Both ARMOUR Residential REIT Inc. (NYSE:ARR) and New York Mortgage Trust Inc. (NASDAQ:NYMT) are mortgage REITs; but they are very different types of companies. ARR invests in Agency ARMs, Hybrid ARMs, and fixed rate RMBS. NYMT invests in Agency and non-Agency RMBS, prime adjustable rate mortgage loans held in securitization trusts, CMBS, commercial mortgage loans, and other commercial real estate related debt investments. Both pay 14%+ dividends; but in Q1 2014 NYMT gained +$0.15 per common share in book value (from $6.33 to $6.48), while ARR lost -$0.08 per common share in book value (from $4.75 to $4.67). This gave them very different total economic returns: +5.56% for the quarter for Q1 2014 for NYMT and +1.66% for Q1 2014 for ARR for the quarter.
NYMT declared a $0.27 per common share dividend for Q1 2014. It had net income of $21.3 million (or $0.29 per common share) versus $15.4 million (or $0.31 per common share) in the year ago quarter. Net interest income rose to $19.8 million in Q1 2014 (up $6.8 million from Q1 2013 and up $1.7 million from Q4 2013). Portfolio net interest margin increased to 439 basis points from 410 basis points in Q4 2013.
NYMT also completed a public offering of 11,500,000 shares of common stock. This resulted in net proceeds to the company of approximately $75.8 million after expenses. Subsequently in April 2014 NYMT completed a public offering of 14,950,000 shares of common stock. This resulted in net proceeds to the company of approximately $109.9 million after expenses.
The refinancing activity, workouts, and resales (mostly resales) in NYMT's distressed loan portfolio resulted in a realized gain of $8.2 million. The high demand for credit sensitive assets, such as NYMT's multi-family CMBS, favorably impacted the valuation of NYMT CMBS. As of March 31, 2014, 61% of NYMT's capital was allocated to investments in multi-family investments and distressed residential loans. This was up from 48% in the year ago quarter. This concentration is serving NYMT well.
NYMT's capital allocation as of March 31, 2014 is in the table below.
NYMT's portfolio asset yields are in the table below.
ARR's Agency RMBS investments did not perform as well as NYMT's CMBS investments and other investments. I was surprised to see that ARR's book value actually went down in Q1 2014. With the drop in the 10 year US Treasury Note yield from 3.03% on December 31, 2014 to 2.72% on March 31, 2014 (-31 bps), one would normally have expected Agency RMBS assets to increase in book value even including hedges. The net interest margin was not the culprit. The net interest margin for Q4 2013 was 1.60%. The net interest margin for Q1 2014 was 1.82%. One would have expected this to be the reverse too. The leverage in Q4 2013 was 6.92x versus 8.12x for Q1 2014. Again one would have expected higher overall earnings in Q1 2014. The CPR (constant prepayment rate) was also lower in Q1 2014 (3.68%) versus in Q4 2013 (4.8%).
Trying to account for ARR's book value problems from the above is hard. ARR's book value problems were instead likely caused by the sell-off of its 25 and 30 year Agency pass-throughs in order to purchase 15 and 20 year Agency pass-throughs. This kind of exchange almost always costs money. However, it should lead to better future performance. The shorter duration securities allow ARR to reduce spread risk and improve hedging efficiency. However, the shorter duration securities do produce higher levels of amortization. ARR believes these new securities will support the current $0.05 per common share per month dividend. ARR book value should experience lower losses or gains in Q2 2014, since the above action is now done. Further ARR will be able to use 5 year swaps and swaptions as well as swap and euro-dollar futures with the above new securities. These have lower initial margin requirements; and they are much more cost effective.
In addition to this the amount of hedges have been reduced from Q4 2014 to Q1 end 2014. The following conditions existed as of January 9, 2014:
- $16.0B in derivatives (swaps, swaptions, and futures).
- 103.1% of assets hedged with derivatives.
- 121.4% of repos hedged with derivatives.
ARR made the above hedge holdings changes by April 15, 2014:
- $15.3B in derivatives (swaps, swaptions, and futures).
- 91.5% of assets hedged with derivatives.
- 101.3% of repos hedged with derivatives.
The 10 year US Treasury Note yield has already fallen from 2.72% as of March 31, 2014 to 2.49% as of this writing on May 16, 2014 (-23 bps). When this yield falls, MBS values normally rise; and hedges lose value. When more than 100% in notional value of assets are hedged, a company can lose value even as MBS prices rise. This likely accounted for some of the poor book value performance in Q1 2014 when the 10 year US Treasury Note yield fell -31 bps for the quarter. If the current 10 year yield remains lower than the yield at Q1 end 2014 (or the 10 year yield falls farther), hedge losses should be less. ARR is hedged at only 91.5% as of April 15, 2014 versus 103.1% of assets as of January 9, 2014. ARR should add book value if the 10 year US Treasury Note yield stays below its March 31, 2014 value. This means that ARR may roughly duplicate NYMT's performance in Q2 2014 if events follow their current trends.
The following article, "10%+ Dividend Payer Annaly Capital Is Still A Safe Place To Put Your Money", contains a good discussion of what factors may lead interest rates to go lower or higher as 2014 progresses. If you are investing in Agency mortgage REITs, it is worth a read. Plus it contains an analysis of Annaly Capital Management's (NYSE:NLY) recent performance. The article, "American Capital (NASDAQ:AGNC) And CYS (NYSE:CYS) both Posted Great Q1 2014 Results -- CYS Seems To Have Led The Way", may give investors a good idea if they would rather invest in one or more of these stocks instead of ARR.
All told both NYMT and ARR look like they are well positioned for Q2 2014. Both should produce 14%+ dividends again. Both should have positive book value gains. At this point many people would say you have to buy NYMT. However, ARR trades at $4.21 per share as of the close May 15, 2014. This is a discount of almost -10% to its book value of $4.67 per share; and that book value seems likely to go up in Q2 2014. NYMT trades at $7.55 per share. This is a premium of +16.5% to its book value. That's a roughly 25% spread versus ARR in book value terms. Many investors may decide that ARR is the better value at this point. It also may be the more stable stock even though it has a slightly higher Beta at 0.36 versus NYMT's Beta of 0.28. Both stocks appear to be good longer term buys at this time, although it is easier to consider ARR a bargain at the current time.
For those who like to see portfolio composition tables, ARR's as of April 15, 2014 is below.
As readers can see, all of the 25 and 30 year Agency RMBS are now gone.
The two year chart of NYMT provides some technical direction for this trade.
The slow stochastic sub chart shows that NYMT is at overbought levels. The main chart shows that NYMT is in an uptrend. The Q1 2014 results were good to great. They should only help NYMT continue its uptrend. That said, it is trading at a +16.5% premium to its book value as of March 31, 2014; and it is technically overbought. It is a long term buy; but investors may wish to wait for a pullback in order to enter at a more profitable point.
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 bottomed in late 2013. It has been trending weakly upward since then. The Q1 2014 results at first appear to be much worse than they were. However, the adjustments to the portfolio and the higher level of hedging likely accounted for a lot of this. The company should be much better positioned for the future in Q2 2014. ARR is a buy at this time.
Both stocks have an analysts' mean recommendation of 2.8 (a hold). However, ARR has a four star CAPS rating (a buy). NYMT only got three stars from CAPS (a hold). This is likely due to NYMT's +16.5% premium to its book value as of March 31, 2014. Relatively NYMT is trading at a roughly 25% premium to ARR based on book value, since ARR is trading at only roughly 90% of its book value (-10%). It is easy to see why CAPS rates ARR higher at the current time. However, as a long term investment NYMT does appear to be a good investment.
One caveat for investing in either stock is that the overall market could be in for a significant pullback in the near future. Even guru, David Tepper, has been suggesting this lately. If such a pullback happens virtually all stocks will fall. For that reason investors may wish to average into ARR and/or NYMT over the next year or so, if they decide to invest.
NOTE: Some of the above fundamental fiscal data 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.