The Federal Reserve said it is likely to leave short-term interest rates at rock-bottom levels at least through late 2014, giving businesses and consumers much more time to borrow money cheaply and bolster a slowly recovering economy. The Fed cut rates to near zero in December 2008 during the financial crisis and has held them there ever since. The announcement that it expected rates to remain low was a sign that the Fed expects the U.S. economy, which is improving, to need significant help for three more years. But it also reinforced investors' confidence that the Fed was committed to restoring growth. This is great news for those investing in virtual banks.
These stocks are called "virtual banks" because they do the same thing as a bank does. They make money by taking in cash at a low interest rate and lending it out at a higher one. This is the banks' profit, called the "interest rate spread."
Hatteras Financial (NYSE:HTS) is one of these virtual banks. It only invests in these 100% government-guaranteed mortgage deals. And right now, Hatteras can borrow money at the lowest rates in its history, thanks to the Federal Reserve cutting short-term interest rates to near zero. HTS has a 60% profit margin. HTS is currently trading at $27.93 above its price when it announced a $0.90 cent dividend on December 13 2011. Hatteras, by law, pays out basically all of its earnings in the form of dividends. Based on its current share price of $25, that's a 13% dividend yield. HTS has an equity summary score of 8.6 out of 10 which is rated as bullish.
Just like Hatteras, Annaly Capital (NYSE:NLY) makes big money when the interest-rate spread is high. And just like Hatteras, it pays out basically all of its earnings in dividends. NLY is trading at $16.88 with a 14% dividend yield. NLY is the largest stock in this industry with a market capitalization of $16.2 billion. Dividend payouts for these stocks will remain hefty as long as interest rates stay at historical lows. With the Fed keeping rates low until 2014, there does not appear to be much risk in the near future.
The best time to buy these stocks is when they are trading at or below book value. Currently, both HTS and NLY have a price to book of around 1.0 which is still in the buying range.
Another stock in this industry is Two Harbors Investment Corp (NYSE:TWO). TWO is trading at $9.85 with a dividend yield of 16.5%. TWO has a market cap of $1.7 billion and trades at a P/E of 6.5. It has a price to book ratio of 1.02, valued similar to HTS and NLY. The big difference of TWO is that it only invests 80% of its capital in 100% backed government bonds with the other 20% in underpriced bonds. This is called a hybrid model that increases its yield through the 20% underpriced bonds (higher yield) investment.
Two other stocks in this category include Chimera Investment Corp (NYSE:CIM) and CYS Investments (NYSE:CYS). CIM is trading at $2.99 with a 15% dividend yield. This small cap is cheap with a price to book ratio of 0.88 and a PE of 5.77. CIM has a bullish equity summary score of 8.6. Similarly, CYS is trading at $13.85 with a 15% dividend yield. CYS is not as cheap with a price to book ratio of 1.12. However, it has the highest equity summary score of 9.7 which is a very bullish outlook.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.