Mortgage REIT Discounts Remain: Recent Questions Answered
Summary
- Uncertainty around earnings is exceptionally high. The volume of reader questions we are getting remains elevated.
- We'll run readers through several of the best questions we've heard lately.
- March was rough for all mortgage REITs, but it was much more difficult for the mortgage REITs taking on more credit risk.
- Two of the mortgage REITs we are bullish on today are NRZ and CIM. Each trades at a very unusual discount and recently provided its latest earnings reports.
- Looking for a portfolio of ideas like this one? Members of The REIT Forum get exclusive access to our model portfolio. Get started today »
As the mortgage REIT earnings reports come in, investors are finding out how different mortgage REITs can be. With so many reports coming in, we're seeing an elevated volume of questions of investors. Consequently, we want to share several of the best questions and answers we've had lately.
The topics we discuss are going to be extremely relevant to the residential mortgage REITs:
| Ticker | Company Name |
| (AGNC) | American Capital Agency Corp. |
| (AI) | Arlington Asset Investment Corporation |
| (ANH) | Anworth Mortgage Asset Corporation |
| (ARR) | ARMOUR Residential REIT |
| (CHMI) | Cherry Hill Mortgage Investment |
| (CMO) | Capstead Mortgage Corporation |
| (NLY) | Annaly Capital Management |
| (ORC) | Orchid Island Capital |
| (DX) | Dynex Capital |
| (CIM) | Chimera Investment Corporation |
| (EFC) | Ellington Financial |
| (IVR) | Invesco Mortgage Capital |
| (MFA) | MFA Financial |
| (MITT) | AG Mortgage Investment Trust, Inc. |
| (TWO) | Two Harbors Investment Corp. |
| (WMC) | Western Asset Mortgage Capital Corp. |
| (NYMT) | New York Mortgage Trust |
| (NRZ) | New Residential Investment Corp. |
| (PMT) | PennyMac Mortgage Investment Trust |
Sector Overview
The month of March was particularly hard for mortgage REITs exposed to credit risk. It was still rough for mortgage REITs focused on Agency MBS, but it wasn't as rough on average. When we get into mortgage REITs focused on credit assets, the disparity in performance is dramatic.
The Agency group:
- AGNC
- AI
- ARR
- CHMI
- CMO
- DX
- NLY
- ORC
The Non-Agency group:
- ANH (barely, they are more agency than most listed here)
- CIM
- EFC
- IVR
- MFA
- MITT
- WMC
Multipurpose (too many unique aspects to toss into one category):
- NYMT
- NRZ
- PMT
Note: Two Harbors started the quarter as "non-agency" and ended as "agency", consequently we didn't list TWO as part of either group. Its non-agency exposure was the overwhelming factor in its first-quarter performance, so lumping them in as Agency MBS could be confusing for some people.
With the general sector layout established, let's get into the questions we've been hearing.
Annaly Capital Management
Question: Curious about this statement made by Annaly CFO Serena Wolfe on the NLY results call this week:
"It is important to note that the vast majority of our assets and liabilities are at fair value. And our book value reduction illustrates a significant market disruption that occurred prior to quarter-end and the impact on fair value measures. Our book value decline was not a function of forced asset sales but rather unrealized mark-to-market losses with potential full recoupments."
Does this statement suggest that, as the market situation improves, say over the next 12-18 months, the book value would recoup much of the loss experienced over the last few weeks, not necessarily by releveraging but through a natural improvement in the underlying FMVs of its assets? Does this also apply to AGNC?
This seems to imply better upside opportunity over time than your current price targets suggest, and other mREITs that suffered BV losses as a result of forced sales, etc.?
Answer (By Scott Kennedy):
I would just point out, as indicated in yesterday's "rapid fire" article, the vast majority of recent valuation losses were within NLY's hedges (NOT MBS). That's where the losses occurred. Since rates are notably lower, the probability of another extremely severe valuation loss within NLY's derivatives has now notably decreased. Also, NLY terminated / cancelled a good chunk of derivative instruments. That "loss per se" is already booked and they won't be getting that back (those sold positions are gone / closed).
She's stating that, yes, the agency MBS values temporarily "dropped off a cliff" but they subsequently rebounded. A majority of NLY's MBS position was NOT sold. As such, as pricing has continued to stabilize-move higher in April (especially spec. pools), assets values have continued to improve.
Now, that said, MBS / agency pricing, across the board, are approaching recent historical highs. This is directly due to the "rush to safety" and the FED's very aggressive purchases in this specific marketplace. Could pricing "tick up" another couple percentage points? Yes, they can. However, I would just keep prepayments in mind; as well as premium amortization. The higher the purchase price, the larger the amortization expense becomes on new purchases.
If, for some unknown reason(s), rates / yields materially increase in say May, NLY would certainly be vulnerable to MBS price decreases with a historically low hedging coverage ratio to mitigate these MBS losses with derivative valuation gains. If rates / yields remain low, then NLY is in better shape when it comes to BV.
Beta and Book Value
Question: The REIT Forum provides price levels below which mREITs are buys or strong buys. They are updated often, but between updates, should we beta-adjust them based on SPX's moves? According to Yahoo Finance, the iShares Mortgage Real Estate Capped ETF (REM) has a monthly beta of 1.6 to SPX over the last 5 years. If price levels are not adjusted, you are trading a stock market mean reversion system on top of a deep-value mREIT strategy.
Answer (by CWMF):
Look at changes throughout the sector and changes in REM to get a feel for any momentum issues. That'll give you a better estimate of the potential impact from recent momentum. IE, if 4 of the agency mortgage REITs just fell by 10% and one did not, that 1 is much more exposed to downside than if the other 4 had just rallied by 10%.
Answer (by Scott Kennedy):
I would just point out SPX moves don't "coincide" with daily CURRENT BV fluctuations. That's important to understand.
Simply put, there's no way we can accurately provide daily BV / NAV fluctuations on all the stocks we cover. Just for the 21 mREIT stocks I cover, it takes, at a minimum, of 7 hours to model out each mREIT portfolio (including both investment and derivatives portfolio). There's easily 10 factors constantly at play which directly impact underlying CURRENT BVs. If I'm not mistaken, we are the only service to even provide any type of projected CURRENT BV throughout the entire quarter, let alone weekly.
I also would not track / shadow REM's price movements to our projection of CURRENT BV. Again, two different valuation concepts going on there. Unless we see / are expecting a 5%+ move weekly in CURRENT BVs, the figure we provide as of the prior week's end should remain appropriate the following week. The only other exception to this is when a company reports earnings and provides a material update to their portfolio (which just occurred this past week regarding a couple of the mREITs).
When do Dividends Return?
Question (for Scott): I am new to the service and love the quality of information. I do have a question, please. How long do you think it might be before the mREITs' dividends return to their pre-crisis levels, and considering everything the Fed has done recently, do you see the dividends eventually surpassing where they were pre-crisis?
What entities are likely to survive to pay preferred dividends, and which ones aren't?
Answer (by Scott Kennedy):
Welcome and thanks for joining.
Regarding dividends, I still believe the mREITs want to preserve capital in this environment. Regarding raising dividends, you really have to go from "mREIT-to-mREIT". Some decreased the dividend (70%)-(90%) while others cut the dividend only (25%). Generally speaking, the ones who are grouped in the first classification have a higher probability of an increase moving forward. For the agency mREITs, I believe the new dividend level is a level that will be sustained, in most instances, through the rest of 2020.
If you have a specific mREIT in mind, then I can "tailor" my answer more specifically.
Granite Point Mortgage Trust
Question (for Scott): Can you comment on why you think there is such a large disconnect between your analysis of GPMT and the market's analysis. I mean, with so much uncertainty settled out in the MRET market, why is GPMT still being so punished by the market. I picked up some shares around $4.00 and am wondering if I should buy more at current prices, but would like your read before doing so. Thank you.
Answer (by Scott Kennedy):
Even though I currently have GPMT as an investment, I also acknowledge there WAS stress on their investment portfolio this past quarter. No different when you "dig deeper" into BXMT's portfolio.
This might sound "counter" to what a typical investor thinks / believes but I want to see GPMT report a BV decline that is closely "aligned" to my projection. That's where their FMV "should be". If they report a (3%) decrease in BV, which would be similar to what BXMT reported, then I will also "call out" GPMT management on their assumptions / judgments.
Simply put, 19 other mREIT peers are, for the most part, trying to correctly value their investment portfolio (even when there's level 3 assets which don't have a direct quote or similar quote). As such, why should 2 peers be put on a different "playing field" and base FMVs off of a "best case" or near best case scenario. Simply put, they shouldn't. There should be an "even playing field". Commercial whole loans, as an entire sector, experienced a steep decline in valuations in March; just like basically all other sectors (except "rush-to-safety" assets). That should be represented in BVs..."
Regarding the whole market perspective, the market is obviously discounting a very large portion of GPMT's investment portfolio is either on non-accrual status and/or at a VERY HIGH risk of default. My recommendations price certainly price in a lot of stress (but not over HALF the portfolio as is implied in the pricing).
Two Harbors Preferred Share vs. AGNC and NLY Preferred Shares
Question: Any thoughts on why TWO preferred shares are trading below AGNC and NLY preferred shares? I thought TWO was mostly Agency MBS at this point.
Answer (by CWMF):
They are mostly agency now, but they also have some MSR exposure and their ratio of common equity to preferred equity is lower (weaker coverage for the preferred share).
How Much in Equity REITs?
Question: If you were to start a portfolio today from scratch, what percentage would you devote to equity REITs for long-term growth (not income)?
Answer (by CWMF):
For building a portfolio with equity REITs long term, I'd say a minimum of 25% and a maximum closer to 70%, though I should point out that I tend to allocate vastly more to REITs than to other sectors simply because I understand REITs and like to invest in the companies I understand. Most investors would want far more diversification within their portfolio.
Another difficulty in answer the question could be the amount of the portfolio that is in tax-advantaged accounts. The more tax-advantaged accounts I can use, the more I want to incorporate our preferred share and trading strategies. Those trading techniques are less tax-efficient, but we've generated extremely strong returns with them.
NLY-D vs. NLY-F and NLY-I
Question: Trying to get a read on how to gauge price recovery for mREIT prefs, especially those I own. I charted 3 months of NLY-D (NLY.PD), NLY-F (NLY.PF) and NLY-I (NLY.PI).
All three ran close together until March 13, when NLYpD opened a gap that's hovered around $2 above the other two. I'm wondering if that signals a new normal significant differentiation between fixed-rate NLY-D shares and fix-to-float NLY-F and NLY-I preferred shares?
Answer (by CWMF):
While prices are at least a few bucks under $25.00, you'll probably see NLY-D with the highest share price. If we see a bit of credit spreads thinning, we should expect the other NLY preferred shares to outperform because NLY-D would have a hard time rallying past about $25.70 or so (due to call risk).
MFA Survival
Question: How do you view the prospects for MFA's survival and the prospects of preferred dividend resumption?
Answer (by Scott Kennedy):
Under the 2nd Forbearance Agreement, there can be no dividends declared; common or preferred. As such, def. won't be any dividend resumed prior to June 2020.
MFA still isn't out of the woods. We'll get a much better "read" when they announce earnings. That's when many of the puzzle pieces are provided.
Which REITs Are Most Uncertain?
Question: What mREITs are you most unsure about their announcements coming into earnings season?
Answer (by Scott Kennedy):
I'd say MITT is up there on the list. They have yet to disclose a BV range. They are the only mREITs who publicly announced they couldn't meet margin calls at some point during March / April, to not subsequently provide a BV range. As such, when it comes to my projections, I am remaining cautious. I remember one or two subscribers, at the time, basically "called me out" on the my cautious MITT BV estimates at the time. However, as IVR more recently disclosed, a (70%+) decrease in quarterly BV is certainly not out of the question. In the end, all depends how management reacted to the situation.
It will also be interesting how BXMT and GPMT valued their holdings as of 3/31/2020. Simply put, there's some "managerial judgment" that will go into their values (similar to the BDCs). If their valuations notably differ vs. my projection, as is the case with any mREIT or BDC I cover, I will "call them out" on it. In most instances, when I do this, the company subsequently adjusts their valuations to a more "appropriate" level the following quarter (of course while factoring in current quarter movements).
Conclusion
Uncertainty amid the Q1 2020 earnings is exceptionally high. Some mortgage REITs have delivered far more information to shareholders than others. Even though some mortgage REITs provided significant guidance prior to their earnings releases, we're still witnessing exceptionally high volatility.
There are several attractive opportunities in the sector today. We aren't going to highlight all of them, but I will mention two of our Buy ratings.
We're bullish on NRZ and CIM.
Both NRZ and CIM very recently announced their Q1 2020 earnings. We'll have additional coverage coming up on both stocks. They have a few key traits we want to highlight. Each REIT has a somewhat unique structure. NRZ has operating businesses and CIM runs a huge portion of its credit risk through securitizations (reducing exposure to repo financing). Further, they both have a long history of trading near or above book value, rarely below it. Their price-to-book ratios were often among the highest in the mortgage REIT sector. Finally, each currently trades at a substantial discount to current book value.
We've purchased shares of NRZ three times and shares of CIM twice. Those 5 purchases (combined) all came from 3/31/2020 through 4/14/2020. We waited for years to see these mortgage REITs trade at large discounts to book.
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Colorado Wealth Management is a REIT specialist who began his decades-long investment career in a family-owned realtor office before launching his own company and embracing his drive for deep-dive REIT analysis. He passed all 3 CFA exams. He focuses on Equity REITs, Mortgage REITs, and preferred shares.
Features of the group include: Exclusive REIT focus analysis, proprietary charts and data models, real-time trade alerts posted multiple times a month, multiple subscriber-only portfolios, and access to the service's team of analysts and support staff for dialogue and questions on the REIT space.
Analyst’s Disclosure: I am/we are long ANH, CMO, NRZ, CIM, AIC, IVR-C, NLY-F, NLY-I, CMO-E, AGNCO, MFO, NYMTM, ANH-C, NYMTN, TWO-B, MFA-C, TWO-A. 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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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