3 Mortgage REITs To Consider

Includes: AGNC, ARR, NLY
by: Efsinvestment

By Siraj Sarwar

Instead of retreating to traditional income generating investments like bonds, income seekers have had to get fancy with their income portfolios. Investors are searching for specialized investments that offer substantial returns with low risk.

In this article, I investigated mortgage REITs. Specifically, I picked three Mortgage REITs for income-seekers. Mortgage REITs are real estate investment trusts that mainly invest in mortgage-backed securities [MBS]. Mortgage REITs pays at least 90 percent of net income to shareholders in the form of nifty dividends. In addition, REITs do not have to shell-out any corporate-level tax. Mortgage REITs are offering enormously high dividend yields. REITs have had no deficiency of advocates, but subsequent to years of providing solid income, some cracks have begun to emerge in some of their business plans. Let's take a look at income generating powerhouses to see if their returns still outweigh the risks involved.

Key Metrics
















Dividend Yield




Rev Growth




Net Margin




Source: Morningstar.com

American Capital Agency (NASDAQ:AGNC) is a REIT that invests solely in collateralized mortgage obligations and agency pass-through securities. Externally, the company is advised and managed by American Capital Strategies.

Recently, AGNC declared a quarterly dividend of $1.25 per share (Trailing yield stands at 15.88 percent.) However, the company reduced its dividend by 10.7 percent from its previous dividend of $1.40 per share. American Capital reduced its dividend because of the contraction in spread rates. Nonetheless, the company quarterly dividend of $1.25 per share is well-above the industry average.

At the end of Q3, American's taxable EPS reduced by 26 cents. Taxable EPS reduced due to the reduction in spread rates. The firm spread rates decreased from 1.62 to 1.5. I believe after Fed's QE3, the company spread rates will also rise. Moreover, American Capital Agency is moving its portfolio holdings to lower coupon mortgage-backed securities.

AGNC owns mortgage-backed securities at low coupon and low balances. The company shifted its portfolio holdings to HARP securities and lower coupon mortgage-backed securities. These moves will also shield American from prepayments risks. These moves in the portfolio can also lower the impact of reduced net interest rate spreads. These initiatives will help the company against the Fed's buying and from the accelerated prepayments.

Annaly Capital Management (NYSE:NLY) is a real estate investment trust which invests in mortgage pass-through certificates. The company has a relatively simple and safe business model. The company invests in collateralized mortgage obligations, and other mortgage-backed securities.

Annaly has an extensive history of dividends. According to NASDAQ, Annaly paid quarterly cash dividends since 2000. Currently, Annaly offers a cash dividend of $0.45 per share, yielding at 13.87. At the end of Q3, Annaly paid $1.64 billion in dividend payments from operating cash flow of $7.28 billion.

Its business model is simple. The company produces net income from the spread between the interest income on interest-earning assets and the costs of borrowing to finance the acquisition of interest-earning assets. Government-sponsored agencies such as Ginnie Mae, Freddie Mac, and Fannie Mae guarantee all principal payments and interests on Annaly's investments. Its subsidiaries also contribute healthy sums in the form of dividends.

Recently, Annaly announced a share repurchase program, which I believe further increase dividends. Moreover, Annaly shows strong growth metrics for dividend hikes. Annaly has a three-year revenue growth rate of 10.5 percent. As one of the well-known mREITs, Annaly is recognized as one of the top dividend payers in the REIT industry.

Armour Residential (NYSE:ARR) is a REIT that invests mainly in hybrid adjustable rate and fixed rate residential mortgage backed securities. Armour is externally advised and managed by Armour Residential Management LLC. Armour Residential has a long history of dividends. For the first quarter of 2013, Armour declared a cash dividend of $0.08 per share for each month. The company has a three-year revenue growth rate of 30.9% along with healthy margins.

Armour Residential is trading at a discount with attractive multiples. The company share price of $6.92 represents a P/B ratio of 0.9 and trailing dividend yield of 16.91 percent. However, the average stock in the peers group yields at 3.9 percent and trades at P/B ratio of 1.9. Moreover, the company's price-to-sales ratio stands at 6.0 compared with the industry average of 8.0 Furthermore, the company is displaying attractive multi-year growth rates in essential fundamental data metrics.

Armour's business model has huge growth prospects. During the Q3 of 2012, the annualized yield on the company assets was 2.70 percent, and the annualized cost of funds on average liabilities stands at 0.89 percent. This indicates the company has a net interest spread of 1.82 percent. Moreover, the company is not losing its shareholders cash in the operating business cycle. The company has an operating margin of 67.4 percent and net margin on sales of 67.4 percent.

Armour has the highest net interest spread over its competitors. Armour has a net interest spread of 1.82%. Armour's MBS portfolio has a small prepayment risk as calculated by its CPR of 13%. I believe Armour is a nifty cash-generating machine for income-seekers.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: EfsInvestment is a team of analysts. This article was written by Siraj Sarwar, one of our equity researchers. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.