Agency and non agency mortgage real estate investment trusts (mREITs) are offering 15.0% and up yields. This is a tremendous interest rate yield compared to the Treasury Bond market. A 10 year Treasury Bond, as of February 10th, yields 1.96%. However, investors must recognize the risks associated with owning mREITs to determine if they are appropriate for their personal portfolios. In this article I will highlight 3 mREITs to buy and 2 to avoid.
Agency mREITs are in reality levered bond funds. The mREITs have risk control teams to hedge their positions. The agency entities borrow at short term repurchase agreement rates. Agency mREITs use these funds to purchase mortgage securities issued or guaranteed by U.S Government agencies or U.S. Government sponsored entities. These entities include Fannie Mae, Freddie Mac, and Ginnie Mae. The U.S. Federal Government has an implicit 100% guarantee on these pass through securities. The mortgage securities are Level 1 assets on company's SEC 10Q and 10K balance sheets. Treasury Bonds are Level 1 assets and are very liquid on the trading markets. Agency mREITs earn money on the difference between borrowing costs and the yield on longer duration agency pass through securities. This difference is levered at a 5 through 8 multiple.
Non Agency mREITs
Non agency mREITs can own agency mortgage backed securities and mortgage securities not backed by the U.S. Federal Government. Non agency mortgage backed securities are not listed as Level 1 assets on the balance sheet. Non agency mREITs attempt to cherry pick mortgage securities for pennies on the dollar. Because the non agency assets are not guaranteed by the U.S. Government, the book value per share is critical. Non agency mREITs can own agency mortgage securities too. Non agency mREITs are known as "hybrids" because they own agency and non agency mortgage backed securities.
Buy American Capital Agency (AGNC)
American Capital Agency is an agency mREIT that has posted the best publicly traded returns over the past 5 years. The above figures do not reflect the reinvestment of dividends.
I have stated many times, including in this article, that this mREIT is head and shoulders above the competition. I still believe this to be the case, although there is a better value for investors-- Gary Kain and team. Mr. Kain has beat the competition over any period of time you look at.
The company trades at a 8.99% premium to net asset value. The company is likely to issue an additional share issuance per its SEC approval. This would differ from the typical secondary offering. American Capital Agency has a SEC FORM 424(B)(2) to generate new funds.
American Capital Agency has generated a 23.4% total annualized rate of return over the past 3 years. This assumes dividends are not reinvested. The mREIT currently yields $1.25 per share, or $5.00 per year. This equates to a 16.7% yield on a current stock price of $30.20.
Buy American Capital Mortgage (MTGE)
American Capital Mortgage is a non agency (hybrid) mREIT. American Capital Mortgage is the best value on the mREIT board. The hybrid has over 97% of assets in agency mortgage backed securities. Gary Kain manages the agency mortgage securities. The $20.87 book value per share is the key metric to examine. New investors can obtain Gary Kain's acumen at a discount to book value per share.
Investors can choose between American Capital Agency, with a 8.99% premium to net asset value or American Capital Mortgage. American Capital Mortgage offers Gary Kain and a mREIT trading at 86 basis points discount to net asset value. I believe this is a better value than American Capital Agency.
Buy CYS Investments, Inc. (CYS)
CYS Investments is an agency mREIT. The company announced, on February 7th, a 4th quarter dividend of 50 cents. This is down slightly from the 3rd quarter dividend of 55 cents. An annual $2.00 dividend equates to a 15% annual dividend yield. Management did present a February 9th presentation indicating the state of affairs in the mREIT space. The dividend has decreased, as expected, due to the declining long end mortgage pass through security yields. This has placed a negative impact upon the net yield margin. The company stated hedging costs were lower than prior periods. I would argue a 15% dividend yield is ample reward for investing in today's stock market.
Avoid Two Harbors Investment Corp (TWO)
Two Harbors is a hybrid mREIT. The company, on February 7th, announced its book value per share was $9.03. Two Harbors owns agency mortgage backed securities and non agency backed securities. Below is a break down of the non agency holdings:
Premise to Avoid
The one way to lose money is to invest in a hybrid mREIT trading at a premium to net asset value. Not only does Two Harbors have non Level 1 assets on its balance sheet, but the 9.52% premium is ridiculous when agency mREITs are trading below net asset value. Pine River Capital Management may be the greatest mREIT traders since Michael Farrell from 20 years ago. If an investor pays close to 10% premium to net asset value for a hybrid mREIT, they are asking for a capital loss.
This is rule number one when it comes to investing in hybrid mREITs. Two Harbors returns indicates that it has not provided outstanding returns compared to American Capital Agency or American Capital Mortgage.
Avoid Annaly Capital Management Inc (NLY)
Annaly Capital Management is an agency mREIT. We all hope Chief Executive Officer Michael Farrell's medical situation goes well. He is a fighter and has said he will be at work performing his regular duties. Mr. Farrell's health is far more important than whether Annaly has an up or down year.
Annaly Capital Management announced a disappointing 4th quarter. The company decreased its leverage from 5.5x in the 3rd quarter to 5.4x in the 4th quarter. The book value per share decreased less than one percent to $16.06. The company is trading at a 2.99% premium to net asset value. In my opinion, I don't see any value added in establishing a new position or adding to a current position. Other agency mREITs are offering better year over year returns.
Investors are typically not rewarded when buying agency mREITs at a premium to net asset value, and book values per share are decreasing. I would not recommend buying any Annaly Capital Management shares unless Annaly Capital Management is trading at a 5% discount to net asset value. Annaly Capital Management has simply been unable to match its peer group in the past 2 through 5 year performance. The company also decreased its 4th quarter dividend to 57 cents from 60 cents in the 3rd quarter, 2011. I own Annaly shares. I will not be adding to my position, and I would recommend that investors on the sidelines avoid Annaly.
I believe in using quantitative analysis to make return differentiations between mREITs. The data supports, over a 2 through 5 year comparison, the winning names to own. I believe investors should never pay over book value for a non agency mREIT. This indicates investors should avoid Two Harbours. Annaly Capital Management has failed to compete at the same level of its peers. I recommend investors buy American Capital Agency, American Capital Mortgage, and CYS Investments in equal position size.