Thoughts On A Handful Of mREITs And The State Of The Industry (Week 31)

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Includes: AGNC, AI, AMTG, ANH, ARR, BXMT, CHMI, CIM, CMO, CYS, DX, EARN, JMI, MFA, MORT, MTGE, NLY, NRZ, NYMT, ORC, REM, STWD, TWO, WMC, ZFC
by: ColoradoWealthManagementFund

Summary

The yield curve is tying the record for flatness from the end of February.

I’m starting to keep an eye on REM as a proxy for how much money is flooding into the sector from investors/speculators without due diligence.

The presence of investors that aren’t doing due diligence indicates a higher potential for relative mispricing opportunities.

Dividends are looking dangerous on common shares due to the flatness of the yield curve.

Welcome to week 31.

The mREITs (and two ETFs)

The table is demonstrated below:

(NYSE:NLY)

Annaly Capital Management

(NASDAQ:AGNC)

American Capital Agency Corp

(NYSE:ARR)

ARMOUR Residential REIT

(NYSE:CMO)

Capstead Mortgage Corporation

(NYSE:CYS)

CYS Investments

(NYSE:DX)

Dynex Capital

(NYSE:JMI)

Javelin Mortgage Investment

(NASDAQ:NYMT)

New York Mortgage Trust

(NYSE:ORC)

Orchid Island Capital

(NYSE:TWO)

Two Harbors Investment Corp

(NYSE:WMC)

Western Asset Mortgage Capital Corp.

(NYSE:MFA)

MFA Financial

(NYSE:EARN)

Ellington Residential Mortgage REIT

(NYSE:AI)

Arlington Asset Investment Corporation

(NYSE:ZFC)

ZAIS Financial

(NYSE:AMTG)

Apollo Residential Mortgage

(NYSE:ANH)

Anworth Mortgage Asset Corporation

(NASDAQ:MTGE)

American Capital Mortgage Investment

(NYSE:CHMI)

Cherry Hill Mortgage Investment

(NYSE:STWD)

Starwood Property Trust

(NYSE:BXMT)

Blackstone Mortgage Trust

(NYSE:CIM)

Chimera Investment Corporation

(NYSE:NRZ)

New Residential Investment Corp.

(NYSEARCA:REM)

iShares Mortgage Real Estate Capped ETF

(NYSEARCA:MORT)

Market Vectors Mortgage REIT Income ETF

Click to enlarge

Spreads

Remember that the simplest explanation of the mortgage REIT is to say that they have a leveraged portfolio of long term bonds financed with short term rates. As we get deeper into the fundamental operations of the mREIT we need to talk about things like convexity of the yield curve, the difference between the fed funds rate and the repo rate, and the spread between LIBOR swaps relative to MBS yields. The first starting point should be reading the steepness of the yield curve, so each week starts with this reading.

7 to 1

10 to 2

Q4 2014

1.72

1.5

Q1 2015

1.45

1.38

Q2 2015

1.79

1.71

Q3 2015

1.42

1.42

Q4 2015

1.44

1.21

1/8/2016

1.27

1.19

1/15/2016

1.3

1.18

1/22/2016

1.34

1.19

1/29/2016

1.2

1.18

2/5/2016

1.03

1.12

2/12/2016

0.99

1.03

2/19/2016

1

1

2/26/2016

0.95

0.96

3/4/2016

1.02

1

3/11/2016

1.09

1.01

3/18/2016

1.04

1.04

3/24/2016

1.07

1.02

4/1/2016

0.94

1.03

4/8/2016

0.93

1.02

4/15/2016

0.99

1.02

4/22/2016

1.11

1.05

4/29/2016

1.04

1.06

5/6/2016

1.04

1.05

5/13/2016

0.96

0.95

Click to enlarge

The steepness of the yield curve at the end of the week was the flattest reading I've seen in the weakly measurements since late February.

Discounts To Book

Discounts throughout the industry remain fairly flat. This time I'm writing my thoughts on the industry before writing the piece on the discounts t book value. I'm doing some work on the charts for that series and recently pulled the new book values across almost every mortgage REIT I've been including.

You'll want to make sure you see it since using the latest data confirms that the market is making some mistakes.

REM

Let's talk about the big mortgage REIT ETF. I've been putting more time into researching REM lately, but it isn't because I'm suddenly interested in buying an ETF to get diversified exposure. There are only a couple ETFs for the mortgage REIT sector and a flood of money into the sector from investors that aren't familiar with the sector could, at least theoretically, result in more demand for the ETF. If I'm correct about the sector being flooded with buyers that don't understand mortgage REITs, then I would expect REM to be creating new shares at a material rate. I recently started downloading the fund holdings on a frequent basis to test that theory and can confirm that assets under management are growing rapidly.

Belief About Industry

It is my opinion that the current pricing wave is heavily supported by new buyers that don't understand the fundamentals of the mortgage REITs they are buying. The rapid increases in prices makes finding value more difficult for long term buying, but it also means there should be some great opportunities for the long/short pair trade if investors have the patience to wait for a correction on relative valuation.

For investors that want a simple "buy and hold" investment, there are relatively few options available at attractive prices. I'll go into more specifics using my discount to book piece.

Dividends

Several mortgage REITs have cut dividends within the last year and the currently flattening of the yield curve is reinforcing that problem. Expect a few more cuts throughout the sector before the year is done. As I pointed out recently, I expect a dividend cut for New York Mortgage Trust. As a reminder, this is simply my expectation.

I'm predicting the new dividend to be around $.20. When (or if) the cut happens, there might be a great sale. The company might fall to a level where it becomes a buy, but it is difficult to predict how harshly the market will react if a cut is announced. My outlook is bearish with the latest price of $5.67.

Preferred Shares

I would be wary of preferred shares trading above par value and past the call dates. As low rates push lower it wouldn't shock me to see a call or two go out if the preferred share is trading past call date with a stripped price (price minus accrued dividend) exceeding about $25.50.

I continue to have some open buy-limit orders on preferred shares for mortgage REITs and triple net lease REITs. Currently the only preferred shares in my portfolio are from Dynex Capital. There are one or two common stock positions that I am contemplating, so I'm tagging this piece to indicate that I might buy anything. I believe most of the field is severely overvalued, but I am currently researching some relative value plays.

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

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