Mortgage REITs own the mortgages on real estate rather than the property. Some mortgage REITs concentrate on commercial mortgages, while others concentrate on residential property mortgages. Agency mortgages are backed by federal agencies, while non-agency debt has no such backing.
Most of these mREITs have recently performed poorly over the last month and into the strong sell-off within August. Mortgage REITs have been hit by added risks such as the debt ceiling debate, debt downgrading, interest rate fluctuations hurting their spreads and further real estate weakness causing defaults and reduced MBS paper value.
Most mortgage REITs produce high yield returns by leveraging a spread. The spread is the profit margin the REIT can achieve between the rate on the money they borrow and the rate paid by the mortgage paper they hold. For example, if a company can borrow at 3% and buy paper that yields 5%, the spread is 2%. The level of leverage used by the REIT then multiplies that spread payout. A major risk for mortgage REITs has been that the spreads will get hurt due to increasing interest rates decreasing the spreads due to a raise in borrowing costs.
Yesterday, Ben Bernanke added some greater certainty to the interest rate question. Prior to today, the Federal Reserve comment as to the interest rate was that it would be kept low for an extended period. The problem there was that it is unclear what an extended period is, and whether it has already been one of those. As a result, and especially due to the end of QE2, many people have estimated that the Federal Reserve would soon facilitate a rising rate. Yesterday, though, the Federal Reserve Board stated that it would keep the Federal Funds Rate near zero through mid-2013. The reasoning by the fed was due to a diminished economic outlook.
This is arguably a good or bad policy for the nation, but it is most certainly good for Mortgage REIT spreads, by ensuring that the borrowing rates will stay under pressure for the next few years. As a result of this reduced uncertainty, several mortgage REITs have exceptional days today, with many increasing at double the rate of the broader market. Below are yesterday’s performances and present yields for seven well-known mREITs.
American Capital Agency Corp. (AGNC)
- Current Yield: 19.7%
- 1 Day Performance: 11.39%
Annaly Capital Management, Inc (NLY)
- Current Yield: 14.5%
- 1 Day Performance: 9.3%
Hatteras Financial Corp (HTS)
- Current Yield: 13.9%
- 1 Day Performance: 10.15%
Chimera Investment Corporation (CIM)
- Current Yield: 16.7%
- 1 Day Performance: 10.88%
Cypress Sharpridge Investments (CYS)
- Current Yield: 19.1%
- 1 Day Performance: 9.53%
Invesco Mortgage Capital, Inc. (IVR)
- Current Yield: 18.5%
- 1 Day Performance: 10.27%
MFA Financial (MFA)
- Current Yield: 12.8%
- 1 Day Performance: 11.72%
These substantial 1-day increases are not exclusively due to the Federal Reserve Board’s comments, as this was an exceptionally positive day for the broader market. Nonetheless, the uncertainty that the Fed now eliminated is of special note to these mREITs as it is one of their greater risks.
The explanation of what an extended period means now makes it much easier to forecast borrowing costs, and the decrease in risk was priced into the mREITs’ shares. This should help mREITs maintain their spreads. Additionally, this makes the high yield aspect of these mREITs even more appealing, as the risk free rate will be under continued pressure going forward.
REITs must distribute at least 90% of their taxable income in order to eliminate the need to pay income tax at the corporate level. Under the current tax laws, REIT dividends are taxed as ordinary income, and not at the lower corporate dividend rate.
Disclaimer: This article is intended to be informative and should not be construed as personalized advice as it does not take into account your specific situation or objectives.