Think about it.  The world capital markets are willing to give the US money for five years, and get their dollars back with a whopping 0.75% interest per year.

The real money is shouting at us that our deficits are not the issue.  Are you listening?

On another front, speculators and hedgers got a new toy today, or, more precisely, gave the unwashed masses access to one of their leveraged toys.  My inbox this morning had a short blurb from Jody Shenn at Bloomberg about a house price index opening up for public trading on the CBOE (the options market).

It’s not ground-breaking, since the cross-town rivals at the CME have traded the Case-Schiller contracts for a while now, but the Radar Logic data set is so much larger that we may see some very sophisticated players look for arbitrage between the two, especially on a city-by-city basis.

More to the point, offering a way to hedge against falling home prices to the public at this point sounds like nailing the barn door shut to make sure the horses can’t get back in.

hh

I’m here to do my bit to start a conspiracy right out in the open.  Call it reality-based planning for the post-rapacious economy.  As many readers know, George Ure was a survivalist before it was popular, and he stayed on the cutting edge of that world when he shifted to “prepper” a few years back.

He and I even wrote about 300 pages of a (rough draft) book that let us continue our multi-decade argument over what’s happening and what can be done about it.

In today’s column (linked above), if you scroll down to the section titled Coping:  A Fifth Order House, you’ll see a different George than the one I’ve talked to these past dozen years (plus).  I even called to ask what had happened to real George after reading it.

In short form, though George and I agree about much, such as the inextricable joining of business and government and the Kabuki Theater of the two-party system, most of the time we were collaborating on our book George was a strong proponent of rugged individualism — individualism that went as far as growing his own food, arming himself for the revolution, generating his own power, and even keeping his Morse Code up to snuff so his 55-foot radio antenna could truly reach other survivors anywhere on the planet after the apocalypse.

America, and most of the rest of the G-20 economies have basically been on a binge of cash-out refi’s for decades now, and the bill started coming due in 2008.  The Powers That Be continue to think that even more wealth concentration, even more broadly based debt, and even more “privatization” of previously public goods and services is some kind of solution.  It isn’t.  It’s only doubling down on a bad bet.

My approach to surviving was quite different.  I have a well-stocked pantry, but no farm animals.  I keep my oil tanks topped up, own a car that can go 700 miles on a tank of gas, and I have a few basic skills and tools to maintain my home.  I don’t have a machine shop, buried MRE’s, or an arsenal.  That’s because I think surviving in a post-crisis world won’t depend on being able to kill your neighbors or strangers, but rather in being able to trade with them and share what you have.  I call it cooperationism.

No, it’s not communism, or bleary-eyed socialism.  It’s my view that our world of supply chains and concentrated production of food and other essentials will have to evolve toward a system that keeps most of the logistic structure working no matter what happens to the economic infrastructure.  Even if debt is being repudiated, money is suspect, and the gold freaks are right about the eventual value of the metal, we’ll still need to move foodstuffs from farm to city, or mass starvation will be the result.  I guess I am an optimist, since I think we humans won’t choose to accelerate others’ death when push comes to shove.

Along those lines, I think people who are capable of compromising, and behaving cooperatively even without the traditional profit motive will be the survivors, not the people in their cabins in the woods prepared to shoot any intruder.

George is probably going to expand on this idea in his Peoplenomics column tomorrow.  If it’s as good as I think it will be, his subscribers may be getting their yearly subscription’s value in that one column.  The other 103 columns they read will be gravy.

hh

I was already amazed, as a bond guy, when the Fed started telling us how long they thought they would hold short rates at zero (until at least second half of 2013).  Comments here and here.

Today comes the news that the Fed will share its musings on the future path of their Fed Funds rate as part of their release of meeting minutes.  Gadzooks!  Think how far this is from the days when they told us exactly nothing, and people got paid millions of dollars to guess what the current policy might be.  Fuggedaboutit if you wanted to know what they were thinking about the future.

Never thought I’d see this day.

hh

Just ask the Europeans how that feels.  If that were to happen, then the fully hedged amREITs will survive, but the ones playing the duration gap too aggressively may not.

Still, the announcement from ANH that they are converting to “externally managed” is not in my best interest as a retail shareholder.  These arrangements are typically set up so an affiliated company owned by the management provides asset management for a fee.

Historically, smaller, newer mREITs did this because their manager is a successful fund management company that can afford to carry the staffing levels the mREIT needs, without making the small ($300 million or lower equity) mREIT carry the whole load.  Also, it gives the sponsoring asset management company the option of boosting shareholder return by forgoing the fee.  (I remember Blackrock doing that for the first several years I owned their commercial mREIT, Anthracite.)

Going the other direction when shareholder equity is above a billion dollars is simply not in the mREIT playbook, and with good reason.  With a billion dollars equity under management, an amREIT can manage itself internally for cost in the 1% per annum neighborhood.  That $10 million a year is sufficient to keep the staff they need (20 to 30 people), and incentive compensation in the form of restricted stock or long-vesting options can provide the kind of pay package that rewards the management team with a comfortable life and affluent retirement.

Color me disappointed, and out of my remaining ANH stock.

hh

Au contraire.

Those e-mails will remain my virtual diary of the runup and meltdown.

Still, they do make interesting reading, especially during the time in mid to late 2007 when Washington and the media establishment decided that “subprime” was as likely to boost ratings as Lindsey Lohan’s latest DUI.

After the break, I’ll post a couple of weekly missives (appropriately scrubbed of portfolio performance, specific trades, or other proprietary information).  They dated to late summer, 2007, and showed that the political and financial world was definitely, positively going mad and looking to find scapegoats.

Now that I think about it, not much has changed these past four plus years, has it?

Merryall weekly, August 24

In the same logic that makes any resistance to US military action “terrorism”, it seems that now that any credit difficulties anywhere are somehow linked to US subprime mortgages.  Today’s folly is the report I just read that tracks corporate bankruptcies, expected to be up 51% in 2007 vs. 2006.

Strangely enough, the reason so many corporations are declaring bankruptcy is reported as “contagion” from subprime lending, as is the marked increase in delinquencies of super-prime seven figure mortgages and the substantial year-over-year rise in credit card and auto loan delinquencies.

Somehow, the 14% of the subprime mortgage loans that are delinquent are directly responsible for any late payment or default, anywhere.  All that from a group of mortgage loans that are themselves only about 15% of the total US mortgage market.

I’d be willing to bet that this particular 1% of the population never knew they had that kind of economic power (14% of subprime loans times 15% of mortgages times 69% of households that own homes times 70% of homes with any mortgage at all).

In fact, the subprime borrowers themselves would probably guess that the 1% of the population on the other end of the economic spectrum had more to do with today’s financial stress than those people on the bottom rung of the ladder.

I’m not trying to make light of the very real difficulties facing these two million or so households, but I do think it’s a cheap excuse for something much larger.

This raises the question of what the economic world will look like (and when) we come out of the other side of this de-levering .

If we assume that the credit standards will tighten more or less permanently on the bottom quintile of borrowers, we might assume that half of them won’t qualify for the kind of loans lenders will be willing to make in 2008 and beyond.

That still leaves a pretty substantial $300 billion per year market to be divided among a vastly smaller universe of lenders.  Anyone who thinks the depositories will take up the slack has never experienced a Bank Examination.

The whole reason non-bank lenders exist is that the Fed, the FDIC, and the OTS (Office of Thrift Supervision) already have it as a given that any bank is playing with radioactive material if it has subprime loans in its investment portfolio.

They’ve treated it that way since the melt-down of the 1980′s led to the RTC bailout, and the news this year can only have made their bias against poor credit borrowers even more black-and-white.

In fact, if we look at the handful of lending institutions that do still hold market share in the subprime mortgage sector, we see that they do so only in the context of truly huge balance sheets, with names like Wamu, Wells Fargo and Citi leading.

In a development that was probably just as significant as GE leaving the subprime sector (shutting down their WMC subsidiary), Lehman Brothers announced they were shutting down BNC Mortgage last week.

A skeptic would say that both these operations had the wrong people and wrong systems, since their credit performance was abysmal compared to peers, and the current environment just gave cover to senior management that knew they had bet on the wrong horse for some time.  Still, capacity leaving the market this way can only benefit the survivors.  First they have to survive.

Speaking of survival, what will happen to the “prime” borrowers if the general economy takes a downturn?  As a friend pointed out recently, the subprime borrower is used to living on the edge, and may actually be better equipped to deal with real economic trouble than their “flabbier” FICO 710 prime borrower cousins.

Consider this:  Press written by innumerates likes to talk about payment shocks for subprime borrowers, but the reality is that those borrowers were paying 8% and may soon have to pay 11% if the Fed gives no relief by this time next year.  That amounts to a jump in mortgage payments of a few hundred dollars a month for the typical subprime borrower.

On the other hand, about half the “prime” loans in California are Interest Only, and a huge percentage of them are extremely low payment Option ARMs that allow negative amortization.  A significant fraction of these loans, many of which have balances in the high six figures, can go from a starting payment of $1,500 a month to a fully amortizing payment north of $5,000.

Try that with a middle class family that thinks economizing consists of leasing a less expensive car when the current lease ends.

What I’m saying is that poor people are probably better at dealing with tough times than we give them credit for, while our middle class may not be nearly as well equipped, if it comes to that.

Merryall weekly, special pre-holiday [Labor Day] message

In response to CNBC’s success after converting into the Subprime Channel, Bloomberg television has done the same.  Even PBS is jumping on the bandwagon, along with every politician in America.

The underlying assumptions for the media and political hacks is that any credit weakness from any borrower anywhere is caused by US subprime problems, and that any borrower not paying their debts must have been tricked into lying about their income by predatory lenders, especially if they did it on ten different mortgage applications for ten houses at the same time after reading “Rich Dad, Poor Dad.”

Confirming a suspicion some have held since Medicare was expanded into a giant prescription drug giveaway at full list price, it is now clear that Vladimir Putin actually replaced George W. Bush with a communist puppet when George made the mistake of “looking into his eyes” at that Camp David weekend five years ago.

The latest purely socialist proposal from our Decider in Chief is to continue to keep private enterprise restricted from using prudent investment criteria to add to the portfolios of shareholder-owned Fannie Mae and Freddie Mac, but rather to use real taxpayer money in the fully government guaranteed FHA program to refinance subprime borrowers, but only those who are 90 days’ delinquent.

What looking glass have I fallen through?

The Democrats want private enterprise to be able to invest more, and the Republicans say “No, we want the taxpayers to foot the bill”….

On top of that, they’ll only foot the bill for the borrowers that shouldn’t have gotten the loans in the first place.  Screw the 86% of the subprime borrower universe that have managed to pay their mortgages on time every month.

While the Presidential replacement theory has its adherents, there are others who suggest there is a more spiritual explanation for the radical change in behavior from the West Wing.  The psychic phenomenon called “channeling” has been suggested by this smaller contingent of observers.

They are divided on whether the spirit of FDR or that of Eugene V. Debs is actually controlling the situation.  The tendency to attack foreign countries Americans can’t find on a map argues for FDR, but bailing out only those who don’t work or even try argues for Eugene.

No matter the cause for this bizarre behavior, it’s good for our mortgage lender stocks, and might even help our bonds, assuming some sort of liquidity relief is in the offing.  Still, if the ABCP (Asset Backed Commercial Paper) continues to shrivel up and die, there just isn’t enough money in the world to buy the amount of AAA ABS bonds that will have to be sold.  We’ll find out soon enough if Ben Bernanke deserves his Helicopter appellation.

War is Peace.  Freedom is Slavery.  Ignorance is Strength.

Tuesday we’ll return to our normal program with month-end figures on the Merryall Fund.

PS — Now that we have healthy competition in the blockbuster prescription drug arena for “Restless Leg Syndrome”, I just want to ask whether anyone reading this even knows anyone who ever complained of this malady before the drug companies invented a treatment.  Personally, I’ve never had a dinner guest call and cancel at the last minute saying “Ruth and I won’t be making it tonight — it’s those darn restless legs again.”

hh – (The preceding was written during the storm in 2007, presented without additional comment on December 29, 2011)

While not as universally applicable as the disgust and anger the 1976 cult classic movie portrayed, Nocera was pointing out how outright propaganda machines masquerading as tax-exempt and subsidized think tanks can create an alternate reality out of whole cloth, and how our main stream media and Congress adopt and spread that propaganda.  In this case, his target was one of the more dishonest Resident Scholars at the American Enterprise Institute, and his widely repeated lies.

As I mentioned at the time the Financial Crisis Inquiry Commission made its initial report to Congress, this campaign of disinformation about the root cause of the financial crisis is unfortunately repeated as “truth,” that Federal government community reinvestment policy and government sponsored enterprises Fannie Mae and Freddie Mac were the main reasons we went into a financial tailspin.

The reality, that subprime and alt-A mortgage securitization madness was the cause — that reality is being swept under the rug. 

Those two previously quite small mortgage market subsectors were terribly abused by Wall Street and the real estate industry, and they were completely the creation of the free-market capitalists that the AEI owes allegiance to.

It’s something to behold when a significant fraction of our citizens and our lawmakers are so invested in protecting their fundamental (almost religious) beliefs that they end up giving a free pass to the crooks and their methods.  Along the way, “true believers” like Peter Wallison actually invent facts and re-write history rather than face the truth that their ideology needs examination and maybe a fix or two.

As the main proponent of this baldfaced lie, Wallison knows the untruth of his positions.  If he had any doubts, he could ask his fellow AEI employee (Fellow of AEI) and real housing finance expert Alex Pollock, who gave us this excellent warning about the coming crisis in late 2007.

That said, here’s Nocera’s withering broadside.

A few choice paragraphs for those who don’t follow the links:

“You begin with a hypothesis that has a certain surface plausibility. You find an ally whose background suggests that he’s an “expert”; out of thin air, he devises “data.” You write articles in sympathetic publications, repeating the data endlessly; in time, some of these publications make your cause their own. Like-minded congressmen pick up your mantra and invite you to testify at hearings.

You’re chosen for an investigative panel related to your topic. When other panel members, after inspecting your evidence, reject your thesis, you claim that they did so for ideological reasons. This, too, is repeated by your allies. Soon, the echo chamber you created drowns out dissenting views; even presidential candidates begin repeating the Big Lie.

Thus has Peter Wallison, a resident scholar at the American Enterprise Institute, and a former member of the Financial Crisis Inquiry Commission, almost single-handedly created the myth that Fannie Mae and Freddie Mac caused the financial crisis.”

Now, back to effort of correcting the record and telling the inside story.

hh

I called what I was doing “financial engineering” when my friends outside the business asked for stock tips. Even though I paid attention to the stock market before I worked on Wall Street and after, I actually had no time for stocks when I worked there, so I never had any tips for my friends.

But back to Financial Engineering.  As far as I know, I was the first person to refer to my vocation by that phrase, though since that time I’ve seen universities award degrees in it.

During those early years of my career, I was lucky enough to love what I did, to get paid well (though not nearly as well as the more effective political operators around me), and to perform a service that I could see was helping a huge swath of my fellow Americans.

So why did structured mortgage finance turn into a “force of evil” that nearly drove the world economy into a second great depression?

The answer, as always, is not to blame the tools but to look at how they were used.

At this point it is just about exactly four years since I wrote “Mortgage Market Mayhem.”  At the time, I was involved in damage control on a hedge fund my employer set up for me to run.  It was a long-biased equity and debt fund running 5:1 leverage investing exclusively in “down in credit” private label mortgage company stock and bonds.  Subprime, in other words.

About that time, the word “subprime” was chosen as the Word of the Year, and even though the losses in my fund were far less than any other (long-biased) fund in that sector, it was clear that no one would be interested in investing new money in that sector for a very long time, if ever.

Having been one of the early inventors of the financial technology in my years on Wall Street, and then a customer with a mandate and money to buy in that sector, I saw the whole slow-motion train wreck first hand.

When I first thought of writing the book, I was going to “sanitize” my weekly missives to management, written every Friday from mid-2006 through the end of 2007.  A number of the senior executives at my firm told me they loved reading my Friday letters, even though they were more often than not describing an unfolding disaster.

Even after the names of the innocent (and the guilty) were removed, those e-mails (more than 100,000 words) served as a fascinating real-time diary of the events of the subprime disaster and subsequent global market meltdown.  Add that to the 25 years I spent developing and studying and investing in the market, and I knew I had a unique perspective that no financial reporter would ever get by interviewing people in the news.

In fact, since losers seldom want to talk to reporters, the books that followed were almost all of the “history is written by the winners” variety.  Even well-respected reporters that should have known better were taken in by the outright dishonesty of some of the players who made retirement-level (or even multi-generation wealth level) money off the “play” they had engineered.

For that reason, and others, I will be publishing my book this spring.

I think the real story from an insider recorded in real time even before the last act of the play was done will serve as a cautionary tale, and as a much-needed counterbalance to the virtual propaganda that the subject has gotten so far.

Here’s hoping all my readers have a safe, happy and joyous holiday.  I’ll post from time to time as a kind of break from writing the necessary update and intro that four years of events requires.

All the best,

howard

I hope it’s been helpful for my readers to recognize the styles and methods the managers of these companies use, and their relative transparency and quality of disclosure on this front.

Jon Rosenbaum asked in a comment today:

“What is the best way to protect your principle and retain dividends for amreits? What hedging instruments work best?

What about SDS for general market drops? or some other vehicle?”

Before I take a shot, let me remind everyone that there is no perfect hedge.  Back in the 80′s, the First Boston (today Credit Suisse) traders kept a small potted miniature (English) boxwood near their trading desk with the legend  “The Perfect Hedge”…. Before I let go of the hedging lore from Wall Street, I need to repeat one other bit of wisdom, which, unfortunately, doesn’t answer Jon’s question.

“The only perfect hedge is a sale ticket.”

While true, when you sell your assets, you lose the future income.  That’s the rub for retail investors, and, for that matter, for what we call the “real money” investors like insurance companies and pension funds.  The need for future income overrides the reality that selling the assets may be the best thing to do sometimes.

A portfolio manager or a retired person generally doesn’t have the choice to just sit out during an apparently overheated market, because the insured pool for a life company continues to have claims, the retirees depending on the pension or annuity have to get their monthly checks, and the retiree living off their investments still has to put groceries on the table.

So let me start with what didn’t work for me, since it was perilously similar to Jon’s suggestion of SDS for protection against a general market move.

Back in 2009, I bought at nearly the right time (March), though with not nearly enough of my capital.  By that fall, I was nervous with my gains, and thought a correction was due in all the deeply discounted mREITs, insurance and bank stocks I had bought.

I bought into leveraged inverse financial funds (first SKF, later FAZ) thinking that a general correction of the dozen or more financials I had ridden on the upwave would result in quick profits to offset the losses on the stocks.  To help with the income issue (as I was also writing out-of-the-money calls on some of the positions), I wrote far out-of-the-money calls on SKF.

To make a long story short, I did keep the premium from the SKF calls, but the loss in principal as it collapsed, reverse-split, and kept going down was a largest enough loss to take away most of the gains I had originally sought to protect.

Why is that?

Because of the mathematics of those double and triple levered ETF’s.  They are structured to provide the return for one day only.  If, as is normal, a market does not go in one direction only, but up and down on successive trading days, the levered ETF will lose money overall.

Here’s how it works:

Say you have a portfolio that’s at $100 today, and you buy $50 worth of the double inverse ETF.  If your portfolio went up by 2 points the first day, your inverse would go down by 2 points.

After Day One, your hedge is working.

But on Day Two, let’s say your $102 portfolio drops back down to $100.  Your inverse will go up from $48 by twice the fraction that your long portfolio went down.  That’s just under 2% (2/102), or 0.196%.  Doubling that, the inverse goes up by 3.9216%, leaving its new price at $49.88.  You’ve lost 12 cents due to the mathematics of daily compounding on the ETF.

It’s a mathematical artifact at work.  If the market, and your portfolio value, go up and down over time, if you simply hold the levered ETF, you’ll end up with less money over time.

Having said that, I have had some success this year by buying next month out-of-the-money calls on triple-levered inverse FAZ when the financials have been strong for a few days and political risk is present before the weekend (e.g. Europe PIIGS crisis or the Congressional game of political hostage taking).  When Monday comes, the news is usually enough to move the market up or down at the open.

Maybe a half hour after the open, I either close the option position with smallish loss (the news is good and my main portfolio is up or not being killed), or I look to sell a call option at a higher strike price than the one I bought on Friday (when the news is being interpreted as bad for financials).  Whichever way the news drove the market that morning, by midweek it usually becomes clear that the world is not coming to an end, or that more problems are cropping up in what was supposed to rescue the world.

Since my main bias is toward protecting against disaster, building a position of “vertical” call spreads on FAZ at no cost or even slight profits gives me the kind of disaster insurance I’m looking for.  I have no doubt that the market can punish me more than this small protection will give me, but I just don’t see another method that doesn’t result in losing so much money over time on “hedging” that my net worth goes down rather than up over time.

Hope this helps, Jon.  Feel free to ask more questions.

hh

“So far, AGNC, TWO and MFA were able to maintain dividends, while CYS, IVR, HTS, and CMO cut. We think the difference in performance can be attributed to asset selection, but there is no doubt the flatter curve will put pressure on spreads.

We believe the next quantitative easing will focus on agency MBS in order to keep mortgage rates low, but the fact that $1.1 trillion of bonds are held offshore and $1.6 trillion are held by financial institutions that might have to downsize because of deteriorating sovereign debt means that QE3 might not be effective at driving mortgage rates lower, though the benchmark 30-year fixed rate mortgage is likely to stay around 4% for the first half of 2012.

Despite market pressures, the mortgage carry trade is alive and well, and we think the top performers continue to be undervalued.

The indirect linkage between US MBS and foreign debt shows the point that I keep trying to make  — even though you hold uncorrelated assets when they are in a bull market, liquidation hits all.

hh

Hello Everyone,

Happy Holidays to all:

This has been a very good year for myself and those I trade for. My basic philosophy is to make money every quarter, be conservative by using income stocks that in some small way limit downside risk, make at least 20% a year, go to cash at the end of each quarter and reevaluate, limit losses where appropriate and know my major stock positions well and control my emotions.

This year I will end up making 35% on my accounts. In a year like this I feel very good about that. What an emotional roller coaster. And next year could be worse. Such is the life of an investor.

Let’s start with the amreits. My major, very concentrated, position this quarter was in AGNC. I have now sold all my AGNC and gone to cash. Since I try to go to cash each quarter I consider myself a swing trader. Regarding concentration, I harken back to the days some of my friends traded in the commodities pits. One trader just traded cattle, another just traded hogs, etc. These guys did this for a living and they didn’t “diversify”. They knew their business and they traded their business. For me stock trading is my business. I concentrate on one area and try to learn the strategies to make the most money I can in that one area with the least amount of risk. So far that has worked very well.

I have chosen AGNC to be my primary amreit investment because it is the best of breed in terms of returns to the shareholder. The AGNC strategy, as best as I can interpret it, is to pay a high dividend, even if the dividend is greater than GAAP or Core for short periods. This high dividend will increase share price to well above book value right before the ex date and at other opportune times as well. This will allow AGNC to do a secondary and increase their capital base (something they do about every quarter). This strategy allows them to claim the secondary is accretive to book value and therefore good for existing shareholders. The stock price goes down at the offering but has always recovered by the ex date – making this a superb trading opportunity. The strategy works well for management because they are paid based upon total capital so the more capital they raise the better. AGNC takes the capital, levers it a little bit more than the average amreit, buys expensive low prepay MBS securities, finances them with cheap repo financing, hedges much of that using creative swap positions – all of which generates very acceptable yields. Add to this strategy an active management that sells high yielding, high priced, high prepay securities for gain on sale and their taxable income ends up being greater than the dividend payout. For the past two years this has provided a cushion of undistributed taxable income that could be used if the dividend was greater than taxable in any one quarter. Mr. Kain has shown he is clearly head and shoulders above the other amreit managers during this particular phase of the amreit cycle, thus I have chosen to ride this horse and trot to the winner’s circle with returns that are consistently above 5% per quarter.

Now let’s take a look at each of the amreits and where we are in the cycle. You could call this the technical side of the trade. I am also going to comment on management skills of each of the amreits, as I see it.

1. AGNC – Kain is the best and most honest and upfront. The presentations at conference calls and analyst conferences are the best and most transparent. AGNC has been able to maintain its $1.40 dividend for the last three quarters but look at the price action. Two quarters ago the high price for the quarter was in the 30s, last quarter the high price was in the 29.90s and this quarter the price could barely break 29. My theory is the price will not end the day above 29 and many covered call holders will end up holding their shares. (today is expiration day) Short interest moved up from November 15th to November 30th and my bet is it will move up again in the November 30th to December 15th cycle. As my strategy of sell and the end of the quarter and rebuy, say 1.5 to 2.0 times the dividend lower, after the ex-date has become more well known, the strategy has become harder to implement. New strategies then need to be implemented. For the next few quarters spreads will continue to be squeezed, net interest income will continue to decrease, dividends will continue down for the amreits and share price will decline. Not exactly great stuff for a buy and hold investor.

2. ARR – This company has adopted the AGNC high dividend/high share price/secondary policy. They don’t exactly earn their dividend but some of the secondary money can be used to pay for the monthly dividend. I really don’t know management that well. Oh yes, I have heard the negatives but sometimes the negatives can be a good thing. Maybe these guys will try to prove themselves to be better, maybe they can change their spots, maybe not. This is a great trading stock because it recovers so quickly. It pays monthly and you know what your return will be before you invest at your particular stock price. I made one big trade(s) of this stock on October 4 and thereabouts. I bought 100,000 shares at an average price of $5.50. Within 6 days the price had recovered and I sold at $6.99. I did great, yes I could have held for a higher price but I have learned that trying to sell for the very top dollar costs money in the end. So I leave a little on the table for others and if I buy right I do not get hurt. Two quarters ago the dividend was .36, this quarter is was .33 an 8.3% cut, next quarter has not been announced but my bet is at least another 8.33% cut. Typically dividend cuts make the share price drift down, we shall see.

3. CYS – This company invests in 15 year MBS for the most part and uses forward purchases. I don’t particularly like the forward purchase strategy as I do not believe CYS is getting better securities than Kain and giving up the interest. I would rather have the sure thing of the interest income that the possibility of the value of the securities going up into delivery. I don’t trust the CEO Grant. During one conference call Grant stated that by using his strategy he believed that he could keep the quarterly dividend at .60 for a very long time. Now that he is not doing secondaries, CYS’s dividend has gone from .60 in June to .55 in September (an 8.3% cut) and then to .50 in December (a 9% cut). So far the price of the securities has held up well but my 20% criteria is not met with this stock.

4.  HTS – This company buys hybrid arms (typically 5-1 hybrids). Bad strategy in this environment. Prepays do matter and this company has a high prepay rate. High prepays lower returns. Back in the day this management made fun of AGNC, now AGNC makes fun of this management. Dividend was $1.00 in June, 1.00 in September (they held the dividend in September because they sold some of their securities at a gain – something they said they would never do back in the day) and .90 in December. (a 10% dividend cut).

5. NLY – This company invests in 30 year mortgages. Biggest of the group. Farrell just seems arrogant to me. His attitude – I am providing you with 13% returns and you can’t get that anywhere else so don’t complain. No I won’t increase leverage, no I won’t try to increase your shareholder value and yes I will try to be unpredictable with the dividend. No I do not believe in transparency but I am pretty good at giving my opinion on the economy as whole. He is a smart guy I just find better amreits to invest in. In June the dividend was .65, in September the dividend was .60 (a 7.7% drop), in December ? probably another drop.

6. CMO – This company invests in short term one year reset ARMs. Real bad strategy in this environment. JMP analyst Steve Delaney insults them on every conference call. “Boy, this is a bad strategy for this environment, ever consider changing it?” Then he just goes on to more mundane issues like what are your one year arms going to reset down to this quarter. Looks like another dividend cut. June dividend .48, September dividend .44 (an 8.33% cut), December dividend .43 (a 2.2% cut)

7. ANH – This company invests in say 5 year arms. Selling way under book value. Great deal Huh? Stock keeps going down, dividend keeps going down. Management recently changed from internal management (supposed to be the better, cheaper form) to external management so Lloyd’s family could hide their compensation from the rest of us. These guys are just embarrassingly bad managers. High dollar swaps are coming off so that should help eh, nope they cut the dividend again. This is where we sit around the bar with a drink in our hands laughing at those that preach what a good deal it is to buy and hold below book value Anworth, but it keeps going down. I am sure Lloyd is a very nice guy but … The dividend was .25 in June, .23 in September (an 8% drop) and .21 in December (an 8.7% drop).

8. So to summarize in the last two quarters CYShas cut their dividend 17.3%, ANHhas cut their dividend 16.7%, CMOhas cut their dividend 10.5%, and AGNChas not cut their dividend. Of the others I only have one quarter of data. HTScut their dividend 10%, ARRcut their dividend 8.3% and NLYcut their dividend 7.7%. Not a great buy and hold environment for this sector.

9. On to a couple of semi-agency reits. MTGE, AMTG and TWO. First, two didn’t cut their dividend so there has to be something good about that. Other than MTGE, management is best in space. Best in space management is MTGE. Why, well it’s AGNC’s management. MTGE is 95% agency paper in low loan balance and Harp low prepay stuff and it sells at a $2.00 discount to book. Or at least it used to. And it is paying an .80 dividend. My feeling is that Kain will try his darnedest to increase the share price above 19.97 (the book value) so he can start doing secondaries on this one. Thus I could see a dividend increase here. And I would much rather see a big dividend than a possible increase in share price because of low book value. Just recently I switched some of my AGNC to MTGE. I do want to thank SS94 for some discussions we had. The big problem with MTGE is no option action to speak of and low volume. So if you need liquidity, be careful here. BZ wants me in AMTG and this stock has done pretty well since its drop to the 14.50s but the dividend was terrible and I question the management so I will wait this one out.

10. And just for the sake of diversification I have very small positions in CHKR, SDTand GLNG. SDT is up 19% since I bought it. GLNGis up 5% and CHKRis up 5%. It just goes to show you that there is money to be made in stocks other than amreits

11. One last thing, my personal opinion is that you don’t buy a basket of AMREITS – only buy the very best. When they go down, they will all go down. When they go up, they all tend to go up. So why lower your return by buying the worst of the sector or the ones that have a bad strategy in this environment. Just a thought.

I wish great investing to all of you.

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