NYSE: CMO - Capstead Mortgage Company. 16% dividend yield. Holder of government-backed mortgage securities.

The difference between you and me holding highly leveraged US Gov backed securities and a NYSE-listed company holdig the same securities is that me and you can continue to hold those securities without additional operational expenses. A company like CMO cannot. So when the markets turn south even temporarily me and you simply move on to something else while keeping the securities on the books and wait. A company like CMO has to continue to spend the money to maintain its operations. If it cannot obtain access to capital it will be forced to sell its assets at a steep discount.

largeeyes said: When did the stock rule change?
here

HTS (Hatteras Financial ) has been profiled +vely twice in Barrons. The first time was when it was at $14-$16. A few weeks ago, when it was at $33, the same author suggested that one should wait till it pulls back to $28 and add more. Right now at $27 but gives 16% yield. And it holds govt. backed securities only.
Can someone please comment/compare?

http://www.google.com/finance?q=hts

gandhis said: HTS (Hatteras Financial ) has been profiled +vely twice in Barrons. The first time was when it was at $14-$16. A few weeks ago, when it was at $33, the same author suggested that one should wait till it pulls back to $28 and add more. Right now at $27 but gives 16% yield. And it holds govt. backed securities only.
Can someone please comment/compare?

http://www.google.com/finance?q=hts

I would go with CMO rather than HTS. CMO= lower leverage, and its been around a long time vs. HTS being new.

kharvel said: EvilCapitalist said: The difference between you and me holding highly leveraged US Gov backed securities and a NYSE-listed company holdig the same securities is that me and you can continue to hold those securities without additional operational expenses. A company like CMO cannot. So when the markets turn south even temporarily me and you simply move on to something else while keeping the securities on the books and wait. A company like CMO has to continue to spend the money to maintain its operations. If it cannot obtain access to capital it will be forced to sell its assets at a steep discount.

Thanks for the info. Can you expand on this? If markets turn south, how can CMO suffer from it? It is holding government-backed securities, so even if the housing market declines substantially, the securities themselves will not decline in value due to the full backing of the U.S. government. Therefore, CMO should be able to continue to hold its securities without having to do anything.

How would a declining market increase its operational expenses?

You should be aware that you're not investing in those government backed securities. You're investing in the company that has those securities. The difference is that the company can still lose money. And you can still lose money by investing in it. You need to do more research to find out HOW and WHY they are giving 16% dividend yields. More than likely, they are borrowing money using their government backed securities as the collateral, and then doing other things with that money. When you buy this stock, you're buying into THOSE investments rather than the government backed securities themselves.

Also keep in mind that dividend yields are not set in stone. They can turn right around and make the dividend as low as 1% the next quarter.

Someone correct me if I'm wrong. I'm not an expert on this stuff.

mrlandlord said: The risk is not in defaults of Fannie/Freddie agency securities but in a flattening of the yield curve, or their repo lines being pulled suddenly. Neither seems likely in the near term, and I have owned CMO for about 2 years ever since it was under 10 and i am enjoying a huge yield.

Let's discuss this further. You said that it is unlikely the repo lines will be pulled suddenly. And even if the yield curve flattens, the dividend yield would still be considerably higher than the Treasuries.

Do you believe that the stock is underpriced and if so, why? Why do you think the market is pricing the stock at such low value at least within the context of dividend yields? Such low pricing would imply that the dividend yield is unsustainable and would fall without any increase in the stock price. Do you agree with this sentiment?

Shaz said: You need to do more research to find out HOW and WHY they are giving 16% dividend yields. More than likely, they are borrowing money using their government backed securities as the collateral, and then doing other things with that money. When you buy this stock, you're buying into THOSE investments rather than the government backed securities themselves.

[...]

Someone correct me if I'm wrong. I'm not an expert on this stuff.
Well, *someone* needs to do more research

They hold only Ginnies, Freddies, and Fannies. Now that the implied federal backing of Freddie and Fannie has become an implicit guarantee, the danger of the securities defaulting is gone (well, transferred to us taxpayers). That leaves the possibility of credit line withdrawal. I doubt that's likely, as the securities are now effectively as good as Treasuries, so there's virtually no collateral risk.

mREITs are in their sweet spot right now, with spreads well in excess of 2%. Lever that up 5, 6, maybe 7 times, and you're rolling in it.

Eventually spreads will tighten, once the Fed takes away the 0% punchbowl. In the meantime, these guys (CMO, NLY, HTS, ANH, AGNC, etc) have their own printing press.

NoBoB said: Shaz said: You need to do more research to find out HOW and WHY they are giving 16% dividend yields. More than likely, they are borrowing money using their government backed securities as the collateral, and then doing other things with that money. When you buy this stock, you're buying into THOSE investments rather than the government backed securities themselves.

[...]

Someone correct me if I'm wrong. I'm not an expert on this stuff.
Well, *someone* needs to do more research

They hold only Ginnies, Freddies, and Fannies. Now that the implied federal backing of Freddie and Fannie has become an implicit guarantee, the danger of the securities defaulting is gone (well, transferred to us taxpayers). That leaves the possibility of credit line withdrawal. I doubt that's likely, as the securities are now effectively as good as Treasuries, so there's virtually no collateral risk.

mREITs are in their sweet spot right now, with spreads well in excess of 2%. Lever that up 5, 6, maybe 7 times, and you're rolling in it.

Eventually spreads will tighten, once the Fed takes away the 0% punchbowl. In the meantime, these guys (CMO, NLY, HTS, ANH, AGNC, etc) have their own printing press.

Maybe I'm misunderstanding how REITs are structured. I'm sort of assuming that they still operate as a company, and that when you buy their stock you are not directly buying into their assets. I suppose I could be wrong about this. Is that the case?

Because if I'm not, and this company has in fact used their ginnie, freddie, and fannie securities as collateral, then you, as an investor, own no part of those securities if the company gets into trouble. The bank that gave them loans based on those securities does. Investors in the stock will undoubtedly be the ones that get screwed. You have the LEAST amount of guarantee in this situation.

I only bring this up because it seems to me that OP is under the impression that he is buying a guaranteed return on investment with no risk. This appears to be false. They might be making a lot of money right now, but you're looking a possible loss on your investment if, say, the dividend falls next year around this time and everyone sells the stock, which will lower the price of the stock, and suddenly your 16% gain is offset by a 30% nosedive in stock price. Just looking at the charts, it looks like CMO has had a 90% dive since the late 90's.

Shaz said: Maybe I'm misunderstanding how REITs are structured. I'm sort of assuming that they still operate as a company, and that when you buy their stock you are not directly buying into their assets. I suppose I could be wrong about this. Is that the case?
Yes, that's right. Just as with any other company, your trust units (often referred to as shares) are equity. Lenders to the company have a higher-ranking claim on assets. Lenders will have covenants allowing them to demand immediate repayment if the company doesn't maintain certain criteria (debt to equity ratios, income coverage of interest payments, etc.). Secured lenders can seize collateral in that situation.

Really, the same is true even of a leveraged mutual fund (common with some categories of closed end funds). As a shareholder, your only claim is to what's left once the creditors are repaid.

kharvel said: So you believe that the only risk to this company is the interest rate risk that would reduce the value of their holdings.
Whoa! Just because I said that there was interest rate risk doesn't mean I don't think there are other risks.

I think someone already mentioned the possibility the their repo financing could dry up if we have another credit shutdown. Even if repo financing remains easily available, it's almost certain that the cost will go up as the Fed returns to normal monetary policies, which will squeeze CMO's spread (the difference between what they pay and what they earn when they invest the money). If they bought MBS paying above-market rates, and there's a rash of refinancings, it hurts them. All sorts of things can go wrong.

Even if CMO has to de-leverage its RMBS portfolio and reduce its dividends accordingly, even a 50% reduction in the yield would still provide far higher returns than the Treasuries
First, most people care more about total return. If your dividend gets slashed in half, and your share price gets slashed in half, you may still have a 16% yield, but will you be happy about it?

Second, did you do as I suggested at look at NLY's history? A MREIT may have to slash by much more than 50%. I'm sure people buying NLY in '04 were saying, "Look, it pays $0.50 per quarter! Even if they slash the dividend in half, it's still a great deal." In '05 and '06 when it was paying more like $0.12 per quarter, I doubt many were saying, "Well, they only slashed the dividend by three quarters, and with the share price down 40%, it's still a 4% yield, so go NLY!"

In general, the REIT business model is borrow short term (variable rate) and buy long (fixed). So if short term interest rates spike up, when it comes time to refinance they can't AND the asset values go down. Also, if the paper defaults they lose money. Government is only backing principal.

kharvel said: NoBoB said: mREITs are in their sweet spot right now, with spreads well in excess of 2%. Lever that up 5, 6, maybe 7 times, and you're rolling in it.

Eventually spreads will tighten, once the Fed takes away the 0% punchbowl. In the meantime, these guys (CMO, NLY, HTS, ANH, AGNC, etc) have their own printing press.

Any comment on why these companies are so underpriced at this moment, relative to their yields?

Because in a flat or inverted yield curve environment, and there will be one one day, divs as well as share prices will be slashed mercilessly, and it all kind of evens out, maybe you get an %8 overall result over a cycle.

I have been hoping that CMO would run to 17 on yield hog buying and let me cash out.

If you are looking for reasonably high yield with little to no risk of a dividend cut look at some of the preferreds such as HRP-D, SSRAP, WFC-L, DDT, JBR, or oil trusts such as PWE.

tripleB said: 16% dividend = return of capital with taxable consequences. SWEET!

CMO = no return of capital. O tax if held in IRA.

NoBoB said: Eventually spreads will tighten, once the Fed takes away the 0% punchbowl. In the meantime, these guys (CMO, NLY, HTS, ANH, AGNC, etc) have their own printing press.It seems that way. Any other risks?

Also from the 6x leverage, you can derive the lenders of the short term financing is expecting the collateral bonds won't decline by more than 1/7 in value during the time window when they pull the line. It seems pretty safe loan.

lray said: I think most are aware that holding an REIT in a taxable account is tax suicide.
Usually, although not always. Certainly for a mortgage REIT that'll be the case. There are some property REITs that, thanks to depreciation and the like, lose money for tax purposes every year. Yet, these same firms often have healthy FFO and distributions. For these companies, all of the money is either return of capital or qualified dividends (if it's money generated in a taxable REIT subsidiary). Tax recordkeeping of ROC can be a pain, but it's not tax suicide.

Of course, you'd want to make sure that REIT you're buying falls into this category.

CMO is discussed at SmartMoney: http://www.smartmoney.com/Investing/Stocks/Trusts-Offer-16-Yields-With-a-Catch/?afl=yahoo

Shaz said: Maybe I'm misunderstanding how REITs are structured. I'm sort of assuming that they still operate as a company, and that when you buy their stock you are not directly buying into their assets. I suppose I could be wrong about this. Is that the case?

Because if I'm not, and this company has in fact used their ginnie, freddie, and fannie securities as collateral, then you, as an investor, own no part of those securities if the company gets into trouble. The bank that gave them loans based on those securities does. Investors in the stock will undoubtedly be the ones that get screwed. You have the LEAST amount of guarantee in this situation.Correct. This is true of every company that has borrowed money on their balance sheet. Holders of the common stock are on the bottom of the totem pole. In this case, though, there is more assets than liabilities. There's almost $8B in assets, but just under $7B in liabilities. If they wished to liquidate, there would be (as of their last quarter) $11.48 per share in equity remaining. It's not like they owe more than they're worth or anything like that.

I only bring this up because it seems to me that OP is under the impression that he is buying a guaranteed return on investment with no risk. This appears to be false. They might be making a lot of money right now, but you're looking a possible loss on your investment if, say, the dividend falls next year around this time and everyone sells the stock, which will lower the price of the stock, and suddenly your 16% gain is offset by a 30% nosedive in stock price. Just looking at the charts, it looks like CMO has had a 90% dive since the late 90's.This is also true. They're not a buy-and-hold vehicle. You have to be ahead of the curve when it comes to interest rates. As long as they can borrow at below 2% and invest at almost 4.5% levered up 6.6 times, they're golden. Once that spread tightens, their income will fall and the shares will likely follow. They've already had a pretty decent run price-wise.

kharvel said: Any comment on why these companies are so underpriced at this moment, relative to their yields?
I think most are aware that the Fed-induced low short term interest rate party cannot continue unabated.

nycll said: It seems that way. Any other risks?

Also from the 6x leverage, you can derive the lenders of the short term financing is expecting the collateral bonds won't decline by more than 1/7 in value during the time window when they pull the line. It seems pretty safe loan.Agreed. As far as risks, these companies have been around for a while, but you're going to have to trust management to properly run the company. It's easy to do considerable damage to shareholders equity when you're leveraged like this. In 1998, CMO's management goofed badly enough to drive the stock price from $20 at the beginning of '98 to below $3 near the end. Of course, now you'd have to be a complete buffoon to not know which way interest rates are going next (eventually). And, of course, like every other equity, you're at the mercy of Mr. Market, who hasn't been the most rational dude of late.

Disclosure: No position in CMO, but I'm long AGNC since options expiration in March.