Non-agency
Since PennyMac Mortgage Investment Trust (NYSE:PMT) is a non-Agency mREIT, the most dominant risks for its investors include a decline in the U.S. residential home prices and the company’s portfolio credit risk. These are apart from the aforementioned risks faced by Agency mREITs.
Decline in home prices – Underlying home prices are the key determinant of the value of the loans and mortgage securities companies like PennyMac Mortgage Investment Trust (NYSE:PMT) hold. If the housing market sees another period of significant home price declines, PennyMac could be in trouble as the value of its loans and securities will decline. This could put severe pressure on the company’s earnings and dividends.
Credit risk – Since PennyMac owns a large chunk of non-Agency MBS, its portfolio is exposed to default risk. The company is exposed to risk that the home borrower would default, resulting in a foreclosure and loss to the lender. A bulk of securities that PennyMac holds are non-performing. This further exaggerates the situation for PennyMac. PennyMac can register significant losses if credit turns sour.
What lies ahead?
The future of American Capital Agency does not look very bright, as I believe that the recent portfolio re-balancing exercise would lead the company towards a lower earnings potential and ultimately a lower dividend. I believe that American Capital Agency Corp. (NASDAQ:AGNC) is in need of new equity, which should be used to purchase the new production MBS with higher yields.
In contrast, Annaly Capital Management, Inc. (NYSE:NLY) is poised to post the lowest decline in its book value and a surge in its earnings. Lowest levels of leverage and the presence of commercial real estate (CRE) loans will provide some cushion to the book value, while its recent investment in CreXus Investments will lead the Annaly to better earnings.
PennyMac’s investors have an opportunity to purchase its non-performing loans portfolio below economic value, and current valuation implies zero value to the mortgage origination business. Further, analysts at Citigroup Inc (NYSE:C) believe that there is a possible upside to the company’s dividends.
Conclusion
Mortgage REITs pay dividends in excess of 20% in some cases. However, they are granted a lot of regulatory exemptions, which, if discontinued, could threaten their shareholder distributions. Besides, their business models significantly expose them to macroeconomic factors. So, proper due diligence is required to determine the future of these stocks before you can invest in them. Personally, I am bullish on Annaly Capital Management, Inc. (NYSE:NLY) and PennyMac because of their brighter future.
The article Know the Risks Before You Invest originally appeared on Fool.com and is written by Adnan Khan.
Adnan Khan has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Adnan is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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