The 'Catch 22' Of The mREIT Sector

by: Regarded Solutions

At the risk of reading all sorts of negative comments telling me how wrong I am, or worse, I am going to lay out why I believe the entire mREIT sector should be avoided by those of us who are either retired or on the verge of retiring.

First, I found a Seeking Alpha "Market Current" today, very odd. It seems to me it only adds to the debate, or confusion. For me there is no confusion. The entire mREIT sector is in a "Catch 22" situation.

Whether the "news" is something like this (the SA Market Current from around 1PM today):

Mortgage REITs welcome jobs news

  • Throwing a small party in wake of the slow jobs number and resultant tumble in interest rates is the mREIT sector (REM +1.5%). The stocks were mercilessly punished all late spring and summer as interest rates rose, but have regained their footing since about September. The 10-year Treasury yield is at a 3-month low of 2.53%.

  • Sector giants American Capital (AGNC +2%) and Annaly (NLY +1.5%) are now up about 15% from their 52-week lows set a couple of months ago.

  • Sector fans will recall the stocks getting hit late in 2012 over fears rates - rate spreads, actually - were too low for the companies to earn any return on. With the taper off the table, will those worries return? Tough business.

  • Other big movers today: Invesco (IVR +2.6%), Hatteras (HTS +2.9%), CYS (CYS +2.8%), Anworth (ANH +4.7%), New York Mortgage (NYMT +1.5%), Western Asset (WMC +1.1%).

Or, whether the news is something like this:

After reaching their highest level in nearly four years in August, existing-home sales dropped in September thanks to limited inventory and rising home prices, according to the National Association of Realtors (NAR)....Total existing-home sales-measured as completed transactions of single-family homes, townhomes, condos, and co-ops-fell 1.9 percent in September to a seasonally adjusted annual rate of 5.29 million. August's sales were revised downward to 5.39 million.

In the first pronouncement of mREITs welcoming the jobs news, what actually does that mean? Keep in mind that income levels have not risen, but mortgage rates certainly have. Does it mean the just because the unemployment rate dropped to 7.2% that mREITs are now in the clear? Not in my book.

Actually the news that less homes are being sold is much more of a negative than $148k new jobs being created.

What About Interest Rates?

With the ballyhoo of what I still consider to be an anemic jobs report, does it mean that the Federal Reserve can once again start a new round of "taper talk"? Perhaps. That is NOT something the mREIT sector wants to go through again, is it?

Interest rates are already climbing (excluding today) even without the Fed doing any tapering.

US 30 Year Mortgage Rate Chart
(Click to enlarge)

In a one year period the 30 year mortgage rate has climbed more than 100 basis points. At the same time, the two most "significant" mREITs, Annaly Capital , and American Capital , have also had to cut dividends and have seen their share prices plummet.

NLY Chart
(Click to enlarge)

AGNC Chart
(Click to enlarge)

Is this just a coincidence? I do not believe in these kinds of coincidences. The correlation of higher mortgage rates, which has led to less mortgage applications (off by 57% year over year), has also led to a complete deterioration of shareholder value of these two stocks, and most of the others in the mREIT sector.

By the same token, it does appear that the HARP program is picking up steam, even as regular refinancing dipped.

August's rising mortgage rates continued to impact refinance numbers reported by Fannie Mae and Freddie Mac, according to the Federal Housing Finance Agency's (FHFA) latest data.......HARP share increased, with volume representing 23 percent of total refinance activity during the month compared to 22 percent in July......Since HARP started, approximately 2.5 million refinances going through the program have been for primary residences, with 92.6 million made for second homes. The remainder (338,495) have been for investment properties.

The HARP numbers will impact the mREITs negatively, the higher mortgage rates will impact loan applications, which in turn will negatively impact the mREITs, and lower housing sales will ultimately impact the mREITs negatively.

Will higher employment help the mREITs? Maybe so, but I see it as a selling opportunity, not a road to "nirvana" for these battered stocks.

The "Other" Catch 22

So let's assume that the employment numbers begin to heat up and salaries begin to rise, and people start buying homes. Sounds great right?

Not so fast.

The Fed will likely take their foot off the brakes, interest rates will rise and the mREITs could be left holding a bunch of puny paying mortgages. If the rates rise fast enough, the mREITs will not be able to turn over their inventory fast enough, and the hedging in place becomes almost unmanageable from my viewpoint.

To summarize; these stocks are too risky and have too many unknowns for a SWAN investment. Retirees and those close to retired should avoid this sector for now.

Let the tomato tossing commence!

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.