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Section 1: 10-Q (10-Q)

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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 March 31, 2020
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 
For the transition period from                      to                     
 
ARMOUR RESIDENTIAL REIT, INC.
(Exact name of registrant as specified in its charter) 
Maryland
001-34766
26-1908763
(State or other jurisdiction of incorporation or organization)
(Commission File Number)
(I.R.S. Employer Identification No.)
3001 Ocean Drive, Suite 201, Vero Beach, FL  32963
(Address of principal executive offices)(zip code)
(772) 617-4340
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class
 
Trading symbols
 
Name of Exchange on which registered
Preferred Stock, 7.00% Series C Cumulative Redeemable
 
ARR-PRC
 
New York Stock Exchange
Common Stock, $0.001 par value
 
ARR
 
New York Stock Exchange

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 April 30, 2020 was 64,586,296.
 





ARMOUR Residential REIT, Inc.
TABLE OF CONTENTS







1
PART I. FINANCIAL INFORMATION

Item 1. Financial Statements


ARMOUR Residential REIT, Inc.
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(in thousands, except per share)
 
 
March 31,
2020
 
December 31, 2019
Assets
 

 

Cash
 
$
333,884

 
$
181,395

Cash collateral posted to counterparties
 
350,348

 
91,771

Investments in securities, at fair value
 
 
 
 
Agency Securities (including pledged securities of $2,764,806 at March 31, 2020 and $11,188,502 at December 31, 2019, net of allowance for credit losses of $1,012 at March 31, 2020)
 
2,786,962

 
11,941,766

Credit Risk and Non-Agency Securities (including pledged securities of $761,537 at March 31, 2020 and $810,549 at December 31, 2019)
 
765,553

 
883,601

Receivable for unsettled sales (including pledged securities of $220,543 at March 31, 2020)
 
688,183

 

Derivatives, at fair value
 
24,099

 
24,751

Accrued interest receivable
 
9,545

 
35,085

Prepaid and other
 
1,605

 
9,051

Subordinated loan to BUCKLER
 
105,000

 
105,000

Total Assets
 
$
5,065,179

 
$
13,272,420

Liabilities and Stockholders’ Equity
 
 
 
 
Liabilities:
 
 
 
 
Repurchase agreements
 
$
3,465,472

 
$
11,354,547

Cash collateral posted by counterparties
 
130,297

 
14,958

Payable for unsettled purchases
 
470,441

 
358,712

Derivatives, at fair value
 
200,275

 
71,974

Accrued interest payable- repurchase agreements
 
3,490

 
31,932

Accounts payable and other accrued expenses
 
8,954

 
3,590

Total Liabilities
 
$
4,278,929

 
$
11,835,713

 
 
 
 
 
Commitments and contingencies (Note 9)
 

 

 
 
 
 
 
Stockholders’ Equity:
 
 
 
 
Preferred stock, $0.001 par value, 50,000 shares authorized;
 
 
 
 
7.875% Series B Cumulative Preferred Stock; 8,383 shares issued and outstanding ($209,583 aggregate liquidation preference) at December 31, 2019
 

 
8

7.00% Series C Cumulative Preferred Stock; 5,303 shares issued and outstanding ($132,588 aggregate liquidation preference) at March 31, 2020
 
5

 

Common stock, $0.001 par value, 125,000 shares authorized, 58,881 and 58,877 shares issued and outstanding at March 31, 2020 and December 31, 2019, respectively
 
59

 
59

Additional paid-in capital
 
2,974,469

 
3,054,604

Accumulated deficit
 
(2,413,300
)
 
(1,973,437
)
Accumulated other comprehensive income
 
225,017

 
355,473

Total Stockholders’ Equity
 
$
786,250

 
$
1,436,707

Total Liabilities and Stockholders’ Equity
 
$
5,065,179

 
$
13,272,420

 
See financial statement notes (unaudited).

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2
ARMOUR Residential REIT, Inc.
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(in thousands, except per share)



 
 
For the Three Months Ended March 31,
 
 
2020
 
2019
Interest Income:
 
 
 
 
Agency Securities, net of amortization of premium and fees
 
$
79,776

 
$
79,832

Credit Risk and Non-Agency Securities, including discount accretion
 
12,355

 
13,592

Interest-Only Securities
 

 
345

U.S. Treasury Securities
 
469

 
482

BUCKLER Subordinated loan
 
258

 
539

Total Interest Income
 
$
92,858

 
$
94,790

Interest expense- repurchase agreements
 
(51,520
)
 
(60,978
)
Net Interest Income

$
41,338


$
33,812

Other Income (Loss):
 
 
 
 
Realized gain (loss) on sale of Agency Securities (reclassified from Other comprehensive income (loss))
 
93,325

 
(2,910
)
Credit loss expense
 
(1,012
)
 

Gain (loss) on Credit Risk and Non-Agency Securities
 
(183,111
)
 
496

Loss on Interest-Only Securities
 

 
(368
)
Gain (loss) on U.S. Treasury Securities
 
21,771

 
(693
)
Subtotal

$
(69,027
)

$
(3,475
)
Realized loss on derivatives (1)
 
(235,148
)
 
(22,131
)
Unrealized loss on derivatives
 
(133,887
)
 
(113,067
)
Subtotal

$
(369,035
)
 
$
(135,198
)
Total Other Loss

$
(438,062
)
 
$
(138,673
)
Expenses:
 
 
 
 
Management fees
 
7,458

 
7,258

Professional fees
 
846

 
1,035

Insurance
 
183

 
165

Compensation
 
1,465

 
787

Other
 
(17
)
 
275

Total Expenses

$
9,935


$
9,520

Net Loss

$
(406,659
)
 
$
(114,381
)
Dividends on preferred stock
 
(2,827
)
 
(4,259
)
Net Loss related to common stockholders

$
(409,486
)
 
$
(118,640
)
Net Loss per share related to common stockholders (Note 12):
 
 
 
 
Basic
 
$
(6.95
)
 
$
(2.21
)
Diluted
 
$
(6.95
)
 
$
(2.21
)
Dividends declared per common share
 
$
0.51

 
$
0.57

Weighted average common shares outstanding:
 
 
 
 
Basic
 
58,884

 
53,630

Diluted
 
58,884

 
53,630


(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).

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3
ARMOUR Residential REIT, Inc.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (UNAUDITED)
(in thousands)


 
 
For the Three Months Ended March 31,
 
 
2020
 
2019
Net Loss
 
$
(406,659
)
 
$
(114,381
)
Other comprehensive income (loss):
 
 
 
 
Reclassification adjustment for realized (gain) loss on sale of available for sale Agency Securities
 
(93,325
)
 
2,910

Reclassification adjustment for credit loss expense on available for sale Agency Securities
 
1,012

 

Net unrealized gain (loss) on available for sale Agency Securities
 
(38,143
)
 
184,248

Other comprehensive income (loss)
 
$
(130,456
)
 
$
187,158

Comprehensive Income (Loss)
 
$
(537,115
)
 
$
72,777

 
See financial statement notes (unaudited).


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4
ARMOUR Residential REIT, Inc.
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY (UNAUDITED)
(in thousands)

 
Preferred Stock
 
Common Stock
 
 
 
 
 
 
 
 
 
7.875% Series B
 
7.00% Series C
 
 
 
 
 
 
 
 
 
 
 
 
 
Shares
 
Par
 
Shares
 
Par
 
Shares
 
Par
 
Total
Additional Paid-in
Capital
 
Accumulated
Deficit
 
Accumulated
Other
Comprehensive Income (Loss)
 
Total
Balance, December 31, 2019
8,383

 
$
8

 

 
$

 
58,877

 
$
59

 
$
3,054,604

 
$
(1,973,437
)
 
$
355,473

 
$
1,436,707

Series B Preferred dividends

 

 

 

 

 

 

 
(1,375
)
 

 
(1,375
)
Series C Preferred dividends

 

 

 

 

 

 

 
(1,452
)
 

 
(1,452
)
Common stock dividends

 

 

 

 

 

 

 
(30,377
)
 

 
(30,377
)
Series B Preferred stock, called for redemption
(8,383
)
 
(8
)
 

 

 

 

 
(209,575
)
 

 

 
(209,583
)
Issuance of Series C Preferred stock, net of expenses

 

 
5,303

 
5

 

 

 
129,216

 

 

 
129,221

Stock based compensation, net of withholding requirements

 

 

 

 
44

 

 
1,001

 


 

 
1,001

Common stock repurchased, net

 

 

 

 
(40
)
 

 
(777
)
 

 

 
(777
)
Net Loss

 

 

 

 

 

 

 
(406,659
)
 

 
(406,659
)
Other comprehensive loss

 

 

 

 

 

 

 

 
(130,456
)
 
(130,456
)
Balance, March 31, 2020

 
$

 
5,303

 
$
5

 
58,881

 
$
59

 
$
2,974,469

 
$
(2,413,300
)
 
$
225,017

 
$
786,250

 
See financial statement notes (unaudited).

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5
ARMOUR Residential REIT, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(in thousands)


 
 
For the Three Months Ended March 31,
 
 
2020
 
2019
Cash Flows From Operating Activities:
 
 
 
 
Net Loss
 
$
(406,659
)
 
$
(114,381
)
Adjustments to reconcile net income (loss) to net cash and cash collateral posted to counterparties provided by (used in) operating activities:
 
 
 
 
Net amortization of premium on Agency Securities
 
14,130

 
6,347

Accretion of net discount on Credit Risk and Non-Agency Securities
 
(1,078
)
 
(932
)
Net amortization of Interest-Only Securities
 

 
936

Net amortization of U.S. Treasury Securities
 
84

 
(453
)
Realized (gain) loss on sale of Agency Securities
 
(93,325
)
 
2,910

Credit loss expense
 
1,012

 

(Gain) loss on Credit Risk and Non-Agency Securities
 
183,111

 
(496
)
Loss on Interest-Only Securities
 

 
368

(Gain) loss on U.S. Treasury Securities
 
(21,771
)
 
693

Stock based compensation
 
1,001

 
644

Changes in operating assets and liabilities:
 
 
 
 
Increase (decrease) in accrued interest receivable
 
25,728

 
(17,178
)
Increase in prepaid and other assets
 
7,446

 
459

Change in derivatives, at fair value
 
128,953

 
95,796

Increase (Decrease) in accrued interest payable- repurchase agreements
 
(28,442
)
 
11,522

Increase in accounts payable and other accrued expenses
 
5,364

 
2,431

Net cash and cash collateral posted to counterparties used in operating activities
 
$
(184,446
)
 
$
(11,334
)
Cash Flows From Investing Activities:
 
 
 
 
Purchases of Agency Securities
 
(1,657,148
)
 
(6,608,566
)
Purchases of Credit Risk and Non-Agency Securities
 
(237,928
)
 

Purchases of U.S. Treasury Securities
 
(3,763,561
)
 
(101,039
)
Principal repayments of Agency Securities
 
475,766

 
145,777

Principal repayments of Credit Risk and Non-Agency Securities
 
31,404

 
6,335

Proceeds from sales of Agency Securities
 
9,777,373

 
1,017,396

Proceeds from sales of Credit Risk and Non-Agency Securities
 
72,437

 

Proceeds from sales of U.S. Treasury Securities
 
3,785,248

 
199,445

(Decrease) increase in cash collateral posted by counterparties
 
115,339

 
(47,387
)
Net cash and cash collateral posted to counterparties provided by (used in) investing activities
 
$
8,598,930

 
$
(5,388,039
)
(Continued)

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6
ARMOUR Residential REIT, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(in thousands)

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
 
129,221

 

Issuance of common stock, net of expenses
 

 
321,992

Proceeds from repurchase agreements
 
42,459,521

 
50,656,945

Principal repayments on repurchase agreements
 
(50,348,596
)
 
(45,551,322
)
Series A Preferred stock dividends paid
 

 
(1,124
)
Series B Preferred stock dividends paid
 
(1,375
)
 
(3,135
)
Series C Preferred stock dividends paid
 
(1,452
)
 

Common stock dividends paid
 
(30,377
)
 
(29,814
)
Common stock repurchased, net
 
(777
)
 

Net cash and cash collateral posted to counterparties provided by (used in) financing activities
 
$
(8,003,418
)
 
$
5,393,542

Net Increase (decrease) in cash and cash collateral posted to counterparties
 
411,066

 
(5,831
)
Cash and cash collateral posted to counterparties - beginning of period
 
273,166

 
232,199

Cash and cash collateral posted to counterparties - end of period
 
$
684,232

 
226,368

Supplemental Disclosure:
 
 
 
 
Cash paid during the period for interest
 
$
139,313

 
98,627

Non-Cash Investing Activities:
 
 
 
 
Receivable for unsettled sales
 
$
688,183

 

Payable for unsettled purchases
 
$
470,441

 
198,172

Net unrealized gain (loss) on available for sale Agency Securities
 
$
(38,143
)
 
184,248


See financial statement notes (unaudited).

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7
ARMOUR Residential REIT, Inc.
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% 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 for additional discussion). 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.

We invest in mortgage backed securities ("MBS"). Some MBS are 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. Other MBS 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, "Credit Risk and Non-Agency Securities"). From time to time we may also invest in 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 months ended March 31, 2020 are not necessarily indicative of the results that may be expected for the calendar year ending December 31, 2020. 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, 2019.
 
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.


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8
ARMOUR Residential REIT, Inc.
FINANCIAL STATEMENT NOTES (UNAUDITED)
(in thousands, except per share)


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), 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, interest on repurchase agreements and may, at certain times, contain 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"). 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.

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9
ARMOUR Residential REIT, Inc.
FINANCIAL STATEMENT NOTES (UNAUDITED)
(in thousands, except per share)


 
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 March 31, 2020 and December 31, 2019.
 
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 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 greater than amortized cost. Impairment losses recognized establish a new cost basis for the related available for sale securities.

Revenue Recognition

Available for Sale Securities - 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 the sale of securities are reclassified into income from other comprehensive income and are determined using the specific identification method.


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10
ARMOUR Residential REIT, Inc.
FINANCIAL STATEMENT NOTES (UNAUDITED)
(in thousands, except per share)


Trading Securities - 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. Those not listed below were deemed to be either not applicable, are not expected to have a significant impact on our consolidated financial statements when adopted, or did not have a significant impact on our consolidated financial statements upon adoption.

Accounting Standard
 
Description
 
 
 
ASU 2018–07, Improvements to Non-employee Share –Based Payment Accounting (Topic 718)
 
The standard is effective for fiscal years beginning after December 15, 2018, including interim periods within that fiscal year. The standard largely aligns the accounting for share-based payment awards issued to employees and non-employees. Equity-classified share-based payment awards issued to non-employees are measured on the grant date, instead of being remeasured through the performance completion date (generally the vesting date). The standard was applied on a modified retrospective basis through a cumulative effect adjustment to retained earnings as of the beginning of the fiscal year when adopted. The cumulative effective adjustment was recorded in our consolidated statement of stockholders' equity as of January 1, 2019, and did not have a material impact on the Company's financial condition or results of operations.
 
 
 
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 applies 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 was effective for fiscal years beginning after December 15, 2019. The adoption of the standard on January 1, 2020 did not have a significant impact on the Company, since at that time we did not intend to sell our investments in available for sale Agency Securities. The Company determined that it was not more likely than not that we would be required to sell the investments before recovery of their amortized cost bases as the contractual cash flows of these federal agency mortgage backed securities are guaranteed by an agency of the U.S. government and we expected that all securities would not be settled at a price less than their amortized cost.



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11
ARMOUR Residential REIT, Inc.
FINANCIAL STATEMENT NOTES (UNAUDITED)
(in thousands, except per share)


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.
    
Agency Securities, Credit Risk and Non-Agency Securities, Interest-Only Securities and U.S. Treasury Securities:
 
Fair value for these 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.

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12
ARMOUR Residential REIT, Inc.
FINANCIAL STATEMENT NOTES (UNAUDITED)
(in thousands, except per share)


The following tables provide a summary of our assets and liabilities that are measured at fair value on a recurring basis at March 31, 2020 and December 31, 2019.

March 31, 2020
 
(Level 1)
 
(Level 2)
 
(Level 3)
 
Balance
Assets at Fair Value:
 
 
 
 
 
 
 
 
Agency Securities
 
$

 
$
2,786,962

 
$

 
$
2,786,962

Credit Risk and Non-Agency Securities
 
$

 
$
765,553

 
$

 
$
765,553

Derivatives
 
$

 
$
24,099

 
$

 
$
24,099

Liabilities at Fair Value:
 
 
 
 
 
 
 
 
Derivatives
 
$

 
$
200,275

 
$

 
$
200,275

 
 
 
 
 
 
 
 
 
December 31, 2019
 
(Level 1)
 
(Level 2)
 
(Level 3)
 
Balance
Assets at Fair Value:
 
 
 
 
 
 
 
 
Agency Securities
 
$

 
$
11,941,766

 
$

 
$
11,941,766

Credit Risk and Non-Agency Securities
 
$

 
$
883,601

 
$

 
$
883,601

Derivatives
 
$

 
$
24,751

 
$

 
$
24,751

Liabilities at Fair Value:
 
 
 
 
 
 
 


Derivatives
 
$

 
$
71,974

 
$

 
$
71,974



There were no transfers of assets or liabilities between the levels of the fair value hierarchy during the three months ended March 31, 2020 or for the year ended December 31, 2019.

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 March 31, 2020 and December 31, 2019.

Note 6 - Investments in Securities
 
As of March 31, 2020 and December 31, 2019, our securities portfolio consisted of $3,552,515 and $12,825,367 of investment securities, at fair value, respectively, and $1,292,462 and $1,006,280 of TBA Agency Securities, at fair value, respectively. Our TBA Agency Securities are reported at net carrying value of $22,044 and $(592), at March 31, 2020 and December 31, 2019, respectively, and are reported in Derivatives, at fair value on our consolidated balance sheets (see Note 8 - Derivatives for additional information). 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.


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13
ARMOUR Residential REIT, Inc.
FINANCIAL STATEMENT NOTES (UNAUDITED)
(in thousands, except per share)


The following table summarizes our investments in securities as of March 31, 2020 and December 31, 2019, excluding TBA Agency Securities (see Note 8 - Derivatives for additional information).

 
 
Available for Sale
Securities
 
Trading Securities
 
 
 
 
Agency
 
Credit Risk and Non-Agency
 
Interest-Only
 
U.S. Treasuries
 
Totals
March 31, 2020
 
 
 
 
 
 
 
 
 
 
Beginning balance
 
$
11,941,766

 
$
883,601

 
$

 
$

 
$
12,825,367

Purchases (1)
 
1,768,689

 
237,928

 

 
3,763,561

 
5,770,178

Proceeds from sales 
 
(9,777,373
)
 
(72,437
)
 

 
(3,785,248
)
 
(13,635,058
)
Receivable for unsettled sales
 
(618,081
)
 
(70,102
)
 

 

 
(688,183
)
Principal repayments
 
(475,766
)
 
(31,404
)
 

 

 
(507,170
)
Gains (losses)
 
(37,131
)
 
(183,111
)
 

 
21,771

 
(198,471
)
Credit loss expense
 
(1,012
)
 

 

 

 
(1,012
)
Amortization/accretion
 
(14,130
)
 
1,078

 

 
(84
)
 
(13,136
)
Ending balance
 
$
2,786,962

 
$
765,553

 
$

 
$

 
$
3,552,515

Percentage of Portfolio
 
78.45
%
 
21.55
%
 
%
 
%
 
100.00
%
 
 
 
 
 
 
 
 
 
 
 
December 31, 2019
 
 
 
 
 
 
 
 
 
 
Beginning balance
 
$
7,051,954

 
$
819,915

 
$
20,623

 
$
98,646

 
$
7,991,138

Purchases (1)
 
9,130,512

 
138,767

 

 
1,685,058

 
$
10,954,337

Sales
 
(2,894,339
)
 

 
(18,822
)
 
(1,786,090
)
 
$
(4,699,251
)
Principal Repayments
 
(1,701,406
)
 
(53,641
)
 

 

 
$
(1,755,047
)
Gains (losses)
 
408,954

 
(24,396
)
 
123

 
2,024

 
$
386,705

Amortization/accretion
 
(53,909
)
 
2,956

 
(1,924
)
 
362

 
$
(52,515
)
Ending balance
 
$
11,941,766

 
$
883,601

 
$

 
$

 
$
12,825,367

Percentage of Portfolio
 
93.11
%
 
6.89
%
 
%
 
%
 
100.00
%
(1)
Purchases include cash paid during the period, plus payable for investment securities purchased during the period as of period end. At March 31, 2020 and December 31, 2019, we had investment related payables with respect to unsettled purchases of Agency Securities of $470,441 and $358,712, respectively.

Available for Sale Securities:

At March 31, 2020, we evaluated our available sale securities to determine if an allowance for credit losses was required for securities which were in an unrealized loss position and determined that, as we may be be required to sell these securities in the near future we recognized an impairment of $1,012 in our consolidated statements of operations.
At March 31, 2019 and December 31, 2019, we evaluated our available for sale securities with unrealized losses to determine whether there was an OTTI. At those dates, we also considered whether we intended to sell available for sale securities and whether it was more likely than not that we could meet our liquidity requirements and contractual obligations without selling available for sale securities. No OTTI was recognized for the three months ended March 31, 2019 or for the year ended December 31, 2019.

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14
ARMOUR Residential REIT, Inc.
FINANCIAL STATEMENT NOTES (UNAUDITED)
(in thousands, except per share)



The table below presents the components of the carrying value and the unrealized gain or loss position of our Agency Securities at March 31, 2020 and December 31, 2019. Our Agency Securities had a weighted average coupon of 3.98% and 3.76% at March 31, 2020 and December 31, 2019.

 
 
Principal Amount
 
Amortized Cost
 
Gross Unrealized Loss
 
Gross Unrealized Gain
 
Fair Value
March 31, 2020
 
 
 
 
 
 
 
 
 
 
Total Fannie Mae
 
$
1,930,475

 
$
1,981,977

 
$

 
$
202,987

 
$
2,184,964

Total Freddie Mac
 
536,387

 
558,004

 

 
22,023

 
580,027

Total Ginnie Mae
 
21,418

 
21,964

 

 
7

 
21,971

Total
 
$
2,488,280

 
$
2,561,945

 
$

 
$
225,017

 
$
2,786,962

 
 
 
 
 
 
 
 
 
 
 
December 31, 2019
 
 
 
 
 
 
 
 
 
 
Total Fannie Mae
 
$
8,779,331

 
$
8,975,140

 
$
(291
)
 
$
294,937

 
$
9,269,786

Total Freddie Mac
 
2,522,870

 
2,587,512

 
(40
)
 
61,323

 
2,648,795

Total Ginnie Mae
 
22,504

 
23,641

 
(461
)
 
5

 
23,185

Total
 
$
11,324,705

 
$
11,586,293

 
$
(792
)
 
$
356,265

 
$
11,941,766



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 March 31, 2020 and December 31, 2019. All of our Agency Securities are issued and guaranteed by GSEs or Ginnie Mae. The GSEs have a long term credit rating of AA+.

 
 
Unrealized Loss Position For:
 
 
< 12 Months
 
≥ 12 Months
 
Total
 
 
Fair Value
 
Unrealized
Losses 
 
Fair Value
 
Unrealized
Losses 
 
Fair Value
 
Unrealized
Losses 
March 31, 2020
 
$

 
$

 
$

 
$

 
$

 
$

December 31, 2019
 
$
2,136

 
$
(10
)
 
$
43,939

 
$
(782
)
 
$
46,075

 
$
(792
)


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 March 31, 2020 and December 31, 2019.

 
 
March 31, 2020
 
December 31, 2019
Weighted Average Life of all Agency Securities
 
Fair Value
 
Amortized
Cost
 
 
Fair Value
 
Amortized
Cost
 
< 1 year
 
$
55

 
$
55

 
$

 
$

≥ 1 year and < 3 years
 
44,473

 
43,320

 
22,237

 
22,254

≥ 3 years and < 5 years
 
1,194,131

 
1,148,197

 
6,542,389

 
6,365,623

≥ 5 years
 
1,548,303

 
1,370,373

 
5,377,140

 
5,198,416

Total Agency Securities
 
$
2,786,962

 
$
2,561,945

 
$
11,941,766

 
$
11,586,293




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15
ARMOUR Residential REIT, Inc.
FINANCIAL STATEMENT NOTES (UNAUDITED)
(in thousands, except per share)


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 March 31, 2020 and December 31, 2019 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.

Trading Securities:

Our Credit Risk Transfer securities are collateralized by residential mortgage loans meeting agency criteria. However, our securities principal and interest are not guaranteed by the agencies. Credit Risk Transfer securities include tranches issued since 2014. Our Non-Agency Securities are collateralized by residential mortgage loans not guaranteed by any agency and include legacy securities issued between 2005 and 2007.

The components of the carrying value of our Trading Securities at March 31, 2020 and December 31, 2019 are presented in the table below. We did not have any U.S. Treasury Securities or Interest-Only Securities at March 31, 2020 and December 31, 2019.

 
 
Principal Amount
 
Amortized Cost
 
Gross Unrealized Loss
 
Gross Unrealized Gain
 
Fair Value
March 31, 2020
 
 
 
 
 
 
 
 
 
 
Credit Risk Transfer
 
$
821,060

 
$
808,091

 
$
(112,182
)
 
$
132

 
$
696,041

Non-Agency Securities
 
90,721

 
70,154

 
(1,675
)
 
1,033

 
69,512

Total Credit Risk and Non-Agency Securities
 
$
911,781

 
$
878,245

 
$
(113,857
)
 
$
1,165

 
$
765,553

 
 
 
 
 
 
 
 
 
 
 
December 31, 2019
 
 
 
 
 
 
 
 
 
 
Credit Risk Transfer
 
$
754,729

 
$
751,940

 
$

 
$
52,024

 
$
803,964

Non-Agency Securities
 
93,723

 
72,904

 
(3
)
 
6,736

 
79,637

Total Credit Risk and Non-Agency Securities
 
$
848,452

 
$
824,844

 
$
(3