Catalysts Intact For This Mortgage REIT
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Mortgage REIT Newcastle Investment (NYSE: NCT) reported fourth-quarter EPS that lagged analysts' expectations. While the earnings miss might look troublesome, there may be macroeconomic catalysts that can help the stock outperform in the future.
Earnings review
Newcastle Investment reported its fourth-quarter 2012 performance on Feb. 28. The earnings per share of $0.19 remained $0.09 behind Wall Street's estimate. I feel the earnings miss is nothing to worry about, because the poor performance was partially due to uninvested capital which produced a drag of $0.05 to $0.06 per share. During the quarter, the company increased its investment portfolio 4% from last quarter to $3.1 billion.
The reported GAAP income of $55 million came down from the prior quarter’s $272 million. GAAP income includes core income and other income. The company reported core income of $33 million, down 23% from the prior quarter. Other income for the quarter included $16 million from break-up fees and $12 million from unrealized gains on loans. Meanwhile, there was $5 million in depreciation and amortization costs.
As a result, the company generated Cash Available for Distribution (CAD) of $35 million, compared to $36 million at the end of the linked quarter.
During the quarter, the company earned $70.3 million in interest income, down 4.5% from a year ago. Over the same time period, the interest expense declined 30.5% to $21.9 million. As a result, the net interest income came in at $48.4 million, up 15% over the prior year. Strong growth in rental income of $9.4 million supported the bottom line, partially offset by a two-fold surge in quarterly expenses.
Future catalysts
A major catalyst for Newcastle is the reluctance of some of the largest US mortgage lenders to originate mortgages after the housing collapse of 2008. This has resulted in the decline of the five largest mortgage lenders’ market share from 67% in 2010 to 53.2% in 2012. It has also created a void in the mortgage market, causing an opportunity for the smaller players like Newcastle.
The investments made during the fourth quarter will help the company report higher core earnings in coming quarters. During the quarter, Newcastle made investments in the following:
- $134 million worth of non-agency RMBS purchased at a price of $87 million; this investment is expected to return 6% when unlevered and 12% when levered.
- two bank loans totaling $18 million but worth $52 million at face value
- senior living properties worth $16 million, besides a $10 million issue of non-agency securities.
Competition
Newcastle Investment competes with other small mortgage REITs like PennyMac Mortgage (NYSE: PMT) and Dynex Capital (NYSE: DX). Both rivals reported strong performances for the fourth quarter of 2012. Dynex Capital experienced a 36% year over year increase in its bottom line, while PennyMac reported 22% growth in its bottom line.
The fourth-quarter results for Dyenx Capital were supported by the diversification of its investment portfolio, which led to the increase in its dividend in 2012, when the rest of the mREITs (e.g. Annaly Capital and Armour Residential) were forced to cut theirs. PennyMac, on the other hand, experienced tremendous growth in its Correspondent Lending and Investment Activities business segments.
Conclusion
While the shareholders of Newcastle might be worried about the poor performance of their company during the fourth quarter, I believe catalysts for future growth are present. Therefore, given the challenging macroeconomic environment, I recommend investors buy the stock and benefit from its 8% dividend yield.
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