I may have to be back in Capstead Mortgage

October 29, 2009

As some of you may recall, I suggested getting out of Capstead Mortgage (CMO) on the grounds that its fat dividend (currently 17%) couldn’t last forever and that, at a price of $14.60 and a book value per share of $11.50,  the price represented well over a year of excess dividends, and the Federal Reserve is not likely to keep interest rates low for that long.

Now, the price has fallen back to $12.80 as of yesterday and $13.30 as of today. However, their latest report indicates a book value per share of $12.20. However, the principal value per share is, I believe, sitting at around $10 per share, since adjustable-rate mortgages tend to keep their value in over time the face of interest rate movements and these are explicitly guaranteed by the US government, thus producing a nice premium over principal value. The principal value is important because mortgages are prepaid at their principal value, and last quarter Capstead Mortgage’s prepayments were running at a 23.5% annual rate. The prepaid securities can be replaced, but at the same premium which, based on the latest results, is 3.5%.

At any rate, $13.30 set against an unmodified book value of $12.20 is only six months’ of excess dividend, which seems to be long before the Fed will consider raising rates  (even though the economy is officially growing again) and even after interest rates rise, as long as they stabilize in a reasonable range Capstead Mortgage will be able to earn reasonable, if not their current outsize, returns. However, the mob in the marketplace will probably react to a diminution of the dividend as a sign of disaster, selling until the stock represents no premium at all, or even a discount, to book value. As I stated before, that is the time to really pile on Capstead Mortgage.

P.S. I know that American Lorain has just made a potentially dilutive equity offering. I’ll collect my thoughts on the matter and let you all know.


Leave a Reply