Patrick Harden

Resource Capital's Dividend Dilemma

REITs have to pay out 90% of their ordinary taxable income to shareholders in order to retain REIT status. RSO is paying out more to shareholders than necessary (over 100% of taxable income) - thus you are getting a portion of your original investment back as a return of capital. Instead, RSO could buy back its own shares at market prices that are below book value and add shareholder value that way.

Resource Capital's Dividend Dilemma

RSO did execute some debt repurchases at a significant discount during the quarter. I was implying that the Company could increase the debt repurchases even further using the capital retained from a dividend decrease.

Ackman Explains Why He's Short REIT Realty Income

I've questioned O's dividend policy in the past of overdistributing its taxable income, but really, the short thesis here is lacking some meat. It's as if Ackman has shorted the best of breed on the theory that the REIT model itself is unsustainable.

All REITs have to continually raise equity if they are successful - it's a circular path. To successfully generate cash flow over the long term, REITs must earn some taxable income. If the REITs earns taxable income, it must pay it out to shareholders. There is little to no remaining operating cash flow to grow the business, so it's time for either debt or equity.

Like most of the commenters, I'm totally puzzled why Ackman going after Realty Income? There are plenty of other junky REITs out there that have gotten ahead of themselves in the dash for trash.

Commercial Mortgage REIT IPOs: Coming Up Short

Even the successful launch of Starwood Property Trust (STWD) has produced nothing in the way of return. The stock is barely trading above the $20.00/share IPO price and has declared a Q3 dividend of just $0.01/share. Worse, the company has already declared the Q4 dividend to be just $0.10/share. I posted an article back in July (seekingalpha.com/artic...) that outlines exactly why these REITs are not going to work out. They're just another debt-for-equity exchange.

Previously existing mREITs that include distressed debt (mostly non-agency RMBS) like Redwood Trust (RWT) and Chimera Investment (CIM) have much better returns AND a track record.

Cypress Sharpridge Has Sweet Surprises in Store

Well, strike one for me...CYS declared a dividend of $0.35/share in respective of the third quarter for a forward annualized dividend yield of just under 10%.

I'm curious to find out more about normalized post-IPO core earnings when the Company releases third quarter results.

AmREITs on Fire: Prelude or Crescendo?

The agency-backed mREITs generally have two main risks:

1) interest-rate risk
2) counterparty risk

If short-term interest rates rise quickly and long-term rates don't move much (a flattening of the yield curve), the net interest spread available to earn disappears. See Annaly's stock price from June 2005 - December 2005 for an example of what happens in a flat or inverted yield curve environment.

Counterparty risk is sort of intertwined with fat tail or Black Swan risk. Should the liquidity associated with agency-backed MBS be threatened, the ability to finance the portfolio with cheap short-term debt may disappear. See Annaly's stock price in the last week of February 2008 (when Carlyle Capital blew up) for an example of counterparty risk.

AmREITs on Fire: Prelude or Crescendo?

Continued great coverage of the agency-backed mortgage REITs! I thank you for continuing to bring these articles to SA to help investors distinguish among the various types of mortgage REITs, especially with all of the distressed debt mREIT IPOs pricing recently. It's very important to make a distinction between those mREITs bearing credit risk and the amREITs.

I guess JMP Securities has made the first call for a crescendo, downgrading both HTS and AGNC to Mkt Perform this morning. The amREITs have gotten very richly valued on a market to book basis, so it's tough to see much more forward upside performance above S&P returns.

One agency-backed name that has sort of stayed below the radar is Cypress Sharpridge Investments (CYS), which IPOed earlier this year before the rush of mREIT IPOs. CYS is trading at a modest 1.13x premium to 6/30 book value and produced $0.74/share in core earnings for Q2. I also like CYS because the company marks all its assets to fair value like RICs do, which makes for a much easier set of financials to parse.

Three IPOs priced today while a fourth was postponed. Julius Baer's Artio Global Investors (ART) raised $650M, pricing at a high-end $26/share. Apollo Commercial Real Estate Finance (ARI) priced at $20, in line, raising $200M. Colony Financial (CLNY) also priced at $20/share, in line, raising about $250M. Foursquare Capital (FSQR), a real estate investment trust managed by AllianceBernstein (AB), postponed its IPO. Abbi Adest has all the overviews: ART, ARI, CLNY, FSQR.

What is the source on the FSQR IPO postponement? I thought FSQR was pricing tonight and beginning trading Friday.

Realty Income: Follow-Up on Barron's Article

In reference to the dividend growth, it's important to note that 18.8% of the 2008 distributions made to common stockholders were classified as a return of capital for federal income tax purposes. In other words, Realty Income distributed more than the amount necessary to achieve the full taxation benefit available to it as a REIT.

Realty Income's preference for exceeding its REIT distribution requirements has grown over time:

2006: O's cash distributions totaled $139.1 million, or approximately 113.3% of its estimated REIT taxable income of $122.8 million. [source: Realty Income 2006 10-K]

2007: O's cash distributions totaled $182.2 million, or approximately 113.6% of its estimated REIT taxable income of $160.4 million. [source: Realty Income 2007 10-K]

2008: O's cash distributions totaled $193.9 million, or approximately 122.7% of its estimated REIT taxable income of $158.0 million. [source: Realty Income 2008 10-K]

Instead of retaining the excess capital for share repurchases or strategic activities that provide a return ON investment, Realty Income chooses to provide shareholder dividends that are, in part, a return OF shareholder investment.

Why I'm Long Mortgage REIT Chimera

I'm not entirely sure that I buy into Annaly's divide and conquer methodology on the distressed debt orgy. First of all, they were way too early in effectively calling the non-agency backed RMBS bottom with the Chimera IPO. On the heels of that disaster, Annaly now has another spinoff for the commercial side of the house in CreXus (how do you even pronounce that?).

I'm not convinced that the Annaly machine has enough experience outside of the agency arena to run either REIT, frankly. Chimera's only defensive strategy during the 2008 crisis was to launch one dilutive secondary after another -- perhaps just throwing good money after bad in an attempt to bury bad paper deep in the portfolio.

I think investors stand a better shot with Redwood Trust (RWT), which has much more relevant experience in non-agency MBS than Chimera & crew. Even one of the newly launched vulture REITs will have a cleaner balance sheet and less share dilution.

American Agency Mortgage: Huge Dividend REIT

One minor housekeeping note: the company in focus is named American Capital Agency Corporation (AGNC).

As for the agency-backed mortgage REITs in general, the entire sector is guaranteed to succeed in an environment where there is a steeply positive yield curve. The agency backing of their holdings minimizes credit risks, so their business model becomes a virtually pure-play interest-rate gambit. The Federal Reserve has not yet indicated the need to push rates back to historical norms, so the available spread to be earned remains quite wide.

Of course, the companies within the agency-backed mREIT sector differ in certain respects, and as mortgage rates have fallen over the last few years, those companies that have seasoned fixed-rate debt should outperform those with short-reset adjustable-rate holdings. Another factor to consider is those companies with short-duration swaps that are due to roll off. Many of the agency mREITs have swap-adjusted cost of funds that are much higher than the unadjusted market cost of repurchase agreements. Those with higher swap-adjusted COF have limited their spread potential.

As for AGNC itself, although I have criticized AGNC's sponsor, American Capital Ltd as "questionable", AGNC's Q2 financial results were quite robust. The company earned $1.98/share in Q2 taxable income and still has $0.79/share in undistributed taxable income to support the dividend for the rest of the year. I believe the $1.50/share dividend is sustainable for Q3 & Q4 2009 based on AGNC's remaining taxable earnings. 2010 may be a different story.

Snowjob3 made a good point about the capital gains. AGNC's taxable income calculations appear to include both ordinary & capital gain income. Capital gains, of course, are typically non-recurring. Plus, REITs are only required to distribute 90% of ordinary taxable income.

How Debt Becomes Equity, REIT Edition

Let's look at the evidence from these new REITs' S-11 filings:

"We expect to use leverage, directly and indirectly through financing vehicles, to increase potential returns to our stockholders and to fund the acquisition of our assets." [Source: Foursquare Capital Corp. S-11 filing, page 9]

"We expect to use leverage to finance our assets through borrowings from repurchase agreements, to the extent available to us, borrowings under programs established by the U.S. Government such as the TALF and PPIP, and other secured and unsecured forms of borrowing." [Source: AG Financial Investment Trust, Inc. S-11 filing, page 46]

"Initially, we intend to deploy leverage on our target assets, on a debt-to-equity basis, of up to 1.0 to 1.0 on a portfolio basis. If we obtain financing under the TALF or any other U.S. Government programs, we expect to incur significantly more leverage. For example, with respect to the TALF, we expect to finance up to 85% of each of our eligible CMBS assets on a non-recourse basis. When market conditions allow, we intend to finance our first mortgage loans in part through the issuance of AAA-rated CMBS, which we expect should be eligible to be purchased by investors who are able to borrow under the TALF, while retaining the subordinate securities in our portfolio. " [Source: Ladder Capital Realty Finance Inc. S-11 filing, page 11]

I question the viability of these new REITs in my July 14 article: seekingalpha.com/artic...

These mortgage REITs are likely to have substantial taxable income in excess of cash available for distribution, forcing them to borrow more money under unfavorable market conditions or issue even more equity to satisfy the REIT distribution requirements.

Commercial Real Estate Won't Blow Off Leverage

Let's look at the evidence from these new REITs' S-11 filings:

"We expect to use leverage, directly and indirectly through financing vehicles, to increase potential returns to our stockholders and to fund the acquisition of our assets." [Source: Foursquare Capital Corp. S-11 filing, page 9]

"We expect to use leverage to finance our assets through borrowings from repurchase agreements, to the extent available to us, borrowings under programs established by the U.S. Government such as the TALF and PPIP, and other secured and unsecured forms of borrowing." [Source: AG Financial Investment Trust, Inc. S-11 filing, page 46]

"Initially, we intend to deploy leverage on our target assets, on a debt-to-equity basis, of up to 1.0 to 1.0 on a portfolio basis. If we obtain financing under the TALF or any other U.S. Government programs, we expect to incur significantly more leverage. For example, with respect to the TALF, we expect to finance up to 85% of each of our eligible CMBS assets on a non-recourse basis. When market conditions allow, we intend to finance our first mortgage loans in part through the issuance of AAA-rated CMBS, which we expect should be eligible to be purchased by investors who are able to borrow under the TALF, while retaining the subordinate securities in our portfolio. " [Source: Ladder Capital Realty Finance Inc. S-11 filing, page 11]

I question the viability of these new REITs in my July 14 article: seekingalpha.com/artic...

These mortgage REITs are likely to have substantial taxable income in excess of cash available for distribution, forcing them to borrow more money under unfavorable market conditions or issue even more equity to satisfy the REIT distribution requirements.

REITs Are Not Right for PPIP Players

U.S. federal income tax law generally requires that a REIT distribute annually at least 90% of its REIT taxable income. Therefore, if REIT taxable income greatly exceeds the cash available for distribution, the REIT will face a serious liquidity problem.

MFA Financial: Raising an Already Impressive Dividend

MFA Financial (MFA) is actually one of the lowest-yielding stocks in its subsector (mortgage REITs specializing in agency-backed paper). MFA's portfolio is composed almost entirely of adjustable-rate securities, which place an upper limit on the net income spread available in a falling interest rate environment.

Higher-yielding options in the sector include Capstead Mortgage (CMO), Anworth Mortgage (ANH), Annaly Capital (NLY), Hatteras Financial (HTS), and American Capital Agency (AGNC).