On Wednesday October 3rd, shares of Javelin Mortgage Investment Company (JMI) hit the market, and after roughly 6.4 million shares exchanged hands, the new issued closed trading at $19.60/share. In my opinion, a performance such as that isn't so terrible, and given the recent performance of several other IPOs, most would agree the numbers really aren't all that bad. Potential investors should note that Javelin isn't your normal IPO, in the fact that it is a true new issue. The offering is actually a very clever way of implementing an investment strategy that protects the shareholders of one firm from way too much risk, and on the hand attracts a new group of shareholders that actually has a greater appetite for such risk.
Overview: Javelin Mortgage Investment Co.
According to JMI's recent S-11 Filing, "We will be externally managed and advised by ARMOUR Residential Management, LLC ("ARRM", or the "Manager"), the external manager of ARMOUR Residential REIT, Inc. ("ARMOUR"), a publicly-traded real-estate investment trust ("REIT") that trades on the NYSE under the symbol (ARR), and invests primarily in agency mortgage-backed securities. ARMOUR is an entity affiliated with the executive officers of JAVELIN and ARMOUR". If we examine that statement closely we'll notice that Javelin will be externally advised and managed by none other than, ARMOUR Residential REIT, Inc. which makes me question the intentions of Javelin because this offering is very similar in scope to the current relationship of both Annaly Capital (NLY) and Chimera Investment Corp. (CIM), considering the fact that CIM is a wholly-owned subsidiary of NLY.
Should potential investors consider Javelin a subsidiary of ARMOUR? In my opinion, I think they should consider Javelin a subsidiary and as is the case with Chimera, and understand that the investment objectives of the latter may be a little riskier in scope. For example, and according to Chimera's website, "Chimera may use leverage to increase potential returns to our stockholders. Subject to maintaining our REIT qualification and availability of funding, we may use a number of sources to finance our investments, including repurchase agreements, warehouse facilities, securitizations, asset backed commercial paper and term financings. Our strategy of balancing both interest rate and credit sensitive assets is designed to generate attractive, risk-adjusted returns in a variety of market conditions. Over time, we will modify our investment allocation strategy as market conditions change to seek to maximize the returns from our investment portfolio". The ability by Chimera to use leverage in an effort to generate attractive returns demonstrates the fact that individual investors must have an implied appetite for greater risk given the company's investment objectives. That same seems to be true in the case of Javelin.
Similar in scope to the investment strategy of Chimera, Javelin also notes in its most recent S-11, that "We intend to hedge some of our exposure to potential interest rate mismatches between the interest we earn on our longer term investments and the borrowing costs on our shorter term borrowings. Because our leverage will primarily be in the form of repurchase agreements, our financing costs will fluctuate based on short-term interest rate indices, such as LIBOR. Because some of our investments will be in assets that have fixed rates of interest and mature in up to 30 years, the interest we will earn on those assets will generally not move in tandem with the interest rates that we pay on our repurchase agreements, which generally have a maturity of less than one year. We may experience reduced income or losses based on these rate movements. In order to mitigate such risk, we may utilize certain hedging techniques as discussed further on in this filing".
Should potential investors consider a position in Javelin, given the fact that Armour Residential is seemingly taking a page from Annaly Capital? There are two things to consider before establishing a position in any REIT. First, potential investors should note that as a result of QE3, the Federal Reserve is looking to purchase as much as $40 billion dollars in underwater mortgage loans in an effort to restructure them and in-turn help many of the borrowers of those loans improve their individual credit ratings. Second and most importantly, potential investors need to understand that the revenues of many of the mREITs will diminish if interest rates increase by as little as 0.25% in the next 12-24 months. Why? An increase in interest rates will essentially shrink something called the 'interest-rate spread', which is a catalyst many of these firms use to generate revenue quarter after quarter. If rates decrease, the spread increases, which then generates more revenue. If rates increase, the spread decreases, which then generates less revenue.
In my opinion, I think the team at ARMOUR has done very well over the last few years and should continue to do so, in the next 12-24 months, especially when it comes to Javelin. The same could almost be said of the teams at Annaly and Chimera, except for the fact both firms are starting to feel the pressures of the Fed as both have reduced dividend distributions in the last 12 months. If you are in the market looking for a short-term investment that could yield roughly 12.00% or higher in the next 12 months, then this sector is ripe for the picking. If you are looking for longer term investment I'd stick with what I know and not have nightmares of interest rate increases.