Thoughts On A Handful Of mREITs And The State Of The Industry (Week 52)

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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 new spreads were at .89 for the 7-1 and .90 for the 10-2. A slight steepening of 6 to 7 basis points which is healthy for the industry.

Despite a nice movement to a slightly steeper yield curve, the mREITs got hammered as rates moved higher.

A huge and rapid movement in yields is bad for mortgage REITs, but a slow steepening of the yield curve isn’t a large problem.

The latest selling frenzy created some opportunities for investors.

Welcome to week 52.

The current scenario is incredible. Analysts are hypothesizing over whether we are headed into another recession and the Federal Reserve is talking about how many hikes they should have in the near term. Unemployment inched higher from 4.9% to 5.0% and the case for a rate hike was not weakened. Expect unemployment to remain incredibly stubborn. A moderate increase in wages combined with unemployment running under 5% is enough to encourage the discouraged workers to return to the labor force.

The official unemployment rate only measures unemployment among those who are actively looking for work. Consequently, it will materially understate the unemployment rate that would exist if the "discouraged" workers believed they could find job offers that would be worth accepting. This is challenge to effective monetary policy. The Federal Reserve watches the numbers like a hawk, but they don't seem to look deeply into the factors that can distort those numbers.

I'll continue the implications below the tables of mREITs and yield spreads.

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 (bought by ARI)

(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

Spreads got a little flatter.

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

7/29/2016

0.79

0.79

8/5/2016

0.85

0.87

8/12/2016

0.8

0.8

8/19/2016

0.84

0.82

8/26/2016

0.87

0.78

9/2/2016

0.88

0.8

9/9/2016

0.93

0.88

9/16/2016

0.9

0.93

9/23/2016

0.84

0.85

9/30/2016

0.83

0.83

10/7/2016

0.89

0.9

Source: Data from Treasury Website

Click to enlarge

Factors Influencing Unemployment Rate

I believe unemployment rates are artificially low as more potential workers opt to continue their education or leave the workforce early because finding a new job in the twilight of the career doesn't seem worth it when unemployment rates are high. For the potential workers choosing to pursue education on student loans, the unemployment situation could be dire. I'd like to see the Federal Reserve treating full unemployment as 3% rather than 5% and considering the total portion of the working-age population with jobs as an alternate measure. If new graduates are unable to find work and make payments on their loans, the gains to wages could stall out due to more intense competition.

Don't expect the boomerang trend to break suddenly. The economy is much better than it was 7 years ago, but there will still be college students returning home to live with their parents in large numbers.

Why is this all so critical for mortgage REITs? Their ability to earn profits for investors relies on earning an interest spread between the cost of financing and the rate earned on assets. Since most mortgage REITs will hedge less than 100% of their exposure to the cost of financing, shifts in the short-term rate can push their cost of funds higher. On the other hand, when rates were exceptionally low at the end of Q2 and in early Q3 the mortgage originators were more resistant to dropping rates to the point that would have driven refinancing levels exceptionally high. They will still be high, but they shouldn't be insane. Consequently, gross interest income should look better for many mortgage REITs.

My condolences to readers that will end up seeing some articles stating things like "sales are up X% for this mortgage REIT". If you see those headlines, disregard the entire analysis. When interest rates increase and projected prepayments are decreased it leads to higher levels of gross interest income, which shows up as "sales" in some automated systems.

Expectations

Last week, I stated:

"I'm currently seeing more opportunities in the preferred shares than in common stock."

Now I'm seeing opportunities in both. Preferred shares on average dropped by 1% while the common shares dropped by 3.5% to 4% on average. The slightly steeper yield curve is positive.

I'm long AGNCB, AGNCP, NLY-E, ZFC, ANH, and MTGE. I may buy or sell anything at any point.

Want to learn more?

The Mortgage REIT Forum is a new subscription research platform. It is nearing 100 subscribers. The first 100 subscribers will be able to lock in their subscription rates at only $240/year. After the service gets past 100 subscribers, there will be a price increase for new subscribers only. All existing subscribers will be grandfathered in at the current rate. The service includes coverage on about a weekly basis for preferred shares of almost every mortgage REIT and recalculations of current book values and discounts for common shares of a small handful of mREITs. It also includes advance previews of some of my public articles on mREITs.

Disclosure: I am/we are long MTGE, ANH, ZFC, NLY-E, AGNCB, AGNCP.

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.