Credit Suisse (CS) Research analysts Douglas Harter, CFA and Tapfuma Chibaya have published a report titled “2012 Outlook: Attractive Returns to Continue, Prefer Non-Agency REITs” on Dec 19, 2011. As we enter 2012, analysts have tried to analyze themes that will be relevant in the mortgage REITs sector. Analysts are of the opinion that attractive value lies in the hybrid/non-Agency REITs with higher potential for capital appreciation and stability in dividends.
Two Harbors (TWO) has been shortlisted as Credit Suisse’s top pick in the mortgage REITs sector. The company is geared toward non-agency positions at incrementally accretive risk-adjusted yields, while at the same time agency portfolio presents favorable prepayment characteristics. Mortgage REITs are currently trading at 8% discount to estimated fourth-quarter book value and currently yield 14.8%, which is 5.6 percentage points above the long-term average yield. Credit Suisse expects above average yields to continue because the yield curve isn’t expected to flatten anytime soon.
Over the 2009-2011 period non-Agency REITs have traded at 3% discount to book value, with an improving macro-economic environment it is expected that hybrids like TWO would trade at a premium to book value as investors’ risk appetite increase.
Apollo Residential Mortgage Inc. (AMTG) has been given an Outperform rating by Credit Suisse. AMTG belongs to the hybrid/non-Agency mortgage REITs subsector trading at the cheapest valuations compared with its peers with a 0.79x forward price to book multiple. Credit Suisse expects that hybrid/non-Agency REITs will improve on valuations going forward with improving macro-economic fundamentals and will trade at a premium to the historical trend. Historically non-Agency REITs traded at 3% discount to book value.
Additionally expectations regarding continuation of a steep yield curve and above-average returns is likely to result in continuation of an above average dividend yield, and total return to the investors.
Chimera Investment Corporation (CIM) also has an Outperform rating in the Mortgage REITs sector. CIM belongs to the hybrid/non-Agency mortgage REITs subsector currently trading at a 12% discount to its book value.
CYS Investments, Inc. (CYS) has been rated Outperform by Credit Suisse in the Mortgage REITs sector. The stock is currently trading at a 6% discount to its book value.
Invesco Mortgage Capital Inc. (IVR) also has been assigned an Outperform rating by Credit Suisse. Being part of the hybrid/non-Agency Mortgage REITs subsector this company trades at 0.87x its 4Q forward book value.
PennyMac Mortgage Investment (PMT) is rated as Outperform by Credit Suisse. The stock currently trades at a 13% discount to its 4Q estimated book value. The total return expected from the company is higher than industry average. Mortgage REITs currently yield 14.8%, which is 5.6 percentage points above the long-term average. Continuation of the steep yield curve and above-average return expectations are likely to help the stock in 2012.
American Capital Agency Corp. (AGNC) has been enlisted as the favorite stock from the agency-only REITs by Credit Suisse primarily because of its superior portfolio selection. Though analysts preferred the hybrid/non-Agency subsector, the total return opportunities in the agency-only REITs also still seem attractive. Agency's portfolio presents favorable prepayment characteristics, which supports the sustainability of current yield of 16.8%.