On occasion we can see some spectacular failures within the preferred share market. One of the most incredible failures to come up from time to time is a disconnect between preferred shares from the same company. The mortgage REIT in question is Anworth (NYSE:ANH). I spotted this deviation in value a couple days ago and was shocked to see it last for so long. The table below contains my ratings for when ANH-A and ANH-C are attractive investments. I include ANH-B because it is in the later tables, but ANH-B is so strongly tied to the common stock that it should be valued in relation to the common stock rather than against the other preferred shares. Here is that table:
These are my price ratings as they were a few days ago, but movements in my estimated values have been very small since then.
The real question for investors is why I would be so bullish on ANH-A when I like ANH-C so much. I’m even long ANH-C. I bought it shortly prior to the ex-dividend date.
To really understand the trading ranges and targets for these shares, you need to know more about them:
For ANH-A, it is possible for a call to come out in the very near future. The company merely need give notice and initiate the call. The investor would still get some dividend accrual, around $.30 by my estimate, but they would suffer a capital loss (based on buying at the latest price) of $1.82. The net result would be a loss of around $1.52 in value. On preferred shares, which are relatively stable in prices, losing $1.52 is substantial.
As an alternative, I like ANH-C. The stripped yield is lower by 33 basis points, but it still trades below par value and carries a healthy amount of call protection. Unlike ANH-A, it is well within its normal trading range.
Why ANH-A Is a Poor Investment
In a prior article on Anworth, I pointed out:
“I expect ANH-C to remain in a range of $24.60 to $24.95 for most transactions. Based on the disclosed transactions, ANH received gross proceeds of $24.82655 per share and that turned into net proceeds of $24.57828 per share (very reasonable transaction costs). Each share of ANH-C costs $.25 less in annual dividend payments. They are getting net issuance proceeds of only $.43 less than the call price on ANH-A.
That payback period is under two years. Yes, the call risk on ANH-A is substantial. Perhaps most notably is the risk that if interest rates move lower it could push preferred share prices which would drive ANH-C into a scenario of rapidly issuing a very massive amount of shares.”
When I was looking into ANH-C previously, I found evidence that an agent working for the company was issuing a high volume of shares with an enormous number of small limit-sell orders. Anworth effectively confirmed it with this 8-K.
As Anworth issues the shares of ANH-C, they have a significant inflow of cash that can be used to fund calling the shares of ANH-A. While the net spreads available to mortgage REITs are fairly poor right now, an opportunity for a 2 year payback period on calling ANH-A is exceptional.
What to Expect
An investor buying ANH-A today needs those shares to remain uncalled for another 9 months or so simply to avoid losing money. I believe ANH will call the shares of ANH-A before then unless rates move substantially higher. That means shareholders in ANH-A would have a net loss compared to simply taking the last closing value for ANH-A of $26.82. If investors want to bet on rates moving higher, there are far simpler ways to do it than hoping ANH-A doesn’t get called.
I have no position in ANH-A. If it were available very close to par value plus accrued dividend, I would be interested in buying it. That would eliminate the risk of negative total return through a call. I am long ANH-C. I am aware that another Seeking Alpha author is shorting ANH-A. I have no affiliation with that author. Due to the interest costs on shorting preferred shares, I do not recommend them for shorting. However, I do recommend harvesting gains when I believe shares are overvalued.
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Disclosure: I am/we are long ANH-C, RSO.
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.
Additional disclosure: No financial advice. Investors are expected to do their own due diligence and consult a professional who knows their objectives and constraints. I might take bearish positions in ORC or WMC if I detect the right catalysts.