Next in order of capitalization is Anworth mortgage, my largest holding in the residential mortgage REIT peer group.
I don’t hold more of it because I think Lloyd and his team are the best traders or hedgers, but because their stock is cheapest when compared to its capital and earnings risk. Having said that, THIS IS NOT FINANCIAL ADVICE. I can virtually guarantee that my financial situation is substantially different from yours, and that what is worth doing for me is potentially much too risky for you.
For that reason, I’ll share how I decided to do what I’m doing, but it’s up to you to decide how you need to invest for yourself in your situation.
With Agency mortgage securities setting yet another record for high prices (and low yields) today, I have no doubt that Anworth’s book value will be higher at the end of the current quarter than it was at the end of the last quarter. Last quarter it was $7.46 per share.
My friend and former colleague Scott Simon describes today’s MBS prices as “insane,” but he still owns them. As Andy Harding, another former Wall Streeter who now works on the buy side explains, as steamy as the MBS market has become, there’s still reason to own them.
Unfortunately for Anworth shareholders, the company seems to be a kind of Rodney Dangerfield of the group, never getting any respect. In the 2006 review I mentioned in another company-specific post in this series, Anworth was grouped with four other RMBS investors. All the others were trading at least at book value, with Annaly sporting a healthy premium of 36% over book. Poor Anworth was trading at 86% of book value.
At the time I wasn’t investing in Agency REITs, so it would take a little research and forensics to explain why, but I’ll hazard a guess. My guess is that Anworth had taken in too many premium MBS and been burned by the crazy refinancing binge that was going on in America at the time. That would explain the paltry 8 cent quarterly dividend from Q2, 2006.
This is actually a good example of why I like to understand the management and how they react to the market more than I care to dissect the snapshots of specific portfolio elements at any given time. For me, the portfolio mix and the hedges (especially) help me know the philosophy of the managers.
With Anworth, it’s clear. They are very straight-forward, and they hedge every risk they can afford to hedge, even if it cuts into earnings. That’s why they had the highest effective financing rate in the group right through 2008 and most of 2009, because they bought new-issue 5/1 ARMs in 2004 and 2005 after the Fed tightened and immediately hedged all five years of the fixed rate exposure. It’s also why they get no respect as they “underperform” the peer group that takes on more risk and pays out more dividends per dollar of capital.
Recall that MFA only hedges the first 2.5 years, and Annaly used to go without hedging its hybrid ARMS at all. Even today, Annaly only hedges some (less than half) of its fixed-rate MBS, and seems to be leaving the ARMs and floating rate CMOs to fend for themselves. That makes for higher earnings and higher investor yields, so today NLY has 12 times the market cap that Anworth sports, even though they were only four times Anworth’s size in September of 2006.
So why would I put more of my personal money into the less adventurous management team that hedges so much that they pay a lower dividend? Because I know that this environment is nearly perfect for all spread traders who avoid credit risk, and I think that Anworth will be paying excellent dividends and increasing book value for a while longer.
The Fed confirmed again today that it won’t be tightening at the short end of the curve any time soon, and the main reason is the continued weakness of the housing market. Since Ben and Boyz haven’t joined Jimmy Carter in Habitat for Humanity yet, they can only try to help the housing market by facilitating housing finance. That means they will be the repo lender even if the banks lose their shirts in European CDS or some other foolishness like that.
I’ll lighten up on Anworth when it trades to 105% of book value or higher. Right now, that would be a number in the $8 region, I would guess. Even if MBS spreads widen out to more normal levels, Anworth won’t be taking an enormous hit on its capital base because of their hedging, so I can comfortably wait it out.
I don’t expect Anworth to change who they are, and I am comfortable with the idea that they may continue to trade at a cheaper ratio to book value than the others. I also don’t expect them to miss out on this amazing Fed-driven recapitalization of the banks through the carry trade, and some of that capital will flow out of savers’ pockets (getting their lousy 1.5% CD yields, or 0.25% money market yields) into amREIT investor’s pockets (getting their 15% yields).
I bet the management of these companies are sorry they have to pay out all the earnings right now, because they could gather an amazing amount of capital to grow their companies if they didn’t have to distribute it to us.
Some will make up for that by issuing secondaries, especially if they are “externally” managed.