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Summary

  • In each of the past five quarters, WMC has seen a reduction in book value.
  • The offering of common stock was priced ~$14.75 net expenses.
  • The recent public offering was more than half of the previously reported total outstanding shares.
  • ARMOUR has authorized the repurchasing of stock, and didn't exercise it before.
  • Over the last four years, ARMOUR has cut its dividend by over 50%.

Introduction

After big declines in the mREIT industry throughout 2013, there are many great investment opportunities. Two companies I have seen talked about lately are ARMOUR Residential REIT (NYSE:ARR) and Western Asset Mortgage Capital Corp. (NYSE:WMC). They are both trading at a discount to book and have enticing dividends, but they have some serious issues that people should know about before investing.

Over the last year, WMC and ARR have performed terribly, like many of their peers. WMC will have trouble maintaining its $.67 dividend, especially after it just issued so many shares of common stock. ARR's dividend has been on the decline, and will continue to decline in the future. Also, don't be so certain that ARMOUR is going to repurchase shares.

Western Asset Mortgage Capital Corp. - $14.69

If you haven't, you should check out this article written by Rubicon Associates (Article). It is a great article that goes more in depth about the composition of WMC and explains why the current dividend is questionable.

Western Asset is currently yielding a huge 18%.

Quarter

Book Value

Dividend

Earnings

Economic Returns

2Q 2012

$ 20.17

$ 0.38

$ 0.47

$ 1.13

3Q 2012

$ 21.76

$ 0.85

$ 0.89

$ 2.44

4Q 2012

$ 21.67

$ 1.12

$ 1.05

$ 1.03

1Q 2013

$ 19.42

$ 0.95

$ 0.93

$ (1.30)

2Q 2013

$ 17.39

$ 0.90

$ 0.94

$ (1.13)

3Q 2013

$ 16.81

$ 0.90

$ 0.83

$ 0.32

4Q 2013

$ 15.27

$ 2.35

$ 0.70

$ 0.81

1Q 2014

NA

$ 0.67

NA

NA

The stability of this $.67 dividend is questionable, and is likely to be reduced in the coming quarters. In each of the past five quarters, WMC has seen a reduction in book value.

The recent offering of common stock is troubling. It could be that the company is foreshadowing a sizeable decrease in the book value to below $14.75 (the net proceeds per share of the public offering), or maybe the company issued the offering at a sizeable discount to the current book value per share. Both explanations would be bad news for current shareholders.

Something that hasn't been mentioned by anyone is the size of the offering. As of December 31, 2013, the company had about 27,000,000 outstanding shares (Source). The company recently announced April 9, 2014 it closed a public offering of 13,000,000 shares of its common stock and a private placement of 650,000 shares of its common stock, and an option for underwriters to purchase an additional 1,950,000 shares (Source). In total, this is 15,600,000, more than half of the previously reported total outstanding shares.

ARMOUR Residential REIT - $4.21

Quarter

Book Value

Dividend

Earnings

Economic Returns

Outstanding Shares

3Q 2012

$ 7.77

$ 0.30

$ 0.30

$ 1.03

308972000

2Q 2012

$ 7.29

$ 0.27

$ 0.29

$ (0.21)

309013000

1Q 2013

$ 6.69

$ 0.24

$ 0.25

$ (0.36)

309045000

2Q 2013

$ 5.43

$ 0.21

$ 0.23

$ (1.05)

370737000

3Q 2013

$ 5.26

$ 0.21

$ -

$ 0.04

370905000

4Q 2013

$ 4.75

$ 0.15

$ 0.15

$ (0.36)

357612501

1Q 2014

$ 4.67

$ 0.15

$ 0.15

$ 0.07

357102680

At first look, ARMOUR may look like a great buy. Currently trading at 90% of book value with a 14% yield, many people would argue ARMOUR should be bought at these levels. Another argument is that the company is repurchasing shares at a discount, and you may even see an increase in the company's dividend!

Over the last 4 years, ARMOUR has cut its dividend by more than half, and this trend will continue in the following years. Also, it isn't a 10% discount to book value if the book value will decrease in the following quarters.

Don't be fooled by the company increasing the repurchase authorization up to 50,000,000 shares. Take a look back to the December 17, 2012 press release, when the company authorized up to $100 million in stock repurchases (Source). Since then, the company has increased its outstanding shares by nearly 50,000,000 shares. This includes a public offering of 65,000,000 shares two months after that press release. If that isn't deception, I don't know what is.

Conclusion

The public offering from WMC is the largest shareholder dilution I have ever seen. Seldom does an mREIT post strong results in a quarter it issues a public offering. Remember that the offering will not impact the first quarter results, as the issuance was after the first quarter. This means the impact won't be seen until the second quarter earnings report. If you catch this falling knife, you might lose more than your fingers.

It is not certain that ARMOUR will repurchase shares. In fact, I could see it raising more capital in the near future, whether it be common stock or an alternative method, as American Capital Agency Corp. (NASDAQ:AGNC) recently did. This company has repeatedly diluted shareholder value. It's no wonder why this company doesn't host a conference call. Steer far clear of this company.

Source: Avoid These 2 High-Yield Mortgage REITs

Additional disclosure: Information in this article is my opinion only and shouldn't be construed as advice to buy or sell securities. Recommendations don't take into account individual readers' investment risk or return objectives and constraints. The article is for information purposes and you are encouraged to do your own research before making any investment decisions. All information here in this article is accurate to my knowledge.