Protected Principal Retirement Strategy: Mortgage REITs - Are They Worth It?

by: Akaralph

I have long been a critic of the mortgage REIT [mREIT] sector. The primary reason for my negative posture is the fact that I lived through the mREIT debacle in 2008-2009 (read lost money), and in many instances was not able to extricate myself before dividends were slashed and several went into the crapper.

Over the past several quarters I have followed several of the more popular mREIT names and have noticed that many are trending in the same direction as the field headed in the last big bear market.

I realize that many whom avidly read SA constitute a "cult following" of many mREITs so I fully expect a hearty round of criticism for what I am about to discuss.

mREITs And The Bear Market Of 2008-2009

When commenting on SA mREIT articles the typical response I receive is "I looked back at 2008-2009 and just don't see the collapse". The primary reason for this is that most are either (1) no longer around, or (2) have re-invented themselves under new names.

In this article I will limit my discussion to "today's" popular mREITs, and should anyone wish to reviewed what happened in 2008-2009, Google has a wealth of information. One that I consider the "poster child" for the debacle was Thornburg Mortgage, and their story is well-documented in the internet.

The Ones I Follow

Since the Protected Principal Retirement Strategy portfolio seeks higher yields I follow a number of the more popular mREITs. The following are the ones that I try to stay abreast of:

  • American Capital Agency Corp. (NASDAQ:AGNC)
  • American Capital Mortgage Investment Corp. (NASDAQ:MTGE)
  • Annaly Capital Management (NYSE:NLY)
  • Anworth Mortgage Asset Corp. (NYSE:ANH)
  • Apollo Residential Mortgage (NYSE:AMTG)
  • ARMOUR Residential Mortgage (NYSE:ARR)
  • Capstead Mortgage (NYSE:CMO)
  • Dynex Capital (NYSE:DX)
  • Hatteras Financial Corp. (NYSE:HTS)
  • Invesco Mortgage Capital (NYSE:IVR)
  • MFA Financial (NYSE:MFA)
  • NY Mortgage Trust (NASDAQ:NYMT)
  • PennyMac Mortgage Investment Trust (NYSE:PMT)
  • Redwood Trust (NYSE:RWT)
  • Two Harbors Investment Corp. (NYSE:TWO)

I am aware that this does not constitute a complete list, but I believe it covers the major mREIT players.

Since my concern with this sector is that their profits are measured by their ability to borrow money using short-term debt, using these funds to purchase longer-term mortgage securities, thereby earning the spread between the rates. Some also employ a leverage strategy. Over the past year or so, the spread has been narrowing for many mREITs.

Narrowing spreads lead to reduced earnings and subsequently to dividend cuts.

The Table below depicts basic metrics for the mREITs listed above. It includes the highest quarterly dividend payment during the past four to five years, the current quarterly dividend payment, the number of reductions (or increases) to the quarterly dividend payment, the most recent quarterly earnings, and the coverage ratio (dividend/earnings - anything less than 1.0 is considered good) for the current quarter.

mREIT High Q Div. Current Q Div. Q Div Reductions (Increases) Recent Q Earnings Dividend Coverage Ratio
AGNC $1.50 $1.25 2 -$1.57 N/A
MTGE $.80 $.90 (1) $.62 1.45
NLY $.75 $.45 7 $.47 0.96
ANH $.32 $.15 8 $.13 1.15
AMTG $.75 $.70 1 $.74 0.95
ARR* $.12 $.07 5 $.18 1.17
CMO $.58 $.31 5 $.31 1.00
DX $.29 $.29 (4) $.34 0.85
HTS $1.00 $.70 3 $.62 1.13
IVR $1.00 $.65 3 $.64 1.02
MFA $.27 $.22 4 $.20 1.10
NYMT $.27 $.27 Varies $.31 0.87
PMT $.57 $.57 (4) $.90 0.63
RWT $.28 $.28 (1) $.69 0.41
TWO $.37 $.32 2 $.29 1.10
Click to enlarge

* Monthly Dividend Payer

Data Source: Yahoo Finance.


Since the Protected Principal Retirement Strategy portfolio has an aversion to including either mREITs or equity REITs [eREITs] whose earnings (funds from operations) do not adequately cover dividends we can eliminate AGNC, MTGE, ANH, ARR, CMO, HTS, IVR, MFA, and TWO from further consideration. It appears that several of these could be facing further dividend reductions in coming quarters.

Further, we also would steer clear of those REITs with a history of dividend cuts. This would eliminate NLY, AMTG, and NYMT from consideration.

We are left with just three to take a more in depth look at: DX, PMT and RWT.

DX - Dynex recently announced first quarter 2013 earnings of $.34, one penny more than the comparable quarter in 2012. At today's price it sells at just a tad above book value of $10.50. Of note is that DX interest rate spreads have continued to decline over the past several quarters. Its five year forward compound annual growth rate [CAGR] for earnings is 5.0 percent. Return on equity is 13.4 percent. DX presently yields 10.7 percent.

PMT - PennyMac's first quarter earnings of $.90 showed a year-over-year increase of 180 percent. Corresponding revenues increased by 146 percent year-over-year. Management noted that spreads were tightening. The five year CAGR is 25.0 percent. Return on equity is 19.0 percent. PMT has a current yield of 8.9 percent.

RWT - RWT recently reported first quarter 2013 earnings of $.69. This compared with $.50 for the same quarter in 2012. Revenues were up by 150 percent year-over-year. Book value increased for the third consecutive quarter. RWT's CAGR is presently 5.0 percent. Return on equity is 15.1 percent. At Friday's closing price, RWT yielded only 5.2 percent.

If I were to be in the market for an mREIT (which, at the present I am not until I see some widening in the spreads) I would look first to PMT.

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

Additional disclosure: This article does not constitute either a buy or sell recommendation for any of the stocks mentioned.