mREIT Preferred No Fluff Update - June 30, 2017

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Includes: AGNC, HCFT, PMT, XAN
by: Rubicon Associates

Summary

The universe yields just shy of 8% (7.95%) and the optimal list yields 7.88% - approximately 3 bps lower than last week.

Investors pay approximately 281 basis points for the preferred stability (+1 from last week) and receive over 568 basis points above the risk-free rate (-14 bps from last week).

The average price on the universe is up $0.09 on the week to $24.89.

New to the "no fluff" this week is the addition of PennyMac (PMT) and their preferred stocks (they have a new issue and my numbers have been adjusted accordingly) and some additional numbers in the price data and equity coverage tables. In the price data table, I have included the range to give a sense of the high-low distance - the greater it is, the greater the potential volatility of the preferred (recall that most investors want a nice stable price chart for their preferred stocks). In the equity coverage table, I have included the market capitalization to preferred (at liquidation value, i.e., shares times par) in order to give another metric for coverage. I have also added generic current coupon 15- and 30-year mortgages as a chart at the end.

All-in-all, it was a decent week for mREIT preferreds and I don't see that changing in the near term. I like valuations at these levels and continue to hold my positions and will potentially add more (still determining which ones).

Without further ado, the universe:

The universe yields just a tad shy of the 8% mark, still a healthy yield/income level for the space.

The "optimal list" (the one preferred from each issuer that appears to have the best balance of call protection and yield):

Before getting to the graphs (yes, there are always graphs), there was an article written this week by Nikolai Gouliaev (found here) that believes I am in error in choosing the AGNCB issue from AGNC Investment (AGNC). He makes very valid points in the article, it is worth a read. Given my view on rates (going a bit higher than they are now), I am considering selling call protection and Nikolai has some good points as to how to look at the ability of a REIT to economically refinance. Potentially being wrong is fine, refusing to accept you might be wrong and reassess your thesis is not fine.

Graphically, the stripped price:

And the stripped yield:

The cost of stability this week was 281 basis points - 1 bp higher than last week but still lower than a month ago. A reader asked me the value of this metric and what it means, so here goes: when purchasing the preferred stock of mortgage REITs, there is a trade off - you will get less yield on the preferred stock than you will on the common equity due to the lower volatility (and known dividend) of the preferred. In other words, you are paying up (on a yield basis) to reduce uncertainty. The value comes in two forms - the directionality (is that even a word?) of the number or what is the trend in the value of stability and the absolute number or are you giving up too much yield given the outlook. Personally, I am willing to pay up for the stability as I think the market has overly discounted the effect of the Fed's balance sheet unwind on mortgage spreads (and values) as well as the potential balance sheet/book value/earnings impact of higher rates after the brief interruption of lower/calmer rates.

I am trying to assemble historical data on this to get a better relative feel for where we are versus where we have been.

Graphically:

The spread to the risk free (the risk premium as it were) is currently 568 basis points - this has compressed 15 bps over the last week as the 10 year has increased 14 basis points in yield and the preferreds have had positive price action.

Graphically:

Price data for the preferred stocks and equities over the last week - with the new "range" column referred to earlier which shows Five Oaks (OAKS) and Resource Capital (RSO) as having the greatest ranges (and potentially higher volatility risk):

Graphically, the highs and lows:

And the ranges:

A brief equity overview of the preferred issuers:

Graphically:

Book value change graphically:

The equity coverage table referenced earlier (with fancy new color coding for the weakest - red - and the strongest - green)

The five- and ten-year swap rates - note the tick up, pay fixed guys will have a bit of a negative on their mark to market:

Current coupon mortgages respond in kind:

To those in the States - have a great independence day, many have given so much for us to be where we are. To those abroad, enjoy the day and remember your fallen and the luxuries they have afforded - and still afford - your countrymen.

Disclosure: I am/we are long NLY, MITT, MTGE, OAKS, CYS.

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: I am long the common stock of NLY, CYS, LADR and MTGE and the preferred of OAK (Series A), MITT (Series B) and NYMT (NYMTO).

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.