An 18% Yield Makes This Hybrid mREIT the Best Buy
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Two Harbors Investment (NYSE: TWO) commenced operations in 2009 and seeks to invest in residential mortgage-backed securities, residential loans, residential real properties and other financial assets. The company’s target portfolio includes Agency RMBS and Non-Agency RMBS, therefore TWO is classified as a hybrid mortgage REIT. The stock is currently offering an elevated dividend yield of 17.7% and is trading at 38% premium to its book value.
4Q Performance Review
Two Harbors reported its performance for the fourth quarter of 2012 with better than expected book value and lower asset drag on core bottom line. The company reported a bottom line of $0.28 per share, missing estimate by $0.05.
Interest income of $137 million surged 85% year over year, while the net interest spread was 2.9% for the quarter, 20 bps lower than last quarter.
During the most recent quarter TWO reduced its Agency MBS allocation by 4% to 53%, with the bulk of the equity going to residential rentals. With the successful completion of the Silver Bay IPO, this capital will be distributed to shareholders as early as the first quarter of the current year. At Silver Bay’s current price, this will be a $1.24/share distribution.
TWO repositioned the Agency portfolio to reduce prepayment and pay-up risk, and I expect future investments to have a bias towards credit given continued improvement in underlying fundamentals. Along these lines TWO completed a non-Agency securitization last week, where it retained the credit tranches. As Two Harbors Investment sold some RMBS assets, its MBS portfolio decreased by $1.3 billion. The portfolio will grow as TWO deploys the $821 million in un-invested cash at year-end. The end-of-period MBS portfolio was $1.8 billion.
Two Harbors employed 3.4 times leverage on the MBS portfolio (excluding the Treasuries) at the end of the fourth quarter, down 0.5x from the linked quarter. As of the end of the recent quarter, TWO had 100% of its repo hedged with swaps and swaptions coverage of an additional 39%; this compares to 86% and 37% coverage last quarter.
MFA Financial has been in business since 1998 and seeks to invest in both Agency and Non-Agency MBS. Around 60% of the company’s asset portfolio is invested in Agency MBS, while the rest is non-Agency. Most of the non-Agency MBS are purchased at discounts to their par values and are considered very high quality. Within the Agency MBS, the company has a large concentration in 15-year fixed rate securities, which increases the prepayment protection, however a majority of it is not eligible for HARP. The company reported CPR of 21.6% for the third quarter, up from 20.4% at the end of the second quarter. MFA is currently yielding 8.8% and is trading at 29% premium to its book value.
AG Mortgage Investment Trust is a relatively new mortgage REIT. At the end of the third quarter around 80% of the company’s portfolio was invested in Agency securities, followed by non-Agency at 15%. Besides, the company has invested in commercial MBS (3% of portfolio) and asset backed securities. The company reported a surge in its net interest margin during the third quarter over the prior quarter due to an increase in non-Agency debt. 30-year fixed rate securities are 50% of the entire Agency MBS portfolio, followed by 15-year fixed rate at 35%. The company reported a CPR of 6.2% at the end of the third quarter. The stock offers a dividend yield of 12.5% and is trading at 24% premium to its book value.
American Capital Mortgage is managed by the same team that manages American Capital Agency. While American Capital Agency is an exclusive Agency mREIT, American Capital Mortgage is classified as a hybrid REIT. The company started its operations in 2011 and has large chunks of Agency MBS in its portfolio. Around 92% of the portfolio is invested in Agency MBS, while the remaining 8% is non-Agency. Agency MBS, 30-year fixed rate are 59%, followed by 15-year fixed rate securities at 31% of the entire MBS portfolio at the end of the third quarter of 2012. The stock is currently offering 13.9% dividend yield and is trading at 24% premium to its book value.
I am bullish on Two Harbors Investment. The company has a diversified MBS mix, which under the challenging macroeconomic environment is supporting the company’s net interest spread and dividend distributions.
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