As we approach the end of a tumultuous 2011, it's time to look back at the biggest winners and losers.

So in this series, that's exactly what we're doing, sector by sector. Today, let's take a look at the 10 biggest winners in the mortgage REIT industry. First, the backstory, then the results.

The backstory
This year, we saw U.S. Treasuries get downgraded from AAA status while Congress played politics instead of fixing the budget, a domestic economy that has been recovering from its financial crisis in fits and starts, big trouble in Europe, and a Chinese economy that doesn't seem so bulletproof.

The daily volatility in the financial industry has been tremendous, but mortgage REITs haven't been swinging around as wildly as banks. Part of that is European debt fears manifesting in bank stock volatility, but the mortgage REITs have also been less volatile because of the massive, frequently double-digit dividend yields in the industry.

Since REITs have to pay out most of their profits, high dividends imply high profits. Mortgage REITs make their money off the interest-rate spreads between their generally longer-term mortgage debt holdings and their generally shorter-term borrowings. Since the Federal Reserve has kept short-term interest rates near zero, the mortgage REITs have feasted on the resulting spread.

The danger lies in any interest-rate compression, regulatory changes, and the risk inherent in individual REIT portfolios. On the latter point, REITs differ markedly in their holdings (e.g., agency vs. non-agency residential debt, commercial vs. residential) and strategies (e.g., the amount of leverage).

The 10 best mortgage REIT stocks of 2011
For context, the S&P 500 has returned 2.7% after dividends this year. In other words, the market has been basically flat.

REIT Name

2011 Dividend-Adjusted Return

Price-to-Tangible Book Value

CYS Investments (NYS: CYS) 22.7% 1.0
American Capital (NAS: AGNC) 19.8% 1.1
Capstead Mortgage (NYS: CMO) 19.1% 1.0
NorthStar Realty Finance (NYS: NRF) 15% 0.6
Anworth Mortgage 12.6% 0.9
Two Harbors (NYS: TWO) 12% 1.0
ARMOUR Residential REIT (NYS: ARR) 8.1% 1.0
Annaly Capital (NYS: NLY) 5.1% 1.0
PennyMac Mortgage Investment Trust 2.8% 0.9
Hatteras Financial 1.9% 1.0

Source: S&P Capital IQ.

The massive dividends in this space proved a lifesaver for these winners. For example, without dividends, CYS returned only 3%. In fact, only CYS, Capstead, and NorthStar eked out positive returns before dividends.

A flattish stock price and a double-digit dividend are perfectly fine for investors. However, before buying in, consider the macro factors that could reduce those dividends as well as the company-specific strategies and management.

If you're looking for other opportunities in the financial space, let me leave you with a regional bank that has some of the best operational numbers I've ever seen. I wrote about it in our brand new free report: "The Stocks Only the Smartest Investors Are Buying." I invite you to take a free copy and find out the name of the bank I believe Warren Buffett would be interested in if he could still invest in small banks.

At the time this article was published Anand Chokkavelu doesn't own shares of any company mentioned. The Motley Fool owns, and Motley Fool newsletter services have recommended buying, shares of Annaly Capital Management. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Terry Clinez

Mortgage refinancing may be able to offer you benefits such as reducing your monthly payment, lowering the interest expenses you pay over the life of the loan, and/or increasing your cash flow by making more discretionary funds available to you every month. Check 123 Refinance to find refi rates in 3 sec.

December 29 2011 at 12:42 AM Report abuse rate up rate down Reply