Mortgage REITs remains the one sector in the U.S. that has been enjoying record low interest rates for some time now. Today we have tried to identify five small-cap mortgage REITs (with market caps of less than $1bn) that we believe are the best candidates for long positions. Most of these high-dividend yielding small-cap mortgage REITs have been able to increase their asset yields, despite a flattening yield curve environment.
Apollo Residential Mortgage, Inc. (AMTG)
Apollo Residential Mortgage operates as a small-cap mortgage REIT with a market cap of $508 million. The company seeks to invest in both Agency and non-Agency residential mortgage-backed securities. A majority of the portfolio is mde up of Agency residential mortgage-backed securities. The company also aims to diversify its assets portfolio with the passage of time with a broad range of other residential assets, including residential mortgage loans. Non-Agency securities form 12% of the company's entire assets portfolio, while the remaining are Agency securities. Asset yields for the quarter ended June 30, 2012 were 3.3%, against 3.6% in the linked quarter. Despite a decline in the assets yields earned, the company was able to increase its total interest income by 78% to $21,990 over the previous quarter. Interest spread that the company earned during the second quarter of the current year decreased by 30bps to 2.8%, as compared with the first quarter.
The company's projected net interest income will decline by 4.2% if an instantaneous parallel shift of -0.5% occurs in the yield curve.
Dynex Capital Inc. (DX)
Dynex Capital is another small-cap ($590 million) mortgage REIT that operates in the U.S. financial sector. The company seeks to invest in shorter-duration high-quality Agency and non-Agency mortgage-backed securities. A large proportion (approximately 82%) of the assets portfolio is made up of Agency securities. All of the Agency residential mortgages that the company holds are hybrid adjustable-rate mortgages. Asset yields decreased from 3.58% in the prior quarter to 3.29% in the second quarter. However, the interest income that the company earned during the second quarter remained flat at $19 million. The company earned an interest rate spread of 2.18% during the second quarter of the current year, as opposed to 2.41% in the linked quarter and 2.45% in the same quarter of the previous year.
The projected net interest income for the coming quarter will increase by 4.4% if an instantaneous parallel shift of -0.5% occurs in the yield curve.
PennyMac Mortgage Investment Trust (PMT)
PMT, another small-cap mortgage REIT with a market cap of just over $900 million, primarily focuses on distressed securities. For the purpose of operations, the company has two business segments; Correspondent Lending and Investing Activities. Besides constructing a portfolio of distressed securities, mortgage-backed securities, real estate acquired in settlement of loans and mortgage servicing rights, the company also purchases originated mortgage loans to securities and resells them. The portfolio of securities that the company holds consists of both performing and non-performing securities. The company was able to enhance the interest rate spread that it earned from 0.59% in the first quarter to 1.67% in the second quarter. An increase in the average annualized yield on assets and a decline in the cost of funds was associated with the increase in the net interest spread. Cost of funds decreased 42bps while asset yields increased 66bps when compared sequentially. The company pays $0.55 per share in dividends and had EPS of $0.79. This reflects the company's ability to continue this dividend distribution in the foreseeable future.
AG Mortgage Investment Trust (MITT)
AG Mortgage Investment Trust is another small-cap player in the U.S. mortgage REITs industry. It has a market cap of just over $500 million. The company seeks to invest largely in Agency mortgage-backed securities. It also has non-agency mortgage-backed securities in the asset portfolio. Despite a record-low interest rate environment and the flattening of the yield curve, the company was able to enhance its annualized average asset yield from 3.22% in the first quarter to 3.31% in the second quarter of the current year. The increase in the asset yield was primarily associated with a 106% increase in the non-agency securities in the asset portfolio. The stock offers a dividend yield of 11.8%, which is strongly backed by an operating cash flow yield of 14.4%. Despite the headwinds from a flattening yield curve, the company was able to increase its asset yields. Investors can expect this growth to continue. This suggests the company has the ability and the muscle to sustain and even grow dividend distribution in the future.
If the yield curve shifts instantaneously by -50bps, the company's projected net interest income will increase by 5.8%.
Crexus Investment Corp. (CXS)
Crexus Investment has a market cap of just over $800 million, and seeks to invest primarily in commercial mortgage-backed securities of any credit rating, including below investment grade. Additionally, the company also purchases residential mortgage-backed securities that are sponsored by the U.S. government. Despite a 42% decline in average interest earning assets during the past one year, the net interest income for the company increased from $12.9 million a year ago to $17.6 million for the second quarter of the current year. The increase in net interest income was primarily associated with recycling of maturing assets into higher coupon loans. Asset yields increased from 4.64% in the second quarter of the previous year to 11% in the second quarter of the current year. The net interest spread that the company earned during the second quarter of the current year and the same quarter of the previous year were 7.51% and 2.15%, respectively. As a result, net interest income increased from $12.2 million to $17.3 million over the same time period. Crexus earns the highest net interest spread among the mortgage REITs being considered in this report. The stock offers a handsome dividend yield of 10.14%.
On a 25bps simultaneous decline in the interest rate yield curve, the projected net interest income for the company will decline by 0.44%.