The fall of securitized mortgages caused a major financial crisis just a few years ago. After their ballistic rise, fueled by the low rate environment that followed the bursting of the Internet bubble and lax mortgage practices by a historically strict group, their consequential collapse brought down almost everything else.
There are many REITs that manage portfolios of these securitized mortgages. These companies buy the mortgage paper as an investment, or in order to re-securitize them and sell them to another REIT or some other entity that is investing in real estate loans. Many of these mortgage REITs that have a longer track record performed very poorly through and following the real estate collapse, largely due to their using leverage to purchase then overpriced paper.
Nonetheless, 2010 was a fairly stable year for the group and the group offers some of the highest yields one can find in the open market. Yield hungry investors must be salivating at the concept of payouts that are nearing 20% on some of these institutions.
Mortgage REIT Risk on the Horizon
Those investors should take those yields with a grain of salt. Those yields are representative of the risk that these mortgages still hold.
One concern overhanging the industry is that another large wave of adjustable rate mortgages (ARMs) will reset in 2012, and that higher interest rates, underlying real estate valuations and debtor quality will further push down these mortgages, along most real estate, and that foreclosures shall riddle these securitized products with holes. Of course, with that risk comes the opportunity to receive both capital appreciation and sizable cash payouts, should this risk turn out to be unrealized.
Agency Backed & Non-Agency Backed
Some mortgages are agency backed, which means that the mortgages were issued and/or guaranteed by a quasi-government agency (Fannie Mae and Freddie Mac). Such mortgages are considered virtually risk free, because these agencies are supposed to step-in and make payments to the lender on behalf of the non-paying borrower that they backed. These agencies can also choose to buy-out the mortgage, and they often do exactly that after a borrower’s default continues for several months.
Mortgages that are backed by these agencies carry the least default risk because of that agency guarantee, but that risk also means that these mortgages carry the lowest yield. As a result, most REITs that specialize in agency backed mortgage securities use a high level of leverage to increase the yield. In so doing, these companies are substituting default risk for leveraged interest rate risk.
The largest and most well known REIT within this space is Annaly Capital Management, Inc. (NLY), though American Capital Agency Corp. (AGNC) and others hold agency portfolios and have high leverage profiles. Differences do exist amongst REITs housing agency-backed mortgages, such as the level of fixed versus adjustable rate mortgages, leverage rates and methods used, if any, to hedge interest rate risk. Annaly actually handled the real estate collapse rather well, largely due to that government guarantee.
The poster-child for non-agency mortgage REITs is likely Chimera Investment Corporation (CIM), since Annaly spun-off the company in late 2007 in order to separate those non-agency securities from Annaly’s agency-backed portfolio. Chimera did not handle the collapse well because there was no guarantee. Annaly manages Chimera’s portfolio, which is primarily composed of non-agency mortgages and CDOs. Chimera sells mortgages it securitized and keeps those Annaly tells it to keep, probably based on a greater likelihood of continued payments and/or paper that represents more stable underlying real estate (though still a risky asset). Several other mortgage REITs implement a similar strategy to Chimera.
Okay, enough of me trying to explain these complex entities. Please do some due diligence of your own. Having said that, here are, in alphabetical order, 8 mortgage REITs that yield well over 10%:
1. American Capital Agency Corp. (AGNC)
- Expected Yield: 19.5-19.8%
- Market Capitalization: $2.64 Billion
- Debt: $12.08 Billion (4.57 to 1 leverage)
2. Annaly Capital Management, Inc. (NLY)
- Expected Yield: 13.7-14.3
- Market Capitalization: $14.14 Billion
- Debt: $67.11 Billion (4.75 to 1 leverage)
3. Anworth Mortgage Asset Corporation (ANH)
- Expected Yield: 12.4-14.3%
- Market Capitalization: $854.73 Million
- Debt: $6.48 (7.58 to 1 leverage)
4. Chimera Investment Corporation (CIM)
- Expected Yield: 13.5-14.4%
- Market Capitalization: $4.05 Billion
- Debt: $4.06 Billion (1.002 to 1 leverage)
5. Hatteras Financial Corp (HTS)
- Expected Yield: 14-14.5%
- Market Capitalization: $1.61 Billion
- Debt: $8.76 Billion (5.44 to 1 leverage)
6. MFA Financial, Inc. (MFA)
- Expected Yield: 11.4-12.1%
- Market Capitalization: $2.18 Billion
- Debt: $6.35 Billion (2.9 to 1 leverage)
7. Resource Capital Corp. (RSO)
- Expected Yield: 14.1-16.1%
- Market Capitalization: $366.64 Million
- Debt: $1.56 Billion (4.25 to 1 leverage)
8. Two Harbors Investment Corp. (TWO)
- Expected Yield: 15.3-15.8%
- Market Capitalization: $723.3 Million
- Debt: $1.17 Billion (2.79 to 1 leverage)
Watch the Leverage
As stated earlier, some of these REITs achieve their lofty yield through the implementation of significant leverage. This leverage makes them more sensitive to changes in the market, positive or negative, especially where not hedged.
In closing, should you be interested in investing broadly in this sector, iShares has created an Exchange Traded Fund that tracks the performance of the index of residential and commercial mortgage real estate, mortgage finance and savings associations sectors (REM). Six of the listed REITs are within REM’s top 10 holdings (where the top 10 holdings make up about 65% of the fund).
Disclaimer: Yield is but one consideration in choosing a proper investment.