Desktop Stock Ticker | Trusts Offer 16% Yields, With a Catch

Trusts Offer 16% Yields, With a Catch

Savings rates are paltry. Money-market funds pay 1% and bank accounts even less. Commit to a five-year certificate of deposit and you might get 3%. stock ticker dividends are laughable, especially considering the extra risk attached to them. More than a quarter of America’s 500 largest companies pay nothing. The rest offer a median yield of 2%.

Against this backdrop, <a href="http://www.desktopstock”>stock ticker tickers yielding 16% are equal parts intriguing and suspicious. Financial planners typically say not to count on yearly stock ticker market returns of more than 8%, counting price gains and reinvested dividends. What kind of stock ticker provides twice as much in dividends alone?

Mortgage REITs do. There’s a catch, naturally. It’s not an automatic deal-breaker, but it’s certainly reason for caution.

REIT (pronounced like “street”) stands for real estate investment trust. Like mutual funds, which buy <a href="http://www.desktopstock”>stock ticker tickers bonds and other assets and pass the bulk of returns and taxes on to shareholders, REITs invest in the real estate market on behalf of shareholders. Most are equity REITs, which buy property: office buildings, ports, hotels, malls, apartments and more. Some REITs buy only mortgages that have been turned into investments. This group includes Capstead Mortgage (CMO), with a dividend yield of 16.3%; MFA Financial (MFA), paying 13.3%; and Annaly Capital Management (NLY), which yields 16.0%.

Mortgage rates aren’t nearly that high, of course. Even after rising over the past week, the benchmark 30-year fixed-rate mortgage costs slightly under 5%, according to Freddie Mac (FRE). How is it that mortgage REITs turn 5% mortgages into 13% to 16% dividend yields?

The answer isn’t what you might think. These trusts don’t generally buy shaky mortgages at deep discounts and hope for the best. Nearly all the securities they buy are made from mortgages backed by government agencies. That means default risk is borne by the taxpaying many, not the shareholding few. The number of homeowners pulled into foreclosure has increased 23% over the past year, but many mortgage trusts have outperformed the broad stock ticker market this year on price gains alone, and have trounced it counting their dividends.

Here’s the recipe for a high-yield mortgage trust: Using securities as collateral, borrow heaps of money cheaply through overnight repurchase agreements, or repos, which currently cost less than 0.5% a year. Buy mortgage securities with the money you raise. You won’t get more than 5% at the moment, because even though mortgages seem risky, government-backed ones sell for a premium over their repayment value, which pushes yields well below the rates house buyers pay. Let’s say you get 4%. Interest rate swings can create havoc for investors in long-term, fixed-rate securities, a risk you must protect against. Hedge the portfolio using interest rate swaps at a cost of about 1.5%. Your 4% yield, minus your 0.5% borrowing costs and 1.5% hedging costs, leaves you with a 2% return. Multiply it several times over by borrowing well more than the value of your portfolio. Many mortgage trusts use seven to eight times leverage at the moment. Thus, the 16% yields.

Easy, right? Not always.

“This year has been an absolute paradise for mortgage REITs,” says Henry Coffey of Sterne Agee, an investment bank based in Birmingham, Ala. Early in the year, they were priced for dismal expectations. For example, Capstead yielded more than 20% at one point in March. Investors feared that a scarcity of credit would prevent mortgage REITs from borrowing cheaply, robbing them of precious leverage. Some worried that a government rewriting of mortgages would punish investors to aid homeowners. In fact, credit has become more plentiful and government interference in existing mortgages has been more limited than feared. Mortgage trusts have reduced leverage anyway, but so large has been the spread between short-term interest rates (which affect repos) and long-term ones (which affect mortgages) that the business has been unusually profitable.

Coffey urged clients to buy shares of Capstead, MFA and Annaly in April, but he has since turned neutral on the group. Perfect conditions can’t last forever, he says. As spreads contract, trusts will have to choose between cutting their dividends or increasing their leverage.

On Oct. 12, when Anworth Mortgage Asset (ANH) announced it was cutting its dividend, its shares fell 6% in the first hour of trading. Capstead shares fared better when the trust cut its dividend on Sept. 10, perhaps because investors had feared a bigger cut. But more cuts might become necessary, and the mere fear of them can sour demand for mortgage REITs. Since mid-September, they’ve sharply underperformed the broad stock ticker market.

As for leverage, levels are slightly conservative at the moment compared with recent years, but it’s unclear how much leverage shareholders will stand for these days. Many are scarred by the memory of longstanding Wall Street firms collapsing last year on high-leverage mortgage bets gone bad.

All told, there’s no reason to believe mortgage REITs are in peril, but there’s enough reason to worry that those 16% dividend yields will turn into something less than 16% in total returns over the next year.

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