Annaly Capital Management Inc. (NLY-N)

Dividend dropped 12%? He has not looked at this one for a few years. It is a rolling of US mortgages and real estate instruments and comes with a high yield. He has never found these types of products to make money for investors. You may not want this long term -- perhaps for a short term trade.

It is a mortgage REIT making money by borrowing on the short end of the curve and lending on the long end. The portfolio is much larger than the capital they have to play with, so there is volatility. If rates go up next year it creates refinancing risk for them. He is not comfortable with the leverage in the portfolio.

A mortgage REIT. They leverage the slope of the yield curve, to invest in mortgages. Rising rates are not necessarily a good thing for them. It really all revolves around their ability to leverage the spread in the yield curve. There is also some reinvestment risk. If existing pools of mortgages are maturing at higher rates than what you can invest in, that impairs profitability.

Mortgage REITs. These tend to attract a lot of investors. The yield is very high, between 12% and 15%. They use debt to lend it as mortgages. The stock has been in decline. Why get a high yield vehicle when you are going to lose it all on capital? It is better to focus on high quality real estate.

See comments under American Capital Agency (AGNC-Q). The stock has been bumping along in a range and paying a dividend. There is a new CEO in place. The relative strength is not good. There are quite likely a number of headwinds from different perspectives here.

With this, you are borrowing on the short end of the curve and lending on the long end, so it is very much a spread business. You are using a lot of leverage when you do that. The rule of thumb is that you typically want to buy them when they are trading at a discount to BV. He doesn’t own any of these, because there is a significant risk if interest rates move up too quickly. There is reinvestment risk and prepayment risks. However, for the most part the dividends are safe and you are getting a good entry point.

You want to buy when it is at a discount to book and it is now at $.80 on the dollar. These mortgage REITs have a habit of cutting the distribution if the rates flatten. Not a bad one to own if you want to take a flyer and get a decent yield.

A mortgage-backed securities lender in the US. Highly levered. They lend and then get free funding from the Fed and distribute out 100% of their earnings. Because you are getting 13%-14%, all you want it to do is just stay stable. If you think the Fed is going to raise rates, it generally hurts them. On the opposite side, they have the underlying security of US housing improving every day. 2 out of 3 years you will make 14%-15%, but you could be down 20% in one year. You have to be very careful. This probably would not be the greatest timing to get in.

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 value 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.