MFA and ANH: Fed Backing of Agency Debt Creates New Oppurtunities

We are going to take a second run at MFA Mortgage Investments (MFA). We tried this stock back in the winter pre-Bear Stearns (BSC) [Feb 8: Initiating MFA Mortgage Investments] and the credit market was so troubled that we were decimated to the tune of a quick $10K loss [Mar 26: Closing MFA Mortgage Investments] So we were "early" (i.e. wrong)

When we exited in March the stock was in the $6.70s and today we are buying in the $6.80s. Considering the market since March a 0%ish return would of been wonderful :) This market has been punishing buying 90%+ of "breakouts" so we've been trying to buy "breakdowns". The problem with that as I've outlined many times, and why I don't normally do it - is if you are early by even a few days you get punished. We saw that just this past week as we tried to buy a breakdown in commodities last Friday and then were punished in many stocks to the tune of 20-25% in 2 sessions. It is just that horrific of an atmosphere.

Now we do have a catalyst here in that the rules of the game have been changed since Sunday night - whereas when we bought in the late winter we were banking on the implicit guarantee of the US government to back agency debt (GSEs aka Fannie/Freddie) now we have an explicit guarantee. So the business model is pretty simple: borrow money cheap (the Federal Reserve is helping there) and invest in mostly agency debt at a higher price and bank the spread. The Wall Street Journal actually has a piece out today about the REIT market in general - but we're just focusing on mortgage REITs.

• The beaten-down stocks of commercial real-estate companies initially got a big boost in response to the government's decision to take over mortgage giants Fannie Mae (FNM) and Freddie Mac (FRE). But that excitement started to quiet after investors began to contemplate the long-term outlook. Investors had pushed up the stocks of real-estate investment trusts on Friday and Monday as the federal government moved to stabilize the reeling agencies
• The short-lived rebound in REIT stocks came as investors breathed a sigh of relief that Freddie and Fannie -- major purchasers of mortgages and big lenders to the apartment industry -- won't be allowed by the government to fail.
• The takeover "certainly provides some support for the credit markets in the short term," Goldman, Sachs & Co. analyst Jay Habermann said in explaining this week's rise in REIT stocks. "But it doesn't remove the longer-term concerns that we have, whether it is debt coming due in the next few years or [economic] conditions continuing to deteriorate."
• The takeover appears likely to benefit the handful of REITs specializing in buying mortgage securities guaranteed by the Fannie and Freddie. (that's us)
• Among the many measures that the Treasury Department outlined to shore up Fannie, Freddie and the ailing mortgage market is to buy up mortgage-backed securities on the open market. That will help to lift the prices of those securities, which in turn will ease pressure on companies that hold the securities, including mortgage REITS.
• Historically, mortgage-backed bonds have been deemed risk-free because of the implicit backing by the U.S. government. But recently, the deepening financial woes of Fannie and Freddie and their uncertain future pushed the value of those securities lower.
• The spread -- or difference between yields on those Fannie- and Freddie-guaranteed bonds and those on the benchmark 10-year Treasury -- widened to 2.15 percentage points in mid-August, the widest in 15 years. Now, with the U.S. government making its backing explicit, the spreads have started to narrow, resulting in higher prices on those bonds. That amounts to a boost for mortgage REITs such as Annaly Capital Management Inc. and Anworth Mortgage Asset Corp., which saw their shares rise 11.6% and 9.1%, respectively, since Friday. Bose George, an analyst at Keefe, Bruyette & Woods Inc., estimates that Annaly's book value would increase by about 9% as a result.

On word of the bailout the entire group jumped and created a huge gap in the charts. Today, most of these names have been filling the gaps so I am going to use this as my sign to try to get in. It is not a very nice chart otherwise so we'll see if it can show any strength.

The other name I was interested in simply on the fact there has really been no pullback which is a great sign of strength is Anworth Mortgage (ANH) but I decided to go with a name I already have owned. There are about half a dozen players in the field here and a quick look on forward P/Es on 09 estimates shows them all in a very narrow band of 5.7-5.9. So I believe this is another case where "if you buy one, you buy them all".

We'll start MFA with a 1.5% allocation in the $6.80s and see if we have a better result this time around. It looks like my old thesis was correct, but in this market if your timing is off you lose capital left and right. The stock trades in between the 200 day ($6.50) and 50 day ($7.50) - we'd like to see it break north of $7.50 to "add on strength" but then again, that has been a losing strategy in this trendless market. By the time the breakout happens the move is almost always over.

MFA's latest earnings report here.

• "We remain focused on high-quality Agency MBS and our portfolio spread has trended up in each of the last six quarters. During the second quarter of 2008, Agency MBS were available at attractive spreads and additional repurchase funding capacity was available to us from multiple counterparties. As a result, utilizing the net proceeds of $304.3 million raised in our June 3, 2008 public equity offering, we grew our Agency MBS portfolio by $2.4 billion and our repurchase agreement balances by $2.0 billion.
• At June 30, 2008, Agency MBS and related receivables constituted approximately 94.7% of MFA's assets (or approximately $10.2 billion), AAA MBS and related receivables were approximately 2.8% (or approximately $305 million), and cash was approximately 2.1% (or approximately $232 million).
• During the second quarter of 2008, MFA's portfolio spread, which is the difference between MFA's interest-earning asset portfolio net yield of 5.23% and its 3.85% cost of funds, was 1.38% versus 0.90% for the first quarter of 2008.

For an explanation of the market and comparable companies see [Thank you Readers - Found a Bull Market - 4 Mortgage REITs]

Disclosure: Long MFA Mortgage Investments in fund; no personal position.

Comments

[jimmy46:]

mortgage interest rates dropped sharply this week,
now below 6%

I'd expect this to increase the value of agency paper as well.

2008 Sep 11 03:46 PM