Armour Residential REIT Prepping for Growth

Despite the lingering uncertainty in the United States Treasury yield curve and the state of the residential mortgage market, ARMOUR Residential REIT, Inc. (NYSE: ARR) executives are optimistic about the opportunities for both ARMOUR and the Agency Mortgage REIT businesses model.

The residential mortgage company invests in low duration agency mortgage-backed securities from the Federal National Mortgage Association (Fannie Mae), the Federal Home Loan Mortgage Corporation (Freddie Mac) and the Government National Mortgage Administration (Ginnie Mae).

ARMOUR Residential has grown from 80 million to more than 600 million of additional paid-in capital from June 2010 to June 2011, and revenues have grown accordingly. Returns on equity have averaged close to 19 percent for the last year, according to company executives.

Jeffrey Zimmer and Scott Ulm, co-chief executive officers, started ARMOUR through a reverse merger with a special purpose acquisition corporation in late 2009.  In June 2010 the company was listed on the American Stock Exchange following an underwritten deal led by Ladenburg Thalmann & Co. Inc., a subsidiary of Ladenburg Thalmann Financial Services Inc.

The Securities and Exchange Commission (SEC) is currently reviewing whether it should issue any new rules that would clarify under what circumstances companies primarily holding mortgages should continue to be exempt from the Investment Company Act of 1940. According to Zimmer, mortgage REIT stocks have faced pressure over the past few weeks as a direct result of this review.

If the Investment Company Act applies, an issuer would be subject to limits on the amount of leverage it could use as well as limits on the fees that investors can be charged.

"The SEC Investment Act review has to be resolved, ideally on a limited and rapid basis in order for capital raising to start again in the sector. I am quite optimistic about the long-term opportunities of this business model. Once the SEC issue is resolved, you should expect to see capital start flowing back into the mortgage REIT sector."

Zimmer said mortgage REITs are well positioned as part of the solution to the residential mortgage issue, as Fannie and Freddie continue to be forced out of the market through legislative action.

ARMOUR also has a unique attribute in the mortgage REIT area, according to Zimmer.

"We pay a dividend monthly; we are the only type of company in this space that pays a monthly dividend," he said.

In terms of corporate governance, Zimmer said the company prides itself on its transparency and application of best practices. He said the board chair, Daniel Stanton, is a non-executive with a REIT background. He has served as COO of Duke Realty Corporation, (NYSE: DRE) and serves on the board of Public Storage (NYSE: PSA). ARMOUR also publishes a monthly company update detailing its assets and liabilities, in addition to quarterly SEC reporting.

Target Assets

ARMOUR acquires its agency mortgage assets from various sources, including originators, dealer inventories and bid lists. Most importantly, however, Zimmer said the company focuses on the underlying credit, structure and particular characteristics of each mortgage pool.

"We dig very deep because we want to know exactly what we own; we have to know everything we can about the pool in order to manage our prepayment risk," he said.

Zimmer added that the company targets mortgages with a low duration of 1.5 years or less. It purchases agency securities that are easily traded and priced, such as "pass-through" securities. It doesn't own any derivative mortgage investments or collateralized mortgage obligations (CMOs).

"Our belief is we want to be extremely diversified in our securities selection so as not to be subject to idiosyncratic pool risk," he said.

ARMOUR is very focused on liquidity and holds up to 40 percent of unlevered equity in cash between prepayment periods, which equates to about 18 to 22 percent of additional paid-in capital.

"We strive to maintain extremely high levels of liquidity," he said. "This can really pay off in periods of stress, like today's environment."