ARMOUR Residential REIT (NYSE:ARR) has been a mess. Recently some momentum picked up in the mREIT sector following a long, painful decline in share prices. As you are aware I have followed ARMOUR Residential REIT and have been extremely sour on the name for some time. I have urged investors against jumping in despite the massive discount-to-book for over a year. In this sector, things do change rapidly. I recently gave the name a little bit of praise following its Q4 report, but had to reverse course just the next quarter when it put another terrible quarter in for Q1. I stated in the article that "I think ARMOUR has started to turn the corner". I went on to say "all I ask in a name is for dividend coverage without massive book value erosion." Now as we know so much of this can be beyond the company's control (e.g. prepayments, interest rate movements) but the company can try to position itself appropriately given known and predicted circumstances. But to me it's about the dividend, and that is why we own REITs. And sadly, the dividend is spiraling downward.
ARMOUR had consistently been having issues covering its dividend quarter-after-quarter, resulting in multiple cuts. Remember a few months ago we learned it was cutting its dividend down to $0.27. Then of course the company cut its dividend AGAIN, to $0.22. But what is even worse is that the company just put out a weak Q2 2016 report.
So just how rough was it? Well first, core income, a great measure for determining income available to pay dividends, came in at $27.1 million, which was $0.63 per share. You cannot keep ignoring earnings! These earnings were down heavily quarter-over-quarter from the $30.3 million, or $0.72 per share in Q1. While not a measure that is as important for mREITs as core income, the company actually swung to a GAAP net income $21.2 million or $0.47 per share compared to a loss of $280 million (or $7.73 per share) per share last quarter. The key here though is that the company's core (plus drop) income was far less than what was needed to cover the dividends of $0.71 paid in the quarter. The company also paid monthly dividends in Q4 2015 of $0.171875 per outstanding share of 8.250% Series A Cumulative Redeemable Preferred Stock and $0.1640625 per outstanding share of 7.875% Series B Cumulative Redeemable Preferred Stock, resulting in payments to preferred stockholders of an aggregate of approximately $3.9 million.
Despite the company reporting two decent quarters to close 2015 on the earnings front, looks like it's business as usual here in 2016. Or is it? As most of you know by now, one of the key metrics I always look for in mREITs is the net interest rate spread because it is a proxy for the earnings power of the portfolio. In the first quarter, the annualized yield on average assets jumped dropped to 2.68% from 2.73% in Q1. Further the annualized cost of funds, was 1.45%, up heavily from 1.136% in Q1. The end result? The net interest spread narrowed from 1.37% to 1.35%. Business as usual. This is quite low in the mREIT sector.
Of course there is always the all-important book value. Business as usual? Well not so much. For once, the company saw a reversal. Let me remind you of the trend. ARR reported its so-called shareholder equity to be $3.96 at the end of Q2; adjusting for the reverse split this was $31.69. It fell in Q3 to just $29.05. It was down again another 3.5% to $28.00 in Q4. In Q1 2016 it got crushed and fell to $25.52. But here in Q1, book value jumped 4.86%. This means book value was $26.94. Now look. It's still down 4% from where it was in Q4, so this isn't a major accomplishment, but it is undoubtedly positive. But what does it mean for you?
Let's set aside past coverage. If I am looking at this quarter from a stand-alone viewpoint, I would conclude that barring the book value, the company showed a pitiful performance. It is just reality. Now, the yield is still stellar despite all of the dividend cuts. There could be cuts coming again as core earnings once again came in under the new monthly dividend of $0.22 (the company earned an average of $0.21 per quarter), so that is not good. But the stock does have momentum. I can't recommend a buy here, but if you own the stock, I would be holding. Don't buy.
Note from the author: Christopher F. Davis has been a leading contributor with Seeking Alpha since early 2012. If you like his material and want to see more, scroll to the top of the article and hit "follow." He also writes a lot of "breaking" articles, which are time sensitive, actionable investing ideas. If you would like to be among the first to be updated, be sure to check the box for "Real-time alerts on this author" under "Follow."
Disclosure: I/we 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.