Bulldog Targets REITs For Shakeup After Javelin Win: Mortgages

Phil Goldstein smells blood.

The activist hedge fund manager is setting his sights on real estate investment trusts after winning a five-month fight with Javelin Mortgage Investment Corp. After pressuring management to significantly repurchase stock without success, Goldstein’s Bulldog Investors turned up the heat in November, announcing it planned to nominate new board members and proposed liquidating the company. Javelin’s Vero Beach, Florida-based executives capitulated and by the end of the quarter bought back 9 percent of its shares.

Since the $600 million investment firm said in August it had built a stake in Javelin, the REIT has returned 32 percent, even as similar companies, including the two largest, Annaly Capital Management Inc. and American Capital Agency Corp., declined. REITs that buy mortgage debt tumbled last year after struggling to navigate Federal Reserve policies, leaving them exposed to investors prepared to push for changes.

“There are some vulnerable companies that better be looking at what happened with Javelin,” said Steven DeLaney, an analyst in Atlanta at JMP Securities LLC. “Management doesn’t have a lot to stand on if the REIT’s stock is trading at 80 percent of its book value,” he said, referring to the amount assets would be worth if liquidated. In that scenario, every dollar of equity repurchased would yield a 20 percent return.

‘Clear Target’

Goldstein, 68, who said he’s eyeing property REITs and those investing in mortgages, declined to name which firms he’s considering next. He has agitated for change at companies including Casey’s General Stores Inc. and Firsthand Technology Value Fund Inc. Bulldog’s methods are working. Its main fund returned 16.4 percent in 2013 and more than 123 percent in the past five years.

Anworth Mortgage Asset Corp., with $8.8 billion in assets at the end of September, is a “clear target” for investors like Goldstein, since it’s trading at a 24 percent discount to book value, DeLaney said.

The Santa Monica, California-based firm primarily buys government-backed home loan bonds, which suffered their first annual loss last year in almost two decades. Companies that primarily own the debt could be liquidated in a month or less, according to DeLaney, making them attractive to activists.

Anworth has already repurchased at least 2.8 million shares in the fourth quarter and last month announced board approval to buy back as many as 5 million more. Its shares rose 2.7 percent to $4.52 in New York trading at 4:15 p.m., the highest since November. A company representative didn’t return calls seeking comment.

Too Big

American Capital, which oversees about $97.3 billion of assets, and Annaly, with about $93.4 billion, are too big for most activists to influence, DeLaney said. Shares of both firms declined at least 20 percent last year. REITs backed by large investment firms like Leon Black’s Apollo Residential Mortgage Inc. will probably be left alone as well, he said.

REITs buy property-linked assets and are exempt from taxes as long as they pay out 90 percent of their earnings in dividends. The firms lured investors with returns of 19 percent in 2012 and dividends of more than 13 percent, almost twice the average yield on company junk bonds.

Mortgage REITs rely on leverage, typically borrowing about six to eight times their capital, helping firms that had virtually no assets six years ago expand to hold more than some regional banks.

The companies more than tripled holdings of government-backed home-loan bonds since 2009, growing so large that the International Monetary Fund, the U.S. Financial Stability Oversight Council and Fed governor Jeremy Stein warned last year that they posed risks to the markets. REITs held $400 billion of assets at their peak last year.

‘Fed Signals’

The companies started plunging in May as investors speculated that the Fed would slow its debt-buying program as the economy started to strengthen. The next month, investors pulled about $60 billion from U.S. bond funds, the biggest monthly redemptions in records going back to 1961, according to estimates from the Investment Company Institute. Mortgage rates jumped to 4.46 percent at the end of June, up from a near-record low of 3.35 percent in early May.

In Javelin’s case, the company’s shares lost almost 40 percent, including reinvested dividends, from May to Aug. 16, when Bulldog said it had built a 5.5 percent stake and intended to engage with management. The REIT is run by Scott Ulm and Jeffrey Zimmer, who also oversee Armour Residential Reit Inc. Goldstein called Ulm repeatedly, urging him to buy back stock, even after Javelin’s board authorized Oct. 30 for as many as to 2 million shares to be repurchased.

Repurchasing Shares

“There are lots of things to consider and plan for when you buy back shares of a REIT,” said Ulm. For a REIT to repurchase shares, it may need to sell assets and reduce its use of borrowed money. If several REITs sold securities, they could push down values for some mortgage-backed debt.

On Nov. 21, Goldstein escalated his campaign, threatening a proxy fight to replace six of the REIT’s directors and liquidate the company in a letter to management that was filed with the Securities and Exchange Commission.

“It is clear that Javelin has been an unqualified failure for investors,” Goldstein wrote. “Liquidation will at least allow shareholders to recoup some of their losses.”

Javelin repurchased 516,000 shares directly from Bulldog in December and its stock gained 10 percent in three weeks; about the time it took for the two firms to reach an agreement after the hedge fund threatened a proxy fight.

“How hard is it to run a mortgage REIT?” Goldstein said this month in an interview. “I could run one in my basement.”

Proxy Fights

Goldstein speaks from experience. He started his hedge fund in a basement in 1992 with Steven Samuels and about $700,000. Goldstein had only invested funds for himself and his father when he quit his job as a New York City engineer and set up a card table in a Brooklyn house to manage people’s money.

The activist hedge-fund firm, now based in Saddle Brook, New Jersey, has run about 40 proxy fights, according to Goldstein. Bulldog, a name picked to characterize the firm’s tenacity, typically buys closed-end funds, which have a limited number of shares outstanding that can trade above or below a company’s net asset value.

“Goldstein is a very shrewd investor,” said Damien Park, head of Hedge Fund Solutions LLC, which compiles data and consults on activism. “He figured it out essentially on his own. Bulldog is very good at finding those undervalued companies and a mechanism to help realize the value gap.”

Some REITs have already accelerated stock repurchases. American Capital bought back 7 percent of its shares in the fourth quarter. The company rose 0.7 percent today to $20.28 and has gained 5.1 percent this year.

‘Meaningful Value’

The firm is committed to buying back stock while it’s trading at a discount, which “can generate meaningful shareholder value without increasing risk,” President Gary Kain said on an Oct. 29 call with investors.

Repurchasing stock won’t be enough. More mortgage REITs will have to diversify their investments after an “underperformance of epic proportions,” in 2013, said Merrill Ross, an analyst with Baltimore-based Wunderlich Securities Inc.

The companies, which are sensitive to rises in interest rates, have already taken more defensive positions to prepare for the Fed’s retreat. They’ve reduced their use of borrowed money, shifted to shorter-term bonds and added to cash reserves.

Mortgage REITs have been “unduly punished” by investors driven by fear and not economic reality, according to Jason Arnold, an analyst at RBC Capital Markets in San Francisco. The firms are generating good returns, have highly liquid assets that could be sold quickly and are limiting risk by putting money into assets that are less sensitive to interest rates, like mortgage servicing rights, he said.

Challenging Environment

Even though the companies have stabilized, they’ll remain in a challenging environment for a while, said Jason Stewart, an analyst at Compass Point Research & Trading LLC. Meanwhile, activist investors should get involved in REITs that aren’t repurchasing shares.

“There is no management team that can justify why purchasing a mortgage-backed security today is a better investment than buying their stock back at 75 percent or 80 percent of book value,” he said.