I’m out of Capstead Mortgage

September 17, 2009

I suppose the ideal solution for me would be to align this blog with a subscription newsletter. Telling you what to buy would be free, but telling you when to sell would cost you. Since that strikes me as a little mercenary, I’m telling you all that I’m out of CMO.

If you’ll recall, I recommended CMO because the low interest rates have produced a huge financing spread for their mortgage portfolio, and I did warn that if interest rates went up, CMO’s dividend would lag. Although interest rates presently show hardly any signs of going up, what has gone up is CMO’s price; it hit 14.60 today. The company’s book value per share is in the neighborhood of $11.50, and the face value of their debt per share is about $3.50 lower. Although the mortgages are probably entitled to a premium over face value while trading because of the government explicitly guaranteeing them,  interest is paid on the face value, and principal repayments are also made at face value.

Now, interest rates are going to rise eventually, and when that happens CMO’s fat dividend will diminish, or depending on the speed of the rate change, may even disappear, at which point the yield-hungry investors will look elsewhere, collapsing the price back down to book value or even face value. At any rate, the dividends that CMO is likely to generate until then are probably equal to or exceeded by the current premium over book value, so there is no real purpose in holding on any longer to collect a dividend that is already priced in.

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