Thoughts On A Handful Of mREITs And The State Of The Industry (Week 47)

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Includes: AGNC, AI, AMTG, ANH, ARR, BXMT, CHMI, CIM, CMO, CYS, DX, EARN, MFA, MORT, MTGE, NLY, NRZ, NYMT, ORC, REM, STWD, TWO, WMC, ZFC
by: Colorado Wealth Management Fund

Summary

The worry of the week was the jobs report, which was released Friday morning.

The 10-2 spread moved up to 80 basis points, from 78 last week. The yield curve was flatter heading into Friday, but grew a little taller.

The jobs report showed that gains were below the consensus forecast. The great news (what?) sent markets higher, and Treasury prices lower (yields higher).

To go with yields moving higher at duration beyond 1 year, the odds of a September rate hike declined from 24% to 21%.

Welcome to week 47.

When the jobs report comes in materially below the forecast, you can't help but feel great about the equity markets. As all investors know, nothing says prosperity like a smaller than expected gain in jobs. Following on the news the market gave a healthy rally to show support for fewer people being employed.

Of course, the market is rallying on more than the low number of jobs. When the jobs don't increase as fast as predicted, it reduces the odds of a rate hike by the Federal Reserve. Since a longer delay on hiking rates means investors won't get much interest on short term investments in the near future, they might as well aim for new record highs on the equity markets. What could possibly go wrong?

On the other hand, a decline in the expectation for a rate hike in the very near future is a clear positive for mortgage REITs and most of them ended the day with gains, in some cases the gains were over 2%.

The mREITs (and two ETFs)

The table is demonstrated below:

(NYSE:NLY)

Annaly Capital Management

(NASDAQ:AGNC)

American Capital Agency Corp

(NYSE:ARR)

ARMOUR Residential REIT

(NYSE:CMO)

Capstead Mortgage Corporation

(NYSE:CYS)

CYS Investments

(NYSE:DX)

Dynex Capital

(NASDAQ:NYMT)

New York Mortgage Trust

(NYSE:ORC)

Orchid Island Capital

(NYSE:TWO)

Two Harbors Investment Corp

(NYSE:WMC)

Western Asset Mortgage Capital Corp.

(NYSE:MFA)

MFA Financial

(NYSE:EARN)

Ellington Residential Mortgage REIT

(NYSE:AI)

Arlington Asset Investment Corporation

(NYSE:ZFC)

ZAIS Financial

(NYSE:AMTG)

Apollo Residential Mortgage

(NYSE:ANH)

Anworth Mortgage Asset Corporation

(NASDAQ:MTGE)

American Capital Mortgage Investment

(NYSE:CHMI)

Cherry Hill Mortgage Investment

(NYSE:STWD)

Starwood Property Trust

(NYSE:BXMT)

Blackstone Mortgage Trust

(NYSE:CIM)

Chimera Investment Corporation

(NYSE:NRZ)

New Residential Investment Corp.

(BATS:REM)

iShares Mortgage Real Estate Capped ETF

(NYSEARCA:MORT)

Market Vectors Mortgage REIT Income ETF

Spreads

Remember that the simplest explanation of the mortgage REIT is to say that they have a leveraged portfolio of long term bonds financed with short term rates. The first starting point should be reading the steepness of the yield curve, so each week starts with this reading.

I guess this week I didn't start with the reading, but it is still listed below.

7 to 1

10 to 2

Q4 2014

1.72

1.5

Q1 2015

1.45

1.38

Q2 2015

1.79

1.71

Q3 2015

1.42

1.42

Q4 2015

1.44

1.21

1/8/2016

1.27

1.19

1/15/2016

1.3

1.18

1/22/2016

1.34

1.19

1/29/2016

1.2

1.18

2/5/2016

1.03

1.12

2/12/2016

0.99

1.03

2/19/2016

1

1

2/26/2016

0.95

0.96

3/4/2016

1.02

1

3/11/2016

1.09

1.01

3/18/2016

1.04

1.04

3/24/2016

1.07

1.02

4/1/2016

0.94

1.03

4/8/2016

0.93

1.02

4/15/2016

0.99

1.02

4/22/2016

1.11

1.05

4/29/2016

1.04

1.06

5/6/2016

1.04

1.05

5/13/2016

0.96

0.95

5/20/2016

0.98

0.96

5/27/2016

0.99

0.95

6/3/2016

0.9

0.93

6/10/2016

0.87

0.91

6/17/2016

0.9

0.92

6/24/2016

0.87

0.93

7/1/2016

0.82

0.87

7/8/2016

0.71

0.76

7/15/2016

0.9

0.89

7/22/2016

0.85

0.86

7/29/2016

0.79

0.79

8/5/2016

0.85

0.87

8/12/2016

0.8

0.8

8/19/2016

0.84

0.82

8/26/2016

0.87

0.78

9/2/2016

0.88

0.8

Source: Data from Treasury Website

Rate Movements

Slightly steeper is still good for something, even if it isn't much. The curve has been pretty flat for a while, but the spread between agency RMBS yields (or expected yields) and the expected cost of financing through repurchase agreements (including the cost of hedging with LIBOR swaps) was still large enough to provide a decent incentive for investors.

Price Movements

The hike in mREIT prices seems like it makes sense, but some of the top gainers were mREITs with extensive credit exposure and the possibility to earn higher interest rates on their investments if the 1 year LIBOR rate moves higher. The market didn't seem too preoccupied with assessing which mREIT owns which investments, it simply saw markets higher and delayed expectations for a hike (really, is 24% and 21% that different?) and went into rally mode. I won't complain too much, I own a few of the mREITs and if the market moves rapidly and ignores the contents of the portfolio it helps me find better opportunities. An efficient market would really devalue my work since all changes would be instantly incorporated and analysis would become useless.

Want to learn more?

Since the Mortgage REIT Forum is a new exclusive research platform, the first 100 subscribers will be able to lock in their subscription rates at only $240/year. My investment ideas emphasize finding undervalued mortgage REITs, triple net lease REITs, and preferred shares. With the market at relatively high levels, there is also significant work on finding which securities are overvalued to protect investors from losing a chunk of their portfolio.

Disclosure: I am/we are long MTGE, ZFC.

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.

Additional disclosure: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. This article is prepared solely for publication on Seeking Alpha and any reproduction of it on other sites is unauthorized. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis.