Don’t Chase the Obvious REITs

Amid the recent resurgence in the bond market, the mortgage REIT sector came under pressure as fears of further dividend cuts weighed on some of the biggest names, including Annaly Capital Management (NYSE:NLY) and American Capital Agency (NASDAQ:AGNC), the 800-pound gorillas in the space. This has been the most notable development within the high-yield universe during the past week.

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The one-year chart of Annaly tells the story of what is happening to those mREITS that invest only in Fannie Mae- and Freddie Mac-conforming mortgages, and it’s not pretty. The squeeze on the spread is on — and without the use of derivatives and non-conforming loans, the market fears that future lower payouts are in the offing.

As opposed to giants like AGNC and NLY, hybrid mortgage REITs — which incorporate a number of creative strategies — are where the money seems to be headed.

One such REIT is KCAP Financial (NASDAQ:KCAP), which has shown extremely good strength relative to what I would call the more “vanilla” structure for the sector.

When KCAP announced it had raised its dividend by 33% this June, my interest was piqued. According to the CEO, the increase was due in part to the acquisition of a company that manages CMOs, term loans and corporate bonds. That’s my kind of outfit.

The company previously operated as one of many business development companies operating middle-market business origination, as well as financing and managing a portfolio of term loans and providing mezzanine bridge financing. But the company has since expanded its business to include venture capital and asset management of alternative assets.

KCAP has taken on a diversified approach to delivering strong earnings and dividend performance, and adopted a dividend reinvestment program that provides for reinvestment of dividends for stockholders. At their current annual payout of 96 cents, KCAP shares are sporting a yield of 10.9%.

Recommendation: Buy KCAP Financial.

Bryan Perry is editor of Cash Machine, a newsletter focused on dividends and income investing. As of this writing, he did not own a position in any of the aforementioned securities.

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