Monday, September 17, 2012

Capture a 10% Dividend in a Low-Yield Market

In its third round of quantitative easing, the Federal Reserve will be buying at least $40 billion worth of mortgage-backed securities a month with no end in sight for those purchases. Their action decreases the risk of mortgage securities since we know there will be constant demand from the Fed.

This buying is coming at a time when distressed mortgages are looking a little less distressed. Home prices may have finally found a bottom, according to some experts, and that is helping homeowners. Traders can benefit from these trends by buying a company that is active in this distressed mortgage market.

Distressed mortgages include loans that are being paid late or are underwater, meaning the homeowner owes more on the mortgage than the home is worth. These borrowers might default or try to work with their lender to sell the house at market value and have the lender write off the debt. A home with a mortgage like this will often sell at a discount to its neighbors because lenders want a quick sale and homeowners generally just want to move on. Buyers of these homes have been able to profit and there are even some hedge funds looking at how to get into this market.

Recent news reports estimate that the number of underwater mortgages is declining, but there are still about 10.8 million American households facing this problem. That represents about 22.3% of all outstanding mortgages. Despite negative equity, most homeowners (about 85%) in this situation are still paying their mortgages on time. These mortgages are profitable to the lender, and a continuing real estate recovery could increase profits in the mortgage market.

There is one publicly traded company that offers traders a way to profit in this segment and pays a dividend of almost 10%, allowing traders to consider this as much an income trade as it is an equity trade.

PennyMac Mortgage Investment Trust (NYSE: PMT) invests in mortgage loans, "a substantial portion of which may be distressed and acquired at discounts to their unpaid principal balances," according to the company. The company will use loan modification programs and other initiatives to try to keep borrowers in their homes and paying on the loans. An improving economy should help their efforts. (more)

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