With the re-election of President Obama, there has been speculation that Ed DeMarco, head of the Federal Housing Finance Agency, will be fired and replaced with a more administration-friendly ally who will more aggressively push for principal reductions and forgiveness, among other ideas. Subsequently, agency mortgages such as Fannie Mae and Freddie Mac bonds have sold off somewhat dramatically (well, dramatically in "bond world"). Agency bonds typically trade at premiums to par value. Any forced prepayments or refinances would mean these premium bonds trade down to par, and investors would lose the premium (around 4%-7% depending on the bond).
Also, there is speculation that the tax rate of dividends will go from 15% to 43.4% for top earners if policy makers can't come to a conclusion prior to the fiscal cliff. While mREITs have always been taxed at ordinary income, they may be lumped in with high dividend paying models that money may be flowing out of. To a lesser extent, there may be some selling of the mortgage REITs (mREITs) due to their strong performance over the past year to lock in lower capital gains rate.
It is our assumption that the recent sell-off in all mREITs is due to adjustments in assumptions going forward, and not any structural change in the fundamentals of Apollo Residential Mortgage (AMTG). We have the opportunity to purchase AMTG at a discount to book value and a 17.5% dividend yield.
What is book? AMTG targets 60% in agency, 30% in non-agency, and 10% in cash. Its current portfolio looks more like 63/22/15. That's right: AMTG has 15% cash. Some of this cash is used as margin for the leverage, but it is the most liquid mREIT, which gives it a great opportunity to use this cash to buy bonds on the cheap as prices come in. In addition, the 63% agency position that is called into question has pre-payment protection, so any policy change with regard to forced refinancing would leave AMTG's portfolio relatively unaffected.
What's more, the housing market has shown some strong signs of finding a bottom. Housing prices in many communities are starting to creep up, inventory is starting to move, and foreclosures are dropping. The market for agency bonds should have a floor under it. The Federal Reserve announced QE3 this past September. Under this plan, it has the ability to purchase $40 billion in mortgage-backed securities every month.
AMTG is managed by ARM Manager LLC, an indirect subsidiary of Apollo Global Management LLC. It has an experienced management team including Michael A. Commaroto, who serves as CEO and has over 25 years of experience in the mortgage market, and Stuart A. Rothstein, who serves as CFO. It will also draw on the extensive transactional, financial, managerial, and investment skills of Apollo Global Management's private equity, credit-oriented capital markets and real estate investment professionals.
I doubt the opportunity to purchase AMTG at these levels will last too much longer once the weaker retail inventors have panicked out of this technical decline. Let's also not forget that this administration has bigger fish to fry with the fiscal cliff. So DeMarco might have a job for at least a few months longer. In the meantime, we are happy to pick up shares at this attractive rate.
Other mortage REITs to consider include:
- Two Harbors Investment Corp. (TWO) -- 14% Yield
- Annaly Capital Management (NLY) -- 14% Yield
- New York Mortgage Trust (NYMT) -- 19% Yield
Disclaimer: This discussion is for informational purposes and should not be taken as a recommendation to purchase any individual securities. Information within this discussion and investment determination of the author may change due to changes in investment strategy when warranted by changing market conditions, or if a security's underlying fundamentals or valuation measures change. There is no guarantee that, should market conditions repeat, this security will perform in the same way in the future. There is no guarantee that the opinions expressed herein will be valid beyond the date of this presentation. There can be no assurance that the author will continue to hold this position in companies described herein, and may change any of his position at any time. We use or best efforts to obtain good data in our models, however it can't be guaranteed that our inputs and data are correct. This is not a recommendation for readers to purchase shares in the above security without consulting your financial professional to discuss your own risk tolerance and objectives.