For These Mortgage REITs Non-Agency Acquisitions May Be The Best Medicine

by: Matt Schilling

On December 12th it was announced by the Federal Reserve that it will expand its pre-existing asset purchase program by buying $45 billion a month of Treasury securities starting in January in an effort to spur the economy. These purchases will be in addition to $40 billion a month of existing mortgage-debt purchases. These purchases, which will total $85 billion per month, will clearly hinder the growth of the agency-based Mortgage sector and as a result hinder the sustainability of each company's dividend. In this article I wanted to highlight some of the possible acquisition targets these firms may want to consider in the wake of this.

Annaly Capital (NYSE:NLY): In the past 18 months, one thing Annaly Capital has been known for is the cutting of its dividend a total of five times from its high of $0.65/share (June 2011) to its current low of $0.45/share (December 2012). That equates to a decrease of 38.46% or $0.20/share.

Annaly Capital clearly needs to begin to consider alternative investment options, especially if the Fed is going keep up its pseudo-Mortgage REIT behavior. On November 12th the company took the first steps in diversifying its holdings by making a bid of $12.50/share for all the outstanding shares of Crexus (NYSE:CXS) which operates a portfolio consisting of commercial paper. In my opinion, this idea is a great first step but a lot more needs to happen in the next 12-18 months before Annaly is in the clear. Continued acquisitions that are built on the premise of diversification may be something to consider as non-agency names like Chimera (NYSE:CIM) could be ripe for the picking.

Hatteras Financial (NYSE:HTS): Since June 2011 Hatteras Financial has been known for cutting its dividend a total of three times from its high of $1.00/share (June 2011) to its current low of $0.70/share (December 2012).

When it comes to some of the bigger Mortgage REITs such as Hatteras, near-term acquisitions should be considered a viable option. Smaller, non-agency firms such a Chimera Investment or Newcastle Investment (NCT) offer non-agency-based assets, and although seemingly disproportionate to current holdings every little bit should help in an environment in which the Fed has increased its position as a pseudo-Mortgage REIT. Though no official plans to acquire either have been announced, both non-agency-based Mortgage REITs would offer off-setting assets that may boost the bottom line numbers for a company like Hatteras, especially since the Fed has become more aggressive in its spending behavior in after to balance out the labor markets.

American Capital Agency (NASDAQ:AGNC): When it comes to dividend behavior, American Capital Agency is the clear winner over the last 18 months. Since June 2011, AGNC has only lowered its dividend once from $1.40/share in December 2011 to $1.25/share in March 2012. That decrease equates to a cut of 10.71% or $0.15/share.

Though not an immediate need, the issue of diversification needs to be addressed. The Fed's behavior will eventually catch up with American Capital Agency and as a result an acquisition should be considered. The next 12-18 months are going to be very touch-and-go for AGNC especially if the Fed increases its $85 billion per month on MBS and US Treasury spending and as a result a non-agency or CMBS acquisition similar to Annaly's may be an option in the near-term. Though no targets have been named as of yet, I think firms such as Invesco Mortgage Capital (NYSE:IVR) currently valued at $2.43 Billion or AG Mortgage Investment Trust (NYSE:MITT) currently valued at $540 million may be excellent possibilities.

Final Analysis

When considering all three agency-based Mortgage REITs potential investors need to proceed with caution. Just because a double-digit yield and heavily undervalued security looks attractive on the outside, doesn't necessarily mean it is, nor does it mean such yields are sustainable given the current MBS environment. The next 12-18 months are going to be critical since no one really knows how the Fed will continue to spend, and as a result all three firms need to serious consider investing outside of their proverbial agency-based box.

Disclosure: I am long AGNC, HTS, NLY, CIM, IVR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.