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12% Yield Comes With Risk, The Market Messed Up On Capstead Mortgage

Published Mon, 30 Mar 2020 06:27:44 -0400 on Seeking Alpha

We recently purchased Capstead Mortgage.
The investment came with risks, but the discount was too large to pass up.
We will give you a better look into CMO.
We see solid earnings across the next few quarters.
This research report was produced by The REIT Forum with assistance from Big Dog Investments.
That market is back to failing.

We recently purchased Capstead Mortgage Trust (CMO) when the market decided to let them trade at a staggering discount:

Source: The REIT Forum
Prices from when we made the trade
The common shares were rallying hard for most of the sector:

Source: Seeking Alpha
You couldn’t see CMO on that chart. You would need to scroll down pretty far:

Source: Seeking Alpha
Given the dramatic difference in price movements, we decided to take on the additional risk by allocating into the common shares of CMO. That's an important distinction from the majority of our purchases. We've been mostly buying preferred shares in the sector instead of common.
Let’s break down Capstead Mortgage Corporation
Capstead Mortgage Corporation was more than on sale. It was offering a better sale than many peers. We wanted to highlight this opportunity because it is quite unusual. Today, the price has rallied significantly:

CMO is unique for its extreme focus on ARMs (adjustable-rate mortgages). Beyond emphasizing ARMs, they also have internal management with exceptionally low operating expenses. The combination puts them in an attractive position whenever ARMs are able to deliver.
The Environment for Adjustable-Rate Mortgages
For CMO, the ability to generate earnings and protect book value are tied together. The simple version goes like this:
When the yield curve is steepening, CMO’s earnings should improve.
Yeah, it is that simple. When a mortgage REIT invests heavily in ARMs, they want to see 30-year fixed-rate mortgages become less attractive by comparison. When you hear... Read more

Stock name Last trade   P/E Earnings/Share Dividend/Share Dividend yield
WESTERN ASSET MORTGAGE CAPITAL 9.83   10.7 0.92 1.24 12.58
AMERICAN CAPITAL AGENCY 15.64   0.0 -1.54 1.92 12.21
TWO HARBORS INVESTMENT 13.28   0.0 -2.81 1.60 12.02
INVESCO MORTGAGE CAPITAL 15.18   0.0 -1.01 1.80 11.80
AG MORTGAGE INVESTMENT TRUST 17.47   6.1 2.87 1.90 10.89
MFA FINANCIAL 7.39   10.4 0.71 0.80 10.81
ELLINGTON FINANCIAL 17.90   16.3 1.10 1.68 9.44