Anworth (NYSE:ANH) is finally on a tear. The stock has been rocketing higher over the 8 days or so. November 14 th, 2016 was the last time shares closed under $5.00 and they only touched under that level for a short period the next day before the rally got strong. Investors seemed to suddenly recognize that ANH's portfolio had the adjustable rate mortgage mortgages that are present for several of the recent winners in the RMBS mREIT space.
Why Investors Love the Adjustable Rates
The biggest risk on adjustable rate agency RMBS is the risk of prepayments. If the homeowner prepays the loan it results in a loss on the loan since the fair value of the loan is regularly more than par value. There is also some risk that rates could move dramatically higher before the rates begin resetting, but that tends to be a smaller factor than the prepayment risk outside of enormous movements higher in rates.
The rates on fixed-rate loans have been soaring higher as Treasury yields climbed rapidly following Trump's election. Those higher fixed-rate mortgages mean prepayments should be down dramatically. Yes, the Federal Reserve is expected to raise rates in December, but it is such a foregone conclusion that the impact is already priced into the cost of funds for the mortgage REITs. Short-term rates are pricing in the hike, so there is no magical change if the rate increase comes to pass in December.
Cost of Funds
The area where mortgage REITs could see an increase in their cost of funds during the next few quarters is the cost of hedging the portfolio since new LIBOR swaps would require higher rates upon entry. Those rates are not necessarily higher than the mortgage REIT was already paying though. Even though rates climbed substantially, they are still well below where they were a few years ago and many mortgage REITs have some older swaps on the books where they are still paying the higher fixed rate. Consequently, the impact on the cost of funds shouldn't be overly dramatic unless the mortgage REIT suddenly increases their hedge ratio and runs with a much larger hedge position than in prior periods.
A History of Calling This Out
It is worth mentioning (or bragging, whatever) that I predicted this move multiple times. I published 3 public articles indicating it was coming. In the middle of September, I told investors I bought the 12.2% yield on ANH. In that article:
"Anworth Mortgage Asset Corporation was the most attractively priced mortgage REIT in the sector on Friday afternoon. By the time this is published publicly, the prices may have corrected a material amount. I bought shares of ANH at $4.91 on Friday. I believe they are a great deal at that price."
Note that since then the price has increased to about $5.25 and shares paid a dividend of $.15 shortly after I acquired them. If I ended my position at $5.25, I would be up 9.9% on that investment between the dividend and the capital gain.
On October 26th, I predicted a great earnings release for ANH. At the time, I stated:
"By my estimate, current book value per share should be running around $6.25. That puts the discount to book value over the weekend in the ballpark of 22%. My estimates are based on fluctuations in asset and hedge values and shares have been rallying since the weekend."
I came back to hammer those points home with another article on November 3rd. I established a strong buy rating for ANH. In that article, I stated:
"As of the last close, shares were at $4.76 which represents a 24% discount to the Q3 book value of $6.25. The discount is 8% to 12% larger than it should be."
Even More Call Outs
I didn't write about ANH often in the public articles, but I highlighted it several times for subscribers. Since links would go to articles that are not public, I won't hyperlink these.
On 11/13/2016: Poor Anworth may be the most misunderstood of the mortgage REITs. Share prices moved slightly higher but only slightly. Meanwhile I believe book value should have taken a nice little boost. The market rewarded mortgage REITs that invested heavily in ARMs, so why were they so stingy with ANH? Did they forget what ANH carries?
I hit it with a strong buy rating at $4.97.
"I think the huge discount for ANH gives it better protection from downside risk." I repeated a strong buy rating at $4.92.
"The first two choices I want to highlight are still the same. Annaly Capital Management (NYSE: NLY) and Anworth offer the best discounts within their respective tiers. Based on prices over the weekend, those are the first two I would want to consider. I am very comfortable with share prices on each of them."
I had the strong buy rating on each with NLY at $10.22 and ANH at $4.93.
"ANH trades at a discount that is far too large."
Again, it carried the strong buy rating at $4.89.
It got another strong buy rating at $4.80.
It was a strong buy rating at $4.72.
I think you get the trend.
Remarkably No Rating
I feel no need to close down that rating. The discount to book value was so large that I can leave a buy rating open on ANH. It moved much closer to fair value, but there is no need to close the rating down yet. This is simply a case of absolutely nailing which mREIT was significantly undervalued.
While I'm not going to drop to a hold rating yet, I'm also not going to reiterate the rating. I'm not big on trend following and over half of the expected gains are no longer available because the price rose so substantially recently. Consequently, I'm neither closing existing ratings nor reiterating the rating.
ANH has been on a tear lately as investors seemed to suddenly come to a recognition of what assets Anworth is holding. The other mortgage REITs with similar assets have had an exceptionally strong period of outperformance in the sector and now ANH is joining in on that fierce rally. Of course, ANH is not all ARMs, but it is their largest allocation.
Want to know when great income investments go on sale? Consider joining The Mortgage REIT Forum. For the cost of one lunch per month, you can get access to the research I'm using for managing my own investments. On average, I publish about 3 subscription articles per week. One is for calculating new estimated book value for several mortgage REITs and finding the current discounts to those estimates. Another covers the preferred shares for each mortgage REIT that has preferred shares. The third is used to either preview articles I'm working on for the public or to provide real-time updates on liquidity failures where prices for a small number of securities detached from other similar stocks. The most notable recent alert was when Resource Capital Corporation (NYSE:RSO) went on sale.
Disclosure: I am/we are long ANH, NLY, NLY-D, RSO, RSO-B.
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.
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