I have written about Armour Residential REIT (ARR) extensively in my newsletter, The Portfolio Guru Post, and several times for RealMoney. I recently had the opportunity to speak at length with ARR's CFO, James Mountain, and I believe ARR has reached an inflection point.
It's fair to say that 2013 was not a lucrative year for long-term ARR holders. The "Taper Tantrum" sent mortgage backed securities prices into a tailspin. ARR and its mREIT brethren suffered the double whammy of book-value erosion and a revaluation (i.e. discounts to book instead of the premia that had prevailed for the prior three years) by the market.
Just when asset prices fell, Armour management began massively reducing its portfolio size. Leverage was greatly reduced and in the process reducing ARR's ability to pay dividends. Strategically, this was the antithesis of "buy low" and ARR's shares felt the pain.
But every asset has its price and as ARR's yield still drew attention I continued to field "when to buy" questions.
I established four ground rules for getting back into ARR common:
- Management resumes growing the balance sheet;
- The company buys back stock;
- Management gives visibility on the dividend;
- The MBS markets adjust to the Fed's tapering of QE.
Lo and behold: ARR's January company update showed that the management had gone a perfect 3 for 3 in the variables they control:
- As of the January 10 update, ARR's portfolio grew by 6% to $15.5 billion, the first increase since May;
- ARR's update indicated the company had bought back 13.4 million shares in the fourth quarter (bringing the total outstanding to 358 million), a fact that had not been disclosed previously;
- On December 18, ARR announced a $0.05 monthly dividend rate for all of 2014 a departure from management's prior practice of announcing the dividend rate each quarter.
I wouldn't buy ARR for clients until management showed they had the confidence to buy it themselves. Now they have, and I'm back in.
In terms of the Treasury market, the gyrations of the summer's Taper Tantrum seem like a distant memory. We've priced in a gradual tapering of the Fed's MBS purchases (QE3, which gets far less attention than the Treasury-purchase program aka QE4) and the mortgage-backed securities market has recovered much of the summer's losses.
The implicit pressure on ARR's book value is abating, and as management increases (albeit carefully) ARR's portfolio size, we'll see that the impact of leverage goes both ways.
I added ARR to my 10-stock Mad Money portfolios, and I will be buying more in the future. With a now safe 14.6% dividend, I believe ARR will cushion Mad Money returns against the backdrop of a market that I believe will have many more declines like Thursday.
And there's the rub. The stock market decline on Thursday was matched with a decline in the 10-Year Treasury rate. Market participants were selling stocks to buy bonds -- and as ARR is nothing more than a leveraged bond fund (with REIT tax treatment) that is the best of both worlds -- and a market contrarian's dream