Fat Yields, Less Risk
Summary
- We’ve loaded up on mortgage REIT preferred shares. As the common shares kept pushing higher, the lower risk gets appealing.
- The preferred shares are higher in the capital stack than the common shares, which enabled them to bounce back after the pandemic panic.
- We’ve been buying up positions in preferred shares so we can continue to earn a solid return on our capital.
- Some investors are thoroughly pumped up for common shares in the sector. Someone always buys in after the price has rallied.
- This is a great opportunity to be hunting through the preferred shares for opportunities to maintain income with less risk.
- Looking for more investing ideas like this one? Get them exclusively at The REIT Forum. Learn More »
Get ready for charts, images, and tables because they are better than words. The ratings and outlooks we highlight here come after Scott Kennedy provides his weekly updates in the REIT Forum. Your continued feedback is greatly appreciated, so please leave a comment with suggestions.
Today we’re highlighting a few common shares and a few preferred shares.
AGNC
Neutral on AGNC Investment Corporation (AGNC). We still have a small position. Shares are trading at a discount to GAAP BV, but pretty close to tangible BV estimates. That looks like a reasonable range for the stock.
DX
Neutral on Dynex Capital (DX) as well. Shares are trading pretty close to our estimated book value. Management did a great job delivering better returns to shareholders during the pandemic by protecting book value better than peers. This looks pretty reasonable. We would expect shares to generally trade around book value.
ORC
We’re taking a bearish outlook on Orchid Island Capital (ORC) as shares carry a larger premium to our projected book value.
Preferred Shares
If you're still looking for a big dividend yield (with less risk), you may want to consider some of the mortgage REIT preferred shares. That doesn't mean "go buy them all". That would be stupid and wouldn't fit the standard we've established for analysis. However, we will take you through a recent share we considered. We were hoping to get a nice entry opportunity with a dip, but it didn't happen. We would still be interested if the shares dip.
We had a preferred share we highlighted for subscribers during Preferred Shares Week 246 that we want to share in the public article.
Source: The REIT Forum
CHMI-A (CHMI.PA) joins the list of potential opportunities. Has this happened before? That’s rhetorical, we’ve suggested CHMI-A was more expensive than most of their peers for a few months. The fixed-rate dividend is high. Shares trade at a premium to call value, but the yield to call still comes in around 6.4% since the shares are about to pay out a $.51 dividend. If shares aren’t called, investors retain a share with a particularly strong yield.
Didn’t we previously suggest CHMI-A was a much worse deal than many other preferred shares? We certainly did. So what changed? The environment. Consider the historical prices (not adjusted for dividends) of the CHMI preferred shares:
Source: The REIT Forum
Late last year (just prior to the ex-dividend date), shares traded at about the same price they do today. The sector has seen a significant rally during that time, but these shares hardly gained. We can also see that as far back as June 6th, 2020, shares were over $24.00. Over the last 9 months, we’ve been capturing substantial increases in share prices in addition to yield. With the sector priced more reasonably (offering fewer opportunities for significant capital gains with moderate risk or less), CHMI-A begins to look more appealing.
To create a better contrast on the performance of CHMI-A, which simply rallied “too soon”, with other preferred shares, we built the following chart contrasting CHMI-A with some of our positions. To limit the number of shares in the chart (for legibility), we had to put some constraints on the choices. To be included the positions need to be:
- Still open (our closed positions delivered substantial gains)
- Purchased after 10/01/2020 (this only excludes AGNCO)
- Purchased before 3/22/2021 (this only excludes CMO-E)
That brings us to the following chart:
Source: The REIT Forum
The arrows indicate the purchase of a position that is still open. If we included positions we closed, we would need more lines (for more tickers), more symbols (down arrows), and the whole thing would get a bit messy. Since we were closing positions to lock in substantial gains, the returns on those positions would be even more impressive. For transparency, we’re using the open positions which generally have smaller gains.
Note: Subsequent to publishing this chart for subscribers, we purchased additional shares of AGNCO.
For transparency, here are our preferred share positions as of 3/31/2021:
Source: The REIT Forum
For anyone who isn’t paying attention, we purchased batches of preferred shares 3 times in March. The risk ratings on those purchases were 1, 2, and 1. We’re still getting a strong yield, but we’re minimizing risk. If we take any risk, we want to get paid handsomely for it. So we’ll watch for opportunities in some of the higher risk positions, but we’ll also be keeping even more of an eye out for the lower risk positions.
If CHMI-A would've given us a nice dip, we would've been interested in a small position. It didn't, so we stuck to the main strategy of finding underpriced shares with lower risk.
Since CHMI-A went ex-dividend between the original post for subscribers and the public release, we’re including an updated card that reflects valuation with 3 months leading up to the next ex-dividend date.
Source: The REIT Forum
A Great Quote
I remember a time a little over a year ago. It was in the months leading up to the pandemic. We told investors to go for Annaly Capital Management’s (NLY) preferred shares rather than their common shares. Our argument was that NLY’s higher share price (at that time) left plenty of risks, but little upside. A reader commented saying the difference in yield, a few percentage points, was worth “any amount of risk”. They didn’t care about risk, they only wanted yield and that was everything. Unfortunately, you can guess what happened to their picks over the following months.
I should’ve labeled this section “An uninformed quote” or “a near-sighted quote”. Oh well. You didn’t click this article because of my expertise in naming sections.
Stock Table
We will close out the rest of the article with the tables and charts we provide for readers to help them track the sector for both common shares and preferred shares.
We’re including a quick table for the common shares that will be shown in our tables:
Type of REIT or BDC | ||||
Agency | Hybrid | Multipurpose | Commercial | BDC |
Let the images begin!
Residential Mortgage REIT Charts
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Source: The REIT Forum
Commercial Mortgage REIT Charts
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BDC Charts
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Notes on Price-to-Trailing Book Ratios - Using Q4 2020 Book Value
Remember that these are price-to-trailing-book ratios. They are not using estimates of current book value. Book values continue to change every day. Scott Kennedy provides frequent updates on estimated book value, ratings, and price targets through The REIT Forum.
Repeated Note: There are three points we need to highlight here:
- AG Mortgage Investment Trust - We are using the Q4 2020 book value reported by management and classified as “adjusted book value per share”. Adjusted book value of $3.94 is lower than GAAP book value of $4.13.
- MFA Financial reports “GAAP book value” and “economic book value”. We’ve chosen to use the GAAP book value to remain consistent. GAAP book value per share of $4.54 is lower than economic book value per share of $4.92.
- If the book value per share ratio is absent in the chart, the company has not reported Q4 2020 yet (or did it so recently it isn’t in this sheet yet).
Unfortunately, we have to repeat those bullet points every time we publish because it regularly comes up if we don’t mention it.
Notes on Common Share Dividend Yield
Dividend yield often comes up in the comments, but picking based on dividend yield is stupid and regularly results in terrible performance. Don’t do it.
This chart is still in the same order as the prior charts. Consequently, you know the highest price-to-book ratios (using trailing GAAP book value) for each segment will be at the top. If you see a mistake, please feel free to say something. Occasionally the data for dividend rates requires a manual update.
Notes on Earning Yields
One of the next things investors may ask about is the yield using core earnings. This chart puts together the core earnings based on the consensus analyst estimate. Beware that the consensus estimate may not always be the best estimate. Further, there are ways to increase “Core Earnings” through accounting decisions or modifying hedges. Consequently, investors should still take these values cautiously. We do not depend on the consensus estimate to make decisions.
Preferred Share Charts
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Notes on Preferred Share Prices
This chart gives you a pretty quick feel for which shares are trading at a discount to call value. Each of these preferred shares has a call value of $25.00, but that doesn’t mean a share will be called. The company decides if they want to issue a call or not.
Notes on Dividend Yield / Stripped Yield
Stripped yields are vastly more useful than “current” yields for preferred shares. The stripped yield uses the stripped price. That’s different from using the current price because it means we already adjusted for dividend accrual. This makes the process easier for investors.
We can talk about shares using “regular prices”. Those are the prices an investor would actually use when entering an order.
However, we will provide the stripped yield to adjust for the dividend accrual. In the spreadsheets we host for subscribers, we include the actual ex-dividend date, or the projected ex-dividend date if the actual date isn’t yet known. If you’re planning to buy a share, it’s always wise to check if the shares just went ex-dividend so you can adjust your targets accordingly.
Notes on Floating Yield on Price
Since many of these shares switch over to floating rates, we also want to consider what the yield would be if the floating rate was in effect and shares were still at the current price. To demonstrate that, we use the “Floating Yield On Price”. If the share remains at a fixed-rate indefinitely, then the value doesn’t change.
One point we need to emphasize here is that we are dealing with yields. A yield must involve the share price. We aren’t simply showing the new “rate” if the share began floating, we are adjusting the new rate for the stripped price.
Floor
ACR-C has a floor that interferes with the eventual floating rate. The floor prevents the floating rate from being less than the initial fixed-rate. Consequently, while ACR-C is one of the FTF shares, it doesn’t exhibit the same decrease as other FTF shares when we switch over to the “Floating Yield on Price”. However, it remains a higher-risk share because of the type of assets the REIT owns.
Preferred Share Data
Beyond the charts, we’re also providing our readers with access to several other metrics for the preferred shares.
After testing out a series on preferred shares, we decided to try merging it into the series on common shares. After all, we are still talking about positions in mortgage REITs. We don’t have any desire to cover preferred shares without cumulative dividends, so any preferred shares you see in our column will have cumulative dividends. You can verify that by using Quantum Online. We’ve included the links in the table below.
To better organize the table, we needed to abbreviate column names as follows:
- Price = Recent Share Price - Shown in Charts
- BoF = Bond or FTF (Fixed-to-Floating)
- S-Yield = Stripped Yield - Shown in Charts
- Coupon = Initial Fixed-Rate Coupon
- FYoP = Floating Yield on Price - Shown in Charts
- NCD = Next Call Date (the soonest shares could be called)
- Note: For all FTF issues, the floating rate would start on NCD.
- WCC = Worst Cash to Call (lowest net cash return possible from a call)
- QO Link = Link to Quantum Online Page
Ticker | Price | BoF | S-Yield | Coupon | FYoP | NCD | WCC | QO Link | P-Link |
$25.58 | FTF | 6.72% | 6.88% | 4.43% | 4/15/2024 | $4.58 | |||
$25.60 | FTF | 6.84% | 7.00% | 5.19% | 10/15/2022 | $2.03 | |||
$24.70 | FTF | 6.58% | 6.50% | 5.26% | 10/15/2024 | $5.99 | |||
$23.76 | FTF | 6.44% | 6.13% | 5.15% | 4/15/2025 | $7.37 | |||
$25.04 | FTF | 6.98% | 6.95% | 5.22% | 9/30/2022 | $2.58 | |||
$24.76 | FTF | 6.60% | 6.50% | 4.44% | 3/31/2023 | $3.50 | |||
$25.41 | FTF | 6.68% | 6.75% | 5.14% | 6/30/2024 | $5.09 | |||
$24.63 | 7.13% | 7.00% | 7.13% | 1/28/2025 | $7.10 | ||||
$25.22 | FTF | 6.84% | 6.90% | 5.61% | 4/15/2025 | $6.67 | |||
$25.17 | 7.45% | 7.50% | 7.45% | 4/27/2021 | -$0.11 | ||||
$25.74 | FTF | 6.65% | 6.75% | 5.31% | 10/30/2024 | $5.59 | |||
$25.31 | FTF | 7.52% | 7.50% | 6.02% | 8/15/2024 | $6.26 | |||
$24.77 | FTF | 7.30% | 7.13% | 5.99% | 8/15/2024 | $6.47 | |||
$22.58 | FTF | 7.16% | 6.38% | 5.81% | 2/15/2025 | $8.81 | |||
$26.02 | FTF | 7.86% | 8.13% | 5.84% | 3/15/2024 | $5.09 | |||
$26.10 | FTF | 7.72% | 8.00% | 5.97% | 6/15/2024 | $5.42 | |||
$25.14 | Bond | 6.75% | 6.75% | 6.75% | 4/27/2021 | $0.05 | |||
$25.40 | Bond | 6.61% | 6.63% | 6.61% | 4/27/2021 | -$0.02 | |||
$25.60 | 7.82% | 8.00% | 7.82% | 10/30/2021 | $0.44 | ||||
$24.45 | FTF | 8.19% | 8.00% | 6.14% | 3/30/2024 | $6.42 | |||
$23.90 | FTF | 8.12% | 7.75% | 5.18% | 9/30/2025 | $9.70 | |||
$24.14 | FTF | 8.30% | 8.00% | 5.79% | 3/30/2024 | $6.73 |
Second batch:
Ticker | Price | BoF | S-Yield | Coupon | FYoP | NCD | WCC | QO Link | P-Link |
$26.35 | FTF | 7.84% | 8.13% | 5.66% | 4/27/2027 | $11.34 | |||
$25.75 | FTF | 7.52% | 7.63% | 5.48% | 07/27/2027 | $11.63 | |||
$24.79 | FTF | 7.43% | 7.25% | 5.34% | 01/27/2025 | $7.46 | |||
$25.65 | 7.99% | 8.20% | 7.99% | 08/17/2022 | $2.02 | ||||
$24.98 | FTF | 8.26% | 8.25% | 5.84% | 4/15/2024 | $6.13 | |||
$24.33 | 7.96% | 7.75% | 7.96% | 4/27/2021 | $0.69 | ||||
$24.52 | FTF | 7.95% | 7.75% | 5.52% | 12/27/2024 | $7.76 | |||
$24.08 | FTF | 7.83% | 7.50% | 5.73% | 9/27/2027 | $13.12 | |||
$24.45 | FTF | 8.05% | 7.88% | 6.78% | 1/15/2025 | $7.93 | |||
$24.80 | FTF | 8.06% | 8.00% | 5.94% | 10/15/2027 | $13.20 | |||
$24.60 | 8.00% | 7.88% | 8.00% | 4/27/2021 | $0.45 | ||||
$24.45 | 7.92% | 7.75% | 7.92% | 4/27/2021 | $0.60 | ||||
$24.66 | 7.65% | 7.50% | 7.65% | 4/27/2021 | $0.47 | ||||
$22.77 | FTF | 7.17% | 6.50% | 6.12% | 3/31/2025 | $8.73 | |||
$23.63 | 7.46% | 7.00% | 7.46% | 5/12/2022 | $3.34 | ||||
$23.51 | FTF | 8.85% | 8.25% | 6.29% | 3/30/2024 | $7.70 | |||
$24.69 | 8.42% | 8.25% | 8.42% | 4/27/2021 | $0.51 | ||||
$24.20 | 8.33% | 8.00% | 8.33% | 4/27/2021 | $1.00 | ||||
$22.53 | FTF | 8.95% | 8.00% | 7.47% | 9/17/2024 | $9.45 | |||
$24.95 | FTF - Floor | 8.64% | 8.63% | 8.64% | 7/30/2024 | $7.06 |
There are a few things you should know at the start:
- When a share can be called on short notice, the annualized yield-to-call reaches absurd levels. Investors shouldn’t put too much weight on it. On the other hand, a negative number can be a significant concern. Consequently, we decided to include it in the chart.
- We sort our spreadsheet for subscribers by risk ratings within each sector. We decided to use the same technique for this series since it communicates more information to readers. You’ll notice a general correlation where lower risk correlates with a higher price and lower yield, though this link isn’t absolute.
- Worst Cash to Call example: Imagine a preferred share that could be called in a few months and would pay out a total of $.75 in dividends by that time. If an investment in those shares ends in a call, the smallest amount of cash inflows possible would be $25.00 (call value) plus $.75 (total dividends). If the share price was $25.60, then the “Worst Cash to Call” would be $.15. That comes from the following equation: $25.00 + $.75 - $25.60 = $.15. If the share price increased by $.20 in the next hour, the “Worst Cash to Call” would decline to negative $.05.
Strategy
Our goal is to maximize total returns. We achieve those most effectively by including “trading” strategies. We regularly trade positions in the mortgage REIT common shares and BDCs because:
- Prices are inefficient.
- Long term, share prices generally revolve around book value.
- Short term, price-to-book ratios can deviate materially.
- Book value isn’t the only step in analysis, but is the cornerstone.
We also allocate to preferred shares and equity REITs. We encourage buy-and-hold investors to consider using more preferred shares and equity REITs.
Performance
We compare our performance against 4 ETFs that investors might use for exposure to our sectors:
Source: The REIT Forum
The 4 ETFs we use for comparison are:
Ticker | Exposure |
One of the largest mortgage REIT ETFs | |
One of the largest preferred share ETFs | |
Largest equity REIT ETF | |
The high-yield equity REIT ETF. Yes, it has been dreadful. |
When investors think it isn’t possible to earn solid returns in preferred shares or mortgage REITs, we politely disagree. The sector has plenty of opportunities, but investors still need to be wary of the risks. We can’t simply reach for yield and hope for the best. When it comes to common shares, we need to be even more vigilant to protect our principal by regularly watching prices and updating estimates for book value and price targets.
Conclusion
There are still some great opportunities when investing in REITs and preferred shares. However, investors need to be careful. They need to be disciplined about their price targets, rather than buying crap because someone claims it has 50% to 100% upside. At this point in the recovery, 100% upside simply isn’t realistic. It’s like saying that you may be a millionaire because your lottery ticket has so much upside. Yet many investors fall for it every day. They got pummeled in the Pandemic Panic and many are still nursing huge losses to their portfolio because they listened to bad advice.
Ratings:
- Neutral on AGNC and DX
- Bearish on ORC
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This article was written by
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 holds an MBA and has passed all 3 CFA exams. He focuses on Equity REITs, Mortgage REITs, and preferred shares.
He leads the investing group The REIT Forum. 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. Learn more.Analyst’s Disclosure: I am/we are long AGNCO, NYMTM, CIM-A, AGNCP, ARR-C, NRZ-B, CMO-E, NRZ, AGNC, SLRC, GPMT, PMT. 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.
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.
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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Comments (43)
VIABP is down $15 today @ $67.50. The VIACP is @ $67.55 for a yield of 8.5%.
VIACA // 67.09 // 4*0.96=3.84 // 70.93
VIACP // 47.49 // 4*5.75=23 // 70.49
I don't foresee any dividend increases yet. Too many unknowns coming out of the pandemic. Maybe by Q3.
JMTC.
Why does WMC seem so sickly? it seems like a decent chance to get a little upside. I understand AAIC because of no dividend...but would that give it a larger shot at return? CWMF, what do you think about WMC vs AAIC?
WMC and AAIC both have large discounts and high-risk ratings. We've got targets on both inside the service, but I haven't posted them in our public articles for quite a bit.
"recent earnings reports have been terrible"
I guess that answers my question doesn't it?? Wondered why CHMI A had a risk rating of 3.5. I noticed the outsized Common Yield and thought there must be problems.
Already looking forward to what's next. Thanks!!
I'll still take CIM-B over most preferred issues. And over its common.
NLY common starting to look decent again, having come off those pre-dividend prints around $9. You called it.