Recent Performance Review For 5 High-Yield Hybrid Mortgage REITs

Includes: CIM, IVR, MFA, RWT, TWO
by: Zvi Bar

Hybrid mortgage REITs hold RMBSs both with and without agency insurance. Agency-backed RMBS paper is considered to have virtually no default risk, but provides a low yield. Non-agency RMBSs are often considerably higher yielding than agency RMBSs, but also contain the risk of borrower default. A good deal of non-agency paper is rated as junk, while agency-backed paper gets a rating commensurate with the nation's implied guarantee.

Among non-agency mortgages, there are four main categories: Prime, Alternative-A (Alt-A), Option Adjustable Rate Mortgages (Option ARMs), and Subprime. The Subprime mortgage category largely imploded in 2007 and 2008, taking down the greater economy, with scattered defaults across all other types subsequently occurring. Several analysts estimate that the a final wave of defaults will hit the Alt-A and Option ARM categories when interest rates begin to rise.

Most hybrid mREITs now hold large and growing positions in agency RMBSs that were acquired in order to reduce income-stream and portfolio value volatility. Additionally, since few non-agency mortgages have been issued recently, the lack of non-agency paper has forced many hybrid mREITs to accumulate larger positions of agency paper out of necessity. Adding agency paper also often includes increasing leverage, given that the paper yields significantly less.

Below are the recent performance rates and current annual dividend rates for five mortgage REITs that are largely invested in non-agency RMBS paper: Chimera Investment (CIM), Invesco Mortgage Capital (IVR), MFA Financial (MFA), Redwood Trust (RWT), and Two Harbors Investment (TWO).

Click to enlarge image.

Non-agency RMBS paper valuations declined significantly during 2011, bringing down most of these hybrid mREITs. So far in 2012, after several months of declining equity prices, these mREITs have averaged 13.11% equity appreciation, even after falling by an average of 4.06% over the last month. This compares to the S&P 500 appreciating 9.26% since the start of 2012 and declining 2.54% over the last month.

Under the current tax laws, mREIT dividends are taxed as ordinary income, and not at the lower corporate dividend rate. Since mREIT dividends are taxed as income, they are considered substantially better performing investments when held within tax deferred or exempt accounts.

Mortgage REITs continue to be one of the highest-yielding options available to income-oriented investors. Nonetheless, due to their significant risk profile exposure to non-agency RBMS should be limited to a reasonable percentage of a high-risk portfolio, based on an investor's total risk profile, time horizon, income requirements, and total portfolio of investments.

Disclosure: I am long CIM.

Disclaimer: This article is intended to be informative and should not be construed as personalized advice as it does not take into account your specific situation or objectives.