Based on the data compiled as the result of a recent Reuters survey, the Fed will have purchased a total of $1.25 trillion in bonds by the end of its third installment of Quantitative Easing. The ranges of estimates from a number of people whom The Fed has purchased these bonds range from $885 billion to $1.6 trillion, and most conclude that these purchases will last well into 2014.
According to Tom Simons, an economist at Jefferies & Co. in New York, "The Fed will want to see a sustained improvement in the outlook for the labor market before making adjustments to policy. Given the significant volatility in recent months, we highly doubt that the Fed will be quick to adjust their outlook. Lastly, the recent decline in the inflation data suggests that the Fed will continue to be accommodative even as the labor market continues to heal".
So how will the above mentioned bond purchases affect two of the more well-known agency Mortgage REITs and their performance over the next 12 months? In an effort to demonstrate why I think such purchases will hinder the near-term performance of both firms I've not only broken down each company's most recent quarterly results but highlighted two of the more important catalysts investors need to consider before investing in either of these high-risk agency-mortgage REIT plays.
Q1 Earnings Comparison
Annaly Capital (NLY) (Yield: 11.90%, Dividend $1.80): Included in the company's quarterly results were a number of key comparisons. The company's Q1 income of $0.47/share demonstrates a slight improvement over its Q4 income of $0.46/share, but still trails the performance of last year's Q1 by a margin of $0.07/share (during Q1 2012, Annaly had earned income of $0.54/share). Annaly's Constant Prepayment Rates were 18% (Quarter Ending 03/31/13), 19% (Quarter Ending 12/31/12) and 19% (Quarter Ending 03/31/12). I personally think that if Annaly Capital continues to seek out various diversification opportunities, the company may be able to deflect some of the pressure it faces as a direct result of the Federal Reserve's purchasing policy under the auspices of QE3.
American Capital Agency (AGNC) (Yield: 16.30%, Dividend $5.00): As most investors already know the company's quarterly performance lacked in several categories. The company's Q1 income of $0.64/share helped minimize its comprehensive loss per share of $2.21, which occurred as a result of the company's secondary offering which took place on February 27th. American Capital Agency's Constant Prepayment Rates were 10% (Quarter Ending 03/31/13), 11% (Quarter Ending 12/31/12) and 10% (Quarter Ending 03/31/12). The risks associated with the company's secondary offering, clearly haven't paid off and by coupling that transaction with the pressure of the Federal Reserve, a near-term investment at current levels may be a rush to judgment when it comes to AGNC, especially since Dane Bowler thinks shares will bottom at around $25/share.
For those you who may be looking to establish a position in either Annaly Capital or American Capital Agency there are two important cautionary catalysts to keep in mind.
The first catalyst any potential investor (or current shareholder) needs to consider is obviously the Federal Reserve. With an estimated $1.25 trillion being spent on MBS and Treasuries as part of its Quantitative Easing policy, who says the Fed's spending won't climb higher if economic improvement is unable to be sustained? Unfortunately there is no clear answer to that question, and as investors, we must brace ourselves for the worst and hope for the best.
The second thing that must be considered is this idea that mortgage REITs are a formidable safe-haven given their double digit yields. My Seeking Alpha colleague Regarded Solutions put it best when he noted, "To tell investors that a stock in the mREIT sector is a safe haven is more than misleading, it could be dangerous. The entire sector is fraught with headwinds, many of which are not in the control of the company. If any of the headwinds come to pass, and they always do, an investment in any of the stocks in the sector will be hit very hard".
By closely examining the risks associated with the sector (such as the Fed's spending policy, and the possibility of additional housing programs similar in scope to HAMP or HARP), only then can we truly understand the fact that although these yields seem attractive at present levels there may be a chance dividends could be reduced even further over the next 12 months if and when any of these headwinds begin to factor in.
It's pretty incredible to think that the Federal Reserve will not only purchase $1.25 trillion in bonds by the end of QE3 but on the same token create one the most attractive buying opportunities investors in the Mortgage REIT sector have ever seen. Why do I think an attractive buying opportunity has been created? For the simple reason that the Federal Reserve's third round of quantitative easing must come to an end.
Since QE3's initiation on September 12th 2012, both Annaly and American Capital have fallen just over 14%, and as a result of those sell-offs investors should begin to reconsider a position in either mortgage REIT play. Why? I strongly believe that once QE3 ends, an immediate pop in share price could occur and if we couple that with any interim dividend distributions investors may have received, the near-term growth could end up being quite favorable.