Hatteras Financial (HTS)

Sporting $1.1 billion market cap at its $30 current price, Hatteras is a “second generation” amREIT, having been started in late 2007 and IPO’d in April of 2008.

It is a clean Agency mortgage REIT that buys ARM and hybrid ARM Agency MBS.  (Hybrid ARMs are the bonds backed by the most common type of ARM — fixed rate for 3, 5, 7 or 10 years, and then resetting to a floating rate relative to a common index.)

Their strategy is to be an active manager, taking profits when they can, so the portfolio turns over surprising fast.  That has allowed the management team to deliver some upside surprises on earnings in spite of their stated “plain vanilla” portfolio mix.

A trading strategy like this can be a little nerve-wracking for shareholders, but so far the team at HTS has managed to deliver.  Since they haven’t been through a bear market, or even a serious spread widening event, the jury is out on their lasting power.

Still, you can’t get in too much trouble if you stick to ARMs and don’t pay too much of a premium.  As to the hybrids, the most frequent index for these prime Agency-guaranteed ARMs is the 1-year US Treasury rate, and the most common bond would be the “5/1 ARM,” which translates to a fixed rate bond for five years followed by annual rate resets at a fixed spread over the treasury’s H-15 published average 1-year rate.

If the Hatteras holdings go “underwater” so they can’t realize trading profits, they can simply keep funding them via repo and taking out spread.

My impression is that they also hedge out half or more of their exposure to fixed rates, but only for the first 2.5 years.  That would leave them exposed for years 3, 4 and 5 on a fraction of the 5/1 ARM balances.   At this point, they are extracting about 250 basis points net spread, but yield on the portfolio has declined to around 4%.

The company was formed by a group of Carolina bond mavens whose roots come from Wachovia, BB&T, MBNA and a couple of regional dealers.  The principals (CEO and co-CIO) made their living managing assets in their private REIT, Atlantic Capital Management (ACM) since 1998.  They probably just missed the “window” that Annaly, MFA and Anworth all hit to launch public REITs prior to the LTCM meltdown, and managed institutional money until the public issue amREIT window opened again in 2007.

That eight-year track record enabled them to sell plenty of stock in the run-up to the IPO in 2008, so that they already had over $300 million in equity before the IPO.

With a mid-15’s yield and return on equity in the high teens, HTS is trading at a premium to book value high enough to justify another secondary offering when the stock trades around $30 per share.

Just to be clear, secondary offerings of amREITs, if done at premiums to book value, are a kind of virtuous Ponzi scheme.

I look at it this way:   If each dollar of book value (equity capital) is earning 20 cents and trading for $1.20, any new dollars will also earn 20 cents.  If I had $100 of book value and $120 of market cap before a secondary offering a new $120 in stock (doubling the shares outstanding), then I would have $220 in equity capital to work with after the offering, or 10% more capital per share.

Obviously there are a thousand details, and they all matter — things like how long it takes to put the new capital to use, how much is eaten up in commissions, legal costs, etc. in the offering, and, most importantly, whether the new money can be equally as productive as the money the company has already invested.  In pure Agency mREIT land, this is not nearly as big a deal as it is in commercial mortgage or or private label MBS or “whole loan” (unsecuritized mortgage) land.

One the whole, these uncertainties are enough so that most amREIT secondary offerings put a damper on the stock prices, even though, in the example above, current owners should be thrilled, since they just got a 10% increase in their expected per-share income.

Anyway, that’s the way I see these beasts when they do secondaries.

I ask myself how much capital per share there will be after all expenses are paid and how likely they are to get the same return on the new dollars as the old ones.

hh

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2 Responses to Hatteras Financial (HTS)

  1. hhill51 says:

    WINSTON-SALEM, N.C.–(BUSINESS WIRE)–The Board of Directors of Hatteras Financial Corp. (NYSE: HTS) (“Hatteras” or the “Company”) today declared a quarterly dividend of $1.10 per common share for the second quarter of 2010. The dividend will be paid on July 23, 2010, to stockholders of record on July 2, 2010, with an ex-dividend date of June 30, 2010.

    “We are pleased to declare a $1.10 per share dividend this quarter,” said Michael R. Hough, the Chief Executive Officer of Hatteras. “Although down slightly from the previous quarter, we believe this quarterly dividend level is appropriate given our outlook for the remainder of 2010 and reflects the expected impact of the one-time Fannie and Freddie buyback program and the timing of the reinvestment of the proceeds. Going forward, the operating environment continues to be attractive in light of current financing rates and net interest margins.”

  2. Patrick says:

    Jim Cramer’s ridiculous assault on Hatteras this evening just about pushed me over the edge. He is so dead-set on only recommending ONE stock in any particular sector that once he picks a favorite (Annaly Annaly ANNALY), it’s over for rest of the lot.

    He is so embarrassingly clueless about mortgage REITs that I almost feel sorry for him.

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