Updated on July 2nd, 2020 by Nate Parsh
ARMOUR Residential REIT Inc. (ARR) is a mortgage Real Estate Investment Trust (mREIT) that offers an appealing 12.6% dividend yield, making it a ‘high yield’ stock. You can see the full list of 200+ stocks with 5%+ dividend yields here.
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.
There are currently only 56 stocks with monthly dividend payments. 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 $600 million and $151 million in annual revenue, it is a significant national player in residential investment.
Source: Investor presentation, page 3
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. For example, last year the trust generated income of $2.31 per share but only paid out $2.16 per share in dividends.
In the first quarter of 2020, management was active in capital markets, raising approximately $48.4 million in the first three months of the year. In the process, the trust issued approximately 5.7 million common shares at approximately $8.49 per share, bringing the total capitalization to nearly $850 million.
While this most recent capital raise provided additional funds, it is vastly lower than the same capital raise that the trust conducted in the first quarter of 2019. Part of the reason might be the current share price. At this time last year, the stock was trading at ~$20, so the trust took advantage of the price to raise $322 million in capital by issuing ~16 million shares.
A lower share price and less demand for stock factored into the amount the trust was able to raise this time around. Still, ARMOUR had $460 million in cash and unencumbered securities as of April 27, 2020.
Recent results at ARMOUR have been mixed. In the first quarter of 2020, core income declined 30% to $0.41 per share. The trust was severely impacted by the COVID-19 pandemic, but was able to meet all of its margin calls and all 17 active counter parties continued to provide ARMOUR with access to repurchase financing during the quarter. Book value per share had been reduced by nearly 50% to $11.10 at the end of the quarter and was at $11.01 at the end of April.
ARMOUR also took additional steps to strengthen its business. The trust reduced its portfolio agency securities by two-thirds and terminated interest rate swaps during March, reducing its swap portfolio from $8 billion to $4 billion. Remaining term was lowered to 46 months from 52 months.
Additionally, the trust also did not pay a dividend in April or May, before announcing payments for the months of June, July, August and September.
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, page 5
Another positive trend is that, despite the large decline in mortgage rates and the pickup in REIT finance activity from historical lows, the MBA financing index remains muted. In fact, it remains well below average levels in the ultra-low interest rate period of 2010 to 2016.
This means that ARMOUR’s higher-yielding assets are not being repaid as quickly as the declining interest rates would otherwise indicate, preserving and even enhancing their profit margins in the short-term.
The trust also has a significant proportion of prepayment protected securities that will help it from experiencing any significant hits to profitability from prepayments, should they pick up in the coming months.
While there have certainly been some positive developments at work for ARMOUR, there are still several risks to be concerned about. First, declining interest rates and rising prepayments – though hedged to some degree by management – will pose a significant headwind to earnings growth, especially if interest rates continue to fall.
With interest rates already very low, portfolio constant prepayment rates have been on the rise, particularly in the first and second quarter:
Source: Investor presentation, page 8
This trend, plus the impact from the COVID-19 pandemic, resulted in a suspended dividend for the second quarter. The trust then distributed a $0.09 per share dividend on June 29th, which is a 47% decrease from the previous dividend.
ARMOUR did announce third quarter dividends of $0.10 per share, an 11% increase from the prior payment. Overall, shareholders are likely to see dividends of $1.66 per share this year, 22% lower than last year. And that requires the trust to maintain its third quarter dividend into the fourth quarter.
Additionally, if the economy were to go into recession, mortgage defaults could surge, leading to steep losses. With the uncertain macroeconomic outlook and declining foreign investment in American real estate, this risk is increasingly relevant.
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 recent dividend pause and subsequent cut.
While the trust is covering its dividend currently, declining interest rates will 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 slips into recession and defaults rise.
Clearly management views this as a clear and present risk and have lowered dividends as a result. This makes the investment highly speculative right now, especially for income investors. As a result, we encourage investors to look elsewhere for sustainable and growing income.