ARMOUR Residential REIT (NYSE:ARR), a REIT that invests in mortgage backed paper of various types, is a relative newcomer to the mREIT scene. Various interest rate related issues have pummeled the common stock to under $4 as of this writing but in this piece, we will take a look at a different way to invest in this mREIT; preferred stock. The subject of this article is the Series A Cumulative Preferred Stock (ARR-A, may differ depending on your broker). We'll take a look at ARR-A to see if it is right for your income portfolio.
To begin, we'll define exactly what we're dealing with. In this case, we see a true preferred issue in that it has no maturity date and is also not backed by some sort of debt issue. Issued at $25 per share, this preferred has a coupon rate of 8.25%, or annualized dividends of $2.0625 per share. This robust yield is impressive on its own but consider that ARR-A is currently trading for only $21 as of this writing and thus, the current yield of 9.8% is even better. This is one of the reasons I like ARR-A but the other is its monthly payouts.
Unlike traditional preferred stock that pays out quarterly dividends, ARR-A makes monthly distributions to its holders. This means that not only are you getting a huge yield but you also don't have to wait three months to get your money. This is tremendously advantageous for a variety of reasons including having access to the income to spend or purchase more shares before the next ex-dividend date. This would allow holders to compound their yield more by experiencing monthly compounding as opposed to quarterly. While not a huge difference, it is a nice feature of ARR-A and could end up boosting the effective yield on your shares.
While ARR-A has no stated maturity date it does have a call date. Beginning in June 2017 ARR can call ARR-A at the full issue price of $25. Assuming this were to happen holders of ARR-A would receive not only dividends on their shares but also a $4 capital gain associated with buying at the large discount to the call price shares currently trade at. Thus, ARR-A could provide not only robust dividends but also a ~19% capital gain as well. I'm not suggesting the issue will be or won't be called but it is something to keep in mind when buying a preferred at such a large discount to its call price. We are also 3.5 years from a call even becoming a possibility so if it bothers you, simply sell your shares before they can be called.
Another nice feature of ARR-A is the fact that the dividends are cumulative. Even if ARR misses payments on ARR-A it is obligated to make them up to holders of ARR-A. Thus, dividend payments on ARR-A are as guaranteed as they can be considering they aren't insured in any way like a CD or savings account. The point is that even though ARR engages in what is considered a risky business the dividends on ARR-A are safe barring bankruptcy, which I don't believe is even remotely possible at present.
There are some risks, of course, to owning ARR-A or any other income security. There is interest rate risk, which will be magnified for a preferred stock anyway but particularly one that is paid by a company that deals in interest rate spreads in order to produce revenue and profit. Should interest rates spike holders of ARR common stock and ARR-A could experience wild fluctuations in value. While the latter will undoubtedly have more muted movements up and down it is something to keep in mind. Income securities such as ARR-A are sensitive to interest rates on comparable securities and if Treasuries move up in yield, ARR-A will move down in price. Interest rate risk is a part of life investing in preferreds and never more so than with ARR-A.
The other risk is that ARR-A will be called at some point in the future. However, given that shares currently trade for a sizable discount to the call price I would actually welcome being called. Not only would such a scenario produce $7+ in dividends between now and then but also a $4 capital gain for a total of $11+ per share on a $21 investment. That is a ridiculous return for anything but particularly for a boring old preferred stock. Again, I'm not suggesting it will or won't be called but that is a pretty sweet scenario if you ask me.
One final note on ARR-A is that it is not eligible for the favorable dividend tax treatment. Unfortunately, holders of ARR-A will be subject to taxation as though the distributions are interest payments and not dividends. In a retirement account it won't matter but taxable account holders will suffer with a much lower after-tax yield than if the distributions were given the favorable dividend tax treatment.
Overall, ARR-A represents a fantastic opportunity to receive a huge yield that is also paid out in monthly installments instead of quarterly or semiannual payments like many preferreds. In addition, if you believe ARR is on the mend following the beginning of the Fed's QE taper now may be a terrific time to lock in a nearly 10% yield and the possibility of a 20%+ capital gain to boot.
Additional disclosure: I may initiate a long position in ARR-A at any time.