The new ETF tracks the performance of the Market Vectors Global Mortgage REITs Index.  The underlying index has 25 constituents and is a market cap-weighted index where the companies have to derive at least half of their revenues from mortgage REITs. The allowance can include those which purchase or service commercial or residential mortgage loans or mortgage-related securities.  Van Eck noted, “Unlike other indexes used in mortgage REIT-focused ETFs, the Index does not include mortgage finance companies or savings associations.”

The weighting of the top-5 members in the index is as follows (as of July 31, 2011): Annaly Capital Management, Inc. (NYSE: NLY) at 19.73%; American Capital Agency Corp. (NASDAQ: AGNC) at 11.46%; Chimera Investment Corporation (NYSE: CIM) at 7.27%; MFA Financial, Inc. (NYSE: MFA) at 6.07%; and Hatteras Financial Corporation (NYSE: HTS) at 5.04%.  The top five of the twenty-five constituents account for just over 49.5% of the entire weighting.

This new ETF has a gross expense ratio of 0.54% and a net expense ratio of 0.40%, with expenses capped at 0.40% until May 1, 2013.

What makes this interesting is that all five of the top constituents carry a yield of well above 10% based on the last dividend payments.  These underlying entities are required to distribute 90% of their income as dividends to investors, so the returns can fluctuate wildly.

With a promise from Ben Bernanke to keep rates at near-zero for the next two years, the spread between short-term borrowings and leveraging up for mortgage yields is likely to keep the environment positive for entities such as these.  The problem is when the short-term borrowing rates go back up.  When… If…

JON C. OGG

No money was injured while filming

The world of Mortgage REITs offers massive yields for income investors.  There is a big caveat here.  It offers massive yields, until it doesn’t… then you don’t want to be around this sector.  Over the weekend came a report from Barron’s highlighting both Hatteras Financial Corporation (NYSE: HTS) and Capstead Mortgage Corporation (NYSE: CMO).  The benefit that Barron’s sees here is that these tend to be exposed to adjustable rate mortgages sponsored by the government-sponsored entities.  We have a whole host of concerns that were not really addressed.

Some of the more frequent mortgage REITs that we cover are as follows: Annaly Capital Management, Inc. (NYSE: NLY); Chimera Investment Corporation (NYSE: CIM); Anworth Mortgage Asset Corporation (NYSE: ANH); and MFA Financial, Inc. (NYSE: MFA).  ETF investors can look to the FTSE NAREIT All Mortgage Capped Index (NYSE: REM).  There is a reason we highlight this sector.  There are risks here in this sector even though Barron”s did warn that investors should not buy these for capital appreciation.  It believes that the yields are the juice here and also believes that ARM-related mortgage REITs could even see rising yields.

Investors always have to assume an “implied dividend” rather than a static dividend because REITs have to pay out 90% of their income for their tax structure.  It is the leverage that can boost this yield, but it is that same leverage which can act as a guillotine under the right (or wrong) circumstances.  Barron’s noted that the eventual rise in rates will hurt payouts in many but believes these are safe until around January 2013.  Barron’s did at least pick the cheaper REITS in the group at about 1.1-times book value.

Our concerns are much more pointed than those of Barron’s.  There are more risks that have started to come to light in the recent days and weeks that were not given much concern.  If something closer to a double-dip recession arises then these are going to suffer more P&I delinquencies and defaults.  While many or most mortgages held by these REITs are GSE-backed, there is now the risk that Uncle Sam might actually enter into a period of a temporary debt default.  That is why you saw the outlook go to “CreditWatch Negative” on Friday at S&P for the government, many GSEs, government dependent entities, and even insurance companies which are riddled with long-term government and agency debt securities.  Keep in mind that Egan Jones did formally downgrade the U.S. government over the weekend as a warning signal that US investors have to worry.

Hatteras Financial Corporation (NYSE: HTS) offers an implied dividend yield of about 14.1%.  The shares recently closed at $28.44 and the 52-week trading range is $27.12 to $31.98.  Capstead Mortgage Corporation (NYSE: CMO) offers an implied dividend yield of about 14.6%.  The shares recently closed at $13.16 and the 52-week trading range is $10.78 to $13.95.  The four mortgage REITs we routinely cover are as follows:

Annaly Capital Management, Inc. (NYSE: NLY) offers an implied dividend yield of about 14.5%.  The shares recently closed at $17.96 and the 52-week trading range is $16.73 to $18.79.

Chimera Investment Corporation (NYSE: CIM), often considered Annaly’s vulture vehicle, offers an implied dividend yield of about 16%.  The shares recently closed at $3.25 and the 52-week trading range is $3.18 to $4.36.  Its shares are down 4% today as the market woes continue and is down at $3.11.

Anworth Mortgage Asset Corporation (NYSE: ANH) has an implied dividend yield of about 13.8%.  The shares recently closed at $7.23.  The 52-week trading range is $5.74 to $7.52.

MFA Financial, Inc. (NYSE: MFA) offers an implied dividend yield of close to 12.8%.  The shares recently closed at $7.79 and the 52-week trading range is $7.10 to $8.64.

We are taking a more cautious stance than Barron’s is willing to take, even if they are focusing on Mortgage REITs tied closer to ARMs than to traditional mortgage products.  The politics in Washington can often bring havoc where there should be at least some harmony.  That is the case today.

Another alternative is the FTSE NAREIT All Mortgage Capped Index (NYSE: REM), but it tends to offer a lower implied yield with equally sporadic payout fluctuations.  It is less liquid than many other REIT ETFs and is less liquid than many of its components. The fund invests in securities of the index and in depositary receipts representing securities of the index.  After recently closing at $14.65, the 52-week trading range is $13.98 to $16.07.

After taking a look at this, it might seem like you are seeing a “Sell” rating.  That is not really the case.  If the politicians will stop gambling the entire U.S. credit ratings for political gains and for political ambitions, many of our fears normalize.  Our fears will normalize for this year, but not into early 2013 as Barron’s suggested.

JON C. OGG

MFA Financial, Inc. (NYSE: MFA) is down 2.7% today at $8.26 after announcing that it was making a sale of 65,000,000 shares of its common stock.  Shares have traded in a range of $6.14 to $8.64 and the market cap is $2.3 billion before the effects of this $500 million or so offering.  Its latest dividend was $0.235 and if that were to remain static it would generate a yield of roughly 11.3%.  As with all mortgage-REITs, that quarterly payout fluctuates as it depends upon the mortgage related income and some 90% of that income has to be paid out as dividends to owners.

Annaly Capital Management, Inc. (NYSE: NLY) is another mortgage-REIT that usually screens for dividend yields of 10% and higher.  Shares are currently down by 0.6% at $17.79 and the 52-week trading range is $14.09 to $18.75.  Its most recent dividend was $0.64 and that was the lowest payout in six quarters.  Still, it yields about 14.3% today.  Traditionally, Annaly has been a winner by being able to play mortgage spreads.

Chimera Investment Corporation (NYSE: CIM) is closely tied to Annaly and originally had much of the same ownership.  The two still share the same corporate address.  Where Chimera is different is that it was originally meant to be more of a vulture fund that was reaching for yield and returns and employing some of the same criteria and discipline as Annaly.  Chimera trades at $4.28 and its 52-week trading range is $3.50 to $4.36.  Its current dividend of $0.17 was lower than the prior quarter but the same as the three prior quarters before that.  The current yield is closer to 15.8%.

Anworth Mortgage Asset Corporation (NYSE: ANH) is one that makes the 10% screen but is one that may need to be watched.  Its most recent $0.22 dividend was the lowest payout in ten quarters.  Even with the lower payout, the yield comes to 12.4% based upon its $7.06 price and its 52-week range is $5.74 to $7.52. It also invests primarily in guaranteed or federally sponsored mortgages and earnings its income on the difference between the yield on its mortgage assets and the cost of its borrowings.

The benefits here evident: high-high dividend yields.  The risks are less evident but need to be considered.  The current environment of low interest rates gives a huge spread for these mortgage-REIT players to earn substantial income.  If you can borrow at 2% and collect 5% and higher in income, imagine how much more can be made if leverage is used.  As rates rise or as the yield curve flattens out, those opportunities will diminish. Another large risk is that mortgage-REITs tend to raise capital routinely via dilutive secondary offerings.

Double-digit yields are great, but as always… Know what you are investing in.

JON C. OGG

Airgas Inc. (NYSE: ARG) Raised to Overweight at Piper Jaffray.
American Capital Agency Corp. (NASDAQ: AGNC) Started as Outperform at Credit Suisse.
Broadcom Corporation (NASDAQ: BRCM) reiterated Buy and $50 target at Argus.
Chimera Investment Corporation (NYSE: CIM) Raised to Outperform at Credit Suisse.
CME Group Inc. (NYSE: CME) Raised to Buy at BofA/ML.
First Solar Inc. (NASDAQ: FSLR) Reiterated Buy at Argus.
Huntington Bancshares Inc. (NASDAQ: HBAN) Raised to Buy at BofA/ML.
IntercontinentalExchange Inc. (NYSE: ICE) Reinstated as Buy at BofA/ML.
MannKind Corp. (NASDAQ: MNKD) Cut to Neutral at BofA/ML.
McDonald’s Corporation (NYSE: MCD) Reiterated Outperform at Credit Suisse.
MFA Financial, Inc. (NYSE: MFA) Cut to Neutral at Credit Suisse.
Moneygram International Inc. (NYSE: MGI) Started as Buy and $3.40 target at BofA/ML.
Netflix, Inc. (NASDAQ: NFLX) Started as Neutral at Goldman Sachs.
NetApp, Inc. (NASDAQ: NTAP) Raised to Buy at Stifel Nicolaus.
Oracle Corporation (NASDAQ: ORCL) Reiterated Buy and Raised target to $39 at Argus.
Synchronoss Technologies, Inc. (NASDAQ: SNCR) Started as Outperform and $34 target at Credit Suisse.
Vertex Pharmaceuticals, Inc. (NASDAQ: VRTX) Reiterated Buy and $43 target at BofA/ML.

You can join our free daily email distribution list to hear more about dividend trends, analyst upgrades and downgrades, top day trader and active trader alerts, news on Buffett and other investment gurus, IPOs, secondary offerings, private equity, and more.

JON C. OGG

This may seem like a small raise, but you have to consider the ills of the sector.  In December, the company cut its dividend by a penny to $0.21.  It raised its dividend in April to $0.22.  And the new rate today is $0.25.  At the end of 2007, this rate was only $0.10 per quarter.

MFA has a market cap north of $1.5 billion and is said to hold roughly $10 billion in mortgage-backed securities.  One reason that MFA has held up better than many is that most of its mortgages have an implied government guarantee.  If the government is trying to prop up the mortgage market, making those bets with the government guarantee sounds like the winning formula.

We say “implied” because some are Ginnie Mae-back with a solid guarantee, and others have Fannie Mae or Freddie Mac backing.  MFA invests on a leveraged basis in a portfolio of hybrid and adjustable rates.

While its dividend did get as low as $0.05 in 2006, this mortgage REIT actually never eliminated it entirely.

This new rate puts the dividend yield around 14%.  Shares closed at $6.92 and are indicated up around $7.00 in thin trading.  Its 52-week trading range is $3.98 to $7.70 and it trades close to 5 million shares per day.

Jon C. Ogg
July 1, 2009

• Alcatel-Lucent (NYSE: ALU) Raised to Neutral from Sell at Goldman Sachs.
• Chico’s FAS (NYSE: CHS) cut to Sell at Citigroup.
• eLong (NASDAQ: LONG) Cut to Sell from Hold at Citigroup.
• Infineon (NYSE: IFX) Cut to Reduce at Oppenheimer.
• Juniper Networks (NASDAQ: JNPR) cut to Neutral at UBS; started as Hold at Lazard.
• Marriott International (NYSE: MAR) Cut to Equalweight at Morgan Stanley.
• MFA Mortgage (NYSE: MFA) raised to Outperform at Keefe Bruyette Woods.
• Norfolk Southern (NYSE: NSC) Raised To Buy from Neutral at Merrill Lynch.
• Shanda Interactive (NASDAQ: SNDA) Cut to Hold from Buy at Citigroup.
• Vivus (NASDAQ: VVUS) cut to Market Perform at Wachovia.

Jon C. Ogg
May 29, 2008

• China Netcom (NYSE: CN) downgraded to Neutral at Credit Suisse.
• China Unicom (NYSE: CHU) raised to Outperform at Credit Suisse.
• DISH Network (NASDAQ: DISH) raised to Neutral at Credit Suisse.
• Fluor (NYSE: FLR) raised to Buy at Citigroup.
• IPC The Hospitalist (NASDAQ: IPCM) started as Buy at Jefferies.
• McDermott (NYSE: MDR) raised to Buy at Citigroup.
• MFA Mortgage (NYSE: MFA) downgraded to Market Perform at KBW.
• ProLogis (NYSE: PLD) raised to Top Pick at RBC Capital Markets.
• Saks (NYSE: SKS) downgraded to Neutral at Banc of America.
• Washington REIT (NYSE: WRE) started as Outperform at RBC Capital.

Jon C. Ogg
March 6, 2008

MFResidential Investments will target residential mortgage-backed securities (MBS) and residential mortgage loans, as well as other real estate-related financial assets on a leveraged basis.  MFA Mortgage Investments, Inc. (NYSE: MFA) owns MFA Manager, LLC, who will externally manage MFResidential Investments. The company will seek to provide appealing risk-adjusted returns to its shareholders by investing in a diverse spectrum of real-estate financial assets. These assets will be financed through repurchase agreements, warehouse facilities and other forms of borrowing. MFResidential and its manager, MFA, believe that the current housing market situation has provided opportunities to take advantage of low interest rates and credit spreads. MFA engages in similar investing and financing activities for real-estate financial assets.

This isn’t at all the first of the mortgage vulture investing in this sector.  We have been pounding the table on  the Annaly Capital Management (NYSE: NLY) spin-off Chimera Corp. (NYSE: CIM) even before they came public as having the right expertise and model for pulling this off.  The Blackstone Group (NYSE: BX) has also made its vulture ventures known.  Octavian recently went vulture too, although this was on an international scope.  Even hedge fund Marathon announced plans to go vulture investing with TCW Group.

MFA Mortgage has a $1.12 Billion market cap and its shares are unchanged today at $10.70; its 52-week trading range is $5.55 to $11.07.

Rachel Lopez
February 13, 2008

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Jon C. Ogg
September 19, 2007

Jon C. Ogg produces the 24/7 Wall St., LLC Special Situation Investing Newsletter; he does not own securities in the companies he covers.

Jon C. Ogg
June 14, 2007

Jon Ogg can be reached at jonogg@247wallst.com; he does not own securities in the companies he covers.