The third round of quantitative easing (QE3) and the Fed's previous attempts to stimulate the sluggish U.S. economy have flattened the yield curve, resulting in decreased earnings for mortgage REITs.
This downward pressure on mREITs' net interest income will result in the dividend yields being slashed. Anworth Mortgage Asset Corporation (ANH) happens to be another mortgage REIT that was forced to cut its dividend yield by over 16% - the new dividend yield comes out to be 8.8%. We have been able to identify another mortgage REIT, Hatteras Financial Corp (HTS), which we believe will continue its current dividend yield of 11.4%.
Anworth's Dividend Cut
Anworth Mortgage Asset Corporation, on September 28, 2012, announced its quarterly dividend for the third quarter of the current year. It slashed its dividend by over 16% to $0.15 per share. Previously, the company had made dividend cuts, suggesting that it had insufficient resources to continue shareholder distributions. With the new dividend per share being $0.15, the new dividend yield comes out to be 8.8%. Even though it is still above the prevailing 10-year treasury yield of 1.64%, it is below what most of its peers are offering. Anworth has a market cap of just below $1 billion. A similar market cap mortgage REIT, PennyMac Mortgage Investment Trust (PMT), offers a 9.4% dividend yield, while the large cap Annaly Capital Management (NLY) and American Capital Agency (AGNC) offer dividend yields of 11.9% and 14.5%, respectively.
On September 27, 2012, just one day before Anworth Mortgage announced a dividend cut, we forecasted that the company was likely to make such a move. We looked at the possibility of a dividend cut from both a cash flow and earnings perspective. We concluded that even though the company's dividend yield was backed by a higher operating cash flow yield, its interest income in the coming quarters would be squeezed due to the flattening of the yield curve, resulting in its inability to continue dividend distributions. On the other hand, we thought that Capstead Mortgage Corporation (CMO) had the financial muscle to continue its dividend distributions.
Hatteras Financial Corp
In the remainder of this investment thesis, we will show that the possibility of a dividend cut by Hatteras Financial Corp is very low. The following table represents the operating cash flow and dividends paid over the past four quarters, and their respective averages. The cash dividend coverage ratio, using the average operating cash flow and dividends paid, comes out to be 1.28 times. On average, the company paid $72.7 million in dividends each quarter, and generated $92.8 million in cash through its operations. This analysis reflects that the company had generated significant cash to pay dividends.
The company generated net interest income of $82.9 million during the second quarter of the current year. According to the company's quarterly SEC filings, it has constructed its portfolio in such a way that a 50bps decline in the interest rate yield curve will bring about a 3% increase in the company's net interest income. Assuming the company earns the same $82.9 million in the next quarter, and taking into account the 48 basis point decline in the 10-year treasury spread and Agency MBS, the projected net interest income comes out to be $85.3 million. This is still above the average dividend payment of $72.6 million. Therefore, we believe the company will be able to continue its dividend distribution in the coming quarter.
The stock of Anworth trades at a P/B value multiple of 0.94 times, against 1.03 times for Hatteras Financial. This is compared to 4% and 14% premiums for Annaly Capital Management and American Capital Agency.