Capstead Mortgage: Despite Crisis, Still in Good Shape

Capstead Mortgage, (CMO), is a mortgage REIT which invests mostly in residential Adjustable Rate Mortgages that are issued and backed by U.S. government agencies, Fannie Mae (FNM), Freddie Mac (FRE), and Ginnie Mae.

Obviously, the residential ARM market has been a tumultuous place during the housing and credit crisis, but CMO has managed to make it through the crisis in good shape, and appears to be in a sweet spot for the next few quarters.

CEO Andrew Jacobs stated recently,

Looking out over the next several quarters, we anticipate somewhat higher mortgage prepayment levels, along with lower asset yields resulting from lower coupon interest rates on currently resetting ARM securities and lower yields on acquisitions. As a result, we anticipate financing spreads will decline modestly in the third quarter before beginning to improve in the fourth quarter and into the first half of 2010... If current market conditions persist, we should continue to generate what we believe to be very attractive dividends for our common shareholders.

We are confident our core investment strategy of managing a conservatively leveraged portfolio of agency-guaranteed residential ARM securities can produce attractive risk-adjusted returns over the long term while reducing, but not eliminating, sensitivity to changes in interest rates.

CMO increased its book value by over 25% for the 6 months ending 6/30/09, from $9.14 to $11.48/share, largely as a result of improvements in the value of interest rate swap agreements. Their profitability also benefitted from lower short term borrowing costs, while diluted EPS was steady at $.058. Here are some industry comps:

Capstead Mortgage vs. Real Estate Industry

	Capstead	Industry
Dividend Yield	17.13%	5.68%
LongTerm Debt/Equity	11.25%	165.00%
Total Debt/Equity	7.49	2.13
P/Book	1.17	2.03
P/Free cash/Share	16.49	38.28
P/E	6.72	27.80
ROI	17.67	1.43
ROE	18.62	3.39

Looking at their current debt load, you can see that CMO is more highly leveraged than their industry, but when you compare them to the other 3 high dividend paying stocks with strong ROE and ROI figures in this group, that figure, although still higher than this sub-group, isn't as outlandish:

Obviously, this group of high dividend stocks employs heavy leverage to turn a profit. If you're OK with that, and you're confident that the U.S. government will continue to stand behind its agencies' debts, then CMO could be a good dividend stock to add to your "best stocks" watch list. The other caveat is that if and when rates go up, their margins will most likely shrink.

There's not a lot of volatility in CMO, but it has recently been pushing higher - it closed Thursday at $13.77. If you're looking for a cheaper price, or for another way to profit, you might consider selling the November $12.50 puts, (CMOWV), which currently have a $.40-$.60 bid/ask.

Disclosure: Author is long CMO shares

Comments

[prairiedog555:]

So, when the fed raises interest rates the profit of these mortgage reits will fall and the stocks will fall? Is this correct?
And when I look at the 5 yr. charts of the industry it seems that the only time to buy is when they are really cheap.

Aug 21 08:15 AM

[coolsoupy:]

One is betting on a slow recovery. The FED cannot raise rates in the foreseeable future.


On Aug 21 08:15 AM prairiedog555 wrote:

> So, when the fed raises interest rates the profit of these mortgage
> reits will fall and the stocks will fall? Is this correct?
> And when I look at the 5 yr. charts of the industry it seems that
> the only time to buy is when they are really cheap.

Aug 21 08:33 AM

[Alan Young:]

I invested in several mortgage REITs last year, and they have been great performers, with about 40% total returns on my investment to date and ongoing dividends.

Aug 21 11:21 AM

[FranzSchubert:]

Prairiedog--It is not the rate but the steepness of the yield cureve that counts. CMO (and all other MREITs) borrow short and lend long. When rates go up, as they eventually must, as long as long and short rates rise proportionately, the mortgage REITs make money. When short rates go up precipitiously and long rates do not follow (or vice versa), then margins are squeezed and mREITs start running into trouble.
Given the state of the economy, the Fed is not going to raise rates soon.

Aug 21 01:34 PM

[Amanda Lauren:]

I guess people are playing the Charge Large Board Game!!

Aug 21 01:46 PM

[Lynn:]

Past performance is no indication of future returns.


On Aug 21 11:21 AM Alan Young wrote:

> I invested in several mortgage REITs last year, and they have been
> great performers, with about 40% total returns on my investment to
> date and ongoing dividends.

Aug 21 04:45 PM

[coolsoupy:]

The Fed will give plenty of notice of when to get out!

Meanwhile smile and take the divy's to the bank. (I even "cheat" and sell covered calls on NLY) Oh if iot could last forever?

Sep 01 09:30 AM