Merrill Ross (formerly with FBR and BGB) is now with Wunderlich Securities. I get the feeling that it’s the same crew of people, and that she probably didn’t even have to move the stuff on her desk to change employers.
She just launched his coverage of the mREIT space with individual reports on the same ten mREITs I wrote about these past few weeks, and a summary report on the whole group.
In what I always like to see in investments, she chooses different favorites than I did, and says why.
With permission, I post a comparative chart with price/book targets for these companies, and some of her conclusions.
The reports on each REIT and the group as a whole came out last week. In the overview report, Merrill came up with a chart to describe her preferences among the group.
As you can see, Merrill recommends AGNC, HTS, CYS, NLY and TWO. The three mREITs that are currently allocating their capital to buying non-Agency paper (CIM, IVR and MFA) didn’t make the cut, nor did CMO or ANH in the amREIT peer group.
From her specific write-up on AGNC, she acknowledges that their excess return (above static ROE due to leverage) is coming from timely profit-taking, but she figures they will be able to continue to do so.
I can’t agree until I see how they do through a complete interest rate cycle. I suppose though, if you make enough money in the bull side of the cycle, what happens in the bear side makes less difference.
The lower leverage and robust hedging used by ANH and CMO necessarily lowers their Return on Common Equity (ROCE), but I tend to reward those predilections with a willingness to own the stocks at lower yields than their less hedged brethren.
Her recommendation on Two Harbors is interesting, and may be based on face-to-face interviews. In that company-specific report she cites their “franchise” consisting of full staffing for both Agency and non-Agency (credit) analysis. At just over $200 million in capital in the REIT, I see an issue with expenses carrying such a large staff. In fairness, I should mention that the company (Pine River) manages assets outside the REIT, as well.
Another chart was really interesting to me, and it may explain part of Merrill’s choice of which companies to rate “buy” and which to rate “hold.”
It was simply facts pulled from years of quarterly reports, but because the data were gathered by a subscription service that I don’t have a relationship with, I’ll have to summarize rather than copying the results.
That chart was a list of reported quarterly book values per share going back to Q1, 2005 (for the four companies around that long), and for the others from the first quarter they reported earnings as public companies.
Among the four “old timers” the early peak in book value was Q2, 2005 for NLY and ANH, but CMO and MFA gained book value per share until Q4, 2005 and Q1, 2006, respectively. They bottomed together in Q2, 2006, and the recovery was on for those four names.
NLY added 40% to its lowest quarterly book value ($9.48), to peak a second time at $13.03 in Q2, 2008, a point in time that any peer invested in any non-Agency paper was already suffering. CIM, for example, had already lost more than half its equity by then, just eight months after the company IPO.
That pair of companies is unique in the space, being managed by the same people, so you have to conclude that the difference in capital appreciation/depreciation must have been almost exclusively determined by the sector of the market.
The whole group slid down more or less together during the liquidity crisis. The older four had been joined by newcomers CIM and HTS in Q4, 2007. Those two newbies promptly joined the decline in book value party after they were launched, with CIM performing a spectacular new-issue-to-bottom loss of nearly 85% of shareholders’ equity in just over a year.
I expect that we will see a number of new highs in these book values when the second quarter of 2010 gets announced, but the crisis peak-to-trough losses and the subsequent trough-to-peak gains look like this (as a percentage of capital):
NLY 2.5% loss, followed by 33.4% gain, for a net increase of 30%
MFA 38.5% loss, followed by 45% gain, for a net loss of 10.8%
CMO 12.3% loss, followed by 31.2% gain, for a net gain of 15.1%
ANH 42% loss, followed by 34.1% gain, for a net loss of 22.1%
CIM 84.4% loss, followed by 46.1% gain, for a net loss of 77.2%
HTS 12.5% loss. followed by 29.4% gain, for a net gain of 13.24%
I should put this in context, because of clear phase differences between sectors (and even sub-sectors like fixed vs. ARMs in the Agency MBS).
By the time CIM and HTS did their first quarterly reports as public companies (March of 2007), the bloodbath in private-label subprime MBS was already in process. Peloton Partners and Carlyle Capital had each failed by then, and they did so because they couldn’t meet margin calls.
They were more highly levered than the mREITs, but there was no doubt that forced selling had already begun to take its self-reinforcing toll on holdings like those held by CIM. On the other hand, Agency MBS were bid very well until the Government takeover and the Lehman collapse.
The HTS decline of 12.5% is calculated from the IPO price, so it automatically lost more than 7% from the IPO expenses. CIM was a year too early with its distressed investment strategy.
The other four mREITs covered in the Wunderlich report are all too new to be considered for their “dip.” Three of the four did participate in the rally from the bottom, though, and the numbers come out like this:
AGNC 33.2% gain from the bottom, and 27.3% gain from the IPO
CYS 7.3% gain from the bottom, and 4.5% gain from the IPO
IVR 6.9% gain from the bottom, and 4.1% gain from the IPO
TWO only two quarters reported, so no trend worth mentioning
Ron Popeil would probably want to invest in mREITs with a “set it and forget it” portfolio, and if he did, he’d get screwed once or twice each cycle. The fascinating thing about this investment group is that they each have their own “flavor” and there will be times when, within the group, sector rotation will make sense.
I know it sounds strange to talk about sector rotation in what some consider an tiny specialized afterthought in the REIT sector, but we always need to keep in mind that this is the levered investment you and I can make in the mortgage market, still the largest market in the world.
Next I’ll do a walk down memory lane using some of the stuff from that Flagstone report I mentioned several weeks ago.
That report really shows how sector rotation is real. There were 26 companies covered. Over half of them are gone, and among the survivors I have to say that only a handful are still mortgage investors.