Agency mortgage real estate investment trusts (mREITs) provide up to 16.6% annual dividend yields. Most investors desire a safe 16.6% dividend yield. Investors must recognize what data indicates a relatively safe mREIT versus a risky mREIT. In this article I will highlight a few mREIT valuation metrics
In 2011, as Treasury yields continued to hover near their historic lows, agency [e.g., Freddie Mac (OTCQB:FMCC)] backed mortgage real estate investment trusts emerged as the go-to investment for yield seekers. With more of the same expected in 2012, the environment continues to favor these investments that offer high yields along with the safety of government-backed obligations. While there are several strong performers in the mREIT group, Anworth Mortgage Asset Corporate (ANH) stands out in a number of ways.
Anworth is an agency backed mREIT, which means the mortgage securities it invests in are guaranteed by Fannie Mae (OTCQB:FNMA) and Freddie Mac, so the risk of default is essentially nil. As a mREIT, its central business purpose is to maximize the income from its portfolio for distribution to shareholders. Anworth's business model is to generate profits through the spread between the interest income it receives from mortgage backed securities and its cost of borrowing the funds to purchase them. The current low interest rate environment provides a healthy spread, which is why their yields are so high. Because mREITs like Anworth avail themselves of special tax treatment on earnings, they are required to distribute 90% of income as dividends.
Anworth, per the above table is trading as of February 1, at a 6.2% discount to net asset value. This is a strong value play for those who understand what assets an agency mREIT owns. Anworth owns very liquid balance sheet Level 1 securities. These trade as liquid as GE stock, Treasury Bonds, or any highly liquid publicly traded security. Anworth owns Government Sponsored Entity (GSE) securities. They are 100% Federal Government backed instruments.
Since its first dividend payment in 1998, Anworth has built a strong track record of consistency and growth in its payments to shareholders. It currently trades at $6.50, as of the January 31 closing price, which produces a 13% dividend yield. It's not one of the larger mREITS in terms of market capitalization ($863 million), yet it generates operating cash flow like the larger mREITs ($232 million).
Aside from credit or default risk, the other risk exposure for mREITS is interest rates. High yield investments are especially vulnerable to rising interest rates. Generally, when interest rates increase, the value of the underlying investment decreases. For investors concerned with interest rate risk, Anworth provides downside protection because it invests primarily in floating rate securities (80%), which means, as interest rates increase, its portfolio will adjust limiting the downside price movement on its securities.
An investment in Anworth is not without risk, however. Mortgage REITs have come under the scrutiny of the SEC, which is considering a reclassification of mREITs that could adversely impact their tax treatment. Additionally, Congress and the administration want to pursue additional homeowner refinancing initiatives, which could spur prepayments. That would have a negative effect on mREIT portfolios as higher rate mortgages are paid off. Neither of these issues is likely to gain traction in an election year, so, at least for the next year, they don't pose any, in my opinion, high risk outcome.
Annaly is the largest market cap agency mREIT. Annaly has a 16.34 billion market capitalization. Annaly's dividend is 13.60% per year. Annaly is trading at a 4.27% premium to book value per share. Typically secondary offerings occur when securities are trading at 7% or above their book value per share. Investors have some cushion room when they buy assets below book value per share. This is the case with Anworth but not with Annaly.
Chimera's mortgage backed securities are managed by Annaly's FIDAC division. Chimera owns both agency and non agency mortgage backed securities. The non agency mortgage backed securities are not guaranteed by the Federal government. Chimera's share price could spike if the Federal government sponsored an action to guarantee the non agency mortgage-backed securities on Chimera's portfolio. Chimera yields 14.5%. The strength of Chimera's mortgage-backed security portfolio will increase if housing prices can stabilize and the economy can improve.
Invesco is a hybrid mREIT owning agency mortgage-backed securities and non agency backed securities. Invesco experienced a negative derivative holding during the summer causing damage to its book value per share. Management is central to the success of any mREIT. Risk management plays a vital control over proper portfolio management.
Invesco has experienced insider purchases, which is typically a good sign.
Two Harbors (TWO)
Two Harbors is a hybrid mREIT owning both agency and non agency mortgage-backed securities. It has experienced a significant amount of insider buying. Insiders typically buy when they believe their shares are under valued.
Pine River Capital Management LP is the the parent of PRCM Advisers LLC. PRCM Advisers LLC is Two Harbors' external manager. Thomas Siering is Two Harbors' President and Chief Executive Officer. Jeffrey Stolt is the Partner and Chief Financial Officer of Pine River Capital Management LP.
Two Harbors is trading at a 10% premium to book value per share. This is a high premium for a hybrid mREIT.
With interest rates expected to remain low, and little likelihood of any policy changes, the next 12 months offer a tremendous opportunity for investors to capture double-digit yields from government-backed securities. Anworth, with its solid management experience and track record should be at the top of the list of yield seekers in 2012.
Anworth is trading at a discount to its book value per share. The company has announced a common stock buy back plan. Investors are eagerly awaiting the December 31st book value per share and earnings results. I own Anworth shares and believe they offer a compelling value.