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Two Mortgage REIT Picks for 2014

Tickers in this article: AGNC TWO
NEW YORK (TheStreet) --Mortgage REITs offer value as a sector following a sharp selloff in 2013, according to a Credit Suisse report published Friday.

Credit Suisse analyst Douglas Harter expects a 6% total return for the sector as a whole, with book values declines of 4% being offset by hefty 10% dividends.

The business model of many mortgage REITs is to fund themselves for short periods of time and then, using leverage, to buy longer-dated mortgage-backed securities and debt issued by U.S. agencies such as Fannie Mae and Freddie Mac . But when bonds sell off, it creates a problem for the REITs since their funding costs rise while the value of the securities they hold declines.

Nonetheless, mortgage REITs were defensively positioned for the rise in long term interest rates in the fourth quarter, as the Federal Reserve announced it would finally begin tapering its $85 billion in monthly bond purchases.

Harter favors Two Harbors Investment Corp. and American Capital Agency Corp. as his top sector picks.

Harter singles out Two Harbors "for its risk/reward profile coupled with the potential to ultimately receive a better valuation as it grows the capital allocation to [mortgage servicing rights]and jumbo securitizations. He favors American Capital Agency "given its current hedging, asset mix, and 23% discount to book value."

TWO Chart data by YCharts-- Written by Dan Freed in New York.