UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

                                  

FORM 10-Q

                                  

ý

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

For Fiscal Quarter Ended March 31, 2011

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	001-33736	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 Class	Name of Exchange on which registered
Common Stock, $0.001 par value Warrants to Purchase Common Stock	NYSE NYSE

Securities registered pursuant to Section 12(b) of the Act:

None.

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 twelve 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 ý NO ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding twelve months (or for such shorter period that the registrant was required to submit and post such files).  Yes  ¨    NO  ¨

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

Large accelerated filer ¨          Accelerated filer ¨          Non-accelerated filer ý          Smaller reporting company ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES ¨ NO ý   

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

The number of outstanding shares of the Registrant’s common stock as of May 2, 2011 was 49,260,077.

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TABLE OF CONTENTS

PART I. Financial Information	3
Item 1. Financial Statements	3
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	25
Item 3. Quantitative and Qualitative Disclosures About Market Risk	40
Item 4. Controls and Procedures	42
PART II. Other Information	43
Item 1. Legal Proceedings	43
Item 1A. Risk Factors	43
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	43
Item 3. Defaults Upon Senior Securities	43
Item 4. Removed and Reserved	43
Item 5. Other Information	43
Item 6. Exhibits	43

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ARMOUR Residential REIT, Inc. and Subsidiaries

CONDENSED CONSOLIDATED BALANCE SHEETS

PART I. Financial Information

Item 1. Financial Statements

Assets		(Unaudited) March 31, 2011		December 31, 2010
Cash	$	47,174,161	$	35,343,907
Restricted cash		13,713,222		4,680,603
Agency securities, available for sale, at fair value (including pledged assets of $2,206,904,817 and $1,023,749,488)		2,273,914,732		1,161,850,680
Principal payments receivable		2,878,391		2,642,149
Accrued interest receivable		7,705,149		3,892,834
Prepaid and other assets		287,908		266,203
Refundable income taxes		-		547,574
Total Assets	$	2,345,673,563	$	1,209,223,950
Liabilities and Stockholders’ Equity
Liabilities:
Repurchase agreements	$	2,099,366,245	$	971,675,658
Payable for unsettled securities		19,941,430		125,418,369
Interest rate contracts, at fair value		4,666,298		2,530,645
Accounts payable and accrued expenses		971,324		454,379
Dividends payable		115,891		436,322
Total Liabilities		2,125,061,188		1,100,515,373
Stockholders’ Equity:
Preferred stock, $0.001 par value, 25,000,000 shares authorized, none outstanding at March 31, 2011 and December 31, 2010		-		-
Common stock, $0.001 par value, 250,000,000 shares authorized, 32,254,054 and 16,441,554 shares issued and outstanding at March 31, 2011 and December 31, 2010, respectively.		32,254		16,442
Additional paid-in capital		229,733,052		116,748,175
Accumulated deficit		(4,677,964)		(3,826,510)
Accumulated other comprehensive loss		(4,474,967)		(4,229,530)
Total Stockholders’ Equity		220,612,375		108,708,577
Total Liabilities and Stockholders’ Equity	$	2,345,673,563	$	1,209,223,950

See notes to condensed consolidated financial statements.

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ARMOUR Residential REIT, Inc. and Subsidiaries

CONDENSED CONSOLIDATED STATEMENTS of OPERATIONS

(Unaudited)

		Three months Ended March 31, 2011		Three months Ended March 31, 2010
Interest Income:
Interest income, net of amortization of premium	$	13,734,829	$	1,108,138
Total interest income		13,734,829		1,108,138
Interest expense:
Repurchase agreements		(1,355,481)		(120,646)
Interest rate swap contracts		(2,021,259)		-
Total interest expense		(3,376,740)		(120,646)
Net interest income		10,358,089		987,492
Other Income:
Change in fair value of interest rate contracts		(266,223)		(603,579)
Net interest income after change in fair value of       interest rate contracts		10,091,866		383,913
Realized loss on interest rate contracts		(116,159)		-
Realized gain on sale of agency  securities		-		208,199
Total net revenues		9,975,707		592,112
Expenses:
Professional fees		371,014		146,030
Insurance		51,156		51,912
Management fee		755,820		57,598
Other		192,644		28,339
Total expenses		1,370,634		283,879
Net income before taxes		8,605,073		308,233
Income tax expense		(9,000)		(2,400)
Net Income	$	8,596,073	$	305,833
Weighted average shares outstanding :
Basic and diluted		26,398,637		2,304,054
Net income per share
Basic and diluted	$	0.33	$	0.13

See notes to condensed consolidated financial statements.

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ARMOUR Residential REIT, Inc. and Subsidiaries

CONDENSED CONSOLIDATED STATEMENTS of STOCKHOLDERS’ EQUITY

(Unaudited)

									Accumulated Other Comprehensive Loss
					Additional Paid-In Capital
	Common Stock						Accumulated Deficit				Comprehensive Income
	Shares		Amount										Total
Balance, December 31, 2010	16,441,554	$	16,442	$	116,748,175	$	(3,826,510)	$	(4,229,530)	$	-	$	108,708,577
Dividends declared	-		-		-		(9,447,527)		-		-		(9,447,527)
Sale of 15,812,500 shares, net of underwriters’ discount and offering expenses	15,812,500		15,812		112,974,513		-		-		-		112,990,325
Stock based compensation awarded to directors	-		-		10,364		-		-		-		10,364
Net income	-		-		-		8,596,073		-		8,596,073		8,596,073
Net change in unrealized loss on investment in Available for Sale securities	-		-		-		-		(245,437)		(245,437)		(245,437)
Comprehensive income	-		-		-		-		-	$	8,350,636
Balance, March 31, 2011	32,254,054	$	32,254	$	229,733,052	$	(4,677,964)	$	(4,474,967)			$	220,612,375

See notes to condensed consolidated financial statements.

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ARMOUR Residential REIT, Inc. and Subsidiaries

CONDENSED CONSOLIDATED STATEMENTS of CASH FLOWS

(Unaudited)

		Three months Ended  March 31, 2011		Three months Ended  March 31, 2010
Cash Flows From Operating Activities:
Net income	$	8,596,073	$	305,833
Adjustments to reconcile net  income to net cash provided by operating activities:
Net amortization of premium on Agency Securities		3,274,606		610,659
Change in fair value of interest rate contracts		2,135,653		596,925
Gain on sale of Agency Securities		-		(208,199)
Stock based compensation		10,364		-
Changes in operating assets and liabilities:
Increase in accrued interest receivable		(3,812,315)		(550,054)
Decrease (increase) in prepaid income taxes and other assets		525,869		(24,296)
Increase in accounts payable and accrued expenses		516,945		45,694
Net cash provided by operating activities		11,247,195		776,562
Cash Flows From Investing Activities:
Purchases of Agency Securities		(1,189,243,231)		(147,963,888)
Principal repayments of Agency Securities		71,252,666		6,562,794
Proceeds from sales of Agency Securities		-		31,531,266
Unsettled security purchases		(103,306,711)		(15,927,169)
Net cash used in investing activities		(1,221,297,276)		(125,796,997)
Cash Flows From Financing Activities:
Sale of common stock, net of expenses		112,990,325		-
Proceeds from repurchase agreements		4,541,638,738		306,657,050
Principal repayments on repurchase agreements		(3,413,948,151)		(184,520,559)
Increase in restricted cash		(9,032,619)		(917,184)
Dividends paid		(9,767,958)		(70,447)
Net cash provided by financing activities		1,221,880,335		121,148,860
Net Increase (decrease) in cash		11,830,254		(3,871,575)
Cash - beginning of period		35,343,907		6,653,331
Cash - end of period	$	47,174,161	$	2,781,756
Supplemental Disclosure:
Cash paid for income taxes (not including tax refunds received)	$	12,000	$	3,025
Cash paid during the period for interest	$	1,104,971	$	88,381
Non-Cash Investing Activity:
Net unrealized(loss) gain or investment in available for sale securities	$	(245,437)		542,418

See notes to condensed consolidated financial statements.

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ARMOUR Residential REIT, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2011

(Unaudited)

Note 1 – Basis of Presentation

The balance sheet as of December 31, 2010, which has been derived from the audited financial statements, and the unaudited financial statements included herein have been prepared from the books and records of ARMOUR Residential REIT, Inc. (“the Company”) pursuant to the rules and regulations of the Securities and Exchange Commission for reporting in the Quarterly Report on Form 10-Q. The information and note disclosures normally included in complete financial statements prepared in accordance with generally accepted accounting principles in the U.S (“GAAP”) have been condensed or omitted pursuant to such rules and regulations. The interim financial information should be read in conjunction with the audited financial statements and notes thereto for the year ended December 31, 2010, which are filed on Form 10-K.

The Company’s management is responsible for this interim financial information. Interim results may not be indicative of the results that may be expected for the year. However, we believe that all adjustments considered necessary for a fair presentation of this financial information have been included and are of a normal and recurring nature.  

Note 2 - Organization and Nature of Business Operations

Business

References to “we”, “us”, “our”  "ARMOUR" or the “Company” are to ARMOUR Residential REIT, Inc. References to "ARRM" are to ARMOUR Residential Management LLC, a Delaware limited liability company. References to “Enterprise” are to Enterprise Acquisition Corp., a wholly-owned subsidiary of ARMOUR.

We are an externally-managed Maryland corporation organized in 2008, managed by ARRM. We invest primarily in hybrid adjustable rate, adjustable rate and fixed rate residential mortgage backed securities issued or guaranteed by a U.S. Government-chartered entity, such as the Federal National Mortgage Association (more commonly known as Fannie Mae) and the Federal Home Loan Mortgage Corporation (more commonly known as Freddie Mac), or guaranteed by the Government National Mortgage Administration, a U.S. Government corporation (more commonly known as Ginnie Mae) (collectively, "Agency Securities").  From time to time, a portion of our portfolio may be invested in unsecured notes and bonds issued by U.S. Government-chartered entities (collectively, “Agency Debt”), U.S. Treasuries and money market instruments, subject to certain income tests we must satisfy for our qualification as a real estate investment trust (“REIT”).

We intend to qualify and have elected to be taxed as a REIT under the Internal Revenue Code (“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 federal income tax purposes, we may still be subject to some federal, state and local taxes on our income.

Note 3 - Summary of Significant Accounting Policies

Basis of Presentation and Consolidation and Use of Estimates

Our financial statements are presented in U.S. dollars in conformity with GAAP. The condensed consolidated financial statements include the accounts of ARMOUR and all subsidiaries; all intercompany accounts and transactions have been eliminated.   

The preparation of financial information in conformity with GAAP requires management to make estimates that affect the reported assets and liabilities at the date of the balance sheet and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

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ARMOUR Residential REIT, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2011

(Unaudited)

Cash

Cash includes cash on deposit with financial institutions and investments in high quality overnight money market funds, all of which have maturities of three months or less, at time of purchase. 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 of the depository institutions in which those deposits are held. The carrying amount of cash is deemed to be its fair value.

Restricted Cash

Restricted cash at March 31, 2011 and December 31, 2010, represents approximately $13.7 million and $4.7 million, respectively, held by counterparties as collateral for interest rate contracts.

Agency Securities, at Fair Value

We invest primarily in Agency Securities. A portion of our portfolio may be invested in Agency Debt, U.S. Treasuries and money market instruments, subject to certain income tests we must satisfy for our qualification as a REIT. We have committed ourselves to the Agency asset class by including in our charter a requirement that all of our financial instrument investments will consist of Agency Securities, Agency Debt, U.S. Treasuries and money market instruments (including reverse repurchase agreements) and hedging and other derivative instruments related to the foregoing investments.

We classify our Agency Securities as either trading, available for sale or held to maturity securities.  Management determines the appropriate classifications of the securities at the time they are acquired and evaluates the appropriateness of such classifications at each balance sheet date.

  

We may recognize impairments in our investment portfolio which, among other things, requires: the determination as to when an investment is considered impaired; whether that impairment is other than temporary; the measurement of an impairment loss; accounting considerations subsequent to the recognition of an other than temporary impairment; and certain disclosures about unrealized losses that have not been recognized as other than temporary impairments.  

We assess our investment portfolio for other than temporary impairment on a quarterly basis, or more frequently if conditions merit.  When the fair value of an investment is less than its amortized cost at the balance sheet date of the reporting period for which impairment is assessed, the impairment is designated as either “temporary” or “other than temporary.”

Fair Value of Financial Instruments

We consider our cash, restricted cash, Agency Securities, Available for Sale (settled and unsettled), accrued interest receivable, accounts payable, interest rate contracts, repurchase agreements and accrued interest payable to meet the definition of financial instruments. The carrying amount of cash, restricted cash, accrued interest receivable and accounts payable approximate their fair value due to the short maturities of these instruments. See Notes 5 and 6, respectively, for discussion of the fair value of Agency Securities, Available for Sale and Interest Rate Contracts. The carrying amount of repurchase agreements and accrued interest payable is deemed to approximate fair value due to the short-term maturities of these instruments.

Agency Security Valuation

Agency Securities are valued using third-party pricing services and dealer quotes. The third-party pricing services use common market pricing methods including pricing models that 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 independent pricing service, or such data appears unreliable, we obtain valuations from up to three dealers who make markets in similar financial instruments. The dealers will incorporate common market pricing methods, including a spread measurement to the Treasury curve or interest rate swap curve as well as underlying characteristics of the particular security including coupon, periodic and life caps, collateral type, rate reset period and seasoning or age of the security. Management reviews pricing used to ensure that current market conditions are properly represented. This review may include, but is not limited to, comparisons of similar market transactions, alternative third-party pricing services and dealer quotes, or comparisons to a pricing model. The resulting unrealized gains and losses are reflected in our condensed consolidated balance sheets as accumulated other comprehensive loss.

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ARMOUR Residential REIT, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2011

(Unaudited)

Repurchase Agreements

We finance the acquisition of elements of our investment portfolio through the use of repurchase agreements.  Our repurchase agreements are secured by our Agency Securities and bear interest rates that have historically moved in close relationship to the London Interbank Offered Rate (“LIBOR”). Under these agreements, we sell securities to a lender and agree to repurchase the same securities 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.  Although structured as a sale and repurchase obligation, a repurchase agreement operates as financing under which we pledge our securities 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 financing 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. 

Derivatives

We seek to mitigate the exposure to potential interest rate mismatches between the interest earned on investments and the borrowing costs caused by fluctuations in short-term interest rates. In a simple interest rate swap, one investor pays a floating rate of interest on a notional principal amount and receives a fixed rate of interest on the same notional principal amount for a specified period of time. Alternatively, an investor may pay a fixed rate and receive a floating rate. During the term of the interest rate swap, we make or receive periodic payments and unrealized gains or losses are recorded as a result of marking the swaps to their fair value. If a swap is terminated prior to maturity, we record a realized gain or loss equal to the difference between the proceeds from (or cost of) the closing transaction and our cost basis in the contract, if any. The periodic payments and any realized gains or losses are reported under realized gain (loss) on interest rate contracts in our statement of operations. All unrealized gains or losses are reported under change in fair value of interest rate contracts in our statements of operations. Swaps involve a risk that interest rates will move contrary to our expectations, which may reduce the periodic payments we receive or increase our payment obligations.

We are exposed to credit loss in the event of nonperformance by the counterparty to the swap, limited to any gains recognized. However, as of March 31, 2011, we did not anticipate nonperformance by any counterparty. Should interest rates move unexpectedly, we may not achieve the anticipated benefits of the interest rate swaps and may realize a loss.

We recognize all derivative instruments as either assets or liabilities at fair value on our condensed consolidated balance sheet. We do not designate our interest rate risk mitigation activities as cash flow hedges, which, among other factors, would require us to match the pricing dates of both hedging transactions and repurchase agreements. Operational issues and credit market volatility make such matching impractical for us.  Since we will not qualify for hedge accounting treatment as prescribed by GAAP, our operating results may reflect greater volatility than otherwise would be the case, because gains or losses on the interest rate risk mitigation instruments may not be offset by changes in the fair value or cash flows of the transaction within the same accounting period, or ever. Consequently, any declines in our interest rate contracts would result in a charge to earnings. We will continue to designate interest rate risk mitigation activities as hedges for tax purposes and any unrealized gains or losses should not affect our distributable net income.  

Credit Risk

We have limited our exposure to credit losses on our portfolio of Agency Securities by only purchasing securities issued by Freddie Mac, Fannie Mae or Ginnie Mae. The payment of principal and interest on the Freddie Mac and Fannie Mae Agency Securities are guaranteed by those respective agencies, and the payment of principal and interest on the Ginnie Mae Agency Securities are backed by the full faith and credit of the U.S. government.

Market Risk

Weakness in the mortgage market may adversely affect the performance and market value of our investments. This could negatively impact our net book value. Furthermore, if our lenders are unwilling or unable to provide additional financing, we could be forced to sell our Agency Securities at an inopportune time when prices are depressed. The principal payments are guaranteed by Freddie Mac, Fannie Mae, or Ginnie Mae on our Agency Securities.

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ARMOUR Residential REIT, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2011

(Unaudited)

Preferred Stock

We are authorized to issue 25,000,000 shares of preferred stock with such designations, voting and other rights and preferences as may be determined from time to time by the Board of Directors (“Board”) or a committee thereof.

Common Stock and Warrants

At March 31, 2011, we had 32,254,054 shares of common stock issued and outstanding, and have authorized 250,000,000 shares of common stock, par value $0.001.  At March 31, 2011, we had outstanding warrants to purchase 32,500,000 shares of common stock, which are exercisable at $11.00 per share and expire in 2013.

Income per Common Share

Basic income per common share for all periods is computed by dividing the earnings applicable to common stockholders by the weighted average number of common shares outstanding for the period.  Warrants issued in the offering and sponsor warrants were contingently exercisable upon consummation of a business combination. The basic and pro forma diluted income per common share for the quarter ended March 31, 2011 and March 31, 2010, does not include 32,500,000 warrants as the effect of including such warrants would be anti-dilutive. Pro forma diluted income per share would reflect the potential dilution assuming common shares were issued upon the exercise of outstanding warrants and the proceeds thereof were used to purchase common shares at the average market price during the period.  

Comprehensive Income

Other comprehensive income refers to revenue, expenses, gains and losses that are recorded directly as an adjustment to shareholders’ equity.  Other comprehensive income arises primarily from changes in unrealized gains or losses generated from changes in market values of our Agency Securities held as available for sale.

Revenue Recognition

Interest income is earned and recognized based on the outstanding principal amount of the investment securities and their contractual terms.  Premiums and discounts associated with the purchase of investment securities are amortized or accreted into interest income over the actual lives of the securities.

Income Taxes

We intend to qualify and have elected to be taxed as a REIT under the Code. We will generally not be subject to federal income tax to the extent that we distribute 90% of our taxable income to our shareholders, and as long as we satisfy the ongoing REIT requirements including meeting certain asset, income and stock ownership tests.

Our management is responsible for determining whether a tax position taken by us is more likely than not to be sustained on its merits. We have no material unrecognized tax benefits and have not recognized in these financial statements any interest or penalties related to income taxes. Should any such penalties and interest be recognized, they will be included in other expenses and interest expense, respectively. No tax returns of ours have been examined by federal, state or local authorities; therefore all years which are statutorily open are subject to examination by the appropriate authorities.

Note 4 - Recent Accounting Pronouncements

In January 2010, the Financial Accounting Standards Board (“FASB”) issued new authoritative literature, which clarifies certain existing disclosure requirements and requires additional disclosures for recurring and nonrecurring fair value measurements. These additional disclosures include amounts and reasons for significant transfers between Level 1 and Level 2 of the fair value hierarchy; significant transfers in and out of Level 3 of the fair value hierarchy; and information about purchases, sales, issuances and settlements on a gross basis in the reconciliation of recurring Level 3 measurements. The requirements of this standard are effective for periods beginning after December 15, 2009, with the exception of the requirement of information about purchases, sales, issuances and settlements of Level 3 measurements, which becomes effective for periods beginning after December 15, 2010. We adopted the guidance related to Level 1 and Level 2 disclosures effective January 1, 2010 and adopted the guidance related to Level 3 disclosures effective January 1, 2011; the full adoption of this guidance did not have a material effect on our financial statements.

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ARMOUR Residential REIT, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2011

(Unaudited)

In July 2010, the FASB issued guidance that primarily requires additional disaggregated disclosures of (i) credit risks associated with financing receivables, and (ii) impaired financing receivables and the related allowance for credit losses. The guidance is generally effective for the first interim or annual period ending after December 15, 2010; however certain disclosures are not required until the first interim or annual period beginning after December 15, 2010. The adoption of the guidance did not require us to include additional disclosures in the notes to our condensed consolidated financial statements.

Note 5 - Agency Securities, Available for Sale

All of our Agency Securities are classified as available for sale and, as such, are reported at their estimated fair value. Management generally determines the fair values of Agency Securities by using third-party pricing services and dealer quotes. The third-party pricing services use common market pricing methods including pricing models that 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. The dealer quotes incorporate common market pricing methods, including a spread measurement to the Treasury curves or interest rate swap curve as well as underlying characteristics of the particular security including coupon, periodic and life caps, rate reset period, issuer, additional credit support and expected life of the security. Management reviews pricing used to ensure that current market conditions are represented. This review may include, but is not limited to, comparisons of similar market transactions, alternative third-party pricing services and dealer quotes, or comparisons to a pricing model. At March 31, 2011 and December 31, 2010, all of our Agency Security values were based solely on third-party sources.

As of March 31, 2011, we had the following securities in an unrealized loss and/or a gain position as presented below. The table below includes $20.0 million of current carrying value of forward settle security purchases.

As of December 31, 2010, we had the following securities in an unrealized loss and/or a gain position as presented below. The table below includes $125.3 million of current carrying value of forward settle security purchases.

The components of the carrying value of available for sale Agency Securities at March 31, 2011, are presented below.

		March 31, 2011
Principal balance settled securities	$	2,169,947,596
Principal balance forward settle securities		19,011,912
Unamortized premium settled securities		88,500,672
Unamortized premium forward settle securities		929,519
Gross unrealized gains		5,553,658
Gross unrealized losses		(10,028,625)
Carrying value/estimated fair value	$	2,273,914,732

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ARMOUR Residential REIT, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2011

(Unaudited)

The components of the carrying value of available for sale Agency Securities at December 31, 2010, are presented below.

		December 31, 2010
Principal balance settled securities	$	995,994,552
Principal balance forward settle securities		120,473,239
Unamortized premium settled securities		44,724,477
Unamortized premium forward settle securities		4,887,942
Gross unrealized gains		3,643,479
Gross unrealized losses		(7,873,009)
Carrying value/estimated fair value	$	1,161,850,680

As of March 31, 2011, our Agency Securities portfolio was purchased at a net premium to par value with a weighted average amortized cost, including settled and forward settle securities, of 104.09%, due to the average interest rates on these securities being higher than prevailing market rates. As of March 31, 2011, we had approximately $89.4 million of unamortized premium included in the cost basis of our investments, inclusive of both settled and forward settle securities. As of March 31, 2011, our investment portfolio of securities consisted of Agency Securities as follows:

Adjustable Rate Settled Securities as of March 31, 2011

Fixed Rate Settled Securities as of March 31, 2011

All Settled Securities as of March 31, 2011

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ARMOUR Residential REIT, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2011

(Unaudited)

As of March 31, 2011, we had committed to purchase securities for settlements in April of 2011. The information below was current as of March 31, 2011, but subject to change due to amortization prior to settlement. In addition, some forward trades of new issue securities are subject to modest changes in delivery size and coupon.

Adjustable Rate Forward Settle Securities as of March 31, 2011

Fixed Rate Forward Settle Securities as of March 31, 2011

All Forward Settle Securities as of March 31, 2011

All Settled and Forward Settle Securities as of March 31, 2011

13

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ARMOUR Residential REIT, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2011

(Unaudited)

As of December 31, 2010, our Agency Securities portfolio was purchased at a net premium to par value with a weighted average amortized cost, including settled and forward settle securities, of 104.44%, due to the average interest rates on these securities being higher than prevailing market rates. As of December 31, 2010, we had approximately $49.6 million of unamortized premium included in the cost basis of our investments, inclusive of both settled and forward settle securities. All unsettled purchases of securities as of December 31, 2010, were settled in January and February 2011. As of December 31, 2010, our investment portfolio of settled securities consisted of Agency Securities as follows:

Adjustable Rate Settled Securities as of December 31, 2010

Fixed Rate Settled Securities as of December 31, 2010

All Settled Securities as of December 31, 2010

14

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ARMOUR Residential REIT, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2011

(Unaudited)

(1)	The current face is the current monthly remaining dollar amount of principal of an Agency Security. We compute current face by multiplying the original face value of the security by the current principal balance factor. The current principal balance factor is a fraction, where the numerator is the current outstanding balance and the denominator is the original principal balance.
(2)	For a pass-through certificate, the coupon reflects the weighted average nominal rate of interest paid on the underlying mortgage loans, net of fees paid to the servicer and the agency. The coupon for a pass-through certificate may change as the underlying mortgage loans are prepaid.
(3)	Amortized purchase price is the dollar amount, per $100 of current face, of our purchase price for the security, adjusted for amortization as a result of scheduled and unscheduled principal repayments.
(4)	Amortized cost is our total purchase price for the Agency Security, adjusted for amortization as a result of scheduled and unscheduled principal repayments.
(5)	Market price is the dollar amount of market value, per $100 of nominal, or face value, of the Agency Security. We value our Agency Securities using a third party pricing service whose pricing model incorporates common market pricing methods. Management reviews the pricing to ensure that current market conditions are properly represented.
(6)	Market value is the total market value for the security.

As of December 31, 2010, we had committed to purchase securities for settlements in January and February of 2011. The information below was current as of December 31, 2010, but subject to change due to amortization prior to settlement. In addition, some forward trades of new issue securities are subject to modest changes in delivery size and coupon. All, but one, of the forward settling Agency Securities were adjustable rate with a minimum expected reset of 11 months and a maximum expected reset of 71 months.

Adjustable Rate Forward Settle Securities as of December 31, 2010

Fixed Rate Forward Settle Securities as of December 31, 2010  

All Forward Settle Securities as of December 31, 2010

All Settled and Forward Settle Securities as of December 31, 2010

15

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ARMOUR Residential REIT, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2011

(Unaudited)

(1)	The current face is the current monthly remaining dollar amount of principal of an Agency Security. We compute current face by multiplying the original face value of the security by the current principal balance factor. The current principal balance factor is a fraction, where the numerator is the current outstanding balance and the denominator is the original principal balance.
(2)	For a pass-through certificate, the coupon reflects the weighted average nominal rate of interest paid on the underlying mortgage loans, net of fees paid to the servicer and the agency. The coupon for a pass-through certificate may change as the underlying mortgage loans are prepaid.
(3)	Amortized purchase price is the dollar amount, per $100 of current face, of our purchase price for the security, adjusted for amortization as a result of scheduled and unscheduled principal repayments.
(4)	Amortized cost is our total purchase price for the Agency Security, adjusted for amortization as a result of scheduled and unscheduled principal repayments.
(5)	Market price is the dollar amount of market value, per $100 of nominal, or face value, of the Agency Security. We value our Agency Securities using a third party pricing service whose pricing model incorporates common market pricing methods. Management reviews the pricing to ensure that current market conditions are properly represented.
(6)	Market value is the total market value for the security.

Our investment portfolio consisted of the following breakdown between Fannie Mae, Freddie Mac and Ginnie Mae at March 31, 2011.

Agency Securities		March 31, 2011
		Estimated Fair Value		Percentage of Total
Settled Securities
Fannie Mae Certificates	$	1,549,507,563		68.1	%
Freddie Mac Certificates		295,920,612		13.0
Ginnie Mae Certificates		408,454,526		18.0
Forward Settle Securities
Fannie Mae Certificates		13,672,664		0.6
Freddie Mac Certificates		1,424,893		0.1
Ginnie Mae Certificates		4,934,474		0.2
Total Securities	$	2,273,914,732		100.0	%

Our investment portfolio consisted of the following breakdown between Fannie Mae, Freddie Mac and Ginnie Mae at December 31, 2010.

Agency Securities		December 31, 2010
		Estimated Fair Value		Percentage of Total
Settled Securities
Fannie Mae Certificates	$	718,542,007		61.8	%
Freddie Mac Certificates		257,316,342		22.2
Ginnie Mae Certificates		60,662,164		5.2
Forward Settle Securities
Fannie Mae Certificates		125,330,167		10.8
Freddie Mac Certificates		-		-
Ginnie Mae Certificates		-		-
Total Securities	$	1,161,850,680		100.0	%

As of March 31, 2011 and December 31, 2010, the adjustable and hybrid adjustable rate mortgage loans underlying our Agency Securities have fixed interest rates for an average period of approximately 54 months and 64 months respectively, after which time the interest rates reset and become adjustable. After a reset date, interest rates on our adjustable and hybrid adjustable Agency Securities float based on spreads over various indices, typically LIBOR or the one-year Constant Maturity Treasury (“CMT”), rate. These interest rates are subject to caps that limit the amount the applicable interest rate can increase during any year, known as an annual cap, and through the maturity of the security, known as a lifetime cap.

16

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ARMOUR Residential REIT, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2011

(Unaudited)

Note 6 - Interest Rate Contracts

We enter into transactions to manage our interest rate risk exposure. These transactions include purchasing or selling Eurodollar futures contracts (“Futures Contracts”) as well as purchasing or selling interest rate swap contracts. These transactions are designed to lock in funding costs for financing activities associated with our assets in such a way to help assure the realization of attractive net interest margins.  Such transactions are based on assumptions about prepayments which, if not realized, will cause transaction results to differ from expectations. We do not designate our activities as cash flow hedges, and as such, we recognize changes in the fair value of these transactions through earnings (See Note 3). For the quarter ended March 31, 2011 and 2010, we recognized non-cash losses of $0.3 million and $0.6 million, respectively. Our derivative instruments are carried on our condensed consolidated balance sheets at fair value, as assets, if their fair value is positive, or as liabilities, if their fair value is negative.

As of March 31, 2011 and December 31, 2010, we had entered into $134.0 million and $214.0 million (notional amount), respectively, of Eurodollar Future swap equivalents traded in 1,435 and 2,361 individual contract transactions, respectively. Our Futures Contracts are traded on the Chicago Mercantile Exchange (“CME”) which requires the use of daily mark-to-market collateral and the CME provides substantial credit support. The collateral requirements of the CME require us to pledge assets under a bi-lateral margin arrangement, including either cash or Agency Securities, and these requirements may vary and change over time based on the market value, notional amount, and remaining term of the Futures Contracts.  In the event we are unable to meet a margin call under one of our Futures Contracts, the counterparty to such agreement may have the option to terminate or close-out all of the outstanding Futures Contracts with us. In addition, any close-out amount due to the counterparty upon termination of the counterparty’s transactions would be immediately payable by us pursuant to the applicable agreement.  

As of March 31, 2011 and December 31, 2010, we had entered into $965.0 million and $155.0 million (notional amount) of swap contracts, respectively, traded in 37 and 10 individual transactions, respectively. Consistent with market practice, we have agreements with our swap counterparties that provide for the posting of collateral based on the fair values of our interest rate contracts. Through this margining process, either we or our swap counterparty may be required to pledge cash or securities as collateral. Collateral requirements vary by counterparty and change over time based on the market value, notional amount and remaining term of the swap. Certain interest rate swap contracts provide for cross collateralization and cross default with repurchase agreements and other contracts with the same counterparty.

We had $4.0 million and $4.4 million of restricted cash related to margin posted for Futures Contracts as of March 31, 2011 and December 31, 2010, respectively. We had $9.7 million and $0.3 million of restricted cash related to interest rate swap contracts as of March 31, 2011 and December 31, 2010, respectively.

The following tables present information about interest rate swap contracts which are included in interest rate contracts on the accompanying condensed consolidated balance sheet as of March 31, 2011 and December 31, 2010:

		Notional Amount		Value as of March 31, 2011		Fixed Rate
Interest rate swaps maturing 12-24 months	$	20,000,000	$	(11,376)		0.5	%
Interest rate swaps maturing 24-36 months		290,000,000		167,692		1.1
Interest rate swaps maturing 36-48 months		305,000,000		170,036		1.6
Interest rate swaps maturing 48-60 months		350,000,000		(2,217,262)		2.1
Totals	$	965,000,000	$	(1,890,910)		1.6	%

		Notional Amount		Value as of December 31, 2010		Fixed Rate
Interest rate swaps maturing 12-24 months	$	20,000,000	$	(9,981)		0.5	%
Interest rate swaps maturing 24-36 months		100,000,000		147,282		1.0
Interest rate swaps maturing 36-48 months		10,000,000		(9,195)		1.4
Interest rate swaps maturing 48-60 months		25,000,000		(26,039)		1.9
Totals	$	155,000,000	$	102,067		1.1	%

17

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ARMOUR Residential REIT, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2011

(Unaudited)

The following tables present information about Futures Contracts which are included in interest rate contracts on the accompanying condensed consolidated balance sheet as of March 31, 2011 and December 31, 2010:

		Notional Amount		Value as of March 31, 2011		Weighted Average Rate
Eurodollar future strips maturing 3/19/12-9/17/12	$	13,000,000	$	(118,788)		1.0	%
Eurodollar future strips maturing 3/18/13-9/16/13		47,000,000		(954,937)		1.6
Eurodollar future strips maturing 3/17/14-12/15/14		64,000,000		(1,603,725)		2.1
Eurodollar future strips maturing 9/14/15		10,000,000		(97,938)		2.1
Totals	$	134,000,000	$	(2,775,388)		1.8	%

		Notional Amount		Value as of December 31, 2010		Weighted Average Rate
Eurodollar future strips maturing 3/19/12-9/17/12	$	28,000,000	$	(137,950)		0.8	%
Eurodollar future strips maturing 3/18/13-12/16/13		107,000,000		(1,114,125)		1.3
Eurodollar future strips maturing 3/17/14-9/15/14		64,000,000		(1,193,113)		1.8
Eurodollar future strips maturing 9/14/15		15,000,000		(187,524)		2.1
Totals	$	214,000,000	$	(2,632,712)		1.6	%

Note 7 - Repurchase Agreements

At March 31, 2011 and December 31, 2010, we had repurchase agreements in place in the amount of $2.1 billion and $1.0 billion, respectively, to finance Agency Security purchases.  For the quarter ended March 31, 2011 and the year ended December 31, 2010, the weighted average interest rate or cost of funds was 0.29% and 0.35%, respectively.  At March 31, 2011 and December 31, 2010, we had repurchase agreements outstanding with fourteen and eleven counterparties, respectively, with a weighted average maturity of 34 days and 32 days, respectively.

 

The following tables represent the contractual repricing information regarding our repurchase agreements:

March 31, 2011		Balance		Weighted Average Contractual Rate			Contractual Interest Payments		Total Contractual Obligation
Within 30 days	$	1,330,270,245		0.29	%	$	172,150	$	1,330,442,395
31 days to 60 days		459,216,000		0.30			151,380		459,367,380
61 days to 90 days		280,790,000		0.30			36,045		280,826,045
Greater than 90 days		29,090,000		0.36			8,436		29,098,436
Total	$	2,099,366,245		0.29	%	$	368,011	$	2,099,734,256

December 31, 2010		Balance		Weighted Average Contractual Rate			Contractual Interest Payments		Total Contractual Obligation
Within 30 days	$	656,601,658		0.36	%	$	120,965	$	656,722,623
31 days to 60 days		123,840,000		0.33			27,244		123,867,244
61 days to 90 days		191,234,000		0.32			71,349		191,305,349
Total	$	971,675,658		0.35	%	$	219,558	$	971,895,216

18

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ARMOUR Residential REIT, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2011

(Unaudited)

At March 31, 2011, our repurchase agreements had the following counterparties, amount at risk and weighted average remaining maturities:

(1)

Equal to the fair value of securities sold, minus the sum of repurchase agreement liabilities plus accrued interest expense.

At December 31, 2010, our repurchase agreements had the following counterparties, amount at risk and weighted average remaining maturities:

(1)

Equal to the fair value of securities sold, minus the sum of repurchase agreement liabilities plus accrued interest expense

As of March 31, 2011 and December 31, 2010, the weighted average margin requirement, or the percentage amount by which the collateral value must exceed the loan amount, which we also refer to as the haircut, under all our repurchase agreements was approximately 5.2% and 5.3%, respectively.

19

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ARMOUR Residential REIT, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2011

(Unaudited)

Note 8 - Commitments and Contingencies

Management Agreement with ARRM

As discussed in Note 14 “Related Party Transactions,” we are party to a management agreement with ARRM. Pursuant to the management agreement, as amended, ARRM is entitled to receive a monthly management fee equal to 1/12^th of 1% of  gross equity raised (including initial gross merger equity as well as any future gross equity raised) until gross equity raised is $50 million, inclusive of gross merger equity. Thereafter, the monthly management fee shall be 1/12^th of (a) 1.5% of gross equity raised up to $1.0 billion and (b) 0.75% of gross equity raised in excess of $1.0 billion, with a monthly minimum based on 1/12^th of $900,000 (inclusive of the original gross merger equity).

Operating Leases

We are not party to any agreement for the rental of real property and office space, or any significant leases for office, computer and other equipment or office furnishings.

Litigation

We are not party to any pending, threatened or contemplated litigation.

Note 9 - Share-Based Compensation

2009 Stock Incentive Plan

We  adopted the 2009 Stock Incentive Plan (the "Plan") to attract, retain and reward directors, officers and other employees of ours, and other persons who provide services to us in the course of operations  (collectively "Eligible Individuals").

The Plan provides for grants of common stock, restricted shares of common stock (“RSU’s”), stock options, performance shares, performance units, stock appreciation rights and other equity and cash-based awards (collectively “awards.”) On May 12, 2010, our Board allocated up to 250,000 shares to be available under the Plan. In considering such allocation, the Board considered the size of the Plan relative to our capital base and our current and potential future performance and capitalization.

The Plan allows for the Board to expand the types of awards available under the Plan and determine the maximum number of shares that may underlie these awards in any one year to any Eligible Individual. If an award granted under the Plan expires or terminates, the shares subject to any portion of the award that expires or terminates without having been exercised or paid, as the case may be, will again become available for the issuance of additional awards.

Awards Under the Plan

During the quarter ended March 31, 2011, we awarded a total of 192,500 RSU’s to members of our Board (the “Board Awards”) and employees of ARRM (the “ARRM Awards”). We account for the ARRM Awards under ASC Topic No. 505-50 ”Equity Based Payments to Non-Employees.”. We account for the Board Awards under ASC Topic No. 718 “Compensation- Stock Compensation.” The Board Awards and the ARRM Awards were awarded at a weighted average grant date fair value per RSU of $7.91, determined at the grant date based on the closing price of our common stock. Both awards are service-based awards, and vest quarterly in equal amounts over a five year term ending December 31, 2015. We recorded $0.7 million of non-cash restricted cash compensation expense in the quarter ended March 31, 2011, of this amount, $0.01 million is included in additional paid-in capital and $0.06 million is included in accounts payable and accrued expenses, representing shares issuable per the agreements.

As of March 31, 2011, there was approximately $1.2 million and $0.2 million of unearned non-cash stock-based compensation related to the AARM Awards and to the Board Awards, respectively, that we expect to recognize as an expense over the next 5 years. The Board Awards are expensed on a straight-line basis over the requisite service period of 5 years; the ARRM Awards are valued and expensed as they vest at each quarter end commencing March 31, 2011 and ending December 31, 2015, based on the closing price of our common stock on the last trading day of the quarter. At March 31, 2011, 9,630 of our outstanding RSU’s were vested.

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ARMOUR Residential REIT, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2011

(Unaudited)

RSU transactions for the quarter ended March 31, 2011, are summarized below:

		Number of Awards
Awards Outstanding December 31, 2010		-
Awards Granted		192,500
Awards Forfeited		-
Awards Outstanding March 31, 2011		192,500

Non-vested transactions for the quarter ended March 31, 2011, are summarized below:

		Number of Awards		Weighted Average Grant Date Fair Value per Award
Non-vested Awards Outstanding, December 31, 2010		-	$	-
Granted		192,500		7.91
Vested		(9,630)		7.91
Forfeited		-		-
Non-vested Awards Outstanding March 31, 2011		182,870	$	7.91

Note 10 - Shareholders’ Equity

On January 26, 2011, we completed an underwritten secondary public offering of 6,000,000 shares of common stock. The underwriters fully exercised the over-allotment option for 900,000 additional shares at a price of $7.55 per share. Net proceeds were $49.0 million, net of issuance costs of approximately $3.1 million.

On January 28, 2011, a cash dividend of $0.12 per common share, or $2.0 million in the aggregate, was paid to holders of record on January 15, 2011.  This amount included $0.02 per common share of taxable income related to the year ended December 31, 2010.

On February 8, 2011, we completed an underwritten secondary public offering of 7,750,000 shares of common stock. The underwriters fully exercised the over-allotment option for 1,162,500 additional shares at a price of $7.60 per share. Net proceeds were $64.0 million, net of issuance costs of approximately $3.7 million.

On February 25, 2011, a cash dividend of $0.12 per common share, or $3.9 million in the aggregate, was paid to holders of record on February 15, 2011.

On March 30, 2011, a cash dividend of $0.12 per common share, or $3.9 million in the aggregate, was paid to holders of record on March 15, 2011.

Note 11 - Fair Value of Financial Instruments

A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.  The three levels of valuation hierarchy are defined as follows:

Level 1 - inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.

Level 2 - inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

Level 3 - inputs to the valuation methodology are unobservable and significant to the fair value measurement.

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ARMOUR Residential REIT, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2011

(Unaudited)

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.

Cash and restricted cash – Cash includes cash on deposit with financial institutions and investments in high quality overnight money market funds, all of which have maturities of three months or less, at the time of purchase. The carrying amount of cash is deemed to be its fair value. Restricted cash includes cash held by counterparties as collateral for interest rate contracts.

 

Agency Securities Available for Sale - Fair value for the Agency Securities in our portfolio is based on obtaining a valuation for each Agency Security from third-party pricing services and dealer quotes. The third-party pricing services use common market pricing methods including pricing models that 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. The dealer quotes incorporate common market pricing methods, including a spread measurement to the Treasury curves or interest rate swap curve as well as underlying characteristics of the particular security including coupon, periodic and life caps, rate reset period, issuer, additional credit support and expected life of the security. Management reviews pricing used to ensure that current market conditions are properly represented. This review may include, but is not limited to, comparisons of similar market transactions, alternative third-party pricing services and dealer quotes, or comparisons to a pricing model. Values obtained from the independent pricing service for similar instruments are classified as Level 2 securities if the pricing methods used are consistent with the Level 2 definition. If quoted prices for a security are not reasonably available from the pricing service, but dealer quotes are, the security will be re-classified as a Level 3 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 received from dealers and classify it as a Level 3 security. At March 31, 2011 and December 31, 2010, all of our Agency Security values were based solely on third-party sources.

Derivative Transactions - The fair value of our Eurodollar Futures Contracts are based on closing prices on the CME.  The fair value of our interest rate swap contracts are valued using a third-party. Our Futures Contracts are classified as Level 1. The accrued interest of our interest rate swap contracts are Level 1. The present value of estimated future cash flows of our interest rate swap contracts are Level 3.

Repurchase Agreements - The fair value of repurchase agreements reflects the present value of the contractual cash flows discounted at the estimated LIBOR based market interest rates at the valuation date for repurchase agreements with a term equivalent to the remaining term to interest rate repricing, which may be at maturity, of our repurchase agreements. The carrying amount of repurchase agreements is deemed to be their fair value.

The following table presents our financial instruments measured at fair value as of March 31, 2011.

		Level 1		Level 2		Level 3		Total
Assets (liabilities) carried at fair value:
Agency Securities, available for sale	$	-	$	2,273,059,805	$	854,927	$	2,273,914,732
Interest rate contracts		(2,775,388)		(1,890,910)		-		(4,666,298)
Total	$	(2,775,388)	$	2,271,168,895	$	854,927	$	2,269,248,434

The following table presents our financial instruments measured at fair value as of December 31, 2010

		Level 1		Level 2		Level 3		Total
Assets (liabilities) carried at fair value:
Agency Securities, available for sale	$	-	$	1,114,175,921	$	47,674,759	$	1,161,850,680
Interest rate contracts		(2,632,712)		-		102,067		(2,530,645)
Total	$	(2,632,712)	$	1,114,175,921	$	47,776,826	$	1,159,320,035

When a new pool of mortgages is created, the third party pricing services do not always become aware of the new pool for the early period of its existence. To the extent that we purchase a pool which the pricing service does not have listed, we seek independent third party pricing from other services or brokers. Additionally, we will ask the third party pricing service to include those assets in its list of priced assets in the future. As of December 31, 2010, we owned certain assets which were not priced by the independent third party pricing service and those assets were therefore classified as Level 3 assets. On March 31, 2011, these assets were priced by the pricing service and were therefore, reclassified as Level 2 assets. As of March 31, 2011, certain bonds purchased during the quarter were not priced by the pricing service which were valued using dealer quotes and therefore classified as Level 3 assets.

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ARMOUR Residential REIT, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2011

(Unaudited)

The following table presents detail of our Level 3 financial instruments measured at fair value as of March 31, 2011.

		Level 3
Balance as of December 31, 2010	$	47,776,826
Reclassification of agency securities		(47,776,826)
Purchases of agency securities, at cost		849,582
Unrealized gain on agency securities included in other comprehensive income		5,345
Balance as of March 31, 2011	$	854,927

The following table presents detail of our Level 3 financial instruments measured at fair value as of December 31, 2010.

		Level 3
Balance as of January 1, 2010	$	-
Purchases of agency securities, at cost		47,681,986
Unrealized loss on agency securities included in other comprehensive income		(7,227)
Unrealized gain on interest rate contracts included in change in fair value of interest rate contracts on the Statements of Operations		102,067
Balance as of December 31, 2010	$	47,776,826

Note 12 – Income Taxes

We intend to qualify and have elected to be taxed as a REIT under the Code. We will generally not be subject to federal income tax to the extent that we distribute 90% of our taxable income to our shareholders, and as long as we satisfy the ongoing REIT requirements including meeting certain asset, income and stock ownership tests.

We have elected to treat Enterprise as a taxable REIT subsidiary, which is a tax paying entity for income tax purposes and it is taxed separately from ARMOUR. As of December 31, 2010, we had recognized refundable income taxes of $0.5 million, related to the carry back of net operating losses incurred by Enterprise in 2009 to prior years in which Enterprise reported taxable income. This amount was received in January 2011.

Our provision for income taxes for the quarter ended March 31, 2011 and March 31, 2010, included $9,000 and $2,400 of federal income tax expense resulting from undistributed REIT taxable income for the year ended December 31, 2010 and December 31, 2009, respectively which is included in accounts payable and accrued expenses.

Note 13 - Interest Rate Risk

Our primary market risk is interest rate risk. Interest rates are highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors beyond our control. Changes in the general level of interest rates can affect net interest income, which is the difference between the interest income earned and the interest expense incurred in connection with the liabilities, by affecting the spread between the interest-earning assets and interest-bearing liabilities. Changes in the level of interest rates also can affect the value of Agency Securities and our ability to realize gains from the sale of these assets. A decline in the value of the Agency Securities 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. Liquidation of collateral at losses could have an adverse accounting impact.

We seek to manage the extent to which net income changes as a function of changes in interest rates by matching adjustable rate assets with variable rate borrowings. We may seek to mitigate the potential impact on net income of periodic and lifetime coupon adjustment restrictions in the portfolio of Agency Securities by entering into interest rate agreements such as interest rate swaps. As of March 31, 2011 and December 31, 2010, we had entered into interest rate swap contracts to pay a fixed rate and receive a floating rate of interest, with a total notional amount of $965.0 million and $155.0 million, respectively. Changes in interest rates may also have an effect on the rate of mortgage principal prepayments and, as a result, prepayments on Agency Securities. Prepayments, which result in the expensing of unamortized premium, will reduce net income compared to what net income would be absent such prepayments.

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ARMOUR Residential REIT, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2011

(Unaudited)

Note 14 - Related Party Transactions

We entered into a Management Agreement (see Note 8 “Commitments and Contingencies” for additional discussion) with ARRM to manage our business affairs in conformity with certain restrictions contained in the management agreement, including any material operating policies we may adopt.  Pursuant to the terms of the management agreement, ARRM will be responsible for the following primary roles:

·

Advising us with respect to, arrange for, and manage the acquisition, financing, management and disposition of, elements of our investment portfolio,

·

Evaluating the duration risk and prepayment risk within the investment portfolio and arranging borrowing and hedging strategies,  

·

Coordinating capital raising activities,

·

Advising us on the formulation and implementation of operating strategies and policies, arranging for the acquisition of assets, monitoring the performance of those assets, arranging for various types of financing and hedging strategies, and providing administrative and managerial services in connection with our day-to-day operations, and

·

Providing executive personnel along with administrative personnel, office space, and other appropriate services required in rendering management services to us.

In return for these services, we incurred $0.8 million and $0.06 million of management fees to ARRM, for the quarter ended March 31, 2011 and March 31, 2010, respectively. We did not reimburse any expenses incurred by ARRM on our behalf.

Note 15 – Subsequent Events

On April 13, 2011, we completed an underwritten secondary public offering of 17,000,000 shares of common stock. This included the underwriter’s partially exercised over-allotment option of 1,000,000 additional shares at a price of $7.40 per share. Net proceeds were $121.4 million, net of issuance costs of approximately $4.4 million.

On April 28, 2011, a cash dividend of $0.12 per common share, or $6.0 million in the aggregate, was paid to holders of record on April 15, 2011.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion of our financial condition and results of operations should be read in conjunction with our financial statements and related notes included elsewhere in this report.

References to “we”, “us”, “our”, “ARMOUR” or the “Company” are to ARMOUR Residential REIT, Inc. References to “ARRM” are to ARMOUR Residential Management LLC, a Delaware limited liability company. References to “Enterprise” are to Enterprise Acquisition Corp., which became a wholly-owned subsidiary of ARMOUR after completion of the business combination described below.

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This report contains various “forward-looking statements.” Forward-looking statements relate to expectations, beliefs, projections, future plans and strategies, anticipated events or trends and similar expressions concerning matters that are not historical facts. In some cases, you can identify forward-looking statements by the use of forward-looking terminology such as “believes,” “expects,” “may,” “will,” “would,” “could,” “should,” “seeks,” “approximately,” “intends,” “plans,” “projects,” “estimates” or “anticipates” or the negative of these words and phrases or similar words or phrases. All forward-looking statements may be impacted by a number of risks and uncertainties, including statements regarding the following subjects:

·

our business and investment strategy;

·

our anticipated results of operations;

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statements about future dividends;

·

our ability to obtain financing arrangements;

·

our understanding of our competition and ability to compete effectively;

·

market, industry and economic trends; and

·

interest rates.

The forward-looking statements in this report are based on our beliefs, assumptions and expectations of our future performance, taking into account all information currently available to us. These beliefs, assumptions and expectations are subject to risks and uncertainties and can change as a result of many possible events or factors, not all of which are known to us. If a change occurs, our business, financial condition, liquidity and results of operations may vary materially from those expressed in our forward-looking statements. You should carefully consider these risks before you make an investment decision with respect to our common stock.

We cannot guarantee future results, levels of activity, performance or achievements. You should not place undue reliance on forward-looking statements, which apply only as of the date of this report. We do not intend and disclaim any duty or obligation to update or revise any industry information or forward-looking statements set forth in this report to reflect new information, future events or otherwise, except as required under the U.S. Federal securities laws.

Overview

We are an externally-managed Maryland corporation organized in 2008, managed by ARRM. We invest primarily in hybrid adjustable rate, adjustable rate and fixed rate residential mortgage backed securities issued or guaranteed by a U.S. Government-chartered entity, such as the Federal National Mortgage Association (more commonly known as Fannie Mae) and the Federal Home Loan Mortgage Corporation (more commonly known as Freddie Mac), or guaranteed by the Government National Mortgage Administration, a U.S. Government corporation (more commonly known as Ginnie Mae), which we refer to collectively as Agency Securities.  From time to time, a portion of our portfolio may be invested in unsecured notes and bonds issued by U.S. Government-chartered entities, which we refer to as Agency Debt, U.S. Treasuries and money market instruments, subject to certain income tests we must satisfy for our qualification as a real estate investment trust, or REIT.

We seek attractive long-term investment returns by investing our equity capital and borrowed funds in our targeted asset class. We earn returns on the spread between the yield on our assets and our costs, including the interest cost of the funds we borrow, after giving effect to our hedges. We intend to qualify and have elected to be taxed as a REIT under the Internal Revenue Code, (“ the Code”). We will generally not be subject to federal income tax to the extent that we distribute 90% of our taxable income to our shareholders, and as long as we satisfy the ongoing REIT requirements including meeting certain asset, income and stock ownership tests. Our business plan is to identify and acquire Agency Securities, finance our acquisitions with borrowings under a series of short-term repurchase agreements at the most competitive interest rates available to us and then cost-effectively mitigate our interest rate and other risks based on our entire portfolio of assets, liabilities and derivatives and our management's view of the market. Successful implementation of our business plan requires us to address interest rate risk, maintain adequate liquidity and effectively mitigate interest rate risks. We execute our business plan in a manner consistent with our intention of qualifying as a REIT and avoiding regulation as an investment company.

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Our Manager

We are managed by ARRM pursuant to a management agreement between ourselves and ARRM.  As an externally-managed company, we depend on the diligence, experience and skill of ARRM for the selection, acquisition, structuring, hedging and monitoring of our Agency Securities and associated borrowings.  Pursuant to the management agreement, ARRM is entitled to receive a monthly management fee that is based on the total of all gross equity (including initial gross merger equity as well as any future equity raised), as measured as of the date of determination, regardless of our performance.  The management agreement became effective on November 6, 2009 and has an initial term of 5 years; following the initial term, the management agreement automatically renews for successive 1-year renewal terms unless we or ARRM give notice to the respective other of its intent not to renew the agreement 180 days prior to the expiration of the initial term or any renewal term, as applicable.  On November 6, 2009, we entered into an amended and restated management agreement with ARRM for the sole purpose of reducing the monthly management fee to 1/12^th of 1% of gross equity raised (including initial gross merger equity as well as any future gross equity raised) until gross equity raised is $50.0 million inclusive of gross merger equity. Thereafter, the monthly management fee shall be 1/12^th of (a) 1.5% of gross equity raised up to $1.0 billion and (b) 0.75% of gross equity raised in excess of $1.0 billion, with a monthly minimum based on 1/12^th of $900,000. There is no incentive compensation payable to ARRM pursuant to the management agreement.

As of March 31, 2011, our Agency Security portfolio, both trades that have settled and forward settle trades that we have committed to settle, consisted of approximately $2.3 billion, in market value, of Agency Securities with initial fixed-interest rate periods of three years, five years, seven years, ten years and 15 years.

The following table represents key data regarding our results of operations since the beginning of operations on November 6, 2009: