There is no doubt after the third quarter's earnings reports that the agency-backed mortgage REIT sector is beginning to splinter into markedly different strategic approaches. FOMC minutes confirm the high demand for agency MBS, noting that:

To provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of $1.25 trillion of agency mortgage-backed securities and about $175 billion of agency debt. The amount of agency debt purchases, while somewhat less than the previously announced maximum of $200 billion, is consistent with the recent path of purchases and reflects the limited availability of agency debt.

Resource Capital (RSO) is one of the few specialty finance REITs that has been able to maintain a significant cash dividend throughout the credit crisis, most recently sporting a $0.30/share quarterly cash dividend. At a stock price of about $5.00, that's an amazing 24% yield.

More compellingly, Resource Capital has been able to maintain this high yield for over a year, since the stock price first dipped below $5.00 in September 2008. At one point during the lows of March 2009, RSO was paying a quarterly dividend of $0.30/share against a share price of $1.43 - a yield of nearly 84%!

High-flying, agency-backed mortgage REIT, American Capital Agency Corp. (AGNC), recently turned in its third quarter numbers, making the company the first in its sector to report for Q3. The headline numbers were impressive, with $1.82/share in GAAP earnings and $1.89/share in taxable income - well above the $1.40/share Q3 dividend. However, a quick review of the earnings release and the shareholder presentation reveals that AGNC's stunning results were once again the result of selling off its appreciated MBS holdings.

Last quarter, the company traded out its high-yield fixed MBS for higher-yielding ARMs, using the capital gains to boost EPS by $0.72/share. This quarter, the company traded out the high-yielding ARMs for lower-yielding ARMs, again achieving capital gains that boosted EPS by about $0.73/share.

Have you missed the awesome run in agency-backed mortgage REITs? There may still be time to get in on the great returns by picking a sleeper stock that is poised to break out.

Cypress Sharpridge Investments, Inc. (CYS) is a recent entrant to the mortgage REIT world. The Company, which primarily invests in agency residential mortgage-backed securities, came public in June 2009, raising $100 million by offering 9.1 million shares at $11.00, the low end of the proposed $11.00 to $13.00 range.

Apparently, there is a reason while REITs include this risk factor in their SEC filing boilerplate:

The U.S. federal income tax laws governing REITs are complex.

This week, Angelo, Gordon & Co. became the latest of the nine firms awarded the right to take part in the U.S. Treasury's Public-Private Investment Plan to file a prospectus for a new real estate investment trust. These REITs are designed, of course, as tax-efficient vehicles to hold the legacy assets purchased through the PPIP. AG follows in the footsteps of both AllianceBernstein (AB) and Invesco (IVZ), who have also thrown together newly-formed REITs for the same purpose -- loading up on distressed real estate debt with the government’s blessing.

Disclosure: Author has no positions in any securities mentioned in this article.

So the SEC is going on a tirade against short selling after public pressure forced them to do something. However, exactly how and why were the 799 financial firms selected for the temporary short selling prohibition chosen? Granted, most of the companies on the list are bank holding companies, which make sense. However, there were a few oddball choices, such as Apollo Investment Corp. (AINV), which is a business development company, and FBR Capital Markets (FBCM). None of the mortgage-focused real estate investment trusts, which play an important role in loan origination for the primary market and which purchase numerous mortgages and MBS in the secondary market, made the list.

Commercial mortgage REIT BRT Realty Trust (BRT), an originator of short-term bridge financing, is pumping out some smokin' hot dividends. In the Company's most recent 10-Q, it disclosed that in additional to its regular quarterly dividend of $0.62/share, BRT would also be paying a $0.70/share special dividend. Including the special dividend, BRT's annual yield rises to a stunning 27%.

Remember the old adage: Where there's smoke, there's fire. BRT is rapidly burning through its legacy investment in Entertainment Properties Trust (EPR), an equity REIT that invests in retail center. Sales of EPR shares have been supporting BRT's earnings for several quarters now, and until this most recent quarter, prevented the Company from recognizing a net loss. For the third fiscal quarter, however, BRT suffered a loss of $0.48/share after recording an addition of $6,400,000 to its allowance for possible loan losses ($0.54 per share) and an impairment charge of $4,019,000 ($0.34 per share), primarily related to real estate acquired in foreclosure and deed in lieu of foreclosure.

Redwood Trust's (RWT) shocking second-quarter results are a painful reminder of a very important mortgage REIT tenet: over time, cumulative GAAP and taxable income should converge, suggesting that GAAP income should increase or taxable income decrease over time relative to the other.

Unfortunately for Redwood, it's quite clearly the latter case. Estimated taxable earnings for this quarter were just $4 million ($0.11 per share). These taxable earnings included $30 million (-$0.92 per share) of taxable income deductions related to credit losses, up from $14 million in the prior quarter. RWT also noted that it expects credit losses will increase in subsequent quarters, perhaps not peaking until 2009 or 2010. These increased credit losses will continue to pressure REIT taxable income throughout the period.

When UBS downgraded Capital Trust (CT) five weeks ago, citing the company’s low reserve levels and its belief that CT will have to take meaningful reserve charges in future quarters, analyst Tayo Okusanya couldn't have known how right he would be.

Capital Trust recently posted an unexpected loss of $1.59/share for the second quarter and adjusted income of $0.73/share, well short of the $0.84/share earnings consensus.

The origination market for the battered mortgage REIT sector has all but dried up, with few new loans being made. Many borrowers, even large commercial tenants, are simply trying to extend or modify existing loans. Even the few new borrowers in the market no longer meet most underwriting standards now that the securitization market is dead and the credit risk can't be offloaded. However, for those mortgage REITs who are largely match-funded with existing CDO liabilities and don't have immediate liquidity concerns, there is a question of how to best deploy loan repayments (and prepayments).

Enter a rather clever solution. Perhaps best thought of as an extension of marking CDO liabilities to market under FAS 159, a few mortgage REITs have chosen to begin buying back previously sold CDO tranches for cents on the dollar. The buy back of the CDO debt has many positive accounting implications. Assuming the CDO is consolidated and accounted for as a financing for GAAP purposes, the repurchase of the CDO debt allows the original issuer to extinguish the CDO liability on its books, reducing leverage ratios and more importantly, generating a gain on the extinguishment of debt. This gain is also a source of taxable income, allowing mortgage REITs who are facing realized tax losses from foreclosures to offset these losses and potentially support their existing dividend payouts.

With the seizure of Indymac Bancorp, Alesco Financial's (AFN) CDO agony has reached a crisis point. Alesco reported that the seizure of IndyMac will cause AFN to record a realized tax loss of approximately $86 million. The realized tax loss is expected to significantly offset AFN's expected 2008 taxable income including the non-cash income relating to the CDOs that are failing overcollateralization tests as of June 30, 2008.

In addition, subsequent to the original IndyMac deferral, four additional banks elected to defer interest payments on their trust preferred securities, which has resulted in the failure of overcollateralization tests in two additional CDOs in which Alesco holds equity interests. That makes six failing CDOs in the AFN portfolio.

A few months ago, I suggested that CapitalSource's (CSE) operational execution was being hindered by its overly broad SuperREIT structure.

At that time, it seemed pretty obvious to me that CapitalSource could unlock significant value by selling off its poorly performing residential mortgage portfolio, spinning off its profitable healthcare net lease REIT as a separate entity, and restructuring its corporate loan portfolio as a BDC.

The initially successful Chimera Investment Corp. (CIM), which came public back in November, is having to admit they may have bitten off more than they can chew.

I originally posited in March that Chimera was quietly struggling to stay afloat after levering up at just the wrong time -- levering up four-fold just as competitor MFA Mortgage (MFA) was selling assets to de-lever its balance sheet.

PMC Commercial (PCC) is one mortgage REIT that's flying way under the radar - no analyst coverage, no quarterly earnings calls. The micro-cap (~$80 million market cap) commercial originator has seen its stock sink 30% in the past two months, falling from $10 in March to just $7 in May. But has PMC's pounding been overly punitive?

Embattled diversified REIT RAIT Financial Trust (RAS) had a dismal 2007. The stock tanked and RAIT was forced to slash its dividend almost in half. The company came roaring back with a vengeance Tuesday. For Q1 2008, adjusted earnings per diluted share, the metric which the company essentially uses to set the dividend, more than covered the most recently announced payout. Friedman Billings Ramsey analyst Merrill Ross wrote in a research report the company has proved its dividend is viable.

The $0.07 beat on adjusted earnings and $7 million beat in investment revenue lifted the stock powerfully on Tuesday. It was a roaring 22% day for RAIT, which definitely deserves some love as it is trading far below its economic book value.

Annaly Capital recently reported solid first quarter results, with core EPS of $0.51/share that was in-line with analyst estimates. Spreads improved by an impressive 58 bps on a sequential basis to 1.46%. Leverage remained at 8.1:1, however, which seems slightly aggressive. However, with no exposure to non-agency assets and no apparent margin call pain, the 8.1:1 ratio appears reasonably comfortable to me.

I've complained before about CapitalSource (CSE) getting too big to focus on its core competencies, but with the acquisition of the Fremont branches, CapitalSource is looking less a mortgage REIT and more like, well, Countrywide (CFC). In fact, this deal reminds me a bit of the IndyMac (IMB) restructuring from a REIT to a thrift back in 1999 after liquidity concerns forced IMB to seek new sources of funding in order to grow the business.

Scott Valentin at FBR Capital Markets asked precisely the question that concerned me the most:

Chimera Investment Corporation (CIM) is quietly struggling to stay afloat after levering up at just the wrong time. Although the Company had reported leverage of just 0.5 to 1 at 12/31/07, the calculation excluded a $750 million payable for MBS, which was resolved at the end of January, when CIM entered into a $500 million repo facility with CSFB and a $350 million repo facility with Deutsche Bank -- levering up four-fold in the process just as competitor MFA Mortgage (MFA) was selling assets to de-lever its balance sheet.

A Fed-fueled rally pushed shares of JER Investors Trust (JRT), a commercial-focused specialty finance mREIT to their September 30 book value, as shares jumped 6% to land at $8.45/share. But JRT has been strangely silent since December, when the Company announced a special $0.65/share dividend.