Any major disruptions in the repurchase markets could lead to a funding risk for Javelin Mortgage Investment Corp (NYSE:JMI)and could significantly increase its funding costs. Given the company’s high leverage ratio of 7.9 times and a funding cost of 1.03%, the impact could be magnified. One way to get around with this risk is to increase its repo counterparties from the current 28. Further, the company can diversify its funding base just like Invesco Mortgage Capital Inc (NYSE:IVR) did. Invesco Mortgage increased its exposure to term financing in order to reduce its reliance on the repo markets.
Competition
The prevailing environment is challenging for mREITs, particularly the ones which are exclusively invested in Agency RMBS like ARMOUR. ARMOUR’s portfolio is constructed in such a way that its projected net interest income could fall by 4% if the rates climb 50 bps. Besides, the company’s current cash dividend coverage ratio is 1.15 times. A hike in rates is the most common consequence of the Fed’s exit. Therefore, a decline in the interest income coupled with the dividend coverage which can take only a moderate hit, lead me to think that ARMOUR is up for a dividend cut.
Invesco Mortgage Capital (NYSE:IVR) is a similar mortgage REIT. However, it invests in both Agency and non-Agency RMBS causing is to be classified as a hybrid mREIT. Besides, the company differs from ARMOUR because its portfolio is constructed in a way that it will benefit from rising interest rates. Its projected net interest income could go up by a significant 19% if the rates climb 50 bps. Besides, it has a healthy cash dividend coverage ratio of 1.53 times, meaning it has sufficient financial muscle to sustain its current dividend rate. Further, its move to diversify the funding base could help the company in case the repo markets are disrupted.
Investment strategy
I recommend investors stay away from JAVELIN. The company’s book value appears to be under pressure and this pressure could build up if the Fed starts tapering its bond purchases. Therefore, a QE tapering could result in a downside in Javelin Mortgage Investment Corp (NYSE:JMI)’s book value. Additionally, the company is faced with elevated prepayments and a funding risk. The recent hike in the 10-year Treasury yield signals the market sentiments about the Fed’s potential actions. Further, any confirmation on the Fed’s exit could increase volatility. That said, I would recommend investors stay away from the pure-play mREITs including ARMOUR Residential and consider Invesco Mortgage Capital as a potential investment.
Adnan Khan has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.
The article This 18% Yield Comes With Headwinds originally appeared on Fool.com.
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