ARMOUR Residential REIT (NYSE:ARR) is a mortgage REIT. It is managed externally by ARMOUR Residential Management LLC. ARR pays a monthly dividend of $0.05 per month (14%+ annually). This dividend has been consistent since Q4 2013, and it has been declared for Q3 2014 already. The stabilization of this metric has been bringing people back to ARR.
ARR turned in a great Q2 2014. It had core income and estimated REIT income of approximately $50.9 million (or $0.13 per common share), which was down from $58.3 million in Q1 2014 (or $0.15 per common share). This core income represented a 10.90% ROE at the beginning of the quarter.
ARR grew its book value from $4.67 per common share as of March 31, 2014 to $4.90 as of June 30, 2014. ARR's stock price closed on August 1, 2014 at $4.20 per share. The stock price would have to rise +16.7% just to reach its book value of $4.90 per common share as of June 30, 2014.
The leverage as of June 30, 2014 was 7.90x. This was down slightly from the 8.12x as of March 31, 2014. The Q2 2014 average net interest margin was 1.46%. This was down significantly from the 1.82% of Q1 2014. The Q2 2014 decrease in net interest spread was what one would expect from lowered interest rates and a higher average portfolio CPR (constant prepayment rate). The CPR rose from 3.68% in Q1 2014 to 5.12% in Q2 2014. The higher CPR led to higher amortization of loans (and hence lower net spread income).
During Q2 2014, ARR completed its exit from its 30-year fixed rate Agency RMBS. As of June 30, 2014, the longest dated fixed rate Agency RMBS it held were 20 year fixed rate Agency RMBS. The table below shows the portfolio as of July 8, 2014.
As readers can see the largest portion of the portfolio is now in 15 year fixed rate Agency RMBS. Both the repos and the hedges for these securities are cheaper than those for 30-year fixed rate Agency RMBS. The 15-year fixed rate Agency RMBS also represent much less extension risk in what many expect to be a rising interest rate environment in the coming quarters and years.
As ARR completed the move out of 30 and 25-year fixed rate Agency RMBS in Q2 2013, it sold approximately $1.2B of Agency securities. This resulted in GAAP gains of approximately $11.2 million and realized capital losses of approximately -$314.9 million for tax purposes. This sounds terrible; but it likely means that ARR has a much safer portfolio for the likely rising interest rate environment expected as the Fed ends QE3 (October 2014) and begins to raise Fed Funds rates (an unspecified time in 2015). To further ensure the book value of the portfolio, ARR as of July 8, 2014, had 96.9% of its assets hedged or 106.7% of its repos. ARR has $16.3B in hedges (swaps, swaptions, and futures).
ARR is looking good. The $0.15 per quarter dividend appears to be in a slight amount of danger due mostly to the higher average CPR in Q2 2014, and the lower interest rates. In the latter's case, the 10-year U.S. Treasury Note yield fell from 3.03% on December 31, 2014 to 2.72% on March 31, 2014 to 2.53% on June 30, 2014. In other words, the net interest spread has been decreasing this year so far. The resultant $0.13 per common share of comprehensive income in Q2 2014 does not fully cover the dividend of $0.15 per common share. However, the company has announced no plans to cut the dividend. In fact, it has thus far stated that it will remain unchanged throughout 2014. Many expect higher interest rates as the Fed ends QE3 and nears and/or starts raising the Fed Funds rate. When these likely raises near or occur, ARR's net interest spread should widen again, and the core income will hopefully support the current dividend. It is possible that the dividend itself could even rise over time.
With the above in mind, ARR is probably a weak buy. It still faces possible book value losses when interest rates rise again. However, it is well-positioned for these rises with hedges and with shorter dated MBS than it had last year. This decreases its extension risk. Its net balance sheet duration is only 0.66. The losses in book value should be much less, if they occur. Meanwhile ARR pays a 14%+ dividend with little risk. Remember its current stock has to gain 16.7% just to get to its June 30, 2014, book value of $4.90 per common share.
The two year chart of ARR provides some technical direction for this trade.
The slow stochastic sub chart shows that ARR is oversold. The main chart shows that ARR is in a sideways consolidation pattern or a slight uptrend. The results from Q2 2014 should do nothing to tip this pattern to the downside. Rather they argue for more upside movement. ARR's Beta of 0.39 tells investors that ARR should be less susceptible to an overall market downdraft than most other stocks.
As Gary Cain said recently, MBS are very liquid assets. They can be sold easily. When the stock is trading at a huge discount to those liquid assets, it is a bargain that should not be passed up. ARR is a weak buy in this troubled market if you are an income investor. It appears to be well protected. It should be able to both keep its value and to pay a good dividend for some time into the future.
NOTE: Some of the fundamental fiscal data above is from Yahoo Finance.
Good Luck Trading.
Disclosure: The author has no positions in any stocks mentioned, but may initiate a long position in ARR over the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.