Buy This Exciting mREITs Portfolio Yielding 11%
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As John Williams, president of the San Francisco Federal Reserve Bank, sees the need for QE3 well into 2013 and rates to be kept near zero until at least mid-2015, I see Anworth Mortgage Asset (NYSE: ANH) and CYS Investments (NYSE: CYS) presenting an excellent buying opportunity. Despite the fact that both mREITs have an abundance of Agency MBS, these securities are either hybrid ARMs or 15-year fixed rates, which the Fed is not interested in buying. Therefore, I believe these companies will not experience much acceleration in prepayments and downward pressure on net interest spread as Annaly Capital (NYSE: NLY) is expecting. Anworth and CYS Investments combined give the income oriented investors a dividend yield of 11.2%.
Anworth Mortgage Asset Corporation
After starting its operations in 1998, Anworth Mortgage has continued to provide its investors with high returns based upon the spread between the interest income on its interest yielding assets and cost of borrowing to finance their assets. The company seeks to invest largely in mortgage backed securities for which any of the US Agencies guarantees the principal and interest payments. However, part of the MBS holdings are invested in non-Agency MBS. The selection of Agency MBS reduces the default risk for Anworth. At the end of the third quarter of 2012, only less than 0.5% of the assets were non-Agency MBS.
The graph above divides the Agency MBS into each of the classifications. It is evident that around 58% of the entire Agency holdings are Hybrid adjustable-rate securities, followed by ARMs at 22% and 15-year fixed rate securities at 16%. The 30-year fixed rate MBS, which the Fed is buying under its QE3 program, form only 4% of the Agency MBS. Average coupon rate on the company’s securities decreased 49 basis points to 3.036% from a year ago. The conditional prepayment rate for Anworth’s holdings is 26% at the end of the third quarter of 2012, up 2% from the linked quarter. The company offers a dividend yield of 9.74%.
In comparison, Annaly Capital Management has a weighted average of coupon rate of 4.1% with a CPR of 20%. Despite higher CPR compared to Annaly Capital, Anworth is preferred over it. The reason being, Annaly Capital has concentrated the high coupon, 30-year MBS in its asset portfolio, which the Fed is interested in buying. This is why Annaly Capital’s net interest spread would experience more downward pressure due to QE3 than Anworth’s.
CYS commenced its operations in 2006 and, like Anworth, CYS Investments’ objective was to generate high returns to be distributed into its shareholders in the form of both dividends and capital appreciation. For this purpose, the company seeks to invest in Agency residential mortgage backed securities collateralized by fixed rate single family residential mortgage loans, ARMs that reset monthly, and hybrid ARMs with an initial fixed period ranging from 3 – 30 year and thereafter reset at a regular interval.
The graph above shows the proportion of each security type in the company’s MBS portfolio. The largest chunk is of 15-year fixed rate MBS, followed by 30-year fixed rate MBS at 25%. The weighted average coupon rate of the company’s entire MBS portfolio at the end of the third quarter of 2012 was 3.33%, down from 3.66% in the fourth quarter of 2011. The company reports a CPR of 17.4%, down from 19.5% over the same time period. The company has been able to increase its quarterly dividends over the prior year, in sharp contrast to dividend cuts by most of the other mREITs, including Annaly Capital and Armour Residential (NYSE: ARR). CYS is currently offering a dividend yield of 12.5% when the 10-year treasuries are barely offering 1.89%.
In comparison, American Capital Agency and Armour Residential reported prepayments speeds of 12% and 13%, respectively. Both have MBS portfolios that are highly prepayment protected portfolio, which is why they are among my favored Agency mREITs.
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!