Investing

In Defense of Mortgage REITS, Despite Rising Interest Rates

We have extensively covered the risks brought on by higher interest rates against certain sectors of the stock market. The sector of mortgage real estate investment trusts (REITs), with its high dividend yields, has severe exposure to rising interest rates. Oppenheimer’s research team has issued a report that dissected the mortgage REITs and gave some good data for examining which of these fallen angels actually might be stocks to buy for yield-hungry investors. For those who fear asset purchase tapering from Ben Bernanke, those high dividends likely will come under more scrutiny.

Oppenheimer’s research report included price performance and total returns, dividend yields, capital actions, industry fundamentals, current trading valuations and company-specific data. The key takeaway is that book values on average are declining again in the second quarter, following the drop in value of agency mortgage-backed securities (MBS), but that the return potential (dividends) has improved somewhat with spreads widening.

While Oppenheimer as a firm only covers two mortgage REITs, they did a comprehensive look at all the names in the space. We screened those names for the highest book-value-to-price and then factored in current yield. Investors should remember that dividends from mortgage REITs may include return of principal.

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Armour Residential REIT (NYSE: ARR) trades at the highest discount to its book value. In the first quarter 2013, it had estimated taxable income of approximately $86.0 million. This represented a 13.8% annualized yield on first quarter 2013 weighted average paid-in-capital. The book value of the stock is $6.72. Armour is trading today close to the $5 level. The Thomson/First Call estimate for the stock is $7. Investors receive a 16.35% dividend paid monthly.

Anworth Mortgage Asset Corp. (NYSE: ANH) is paying $0.15 in dividends per share quarterly, while it earns $0.21 per share. Although dividends are paid out from cash, it seems the company’s earnings are sufficient to cover the prevailing dividend rate. Currently its dividend cover ratio comes out to be 1.4 times. The book value for the stock is $7.05, and the shares are trading around $5.50. The consensus price target for the stock is $6.75. Investors receive a 10.82% dividend.

CYS Investments Financial Corp. (NYSE: CYS) has made a smart move by focusing on 15-year fixed rate securities. These securities are not immune to prepayment risk, but have much lower risk in comparison to 30-year fixed rate notes. Book value for the stock is $12.87, and today it is trading in the $10.46 range. The consensus price target is at $13. Investors are paid a 12.20% dividend.

American Capital Mortgage Investment Corp. (NASDAQ: MTGE) has had solid insider buying dating back to last December. Book value for the stock is $24.25, and it trades today in the $20.71 range. The consensus for the stock is $26.75. Investors receive a 17.40% dividend.

Capstead Mortgage Corp. (NYSE: CMO) gross profit margin is currently very high, coming in at 94.80%. The net profit margin of 59.57% significantly outperformed the industry average. The book value stands at $13.60, while the stock is trading at the $11.75 level. The consensus price objective for the stock is $14. Investors are paid a 10.52% dividend.

Apollo Residential Mortgage Inc. (NYSE: AMTG) is already an experienced hybrid mortgage REIT, which seems to be the more stable model for the eventual rising interest rate market. The book value is $21.72. The stock is trading in the $18.42 range. The consensus price target is $24. Investors are paid a 15.21% dividend.

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The bond market is an anticipatory vehicle. Rates have spiked in the past week on the mere mention of the tapering off of the Federal Reserve’s aggressive bond-buying program known as quantitative easing (QE). While rates are destined to go higher, many of these mortgage REITs are hedged for that eventuality. It is very possible that hedge funds may be shorting these names as a quick momentum play. The quality names could snap back fast, as all these stocks are very oversold.