Your High Dividend Portfolio For 2013: 13.9% Yield
Adnan is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
In my opinion the regulatory and macroeconomic environment is still threatening the survival of Agency Mortgage REITs. The Fed is busy bringing down the long-term mortgage rates through QE3 to facilitate home borrowers. On the other hand it has shown its commitment in keeping the policy rate (the short-term rate) at the lowest possible level at least until mid-2015. Following the December 2012 Fed meeting, the policymakers anticipate a target range for the federal fund rate of 0 to 0.25% until:
- Unemployment remains above 6.5%
- Projected inflation to be no more than 2.5% and longer-term inflation expectations continue to be well anchored.
Currently, US unemployment rate is 7.8%, while inflation is at 1.76%.
Given the situation where most of Agency Mortgage REITs are forced to cut their dividends, I recommend investors to take a look at the hybrid mortgage REITs for part of their income focused or high dividend portfolio. Hybrid REITs own and invest in Agency and non-Agency mortgage backed securities with different exposures and concentration levels. For the purpose of this high dividend portfolio, I recommend investors to consider MFA Financial (NYSE: MFA), Two Harbors (NYSE: TWO), and American Capital Mortgage (NASDAQ: MTGE).
Around 60% of MFA’s assets portfolio is composed up of Agency MBS, while the rest constitutes non-Agency MBS. The non-Agency MBS holdings purchased at a discount by MFA are considered to be high quality debt. Around 29% of the Agency holdings of the company are 15-year fixed rate MBS, which the Fed is not interested in purchasing. A majority of the Agency debt is also relatively new, making it ineligible for HARP. The prepayment speeds for the company’s portfolio remained at 21.6% at the end of the third quarter of 2012, however, inclusion of prepayment protected securities and recent rise in interest rates should moderate prepayment speeds in the coming quarter.
During the third quarter of the prior year, the company’s net interest margin declined from 2.45% to 2.22%, however, I believe the NIM is enough to sustain the current shareholder distribution if the asset yields and leverage remains at the current levels.
The company employs 2.9 times leverage to enhance its returns and offers a dividend yield of 9.23%. The company recently declared a quarterly dividend of $0.2 per common share. MFA’s shares appreciated over 20% in year 2012. In comparison, Annaly Capital’s (NYSE: NLY) shares depreciated 12% in value over the same time.
Two Harbors, besides owing Agency and non-Agency MBS, owns homes directly in order to differentiate and diversify. Owing homes directly is an illiquid investment compared to the liquid MBS portfolio. Much of the company’s Agency MBS portfolio is low-balance, high loan-to-value with prepayment protected mortgage backed securities. On the other hand, the non-Agency MBS are purchased at deep discounts to their par values. Around 84% of the company’s MBS portfolio is composed of Agency MBS, while the rest is non-Agency. The reported prepayment speeds for the company’s Agency and non-Agency MBS at the end of the third quarter were 6% and 3%, respectively.
The reported net interest margin at the end of the third quarter for Two Harbors was 3.1%, down from the linked quarter’s 3.6%. The company employs 3.8 times leverage and offers a dividend yield of 18.14%. The company recently declared its fourth quarter dividend of $0.55 per common share. Shares of Two Harbors have appreciated around 20% in value in year 2012. In comparison, American Capital Agency’s shares appreciated only 3% over the same time period.
American Capital Mortgage
A sister company of American Capital Agency, American Capital Mortgage is a hybrid mortgage REIT and invests in non-Agency MBS too, unlike American Capital Agency. Around 8% of American Capital Mortgage’s MBS portfolio is invested in non-Agency securities, while the rest is Agency MBS. Much of the Agency portfolio is highly prepayment protected as 73% of Agency MBS are lower loan balance and HARP loans.
The net interest margin at the end of the third quarter declined from 1.94% in the linked quarter to 1.88%. The company employs 6.6 times leverage and offers a dividend yield of 14.33%. The company recently declared a quarterly dividend of $0.9 per common share. Share price of the company has appreciated 25% over the year 2012. In comparison, Armour Residential depreciated 8% in value over the same time period.
Hybrid mortgage REITs have shown less volatility over the recent past, compared to Agency mortgage REITs. Hybrid mortgage REITs have hovered a price to book value multiple of 1 times since 2009. Currently, MFA Financial trades at 4% discount to its third quarter book value, while Invesco Mortgage trades at 2% discount to its third quarter book value. Two Harbors trades at 6% premium to this book value and American Capital Mortgage is trading in line with its third quarter book value. In comparison, the Agency mortgage REITs, American Capital Agency, Annaly Capital Management and Armour Residential trade at 5%, 11% and 12% discounts to their third quarter book values, respectively.
In conclusion, the portfolio consisting of MFA, TWO, MTGE offer a dividend yield of 13.9% with potential of price appreciation. Therefore, investors looking to add stocks in their income focused portfolio should consider the above mentioned stocks.
equityfinancials has no position in any stocks mentioned. The Motley Fool owns shares of Annaly Capital Management. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!