Mortgage REIT Showdown: A Comparison Of 5 High-Yield Trusts

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Includes: ARR, EARN, NRZ, NYMT, ORC
by: Jason Ditz

Summary

NRZ is far less leveraged than its competitors, suggesting relative safety.

Despite buying Javelin, ARR still has a very strong cash position.

NYMT is both the highest yielding of the bunch, and trading at the largest discount to book.

For people chasing the highest sustained yields possible on the stock market, it's tough to go wrong with real estate. Mortgage REITs, also known as mREITs, have an extremely straightforward business model, which allows for good apples-to-apples comparisons among them, and tend to be highly leveraged, allowing for well above market average yields.

Today, we will be looking at five of the highest yielding mREITs on the market today, carefully comparing the numbers underpinning those yields, in an effort to find the safest way to secure a major yield. This will include big trusts like New Residential Investment (NYSE:NRZ) and Armour Residential REIT (NYSE:ARR), along with smaller companies like Orchid Island Capital (NYSE:ORC) and Ellington Residential (NYSE:EARN), as well as the highest yielding of all, New York Mortgage Trust (NASDAQ:NYMT).

An introduction to mREITs
Unlike traditional Real Estate Investment Trusts, which invest directly in real estate, mREITs play the real estate market by investing in mortgages, or more commonly mortgage-backed securities. This takes them further away from having to manage physical property.

Investing in mortgage-backed securities allows mREITs to diversify heavily across the country, which ideally will shield them from regional property value woes. Payments on the mortgages are returned to the mREIT investors as dividends.

You may notice that these trusts are all paying around 15% yields, or more in the case of New York Mortgage Trust, and are wondering how that is possible, with the average mortgage in the 3%-4% range.

The answer is leverage. By using their position as significant companies, the trusts are able to borrow money to buy more mortgages, and add the difference on those yields to the overall payout they make to unitholders.

This huge leverage comes at a cost, exposing the trusts to considerable additional risk, but allows them to pay very attractive yields. With careful examination of their financials, we should be able to spot targets with the least risk.

Leverage and Book Value
All mortgage-backed securities aren't created equal, and I don't want to give the idea that I'm oversimplifying things. Still, these straight comparisons give us an early basis for valuation.

NYMT ORC NRZ ARR EARN
Mortgage Held $7.10 bil $2.16 bil $5.35 bil $12.4 bil $1.24 bil
Mort. Obligations $6.82 bil $1.80 bil $4.04 bil $11.5 bil $1.22 bil
Total Assets $9.06 bil $2.24 bil $15.2 bil $13.0 bil $1.55 bil
Total Equity $880 mil $253 mil $2.80 bil $1.22 bil $145 mil
Price/Book 0.63 0.91 0.98 0.63 0.77
Asset/Equity 10.29 8.86 5.43 10.66 10.73
Click to enlarge

This first set of data gives us some important information. Assets over equity is an excellent measure of leverage, and we see three of the companies are in excess of 10. New Residential, by contrast, has a much lower leverage, and it is quite impressive it has been able to keep up its yields.

New York Mortgage Trust and Armour Residential REIT are both trading at a considerable discount to book. They have higher leverage though, which suggests that investors are demanding a bigger discount to make up for this additional risk. New Residential, by contrast, has the least leverage and is trading basically at book value.

Cash and sustainability
That's just part of the story though. The real reason we're buying mortgage REITs isn't chiefly for book value discounts, as nice as those are, but for the massive yield.

NYMT ORC NRZ ARR EARN
Net Cash Flow ($13 mil) ($36 mil) $37 mil ($205 mil) ($5 mil)
Cash on Hand $61.9 mil $57.2 mil $250 mil $290 mil* $40 mil
Dividend Payout $104 mil $36.4 mil $423 mil $119 mil $16.4 mil
Dividend Yield 19.16% 15.54% 15.35% 15.29% 14.71%
Click to enlarge

Note: The cash on hand figures are as of the companies' recent 10-Ks. Since then, Armour Residential REIT spent about $85 million in cash acquiring Javelin Mortgage Investment.

Net cash flow, in this case, reflects the change in cash on hand from the most recent 10-K to the previous 10-K. It's not a big deal if it is negative, these aren't companies we necessarily want sitting on large piles of cash after all. We do, however, want to make sure that the cash flow makes the payout pretty sustainable, and it would be nice if a given trust has enough cash on hand to weather a small rough patch without having to immediately slash the dividend.

None of the trusts' dividends seem immediately in danger, though naturally this can change. New Residential seems nice, having lots of cash and a positive cash flow last year. Its high payout, however, means that if the business hits a roadblock, it will burn through that cash relatively quickly.

Ellington Residential, by contrast, is such a small company that its dividend seems quite secure, even though it has the least cash on hand. Armour Residential REIT's recent acquisition of Javelin seems a good vote of confidence that the company believes it can afford to spend some of its considerable cash growing.

New York Mortgage Trust is the outlier, with the highest yield of the bunch, and has so far managed to do so without having to dip too far into its cash flow.

Conclusion
High yield mREITs, as I've tried to emphasize, are necessarily a bit risky because of their leverage. With yields that dramatically beat the what can be found virtually anywhere else, however, and probably does deserve a spot, if a limited one, in a portfolio looking to generate income.

Out of the five trusts covered here, New Residential Investment seems head and shoulders above the others. It has the narrowest discount to book value, but with the least leverage and a strong cash balance, I think it warrants this premium.

Beyond it, Armour Residential REIT deserves some consideration for both its strong cash position and its discount to book. New York Mortgage Trust also deserves some consideration because of its staggering, but seemingly sustainable, yield, though again, both of these trusts are much more leveraged, meaning investors should be even more careful before dipping in too deeply.

As always, you should dig deeply into the filings of any company before investing. Hopefully, the figures provided here will give readers a basic understanding of how these companies compare with one another, and serve as a good jumping off point.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in NRZ over the next 72 hours.

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.