Thoughts About A Handful Of mREITs And The State Of The Industry (Part 2)

Summary

• I’ve put together thoughts about most of the mREITs I would typically cover.
• This article focuses on DX, JMI, NYMT, ORC and WMC.
• Leading up to Thanksgiving the prices were fairly flat for MBS and Treasury securities, but over the last month we’ve seen the yield curve flattening.

I've grabbed a group of mREITs that I intend to be providing a substantial amount of coverage on throughout the winter. This includes a few names that I have not covered much during the fall as I've been prioritizing which companies to cover while I worked on building out some of the models I'm using.

Annaly Capital Management	NLY
American Capital Agency Corp	AGNC
ARMOUR Residential REIT	ARR
Capstead Mortgage Corporation	CMO
CYS Investments	CYS	Long CYS
Dynex Capital	DX	Long DX
Javelin Mortgage Investment	JMI
New York Mortgage Trust	NYMT
Orchid Island Capital	ORC
Two Harbors Investment Corp	TWO
Western Asset Mortgage Capital Corporation	WMC

Click to enlarge

In the previous article I covered NLY, AGNC, ARR, CMO and CYS.

In this piece I'll be covering DX, JMI, NYMT, ORC and WMC.

I've been very busy lately and had to let something slip. This piece isn't tagged for TWO because they are one of the mREITs that takes longer for me to keep up-to-date on.

Dynex Capital

I like this mREIT for their positions in CMBS and their talented internal management team. I kept holding them even though I felt lower rates for longer made sense. During the third quarter they increased their hedging to prepare for a rate increase. Unfortunately the hedging is using LIBOR swaps which have not increased in yield at the same rate as treasuries. This is a problem hitting most mREITs. The biggest difficulty in evaluating their performance during the quarter is the challenge of tracking CMBS and ARMs. For precise predictions, information on fixed rate Agency MBS is easier to acquire.

Javelin Mortgage Investment

Going from the October portfolio update to the November portfolio update showed a very small book value loss compared to what many mREITs should have experienced. Share prices have been climbing over the last week since the information was released indicating that the shares were trading at almost 40% discount to book value. They did better than I expected for the period even though non-Agency MBS didn't get hammered as hard in fair values as Agency MBS.

New York Mortgage Trust

It feels like a decent quarter for IO strips and distressed residential loans seem like they should be doing significantly better this quarter than they were at the end of the third quarter. I feel the risk level in this portfolio is pretty high and I'm concerned about the cost of management, but in general the assets seem decent for a quarter that has seen increasing rates and less fear about credit sensitive assets. This is one of the most difficult mREITs to establish fair values on.

Orchid Island Capital

My most recent coverage on Orchid Island Capital looks into the change in the portfolio that occurred prior to rates jumping higher. This was a nice factor for reducing the damage. They increased their position in higher coupon MBS at the cost of lower coupon MBS. When rates increase the higher coupon MBS see a smaller decline in fair values because investors expect a lower prepayment rate that increases the yield on par value. This is one of the nice features of MBS when rates are increasing.

Western Asset Mortgage Capital Corporation

Western Asset Mortgage Capital Corporation has been on a tear over the last week or so. I saw the climb and went looking for any kind of announcement that could have encouraged such a climb but I didn't find anything. Lacking any compelling reason for their sudden outperformance of peers, I have to conclude that this is probably a fluke and a nice selling opportunity.

Thoughts on the Industry

Over the last month we have seen highly liquid fixed rate Agency MBS fall significantly in price. As of Thanksgiving the prices on the 30-year FNMA 4.0 was roughly flat from the end of trading on Friday. Two year Treasury securities also have suffered from significantly lower prices over the last month and they also were fairly flat this week. The 10-year Treasury has also seen prices falling and yields rising, but the problem here is that the two-year rates are rising faster than the 10-year rates which are creating a flatter yield curve. This flatter yield curve is encouraging most mREITs to fall in prices.

A flatter yield curve is a substantial problem for mREITs because it indicates weaker earnings since repo costs which determine a substantial portion of their cost of funds are expected to rise faster than the yield on their long term assets.

Analyst’s Disclosure: I am/we are long DX, CYS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis.