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jpmist
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Retired Atlanta dentist with a specific interest in agency mortgage REITs and leveraged Munis.
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  • "I'm Out!"

    The pic is from Seinfeld's "The Contest" where Kramer slams down the money he lost from his bet and declares "I'm out."

    Me too, Kosmo.

    Naturally this will be a contrary indicator for everything I got out of. And it's very likely that I've gotten out too soon. Not the first time, won't be the last. The market just doesn't make sense to me. My munis had peaked and were dribbling lower on a daily basis. My STPP position was simply one where I stayed too long on the wrong thesis of a widening 2-10 spread that I finally realized was simply not going to happen again during this business cycle.

    Thanks to Califia Beach for the chart which shows that should the day come when long rates finally go up, the short rates are projected by Fed members to go up as well leaving a narrower spread than we have now. This portends a lot of bad news for the mREIT sector since their need a wide spread to generate dividends. Shrinking the spread will cause them to increase leverage and churn their holdings for trading profits to keep their dividends level with prior quarters.

    I made some interesting bets on several leveraged ETNs that I was able to take profits on, but where I'm getting queasy is the idea of having any positions that contain any leverage at all. The 2X ETNs certainly did as well as the levered munis. My positions in the mREIT sector had a nice run, but the Fed imminent short rate increase and the game of chicken that the bond market is playing with long rates is giving me more agita than I wanna deal with.

    I suppose the wounds are still fresh from Bernanke's Taper hints of last spring. It's hard not to assume that the market will react with similar turmoil when it finally dawns on the bond market that short rates are going up.

    The day will come and when it does I'll be glad that "I'm out!"

    Jul 17 5:46 PM | Link | Comment!
  • "What now?" for the Mortgage REIT Sector

    Today I read on twitter that today is the one year anniversary of Bernanke's delightful comment on tapering. What a year it's been since.

    As you can see, the MBS market has stopped plummeting, volatility has declined and now the mREIT sector can ease back on expensive hedging and enjoy watching their book value increasing.

    Not to sprain my elbow patting myself on the back but my hunch was correct in that the mREIT sector hit bottom last December.

    Butch: What now?

    Marsellus: Oh, that what now. I tell you what now between me and you. There is no me and you. Not no more.

    Well, it's not quite that bad. Not yet anyway. Why? Here's what's currently in my anxiety closet:

    1. The bond market hasn't followed by prediction that with the Fed winding down QE rates would increase.

    2. Are we turning Japanese? Are low rates the new normal? It's spring and the fact that mortgage rates are trending lower is not a good sign for the economy or the likelihood that increasing pre-pays will start hurting mREIT earnings.

    3. Are we done for this expansion? Recessions hit on average every 6, 7 years and depending on when you start the clock we may be due for the start of another downdraft.

    4. Will the Fed ever stop it's financial repression? How many more years must savers subsidise the health of too big to fail and too big to jail banks and brokers?

    5. At some point in the future, short term rates are going to ramp up and with it Repo rates that factor heavily into mREIT earnings. Will the mREIT market respond as violently to rate increases as it did at the mere hint of tapering we suffered a year ago?

    May 23 11:26 AM | Link | Comment!
  • The End Is Near! No, Really!

    Well, it's been almost 2 months. Really didn't have anything new to add, but the landscape has changed now. The Congressional Clown show has finished another chapter in their magnificent incompetence and in doing so threw sand in the gears of data the Fed needs for them to decide when to start tapering. It was seemingly a done deal for September until it wasn't and the MBS market reacted by rallying. It's retraced about 35% of the April taper tantrum at this point and last week we got a stronger than predicted employment report that dropped prices back down a bit. So volatility remains, but the guys at Mortgage News Daily feel we're simply at the low of another trading range.

    The main news last week was that by now most of the agency mREITs I follow have announced financial data for Q3. As you can see from the MORT chart, the market didn't like the reports. AGNC in particular crapped the bed with it's aggressive bets on MBS rates in the tba market, then Annaly's new CEO didn't impress anyone during the conference call by raving at the Fed for not making her job any easier.

    On Seeking Alpha there was the usual wailing and gnashing of teeth but a new voice of calm, goes by the name of "Cash King" with some rational thoughts that we might be at the bottom of the mREIT carnage. Then there was poor Scott Kennedy who's spent days of his life trying to guess AGNC's Q3 number only to get blindsided by the awful numbers AGNC reported. Poor guy. Yet another bearish author Regarded Solution heaps snark and scorn on anyone questioning his take that the mREIT sector will be toxic for quite some time.

    In spite of my thin grasp of what the numbers in the reports actually mean, I did some quick back of the envelope scanning and came up with some numbers that lead me to believe that the sector has bottomed. All we need to do is get past the next Clown Show episode, and the long awaited beginning of the Fed Taper of MBS purchases for rate volatility to subside. Once that happens mREITs can spend less on hedging, expand their leverage and take advantage of the increased net spreads that are already showing up in their reports.

    There are a lot of terms I don't understand in those quarterly reports, but I do have a good grasp on some key ones. Book value I get and it's a pretty clean number - just add up the MBS you have on the books as well as cash, Treasuries and the value of the hedges. Currently all the mREITs are trading at discounts to book, but I won't dwell on that because that would imply respect for the mREIT market, the vast majority of who don't exactly know how the companies actually work.

    Another one is core earnings. This one's a bit slippery but it's needed to draw focus off GAPP earnings which don't work well for mREIT due to more stuff I don't quite grasp, but I'll take everyone's word for it. Core earnings has an actual definition that all the mREITs use, so it's a handy number. To me, it simply means how well the carry trade working. Cash from interest on the MBS notes subtract interest paid on the short term debt it uses to buy the stuff and there you have it. The number leaves out what's spent on hedging which is fine by me cause that's an opaque black box as far as I'm concerned- by the time we know how they've hedged its too late to do anything about it.

    Last but not least is my favorite, the net interest rate spread. This is another one that doesn't get too squirmy, the spread is simply the difference between the rate they're getting on their MBS portfolio and the rate their paying on their repo financing. Again, no hedging, but it's a indication of the potential the company has to generate revenue.

    I suppose I should also mention the leverage ratio. It's not a bad number but it gets tainted with mention of the tba market. AGNC breaks out leverage with and without the tba number and I don't know how to weigh that. I do know that without exception all the agency mREIT have knocked down their ratios in double digits. This is a good thing for safety, but a bad thing for earnings.

    So Charts and Numbers!

    I had to leave off AGNC's numbers which were negative and threw off the whole point of the chart. AGNC did end up in positive numbers in Q3. At first glance the chart isn't too encouraging, but 3 of the 6 companies showed improvement or leveling off. A mistake a lot of the mREIT bears make is in projecting the downward slope of the curves down to infinity. That's only going to happen if we have another 106 to 100 two month swoon in the MBS market like we did in Q2. I doubt that will repeat itself because the bond market has figured out it over-reacted to the Fed withdrawal from the MBS market. We'll still have volatility when the Taper is put in play, but it's doubtful we'll have a similar plunge.

    This gets better. Note that the extreme downturn all of the companies took from Q1 to Q2 have leveled off? This tells me the majority of the damage has been done. The bears are wrong again in projecting these lines down to zero. Not going to happen.

    Saved the best for last. This is a data-point that some of the mREIT bears don't want to even acknowledge. For most of the sector the net interest spread has increased from Q2. Admittedly, it's been confusing for me to see the sector get hammered every time rates go up. Last Friday was a great example, the ten year went up 7 bp and MORL got hammered down 5%. A rapid rise in rates is hard to predict and expensive to hedge for as we saw in Q2 of this year. But at the end of the day, once the higher spread is adapted to, the more money the mREITs can make. Particularly when all they have to do is hike leverage.

    These data-points are why I think the end is near. What to do about it will have to wait for another post. The market is still currently over-focused on increased rates harming Book value instead of seeing the greater revenue from increased net interest spread. Until the sector can show it can manage the higher rates while keeping BV level, it's not quite time to get back in.

    But we're close. The end is near!

    Nov 10 8:30 PM | Link | 2 Comments
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