This article is part of our Rising Star Portfolios series. You can read about the Dada Portfolio here.
It's a good idea to check up on your stocks from time to time. At the real-money Dada portfolio I co-manage for The Motley Fool, we've taken several positions in the financial sector over the past half-year.
Here's how we're doing:
|
Company |
Purchase Date |
Return |
+/- S&P |
|---|---|---|---|
|
Annaly Capital |
Nov. 16, 2010 | 12% | +8 percentage points |
|
Bank of America |
Dec. 22, 2010 to Aug. 15, 2011 | 45% | +42 percentage points |
|
Lender Processing Services |
Dec. 22, 2010 | 40% | +37 percentage points |
|
Chimera |
May 23, 2011 | (18%) | -8 percentage points |
| Annaly Capital | May 23, 2011 | 2% | +10 percentage points |
Source: Google Finance and Yahoo! Finance.
It's been an ugly ride for much of the industry over the past several months, but we were spared the worst of it because of our bullish bets on residential mortgage REITs, which tend to benefit from the current weak state of the economy, and bearish bets on companies tied to the worst of the ongoing mortgage and foreclosure fiasco.
About those REITs
Low short-term interest rates have been a boon for mortgage REITs, which make money on the spread between short- and long-term rates:
Source: Capital IQ, a division of Standard & Poor's, and the Federal Reserve Bank of New York.
Across the industry, we see large spreads between funding costs and portfolio yields:
|
Company |
Cost of Borrowing |
Asset Yield |
Interest Rate Spread |
Leverage |
|---|---|---|---|---|
|
American Capital Agency |
0.9% | 3.4% | 2.5% | 7.4 times |
|
ARMOUR Residential |
1% | 3.4% | 2.4% | 8.8 times |
|
Cypress Sharpridge |
1.1% | 3.4% | 2.3% | 7.5 times |
| Annaly Capital | 1.6% | 4.1% | 2.5% | 5.8 times |
| Chimera | 2.4% | 6.6% | 4.2% | 1.9 times |
Source: Capital IQ, as of latest quarter.
As you can see from the table, Chimera is a bit of a unique case. The company, which is managed by top-of-the-class Annaly, invests in the heavily eschewed non-Fannie/Freddie (read: toxic) mortgage market. This means a higher asset yield, but also a riskier portfolio and higher costs of borrowing that can make the stock more volatile than its peers, particularly if financial markets freeze up again. But the wider degree of freedom also gives the company the opportunity to capitalize on mispricings.
With unemployment continuing to linger, and almost no effort on the part of Congress to stimulate the economy, the Federal Reserve will likely be forced to hold short-term interest rates low for at least another couple of years.
Foreclosure woes
When we initially shorted Bank of America and Lender Processing Services, both stocks were cheap. Bank of America traded for just 0.6 time book value, while LPS had a price-to-earnings ratio of nine times and trailing earnings-per-share growth of 22%. But the market was missing the extent of the problems facing the industry with regards to mortgage documentation and improper foreclosures. Since then, shares of both companies have plummeted as more investors have caught on, AIG joined the Countrywide plaintiff pinata, and foreclosures began to freeze up, in part due to court rulings that, yes, you need valid documentation to take someone's house.
We still think both companies face a difficult time going forward, but we closed out Bank of America short once the stock plunged so far as to be valued as though the company had $60 billion in unprovisioned losses. That's not to say losses won't exceed that level -- they certainly could -- but it's not a bet we felt like making.
To stay up to speed on the Dada Portfolio, follow us on Twitter @TMFDada. You can also track any of these companies by adding them to your stock watchlist.
