The Fed’s intentions of tapering Agency MBS purchases have increased interest rate volatility, causing the mortgage real estate investment trusts (mREITs) to skydive amid concerns of book value erosion.
However, each mREIT will be impacted differently due to their diverse investment portfolios and exposures. Let’s look at some of the most preferred and least preferred mREITs under the new situation.
Most preferred mREIT
I prefer PennyMac Mortgage Investment Trust (NYSE:PMT) the most under today’s macroeconomic situation. I believe investors have an opportunity to purchase PMT’s non-performing loans below their economic book value and the current valuation implies zero value to the mortgage origination business. Further, I believe PennyMac Mortgage Investment Trust (NYSE:PMT)’s dividends are on an upward course.
I will buy PennyMac Mortgage Investment Trust (NYSE:PMT)’s stock until it reaches $28 per share. The company is well positioned to grow its loan originations business and their distressed residential mortgage loans portfolio should benefit from the recovery in the U.S. housing markets and improving housing prices. In the longer-term, I like companies leveraged to the residential mortgage market as reliance on the agencies shifts and more private capital comes into the mortgage market.
Annaly Capital Management Inc. (NYSE:NLY) is the largest player among the mREITs that invests in Mortgage-Backed Securities (MBS) for which government guarantees the principal and interest payments. These are known as Agency MBS. Despite the fact that it is largely invested in Agency MBS, I believe the company will perform better than its peers.
Its recent acquisition of CreXus Investments, an mREIT that is exclusively invested in high yielding commercial MBSs, gives the company a entirely different exposure and will act to support its interest income. Besides, the relatively low leverage (6.7 times) that Annaly Capital Management Inc. (NYSE:NLY) has employed will act as a cushion to prevent book value depreciation.
Least preferred mREIT
I believe American Capital Agency Corp. (NASDAQ:AGNC) will remain out of favor as the Fed potentially tapers the third round of quantitative easing, which could drive book value volatility. Also, a dividend cut cannot be ruled out as the company’s board considers both core earnings and the direction of book value important. Therefore, I recommend investors stay away from American Capital Agency Corp. (NASDAQ:AGNC) around the unwinding of QE.
Given the current situation, American Capital’s dividends are highly variable. If we look back, Annaly Capital Management Inc. (NYSE:NLY) was forced to cut its dividends to $0.13 per share as a result of the Fed’s tightening in the third quarter of 2005. The dividends fell from $0.36 per share in the previous quarter. I believe the mortgage REITs are almost 2 times more volatile than equity REITs from a total return perspective and notably more prone to dividend cuts.
The only positive stock price driver for American Capital Agency is if the Fed decides to hold on to easing for a longer period of time. That way, American Capital should benefit from a wide portfolio spread due to the current steep yield curve and boost earnings and dividends.
Valuations
PennyMac Mortgage Investment Trust (NYSE:PMT)’s book value should benefit as its distressed book of whole loans is refurbished and the fair value marks increase. The stock is currently trading at 1.08 times its book value multiple, which is well below the premium it demanded during prior quarters. Therefore, I believe the stock has simply gotten too cheap. Citigroup estimates a 1.35 times price to book value multiple for it.
Annaly Capital Management Inc. (NYSE:NLY) is trading at a 10% discount to its recent quarter’s book value. This is in contrast to the moderate premium on which the stock has been exchanging hands over the past few months. With the presence of positive stock price drivers, I feel the stock is cheaply valued.
American Capital Agency is changing hands at a 9% discount to its book value, which is in contrast to the moderate premium the stock has been trading over the past few months. Citigroup also has a moderate premium estimate for the stock. While American Capital Agency is also trading below its historical book value premium, I think the lack of positive drivers at the time make the stock unattractive.
Conclusion
While the entire mREITs sector is trading well below its historic lows, only a few mREITs have positive stock price drivers. This article featured PennyMac Mortgage Investment Trust (NYSE:PMT) and Annaly Capital Management Inc. (NYSE:NLY) as two such companies with positive revenue and dividend trajectories. Therefore, I am bullish on them.
The article Is Your mREIT Least Preferred Amid QE Tapering? originally appeared on Fool.com.
Adnan Khan has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Adnan is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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