Income Producers Propelled By The Fed

Includes: CS, EARN, EFC, PMT, TWO, WFC
by: Marc Courtenay

When the Federal Reserve's monetary policies are good for entire sectors of the stock market that's usually good news for investors.

Yet many of the beneficiaries of Fed policies like the big financial money-center banks have already had great rallies on heavy volume. Take Wells Fargo (NYSE:WFC) for example. It hit a new 52-week high on July 17th at $43.88 before closing the day at $43.51.

This 1 year chart demonstrates its impressive run-up. I've included the 50-day simple moving average (SMA) price and the 200-day SMA price lines.

Chart forWells Fargo & Company (<a href=

WFC's dividend yield-to-price is now slightly below 2.8%. The consensus estimate 1-year price target among analysts is slightly above $44-a-share. Not a lot of upside potential at current price levels.

A Sector and 3 Companies Yet to Feel the Fed's Support

One specific sector of the stock market that has been greatly depressed in spite of the Fed's massive bond-buying program and monetary easing policies is the mortgage REITs.

No matter what kind of Mortgage-backed securities (MBS) or other kinds of Asset-backed securities (ABS) these REITs have invested in, Wall Street has treated them like they have cholera. This has become overdone and irrational.

This motivated Credit Suisse to recently opine on July 16th, "The current rate environment is expected to be more favorable than the second quarter, which should allow for the mortgage real-estate investment trusts to narrow their price-to-book discount."

Credit Suisse continues to see the hybrid mortgage REITs as offering better risk/reward ratios, and on their recommended list were 3 names that look considerably more favorable now that the yield curve has steepened.

Before introducing these 3 I'd like to direct your attention to an article I wrote 5 weeks ago in connection with this overlooked, generous-payout group of stocks. In my article I focused on the excuse and culprit behind this yet to rally, rare buying opportunity:

"For those of you who have the latest phobia - fear of tapering - about what the Fed may do regarding their massive bond-buying program and QE-4ever, let me put your mind at ease. As one of the nation's most honored commander-and-chiefs stated, "We have nothing to fear but fear itself."

"The good news is that taper-phobia has been somewhat responsible for putting some darn good publicly-traded companies in the 'taper toilet' for the past few weeks."

Hybrid Mortgage REITs in the Spotlight

One of the hybrid mortgage-REITs ready to ascend out of the fear-based "taper toilet" is Two Harbors (NYSE:TWO). TWO is a Maryland corporation structured as a REIT that invests in residential mortgage-backed securities, residential mortgage loans and other financial assets.

Two Harbors is headquartered in Minnetonka, Minnesota, and is externally managed and advised by PRCM Advisers LLC, a wholly-owned subsidiary of Pine River Capital Management L.P. The company's current dividend yield-to-price is an outstanding 12%, and management has commented as recently as June 13th that this yield is sustainable

On the company's website is stated its objectives:

"Our objective is to provide attractive risk-adjusted returns to our stockholders over the long-term, primarily through dividends and secondarily through capital appreciation.

"We intend to achieve this by constructing a well-balanced portfolio consisting primarily of RMBS, with a focus on managing various associated risks, including interest rate, prepayment, mortgage spread, financing, and credit risk. We focus on security selection and implement a relative value investment approach across various sectors within the residential mortgage market."

TWO's target assets include:

  • Agency RMBS, meaning RMBS whose principal and interest payments are guaranteed by the Government National Mortgage Association (or Ginnie Mae), the Federal National Mortgage Association (Fannie Mae (OTCQB:FNMA)) or the Federal Home Loan Mortgage Corporation (Freddie Mac (OTCQB:FMCC));
  • Non-Agency RMBS, meaning RMBS that are not issued or guaranteed by Ginnie Mae, Fannie Mae or Freddie Mac; and
  • Financial assets other than RMBS, comprising 5% to 10% of the portfolio.

Another of Credit Suisse' (NYSE:CS) recent recommendations on July 16th is a manager of mortgage REITs. Ellington Financial LLC (NYSE:EFC) manages a residential mortgage REIT with the symbol (NYSE:EARN). Shareholders of EFC are currently receiving a dividend yield of around 13%.

Ellington Financial is a specialty finance company that specializes in acquiring and managing mortgage-related assets, including residential mortgage backed securities backed by prime jumbo, Alt-A, manufactured housing and subprime residential mortgage loans and residential mortgage-backed securities.

These securities are the kind where the principal and interest payments are guaranteed by a U.S. Government agency or a U.S. Government-sponsored enterprise. EFC also offers mortgage-related derivatives, commercial mortgage-backed securities, commercial mortgage loans and other commercial real estate debt.

EFC is externally managed and advised by Ellington Financial Management LLC, an affiliate of Ellington Management Group, L.L.C.

On July 8th EFC announced that its estimated book value per common share as of June 30, 2013, was $24.90, or $24.50 on a diluted basis. Estimated book value per share on a diluted basis takes into account securities convertible into the company's common shares.

These estimates are subject to change upon completion of the company's month-end valuation procedures relating to its investment positions, and any such change could be material. "There can be no assurance that the company's estimated book value per common share, as of June 30, 2013, is indicative of what the company's results are likely to be for the three or six month periods ending June 30, 2013 or in future periods," EFC clarified in its press release.

In its press release EFC also warned that it "...undertakes no obligation to update or revise its estimated book value per common share prior to issuance of financial statements for such three and six month periods."

Shares of EFC closed at $22.80 on July 16th. The company's website claims by utilizing "a flexible and opportunistic investment strategy, Ellington Financial has built a portfolio of mortgage-related investments, consistently striving to deliver attractive returns to shareholders."

Additionally, an emphasis on risk management is fundamental to the Ellington Financial approach. It states on its site that this strategy is "driving attractive, risk-adjusted returns across market cycles and enabling us (EFC) to identify and succeed in investment opportunities that we believe are consistent with our investment strategy."

"Ellington Financial's understanding of the market across asset classes, over time, and through a highly analytical lens helps us to realize potential and unlock value," its website also added.

A Third Mortgage REIT Recommendation

Another of the July 16th recommendations was PennyMac Mortgage Investment Trust (NYSE:PMT). The Moorpark, CA, company was founded in 2009 and operates as a specialty finance company.

Through its subsidiaries, PMT invests primarily in residential mortgage loans and mortgage-related assets.

It has chosen to be taxed as a REIT and is required to pay out most of its funds from operations. This is reflected in its $2.28-per-share dividend which yields slightly more than a 10% yield.

PMT's Chairman of the Board and CEO Stanford Kurland owns 428,000 shares including 40,000 shares he purchased on May 22nd at share prices ranging between $22.44 and $22.81. He obviously believes in the future of PMT and the upside potential of its share price.

The Vanguard Group is the top institutional investor of PMT shares, owning more than 5% of the outstanding shares as of March 31, 2013. The consensus analysts' estimated 1-year target price for PMT shares is $25.72.

To help illustrate the buying opportunity presently available on shares of PMT, EFC and TWO I encourage you to carefully study this 1-year price comparison chart below. All three are at the low end of their trading ranges.

Chart forPennyMac Mortgage Investment Trust (<a href=

All three bounced off recent bottoms and are moving higher in tandem.

The Fed's easy money policies will be with us to one degree or another for the immediate future. If you agree, and you realize that these companies directly benefit from both government-guaranteed interest income and return-of-principal by owning mostly government-guaranteed debt securities, you can enthusiastically begin accumulating them before the "herd" catches on and climbs aboard.

The upside potential and the outstanding dividend yields makes this group a compelling theme for income-hungry investors. These 3 mortgage REITs will continue to thrive off the Fed's QE4-ever programs, and remember the Fed is likely to be the end-buyers of the securities that TWO, EFC and PMT are now holding. That's a reassuring factor.

Disclosure: I am long TWO. 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.