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.