My guess is that most people probably think mortgage-backed securities are boring. Some money is loaned, homeowners pay their bills, and some interest gets paid. The hum of the finely tuned mortgage system engine is enough to lull you to sleep. But remember that millions of people put trillions of dollars through the system. Do I have your attention now?
MFA Mortgage Investments (NYSE:MFA), which participates in the mortgage-backed securities market, reported its third-quarter earnings yesterday. It earned $0.22 per share and said it would pay a dividend of $0.23 per share. These were a few cents below what analysts were forecasting, and yet shares rose slightly today to $8.65. Don't you remember the days when missing earnings by a penny could slaughter a technology stock?
But alas, real estate investment trusts (REITs) are boring. Well, at least MFA Mortgage deals with sexy mortgage-backed securities such as adjustable-rate and hybrid/balloon mortgages (ARMs), some of the most popular mortgage products on the market today.
Wake up, Fools. A good mortgage-backed securities REIT can do wonders for your portfolio. The returns generated by Annaly Mortgage (NYSE:NLY) and iStar Financial (NYSE:SFI) in Mathew Emmert's Income Investor newsletter portfolio have been generous indeed. Redwood Trust (NYSE:RWT) is another REIT with excellent management and a good dividend that generates above-average returns.
So let's see how these REITs compare.
| Mortgage Type | Spread | D/E | Yield | |
|---|---|---|---|---|
| MFA Mortgage | ARMs | 1.24% | 8/1 | 10.8% |
| Annaly Mortgage | Fixed and ARMs | 1.56% | 9.4/1 | 11.1% |
| iStar Financial | Commercial | 4.5%* | 1.7/1 | 6.7% |
| Redwood Trust | Jumbo | 0.9% | 28/1 | 4.4% |
While MFA Mortgage has a large yield and a moderate debt/equity ratio, its interest rate spread (the difference between the net return generated and the cost of funds used) has dropped from 1.77% in the first quarter to 1.24%. This is mainly due to the current environment because of the cost of funds increasing (think Greenspan raising rates) at a faster pace than interest rates on ARMs (think returns to MFA Mortgage). In addition, analysts are predicting a slight drop in the dividend payout over the next few years. Together, these two factors are likely keeping the stock price low and the dividend yield high.
But here are some parting thoughts. The market for ARMs is likely to remain strong given the product's ability to help younger people get affordable mortgage payments. Also, like Annaly Mortgage, MFA Mortgage has invested 99% of its portfolio in securities sponsored by Fannie Mae (NYSE:FNM), Freddie Mac (NYSE:FRE), and Ginnie Mae, all of which carry a AAA credit rating. So the implied credit risk to the portfolio is virtually zero. So creating value is all about accessing capital at low prices and making the right investment choices. Perhaps MFA Mortgage is a way to arm your portfolio with some extra punch that could lead to 20% yields in the future.
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Fool contributor David Meier has a hybrid mortgage but does not own shares in any company mentioned.
