Agency mREIT Book Value Change Analysis (Short-Term Potential For 10% Upside For Sector)

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 |  Includes: AGNC, ARR, CMO, CYS, HTS, NLY
by: Scott Kennedy

Focus of Article:

The focus of this article is to examine the recent book value ('BV') changes of most of the agency mortgage real estate investment trust (mREIT) companies within the sector. This analysis will show recent past and current data with supporting documentation (via Table 1). Table 1 will compare past BV per share figures from six agency mREIT companies from the end of the first quarter of 2013 to the end of the third quarter of 2013. This analysis will be presented after a discussion on the difference between an agency and non-agency mREIT including the difference between a mainly fixed and variable-rate mortgage-back securities (MBS) portfolio. This will then be followed by a discount to BV analysis between the six agency mREIT companies using stock prices as of 12/13/2013. This article will allow readers to gain a better perspective in regards to the current situation at hand regarding recent BV per share changes and current discount to BV valuations.

At the end of this article, there will be a conclusion on which agency mREIT companies had the best and worst recent BV per share changes (percentage wise) during the past two quarters and which companies currently have the best and worst discounts to BV. I will also state where I see some attractive short-term upside potential in the sector if the Federal Reserve ('FED') continues its Qualitative Easing ('QE') Bond Purchasing Program at its current level ($85 billion per month; $45 billion of U.S. Treasury securities and $40 billion of MBS) into 2014.

I am writing this particular article due to the recent requests that such an analysis be performed in light of the continued volatility in the entire mREIT sector. Understanding the general characteristics of each company's MBS and derivative portfolios can shed some light on which companies are possibly "oversold" strictly per a "numbers" analysis. This is not the only data that should be examined to initiate a position within a particular stock/sector. However, I feel this analysis would be a good "starting-point" to begin a discussion on the topic. Therefore, I feel it is necessary to take a step back and see the bigger picture when it comes to the mREIT sector.

Overview of an Agency versus Non-Agency mREIT Company and Fixed versus Variable-Rate MBS:

A majority of agency and non-agency MBS are generated when various mortgages, typically from commercial banks, are sold to financial institutions (government-sponsored entities ('GSE') or private investment banks) who "bundle" these loans together into securities (pools) that can be sold to investors in the respective MBS markets. These MBS can either be residential ('RMBS') or commercial ('CMBS'). An mREIT typically earns a majority of the company's income from the difference between the yields generated from the longer-termed MBS less all interest expenses that are paid on the company's shorter-termed debt/borrowings that finance the purchase of the MBS. This difference is also known as the "net spread" interest yield. Through the use of leverage, mREIT companies can increase/enhance returns generated from the net spread interest yield. This general business model is how these companies are able to pay high dividend yields, even if mortgage interest rates remain relatively low. However, whenever a company bases its business operations on the use of leverage, risk is heightened. Specifically regarding mREIT companies, this heightened risk comes in the form of quick, rapid increases to market interest rates which cause material declines to MBS prices. Due to these MBS price declines, the value of the assets held within an mREIT's MBS portfolio rapidly lose value. Through the use of leverage, these losses can be magnified. This sector uses various forms of derivative instruments to offset the risk of quick MBS price declines. Further discussion of the sector's derivative instruments is beyond the scope of this article.

An agency mREIT is a company that mainly invests in RMBS, CMBS, collateralized mortgage obligations ('CMO'), and agency debentures for which the principal and interest payments are guaranteed by a GSE. For simplicity, all these types of security holdings will be classified as MBS within this article. A few examples of a GSE/government agency are the following: 1) the Federal National Mortgage Association (Fannie Mae) (OTCQB:FNMA); 2) the Federal Home Loan Mortgage Corporation (Freddie Mac) (OTCQB:FMCC); and 3) the Government National Mortgage Association (Ginnie Mae). An agency mREIT will typically have lower-yielding MBS holdings but also have a higher level of credit safety due to the reduced risk on these certain types of MBS.

A non-agency mREIT is a company that mainly invests in non-agency holdings backed by residential mortgages that are not guaranteed by a GSE or government agency. These holdings could include non-agency MBS investments such as prime, subprime, "adjustable-rate mortgages" ('ARM'), and Alt-A loans. The loans within these investment pools may also be jumbo home mortgages that are not eligible for agency underwriting or mortgages on commercial properties that are securitized by private investment banks. Without the agency backing, non-agency MBS typically pay a higher interest yield but are subject to default risk. However, by bundling these types of mortgage loans together to form a non-agency MBS, overall default risk can be minimized (to an extent).

Side Note: Currently, there are various mREIT companies that acquire both agency and non-agency MBS holdings. This type of company is known as a "hybrid" mREIT. Due to the subtle differences between agency and non-agency MBS, I like to differentiate between agency and hybrid mREIT companies. As such, this article will only be focusing on "pure" (100%) agency mREIT companies.

MBS are either classified as being fixed or variable-rate in nature. Most fixed and variable-rate agency MBS have maturities of 15, 20, or 30-years. Variable-rate agency MBS are generally referred to as ARM holdings that have varying interest rate "reset" periods. Some ARM characteristics include the following (but not limited to): 1) initial fixed-rate period lengths (5/1, 7/1, etc.); 2) interest and payment adjustment frequencies (reset periods mentioned above); 3) interest rate "cap" percentages; and 4) convertibility terms. ARM holdings are usually classified together based on each security's average number of months to coupon reset. This can also be known as the security's "months-to-roll". This is a typical indicator of asset duration which helps identify each security's price sensitivity to market interest rate movements.

Agency mREIT BV Change Analysis (Including Current Discount to BV Analysis) - Overview:

Let us start this analysis by first getting accustomed to the information provided in Table 1 below. This will be beneficial when explaining how each agency mREIT matches up to its peers regarding quarterly BV changes and each company's current discount to BV.

Table 1 - Agency mREIT BV Change Analysis (Including Current Discount to BV Analysis)

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(Click to enlarge)

Using Table 1 above as a reference, six agency mREIT companies are presented in alphabetical order according to its stock ticker symbol. The table provides each company's fixed and variable-rate holdings as of 9/30/2013 (see blue reference "A" in Table 1 above). The difference between mainly having a fixed or variable-rate MBS portfolio is important. Each type of MBS portfolio has inverse prepayment characteristics as interest rates move. For instance, as interest rates rise, a mainly fixed-rate MBS portfolio will have less prepayment risk due to the fact these holdings generally have lower interest rates than what is currently offered in the MBS market. As such, it would not make much sense to prepay a mortgage that has a lower interest rate than what the market is currently offering (generally speaking). However, a mainly variable-rate MBS portfolio has ARM holdings which have periodic reset periods where interest rates of the underlying mortgages readjust to the would be current market interest rate. In a rising interest rate environment, these ARM holdings would eventually reset to a higher interest rate. As such, it makes more sense to prepay/convert a variable-rate mortgage that is about to reset to a materially higher interest rate (generally speaking). Therefore, these ARM holdings generally see higher prepayment risk in a rising interest rate environment. This is an important concept to understand because it has a direct impact on MBS prices and amortized costs.

After breaking down the percentage of fixed and variable-rate MBS holdings as of 9/30/2013, Table 1 above states the following information on each agency mREIT company (from left to right): 1) market capitalization as of 12/13/2013; 2) BV at the end of the first quarter of 2013; 3) BV at the end of the second quarter of 2013; 4) BV change during the second quarter of 2013 (dollar amount per share); 5) BV change during the second quarter of 2013 (percentage amount); 6) BV at the end of the third quarter of 2013; 7) BV change during the third quarter of 2013(dollar amount per share); 8) BV change during the third quarter of 2013 (percentage amount); 9) stock price as of 12/13/2013; 10) current (discount)/premium to BV at the end of the third quarter (dollar amount per share); and finally 11) current (discount)/premium to BV at the end of the third quarter (percentage amount).

Side Note: Out of these six agency mREIT peers, I feel a further breakdown is warranted. Currently, CMO and HTS should be classified as variable-rate agency mREIT companies while AGNC, ARR, CYS, and NLY should be classified as fixed-rate agency mREIT companies. Readers should be aware as such while the analysis is presented below.

Now that a brief overview of Table 1 above has been established, this article will now proceed to a BV change analysis including a current discount to BV analysis for six agency mREIT companies.

1) American Capital Agency Corp. (NASDAQ:AGNC)

The first agency mREIT to discuss is AGNC. Using Table 1 above as a reference, AGNC had a 97% fixed-rate (3% variable-rate) agency MBS portfolio as of 9/30/2013 and has a market capitalization of $7.69 billion as of 12/13/2013. AGNC had a BV of $28.93 per share at the end of the first quarter of 2013. AGNC had a BV of $25.51 per share at the end of the second quarter of 2013. This calculated to a BV reduction of ($3.42) per share or (11.82%). Even though this was a material reduction, AGNC still outperformed the company's agency mREIT peers for the quarter with the exception of Capstead Mortgage Corp. This was mainly due to the relatively high "hedging coverage ratio" AGNC had before the "spike" in market interest rates during the second-half of the second quarter of 2013. AGNC increased the company's hedging coverage ratio to 102% as of 6/30/2013.

AGNC had a BV of $25.24 per share at the end of the third quarter of 2013. This calculated to a BV reduction of ($0.24) per share or (0.94%). Even though this was a disappointment for some market participants, AGNC still outperformed the five other agency mREIT peers during the third quarter of 2013 regarding mitigation of BV losses (percentage wise). This was attributed to management's cautious investment strategy of reducing AGNC's more price sensitive 30-year fixed-rate MBS holdings while also selling the company's lowest coupon MBS. This "defensive posture" by AGNC's management team helped mitigate BV erosion during the third quarter of 2013. Unfortunately, this also caused net income and estimated real estate investment trust taxable income (ERTI) to be fairly low for the quarter (hence the continued material dividend cut). Partially based on the lower quarterly ERTI figure, AGNC slightly lowered the company's hedging coverage ratio from 102% at the beginning of the quarter to 93% as of 9/30/2013.

Still using Table 1 above as a reference, as of 12/13/2013 AGNC's stock price trades at $20.02 per share. When calculated, this shows AGNC's stock price is currently trading at a ($5.25) per share or (20.78%) discount to BV as of 9/30/2013. This is a material discount to BV. Even if one makes the argument CURRENT BV is down approximately (5%) in the fourth quarter of 2013, a (15.78%) discount to CURRENT BV is still a material discount. Depending on future economic indicators and more importantly if the FED continues its QE Bond Purchasing Program at its current level ($85 billion per month) into 2014, I feel AGNC has the possibility of some nice short-term upward momentum/price appreciation.

Let us perform this same analysis on the five other agency mREIT companies and see how each company performed regarding past BV changes and a current discount to BV analysis.

2) ARMOUR Residential REIT Inc. (NYSE:ARR):

Using Table 1 above as a reference, ARR had a 98% fixed-rate (2% variable-rate) agency MBS portfolio as of 9/30/2013 and has a market capitalization of $1.38 billion as of 12/13/2013. ARR had a BV of $6.69 per share at the end of the first quarter of 2013. ARR had a BV of $5.43 per share at the end of the second quarter of 2013. This calculated to a BV reduction of ($1.26) per share or (18.83%). ARR was basically in line with the company's agency mREIT peers regarding BV reductions during the second quarter of 2013. However, this was still a material reduction in BV for just one quarter. This was mainly due to the fact approximately 66% of ARR's MBS portfolio was in the more price-sensitive 30-year fixed-rate holdings. When compared to 15-year fixed-rate MBS, 30-year fixed-rate MBS are generally more susceptible to price movements as market interest rates move. Furthermore, ARR's hedging coverage ratio was only approximately 58% as of 6/30/2013. This ratio was even lower as of 3/31/2013. As such, these two factors explain why ARR had a material reduction in BV of (18.83%) for the second quarter of 2013.

ARR had a BV of $5.26 per share at the end of the third quarter of 2013. This calculated to a BV reduction of ($0.17) per share or (3.13%). Even though this was only a relatively minor reduction in BV, ARR underperformed several other agency mREIT peers during the third quarter of 2013 regarding mitigation of BV losses (percentage wise). However, when compared to the BV change during the second quarter of 2013 (18.83%), this minor drop to BV in the third quarter of 2013 was a positive sign. This was mainly attributed to the large increase in ARR's hedging coverage ratio. As stated above, ARR had a hedging coverage ratio of only 58% as of 6/30/2013. However, this ratio materially increased to 85% as of 9/30/2013. As such, ARR was able to mitigate BV erosion during the third quarter of 2013 (to an extent).

Still using Table 1 above as a reference, as of 12/13/2013 ARR's stock price trades at $3.73 per share. When calculated, this shows ARR's stock price is currently trading at a ($1.53) per share or (29.09%) discount to BV as of 9/30/2013. This is a material discount to BV and the largest out of the agency mREIT peers. One could make the argument CURRENT BV is down approximately (8%) in the fourth quarter of 2013. As such, ARR is still trading at a material discount to CURRENT BV of approximately (21%). Since ARR continued to have nearly 66% of the company's MBS portfolio in the more price sensitive 30-year fixed-rate holdings, this steep discount should be taken "with a grain of salt". Depending on future economic indicators and more importantly if the FED continues its QE Bond Purchasing Program at its current level ($85 billion per month) into 2014, I feel ARR has the possibility of some nice short-term upward momentum/price appreciation even though this company tends to "lag" behind its agency mREIT peers.

3) Capstead Mortgage Corp. (NYSE:CMO):

Using Table 1 above as a reference, CMO had nearly the company's entire MBS portfolio in variable-rate (also known as ARM) agency holdings as of 9/30/2013 and has a market capitalization of $1.16 billion as of 12/13/2013. CMO had a BV of $13.60 per share at the end of the first quarter of 2013. CMO had a BV of $12.80 per share at the end of the second quarter of 2013. This calculated to a BV reduction of ($0.80) per share or (5.88%). CMO vastly outperformed the company's agency mREIT peers regarding BV reductions during the second quarter of 2013. This was mainly due to the fact CMO's entire MBS portfolio was in ARM holdings which have interest rate reset periods (discussed earlier). CMO's MBS portfolio as of 6/30/2013 had the following percentages regarding the company's interest rate reset periods: 1) approximately 82% reset annually; 2) approximately 11% reset semi-annually; and 3) approximately 7% reset monthly. Even though the company's 6/30/2013 weighted average coupon ('WAC') and weighted average net yield were the lowest out of the agency mREIT peers, CMO also had very low hedging costs. CMO utilized forward-starting 1-month London Interbank Offered Rate (LIBOR) payer interest rate swaps. These interest rate swaps were directly tied to the current and forecasted 1-3 month borrowing rates of the company's repo loans. As such, these interest rate swaps had extremely low durations and overall costs associated with them. CMO's interest rate swaps had a weighted average fixed pay rate of only 0.61% as of 6/30/2013. As such, these two factors explain why CMO had only a modest reduction in BV of (5.88%) for the second quarter of 2013.

CMO had a BV of $12.35 per share at the end of the third quarter of 2013. This calculated to a BV reduction of ($0.45) per share or (3.52%). Even though this was only a relatively minor reduction in BV, CMO underperformed the five other agency mREIT peers during the third quarter of 2013 regarding mitigation of BV losses (percentage wise). This was mainly attributed to the prepayment risk of ARM holdings in a rising interest environment (discussed earlier). For instance, the constant prepayment rate ('CPR') for CMO was 25.49% at the end of third quarter of 2013. When compared to the end of the prior quarter, this was an increase of 2.37%. Prepayment risk will continue to increase within CMO's variable-rate MBS portfolio in a rising interest rate environment. However, this prepayment risk is offset by the following: 1) lower valuation risk on CMO's MBS portfolio due to the nature of the ARM holdings (rates reset); and 2) continued low overall hedging costs due to extremely low durations.

Still using Table 1 above as a reference, as of 12/13/2013 CMO's stock price trades at $12.08 per share. When calculated, this shows CMO's stock price is currently trading only at a ($0.27) per share or (2.19%) discount to BV as of 9/30/2013. This is only a minor discount to BV. One could make the argument CURRENT BV is down approximately (3%) in the fourth quarter of 2013. As such, CMO is basically trading at CURRENT BV. While CMO seems to be generally a safer investment overall when compared to the other five agency mREIT peers, this aspect seems to be already priced into the stock. Also, CMO's current dividend yield is the lowest out of the agency mREIT peers at an annual dividend yield of approximately 10%. This is due to the fact CMO has the lowest WAC and weighted average net yield of the company's agency mREIT peers (discussed earlier). While past and current holders of this company have benefited from owning this stock when compared to the five other agency mREIT peers regarding BV reductions, the non-discount to CURRENT BV would seem to point out a lack of short-term material upward momentum/price appreciation for CMO if the FED continues its QE Bond Purchasing Program at its current level ($85 billion per month) into 2014 while the rest of the sector could have a nice "bounce-back" rally.

4) CYS Investments Inc. (NYSE:CYS):

Using Table 1 above as a reference, CYS had an 85% fixed-rate (15% variable-rate) agency MBS portfolio as of 9/30/2013 and has a market capitalization of $1.22 billion as of 12/13/2013. CYS had a BV of $12.87 per share at the end of the first quarter of 2013. CYS had a BV of $10.20 per share at the end of the second quarter of 2013. This calculated to a BV reduction of ($2.67) per share or (20.75%). CYS had the second worst BV reduction (percentage wise) when compared to the company's agency mREIT peers during the second quarter of 2013. There were two main reasons for the underperformance. First, approximately 45% of CYS's MBS portfolio was in the more price-sensitive 30-year fixed-rate MBS while only 34% were in the less price-sensitive 15-year fixed-rate MBS. When compared to 15-year fixed-rate MBS, 30-year fixed-rate MBS are generally more susceptible to price movements as market interest rates move. Second, CYS's hedging coverage ratio was approximately 76% as of 6/30/2013. This really was not that low of a ratio (percentage wise). However, the problem CYS had was the weighted average duration of the company's hedges. During the second quarter of 2013, the rate paid by the fixed-rate payer had increased at a greater percentage rate the longer the interest rate swap tenor (maturity) was. For instance, the rate paid by the fixed-rate payer on a 3-year interest rate swap had increased 30 basis points ('bps') while the rate paid by the fixed-rate payer on a 7-year interest rate swap had increased 74 bps. This may not seem like a big difference to some readers. However, since the rate paid by the fixed-rate payer on a 7-year swap had increased over two times the rate paid by the fixed-rate payer on a 3-year swap, the 7-year swap valuation gain was double when compared to the 3-year swap valuation gain. As such, the lower the interest rate swap/cap tenor was, the less the valuation gains occurred to offset the reduction in MBS valuations. Since CYS had a relatively low weighted average duration on the company's interest rate swaps/caps, CYS's derivative valuation gains suffered (to an extent). CYS still had interest rate swap/cap valuation gains, however, lower than some of the company's agency mREIT peers (AGNC/NLY) who had longer weighted average durations (percentage wise). As such, these two factors explain why CYS had a material reduction in BV of (20.75%) for the second quarter of 2013.

CYS had a BV of $10.10 per share at the end of the third quarter of 2013. This calculated to a BV reduction of ($0.10) per share or (0.98%). This was a nice improvement when compared to the second quarter of 2013. As such, CYS outperformed all other agency mREIT peers during the third quarter of 2013 regarding mitigation of BV losses (percentage wise) with the exception of AGNC. CYS continued to maintain the company's hedging coverage ratio of 76% through the end of the third quarter of 2013. Furthermore, as was the case with AGNC, CYS rebalanced the company's MBS portfolio into the less price sensitive 15-year MBS. As of 9/30/2013, only approximately 42% of CYS's MBS portfolio was in the more price-sensitive 30-year fixed-rate MBS while the company increased its exposure to the less price-sensitive 15-year fixed-rate MBS to 43%. This was an increase of approximately 9% regarding CYS's 15-year fixed-rate MBS holdings when comparing portfolios as of 9/30/2013 versus 6/30/2013. As such, CYS was able to mitigate BV erosion during the third quarter of 2013.

Still using Table 1 above as a reference, as of 12/13/2013 CYS's stock price trades at $7.33 per share. When calculated, this shows CYS's stock price is currently trading at a ($2.77) per share or (27.43%) discount to BV as of 9/30/2013. As was the case with AGNC and ARR, this is a material discount to BV. One could make the argument CURRENT BV is down approximately (6%) in the fourth quarter of 2013. As such, CYS is still trading at a material discount to CURRENT BV of approximately (21%). Depending on future economic indicators and more importantly if the FED continues its QE Bond Purchasing Program at its current level ($85 billion per month) into 2014, I feel CYS has the possibility of some nice short-term upward momentum/price appreciation as this company tends to trade in line with its agency mREIT peers.

5) Hatteras Financial Corp. (NYSE:HTS):

Using Table 1 above as a reference, HTS had a 94% variable-rate (6% fixed-rate) agency MBS portfolio as of 9/30/2013 and has a market capitalization of $1.61 billion as of 12/13/2013. HTS had a BV of $28.18 per share at the end of the first quarter of 2013. HTS had a BV of $22.18 per share at the end of the second quarter of 2013. This calculated to a BV reduction of a massive ($6.00) per share or a sector worst (21.29%). HTS had the worst BV reduction (percentage wise) when compared to the company's agency mREIT peers during the second quarter of 2013. There were three main reasons for the underperformance. First, even though a majority of HTS's MBS portfolio was in ARM holdings which have interest rate reset periods (discussed earlier), HTS only had a hedging coverage ratio of 44% as of 6/30/2013. Second, even though HTS's WAC and weighted average net yield were on the lower end of the agency mREIT peer range, the company had extremely high hedging costs compared to the type of MBS held (ARM holdings). HTS's interest rate swaps had a weighted average fixed pay rate of 1.41% as of 6/30/2013. When compared to CMO's weighted average fixed pay rate as of 6/30/2013, this was an 80 bps difference. Third, the same problem CYS experienced, regarding the weighted average duration of the company's hedges, occurred on HTS's derivatives portfolio during the second quarter of 2013. HTS's weighted average duration on the company's interest rate swaps was only 2.4 years as of 6/30/2013. As was discussed within CYS above, the lower the interest rate swap tenor was during the second quarter of 2013, the less the valuation gains occurred to offset the reduction in MBS valuations. HTS had a very low weighted average duration on the company's interest rate swaps when compared to the company's peers and a very high fixed-pay rate on the company's interest rate swaps compared to the assets HTS was trying to hedge (ARM holdings). HTS actually had a derivative net valuation (loss) of ($1.33) per share where the five other agency mREIT peers had a modest to material derivative net valuation gain during the second quarter of 2013. As such, these three factors explain why HTS had a material reduction in BV of (21.29%) for the second quarter of 2013.

HTS had a BV of $21.31 per share at the end of the third quarter of 2013. This calculated to a BV reduction of ($0.87) per share or a sector worst (3.92%). Even though this was a minor drop in BV when compared to the prior quarter, HTS still underperformed the five other agency mREIT peers during the third quarter of 2013 regarding mitigation of BV losses (percentage wise). This was partially attributed to the prepayment risk of ARM holdings in a rising interest environment. For instance, the CPR for HTS was 19.7% at the end of the third quarter of 2013. When compared to the prior quarter, this was a decrease of only (1.1%) and was still much higher than HTS's fixed-rate agency mREIT peers. Prepayment risk will continue to increase within HTS's variable-rate MBS portfolio in a rising interest rate environment. However, this prepayment risk is offset by the following: 1) lower valuation risk on HTS's MBS portfolio due to the nature of the ARM holdings (rates reset). However, HTS's interest rate swaps had a weighted average fixed pay rate of 1.37% as of 6/30/2013. When compared to the assets HTS was trying to hedge (ARM holdings), this rate was still high. Furthermore, HTS still had a relatively low hedging coverage ratio of 54% as of 9/30/2013.

Still using Table 1 above as a reference, as of 12/13/2013 HTS's stock price trades at $16.47 per share. When calculated, this shows HTS's stock price is currently trading at a ($4.84) per share or (22.71%) discount to BV as of 9/30/2013. As was the case with AGNC, ARR, and CYS, this is a material discount to BV. One could make the argument CURRENT BV is down approximately (6%) in the fourth quarter of 2013. As such, HTS is still trading at a material discount to CURRENT BV of approximately (17%). Out of the two variable-rate agency mREITs, CMO has clearly performed better over the past several quarters. However, CMO is currently trading at a (2.19%) discount while HTS is trading a material (22.71%) discount. Granted, CMO seems to have the more efficient business model. However, a 21% "advantage" seems to be slightly overdone. As such, while CMO has limited upside potential, HTS has room to move closer to BV in the future. Dependent on an investor's risk tolerance and timing of the market, I feel HTS has the better opportunity for stock price appreciation when compared to CMO. Depending on future economic indicators and more importantly if the FED continues its QE Bond Purchasing Program at its current level ($85 billion per month) into 2014, I feel HTS has the possibility of some nice short-term upward momentum/price appreciation even though this company tends to "lag" behind its agency mREIT peers.

6) Annaly Capital Management Inc. (NYSE:NLY):

The last agency mREIT to discuss is NLY. Using Table 1 above as a reference, NLY had a 94% fixed-rate (6% variable-rate) agency MBS portfolio as of 9/30/2013 and has a market capitalization of $9.42 billion as of 12/13/2013. NLY had a BV of $15.19 per share at the end of the first quarter of 2013. NLY had a BV of $13.03 per share at the end of the second quarter of 2013. This calculated to a BV reduction of ($2.16) per share or (14.22%). Even though this was a material reduction, NLY was basically slightly outperformed the company's agency mREIT peers during the second quarter of 2013. However, when compared to NLY's closest peer AGNC, NLY's BV reduction was (2.40%) worse during the second quarter of 2013. There were two main reasons for NLY's underperformance when compared to AGNC. First, approximately 70% of NLY's MBS portfolio was in the more price-sensitive 30-year fixed-rate MBS as of 6/30/2013. When compared to 15-year fixed-rate MBS, 30-year fixed-rate MBS are generally more susceptible to price movements as market interest rates move. NLY had only approximately 12% of the company's MBS portfolio in 15-year fixed-rate MBS as of 6/30/2013 (including fixed-rate CMO and "callables"). In comparison, AGNC had 57% of the company's MBS portfolio in 30-year fixed-rate MBS and a much higher 41% in 15-year fixed-rate MBS as of 6/30/2013. Second, NLY's hedging coverage ratio was only approximately 51% as of 6/30/2013. This was in sharp contrast to AGNC's hedging coverage ratio of 102% as of 6/30/2013. It should be noted AGNC had a material net valuation loss on the company's HARP and LLB securities in relation to the "pay-up" price premiums added to those securities for added prepayment protection. NLY did not have this material net valuation loss during the second quarter of 2013. As such, this factor partially offsets AGNC's higher composition of less price-sensitive 15-year fixed-rate MBS and a higher weighted average hedging coverage ratio as of 6/30/2013 when compared to NLY. As such, these two factors explain why NLY had a material reduction in BV of (14.22%) for the second quarter of 2013.

NLY had a BV of $12.70 per share at the end of the third quarter of 2013. This calculated to a BV reduction of ($0.33) per share or (2.53%). Even though this was a rather minor drop in BV, NLY was basically in line with the company's agency mREIT peers during the second quarter of 2013. NLY performed worse than both AGNC and CYS during the third quarter of 2013 regarding mitigation of BV losses (percentage wise) but better than ARR, CMO, and HTS. When compared to NLY's closest peer AGNC, NLY's BV reduction was (1.59%) worse during the third quarter of 2013. This was mainly due to the same two factors described when analyzing the prior quarter. First, approximately 66% of NLY's MBS portfolio was in the more price-sensitive 30-year fixed-rate MBS as of 9/30/2013. This was only a reduction of (4%) when comparing MBS portfolios as of 9/30/2013 versus 6/30/2013. NLY slightly increased the company's percentage of 15-year fixed-rate MBS to approximately 15% of the company's MBS portfolio as of 9/30/2013 (including fixed-rate CMO and "callables"). This was only an increase of (3%) when comparing MBS portfolios as of 9/30/2013 versus 6/30/2013. In comparison, AGNC had only 45% of the company's MBS portfolio in 30-year fixed-rate MBS and a much higher 53% in 15-year fixed-rate MBS as of 9/30/2013. Second, NLY's hedging coverage ratio modestly increased to approximately 68% as of 9/30/2013. This was closer to AGNC's hedging coverage ratio of 93% as of 9/30/2013 but these companies still a modest difference. It should also be noted AGNC's material net valuation loss on the company's HARP and LLB securities in relation to the "pay-up" price premiums added to these securities for added prepayment protection was much lower in the third quarter of 2013. This pay-up valuation loss risk was only approximately ($0.25) per share as of 6/30/2013. This was over a ($2.00) per share pay-up valuation loss risk reduction when compared to 3/31/2013. As such, these two factors explain why NLY had a slightly worse BV reduction when compared to AGNC for the third quarter of 2013.

Still using Table 1 above as a reference, as of 12/13/2013 NLY's stock price trades at $9.94 per share. When calculated, this shows NLY's stock price is currently trading at a ($2.76) per share or (21.73%) discount to BV as of 9/30/2013. As was the case with all the other agency mREIT companies except CMO, this is a material discount to BV. One could make the argument CURRENT BV is down approximately (6%) in the fourth quarter of 2013. As such, NLY is still trading at a material discount to CURRENT BV of approximately (16%). Since NLY continued to have approximately 66% of the company's MBS portfolio in the more price sensitive 30-year fixed-rate holdings, this steep discount should be taken with some continued caution. Depending on future economic indicators and more importantly if the FED continues its QE Bond Purchasing Program at its current level ($85 billion per month) into 2014, I feel NLY has the possibility of some nice short-term upward momentum/price appreciation as this company tends to trade in line with its agency mREIT peers.

Side Note: NLY also has a minor corporate debt (also known as "commercial paper") and commercial real estate portfolio. In my opinion, these two additional facets make NLY a slightly more attractive investment (when compared to NLY not having these two portfolios). To maintain the company's qualified REIT per the Internal Revenue Code ('IRC'), NLY is limited on how much of the company's overall asset portfolio can consist of commercial real estate. However, NLY's real estate portfolio is currently not near this threshold (IRC's REIT "asset test" provision). As such, continued expansion of these two portfolios could be seen as a promising sign.

Conclusions Drawn:

This article has examined (via Table 1) six agency mREIT peers in regards to recent BV changes and a current discount to BV analysis. By analyzing such information, this analysis has shed light on certain factors and trends between the six agency mREIT peers.

The following were the combined BV changes for the variable-rate agency mREITs during the second and third quarters of 2013 (percentage wise; best to worst):

CMO: (9.40%) reduction in BV

HTS: (25.21%) reduction in BV

The following were the combined BV percentage changes for the fixed-rate agency mREITs during the second and third quarters of 2013 (best to worst):

AGNC: (12.76%) reduction in BV

NLY: (16.75%) reduction in BV

CYS: (21.73%) reduction in BV

ARR: (21.96%) reduction in BV

The following are the current discount to BV as of 9/30/2013 percentages for the variable-rate agency mREITs as of 12/13/2013 (best to worst):

HTS: (22.71%) price to book discount

CMO: (2.19%) price to book discount

The following are the current discount to BV as of 9/30/2013 percentages for the fixed-rate agency mREITs as of 12/13/2013 (best to worst):

ARR: (29.09%) price to book discount

CYS: (27.43%) price to book discount

NLY: (21.73%) price to book discount

AGNC: (20.78%) price to book discount

Therefore, it seems CMO had the least BV reduction by a modest margin. However, CMO currently trades only at a minor discount to BV. In comparison, AGNC had only lost (3.76%) more in BV (percentage wise) when compared to CMO yet currently trades a net discount to BV as of 9/30/2013 of (18.59%) when compared to CMO.

Technically, variable-rate agency mREIT companies "should" have less valuation losses if interest rates once again spike higher due to the interest rate reset factor regarding ARM holdings. However, variable-rate agency mREIT companies would also have to deal with an increase in CPR due to the enhanced prepayment risk on ARM holdings. As such, losses could occur on these portfolios as well due to the fact the variable-rate mREIT companies may not be able to recover the company's cost basis prior to the prepayments of the underlying ARM holdings. This notion seemed to play out during the third quarter of 2013 where CMO had a BV reduction of (3.52%) while AGNC and CYS only had a BV reduction of (0.94%) and (0.98%), respectively.

If I were currently looking to initiate or add to my position in the agency mREIT sector based on the factors of past mitigation of BV losses and the present discount to CURRENT BV, I would first look to AGNC followed by NLY and CYS. If one currently holds a position in CMO, I would continue to hold this investment but not add to my position due to the relatively non- discount to CURRENT BV.

Depending on future economic indicators and more importantly if the FED continues its QE Bond Purchasing Program at its current level ($85 billion per month) into 2014, I feel most of the agency mREIT sector has the possibility of some nice short-term upward momentum/price appreciation as this entire sector (with the exception of CMO) continues to trade at a material discount to CURRNENT BV.

A FED tapering decision will be known this Wednesday (12/18/2013). Since I anticipate the FED to continue its Q3 Bond Purchasing Program at its current level of $85 billion per month into 2014, this strategy would be an immediate trade (prior to Wednesday) for a short-term upside potential of approximately 10% for most of the companies within this sector.

Final Note: After dividends are declared for the entire mREIT sector (agency and hybrid) for the fourth quarter of 2013, I will provide a future article taking a look at the recent past and current dividend rates and yields for these six agency mREIT companies. Time permitting, I may perform a similar BV and dividend analysis on five hybrid mREITs (JMI, IVR, MTGE, TWO, and WMC).

Disclosure: I am long AGNC. 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.