Plenty Of Upside From Discounts To NAV

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

The topics we discuss are going to be extremely relevant to the residential mortgage REITs. The table below uses BV as of Q2 2020 (if the company has reported earnings):

Ticker

Company Name

Focus

Price to Trailing BV

BV Q2 2020

Price

ORC

Orchid Island Capital

Agency

0.97

$5.22

$5.04

DX

Dynex Capital

Agency

0.91

$16.69

$15.22

AGNC

American Capital Agency Corp.

Agency

0.89

$15.86

$14.11

ARR

ARMOUR Residential REIT

Agency

0.89

$11.11

$9.84

NLY

Annaly Capital Management

Agency

0.89

$8.39

$7.43

CMO

Capstead Mortgage Corporation

Agency

0.87

$6.79

$5.91

TWO

Two Harbors Investment Corp.

Agency

0.71

$7.24

$5.11

CHMI

Cherry Hill Mortgage Investment

Agency

0.69

$13.41

$9.20

AI

Arlington Asset Investment Corporation

Agency

0.48

$5.63

$2.69

MITT

AG Mortgage Investment Trust, Inc.

Hybrid

0.95

$2.75

$2.61

IVR

Invesco Mortgage Capital

Hybrid

0.85

$3.17

$2.71

CIM

Chimera Investment Corporation

Hybrid

0.81

$10.63

$8.60

EFC

Ellington Financial

Hybrid

0.78

$15.68

$12.24

WMC

Western Asset Mortgage Capital Corp.

Hybrid

0.63

$3.17

$1.99

MFA

MFA Financial

Hybrid

0.61

$4.51

$2.73

ANH

Anworth Mortgage Asset Corporation

Hybrid

0.60

$2.85

$1.72

PMT

PennyMac Mortgage Investment Trust

Multipurpose

0.87

$19.39

$16.83

NRZ

New Residential Investment Corp.

Multipurpose

0.68

$10.77

$7.27

NYMT

New York Mortgage Trust

Multipurpose

0.57

$4.35

$2.48

REM

iShares Mortgage Real Estate Capped ETF

ETF

MORT

VanEck Vectors Mortgage REIT Income ETF

ETF

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.

Price-to-Book Value

The next image provides a graphical representation:

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 even during Q3 2020. The only update we’ve included is adding $.54 to the value for Two Harbors based on their announcement that the management agreement would be terminated for cause.

Dividend Yields

You absolutely should not value mortgage REITs based on dividend yield. However, it often comes up in the comments, so I added a chart for dividend yields:

Chart

Source: The REIT Forum

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

AI is the only mortgage REIT that isn’t in the “hybrid” space yet still has a 0% dividend yield. While they aren’t officially a “hybrid” yet, they could get there. They moved into owning more credit-based assets in 2020.

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.

AGNC

A quick note is due on AGNC. The company just provided their end of August portfolio update. Book value per share was up slightly more than expected, representing a solid month. In August, tangible book value per share rose by another 6.1%.

New Residential

New Residential was one of the sweethearts of mortgage REITs for many years. The company was able to grow book value, grow earnings, and win accolades from investors of all kinds. That came screeching to a halt in March when panic reached incredible levels. We were actively buying back then, with 3 purchases from late March through the middle of April. Why? Because the REIT was hurt but it wasn’t dead. It is entirely reasonable to believe the price-to-book ratio will increase significantly in the coming quarters or years.

The company was able to make some progress since then:

Source: NRZ

A reduction in the mark-to-market exposure is great for reducing risk. Shareholders don’t want their REIT exposed to daily adjustments in the valuation of the collateral. While small changes in book value are occurring every day, it is far better for the REIT to have greater certainty about their access to capital.

Following the second quarter, NRZ set new records for the amount of cash they had available on the balance sheet:

Source: NRZ

You may notice that management also provided some figures for “Q2’20 Pro Forma Core EPS”. We didn’t add those in. We didn’t even apply the bright green circle. That was management telling investors what they see as potential core EPS when they no longer need to hold so much cash on hand. The company’s market cap for common equity is around $3 billion to $3.1 billion. Obviously, the number shares with the share price. That makes over $1 billion in cash a substantial amount.

Core earnings may increase in future periods, but predicting the exact timing of dividend increases is complex and well beyond the scope of our public articles. Scott Kennedy handles those predictions for The REIT Forum.

NRZ is one of the few mortgage REITs that was able to argue for a premium to book value and to achieve that premium quite a few times. They highlight the value of their operating company, which has produced substantial earnings for the REIT:

Source: NRZ

Management views the value of the company as being worth around $4.01 to $4.37 per share. So when we argue that NRZ deserves a higher valuation, they have plenty of upside.

Our index card, complete with rating, price targets, and our allocation is shown below:

Source: The REIT Forum

Conclusion

Want to learn how to trade mortgage REITs? Click the follow button. Want to learn how to ignore mark-to-market losses while claiming a dwindling stream of dividends? You’ve got countless options for other authors.

You’ll see some upcoming articles that cover more of the basics for investing in the sector. Those articles should help investors who are still getting a grasp on how this sector works.

Ratings:

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

Try our service. See how much better investing can be.

Disclosure: I am/we are long NLY-F, NLY-I, AGNCO, NLY-G, NRZ, NLY, AGNC, NYMT. 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.

Editor’s Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.

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