Updated on June 28th, 2021 by Bob Ciura
ARMOUR Residential REIT Inc. (ARR) is a mortgage Real Estate Investment Trust (mREIT) that offers an appealing 10.4% dividend yield, making it a high dividend stock.
ARMOUR Residential also pays its dividends on a monthly basis, which is rare as the vast majority of companies that pay a dividend, pay them quarterly or semi-annually.
There are currently only 52 monthly dividend stocks in our coverage universe. You can download our full list of monthly dividend stocks (along with price-to-earnings ratios, dividend yields, and payout ratios) by clicking on the link below:
ARMOUR Residential’s high dividend yield and monthly dividend payments make it an intriguing stock for dividend investors, even though its dividend payments have been declining over the years.
As with many high-dividend stocks yielding over 10%, the sustainability of the dividend is in question. This article will analyze the investment prospects of ARMOUR Residential.
As an mREIT, ARMOUR Residential invests in residential mortgage backed securities that include U.S. Government-sponsored entities (GSE) such as Fannie Mae, Freddie Mac. It also includes Ginnie Mae, the Government National Mortgage Administration’s issued or guaranteed securities backed by fixed rate, hybrid adjustable rate, and adjustable rate home loans.
It also includes unsecured notes and bonds issued by the GSE and the United States treasuries, money market instruments, as well as non-GSE or government agency backed securities.
The mortgage REIT was founded in 2008 and is based in Vero Beach, Florida. It seeks to create shareholder value through careful investment and risk management practices that produce current yield and superior risk-adjusted returns over the long-term.
With a market cap of approximately $800 million and ~$150 million in annual revenue, it is a significant national player in residential investment.
Source: Investor presentation
The trust makes money by raising capital through issuing debt as well as preferred and common equity, and then reinvesting the proceeds into higher-yielding debt instruments.
The spread (i.e., the difference between the cost of capital and the return on capital) is then largely returned to common shareholders via dividend payments, though the trust often retains a little bit of the profits to reinvest in the business.
Recent results at ARMOUR have been mixed. The trust was severely impacted by the COVID-19 pandemic, but was able to meet all of its margin calls and it maintained access to repurchase financing.
ARMOUR reported 2021 first-quarter results on April 21st, 2021. The trust’s liquidity including cash and unencumbered securities amounted to $687 million with $12.40 in book value per common share at quarter-end. Core income fell from $0.32 per share in Q4 2020 to $0.23 per share in the 2021 first quarter.
ARMOUR also reported debt–to–equity ratio of 4.2–to–1 compared with 4.8–to–1 at March 30th. Its securities portfolio included $7.7 billion of agency MBS and includes TBA securities. Meanwhile, comprehensive income stood at $29.1 million, representing 12% annualized return based on stockholder’s equity at the beginning of the quarter.
Looking ahead, lower short-term interest rates could help the business profit margins as they can now borrow funds at cheaper rates and use the proceeds to repurchase preferred and common equity shares at a discount to the prices they were issued at.
Source: Investor Presentation
Of late, a shrinking balance sheet and declining spreads have crimped the trust’s ability to produce cash flow. That being said, the economic disruption caused by the coronavirus outbreak has disrupted the business model, leading to a sharp decline in cash flow per share,as well as a steep dividend cut.
Moving forward, we expect the low interest rate environment and heavy government stimulus to enable the company to resume growth, though it will likely take a while for them to rebuild to previous levels of book value and earnings power.
While there have certainly been some positive developments at work for ARMOUR, there are still several risks to be concerned about. ARMOUR’s quality metrics have been volatile given the performance of the trust as rates have moved around over the years. Gross margins have moved down since short–term rates began to rise meaningfully a couple of years ago, although it appears most of that damage has been done.
Balance sheet leverage had been moving down slightly,but it saw an uptick again this past quarter. However, we do not forecast a significant movement in either direction from this point. Interest coverage has declined with spreads but also appears to have stabilized, so we are somewhat optimistic moving forward, while keeping in mind the significant potential for volatility.
ARMOUR is facing headwinds from the coronavirus outbreak and an overall economic downturn. As a result, a steep dividend cut was necessary to preserve the balance sheet and allow the REIT to reposition itself for survival and future growth.
At the current level, the annualized dividend payout of $1.20 per share will represent nearly all the company’s EPS (we estimate 2021 EPS of $1.22), resulting in a payout ratio near 100%. This is a red flag that the dividend could be at risk of a further reduction, if EPS were to fall.
As an example, if the economy were to go into recession, mortgage defaults could surge, leading to steep losses. With the uncertain macroeconomic outlook, this risk is relevant for investors.
ARMOUR Residential’s high dividend yield and monthly dividend payments make it stand out to high yield dividend investors. However, we remain cautious on the stock especially in light of the multiple dividend cuts in recent years.
While the trust is covering its dividend currently, declining interest rates could continue to force the trust ever further out on the risk spectrum to maintain its cash flows as its older mortgages roll off the balance sheet. This sets it up for potentially steep losses if the economy were to slip into a recession.
Therefore, ARMOUR stock carries notably higher levels of risk. This makes the investment highly speculative right now, especially for risk-averse income investors such as retirees. As a result, we encourage risk-averse investors to look elsewhere for sustainable and growing income.