Are High Yielding aMREITs Ready to Run?
Fri, Jun 26, 2:49 PM ET, by Scott V. Nystrom
Agency mortgage backed real estate investment trusts, or aMREITs, are an often overlooked sub-industry in the MREIT industry and are showing recent divergence from the S&P 500. There is good reason for this divergence given recent economic news on the underlying weak fundamentals of the U.S. economy and the underlying fundamentals in aMREITs.
What are aMREITs?
Many self directed investors do not understand aMREITs. Investors avoid aMREITs either because they are perceived as: (a) “risky” REITs, or (b) deal with even “riskier” mortgage backed securities, or (c) both. These perceptions of risk are wrong and here is why.
aMREITs are characterized by the following key traits:
1. aMREITs are not lenders and do not hold individual mortgages;
2. aMREITs are generally high yielding securities currently ranging from 13 to 25 percent non-qualified annual yield;
3. aMREITs invest solely or primarily in low-risk agency paper (Fannie Mae, Freddie Mac, VA, FHA) backed by the U.S. government;
4. aMREITs take advantage of the upward sloping shape of the yield curve, borrowing on a low-cost short term basis and investing in high-yielding, long term securities and generally have a net interest margin of 2 to 4 percentage points.
5. aMREITs borrow to apply leverage (4x to 10x) to the net interest margin to produce earnings and dividends.
6. aMREITs are organized as REITs and under U.S. tax law, they must pay out more than 90 percent of their earnings to retain REIT tax advantages.
7. aMREIT secondary offerings are generally accretive, not dilutive, as companies opportunistically taken advantage of wider net interest margins and higher leverage.
aMREITs are a sub-group of the MREIT industry that eliminate credit risk by investing in U.S. government backed securities issued by Fannie Mae, Freddie Mac, and others. Eliminating credit risk is a good thing.
aMREITs generally pay in excess of a 10 percent non-qualified dividend. High yield is a good thing.
So, what are the risks?
One risk is that the yield curve will become less steep once the economy recovers and the Federal Reserve begins to raise the Fed Funds rate. This would reduce the net interest margin.
Funding risk—especially for highly leveraged aMREITs—is also a possibility via a failure in the short term borrowing market.
aMREITs Pay High Dividends
There are six companies I follow in the aMREIT sub-industry. They are American Capital Agency (AGNC), Annaly Capital Management (NLY), Anworth Mortgage Asset (ANH), Capstead Mortgage (CMO), Hatteras Financial (HTS), and MFA Financial (MFA).
Each company is managed a little differently from the others. For example, each has a slight variation on the general theme of investing in low-risk, long term securities. As a case in point, ANH invests largely in securities characterized by adjustable rate mortgages and is subject to re-financing risk when initial rates begin to adjust. On the other hand, AGNC invests in longer term fixed rate mortgages and could be disadvantaged in a rising long bond environment.
As a first start at due diligence, the following table provides current yield metrics based on most recently quarterly dividend announcements and ranked by market capitalization for six aMREITs as of mid-day June 26, 2009.
|
Ticker
|
Market Cap
(millions of $)
|
Yield
|
|
NLY
|
$8,110
|
16.0%
|
|
MFA
|
$1,480
|
13.3%
|
|
HTS
|
$1,020
|
15.7%
|
|
CMO
|
$796
|
17.9%
|
|
ANH
|
$723
|
16.8%
|
|
AGNC
|
$354
|
25.3%
|
Source: Self Directed Investor
The table is useful as a first look at comparing these companies. But it can be misleading for several reasons. For example, the quality of earnings and therefore future dividend yield differ by company. Another disconnect with the comparison above is that ANH and MFA haven’t declared their second quarter dividends. The other companies recently declared second quarter dividends.
Divergence from S&P 500 Benchmark
A divergence between aMREITs and the S&P 500 index ETF (SPY) has developed over the past couple of weeks as illustrated by the chart below. The green line represents the six aMREITs listed above purchased in equal weights. The pink line is the SPY.
This divergence may just be noise.
On the other hand, recent bad economic news may be drawing new money into the aMREIT sector. A weakened economy makes it less likely that the Fed will raise the Fed Funds rate. As a result, investors likely perceive the current upward sloping yield curve as enduring for some time. To borrow a popular term, if the “green shoots” are turning into “brown stalks,” aMREITs are likely to continue paying high yields. In fact, many aMREITs are underleveraged compared to past economic cycles and could take advantage of a weak economy by increasing leverage.
Self directed investors willing to manage the risk of a flattening yield curve and able to tolerate “funding risk” may want to look more closely at aMREITs. If the economy remains weak, I don’t expect these relatively low valuations to last much longer.
Full Disclosure: Long AGNC, NLY, ANH, CMO.
SDI Glossary: "Asset" Definition
SDI Glossary: "CMO" Definition
SDI Glossary: "Dividend" Definition
SDI Glossary: "the Fed" Definition
SDI Glossary: "Yield" Definition
This Article's Word Cloud:
AGNC
There
This
aMREIT
aMREITs
advantage
backed
borrowing
companies
company
current
curve
directed
divergence
dividend
dividends
earnings
economic
economy
from
generally
good
green
high
industry
interest
investing
investors
invests
leverage
likely
long
look
margin
mortgages
other
past
percent
rate
recent
risk
securities
take
term
that
they
underlying
weak
yield
yielding
 2 Comments
 Well done, Scott. Even sophiscated investors have a less than clear understanding of aMREITS. This article provides a basic understanding in just a few words. I will pass it on to Jesse and a few of my colleagues. I am long AGNC, ANH, CMO, NLY, ANH-PRA, CMO-PRA & MFA-PRA. I like the preferreds in this sub-industry also.-- Marvelousmarv
Sat, Jun 27, 0:08 AM ET |
| Scott, great article. You mentioned the risk of a flattening yield curve. This is a very definite risk, and you probably should mention that the market looks forward about six months, and when the big money gets a hint that the FED will start raising short term rates, they will start moving money out of this sector. This sector has already had at least one downgrade in anticipation of this, which was premature, but it was enough to convince me to find something else less interest sensitive. -- rmnuckols
Sun, Jun 28, 9:25 AM ET |
More articles: 1 2 3 4 5 6 7 next »
|
RSS