crossposthttp://boards.fool.com/yellow-flag-up-on-mortgage-reits-3033... Recommendations: 22 Mortgage REIT’s have been very popular over the last few years. With the Fed driving short term rates to zero, MREIT’s with their high dividend yields have been an easy sell. Few investors seem to care or remember about past hard times that MREIT’s went through. All investors see if the upside of high yields. I am not sure they see any downside risk at all. Last I heard any product with outsized yields had outsized risk! Maybe the laws of risk and reward no longer apply? A portfolio manager named David Schawel thinks that investors are not aware of the risks they are taking with MREIT’s. He wrote an article for the CFA institute entitled: Mortgage REITs: Does Doubling the Leverage Make Them a Good Investment?  I have excerpted one section from the article: I’d be scared to own mortgage REITs even before you double the leverage, for the following reasons: Record high MBS prices. Shortly after QE3 was announced, 30-year 3% Fannie Mae mortgage pools traded at 106 cents on the dollar, for a projected yield to maturity between 1.8% and 2%. As the REITs purchase new bonds, the yield at purchase is significantly lower than what’s already on their books. Extremely tight spreads. Spreads over a comparable maturity U.S. Treasury or swap are also at historically low levels; thus, these bonds don’t have the ability to tighten in spread to offset a decline in price. Expected increase in prepayments. Given the recent drop in mortgage rates, there has been a dramatic pickup in refinancing activity as measured by the refinancing index. The problem for the mortgage REITs is that an increasing amount of their earlier purchased bonds yielding 3% or higher will be returned at par (100), instead of where they may be currently trading. Margin compression. The implication of reasons one through three is that mortgage REITs are facing and will face strong margin compression in the coming quarters. High-yielding bonds are running off and being replaced with lower-yielding securities, while the cost of their funding hasn’t changed. This is a perfect combination for future dividend cuts, which have already begun in some cases. Dividend popularity. With dividend paying stocks now in vogue, mortgage REITs are trading under a halo; they are one of the few places to find a significant yield. As quickly as these stocks have come into favor, they can also fall out of favor. Stocks that were trading at a premium to book value could quickly find themselves trading at a discount. If you own any MREIT commons or preferreds, I STRONGLY recommend you read the article. The article is NOT a sell signal for MREITs, only a cautionary yellow flag that should be understood. PS: I need to dust off and update an MREIT research project I started last year. It was original work and was a different reason to raise the yellow flag. Thanks, Yodaorange  David Schawel article “Mortgage REITs: Does Doubling the Leverage Make Them a Good Investment?” http://blogs.cfainstitute.org/insideinvesting/2012/10/22/mor......
Isn't NLY trading at a discount to BV? I think that gives us some risk safety.
Best Of |
Favorites & Replies |
Start a New Board |
My Fool |