New York Mortgage Trust Inc. (NASDAQ:NYMT) is an internally managed hybrid mortgage REIT. NYMT acquires and manages primarily real estate related assets. These assets include: Agency ARMs, fixed rate Agency RMBS, Agency IOs (interest only) including TBAs, CMBS, distressed mortgage loans, residential securitized loans, and CLOs (collateralized loan obligations). NYMT employs RiverBanc, The Midway Group, and Headlands Asset Management to provide investment management services expertise for certain specific asset classes. It declared aggregate 2013 dividends of $1.08 per common share (or 15.45% at the December 31, 2013 stock price of $6.99). Book value at the end of Q4 2013 was $6.33. This was up $0.01 from September 30, 2013. However, it was down from $6.50 at December 31, 2012. In other words it lost -$0.17 (-2.6%) of book value in FY2013; but it paid $1.08 in dividends for a net total economic gain of +$0.91 (+14.0%) per common share for FY2013.
Armour Residential REIT (NYSE:ARR) is a mortgage REIT. It is managed externally by Armour Residential management LLC. It is primarily an Agency RMBS investor. On December 1, 2011, ARR's stockholders voted to amend its charter to allow ARR to invest in non-Agency MBS. Many thought ARR would soon start to diversify its investment base to include non-Agency RMBS and CMBS. ARR has failed to do this. As of February 26, 2014, ARR had only Agency fixed rate RMBS, Agency adjustable rate RMBS, and hybrid adjustable rate RMBS in its portfolio. ARR's failure to diversify into non-Agency investments has led it to lose book value at a faster rate than diversified mortgage REITs like NYMT. ARR's book value dropped from $7.29 per common share as of December 31, 2012 to $4.75 per common share as of December 31, 2013. ARR paid $0.27 for Q4 2012, $0.24 for Q1 2013, and $0.21 each for Q2 and Q3 2013 in dividends. This was a total of $0.93 per common share in 2013. However, ARR lost $2.54 in book value for a total economic return of -$1.61 per common share (-22.1%). That's roughly 36% underperformance compared to NYMT.
The NYMT portfolio as of December 31, 2013 is below (values are in thousands).
For NYMT's portfolio net income per diluted common share was $1.11 for FY2013 and $1.08 for FY2012. It was $0.34 per diluted common share for Q4 2013 and $0.19 per diluted common share for Q4 2012. The table below shows the overall improvement in NYMT's net interest spread over FY2013.
ARR had decent core income. It recorded $69.8 million in Core Income in Q4 2012 ($0.22 per common share); and it recorded Core Income of $59.3 million in Q4 2013 ($0.15 per common share). This constitutes a fall off; but it does not explain the book value losses. Rather those were mostly due to the losses in the value of ARR's Agency RMBS, which usually trade at a significant premium to par. As the interest rates rose in FY2013, Agency RMBS, especially fixed rate Agency RMBS, lost a lot of their premium to par. Those losses that were not offset by hedges were the book value losses.
Fixed rate Agency RMBS did not fare well in FY2013 compared to NYMT's more diverse portfolio. The apparent plan for ARR to diversify (indicated by the charter change at the end of 2011) didn't happen; and both ARR and its shareholders have paid a high price for that. The strategy statement by external management says, "ARMOUR employs a strong bias toward a 'buy and hold' strategy rather than a 'trading' strategy." From the above described behavior it sounds more like management was too lazy to implement what was in hindsight a good plan in late 2011 to diversify into non-Agency investments. ARR's stockholders have paid a heavy price for this.
Some might suggest that the CPR's (constant prepayment rates) were a big problem. They did cause some of the problems seen in FY2013; but overall they dropped from 19.1% in January 2013 to 5.0% in January 2014. This should have been an overall positive. Management can't lay the problem on CPR's.
The excuse can't be found in the interest income either. ARR's average yield on assets for Q4 2012 was 2.47% and the net interest margin was 1.55%. For Q4 2013 ARR's average yield on assets was 2.98% and the average net interest margin was 1.60%. For Q4 2012 the leverage was 6.92x as of December 31, 2013 and about 7.96x as of December 31, 2012. The portfolio size was also down to $14.6B at December 31, 2013 from $19.1B as of December 31, 2012. No doubt this led to lower earnings, but it did make the book value losses lower too; and ARR did have book value losses in Q4 2013.
NYMT's story is the "story that could have been" for ARR, if it had acted on its apparent inclination to diversify into non-Agency investments in 2012. By now ARR's external management team has lost most of the credibility they had. Oddly it will now be harder for them to get the ARR board to approve a diversification into non-Agency RMBS and CMBS. It is now a more troubled longer term play. In contrast, NYMT's management has a lot of credibility. It is in a much better position to succeed.
How do you invest in these mortgage REITs? NYMT seems the better long term play on both its performance record and its management team. However, NYMT is trading at $7.97 per share as of the close March 5, 2014, which is approximately 1.26 times its book value of $6.33 per common share as of December 31, 2013. ARR is trading at $4.34 per share as of the close March 5, 2014, which is approximately 0.91x times its book value of $4.75 per common share as of December 31, 2013. Plus the 10 year US Treasury Note yield has fallen from 3.03% on December 31, 2013 to 2.71% as of this writing on March 5, 2014. This means ARR investors at this time have 32 bps in their pockets. ARR's fixed rate Agency RMBS would be expected to gain book value on a 32 bps loss in yield on the 10 year US Treasury Note. Therefore ARR is likely trading at an even larger discount to current book value.
Investors should probably wait for a pullback to invest in NYMT. Even premium mortgage REITs usually only trade at from 1.0-1.2 times book value. At 1.26 times book value, NYMT is overvalued, and it is likely to fall back on a fundamental basis. Since NYMT is essentially an investor in debt instruments, NYMT's stock price should follow fundamentals with time.
On the other hand, ARR is paying a $0.05 monthly dividend (13.82%), which it currently says it will pay for the rest of 2014. Plus it has book value upside. ARR can be bought on a fundamental basis. We have already seen a flight to quality in more than one instance in 2013. The emerging market problems such as Ukraine's could keep interest rates down or flat for the rest of 2014. In that type of environment ARR should excel with its Agency fixed rate RMBS portfolio. If investors do buy, they can always sell if interest rates start climbing quickly again. However, this is a trade/investment for an attentive investor.
The two year chart of ARR provides some technical direction for this trade.
The slow stochastic sub chart shows that ARR is neither overbought nor oversold. The main chart shows that it has bottomed after a downtrend. It now appears to be trying to start an uptrend. However, this uptrend is weak as only the 50-day SMA has passed upward through the 100-day SMA. It has not yet passed the 200-day SMA on its way upward. Investors can buy ARR on technicals and fundamentals.
The two year chart of NYMT provides some technical direction for this trade.
The slow stochastic sub chart shows that NYMT is overbought in the near term. The main chart shows that NYMT is overbought. NYMT is in a strong uptrend. However, it is fundamentally too highly priced at 1.26 times book. Investors may wish to own NYMT; but they should probably wait for a pullback in this stock before buying. If the long term chart is any indication, investors should be able to get in at a much lower price.
ARR has a mean analysts' recommendation of 2.6 (a high hold). It has a CAPS rating of three stars (a hold). However, it can be bought by an attentive investor on fundamentals and technicals, since it is trading at 0.91x the December 31, 2013 book value.
NYMT has a mean analysts' recommendation of 2.0 (a buy). It has a CAPS rating of three stars (a hold). This would seem better; but it should probably not be bought on a fundamental basis at this time. It is trading at 1.26 times December 31, 2013 book value. Interested investors should wait for a pullback. On a technical basis NYMT is also over extended. Wait for a pullback. On a long term basis, NYMT does appear to be the preferable stock to own.
NOTE: Some of the fundamental fiscal information above is from Yahoo Finance.
Good Luck Trading.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in ARR over the next 72 hours. 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.