Seeking Alpha

"I would not overestimate retail investors' knowledge of how this business works," says Scott...

"I would not overestimate retail investors' knowledge of how this business works," says Scott Ulm, co-CEO of Armour Residential (ARR -1.3%). Income fans love mREITs (MORT -1.3%) but can suffer quick losses as rates rise. "We believe mREITs are not appropriate for most individual investors," says Edward Jones' Kate Warne, warning brokers to steer clients away from the sector. Ulm remains hopeful: "As bonds become cheaper, reinvestment becomes more profitable." Beneath a big rally for the averages, the sector is hit again today: American Capital (AGNC -2.6%), (MTGE -1.2%), Annaly (NLY -1.9%), Two Harbors (TWO -0.9%), Hatteras (HTS -1.9%), CYS (CYS -2.8%), Anworth (ANH -0.9%).
Comments (44)
  • It's true that with their stellar performance, ARR definitely knows how the business works.
    7 Jun 2013, 04:13 PM Reply Like
  • The message I get is that REITs, like bonds, will be a very bad place to invest for the next five years as interest rates and mortgages rise. Maybe best to buy PUTs on these REITs.
    7 Jun 2013, 04:34 PM Reply Like
  • Need to distinguish mREITs from REITs. Real estate plays that are not over-leveraged are currently a buy...their depression based largely on "guilt by association." mREITs are plays on interest rates, not real estate.
    7 Jun 2013, 04:52 PM Reply Like
  • I will add my name to those that say that mREITS are generally NOT appropriate for retail investors.

     

    These things are highly leveraged bond funds. Lots of things can go very wrong at a time when interest rates are moving rapidly and there can be dislocations in credit markets.

     

    To those that say that the mREIT managers are smart, I say, "I agree. So were the managers at LTCM."

     

    Highly leveraged investment strategies held together with complex derivative hedging strategies have a way of falling apart.
    I am not saying that mREITS will fall apart. I am saying that they are not worth the risk and that individual investors should not be messing with them right now.
    7 Jun 2013, 04:35 PM Reply Like
  • Would you allow that perhaps individual investors should not be messing with mREITs at all...and not just "right now"? Unless one is a skilled insider, never taking their eye off the ball, any moment can become "right now" in a heartbeat.
    7 Jun 2013, 04:57 PM Reply Like
  • CR:

     

    My view is that mREITS are not appropriate for most individual investors as they are currently structured.
    7 Jun 2013, 05:21 PM Reply Like
  • @Reitanalyst...OK. so you're observant. Many of these are significantly oversold. The shorts are having a field day...soon, it will be over and they'll bounce. You have to weight out risk/reward.

     

    At these levels, the well managed mReits could represent a buying opportunity..
    7 Jun 2013, 05:03 PM Reply Like
  • Risk assets cannot be bought and held forever. There was a time to buy and sell mREITs, just as there is a time to buy and sell any other equity or equity proxy, especially those that appreciate considerably in price. mREITs are leveraged, but so is any other REIT. These are structured investment vehicles. Almost all high yield closed end bond funds are leveraged, and are also sensitive to credit market and interest rate risk. Those looking for a stable streams of income and don't expect the underlying to go bankrupt or call the bond: buy the debt to maturity, with DD. Diversify.
    7 Jun 2013, 05:10 PM Reply Like
  • Those looking for some history of how markets affect mREITs: look at a 13yr chart of NLY, and esp the response and follow on when rates moved up in 2004. The risk in agencies is much greater going forward than non-agencies, as the Fed stops buying/supporting them (as much).
    7 Jun 2013, 06:06 PM Reply Like
  • WhiteHawk:

     

    Excellent point. Here is the NLY weekly chart showing the decline of over 45% from 6/17/2005 to 12/30/2005 - http://bit.ly/16RPh0S

     

    Because I was concerned about the volatility of the mREITs, I bought some of the NLY-C preferreds that pay a 7.625% coupon thinking that it would be "safer". Lo and behold, NLY was off about 15% in May and the preferred was off about 5%. The decline was about 1/3, the dividend was a little under 1/2. Thank goodness I bought it at $25.06 back in Nov 2012. I gave back about $1.30 in capital gains, but still above my Buy point.
    8 Jun 2013, 09:19 AM Reply Like
  • Just did that and the price of NLY and FED interest rate has good inverse relationship. What about commercial and other REITS such as NRF, NCT (going to senior living), BRT, RSO?
    9 Jun 2013, 09:14 AM Reply Like
  • Insiders have been buying while retail has been dumping. People running the mREITs are drinking their own Koolaid. Good time to put on a satellite allocation to mREITs to juice up the fixed income side of the portfolio.

     

    http://onforb.es/ZWJFPB
    7 Jun 2013, 06:57 PM Reply Like
  • I am not sure of the point of this "news flash." Is it to help the poor retail investor out? The time to invest is when others are scared, not when everyone is investing. I question the intent of all of the warnings...we get it. If people aren't smart enough to know bond prices go down when rates go up then they shouldn't be reading this blog. The difference here is this is a hedged portfolio that invests largely in assets backed by the US government (i.e., low credit risk). I am not sure LTCM was investing in Agency MBS (correct me if I am wrong). I believe retail investors are panicked and we are oversold.
    7 Jun 2013, 07:38 PM Reply Like
  • Agency MBS really don't have much credit risk. But they have a tremendous amount of duration risk.

     

    I am not saying mREITS are going bust. I am simply saying that there is tremendous risk in the sector for price declines in these stocks. 2005 is a decent analogy (these stocks got hammered), but the current situation is even more dangerous for long-duration instruments.
    7 Jun 2013, 08:15 PM Reply Like
  • Don't forget they have hedged their assets with swaps, etc. While not wholly familiar with the details of their hedges, they basically use matched duration maturity treasuries to hedge for large moves in rates. Not to be elementary but the hedges increase in value as the mortgages decline in value. The duration gap was 0.5 years at the end of March. Treasury yields have increased in Q2 (unlike Q1) consistently with the increase in mortgage rates. The profits on the hedges offset the unrealized losses on the asset portfolio (maintaining book value). The yield curve, however has remained upward sloping and in fact, likely steepened as short term rates have remained low while longer term have increased. This is a point of increasing profitability/yield for the model.

     

    My main concern arises if the yield curve flattens and yields are reduced. This will be a function of rising short rates which is likely further off due to the fed policy. I believe even with a flatter curve they can likely generate a respectable return appropriately leveraged. Stock prices may bounce around some but the upward sloping curve will drive profitability and the Company will continually re-balance its portfolio and hedge position as asset prices/rates change. The better managers will be more successful during the transition from declining to increasing rates. This is an important asset class providing liquidity to the mortgage market (as GSE's hopefully wind down) and I don't see it disappearing. The managers of AGNC have managed much larger portfolios of mortgages in a variety of rate environments (albeit not at this low a level but both rising and falling).
    7 Jun 2013, 11:55 PM Reply Like
  • Yes, the risk is that the taper will flatten the curve and bring short term rates up quickly. They will be forced to sell assets, b/c cost of financing doubles, triples etc ( no more free money at zero ). All depends how leveraged they are. The YC today looks basically the same as it has for the past 2 years. Look at YC on June 2013 compared to May 1, May 22 of 2013. Then look at Jan 2012, Jan 2011 and June 2007, 2008 and 2009 - we basically went from flat to steep, and have not changed - all positives for mREITs. Most mREITs know how to handle a taper with the appropriate hedges.
    9 Jun 2013, 10:16 PM Reply Like
  • whtmtn

     

    LTCM was investing in fixed income too..in.Russian bonds guaranteed by the full faith and credit of the Russian government .....Ok ....I guess it s a different situation.
    7 Jun 2013, 08:02 PM Reply Like
  • I believe it was foreign currencies as well. Also, I believe their leverage was far higher.
    7 Jun 2013, 11:15 PM Reply Like
  • Russia defaulted in '98. All spread products blew out. LTCM was long spread products and short tsy - as was every desk on the street including Morgan Stanley, GS and Deutsche. The correct trade after Russia announced the default was to be long safety ( ie TSYs ) and short spread product - prices took a nose dive and anyone levered got hammerd on margin calls and was forced to sell inventory even if they did not want to ( at bargain basement prices ). Many Vultures started their Hedge Funds at precisely this time.

     

    Should be fun to see who is hedged and who is not this time, I have my picks. Most thought the taper would not happen until 2015 ( still may not ), and have been quoted as such, those hedges just got more expensive, unless they had them already ( IOs, Swaptions etc ). If the stock market tanks in the next few weeks, no chance of Taper talk this year. Still awaiting that big correction. Last few weeks have been a tease. mREITs, SLV, GLD could do quite well at the right entry points and if the YC stays steep and no taper occurs.
    9 Jun 2013, 10:28 PM Reply Like
  • I find it odd that Ulm from ARR would make a statement that would make the performance of his stock even worse. Anyway, there are no doubt many out here would like to know how the business works.
    7 Jun 2013, 09:23 PM Reply Like
  • It is kind of a bold statement coming from ARR...would have liked to see the context, there is no link to where the quote came from.
    7 Jun 2013, 11:24 PM Reply Like
  • It came from the Financial Times of today.
    9 Jun 2013, 07:34 AM Reply Like
  • I own REM and will accumulate more if this stock is going further down.
    7 Jun 2013, 09:28 PM Reply Like
  • Still not buying REM yet. IT will go lower. When the stock market corrects, BUY IT ALL. ok - was watching Wall Street and got carried away.
    9 Jun 2013, 10:31 PM Reply Like
  • Please help me to short down this ETF faster. Thanks everybody.
    7 Jun 2013, 09:30 PM Reply Like
  • One of the difficult aspects of evaluating mReits is trying to get a feel for the quality of the collateral. I had the pleasure of liquidating a smaller publicly traded mReit some years ago and after foreclosing on a good portion of the portfolio, we found ourselves stuck with some awful properties where it was clear that the original lending was driven not by the quality of the collateral, but the richness of the origination fee structures. It only takes a few sick dogs to make the whole kennel stink!
    7 Jun 2013, 11:49 PM Reply Like
  • Several years ago, it was widely known that the quality of much of the mortgage related holdings was very poor. From my experience, the due diligence before granting loans has tightened up because of that experience. I do not know, however, if the overall quality has increased other than what I have experienced anecdotally.
    8 Jun 2013, 10:32 AM Reply Like
  • Stick with the folks buying specified pools. They have better prepay & default models in place. CMO, NLY, WMC and AGNC are all pretty good. But I do think they will all get a lot cheaper, so wait. Too many people bought these companies purely on Yield not realizing they were investing in companies buying MBS.
    9 Jun 2013, 10:34 PM Reply Like
  • James, Cincinnati, et al,

     

    Ulm is right. Most individual investors know a few mREIT buzz words and phrases, which gives them just enough knowledge to be dangerous. I learned real fast that this sector is not for me, except for window shopping and eavesdropping in on articles.

     

    It's unfortunate that regular REITs got tarred with the same brush as their second cousins.
    7 Jun 2013, 11:51 PM Reply Like
  • Anything coming from ARR is not good for anyone. Maybe some Mreits are worthwhile but definitely not ARR.
    8 Jun 2013, 12:07 AM Reply Like
  • It's important for any potential investor to question how dividends can be so good on a company that services mortgages of comparatively low interest. It's leverage, and every leveraged investment has higher risks and rewards. I don't think this is a difficult concept to understand.
    8 Jun 2013, 12:58 AM Reply Like
  • Yes, I get it. There are risks. But, this mReits are paying !2% + and bonds are paying +2%. So, are you not being paid for the risk?
    8 Jun 2013, 01:48 AM Reply Like
  • Typical Edward Jones mentality, wait for the sector to drop 20% and then issue a warning.
    8 Jun 2013, 06:43 AM Reply Like
  • LOL, Freddesain. I was thinking the time for the warning was a month ago. ...not that anyone would have listened, but they could at least say, "I told you so."
    8 Jun 2013, 07:11 AM Reply Like
  • ARR is not an equity reit (eReit). It simply finances purchases of bonds and collects a spread, which any Wall Street idiot can do. Investors should understand the difference between spread scalper mReits like ARR, CYS and NLY, and eReits who know how to build strong businesses, like say, TCO, KIM, and O.
    8 Jun 2013, 09:43 AM Reply Like
  • I think that if a major concern was economic or social value added, that most of the stock market would close down. I would imagine that most of us would survive just fine if they dropped a bomb on wall street tomorrow. Think of all the brain power wasted on this enterprise which is only tangentially related to the real world, the real economy, and real people who actually have to produce goods and service for a living.
    8 Jun 2013, 10:38 AM Reply Like
  • Comment re: tapering and labor market:

     

    Dean Maki, chief economist at Barclays, told CNBC that May's jobs report does little to clarify the Fed's next policy move even though Chairman Ben Bernanke had said he would reduce bond purchases in the next few months if employment levels stayed strong.

     

    "I think this will be seen as a report that's not convincing either way in terms of tapering," said Maki. "We think not until March of 2014. Our view is that the labor market and GDP will be slow enough that the Fed decides it's not worth tapering at this point and it's because we do not expect the bounce back to 3 percent (GDP growth) that they are expecting."

     

    Plenty of time for re-balancing a portfolio.
    8 Jun 2013, 11:19 AM Reply Like
  • whtmtn

     

    The only thing that seems predictable at this point is that investors will overreact to whatever happens. By this time, one might think that we have already discounted any tapering. But even if people think tapering will be delayed until March 2014, that's only ten months away and I think it is prudent to assume that this will be discounted over and above what is already discounted.

     

    Does anyone know who is driving these stock decreases? Is it primarily the institutional or the individual investor?
    8 Jun 2013, 06:06 PM Reply Like
  • Great - NOW they tell us that brokers should steer individual investors away from mREITS...
    9 Jun 2013, 10:43 AM Reply Like
  • That's for sure.
    9 Jun 2013, 08:20 PM Reply Like
  • With Treasuries yielding near zero mREITS are going to be just fine.
    9 Jun 2013, 08:20 PM Reply Like
  • there is just too much turmoil with this administration to handle. all this screw ups and heads are still not be replaced with this massive cover up which this president just ignores. this president should be removed from office.......
    9 Jun 2013, 08:21 PM Reply Like
  • Massive, always increasing, and unpredictable (in timing and effect, short-term and long-term) government intrusion into the "free" market makes all investing--from mREITS to apartment buildings--little more than a trip to Las Vegas. It was government intrusion in the economy (Community Investment Act, fed tightening/loosening, etc., etc.) that set up the bubble and inevitable collapse in 2008, and as far as I can tell, nothing has really changed at all. There is precious little "real" capitalism left in the Western world, and with government fiat money "counterfeiting" rampant nearly everywhere, I don't see anything changing this state of politico-economic chaos significantly anytime soon. The world's socio-political-economic philosophy and practice is morally bankrupt and I do not see this all ending well for anyone but our government-bankster masters--and, perhaps, not even for them when the REAL disaster finally occurs. There...I said it (I/we can only hope I am a paranoid moron and am somehow completely wrong).

     

    In the meantime, the birds are chirping and it is a beautiful day here (San Diego); I think I'll go for a walk and enjoy the view of the local mountains and ocean from 3,000 feet. Best to one and all. And, as Larry Levin is fond of saying, "Trade well and follow the trend."

     

    PS -- I heard a rumor that there is a bunch of laissez-faire capitalism breaking out in India. I wonder how hard it is to learn how to speak Hindi?
    10 Jun 2013, 01:42 PM Reply Like
  • Judging from the performance of ARR, maybe we shouldn't overestimate Ulms' knowledge of "how this business works".
    11 Jun 2013, 08:00 PM Reply Like
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