Investors who gravitate toward the mortgage REIT sector naturally love the great dividends, aided by the tax law that requires 90% of these companies' profits to be dispersed to shareholders. But that same favorable tax status also limits the trusts, which must rely on leverage to make their money. This situation makes for a special type of business, and a particular kind of risk -- which is why the management of a mREIT is so very important to its success.
As fellow Fool Rich Duprey has pointed out, discipline and a long-term view are essential for a mREIT manager, as well as the ability to judge correctly and react appropriately to both the current and future economic environment.
Who are these managers who are able to successfully steer their REITs through all manner of circumstances? I think it's safe to say that the late Mike Farrell, of Annaly Capital (NYSE:NLY) was one of those leaders. I would also opine that Gary Kain, president and CEO of agency mREIT American Capital Agency (NASDAQ:AGNC) and its hybrid cousin American Capital Mortgage (NASDAQ:MTGE), should also be up for nomination.
A background in the mortgage business
It's possible that Kain understands the mortgage investment business better than most. Before his time at American Capital Agency, he worked at Freddie Mac, serving in various capacities from 1988 to 2009. He started work at AGNC in 2009, when the company was only a year old.
Kain has brought a special prescience to each of the mREITs he serves, but it is especially apparent at AGNC. When faced with a probable QE3 program last year, he began preparing early, noting that the Fed would likely scarf up the lower-coupon mortgage-backed securities, and that a mREIT holding those would enjoy a boost to book value. He jacked up leverage to bulk up, unlike Annaly.
That plan has helped AGNC immensely, as the REIT gobbled up loans that would cut its prepayment risk: loans with low balances, and those that had been previously refinanced. American Capital Agency's prepayment rate is a cool 11%, compared to Annaly's 19%.
Financing alternatives keep the spread wider than most
Both AGNC and MTGE have been taking advantage of the to-be-announced dollar roll market for financing, and it's been a winner.
As Kain notes, the Fed's involvement actually makes that type of financing more attractive, since the scarcity of comparable agency MBSes in any given month bids up prices and is apt to prompt a "roll" into the next month, causing a larger price difference, or drop, for the new settlement date. Buyers of MBSes win because they can receive the principal and interest from the securities they hold, in addition to having the flexibility of returning nearly identical MBSes at the settlement date. Rolling their positions has helped increase the spreads for both of the mREITs managed by Kain, which turns QE3 from a hindrance into an advantage.
Is Gary Kain comparable to Mike Farrell? While Farrell had a different outlook and management style than Kain, both have been able to create a profitable, stable enterprise out of the business of borrowing short and lending long. When it comes to mREIT guidance, I think Kain is Farrell's equal any day.