Quick And Dirty mREIT Discounts For 6/4/2019

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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 a major part of evaluating mortgage REITs.

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

The ideal method utilizes current estimated book values, but using trailing book values is quick, and it still provides enough information to enhance decisions.

Prices are from 6/4/2019 (before close), trailing book values are as of 3/31/2018. Our subscriber series uses book values updated for projected change in book value.

We have far more opportunities available today than in prior months.

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

AGNC Investment 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 3/31/2019. We're still using tangible book value, so assets such as "Goodwill" are stripped out. We believe this creates a much better comparison.

Ticker Q1 Tangible BV Price Price to Trailing Tangible BV
AGNC $17.23 $17.54 1.02
ANH $4.76 $4.16 0.87
ARR $21.29 $19.11 0.90
CHMI $17.54 $17.20 0.98
CMO $9.43 $8.70 0.92
NLY $9.67 $9.72 1.01
ORC $6.82 $6.54 0.96
CIM $16.15 $19.05 1.18
DX $6.24 $6.00 0.96
IVR $16.29 $16.20 0.99
MFA $7.11 $7.49 1.05
MITT $17.44 $16.84 0.97
NYMT $5.75 $6.28 1.09
TWO $13.83 $13.63 0.99
WMC $10.70 $10.54 0.99
EARN $12.69 $11.67 0.92

We've got a few rating updates to provide. The summaries will come from CWMF: Residential Mortgage REITs Sector Update. In that article, we provided a thorough explanation of several key factors driving fundamentals.

Which REITs are Ripe For Trading?

We want to use sector momentum to our advantage. We want to catch REITs that have recently underperformed through no fault of their own. That eliminates Arlington Asset Investment Corp. (NYSE:AI) has been the worst performer, but it was due to massive book value losses, issuing dilutive equity, and we’re not particularly fond of their issuing preferred shares at an 8.25% coupon rate. Those moves all stink of terrible management. While most price-to-book targets are increased, we’re lowering the targets on AI to demand a larger discount on the stock.

The following chart highlights NLY, Two Harbors, and ARMOUR Residential REIT as 3 REITs which appear to be hitting attractive valuations.

Note: We arranged the order of the stocks on the right to match the order of the lines as they enter the chart. That should make it a little quicker to spot the relevant line.

Based on that chart, MFA Financial would be pretty dangerous. They did quite well the last two quarters and we still like their fundamentals, but we are concerned by their momentum relative to the sector. They went from a cheaper than average price-to-book ratio to a far above average ratio. The only two residential mortgage REITs with higher price-to-book ratios are Chimera and New York Mortgage Trust, which have regularly been the two REITs with the highest price-to-book ratios.

We also have Dynex Capital and Anworth within our target buying ranges. However, we’re prioritizing the other 3 on the basis of recent relative performance. DX and ANH don’t have the “benefit” of recently underperforming their peers by a large margin. That separates them from NLY, TWO, and ARR as short-term trading opportunities.

Outlooks

Bullish on DX, ANH, NLY, TWO, and ARR. Neutral on MFA.

Trading

We see the preferred shares as a superior option for investors hunting for a long-term buy-and-hold investment. The preferred shares carry slightly lower yields but have substantially less risk. Investors who don't care about the risk level are taking excessive risks for very marginal expected returns.

We utilize the common shares as a trading investment because many investors in the sector don't understand how to project current book values or how to evaluate the spreads between mortgage rates and hedging rates. Our outlooks on the common shares should be seen as a view on the potential for trading opportunities.

Disclosure: I am/we are long TWO, NLY, DX, ARR, AND SEVERAL 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.