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Opportunity For Mortgage REITs | Seeking Alpha

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See, that’s better than the yields and mortgage statements you’ve seen this week, or the 15th Wall Street billboard image.

Orla/iStock via Getty Images

Get your graphs, images and tables ready. words. Ratings and outlooks covered here follow Scott Kennedy weekly updates on the REIT forum. Your continued feedback is greatly appreciated, so please leave your suggestions in the comments.

last time, Spread between MBS and US TreasuriesThese spreads are important because they are central to how mortgage REITs aim to generate net interest income. They have his three main tools. They can assume credit risk, duration risk (hedging that reduces duration exposure), or negative convexity risk (hit by large changes in interest rates). These are the three main types of risk that mortgage REITs can use to generate income. No free or at-risk income.

Whichever option a mortgage REIT chooses, there is also the risk of the book value being taken from the spread. Over time, we typically see book values ​​increase or decrease. Since book values ​​are modeled on a weekly basis, these changes are rarely surprising.

net interest spread

Before we really dive into this article, it should be noted that an increase in today’s spread does not automatically translate into a higher NIS (net interest spread) value tomorrow. Mortgage REITs do not review their portfolios quarterly or annually. Due to the flattening of the yield curve and the way historical data is reflected in interest income and interest expense, dramatic The time lag between the occurrence of these conditions and the occurrence of the net interest spread.we are Absolutely not We expect mortgage REITs to report higher NIS in the near future. Furthermore, we are not suggesting that all dividends are safe. We also see some likely cuts in the next few quarters.

The spread we are going to talk about today has a rapid impact on the book value and future The level of income a mortgage REIT can generate using today’s book value.

I would be pleasantly surprised if no one jumped into the comments section to misquote me and declare “the author is wrong”.

MBS spread

In a previous article, I used a table provided by AGNC to compare spreads between government bonds and fixed-rate MBS (mortgage-backed securities).

Using the values ​​from these slides, I created the following graph.

Comparing Treasuries and Mortgage Backed Securities Using AGNC Data

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Note: Values ​​for Q4 2021 were used as the slide may contain conflicting data between Q4 2021 and Q2 2021.

This chart shows the feel of the spread (black line) between government bond yields (blue line) and MBS yields (red line) at the end of each quarter. Spreads at the end of Q2 2022 were comparable to spreads at the end of Q2 2020. By measurements so far, this is large. I have often run these spreads using 10-year Treasury rates, as well as 5- and 7-year rates. Here are the values ​​I calculated:

Comparison of MBS yields and government bond yields

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The only significant difference is Q2 2020. So why is it so hard? The lowest 30-year fixed rate MBS pool we could find had a 2% coupon rate and was trading at $102.2969. None of the pools were trading below or very close to $100, so extrapolation was needed to find the hypothetical price. The more you have to extrapolate, the less accurate your results will be. I don’t think a guide on how to extrapolate in these scenarios enhances this article, so I’ll leave it at that.

However, I think it would be helpful to extend the chart to include the spreads calculated for Q4 2019 and Q1 2020.

Comparison of expansion of MBS yields and government bond yields

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The Q4 2019 and Q1 2020 values ​​provide valuable historical context. At the end of Q1 2020, it is clear that the spread between 5-year Treasuries and 30-year current fixed-coupon MBS has widened. But the spread using 7-year and 10-year government bonds is actually tighter. what happened? The yield curve has reversed significantly. The discount rate for the next few years will be significantly higher than the discount rate after that. For example, a 5-year US Treasury yield is 3.261% and a 10-year US Treasury yield is 3.114%.

Just using the back-of-the-envelope calculation suggests that the implied rate over 5 to 10 years must be 2.97%. It’s actually pretty easy. His first five-year yield (3.26%) is 15 basis points higher than the 10-year average (3.11%). To offset the 15 basis points higher in the first five years, he must be 15 basis points lower in the next five years. After adjusting for rounding errors, we get 2.97%.

Why did you let me do math?

This is actually important!

There are a few things I would like you to understand.

  1. These spreads are very relevant to understanding how much income a mortgage REIT can generate.
  2. If these spreads are narrowing (the black bars are getting shorter), the book value will usually go up.
  3. When these spreads widen (higher black bars), the book value usually goes down.

The sample period used includes periods with wide spreads and periods with narrow spreads. When spreads were wide, it was a better environment for investing. Investors saw a significant increase in book value per share as spreads tightened. This created a leverage effect for investors buying at bargain prices. They achieved a significant discount on their book value (which eventually narrowed) and their book value was lower due to wider spreads. Despite this, it was often purchased at a premium to book value. Those investors have experienced leverage losses. In my experience, these investors tend to be more bitter about their experience.

Rising short-term interest rates may push up borrowing costs due to imperfect hedging, but investors shouldn’t give it too much weight. It’s just part of the picture. Comparisons between REITs are detailed in a separate article. For now, I think it’s time to mention some picks.

some high yield picks

Investors always want at least a few picks, so here are some of my bullish picks. We didn’t list the dividend yield, but you can see it in the chart below.

  • I continue to love Dynex Capital (DX) as one of the best mortgage REITs. A small agency mortgage REIT that has outperformed its peers over the years with excellent portfolio management. The largest mortgage REITs are much slower to adjust their positions. However, DX can take advantage of changes in the risk/reward profile more quickly (due to smaller portfolios).
  • Ready (RC) also looks great. They performed very well and withstood some challenging circumstances with relatively minor damage to book value. Stocks offer a lot of upside for being attractive.
  • rhythm (RITM) mentioned again with a big discount. RITM has introduced, but recognizes that mortgage origination is unattractive 40 year interest only mortgagePersonally, I don’t like the existence of these products. Because I think high leverage creates a potential incentive for homeowners to default if home values ​​drop significantly. However, this is likely to strengthen their composition activity, supporting home values ​​(replacement costs) despite rising interest rates if inflation continues to increase the cost of building new homes.
  • MFA Finance (MFA) is still a good choice for investors willing to take some credit risk. The uptick in this pick is dramatic, with the stock trading at a significant discount to its projected book value and our target.

The rest of the charts in this article may be self-explanatory for some investors.However, if you want to know more about them, I recommend taking a look series notes.

stock table

We conclude the rest of the article with tables and charts we provide to help our readers track both the common and preferred sectors.

Include a brief table of common stocks that appear in the table.

Let the images begin!

Mortgage REIT Chart

Note: Charts in published articles use book value per share from the most recent earnings release. The current estimated book value per share will be used for target achievement and trading decisions. It is available at our service, but those quotes are not included in the table below.

Mortgage REIT Price to Book Ratio Chart

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Mortgage REIT Dividend Yield Chart

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Mortgage REIT Income Yield Chart

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Commercial Mortgage REIT Chart

Commercial Mortgage REIT Price to Book Ratio Chart

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Commercial Mortgage REIT Dividend Yield Chart

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Commercial Mortgage REIT Earnings Yield Chart

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BDC chart

BDC Price to Book Ratio Chart

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BDC dividend yield chart

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BDC earnings yield chart

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preferred stock chart

Preferred stock price comparison table

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Preferred Stock Strip Yield Comparison Chart

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Preferred Stock Floating Yield Comparison Chart

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Comparison of Preferred Shares for Risky Stocks

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Comparison of preferred stock stripping yields for high-risk stocks

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Preferred Stock Floating Yield Comparison of High-Risk Stocks

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preferred stock data

Besides charts, we also provide our readers with access to several other indicators of preferred stocks.

After testing a series of preferred stocks, we decided to consolidate them into a series of common stocks. After all, we’re still talking about mortgage REIT positions. The preferred stocks that appear in the columns have cumulative dividends because we do not want to cover the preferred stocks without cumulative dividends. You can check using Quantum Online. Links are provided in the table below.

I had to shorten the column names to:

  • price = recent stock price – displayed on chart
  • BoF = Bond or FTF (Fixed-to-Floating)
  • S-Yield = Forfeiture Yield – Shown on Chart
  • Coupon = Initial Fixed Rate Coupon
  • FYoP = Price Volatility Yield – displayed on chart
  • NCD = Next Call Date (earliest stock that can be called)
  • Note: For all FTF issues, floating rates start at NCD.
  • WCC = Worst Cash to Call (worst net cash return from a call)
  • QO link = link to Quantum online page

Second batch:

strategy

our goal is Maximize total returnYou achieve these most effectively by including a ‘trading’ strategy. We regularly trade mortgage REIT common stock and BDC positions for the following reasons:

  1. Prices are inefficient.
  2. Long-term stock prices usually revolve around book value.
  3. Short-term price-to-book ratios can deviate significantly.
  4. Book value is not the only step in the analysis, but it is the cornerstone.

We also make allocations to preferred stock and equity REITs. We encourage buy-and-hold investors to consider using more preferred stock and equity REITs.

performance

Compare performance with four ETFs that investors may use for exposure to the sector.

Chart showing performance of Seeking Alpha's best offering compared to four ETFs for dividend investors

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The four ETFs used for comparison are:

ticker

exposure

Mote

One of the Largest Mortgage REIT ETFs

PFF

One of the largest preferred stock ETFs

VNQMore

Largest Equity REIT ETF

KBWY

High Yield REIT ETFs. Yes it was horrible.

If an investor believes that preferred stock or mortgage REITs cannot deliver reliable returns, we respectfully disagree. While there are many opportunities in this sector, investors should still be aware of the risks. You can’t simply go for yield and do your best. With respect to common stock, additional vigilance must be exercised to protect principal by regularly monitoring prices and updating book value and price target estimates.

evaluation:

  • Bullish on DX, RC, RITM and MFA

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