Mortgage REITs Rip Higher
Summary
- We’ve been telling investors for the last 2 months that price-to-book ratios were too good (too low) to last.
- We’ve included tables to reflect the discounts to trailing book value. The subscriber series uses current estimates for book value, which results in different ratios.
- We’re including a few recent ratings along with the index cards for those REITs. The estimated book value within the index cards uses current (as of this week) estimates.
- We’re still bullish on NLY, NRZ, ANH, AI, and AGNCP.
- Looking for a portfolio of ideas like this one? Members of The REIT Forum get exclusive access to our model portfolio. Get started today »
This research report was produced byThe REIT Forum with assistance from Big Dog Investments.
Your feedback has improved this series week after week. Thank you, readers, for all you do.
Due to the dramatically higher than usual volatility in the sector, we’re planning to post this series a little more frequently than normal. That allows us to provide more ratings and ensure readers of our public work still have recent numbers.
The topics we discuss are going to be extremely relevant to the residential mortgage REITs. The table below uses BV as of Q1 2020 (if the company has reported earnings):
Ticker | Ticker | Company Name | Focus | Price to Trailing BV | BV Q1 2020 | Price |
ORC | Orchid Island Capital | Agency | 0.98 | $4.65 | $4.55 | |
AGNC | American Capital Agency Corp. | Agency | 0.95 | $14.55 | $13.88 | |
NLY | Annaly Capital Management | Agency | 0.90 | $7.50 | $6.72 | |
DX | Dynex Capital | Agency | 0.89 | $16.07 | $14.26 | |
CMO | Capstead Mortgage Corporation | Agency | 0.86 | $6.07 | $5.20 | |
ARR | ARMOUR Residential REIT | Agency | 0.81 | $11.10 | $9.03 | |
TWO | Two Harbors Investment Corp. | Agency | 0.78 | $6.96 | $5.44 | |
CHMI | Cherry Hill Mortgage Investment | Agency | 0.70 | $13.73 | $9.65 | |
AI | Arlington Asset Investment Corporation | Agency | 0.53 | $5.28 | $2.79 | |
CIM | Chimera Investment Corporation | Hybrid | 0.81 | $12.45 | $10.05 | |
EFC | Ellington Financial | Hybrid | 0.76 | $15.06 | $11.51 | |
WMC | Western Asset Mortgage Capital Corp. | Hybrid | 0.76 | $3.41 | $2.59 | |
ANH | Anworth Mortgage Asset Corporation | Hybrid | 0.66 | $2.69 | $1.78 | |
IVR | Invesco Mortgage Capital | Hybrid | $3.59 | |||
MFA | MFA Financial | Hybrid | $2.32 | |||
MITT | AG Mortgage Investment Trust, Inc. | Hybrid | $2.81 | |||
PMT | PennyMac Mortgage Investment Trust | Multipurpose | 0.92 | $15.16 | $13.94 | |
NRZ | New Residential Investment Corp. | Multipurpose | 0.77 | $10.71 | $8.27 | |
NYMT | New York Mortgage Trust | Multipurpose | 0.70 | 3.89 | $2.73 | |
iShares Mortgage Real Estate Capped ETF | ETF | |||||
VanEck Vectors Mortgage REIT Income ETF | ETF |
Note: Some mortgage REITs such as AGNC and ORC have reported material gains to book value during Q2 2020. They aren’t the only mortgage REITs who should see book value higher as of 6/4/2020 than it was on 3/31/2020.
Price-to-Book Value
The next image provides a graphical representation:
Source: The REIT Forum
Sector Overview
Discounts to book remain exceptionally large. Consequently, there are plenty of opportunities. However, the sector has demonstrated incredible upwards momentum over the last few days. Prices roared dramatically higher and made bears look downright silly.
As a reminder, Scott Kennedy also is an author for the REIT Forum. You may see his commentary featured in our articles and may notice an extremely high amount of overlap in our ratings, so subscribers reading this article should see Scott’s latest REIT Forum sector update for more detail.
Bears Got Stomped Out
It’s time for the bears on mortgage REITs to own up to their mistakes.
Image source: Reddit
The sector ripped higher:
Source: Seeking Alpha
Despite this rally, several mortgage REITs and preferred shares still have room to run. Too many bears built their entire argument on:
“The price is down, so anyone who buys now is dumb!”
It still shocks me to see how many investors don’t understand that buying a stock means getting the returns going forward, not backward.
The Fear Impulse
Fear is a natural human reaction and sadly it can cause investors to react in the wrong manner.
Some investors lost faith around April 3rd, 2020:
Source: Seeking Alpha
If you read that image closely, you'll notice NRZ was one getting a downgrade. Shares closed at $3.33 that day, the single lowest close in company history. While writing this article, NRZ shares traded at $8.26. That's up 148% from April 3rd, 2020. It would've been a great time to buy, however, I must admit that we missed buying that day. Fortunately, we did buy on 3/31/2020 and 4/06/2020 and again on 4/14/2020:
Source: The REIT Forum
Those trades were all disclosed in real time:
Source: The REIT Forum
What Can We Buy?
You want to know some of the REITs that still get a bullish rating? Alright, we can do that. Here are a few ratings where we get to stay bullish.
We’re still bullish on NLY:
Source: The REIT Forum
We told you to buy shares recently when we said NLY was Ready to Rise. Shares are up about 5.7% since then, but they are still at a huge discount to projected book value.
NLY is the largest mortgage REIT and most of their capital is invested in agency RMBS. They usually trade at a higher-than-average price-to-book ratio. Normal for NLY is somewhere around 1.00, rather than the 0.81 we are seeing today.
We’re still bullish on NRZ:
If you don’t mind a business model that includes MSRs (mortgage servicing rights), NRZ may be a great fit for you. They have a long history of excellent performance. Essentially, anything prior to March 2020 looked great.
Perhaps you want an even bigger discount to book? Perhaps you think a .76 price-to-book ratio is too high.
ANH has rallied significantly, but still trades at a massive discount to book value:
Source: The REIT Forum
ANH mostly owns agency RMBS, but they also include a little credit risk in their portfolio. Consequently, we consider them a hybrid mortgage REIT. The low price-to-book is the major appeal here. We aren’t saying ANH is the best mortgage REIT, but the discount to book value here is quite massive.
If you like big discounts to book value, AI carries one of the biggest. This is a high-risk choice in our view, but the upside remains absolutely massive:
Source: The REIT Forum
Shares trade at a massive discount to book value, which gives them more room to rally. The ideal scenario for shareholders would be a buyout. They aren't looking to find that "forever" stock, just a pop higher on the price-to-book ratio. We warn investors that the common shares of mortgage REITs are meant for trading, and that's certainly the case here. You aren't seeing a suggestion to have shares for passing onto your kids, but the shares have a decent probability of bouncing towards a higher price-to-book ratio.
Perhaps you prefer lower risk or want to hedge against short-term interest rates rising? You get both of those things with AGNCP. This is a preferred share from AGNC Investment Corporation:
Source: The REIT Forum
The dividend yield isn’t huge on AGNCP, but the volatility is lower and it would be expected to benefit if short-term rates eventually increase. We aren’t saying that it will happen, but we don’t want to write it off entirely either. In the meantime, getting a 7.2% stripped yield isn’t bad at all.
Steepening Curve
So what’s helping the mortgage REITs rally so much lately? One factor could be the steepening yield curve. As of 6/4/2020, the spread between 2-year Treasuries and 10-year Treasuries is 62 basis points. That may not sound like much, but it is quite a bit steeper than we’ve seen lately:
Source: Federal Reserve
That isn’t enough to warrant such a big rally by itself, but we have to consider the broader equity markets.
Equity Markets
The S&P 500 (SPY) isn’t trading that far off prior highs. Investors are looking for opportunities to put capital to work. When they realize mortgage REITs trade at dramatic discounts to book value, that starts to look pretty favorable. After all, many of these mortgage REITs often traded around book value prior to the crisis.
Book values declined in Q1 2020, but share prices declined dramatically further. The result was bargain pricing throughout the sector. As before, some opportunities are much more attractive than others. We may put together a few articles to highlight some of the shares where the market may have reacted a little too positively.
Headlines
Remember when every headline about mortgages was tied to forbearance?
Here’s a fun fact. The pace of borrowers requesting forbearance continues to slow. Housingwire.com reports:
The pace of borrowers seeking delayed mortgage payments is slowing, according to data released Monday by the Mortgage Bankers Association.
The number of loans in forbearance increased 10 basis points for the week ending May 24, to 8.46% of outstanding home loans from 8.36% the prior week, the MBA said. That’s the smallest increase reported week-over-week since the week of March 9.
They went on to report:
Weekly call center volume has also declined to the lowest level since the forbearance survey series started the week of March 2, MBA said, to 6.6% from 8.6% of servicing portfolio volume.
Conclusion
The sector is filled with opportunities. Some of those opportunities are much more attractive than others. If you aren’t careful, you could wind up with one of the very few mortgage REITs trading at a premium to current book value. If you want to learn more about opportunities in the sector, start by clicking the "Follow" button beside my name.
Ratings:
- Bullish on common shares: NLY, NRZ, AI, and ANH
- Bullish on preferred share: AGNCP
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This article was written by
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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 AIC, IVR-C, NLY-F, NLY-I, AGNCO, MFO, NYMTM, ANH-C, NYMTN, TWO-B, MFA-C, ANH, NRZ, CIM, NLY. 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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