Is Armour Residential's 15.4% Dividend Yield Sustainable?

| About: ARMOUR Residential (ARR)

I give Armour Residential (NYSE:ARR) a buy rating. The company's dividend coverage ratio and its projected interest income's interest rate sensitivity revealed that Armour has the financial muscle to continue its monthly dividends at the current rate. The company's attractive valuations and heavy recent insider purchases by some of the top officials of Armour make me more bullish on the stock. Therefore, I recommend investors to go long on the stock and benefit from its sustainable dividend yield of 15.4%.

Additionally, the company's charter allows Armour the flexibility to include non-Agency securities into its MBS portfolio. Therefore, I expect the company to tilt its MBS portfolio towards high yielding non-Agency securities under the current economic situation.

MBS Holdings

The company invests primarily in hybrid ARM and fixed rate residential mortgage backed securities that are guaranteed by any government sponsored Agency. Looking at the current situation where the Fed is committed to purchase Agency MBS, the shareholders of Armour Residential approved and amended the company's charter to include non-Agency in the MBS portfolio. This flexibility will allow the management to drive the company smoothly through the current challenging environment. At the end of the third quarter, the company was exclusively invested in Agency MBS. However, given the situation, I believe addition of high yielding non-Agency MBS will benefit Armour Residential by expanding its net interest margin.

Insider Activity

Over the past 3 months 20 insider purchases were conducted by some of the top officials of Armour Residential. On November 15th alone, the Chairman, Co-Chief Executive, a Director, the President and the CFO of the company purchased stocks worth $90,550. This heavy insider activity reflects the company's top officials' confidence in Armour Residential's future.

Are the Elevated Shareholder Distributions in Danger?

Besides offering one of the highest dividend yields, the company offers another benefit of paying dividends on a monthly basis. Armour Residential pays a monthly dividend of $0.09 per share, which makes the annual dividend yield of 15.4% very attractive to income oriented investors. I will attempt to determine the company's dividend sustainability by looking at its dividend coverage ratio and its projected net interest income's interest rate sensitivity.

The following table gives a clear picture of the cash dividend coverage ratio of the past four quarters. The company paid $85.4 million in dividends the last quarter, while it generated $105.8 in operating cash flows. The cash dividend coverage ratio for the most recent quarter comes out to be 1.24 times, while the average cash dividend coverage ratio of the past four quarters remained at 1.1 times.

Looking from the interest rate perspective, the company can sustain its dividends. According to the company's latest SEC filings, the projected net interest income will decline by 3.97% if the interest rates plunge 50 basis points. Armour Residential generated $97.5 million in net interest income during the most recent quarter. Assuming the interest rates decline by 50 basis points, the company will generate $93.6 million, which is still sufficiently above the most recent quarter's dividend payment of $85.4 million.

Both perspectives reveal that the company has sufficient financial muscle to continue its monthly dividends in the near future.

Attractive Valuations

Armour Residential is trading at an 11% discount to its third quarter book value. Compared to this, MFA Financials (NYSE:MFA) is trading at an 8% discount to its book value. Both the mortgage REITs have similar market cap which is why MFA is considered for comparison.

Comparatively, the large cap mortgage REITs such as Annaly Capital Management (NYSE:NLY) and American Capital Agency (NASDAQ:AGNC) trade at 12% and 3% discounts to their respective book values.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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