mReits

[hyten1]

anyone watching, tracking the various mReits stocks?

 

i know the risk (rising rates), what does everyone think? will the rates rise as fast as the market is pricing in?

 

 

hy

[actuary]

Unless repo liquidity for high quality collateral freezes up, shouldn't the rise in long rates be a good thing in terms of the spreads and earnings power in this space? I'm getting very interested as it seems the recent market action does not reflect the various interest rate hedges these guys have in place. There could be some catalysts coming up - declines in BV more modest than expected during the next round of earnings reports, stronger comments from fed officials about the taper / rate increase timeline, less volatile bond market action, etc. Read NLY 10K and some call transcripts this weekend... it really looks like these guys prep for a wide variety of scenarios - not just changes in fed action but reform to the gses. I can respect an attitude that these should fall into the "too hard" pile but am planning to allocate a small position this week. Implied vol on leaps is quite low, even after the recent market action.

[HJ]

That's why NLY choses to be the least levered of the bunch.  I don't know why the other agency REIT's are not as concerned with the GSE reform stuff, since it could easily rock the foundation of their existence.  Just think about the impact it could have on repo terms and conditions on whatever security gets manufactured on the other side of the reform.

 

As far as clipping the mortgage carry is concerned, first of all, most of these guys are 50%-60% hedged on rates.  But it's not just the ultimate level of rates, but also how wide the mortgage spread gets (now that Fannie and Freddie are no longer in there buying their own bonds, which they used to do in massive scale in environment like this), how long will this up rate cycle be, what the curve look like in the interim, how prepayment reacts, and whether you trust the manager to ultimately navigate through this whole macro back drop mostly unharmed.  If you had to pick one, NLY would be it, but they are definitely fighting the uphill portion of this battle, with very limited visibility.

 

 

[claphands22]

I'm definitely interested in NLY, but I can't figure out how much to pay for it.

 

How much do you pay for a bunch of levered mortgage securities that are managed by somebody else? How do you make a reasonable estimate of their EPS in the next 5 to 10 years?

 

NLY seems to have consistent ROA of a bit over 1% which is normal for a financial institution, then you can figure out their ROE based on their leverage. Yet, what happens to them when interest rates rise? In 2005'ish they faced rising interest rates which caused trouble, imagine if interest rise much faster and in a secular fashion? They are still a financial institution that lends long and borrows short, it's not like they own a whole bunch of low cost deposits like BAC, their net interest margin would be squeezed in that environment and their assets would become worth less as YTM would need to raise with rising interest rates.

 

Yet, maybe rising interest rates could be not such a bad thing for NLY -- they want to be at a 12X leverage and are currently at 6.5X which means they could expand if things get better and are not as precarious if rates raise faster than normal.

 

I am also not sure how to value their interest rate swaps and what that will mean to NLY, other than being more hedge for raising rates is good if rates rise.

 

If anyone knows of a well written article how to think about valuing mREITs I would greatly appreciate it.

[Josh4580]

Capstead Mortgage's (CMO) portfolio is 100% in adjustible rate mortgages.  Could be a much safer play than NLY. 

[HJ]

Since both sides of the balance sheet are quite efficient markets, I think you are supposed to value it at book value (adjusted for any ups and downs intra-quarter).  What ever above average yield you are getting from these efficient markets imply that you are taking certain tail risks that may or may not be underappreciated by either side of the market.  The only way to manage those risks, of course, is to rely on the manager to dial back leverage at the appropriate time, and still hit a yield target. 

 

All hangs on whether the manager will make those decision, pick up the right kind of yield or avoid the pitfalls to justify their management fee.  Both Carlyle and KKR had mortgage REIT's that blew up during the crisis (I presume managers were fired as a result).  You may call that once in a generation event, but then in 94-95, there were also pretty well publicized blow ups.  The current set up is somewhat analogous, plus the GSE reform overhang.

[jay21]

Since both sides of the balance sheet are quite efficient markets, I think you are supposed to value it at book value (adjusted for any ups and downs intra-quarter). 

 

Agreed.  It's insane that some of these are being priced above book.  Now you have PE and HFs looking to buy pools of agencies, lever them up, and sell them above book.  It's basically arbitrage. (This may have cooled due to the rate vol over the last month).

 

However, there are some mREITs that invest in PL RMBS, which were not efficient and would justify a premium years ago as the market was shattered and even if you paid a premium you could still see an amazing return.

 

I would probably only be interested in these vehicles in extreme environments, but even then there will probably be better things to buy.

 

Capstead Mortgage's (CMO) portfolio is 100% in adjustible rate mortgages.  Could be a much safer play than NLY. 

 

It could also be riskier.  There's probably some basis risk in there and if rates shoot up, things might get ugly.

[HJ]

 

However, there are some mREITs that invest in PL RMBS, which were not efficient and would justify a premium years ago as the market was shattered and even if you paid a premium you could still see an amazing return.

 

I would probably only be interested in these vehicles in extreme environments, but even then there will probably be better things to buy.

 

 

And guess what they do when they do trade to premium, they dilute you by issuing more stocks.  CIM is the classical example, at the end of 2008, it's arguably positioned to deliver awsome returns in the following years, and some of the early re-remics they did had ridiculous economics, but on the back of that, they grew market cap from something like $200MM to $2 billion.  So what would have been 40-50% type of IRRs if they didn't do any follow on capital raise gets diluted down to the low teens.  The managers are not incentivised to optimizing IRR's, but maximizing AUM's.

 

These things are there to give retail investor access to mortgage carry.  There is a time and place for it, but arguably not  today.

 

 

[A_Hamilton]

 

However, there are some mREITs that invest in PL RMBS, which were not efficient and would justify a premium years ago as the market was shattered and even if you paid a premium you could still see an amazing return.

 

I would probably only be interested in these vehicles in extreme environments, but even then there will probably be better things to buy.

 

 

And guess what they do when they do trade to premium, they dilute you by issuing more stocks.  CIM is the classical example, at the end of 2008, it's arguably positioned to deliver awsome returns in the following years, and some of the early re-remics they did had ridiculous economics, but on the back of that, they grew market cap from something like $200MM to $2 billion.  So what would have been 40-50% type of IRRs if they didn't do any follow on capital raise gets diluted down to the low teens.  The managers are not incentivised to optimizing IRR's, but maximizing AUM's.

 

These things are there to give retail investor access to mortgage carry.  There is a time and place for it, but arguably not  today.

 

HJ great post. Same feelings I had on NYMT which I owned in the depths of the crisis...they did these great deals and then diluted the crap out of everyone.

[BargainValueHunter]

Two years ago I'd bet most on this thread thought interest rates would have moved higher by late 2015.

 

Its beginning to look like it will be a MUCH longer wait until interest rates rise.

 

http://www.tradingeconomics.com/germany/interest-rate

 

http://www.tradingeconomics.com/switzerland/interest-rate

 

https://research.stlouisfed.org/fred2/series/T5YIFR

 

[tede02]

Jeffrey Gundlach bought NLY over the summer and discussed it publicly.  http://blogs.barrons.com/incomeinvesting/2015/07/15/annaly-gets-boost-from-gundlach/.  At the time he said he liked the company but didn't understand why they didn't buy back shares because the company trades at a significant discount to book.  Not long after his comments, the company announced the board approved a share repurchase plan.  I wonder how aggressive the firm has been in buying back shares?  I've owned NLY for 5+ years.  Bought at different prices. 

[maverick]

Since both sides of the balance sheet are quite efficient markets, I think you are supposed to value it at book value (adjusted for any ups and downs intra-quarter). 

 

Agreed.  It's insane that some of these are being priced above book. 

Capstead Mortgage's (CMO) portfolio is 100% in adjustible rate mortgages.  Could be a much safer play than NLY. 

 

It could also be riskier.  There's probably some basis risk in there and if rates shoot up, things might get ugly.

 

Folks most mortgage REITs have been trading at a significant discount  to their book value (0.65XBV - 0.85XBV) for the past 1-2 years. The reason is that the market is pricing in the increase in rates. In the past, mREITs have traded at 1.1x-1.2X their book value too.

 

If rates were to go up rapidly, a hybrid mortgage REIT may perform better than a pure agency mortgage REIT.

 

For those not comfortable in venturing out too far away from one's circle of competence, I would recommend taking a look at the mREITs preferreds. With that not only one gets a high dividend but has more price stability (and higher up in capital structure) too.

[jay21]

Anyone interested in mREITs or other YieldCo structures in this environment?

[Jurgis]

FYI Jeffrey Gundlach pitched NLY again in second part of Barron's roundtable.

 

 

I have no holdings in this space.

[gym97]

for those in Canada, MTG (Timbercreek Senior). They have been buying back shares to narrow the price / NAV discount to their detriment and to shareholder's benefit, i.e. this will lower their fees. Management passes along all loan fees to unitholders (i.e. they have no incentive to churn) and they publicly said that they will be buying shares personally in the last conference call. Unlike the US, in Canada, there is a huge dearth of capital between traditional bank debt and traditional equity, which is where mortgage REITs come into play. Average duration is less than 2 years and exposure to Alberta is minimal. All loans are variable rate. I don't foresee rising rates to be a problem here. They are trading at a 0.78x NAV and I think they are unfairly being lumped in with US mREITs, many of whom may have poorer management incentives.

[Guest cherzeca]

posting on this generic mREIT thread an interesting take by Harley S. Bassman: 

http://www.convexitymaven.com/images/Convexity_Maven_War_and_Peace.pdf

 

twin thesis:  speculative thesis that a huge amount of equity-like IRA assets will be distributed per federal rule and end up in FI, plus the thesis that low rates into 2023 (thanks Fed) preserves low cost of leverage, ensuring long runway.