Hybrid mREITs vs. Agency mREITs

by: Todd Johnson

Investors constantly ask me, "are hybrid mREITs safe?". My answer is a constant "everything is safe at a low enough price". Let's look at the hybrid mREIT space. There is a lot of confusion in risks and valuations in owning hybrid mortgage backed securities (MBS). This is a dynamic sector. These funds are levered and therefore, mistakes or correct actions have a draconian impact upon book value per share.

Sell Recommendation: IVR Hybrid mREIT

Let me cut to the chase: I recommend selling Invesco Mortgage (NYSE:IVR) for reasons mentioned in the below mREIT commentary. They are clearly under performing the mREIT sector, including the hybrid mREIT niche.

I previously wrote the article, titled "Sticking With Proven agency mREIT Winners Until Invesco Proves Itself" on July 12th. How could a company with Wilbur Ross personally invested, lose so much book value per share (BVPS) in the ideal mREIT market? I do not know the answer. The short-term answer is clear. Stick with agency mREITs or proven non-agency mREITs. IVR has clearly shown it is not performing equal to its peers.

click on image to enlarge

IVR is under performing the S&P 500 since its IPO. The above chart does not reflect tomorrow's secondary or the fact that the book value per share is $18.39 as of July 31st, 2011. If the swaps or non-agency MBS was not adjusted since July 31st, we can not rest assure that the present day BVPS has not continued to decrease. The company has not provided a BVPS as of August 17th when the new IVR secondary was announced.

Define: Hybrid Mortgage REITs

Hybrid mREITs own mortgage backed securities (MBS) or any debt obligations which do not have an implicit guarantee of the U.S. Federal Government. Fannie Mac, Freddie Mae, Ginnie Mae all are Governmental Sponsored Entities. GSE's possess implicit U.S. Federal Government guarantees.

Hybrid mREITs own, technically, riskier MBS than agency mREITs. This does not mean the non-agency MBS is toxic. A friend, for example, purchased a home for his family. The cost was $950,000. He did not qualify for a Freddie Mac loan. The 2010-2011 loan limit in the domestic U.S., is $417,000.

His wife is a medical doctor in a high-paying specialty field. Her income is $500,000 per year. They were able to obtain a jumbo loan, non-agency MBS, because of her profession. Although I have not been invited to their social gatherings, including holiday parties, the house by all accounts is gorgeous. The non-invitations are a side-issue and best left addressed in a private discussion. My jealousy is not relevant. The fact remains this household is more than able to make their mortgage payments on their palatial estate.

As long as underwriters perform rigid underwriting-duties on borrowers, the less risk in non-agency MBS potential losses. Recent history has proven there was lack of due diligence in the mortgage underwriting industry.

Short-Term Price Resistance: August 19th Option Expiration

Option traders, and equity investors, know this Friday is the third Friday of the month. The third Friday means the August 2011 options expire. Many stocks, including American Capital Agency Corp. (NASDAQ:AGNC) trading at sub-$30, have a lot of upside resistance due to outstanding calls and puts. These derivatives expire this Saturday, technically, and Friday for all intents and purposes.

I believe we will see an AGNC bounce above $30 when next Monday arrives. Take note in the equity and outstanding calls and puts for August. These option ratios and outstanding option counts can have a direct impact on short-term weakness or strength.

mREIT Insiders: Stock Buybacks

Two Harbors Investment Corp. (NYSE:TWO), a hybrid mREIT, insiders purchased a total 81,000 shares between August 8th - August 9th. This equates to close to $750,000 in insider buying. This, in my opinion, is significant. The stock has rallied 10% since then, so the easy money has been made.

IVR had 25,000 insider purchases in early August. Kelley Karen Dunn, director, purchased 20,000 shares at $17.90 price per share. This $358,052.00 transaction occurred on August 10th.

Annaly's (NYSE:NLY) Chief Strategic Officer, Kevin Keyes made an insider purchase of 50,000 shares on August 8th. The cost per share was $17.13 and a total transaction value of $856,500.00. This is a significant insider purchase too.

Insiders are not always right. Insiders, however, have a sense of the industry as they are operating on public knowledge and working with corporate leaders. They can appreciate when their company is undervalued by the market place.

mREIT Secondaries: Good or Bad

Both hybrid and agency mREITs can offer secondaries to the public. An investor must recognize mREITs as leveraged bond funds versus the typical stock. If McDonald's (NYSE:MCD) wants to raise additional funds, they can either sell debt instruments or issue a MCD secondary.

An IVR secondary, issued last night, is quite different. Per the 8K, IVR's book value decreased to $18.39 price per share as of July 31st, 2011. IVR's book value was $19.34 on June 30th. The swaps and losses in non-agency MBS have impaired IVR's book value per share. This is exactly the wrong way to operate a mREIT.

An effective mREIT secondary provides shares to the public at a premium to BVPS. This results in the mREIT possessing an increase to BVPS as money received via the secondary was above the BVPS. These funds are then used in the mREIT market to purchase positive yield spreads for enhanced shareholder dividends.


As investors we can choose to invest in agency mREITs or hybrid mREITs. AGNC, NLY, HTS, CYS own agency MBS. The annual dividends are 14% and higher. In my opinion, there isn't a need to leave the safe lands of implicitly U.S. Government-backed MBS mREITs. The risks in non-agency MBS are well known.

Separating Hybrid mREITs vs. Agency mREITs
Company Hybrid or Agency Symbol Aug 17th

Stock Price

June 30th


Price to BVPS Dividend Yield
Annaly Agency NLY $18.31 $16.45 1.11x $2.60 14.2%
Anworth Agency ANH $7.28 $7.06 1.03x $1.00 13.7%
American Agency Agency AGNC $29.96 $26.76 1.12x $5.60 18.7%
Capstead Agency CMO $13.23 $12.46 1.06x $1.92 14.5%
Chimera Hybrid CIM $3.18 $3.35 .95x $0.52 16.4%
Cypress Agency CYS $13.65 $12.35 1.11x $2.40 17.6%
MFA Hybrid MFA $7.66 $7.43 1.03x $1.00 13.0%
Hatteras Agency HTS $28.24 $26.72 1.06x $4.00 14.2%
Invesco Mortgage Hybrid IVR $19.29 $19.34 .99x $3.88 20.11%
Two Harbors Hybrid TWO $10.01 $9.89 1.01x $1.60 16.0%

Disclosure: I am long AGNC, HTS, NLY, CYS.

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