2 High-Yield Plays For Falling Interest Rates

Includes: RAS, TWO
by: Bret Jensen

The yield on ten year treasuries continues to fall after the Federal Reserve got "cold feet" and decided against any "taper" at the FOMC meeting last week. Yields have plunged some 35bps since the announcement. This pullback in rates has obviously benefited the high yield sectors that had been hurt by the rapid rise in interest rates since May prior to the latest Fed announcement.

I believe the rate on the 10-year treasury yield will stay below the 3% level for at least the end of year. Job and economic growth are too tepid to support higher rates. In addition, the next month is likely to bring escalating political tension in D.C. around the debt limit and budget talks. With a dove (Janet Yellen) being lined up to be the next Fed chairperson, I think the institution's money printing will continue for the foreseeable future.

Given this outlook, some high yield plays should do well in this environment. Here are two mortgage REITs I like here to bounce back after significant pullbacks.

RAIT Financial Trust (NYSE:RAS) is a multi-strategy commercial real estate company incorporated as a real estate investment trust. The company operates in three core areas. It originates commercial real estate loans, purchases commercial real estate properties and invests in commercial mortgage backed securities. It is different than most mortgage REITs as it owns and operates properties. This provides it with management fees as well as greater earnings stability and less volatility.

The shares yield a juicy 8.6% and the company recently showed confidence in its business prospects by hiking its quarterly payout by 15%. It also bumped its payout by 8% in June. The shares are cheap at under book value and below 5x this year's expected earnings. Only two analysts follow the stock. Each has a price target of $10 a share on RAS, substantially above the current stock price of ~$7 a share.

The company lost 20% of its market capitalization during the run up in interest rates starting in May. As interest rates stabilize or continue to fall the stock should recapture some of those losses in addition to providing a very healthy yield.

Two Harbors Investment (NYSE:TWO) focuses on investing in, financing and managing residential mortgage-backed securities, residential mortgage loans, and other financial assets. It does offer the diversity of earnings streams as RAIT but it does pay a higher dividend yield. The stock has fallen ~30% since its highs earlier this year and the stock is below the level several insiders made small purchases at earlier in the year.

JPMorgan just initiated the shares as a "Buy" this morning. Maxim also had favorable comments on the firm earlier in the week. This follows an upgrade by Ladenburg Thalman to "Buy" in August. The same month Credit Suisse listed it as one of its top picks among mortgage REITs.

The shares yield over 11 percent (11.2%) and company bought back 1mm shares in the most recently completed quarter. The stock is too cheap selling at less than book value and 4x trailing earnings.

Disclosure: I am long RAS. 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.