In recent months, mortage REITs have looked like an increasingly risky bet for investors. Yet a stock screen has revealed that insiders at the following mortgage REITs are still buying shares:
American Capital Agency Corp. (NASDAQ:AGNC)
Hatteras Financial Corp. (NYSE:HTS)
Apollo Residential Mortgage Inc. (NYSE:AMTG)
Let’s explore the current state of the mortgage REIT market, then examine each of the stocks above to see why insiders might be buying.
In a recent announcement, the Fed dispelled all concerns regarding the risks and the probable halt of its aggressive $85 billion per month bond buying program. Therefore, the mortgage REITs sector will be hurt further.
The massive bond buying program is aimed at keeping the long-term mortgage rates lowm while the Fed keeps the short-term rates near zero. As a result, the interest rate yield curve began to flatten, and continued easing would mean further flattening.
Mortgage REITs invest in mortgage backed securities and receive yields that are linked to the long-term mortgage rates. They invest in MBS using short-term financing and pay the cost that is linked to the short-term borrowing rate. Finally, mREITs earn a spread between the MBS yield and their cost of financing. The flattening of the yield curve results in lower MBS yields, and the resultant compressed spread. This will translate into dividend cuts and stock price depreciation in the future
What makes these insiders bullish?
American Capital Agency Corp. (NASDAQ:AGNC), Hatteras Financial Corp. (NYSE:HTS) and Apollo Residential Mortgage Inc. (NYSE:AMTG) have reported notable increases in insider transactions by 78.3%, 140.5% and 30%, respectively.
Over 32,000 shares of the American Capital Agency Corp. (NASDAQ:AGNC) were bought by insiders, including the Chief Executive Officer since the beginning of the current year. In the most recent transaction, the CEO bought 10,000 shares of his company at a price of $32.36. Compared to this, the stock of American Capital Agency is currently exchanging hands at $32.04. The purchases suggest that despite the current low price, management expects American Capital shares to rally in the future.
Similarly, 7,400 and 16,600 shares of Hatteras Financial Corp. (NYSE:HTS) and Apollo Residential Mortgage Inc. (NYSE:AMTG) were bought by their directors and senior executive. This insider activity reflects the management’s bullishness on the companies under consideration.
Institutional ownership for American Capital Agency Corp. (NASDAQ:AGNC), Hatteras Financial and Apollo Residential Mortgage Inc. (NYSE:AMTG) are 41%, 60% and 44%, respectively. Considerable positive institutional transaction activity is also visible for these stocks.
Valuations
With regards to the book value, the short-listed stocks are trading at attractive multiples. While American Capital trades in line with its book value, Hatteras Financial Corp. (NYSE:HTS) and Apollo are trading at 14% and 23% discounts to their respective book values.
In comparison, Annaly Capital Management, Inc. (NYSE:NLY) and CYS Investments Inc (NYSE:CYS) are trading at a moderate 6% discount and 9% discount to their book values. Annaly Capital Management competes directly with American Capital Agency for Agency paper while CYS has a similar hybrid investment portfolio like Hatteras and Apollo Residential.
Past Performance
The management’s ability to select superior securities that provide higher yields even during such challenging times is another reason for being bullish. This is the case for all the aforementioned stocks. Despite the continuous downward pressure on MBS yields and the resultant compression in the net interest rate spreads of mortgage REITs, American Capital Agency posted a 21 basis points increase in its net interest spread. This is against a seven-basis-point decline in Annaly Capital’s net interest rate spread over the third quarter.
Hatteras Financial reported a 14-basis-point decline in its fourth-quarter interest rate spread, while Apollo has yet to report its fourth-quarter results. In contrast, CYS Investments reported a 30 basis points sequential decline in its net interest rate spread.
Prepayments
The structure of investment portfolio has led to lower prepayments at these companies, causing less damage to the bottom line. Since American Capital Agency holds lower coupon mortgage backed securities with low loan balances that are eligible for HARP (Home Affordable Refinance Program), its portfolio is considered to be prepayment protected. This is also reflected by the prepayment speed of 10% that it reported at the end of the fourth quarter. In contrast, Annaly reported 19% CPR for its portfolio, which is down from the third quarter’s 20% CPR.
The weighted average conditional prepayment rate for Hatteras Financials investment portfolio was 26.6% compared to 27.6% during the third quarter of 2012. CYS Investment’s CPR increased from 17.3% in the linked quarter to 17.6%. MFA reported CPR of 21.6% for the third quarter, up from 20.4% at the end of the second quarter. MFA has yet to report its fourth-quarter results.
Dividend Distributions
Apollo and American Capital are among the rare mortgage REITs that were able to sustain their quarterly dividends throughout 2012. However, Hatteras was forced to cut its quarterly dividends 22% the previous year.
Going forward, the likelihood of the continuation of the current quarterly dividends for the three stocks under consideration is high. This is so because the quantitative easing is not hurting American Capital Agency as much as it is hurting other pure play mREITs. It has continued to expand its net interest rate spread and experienced low prepayment speeds. Therefore, its ability to generate cash has not been hurt.
Hatteras Financial and Apollo Residential Mortgage are considered to have exceptionally well diversified MBS portfolios, which include high-yielding assets other than Agency MBSes. Therefore, they have the ability to generate sufficient cash to sustain their current shareholder distributions.
Foolish Takeaways
American Capital Agency, Hatteras Financial, and Apollo Residential Mortgage are the best way to play the mortgage REITs, given the current challenging macroeconomic headwinds. The aforementioned companies have continued to display superior operating performance and have cheap valuations. The positive insider interest shows that their managements are also optimistic about future performance.
The article 3 mREITs With Positive Insider Buying originally appeared on Fool.com and is written by Adnan Khan.
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