In this article, I attempt to screen out undervalued high yielding US mortgage REITs for which analysts have a consensus buy recommendation. For this purpose, I examined their daily trading volumes, discount to book values, dividend yields and consensus recommendation of the analysts covering the stock. The specific criteria are as follows:
- Each of the companies must possess an average daily volume of over 200,000.
- Each of the companies must offer a dividend yield above 8%.
- Each banking companies must trade at least 10% below its book value.
- For each of the banking companies under consideration, analysts must have a consensus mean buy recommendation.
The results show Anworth Mortgage Asset Corporation (NYSE:ANH), Capstead Mortgage Corporation (NYSE:CMO) and Apollo Commercial Real Est. Finance Inc (NYSE:ARI) to have satisfied the criteria. The remainder of the investment thesis will touch each of the short-listed stocks briefly.
Anworth Mortgage Asset Corporation started its operations in 1998 as a mortgage REIT with an objective of providing its shareholders with elevated returns primarily through dividends. For this purpose, the company seeks to invest primarily in mortgage backed securities for which the principal and interest payments are guaranteed by any of the government Agencies like Fannie Mae or Freddie Mac. Traditionally, the company had concentration in adjustable rate mortgages (ARMs). At the end of the fourth quarter, 45% of the company’s investment portfolio was adjustable rate Agency MBS with a 2-5 year reset period. The company earned a net interest rate spread of 0.94% during the fourth quarter, down 15 basis points from the linked quarter. The company earned net interest income of $22.7 million, down from $31.3 million from a year ago and reported prepayment speed of 26% for its entire MBS portfolio.
From a fundamental perspective, Anworth Mortgage trades on volume of roughly 825,000 shares per day and possessed a book value per share of $7.14 at the end of the fourth quarter of 2012, down 4.2% versus the prior year end. Based on Friday’s close of $6.25/share, shares of Anworth Mortgage are trading at a 12.5% discount to their current BVPS. Analysts covering the stock have a consensus outperform recommendation for Anworth Mortgage, with 22.2% of them recommending their investors buy the stock, while another 22.2% rate the stock outperform. Only one analyst rates the stock underperform.
Capstead Mortgage Corporation
Capstead Mortgage is another mortgage REIT that invests largely in adjustable rate Agency residential mortgage backed securities. This large concentration of adjustable rate securities in the company’s asset portfolio gives Capstead Mortgage the advantage of recovering financing spreads diminished during periods of rising interest rates; it allows for only smaller fluctuations in the portfolio value from changes in interest rates compared to portfolios with a concentration in fixed rate securities. At the end of the most recent quarter, Capstead reported to hold 42% current –reset ARMs, while the rest were longer- reset ARMs. The interest rate spread for the fourth quarter of 2012 averaged 1.13%, down 17 basis points from the spread earned during the linked quarter.
From a fundamental perspective, Capstead Mortgage trades on volume of roughly 900, 000 shares per day and possessed a book value per share of $13.58 at the end of the fourth quarter of 2012, down $0.3 versus the prior year end. Based on Friday’s close of $12.27/share, shares of Capstead Mortgage are trading at a 10% discount to their current BVPS. Analysts covering the stock have a consensus outperform recommendation for Capstead Mortgage, with 27.3% of them recommending their investors buy the stock, while another 9% rate the stock outperform. A majority, 64% recommend investors hold the stock.
Apollo Commercial Real Estate Finance
Apollo Commercial, a $500 million company, was organized in 2009 as a mortgage REIT that primarily invests in commercial first mortgage loans, commercial mortgage backed securities and other commercial real estate related debt investments. Apollo has yet to disclose its fourth quarter performance on February 28, 2013.
From a fundamental perspective, Apollo Commercial trades on volume of roughly 205,000 shares per day and is currently trading at a 15% discount to its book value. Analysts covering the stock have a consensus outperform recommendation for Apollo Commercial, with 27.3% of them recommending their investors buy the stock, while another 18.2% rate the stock outperform. A majority, 55% recommend investors hold the stock.
Competition
The aforementioned mortgage REITs are competing with largely followed residential mortgage REITs like American Capital Agency Corp. (NASDAQ:AGNC) and Annaly Capital Management, Inc. (NYSE:NLY). Both have exclusive investments in Agency residential mortgage backed securities. However, the types of Agency RMBS differ within their portfolios. American Capital Agency is invested in lower coupon, low loan balance, HARP eligible mortgage backed securities, which experience lower prepayment speeds, while Annaly Capital Management has a large concentration of high coupon, longer duration mortgage backed securities, which have a tendency to accelerate prepayment speeds for its investment portfolio.
This is why Annaly Capital was forced to cut its dividends during the prior year; however, American Capital remains one of the very few mREITs that have maintained dividends. American Capital is yielding 15.4% and trading at a 3% premium to its book value, while Annaly Capital yields 11.9% and trades at a 4% discount to its book value. However, analysts have a consensus hold recommendation for Annaly Capital, while American Capital Agency is rated as outperform.
Conclusion
I believe the above short-listed stocks and American Capital Agency are the best way to play the US mortgage REITs. These mREITs with elevated divided yields provide the required liquidity as represented by their daily trading volumes, while their attractive valuations provide investors with upside potential, which is also supported by consensus recommendation.
The article Buy These Undervalued mREITs: Offering Upside & Elevated Dividend Yields originally appeared on Fool.com and is written by Adnan Khan.
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