It’s true; I was feeling a bit continental so I decided to take an entire month off from the world of REITs and commercial real estate. But Labor Day is no longer the summer sanctuary it once was. Not only does the holiday fall in September, preceding the month that has become known for Black Monday and the Crash of 1929, but September is now known as the month in which capitalism itself was nearly killed for good. It would have been hard to believe then, but the cynical attack on its iconic symbols eight years earlier is now even more poignant.

Nevertheless, Teddy Roosevelt implores us to get back in the arena, to strive valiantly, even through dust and sweat and blood and tears; to keep fighting even if we come up short. And that is exactly what Annaly did last week with the launch of its new commercial mortgage REIT, CreXus.

While CreXus did manage to raise $200 million to go shopping for distressed commercial mortgages, it had to cut the size of the offering by more than half, and even then it had to sell Annaly almost 30% of the deal in order to clear the market.

CreXus plans to use the proceeds to acquire commercial mortgage real estate related debt and other commercial real estate-related assets, and this was the problem. Buy side managers were not convinced that CreXus management knows its way around the CMBS market as well as Annaly management knows its way around the RMBS market, and several said they would rather wait for Tom Barrack’s new commercial Mortgage REIT to come next week, rather than invest in the unproven CreXus.

While avoiding buyer’s remorse may be the theme of the day with Mortgage REIT IPOs, creating it may be the intention of some limited partners in one of Lehman Brothers’ real estate private equity partnerships. Indeed, the sale of the remants of the Lehman’s real estate group to former management (including Mark Walsh who was “present at the creation”, shall we say) appears to be pretty much on rails.

However, citing “greed, fraud, hubris, deceit, gross mismanagement and disregard of fiduciary obligations”, a committee of limited partners in a real estate fund Walsh helped assemble is building what appears to be a fraudulent conveyance claim against Lehman and some of its affiliates, alleging that they used one of these partnerships to help eject toxic real estate assets from Lehman’s balance sheet in 2007.

The informal complaint, sent in an email to investors and the General Partner, cites Lehman’s “deceit in selling LP interests” to investors in LBREP III, including allegedly selling property to the partnership for $157 million more than Lehman paid for the same property just a few months earlier.

Both sides acknowledge that the investments are now worth about half the what LBREP III investors paid Lehman, and not surprisingly a large number of limiteds balked at a recent capital call to fund on-going expenses, including a retro-active increase in the management fee! Not only that, it appears that Lehman was charging management fees to its investors before they even owned the assets.

Although the email alleges “breach of fiduciary obligations”, astute observers will note that securities firms like Lehman have no such obligations. Lehman was simply obligated to determine “suitability”, which is a much different and much lower standard than a fiduciary standard.

In an oversimplified paragraph, if Lehman determines that it’s suitable to charge investors $157 million more for a pool of assets than Lehman paid, then so be it. Private equity is a caveat emptor world, and the investors in LBREP III may be about to learn an expensive lesson in Latin. CreXus investors on the other hand, by demanding that Annaly buy 30% of its own REIT, appear to be taking no such chances.

Shamefully, I haven’t done much with Agency Mortgage REITs here, but the times they are a changing. Agency REITs are killing it on net interest spreads, and that is causing higher net incomes and increased dividends. What else could an investor want, next to a portfolio of government-guaranteed mortgage debt? Not surpringly, many investors screech to a halt on mention of the latter, and that’s one of the reasons these REITs deliver high teens yields quarter after quarter.

But those who had been yawning at the mention of an Agency Mortgage REIT are probably taking a closer look now. (AGNC), which is a relatively new Agency REIT, surprised everybody on Tuesday when they announced a quarterly dividend of $1.50 per share, a whopping 76% higher than the previous quarter (the dividend is payable July 27th, and the ex-dividend date is June 30).

AGNC’s dividend increase follows dividend increases from Annaly Capital (NLY) last week and Capstead Mortgage (CMO) the week before.

What’s causing all this? The earnings driver is the so-called “steep yield curve”, as it’s known in industry speak. In this market, a steep yield curve basically means nobody wants to own anything with a maturity beyond next week, especially if it has a mortgage attached to it. This is resulting in a huge spread between short yields and long yields, and Agency Mortgage REITs are busy collecting the difference. The difference between these Mortgage REITs and others is that Agency REITs are doing it with portfolios of AAA-rated government paper, not a bunch of dodgy TRUPS and CDOs.

In AGNC’s case, the weighted average yield on its portfolio last quarter was 5.13%, but its average cost of funds was 2.11%, resulting in a margin of 3.02%. This is pretty good work if you can get it, and last quarter AGNC delivered a 24.1% return on equity for sitting in between.

AGNC is not alone. Annaly Capital Management increased its dividend last week – by 20% to $0.60 per share (payable July 29, ex-date is June 25). NLYs net interest margin went from 1.71% to 2.11%, and they rode the recovery in mortgage bonds with a $5 million gain on sale. Combined, this drove earnings to $0.63 per share, up 19% from the year-ago quarter.

CMO’s dividend increase was less spectacular, up 4% to $0.58 per share for the third quarter of 2009, but the story is the same: their net interest margin increased to 2.16%, and they have plenty of cash to invest after participating in the recent frenzy of REIT stock offerings.

Other cashed-up REITs investing in agencies, though not exclusively, include Redwood Trust (RWT) and Chimera (CIM). Incidentally, RWT sold its stock in two separate overnight offerings, the latter at a 10% discount to the previous day’s close.

Despite these rich dividends, Agency Mortgage REITs are not for widows and orphans. Concerns over the government losing its AAA rating (which Annaly management calls “gossip”), interest rate wories, news about Asians selling their dollar assets, inflation prospects, high leverage ratios and re-investment risk all amount to a big detour sign for a lot of investors. From my perspective, owning these things right now amounts to a front row seat for the greatest show on earth (at the very least), and it’s probably worth the risk.

The Fed announced late in 2008 that they would finally follow through on the original TARP intentions and actually buy mortgages. The Fed’s plan is to spend $500 billion by June 30th. That would would be $4 billion a day in government demand for mortgage bonds from the Fed’s munificent money men, so they have some catching up to do.

The program is officially intended to lower home-loan rates, but it also has mortgage traders lining up in anticipation of the giant bid. Mortgage REITs, while still weak, have been looking a little less anemic in response.

Back in early October, numerous analysts and investors jumped into mortgage bonds and REITs after congress finally passed the $700 billion financial rescue package. But anything mortgage-related was subsequently thrown out the window I don’t think we’re in Kansas anymore after the Fed’s focus shifted from buying troubled assets to pumping tax dollars into banks instead.

Some commercial-mortgage bonds fell so low on the news that all the loans could default and a buyer wouldn’t lose money. Then in December, the Fed said that its new $200 billion lending program for buyers of asset-backed bonds may be expanded to include mortgages. Later that month, they confirmed their intention to purchase large quantities of mortgages in the new year. Maybe they should just be buying cheap penny stocks instead.

According to Bloomberg, the Fed’s buying binge began last week with the purchase of $10.2 billion of Fannie Mae, Freddie Mac and Ginnie Mae mortgage-backed securities. Not surprisingly, this support from Uncle Sam is also boosting demand for Mortgage REITs, even after an absolutely bloody November.

In addition to enriching mortgage traders along the way, the program is also having the intended effect on the market for residential home loans. According to Freddie Mac, the average rate on a 30-year fixed-rate mortgage dropped for a 10th week last week to 5.01 percent, the lowest on record. PIMCO believes that rate may fall to 4.5%

The government also has been expanding the $1.6 trillion mortgage portfolios of Fannie Mae and Freddie Mac, which isn’t difficult to do now that they are in receivership and under effective control of the Fed.

Given that the Fed demand is targeting the single family mortgage market, residential Mortgage REITs like Annaly (NLY) are trouncing the broader MREIT index.

The Fed’s $4 billion a day habit is really only the tip of the iceberg intended to sink the titanic housing mess. Under a separate program, the Treasury Department bought $49.7 billion of Fannie Mae and Freddie Mac mortgage securities in September, October and November, and in December the Fed bought $15 billion of the corporate debt from Fannie Mae, Freddie Mac and the Federal Home Loan Bank system. That program may target as much as $100 billion in corporate debt for the two agencies, which is intended to lower their borrowing costs. yikes! what about full faith and credit?

Disclosure: None at the time of publication
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