Investors can obtain 15% yields via mortgage real estate investment trusts (mREITs). The key is to focus on the management, review past performances, and identify which mREITs are likely to outperform the sector. I recommend focusing upon book value per share. Secondly, I have an extreme bias to investing with the best mREIT fund managers. Gary Kain is clearly that individual. I find his mREITs to be priced on the high side. In this article I'll focus upon two mREITs which are trading below book value per share. The names are Dynex Capital (DX) and Apollo Residential Mortgage (AMTG). I recommend investors buy them today. They yield between 11.9% and 16.4%.
Invesco Mortgage Capital, Inc., (IVR) is a mREIT that invests in residential mortgage backed securities (RMBS), commercial mortgage backed securities and mortgage loans. Invesco invests in both, Agency RMBS and non agency RMBS. Agencies are known by their abbreviated names: Ginnie Mae, Freddie Mac (FMCC.OB) and Fannie Mae ((FNMA.OB). Invesco is advised and externally managed by Invesco Advisors, Inc., an independent investment management firm.
Invesco Fourth Quarter Book Value Per Share
Invesco will report first quarter book value on May 8th. Until then we have the fourth quarter book value to support a positive or negative view prior to the earnings release. The December 31st book value share was $16.41. I believe an excellent quarter will offer a 6% book value increase.
The stock is trading at $17.56. If Invesco increase its fourth quarter book value by 6%, the first quarter book value will be $17.39. It appears the market has already priced a 6% increase into the stock. Per the below table, other hybrid mREITs like Two Harbors (TWO) are trading at a 5.58% premium to first quarter book valuations.
Like such mREITs, Invesco generates net interest income from the difference between the interest it earns on its mortgage investments and the interest it pays for its borrowings. Invesco incurs expenses tied to the administration and operation of the REIT, management fees and gains or losses tied to its investments and hedging activities. The resulting net income is what Invesco substantially distributes to shareholders as dividends. In addition, Invesco strives to invest in under priced securities and deliver capital appreciation for its shareholders.
As a mortgage REIT, Invesco faces interest rate risk, prepayment risk and credit risk tied to its balance sheet and its ability to raise equity and debt capital, for which Invesco carefully manages its capital structure. To minimize earnings volatility, Invesco selectively enters into hedging contracts. In 2011, Invesco raised $1.3 billion through three public stock offerings.
As of December 31, 2011, Invesco' MBS portfolio had a fair value of $14.2 billion with, on average, 72% invested in Agency RMBS, 19% in Non-Agency RMBS and 9% in CMBS.
Financials: As the table below shows, for its fourth quarter ended December 31, 2011 (Q4 2011), Invesco reported a 105% increase in net interest income compared to Q4 2010. This income was primarily from the additional equity capital raised and invested in 2011. Q4 2011 earnings per share were 66 cents, down 34% from Q4 2010 due to shares issued in stock offerings in 2011. Its Q4 2011 dividend payout ratio was 98.5%.
For the full year 2011 (see table below), net interest income was up 185% to $298.1 million from $104.7 million in 2010. For 2011, Invesco had an average portfolio yield of 4.12%, down from 5.03% in 2010. Its average cost of funds in 2011 was 1.64%, higher than 2010's cost of 1.4% due to higher hedging costs. Its net interest spread was 2.48%, lower than 2010's net spread of 3.63%, yet Invesco increased profits due to the equity capital raised and invested in 2011.
Net income rose 186.5% to $281.9 million largely due to the $1.3 billion in equity capital raised in 2011. For the full year, earnings per share dropped to $3.27 from $3.78 in 2010, due to the increase in shares for the equity offering. Its full year dividend payout was 104.6%.
As of December 31, 2011, Invesco had $14.2 billion in MBS investments, up 155% over the past year. At year end, Invesco had debt of $12.3 billion, 6.4 times its equity of $1.9 billion.
Dividends: Invesco has regularly paid quarterly dividends. Over the past three years though, Invesco's annual dividend has dipped from $3.49 in 2010 to $3.42 in 2011 to an annualized rate of $2.60 for 2012. For its first quarter of 2012, Invesco paid a quarterly dividend of $0.65.
With shares trading at $17.56 as of May 4th, Invesco had a dividend yield of 14.8%, and a market capitalization of $2 billion.
Peer Non Agency mREITs
Dynex Capital Inc.
Dynex Capital is my favorite hybrid mREIT based upon price. The stock is trading at 98.13% of book value. Management continues to deliver returns with book value upside. This is a quiet mREIT that is outperforming many of the sector's leaders. The yield is on the low side at 11.9%.
Dynex has significant insider ownership, and a constant stream of insider buying:
I believe Dynex should be bought below book value per share. This name will offer mid teen internal rates of return for your portfolio. The company delivers results. This is all I ask from a management team. I want zero excuses and positive results.
American Capital Mortgage Investment (MTGE)
American Capital Mortgage reported first quarter earnings on Friday. The first quarter book value per share is $21.78. Mr. Gary Kain is in charge of the agency MBS. He continues to outperform the entire mREIT sector. As anyone who follows horse racing knows, the jockey makes 80% of the difference in horse racing. Mr. Kain is the jockey who has created tremendous wealth for investors.
I believe in quid pro quo. Nothing in life is free. I believe I found one exception in Mr. Kain and his staff. If I didn't know Mr. Kain's income, I would send him a "thank you" card with money to show my gratitude.
American Capital Mortgage has 53 cents in undistributed estimated taxable income per share. This is up 24 cents from the fourth quarter of 2011. The leverage was 7.6x at quarter end. The average leverage during the quarter was 6.8x. The book value increased by 4.3% from the 4th quarter.
The stock is currently trading at $23.31. This is a 7% premium to book value per share. I would not buy the stock right now. The chances for a secondary have increased immensely. The time to buy isn't the day the good news is released.
Apollo Residential Mortgage
Apollo Residential Mortgage is trading at 5.8% discount to my estimation of first quarter book value per share. Management will report first quarter earnings and book value on May 8th. I estimate the first quarter book value per share will range between $19.37 to $19.48. This estimate includes a significant secondary that doubled the size of the hybrid mREIT.
I believe Apollo Residential Mortgage should be bought right now. Management is highly competent. The secondary funds were needed to level out the operating expenses. All mREITs need the same source of operating subscriptions, services, products. These all have costs. The secondary provided the funding to level the expenses from its peers with larger market caps.
Invesco should hit a home run in the first quarter. Non agency mortgage backed securities were incredibly strong. Earnings will be reported May 8th. I will be shocked if we don't see a 4-7% increase in book value per share from the fourth quarter book value.
I will have to pass on Invesco. It appears the upside is priced into the stock. During the second quarter, agency MBS are trading better than non agency MBS.