As I wrote recently, mortgage REITs as a sector are trading at some of the steepest discounts to book value in their histories. I consider mortgage REITs trading at 80 cents to 90 cents on the dollar to be a fantastic bargain.
With bond yields — and mortgage rates — scraping along near all-time lows and the Federal Reserve expected to at least modestly raise rates this year, the fear is that the interest rate spreads that allow mortgage REITs to pay out such large dividends are about to get crimped.
And that could force the mortgage REITs to slash their dividends.
When mortgage REITs’ higher-yielding mortgages get pre-paid by homeowners, the mortgage REITs are left with slim picking to reinvest in today’s market.
It’s a problem with an easy solution. Rather than buy low-yielding mortgages — or slide down the credit quality scale to chase yield — mortgage REITs trading at discounts to book value should repurchase their own shares. In fact, I’d argue it’s the only sensible solution at current prices.
Mortgage REITs haven’t been very active on the share repurchase front. Annaly Capital Management, Inc. (NYSE:NLY) approved a share repurchase program in 2012, but it didn’t amount to a lot. Looking at Annaly’s history (see chart above), the REIT has been a lot more aggressive in issuing new shares.
That made sense when interest rate spreads were wide and the high yields were there for the taking. But it certainly makes no sense at today’s prices.
And to Annaly’s credit, they’ve moderated the new share issues of late.
Frankly, if Annaly — and the rest of the mortgage REITs trading at deep discounts to book value — care about the best interests of their shareholders, they will step up the share repurchases as their portfolios of mortgage securities roll off.
If you don’t buy your own stock at 80 cents on the dollar, then when would you?
Charles Lewis Sizemore, CFA, is the chief investment officer of investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays. As of this writing, he holds no position in any of the aforementioned securities.