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A long position in New York Mortgage Trust (NASDAQ:NYMT) makes a great hedge for investors seeking to benefit from the high yields of mortgage REITs. Unlike other mortgage REITs, NYMT is asset sensitive. This is because a large tranche of NYMT’s portfolio is in LIBOR-adjusting business loans which yield more as rates increase. The REIT pays a 13.5% yield, but as interest rates rise, company earnings should follow. REITs like Annaly (NYSE:NLY), Capstead Mortgage (NYSE:CMO), MFA Financial (NYSE:MFA) and Anworth (NYSE:ANH) should drop in price as rates rise since their spreads will be compressed.

Alternatively, NYMT’s price should increase as rates rise since its earnings power is directly correlated with higher rates. This combination offers an excellent hedge for investors seeking to balance the risk of their high yield investments while increasing their current dividend income.

NYMT possesses top-quality credit expertise in commercial and residential real estate, and exploits this expertise to its advantage. Jim Fowler, Chairman of the Board, has a long resume covering mortgage investing, mortgage trading, and private and public equity research. His career has taken him through JMP Securities, Thomas Weisel, Montgomery Securities and Oppenheimer.

In the early 2000s, he was a regular on the Wall Street Journal’s annual “Best on the Street” Analyst Survey, culminating in 2003 when he achieved the #1 Ranking for Real Estate Analysts on Wall Street. Steve Mumma, CEO, has additional depth in the real estate markets with Natexis, Credit Agricole, Paine Webber and Citibank. Together with their employees, Jim and Steve possess some of the best real estate credit expertise in the business.

With their deep expertise, NYMT is in a unique position to exploit the opportunities presented in the credit markets, earning excellent risk-adjusted returns. Furthermore, the company is flying under the radar. It’s too small to draw attention from most Wall Street firms, having little coverage or following. Case in point - the last quarterly earnings call only lasted about 15 minutes because there were only 2 questions from the “audience”. Nobody was on the call because nobody follows this stock. Go hear the call on their website – it won’t take much of your time: you can find it here. There is opportunity for investors in that Wall Street hasn’t yet noticed the dramatic turnaround for this under-followed company.

So what is the opportunity for NYMT? Unless you’ve been living in a cave, you’ve noticed that banks have been getting beaten-down lately. There is a great deal of uncertainty with banks and the market doesn’t like uncertainty. There is tremendous uncertainty regarding the creditworthiness of the legacy loans on banks’ books. There is additional uncertainty regarding the future regulatory environment and upcoming increased capital requirements for banks. These are working to push banks out of loans that are deemed “too risky”. This has created a void in the market, pushing up yields on real estate loans. Before the financial crisis, relatively high-risk loans were offered at low interest rates. Now the pendulum has swung completely around -- as it always does. Now even a low-risk credit candidate must pay a high interest rate to get a loan. What you need is the real estate credit expertise to assure that you are getting good loans. With their breadth of credit experience, NYMT and their partners are uniquely positioned to exploit this opportunity left on the table by the banks.

As loans mature, new investments are being made in senior tranches of heavily-collateralized loans. They use little leverage so the loans are very safe under most any realistic forward scenario. Loan-to-value ratios are well less than 50%, but with risk-adjusted ROEs of 15% to 20%. On the residential side, NYMT has a strategic relationship with the Midway Group. Midway has best in class expertise in residential mortgages and IO’s. Risk adjusted returns have been in the low 20% range for these investments and should continue at these levels. On the commercial side, NYMT has a strategic relationship with Riverbanc LLC. Riverbanc has deep expertise in commercial real estate loans, focusing on mezzanine loans and private equity. Returns in the mid-to-high teens are expected here.

NYMT still employs a small amount of leverage, but with interest rate risk hedged on many investments that will actually improve performance as rates increase. This is key. As economic conditions improve, and rates rise, the performance of these loans will actually improve as well. In contrast, REITs such as Annaly (NLY), Chimeras (NYSE:CIM), American Capital (NASDAQ:AGNC) and Cypress (NYSE:CYS) are highly dependent on leverage.

But high leverage means high interest rate risk. They borrow at short term rates, invest at longer term rates and then leverage the spread four to eight times to generate a high yield. Look back to 2005 and you will see what happens when this strategy backfires. In the second half of 2005, Annaly (NLY) lost almost half of its value (dropping from 20 to 11) in less than six months when the yield curve flattened and spreads compressed. If long rates go up significantly and the yield curve flattens then look out below! At an absolute minimum, investors in leveraged REITs should consider diversifying into NYMT as a hedge to the significant interest rate risk they are taking in the leveraged REIT.

On the earnings side, analysts expect $1.10/share for 2011. At a $6.90 market price, this produces a P/E ratio of about six. On the dividend side, cash is being deployed and returns paid out. The last year has been spent cultivating their loan facilities and new relationships, and they are now deploying the cash. NYMT recently raised the dividend from $.18/quarter to $.22/quarter for an annual yield of 13%. It is our opinion that the dividend may increase further as more cash is deployed over the course of this year. By year-end the annual dividend may be over $1.00, for a yield of about 15% at the current market price.

At $6.90/share, NYMT sells at a 9% discount to current GAAP Book Value of $7.54. But GAAP BV is conservatively calculated due to the valuation of their Cratos portfolio. These loans were purchased in the midst of the financial crisis at $.20 on the dollar. They recently sold a portion of this portfolio (booking a large gain) but they retain more than half of the original portfolio, with a carrying book value significantly less than par. As this block of loans approaches maturity, the discounts should grade to zero and the valuations rise. This could create the need for several special dividends from the company to shareholders. Therefore realistic economic book value is much higher than current GAAP BV. It is our opinion that real tangible book value may be above $9 per share. The moves up in this portfolio of loans has increased NYMT’s book value. The recent history is as follows:

Date

BV/Share

12/07

3.20

12/08

4.21

12/09

6.69

Now (3/11)

7.54

In short, NYMT represents one of the true “Ben Graham stocks” available in the market today. Not only can you buy it at less than fair value, but you get paid handsomely (through the sizable dividend) to wait for it to achieve fair value.

NYMT is closely tied to JMP Securities. The management team and new business strategy essentially comes from JMP. JMP owns a large percentage of NYMT through their investment advisory arm Harvest Capital.

Individuals at JMP and NYMT also have large stakes. Given this, management’s interests are completely and totally aligned with shareholders. In our opinion, NYMT won’t do a capital raise that dilutes book value since management would be diluting their stake. Unlike most companies, the management team isn’t there because they need their jobs. They are at NYMT solely to create and build value. If tomorrow they found the marketplace didn’t offer value in their arena, it is our belief that they would shut down the company, sell off the loan portfolios (realizing large gains) and distribute cash well in excess of current book value to the shareholders.

They are still operating the company because they are finding the value by purchasing sound loans with excellent yields. They focus on safety and preservation of capital because it’s largely their capital. If you need more proof, here is a list of all insider stock trades (as reported by Vickers) over the last three years. We count 84 buys with only 1 sell:

Date

Insider

Shares

Type

Transaction

Value*

May 19, 2011

NORCUTT STEVEN G

1,031

Direct

Acquisition

N/A

May 19, 2011

HAINEY ALAN L

1,031

Direct

Acquisition

N/A

May 10, 2011

HAINEY ALAN L

2,000

Direct

Acquisition

N/A

May 10, 2011

NORCUTT STEVEN G

2,000

Direct

Acquisition

N/A

May 10, 2011

OSBORNE DANIEL K

2,000

Direct

Acquisition

N/A

Mar 1, 2011

MUMMA STEVEN R

14,084

Direct

Acquisition

N/A

Jan 3, 2011

NORCUTT STEVEN G

1,500

Direct

Acquisition

10,425

Jan 3, 2011

HAINEY ALAN L

1,511

Direct

Acquisition

10,501

Dec 31, 2010

HARVEST CAPITAL

7,410

Indirect

Purchase

50,980

Dec 30, 2010

HARVEST CAPITAL

3,847

Indirect

Purchase

25,967

Dec 29, 2010

HARVEST CAPITAL

5,000

Indirect

Purchase

33,750

Dec 28, 2010

HARVEST CAPITAL

5,300

Indirect

Purchase at $6.69 per share.

35,457

Dec 27, 2010

HARVEST CAPITAL

5,000

Indirect

Purchase at $6.75 per share.

33,750

Dec 23, 2010

HARVEST CAPITAL

5,000

Indirect

Purchase at $6.75 per share.

33,750

Dec 22, 2010

HARVEST CAPITAL

5,000

Indirect

Purchase at $6.75 per share.

33,750

Dec 21, 2010

HARVEST CAPITAL

90,400

Indirect

Purchase at $6.78 per share.

612,912

Dec 20, 2010

HARVEST CAPITAL

80,900

Indirect

Purchase at $6.75 per share.

546,075

Dec 17, 2010

HARVEST CAPITAL

19,000

Indirect

Purchase at $6.73 per share.

127,870

Dec 16, 2010

HARVEST CAPITAL

38,131

Indirect

Purchase at $6.68 per share.

254,715

Dec 15, 2010

HARVEST CAPITAL

18,349

Indirect

Purchase at $6.60 per share.

121,103

Dec 14, 2010

HARVEST CAPITAL

48,162

Indirect

Purchase at $6.59 per share.

317,387

Dec 10, 2010

HARVEST CAPITAL

34,634

Indirect

Purchase at $6.50 per share.

225,121

Dec 9, 2010

HARVEST CAPITAL

8,900

Indirect

Purchase at $6.48 per share.

57,672

Dec 8, 2010

HARVEST CAPITAL

5,200

Indirect

Purchase at $6.47 per share.

33,644

Dec 7, 2010

HARVEST CAPITAL

16,700

Indirect

Purchase at $6.48 per share.

108,216

Dec 6, 2010

HARVEST CAPITAL

23,700

Indirect

Purchase at $6.46 per share.

153,102

Dec 3, 2010

HARVEST CAPITAL

9,300

Indirect

Purchase at $6.41 per share.

59,613

Dec 2, 2010

HARVEST CAPITAL

38,000

Indirect

Purchase at $6.41 per share.

243,580

Dec 1, 2010

HARVEST CAPITAL

1,400

Indirect

Purchase at $6.35 per share.

8,890

Nov 29, 2010

HARVEST CAPITAL

4,742

Indirect

Purchase at $6.35 per share.

30,111

Nov 26, 2010

HARVEST CAPITAL

600

Indirect

Purchase at $6.35 per share.

3,810

Nov 24, 2010

HARVEST CAPITAL

848

Indirect

Purchase at $6.35 per share.

5,384

Nov 23, 2010

HARVEST CAPITAL

65

Indirect

Purchase at $6.35 per share.

412

Nov 19, 2010

HARVEST CAPITAL

800

Indirect

Purchase at $6.34 per share.

5,072

Nov 18, 2010

HARVEST CAPITAL

2,708

Indirect

Purchase at $6.35 per share.

17,195

Nov 17, 2010

HARVEST CAPITAL

5,300

Indirect

Purchase at $6.34 per share.

33,602

Nov 16, 2010

HARVEST CAPITAL

18,000

Indirect

Purchase at $6.30 per share.

113,400

Nov 15, 2010

HARVEST CAPITAL

9,800

Indirect

Purchase at $6.32 per share.

61,936

Nov 12, 2010

HARVEST CAPITAL

1,499

Indirect

Purchase at $6.35 per share.

9,518

Nov 11, 2010

HARVEST CAPITAL

22,899

Indirect

Purchase at $6.33 per share.

144,950

Nov 10, 2010

HARVEST CAPITAL

3,314

Indirect

Purchase at $6.35 per share.

21,043

Nov 9, 2010

HARVEST CAPITAL

9,000

Indirect

Purchase at $6.35 per share.

57,150

Nov 8, 2010

HARVEST CAPITAL

23,938

Indirect

Purchase at $6.35 per share.

152,006

Nov 5, 2010

HARVEST CAPITAL

8,500

Indirect

Purchase at $6.29 per share.

53,465

Nov 4, 2010

HARVEST CAPITAL

8,200

Indirect

Purchase at $6.30 per share.

51,660

Oct 29, 2010

HARVEST CAPITAL

500

Indirect

Purchase at $6.30 per share.

3,150

Oct 26, 2010

HARVEST CAPITAL

2,200

Indirect

Purchase at $6.30 per share.

13,860

Oct 22, 2010

HARVEST CAPITAL

35,000

Indirect

Purchase at $6.35 per share.

222,250

Oct 21, 2010

HARVEST CAPITAL

500

Indirect

Purchase at $6.35 per share.

3,175

Oct 20, 2010

HARVEST CAPITAL

3,400

Indirect

Purchase at $6.35 per share.

21,590

Oct 19, 2010

HARVEST CAPITAL

12,029

Indirect

Purchase at $6.34 per share.

76,263

Oct 18, 2010

HARVEST CAPITAL

4,200

Indirect

Purchase at $6.30 per share.

26,460

Oct 15, 2010

HARVEST CAPITAL

5,000

Indirect

Purchase at $6.29 per share.

31,450

Oct 14, 2010

HARVEST CAPITAL

13,600

Indirect

Purchase at $6.30 per share.

85,680

Oct 13, 2010

HARVEST CAPITAL

4,919

Indirect

Purchase at $6.30 per share.

30,989

Oct 12, 2010

HARVEST CAPITAL

4,000

Indirect

Purchase at $6.28 per share.

25,120

Oct 11, 2010

HARVEST CAPITAL

800

Indirect

Purchase at $6.49 per share.

5,192

Oct 8, 2010

HARVEST CAPITAL

77,800

Indirect

Purchase at $6.49 per share.

504,922

Oct 7, 2010

HARVEST CAPITAL

9,000

Indirect

Purchase at $6.41 per share.

57,690

Sep 7, 2010

HARVEST CAPITAL

1,390

Indirect

Purchase at $6.36 per share.

8,840

Sep 3, 2010

HARVEST CAPITAL

900

Indirect

Purchase at $6.34 per share.

5,706

Sep 2, 2010

HARVEST CAPITAL

1,500

Indirect

Purchase at $6.35 per share.

9,525

Sep 1, 2010

HARVEST CAPITAL

610

Indirect

Purchase at $6.35 per share.

3,873

Aug 31, 2010

HARVEST CAPITAL

5,600

Indirect

Purchase at $6.22 per share.

34,832

Aug 30, 2010

HARVEST CAPITAL

6,864

Indirect

Purchase at $6.34 per share.

43,517

Aug 27, 2010

HARVEST CAPITAL

100

Indirect

Purchase at $6.34 per share.

634

Aug 25, 2010

HARVEST CAPITAL

10,952

indirect

Sale at $6.43 per share.

70,421

Aug 25, 2010

HARVEST CAPITAL

10,952

Indirect

Purchase at $6.43 per share.

70,421

Aug 23, 2010

HARVEST CAPITAL

300

Indirect

Purchase at $6.20 per share.

1,860

Aug 20, 2010

HARVEST CAPITAL

2,300

Indirect

Purchase at $6.20 per share.

14,260

Aug 19, 2010

HARVEST CAPITAL

3,588

Indirect

Purchase at $6.19 per share.

22,209

Aug 18, 2010

HARVEST CAPITAL

29,800

Indirect

Purchase at $6.31 per share.

188,038

Aug 17, 2010

HARVEST CAPITAL

18,596

Indirect

Purchase at $6.31 per share.

117,340

Aug 9, 2010

OSBORNE DANIEL K

10,000

Indirect

Purchase at $6.25 - $6.28

63,0002

Jul 13, 2010

OSBORNE DANIEL K

5,000

Direct

Acquisition at $6.43.

32,150

Jul 13, 2010

NORCUTT STEVEN G

1,633

Direct

Acquisition $6.43.

10,500

Jul 13, 2010

HAINEY ALAN L

544

Direct

Acquisition at $6.43

3,497

Mar 15, 2010

OSBORNE DANIEL K

4,000

Direct

Acquisition

N/A

Dec 15, 2009

HAINEY ALAN L

100

Direct

Purchase at $6.67 per share.

667

Dec 14, 2009

HAINEY ALAN L

1,000

Direct

Purchase at $6.71 per share.

6,7152

Jul 13, 2009

MUMMA STEVEN R

62,000

Direct

Acquisition

N/A

Jul 13, 2009

REESE NATHAN R

12,000

Direct

Acquisition

N/A

Jul 13, 2009

ABREU STEVEN M

6,000

Direct

Acquisition

N/A

Jul 13, 2009

NORCUTT STEVEN G

6,000

Direct

Acquisition

N/A

Jul 13, 2009

HAINEY ALAN L

6,000

Direct

Acquisition

N/A

NYMT presents an exceptional opportunity and value for investors. In a low interest rate environment, it offers an outstanding current yield, with additional potential upside in price movement and further yield increase as interest rates rise. This underfollowed “Ben Graham stock” offers relative safety under most any realistic forward scenario. A long position in NYMT can be used to hedge a typical mortgage REIT portfolio while most likely benefiting from upside in the dividend and price of the stock.

Disclosure and Disclaimer: This article was written by Doug George and The Banker. Both investors are long the stock NYMT. The stock is a long holding in the high net worth fund managed by The Banker. The Banker's consulting clients also hold long positions in NYMT. This article contains forward looking statements which should not be misconstrued as assurances of gains.

Source: New York Mortgage Trust: Outstanding Value Stock With 13.5% Dividend Yield