Blue Light Specials

This morning in the mREIT aisle the spinning blue light attracted alert shoppers.  In particular, seveal amREITs completed what looks like an “air pocket” end to a week-long trend of dramatically lower prices.

As always, there are both fundamental and emotional reasons for the price movements, but today’s early plunge looks like a mini-capitulation.

Among the stocks I watch, AGNC traded briefly under $30 a share, and ANH traded to just a penny higher than $6.  Those were the “screaming buys” in my opinion, but NLY flirted with the $15 level, and TWO traded solidly under $11, albeit briefly.

MITT also traded down, but I haven’t got a feel for its price action yet, though I admire the bond-picking talents at Angelo Gordon.

But don’t get too upset that you missed the sale.

I’ll explain after the break.

Today could have been “big money” or hedge funds new to the sector pulling the plug, or it could have been shaky retail holders that aren’t sure about the alchemy of the carry trade.  Probably some of both.

But we have to look at the reasons the hedge funds and mutuals might be lightening up in here, even though the family of mREITs still pay well above 10%.

First and foremost is the reality that dividends are trending down as underlying MBS prices go up.  With the Fed now in the game and absorbing $40 billion a month ad infinitum, that problem of lower yield spreads vs. the cost of financing won’t be going away, and may get worse.

Second, housing looks like it has bottomed.  That means people can afford to refinance if they can qualify (and the house has enough value to support the new loan).  So a market that is nearly 100% premium bonds will now see the long-anticipated increase in prepayment rates, especially for MBS that originated in 2009, 2010 and 2011.  And the amREITs have been growing their capital base like mad these past three years, so every one of them has a pantload of newer MBS.  Remember, if you buy a bond for 102 and it gets paid back at 100 three months later, you lose money, even if you were getting a positive carry from holding a 3.5% MBS and financing at lower short term rates.

Third, and maybe the most troublesome, is the reality that none of amREIT management teams I know are willing to give up on the basic business model and sell their MBS to hold cash.  Even if they were, their shareholders would punish them for interrupting the dividend (spread earnings) stream just to preserve capital by selling off MBS that may well go down in price.  Just won’t happen.

So those are all the “funnymental” reasons to sell, borrowing an apt word from my friend Tom Drake.

Having been around the block (and down its dark alleys) once or twice, I also know that fear accompanies any selloff, and fear is actually a very easy sell when your investors are safety-minded income investors.  There are plenty of people out there who assume that something bad is happening (or coming) when stock prices go down, so they sell first and ask questions later.

I can’t help thinking that, for some, this morning’s blaring political news that Romney edged into the lead on several national polls may have had something to do with the sell-off as well.  Whatever their personal politics may be, professional money managers know that the likely result of the advertised tax cuts and domestic spending cuts will be much larger deficits and a much slower economy.  That’s never good for markets.

For mREIT bargain hunters, there will be more fear, and maybe even some loathing over the next few months.  You’ll get another chance to buy at these low prices, but maybe not the chance to do two-point daytrades.



7 Responses to Blue Light Specials

  1. MA says:

    Appreciate the writeup entry. Care to speculate going forward regarding pure agencies versus hybrids ?

    • hhill51 says:

      There’s such a huge difference between strategies and management teams among the hybrids that I can’t give a blanket recommendation. I suggest using the search function on their symbols to see my opinions on the individual teams and strategies. That said, a recovering housing market is a huge plus for anyone owning private label MBS.
      With the Agency holders, the fundamental differences between the strategies are less extreme, but still significant. CMO has the least exposure to decline in BV because their portfolio is largely currently resetting adjustable rate MBS. At the other end of the spectrum is NLY, who have ridden the tiger with the largest duration gap between the assets and the funding. AGNC has been playing the intermediate term “swing trading” game very successfully, but you need to be aware that taking capital gains and avoiding short term capital losses is their goal but can’t be as reliable (predictable) as simply taking out the spread can. That said, ANH shows me year after year that playing it safe (always hedging financing years into the future) can be played badly.
      Maybe you have some specific questions after looking over the summaries from a couple of years back? I know there are new players in the market like Angelo Gordon, Western Asset Management (a solid mortgage team, almost like Pimco North), and Mike V’s team at Ellington, and that at some point I should probably write about them.


      • MA says:

        Thanks much. I have read your prior posts and try to keep a fundamental understanding of these things via ValueForum. The recent sell off of these things spooks me because of the uncertainty of prepays and how they will get valued going forward. Tough to decide to keep holding of get out

      • hhill51 says:

        This is for MA’s second response.
        The thing to keep in mind is that even though we have a first (mREIT nirvana) with the Fed basically guaranteeing that the MBS will have positive carry for the next two years, the stocks have not traded to 30% to 40% premiums to Book Value. Of course, the distortion of the QE programs has pushed the underlying assets too high, but still I think the relatively low leverage (banks run these assets north of 25x leverage) means the risk to book value is only 20% to 30%, assuming the management of the REITs wake up and rebalance at least once a quarter.
        So now we have to look at the income alternatives, and see that even-yield options don’t really exist. I could easily see the market decide to price these to a high single digit yield if the market feels that the underlying MBS aren’t at artificially high prices.

  2. dreverts says:

    It seems the bulk of the damage is in the pure agency area, as the non agency bonds have been rallying nicely. Regarding cheap or or not, would it not depend on what happens to book value as all these bonds get refinanced at a lower rate? With the shrinking spread can it not be a possibility they start trading at a slight discount to book? Anyways, I enjoyed the entry despite reaching logic that this is a Romney crash. The only way I see Romney hurting the market is that Bernanke will be tossed out, which in the long run might not be such a bad thing. Tough to call a bottom in AGNC and NLY when they are trading at similar levels to 6 months ago, IVR near all time highs….

  3. Max Gardner says:

    A very good writeup except for the over the top reach that part of the selloff in this sector was due to Romney inching ahead in some national polls. Bloggers/analysts would enhance their credibility if they leave their personal political feelings out of their analytical commentary. You have plenty of credibility in this sector. No reason to detract from that.

    • hhill51 says:

      Still, I think it matters that a Romney election would lead to $2 trillion deficits, and I think a number of professional money managers know that. They have to run the money with their heads, not their hearts.

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