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A long position in New York Mortgage Trust (NASDAQ:NYMT) makes a great hedge for investors seeking to benefit from the high yields of mortgage REITs. Unlike other mortgage REITs, NYMT is asset sensitive. This is because a large tranche of NYMT's portfolio is in LIBOR-adjusting business loans, which yield more as rates increase. The REIT now pays a 17% yield, but as interest rates rise, company earnings should follow. REITs like Annaly (NYSE:NLY), Capstead Mortgage (NYSE:CMO), MFA Financial (NYSE:MFA) and Anworth (NYSE:ANH) should drop in price as rates rise since their spreads will be compressed.

Here is a dated excerpt from Jason Weaver and Henry Coffey at Sterne Agee putting next year's core EPS at $1.70:

Strong ROE Acceleration in 3Q - Raising Estimates

We see the Midway portfolio's performance as outstanding in the current quarter yet expect forward contributions to be somewhat more modest. In addition, the RiverBanc venture, though highly dependent on asset growth, should become much more apparent in coming periods.

NYMT reported estimated operating EPS of $0.49 v both last quarter and our estimate of $0.14. Earnings growth was driven both by increases in realized spread income from the Midway Residential portfolio as well as growing contributions from the RiverBanc commercial venture. Including both realized and unrealized gains, GAAP EPS was $-0- due mostly to the effect of rising credit spreads on the company's CLO investment yet underlying fundamentals remain strong. We are raising our FY11 and FY 12 estimates from $.91 and $.75 cents to $1.07 and $1.70 respectively.

(Sterne Agee research November 15th 2011)

Unfortunately Sterne has dropped coverage in my opinion because of a lack of banking business thrown its way. However several other firms now cover the company.

DateResearch FirmActionFromTo
21-Dec-12Deutsche BankInitiated Buy
11-Sep-12MLV & CoInitiated Hold
27-Aug-12Ladenburg ThalmannInitiated Buy
26-Jul-12Maxim GroupInitiated Buy

NYMT possesses top-quality credit expertise in commercial and residential real estate, and exploits this expertise to its advantage.

Steve Mumma, CEO, has depth in the real estate markets with Natexis, Credit Agricole, Paine Webber and Citibank. Steve possess some of the best real estate credit expertise in the business.

With deep expertise, NYMT is in a unique position to exploit the opportunities presented in the credit markets, earning excellent risk-adjusted returns. Furthermore, unlike the larger, well known mortgage reits,this company is still flying under the radar.

So what is in the secret sauce at NYMT? As loans mature, new investments are being made in senior tranches of heavily collateralized loans. It uses little leverage so the loans are very safe under most any realistic forward scenario. Loan-to-value ratios are well less than 50%, but with risk-adjusted ROEs of 15% to 20%. On the residential side, NYMT has a strategic relationship with the Midway Group. Midway has best-in-class expertise in residential mortgages and IOs. Risk adjusted returns have been in the low 20% range for these investments and should continue at these levels. On the commercial side, NYMT has a strategic relationship with Riverbanc LLC. Riverbanc has deep expertise in commercial real estate loans, focusing on mezzanine loans and private equity. Returns in the mid-to-high teens are expected here.

NYMT still employs a small amount of leverage, but with interest rate risk hedged on many investments that will actually improve performance as rates increase. This is key. As economic conditions improve, and rates rise, the performance of these loans will actually improve as well. In contrast, REITs such as Annaly (NLY), Chimeras (NYSE:CIM), American Capital (NASDAQ:AGNC) and Cypress (NYSE:CYS) are highly dependent on leverage.

But high leverage means high interest rate risk. They borrow at short-term rates, invest at longer-term rates and then leverage the spread four to eight times to generate a high yield. Look back to 2005 and you will see what happens when this strategy backfires. In the second half of 2005, Annaly (NLY) lost almost half of its value (dropping from 20 to 11) in less than six months when the yield curve flattened and spreads compressed. If long rates go up significantly and the yield curve flattens then look out below! At an absolute minimum, investors in leveraged REITs should consider diversifying into NYMT as a hedge to the significant interest rate risk they are taking in the leveraged REIT.

At $6.70/share, NYMT sells at a slight premium to our intra-quarter estimate of current GAAP Book Value of $6.44. But GAAP BV is conservatively calculated due to the valuation of its Cratos portfolio. These loans were purchased in the midst of the financial crisis at $.20 on the dollar. It recently sold a portion of this portfolio (booking a large gain) but it retains more than half of the original portfolio, with a carrying book value significantly less than par. As this block of loans approaches maturity, the discounts should grade to zero and the valuations rise. This could create the need for several special dividends from the company to shareholders. Therefore realistic economic book value is much higher than current GAAP BV. It is our opinion that real tangible book value may be above $8 per share. The moves up in this portfolio of loans has increased NYMT's book value.

In short, NYMT represents one of the true "Ben Graham stocks" available in the market today. Not only can you buy it at less than, in our opinion, fair value, but you get paid handsomely (through the sizable dividend) to wait for it to achieve fair value.

Individuals at NYMT and institutions also have large stakes.

BlackRock Fund Advisors800,9461.625,646,669Sep 29, 2012
DEUTSCHE BANK AKTIENGESELLSCHAFT499,0921.013,518,598Sep 29, 2012
RENAISSANCE TECHNOLOGIES, LLC447,0650.903,151,808Sep 29, 2012
STATE STREET CORPORATION388,3520.782,737,881Sep 29, 2012
YORKTOWN MANAGEMENT & RESEARCH COMPANY, INC.387,0000.782,728,350Sep 29, 2012
NORTHERN TRUST CORPORATION351,2340.712,476,199Sep 29, 2012
BlackRock Institutional Trust Company, N.A.341,6870.692,408,893Sep 29, 2012
MORGAN STANLEY310,6850.632,190,329Sep 29, 2012
Menta Capital LLC200,2000.401,411,410Sep 29, 2012
Oxford Asset Management191,2730.391,348,474Sep 29, 2012

Given this, management's interests are completely and totally aligned with shareholders. Unlike many companies, we believe the management team isn't there because they need their jobs. They are at NYMT solely to create and build value. If tomorrow they found the marketplace didn't offer value in their arena, it is our belief that they would shut down the company, sell off the loan portfolios (realizing large gains) and distribute cash well in excess of current book value to the shareholders.

NYMT presents an exceptional opportunity and value for investors. In a low interest rate environment, it offers an outstanding current yield, with additional potential upside in price movement and further yield increase as interest rates rise. This under-followed "Ben Graham stock" offers relative safety under most any realistic forward scenario. A long position in NYMT can be used to hedge a typical mortgage REIT portfolio while most likely benefiting from upside in the dividend and price of the stock.

Disclaimer: This article contains forward looking statements which should not be misconstrued as assurances of gains. My fund may trade this stock before and after this article is published.

Source: New York Mortgage Trust: A Hedge In The REIT Space And 17% Yield To Boot

Additional disclosure: My fund can and most likely will trade this security before and after this article is published