I’ve made no secret of my admiration for Merrill Ross’ coverage of the mREIT sector. Today, she sent around a note to investors that could have been one of mine. I say this because she points out the nature of portfolio managers’ choices in a way that doesn’t simply measure price/book, leverage, or spread to see relative value. Far too much of the analysis Wall Street provides is mechanical that way (not that there’s anything wrong with analyzing the numbers — I did choose math as my major in college). But after you’ve looked at the numbers, a very important part of managing investments in the mREITs is understanding how the companies are making their decisions over time, and how they choose which risks to take and which to eschew.
For disclosure purposes, you can read the full legal text at the Wunderlich Securities web site, but what matters is that Merrill currently owns no MFA stock personally, and her firm does not have a current investment banking (capital raising) relationship.
Without further ado, here’s the excellent short note she sent this morning, in its entirety, copied with her kind permission:
The older I get, the more I realize that no single metric captures risk in all its disguises. For example, one can’t just say that low leverage is less risky. Leverage itself is risky. Hedging to reduce interest rate risk engenders counterparty risk. Running a short-duration portfolio might be lower risk, but spreads are compressed . . . et cetera.
However, one can measure relative risk, and financing credit sensitive assets through market value dependent repurchase agreements is decidedly risky, especially when market values decouple from fundamentals, as has been the case with non-agency MBS. Well, MFA continues to reduce the amount of financing it has on its credit sensitive portfolio by entering into resecuritization transactions and collateralized financing agreements. They are more expensive than repo and may involve subordination of rights to accretable discount, but the incremental cost might well be worthwhile.
Thus, we are trimming our EPS estimate, but raising our price target on MFA. If you want to own shares in a company that can benefit from having purchased credit sensitive bonds at a discount, the shares of MFA offer that opportunity.
My personal bias is that while home prices continue to decline, that risk isn’t all that appealing, so I maintain a Hold rating on the shares.