Dennis Mitchell, CFAAmerican Capital AgencyAGNCWATCHAug 20, 2012

A mortgage REIT. They have a big, big secular headwind because of rising interest rates. Also, the charts are not favourable and there is a lot of upside resistance if they try to turn. He does not like bottom fishing. Dividend yield of 13.3%.

The best performing REITs in Canada this year had US properties. He prefers not to go to US REITs because of currency risk. His best idea this year is MRC-T at a 65% discount.

It has a 12.3% dividend. Sustainability is suspect. You are out of cycle. You are waiting a long time for a dividend that is looking a little tight. You are looking at a big wall of sellers. There are better places to put your money. The interest rate cycle is not working for you here.

Weak right now. Big interest rate risk here.

This company basically borrows Short and lends out mortgages. They leverage that up and pay out their returns. He used to own this, but one of the issues he had was if interest rates started to rise, it would really hurt this stock. Highly levered which is another issue you have to look at. Gives you a very good rate of return when things are going well. Dividend rate of 12%.

Represents good value. We are in a lower interest rate environment than we were 5 years ago. Buy these at $0.75 to $0.85 on the dollar which is where they are now. Over time you should do okay.

There is a lot of volatility in the sector. He doesn’t own any of the mortgage REITs, although he does think they are starting to represent pretty decent values here. Simple explanation. They borrow on the short end of the curve, lever it up 6 or 7 times and invest it in the long end of the curve in the form of mortgages. You have seen interest rates go down which have increased their reinvestment risk, so the returns they were getting 3 or 4 years ago, they were no longer getting, which resulted in dividend cuts. Results have stabilized somewhat. The rule of thumb is that you want to buy these when they are trading at about $.75-$.85 on the dollar in terms of book value. If you own, it is a pretty decent place to get high yield, just recognize that there is going to be a lot of volatility embedded within these.

Has been somewhat cautious on this in the last 3 years. They borrow shorter-term debt and lend money on the long end of the curve. They make money on the spread in between, except that they lever up their borrowing versus their lending at a ratio of about 6 to 1. This means they are very sensitive to changes in the yield curve. It is his expectation that over time, the yield curve will flatten. Doesn’t think you will see an erosion in NAV at this time. Usually want to buy these when they are trading at about $.85 on the dollar, which is where they are right now. Very risky.

Does not see it getting back to last year’s prices. Very high yield. There is a little bit of a rally and he would be selling into this rally as when interest rates rise, this one will fall quickly.

Mortgage REITs have got hit very hard. With these, you are buying longer duration mortgages and borrowing short term to fund them. You are collecting the yield difference between the longer-term bonds and the way you are funding them. When that spread compresses, you start to see earnings press as well. Also, BVs come down because the value of the bonds you have purchased have come down as well. Mortgage REITs are probably trading at a 10%-15% discount to their actual BV. Dividends look sustainable but there will be a fair bit of volatility.

The difficulty with these types of companies is that you are buying debt with debt, so there is leverage on leverage. This was fine when there was good visibility that rates were going to be low for a very long time, but we don’t know what rates are going to be. He would urge anyone that has enjoyed these yields to Sell these stocks. You are playing Russian roulette.

Recently announced some dividends and buy backs. What you need to understand about these companies is that they are not dividend payments but a significant portion of their capital that is classified as agency REITs. The Fed is really intervening in this market, because a portion of that is going into the MBS (Mortgage Backed Security) market. You have about a 17% yield at current levels. From a capital appreciation standpoint, the stock probably goes nowhere, but as long as you have that back stop of the Fed in there, you’ll probably earn that 17% for the next 6 to 8 months, but as soon as we start to see tapering, etc these stocks are going to trade off exactly like they did the last time.

Mortgage backed security that basically borrows at the Fed rate and then lends out. Has been wonderful over the last 3-4 years. Not only has the housing market recovered but the curve has been very steep. There is now a threat of higher interest rates which causes stress on their leveraged balance sheet. The housing is improving everyday and that helps because you are getting a really healthy 12%-14% yield. Decent entry point.

The question is, where is BV going to trough and can you buy it at a discount to BV. Right now the BV is around $25.50 so if you can buy it at a discount to that price, you should do pretty well. As the 10 year bond continues to back up, the BV is going to continue to come under pressure and it is a question as to whether they can maintain the dividend. He would wait to see who the next fed governor in the US is going to be.