With the current low-interest rates on cash, CDs and Treasuries, more and more investors are seeking out higher-yielding alternatives to supplement fixed income portfolios. One popular option that offers some of the highest yields among publicly traded equities are agency mortgage REITs.
Mortgage REITs own mortgages on real estate, unlike most REITs, which own and operate real estate. Within the realm of residential mortgage REITs, there are two primary types: those holding residential mortgage-backed securities insured by federal agencies and those that own mortgage backed securities without agency insurance.
Agency mortgage REITs should have portfolios exclusively composed of mortgages insured by federal agencies. Government agencies take numerous mortgages, combine them and then issue the securities. Such agency paper is fairly close to a U.S. Treasury, though it does have added risks and a slightly higher yield. These agency backed securities come with an agency backing and an implied U.S. government backing.
The government has opted to continue bailing out agency securities. Additional borrowers continue to default on agency-backed loans, but the agencies continue to pay on their behalf, initially, and eventually buy out the defaulting mortgage. Such prepayment buying-out of loans has a volatile affect upon an agency REIT's quarterly income, yield and asset valuation, but prepayment is dramatically preferable to an outright default.
This past week, several agency REITs announced their fourth quarter and full year 2011 results, including the two largest agency REITs: American Capital Agency Corp. (NASDAQ:AGNC) and Annaly Capital Management, Inc. (NYSE:NLY). Both reported below expectations, with reduced spreads that are likely to get tighter in the first quarter of 2012.
On Monday, February 6, 2012, American Capital Agency reported net Q4 income of $208.7 million, or $0.99 per share, compared to $1.39 per share during Q3 of 2011. Following their announcement of earnings, AGNC also announced a dividend policy cut, lowering the quarterly payout to $1.25 from 1.40 per share. This was the first time in two and half years that AGNC cut or changed its quarterly dividend.
On Tuesday, February 7, 2012, Annaly reported net Q4 income of 54 cents per share, compared to 60 cents for the same quarter in 2010 and 65 cents for Q3 of 2011. Wall Street expectations were for earnings to be slightly higher, and on average, between 56 and 57 cents per share. Annaly did not yet report on its forthcoming dividend, but a minor dividend reduction appears probable.
Below, I have provided recent performance rates for five reasonably liquid and high yielding Agency Mortgage REITs: American Capital Agency Corp, Annaly Capital Management, Inc, Capstead Mortgage Corp (NYSE:CMO), Cypress Sharpridge Investments (NYSE:CYS) and Hatteras Financial Corp (NYSE:HTS). I have provided 1-week, 2012-to-date and 3-month equity performance rates, as well as each REIT's yield.Click to enlarge
Despite the recent reports by agency REITs that were below Wall Street expectations, these REITs are all positive so far in 2012. The average appreciation by this group so far this year is 4.74 percent. The group's average annual yield now stands at 14.28 percent, though some payouts may come down in the coming weeks.
One reason that these agency REITs are positive this year is that on Wednesday, January 25, 2012, Ben Bernanke updated U.S. interest rate policy in a manner that should benefit agency mREITs. Ben Bernanke commented that the Federal Reserve intends to maintain the Federal Funds Rate near zero through 2014.
Low borrowing rates should help these REITs, at least in the near term, maintain profitable spreads. Additionally, continued low rates should be expected to cause investors to seek out high-yielding income alternatives including REITs. Over the last few years, Federal Reserve comments have generally been positive for agency REITs.
These agency REITs occupy some of the highest-yielding space in most portfolios, but that yield comes with some risks. Exposure to agency REITs should be limited to a reasonable portion of an income oriented portfolio, with the understanding that the dividends are not guaranteed to grow or even be maintained at their current rates in the coming quarters.
Disclosure: I am long (NLY).
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.