mREITs' Golden Era Is Over - Part I

by: Shmulik Karpf

Annaly Capital Management, Inc. (NYSE:NLY) engages in the ownership, management, and financing of a portfolio of investment securities. The company invests primarily in mortgage pass-through certificates, collateralized mortgage obligations, agency callable debentures, and other mortgage-backed securities.

The Business Model

Simply put, NLY makes its living by playing the interest rate curve: It sells low-yield, short-term debt and buys high-yield, long-term debt. With an extensive use of leverage, this operation can amount to some very nice profits.

Lets take a look at the graph below to see how Annaly's shareholders have fared in the course of the past 2 years versus the S&P 500.

Click to enlarge.

Chart for Annaly Capital Management, Inc. (<a href=

As you can see, NLY's share performance is relatively mediocre compared to the S&P 500. But this graph is highly misleading in that it only partially represents the true ROI of investors in this company.

REITs and why they matter

NLY, as well as other similar mortgage investment companies, has elected to be taxed as a real estate investment trust (REIT). As such, the company would not be subject to federal corporate income tax, provided it distributes at least 90% of its taxable income to its shareholders.

And NLY has certainly been distributing income back to its shareholders in the form of dividends over the past few years. An investor who held shares of the company since the start of 2010 would receive an aggregate of $5.84 in the form of dividends, bringing his current dividend-adjusted share price to over $22.44.

You see, NLY is not in the game of price appreciation; it mainly acts as a dividend cow to be milked over and over. Any appreciation in price should simply be regarded as a pleasant surprise.

Not alone

NLY is not alone in this profitable business, other companies such as American Capital Agency Corp. (NASDAQ:AGNC), Invesco Mortgage Capital Corp. (NYSE:IVR), Chimera Investment Corporation (NYSE:CIM) and American Capital Mortgage (NASDAQ:MTGE). Lets take a look at this quick comparison:

Market Cap 16BL 6.8BL 1.8BL 3BL 0.2BL
Trailing P/E 45 6 4.4 5.5 4.6
Price/ Book 1.03 1.08 0.97 0.92 1.04
Trailing Div. Yield 14.7% 18.5% 21.5% 17.1% 4.6%
Payout Ratio 660% 112% 98% 116% N/A

The Bad News

It always pans out to remember that successful investing means understanding why tomorrow is different from today. With this in mind, the bad news is that the golden era for mortgage REITs is over. And the best time to realize it is right now before everyone and his brother rushes for the exit.

The irony is that, as of late, you can find many financial advisors and dividend seekers encouraging investors to pile in those stocks, exactly at the wrong time.

In my follow up article, I will explain the full details why the earnings trend of mREITS is about to reverse and why this is a good time to short those stocks rather than to own them.

Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in MTGE, NLY, AGNC, IVR, CIM over the next 72 hours.

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