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Retired Atlanta dentist with a specific interest in agency mortgage REITs and leveraged Munis.
  • "Welcome To The Hotel California" - mREITs As Value Traps 2 comments
    Jul 20, 2013 9:33 PM | about stocks: MORL

    (click to enlarge)

    "Mirrors on the ceiling, the pink Champaign on ice, and she said, 'we are all just prisoners here, of our own device' - Welcome to the Hotel California. . ."

    So according to one definition, a "value trap" is: A stock that appears to be cheap because the stock has been trading at low multiples of earnings, cash flow or book value for an extended time period. Stock traps attract investors who are looking for a bargain because these stocks are inexpensive. The trap springs when investors buy into the company at low prices and the stock never improves. So substitute dividend yield for "low multiples of earnings, cash flow or book value" you have the situation that mRETIs are in now.

    This week Barry Ritholtz had an interesting article on narrative. He's written on the subject before and basically explains that as humans, we have a need to construct events into a story so we can analyze and act on those events. He points out that once constructed, a narrative can be awfully hard to alter because we invest so much in it's maintenance.

    This brings to light my own narrative in what has happened to the mREIT market since Bernanke started the Taper Tantrum. I thought I had a handle on what happened, thinking that as long as the net interest spread was poised to widen that the only event I had to monitor was when the Fed would raise the Fed Funds rate from zero.

    Boy, did I get my ass handed to me. As I went thru the 5 stages of grief following the recent Taper Tantrum, I still hung on to my narrative and adamantly refused to see the recent turmoil as anything other than an irrational bond market panic that would reverse as soon as everyone took a deep breath. So while the 10 year has softly descended to 2.50% from 2.75% MORL remains stubbornly in a trading range 30% down. Not good! If my narrative was correct, MORL should have retraced that same 1/3rd that the 2-10 spread has by now, but it's a long way off.

    Having spent a lot of time in the past viewing Annaly's response to similar rate spikes in 2010 and 2011, I saw that the short term 10 year spikes didn't affected Annaly's payout. And as we see from last weeks CYS Q2 report, CYS net interest earnings weren't affected either. However, what my narrative didn't allow for is the effect that the book value hit that the market was anticipating was going to trump any relief that the dividend would remain stable. CVS is now trading at a 15% discount to book value, usually a table pounding buy.

    Another aspect of my narrative is that mREIT assets have effectively doubled from 5 years ago and so when the Fed started ZIRP, mREITs became an amazingly lucrative carry trade. Those institutional investors with access to cheap repo loans and even cheaper currency funding soaked up a lot of those mREIT shares. I term these investors ultra fast money so at the first whiff of tapering they bailed out heavily. One quote from the CYS CEO bears this out when he snarked at the Fed's misunderstanding of the MBS market by pointing out that the MBS market is effectively a futures market that would instantly price in future tapering.

    mREIT shares are now held by mostly retail holders who either didn't get out in time or sold out at a loss never to return. There is significantly less demand for the shares now, so for as long as Tapering looms on the horizon, these stocks will take a long time to recover even when dividends get increased.

    That's my story and I'm sticking to it.

    Themes: stpp, mort Stocks: MORL
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  • Dividend Living
    , contributor
    Comments (313) | Send Message
    Lets see how Q2 earnings play out in AGNC and NLY in respect to a MORL rebound. I think you are right in the long time frame for complete recovery. It takes stability in rates and an increase in spreads a while to overcome these losses.
    22 Jul 2013, 02:14 PM Reply Like
  • jpmist
    , contributor
    Comments (341) | Send Message
    Author’s reply » 'REIT Investor' recently made a case for mREIT earnings to be almost entirely dependent on how they hedge as opposed to prevailing rate spread. He's almost convinced me of that, but I view the rate spread as being the raw material for earnings that gets trimmed back by hedges.


    Because of hedging strategy, AGNC and NLY could be anywhere on the map for earnings, but I favor NLY doing well since they've managed long rate spikes more than AGNC.


    Thanks for reading, DL! HTS out this Wednesday, should be interesting.
    22 Jul 2013, 02:47 PM Reply Like
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