Everything You Want to Know About Armour Residential REIT

Key Takeaways

• ARMOUR Residential REIT is a mortgage REIT in the residential sector founded in 2008.
• They do not originate loans. Their investment portfolio is managed by ARMOUR Capital Management and financed by a mortgage brokerage firm, Buckler Securities.
• It invests mainly in government-issued mortgage-backed securities. From time to time, it also invests in credit risk transfers, non-agency securities, interest-only securities, U.S. Treasury securities, and money market instruments.
• As of FY 2020, their real estate investment portfolio is exclusively comprised of Agency Securities from Fannie Mae, Freddie Mac, and Ginnie Mae.
• Predominantly, they invest in fixed-rate loans. The remaining variety is in adjustable-rate and hybrid adjustable-rate residential MBS wherein interest rates may adjust monthly or annually.
• ARMOUR Residential REIT issues monthly dividends. However, due to the effects of the COVID-19 pandemic, they weren’t able to give out dividends for April and May 2020.
• All of the mREITs were heavily affected by the COVID-19 pandemic with an abrupt drop in earnings during Q1 2020 with negative returns. But when compared with its peer residential mortgage REITs and against market indices, ARR ranked the lowest

Company Background

ARMOUR Residential REIT’s primary strategy since 2008 is to earn interest from mortgage loans of American homeowners and credit swaps. They make it possible by partnering with their investment advisor, ARMOUR Capital Management (ACM), and financed by a brokerage company called Buckler Securities. Their corporate headquarters is located at 3001 Ocean Drive, Suite 201, Vero Beach, Florida.

ACM is a SEC-registered investment company specializing in actively managing a diversified mortgage investment portfolio. As of FY 2020, their assets sum up to approximately $5.5B. In exchange for managing ARR’s investment portfolio, ACM gets a monthly management fee based on the total gross equity raised, regardless of the performance. But during Q2 2020, ACM voluntarily waived 40% of their management fee. In Q1 2021 also, ACM waived $2,400 in addition to future monthly fees of $800/month. Currently, ARR’s management contract with ACM runs until June 2027.

Buckler Securities is a repo dealer that finances ARR’s funds. This is a way for ARR to leverage its gains. As of FY 2020, Buckler Securities contributed 66.1% of ARR’s repurchase financing. Aside from similar mortgage REITs, ARR also competes with other companies that invest in mortgage-backed securities like institutional investors, investment and commercial banks, insurance companies, private and government institutions, etc.

ARMOUR REIT Type Summary

ARMOUR Residential REIT falls under publicly traded, mortgage type of REIT in the residential sector.

Mortgage REIT

Mortgage REITs or mREITs earn revenues from the interests on mortgage loan payments. In the case of ARR, they don’t originate mortgage loans. Instead, Buckler Securities refinance the mortgage-backed securities and ACM manages the real estate investments.

Aside from the interest on principal payments, ARR also earns through credit swaps. A credit swap is when a broker insures the mortgage issuer that the loan payments will be paid even if the homeowner defaults on their properties. In exchange for shouldering this risk, ARR earns a part of the interests collected by the mortgage issuer. In Q1 2021, ARR earned 19% of its income from interest rate swaps.

Residential Sector

ARR’s primary investing strategy focuses on residential American homeowners. It may include condominiums, apartments, single-family homes, detached homes, and townhomes. ACM manages the real estate assets.

Publicly Listed REIT

ARMOUR Residential REIT operates as a residential mortgage REIT listed in the New York Stock Exchange as NYSE: ARR since 2008. Since it’s SEC-registered and publicly listed, its SEC filings are openly accessible to the public.

What ARMOUR REIT Fund Invests In

Agency Securities

The main investments of ARR are into mortgage-backed securities (MBS) guaranteed and sponsored by government entities such as:

• Federal National Mortgage Association a.k.a Fannie Mae
• Federal Home Loan Mortgage Corporation a.k.a Freddie Mac
• Government National Mortgage Administration a.k.a Ginnie Mae

But since mREITs are more sensitive to economic cycles compared to equity REITs, ARR diversifies their real estate investment portfolio by varying maturity and interest coupon rates. Predominantly, they invest in fixed-rate loans. The remaining variety is in adjustable-rate and hybrid adjustable-rate residential MBS wherein interest rates may adjust monthly or annually. Since they are backed by the U.S. government, interest returns are steady but relatively low.

As for the maturity rates, their MBS range between 10 to 30 years. Meanwhile, their repurchased borrowing range between 1 to 90 days.

Other Asset Classes

Occasionally, ARR also invests in Credit Risk and Non-Agency Securities, Interest-Only Securities, U.S. Treasury Securities, and money market instruments. This ultimately depends on how ACM assesses and evaluates the risk factors that come with each investment opportunity.

Repurchase Agreements

In terms of financing mortgage-backed securities, ARR has made strong relationships with investment banking firms and other lenders. As of FY 2019 and FY 2020, 25 and 18 financing partners opened repurchase agreements with ARR, respectively.

ARMOUR REIT Investment Portfolio

Portfolio Mix

The charts below compare ARMOUR Residential REIT’s portfolio mix from 2019 to 2020.

Source: 2020 Annual Report (10-K) of ARMOUR Residential REIT

In 2019, 86.3% of their real estate portfolio mix is from Agency Securities, while the rest comes from TBA (to be issued) securities, credit risk transfer securities, and non-agency securities. According to their annual report, TBA securities refer to “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”.

Their 2019 had a more diversified portfolio mix compared to 2020. As of FY 2020, their portfolio mix was exclusive of Agency Securities — 52.7% from Fannie Mae, 12.6% from Freddie Mac, 0.3% from Ginnie Mae, 18.5% from 15-year long and 15.9% 30-year long TBA Agency Securities.

Source: 2020 Annual Report (10-K) of ARMOUR Residential REIT

This exclusive investment in government-sponsored Agency Securities was done to manage the risks of the economic downturn brought by the COVID-19 pandemic. Those difficult times especially starting March 2020, led to delinquencies, foreclosures, and a decline in the fair value of real estate investments. To hedge against these investment risks, they reduced their Agency Securities down to 39.1% compared to 2019.

They liquidated more assets such as Credit Risk and Non-Agency Securities further by the end of Q3 2020. The net loss acquired for FY 2020 can be traced to losses of these assets and termination of repurchase agreements for credit swaps.

Source: 2020 Annual Report (10-K) of ARMOUR Residential REIT

Investment Ownership

Source: Seeking Alpha (ARMOUR Residential REIT)

There’s an almost equal distribution of shareholder composition of ARR’s assets. Public investors, or those directly investing from the NYSE, comprise about 45% of the total shareholders. Meanwhile, about 54% comes from institutional investors and the remaining from private corporations and insider ownerships.

According to CNN Business, the top 5 institutional investors of ARMOUR Residential REIT are:

1. BlackRock Fund Advisors (~$127M)
2. The Vanguard Group, Inc. (~$73M)
3. Global X Management Co. LLC (~$22M)
4. SSgA Funds Management, Inc. (~$21M)
5. Investo Capital Management LLC (~$13M)

ARMOUR REIT Performance Outlook

Historical Price Chart

Source: Reuters

Based on the historical pricing since 2008, it doesn’t look so enticing for ARMOUR Residential REIT. Since it went public and operated as a REIT in 2008, its market price hasn’t gone up except during 2009. But beyond 2009, it has gradually gone down and hasn’t recovered so far.

However, mortgage REITs don’t focus much on the REIT’s market price. Compared to equity REITs, mortgage REITs are more focused on significant income returns through dividends rather than capital appreciation. This is the reason why ARR refinances its funds through Buckler Securities to leverage its interest returns.

So, rather than the historical market price, a better tool for evaluation will be the total returns through the years.

Key Performance Metrics Through The Years

Here are 5 of the performance metric parameters you should look at to measure the company’s operating performance as an mREIT:

• Total Equity — this represents the company’s net worth value. It tells us how big and valuable the company is in the market.
• Total Revenue —this parameter tells us how profitable the company is. How much does the company earn in doing its business?
• Net Income or Loss — how much did the company earn or lose from the interests on its mortgage investments?
• Dividend Payout Ratio — tells us how much of the company’s net income is paid back to its investors in the form of dividends.

With all of those parameters defined, the table below gives you a picture of how well the company has managed its operations for the last 5 years.

Sources: Seeking Alpha, CNN Business, MarketWatch, CNBC; NM – Not Meaningful (erroneous or negative results)

Past data on ARR’s performance show that mortgage REITs are overly sensitive to change in interest rates. Consequently, that means mREITs are sensitive to how the overall economy behaves.

Out of the last 5 years, only FY 2017 had a net income and positive dividend payout ratio. The rest of the years (except 2021) all reported net losses. The company still pays its shareholders dividends, but they may be tapping into their reserves or raising cash just to do this. This is not usually a good sign of performance for a mortgage REIT.

To understand how the company acquires net losses, the charts below show the breakdown.

Source: 2020 Annual Report (10-K) of ARMOUR Residential REIT

In terms of net interests, even if losses from repurchase agreements were incurred, a positive net interest income was still recorded because of the government-sponsored mortgage-backed securities. However, this positive income was offset by the realized and unrealized loss of derivatives.

Source: 2020 Annual Report (10-K) of ARMOUR Residential REIT

Particularly in 2020, a lot of losses came from the assets that had to be liquidated to keep the investment portfolio exclusively Agency mortgage-backed securities.

Dividend History

Source: Seeking Alpha

In mREITs, dividends are unpredictable because of the high-risk nature of mortgage investments. But compared to equity REITs, mREITs generally have much higher dividends. Although, it can be observed that the dividends consistently decreased through the years.

ARMOUR Residential REIT issues monthly dividends. But during the onset of the COVID-19 pandemic, they skipped 2 months of dividends. When the market is not doing well, mREITs may skip dividends. Since then, the dividends paid out were almost half of what they usually give during the pre-pandemic period.

How did ARMOUR Residential REIT Compare To Its Peers?

Compared to the market indices, S&P 500 Index and the NAREIT Mortgage REIT Index, ARR has kept up in performance up until 2017. Since then, it has performed underwhelmingly low against both market indices.

Source: 2020 Annual Report (10-K) of ARMOUR Residential REIT

The S&P 500 Index, which represents the large-cap public companies in the U.S.A, had good returns despite the pandemic. Mortgage REITs on the other hand were understandably more affected by the pandemic. When more people lost their jobs, they also lost the financial capabilities to pay for their residential or commercial properties. This is the competitive advantage of stock companies — essential businesses can continue to operate amid quarantine lockdowns.

But even compared to the market index for mortgage REIT index, ARR lagged in their performance in terms of total returns of shareholders.

Source: CNBC

How about ARR’s performance compared to its peer residential mortgage REITs?

Let’s compare it to these 3 similar residential mREITs:

• Capstead Mortgage Corporation (NYSE: CMO) invests in short-term, adjustable-rate, government-sponsored mortgage-backed securities.
• Cherry Hill Mortgage Investment Corporation (NYSE: CHMI) acquires, invests, and manages agency securities, along with servicing-related assets.
• Dynex Capital, Inc. (NYSE: DX) also invests in ARR’s usual portfolio. But with commercial mortgage-backed securities in addition.

All of the mREITs were heavily affected by the COVID-19 pandemic with an abrupt drop in earnings during Q1 2020. There’s a significant difference in earnings between the S&P 500 Index and the rest of the mREITs — which all had negative earnings. However, among the group of mREITs compared here, ARR was the least performing one. DX performed better because they also have commercial on top of residential mortgage loans.

Overall, ARR’s performance within the last 5 years doesn’t look so good compared to some market indices and with its peers in the residential mortgage REIT sector.

Forecasts From Analysts

For detailed analysis on performance outlooks, sites like Seeking Alpha are good resources for your investment research. Below are their estimated charts on revenue and dividends for this year through the end of 2023.

Source: Seeking Alpha

In the next coming years, analysts from Seeking Alpha are quite optimistic to see positive revenues. But dividends could be consistently stable from 2021 through 2023.

Source: Seeking Alpha

As for the future investment plans of ARMOUR Residential REIT, Jeffrey Zimmer, President, Co-Chief Executive Officer, and Co-Vice Chairman of ARR mentioned that they will prioritize producing dividends for their investors. As they shared in their recent Q2 2021 earnings conference call, they’re not investing as they normally would do to protect the book value as much as they can. Although they see positive revenues coming in this year, they’re not quite ready yet to invest in non-agency securities.