In today's low interest rate environment and the still-struggling real estate industry, investors may find themselves shying away from property and mortgage related holdings. Yet, Armour Residential REIT (ARR) may be worth taking a closer look at predominantly in terms of short-term income.
In this article, I discuss why I think that Armour could be a real winner for investors - especially in the shorter term. Its strong dividend yield along with its more moderate trading strategies in certain areas could make Armour a good buy at its current price.
Analyzing the Fundamentals
Armour, the purchaser of mortgage-backed securities from Fannie Mae (FNMA.OB), Ginnie Mae, and Freddie Mac (FMCC.OB), differs from most of its competition in that this firm buys a variety of different mortgage types - including fixed-rate, adjustable-rate, and hybrid-rate securities.
It is estimated that Armour's earnings per share will quadruple by December 2013. In addition, both Armour and its competitors may benefit from the recent suggestion by the Consumer Financial Protection Bureau that new rules may be proposed for mortgage servicers that could reduce the rate of foreclosures in the near term. One such proposal would require mortgage companies to dedicate additional staff in helping borrowers to avoid foreclosure.
In order to reflect the inherent risk in the mortgage REIT sector, Armour offers a high dividend yield of over 17%. Although one question that investors may be asking is whether or not Armour will be able to sustain its large dividend, I think that the company will likely increase its portfolio quite significantly.
In addition, while this particular REIT tends to focus on mortgages that are considered somewhat riskier, the derivatives that it trades outside of mortgage backed securities seem to be much more moderate in comparison to some of the competition's more aggressive trading methods. Therefore, Armour's more conservative approach in this area could reduce the potential negative returns and easing the fears of more risk-averse investors.
Can Armour's Competitors Compare?
One of Armour's competitors, Annaly Capital Management (NLY), has had mixed reviews from investors, depending on when they purchased their shares. The company's recent EPS was a mere 49 cents along with a dividend yield of just over 3%. And, while those who purchased shares at the IPO price are up roughly 580%, Annaly is currently seeking additional capital. With a new public offering of convertible senior notes worth approximately $750 million, each $1,000 in notes can be converted to just over 52 shares of common stock.
The potential problem comes with the fact that the share price in the offering is just under $19 per - higher than the current $16 to $17 price of the shares. Therefore, should there be a margin call on Annaly's stock, the share price could be moving toward a fast drop. Given this, I'd steer clear of Annaly for the time being.
CYS Investments (CYS) is one contender that could be worth keeping an eye on. Last year, CYS yielded a dividend-adjusted return of just under 23% - although the shares are also considered to be a bit more risky than some of the other REITs.
Due to the Fed's plans to keep federal funds rates near 0% through 2014, though, the risk for REITs overall may be somewhat lessened, making CYS shares somewhat more favorable - especially given its high dividend yield.
One relevant company that I would completely steer clear of at the current time is Chimera (CIM). The firm has recently had some accounting woes. First, due to a replacement of the company's auditor, investors are still waiting for the firm's 2011 year-end results.
In addition, because Chimera is classified as a hybrid mREIT, the company's portfolio encompasses both agency backed and non-agency backed mortgage backed securities. Non-agency backed mortgages typically are categorized as being junk bonds due to their high default risk. Roughly 75% of Chimera's portfolio is made up of these non-agency backed securities. Given this, I would definitely wait on the sidelines before making a purchase here.
Another company that possesses only agency backed mortgage securities is American Capital Agency (AGNC). In the company's recent 10K filing, the discussion on its risks runs on for 17 pages - and for many investors who are risk averse, this is not a good sign.
The company's recent first-quarter 2012 earnings report net income of over $640 million, or $2.66 per share. While the REIT's dividend yield stands at 5%, this may not be enough of a consolation for investors to compensate for the risks that are involved. In addition, the share price is within pennies of its 52-week high. Here, too, investors may want to take a wait-and-see approach with these shares and momentarily hold off on purchasing.
The Bottom Line
It is true that there are some risks involved with purchasing shares in REITs - particularly due to mREIT leverage and the potential peaking of Treasury valuations. Therefore, for most investors, the overall portfolio exposure to REITs should be limited to only a certain percentage of the total.
However, while I feel that mortgage REITs are not a good alternative for fixed income types of investments in today's market, I do think that this sector offers very good prospects for short-term investors.
With interest rates likely remaining stable in the near term, many of the stronger REITs such as Armour and CYS are offering very nice dividends for those seeking income in their portfolios. For these reasons, I feel that Armour and CYS could be a very good buy for those who don't mind a moderate amount of risk.