ARMOUR's 24% Slide Puts Book Value, Not Its 73-Cent Estimate, On Trial

ARMOUR Residential REIT heads into its third-quarter report with an awkward gap between what Wall Street expects it to earn and what the stock market is willing to pay for it. Analysts see distributable earnings holding essentially flat, yet the shares have dropped 24.4% since the last report, closing at $12.28. That is the low of the post-earnings range and far below the 200-day moving average of $16.76. Management's last interim book value estimate was $17.00 as of July 20. With the stock now well under that figure, the market appears to be pricing in meaningful book value damage that the company has not yet disclosed. The October 21 release, due after the close, will show whether that fear is justified.

The earnings bar itself is modest. Consensus calls for $0.73 per share, up from $0.72 last quarter and about 1.4% above the year-ago figure. That is essentially flat performance. It also sits almost exactly on the $0.72 quarterly dividend, paid at $0.24 a month and unchanged across the last four calls. Consensus revenue of $80.8 million implies a 61.6% year-over-year drop. For a mortgage REIT, though, reported revenue moves with how interest income and hedge results are recorded, so that decline says less about the business than net interest income does. Net interest income rose to $76.8 million last quarter. Holding near that level would support the view that dividend coverage remains intact even after deleveraging.

That deleveraging is the center of last quarter's narrative. Management cut implied leverage to roughly 7.5 times, down from 8.1 times a year earlier. It also kept duration near zero and lowered its estimate of incremental returns on new capital to around 15%, from the 16% to 18% range it cited before. The reason was a sharp change in the rate outlook. Markets moved from pricing Fed cuts to weighing possible hikes, driven by energy-led inflation and a new Fed chairman offering less forward guidance. A smaller, better-hedged balance sheet should limit losses if volatility rises, but it also caps earnings power. Distributable EPS has already slipped from $0.76 to $0.72. Another step down below the dividend would raise uncomfortable questions about the payout.

The bullish case management laid out rested on supportive supply and demand for agency mortgage bonds. Net issuance from the government-sponsored enterprises has been negative, bond funds have kept buying, and Fannie Mae and Freddie Mac have more than $100 billion of room to act as backstop buyers. The report should reveal whether that support held up. The GSEs posted their first net decline in retained portfolios in May, an early sign that demand was cooling. Commentary on the agency CMBS position, which management was shifting toward 10-year paper for extra yield and better convexity, will show whether the company still sees attractive opportunities or is mainly playing defense.

Capital raising is another fault line. ARMOUR grew its portfolio past $22 billion for a fifth straight quarter, funded partly by about $219 million of common stock sold through its at-the-market program. With the shares now trading well below the last stated book value, new issuance would dilute existing holders. That likely ends the growth streak and puts more weight on returns from the existing portfolio.

Sentiment has cooled noticeably, slipping to barely bullish from 13.3% bullish before the last report. Matching $0.73 will matter less than the September 30 book value and any update into October. If book value has held reasonably close to the $17.00 interim mark, the selloff will look overdone and management's defensive positioning will look well judged. A steep decline, combined with distributable earnings falling below the dividend, would confirm that the market's pessimism was warranted.

This earnings preview was originally published on Earnings Whispers.

This article is for informational purposes only and is not investment advice. Earnings Whispers and its staff may hold positions in the securities mentioned. It was generated automatically, with the help of AI, from Earnings Whispers and company data, and checked by Earnings Whispers before publication.