Sell Annaly And AGNC Preferreds And Buy Two Harbors Preferreds

Introduction

In this article I examine most of the preferred stocks in the “agency” mREIT space. Agency mREITs are those which hold mortgages which are backed by entities of the U.S. government and thus carry no credit risk. Due to much higher mortgage rates, the cost of purchasing a home with a mortgage has skyrocketed from a year ago. This will almost certainly cause housing prices to tumble which could lead to mortgage defaults. Thus, in the residential mREIT space I am currently sticking with preferred stocks from agency mREITs only.

Having concluded my study of the sector, I believe that there are serious mispricings in this sector which provide an excellent opportunity to exit the relatively overpriced preferred stocks of Annaly (NYSE:NLY), AGNC (AGNC) and Invesco Mortgage (IVR) and purchase the preferred stocks of Two Harbors (NYSE:TWO).

Review of My Buy CHMI.PA Preferred Stock and Sell ARR.PC Preferred Stock Article

On November 23rd, about 5 weeks ago, I submitted this article to Seeking Alpha for publication. It recommended buying CHMI.PA and selling ARR.PC. On that date, CHMI.PA had closed at $20.77 and ARR.PC had closed at $20.04. I took some heat in the comments section of that article from those who thought ARR.PC was the better preferred stock.

Today, December 27th, CHMI.PA closed at $22.38, up $1.61, while ARR.PC closed at $18.58, down $1.54. The net gain from making this swap was $3.15 per share in 5 weeks or a 15% gain. This annualizes to 150% gain. That trade has achieved its goals and should now be exited.

These are the kind of trades we offer our Conservative Income Portfolio subscribers. We have a trading portfolio of recommended shorter term trades and swaps that have been achieving very high annualized returns like this one. The market is currently a much better trading market than a buy and hold market as buy and hold investors have unfortunately discovered.

Sell These AGNC and NLY Preferred Stocks and Buy TWO.PB and/or TWO.PC Preferred Stocks

The chart below pretty much tells the story. The column heading “Float Rate %” is the floating rate at par. Then you add to that number whatever the LIBOR rate (or its substitute) is.

As you can see, TWO.PA and TWO.PB are the standouts in terms of their very high current yield combined with their high floating rates. Initially, I will leave TWO.PA and TWO.PB out of the analysis as they don’t float until 2027. Then I will return to them later in the article.

Instead, I will now focus on those preferred stocks that will start to float between mid-2024 to early 2025. So this is the chart I will use below.

Here is an additional chart of what the floating rate yield will be for the above fixed-to-floaters at their current prices assuming a 4% LIBOR when they float.

TWO.PC Floating Yield = 12.12%

AGNCM Floating Yield = 10.23%

AGNCO Floating Yield = 10.86%

AGNCP Floating Yield = 10.95%

NLY.PI Floating Yield = 10.20%

NLY.PG Floating Yield = 9.07%

So not only does TWO.PB have a much higher current yield advantage over the preferred stocks from AGNC and NLY, but when these float, TWO.PC also will continue to have a very large yield advantage.

I understand that some will say that NLY and AGNC are bigger companies and thus safer companies. I question that belief. NLY, AGNC and TWO all operate at around the same leverage with liabilities approximately around 90% of assets when preferred stock is included. And agency mREITs tend to keep their leverage from getting too high by issuing stock when needed. As long as this is the case, I don’t think there is really much difference in terms of the safety of TWO preferred stocks relative to NLY and AGNC.

Additionally, not long ago TWO announced that it was buying back its preferred stocks in the open market and has been doing so since that announcement. Thus, TWO preferred stocks are currently backstopped by TWO. And TWO’s decision to buy back some of their preferred stock in the open market shows that TWO management also believes that their TWO preferred stocks are a very good value. Afterall, they didn’t announce that they were buying NLY preferred stocks.

I have found over the years that you can outperform by finding the more “under the radar” and smaller cap securities rather than going with what everyone else is looking at or stocks that are receiving the most Seeking Alpha articles.

Why TWO.PB Looks Very Attractive and is My Favorite

So you don’t have to scroll back, here is the complete chart from earlier in the article.

Not only does TWO.PB have a current yield that is way above those of the NLY and AGNC preferred stocks, but its floating rate is also far better. Assuming a 4% LIBOR, as I did earlier, at its current price TWO.PB will float at a yield of 12.78%, the highest of all of these preferred stocks. TWO.PA will float at 12.36% at its current price which makes TWO.PB the better investment.

Some may say that while NLY.PG may look awful relative to TWO.PB, it floats very soon and thus has an advantage. Although the market is predicting that the FED will start cutting short term rates later in 2024, we will use an optimistic scenario for NLY.PG where LIBOR remains at 5% for the next 2 years and then drops to 4%. Personally, I wouldn’t be surprised to see LIBOR below 4% in 2 years and maybe significantly below 4% should the Fed be forced to slash rates due to some financial crisis.

At a 5% LIBOR, NLY.PG will convert at a yield of 10.18%, still below the current yield of 10.62% for TWO.PB. And when LIBOR drops to 4%, NLY.PG’s yield will then drop to 9.18% while TWO.PB continues to yield 10.62% since it is still fixed rate. And then in 2027, TWO.PB will float at 12.78% versus NLY.PG’s 9.18%. So honestly, I don’t understand why NLY.PG is trading at such a high price. It seems people are so thrilled that NLY.PG will see its yield jump in 3 months that they have failed to do a thorough analysis of whether it is currently price attractively.

Since I believe that inflation is fast coming down and that short term interest rates will be significantly lower in 2025 than now, I actually like that TWO.PB doesn’t float until 2027. And since TWO.PB will be fixed-rate for some years yet, let’s compare it to the 2 fixed-rate agency mREIT preferred stocks, CHMI.PA and ARR.PC, to see how it looks.

Sell ARR.PC, CHMI.PA and IVR.PB and Buy TWO.PB

Again, TWO.PB looks very undervalued relative to ARR.PC and CHMI.PA. Not only is its current yield much better, but if it turns out that we are in for many years of high interest rates, the big jump in yield that TWO.PB will experience in 2027 will make it even more undervalued. But even if things go the other way, and LIBOR drops to 2%, in 2027, that would still put TWO.PBs yield above 10% at its current price, beating both ARR.PC and CHMI.PA. TWO.PB looks great regardless of where rates go in the future.

And then we have the closest peer to TWO.PB which is IVR.PC. Both are agency mREIT preferred stocks that float in 2027 so this is the best comparison. Until 2027, TWO.PB is going to provide a current yield of 10.6% versus 9.63% for IVR.PC. And when they float in 2027, if we assume a 4% LIBOR, TWO.PB will float at a 12.78% yield while IVR.PC will only float at a 11.89%. Thus, we strongly recommend those owning IVR.PC sell their shares and buy TWO.PB.

TWO.PC and TWO.PB have the Most Price Upside

As you can see from the graph below, TWO.PC and TWO.PB have been beaten down the most over the last 12 months in this rising rate environment. Thus, a reversal in the interest rate trend should favor TWO.PB and TWO.PC the most – especially TWO.PB which remains fixed-rate for longer. And it is also possible that these 2 preferred stocks have been hit harder by tax loss selling due to their large price drop during the last 12 months. Thus, I believe TWO.PB and TWO.PC will likely outperform in January when tax loss selling is finished and that we have a very good entry point at current prices.

1 Year Price Chart

Summary

First, I reviewed my swap trade, buy CHMI.PA and sell ARR.PC, from 5 weeks ago which returned an annualized 150% return and then I offer some new swap ideas in the same agency mREIT preferred stock space.

I believe that I have provided strong evidence that agency mREIT preferred stocks TWO.PB and TWO.PC are quite undervalued relative to the preferred stocks of agency mREITs NLY and AGNC and that investors would do well to sell their NLY and AGNC preferred stocks and switch to TWO.PB and TWO.PC. Both TWO.PB and TWO.PC have significantly higher current yields and will also float at much better yields. TWO.PB currently yields 10.6%, well above anything from NLY or AGNC and also much better than any fixed rate agency mREIT preferred stocks.

I also documented how much superior TWO.PB is versus fixed-rate agency MREIT preferred stocks CHMI.PA and ARR.PC and recommend those that own CHMI.PA or ARR.PC sell their shares and buy TWO.PB.

Additionally, the closest peer to TWO.PB is IVR.PC which, like TWO.PC, floats in 2027. TWO.PB currently yields 10.6% versus 9.63% for IVR.PC, a very large mispricing, but TWO.PB will also float at a much superior yield in 2027. Thus, we strongly recommend that those who own IVR.PC sell their shares and buy TWO.PB.

With TWO.PC and TWO.PB having been beaten down further than its peers, these 2 preferred stocks are not only going to provide investors with higher yields but I also believe that they will provide more in the way of price appreciation.