Is There a Chink in the Armour of the Market's Biggest Dividends?


Armour Residential (NYS: ARR) reported earnings last week, and it offered a mixed bag for investors. On the one hand, Armour did maintain its hefty quarterly dividend, paying out another $0.36 per share. But on the other, its interest rate spread -- a key measure of profitability -- declined sequentially and year over year.

The company reported estimated taxable REIT income of $31.3 million, but on a GAAP basis, Armour reported a loss of $34.5 million. The discrepancy was due largely to an unrealized loss in the company's derivatives of $65.8 million.

Armour, like the rest of the mortgage REIT industry, endured a volatile quarter due to a variety of factors. Potential regulatory reforms, the ongoing European crisis, Operation Twist, and the revamped HARP rules had many mortgage REIT investors on edge. But Armour noted that less than 2% of its holdings are eligible for the revised HARP program, meaning it has little exposure there.

Despite these challenges, Armour recorded an interest rate spread that was in line with its peers', even if it suffered declines from last quarter and the year-ago period:


Interest Rate Spread Q3 2011

Interest Rate Spread Q2 2011

Interest Rate Spread Q2 2010

Armour Residential




Annaly Capital (NYS: NLY)




American Capital Agency (NAS: AGNC)




CYS Investments (NYS: CYS)




Invesco Mortgage (NYS: IVR)




Source: S&P Capital IQ.

In contrast to peers such as Annaly, American Capital Agency, and CYS, Armour's spread declined markedly from a year ago -- off 70 basis points. In that regard, its quarter looked similar to Invesco's. The interest rate spread is perhaps the most important number to focus on in this report (or any from the mortgage REIT sector).

Like peers Invesco and Annaly, Armour raised fresh capital this quarter. Armour issued nearly 10 million shares this quarter through a secondary offering and its dividend reinvestment plan, at $7.39 and $7.30 per share, respectively. Unlike Invesco, though, Armour managed to issue shares above book value, which was $7.15 at the end of the second quarter. Issuing shares above book value helps a company avoid diluting shareholders.

And for dividend investors, the news remained the same.

Unlike many peers in this space, Armour has kept its dividend more consistent, producing a payout of $0.36 per quarter for four of the last five quarters. Chimera (NYS: CIM) , Annaly, and Invesco adjust their dividends more frequently in response to results, with quarterly changes the norm rather than the exception. At Armour's current payout and price, that amounts to a 20% yield -- hefty even for mortgage REITs.

One final spot that investors might want to watch: the company's high leverage. Armour reported a debt-to-equity ratio of 925% for the quarter, surpassing even American Capital Agency's 813%. High leverage is normal in this space, but Armour's runs higher than the peers listed above. Still, that's about in line with the last five quarters. But it's something to keep an eye on in future quarters should the company's spread continue to decline, since it has less room to increase leverage in order to offset dwindling spreads.

For now, I prefer to invest in the more conservatively run and financed Annaly, which I own in my World's Best Dividend Portfolio. Its yield, at 14% or so, is also much less than Armour's. But that's a trade-off I'm willing to make.

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At the time thisarticle was published Jim Royal, Ph.D., owns shares of Annaly.The Motley Fool owns shares of Annaly and Chimera. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

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Originally published