3 Mortgage REITs With Yields Over 12%

Includes: AGNC, IVR, NLY
by: Efsinvestment

By Siraj Sarwar

Mortgage real estate investment trusts (mREITs) are one of the most popular investment instruments among income-oriented investors. Their investment strategy is quite flexible and quickly adapts with the changing market conditions. Thanks to this flexibility, most mREITs offer significantly attractive distributions compared to the rest of the market.

Recently, the global economy came under intense pressure, and the financial system collapsed dramatically. As a result, mREIT businesses were adversely impacted by the volatile market conditions. Their spread rates have fallen significantly due to lower long term mortgage rates. Amidst these difficult conditions, most mREITs were able to generate massive profits.

In this article, I investigate three well-known mREITs, all of which have returned substantial income to their unit holders under strong headwinds. I believe that these mREITs have exceptionally strong investment strategies and flexible business models to tackle volatile financial conditions. Currently, all of these mREITs offer dividend yields of over 12%. These are Invesco Mortgage Capital (NYSE:IVR), Annaly Capital Management (NLY) and American Capital Agency (NASDAQ:AGNC). Let's examine each mREIT for its projected returns and potential distributions.

Invesco Mortgage Capital offers one of the best quarterly dividends at $0.65 per share. Due to the continuing depressed economy, the mREIT had to reduce quarterly dividends from a previous $1 mark to $0.65. Nevertheless, Invesco has been able to sustain similar dividends over the previous six quarters. At the end of 2012, Invesco paid $2.6 in distributions, yielding 12.71%. Over the last year, its stock price appreciated by almost 25%.

Invesco has a pretty flexible business model which can easily adapt to difficult financial and economic environments. Recently, the mREIT has been reconsidering its position in Agency Residential Mortgage-Backed Securities (NASDAQ:RMBS). With the Fed's recent initiative of Operation Twist, QE3 and QE4, Agency RMBS became a bit expensive. Spread rates have fallen. As a result, they are trading at a premium.

Therefore, Invesco quickly changed its investment strategy. Invesco moved its focus from agency RMBS to non-agency RMBS and commercial mortgage-backed securities (CBMS). At the end of Q4, the mREIT decreased its agency RMBS portfolio by $604 million. In addition, it increased its non-agency RMBS and CBMS portfolio by $534 million and $297 million respectively.

Furthermore, Invesco has been generating enormous earnings over the years. At the end of Q4, the mREIT had generated net income of $90.6 million, or $0.77 per common share. It managed to increase its earnings compared to the past quarter of $84.1 million or $0.72 per common share.

Invesco looks like a fairly valued investment with a price-to-book ratio of 1.0 and a dividend yield of 12.71%. The company has a smart investment strategy and a flexible business model able to sustain and grow returns for shareholders. With its recent change in investment strategies, Invesco is currently well-positioned to sustain attractive returns for investors. On the negative side, with a financial leverage ratio of 7.71, the firm is highly leveraged.

Annaly Capital Management is among the largest mortgage-backed investment trusts. The company is primarily engaged in the business of investing in collateralized mortgage obligations, mortgage pass-through certificates and other mortgage-backed securities.

Annaly has been offering substantial returns to investors over the years. Its dividends are quite inconsistent, mainly due to difficult economic and financial situations. Recently, it announced a quarterly dividend of $0.45 per share, a drop of 0.05 cents per share. For the full year, Annaly returned a dividend of $2.05 per share, yielding at 13.70%.

The company has been showing exceptional earning growth over the years. Recently, it announced Q4 results with remarkable earnings of $700.5 million or $0.70 per common share. It has been able to continue to increase its earnings quarter over quarter and year over year. The fourth quarter earnings are significantly higher compared to $445.6 million in the previous year's quarter.

The Q4 annualized interest rate spread decreased by 0.07% compared with Q3 of 2012. The spread rates fell mainly due to a drop of 0.21% in the coupon for interest-earning assets. At the end of Q4, the annualized yield on interest-earning assets stood at 2.45%, and the annualized cost of funds on interest-bearing liabilities stood at 1.50%. This represents an average interest rate spread of 0.95%.

This mREIT has been performing well in the current uncertain environment. The company is relatively a safer bet than most other mREITs as it applies a conservative approach in investment. I think as the housing market is growing, Annaly is positioned well to sustain current dividends over the next quarter. On the negative side, with a financial leverage ratio of 8.89, the firm is highly leveraged.

American Capital Agency is a real estate investment trust that invests exclusively in single-family residential mortgage pass-through securities, and collateralized mortgage obligations on a leveraged basis.

Over the years, it has been generating substantial returns for shareholders. Recently, it announced a quarterly dividend of $1.25 per share. This mREIT has been able to sustain similar dividends in the past four quarters. Over the year, American returned a hefty annual dividend of $5 per share.

Recently, American Capital announced Q4 comprehensive income of $126 million or $0.36 per common share. At the end of Q4, the mREITs' net book value per common share stood at $31.64. Moreover, economic returns for the period, adding together dividend plus change in book value, was $0.40 per common share, or 5% on an annual basis. In addition, for the full year of 2012, the mREIT reported a 32% economic return on common equity.

Regardless of QE3, the mREITs' investment strategy and asset selection remained stable. The mREIT sustained an economic return of over 30% in the last four consecutive quarters in a row. American's CPR remained 1% lower compared to the past quarter's CPR of 10%. Lower CPR represents stable and solid earnings. In addition, this represents the effective risk management of the mREIT.

Furthermore, at the end of Q4, American Capital's spread rates were raised to 1.63% compared to 1.42% in the past quarter. This is very significant. While most mREITs experienced a contraction in their spreads, American Capital was able to increase its spread substantially. The company is also paying one of the best dividends at $5 per share. While, I am optimistic about the mREIT's ability to sustain returns for next year, similar to other mREITs discussed, AGNC is highly leveraged with a financial leverage of 9.2.

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.