The analyst team at Sterne Agee has updated its book value estimates for the high-yield mortgage-backed securities (MBS) real estate investment trust (REIT) sector. The move is based on rising interest rates that keep adding pressure on MBS asset prices, even while the option-adjusted spreads have remained relatively stable or narrowed. The problem for investors seeking the double-digit dividend yields here is that book value models have continued to decline since the end of the last quarter.
Since the end of the last quarter, the 10-year Treasury yield increased 30 basis points and the low coupons and higher duration 30-year mortgage securities are underperforming higher coupon mortgage securities. The net result is a modest decline in non-agency MBS values. Sterne Agee shows that its models suggest a decline of 1.4% or so this quarter. In the June quarter, the firm's models suggested an average decline of 10% to 12% and the actual book values declined on average about 15%.
So here is the thing to consider. These MBS REITS have been plummeting in price as high-yield dividend buyers know that they have to worry about the effects of rising interest rates. A 1% or 2% drop in book value does not seem enough on the surface to bother with a report of this length. That is just on the surface. Where this gets complicated is that drop is after only one month, and it is on top of significant losses already. imagine what happens to these book values if interest rates really start to rise, say another 100 or 200 basis points.
MFA Financial Inc. (MFA) has an estimated $0.20 decline in book value. This is partially attributable to the company's recent special dividend declaration. For the third quarter, Sterne Agee sees MFA with a core earnings per share of $0.19, yet the dividend of $0.50 is a combined $0.22 estimated and $0.28 special.
Sterne Agee's team said, "We continue to prefer credit risk oriented Mortgage REITs over their Agency-only focused counterparts. Among the larger cap names in our coverage, our top picks are MFA Financial, Inc. (MFA) and PennyMac Mortgage Investment Trust (PMT)."
MFA's target price is $8.25, versus $7.28 recently, and we did not see PennyMac's price target in the full research report. Other companies in the high-yield dividend MBS REITS covered are as follows:
American Capital Agency Corp. (AGNC) with a neutral rating. The firm's price target is $22.00, and that is slightly under the current $22.80 price in the report. Last quarter's book value was $25.53, and Sterne Agee is projecting a book value of $25.31.
Annaly Capital Management Inc. (NLY) is considered king of the MBS REITs. Sterne Agee only rates it as Neutral with a $10.75 price target against a recent price of $11.60. The book value last quarter was $13.03, and Sterne Agee sees the book value as $12.64 by the end of August.
Dynex Capital Inc. (DX) is rated as Buy, with a price target of $9.00, versus a recent price of $8.02. The book value was $8.94 at the end of last quarter and was projected to be $8.91 by the end of August.
Ag Mortgage Investment Trust (MITT) also has a Buy rating, with a target of $19.00, versus a recent price of $17.45. The last book value was $19.78, and the end of August projected book value was $19.58.
Two Harbors Investment Corp. (TWO) has a Neutral rating with a $11.50 price target, but a $9.59 recent price in the report. Its book value was $10.48 at the end of the quarter and was projected to be $10.39 at the end of August.
Again, the drop of 1% or 2% in book value doesn't sound bad on the surface. The issue is that this drop was in just one or two months. Imagine what happens if or when interest rates rise another 100 basis points or more. Stay tuned.