There have been some famous news headlines: Man Bites Dog, Dewey Defeats Truman. But one that really got my attention today was Armour Residential REIT's (ARR) announcement that it would maintain its monthly dividend.
As predicted in my recent column, Armour announced this morning that its $0.07 dividend for the July-August period would remain unchanged. Remember that ARR announces dividends prospectively, so the third-quarter dividend forecast is also an earnings forecast. Armour's management is telling the market that all the dire forecasts for the mortgage-backed-securities market just aren't true.
I'm traveling in Europe, so I don't have all my spreadsheets in front of me, but suffice it to say, the six-week move in the stock price from the mid-$6 range to $4.59 Wednesday was not caused by a market perception that the dividend would be maintained. The market was pricing in a dividend cut of at least 30% -- and that did not happen.
The perception doesn't match reality, and lower prepayment speeds mean that ARR is building a war chest. Specifically, in its earnings release, ARR management noted that the company would have more than $15 million in undistributed taxable REIT income (TRI) at the end of the second quarter.
Mortgage REITs must pay at least 90% of TRI in the form of dividends to maintain their corporate-tax-free status. In reality, mREITs exist to pass through the entirety of their cash earnings. So, that "cushion," which amounts to be about $0.04 in distributable TRI per share, will eventually be disbursed. But keeping some on hand is not a terrible idea given the volatility in MBS pricing.
So, at Wednesday's close of $4.59, ARR yields 18.3% on the third-quarter's dividend rate. That's an attractive spread vs. a current 10-year Treasury rate of 2.2%, or the recent lows of 1.6%, or even a 10-year rate of 3%, 4% and so forth.
At some point, investors need to throw out the spreadsheets and just identify situations that are "out of whack," and an 18.3% yield in a near-zero interest rate world is truly out of whack. At Portfolio Guru LLC, we buy "out of whack" even when short-term market fluctuations hamper our near-term returns and when market sentiment sours on certain sectors. So we are buying ARR for clients at these depressed levels.