Hatteras (HTS) - A Government Implied Dividend?

It is no fun listing a residential real estate investment trust (REIT) in the middle of the biggest housing market collapse in global history, but that is exactly the challenge which faced Hatteras Financial (HTS) when it listed in 2007.

With the housing crisis still fresh in the minds of investors, many would be wary of investing in a company which specializes in investing in "adjustable-rate and hybrid adjustable-rate single-family residential mortgage-backed securities" which is the market in which Hatteras (HTS) operates.

Established in 1997, Hatteras (HTS) offers investors a yield of 16% on an undemanding price to earnings (PE) multiple of 6 times historical earnings. This yield is above the 14.88% which is the industry average for REITs in the US at the end of June 2010. Hatteras' (HTS) return on average equity comes in at 18.4%, above the 15.8% peer average.

In a nutshell Hatteras (HTS) generates net income from the difference between the income on its investment portfolio and the total costs of borrowings and hedging on its portfolio. Importantly, its investments in mortgage backed securities are issued or guaranteed by U.S Government agencies or U.S. Government-sponsored entities such as Fannie Mae, Freddie Mac or Ginnie Mae.

With government adopting the "too big to fail" approach to these organizations, stemming from their continued operation despite insolvency, it may well have created an underpin for companies such as Hatteras (HTS) to benefit.

Reporting second quarter results in July, earnings at the company were depressed as lower quality loans at Freddie Mac and Fannie Mae continued to work their way through the system.

Net interest income for the quarter ended June 30, 2010 was $40.1m, compared to $45.8m for the March quarter while the Company’s average earning assets dropped to $6.6bn for the second quarter of 2010 from $6.7 billion in the previous quarter.

In the second quarter, Hatteras’ (HTS) earnings and investment portfolio felt the full impact of Fannie Mae’s delinquent loan buybacks as they cleared most of their intended purchases affecting the portfolio by June 30th. As the size of the portfolio ramps back up, the company is looking forward to again realize the potential of the portfolio. Excess earnings retained last year when prepayments were unusually and unpredictably slow have allowed the company to distribute $1.10 in dividends to shareholders.

While US housing data remains weak, there are signs that the market may be turning. With this in mind, a low earnings base and high dividend yield make Hatteras (HTS) a stock to be considered for the investor seeking yield.