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2011-06-23 14:07:17
Many investors and trustees are looking for higher yielding equities to include in or supplement a fixed income portfolio. Agency mortgage REITs are a popular option. Most REITs are equity REITs that own and/or manage properties. Mortgage REITs, to the contrary, own mortgages on real estate assets rather than the assets themselves. Some mortgage REITs concentrate on commercial mortgages, while others concentrate on residential property mortgages.
Within the world of residential mortgage REITs, there are two primary subdivisions: those that own mortgages insured by federal agencies and those that own mortgages without agency insurance (non-agency REITs). Agency mortgage REITs are supposed to have portfolios made up principally of mortgages insured by the federal agencies Fannie Mae (FNMA.OB), Freddie Mac (FMCC.OB) and/or Ginnie Mae.
These government agencies make mortgages and then issue a mortgage backed security (MBS). An agency MBS, as opposed to a MBS issued by a non-agency lender, comes with an agency guarantee and an implied U.S. government guarantee. These federal agencies' implied or quasi-government guarantees have, so far, been proven virtually as solid as any paper issued directly by the Treasury.
Agency mortgage REITs must also react to changing interest rates. These REITs obtain their lofty yields through high leverage. These companies all have far more debt than their market value, as indicated above, and make money off the spread between their borrowing costs and the MBS interest payment. Each company has a proprietary allocation of fixed and adjustable rate securities. Changes in rates will affect the value of these securities and the spreads these REITs can make off of them. In short, rising interest rates will largely reduce spreads and values.
I have identified several companies that primarily invest in agency paper using the above-described agency REIT model, and which currently have double digit annual yields.
Annaly Capital Management, Inc. (NLY)
Current Yield: 14.1%
Market Value: $14.2 Billion
Price to Book Value: 1.1
Short Interest: 4.3%
American Capital Agency Corp. (AGNC)
Current Yield: 18.8%
Market Value: $3.7 Billion
Price to Book Value: 1.1
Short Interest: 6.6%
Anworth Mortgage Asset Corporation (ANH)
Current Yield: 13.6%
Market Value: $839 Million
Price to Book Value: 1.06
Short Interest: 5.2%
Capstead Mortgage Corp (CMO)
Current Yield: 13.8%
Market Value: $1.07 Billion
Price to Book Value: 1.14
Short Interest: 4.3%
Cypress Sharpridge Investments (CYS)
Current Yield: 19.2%
Market Value: $1.05 Billion
Price to Book Value: 1.07
Short Interest: 9.2%
Hatteras Financial Corp (HTS)
Current Yield: 14%
Market Value: $2.17 Billion
Price to Book Value: 1.11
Short Interest: 7.6%
Please note the reasonably high short positions on these REITs (between 4.3% and 9.2%). Those with the highest present yields and leverage are also the most heavily shorted. These REITs are also well-known for their secondary offerings, and some individuals may now be speculating on coming offerings in addition to possible interest rate changes potentially affecting their spread-margins.
REITs must distribute at least 90% of their taxable income in order to eliminate the need to pay income tax at the corporate level. Under the current tax laws, REIT dividends are taxed as ordinary income, and not at the lower corporate dividend rate. Because these REITs are taxed as ordinary income, many investors appreciate holding them in tax-sheltered accounts, such as an IRA.
Disclaimer: This article should not be construed as personalized investment advice as it does not take into account your specific situation or objectives.
Disclosure: I am long NLY.