Hybrid Mortgage REITs And Non-Agency RMBS Finish January With Strong Performance And Continued Potential

 |  Includes: CIM, DX, IVR, MFA, RWT, TWO
by: Zvi Bar

Residential mortgages are primarily divided into two subdivisions: mortgages insured by federal agencies and those without agency insurance. Hybrid mortgage REITs hold both agency and non-agency residential mortgage backed securities (RMBS).

Non-agency RMBS are generally higher yielding than agency RMBS, but also present the risk associated with borrower default. Most hybrid mREITs now hold large and growing positions in agency RMBS. This is largely because few new non-agency mortgages are being issued, and many hybrid mREITs have accumulated larger positions in agency debt out of necessity. This diversification was also done in order to reduce volatility, as non-agency backed debt is largely junk rated and capriciously priced by the markets.

Below are recent performance rates for six mortgage REITs that are largely invested in non-agency RMBS paper, though not necessarily exclusively or to a majority, depending on their current portfolio mix: Chimera Investment (NYSE:CIM), Dynex Capital (NYSE:DX), Invesco Mortgage Capital (NYSE:IVR), MFA Financial (NYSE:MFA), Redwood Trust (RWT) and Two Harbors Investment (TWO). None has yet released a Q4 or 2011 annual report for 2011, but most will do so in the next week or two. In addition to their recent equity performance rates and current annual dividend rates.Click to enlarge

And below is a 2012-to-date (January) performance comparison chart for these REITs:
Click to enlarge

Through the first month of 2012, these REITs averaged 11.04 percent equity appreciation, after several months of declining prices. Non-agency RMBS paper valuations declined significantly during 2011, bringing down most of these hybrid mREITs.

These mREITs and RMBS may get a boost from any substantive mortgage refinancing program that President Obama is expected to announce shortly, but the effects of such a program are still unclear and speculative. Moreover, such a program may not include all types of non-agency mortgages, if it includes them at all. There are four primary types of non-agency mortgages: Prime, Alternative-A (Alt-A), Option Adjustable Rate Mortgages (Option ARMs) and Subprime.

Mortgage REITs continue to be one of the highest-yielding options available to income-oriented investors. Nonetheless, due to their significant risk profile, exposure to non-agency RBMS should be limited to a reasonable percentage of a high-risk portfolio, based upon an investor's total risk profile, time-horizon and other investments.

Additionally, under the current tax laws, mREIT dividends are taxed as ordinary income, and not at the lower corporate dividend rate. Since mREIT dividends are taxed as regular income they are generally considered substantially better performing investments when held within tax deferred or exempt accounts.

Disclosure: I am long CIM.

Disclaimer: This article is intended to be informative and should not be construed as personalized advice as it does not take into account your specific situation or objectives.