Two Harbors Investment Corp (TWO): Double Digit Profits From Quantitative Easing

Why invest your money here?

Annaly Capital Management, Inc. (NYSE:NLY) and Arlington Asset Investment Corp (NYSE:AI) only invest in agency-backed mortgages whose principle and interest are guaranteed by the federal government. This means that the government carries virtually all of the risk. These businesses borrow money at current short-term interest rates, currently under 1%, and use it to buy these government-insured mortgages at rates between 3.5% and 4.5%. While a difference of 3% to 4% between borrowing costs and interest earned doesn’t sound like much, these entities can borrow five to six times the level of their actual capital, which multiplies their return by that amount. In other words, rather than making 2.5% to 3.5% on available funds, the leverage they employ through borrowing allows them to multiply those returns five to six-fold! Because these businesses require virtually no infrastructure or physical facilities and very few employees to operate, almost all of this leveraged spread is income. Best of all, these businesses are structured as real estate investment trusts, so they’re required to pay out almost all of their earnings in dividends to shareholders in exchange for not paying corporate income taxes.

Two Harbors Investment Corp (NYSE:TWO) and New York Mortgage Trust, Inc. (NASDAQ:NYMT) are structured the same way, but have some of their capital invested in non-agency mortgages. These are mortgages that collect a higher rate of interest, but are not fully guaranteed by the government. This puts a bit more risk into these businesses. As long as the spread between short-term and long-term interest rates remains above 2.5%, these investments should continue to do very well and pay attractive dividends.

Conclusions and actions

When large numbers of yield-starved investors begin to discover the reality of this opportunity, the prices of these shares will soar as demand outstrips supply. For investors looking for high-yield income-producing stocks with almost no risk, Annaly and Arlington fit the bill perfectly. Arlington further benefits from a price to book of 0.74 against assets guaranteed by the government. The exposure to some mortgage obligations that aren’t fully government-backed gives Two Harbors Investment Corp (NYSE:TWO) and New York Mortgage Trust, Inc. (NASDAQ:NYMT) a bit more risk.

Annaly Capital Management, Inc. (NYSE:NLY) and Arlington Asset Investment Corp (NYSE:AI) will both remain attractive investments until the spread between long and short-term rates begins to shrink. Investors will need to watch for a decrease in the interest rate spread, but that should be some time in coming and those who watch for it will have ample time to react.  Buy now and collect large profits from quantitative easing, whether you agree with the policy or not.

The article Double Digit Profits From Quantitative Easing originally appeared on Fool.com and is written by Ken McGaha.

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