As American corporations continue to report their performance for the second quarter, another largely followed Agency-only mREIT, ARMOUR Residential REIT, Inc. (NYSE:ARR) reported another worse-than-expected performance. Let’s see why this high yielding Agency-only mREIT reported poor results and how its closest peers did in the second quarter.
Another earnings miss
ARMOUR Residential REIT, Inc. (NYSE:ARR) happens to be a largely followed high yielding Agency-only mortgage REIT. According to analysts at Credit Suisse, ARMOUR Residential reported a worse-than-expected decline in its book value, while analysts at Barclays believe it missed its earnings estimate.
ARMOUR Residential REIT, Inc. (NYSE:ARR) reported GAAP earnings of $1.28 per share and core earnings of $0.18 per share. This was $0.01 per share lower than the consensus mean estimate and $0.02 lower than the linked quarter’s core EPS figure. Analysts at Barclays believe the miss was driven by sequentially lower asset balance during the second quarter. During the quarter, the size of the portfolio decreased 7%. ARMOUR Residential REIT, Inc. (NYSE:ARR) further reduced its portfolio in July.
At the end of the quarter, the company reported a 19% sequential decline in its book value, which plunged to new lows of $5.43 per share. Remember, the stock is still exchanging hands at $4.33 per share, which means it’s trading at nearly 20% discount to its latest book value.
On the positive side, the company was able to expand its net interest spread of 1.38% after it increased 4 bps over the prior quarter. Also, the company was able to bring down the portfolio’s prepayment speed from 15.7% to 10.8% over the same time period.
In another development, the company decreased its leverage to 8.9 times its shareholder equity, which I believe is a smart move given the continuous volatility in the interest rates and the uncertainty that prevails around the unwinding of the QE. However, I believe this is still a very high figure given the macroeconomic uncertainty. Leverage cuts both ways, and if volatility in interest rates increases, it would erode book value at a higher pace.
So, now we know that ARMOUR Residential REIT, Inc. (NYSE:ARR) was beaten down by lower asset balance and relatively higher leverage. Now, let’s look at some of ARMOUR Residential’s peers.
Peer performance analysis
Hatteras Financial Corp. (NYSE:HTS) invests in a variety of Agency MBS, including fixed-rate and adjustable-rate. However, its second-quarter performance remained disappointing as its EPS remained 6% behind estimates. The company also reported one of the highest book value declines of 21.3%, while its net interest spread also plunged 18 bps over the prior quarter. Additionally, portfolio prepayment speeds increased moderately to 20.8%. I believe that the massive book value decline was driven by one of the highest leverage ratios that the company currently maintains.
Hatteras Financial had a leverage ratio of 7.4 times at the end of the first quarter, which increased to 9.3 times over the quarter. This, I believe, was not a smart move as we all know leverage cuts both ways. Given the increased volatility in rates, higher leverage will erode book value at a higher pace in the coming quarter. So, if you ask me, I believe the future of Hatteras Financial is at risk if it continues to leverage its portfolio under the given scenario.
American Capital Agency Corp. (NASDAQ:AGNC) is the second-largest mortgage REIT and one of the best managed, too. As Bloomberg reports, it managed to minimize its losses during the second quarter as it disclosed a smaller book value decline compared to expectations. During the second quarter, the company experienced 12% decline in its book value, while its net interest spread plunged 3 bps over the linked quarter. Also, the prepayments speeds for its asset portfolio largely remained unchanged over the same time period.
It’s obvious that American Capital Agency reported the lowest book value and net interest rate spread decline during times when its aforementioned peers faced tremendous pressure. Much of this superior performance was a result of the re-balancing exercise conducted by management during the second quarter. In an effort to preserve book value, management got rid of some of its exposure in the troubled 30-year fixed-rate Agency MBS.
Poor performance continues to haunt ARMOUR Residential REIT, Inc. (NYSE:ARR). Lower asset balances and higher leverage became the reasons for the latest under-performance for ARMOUR Residential. Hatteras Financial was no different either. However, active management at American Capital Agency led the company to report the lowest book value and net interest spread declines among the three. So, I am bullish on American Capital Agency and recommend investors stay away from Hatteras Financial and ARMOUR Residential.
Adnan Khan has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.
The article Disappointment Continues to Haunt This High-Yielding Stock originally appeared on Fool.com and is written by Adnan Khan.
Adnan is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.