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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549 

FORM 10-Q

☒			QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the Quarterly Period Ended June 30, 2021

OR

☐			TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.    Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer" "smaller reporting company" and "emerging growth company" in Rule 12b-2 of the Exchange Act.

Large accelerated filer ☒ Accelerated filer ☐ Non-accelerated filer ☐ Smaller reporting company ☐ Emerging growth company ☐ 

If an emerging growth company, indicate by a check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

The number of outstanding shares of the Registrant’s common stock as of July 21, 2021 was 83,098,691.

PART I. Financial Information			1
Item 1. Financial Statements			1
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations			31
Item 3. Quantitative and Qualitative Disclosures about Market Risk			53
Item 4. Controls and Procedures			56
PART II. Other Information			57
Item 1. Legal Proceedings			57
Item IA. Risk Factors			57
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			57
Item 3. Defaults Upon Senior Securities			57
Item 4. Mine Safety Disclosures			57
Item 5. Other Information			57
Item 6. Exhibits			58
Signatures			59

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

See financial statement notes (unaudited).

ARMOUR Residential REIT, Inc.

CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

(in thousands, except per share)

						For the Three Months Ended June 30,												For the Six Months Ended June 30,
						2021						2020						2021						2020
Interest Income:
Agency Securities, net of amortization of premium and fees						$	18,205					$	23,648					$	36,763					$	103,424
Credit Risk and Non-Agency Securities, including discount accretion						—						4,873						—						17,228
U.S. Treasury Securities						—						—						—						469
BUCKLER Subordinated loan						15						29						32						287
Total Interest Income						$	18,220					$	28,550					$	36,795					$	121,408
Interest expense- repurchase agreements						(1,548)						(5,389)						(3,975)						(56,909)
Interest expense- U.S. Treasury Securities sold short						—						(32)						(87)						(32)
Net Interest Income						$	16,672					$	23,129					$	32,733					$	64,467
Other Income (Loss):
Realized gain on sale of available for sale Agency Securities (reclassified from Other comprehensive income (loss))						—						36,008						7,354						129,333
Credit loss expense						—						—						—						(1,012)
Gain (loss) on Agency Securities, trading						19,183						7,911						(43,403)						7,911
Gain (loss) on Credit Risk and Non-Agency Securities						—						190						—						(182,922)
Gain on U.S. Treasury Securities						—						—						—						21,771
Loss on short sale of U.S. Treasury Securities						—						(414)						(28)						(414)
Subtotal						$	19,183					$	43,695					$	(36,077)					$	(25,333)
Realized loss on derivatives (1)						(3,649)						(180,567)						(31,009)						(415,716)
Unrealized gain (loss) on derivatives						(92,744)						173,325						53,236						39,438
Subtotal						$	(96,393)					$	(7,242)					$	22,227					$	(376,278)
Total Other Income (Loss)						$	(77,210)					$	36,453					$	(13,850)					$	(401,611)
Expenses:
Management fees						7,718						7,382						15,155						14,840
Professional fees						590						1,654						1,328						2,499
Insurance						195						183						388						366
Compensation						1,675						1,357						3,351						2,822
Other						558						205						1,008						187
Total Expenses						$	10,736					$	10,781					$	21,230					$	20,714
Less management fees waived						(2,100)						(2,947)						(4,500)						(2,947)
Total Expenses after fees waived						$	8,636					$	7,834					$	16,730					$	17,767
Net Income (Loss)						$	(69,174)					$	51,748					$	2,153					$	(354,911)
Dividends on preferred stock						(2,996)						(2,320)						(5,482)						(5,147)
Net Income (Loss) available (related) to common stockholders						$	(72,170)					$	49,428					$	(3,329)					$	(360,058)
(Continued)

ARMOUR Residential REIT, Inc.

CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

(in thousands, except per share)

						For the Three Months Ended June 30,												For the Six Months Ended June 30,
						2021						2020						2021						2020
Net Income (Loss) per share available (related) to common stockholders (Note 12):
Basic						$	(0.95)					$	0.78					$	(0.05)					$	(5.87)
Diluted						$	(0.95)					$	0.77					$	(0.05)					$	(5.87)
Dividends declared per common share						$	0.30					$	0.09					$	0.60					$	0.60
Weighted average common shares outstanding:
Basic						76,064						63,741						71,041						61,312
Diluted						76,064						64,340						71,041						61,312

(1) Interest expense related to our interest rate swap contracts is recorded in realized loss on derivatives on the consolidated statements of operations. For additional information, see financial statement Note 8.

See financial statement notes (unaudited).

ARMOUR Residential REIT, Inc.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (UNAUDITED)

(in thousands)

						For the Three Months Ended June 30,												For the Six Months Ended June 30,
						2021						2020						2021						2020
Net Income (Loss)						$	(69,174)					$	51,748					$	2,153					$	(354,911)
Other comprehensive income (loss):
Reclassification adjustment for realized gain on sale of available for sale Agency Securities						—						(36,008)						(7,354)						(129,333)
Reclassification adjustment for credit loss expense on available for sale Agency Securities						—						—						—						1,012
Net unrealized gain (loss) on available for sale Agency Securities						7,842						7,654						(27,038)						(30,489)
Other comprehensive income (loss)						$	7,842					$	(28,354)					$	(34,392)					$	(158,810)
Comprehensive Income (Loss)						$	(61,332)					$	23,394					$	(32,239)					$	(513,721)

 

See financial statement notes (unaudited).

ARMOUR Residential REIT, Inc.

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY (UNAUDITED)

(in thousands)

						Preferred Stock												Common Stock
						7.00% Series C
						Shares						Par						Shares						Par						Total Additional Paid-in Capital						Accumulated Deficit						Accumulated Other Comprehensive Income						Total
Balance, December 31, 2020						5,347						$	5					65,290						$	65					$	3,033,025					$	(2,273,822)					$	179,031					$	938,304
Series C Preferred dividends						—						—						—						—						—						(5,482)						—						(5,482)
Common stock dividends						—						—						—						—						—						(43,254)						—						(43,254)
Issuance of Series C Preferred stock, net of expenses						1,500						2						—						—						36,583						—						—						36,585
Issuance of common stock, net						—						—						17,691						18						212,206						—						—						212,224
Stock based compensation, net of withholding requirements						—						—						117						—						2,404												—						2,404
Net Income						—						—						—						—						—						2,153						—						2,153
Other comprehensive loss						—						—						—						—						—						—						(34,392)						(34,392)
Balance, June 30, 2021						6,847						$	7					83,098						$	83					$	3,284,218					$	(2,320,405)					$	144,639					$	1,108,542

See financial statement notes (unaudited).

ARMOUR Residential REIT, Inc.

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(in thousands)

						For the Six Months Ended June 30,
						2021						2020
Cash Flows From Operating Activities:
Net Income (Loss)						$	2,153					$	(354,911)
Adjustments to reconcile net loss to net cash and cash collateral posted to counterparties provided by (used in) operating activities:
Net amortization of premium on Agency Securities						28,175						23,364
Accretion of net discount on Credit Risk and Non-Agency Securities						—						(2,529)
Net amortization of U.S. Treasury Securities						—						84
Realized gain on sale of Agency Securities, available for sale						(7,354)						(129,333)
Credit loss expense						—						1,012
Loss (gain) on Agency Securities, trading						43,403						(7,911)
Loss on Credit Risk and Non-Agency Securities						—						182,922
Gain on U.S. Treasury Securities						—						(21,771)
Loss on short sale of U.S. Treasury Securities						28						414
Stock based compensation						2,404						2,023
Changes in operating assets and liabilities:
Increase in accrued interest receivable						2,985						22,030
Increase in prepaid and other assets						283						6,603
Change in derivatives, at fair value						(36,155)						(39,645)
Decrease in accrued interest payable- repurchase agreements						(1,077)						(31,256)
Increase in accounts payable and other accrued expenses						2,074						977
Net cash and cash collateral posted to counterparties provided by (used in) operating activities						$	36,919					$	(347,927)
Cash Flows From Investing Activities:
Purchases of Agency Securities						(469,515)						(4,727,162)
Purchases of Credit Risk and Non-Agency Securities						—						(237,928)
Purchases of U.S. Treasury Securities						(390,126)						(4,621,776)
Principal repayments of Agency Securities						502,638						666,156
Principal repayments of Credit Risk and Non-Agency Securities						—						43,768
Proceeds from sales of Agency Securities						901,053						10,855,465
Proceeds from sales of Credit Risk and Non-Agency Securities						—						831,398
Proceeds from sales of U.S. Treasury Securities						390,098						4,643,049
Disbursements on reverse repurchase agreements						(391,125)						(858,156)
Receipts from reverse repurchase agreements						391,125						858,156
Increase (decrease) in cash collateral posted by counterparties						62,194						(6,769)
Net cash and cash collateral posted to counterparties provided by investing activities						$	996,342					$	7,446,201
(Continued)

ARMOUR Residential REIT, Inc.

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(in thousands)

						For the Six Months Ended June 30,
						2021						2020
Cash Flows From Financing Activities:
Redemption of Series B Preferred stock, net of expenses						—						(209,583)
Issuance of Series C Preferred stock, net of expenses						36,585						129,096
Issuance of common stock, net of expenses						212,224						48,886
Proceeds from repurchase agreements						15,545,436						53,582,910
Principal repayments on repurchase agreements						(16,420,134)						(60,699,854)
Series B Preferred stock dividends paid						—						(1,375)
Series C Preferred stock dividends paid						(5,482)						(3,772)
Common stock dividends paid						(43,254)						(36,253)
Common stock repurchased, net						—						(777)
Net cash and cash collateral posted to counterparties used in financing activities						$	(674,625)					$	(7,190,722)
Net Increase (decrease) in cash and cash collateral posted to counterparties						358,636						(92,448)
Cash and cash collateral posted to counterparties - beginning of period						171,668						273,166
Cash and cash collateral posted to counterparties - end of period						$	530,304					$	180,718
Supplemental Disclosure:
Cash paid during the period for interest						$	9,698					166,358
Non-Cash Investing Activities:
Payable for unsettled purchases						$	206,126					443,523
Net unrealized loss on available for sale Agency Securities						$	(27,038)					(30,489)

See financial statement notes (unaudited).

FINANCIAL STATEMENT NOTES (UNAUDITED)

(in thousands, except per share)

Note 1 - Organization and Nature of Business Operations

    References to "we," "us," "our," or the "Company" are to ARMOUR Residential REIT, Inc. ("ARMOUR") and its subsidiaries. References to "ACM" are to ARMOUR Capital Management LP, a Delaware limited partnership. ARMOUR owns a 10.0% equity interest in BUCKLER Securities LLC ("BUCKLER"). BUCKLER is a Delaware limited liability company and a FINRA-regulated broker-dealer, controlled by ACM and certain executive officers of ARMOUR. Refer to the Glossary of Terms for definitions of capitalized terms and abbreviations used in this report.

 

    ARMOUR is an externally managed Maryland corporation incorporated in 2008. The Company is managed by ACM, an investment advisor registered with the Securities and Exchange Commission (the "SEC"), (see Note 9 - Commitments and Contingencies and Note 15 - Related Party Transactions). We have elected to be taxed as a real estate investment trust ("REIT") under the Internal Revenue Code of 1986, as amended (the "Code"). Our qualification as a REIT depends on our ability to meet, on a continuing basis, various complex requirements under the Code relating to, among other things, the sources of our gross income, the composition and values of our assets, our distribution levels and the concentration of ownership of our capital stock. We believe that we are organized in conformity with the requirements for qualification as a REIT under the Code and our manner of operations enables us to meet the requirements for taxation as a REIT for federal income tax purposes. As a REIT, we will generally not be subject to federal income tax on the REIT taxable income that we currently distribute to our stockholders. If we fail to qualify as a REIT in any taxable year and do not qualify for certain statutory relief provisions, we will be subject to federal income tax at regular corporate rates. Even if we qualify as a REIT for U.S. federal income tax purposes, we may still be subject to some federal, state and local taxes on our income.

    At June 30, 2021 and December 31, 2020, we invested exclusively in mortgage backed securities ("MBS") issued or guaranteed by a United States ("U.S.") Government-sponsored entity ("GSE"), such as the Federal National Mortgage Association ("Fannie Mae"), the Federal Home Loan Mortgage Corporation ("Freddie Mac"), or a government agency such as Government National Mortgage Administration ("Ginnie Mae") (collectively, "Agency Securities"). Our Agency Securities consist primarily of fixed rate loans. The remaining are either backed by hybrid adjustable rate or adjustable rate loans. From time to time we may also invest in Credit Risk and Non-Agency Securities, Interest-Only Securities, U.S. Treasury Securities and money market instruments.

Note 2 - Basis of Presentation and Consolidation

 

    The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States ("GAAP") for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X promulgated by the SEC. Accordingly, the condensed financial statements do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and six months ended June 30, 2021 are not necessarily indicative of the results that may be expected for the calendar year ending December 31, 2021. These unaudited consolidated financial statements should be read in conjunction with the audited financial statements and notes thereto included in our annual report on Form 10-K for the year ended December 31, 2020.

 

    The unaudited consolidated financial statements include the accounts of ARMOUR Residential REIT, Inc. and its subsidiaries. All intercompany accounts and transactions have been eliminated. The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates affecting the accompanying condensed consolidated financial statements include the valuation of MBS, including an assessment of the allowance for credit losses, and derivative instruments.

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 our cash positions 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), and repurchase agreements on our MBS and our Agency Securities purchased or sold on a to-be-announced basis ("TBA Agency Securities").

Investments in Securities, at Fair Value

Our investments in securities are generally classified as either available for sale or trading securities. Management determines the appropriate classifications of the securities at the time they are acquired and evaluates the appropriateness of such classifications at each balance sheet date.

    Available for Sale Securities represent investments that we intend to hold for extended periods of time and are reported at their estimated fair values with unrealized gains and losses excluded from earnings and reported as part of the consolidated statements of comprehensive income (loss).

    Trading Securities are reported at their estimated fair values with gains and losses included in Other Income (Loss) as a component of the consolidated statements of operations.

Receivables and Payables for Unsettled Sales and Purchases

    We account for purchases and sales of securities on the trade date, including purchases and sales for forward settlement. Receivables and payables for unsettled trades represent the agreed trade price multiplied by the outstanding balance of the securities at the balance sheet date.

Accrued Interest Receivable and Payable

 

    Accrued interest receivable includes interest accrued between payment dates on securities and interest on unsettled sales of securities. Accrued interest payable includes interest on unsettled purchases of securities and interest on repurchase agreements. At certain times, we may have interest payable on U.S. Treasury Securities sold short.

 

Repurchase Agreements

We finance the acquisition of the majority of our MBS through the use of repurchase agreements. Our repurchase agreements are secured by our MBS and bear interest rates that have historically moved in close relationship to the Federal Funds Rate and short-term London Interbank Offered Rate ("LIBOR"), and more recently the Secured Overnight Funding Rate ("SOFR"). Under these repurchase agreements, we sell MBS to a lender and agree to repurchase the same MBS in the future for a price that is higher than the original sales price. The difference between the sales price that we receive and the repurchase price that we pay represents interest paid to the lender, which accrues over the life of the repurchase agreement. A repurchase agreement operates as a financing arrangement under which we pledge our MBS as collateral to secure a loan which is equal in value to a specified percentage of the estimated fair value of the pledged collateral. We retain beneficial ownership of the pledged collateral. At the 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 June 30, 2021 and December 31, 2020.

 

Derivatives, at Fair Value

 

    We recognize all derivatives individually as either assets or liabilities at fair value on our consolidated balance sheets. All changes in the fair values of our derivatives are reflected in our consolidated statements of operations. We designate derivatives as hedges for tax purposes and any unrealized derivative gains or losses would not affect our distributable net taxable income. These transactions may include interest rate swap contracts, interest rate swaptions 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). We agree to purchase or sell, for future delivery, Agency Securities with certain principal and interest terms and certain types of collateral, but the particular Agency Securities to be delivered are not identified until shortly before the TBA settlement date. We may also choose, prior to settlement, to move the settlement of these securities out to a later date by entering into an offsetting short or long position (referred to as a “pair off”), net settling the paired off positions for cash, and simultaneously purchasing or selling a similar TBA Agency Security for a later settlement date. This transaction is commonly referred to as a “dollar roll.” When it is reasonably possible that we will pair off a TBA Agency Security, we account for that contract as a derivative.

Impairment of Assets

    We assess impairment of available for sale securities at least on a quarterly basis and more frequently when economic or market concerns warrant such evaluation. We consider an impairment if we (1) intend to sell the available for sale securities, or (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) and a credit impairment exists where fair value is less than amortized cost. Impairment losses recognized establish a new cost basis for the related available for sale securities.

Revenue Recognition

    Interest income is earned and recognized on Agency Securities based on their unpaid principal amounts and their contractual terms. Recognition of interest income commences on the settlement date of the purchase transaction and continues through the settlement date of the sale transaction. Premiums and discounts associated with the purchase of Multi-Family MBS, which are generally not subject to prepayment, are amortized or accreted into interest income over the contractual lives of the securities using a level yield method. Premiums and discounts associated with the purchase of other Agency Securities are amortized or accreted into interest income over the actual lives of the securities, reflecting actual prepayments as they occur. Purchase and sale transactions (including TBA Agency Securities) are recorded on the trade date to the extent it is probable that we will take or make timely physical delivery of the related securities. Gains or losses

realized from sales of available for sale securities are reclassified into income from other comprehensive income and are determined using the specific identification method.

Interest income on Credit Risk and 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. Impairment losses establish a new cost basis in the security for purposes of calculating effective yields, 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. Interest income on U.S. Treasury Securities is recognized based on their unpaid principal amounts and their contractual terms. Recognition of interest income commences on the settlement date of the purchase transaction and continues through the settlement date of the sale transaction.

Comprehensive Income (Loss)

 

    Comprehensive income (loss) refers to 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.

Note 4 - Recent Accounting Pronouncements

    We consider the applicability and impact of all Accounting Standards Updates ("ASU") issued by the Financial Accounting Standards Board. We have not identified any ASUs that we deemed to be applicable or that are expected to have a significant impact on our consolidated financial statements when adopted.

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 Inputs - Quoted prices for identical instruments in active markets.

    Level 2 Inputs - Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable.

 

    Level 3 Inputs - Prices determined using significant unobservable inputs. Unobservable inputs may be used in situations where quoted prices or observable inputs are unavailable (for example, when there is little or no market activity for an investment at the end of the period). Unobservable inputs reflect management’s assumptions about the factors that market participants would use in pricing an asset or liability, and would be based on the best information available.

    At the beginning of each quarter, we assess the assets and liabilities that are measured at fair value on a recurring basis to determine if any transfers between levels in the fair value hierarchy are needed.

The following describes the valuation methodologies used for our assets and liabilities measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy. Any transfers between levels are assumed to occur at the beginning of the reporting period.

    

Investments in Securities:

    Fair value for our investments in securities are based on obtaining a valuation for each security from third party pricing services and/or dealer quotes. The third party pricing services use common market pricing methods that may include pricing models that may incorporate such factors as coupons, prepayment speeds, spread to the Treasury curves and interest rate swap curves, duration, periodic and life caps and credit enhancement. If the fair value of a security is not available from the third party pricing services or such data appears unreliable, we obtain pricing indications from up to three dealers who make markets in similar securities. Management reviews pricing used to ensure that current market conditions are properly reflected. This review includes, but is not limited to, comparisons of similar market transactions or alternative third party pricing services, dealer pricing indications and comparisons to a third party pricing model. Fair values obtained from the third party pricing services for similar instruments are classified as Level 2 securities if the inputs to the pricing models used are consistent with the Level 2 definition. If quoted prices for a security are not reasonably available from the third party pricing service, but dealer pricing indications are, the security will be classified as a Level 2 security. If neither is available, management will determine the fair value based on characteristics of the security that we receive from the issuer and based on available market information and classify it as a Level 3 security. U.S. Treasury Securities are classified as Level 1, as quoted unadjusted prices are available in active markets for identical assets.

Derivatives:

    The fair values of our interest rate swap contracts, interest rate swaptions and basis swaps 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. We estimate the fair value of TBA Agency Securities based on similar methods used to value our Agency Securities. Management compares the pricing information received to dealer quotes to ensure that the current market conditions are properly reflected. The fair values of our derivatives 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 June 30, 2021 and December 31, 2020.

    There were no transfers of assets or liabilities between the levels of the fair value hierarchy during the six months ended June 30, 2021 or for the year ended December 31, 2020.

    Excluded from the tables above are financial instruments, including cash, cash collateral posted to/by counterparties, receivables, the Subordinated loan to BUCKLER, payables and borrowings under repurchase agreements, which are presented in our consolidated financial statements at cost which approximates fair value. The estimated fair value of these instruments is measured using "Level 1" or "Level 2" inputs at June 30, 2021 and December 31, 2020.

Note 6 - Investments in Securities

 

    As of June 30, 2021 and December 31, 2020, our securities portfolio consisted of $4,351,478 and $5,178,322 of investment securities, at fair value, respectively, and $3,909,119 and $2,711,977 of TBA Agency Securities, at fair value, respectively. Our TBA Agency Securities are reported at net carrying value of $10,351 and $19,747, at June 30, 2021 and December 31, 2020, respectively, and are reported in Derivatives, at fair value on our consolidated balance sheets (see Note 8 - Derivatives). The net carrying value of our TBA Agency Securities represents the difference between the fair value of the underlying Agency Security in the TBA contract and the cost basis or the forward price to be paid or received for the underlying Agency Security.

    The following tables summarize our investments in securities as of June 30, 2021 and December 31, 2020, excluding TBA Agency Securities (see Note 8 - Derivatives). Beginning in the second quarter of 2020, we designated Agency MBS purchased as “trading securities” for financial reporting purposes, and consequently, fair value changes for these investments will be reported in net income. We anticipate continuing this designation for newly acquired Agency MBS positions because it is more representative of our results of operations insofar as the fair value changes for these securities are presented in a manner consistent with the presentation and timing of the fair value changes of our hedging instruments. Fair value changes for the legacy Agency Securities designated as available for sale will continue to be reported in other comprehensive income as required by GAAP.

(1)Purchases include cash paid during the period, plus payable for investment securities purchased during the period as of period end.

Available for Sale Securities:

    At June 30, 2021, we evaluated our available for sale securities to determine if the available for sale securities in an unrealized loss position were impaired. As a result of this evaluation, no credit loss expense was required. We do not have an allowance for credit losses as all of our available for sale securities consist of Agency MBS.

    During the year ended December 31, 2020, we evaluated our available for sale securities to determine if the available for sale securities in an unrealized loss position were impaired. In the first quarter of 2020, we recognized an impairment of $1,012 in our consolidated statements of operations as we had determined that we may have been required to sell certain securities in the near future. No credit loss expense was required for the remainder of 2020.

    The table below presents the components of the carrying value and the unrealized gain or loss position of our available for sale securities at June 30, 2021 and December 31, 2020. Our available for sale securities had a weighted average coupon of 3.07% and 3.25% at June 30, 2021 and December 31, 2020.

    The following table presents the unrealized losses and estimated fair value of our available for sale securities by length of time that such securities have been in a continuous unrealized loss position at June 30, 2021 and December 31, 2020. All of our available for sale securities are issued and guaranteed by GSEs or Ginnie Mae. The GSEs have a long term credit rating of AA+.

ARMOUR Residential REIT, Inc.

FINANCIAL STATEMENT NOTES (UNAUDITED)

(in thousands, except per share)

    Actual maturities of available for sale securities are generally shorter than stated contractual maturities because actual maturities of available for sale 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 available for sale securities at June 30, 2021 and December 31, 2020.

						June 30, 2021												December 31, 2020
Weighted Average Life of Available for Sale Securities						Fair Value						Amortized Cost						Fair Value						Amortized Cost
< 1 year						$	100					$	99					$	71					$	72
≥ 1 year and < 3 years						31,588						30,899						548,352						520,657
≥ 3 years and < 5 years						535,896						512,424						282,739						269,716
≥ 5 years						1,083,411						962,934						1,139,740						1,001,426
Total Available for Sale Securities						$	1,650,995					$	1,506,356					$	1,970,902					$	1,791,871

    We use a third party model to calculate the weighted average lives of our available for sale securities. Weighted average life is calculated based on expectations for estimated prepayments for the underlying mortgage loans of our available for sale 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 available for sale securities at June 30, 2021 and December 31, 2020 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 available for sale securities could be longer or shorter than estimated.

The following table summarizes the weighted average lives of our trading securities at June 30, 2021 and December 31, 2020.

    

    We use a third party model to calculate the weighted average lives of our trading securities. Weighted average life is calculated based on expectations for estimated prepayments for the underlying mortgage loans of our trading 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 trading securities at June 30, 2021 and December 31, 2020 in the tables above are based upon market factors, assumptions, models and estimates from the third party model and also incorporate management’s judgment and experience. The actual weighted average lives of our trading securities could be longer or shorter than estimated.

 Note 7 - Repurchase Agreements

    At June 30, 2021, we had active MRAs with 34 counterparties and had $3,661,367 in outstanding borrowings with 18 of those counterparties. At December 31, 2020, we had $4,536,065 in outstanding borrowings with 18 counterparties.

    The following table represents the contractual repricing regarding our repurchase agreements to finance MBS purchases at June 30, 2021 and December 31, 2020. No amounts below are subject to offsetting. Our repurchase agreements require excess collateral, known as a “haircut.” At June 30, 2021, the average haircut percentage was 3.49% compared to 3.13% at December 31, 2020. The haircut for our repurchase agreements vary by counterparty and therefore, the changes in the average haircut percentage will vary with the changes in our counterparty repurchase agreement balances.

    Our repurchase agreements require that we maintain adequate pledged collateral. A decline in the value of the MBS pledged as collateral for borrowings under repurchase agreements could result in the counterparties demanding additional collateral pledges or liquidation of some of the existing collateral to reduce borrowing levels. We manage this risk

by maintaining an adequate balance of available cash and unpledged securities. An event of default or termination event under the standard MRA would give our counterparty the option to terminate all repurchase transactions existing with us and require any amount due to be payable immediately. In addition, certain of our MRAs contain a restriction that prohibits our leverage from exceeding twelve times our stockholders’ equity as well as termination events in the case of significant reductions in equity capital. We also may receive cash or securities as collateral from our derivative counterparties which we may use as additional collateral for repurchase agreements. Certain interest rate swap contracts provide for cross collateralization and cross default with repurchase agreements and other contracts with the same counterparty.

    At June 30, 2021 and December 31, 2020, BUCKLER accounted for 57.5% and 66.1%, respectively, of our aggregate borrowings and had an amount at risk of 5.9% and 8.3%, respectively, of our total stockholders' equity with a weighted average maturity of 2 days and 21 days, respectively, on repurchase agreements (see Note 15 - Related Party Transactions).

    In addition, at June 30, 2021, we had 1 repurchase agreement counterparty that individually accounted for over 5% of our aggregate borrowings. In total, this counterparty accounted for approximately 11.0% of our repurchase agreement borrowings outstanding at June 30, 2021. At December 31, 2020, we had 1 repurchase agreement counterparty that individually accounted for over 5% of our aggregate borrowings. In total, this counterparty accounted for 9.0% of our repurchase agreement borrowings at December 31, 2020.

    

Note 8 - Derivatives

    We enter into derivative transactions to manage our interest rate risk and agency mortgage rate exposures. We have agreements with our derivative counterparties that provide for the posting of collateral based on the fair values of our derivatives. Through this margin process, either we or our counterparties may be required to pledge cash or securities as collateral. Collateral requirements vary by counterparty and change over time based on the fair value, notional amount and remaining term of the contracts. Certain contracts provide for cross collateralization and cross default with repurchase agreements and other contracts with the same counterparty.

    Interest rate swap contracts are designed to lock in funding costs for repurchase agreements associated with our assets in such a way to help assure the realization of net interest margins. Such transactions are based on assumptions about prepayments which, if not realized, will cause transaction results to differ from expectations. Interest rate swaptions generally provide us the option to enter into an interest rate swap agreement at a certain point of time in the future with a predetermined notional amount, stated term and stated rate of interest in the fixed leg and interest rate index on the floating leg. Basis swap contracts allow us to exchange one floating interest rate basis for another, thereby allowing us to diversify our floating rate basis exposures.

 

    TBA Agency Securities are forward contracts for the purchase (“long position”) or sale (“short position”) of Agency Securities at a predetermined price, face amount, issuer, coupon and stated maturity on an agreed-upon future date. The specific Agency Securities delivered into the contract upon the settlement date, published each month by the Securities Industry and Financial Markets Association, are not known at the time of the transaction. We may enter into TBA Agency Securities as a means of hedging against short-term changes in interest rates. We may also enter into TBA Agency Securities as a means of acquiring or disposing of Agency Securities and we may from time to time utilize TBA dollar roll transactions to finance Agency Security purchases. We estimate the fair value of TBA Agency Securities based on similar methods used to value our Agency Securities.

    We have netting arrangements in place with all derivative counterparties pursuant to standard documentation developed by ISDA. We are also required to post or hold cash collateral based upon the net underlying market value of our open positions with the counterparty. A decline in the value of the open positions with the counterparty could result in the counterparties demanding additional collateral pledges or liquidation of some of the existing collateral to reduce borrowing levels. We manage this risk by maintaining an adequate balance of available cash and unpledged securities. An event of default or termination event under the standard ISDA would give our counterparty the option to terminate all repurchase transactions existing with us and require any amount due to be payable immediately. In addition, certain of our ISDAs contain a restriction that prohibits our leverage from exceeding twelve times our stockholders’ equity as well as termination events in the case of significant reductions in equity capital.

    The following tables present information about the potential effects of netting our derivatives if we were to offset the assets and liabilities on the accompanying consolidated balance sheets. We currently present these financial instruments at their gross amounts and they are included in Derivatives, at fair value on the accompanying consolidated balance sheets at June 30, 2021 and December 31, 2020.

(1)See Note 5 - Fair Value of Financial Instruments for additional discussion.

(1)See Note 5 - Fair Value of Financial Instruments for additional discussion.

ARMOUR Residential REIT, Inc.

FINANCIAL STATEMENT NOTES (UNAUDITED)

(in thousands, except per share)

    The following table represents the location and information regarding our derivatives which are included in Other Income (Loss) in the accompanying consolidated statements of operations for the three and six months ended June 30, 2021 and June 30, 2020.

												Income (Loss) Recognized
												For the Three Months Ended June 30,												For the Six Months Ended June 30,
Derivatives						Location on consolidated statements of operations						2021						2020						2021						2020
Interest rate swap contracts:
Realized loss						Realized loss on derivatives						$	—					$	(199,990)					$	—					$	(461,374)
Interest income						Realized loss on derivatives						884						1,339						1,756						27,801
Interest expense						Realized loss on derivatives						(8,734)						(8,335)						(13,182)						(40,569)
Changes in fair value						Unrealized gain (loss) on derivatives						(131,815)						180,938						54,145						29,552
												$	(139,665)					$	(26,048)					$	42,719					$	(444,590)
TBA Agency Securities:
Realized gain (loss)						Realized loss on derivatives						4,201						26,419						(19,583)						58,426
Changes in fair value						Unrealized gain (loss) on derivatives						39,071						(7,613)						(909)						9,886
												$	43,272					$	18,806					$	(20,492)					$	68,312
Totals												$	(96,393)					$	(7,242)					$	22,227					$	(376,278)

    The following tables present information about our derivatives at June 30, 2021 and December 31, 2020.

(1)Pay Fixed/Receive Variable.

(2)Of this amount, $5,607,000 notional are Fed Funds based swaps, the last of which matures in 2031 and $1,203,000 notional are SOFR based swaps, the last of which matures in 2023. Includes $850,000 notional of forward settling swap contracts that settle by December 28, 2021.

ARMOUR Residential REIT, Inc.

FINANCIAL STATEMENT NOTES (UNAUDITED)

(in thousands, except per share)