New York Mortgage Trust (NYMT 0.33%) has done shareholders a great service by shifting a larger percentage of its capital into commercial mortgage-backed securities and distressed residential loans in 2012 and 2013. This ultimately allowed the company to emerge from the 2013 mortgage REIT meltdown pretty much unharmed.
While other mortgage REITs in the business were hurt by rising interest rates and weighed down by ongoing book value declines, New York Mortgage Trust actually did a great job in creating value for shareholders in the midst of adversity.
Mortgage REITs are either loved or hated with little ground for compromise in the middle.
Mortgage REITs are loved by investors who like their double-digit annual dividend yields and they are often held as cornerstone investments in income-tilted portfolios. A lack of high-yielding investment alternatives only added to the appeal of mortgage REITs as income vehicles.
On the other side of the equation are the bears, who question the sustainability of high dividend yields and assume, that mortgage REITs will consolidate forcefully as interest rates continue to increase going forward. Since the Federal Reserve promotes interest rates near zero, rates have nowhere else to go but up.
So, who is right?
Both segments of the markets, bulls and bears, have valid concerns about the validity of mortgage REITs as income investments and the truth about whether they are sustainable dividend machines or not largely depends on the REIT's portfolio positioning.
Differences in capital allocation strategies
Annaly Capital Management (NLY 1.31%), for instance, is an industry leader and predominantly invests in agency mortgage-backed securities and related derivatives for hedging purposes.
Agency securities benefit from an implicit or explicit government guarantee which ensures, that both principal and interest payments on the underlying mortgages will be (re)paid.
Government-sponsored enterprises Fannie Mae, Freddie Mac and Ginnie Mae play a hugely important role in the mortgage securitization market and are the entities through which investors are provided with guarantees that they will receive their cash.
As a result of such guarantees, agency mortgage-backed securities are primarily exposed to interest rate risk, not credit risk.
New York Mortgage Trust, on the other hand, is a hybrid mortgage REIT which invests in mortgage-related and financial assets including multi-family commercial mortgage-backed securities, distressed residential mortgage loans, agency residential mortgage-backed securities and agency IOs.
In anticipation of rising interest rates and the projected poor performance of agency securities, New York Mortgage Trust has made a great effort over the course of 2012 and 2013 to shift its capital into less interest- and more credit-sensitive assets such as multi-family commercial mortgage-backed securities.
Overall, New York Mortgage Trust has significantly increased its capital allocation to commercial MBS and distressed residential loans (an allocation of just 33% in 2011 compares to an allocation of 69% in 2013) and significantly decreased its capital allocation to agency securities, including agency residential mortgage-backed securities and agency IOs.
Book value stability
As is widely known, mortgage REITs faced serious headwinds in 2013 as investors started to really doubt underlying portfolio values and the ability of mortgage REITs to continue to be high-yield income vehicles in an environment of rising interest rates.
However, New York Mortgage Trust clearly stood out in 2013 as the company presented solid sequential increases in its book value whereas most other mortgage REITs posted one quarter of book value erosion after another.
Annaly Capital Management also wasn't an exception. Just over the course of 2013, from Q4 2012 to Q4 2013, its book value per share declined more than 23% from $15.85 to $12.13.
Over the same time period, New York Mortgage Trust posted only a slight decline in its book value per share of 3% to $6.33. Its book value declined solely in the second quarter of 2013 by 5%, but rebounded quickly and grew throughout the remainder of the year and the first quarter of 2014.
New York Mortgage Trust has steered the company through the mortgage REIT sector meltdown in an admirable way: As a consequence of its comparatively stable and growing book value, the mortgage REIT was able to sustain its quarterly dividend payments at $0.27 per share whereas Annaly Capital Management cut its dividend three consecutive times in 2013 from $0.45 to $0.30 per share.
The stability of New York Mortgage Trust's book value and stable dividend stream are also the reason why the mortgage REIT trades at a premium to book value which is quite an exception in the mortgage REIT business.
Premium to book value
Investors assign a premium multiple to New York Mortgage Trust as the company convinced the market with its book value resilience and portfolio transition to multi-family commercial MBS and distressed residential loans.
New York Mortgage Trust correctly foresaw higher interest rates and shifted capital into less interest rate- sensitive assets. As a result, the mortgage REIT emerged pretty much unscathed as the sector, and many peers with it, took a nosedive in 2013.
With better investment strategies and a comprehensive portfolio transition, New York Mortgage Trust has successfully differentiated itself from agency players such as Annaly Capital Management and rightfully deserves a premium to book valuation.
In addition to a more diversified investment portfolio, investors in New York Mortgage Trust also get to enjoy a higher dividend yield of 14% which compares against 11% for Annaly Capital Management.