As Annaly And American Capital Disappoint, This MREIT Rises - Don't Short It

| About: Western Asset (WMC)
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I have covered Annaly Capital (NYSE:NLY) and American Capital Agency (NASDAQ:AGNC) for some time now. That said, when it comes down to having a sizable yield and the ability to keep paying a high dividend, neither Annaly or American Capital can possibly be considered the top dogs anymore. Just who is kicking butt and taking names? That distinction and the title of dividend king for 2014 in the mREIT space belongs to Western Asset Mortgage Corporation (NYSE:WMC). For this analysis, I will discuss recent dividend movement and what it means for the stock you should own in 2014.

Annaly's Announcement; More Disappointment

Sometimes I am ashamed that my top mREIT holding is NLY -- at least right now. That said, I like the company long term. It's a survivor. Under $10.00, I think it is a bargain. Still it could drift lower, as the most recent dividend announcement revealed yet another cut, but I had pegged this cut in a recent article. That's why the company didn't sell off on this announcement. I stated:

"This belief [of a dividend cut] has further pressured the stock in the last month. I believe another $0.05 is likely, with a $0.08 to $0.10 cut being priced into the stock."

Still, it lowers the reward for holding the stock right now. For those who didn't see, NLY's dividend will now be $0.30. This dividend is payable January 31, 2014, to common shareholders of record on December 31, 2013. The ex-dividend date is December 27, 2013. This was another cut from the last quarter dividend of $0.35. What has, and continued to annoy me is that the company distributes dividends based on its estimate of taxable earnings per common share, not GAAP earnings. Taxable and GAAP earnings will typically differ due to items such as unrealized and realized gains and losses, differences in premium amortization and discount accretion, and non-deductible general and administrative expenses. And yet, the company historically does not release its estimates of taxable income quarter to quarter. We are somewhat left in the dark. If the capital structure of the company was stronger, I would argue for a buyback policy to be initiated like one of its main competitors

American Capital Agency; Dividend Cut A Touch Larger Than Expected But a Successful Buyback

My second largest holding in the space is AGNC. It's been a rough year accumulating this on the way down. I have a decent cost basis at $22.20 per share, but am in the hole. I continue to have faith in Gary Kain and the management team at AGNC. That said, another cut came rolling in but I was not surprised. AGNC declared a cash dividend of $0.65 per share for the fourth quarter 2013. This was a cut of $0.15 from the last payout of $0.80.The dividend is payable on January 28, 2014 to common shareholders of record as of December 31, 2013, with an ex-dividend date of December 27, 2013. I think the better news was that AGNC also announced today that in the fourth quarter of 2013, it made open market purchases of approximately 28.2 million shares of its common stock, or 7% of the outstanding shares as of September 30, 2013. The shares were purchased at an average price of $20.82 per share, including expenses, totaling approximately $586 million. I like this approach as the buyback reduces outstanding shares meaning existing taxable income can be spread among the remaining shares. This improves earnings per share and reduces the likelihood of a future cut. Still, while better than NLY's announcement, it pales in comparison to the King.

Western Asset Mortgage: I'm in Shock

Ah my fourth largest holding and one that I have been proud to own since the summer of 2013. WMC has made only one cut to its dividend taking it from $0.95 to $0.90 two quarters ago. Now, WMC has caught me by complete surprise. In a sign of strength for 2014, WMC has declared a fourth quarter and year-end dividend of $2.35 for each common share payable in a combination of cash and stock. Shareholders get a choice. Either receive their dividend in cash or stock. If too many elect to take the cash then each stockholder electing cash will receive a pro rata cash amount of no less than $0.80 per share with the balance payable in stock. The expected cash portion of the dividend may be viewed as comparable to the company's regular quarterly dividend. Do not consider this a cut from $0.90. That is foolhardy. The stock portion of the dividend is being paid by WMC to reduce its undistributed taxable income from 2013 and satisfy the REIT distribution requirements. In other words, the company was flush with cash and the law states shareholders have to get paid. I will elect to take the option in stock, to further compound my investment. How did this happen? Well built up undistributed taxable income comes from net gains realized on certain hedging transactions and the inability to offset such gains for federal income tax purposes with net capital losses realized on the sale of mortgage-backed securities.

Overall, the dividend is payable to common shareholders of record as of December 30, 2013, with an ex-dividend date of December 26, 2013. Shareholders of record as of December 30, 2013, will receive an election form allowing them to elect to receive the dividend entirely in cash or in stock. In the case of the cash portion being in high demand, each shareholder electing the cash alternative will receive a pro-rata amount of cash and stock with such cash component being no less than $0.80 per share. The payment date is January 28, 2014.

A Short Candidate?

As I was writing this a market current on Seeking Alpha popped up questioning the WMC share price relative to book value and said it was a short candidate. I guess REIT Analyst, with all due respect, didn't get the memo that you cannot just look to book value, but must ALSO look to economic return on book value for the period. What do I mean? This is the book value of the company PLUS any dividends paid during the quarter. So you cannot say look at share price versus book value (which has stabilized). Yes, NLY and AGNC are trading at huge discounts. This is because the street telegraphed at the end of Q3 further cuts to the dividend. WMC trades at a premium to its book value because it is simply outperforming its competitors as of November 30, 2013, book value. Today's book value could be materially higher (or lower) than what was reported as of November 30th. What I would do, is NOT short the thing, since the yield is so high. That is a huge gamble, and more risk than owning the stock. Instead, if you fear it's headed lower, just sell, or stay away. I am staying in the name. Those on the sidelines could wait until after the stock goes ex-dividend, and buy at a huge discount. Or, you could short it and cover the dividend. Do you really want to challenge The Street's valuation on this one, and cover the dividends? I think not.

Disclosure: I am long AGNC, NLY, WMC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.