mREIT Year-End Review

One of my cyber-buddies (screen name maxx) has taken the time to really get to know the mortgage REIT sector. His views are, IMO, better than just about any of the analysts out there, because he risks his own money on them. And what is more interesting to me, he looks at these stocks as both income and trading vehicles. Without further ado, here is maxx telling us how his year in mREITs worked out, and how he looks at some of the names we all know and love (or hate, on occasion).

Hello Everyone,

Happy Holidays to all:

This has been a very good year for myself and those I trade for. My basic philosophy is to make money every quarter, be conservative by using income stocks that in some small way limit downside risk, make at least 20% a year, go to cash at the end of each quarter and reevaluate, limit losses where appropriate and know my major stock positions well and control my emotions.

This year I will end up making 35% on my accounts. In a year like this I feel very good about that. What an emotional roller coaster. And next year could be worse. Such is the life of an investor.

Let’s start with the amreits. My major, very concentrated, position this quarter was in AGNC. I have now sold all my AGNC and gone to cash. Since I try to go to cash each quarter I consider myself a swing trader. Regarding concentration, I harken back to the days some of my friends traded in the commodities pits. One trader just traded cattle, another just traded hogs, etc. These guys did this for a living and they didn’t “diversify”. They knew their business and they traded their business. For me stock trading is my business. I concentrate on one area and try to learn the strategies to make the most money I can in that one area with the least amount of risk. So far that has worked very well.

I have chosen AGNC to be my primary amreit investment because it is the best of breed in terms of returns to the shareholder. The AGNC strategy, as best as I can interpret it, is to pay a high dividend, even if the dividend is greater than GAAP or Core for short periods. This high dividend will increase share price to well above book value right before the ex date and at other opportune times as well. This will allow AGNC to do a secondary and increase their capital base (something they do about every quarter). This strategy allows them to claim the secondary is accretive to book value and therefore good for existing shareholders. The stock price goes down at the offering but has always recovered by the ex date – making this a superb trading opportunity. The strategy works well for management because they are paid based upon total capital so the more capital they raise the better. AGNC takes the capital, levers it a little bit more than the average amreit, buys expensive low prepay MBS securities, finances them with cheap repo financing, hedges much of that using creative swap positions – all of which generates very acceptable yields. Add to this strategy an active management that sells high yielding, high priced, high prepay securities for gain on sale and their taxable income ends up being greater than the dividend payout. For the past two years this has provided a cushion of undistributed taxable income that could be used if the dividend was greater than taxable in any one quarter. Mr. Kain has shown he is clearly head and shoulders above the other amreit managers during this particular phase of the amreit cycle, thus I have chosen to ride this horse and trot to the winner’s circle with returns that are consistently above 5% per quarter.

Now let’s take a look at each of the amreits and where we are in the cycle. You could call this the technical side of the trade. I am also going to comment on management skills of each of the amreits, as I see it.

1. AGNC – Kain is the best and most honest and upfront. The presentations at conference calls and analyst conferences are the best and most transparent. AGNC has been able to maintain its $1.40 dividend for the last three quarters but look at the price action. Two quarters ago the high price for the quarter was in the 30s, last quarter the high price was in the 29.90s and this quarter the price could barely break 29. My theory is the price will not end the day above 29 and many covered call holders will end up holding their shares. (today is expiration day) Short interest moved up from November 15th to November 30th and my bet is it will move up again in the November 30th to December 15th cycle. As my strategy of sell and the end of the quarter and rebuy, say 1.5 to 2.0 times the dividend lower, after the ex-date has become more well known, the strategy has become harder to implement. New strategies then need to be implemented. For the next few quarters spreads will continue to be squeezed, net interest income will continue to decrease, dividends will continue down for the amreits and share price will decline. Not exactly great stuff for a buy and hold investor.

2. ARR – This company has adopted the AGNC high dividend/high share price/secondary policy. They don’t exactly earn their dividend but some of the secondary money can be used to pay for the monthly dividend. I really don’t know management that well. Oh yes, I have heard the negatives but sometimes the negatives can be a good thing. Maybe these guys will try to prove themselves to be better, maybe they can change their spots, maybe not. This is a great trading stock because it recovers so quickly. It pays monthly and you know what your return will be before you invest at your particular stock price. I made one big trade(s) of this stock on October 4 and thereabouts. I bought 100,000 shares at an average price of $5.50. Within 6 days the price had recovered and I sold at $6.99. I did great, yes I could have held for a higher price but I have learned that trying to sell for the very top dollar costs money in the end. So I leave a little on the table for others and if I buy right I do not get hurt. Two quarters ago the dividend was .36, this quarter is was .33 an 8.3% cut, next quarter has not been announced but my bet is at least another 8.33% cut. Typically dividend cuts make the share price drift down, we shall see.

3. CYS – This company invests in 15 year MBS for the most part and uses forward purchases. I don’t particularly like the forward purchase strategy as I do not believe CYS is getting better securities than Kain and giving up the interest. I would rather have the sure thing of the interest income that the possibility of the value of the securities going up into delivery. I don’t trust the CEO Grant. During one conference call Grant stated that by using his strategy he believed that he could keep the quarterly dividend at .60 for a very long time. Now that he is not doing secondaries, CYS’s dividend has gone from .60 in June to .55 in September (an 8.3% cut) and then to .50 in December (a 9% cut). So far the price of the securities has held up well but my 20% criteria is not met with this stock.

4.  HTS – This company buys hybrid arms (typically 5-1 hybrids). Bad strategy in this environment. Prepays do matter and this company has a high prepay rate. High prepays lower returns. Back in the day this management made fun of AGNC, now AGNC makes fun of this management. Dividend was $1.00 in June, 1.00 in September (they held the dividend in September because they sold some of their securities at a gain – something they said they would never do back in the day) and .90 in December. (a 10% dividend cut).

5. NLY – This company invests in 30 year mortgages. Biggest of the group. Farrell just seems arrogant to me. His attitude – I am providing you with 13% returns and you can’t get that anywhere else so don’t complain. No I won’t increase leverage, no I won’t try to increase your shareholder value and yes I will try to be unpredictable with the dividend. No I do not believe in transparency but I am pretty good at giving my opinion on the economy as whole. He is a smart guy I just find better amreits to invest in. In June the dividend was .65, in September the dividend was .60 (a 7.7% drop), in December ? probably another drop.

6. CMO – This company invests in short term one year reset ARMs. Real bad strategy in this environment. JMP analyst Steve Delaney insults them on every conference call. “Boy, this is a bad strategy for this environment, ever consider changing it?” Then he just goes on to more mundane issues like what are your one year arms going to reset down to this quarter. Looks like another dividend cut. June dividend .48, September dividend .44 (an 8.33% cut), December dividend .43 (a 2.2% cut)

7. ANH – This company invests in say 5 year arms. Selling way under book value. Great deal Huh? Stock keeps going down, dividend keeps going down. Management recently changed from internal management (supposed to be the better, cheaper form) to external management so Lloyd’s family could hide their compensation from the rest of us. These guys are just embarrassingly bad managers. High dollar swaps are coming off so that should help eh, nope they cut the dividend again. This is where we sit around the bar with a drink in our hands laughing at those that preach what a good deal it is to buy and hold below book value Anworth, but it keeps going down. I am sure Lloyd is a very nice guy but … The dividend was .25 in June, .23 in September (an 8% drop) and .21 in December (an 8.7% drop).

8. So to summarize in the last two quarters CYShas cut their dividend 17.3%, ANHhas cut their dividend 16.7%, CMOhas cut their dividend 10.5%, and AGNChas not cut their dividend. Of the others I only have one quarter of data. HTScut their dividend 10%, ARRcut their dividend 8.3% and NLYcut their dividend 7.7%. Not a great buy and hold environment for this sector.

9. On to a couple of semi-agency reits. MTGE, AMTG and TWO. First, two didn’t cut their dividend so there has to be something good about that. Other than MTGE, management is best in space. Best in space management is MTGE. Why, well it’s AGNC’s management. MTGE is 95% agency paper in low loan balance and Harp low prepay stuff and it sells at a $2.00 discount to book. Or at least it used to. And it is paying an .80 dividend. My feeling is that Kain will try his darnedest to increase the share price above 19.97 (the book value) so he can start doing secondaries on this one. Thus I could see a dividend increase here. And I would much rather see a big dividend than a possible increase in share price because of low book value. Just recently I switched some of my AGNC to MTGE. I do want to thank SS94 for some discussions we had. The big problem with MTGE is no option action to speak of and low volume. So if you need liquidity, be careful here. BZ wants me in AMTG and this stock has done pretty well since its drop to the 14.50s but the dividend was terrible and I question the management so I will wait this one out.

10. And just for the sake of diversification I have very small positions in CHKR, SDTand GLNG. SDT is up 19% since I bought it. GLNGis up 5% and CHKRis up 5%. It just goes to show you that there is money to be made in stocks other than amreits :)

11. One last thing, my personal opinion is that you don’t buy a basket of AMREITS – only buy the very best. When they go down, they will all go down. When they go up, they all tend to go up. So why lower your return by buying the worst of the sector or the ones that have a bad strategy in this environment. Just a thought.

I wish great investing to all of you.

maxx

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12 Responses to mREIT Year-End Review

  1. Taymere says:

    Excellent, let’s hear from Max monthly if possible. Please give him my email address taymere@gmail.com

  2. Richard McDaniel says:

    I’m a big fan of AGNC for all the reasons maxx identified. In addition, AGNC has paid $1.40 dividend for 11 quarters in a row now. I trade the options, buying after SPO’s and selling before exdividend date. AGNC did closed at $29.09 on Friday. If there’s an ATM in the market, AGNC would be the head teller.

    RIMBoomer

  3. cojo says:

    ARR just announced Q1 2012 dividend today, 12/16;
    maintained the 11c monthly payout (good at least through March).
    Thanks for a great article.

  4. Ron Faltinsky says:

    Thank you Max for this insightful article!

  5. Wayne says:

    Your opinions are well appreciated, especially those regarding management’s competence. I work for a living and I don’t have the time to follow the pps movement on a day-to-day basis, so I look for stocks that I can buy-and-hold without getting burnt. I’ve followed TWO and AGNC for some time now, and MTGE looks like a stock that I don’t want to miss out on. I was expecially imptessed with Kain’s purchase of 100,000 shares a few months ago; $2 million is not a “token” purchase. Wayne

  6. jeff says:

    i buy and hold AGNC but i cover it with options for protection. I base my trade on an exdiv price of 27.5 I ouy a downside put and sell an upside call. currently I’m using the march 26 puts and 29 calls. the trade usually costs 10-15 cents or so and on a yearly basis costs about 50-60 cents. that reduces the annual dividend to “only” $5 or only 17.25% with downside limited. Im not really worried about the upside since it rally thru my strike and i get called out Ive still made my $1.50 in price appreciation

  7. hogg says:

    Maxx,
    Thanks for all of this great info. It is exactly the type I have needed. I presently buy and hold small positions in AGNC and NLY along with some MLP’s for high yld div. to supplement my retirement. In theory I consider the divies as a reduction in the orginal shareprice with the goal that I will some day have received a total return of all dollars invested and will pass these shares on to my heirs with the stocks all paid for by divies at 100% free money in a Roth account.
    Thanks again,
    Hogg

  8. Tom Drake says:

    AGNC is the champion who had the good sense to launch well after the 2007-08 top. Thus they had no legacy issues or battle fatigue.
    Maxx’s dividend and/or gains capture approach to mREITs makes a lot of sense due to the marked volatility of both yield and stock price. Looking at ten year total returns of several mREITs and of several of their preferred shares shows the 8-9% preferred shares outperforming the higher pay (sometimes)equity shares. http://screencast.com/t/cd7N3dhHcBn
    I put in LSBDX as a comparison to a quality higher yield bond fund.

    Tom

    • Taymere says:

      Thanks Tom, interesting chart. Do you follow bond funds closely? I am interesting in finding one specializing in OAS asset selection that levers their skills by buying IO strips on what they expect to be slow prepayers and PO strips on what they expect to be fast prepayers. Can you imagine using the abilities to assess the motivations and abilities of all the players, GSE, borrower, originator, government, fed, etc… that AGNC has to trade derivatives instead of MBS? There would be a high risk of blowup if such a fund used leverage, but without leverage and with great asset selection and lots of active trading the returns would be phenomenal. Especially if the manager had the special insights into “policy risk” refis that AGNC has.

  9. Tom Drake says:

    Taymere,

    I know nothing about public OAS funds or whether they even exist.

    Regarding mREIT leverage in general, it is essential to their yields of 10-20%. Without it they are like Vanguard’s Ginnie
    Mae fund (VFIJX) at 3.1% or maybe like Grundlach’s Doubletree Total Return (DBLTX) at 7-8%.

    Much of mREIT leverage comes from repo’s, only a tiny amount from preferreds. There may be some interest in this recent Zero Hedge reposting of a 2008 research paper from Citi on the major importance of the repo market to institutional and fund leverage. http://www.zerohedge.com/sites/default/files/images/user5/imageroot/2011/12/Are%20the%20brokers%20broken.pdf
    Any comments from readers about followup after three years would be very welcome.

  10. Taymere says:

    Thanks Tom

  11. Dennis Hill says:

    Dr. Mr. Hill:

    Thank you for your wonderful blog. I find it to be educational and incisive.
    But please tell me why you don’t sell say the AGNC January 2013 22.50 put @1.00 or the January 2013 25.00 put at 1.70?
    The return would be higher given the margin and you would have downside cushion.

    Sincerely,
    Dennis Hill

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