Harsh Words

This week was a flood of information, and my portfolio suffered.

Nearly all the mREITs declared earnings and held their conference calls, and all the analysts did their immediate reaction reports.  In those reports there was one downgrade (CMO buy to hold at DB ), and ominous phrases like “management risked its reputation” and “slow value erosion continues”  from Merrill Ross at Wunderlich.

The market almost immediately took more than a dividend out of the prices of the stocks.

One thing happened that might help explain the violence of the takedown that may not have been noticed by the analysts.  That was the move by a very seasoned, but small, mREIT to raise additional capital.

Dynex has been around a long time.  Longer, in fact, than nearly every mREIT discussed here. They celebrated 20 years on the Big Board in February of 2009, so they were a product of the first generation of mortgage REITs in the 1980’s.

In the meltdown, Dynex had the near-death experience shared with every other mREIT that was not purely Agency MBS.  Today, it survives, but with a market cap just over $100 million, and a $150 million in losses it carries forward to use as a shelter against some income in the future.

I think of that as a potential to retain earnings and grow its capital based without having to issue new stock.

Over the 23 years it has been in business, Dynex moved from sector to sector as various parts of the mortgage market seemed more attractive.  One of those sectors that was attractive in the 1990’s and early 2000’s now has a bonus they can collect.  That was small-balance commercial mortgages, pledged into CMBS.

Like most deals, their CMBS were executed with a “clean-up call” that allowed them to call the existing securitization bonds once the total pool had paid down to (typically) 10% or less than the original deal balance.

Most commercial buildings are going through a wrenching revaluation, so new loans are not being originated into efficient securitizations.  For some borrowers, refinancing is not a very attractive option, and others are finding they have to pay 7% or more, even in today’s low rate environment.

This gives Dynex the opportunity to hold mortgage loans that pay 7%, 8% or more at a net cost of par (either by calling the bonds and holding the seasoned mortgage, or by offering a new loan to refinance the old one).

Either way, at today’s repo rates under 1%, any leverage at all results in huge ROE.  Since the loans are “lumpy” and the seasoned ones are probably all subject to refinancing without penalty, Dynex can’t necessarily predict how long they will be able to capture this wide spread, but as long as they do, even the $30 to $40 million pieces these deals have remaining can produce meaningful earnings as long as they last.

A friend pointed out that he was moving some of his medium sized fortune into a chunk of the 3 million shares sold the other day after the market closed.  That was after Dynex was already his largest position.  Bear in mind that to call the bonds, Dynex needed to come up with cash.  That’s what the new cash is gong for.

I can’t say for sure what he sold to make the new commitment, but, like others, I would guess that he already held about as much mREIT exposure as he wanted.  After all, the mREIT “story” is getting a little long in the tooth, and any professional fund manager willing to buy into the mREIT sector probably already has as much of that group as they want.

While raising $28 million after hours wouldn’t be that big a deal if all the selling were in NLY (though it did pop down close to my magical buy level of $17 when the Dynex trade was executing in the after hours), if they decided to lighten up on CMO, or ANH or the others, they had to wait until the next trading day.

Serendipity took over at that point.  The other companies were announcing their earnings and updating the market on their book value, etc. just when Dynex raised their new cash.

Add that to the fact that most of the amREITs didn’t earn as much as that analysts had predicted, and the setup was perfect to fly these stocks straight into some clear air turbulence.

Hopefully you all had your seat belts fastened, and only your drinks and laptop went flying.

Or maybe the mREITs got shellacked because I mentioned that they were all trading near or above book value.  Times like these I tend to get superstitious, and several of my stocks actually topped out in the exact  half hour I was posting that bit of information.

More later.

hh

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4 Responses to Harsh Words

  1. Tom D says:

    I think Bullard’s paper is having effects across the sector world. By saying that the FOMC’s continued insistence of phrasing “zero rates forever” has inhibited business investment, Bullard is drawing attention to the weakness of the FED’s hand as a positive force. (He’s not a fan of fiscal largesse either, seeing it as quixotic and fragmented and late.)

    http://research.stlouisfed.org/econ/bullard/pdf/SevenFacesFinalJul28.pdf

    His figure 1 chart based upon Benhabib, Schmidt-Grohe, and Uribe’s 2001 paper on how and why the Japanese bit the dust is having an effect on perceptions about the short rate going forward. Perhaps it’s not sacred after all. And since mREITs are all about zero interest rates (well, a wee bit more) for borrowing, some are selling out the mREITs on rally highs.

    CMO PrB bought at a 9% yield, and paying monthly, is still doing very well, although even there I am lightening up considerably.

    • hhill51 says:

      Another potentially valid reason to avoid is the ridiculous spread… another new all-time record vs. Treasuries yesterday.
      \
      This translates into enormous extension risk, with virtually no way to hedge. Those who have longer duration will suffer big capital loss or earnings loss or both when longer rates head back up.
      \
      The more conservative investors seem to have been punished for sticking to lower leverage and lower duration, but the worm could turn with no way out if there is a discontinuity that precipitates higher yields.

  2. Patrick1980SC says:

    The curve has been remarkably stubborn in its bearish-flattening trend, as the 10-yr Treasury remains stubbornly at or below 3% even as the 30-yr creeps up. That said, I’m increasingly likely my CIM and IVR longs, especially after the robust performance announced by AI. I’ve given up on trying to understand why bonds are so pricey and focused more on credit risk and the “reflation” of senior classes of non-agency RMBS.

  3. jill says:

    Fed Statement Regarding Reverse Repurchase Agreements

    http://www.ny.frb.org/markets/opolicy/operating_policy_100803.html

    The Fed is going to insure that if the LIBOR market craters again, the REPO market for GSE MBS and Treasuries will not. They will not rely on banks or other traditional counterparties solely, acting as financing agent themselves if necessary. Great news for AMREITs, as well as anybody else in the grovvy bond carry trade.

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