This research report was produced by The REIT Forum with assistance from Big Dog Investments.

We’re going to focus in on TWO-C (TWO.PC) for this article, but we will include several charts comparing it to the rest of the sector for two reasons:

  1. It provides a much more complete view.
  2. We already have the tables and charts built.

Consequently, you may recognize the layout for the later part of this article from our series on mortgage REITs and preferred shares.

TWO-C comes from Two Harbors (TWO), so investors should start by comparing TWO-C relative to the other FTF (fixed-to-floating) preferred shares from TWO.

Index Cards

The index card provides a quick summary of our view and all the key metrics to consider:

(Source: The REIT Forum)

The yield looks pretty good at 8.65%, and the “Floating Yield on Price” isn’t too bad at 6.22%. However, that floating yield on price is still a pretty big drop compared to the current stripped yield. If you’re not sure how we calculate those metrics, simply see the bottom part of the index card for the math.

Three of the preferred shares from Two Harbors fall into the FTF category. We’ve pulled a screenshot from our “Preferred Shares” tab in the Google Sheets we use for The REIT Forum:

(Source: The REIT Forum)

You can get a feel for the shares pretty quick, and you can tell that we find TWO-C less attractive when contrasted to TWO-A (TWO.PA) or TWO-B (TWO.PB). Why is that? Well, TWO-A and TWO-B both have a lower value for price-to-buy.

That’s a bit too short to explain to our view, though. So, let’s talk about why we think TWO-A and TWO-B deserve to trade at higher prices than TWO-C.

Shares of TWO-A and TWO-B both have a few advantages. They have more call protection on the calendar (lasting until 2027 rather than 2025). Further, the floating rates don’t kick in until the call protection ends. That’s important because these shares would be even more attractive if their current high stripped yield was fixed.

Beyond the difference in when shares become callable, we want to consider the difference in the tripped yields (favoring TWO-A and TWO-B) and the difference in the “Floating Yield on Price”, which also favors TWO-A and TWO-B.

What Scenario Would Let TWO-C Win?

If the preferred shares are all called sometime this decade, then the lower share price on TWO-C creates a larger capital gain on the call, and the difference would be enough to generate a stronger total return. However, there is no guarantee of a call. In this situation, we favor the extra yield and call protection on TWO-A and TWO-B as being great enough to offset the difference in the share price.

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Our Trade with TWO-C

We traded in shares of TWO-C. Some investors may argue that we took our profits a little early. True, we took them before news of a potential vaccine drove markets dramatically higher. However, we also caught shares at a very nice price:

In total, for about 3 weeks we picked over 5%. That’s not bad by any means.

The rest of the article will provide some tables and charts for comparison across the sector.

We aren’t highlighting TWO-D (TWO.PD) or TWO-E (TWO.PE) much here because they are fixed-rate shares and will appeal more to investors who are focused on the fixed-rate side. However, we do own shares in TWO-A, TWO-B, and TWO-E.

Comparisons to the Sector

We don’t have any desire to cover preferred shares without cumulative dividends, so any preferred shares you see in our column will have cumulative dividends. You can verify that by using Quantum Online. We’ve included the links in the table below:

Ticker

Recent Price

Bond or FTF

Stripped Yield

Current Yield

Coupon

Floating Yield On Price

Annualized YTC

Quantum Online Link

AGNCM

$22.15

FTF

7.81%

7.76%

6.88%

5.20%

11.6%

AGNCM

AGNCN

$22.90

FTF

7.69%

7.64%

7.00%

5.85%

12.5%

AGNCN

AGNCO

$22.11

FTF

7.39%

7.35%

6.50%

5.92%

10.7%

AGNCO

AGNCP

$21.60

FTF

7.13%

7.09%

6.13%

5.72%

10.7%

AGNCP

NLY-D

$25.22

7.53%

7.43%

7.50%

7.53%

3.2%

NLY-D

NLY-F

$22.44

FTF

7.84%

7.74%

6.95%

5.88%

14.0%

NLY-F

NLY-G

$20.89

FTF

7.88%

7.78%

6.50%

5.32%

16.2%

NLY-G

NLY-I

$22.45

FTF

7.61%

7.52%

6.75%

5.87%

10.8%

NLY-I

MFO

$23.70

Bond

8.47%

8.44%

8.00%

8.47%

1072.9%

MFO

ARR-C

$23.55

7.46%

7.43%

7.00%

7.46%

8.9%

ARR-C

DX-B

$24.85

7.72%

7.67%

7.63%

7.72%

21.5%

DX-B

DX-C

$21.98

FTF

7.90%

7.85%

6.90%

6.50%

11.0%

DX-C

CMO-E

$23.00

8.21%

8.15%

7.50%

8.21%

151.1%

CMO-E

EFC-A

$20.06

FTF

8.44%

8.41%

6.75%

6.76%

14.6%

EFC-A

NRZ-A

$20.32

FTF

9.26%

9.23%

7.50%

7.43%

15.2%

NRZ-A

NRZ-B

$19.25

FTF

9.29%

9.25%

7.13%

7.63%

17.0%

NRZ-B

NRZ-C

$17.69

FTF

9.05%

9.01%

6.38%

7.35%

18.5%

NRZ-C

AIC

$23.25

Bond

7.35%

7.26%

6.75%

7.35%

140.6%

AIC

AIW

$23.97

Bond

6.93%

6.91%

6.63%

6.93%

73.8%

AIW

ANH-A

$23.20

9.37%

9.29%

8.63%

9.37%

137.2%

ANH-A

ANH-C

$21.58

8.90%

8.83%

7.63%

8.90%

264.9%

ANH-C

CIM-A

$22.46

9.00%

8.90%

8.00%

9.00%

20.5%

CIM-A

CIM-B

$20.53

FTF

9.86%

9.74%

8.00%

7.40%

16.2%

CIM-B

CIM-C

$19.13

FTF

10.25%

10.13%

7.75%

6.56%

16.4%

CIM-C

CIM-D

$19.49

FTF

10.39%

10.26%

8.00%

7.26%

18.6%

CIM-D

PMT-A

$23.22

FTF

8.88%

8.75%

8.13%

6.60%

11.3%

PMT-A

PMT-B

$23.11

FTF

8.78%

8.65%

8.00%

6.81%

11.2%

PMT-B

TWO-A

$21.66

FTF

9.43%

9.38%

8.13%

6.82%

11.8%

TWO-A

TWO-B

$20.44

FTF

9.38%

9.33%

7.63%

6.85%

12.7%

TWO-B

TWO-C

$19.09

FTF

9.55%

9.49%

7.25%

6.88%

16.8%

TWO-C

TWO-D

$22.21

8.79%

8.72%

7.75%

8.79%

212.2%

TWO-D

TWO-E

$21.81

8.66%

8.60%

7.50%

8.66%

244.8%

TWO-E

CHMI-A

$22.83

9.05%

8.98%

8.20%

9.05%

14.3%

CHMI-A

CHMI-B

$19.96

FTF

10.42%

10.33%

8.25%

7.38%

17.6%

CHMI-B

IVR-A

$21.51

9.07%

9.01%

7.75%

9.07%

269.5%

IVR-A

IVR-B

$20.83

FTF

9.44%

9.30%

7.75%

6.57%

14.3%

IVR-B

IVR-C

$20.81

FTF

9.14%

9.01%

7.50%

6.70%

12.0%

IVR-C

NYMTM

$18.66

FTF

10.64%

10.55%

7.88%

8.98%

18.7%

NYMTM

NYMTN

$19.03

FTF

10.60%

10.51%

8.00%

7.83%

15.1%

NYMTN

NYMTO

$19.71

10.07%

9.99%

7.88%

10.07%

441.5%

NYMTO

NYMTP

$19.65

9.94%

9.86%

7.75%

9.94%

447.4%

NYMTP

AI-B

$18.00

9.84%

9.72%

7.00%

9.84%

35.4%

AI-B

AI-C

$18.92

FTF

11.05%

10.90%

8.25%

7.87%

20.4%

AI-C

MFA-B

$19.94

9.54%

9.40%

7.50%

9.54%

423.5%

MFA-B

MFA-C

$17.01

FTF

9.70%

9.55%

6.50%

8.29%

20.3%

MFA-C

MITT-A

$16.75

13.43%

12.31%

8.25%

13.43%

912.4%

MITT-A

MITT-B

$17.00

12.78%

11.76%

8.00%

12.78%

871.8%

MITT-B

MITT-C

$16.96

FTF

12.81%

11.79%

8.00%

10.71%

25.8%

MITT-C

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There are a few things you should know at the start:

  • When a share can be called on short notice, the annualized yield-to-call reaches absurd levels. Investors shouldn’t put too much weight on it. On the other hand, a negative number can be a significant concern. Consequently, we decided to include it in the chart.
  • The last preferred shares in this group with a suspended preferred share dividend are from AG Mortgage Investment Trust (MITT).
  • We sort our spreadsheet for subscribers by risk ratings within each sector. We decided to use the same technique for this series, since it communicates more information to readers. You’ll notice a general correlation where lower risk correlates with a higher price and lower yield, though this link isn’t absolute.

For each metric, we have 2 charts. Why use two charts? Because it is much more convenient for readers who want to enlarge the charts. We simply can’t fit 40+ shares into a single chart and still have it show up well on a mobile device.

Share Prices

We will start with the prices:

Chart

(Source: The REIT Forum)

Chart

(Source: The REIT Forum)

That chart gives you a pretty quick feel for which shares are trading at a discount to call value. Each of these preferred shares has a call value of $25.00, but that doesn’t mean a share will be called. The company decides if they want to issue a call or not.

Dividend Yield

Let’s move onto the stripped yield. This is the way dividend yields should be handled for preferred shares:

Chart

(Source: The REIT Forum)

Chart

(Source: The REIT Forum)

Stripped yields are vastly more useful than “current” yields for preferred shares. The stripped yield uses the stripped price. That’s different from using the current price, because it means we already adjusted for dividend accrual. This makes the process easier for investors.

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We can talk about shares using “regular prices”. Those are the prices an investor would actually use when entering an order.

However, we will provide the stripped yield to adjust for the dividend accrual. In the spreadsheets we host for subscribers, we include the actual ex-dividend date, or the projected ex-dividend date if the actual date isn’t yet known. If you’re planning to buy a share, it’s always wise to check if the shares just went ex-dividend so you can adjust your targets accordingly.

Floating Rate Dividend Yields

Since many of these shares switch over to floating rates, we also want to consider what the yield would be if the floating rate was in effect and shares were still at the current price. To demonstrate that, we use the “Floating Yield On Price”. If the share remains at a fixed rate indefinitely, then the value doesn’t change:

Chart

(Source: The REIT Forum)

Chart

(Source: The REIT Forum)

One point we need to emphasize here is that we are dealing with yields. A yield must involve the share price. We aren’t simply showing the new “rate” if the share began floating, we are adjusting the new rate for the stripped price.

Conclusion

TWO-C was a great deal several weeks ago. Today, it is just a mediocre deal. Investors who own TWO-C and are not facing substantial negative tax consequences may want to consider swapping shares for TWO-A or TWO-B. However, this only makes sense as long as the relative prices hold.

At the time of writing this, TWO-A is $23.09, TWO-B is $22.17, and TWO-C is $21.12. In other words, TWO-A costs about $2.00 more than TWO-C and TWO-B costs about $1.00 more than TWO-C. If the gap in share prices were to increase materially, then we would cease to consider TWO-C less attractive than TWO-A or TWO-B.

Ratings:

  • Neutral rating on TWO-C, no other ratings.

Our method works. We know because we buy the same shares we recommend. We track our results on a real portfolio and we compare our returns with the major ETFs for our sector:

Those four ETFs are:

  • MORT – Major mortgage REIT ETF
  • PFF – The largest preferred share ETF
  • VNQ – The largest equity REIT ETF
  • KBWY – The high-yield equity REIT ETF

Try our service. See how much better investing can be.

Disclosure: I am/we are long NLY-F, NLY-I, AGNCO, TWO-E, TWO-A, NYMTP, NRZ-C, TWO-B, NRZ-B, NYMTM, CIM-A, NRZ, AGNC, NLY, NYMT, GPMT, SLRC, PMT, AAIC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.



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