Attractive amREIT

I think it’s worth noting that the amREIT that manages their capital risk most robustly is now trading at a discount to book value.

Capstead Mortgage (CMO) sports the lowest net duration (just a couple of months) of all the amREITs.

Put into practical terms, their equity exposure to rates moving can be approximated by taking their leverage and multiplying it (plus 1) by the price sensitivity of the Treasury Bill that matures at that duration.

In a recent Street research piece, I saw the estimate of $11.99 for CMO’s book value at the end of Q1.  Seems reasonable to me.  Trading at $11.50, that gives enough cushion to believe that their stock is trading at a slight discount even with the mild spread widening and the impending Agency bad loan buy-outs.

I like how Capstead manages their portfolio to limit exposure to rate hikes.  If they managed it down to zero (only possible if you spend nearly all your carry profits on hedging), rate hikes would have no effect on their portfolio value.

Contrast that with an amREIT that has a duration of 2 years.  The two year T-Note duration is very close to two years (just 1.944 years because its yield is so low).  If rates go up on the two-year, hovering just over 1% at present, assets with two-year duration will decline by just under 2% for every percentage point of rate movement.  Multiply by leverage plus one, and you can see that a 7-1 levered amREIT is exposed to a 15% equity hit from a 1% move in rates on the short end of the curve.

Contrast that with an amREIT sporting the same 7-1 leverage but only 0.25 year duration.  That same move in interest rates only hits the shareholder equity by 2%.

I’m on record saying short rates would stay low a lot longer than many observers expect.  But history tells us the worst stock performance in this group happens when the Fed starts a tightening cycle.

Given the choice, I will take the one that only has 2% a book value exposure to the first few rate hikes over the one that has 15%.  Wouldn’t you?


Disclosure:  Adding to CMO position in the $11.50 neighborhood.


5 Responses to Attractive amREIT

  1. Barry Zern says:

    Couldn’t agree more. I added yesterday and the day before at an average price of $11.52. CMO will suffer some loss in earnings when the Fed increases rates, but its book value is protected much more than its peers.

  2. Kevin says:

    Thanks for sharing, I’ll be picking some up as well.

  3. daan says:

    CIM achieves the same indicated dividend yield without the leverage (only 1x leverage) hence reducing the duration as well. Is it because of the higher credit risk that you prefer CMO? thanks

    • hhill51 says:

      CIM is depending on that leverage from its parent/sister Annaly. A huge chunk of its earnings are accretion of discount, which pressures cash flow (or forces them to sell assets every quarter to pay dividends). In that space, I prefer WAC and IVR, because both of those groups have hands-on servicing and loan level capabilities I don’t see at Chimera.

    • hhill51 says:

      I forgot to mention one other thing… CIM actually runs higher leverage than indicated, because they issued re-REMICs from most of their recent purchases. Those essentially sold off the front end cash flows from the MBS they own, increasing the potential for liquidity problems by taking away current cash flows and making the resulting holding a “derivative” that can’t be sold very easily. It also increased the real leverage.

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