Thoughts On A Handful Of mREITs And The State Of The Industry (Week 35)

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

Summary

The yield curve flattened even further with the 7 to 1 spread at 87 basis points and the 10 to 2 spread at 89 basis points.

The estimated probability of a rate increase on 06/15/2016 is 1.9%.

LIBOR swap to MBS spreads appear slightly larger on the quarter.

Welcome to week 35.

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

(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. 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

5/20/2016

0.98

0.96

5/27/2016

0.99

0.95

6/3/2016

0.9

0.93

6/6/2016

0.93

0.93

6/7/2016

0.92

0.94

6/8/2016

0.91

0.93

6/9/2016

0.9

0.91

6/10/2016

0.87

0.91

6/13/2016

0.87

0.89

Click to enlarge

Major Risk Factors

The flattening of the yield curve is clearly a significant risk factor for the mortgage REITs and having it flatten out at such a low level creates a material challenge for reinvestment since mREITs focusing on agency MBS will be pretty much stuck buying MBS with weak yields. Because of the very weak yields on those assets an increase in rates that was not properly hedged could be incredibly damaging. Therefore, I see more incentive for mortgage REITs to leverage up and hedge up. The spread between MBS yields and the 5-year or 7-year swap still looks fairly attractive so hedging up and running a large portfolio looks like a viable choice.

I ran some approximations on the LIBOR swap to MBS spread and it looks like it increased again slightly in the quarter. It is materially higher than the values I've seen at the end of other quarters and I'm starting to wonder how high it can go. Performance on book value for individual mREITs will depend on their unique positions but performance for the sector can be heavily influenced by the shift in these spreads.

I strongly dislike the flatter yield curve, but I like the spread between swaps and MBS as a way to generate more returns for future periods.

That Seems Ironic

Since 06/03/2016, there has been a decline in most of the larger mortgage REITs and weakness in the S&P 500. The treasury yields have also declined so there was a bit of a bond rally. While big mortgage REITs like NLY are down, mortgage REITs with very high levels of credit risk are up. NYMT and CIM are both up between 1% and 2% on the period. Perhaps even more ironic is that NYMT has a substantial allocation to IO strips and those strips should be getting hammered by the weakness in rates. The rates on MBS haven't fallen as hard as the rates on treasuries and LIBOR swaps, but if MBS rates catch up with that movement it could indicate another wave of prepayments.

Conclusion

The mortgage REIT sector is showing some strange values in relative pricing and the whole situation seems a bit ironic. The market suffered a few weak days lately and the sector appears to be taking a hit along with it. I don't see any reason to be more concerned now than a week ago or two weeks ago. With that said, my outlook has been and continues to be bearish on several names due to their smaller discount to book values or the exceptionally higher operating costs.

Disclosure: I am/we are long ARR, ARR.

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.

Additional disclosure: 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. This article is prepared solely for publication on Seeking Alpha and any reproduction of it on other sites is unauthorized. 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.