Thoughts On A Handful Of mREITs And The State Of The Industry (Week 41)

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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 slipped back to being slightly flatter. Rates were only slightly higher.

The market's bravery towards credit risk seems like foolish behavior.

Downgrades for AGNC are interesting. I do not agree with them on a relative basis.

ARMOUR Residential REIT remains one of the cheapest options on price to estimated book.

Welcome to week 41.

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

6/10/2016

0.87

0.91

6/17/2016

0.9

0.92

6/24/2016

0.87

0.93

7/1/2016

0.82

0.87

7/8/2016

0.71

0.76

7/15/2016

0.9

0.89

7/22/2016

0.85

0.86

Click to enlarge

Rate Movements

The rates are back to about the same spread as the start of the month. That is too small to be attractive. However, it is not so bad that investors should be in a panic. The more interesting story than rates has been the markets bullish attitude towards credit risk. The favorable perception seems a little outlandish to me. Is the economy really so different now than it was in February? That is a real question because I have not seen anything that would justify a 15% change in the value of the domestic equity market. I felt prices were too low at that point and feel they are too high at this point.

AGNC Downgrades

There have been a couple larger firms hitting AGNC with downgrades. I model book value frequently. The span between those models could be as high as a month or as short as a few days, but I ran the numbers just before the weekend. I do not agree with downgrading AGNC on a relative basis because I do not see them as being more expensive relative to book value.

AGNC's management was smart enough to arrange the transaction for the buyout to close in July. Consequently, they will have (or should have) a much more predictable book for 06/30/2016. Book value could be down because of the buyout. If AGNC only records Goodwill plus identifiable assets for part of the transaction, it would reduce the book value of equity. Even if they knocked the expense down to $0 and just recorded it all across a combination of tangible and intangible assets, investors could use "discount to tangible book value" as a replacement for "discount to book value". There is a major problem with that theory.

Goodwill is Not Created Equal

Does that sound strange? How can intangible assets of Goodwill be valued so differently? The simple issue here is that AGNC bought their external manager at what was effectively a very low P/E ratio (or very high earnings yield). Their annual savings from internalizing should save more raw dollars than they could have hoped to earn from investing that into a leveraged portfolio of RMBS. On the other hand, if an mREIT is paying a much higher price relative to the earnings of the manager (which becomes savings after internalization), they could be recording a much higher value for Goodwill. AGNC got a better deal than I would expect most externally managed REITs to achieve.

ARR Remains Cheap to Book

ARMOUR Residential REIT was a pick I made in early June. Returns since then have been solid, but ARR remains at one of the largest discounts to both trailing book value and my estimate of current book value. That seems worthy of noticing. If the discount closed to similar levels to other REITs, I would look to end my position. For now, the additional discount gives me a little more cushion for safety.

Earnings Season Approaches

With earnings almost on top of us, it is a great time for investors and analysts to step up the analysis in advance of the earnings reports. When the mortgage REITs announce earnings numbers, there should be some volatility in the share prices. I expect smaller mortgage REITs on average to demonstrate larger surprises (change in value).

Conclusion

The environment remains moderate for mortgage REITs. The flattening yield curve remains a problem but the MBS to LIBOR spreads kept me involved. The downgrades for AGNC seem a bit harsh unless the same groups are indicating similar opinions on the other major mortgage REITs trading at similar discounts. This buyout of the manager should put an end to any suggestions that externally managing mortgage REITs is good for the shareholders.

Some Extra Specific Disclosures

In the coming days and weeks, I may buy into any mortgage REIT or their preferred shares.

I may also exit positions if the price is high enough that I cease to like the position. Neither ARR nor MTGE is close to high enough for me to exit the position at the current estimated discount to book value.

Pitch for Subscribers

Since the Mortgage REIT Forum is a new exclusive research platform, the first 100 subscribers will be able to lock in their subscription rates at only $240/year. My investment ideas emphasize finding undervalued mortgage REITs, triple net lease REITs, and preferred shares. With the market at relatively high levels, there is also significant work on finding which securities are overvalued to protect investors from losing a chunk of their portfolio.

Disclosure: I am/we are long ARR, MTGE, AND MAY BUY ANYTHING.

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.