ARMOUR Residential REIT (NYSE:ARR) declared their fourth quarter and full year results after the market closed on Thursday, February 18, 2016. Core EPS came in $1.10 per share, which beat expectations by $.11. The story should sound fairly similar because Core EPS and estimates both were similar in the third quarter. The real story could be how ARMOUR Residential REIT is creating the earnings beats. However, the answer is still fairly similar. Forward starting LIBOR swaps push the hedging costs into future periods by creating an unrealized loss on book value that doesn't flow through Core EPS until the loss becomes realized through the net interest payment on swaps.
One paragraph and this already beats most coverage you'll be able to find on ARR. I want to keep going deeper. The book value at the end of the quarter was fairly interesting. I run my own estimates for book value on the mREITs and occasionally check my numbers with the mid-month portfolio updates. They tend to be fairly close since modeling an agency mREIT is more science than art.
To do this analysis, I'll need to reference a few documents. The most recent portfolio update, which was for January 2016, indicated a book value per share in the range of $26.62 to $26.94. That lands reasonably close to my estimates. However, the book value per share for the end of the fourth quarter came in a bit below my expectations. That shouldn't matter too much since we already have the updated values from the January presentation, but it is interesting. Book value was declared at $28 and the company reported a positive impact of $.99 per share from repurchasing shares below book value. Ironically, when they repurchased a great deal of shares just prior to the end of the fourth quarter, they issued a press release that estimated the impact at $1.13. Specifically the words were:
"The stock buyback cost to ARMOUR was $21.25 per Common share on average, resulting in an estimated accretive effect on Stockholders' equity per Common share of approximately $1.13 as of December 31, 2015."
If you were looking at the most recent portfolio update and saw the huge reduction in shares outstanding, you might have to ask yourself how much of that accretive impact happened in the first quarter of 2016. In the January update there were approximately 36,760,555 shares outstanding. At the end of the fourth quarter there were 36,682,436 common shares outstanding. It would appear that the repurchasing of shares was an activity towards the end of December rather than occurring during January.
Why Book Value Keeps Getting Hammered
ARMOUR Residential REIT runs at fairly high leverage ratios even for an agency mREIT. Their latest portfolio update indicated leverage running 8.2 and does not include TBA positions or forward settling transactions. Essentially, it is only counting book leverage but excluding the other positions that may increase economic leverage. MBS have been underperforming LIBOR swaps over the last few quarters and the result is weak book value performance across the industry. Since the ARR hedge strategy is designed to strengthen Core EPS and most of Core EPS is paid out in dividends, the natural result would be an expected decline in book value per share. On the other hand, the exceptionally strong dividends are highly preferable for a company trading at a substantial discount to book value. If investors could get the entire book value in one dividend that liquidated the company, it would represent a substantial immediate upside.
Book Value Since Then
Because ARR changes their positions occasionally, modeling their book value can be more challenging. An mREIT that is more passive in management is easier to value than one that changes the positions during the quarters. As of February 17, 2016, my estimate on book value was $24.93. That should be taken as a rough estimate because book value was lower than I expected at the end of the year and fairly close to my estimates in late January. The variation suggests that the portfolio may have some modifications that still need to be worked into modeling. I'll try to get that done soon so I can provide further insight.
Note that my estimate of $24.93, while being a bit rough, is substantially below the reported book value for the end of the fourth quarter. The company's reported BV ($26.62 to $26.94) in the January portfolio update is also materially below the end of fourth quarter figures. Therefore, investors should be wary of using any "discount to book value" figures that use the Dec. 31st figures.
ARMOUR Residential REIT did exactly what they tend to do. Beat on Core EPS with forward swaps while seeing book value decline materially due to the combination of MBS underperforming LIBOR swaps and a dividend that is technically covered by Core EPS but still beyond what the company can afford over the long haul.
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.
Additional disclosure: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis.