Quick And Dirty mREIT Discounts For 5/02/2019

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Includes: AGNC, ANH, ARR, CHMI, CIM, CMO, DX, EARN, IVR, MFA, MITT, MORL, MORT, NLY, NYMT, ORC, REM, TWO, WMC
by: Colorado Wealth Management Fund
Summary

Discounts to book value are one critical aspect in evaluating mortgage REITs.

We use this series to compare the latest share price with the trailing book value per share.

AGNC and NLY both announced reductions to their common dividend. We've been warning investors about the need for reductions for years.

Investors can utilize price-to-book as part of a trading strategy for the common shares.

Investors looking for income should consider using the preferred shares for a much lower risk alternative.

One of the most important steps in evaluating mortgage REITs is finding the price to book value ratios. Using the mortgage REITs book value gives us an idea for the general range the mortgage REIT should trade in. We expect that all mortgage REITs holding similar assets will generally be correlated with each other.

If you see several mortgage REITs trading at 15% or greater discounts to book value, you should expect comparable mortgage REITs to also trade at material discounts to book value. If a few are trading at premiums, while others trade at huge discounts, it usually represents an opportunity.

The mREITs

I put most of the residential mREITs, two ETFs, and one ETN into the table:

AGNC

American Capital Agency Corp.

ANH

Anworth Mortgage Asset Corporation

ARR

ARMOUR Residential REIT

CHMI

Cherry Hill Mortgage Investment

CIM

Chimera Investment Corporation

CMO

Capstead Mortgage Corporation

DX Dynex Capital
EARN

Ellington Residential Mortgage REIT

IVR

Invesco Mortgage Capital

MFA MFA Financial
MITT

AG Mortgage Investment Trust, Inc.

NLY

Annaly Capital Management

NYMT

New York Mortgage Trust

ORC

Orchid Island Capital

TWO

Two Harbors Investment Corp.

WMC

Western Asset Mortgage Capital Corp.

REM

iShares Mortgage Real Estate Capped ETF

MORT

VanEck Vectors Mortgage REIT Income ETF

MORL

UBS ETRACS Monthly Pay 2x Leveraged Mortgage REIT ETN

The goal here is to have a fairly large sample size, so we can identify trends and similarities throughout the sector. The mREIT sector only contains about 25 total organizations, but the investing and hedging strategies have very material differences.

Price-to-Book Value

We tend to use tangible book value. That's like GAAP book value, but if we spot significant allowances related to tax assets or goodwill, we eliminate those from equity. Consequently, the book value we are using may be different from what you're seeing elsewhere.

We also correctly handled preferred equity. If you're seeing a value that is dramatically different than what we are presenting, the most common cause is a failure of the other tool to properly handle preferred equity. We are regularly challenged on these numbers, but we are consistently right.

On the REIT Forum, we provide estimates of price to current tangible book value. Those estimates incorporate the impact of expected changes in book value throughout the quarter. For the public article, we're providing price to trailing book value, which utilizes the book values as of 12/31/2018. We're still using tangible book value, so assets such as "Goodwill" are stripped out. We believe this creates a much better comparison.

Ticker Q4 Tangible BV Price Price to Trailing Tangible BV
AGNC $16.56 $17.54 1.06
ANH $4.71 $4.16 0.88
ARR $20.86 $19.11 0.92
CHMI $17.58 $17.20 0.98
CMO $9.39 $8.70 0.93
NLY $9.39 $9.72 1.04
ORC $6.84 $6.54 0.96
CIM $15.90 $19.05 1.20
DX $6.02 $6.00 1.00
IVR $15.27 $16.20 1.06
MFA $7.15 $7.49 1.05
MITT $17.21 $16.84 0.98
NYMT $5.65 $6.28 1.11
TWO $13.11 $13.63 1.04
WMC $10.45 $10.54 1.01
EARN $12.30 $11.67 0.95

Q1 2019 Earnings

Some of the mortgage REITs have already reported their Q1 2019 figures. However, many have not. For the "quick and dirty" series, we stick to using the trailing figures until all, or almost all, of the mortgage REITs have reported their latest figures.

Why don't we update the ones that have reported in this series? Because often the majority of residential mortgage REIT book values will move in the same direction. They won't all move by the same amount, but the results will have a significant correlation.

For instance, so far the Q1 2019 results are generally somewhere between flat and up 4% for book value. If we used the new book value for a mortgage REIT which just reported a 4% gain, but didn't use a similar estimate for a peer with a similar portfolio, it would reduce the usefulness of the results.

We run a similar series for subscribers of the REIT Forum. In that series we update book values as they are reported, but we also use estimated book values throughout the entire sector. Even as the mortgage REIT reports their results for 3/31/2019, we are using that to update the estimated BV for 5/2/2019. This is the ideal method. The best information we can use for comparisons relies on real-time estimates throughout the sector. Absent those real-time estimates, the next best thing is to use the exact same date for each mortgage REIT. Our latest earnings updates and full charts are in CWMF: Mortgage REIT Earnings Updates. We provided a RapidFire review of each residential mortgage REIT in CWMF: RapidFire Residential Mortgage REITs.

Dividend Outlooks

AGNC & NLY put substantial pressure on the sector by guiding for dividend cuts.

AGNC announced an intent to go from $.18 to $.16.

NLY announced they were finally planning to go from $.30 to $.25.

We’ve warned investors for years that dividend levels were unsustainable, though we are a little surprised about NLY choosing to announce it now. They still had a premium to book value, so they would’ve been in a fine position to continue issuing new shares. Remember that NLY is externally managed, so issuing equity creates a permanent increase in income for the external manager.

Our best guess on why NLY made the choice is simple: A reaction to AGNC.

They didn’t want to be seen as being slow to move. Following Gary Kain’s remarks on the AGNC Q1 2019 earnings call, they didn’t want to say: “Everything is fine.”

If NLY argued that everything was fine, they would look much worse for cutting in a few quarters.

Given the cuts, we wouldn’t be surprised to several more mortgage REITs follow suit over the next few quarters. Cutting dividends could push the price-to-book ratios a little lower on average for the sector. That makes sense since the valuations are influenced by book values and dividend yields.

These dividend cuts should not have any impact on the preferred shares! Investors in the preferred shares can rest easy. Those shares are still solidly covered.

Outlook

Our outlook on NLY is neutral. Shares declined by enough to trade at a reasonable price-to-book ratio. We were bearish quite a few times when the ratio was higher and when it appeared book value was more likely to decline. While book value could decline at any point, there are certain signs (such as very tight spreads) that make a decline more likely. Today we do not see sufficient reason to be either bullish or bearish on the common stock.

Conclusion

We've been warning investors for years that the double-digit dividend yields were too high. We warned that many mortgage REITs would need to cut dividends. Over the years we took a great deal of flack for that view. While many of the mortgage REITs did cut dividends as predicted, Annaly maintained theirs at $.30 for several years. When they finally did announce a reduction, it was knocking the dividend all the way down to $.25 per quarter.

Our viewpoint is simple. The common shares are an excellent tool for trading. We spot the changes in price-to-book and use those to find opportunities to enter or exit. For long-term income, the stability of the preferred shares offers a much lower risk alternative that still carries a very high yield. On a risk/reward basis, the preferred shares have been offering a much more compelling alternative.

Disclosure: I am/we are long DX and a handful of preferred shares. 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.