AG Mortgage Investment Trust (MITT) is one of the very few mortgage REITs that have been able to enhance their asset yields given the prevailing non-existent interest rate environment and the flattening of the yield curve, which is why we are bullish on the stock. The stock trades at attractive book value multiples and offers a high dividend yield of 11.8%. The company has shown growth in a short time since its inception, and we believe investors can expect a dividend hike if interest rates remain unchanged. However, since the company also invests in non-agency securities, the stock has additional credit risk, as opposed to mortgage REITs that exclusively invest in agency securities.
AG Mortgage Investment Trust Inc , with 15.8 million shares outstanding, operates as a small cap mortgage REIT with a market capitalization of $514 million. The company commenced its operations by the middle of 2011 and seeks to invest in a diversified pool of mortgage assets, largely mortgage backed securities (MBS) for which a government sponsored agency (agency) guarantees the principal and interest payments. The company expects that the proportion of non-agency securities in its portfolio will increase with the passage of time. Besides investing in agency and non-agency securities, the company also invests in collateralized mortgage backed securities (CMBS) and asset backed securities (ABS). The company finances its acquisition of the assets portfolio by short-term borrowing (repurchase agreements).
Recent Quarter's Performance
During the second quarter of the current year, the company was able to generate interest income of $17.88 million against $14 million in the comparable quarter. Despite the flattening of the yield curve due to various efforts initiated by the Federal Reserve Bank, the sequential surge in the interest income was 28%. The surge was associated with the increase in interest yielding assets, and an increase in the weighted average asset yield during the second quarter. Annualized average asset yield, which the company earned during the second quarter of the current year, was 3.31%, higher than the previous quarter's asset yield of 3.22%. During a quarter where the yield curve flattened, the company was able to enhance its asset yields. This happened primarily due to the increase in the high yielding non-agency mortgage backed securities. Fair value of non-agency residential MBS increased 106% sequentially to reach 176.9 million, while the fair value of the entire assets portfolio of the company swelled 4.2% at the end of the second quarter of the current year. AG Mortgage Investment Trust remains the only mortgage REIT that has been able to enhance its weight average asset yield.
The company in its latest 10Q filings to the Securities Exchange Commission stated that its projected net interest income would surge by 5.8%, if interest rates dropped by another 50bps. However, it expects that the projected net interest income will drop by 7.8% if the interest rates increased by 50bps.
Interest expense also surged 34% sequentially, despite the near zero interest rate environment. Interest expense is actually the cost of funds that the company has borrowed to finance its assets portfolio. The annualized average cost of funds for the second quarter was 0.57% against 0.49% in the linked quarter. The hike in interest expense was primarily associated to a 2.3% increase in the repurchase agreements during the second quarter of the current year, partially offset by the record low interest rate environment. Repurchase agreements increased from $2.1 billion in the first quarter to reach $2.13 billion in the second quarter.
The company earned $31.8 million in Other Income, primarily through an unrealized gain on real estate securities, net realizable gains, and gains linked on transactions, partially offset by an unrealized loss on derivatives and a realized loss on periodic interest settlements of interest rate swaps.
The company was not able to manage its overall expenses efficiently. During the second quarter, expenses surged over 14%. Management fee to affiliates was largely blamed for such a hike in expenses.
Overall, during the second quarter of the current year, the company posted a bottom line of $44.9 million, which is against $10.9 million in the first quarter. This is a sequential improvement of 312%.
The stock offers a handsome dividend yield of 11.8%, against the prevailing 10-year treasury yield of 1.57%. The attractive dividend yield is strongly backed by an operating cash flow yield of 14.4%, while the dividend coverage ratio at the current dividend per share of $0.7 comes out to be 1.23 times. This suggests that the company has sufficient financial muscle to continue its dividend distributions at the current quarterly dividend rate in the foreseeable future. Besides, the company has shown its ability to enhance the weighted average asset yield that it earned during the quarter, despite the flattening of the yield curve. Mortgage REITs are bound to payout at least 90% of their earnings. Investors can expect growth in dividends, if the company is able to further increase its interest income in the wake of such a challenging environment.
The stock is trading at cheap multiples. It trades at an 8% premium to its book value, while its closest peers New York Mortgage Trust (NYMT) and PennyMac Mortgage Investment Trust (PMT) trade at premiums of 7% and 12% to their book values. All three have a market cap of below $1 billion. Compared to this, the large cap mortgage REITs Annaly Capital (NLY), Aerican Capital (AGNC) and Two Harbors (TWO) trade at 18%, 8% and 17% premiums to their book values.