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Undervalued Financial Stock Yielding 14%

Sunday - 4/7/2013, 9:22pm  ET

This reports aims to discuss Arlington Asset Investment  as an investment opportunity for investors who prefer regular income. You will also see a head to head comparison with its peers in the REIT space.

Arlington Asset Investment has a market cap of just over $400 million and operates in the US as a mortgage REIT that invests in residential mortgage backed securities, both Agency and non-Agency. Around 82% of the company’s fourth quarter end investment portfolio is composed of Agency securities, while the remainder is private label or non-Agency. Within the Agency portfolio, a large chunk consists of 30-year fixed rate mortgage securities. Therefore, it can be classified as a hybrid mortgage REIT.

In comparison, MFA Financial , which has been operating since 1998, has a policy of investing half of its portfolio in mortgage backed securities, whether Agency or non-Agency. The remainder is other types of MBS and residential mortgage loans, other real estate related debt and equity and other yield instruments in compliance with its qualification as a REIT. At the end of the fourth quarter it had 57% of its portfolio invested in Agency RMBS, while the remainder was non-Agency. Within the Agency portfolio, adjustable rate securities were 68%.

Two Harbors has been in operation since 2009 as a hybrid REIT. The company primarily manages residential mortgage backed securities, residential mortgage loans, residential real properties and other financial assets. Around 81% of its most recent quarter end portfolio was Agency RMBS, and within this another 80% was fixed rate, while the remainder was ARM.

Dividends

The company has been able to deliver stable core income over prior years, which is why its dividend distribution has also been stable compared to its peers. It produced core income of $1.25 for the fourth quarter, well above the quarterly dividend distribution of $0.88 per share. The company has maintained its current dividend rate since June 2011, when it increased 17%.

In comparison, Two Harbors was forced to decrease its quarterly dividend distribution rate from $0.37 to $0.34 during the prior year. Currently, it is yielding 10.6% on its quarterly dividend rate of $0.32 per share. On the other hand, MFA Financial slashed its dividends three times during the prior year. Currently, it is yielding 9.3% on its quarterly distribution of $0.22 per share.

Valuations

Arlington Asset Investment reported book value of $35.47 per share. Since the stock is exchanging hands at $25.49 per share, it is trading at a 28% discount to its fourth quarter book value. In comparison, MFA Financial and Two Harbors are trading at 2% and 4% premiums to their respective book values. Therefore, when compared to its peers within the hybrid mortgage REIT space, Arlington appears to be attractively valued.

Conclusion

I believe Arlington Asset Investment presents and excellent investment opportunity within the mortgage REIT sector. Therefore, investors looking to invest in hybrid mortgage REITs, particularly Two Harbors and MFA Financial, should consider Arlington as it is trading at cheap relative multiples and offers a dividend yield that is stable and appears sustainable. 

This article was originally published as Undervalued Financial Stock Yielding 14%on Fool.com

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