Mortgage REITs use both leverage and equity to augment earnings
In the interest of better understanding and learning, here is an excerpt from a recent Seeking Alpo article. "Mortgage REITs use both leverage and equity to augment earnings and to replenish and grow assets. The difference, or spread, between the interest an mREIT pays to borrow funds (usually as repurchase agreements or "repos") and the interest it earns on the mortgage-backed securities (MBS) it buys with those borrowed funds is around 2%. This in itself is not a big yield. So mREITs leverage, or borrow in multiples of stockholder equity, in order to multiply the spread by the leverage factor. Thus, if the leverage factor is 8 on a 2% net spread, then the effective spread is 16%. 90% of the resulting earnings (plus base asset yield less expenses like management fees and hedging costs) are distributed to shareholders."
"Unlike other entities, mREITs can only retain 10% of earnings, so the mREIT uses equity, in the form of secondary share issues, to fund its asset replenishment and growth."
The full article can be found here: ****://seekingalpha.***/article/709871-mortgage-reit-leveraging-is-it-a-good-thing
The material in the SA article referenced does not strictly apply to the hybrid MREIts, such as NYMT (MTGE, WMC, TWO...) The typical approximately 2% profit spread refers to agency backed mortgages that are the only investments made by the agerncy-backed MREITs, such as NLY, AGNC, and ARR. The hybrids trade in (risk) adjusted commercial mortgages as well as the agency backed mortgages to maximize risk adjusted profit opportunities. The commercial mortgages offer spreads around 6%, but because of inherent risk, the hybrid MREITs use minimal leverage to buy them, say no leverage to 1.5-2.; the high profit spread compensates for lack of leverage.
The QE3 program recently announced by the Fed will place increasing pressure on the profit spread for the agency backed mortgages, so NLY, AGNC, and ARR whose earnings and dividendshad been trending down from TWIST and the first two QEs, will continue to trend down. The hybrids have been abler to maintain and even increase earnings by prudent acquisition of commercial mortgages. In particular, NYMTs focus on multi-unit, apartment mortgages is doing well for both profit and modest risk, as apartments are popular while few are interested or able to buy houses.
QE3 will also provide stable low interest rates into 2015, and perhaps longer as the world's economies struggle, reducing risk for MREITs, and especially for the hybrid MREITs.
The SA and Motely Fool articles are unfortunately useful for folks who already know what's being discussed, and ofter misleadingto others-- or just plain wrong (writers are often ignorant or confused about REIT accounting based on GAAP, when GAAP is misleading)..