Every mREIT (mortgage real estate investment trust) stock has been absolutely decimated in the last month. My favorite mREIT is American Capital Agency (AGNC) and it has been crushed. Annaly Capital (NLY) recently traded under $13.00 for the first time in years. Armour Residential (ARR) was trading below $5.00 for the first time, while Invesco Mortgage (IVR) dipped below $18.00 for the first time in over a year. Despite the pressures on share prices, the latter two stocks were able to maintain their dividends, while AGNC just cut its dividend by 16% to $1.05. This cut was less than expected, as it was widely believed it could be cut to $1.00 or less. At the time of this writing shares are up 2.5% premarket (6/19/13) on the news. But will the dividend boost be enough to counter any news out of Fed this week, which will impact all mREITS?
AGNC Dividend Cut Less Than Expected And Trading Less Than Book Value
The dividend cut was expected because one of the most important indicators of mREIT health, the book value, has likely declined for many mREITs and AGNC was no exception. According to AGNC management's recent presentation, book value was around $26.44 as of June 7th and so it still trades at a discount to its current $25.98 price. With the dividend announcement being better than expected, the stock is signaling buy, but we have to question how we got here.
So why the selloff to begin with? It had started with the belief that the Federal Reserve will be slowing its bond buying program, something that became a real possibility after investors reviewed the May Federal Open Market Committee (FOMC) meeting comments. It is important to remember that these stocks can't catch a break when it comes to the Fed. When they announced purchasing, these mREIT stocks got crushed, and now that the buying may end, they again are getting crushed. I can't predict exactly what will happen during and just after the current June FOMC meeting to these stocks, but I suspect the action will be exceptionally volatile. While the trend has been to the downside lately as a result of interest rate movement, the momentum could change after this meeting.
The Dividend Boost Could be Overshadowed By The June FOMC Meeting Which Begins This Week
Starting today (6/19/13) the FOMC will begin its meeting. I think this meeting is the most important one so far for the near-term action in mREITS as they will likely announce when the third round of quantitative easing will end and when mortgage asset purchases will slow or eventually cease. While the minutes will not be released until well after the meeting, everyone will be watching and listening for any clues in Mr. Bernanke's post-meeting talk. Any decision made during this FOMC meeting will have a significant impact on mREIT prices (either up or down) in the short-term, and could impact interest rates immediately.
The meeting could immediately have an impact on interest rates because I suspect the recent rise in rates will be a topic of discussion. Ben Bernanke certainly must realize that rates have to rise eventually to maintain a healthy market, but the rapid increase in the last month potentially puts the housing recovery at risk as less people will be able to afford a mortgage with a higher interest rate. These rising interest rates were the primary driver of the selling action in the mREITs. This has led to the interest spread widening, which is good in the long-term for mREITS. However, the rising interest rates led to pain in the mortgage backed security (MBS) values, as they have sold off tremendously in the last 6 weeks, which will directly impact the mREITs' holdings. As one of the positives for these companies has been that the long-term interest rate has expanded at a greater pace than the short-term rates we need to be cognizant that the FOMC meeting could center on slowing the growth in long-term rates. This in turn could put a stop to the widening of the yield curve which could means that companies like AGNC and NLY might make less money. While I have warned of a flattening of the yield curve in the past and it seems the curve is actually widening right now, it all could change after this meeting. The pressure in MBS prices has hurt mREITs as well, and I think that reassurance from the Fed that it will continue its asset purchases could result in a bounce in prices, and in turn a bounce in the mREIT stocks.
The Fed's Time Table
In a recent report in the Financial Times that rocked markets upon its release, it was suggested that it is quite likely that Ben Bernanke will inform us the end is near for the asset purchases. At the very least, we are likely to have an inclination as to how close the Fed is to tapering its bond buying programs. US data has been improving slowly; however, unemployment is still well above the Fed's target of 6.5%. This may be the one key to Bernanke maintaining/extending asset purchases, which I think would be a catalyst in a positive direction for the mREITs.
Understanding the Fed's time table is critical. When will, and what will the motivation be for ceasing asset purchasing? I believe that it is still the 6.5% unemployment rate. Bernanke and the FOMC could change this to a higher number, but that is the current target at which the Fed has indicated purchases would stop, despite any other positive economic news. Should Bernanke reassure investors and the market that the Fed will continue purchasing, it could also calm the movement in interest rates. Ideally we would like to see the long-term rates stabilize for now while the shorter term rates hold steady or decline which would allow time for mREIT management to successfully reposition their portfolios during this changing interest rate and MBS market.
The Dividend Announcement is a Buy Signal But Plan Accordingly For The FOMC Volatility
There is no question this dividend cut was coming, but it is indeed less than expected. Numerous articles on Seeking Alpha analyzed the potential cut (including from this author) and it was generally believed to be in the $0.80 to $1.10 range. I called for $1.00-$1.10. So it hit the upper part of range. Therefore I expect to see some buying and wouldn't blame anyone for buying at the open today (6/19/13). However, this FOMC meeting will be a critical catalyst to the future action in mREITs. I'm less concerned about the stock prices of mREITs in the short-term than I am about any discussion of the Fed's view of interest rates, which will have a longer-term impact.
Regardless of what is announced, expect to see volatility in the names, especially AGNC, which just announced this major news. Fellow mREIT holders should be prepared for this volatility in their positions following this meeting. Those who are in this for the long-term could use a several percentage point drop to add to their positions as a decline could be just another opportunity to add to long-term holdings. Those who have come in looking for bargains last week when the mREITs hit a short-term bottom could make a profitable trade if we see a 4%-6% spike in these names if the speech is interpreted as good news. For those holding options, expect the short-term implied volatility to give a boost to options premiums now and shortly after the meeting. One potentially profitable move for those willing to get long these names (which many are bargains now), is to sell some July or August out of the money puts. Collect a premium and if the stock drops enough, you get long at that price. Those holders who are worried about a decline could raise cash selling some calls, but you will cut off your upside. I think the best course of action is to listen, plan your strategy and execute. I personally will be expanding my mREIT holdings if I see a 5% decline in AGNC or NLY. IVR and ARR are discounts below $18 and $4.75 respectively. So I bless buying the AGNC dividend announcement as it is good news being a less than expected cut, but be prepared for the Fed and plan accordingly.