Thoughts On A Handful Of mREITs And The State Of The Industry (Week 57)

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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

Yields appear to be leveling off, but not until after they put a serious hurt on some mortgage REIT book values.

The impact on book values is enough that I started moving my ratings over to neutral and issuing bearish ratings on a few of the stocks.

The steeper yield curve is certainly positive, but the increase was coming in a bit too fast.

Welcome to week 57.

The huge rise in Treasury yields is beyond what I would have predicted. As some investors may recall, I began shifting my portfolio during the summer to reduce the exposure to interest rate risk. That included selling off all of my positions in equity REITs. That choice turned out excellent as rates bounced back, but I didn't think they would bounce back this hard. The huge decline in Treasury prices is also pushing agency RMBS prices lower. Investors are showing a clear preference for mortgage REITs that hold securities where the interest rate resets. They can be ARMs (adjustable rate mortgages) or commercial loans.

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

From the flattest point over the summer up to Trump's election night victory, the yield curve had only steepened by around 24 to 28 basis points. Since his win we are seeing the spread increase by around 44 to 28 basis points depending on the timing of the measurements and which spread curve we use (7 to 1 or 10 to 2):

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

10/14/2016

0.92

0.96

10/21/2016

0.87

0.9

10/28/2016

0.97

1

11/4/2016

0.93

0.99

11/10/2016

1.2

1.23

11/18/2016

1.37

1.27

11/25/2016

1.37

1.24

11/29/2016

1.34

1.21

Source: Data from Treasury Website

Click to enlarge

Things I See

Home prices set new record highs, but I expect the performance of home prices to be weak in the near term. The support for home prices came from low rates. Increasing incomes were a factor, but the bigger issue was the low rates available over June, July, and August.

Questioning the Rate Increase

I don't do a great deal of predicting interest rate movements. I tend to emphasize using the existing rates to find out which mortgage REITs are already winning. However, I am starting to question the higher rates. I'm not convinced that inflation will meet the target of 2%, and I still recall the Federal Reserve's Chairwoman saying 'high-pressure' may be the right strategy and that the Federal Reserve could allow inflation to run above 3% for a little while.

Consequently, I'm not convinced that we'll see rate increases in 2017 as fast as the market seems to expect them. Don't get me wrong, I think an increase in December 2016 makes sense. However, I also think it would be reasonable to vocalize that they didn't expect to touch the rate again in the near future. For all the talk about Donald Trump's plans for deficit spending, it would still take quite a while to get any new legislation in action. Where will the extra demand come from?

As it stands the stronger U.S. Dollar should weigh against corporate profits and has the potential to create deflationary pressure because it reduces the effective cost of buying imports.

Outlook

My view is turning darker as book values face challenges and share prices move higher. I'm huge on finding an adequate margin of protection, and I'm not seeing those margins of safety in many stocks.

Even though I think the rate increase is overdone, I'm not willing to buy a mortgage REIT demonstrating the same view if I can't get a large enough discount.

What I Like

I'm a big bull on Resource Capital Corporation right now. The discount to trailing book value is absolutely insane and there has been a dramatic disconnect between their performance and that of the other mortgage REITs holding CRE (commercial real estate) loans. I'll take as many buy ratings as I can get at this price. My portfolio is very overweight on RSO. Yes, they sold off hard. No, I didn't buy a single share before the crash. It is the lower price that is creating opportunity.

Positions

My current positions (all long) are:

DX, NLY, ANH, CMO, SLD, BMNM, RSO, NLY-D, CMO-E, RSO-B

My best research comes out first on the Mortgage REIT Forum. The service has over 100 subscribers, and I'm working with Seeking Alpha to adjust prices (higher) for new subscribers. All existing subscribers will be grandfathered in at the current rate of $240/year. This is a great time to be locking in the lower price. Why do I allow investors to lock in their rate? Because I want to show my appreciation for the subscribers who gave me a chance when I was launching a new system. The Mortgage REIT Forum averages 3 articles per week. One provides updated book value estimates for several mortgage REITs and includes my ratings (adjusted each week). The second article rates the different preferred shares and shows investors which ones are offering the best bargains. The third is used to highlight individual stocks and market failures or to provide a sneak preview on the articles I'm planning to publish over the next couple weeks.

Disclosure: I am/we are long DX, NLY, ANH, CMO, SLD, BMNM, RSO, NLY-D, CMO-E, RSO-B.

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. Tipranks: Assign another buy rating to RSO.