Rifling Through the Wreckage

 | Jul 14, 2013 | 5:00 PM EDT
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It has been a bad year for real estate investment trusts that primarily invest in mortgage securities. For one example, shares of Annaly Capital Management (NLY) -- one of the most widely followed mREITs -- have lost 18% year to date.

American Capital Mortgage Investment (MTGE) has been hit even harder, suffering a 31% year-to-date drop. Its market capitalization is now down to about $1 billion, and Wunderlich downgraded the firm from Buy to Hold earlier this month, though that may have been a reaction to its troubles rather than anything actually predictive.

In reaction to this, Pine River Capital Management -- which has generally been a major investor in debt securities and in a variety of REITs -- has increased its stake in American Capital Mortgage, per a recent 13G filing. Brian Taylor's firm now holds 5.4 million shares, or 9.2% of shares outstanding -- up from the 1.1 million shares as of the end of March, according to our database of SEC filings. This makes Pine River by far the largest shareholder in the company out of the hedge funds and other notable investors we track.

So let's look into this a bit further. REITs often offer high dividend yields, as they receive favorable tax treatment for distributing a large share of income to shareholders -- and because of the risk in mREITs' underlying assets in particular, these stocks tended to carry especially high yields, creating an attractive risk-return profile. So, over the last couple years, REITs in general had been quite popular amid low yields in U.S. Treasuries and in more conventional dividend stocks. However, rising Treasury rates have cooled some of the interest in this class of stocks.

As for American Capital Mortgage in particular, which went public in 2011, the firm trimmed its quarterly dividend earlier this year from $0.90 to $0.80. The current stock price is around $17, so the quarterly dividend yield is 4.7% -- but, of course, there are a number of caveats for potential income investors.

First, obviously, any buyers from the beginning of this year have seen a negative total return on their investment, and certainly these dividend payments are quite risky. For what it's worth, American Capital Mortgage currently trades at a discount to the book value of its equity -- though investors might not want to put too much weight on the book value of mortgage-backed securities. We generally recommend that income investors focus their portfolio on more dependable larger-cap stocks, with only a small number of more speculative positions in higher-risk (but higher-yield) stocks that might include REITs and mREITs.

Also of note: 13G forms are only filed when a fund owns more than 5% of a company's outstanding shares. So it's possible Taylor and his team are bullish on REITs in general and have been buying stock in other companies as well, but that those peers are large enough that the 5% threshold hasn't been crossed.

It's quite conceivable, therefore, that this filing is less relevant to American Capital Mortgage in particular, and that it might also signify a bullish take on related companies. This name, as well as peers like Annaly and American Capital Agency (AGNC), are offering annual yields between 14% and 20%. So, if they can manage to pay dividends at close to current levels for the next few years without destroying shareholders' principal, they certainly have potential upside.

-- Written by Matt Doiron

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