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More on the Annaly (NLY) downgrade: Morgan's move is part of a larger theme of preferring...

More on the Annaly (NLYdowngrade: Morgan's move is part of a larger theme of preferring hybrid mREITs (those buying non-agency MBS) to agency mREITs. The hybrids should benefit from higher non-agency yields and an improving housing market. Upgraded: Invesco (IVR). Downgraded (other than NLY): American Capital (AGNC) and MFA Financial. Everyone's piling into non-agency paper.
Comments (19)
  • Indeed, non-agencies are fundamentally cheap for a bunch of reasons (tainted names, banks dont want them anymore, tough to understand and model), as opposed to agencies that deliver good earnings to REITs mainly because they take unhedged risks (curve + convexity) and have been lucky so far.
    4 Oct 2012, 01:08 PM Reply Like
  • You say unhedged risks? AGNC's last quarter showed hedging as a big factor in limiting book value growth.
    4 Oct 2012, 01:28 PM Reply Like
  • AGNC might be hedged in duration terms but I don't think they are in terms of negative convexity. Actually, if REITs in general hedged entirely the short options embedded in agency MBS their net interest margins would be much smaller than advertised. There is a metric called "option adjusted spread" that says what the spread is of mortgages over the financing curve, net of all the costs of hedging the prepayment options. It is usually between -0.1 and 0.8% (that latter one for the most illiquid bonds). So if they display a couple % of "net" spread over financing mechanically it implies that they take risks, either in duration, or in volatility.
    4 Oct 2012, 01:49 PM Reply Like
  • Well, there's interest rate hedging, for duration, and a prepayment-defensive portfolio, for negative convexity.


    "69% of the portfolio is backed by either lower loan balance loans or higher LTV HARP loans. Less than 3% of AGNC’s portfolio is eligible for the HARP 2.0 program. Of our remaining non-HARP/non-lower loan balance fixed rate pass through position, 73% is low coupon fixed rate MBS."


    "Our primary objective is not to eliminate risk or to lock in a particular net interest margin, but to maintain our book value within reasonable bands over a wide range of interest rate scenarios."


    "Strong book value performance and the substantial amount of undistributed taxable income give us significant flexibility with respect to our dividend despite a lower spread environment."
    5 Oct 2012, 02:58 AM Reply Like
  • If only we could make some sort of collateralised debt obligation or something out of all these crap non-agency mortgages, to make them safer. We could structure them so that they're rated AAA and then anyone could buy them. That would be ideal since everyone needs to chase yield but not everyone can buy risky assets.
    4 Oct 2012, 01:27 PM Reply Like
  • Bearfund -- you should also throw in a few non-conforming mortgage originators to brew up an out-of-the park no risk no sense ride to the moon! Then the CDO fund (or whatever) could then do infomercials on TV to drum up biz from retirees needing no risk 14%+ returns in their portfolios. But wait, there's more...
    4 Oct 2012, 02:05 PM Reply Like
  • Beautiful!
    4 Oct 2012, 02:25 PM Reply Like
  • And non-agency MBS m-REITs purchases allow the investor to sleep well at night. Next we'll hear of bundling again.
    4 Oct 2012, 01:29 PM Reply Like
  • An improving housing market?? Ask a foreclosure attorney, the flood is about to be released after being bottled up for 4 years--their in boxes are swelling and they're finally resolving all those counterclaims and matching notes to mortgages that they've finally dug up. There's specious reasoning, and then there are plain stupid people who don't do their factual homework, don't understand housing metrics, and yet feel qualified to opine on the matter. The heroin addict lies to himself only for so long--that he's not an addict, then he dies.
    4 Oct 2012, 01:35 PM Reply Like
  • MFA is a hybrid and worth holding for the short term. I am amazed to see the price go down before the dividend is issued in a few days. I see MFA as a sweet balance for long term investments and a savings or money market account.
    4 Oct 2012, 01:41 PM Reply Like
  • kwm3 -
    Being bullish on non agencies is fairly orthogonal to what one might think of housing, barring a massive crash. Non agency MBS (subprime and AltA I mean) price in further home price drops by 5-10%. Besides, home prices are not a significant driver of future cash flows, much less than servicer behavior for example. If anything, I'd see Ocwen's greater footprint in servicing as a negative, much more than whatever doomsday HPI view you might have.
    4 Oct 2012, 01:58 PM Reply Like
  • And I would add, in fact a large increase in liquidations is a positive on many non agency securities. When you buy a bond at 12% yield and 50 cents on the $, getting your $ back much earlier, even at the cost of a marginally greater loss than anticipated, will increase value. It depends on the structure of course, but I'd think that buyers of senior resecuritizations would be very happy.
    4 Oct 2012, 02:13 PM Reply Like
  • There is also the new paradigm that these mREITS are issuing ~8% pfd shares instead of dilutive common. With the common yielding 12-15% on these names, the pfd issuance is accretive and saves the company 4% or more which on $500m issue is over $20m. Partial Offset to decreasing spreads.
    4 Oct 2012, 02:39 PM Reply Like
  • Their position is rather inconsistent. If they favor hybrids, MFA ought to be upgraded rather than downgraded - they have significant non-agency mbs.
    4 Oct 2012, 03:16 PM Reply Like
  • I have not looked in detail into MFA's non agency holdings but it could well be that they hold bonds that are not poised to benefit from the general improvement -- low beta bonds in the non agency market if you will, like seasoned prime paper for example.
    4 Oct 2012, 03:26 PM Reply Like
  • I did a recent piece on MFA, and they do hold mortgages and mbs that they purchased at discount - the discounts are reserved to cover losses, which protects them against defaults and prepayments. All in all, they are covered fairly nicely, with a low d/e ratio to boot.


    Morgan can downgrade them if they wish, and so can anyone else. Just makes MFA more affordable.
    4 Oct 2012, 03:56 PM Reply Like
  • If one is concerned with the problem of all-agency paper, consider AGNC's sister fund, MTGE which can purchase non-agency paper. It too yields about 14% per year.
    6 Oct 2012, 12:55 PM Reply Like
  • MTGE's non agency positions are not particularly attractive (their reported yields are below 8%), and I find that their overall non-agency contribution to the bottom line is under 30% (vs up to 80% on some other REITs).
    7 Oct 2012, 04:25 AM Reply Like
  • Senior citizen, committed to mREITs
    6 Oct 2012, 12:57 PM Reply Like
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