Confusion From The Fed Has Driven These mREITs Into Bargain Territory

| About: Annaly Capital (NLY)

I have read and re-read the press release from the Federal Reserve, as well as the comments made by Ben Bernanke himself. I have come to the conclusion that two of the largest mREITs have been pushed into the "bargain category", just from the confusion that the Fed itself has sparked.

Yes, interest rates have risen on the longer end. That has made the unwinding of positions held by these mREITs more challenging, but I also believe that the reaction has been based more out of panic, than of reality.

Just look at what the press release stated:

The Committee is prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes. In determining the size, pace, and composition of its asset purchases, the Committee will continue to take appropriate account of the likely efficacy and costs of such purchases as well as the extent of progress toward its economic objectives.

In my tiny brain, it appears that the Fed could go either way, right? Given the fact that mortgage rates have risen, and mortgage applications have continued to drop, which way do YOU think the Fed will lean towards?

Here is another excerpt from the press release pertaining to interest rate policies in place:

To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee's 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.

It seems to me, the Fed will keep the shorter term rates at current levels for even longer than the long term rates. As far as I am concerned, the Fed has no real choice in the entire mess, unless they want to derail the housing recovery, send us back into a recessionary spiral that would be harder to extricate ourselves from, than when they first began the easy money train ride.

Keep in mind that one of the ways that both of these companies generate profits, is by using the spread between the short and long term interest rates. As long as the zero interest rate policy (ZIRP) is still in place, the spread on the yield curve is actually widening more than it has in a few years!

US 30 Year Mortgage Rate Chart

The spread has gone from a touch over 125 basis points to 208 basis points, and while both Annaly (NYSE:NLY) and American Capital (NASDAQ:AGNC) have obviously been adjusting their portfolios and hedges, the truth of the matter is that these figures give me an indication that both of these companies will become even more profitable going forward.

The Sharp Price Drops Seems To Have Overshot Reality

Both Annaly and American Capital have taken extreme hits to their share prices in the last few weeks with all of the uncertainty.

NLY Chart

With a recent book value of roughly $15.00/share (yes it might have dropped since the last announcement, but probably not very much) the share price of NLY is now selling at a rather significant discount to BV as the share price sits at roughly 83% of book.

AGNC Chart

The share price of AGNC has taken an even larger hit. Dropping from nearly $30.00/share, the price to book value now sits at only 81%. I believe the difference between NLY and AGNC is due to the higher degree of leverage that AGNC has used, and each of the companies hedging strategies, which are always a moving target, and not very clear to know.

The question now has become if these stocks are now oversold. I believe they are.

Chatter Versus Reality

With all of the chatter about the impending unwinding of QE, or the tapering of the Fed policies, the fact of the matter is that absolutely nothing has changed with the policies.

  • ZIRP remains intact.
  • Asset purchases have not changed one penny.
  • The target goals of the Fed (see the first section here) have not changed.

If these fundamental policies and facts have remained the same, then it is my belief that fear and panic have been the driving force behind both of these stocks share price decline, more than anything else.

Keep in mind, there is someone buying when someone else is selling. I am NOT advocating that investors start backing up the truck to load up on these risk laden stocks, because another reality is that these stocks could be further impacted. Either by more fear and panic, or an actual change in Fed policy (which has NOT happened).

As stated by the Fed itself, the short term zero interest rate policy is staying in place, period. Even if the Fed begins to taper off of asset purchases, I believe the spread will become even wider, and as both NLY and AGNC adjust to the NEW reality, they will potentially become even more profitable.

The Bottom Line

I own NLY and I am not selling the shares. The recent cut in dividends from $.45/share to $.40/share is still very attractive, and if the share price drops further, the yield on cost will attract even more dividend seeking investors.

I am going to avoid the noise, stick to the facts, and keep my eyes wide open as I do with any risk investment, but I do believe that both of these stocks are becoming compelling for a risk allocation of between 2-4% in a dividend income portfolio.

Disclaimer: The opinions of the author are not recommendations to either buy or sell any security. Please do your own research prior to making any investment decisions.

Disclosure: I am long NLY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.