are traded on the Chicago Mercantile Exchange (“CME”) and are classified as Level 1. The fair values of our interest rate swap contracts, interest rate swaptions and basis swaps are valued using
ARMOUR Residential REIT, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share amounts)
(UNAUDITED)
third party pricing services that incorporate common market pricing methods that may include current interest rate curves, forward interest rate curves and market spreads to interest rate curves. We estimate the fair value of TBA Agency Securities based on similar methods used to value our Agency Securities. Management compares pricing used to dealer quotes to ensure that the current market conditions are properly reflected. The fair values of our interest rate swap contracts, interest rate swaptions, basis swap contracts and TBA Agency Securities are classified as Level 2.
The following tables provide a summary of our assets and liabilities that are measured at fair value on a recurring basis at
September 30, 2016
and
December 31, 2015
.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
|
|
Significant
Observable
Inputs
(Level 2)
|
|
Significant
Unobservable
Inputs
(Level 3)
|
|
Balance at September 30, 2016
|
Assets at Fair Value:
|
|
|
|
|
|
|
|
|
Agency Securities, available for sale
|
|
$
|
—
|
|
|
$
|
7,041,228
|
|
|
$
|
—
|
|
|
$
|
7,041,228
|
|
Non-Agency Securities, trading
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
1,001,319
|
|
|
$
|
1,001,319
|
|
Interest-Only Securities, trading
|
|
$
|
—
|
|
|
$
|
95,918
|
|
|
$
|
—
|
|
|
$
|
95,918
|
|
Derivatives
|
|
$
|
—
|
|
|
$
|
10,194
|
|
|
$
|
—
|
|
|
$
|
10,194
|
|
Liabilities at Fair Value:
|
|
|
|
|
|
|
|
|
|
Derivatives
|
|
$
|
—
|
|
|
$
|
243,223
|
|
|
$
|
—
|
|
|
$
|
243,223
|
|
There were no transfers of assets or liabilities between the levels of the fair value hierarchy during the quarter and
nine months
ended
September 30, 2016
.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
|
|
Significant
Observable
Inputs
(Level 2)
|
|
Significant
Unobservable
Inputs
(Level 3)
|
|
Balance at December 31, 2015
|
Assets at Fair Value:
|
|
|
|
|
|
|
|
|
Agency Securities, available for sale
|
|
$
|
—
|
|
|
$
|
12,461,556
|
|
|
$
|
—
|
|
|
$
|
12,461,556
|
|
Derivatives
|
|
$
|
—
|
|
|
$
|
999
|
|
|
$
|
—
|
|
|
$
|
999
|
|
Liabilities at Fair Value:
|
|
|
|
|
|
|
|
|
Derivatives
|
|
$
|
—
|
|
|
$
|
233,301
|
|
|
$
|
—
|
|
|
$
|
233,301
|
|
There were no transfers of assets or liabilities between the levels of the fair value hierarchy during the year ended
December 31, 2015
.
ARMOUR Residential REIT, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share amounts)
(UNAUDITED)
The following tables provide a summary of the carrying values and fair values of our financial assets and liabilities not carried at fair value but for which fair value is required to be disclosed at
September 30, 2016
and
December 31, 2015
.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2016
|
|
|
|
|
|
Fair Value Measurements using:
|
|
|
Carrying Value
|
|
Fair
Value
|
|
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
|
|
Significant
Observable
Inputs
(Level 2)
|
|
Significant
Unobservable
Inputs
(Level 3)
|
Financial Assets:
|
|
|
|
|
|
|
|
|
|
|
Cash
|
|
$
|
401,825
|
|
|
$
|
401,825
|
|
|
$
|
401,825
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Cash collateral posted to counterparties
|
|
$
|
281,397
|
|
|
$
|
281,397
|
|
|
$
|
—
|
|
|
$
|
281,397
|
|
|
$
|
—
|
|
Accrued interest receivable
|
|
$
|
19,271
|
|
|
$
|
19,271
|
|
|
$
|
—
|
|
|
$
|
19,271
|
|
|
$
|
—
|
|
Financial Liabilities:
|
|
|
|
|
|
|
|
|
|
|
Repurchase agreements
|
|
$
|
7,360,670
|
|
|
$
|
7,360,670
|
|
|
$
|
—
|
|
|
$
|
7,360,670
|
|
|
$
|
—
|
|
Cash collateral posted by counterparties
|
|
$
|
15,496
|
|
|
$
|
15,496
|
|
|
$
|
—
|
|
|
$
|
15,496
|
|
|
$
|
—
|
|
Accrued interest payable- repurchase agreements
|
|
$
|
6,025
|
|
|
$
|
6,025
|
|
|
$
|
—
|
|
|
$
|
6,025
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2015
|
|
|
|
|
|
Fair Value Measurements using:
|
|
|
Carrying Value
|
|
Fair
Value
|
|
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
|
|
Significant
Observable
Inputs
(Level 2)
|
|
Significant
Unobservable
Inputs
(Level 3)
|
Financial Assets:
|
|
|
|
|
|
|
|
|
|
|
Cash
|
|
$
|
289,925
|
|
|
$
|
289,925
|
|
|
$
|
289,925
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Cash collateral posted to counterparties
|
|
$
|
263,799
|
|
|
$
|
263,799
|
|
|
$
|
—
|
|
|
$
|
263,799
|
|
|
$
|
—
|
|
Principal payments receivable
|
|
$
|
37
|
|
|
$
|
37
|
|
|
$
|
—
|
|
|
$
|
37
|
|
|
$
|
—
|
|
Accrued interest receivable
|
|
$
|
34,500
|
|
|
$
|
34,500
|
|
|
$
|
—
|
|
|
$
|
34,500
|
|
|
$
|
—
|
|
Financial Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Repurchase agreements
|
|
$
|
11,570,481
|
|
|
$
|
11,570,481
|
|
|
$
|
—
|
|
|
$
|
11,570,481
|
|
|
$
|
—
|
|
Accrued interest payable- repurchase agreements
|
|
$
|
7,724
|
|
|
$
|
7,724
|
|
|
$
|
—
|
|
|
$
|
7,724
|
|
|
$
|
—
|
|
ARMOUR Residential REIT, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share amounts)
(UNAUDITED)
The following table provides a summary of the changes in Level 3 assets measured at fair value on a recurring basis at
September 30, 2016
. We did not have Level 3 assets at
December 31, 2015
.
|
|
|
|
|
|
|
|
|
|
|
|
For the Quarter
Ended
|
|
For the Nine Months Ended
|
Non-Agency Securities
|
|
September 30, 2016
|
|
September 30, 2016
|
Balance, beginning of period
|
|
$
|
916,571
|
|
|
$
|
—
|
|
Non-Agency Securities acquired in the acquisition of JAVELIN, at fair value
|
|
—
|
|
|
223,220
|
|
Purchases of Non-Agency Securities, at cost
|
|
68,186
|
|
|
760,666
|
|
Principal repayments of Non-Agency Securities
|
|
(23,707
|
)
|
|
(37,698
|
)
|
Gain on Non-Agency Securities
|
|
39,522
|
|
|
53,795
|
|
Discount accretion
|
|
747
|
|
|
1,336
|
|
Balance, end of period
|
|
$
|
1,001,319
|
|
|
$
|
1,001,319
|
|
Gain on Non-Agency Securities
|
|
$
|
39,522
|
|
|
$
|
53,795
|
|
The significant unobservable inputs used in the fair value measurement of our Level 3 Non-Agency Securities include assumptions for underlying loan collateral, cumulative default rates and loss severities in the event of default, as well as discount rates.
The following table presents the range of our estimates of cumulative default and loss severities, together with the discount rates implicit in our Level 3 Non-Agency Security fair values at
September 30, 2016
. We did not have Level 3 assets at
December 31, 2015
.
September 30, 2016
|
|
|
|
|
|
|
|
|
|
|
Unobservable Level 3 Input
|
|
Minimum
|
|
Weighted
Average
|
|
Maximum
|
Cumulative default
|
|
0.00
|
%
|
|
1.74
|
%
|
|
40.90
|
%
|
Loss severity (life)
|
|
0.00
|
%
|
|
23.00
|
%
|
|
75.73
|
%
|
Discount rate
|
|
2.38
|
%
|
|
4.08
|
%
|
|
7.84
|
%
|
Delinquency (life)
|
|
0.00
|
%
|
|
4.14
|
%
|
|
47.09
|
%
|
Voluntary prepayments (life)
|
|
1.56
|
%
|
|
15.71
|
%
|
|
28.14
|
%
|
The table above includes the effects of the structural elements of our Non-Agency Securities, such as subordination and over collateralization or insurance. Significant increases or decreases in any of these inputs in isolation would result in a significantly lower or higher fair value measurement. Generally, a change in the assumption used for the probability of cumulative default is accompanied by a directionally similar change in the assumption used for the delinquency and loss severity and a directionally opposite change in the assumption used for voluntary prepayment rates for the life of the security. However, given the interrelationship between loss estimates and the discount rate, overall Non-Agency Security market conditions would likely have a more significant impact on our Level 3 fair values than changes in any one unobservable input.
Note 6 -Agency Securities, Available for Sale
All of our Agency Securities are classified as available for sale and, as such, are reported at their estimated fair value and changes in fair value reported as part of the statements of comprehensive income (loss). At
September 30, 2016
and
December 31, 2015
, investments in Agency Securities accounted for
86.5%
and
100.0%
of our MBS portfolio.
We evaluated our Agency Securities with unrealized losses at
September 30, 2016
,
September 30, 2015
and
December 31, 2015
, to determine whether there was an other than temporary impairment. 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 those dates, we also considered whether we intended to sell Agency Securities and whether it was more likely than not that we could meet our liquidity requirements and contractual
ARMOUR Residential REIT, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share amounts)
(UNAUDITED)
obligations without selling Agency Securities. As a result of this evaluation,
no
other than temporary impairment was recognized for the quarters and
nine months
ended
September 30, 2016
and
September 30, 2015
and for the year ended
December 31, 2015
, respectively, because we determined that we 1) did not have the intent to sell the Agency Securities in an unrealized loss position, 2) did not believe it more likely than not that we were required to sell the securities before recovery (for example, because of liquidity requirements or contractual obligations), and/or (3) determined that a credit loss did not exist.
At
September 30, 2016
, we had the following Agency Securities in an unrealized gain or loss position as presented below. The components of the carrying value of our Agency Securities at
September 30, 2016
are also presented below. Our Agency Securities had a weighted average coupon of
3.53%
at
September 30, 2016
.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2016
|
|
Amortized Cost
|
|
Gross Unrealized Loss
|
|
Gross Unrealized Gain
|
|
Fair Value
|
|
Percent of Total
|
Fannie Mae
|
|
|
|
|
|
|
|
|
|
|
ARMs & Hybrids
|
|
$
|
39,700
|
|
|
$
|
(93
|
)
|
|
$
|
351
|
|
|
$
|
39,958
|
|
|
0.57
|
%
|
Multi-Family MBS
|
|
1,473,296
|
|
|
—
|
|
|
83,738
|
|
|
1,557,034
|
|
|
22.11
|
|
10 Year Fixed
|
|
96,512
|
|
|
(376
|
)
|
|
866
|
|
|
97,002
|
|
|
1.38
|
|
15 Year Fixed
|
|
2,728,932
|
|
|
(10
|
)
|
|
45,721
|
|
|
2,774,643
|
|
|
39.41
|
|
20 Year Fixed
|
|
590,738
|
|
|
(6
|
)
|
|
5,520
|
|
|
596,252
|
|
|
8.47
|
|
25 Year Fixed
|
|
11,956
|
|
|
—
|
|
|
113
|
|
|
12,069
|
|
|
0.17
|
|
30 Year Fixed
|
|
1,120,524
|
|
|
—
|
|
|
20,065
|
|
|
1,140,589
|
|
|
16.20
|
|
Total Fannie Mae
|
|
$
|
6,061,658
|
|
|
$
|
(485
|
)
|
|
$
|
156,374
|
|
|
$
|
6,217,547
|
|
|
88.31
|
%
|
|
|
|
|
|
|
|
|
|
|
|
Freddie Mac
|
|
|
|
|
|
|
|
|
|
|
10 Year Fixed
|
|
50,846
|
|
|
(79
|
)
|
|
864
|
|
|
51,631
|
|
|
0.73
|
|
15 Year Fixed
|
|
372,397
|
|
|
—
|
|
|
7,714
|
|
|
380,111
|
|
|
5.40
|
|
20 Year Fixed
|
|
218,072
|
|
|
(3
|
)
|
|
1,322
|
|
|
219,391
|
|
|
3.12
|
|
25 Year Fixed
|
|
123,857
|
|
|
—
|
|
|
360
|
|
|
124,217
|
|
|
1.76
|
|
Total Freddie Mac
|
|
$
|
765,172
|
|
|
$
|
(82
|
)
|
|
$
|
10,260
|
|
|
$
|
775,350
|
|
|
11.01
|
%
|
|
|
|
|
|
|
|
|
|
|
|
Ginnie Mae
|
|
|
|
|
|
|
|
|
|
|
ARMs & Hybrids
|
|
48,832
|
|
|
(823
|
)
|
|
3
|
|
|
48,012
|
|
|
0.68
|
|
15 Year Fixed
|
|
295
|
|
|
—
|
|
|
24
|
|
|
319
|
|
|
0.00
|
|
Total Ginnie Mae
|
|
$
|
49,127
|
|
|
$
|
(823
|
)
|
|
$
|
27
|
|
|
$
|
48,331
|
|
|
0.68
|
%
|
Total Agency Securities
|
|
$
|
6,875,957
|
|
|
$
|
(1,390
|
)
|
|
$
|
166,661
|
|
|
$
|
7,041,228
|
|
|
100.00
|
%
|
ARMOUR Residential REIT, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share amounts)
(UNAUDITED)
At
December 31, 2015
, we had the following securities in an unrealized gain or loss position as presented below. The components of the carrying value of our Agency Securities at
December 31, 2015
are also presented below. Our Agency Securities had a weighted average coupon of
3.47%
at
December 31, 2015
.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2015
|
|
Amortized Cost
|
|
Gross Unrealized Loss
|
|
Gross Unrealized Gain
|
|
Fair Value
|
|
Percent of Total
|
Fannie Mae
|
|
|
|
|
|
|
|
|
|
|
ARMs&Hybrids
|
|
$
|
46,512
|
|
|
$
|
(210
|
)
|
|
$
|
486
|
|
|
$
|
46,788
|
|
|
0.38
|
%
|
Multi-Family MBS
|
|
2,182,156
|
|
|
(30,879
|
)
|
|
7,312
|
|
|
2,158,589
|
|
|
17.32
|
|
10 Year Fixed
|
|
91,752
|
|
|
(362
|
)
|
|
605
|
|
|
91,995
|
|
|
0.74
|
|
15 Year Fixed
|
|
4,302,585
|
|
|
(10,462
|
)
|
|
5,498
|
|
|
4,297,621
|
|
|
34.49
|
|
20 Year Fixed
|
|
2,692,310
|
|
|
(25,429
|
)
|
|
5,289
|
|
|
2,672,170
|
|
|
21.44
|
|
25 Year Fixed
|
|
18,488
|
|
|
(128
|
)
|
|
—
|
|
|
18,360
|
|
|
0.15
|
|
30 Year Fixed
|
|
1,447,835
|
|
|
(6,645
|
)
|
|
492
|
|
|
1,441,682
|
|
|
11.56
|
|
Total Fannie Mae
|
|
$
|
10,781,638
|
|
|
$
|
(74,115
|
)
|
|
$
|
19,682
|
|
|
$
|
10,727,205
|
|
|
86.08
|
%
|
|
|
|
|
|
|
|
|
|
|
|
Freddie Mac
|
|
|
|
|
|
|
|
|
|
|
ARMs&Hybrids
|
|
12,738
|
|
|
(46
|
)
|
|
197
|
|
|
12,889
|
|
|
0.10
|
|
10 Year Fixed
|
|
37,657
|
|
|
(92
|
)
|
|
652
|
|
|
38,217
|
|
|
0.31
|
|
15 Year Fixed
|
|
192,982
|
|
|
(995
|
)
|
|
310
|
|
|
192,297
|
|
|
1.54
|
|
20 Year Fixed
|
|
1,443,652
|
|
|
(16,380
|
)
|
|
4,006
|
|
|
1,431,278
|
|
|
11.49
|
|
Total Freddie Mac
|
|
$
|
1,687,029
|
|
|
$
|
(17,513
|
)
|
|
$
|
5,165
|
|
|
$
|
1,674,681
|
|
|
13.44
|
%
|
|
|
|
|
|
|
|
|
|
|
|
Ginnie Mae
|
|
|
|
|
|
|
|
|
|
|
ARMs&Hybrids
|
|
59,877
|
|
|
(610
|
)
|
|
69
|
|
|
59,336
|
|
|
0.48
|
|
15 Year Fixed
|
|
314
|
|
|
—
|
|
|
20
|
|
|
334
|
|
|
0.00
|
|
Total Ginnie Mae
|
|
$
|
60,191
|
|
|
$
|
(610
|
)
|
|
$
|
89
|
|
|
$
|
59,670
|
|
|
0.48
|
%
|
Total Agency Securities
|
|
$
|
12,528,858
|
|
|
$
|
(92,238
|
)
|
|
$
|
24,936
|
|
|
$
|
12,461,556
|
|
|
100.00
|
%
|
Recognition of interest income commences on the settlement date of the purchase transaction and continues through the settlement date of the sale transaction.
Actual maturities of Agency Securities are generally shorter than stated contractual maturities because actual maturities of Agency Securities are affected by the contractual lives of the underlying mortgages, periodic payments of principal and prepayments of principal.
The following table summarizes the weighted average lives of our Agency Securities at
September 30, 2016
and
December 31, 2015
.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2016
|
|
December 31, 2015
|
Weighted Average Life of all Agency Securities
|
|
Fair Value
|
|
Amortized
Cost
|
|
Fair Value
|
|
Amortized
Cost
|
Less than one year
|
|
$
|
8
|
|
|
$
|
9
|
|
|
$
|
19
|
|
|
$
|
19
|
|
Greater than or equal to one year and less than three years
|
|
60,891
|
|
|
60,792
|
|
|
30,189
|
|
|
30,375
|
|
Greater than or equal to three years and less than five years
|
|
4,247,064
|
|
|
4,184,635
|
|
|
6,037,851
|
|
|
6,039,218
|
|
Greater than or equal to five years
|
|
2,733,265
|
|
|
2,630,521
|
|
|
6,393,497
|
|
|
6,459,246
|
|
Total Agency Securities
|
|
$
|
7,041,228
|
|
|
$
|
6,875,957
|
|
|
$
|
12,461,556
|
|
|
$
|
12,528,858
|
|
ARMOUR Residential REIT, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share amounts)
(UNAUDITED)
We use a third party model to calculate the weighted average lives of our Agency Securities. Weighted average life is calculated based on expectations for estimated prepayments for the underlying mortgage loans of our Agency Securities. These estimated prepayments are based on assumptions such as interest rates, current and future home prices, housing policy and borrower incentives. The weighted average lives of our Agency Securities at
September 30, 2016
and
December 31, 2015
in the table above are based upon market factors, assumptions, models and estimates from the third party model and also incorporate management’s judgment and experience. The actual weighted average lives of our Agency Securities could be longer or shorter than estimated.
The following table presents the unrealized losses and estimated fair value of our Agency Securities by length of time that such securities have been in a continuous unrealized loss position at
September 30, 2016
and
December 31, 2015
.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized Loss Position For:
|
|
|
Less than 12 Months
|
|
12 Months or More
|
|
Total
|
|
|
Fair Value
|
|
Unrealized
Losses
|
|
Fair Value
|
|
Unrealized
Losses
|
|
Fair Value
|
|
Unrealized
Losses
|
September 30, 2016
|
|
$
|
60,563
|
|
|
$
|
(322
|
)
|
|
$
|
58,538
|
|
|
$
|
(1,068
|
)
|
|
$
|
119,101
|
|
|
$
|
(1,390
|
)
|
December 31, 2015
|
|
$
|
7,105,363
|
|
|
$
|
(58,799
|
)
|
|
$
|
1,861,211
|
|
|
$
|
(33,439
|
)
|
|
$
|
8,966,574
|
|
|
$
|
(92,238
|
)
|
During the
quarter and nine months
ended
September 30, 2016
, we sold
$460,169
and
$5,428,174
of Agency Securities, which resulted in realized gains of
$2,421
and
$18,937
, respectively. During the
quarter and nine months
ended
September 30, 2015
, we sold
$331,196
and
$3,148,831
of Agency Securities, which resulted in realized gains of
$69
and
$1,562
, respectively. Sales of Agency Securities are done to reposition our MBS portfolio and to reach our target level of liquidity.
Note 7 -Non-Agency Securities, Trading
All of our Non-Agency Securities are classified as trading securities and reported at their estimated fair value. Fair value changes are reported in the condensed consolidated statements of operations in the period in which they occur. At
September 30, 2016
, investments in Non-Agency Securities accounted for
12.3%
of our MBS portfolio.
The components of the carrying value of our Non-Agency Securities at
September 30, 2016
are presented in the table below.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-Agency Securities
|
September 30, 2016
|
|
Fair Value
|
|
Amortized
Cost
|
|
Principal
Amount
|
|
Weighted
Average
Coupon
|
Credit Risk Transfer
|
|
$
|
753,901
|
|
|
$
|
703,932
|
|
|
$
|
716,916
|
|
|
5.08
|
%
|
NPL/RPL
|
|
134,850
|
|
|
133,443
|
|
|
134,329
|
|
|
3.80
|
%
|
Legacy Prime Fixed
|
|
20,868
|
|
|
20,029
|
|
|
25,381
|
|
|
6.01
|
%
|
Legacy ALTA Fixed
|
|
62,114
|
|
|
59,619
|
|
|
78,901
|
|
|
5.85
|
%
|
Legacy Prime Hybrid
|
|
12,098
|
|
|
11,567
|
|
|
14,198
|
|
|
2.65
|
%
|
Legacy ALTA Hybrid
|
|
6,118
|
|
|
5,927
|
|
|
7,263
|
|
|
3.02
|
%
|
New Issue Prime Fixed Non-Agency
|
|
11,370
|
|
|
10,802
|
|
|
11,405
|
|
|
3.66
|
%
|
Total Non-Agency Securities
|
|
$
|
1,001,319
|
|
|
$
|
945,319
|
|
|
$
|
988,393
|
|
|
4.93
|
%
|
The following table summarizes the weighted average lives of our Non-Agency Securities at
September 30, 2016
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2016
|
Weighted Average Life of all Non-Agency Securities
|
|
Fair Value
|
|
Amortized Cost
|
Less than one year
|
|
$
|
—
|
|
|
$
|
—
|
|
Greater than or equal to one year and less than three years
|
|
216,630
|
|
|
210,023
|
|
Greater than or equal to three years and less than five years
|
|
460,256
|
|
|
433,484
|
|
Greater than or equal to five years
|
|
324,433
|
|
|
301,812
|
|
Total Non-Agency Securities
|
|
$
|
1,001,319
|
|
|
$
|
945,319
|
|
ARMOUR Residential REIT, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share amounts)
(UNAUDITED)
We use a third party model to calculate the weighted average lives of our Non-Agency Securities. Weighted average life is calculated based on expectations for estimated prepayments for the underlying mortgage loans of our Non-Agency Securities. These estimated prepayments are based on assumptions such as interest rates, current and future home prices, housing policy and borrower incentives. The weighted average lives of our Non-Agency Securities at
September 30, 2016
in the table above are based upon market factors, assumptions, models and estimates from the third party model and also incorporate management’s judgment and experience. The actual weighted average lives of our Non-Agency Securities could be longer or shorter than estimated.
At
September 30, 2016
, we had no Non-Agency Securities in an unrealized losses position less than or greater than twelve months.
Our Non-Agency Securities are subject to risk of loss with regard to principal and interest payments and at
September 30, 2016
, have generally either been assigned below investment grade ratings by rating agencies, or have not been rated. 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.
Note 8 -Repurchase Agreements
At
September 30, 2016
, we had MRAs with
42
counterparties and had
$7,360,670
in outstanding borrowings with
27
of those counterparties. At
December 31, 2015
, we had MRAs with
38
counterparties and had
$11,570,481
in outstanding borrowings with
26
of those counterparties.
The following table represents the contractual repricing regarding our repurchase agreements to finance our MBS purchases at
September 30, 2016
and
December 31, 2015
. No amounts below are subject to offsetting.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2016
|
|
Repurchase Agreements
|
|
Weighted Average Contractual Rate
|
|
Weighted Average Maturity in days
|
|
Haircut for Repurchase Agreements
(1)
|
Agency Securities
|
|
$
|
6,601,439
|
|
|
0.73
|
%
|
|
19
|
|
4.80
|
%
|
Non-Agency Securities
|
|
735,912
|
|
|
2.21
|
%
|
|
33
|
|
23.75
|
%
|
U.S. Treasury Securities
|
|
23,319
|
|
|
0.46
|
%
|
|
0
|
|
0.00
|
%
|
Total or Weighted Average
|
|
$
|
7,360,670
|
|
|
0.88
|
%
|
|
21
|
|
6.68
|
%
|
(1) The Haircut represents the weighted average margin requirement, or the percentage amount by which the collateral value must exceed the loan amount.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2015
|
|
Repurchase Agreements
|
|
Weighted Average Contractual Rate
|
|
Weighted Average Maturity in days
|
|
Haircut for Repurchase Agreements
(1)
|
Agency Securities
|
|
$
|
11,570,481
|
|
|
0.57
|
%
|
|
38
|
|
4.79
|
%
|
Total or Weighted Average
|
|
$
|
11,570,481
|
|
|
0.57
|
%
|
|
38
|
|
4.79
|
%
|
(1) The Haircut represents the weighted average margin requirement, or the percentage amount by which the collateral value must exceed the loan amount.
Our repurchase agreements require that we maintain adequate pledged collateral. A decline in the value of the MBS pledged as collateral for borrowings under repurchase agreements could result in the counterparties demanding additional collateral pledges or liquidation of some of the existing collateral to reduce borrowing levels. We manage this risk by maintaining an adequate balance of available cash and unpledged securities. An event of default or termination event under the standard MRA would give our counterparty the option to terminate all repurchase transactions existing with us and require any amount due to be payable immediately. In addition, certain of our MRAs contain a restriction that prohibits our leverage from exceeding
twelve
times our stockholders’ equity as well as termination events in the case of significant reductions in equity capital. We also may receive cash or securities as collateral from our derivative counterparties which we may use as additional collateral for repurchase agreements. Certain interest rate swap contracts provide for cross collateralization and cross default with repurchase agreements and other contracts with the same counterparty.
ARMOUR Residential REIT, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share amounts)
(UNAUDITED)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2016
|
|
December 31, 2015
|
Maturing or Repricing
|
|
Repurchase Agreements
|
|
Weighted Average Contractual Rate
|
|
Repurchase Agreements
|
|
Weighted Average Contractual Rate
|
Within 30 days
|
|
$
|
5,819,944
|
|
|
0.82
|
%
|
|
$
|
8,089,403
|
|
|
0.55
|
%
|
31 days to 60 days
|
|
1,360,336
|
|
|
0.96
|
%
|
|
2,487,174
|
|
|
0.57
|
%
|
61 days to 90 days
|
|
180,390
|
|
|
1.87
|
%
|
|
343,904
|
|
|
0.71
|
%
|
Greater than 90 days
|
|
—
|
|
|
—
|
%
|
|
650,000
|
|
|
0.67
|
%
|
Total or Weighted Average
|
|
$
|
7,360,670
|
|
|
0.88
|
%
|
|
$
|
11,570,481
|
|
|
0.57
|
%
|
At
September 30, 2016
,
10
repurchase agreement counterparties individually accounted for between
5%
and
10%
of our aggregate borrowings. In total, these counterparties accounted for approximately
61.5%
of our repurchase agreement borrowings outstanding at
September 30, 2016
. At
December 31, 2015
, we had
8
repurchase agreement counterparties that individually accounted for between
5%
and
10%
of our aggregate borrowings. In total, these counterparties accounted for
53.5%
of our repurchase agreement borrowings at
December 31, 2015
. At
September 30, 2016
and
December 31, 2015
, we did not have any repurchase counterparties that individually account for
5%
or greater of our stockholders' equity.
Note 9 -Derivatives
We enter into derivative transactions to manage our interest rate risk exposure. These transactions include entering into interest rate swap contracts and interest rate swaptions as well as purchasing or selling Futures Contracts. These transactions 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. Basis swap contracts allow us to exchange one floating interest rate basis for another, for example, 3 month LIBOR and Fed Funds Rates, thereby allowing us to diversify our floating rate basis exposures. We also utilize forward contracts for the purchase or sale of TBA Agency Securities.
We have agreements with our derivative counterparties that provide for the posting of collateral based on the fair values of our interest rate swap contracts, swaptions, basis swap contracts and TBA Agency Securities. Through this margin process, either we or our swap counterparty may be required to pledge cash or Agency 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 interest rate swap contracts provide for cross collateralization and cross default with repurchase agreements and other contracts with the same counterparty.
Interest rate swaptions generally provide us the option to enter into an interest rate swap agreement at a certain point of time in the future with a predetermined notional amount, stated term and stated rate of interest in the fixed leg and interest rate index on the floating leg.
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 would be unable to meet a margin call under a Futures Contract, 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.
ARMOUR Residential REIT, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share amounts)
(UNAUDITED)
The following tables present information about our derivatives at
September 30, 2016
and
December 31, 2015
.
September 30, 2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivative Type
|
|
Remaining / Underlying Term
|
|
Weighted Average Remaining Swap / Option Term (Months)
|
|
Weighted Average Rate
|
|
Notional Amount
|
|
Asset Fair Value
(1)
|
|
Liability Fair Value
(1)
|
Interest rate swap contracts
|
|
0-12 Months
|
|
9
|
|
|
0.54
|
%
|
|
$
|
150,000
|
|
|
$
|
—
|
|
|
$
|
(46
|
)
|
Interest rate swap contracts
|
|
13-24 Months
|
|
16
|
|
|
0.73
|
%
|
|
100,000
|
|
|
—
|
|
|
(446
|
)
|
Interest rate swap contracts
|
|
37-48 Months
|
|
38
|
|
|
1.48
|
%
|
|
2,410,000
|
|
|
—
|
|
|
(78,270
|
)
|
Interest rate swap contracts
|
|
61-72 Months
|
|
64
|
|
|
2.04
|
%
|
|
275,000
|
|
|
—
|
|
|
(20,999
|
)
|
Interest rate swap contracts
|
|
73-84 Months
|
|
77
|
|
|
2.10
|
%
|
|
1,425,000
|
|
|
—
|
|
|
(77,524
|
)
|
Interest rate swap contracts
|
|
109-120 Months
|
|
113
|
|
|
2.24
|
%
|
|
550,000
|
|
|
—
|
|
|
(65,938
|
)
|
TBA Agency Securities
|
|
—
|
|
—
|
|
|
—
|
|
|
2,650,000
|
|
|
10,194
|
|
|
—
|
|
Total or Weighted Average
|
|
|
|
|
|
$
|
7,560,000
|
|
|
$
|
10,194
|
|
|
$
|
(243,223
|
)
|
|
|
(1)
|
See
Note 5
,
“
Fair Value of Financial Instruments
”
for additional discussion.
|
December 31, 2015
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivative Type
(4)
|
|
Remaining / Underlying Term
|
|
Weighted Average Remaining Swap / Option Term (Months)
|
|
Weighted Average Rate
|
|
Notional Amount
(3)
|
|
Asset Fair Value
(1)
|
|
Liability Fair Value
(1)
|
Interest rate swap contracts
|
|
13-24 Months
|
|
19
|
|
0.63
|
%
|
|
$
|
350,000
|
|
|
$
|
265
|
|
|
$
|
(87
|
)
|
Interest rate swap contracts
|
|
25-36 Months
|
|
27
|
|
1.16
|
%
|
|
700,000
|
|
|
192
|
|
|
(1,633
|
)
|
Interest rate swap contracts
|
|
37-48 Months
|
|
47
|
|
1.46
|
%
|
|
2,000,000
|
|
|
—
|
|
|
(18,120
|
)
|
Interest rate swap contracts
|
|
49-60 Months
|
|
49
|
|
1.53
|
%
|
|
350,000
|
|
|
—
|
|
|
(3,085
|
)
|
Interest rate swap contracts
|
|
73-84 Months
|
|
75
|
|
2.05
|
%
|
|
1,025,000
|
|
|
—
|
|
|
(26,047
|
)
|
Interest rate swap contracts
|
|
85-96 Months
|
|
86
|
|
2.11
|
%
|
|
1,375,000
|
|
|
—
|
|
|
(23,543
|
)
|
Interest rate swap contracts
|
|
109-120 Months
|
|
108
|
|
2.66
|
%
|
|
1,000,000
|
|
|
—
|
|
|
(92,927
|
)
|
Interest rate swap contracts
|
|
121-132 Months
|
|
123
|
|
2.30
|
%
|
|
2,000,000
|
|
|
—
|
|
|
(67,858
|
)
|
Basis swap contracts
(2)
|
|
0-60 Months
|
|
22
|
|
0.22
|
%
|
|
2,000,000
|
|
|
542
|
|
|
(1
|
)
|
Total or Weighted Average
|
|
|
|
|
|
$
|
10,800,000
|
|
|
$
|
999
|
|
|
$
|
(233,301
|
)
|
|
|
(1)
|
See Note 5,
“Fair Value of Financial Instruments”
for additional discussion.
|
(2) Weighted average rate is the spread over the pay index.
(3) Notional amount includes
$3,775,000
of forward starting interest rate swap contracts which become effective within 6 months.
(4) We did not have any TBA Agency Securities outstanding at
December 31, 2015
.
We have netting arrangements in place with all derivative counterparties pursuant to standard documentation developed by the International Swap and Derivatives Association. We are also required to post or hold cash collateral based upon the net underlying market value of our open positions with the counterparty.
The following tables present information about interest rate swap contracts and basis swap contracts and the potential effects of netting if we were to offset the assets and liabilities of these financial instruments on the accompanying condensed consolidated balance sheets. Currently, we present these financial instruments at their gross amounts and they are included in derivatives, at fair value on the accompanying condensed consolidated balance sheet at
September 30, 2016
.
ARMOUR Residential REIT, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share amounts)
(UNAUDITED)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2016
|
|
|
|
Gross Amounts Not Offset in the Condensed Consolidated Balance Sheet
|
|
|
Assets
|
|
Gross and Net Amounts of Assets Presented in the Condensed Consolidated Balance Sheet
|
|
Financial
Instruments
|
|
Cash Collateral
|
|
Net Amount
|
Interest rate swap contracts
|
|
$
|
—
|
|
|
$
|
(243,223
|
)
|
|
$
|
276,927
|
|
|
$
|
33,704
|
|
Agency Securities TBA
|
|
10,194
|
|
|
—
|
|
|
(3,627
|
)
|
|
6,567
|
|
Totals
|
|
$
|
10,194
|
|
|
$
|
(243,223
|
)
|
|
$
|
273,300
|
|
|
$
|
40,271
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2016
|
|
|
|
Gross Amounts Not Offset in the Condensed Consolidated Balance Sheet
|
|
|
Liabilities
|
|
Gross and Net Amounts of Liabilities Presented in the Condensed Consolidated Balance Sheet
|
|
Financial
Instruments
|
|
Cash Collateral
|
|
Net Amount
|
Interest rate swap contracts
|
|
$
|
(243,223
|
)
|
|
$
|
243,223
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Totals
|
|
$
|
(243,223
|
)
|
|
$
|
243,223
|
|
|
$
|
—
|
|
|
$
|
—
|
|
The following tables present information about interest rate swap contracts and Futures Contracts and the potential effects of netting if we were to offset the assets and liabilities of these financial instruments on the accompanying condensed consolidated balance sheets. Currently, we present these financial instruments at their gross amounts and they are included in derivatives, at fair value on the accompanying condensed consolidated balance sheet at
December 31, 2015
.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2015
|
|
|
|
Gross Amounts Not Offset in the Condensed Consolidated Balance Sheet
|
|
|
Assets
|
|
Gross and Net Amounts of Assets Presented in the Condensed Consolidated
Balance Sheet
|
|
Financial
Instruments
|
|
Cash Collateral
|
|
Net Amount
|
Interest rate swap contracts
|
|
$
|
457
|
|
|
$
|
(233,301
|
)
|
|
$
|
241,604
|
|
|
$
|
8,760
|
|
Basis swap contracts
|
|
542
|
|
|
—
|
|
|
—
|
|
|
542
|
|
Totals
|
|
$
|
999
|
|
|
$
|
(233,301
|
)
|
|
$
|
241,604
|
|
|
$
|
9,302
|
|
ARMOUR Residential REIT, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share amounts)
(UNAUDITED)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2015
|
|
|
|
Gross Amounts Not Offset in the Condensed Consolidated Balance Sheet
|
|
|
Liabilities
|
|
Gross and Net Amounts of Liabilities Presented in the Condensed Consolidated Balance Sheet
|
|
Financial
Instruments
|
|
Cash Collateral
|
|
Net Amount
|
Interest rate swap contracts
|
|
$
|
(233,301
|
)
|
|
$
|
233,301
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Totals
|
|
$
|
(233,301
|
)
|
|
$
|
233,301
|
|
|
$
|
—
|
|
|
$
|
—
|
|
The following table represents the location and information regarding our derivatives which are included in Other Income (Loss) in the accompanying condensed consolidated statements of operations for the
quarters and nine months
ended
September 30, 2016
and
September 30, 2015
.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (Loss) Recognized
|
|
|
|
|
For the Quarter
Ended
|
|
For the Nine Months Ended
|
Derivatives
|
|
Location on condensed consolidated statements of operations
|
|
September 30, 2016
|
|
September 30, 2015
|
|
September 30, 2016
|
|
September 30, 2015
|
Interest rate swap contracts:
|
|
|
|
|
|
|
|
|
|
|
Realized gain (loss)
|
|
Realized gain (loss) on derivatives
|
|
$
|
(419
|
)
|
|
$
|
—
|
|
|
$
|
(326,411
|
)
|
|
$
|
28,346
|
|
Interest income
|
|
Realized gain (loss) on derivatives
|
|
6,836
|
|
|
2,837
|
|
|
18,741
|
|
|
10,262
|
|
Interest expense
|
|
Realized gain (loss) on derivatives
|
|
(22,670
|
)
|
|
(24,864
|
)
|
|
(70,826
|
)
|
|
(101,825
|
)
|
Changes in fair value
|
|
Unrealized gain (loss) on derivatives
|
|
45,154
|
|
|
(294,394
|
)
|
|
(6,626
|
)
|
|
(305,732
|
)
|
|
|
|
|
$
|
28,901
|
|
|
$
|
(316,421
|
)
|
|
$
|
(385,122
|
)
|
|
$
|
(368,949
|
)
|
Futures Contracts:
|
|
|
|
|
|
|
|
|
|
|
Realized loss
|
|
Realized gain (loss) on derivatives
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(184
|
)
|
Changes in fair value
|
|
Unrealized gain (loss) on derivatives
|
|
—
|
|
|
—
|
|
|
—
|
|
|
180
|
|
|
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
(4
|
)
|
Basis swap contracts:
|
|
|
|
|
|
|
|
|
|
|
Realized gain
|
|
Realized gain (loss) on derivatives
|
|
—
|
|
|
—
|
|
|
1,468
|
|
|
—
|
|
Interest income
|
|
Realized gain (loss) on derivatives
|
|
—
|
|
|
—
|
|
|
2,617
|
|
|
—
|
|
Interest expense
|
|
Realized gain (loss) on derivatives
|
|
—
|
|
|
—
|
|
|
(3,116
|
)
|
|
—
|
|
Changes in fair value
|
|
Unrealized gain (loss) on derivatives
|
|
—
|
|
|
241
|
|
|
(661
|
)
|
|
(817
|
)
|
|
|
|
|
$
|
—
|
|
|
$
|
241
|
|
|
$
|
308
|
|
|
$
|
(817
|
)
|
TBA Agency Securities:
|
|
|
|
|
|
|
|
|
|
|
Realized gain
|
|
Realized gain (loss) on derivatives
|
|
36,069
|
|
|
4,627
|
|
|
38,723
|
|
|
(5,879
|
)
|
Changes in fair value
|
|
Unrealized gain (loss) on derivatives
|
|
(19,330
|
)
|
|
28,079
|
|
|
10,194
|
|
|
18,464
|
|
|
|
|
|
$
|
16,739
|
|
|
$
|
32,706
|
|
|
$
|
48,917
|
|
|
$
|
12,585
|
|
Totals
|
|
$
|
45,640
|
|
|
$
|
(283,474
|
)
|
|
$
|
(335,897
|
)
|
|
$
|
(357,185
|
)
|
ARMOUR Residential REIT, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share amounts)
(UNAUDITED)
Note 10 -Commitments and Contingencies
Management Agreements with ACM
ARMOUR and its subsidiaries, including JAVELIN are managed by ACM, pursuant to management agreements see also
Note 15
, “
Related Party Transactions
”.
The management agreements entitle ACM to receive management fees payable monthly in arrears. Currently, the monthly ARMOUR management fee is 1/12th of the sum of (a)
1.5%
of gross equity raised up to
$1.0 billion
plus (b)
0.75%
of gross equity raised in excess of
$1.0 billion
. The cost of repurchased stock and any dividend representing a return of capital for tax purposes will reduce the amount of gross equity raised used to calculate the monthly management fee. In connection with the acquisition of JAVELIN, we included in accounts payable and other accrued expenses in our condensed consolidated statements of operations a liability which was recognized as the fair value of JAVELIN’s management agreement with ACM, see
Note 16 -Acquisition of JAVELIN Mortgage Investment Corp.
At
September 30, 2016
and
September 30, 2015
, the effective ARMOUR management fee was
1.05%
, and
1.04%
based on gross equity raised of
$2,469,368
and
$2,620,950
, respectively. The ACM monthly management fees are not calculated based on the performance of our assets. Accordingly, the payment of our monthly management fees may not decline in the event of a decline in our earnings and may cause us to incur losses. We are also responsible for any costs and expenses that ACM incurred solely on behalf of ARMOUR or JAVELIN other than the various overhead expenses specified in the terms of the management agreements. ACM is further entitled to receive termination fees from ARMOUR and JAVELIN under certain circumstances.
Indemnifications and Litigation
We enter into certain contracts that contain a variety of indemnifications, principally with ACM and underwriters, against third party claims for errors and omissions in connection with their services to us. We have not incurred any costs to defend lawsuits or settle claims related to these indemnification agreements. As a result, the estimated fair value of these agreements, as well as the maximum amount attributable to past events, is not material. Accordingly, we have no liabilities recorded for these agreements at
September 30, 2016
and
December 31, 2015
.
Nine
putative class action lawsuits have been filed in connection with the tender offer (the “Tender Offer”) and merger (the “Merger”) for JAVELIN (see
Note 16 -Acquisition of JAVELIN Mortgage Investment Corp.
for more information about the Tender Offer and Merger). 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. On April 25, 2016, the 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. The Motion to Dismiss is fully briefed and ripe for ruling from the Court.
Each of ARMOUR, JAVELIN, ACM and the Individual Defendants intends to defend the claims made in these lawsuits vigorously; however, there can be no assurance that any of ARMOUR, JAVELIN, ACM or the Individual Defendants will prevail in its defense of any of these lawsuits to which it is a party. An unfavorable resolution of any such litigation surrounding the Transactions may result in monetary damages being awarded to the plaintiffs and the putative class of former stockholders of JAVELIN and the cost of defending the litigation, even if resolved favorably, could be substantial. Due to the preliminary nature all of these suits, ARMOUR is not able at this time to estimate their outcome.
ARMOUR Residential REIT, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share amounts)
(UNAUDITED)
Note 11 -Stock Based Compensation
We adopted the 2009 Stock Incentive Plan as amended (the “Plan”) to attract, retain and reward directors and other persons who provide services to us in the course of operations. The Plan authorizes the Board to grant awards including common stock, restricted shares of common stock (“RSUs”), stock options, performance shares, performance units, stock appreciation rights and other equity and cash-based awards (collectively, “Awards”), subject to terms as provided in the Plan.
On May 8, 2014, our stockholders approved an amendment to the Plan to increase the number of shares issuable thereunder from
2,000
to
15,000
shares and the Plan was amended accordingly. In connection with the Reverse Stock Split, the number of shares of common stock issuable under the Plan was properly adjusted to
1,875
shares to reflect the Reverse Stock Split.
Transactions related to awards for the
nine months
ended
September 30, 2016
are summarized below:
|
|
|
|
|
|
|
|
|
|
|
September 30, 2016
|
|
|
Number of
Awards
|
|
Weighted
Average Grant
Date Fair Value
per Award
|
Unvested RSU Awards Outstanding beginning of period
|
|
78
|
|
|
$
|
48.85
|
|
Vested
|
|
(35
|
)
|
|
$
|
56.20
|
|
Unvested RSU Awards Outstanding end of period
|
|
43
|
|
|
$
|
43.86
|
|
At
September 30, 2016
, there was approximately
$980
of unvested stock based compensation related to the Awards (based on the
September 30, 2016
stock price of
$22.54
per share), that we expect to recognize as an expense over the remaining average service period of
0.4 years
. We also pay our non-executive Board quarterly fees of
$33
, which is payable in cash, common stock, or a combination of common stock and cash at the option of the director.
Note 12 -Stockholders' Equity
Preferred Stock
At
September 30, 2016
and
December 31, 2015
, 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. We have designated
9,610
shares as
8.250%
Series A Preferred Stock and
6,210
shares as
7.875%
Series B Preferred Stock. At
September 30, 2016
, a total of
34,180
shares of our authorized preferred stock remain available for designation as future series.
Series A Cumulative Preferred Shares (“Series A Preferred Stock”)
At
September 30, 2016
and
December 31, 2015
, we had
2,181
shares of Series A Preferred Stock issued and outstanding with a par value of
$0.001
per share and a liquidation preference of
$25.00
per share, or
$54,514
in the aggregate. Shares designated as Series A Preferred Stock but unissued totaled
7,429
at
September 30, 2016
. At
September 30, 2016
and
December 31, 2015
, there were no accrued or unpaid dividends on the Series A Preferred Stock. The Series A Preferred Stock is entitled to a dividend at a rate of
8.250%
per year based on the
$25.00
per share liquidation preference before the common stock is entitled to receive any dividends. The Series A Preferred Stock is redeemable at
$25.00
per share plus accrued and unpaid dividends exclusively at our option commencing on June 7, 2017 (subject to our right under limited circumstances to redeem the Series A Preferred Stock earlier in order to preserve our qualification as a REIT). The Series A Preferred Stock is senior to our common stock and therefore in the event of liquidation, dissolution or winding up, the Series A Preferred Stock will receive a liquidation preference of
$25.00
per share plus accumulated and unpaid dividends before distributions are paid to holders of our common stock, with no right or claim to any of our remaining assets thereafter. The Series A Preferred Stock generally does not have voting rights, except if we fail to pay dividends on the Series A Preferred Stock for
eighteen
months, whether or not consecutive. Under such circumstances, the Series A Preferred Stock will be entitled to vote to elect
two
additional directors to the Board, until all unpaid dividends have been paid or declared and set aside for payment. The Series A Preferred Stock has no stated maturity, is not subject to any sinking fund or mandatory redemption and will remain outstanding indefinitely unless repurchased or redeemed by us or converted into our common stock in connection with a change of control by the holders of Series A Preferred Stock.
ARMOUR Residential REIT, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share amounts)
(UNAUDITED)
Series B Cumulative Preferred Shares (“Series B Preferred Stock”)
At
September 30, 2016
and
December 31, 2015
, we had
5,650
shares of Series B Preferred Stock issued and outstanding with a par value of
$0.001
per share and a liquidation preference of
$25.00
per share, or
$141,250
in the aggregate. Shares designated as Series B Preferred Stock but unissued totaled
560
at
September 30, 2016
. At
September 30, 2016
and
December 31, 2015
, there were no accrued or unpaid dividends on the Series B Preferred Stock. The Series B Preferred Stock is entitled to a dividend at a rate of
7.875%
per year based on the
$25.00
per share liquidation preference before the common stock is entitled to receive any dividends. The Series B Preferred Stock is redeemable at
$25.00
per share plus accrued and unpaid dividends exclusively at our option commencing on February 12, 2018 (subject to our right under limited circumstances to redeem the Series A Preferred Stock earlier in order to preserve our qualification as a REIT). The Series B Preferred Stock is senior to our common stock and rank on parity with the Series A Preferred Stock. In the event of liquidation, dissolution or winding up, the Series B Preferred Stock will receive a liquidation preference of
$25.00
per share plus accumulated and unpaid dividends before distributions are paid to holders of our common stock, with no right or claim to any of our remaining assets thereafter. The Series B Preferred Stock generally does not have voting rights, except if we fail to pay dividends on the Series B Preferred Stock for
eighteen
months, whether or not consecutive. Under such circumstances, the Series B Preferred Stock will be entitled to vote to elect
two
additional directors to the Board, until all unpaid dividends have been paid or declared and set aside for payment. The Series B Preferred Stock has no stated maturity, is not subject to any sinking fund or mandatory redemption and will remain outstanding indefinitely unless repurchased or redeemed by us or converted into our common stock in connection with a change of control by the holders of Series B Preferred Stock.
Common Stock
Common Stock
On June 18, 2015, we announced that our Board of Directors had approved a Reverse Stock Split. The Reverse Stock Split took effect at approximately 5:00 p.m. Eastern Time on July 31, 2015 (the “Effective Time”). At the Effective Time, every
eight
issued and outstanding shares of common stock was converted into one share of common stock, and as a result, the number of outstanding shares of common stock was reduced from approximately
350,000
to approximately
43,750
. At the Effective Time, the number of authorized shares of common stock was also reduced, on a one-for-
eight
basis, from
1,000,000
to
125,000
. The par value of each share of common stock remained unchanged. No fractional shares were issued in connection with the Reverse Stock Split.
At
September 30, 2016
and
December 31, 2015
, we were authorized to issue up to
125,000
shares of common stock, par value
$0.001
per share, with such designations, voting and other rights and preferences as may be determined from time to time by our Board. We had
36,713
shares of common stock issued and outstanding at
September 30, 2016
and
36,682
shares of common stock issued and outstanding at
December 31, 2015
.
Common Stock Repurchased
On March 5, 2014, our Board increased the authorization under our common stock repurchase program (the “Repurchase Program”) to
50,000
shares of our common stock outstanding (on a pre-reverse stock split basis). On July 28, 2015, our Board of Directors increased the number of shares of common stock authorized for repurchase under our Repurchase Program to an aggregate of
9,000
shares on a post-reverse stock split basis, effective August 3, 2015. Under the Repurchase Program, shares may be purchased in the open market, including block trades, through privately negotiated transactions, or pursuant to a trading plan separately adopted in the future. The timing, manner, price and amount of any repurchases will be at our discretion, subject to the requirements of the Securities Exchange Act of 1934, as amended, and related rules. We are not required to repurchase any shares under the Repurchase Program and it may be modified, suspended or terminated at any time for any reason. We do not intend to purchase shares from our Board or other affiliates. Under Maryland law, such repurchased shares are treated as authorized but unissued. At
September 30, 2016
, there were
1,874
authorized shares remaining under the Repurchase Program. During the
nine months
ended
September 30, 2016
, we did not repurchase any common shares under the Repurchase Program.
ARMOUR Residential REIT, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share amounts)
(UNAUDITED)
Dividends
The following tables present our common stock dividend transactions for the
nine months
ended
September 30, 2016
.
|
|
|
|
|
|
|
|
|
|
|
|
Record Date
|
|
Payment Date
|
|
Rate per common share
|
|
Aggregate
amount paid
to holders of record
|
January 15, 2016
|
|
January 27, 2016
|
|
$
|
0.33
|
|
|
$
|
12,131
|
|
February 15, 2016
|
|
February 26, 2016
|
|
$
|
0.33
|
|
|
12,131
|
|
March 15, 2016
|
|
March 28, 2016
|
|
$
|
0.33
|
|
|
12,131
|
|
April 15, 2016
|
|
April 27, 2016
|
|
$
|
0.27
|
|
|
9,925
|
|
May 16, 2016
|
|
May 27, 2016
|
|
$
|
0.22
|
|
|
8,087
|
|
June 15, 2016
|
|
June 29, 2016
|
|
$
|
0.22
|
|
|
8,087
|
|
July 15, 2016
|
|
July 27, 2016
|
|
$
|
0.22
|
|
|
8,087
|
|
August 15, 2016
|
|
August 29, 2016
|
|
$
|
0.22
|
|
|
8,087
|
|
September 15, 2016
|
|
September 27, 2016
|
|
$
|
0.22
|
|
|
8,087
|
|
Total dividends paid
|
|
|
|
|
|
$
|
86,753
|
|
The following tables present our Series A Preferred Stock dividend transactions for the
nine months
ended
September 30, 2016
.
|
|
|
|
|
|
|
|
|
|
|
|
Record Date
|
|
Payment Date
|
|
Rate per
Series A
Preferred
Share
|
|
Aggregate
amount paid
to holders of record
|
January 15, 2016
|
|
January 27, 2016
|
|
$
|
0.17
|
|
|
$
|
374.8
|
|
February 15, 2016
|
|
February 26, 2016
|
|
$
|
0.17
|
|
|
374.8
|
|
March 15, 2016
|
|
March 28, 2016
|
|
$
|
0.17
|
|
|
374.8
|
|
April 15, 2016
|
|
April 27, 2016
|
|
$
|
0.17
|
|
|
374.8
|
|
May 15, 2016
|
|
May 27, 2016
|
|
$
|
0.17
|
|
|
374.8
|
|
June 15, 2016
|
|
June 27, 2016
|
|
$
|
0.17
|
|
|
374.8
|
|
July 15, 2016
|
|
July 27, 2016
|
|
$
|
0.17
|
|
|
374.8
|
|
August 15, 2016
|
|
August 29, 2016
|
|
$
|
0.17
|
|
|
374.8
|
|
September 15, 2016
|
|
September 27, 2016
|
|
$
|
0.17
|
|
|
374.8
|
|
Total dividends paid
|
|
|
|
|
|
$
|
3,373
|
|
ARMOUR Residential REIT, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share amounts)
(UNAUDITED)
The following tables present our Series B Preferred Stock dividend transactions for the
nine months
ended
September 30, 2016
.
|
|
|
|
|
|
|
|
|
|
|
|
Record Date
|
|
Payment Date
|
|
Rate per
Series B
Preferred
Share
|
|
Aggregate
amount paid
to holders of record
|
January 15, 2016
|
|
January 27, 2016
|
|
$
|
0.16
|
|
|
$
|
927
|
|
February 15, 2016
|
|
February 26, 2016
|
|
$
|
0.16
|
|
|
927
|
|
March 15, 2016
|
|
March 28, 2016
|
|
$
|
0.16
|
|
|
927
|
|
April 15, 2016
|
|
April 27, 2016
|
|
$
|
0.16
|
|
|
927
|
|
May 15, 2016
|
|
May 27, 2016
|
|
$
|
0.16
|
|
|
927
|
|
June 15, 2016
|
|
June 27, 2016
|
|
$
|
0.16
|
|
|
927
|
|
July 15, 2016
|
|
July 27, 2016
|
|
$
|
0.16
|
|
|
927
|
|
August 15, 2016
|
|
August 29, 2016
|
|
$
|
0.16
|
|
|
927
|
|
September 15, 2016
|
|
September 27, 2016
|
|
$
|
0.16
|
|
|
927
|
|
Total dividends paid
|
|
|
|
|
|
$
|
8,343
|
|
Note 13 -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
quarters and nine months
ended
September 30, 2016
, and
September 30, 2015
.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Quarter
Ended
|
|
For the Nine Months Ended
|
|
|
September 30, 2016
|
|
September 30, 2015
|
|
September 30, 2016
|
|
September 30, 2015
|
Net Income (Loss)
|
|
$
|
118,688
|
|
|
$
|
(221,553
|
)
|
|
$
|
(139,613
|
)
|
|
$
|
(149,003
|
)
|
Less: Preferred dividends
|
|
(3,905
|
)
|
|
(3,905
|
)
|
|
(11,716
|
)
|
|
(11,716
|
)
|
Net income (loss) related to common stockholders
|
|
$
|
114,783
|
|
|
$
|
(225,458
|
)
|
|
$
|
(151,329
|
)
|
|
$
|
(160,719
|
)
|
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding – basic
|
|
36,703
|
|
|
43,561
|
|
|
36,693
|
|
|
43,709
|
|
Add: Effect of dilutive non-vested awards, assumed vested
|
|
43
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Weighted average common shares outstanding – diluted
|
|
36,746
|
|
|
43,561
|
|
|
36,693
|
|
|
43,709
|
|
ARMOUR Residential REIT, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share amounts)
(UNAUDITED)
Note 14 -Income Taxes
The following table reconciles our GAAP net income (loss) to estimated REIT taxable income for the
quarters and nine months
ended
September 30, 2016
and
September 30, 2015
.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Quarter
Ended
|
|
For the Nine Months Ended
|
|
|
September 30, 2016
|
|
September 30, 2015
|
|
September 30, 2016
|
|
September 30, 2015
|
GAAP net income (loss)
|
|
$
|
118,688
|
|
|
$
|
(221,553
|
)
|
|
$
|
(139,613
|
)
|
|
$
|
(149,003
|
)
|
Book to tax differences:
|
|
|
|
|
|
|
|
|
Non-Agency Securities
|
|
(40,249
|
)
|
|
—
|
|
|
(54,767
|
)
|
|
—
|
|
Interest-Only Securities
|
|
438
|
|
|
—
|
|
|
1,681
|
|
|
—
|
|
Changes in interest rate contracts
|
|
(61,473
|
)
|
|
261,447
|
|
|
283,314
|
|
|
265,438
|
|
Gains on Security Sales
|
|
(2,421
|
)
|
|
(69
|
)
|
|
(18,937
|
)
|
|
(1,562
|
)
|
Amortization of deferred hedging costs
|
|
(13,226
|
)
|
|
(1,836
|
)
|
|
(34,583
|
)
|
|
(4,929
|
)
|
Bargain purchase price on acquisition of JAVELIN
|
|
—
|
|
|
—
|
|
|
(6,484
|
)
|
|
—
|
|
Other
|
|
2
|
|
|
3
|
|
|
14
|
|
|
11
|
|
Estimated REIT taxable income
|
|
$
|
1,759
|
|
|
$
|
37,992
|
|
|
$
|
30,625
|
|
|
$
|
109,955
|
|
Interest rate contracts are treated as hedging transactions for tax purposes. Unrealized gains and losses on open interest rate contracts are not included in the determination of taxable income. Realized gains and losses on interest rate contracts terminated before their maturity are deferred and amortized over the remainder of the original term of the contract.
Net capital losses realized in 2013, 2014 and 2015 totaling
$(579,322)
,
$(341,850)
and
$(5,175)
will be available to offset future capital gains realized through 2018, 2019 and 2020, respectively.
The aggregate tax basis of our assets and liabilities was greater than our total Stockholders’ Equity at
September 30, 2016
by approximately
$174,376
, or approximately
$4.75
per common share (based on the
36,713
common shares then outstanding).
We are required and intend to timely distribute substantially all of our REIT taxable income in order to maintain our REIT status under the Code. Total dividend payments to stockholders were
$98,469
and
$139,385
for the nine months ended
September 30, 2016
and
September 30, 2015
, respectively. Our estimated REIT taxable income available to pay dividends was
$30,625
and
$109,955
for the nine months ended
September 30, 2016
and
September 30, 2015
, respectively. Our taxable REIT income and dividend requirements to maintain our REIT status are determined on an annual basis. Dividends paid in excess of taxable REIT income for the year (including amounts carried forward from prior years) 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 15 -Related Party Transactions
ARMOUR and its subsidiaries, including JAVELIN are managed by ACM, pursuant to management agreements with ARMOUR and JAVELIN. All of our executive officers are also employees of ACM. ACM manages our day-to-day operations, subject to the direction and oversight of the Board. The ARMOUR management agreement runs through June 18, 2022 and is thereafter automatically renewed for successive
five
-year terms unless terminated under certain circumstances. The JAVELIN Management Agreement runs through October 5, 2017 and is thereafter automatically renewed for successive one-year terms unless terminated under certain circumstances. Either party must provide
180 days
prior written notice of any such termination.
Under the terms of the management agreements, ACM is responsible for costs incident to the performance of its duties, such as compensation of its employees and various overhead expenses. ACM is responsible for the following primary roles:
|
|
•
|
Advising us with respect to, arranging for and managing the acquisition, financing, management and disposition of, elements of our investment portfolio;
|
ARMOUR Residential REIT, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share amounts)
(UNAUDITED)
|
|
•
|
Evaluating the duration risk and prepayment risk within the investment portfolio and arranging borrowing and hedging strategies;
|
|
|
•
|
Coordinating capital raising activities;
|
|
|
•
|
Advising us on the formulation and implementation of operating strategies and policies, arranging for the acquisition of assets, monitoring the performance of those assets and providing administrative and managerial services in connection with our day-to-day operations; and
|
|
|
•
|
Providing executive and administrative personnel, office space and other appropriate services required in rendering management services to us.
|
In accordance with management agreements, we incurred
$6,521
and
$19,549
in management fees for the
quarter and nine months
ended
September 30, 2016
. For the
quarter and nine months
ended
September 30, 2015
, we incurred
$6,851
and
$20,595
in management fees. In accordance with the JAVELIN management agreement, we paid management fees of
$565
and
$1,092
, for the
quarter and nine months
ended
September 30, 2016
, reducing the liability recorded upon acquisition.
We are required to take actions as may be reasonably required to permit and enable ACM to carry out its duties and obligations. We are also responsible for any costs and expenses that ACM incurred solely on our behalf other than the various overhead expenses specified in the terms of the management agreements. For the
quarter and nine months
ended
September 30, 2016
, we reimbursed ACM
$362
and
$1,245
, respectively, for other expenses incurred on our behalf. For the
quarter and nine months
ended
September 30, 2015
, we reimbursed ACM
$480
and
$1,352
, respectively, for other expenses incurred on our behalf. In consideration of our 2012 results, in 2013, we also elected to make a restricted stock award to our executive officers and other ACM employees through ACM. No new awards have been granted since 2013. The award vests through 2017 and resulted in our recognizing stock based compensation expense of
$123
and
$351
for the
quarter and nine months
ended
September 30, 2016
and
$140
and
$477
for the
quarter and nine months
ended
September 30, 2015
.
Note 16 -Acquisition of JAVELIN Mortgage Investment Corp.
On March 1, 2016, we entered into an agreement to purchase all of the outstanding common stock of JAVELIN and commenced a Tender Offer for cash at a price of
$7.18
, without interest and less any applicable withholding taxes. On April 1, 2016, the Tender Offer expired as the minimum condition was successfully met as greater than
50%
of the total outstanding shares of common shares were validly tendered and not withdrawn. On April 6, 2016, we completed our acquisition of all of the outstanding common stock of JAVELIN upon the merger of Acquisition with and into JAVELIN, for cash consideration of
$85,200
. Subsequently, JAVELIN became a wholly-owned subsidiary of ARMOUR and continues to be managed by ACM pursuant to the pre-existing management agreement between JAVELIN and ACM. The acquisition expanded and diversified our investment portfolio. JAVELIN's complementary assets provided us with investment opportunities in Non-Agency MBS.
We recognized JAVELIN’s assets and liabilities (including JAVELIN’s liability under JAVELIN’s management agreement with ACM) at their fair values on the date of the Merger. None of the bargain purchase price reflected in the table below was included in income for income tax purposes.
ARMOUR Residential REIT, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share amounts)
(UNAUDITED)
The following table summarizes the consideration paid for JAVELIN and the amounts of the assets acquired and liabilities assumed recognized at the acquisition date, as well as the fair value at the acquisition date (amounts in millions):
|
|
|
|
|
|
Consideration:
|
|
|
Cash
|
|
$
|
85.2
|
|
Fair value of consideration transferred
|
|
$
|
85.2
|
|
Acquisition related costs (included in professional fees and other expenses)
|
|
$
|
2.5
|
|
Recognized amounts of identifiable assets acquired and liabilities assumed:
|
|
|
Cash
|
|
$
|
12.0
|
|
Cash collateral
|
|
24.6
|
|
Agency Securities
|
|
440.7
|
|
Non-Agency Securities
|
|
223.2
|
|
Accrued interest receivable
|
|
1.4
|
|
Prepaid and other assets
|
|
5.4
|
|
Repurchase agreements
|
|
(589.6
|
)
|
Derivatives
|
|
(17.5
|
)
|
Accrued interest payable
|
|
(0.9
|
)
|
Accounts payable and other accrued expenses
|
|
(7.6
|
)
|
Total identifiable net assets
|
|
$
|
91.7
|
|
Goodwill/(Bargain purchase price)
|
|
(6.5
|
)
|
Total
|
|
$
|
85.2
|
|
Included in accounts payable and other accrued expenses was a liability of
$3,375
which was recognized as the fair value of JAVELIN’s management agreement with ACM as of April 6, 2016.
From the date of the acquisition, total interest income of
$4,882
and
$10,013
and net income of
$6,931
and
$10,150
are included in the condensed consolidated statements of operations from the operations of JAVELIN for the
quarter and nine months
ended
September 30, 2016
, respectively. Total identifiable net assets of
$102,846
are included in the condensed consolidated balance sheet for the period ended
September 30, 2016
.
We recognized a gain of
$6,484
which is included in Other Income (Loss) in our condensed consolidated statements of operations for the nine months ended
September 30, 2016
as the amount of the identifiable net assets acquired above exceeded the value of the consideration transferred.
Note 17 -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 and the interest expense incurred in connection with the 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.
Note 18 -Subsequent Events
Dividends
On October 27, 2016, a cash dividend of
$0.17
per outstanding share of Series A Preferred Stock, or
$375
in the aggregate, and
$0.16
per outstanding share of Series B Preferred Stock, or
$927
in the aggregate, was paid to holders of record on October 15, 2016. We have also declared cash dividends of
$0.17
and
$0.16
per outstanding share of Series A Preferred Stock and Series B Preferred Stock, respectively, payable November 28, 2016 to holders of record on November 15, 2016 and payable December 27, 2016 to holders of record on December 15, 2016.
On October 27, 2016, a cash dividend of
$0.22
per outstanding common share, or
$8,087
in the aggregate, was paid to holders of record on October 14, 2016. We have also declared cash dividends of
$0.22
per outstanding common share payable November 15, 2016 to holders of record on November 29, 2016.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes included elsewhere in this report.
References to “we,” “us,” “our,” “ARMOUR” or the “Company” are to ARMOUR Residential REIT, Inc. References to “ACM” are to ARMOUR Capital Management LP, a Delaware limited partnership. Refer to the Glossary of Terms for definitions of capitalized terms and abbreviations used in this report. All per share amounts, common shares outstanding and stock-based compensation amounts for all periods presented reflect our Reverse Stock Split, which was effective July 31, 2015.
U.S. dollar amounts are presented in thousands, except per share amounts or as otherwise noted.
Overview
ARMOUR and its subsidiaries, including JAVELIN, are managed by ACM, an investment advisor registered with the SEC. See
Note 10
and
Note 15
to the condensed consolidated financial statements for further details. We are a Maryland corporation formed to invest in and manage a leveraged portfolio of MBS and mortgage loans. We invest in residential mortgage backed securities issued or guaranteed by a U.S. GSE, such as Fannie Mae or Freddie Mac, or a government agency such as Ginnie Mae (collectively, Agency Securities). Interest-Only Securities are the interest portion of Agency Securities, which is separated and sold individually from the principal portion of the same payment. Other securities backed by residential mortgages in which we invest, for which the payment of principal and interest is not guaranteed by a GSE or government agency (collectively, Non-Agency Securities and together with Agency Securities, MBS), may benefit from credit enhancement derived from structural elements such as subordination, over collateralization or insurance.
At
September 30, 2016
and
December 31, 2015
, investments in Agency Securities accounted for
86.5%
and 100% of our MBS portfolio, respectively. During the first quarter of 2016, we began to invest in Non-Agency Securities. At
September 30, 2016
, investments in Non-Agency Securities accounted for
12.3%
of our MBS portfolio. During the second quarter of 2016, we began to invest in Interest-Only Securities. At
September 30, 2016
, investments in Interest-Only Securities accounted for
1.2%
of our MBS portfolio. Our MBS portfolio consists primarily of Agency Securities backed by fixed rate home loans. From time to time, a portion of our assets may be invested in Agency Securities 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 Agency Securities, Non-Agency Securities and Interest-Only Securities.
We seek attractive long-term investment returns by investing our equity capital and borrowed funds in our targeted asset class of MBS. 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 at the most competitive interest rates available to us and then cost-effectively hedge our interest rate and other risks based on our entire portfolio of assets, liabilities and derivatives and our management’s view of the market. Successful implementation of this approach requires us to address interest rate risk, maintain adequate liquidity and effectively hedge interest rate risks. We execute our business plan in a manner consistent with our intention of qualifying as a REIT under the Code and avoiding regulation as an investment company under the 1940 Act.
We have elected to be taxed as a REIT under the Code. We will generally not be subject to federal income tax to the extent that we distribute our taxable income to our stockholders and as long as we satisfy the ongoing REIT requirements under the Code including meeting certain asset, income and stock ownership tests.
Acquisition of JAVELIN
On April 6, 2016, we completed the acquisition of JAVELIN for an aggregate of approximately
$85,200
in cash. From the date of the acquisition, total interest income of
$4,882
and
$10,013
and net income of
$6,931
and
$10,150
, were included in the condensed consolidated statements of operations from the operations of JAVELIN for the
quarter and nine months
ended
September 30, 2016
, respectively. Total identifiable net assets of
$102,846
are included in the condensed consolidated balance sheet for the period ended
September 30, 2016
as well as a non-taxable gain of
$6,484
as a result of the acquisition for the nine months ended
September 30, 2016
. See
Note 16
to the condensed consolidated financial statements for further details.
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. We invest in financial assets and markets. Recent events, such as those discussed below, can affect our business in ways that are difficult to predict and may produce results outside of typical operating variances. Our net interest income varies primarily as a result of changes in interest rates, borrowing costs and prepayment speeds, the behavior of which involves various risks and uncertainties. We look to invest across the spectrum of mortgage investments, from Agency Securities, for which the principal and interest payments are guaranteed by a GSE, to Non-Agency Securities, non-prime mortgage loans and unrated equity tranches of CMBS. As such, we expect our investments to be subject to risks arising from delinquencies and foreclosures, thereby exposing our investment portfolio to potential losses. We are exposed to changing credit spreads, which could result in declines in the fair value of our investments. We believe ACM’s in-depth investment expertise across multiple sectors of the mortgage market, prudent asset selection and our hedging strategy enable us to minimize our credit losses, our market value losses and financing costs. Prepayment rates, as reflected by the rate of principal pay downs and interest rates vary according to the type of investment, conditions in financial markets, government actions, competition and other factors, none of which can be predicted with any certainty. In general, as prepayment rates on our assets that are purchased at a premium increase, related purchase premium amortization increases, thereby reducing the net yield on such assets. Because changes in interest rates may significantly affect our activities, our operating results depend, in large part, upon our ability to manage interest rate risks and prepayment risks effectively while maintaining our status as a REIT.
For any period during which changes in the interest rates earned on our assets do not coincide with interest rate changes on our borrowings, such assets will tend to reprice more slowly than the corresponding liabilities. Consequently, 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.
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. The climate of government intervention in the mortgage markets significantly increases the risk associated with prepayments.
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 MBS 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 MBS portfolio. Also, since we have not elected to use cash flow hedge accounting, earnings reported in accordance with GAAP will fluctuate even in situations where our derivatives are operating as intended. As a result of this mark-to-market accounting treatment, our results of operations are likely to fluctuate far more than if we were to designate our derivative activities as cash flow hedges. Comparisons with companies that use cash flow hedge accounting for all or part of their derivative activities may not be meaningful. For these and other reasons more fully described under the section captioned “Derivative Instruments” below, no assurance can be given that our derivatives will have the desired beneficial impact on our results of operations or financial condition.
In addition to the use of derivatives to hedge interest rate risk, a variety of other factors relating to our business may also impact our financial condition and operating performance; these factors include
|
|
•
|
our degree of leverage;
|
|
|
•
|
our access to funding and borrowing capacity;
|
|
|
•
|
the REIT requirements under the Code; and
|
|
|
•
|
the requirements to qualify for an exclusion under the 1940 Act and other regulatory and accounting policies related to our business.
|
Our Manager
See
Note 10
and
Note 15
to the condensed consolidated financial statements.
Market and Interest Rate Trends and the Effect on our MBS 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 for the longer-term viability of these GSEs. These uncertainties may lead to concerns about the availability of and trading 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
On December 16, 2015, the Fed raised its target range for the Federal Funds Rate to between 0.25% and 0.50%. At the Fed meetings to date in 2016, the Fed has decided to maintain the federal funds rate in the same target range. 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.
Historically, 30-day LIBOR has closely tracked movements in the Federal Funds Rate and the Effective Federal Funds Rate. The Effective Federal Funds Rate can differ from the Federal Funds Rate in that the Effective Federal Funds Rate represents the volume weighted average of interest rates at which depository institutions lend balances at the Fed to other depository institutions overnight (actual transactions, rather than target rate).
Our borrowings in the repurchase market have also historically closely tracked the Federal Funds Rate and LIBOR. Traditionally, a lower Federal Funds Rate has indicated a time of increased net interest margin and higher asset values. The difference between 30-day LIBOR and the Effective Federal Funds Rate can be quite volatile, with the spread alternately returning to more normal levels and then widening out again. Volatility in these rates and divergence from the historical relationship among these rates could negatively impact our ability to manage our MBS portfolio. If rates were to increase as a result, our net interest margin and the value of our MBS portfolio might suffer as a result.
The following graph shows 30-day LIBOR as compared to the Effective Federal Funds Rate on a monthly basis from
September 30, 2014
to
September 30, 2016
.
Long-term Interest Rates and Mortgage Spreads
Our Agency 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 Agency Securities 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 Agency Securities valuations, movements in long-term interest rates or a combination of both. During 2015, interest rate swap rates declined more than U.S. Treasury interest rates, causing the interest rate swap spread to be negative to U.S. Treasury interest rates for certain longer tenors, an inversion of longstanding market norms. The market conditions continued during the
nine months
ended
September 30, 2016
. We mainly use interest rate swap contracts (including swaptions) to hedge against changes in the valuation of our MBS. As of
September 30, 2016
and
December 31, 2015
, we have not entered into any contract or purchased any asset specifically designed to offset the impact of mortgage spreads on our book value.
Results of Operations
Net Income (Loss) Summary
The following is a summary of our condensed consolidated results of operations:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Quarter
Ended
|
|
For the Nine Months Ended
|
|
Change vs. Prior Periods
|
|
|
September 30, 2016
|
|
September 30, 2015
|
|
September 30, 2016
|
|
September 30, 2015
|
|
Quarter
|
|
YTD
|
Net Interest Income
|
|
$
|
41,325
|
|
|
$
|
71,212
|
|
|
$
|
148,272
|
|
|
$
|
234,357
|
|
|
(41.97)%
|
|
(36.73)%
|
Total Other Income (Loss)
|
|
86,478
|
|
|
(283,405
|
)
|
|
(259,029
|
)
|
|
(355,623
|
)
|
|
130.51%
|
|
27.16%
|
Total Expenses
|
|
9,115
|
|
|
9,360
|
|
|
28,856
|
|
|
27,737
|
|
|
(2.62)%
|
|
4.03%
|
Net Income (Loss)
|
|
$
|
118,688
|
|
|
$
|
(221,553
|
)
|
|
$
|
(139,613
|
)
|
|
$
|
(149,003
|
)
|
|
153.57%
|
|
6.30%
|
Dividends on preferred stock
|
|
(3,905
|
)
|
|
(3,905
|
)
|
|
(11,716
|
)
|
|
(11,716
|
)
|
|
0.00%
|
|
0.00%
|
Net Income (Loss) related to common stockholders
|
|
$
|
114,783
|
|
|
$
|
(225,458
|
)
|
|
$
|
(151,329
|
)
|
|
$
|
(160,719
|
)
|
|
150.91%
|
|
5.84%
|
Net income (loss) per share related to common stockholders, basic
|
|
$
|
3.13
|
|
|
$
|
(5.18
|
)
|
|
$
|
(4.12
|
)
|
|
$
|
(3.68
|
)
|
|
160.42%
|
|
(11.96)%
|
Net income (loss) per share related to common stockholders, diluted
|
|
$
|
3.12
|
|
|
$
|
(5.18
|
)
|
|
$
|
(4.12
|
)
|
|
$
|
(3.68
|
)
|
|
160.23%
|
|
(11.96)%
|
The increase in our interest expense on repurchase agreements combined with the decrease in our MBS portfolio, led to a decline in net interest income. The decline in net interest income combined with our net gains on MBS, and net gains (losses) on derivatives in 2016 were the main factors for the change in net income (loss) for the
quarter and nine months
ended
September 30, 2016
, as compared to the
quarter and nine months
ended
September 30, 2015
.
Net Interest Income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Quarter
Ended
|
|
For the Nine Months Ended
|
|
Change vs. Prior Periods
|
|
|
September 30, 2016
|
|
September 30, 2015
|
|
September 30, 2016
|
|
September 30, 2015
|
|
Quarter
|
|
YTD
|
Agency Securities, net of amortization of premium and fees
|
|
$
|
44,544
|
|
|
$
|
85,643
|
|
|
$
|
178,733
|
|
|
$
|
276,896
|
|
|
(47.99)%
|
|
(35.45)%
|
Non-Agency Securities, including discount accretion
|
|
12,969
|
|
|
—
|
|
|
23,148
|
|
|
—
|
|
|
100.00%
|
|
100.00%
|
Interest-Only Securities
|
|
852
|
|
|
—
|
|
|
855
|
|
|
—
|
|
|
100.00%
|
|
100.00%
|
Interest expense- repurchase agreements
|
|
(17,040
|
)
|
|
(14,431
|
)
|
|
(54,464
|
)
|
|
(42,539
|
)
|
|
(18.08)%
|
|
(28.03)%
|
Net Interest Income
|
|
$
|
41,325
|
|
|
$
|
71,212
|
|
|
$
|
148,272
|
|
|
$
|
234,357
|
|
|
(41.97)%
|
|
(36.73)%
|
Net interest income is a function of both our MBS portfolio size, asset yield and repurchase agreements expense and net interest rate spread.
2016
vs.
2015
|
|
•
|
Our nine month average MBS portfolio decreased by
21.4%
from
$13,985,885
at
September 30, 2015
to
$10,987,375
at
September 30, 2016
.
|
|
|
•
|
Our asset yields increased by
0.08%
and our interest expense on our repurchase agreements increased by
0.15%
for the nine months ended
September 30, 2016
, compared to the nine months ended
September 30, 2015
.
|
|
|
•
|
Our nine month net interest rate spread increased by 0.06% from
1.33%
at
September 30, 2015
to
1.39%
at
September 30, 2016
. The increase in the interest rate spread from 2015 to 2016, as well as the decrease in our MBS portfolio resulted in decreased net interest income.
|
At
September 30, 2016
and
December 31, 2015
, our Agency Securities in our MBS portfolio were carried at a net premium to par value with a weighted average amortized cost of
104.8%
and
104.9%
, respectively, due to the average interest rates on these securities being higher than prevailing market rates.
The following table presents the components of the yield earned on our MBS portfolio for the quarterly periods presented.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
MBS
|
|
Asset Yield
|
|
Cost of
Funds
|
|
Net Interest
Margin
|
|
Interest Expense on Repurchase Agreements
|
MBS portfolio:
|
|
|
|
|
|
|
|
|
September 30, 2016
|
|
2.69
|
%
|
|
1.25
|
%
|
|
1.44
|
%
|
|
0.88
|
%
|
June 30, 2016
|
|
2.68
|
%
|
|
1.33
|
%
|
|
1.35
|
%
|
|
0.79
|
%
|
March 31, 2016
|
|
2.73
|
%
|
|
1.36
|
%
|
|
1.37
|
%
|
|
0.67
|
%
|
December 31, 2015
|
|
2.71
|
%
|
|
1.13
|
%
|
|
1.58
|
%
|
|
0.52
|
%
|
September 30, 2015
|
|
2.56
|
%
|
|
1.12
|
%
|
|
1.44
|
%
|
|
0.44
|
%
|
June 30, 2015
|
|
2.60
|
%
|
|
1.24
|
%
|
|
1.36
|
%
|
|
0.40
|
%
|
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.
Other Income (Loss)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Quarter
Ended
|
|
For the Nine Months Ended
|
|
|
September 30, 2016
|
|
September 30, 2015
|
|
September 30, 2016
|
|
September 30, 2015
|
Realized gain on sale of Agency Securities (reclassified from Other comprehensive income)
|
|
$
|
2,421
|
|
|
$
|
69
|
|
|
$
|
18,937
|
|
|
$
|
1,562
|
|
Gain on Non-Agency Securities
|
|
39,522
|
|
|
—
|
|
|
53,795
|
|
|
—
|
|
Loss on Interest-Only Securities
|
|
(1,105
|
)
|
|
—
|
|
|
(2,348
|
)
|
|
—
|
|
Bargain purchase price on acquisition of JAVELIN
|
|
—
|
|
|
—
|
|
|
6,484
|
|
|
—
|
|
Subtotal
|
|
$
|
40,838
|
|
|
$
|
69
|
|
|
$
|
76,868
|
|
|
$
|
1,562
|
|
Realized gain (loss) on derivatives
|
|
19,816
|
|
|
(17,400
|
)
|
|
(338,804
|
)
|
|
(69,280
|
)
|
Unrealized gain (loss) on derivatives
|
|
25,824
|
|
|
(266,074
|
)
|
|
2,907
|
|
|
(287,905
|
)
|
Subtotal
|
|
$
|
45,640
|
|
|
$
|
(283,474
|
)
|
|
$
|
(335,897
|
)
|
|
$
|
(357,185
|
)
|
Total Other Income (Loss)
|
|
$
|
86,478
|
|
|
$
|
(283,405
|
)
|
|
$
|
(259,029
|
)
|
|
$
|
(355,623
|
)
|
2016
vs.
2015
|
|
•
|
Gains on Agency Securities resulted from the sales of Agency Securities during the
quarter and nine months
ended
September 30, 2016
of
$460,169
and
$5,428,174
compared to
$331,196
and
$3,148,831
during the
quarter and nine months
ended
September 30, 2015
. At
September 30, 2016
and
September 30, 2015
, we also considered whether we intended to sell Agency Securities and whether it was more likely than not that we could meet our liquidity requirements and contractual obligations without selling Agency Securities. As a result of this evaluation, no other than temporary impairment was recognized for the quarters and nine months ended
September 30, 2016
and
September 30, 2015
, respectively, because we determined that we 1) did not have the intent to sell the Agency Securities in an unrealized loss position, 2) did not believe it more likely than not that we were required to sell the securities before recovery (for example, because of liquidity requirements or contractual obligations), and/or 3) determined that a credit loss did not exist.
|
|
|
•
|
Gain on Non-Agency Securities resulted from the change in fair value of the securities.
|
|
|
•
|
Gains (losses) on Derivatives resulted from a combination of the following:
|
|
|
◦
|
We decreased our total interest rate swap contracts aggregate notional balance from
$12,325,000
at
September 30, 2015
to
$4,910,000
at
September 30, 2016
.
|
|
|
◦
|
We decreased our total basis swap contracts aggregate notional balance from
$2,000,000
at
September 30, 2015
to
$0
at
September 30, 2016
.
|
|
|
◦
|
We increased our total TBA Agency Securities aggregate notional balance from
$1,600,000
at
September 30, 2015
to
$2,650,000
at
September 30, 2016
.
|
|
|
•
|
Loss on Interest-Only Securities resulted from a decrease in the fair value of these securities.
|
|
|
•
|
Bargain purchase price on acquisition of JAVELIN of
$6,484
for the nine months ended
September 30, 2016
, resulted from the acquisition of JAVELIN as discussed in
Note 16
to the condensed consolidated financial statements.
|
Expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Quarter
Ended
|
|
For the Nine Months Ended
|
|
Change vs. Prior Periods
|
|
|
September 30, 2016
|
|
September 30, 2015
|
|
September 30, 2016
|
|
September 30, 2015
|
|
Quarter
|
|
YTD
|
Management fees
|
|
$
|
6,521
|
|
|
$
|
6,851
|
|
|
$
|
19,549
|
|
|
$
|
20,595
|
|
|
(4.82
|
)%
|
|
(5.08
|
)%
|
Professional fees
|
|
1,090
|
|
|
878
|
|
|
4,756
|
|
|
2,329
|
|
|
24.15
|
%
|
|
104.21
|
%
|
Insurance
|
|
283
|
|
|
174
|
|
|
727
|
|
|
516
|
|
|
62.64
|
%
|
|
40.89
|
%
|
Compensation
|
|
530
|
|
|
543
|
|
|
1,636
|
|
|
1,731
|
|
|
(2.39
|
)%
|
|
(5.49
|
)%
|
Other
|
|
691
|
|
|
914
|
|
|
2,188
|
|
|
2,566
|
|
|
(24.40
|
)%
|
|
(14.73
|
)%
|
Total Expenses
|
|
$
|
9,115
|
|
|
$
|
9,360
|
|
|
$
|
28,856
|
|
|
$
|
27,737
|
|
|
(2.62
|
)%
|
|
4.03
|
%
|
ARMOUR and its subsidiaries, including JAVELIN, are managed by ACM, pursuant to management agreements with ARMOUR and JAVELIN. The ARMOUR management fees are determined based on gross equity raised. Therefore, management fees increase when we raise capital and decline when we repurchase previously issued stock or pay dividends in excess of taxable income. However, because the ARMOUR management fee rate decreased to 0.75% per annum for gross equity raised in excess of $1.0 billion pursuant to the ARMOUR management agreement, the effective average management fee rate declines as equity is raised. Gross equity raised was
$2,469,368
at
September 30, 2016
, compared to
$2,620,950
at
September 30, 2015
. In connection with the acquisition of JAVELIN, we included in accounts payable and other accrued expenses in our condensed consolidated statements of operations a liability of
$3,375
which was recognized as the fair value of JAVELIN’s management agreement with ACM as of April 6, 2016 and which has been reduced by
$1,092
at
September 30, 2016
.
Professional fees include securities clearing, legal, audit and consulting costs and are generally driven by the size and complexity of our MBS portfolio, the volume of transactions we execute and the extent of research and due diligence activities we undertake on potential transactions. The increase in professional fees for the quarter ended
September 30, 2016
compared to the quarter ended
September 30, 2015
, was due to fees related to the operation of JAVELIN. The increase in professional fees for the nine months ended
September 30, 2016
compared to the nine months ended
September 30, 2015
, was mainly due to an increase in costs recognized in connection with the acquisition of JAVELIN of
$2,495
. Other expenses for the nine months ended
September 30, 2015
, include an increase in printing fees of
$140
in connection with the acquisition of JAVELIN.
Insurance includes premiums for both general business and directors and officers liability coverage. The increase in 2016 compared to 2015 is due to the addition of JAVELIN's insurance premiums since acquisition.
Compensation includes both non-executive director compensation as well as the restricted stock awarded to our executive officers and other ACM employees through ACM. The fluctuation from year to year is due to a combination of the change in our stock price and the number of awards vesting to our executive officers and other ACM employees. No new awards have been granted since 2013.
Other expenses include fees for market and pricing data, analytics and risk management systems and portfolio related data processing costs as well as stock exchange listing fees and similar shareholder related expenses. The decrease in other expenses for the
quarter and nine months
ended
September 30, 2016
was due to lower exchange listing fees and data processing costs of
$246
and
$608
, respectively.
Taxable Income
As a REIT, we are generally not subject to taxation. See
Note 14
to the condensed consolidated financial statements.
Other 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. For the quarter and nine months ended
September 30, 2016
, other comprehensive income (loss) totaled
$(9,947)
and
$232,573
, respectively, reflecting net unrealized gain (loss) on available for sale Agency Securities net of amounts reclassified upon sale. For the quarter and nine months ended
September 30, 2015
, other comprehensive income totaled
$137,243
and
$3,679
, respectively, reflecting net unrealized gains on available for sale Agency Securities net of amounts reclassified upon sale.
Financial Condition
Agency Securities, Interest-Only Securities and TBA Agency Securities
Security purchase and sale transactions, including purchases and sales for forward settlement, are recorded on the trade date to the extent it is probable that we will take or make timely physical delivery of the related securities. Gains or losses realized from the sale of securities are included in income and are determined using the specific identification method. We typically purchase Agency Securities at premium prices. The premium price paid over par value on those assets is expensed as the underlying mortgages experience repayment or prepayment. The lower the constant 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.
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 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 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 Agency Securities, Interest-Only Securities and TBA Agency Securities at
September 30, 2016
and
December 31, 2015
.
September 30, 2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Asset Type
|
|
Principal Amount
|
|
Fair Value
|
|
Weighted Average Coupon
|
|
CPR
(1)
|
|
Weighted Average Month to Reset or Maturity
|
|
% of Total Agency Securities
|
ARMs & Hybrids
|
|
$
|
84,598
|
|
|
$
|
87,970
|
|
|
2.55
|
%
|
|
12.14
|
%
|
|
10
|
|
0.89
|
%
|
Multi-Family MBS
|
|
1,440,798
|
|
|
1,557,033
|
|
|
3.19
|
%
|
|
0.00
|
%
|
|
92
|
|
15.75
|
|
10 Year Fixed
|
|
140,993
|
|
|
148,952
|
|
|
3.94
|
%
|
|
10.46
|
%
|
|
115
|
|
1.51
|
|
15 Year Fixed
|
|
2,954,214
|
|
|
3,154,755
|
|
|
3.49
|
%
|
|
12.01
|
%
|
|
159
|
|
31.91
|
|
20 Year Fixed
|
|
756,915
|
|
|
815,643
|
|
|
3.85
|
%
|
|
12.93
|
%
|
|
196
|
|
8.25
|
|
25 Year Fixed
|
|
126,825
|
|
|
136,286
|
|
|
3.88
|
%
|
|
18.94
|
%
|
|
327
|
|
1.38
|
|
30 Year Fixed
|
|
1,057,408
|
|
|
1,140,589
|
|
|
3.87
|
%
|
|
13.90
|
%
|
|
339
|
|
11.54
|
|
Total or Weighted Average
|
|
$
|
6,561,751
|
|
|
$
|
7,041,228
|
|
|
3.53
|
%
|
|
9.88
|
%
|
|
178
|
|
71.23
|
%
|
TBA Agency Securities 15 Year
(2)
|
|
900,000
|
|
|
931,458
|
|
|
2.50
|
%
|
|
—
|
|
|
180
|
|
9.42
|
|
TBA Agency Securities 30 Year
(2)
|
|
1,750,000
|
|
|
1,817,534
|
|
|
3.00
|
%
|
|
—
|
|
|
360
|
|
18.38
|
|
Total or Weighted Average
|
|
9,211,751
|
|
|
9,790,220
|
|
|
|
|
|
|
|
|
99.03
|
|
Interest-Only Securities
(3)
|
|
512,897
|
|
|
95,918
|
|
|
5.12
|
%
|
|
18.59
|
%
|
|
320
|
|
0.97
|
|
Total or Weighted Average
|
|
|
|
|
$
|
9,886,138
|
|
|
|
|
|
|
|
|
100.00
|
%
|
(1) Weighted average for all prepayments during the quarter ended
September 30, 2016
, including prepayments related to Agency Securities purchased during the quarter.
(2) Our TBA Agency Securities are recorded as derivative instruments in our accompanying condensed consolidated financial statements. As of
September 30, 2016
, our TBA Agency Securities had a net carrying value of
$10,194
, reported as derivative asset on our accompanying condensed consolidated balance sheets. The net carrying value represents the difference between the fair value of the underlying Agency Security in the TBA Agency Security and the cost basis or the forward price to be paid or received for the underlying Agency Security. The weighted average months to maturity represents the maximum maturity acceptable within the delivery standards. Securities actually delivered may have shorter maturities.
(3) Interest-Only Securities principal amount represents the outstanding balance of the underlying Agency Securities from which the Interest-Only Security is derived. We are not entitled to receive any of those principal amounts.
December 31, 2015
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Asset Type
(2)
|
|
Principal Amount
|
|
Fair Value
|
|
Weighted Average Coupon
|
|
CPR
(1)
|
|
Weighted Average Month to Reset or Maturity
|
|
% of Total Agency Securities
|
ARMs & Hybrids
|
|
$
|
114,000
|
|
|
$
|
119,013
|
|
|
2.53
|
%
|
|
11.51
|
%
|
|
12
|
|
0.95
|
%
|
Multi-Family MBS
|
|
2,126,155
|
|
|
2,158,589
|
|
|
3.09
|
%
|
|
0.00
|
%
|
|
105
|
|
17.80
|
|
10 Year Fixed
|
|
124,035
|
|
|
130,546
|
|
|
3.88
|
%
|
|
14.25
|
%
|
|
116
|
|
1.04
|
|
15 Year Fixed
|
|
4,295,880
|
|
|
4,489,918
|
|
|
3.33
|
%
|
|
8.92
|
%
|
|
150
|
|
35.97
|
|
20 Year Fixed
|
|
3,900,738
|
|
|
4,103,449
|
|
|
3.64
|
%
|
|
11.70
|
%
|
|
193
|
|
32.66
|
|
25 Year Fixed
|
|
16,960
|
|
|
18,359
|
|
|
4.50
|
%
|
|
14.15
|
%
|
|
279
|
|
0.14
|
|
30 Year Fixed
|
|
1,366,748
|
|
|
1,441,682
|
|
|
3.86
|
%
|
|
5.89
|
%
|
|
347
|
|
11.44
|
|
Total or Weighted Average
|
|
$
|
11,944,516
|
|
|
$
|
12,461,556
|
|
|
3.45
|
%
|
|
7.98
|
%
|
|
178
|
|
100.00
|
%
|
(1) Weighted average for all prepayments during the year ended
December 31, 2015
, including prepayments related to Agency Securities purchased or sold during the year.
(2) We did not have any TBA Agency Securities outstanding at
December 31, 2015
.
Recognition of interest income commences on the settlement date of the purchase transaction and continues through the settlement date of the sale transaction. At
September 30, 2016
and
December 31, 2015
, we did not have any investment related receivables or payables with respect to unsettled sales and purchases of our Agency Securities.
Our net interest income is primarily a function of the difference between the yield on our assets and the financing 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 MBS portfolio, not only for estimating current yield but also for considering the rate of reinvestment of those proceeds into new securities, the yields which those new securities may add to our MBS portfolio and our hedging strategy.
At
September 30, 2016
and
December 31, 2015
, the adjustable and hybrid adjustable rate mortgage loans underlying our Agency Securities have fixed-interest rates for an average period of approximately
10
months and
12
months, respectively, after which time the interest rates reset and become adjustable. After a reset date, interest rates on our adjustable and hybrid adjustable Agency Securities float based on spreads over various indices, typically LIBOR or the one-year constant maturity treasury rate. These interest rates are subject to caps that limit the amount the applicable interest rate can increase during any year, known as an annual cap and through the maturity of the security, known as a lifetime cap.
Non-Agency Securities
We purchase 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.
The table below summarizes certain characteristics of our Non-Agency Securities at
September 30, 2016
.
September 30, 2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Asset Type
|
|
Principal Amount
|
|
Fair Value
|
|
Weighted Average Coupon
|
|
Weighted Average Month to Maturity
|
|
% of Total Non-Agency Securities
|
Credit Risk Transfer
|
|
$
|
716,916
|
|
|
$
|
753,901
|
|
|
5.08
|
%
|
|
124
|
|
75.29
|
%
|
NPL/RPL
|
|
134,329
|
|
|
134,850
|
|
|
3.80
|
%
|
|
377
|
|
13.47
|
|
Legacy Prime Fixed
|
|
25,381
|
|
|
20,868
|
|
|
6.01
|
%
|
|
244
|
|
2.08
|
|
Legacy ALTA Fixed
|
|
78,901
|
|
|
62,114
|
|
|
5.89
|
%
|
|
251
|
|
6.20
|
|
Legacy Prime Hybrid
|
|
14,198
|
|
|
12,098
|
|
|
2.65
|
%
|
|
243
|
|
1.21
|
|
Legacy ALTA Hybrid
|
|
7,263
|
|
|
6,118
|
|
|
3.02
|
%
|
|
231
|
|
0.61
|
|
New Issue Prime Fixed Non-Agency
|
|
11,405
|
|
|
11,370
|
|
|
3.66
|
%
|
|
318
|
|
1.14
|
|
Total or Weighted Average
|
|
$
|
988,393
|
|
|
$
|
1,001,319
|
|
|
4.91
|
%
|
|
173
|
|
100.00
|
%
|
At
September 30, 2016
, investments in Non-Agency Securities accounted for
12.3%
of our MBS portfolio.
Recognition of interest income commences on the settlement date of the purchase transaction and continues through the settlement date of the sale transaction. We did not have any investment related receivables or payables on Non-Agency Securities at
September 30, 2016
or
December 31, 2015
.
Repurchase Agreements
We have entered into repurchase agreements to finance most of our Agency Securities. Our repurchase agreements are secured by our Agency Securities and bear interest at rates that have historically moved in close relationship to the Federal Funds Rate and LIBOR. We have established borrowing relationships with numerous investment banking firms and other lenders,
27
of which had open repurchase agreements with us at
September 30, 2016
and
26
of which had open repurchases agreements with us at
December 31, 2015
. We had outstanding balances under our repurchase agreements at
September 30, 2016
and
December 31, 2015
of
$7,360,670
and
$11,570,481
, respectively, consistent with the decrease in our Agency Securities in our MBS portfolio.
Our repurchase agreements require excess collateral, known as a “hair cut.” At
September 30, 2016
, the average haircut percentage was
6.68%
compared to
4.79%
at
December 31, 2015
. The change in the average haircut percentage reflects the financing of our increased Non-Agency Securities portfolio. No counterparty held collateral in excess of 5% of our total stockholders' equity at
September 30, 2016
or at
December 31, 2015
.
In January 2016, the Federal Housing Financing Authority issued a Final Rule revising its regulations governing FHLB bank membership. The Final Rule changes the definition of “insurance company” to exclude captives, thereby making them ineligible for membership. The Final Rule contains a transition provision to give captives admitted to membership on or after the date of the publication of the proposed rule, which includes our captive insurance companies, until February 2017 to terminate their membership in the FHLB.
Under the Final Rule, we are prohibited from taking new advances or renewing our existing
$100,000
advance, which matures in December 2016. The Final Rule does not directly affect our MRA agreements or related repurchase financing with another FHLB.
Derivative Instruments
We use various interest rate contracts to manage our interest rate risk as we deem prudent in light of market conditions and the associated costs with counterparties that have a high quality credit rating and with futures exchanges. We generally pay a fixed rate and receive a floating rate with the objective of fixing a portion of our borrowing costs and hedging the change in our book value to some degree. The floating rate we receive is generally the Federal Funds Rate or LIBOR. While our policies do not contain specific requirements as to the percentages or amount of interest rate risk that we are required to hedge, we maintain an overall target of hedging at least 40% of our Agency Securities non-adjustable rate mortgages. At
September 30, 2016
and
December 31, 2015
, the notional value of our interest rate swap contracts was
70.6%
and
87.5%
, respectively, of the fair market value of our Agency Securities non-adjustable rate mortgages. For interest rate risk mitigation purposes, we consider Agency Securities to be ARMs if their interest rate is either currently subject to adjustment according to prevailing rates or if they are within 18 months of the period where such adjustments will occur. No assurance can be given that our derivatives will have the desired beneficial impact on our results of operations or financial condition. We have not elected cash flow hedge accounting treatment as allowed by GAAP. Since we do not designate our derivative activities as cash flow hedges, realized as well as unrealized gains/losses from these transactions will impact our GAAP earnings.
Use of derivative instruments may fail to protect or could adversely affect us because, among other things:
|
|
•
|
available derivatives may not correspond directly with the interest rate risk for which protection is sought (e.g., the difference in interest rate movements for long-term U.S. Treasury Securities compared to Agency Securities);
|
|
|
•
|
the duration of the derivatives may not match the duration of the related liability;
|
|
|
•
|
the counterparty to a derivative agreement with us may default on its obligation to pay or not perform under the terms of the agreement and the collateral posted may not be sufficient to protect against any consequent loss;
|
|
|
•
|
we may lose collateral we have pledged to secure our obligations under a derivative agreement if the associated counterparty becomes insolvent or files for bankruptcy;
|
|
|
•
|
we may experience a termination event under one or more of our derivative agreements related to our REIT status, equity levels and performance, which could result in a payout to the associated counterparty and a taxable loss to us;
|
|
|
•
|
the credit-quality of the party owing money on the derivatives may be downgraded to such an extent that it impairs our ability to sell or assign our side of the hedging transaction; and
|
|
|
•
|
the value of derivatives may be adjusted from time to time in accordance with GAAP to reflect changes in fair value; downward adjustments, or “mark-to-market losses,” would reduce our net income or increase any net loss.
|
At
September 30, 2016
and
December 31, 2015
, we had derivatives with a net fair value of
$(233,029)
and
$(232,302)
, respectively. At
September 30, 2016
and
December 31, 2015
, we had interest rate swap contracts with an aggregate notional balance of
$4,910,000
and
$8,800,000
, respectively. We also had TBA Agency Securities with an aggregate notional balance of
$2,650,000
at
September 30, 2016
. We did not have any TBA Agency Securities at
December 31, 2015
. Our basis swap contracts aggregate notional balance was
$0
and
$2,000,000
at
September 30, 2016
and
December 31, 2015
, respectively. At
December 31, 2015
, all of our Futures Contracts had expired, no new contracts were entered into in 2016. Futures Contracts are traded on the CME. Counterparty risk of interest rate swap contracts, interest rate swaptions and Futures Contracts are limited to some degree because of daily mark-to-market and collateral requirements. In addition, substantial credit support for the Futures Contracts is provided by the CME. These derivative transactions are designed to lock in a portion of funding costs for financing activities associated with our assets in such a way as to help assure the realization of attractive net interest margins and to vary inversely in value with our Agency Securities. Such contracts are based on assumptions about prepayments which, if not realized, will cause results to differ from expectations.
Although we attempt to structure our derivatives to offset the changes in asset prices, the complexity of the actual and expected pre-payment characteristics of the underlying mortgages as well as the volatility in mortgage interest rates relative to U.S. Treasury and interest rate swap contract rates makes achieving high levels of off-set difficult. We recognized net gains (losses) of
$45,640
and
$(335,897)
, respectively, related to our derivatives for the
quarter and nine months
ended
September 30, 2016
. For the
quarter and nine months
ended
September 30, 2015
, we recognized net losses of
$(283,474)
and
$(357,185)
, respectively, related to our derivatives. For the
quarter and nine months
ended
September 30, 2016
, the net unrealized gain of our Agency Securities increased (decreased) by
$(7,526)
and
$251,510
, respectively. For the
quarter and nine months
ended
September 30, 2015
, the net unrealized gain of our Agency Securities increased by
$137,312
and
$5,241
, respectively. The net unrealized gain (loss) on Agency Securities is due to market price fluctuations. The increase in our interest expense on repurchase agreements combined with the decrease in our MBS portfolio, led to a decline in net interest income. The decline in net interest income combined with our net gains on MBS, and net gains (losses) on derivatives in 2016 were the main factors for the change in net income (loss) for the
quarter and nine months
ended
September 30, 2016
, as compared to the
quarter and nine months
ended
September 30, 2015
.
As required by the Dodd-Frank Act, the Commodity Futures Trading Commission has adopted rules requiring certain interest rate swap contracts to be cleared through a derivatives clearing organization. We are required to clear certain new interest rate swap contracts. Cleared interest rate swaps may have higher margin requirements than un-cleared interest rate swaps we previously had. We have established an account with a futures commission merchant for this purpose. To date, we have not entered into any cleared interest rate swap contracts.
We are required to account for our TBA Agency Securities as derivatives when it is reasonably possible that we will not take or make timely physical delivery of the related securities. However, from time to time, we use TBA Agency Securities primarily to effectively establish and finance portfolio positions. See the section, Agency Securities, Interest-Only Securities and TBA Agency Securities above.
Contractual Obligations and Commitments
We had the following contractual obligations at
September 30, 2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments Due By Period
|
Obligations
|
|
Total
|
|
Less Than
1 Year
|
|
2-3 Years
|
|
4-5 Years
|
|
Greater Than 5 Years
|
Repurchase agreements
|
|
$
|
7,360,670
|
|
|
$
|
7,360,670
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Interest expense on repurchase agreements
|
|
9,649
|
|
|
9,649
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Related Party Fees
(1)
|
|
184,991
|
|
|
27,150
|
|
|
53,759
|
|
|
52,041
|
|
|
52,041
|
|
Board of Directors fees
(2)
|
|
7,553
|
|
|
1,079
|
|
|
2,158
|
|
|
2,158
|
|
|
2,158
|
|
Total
|
|
$
|
7,562,863
|
|
|
$
|
7,398,548
|
|
|
$
|
55,917
|
|
|
$
|
54,199
|
|
|
$
|
54,199
|
|
(1) Represents fees to be paid to ACM under the terms of the management agreements (Refer to Note 10 and Note 15 to the condensed consolidated financial statements).
(2) Represents fees to be paid to the Board.
We had contractual commitments under derivatives at
September 30, 2016
. We had interest rate swap contracts with an aggregate notional balance of
$4,910,000
, a weighted average swap rate of
1.73%
and a weighted average term of
58
months at
September 30, 2016
.
Liquidity and Capital Resources
Net cash provided by (used in) operating activities was
$(171,699)
and
$180,488
, respectively, for the
nine months
ended
September 30, 2016
and
September 30, 2015
. The decline in cash related to operating activities is primarily related to the overall decline in the size of our MBS portfolio, which caused a decrease in interest income. The change in fair value of our derivatives was also a factor for net loss in the nine months ended
September 30, 2016
. Our average MBS portfolio was
$10,987,375
and
$13,985,885
, respectively, for the nine months ended
September 30, 2016
and
September 30, 2015
, respectively.
At
September 30, 2016
, we financed our MBS portfolio with
$7,360,670
of borrowings under repurchase agreements. Our leverage ratio at
September 30, 2016
, was
6.03
:1. At
September 30, 2016
, we had a leverage ratio of
8.28
:1 including TBA Agency Securities purchased forward and excluding debt related to forward settling sales. At
September 30, 2016
, our liquidity totaled
$625,877
, consisting of
$401,825
of cash plus
$224,052
of unpledged Agency Securities (including securities received as collateral). Our primary sources of funds are borrowings under repurchase arrangements, monthly principal and interest payments on our Agency Securities and cash generated from our operating results. Other sources of funds may include proceeds from equity and debt offerings and asset sales. 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 condensed consolidated balance sheet is significantly less important than our potential liquidity available under our borrowing arrangements.
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 Agency Securities in our MBS 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. We did not have any reverse repurchase agreements outstanding at
September 30, 2016
and
December 31, 2015
.
Both parties to the repurchase and reverse repurchase transactions have the right to make daily margin calls based on changes in the value of the collateral obtained and/or pledged.
We 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.
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.
During the
nine months
ended
September 30, 2016
, we purchased
$1,253,890
of MBS using proceeds from repurchase agreements and principal repayments. During the
nine months
ended
September 30, 2016
, we received cash of
$1,057,877
from prepayments and scheduled principal payments on our MBS. We had a net cash increase from our repurchase agreements of
$4,799,418
for the
nine months
ended
September 30, 2016
and made cash interest payments of approximately
$130,758
on our liabilities for the
nine months
ended
September 30, 2016
. Part of funding our operations includes providing margin cash to offset liability balances on our derivatives. We recovered
$17,598
of cash collateral posted to counterparties at
September 30, 2016
and increased our liability by
$15,496
for cash collateral posted by counterparties at
September 30, 2016
.
During the
nine months
ended
September 30, 2015
, we purchased
$3,485,806
of Agency Securities using proceeds from repurchase agreements and principal repayments. During the
nine months
ended
September 30, 2015
, we received cash of $1,486,497 from prepayments and scheduled principal payments on our Agency Securities. We received net proceeds of $124 from common equity issuances under our common stock DRIP and we repurchased 2,153 shares of our outstanding common stock under our Repurchase Program for an aggregate cost of $45,971. We had a net cash increase from our repurchase agreements of $1,286,348 for the nine months ended September 30, 2015 and made cash interest payments of approximately $184,928 on our liabilities. Part of funding our operations includes providing margin cash to offset liability balances on our derivatives. We recovered $293,732 of cash collateral posted to counterparties and decreased our liability by $39,371 for cash collateral posted by counterparties at September 30, 2015.
We have continued 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.
Repurchase Agreements
Declines in the value of our Agency MBS 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.
Financial sector volatility can also lead to increased demand and prices for high quality debt securities, including Agency Securities. While increased prices may increase the value of our Agency Securities, higher values may also reduce the return on reinvestment of capital, thereby lowering our future profitability.
The following graph represents the outstanding balances of our repurchase agreements (before the effect of netting reverse repurchase agreements), which finance most of our Agency Securities. Our repurchase agreements balance will fluctuate based on our change in capital, leverage targets and the market prices of our assets. The balance of repurchase agreements outstanding will fluctuate within any given month based on changes in the market value of the particular Agency Security pledged as collateral (including the effects of principal paydowns) and the level and timing of investment and reinvestment activity.
See
Note 8
to the condensed consolidated financial statements for more information.
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 means that the lender will require us to pay the margin call in cash or pledge additional collateral to meet that margin call. 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.
We experience margin calls in the ordinary course of our business and under certain conditions, such as during a period of declining market value for MBS and we may experience margin calls as frequently as daily. In seeking to effectively manage the margin requirements established by our lenders, we maintain a position of cash and unpledged securities. We refer to this position as our liquidity. The level of liquidity we have available to meet margin calls is directly affected by our leverage levels, our haircuts and the price changes on our securities. If interest rates increase as a result of a yield curve shift or for another reason or if credit spreads widen, the prices of our collateral (and our unpledged assets that constitute our liquidity) will decline and we may experience margin calls. We will use our liquidity to meet such margin calls. There can be no assurance that we will maintain sufficient levels of liquidity to meet any margin calls. If our haircuts increase, our liquidity will proportionately decrease. If we increase our borrowings, our liquidity will decrease by the amount of additional haircut on the increased level of indebtedness. 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 intend to maintain a level of liquidity in relation to our assets that enables us to meet reasonably anticipated margin calls but that also allows us to be substantially invested in MBS. We may misjudge the appropriate amount of our liquidity by maintaining excessive liquidity, which would lower our investment returns, or by maintaining insufficient liquidity, which would force us to involuntarily liquidate assets into unfavorable market conditions and harm our results of operations and financial condition.
We generally seek to borrow (on a recourse basis) between six and ten times the amount of our total stockholders’ equity. At
September 30, 2016
and
December 31, 2015
, our total borrowings were
$7,360,670
and
$11,570,481
(excluding accrued interest), respectively. At
September 30, 2016
and
December 31, 2015
, we had a leverage ratio of approximately
6.03
:1 and
9.44:1
, respectively. At
September 30, 2016
, we had a leverage ratio of
8.28
:1 including TBA Agency Securities purchased forward and excluding debt related to forward settling sales.
Forward-Looking Statements Regarding Liquidity
Based on our current portfolio, leverage rate and available borrowing arrangements, we believe that our cash flow from operations and our ability to make timely portfolio adjustments, will be sufficient to enable us to meet anticipated short-term (one year or less) liquidity requirements such as to fund our investment activities, meet our financing obligations, pay fees under the management agreements and fund our distributions to stockholders and pay general corporate expenses.
We may increase our capital resources by obtaining long-term credit facilities or making public or private offerings of equity or debt securities, including classes of preferred stock, common stock and senior or subordinated notes to meet our long-term (greater than one year) liquidity. Such financing will depend on market conditions for capital raises and for the investment of any proceeds and there can be no assurances that we will successfully obtain any such financing.
Stockholders’ Equity
See
Note 12
to the condensed consolidated financial statements.
Off-Balance Sheet Arrangements
At
September 30, 2016
and
December 31, 2015
, we had not maintained any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance, or special purpose or variable interest entities, established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Furthermore, at
September 30, 2016
and
December 31, 2015
, we had not guaranteed any obligations of any unconsolidated entities or entered into any commitment or intent to provide funding to any such entities.
Critical Accounting Policies
See
Note 3
to the condensed consolidated financial statements for our significant accounting policies.
Valuation of MBS and Derivatives
We carry our MBS and derivatives at fair value. Our Agency Securities are classified as available for sale, and therefore unrealized changes in fair value are reflected directly in total stockholders' equity as accumulated other comprehensive income or loss. Our Non-Agency Securities and Interest-Only Securities are classified as trading securities, and therefore changes in fair value are reported in the condensed consolidated statements of operations as income or loss. We do not use hedge accounting for our derivatives for financial reporting purposes and therefore changes in fair value are reflected in net income as other gain or loss. To the extent that fair value changes on derivatives offset fair value changes in our MBS, the fluctuation in our stockholders’ equity will be lower. For example, rising interest rates may tend to result in an overall increase in our reported net income even while our total stockholders’ equity declines.
Fair value for the Agency Securities and Interest-Only Securities in our MBS portfolio is based on obtaining a valuation for each Agency 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 an Agency 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 Agency 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.
The fair values of our derivatives 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. Management compares pricing information received to dealer quotes to ensure that the current market conditions are properly reflected.
Fair value for the Non-Agency Securities in our MBS portfolio is based on estimates prepared by our Portfolio Management
group, which organizationally reports to our Chief Investment Officer. In preparing the estimates, our Portfolio Management group uses commercially available and proprietary models and data as well as market intelligence gained from discussions with, and transactions by, other market participants. We estimate the fair value of our Non-Agency Securities by estimating the future cash flows for each Non-Agency Security and then discounting those cash flows based on our estimates of current market yield for each individual security. Our estimates for future cash flows and current market yields incorporate such factors as collateral type, bond structure and priority of payments, coupons, prepayment speeds, defaults, delinquencies and severities. Quarterly, we compare our estimates of fair value of our Non-Agency Securities with pricing from third party pricing services, dealer marks received and recent purchase and financing transaction history to validate our assumptions of cash flow and market yield and calibrate our models.
Realized Gains and Losses on Agency Securities
Security purchase and sale transactions, including purchases and sales for forward settlement, are recorded on the trade date to the extent it is probable that we will take or make timely physical delivery of the related securities. Gains or losses realized from the sale of securities are included in income and are determined using the specific identification method. We realize gains and losses on our Agency Securities upon their sale. At that time, previously unrealized amounts included in accumulated other comprehensive income are reclassified and reported in net income as other gain or loss. To the extent that we sell Agency Securities in later periods after changes in the fair value of those Agency Securities have occurred, we may report significant net income or net loss without a corresponding change in our total stockholders' equity.
Declines in the fair values of our Agency Securities that represent other than temporary impairments are also treated as realized losses and reported in net income as other loss. We evaluate Agency Securities for other than temporary impairment at least on a quarterly basis and more frequently when economic or market concerns warrant such evaluation. We consider an impairment to be other than temporary if we (1) have the intent to sell the Agency Securities, (2) believe it is more likely than not that we will be required to sell the securities before recovery (for example, because of liquidity requirements or contractual obligations), or (3) a credit loss exists. Impairment losses recognized establish a new cost basis for the related Agency Securities. Gains or losses on subsequent sales are determined by reference to such new cost basis.
Gains and Losses on Non-Agency Securities and Interest-Only Securities
We carry our Non-Agency Securities and Interest-Only Securities at fair value and reflect changes in those fair values in net income as other gains and losses.
Inflation
Virtually all of our assets and liabilities are interest rate-sensitive in nature. As a result, interest rates and other factors influence our performance far more than inflation. Changes in interest rates do not necessarily correlate with inflation rates or changes in inflation rates. Our financial statements are prepared in accordance with GAAP and any distributions we may make will be determined by our Board based in part on our REIT taxable income as calculated according to the requirements of the Code; in each case, our activities and balance sheet are measured with reference to fair value without considering inflation.
Subsequent Events
See
Note 18
to the condensed consolidated financial statements.
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This report contains various “forward-looking statements.” Forward-looking statements relate to expectations, beliefs, projections, future plans and strategies, anticipated events or trends and similar expressions concerning matters that are not historical facts. In some cases, you can identify forward-looking statements by the use of forward-looking terminology such as “believes,” “expects,” “may,” “will,” “would,” “could,” “should,” “seeks,” “approximately,” “intends,” “plans,” “projects,” “estimates” or “anticipates” or the negative of these words and phrases or similar words or phrases. All forward-looking statements may be impacted by a number of risks and uncertainties, including statements regarding the following subjects:
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our business and investment strategy;
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our anticipated results of operations;
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statements about future dividends;
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our ability to obtain financing arrangements;
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our understanding of our competition and ability to compete effectively;
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market, industry and economic trends; and
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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. 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:
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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;
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the possible material adverse effect on our business if the U.S. Congress passed legislation reforming or winding down Fannie Mae or Freddie Mac;
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mortgage loan modification programs and future legislative action;
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actions by the Fed which could cause a flattening 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;
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the impact of the delay or failure of the U.S. Government in reaching an agreement on the national debt ceiling;
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availability, terms and deployment of capital;
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changes in economic conditions generally;
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changes in interest rates, interest rate spreads and the yield curve or prepayment rates;
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general volatility of the financial markets, including markets for mortgage securities;
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the 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.;
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inflation or deflation;
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availability of suitable investment opportunities;
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the degree and nature of our competition, including competition for MBS;
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changes in our business and investment strategy;
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our failure to maintain an exemption from being regulated as a commodity pool operator;
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our dependence on ACM and ability to find a suitable replacement if ACM was to terminate its management relationship with us;
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the existence of conflicts of interest in our relationship with ACM, certain of our directors and our officers, which could result in decisions that are not in the best interest of our stockholders;
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our management's competing duties to other affiliated entities, which could result in decisions that are not in the best interest of our stockholders;
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changes in personnel at ACM or the availability of qualified personnel at ACM;
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limitations imposed on our business by our status as a REIT under the Code;
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the potential burdens on our business of maintaining our exclusion from the 1940 Act and possible consequences of losing that exemption;
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changes in GAAP, including interpretations thereof; and
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changes in applicable laws and regulations.
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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.
“Agency Securities” means securities issued or guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae; interests in or obligations backed by pools of fixed rate, hybrid adjustable rate and adjustable rate mortgage loans.
“ARMs” means Adjustable Rate Mortgage backed securities.
“Basis swap contracts” means derivative contracts that allow us to exchange one floating interest rate basis for another, for example, 3 month LIBOR and Fed Funds Rates, thereby allowing us to diversify our floating rate basis exposures.
“Board” means ARMOUR’s Board of Directors.
“Common Stock DRIP” means the Company's dividend reinvestment and stock purchase plan.
“CMBS” means commercial mortgage backed securities.
“CME” means the Chicago Mercantile Exchange.
“Code” means the Internal Revenue Code of 1986.
“CPR” means constant prepayment rate.
“Dodd-Frank Act” means the Dodd-Frank Wall Street Reform and Consumer Protection Act.
“Exchange Act” means the Securities Exchange Act of 1934.
“Fannie Mae” means the Federal National Mortgage Association.
“Fed” means the U.S. Federal Reserve.
“FHLB” means Federal Home Loan Bank.
“Freddie Mac” means the Federal Home Loan Mortgage Corporation.
“Futures Contracts” means Eurodollar Futures Contracts.
“GAAP” means accounting principles generally accepted in the United States of America.
“Ginnie Mae” means the Government National Mortgage Administration.
“GSE” means 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” means 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” means 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” means the interest portion of Agency Securities, which is separated and sold individually from the principal portion of the same payment.
“JAVELIN” means JAVELIN Mortgage Investment Corp., formerly a publicly-traded REIT. Since its acquisition on April 6, 2016, JAVELIN became a wholly-owned, qualified REIT subsidiary of ARMOUR and continues to be managed by ACM pursuant to the pre-existing management agreement between JAVELIN and ACM.
“LIBOR” means the London Interbank Offered Rate.
“MBS” means 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” means the merger of JMI Acquisition Corporation ("Acquisition") with and into JAVELIN following the Tender Offer.
“MRA” means master repurchase agreement. A document that outlines standard terms between the Company and counterparties for repurchase agreement transactions.
“Multi-Family MBS” means MBS issued under Fannie Mae's Delegated Underwriting System (DUS) program.
“Non-Agency Securities” means securities backed by residential mortgages in which we may invest, for which the payment of principal and interest is not guaranteed by a GSE or government agency.
“REIT” means Real Estate Investment Trust. A special purpose investment vehicle that provides investors with the ability to participate directly in the ownership or financing of real-estate related assets by pooling their capital to purchase and manage mortgage loans and/or income property.
“Repurchase Program” means the Company's common stock repurchase program authorized by our Board.
“Reverse Stock Split” means the one-for-eight reverse stock split, which was effective July 31, 2015.
“SEC” means the Securities and Exchange Commission.
“TBA Agency Securities” means 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.
“Tender Offer” means the tender offer by Acquisition to purchase all of the outstanding common stock of JAVELIN.
“U.S.” means United States.
“1940 Act” means the Investment Company Act of 1940.