Why You Should Invest in MITT
AG Mortgage Investment Trust (MITT) is a very good opportunity for investors to purchase a solid company with a sound management team, along with a pool of non-agency and agency MBS at a very steep discount. MITT is a buy at $15.25 with a price target of $20. That is a total return profile of 45% on invested capital over a 12-month period of time. This return is made up of both capital appreciation and dividend income.
The Strategy Of A Hybrid
The hybrid strategy allows for a more balanced level of interest rate risk and credit risk than an agency-only mREIT, while generating a strong comparable dividend return to investors. The shareholder allocation is split 50/50 agency to non-agency in order to keep a balance of interest rate and credit risk, depending on the overall economy and direction of interest rates. It is all about finding that perfect balance for the environment, as agency assets can provide a hedge for non-agency assets and vice-versa. In this environment, MITT has an equal percentage agency to non agency, with much of the interest rate risk hedged using a variety of interest rate hedging tools.
The Net Interest Margin and Why You Should Care
The Net Interest Margin (NIM) is the difference between the cost of funds and the asset yield. The cost of funds can be broken down into two parts. Those two parts being the cost of repurchase agreement interest expense and the hedging expense associated with protecting the book value. As of Q3 2013, MITT had a NIM of 2.12%. It was one of the highest in the industry. Back in the 2005 to 2006 era, many agency mortgage REITs ran into trouble with the spread becoming too narrow and were forced to delever. In the non-agency world, there is a larger spread due to the higher asset yield and credit risk that come with the territory. This is important to MITT, since the ability to buy non-agency allows for wider spreads. This means a higher degree of profitability when the agency side of spreads become narrow.
MITT's Earnings And Future Earnings Outlook
The core earnings per share came in light, around 0.45/share, while paying a 0.60 quarterly dividend. The remaining 0.15/share was covered using undistributed taxable income (UTI). MITT had UTI of $1.59/share as of September 30th, 2013. UTI has to be paid out to investors due to the nature of the company's tax status. The duration gap was slightly higher at the end of Q3 2013 than at the end of Q2 2013. This higher duration gap allows for an increased level of income at the expense of being a little less defensively positioned. Instead of losing 1.7% of shareholder equity on a 100 basis point move in rates, the risk is increased to 2.7% loss to equity on the same move. This compares to American Capital Mortgage Investment Corp.'s (MTGE) 8% loss to equity if interest rates increase by 100 basis points.
The Leverage Factor and Prepayments
The leverage MITT employs has come down and so has prepayment speeds. Prepayments are important for determining the asset yield of the portfolio. The higher the prepayment speed on agency assets, the lower the asset yield and vice versa. For non-agency securities, prepayments are actually a good thing if you own the asset at a discount like MITT does. MITT's non-agency portfolio had a weighted average fair market value of 63.6 cents on the dollar as of September 30th, 2013. When MITT experiences a prepayment on the non-agency portfolio, that security is repaid at par generating realized gains.
How MITT Has Dealt With The Increased Volatility In The Markets
MITT's portfolio was repositioned late in September after the Federal Reserve threw a curve ball to the bond market by saying they will continue to buy 85b a month of treasury and agency MBS securities. Most investors were expecting a "taper-light" scenario in which the Federal Reserve would start by tapering the pace of monthly purchases by five or ten billion. The result was a bond market rally in both agency and non-agency assets. As of late, the agency side has deteriorated while non-agency assets have continued to appreciate on the back of a stronger economy and improved labor market conditions. Despite the losses on the agency MBS side, the non-agency weight should anchor book value in the $19 to $20 range, for the time being, with further upside as long as the economy continues to improve. Just as I was writing this article, I saw MITT declare a 0.60/share dividend for the 4th quarter. I expect this dividend level will improve in future quarters as the company reinvests at higher spreads going forward. The main risk to my theory on higher dividends would be interest rates declining due to a slow economy. I do not believe the economy is slowing and the data does not suggest a weaker economy thus far in the fourth quarter. www.agmit.com