Mortgage Origination For Profits | Seeking Alpha


This research report was produced by The REIT Forum with assistance from Big Dog Investments.

Following reader feedback, we’ve enhanced the layout for this series. Your continued feedback is greatly appreciated, so please leave a comment with suggestions.

This article will be heavy on charts because we like to communicate with images, rather than words, whenever possible. Likewise, we will use several tables to more efficiently structure the data. Enjoy!

Mortgage REITs and Preferred Shares

We’ve consistently incorporated a significant allocation to preferred shares in our portfolio. We could simply hold the positions for income, but we take advantage of trading opportunities as well. Our goal is to maximize total returns and this technique has worked wonderfully.

We also trade positions in the mortgage REIT common shares. We find this sector is particularly attractive because it can be so inefficient. Long-term, share prices revolve around book value. In the short-term, the price-to-book ratios can deviate materially. Simply by understanding that, you can put yourself in a better position.

Our other major source of allocations is equity REITs. While an investor might occasionally choose to trade an equity REIT position, the sector is a great fit for buy-and-hold investors.

We compare our performance against 4 ETFs that investors might use for exposure to our sectors:

Source: The REIT Forum

The 4 ETFs we use for comparison are:

Ticker

Exposure

MORT

One of the largest mortgage REIT ETFs

PFF

One of the largest preferred share ETFs

VNQ

Largest equity REIT ETF

KBYW

The high-yield equity REIT ETF. Yes, it has been dreadful.

When investors think it isn’t possible to earn solid returns in preferred shares or mortgage REITs, we politely disagree. The sector has plenty of opportunities, but investors still need to be wary of the risks. We can’t simply reach for yield and hope for the best. When it comes to common shares, we need to be even more vigilant to protect our principal by regularly watching prices and updating estimates for book value and price targets.

Mortgage REITs

Price-to-Book Value – Using Q2 2020 Book Value

Let the images begin!

Chart

Source: The REIT Forum

Remember that these are price-to-trailing-book ratios. They are not using estimates of current book value. Book values have changed during Q3 2020 and to a lesser degree during Q4 2020.

Repeated Note: There are three mortgage REITs we need to highlight here:

  • Two Harbors – We are using Q2 2020 book value adjusted to add back the $.54 per share as a result of terminating the management agreement for cause. If this decision was made prior to the end of Q2 2020, it would’ve raised BV accordingly. This is equivalent to GAAP book value excluding the $.54 charge recorded during Q2 2020.
  • AG Mortgage Investment Trust – We are using the Q2 2020 book value reported by management, which does not deduct the value of accrued dividends for preferred shares. If the preferred dividends were paid, it would reduce common book value under these calculations. This method is accepted under GAAP.
  • MFA Financial reports “GAAP book value” and “economic book value.” We’ve chosen to use the GAAP book value to remain consistent.

Unfortunately, we have to repeat those bullet points every time we publish because it regularly comes up if we don’t mention it.

Price-to-Book Value – Using Q3 2020 Book Value

Some mortgage REITs have already reported Q3 book values, if so, you can find them in the price-to-book chart below. If a company has reported their book value within 24 hours prior to public release of this article, please cut us a little slack.

Chart

Source: The REIT Forum

Book values will have changed some already during Q4 2020. We aren’t including that in our public articles (except for index cards). Scott Kennedy provides frequent updates on estimated book value, ratings, and price targets through The REIT Forum.

Dividend Yields

Dividend yields often come up in the comments, but picking based on dividend yield is stupid and regularly results in terrible performance. Don’t do it.

Chart

Source: The REIT Forum

This chart is still in the same order as the prior charts. Consequently, you know the highest price-to-book ratios (using trailing GAAP book value) for each segment will be at the top. If you see a mistake, please feel free to say something. Occasionally, the data for dividend rates requires a manual update.

Earning Yields

One of the next things investors may ask about is the yield using core earnings. This chart puts together the core earnings based on the consensus analyst estimate. Beware that the consensus estimate may not always be the best estimate.

Chart

Source: The REIT Forum

Consensus estimates aren’t always the best and there are ways to increase “Core Earnings” through accounting decisions or modifying hedges. Consequently, investors should still take these values cautiously. We do not depend on the consensus estimate to make decisions.

Preferred Shares

After testing out a series on preferred shares, we decided to try merging it into the series on common shares. After all, we are still talking about positions in mortgage REITs. We don’t have any desire to cover preferred shares without cumulative dividends, so any preferred shares you see in our column will have cumulative dividends. You can verify that by using Quantum Online. We’ve included the links in the table below:

Ticker

Recent Price

Bond or FTF

Stripped Yield

Current Yield

Coupon

Floating Yield On Price

Annualized YTC

Quantum Online Link

AGNCM

$22.15

FTF

7.81%

7.76%

6.88%

5.20%

11.6%

AGNCM

AGNCN

$22.90

FTF

7.69%

7.64%

7.00%

5.85%

12.5%

AGNCN

AGNCO

$22.11

FTF

7.39%

7.35%

6.50%

5.92%

10.7%

AGNCO

AGNCP

$21.60

FTF

7.13%

7.09%

6.13%

5.72%

10.7%

AGNCP

NLY-D

$25.22

7.53%

7.43%

7.50%

7.53%

3.2%

NLY-D

NLY-F

$22.44

FTF

7.84%

7.74%

6.95%

5.88%

14.0%

NLY-F

NLY-G

$20.89

FTF

7.88%

7.78%

6.50%

5.32%

16.2%

NLY-G

NLY-I

$22.45

FTF

7.61%

7.52%

6.75%

5.87%

10.8%

NLY-I

MFO

$23.70

Bond

8.47%

8.44%

8.00%

8.47%

1072.9%

MFO

ARR-C

$23.55

7.46%

7.43%

7.00%

7.46%

8.9%

ARR-C

DX-B

$24.85

7.72%

7.67%

7.63%

7.72%

21.5%

DX-B

DX-C

$21.98

FTF

7.90%

7.85%

6.90%

6.50%

11.0%

DX-C

CMO-E

$23.00

8.21%

8.15%

7.50%

8.21%

151.1%

CMO-E

EFC-A

$20.06

FTF

8.44%

8.41%

6.75%

6.76%

14.6%

EFC-A

NRZ-A

$20.32

FTF

9.26%

9.23%

7.50%

7.43%

15.2%

NRZ-A

NRZ-B

$19.25

FTF

9.29%

9.25%

7.13%

7.63%

17.0%

NRZ-B

NRZ-C

$17.69

FTF

9.05%

9.01%

6.38%

7.35%

18.5%

NRZ-C

AIC

$23.25

Bond

7.35%

7.26%

6.75%

7.35%

140.6%

AIC

AIW

$23.97

Bond

6.93%

6.91%

6.63%

6.93%

73.8%

AIW

ANH-A

$23.20

9.37%

9.29%

8.63%

9.37%

137.2%

ANH-A

ANH-C

$21.58

8.90%

8.83%

7.63%

8.90%

264.9%

ANH-C

CIM-A

$22.46

9.00%

8.90%

8.00%

9.00%

20.5%

CIM-A

CIM-B

$20.53

FTF

9.86%

9.74%

8.00%

7.40%

16.2%

CIM-B

CIM-C

$19.13

FTF

10.25%

10.13%

7.75%

6.56%

16.4%

CIM-C

CIM-D

$19.49

FTF

10.39%

10.26%

8.00%

7.26%

18.6%

CIM-D

PMT-A

$23.22

FTF

8.88%

8.75%

8.13%

6.60%

11.3%

PMT-A

PMT-B

$23.11

FTF

8.78%

8.65%

8.00%

6.81%

11.2%

PMT-B

TWO-A

$21.66

FTF

9.43%

9.38%

8.13%

6.82%

11.8%

TWO-A

TWO-B

$20.44

FTF

9.38%

9.33%

7.63%

6.85%

12.7%

TWO-B

TWO-C

$19.09

FTF

9.55%

9.49%

7.25%

6.88%

16.8%

TWO-C

TWO-D

$22.21

8.79%

8.72%

7.75%

8.79%

212.2%

TWO-D

TWO-E

$21.81

8.66%

8.60%

7.50%

8.66%

244.8%

TWO-E

CHMI-A

$22.83

9.05%

8.98%

8.20%

9.05%

14.3%

CHMI-A

CHMI-B

$19.96

FTF

10.42%

10.33%

8.25%

7.38%

17.6%

CHMI-B

IVR-A

$21.51

9.07%

9.01%

7.75%

9.07%

269.5%

IVR-A

IVR-B

$20.83

FTF

9.44%

9.30%

7.75%

6.57%

14.3%

IVR-B

IVR-C

$20.81

FTF

9.14%

9.01%

7.50%

6.70%

12.0%

IVR-C

NYMTM

$18.66

FTF

10.64%

10.55%

7.88%

8.98%

18.7%

NYMTM

NYMTN

$19.03

FTF

10.60%

10.51%

8.00%

7.83%

15.1%

NYMTN

NYMTO

$19.71

10.07%

9.99%

7.88%

10.07%

441.5%

NYMTO

NYMTP

$19.65

9.94%

9.86%

7.75%

9.94%

447.4%

NYMTP

AI-B

$18.00

9.84%

9.72%

7.00%

9.84%

35.4%

AI-B

AI-C

$18.92

FTF

11.05%

10.90%

8.25%

7.87%

20.4%

AI-C

MFA-B

$19.94

9.54%

9.40%

7.50%

9.54%

423.5%

MFA-B

MFA-C

$17.01

FTF

9.70%

9.55%

6.50%

8.29%

20.3%

MFA-C

MITT-A

$16.75

13.43%

12.31%

8.25%

13.43%

912.4%

MITT-A

MITT-B

$17.00

12.78%

11.76%

8.00%

12.78%

871.8%

MITT-B

MITT-C

$16.96

FTF

12.81%

11.79%

8.00%

10.71%

25.8%

MITT-C

There are a few things you should know at the start:

  • When a share can be called on short notice, the annualized yield-to-call reaches absurd levels. Investors shouldn’t put too much weight on it. On the other hand, a negative number can be a significant concern. Consequently, we decided to include it in the chart.
  • The last preferred shares in this group with a suspended preferred share dividend are from AG Mortgage Investment Trust (MITT).
  • We sort our spreadsheet for subscribers by risk ratings within each sector. We decided to use the same technique for this series since it communicates more information to readers. You’ll notice a general correlation where lower risk correlates with a higher price and lower yield, though this link isn’t absolute.

For each metric we have 2 charts. Why use two charts? Because it is much more convenient for readers who want to enlarge the charts. We simply can’t fit 40+ shares into a single chart and still have it show up well on a mobile device.

Share Prices

We will start with the prices:

Chart

Source: The REIT Forum

Chart

Source: The REIT Forum

That chart gives you a pretty quick feel for which shares are trading at a discount to call value. Each of these preferred shares has a call value of $25.00, but that doesn’t mean a share will be called. The company decides if they want to issue a call or not.

Dividend Yield

Let’s move onto the stripped yield. This is the way dividend yields should be handled for preferred shares:

Chart

Source: The REIT Forum

Chart

Source: The REIT Forum

Stripped yields are vastly more useful than “current” yields for preferred shares. The stripped yield uses the stripped price. That’s different from using the current price because it means we already adjusted for dividend accrual. This makes the process easier for investors.

We can talk about shares using “regular prices.” Those are the prices an investor would actually use when entering an order.

However, we will provide the stripped yield to adjust for the dividend accrual. In the spreadsheets we host for subscribers, we include the actual ex-dividend date, or the projected ex-dividend date if the actual date isn’t yet known. If you are planning to buy a share, it’s always wise to check if the shares just went ex-dividend so you can adjust your targets accordingly.

Floating Rate Dividend Yields

Since many of these shares switch over to floating rates, we also want to consider what the yield would be if the floating rate was in effect and shares were still at the current price. To demonstrate that, we use the “Floating Yield On Price.” If the share remains at a fixed-rate indefinitely, then the value doesn’t change:

Chart

Source: The REIT Forum

Chart

Source: The REIT Forum

One point we need to emphasize here is that we are dealing with yields. A yield must involve the share price. We aren’t simply showing the new “rate” if the share began floating, we are adjusting the new rate for the stripped price.

Focusing On Individual Shares

With the broad view of the sector covered, we’re going to focus on a few individual shares.

New Residential

Source: The REIT Forum

New Residential is in an unusual position where their book value is substantially understating the total value of the REIT:

Source: NRZ

The REIT still trades at a huge discount to the reported book value of $10.86 and that isn’t recognizing the full value of the operating company. A dramatic increase in origination production and solid gains on sale of mortgage loans originated have been a nice boost for the REIT:

Source: NRZ

They’ve been growing that business rapidly. However, earnings have been weakened currently due to the additional cost to service loans due to the impact from COVID-19:

Source: NRZ

Those costs should dip back down in the future. Investors are free to disagree about the timing for getting past the pandemic, but it isn’t simply a new way of life. Forbearance trends suggest that the impact on servicers is starting to improve:

Source: NRZ

While my overview on NRZ is pretty brief, Scott Kennedy provided a more thorough assessment for subscribers of The REIT Forum.

PennyMac Mortgage Trust

Source: The REIT Forum

Since PMT hasn’t reported Q3 2020 results yet, we will use some slides from Q2. Just like NRZ, you’ll notice that PMT is highlighting the profitability of their mortgage origination:

Source: PMT

An annualized ROE of 38.3% is pretty great. Delinquency was going down as of July 2020:

Source: PMT

That matches with the slide we saw from NRZ discussing their situation with mortgages in forbearance.

Positions

We don’t get every call right, but we win far more than we lose. Below you can see all of our open positions for the common shares:

Source: The REIT Forum

That’s a pretty solid record. Our record on closed positions is quite solid as well. It’s simply been a nice sector to make money by understanding which shares are trading at the most attractive discounts.

Conclusion

You don’t have to follow us. You don’t have to care about our research. If you are happy with a high dividend yield and a dwindling account value, there are plenty of authors who can cater to you. On the other hand, if you are focused on generating total returns and want to use REITs to do it, you may love our research. Hit the “Follow” button beside my name to start seeing more of our research.

Make sure to leave a comment and let us know what you think of the layout.

Ratings:

  • Bullish rating on PMT and NRZ

Our method works. We know because we buy the same shares we recommend. We track our results on a real portfolio and we compare our returns with the major ETFs for our sector:

Those four ETFs are:

  • MORT – Major mortgage REIT ETF
  • PFF – The largest preferred share ETF
  • VNQ – The largest equity REIT ETF
  • KBWY – The high-yield equity REIT ETF

Sign up now. Take advantage of our November sale!

Disclosure: I am/we are long NLY-F,NLY-I,AGNCO,TWO-E,TWO-A,NYMTP,NRZ-C,TWO-B,NRZ-B,TWO-C,NYMTM,CIM-A,NRZ,AGNC,NLY,NYMT,GPMT,SLRC,PMT,AAIC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: As a reminder, Scott Kennedy also is an author for the REIT Forum. You may see his commentary featured in our articles and may notice an extremely high amount of overlap in our ratings, so subscribers reading this article should see Scott’s latest REIT Forum sector update for more detail.

Be the first to comment

Leave a Reply

Your email address will not be published.


*