Disecting This mREIT
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Since 2008, CreXus Investment (NYSE: CXS) has operated as a mortgage REIT with investments in commercial mortgage loans, commercial mortgage backed securities, commercial real property, Agency Residential mortgage backed securities, commercial real estate debt and other commercial real estate related assets. Since the company is operating as a mortgage REIT, its objective is to provide its shareholders with high risk-adjusted returns, primarily through dividends.
For the purpose of reporting, the company has divided its investment portfolio into two segments; commercial real estate debt & preferred equity and real estate properties. The following graphs show the percentage of each type of security within the commercial real estate debt & preferred equity segment and the company’s investment portfolio in general.
It is evident from the above graph that around 87% of the company’s investment portfolio was commercial real estate loans, while 8% was real estate investments. Within the commercial real estate debt & preferred equity, a large concentration (71%) are fixed rate, while the rest are adjustable-rate securities.
Recent Quarter’s Performance
CreXus Investment reported its fourth quarter performance on February 19, 2013. The bottom line of $0.23 for the fourth quarter remained in line with expectations, while the book value of $11.85 came down from the linked quarters’ book value of $11.93.
The company reported $20.4 million interest income during the quarter, down 24% from the linked quarter. Much of the decline in the top line of the company was a result of a decline in the weighted average yield on assets during the quarter. The company earned a 10.52% yield on its commercial loans, 11.35% on its preferred equity and 9.55% on its real estate portfolio. This is compared to a 29.86% yield on commercial loans and 7.67% yield on its real estate portfolio during the linked quarter.
Interest expense of $281,000 was up 50% from the linked quarter on higher cost of funds. Cost of funds edged up 1 basis point from the linked quarter to 3.49%. Servicing fees of $152,000 were up 2% over the same time period, providing some support to the net interest income which arrived at $19.97 million, down 25%, compared to the third quarter of 2012.
Other income items during the fourth quarter gave some support to the bottom line. The company realized rental income of $821,000, up 1.5% from the third quarter of the prior year. Other expenses of $5.25 million were up 2% over the same time period. The hike in expense was blamed on the hike in management fees to affiliate, partially offset by a slight decline in the depreciation expense.
As a result, the company posted a net income from continuing operations of $15.53 million. The net income, compared to the linked quarter was down 32%. Net income from discontinued operation of $2.4 million provided further support to the bottom line, which resulted in net income of $17.9 million for the fourth quarter, compared to $22.6 million at the end of the linked quarter of 2012.
CreXus Investment competes with other mortgage RIETs within the United States. One such mortgage REIT, which happens to be in the process of acquiring CreXus Investment is Annaly Capital Management (NYSE: NLY). CreXus announced on Jan. 31, 2013 that it has reached a definitive agreement with Annaly Capital to be acquired for $13 per share in cash. In addition, the share will continue to accrue dividends until the deal closes, which is expected by late April. Currently CreXus is serving the period under which it is free to solicit, evaluate and enter into negotiations on alternative proposals from third parties through March 16. I believe it’s hard for CreXus to receive another higher bid, given the 9% premium to its book value coupled with the fact that Annaly Capital is the external manager to CreXus, which eliminates any integration risks.
Annaly Capital Management is America’s largest mortgage REIT. It has been facing a hard time in the wake of the Fed’s all out efforts to keep the short-term rates low and at the same time bring down long-term rates. Annaly has a large concentration in 30-year high coupon fixed rate MBS, which are accelerating its prepayments to 19% under the prevailing challenging macroeconomic environment. This is why the company experienced a 7 basis point decline in its interest rate spread during the fourth quarter. At the end of the third quarter, Annaly reported an over 50 basis point sequential decline in its net interest rate spread. On a positive side, the company reduced its operating expense by 36% over the linked quarter, which provided partial support to the bottom line during the fourth quarter.
I have a hold rating for CreXus Investment with a target price of $13.35. I recommend investors hold the stock and benefit from its elevated dividend yield of 9.6%, which the company has been able to increase during the prior year.
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!