Two Harbors is an Overlooked Gem in the Crowded mREIT Sector

Two Harbors Investment Corp. is a mortgage REIT which makes a convincing value proposition. With a high dividend yield, attractive portfolio characteristics, a consistently improving leverage profile and an extended consolidation in the mortgage REIT sector coming to an end, the company might be an interesting investment opportunity for yield-hungry investors who seek exposure to a well-run, smaller market capitalization REIT.

While Annaly Capital Management and American Capital Agency Corp. usually determine the news headlines of the mortgage REIT sector, less followed, second-league mortgage investment companies such as Two Harbors Investment Corp. also are attractive investment candidates.

Two Harbors Investment Corp. is a mortgage REIT that aims to deliver high risk-adjusted returns over a variety of market and interest rate cycles.

The mortgage REIT largely invests in both agency residential mortgage-backed securities (securities that carry an implicit guarantee of government sponsored enterprises Fannie Mae or Freddie Mac as well as Ginnie Mae) and non-agency RMBS. In addition, Two Harbors Investment Corp. invests in mortgage servicing rights and other, related financial assets.

Mortgage REITs have had a difficult year in 2013. With increasing interest rate volatility and pressure on mortgage portfolios, many mortgage REITs adjusted their dividend payouts and saw their share prices plummet. Now, however, might be just the right time to buy.

High dividend yield and improving leverage profile
Mortgage REITs often deliver substantial returns for shareholders in form of dividends with double-digit dividend yields more common than investors might think.

Two Harbors Investment Corp., for instance, currently pays investors a quarterly dividend of $0.26 per share which translates roughly into an annual dividend yield of 10% and its yield can certainly compete with those of heavy hitters Annaly Capital Management and American Capital Agency Corp. which offer 10% and 11% respectively.

With a consistently improving leverage ratio, a ratio that, by the way, is significantly lower than the average leverage ratio of its competitors, and attractive portfolio characteristics including a low level of prepayment risk, Two Harbor Investment Corp. indeed makes an attractive value proposition.

Source: Two Harbors Investment Corp. KBW 2014 Mortgage Finance Conference June 3, 2014

Mortgage REIT sector ending adjustment process
Though the mortgage REIT sector consolidated strongly in 2013, investors seem to feel much better now about mortgage REIT investments compared to last year. With more clarity about the monetary policy of the Federal Reserve, which is a primary determinant of interest rates in the United States and, ultimately, influences the intensity of refinancings and prepayment rates, confidence has been returning to the sector.

Two Harbors Investment Corp. shares have gained 11% since the beginning of the year as investors are more confident, that mortgage REITs have adjusted their portfolios, realigned dividend payments with their profitability and de-risked their balance sheets.

Shares of Annaly Capital Management have gained almost 15% and shares of American Capital Agency Corp. 21% since the beginning of the year in the latest display of returning investor confidence.

Final assessment
Less visible mortgage REITs are an interesting alternative to other, more high-profile investments in the crowded mortgage REIT sector. With much significantly lower leverage ratios than its peers, a competitive dividend yield of 10% and improving investor sentiment in the mortgage REIT sector, Two Harbor Investment Corp. is a solid choice for yield-hungry investors.

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Kingkarn Amjaroen has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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