Mortgage REITs own mortgages on real estate. Within the world of residential mortgage REITs, there are two primary types: those holding residential mortgage backed securities insured by federal agencies and those that own RMBSs without agency insurance. Many subcategories and hybrid types also exist.
Agency mortgage REITs should have portfolios exclusively composed of residential mortgage backed securities insured by federal agencies. Government agencies make mortgages and then issue a mortgage backed security. These agency RMBSs come with an agency backing and an implied U.S. government backing.
Due to the recent and continuing low-interest rate environment with cash, CDs and Treasuries, many investors are looking for higher-yielding alternatives to supplement fixed income portfolios. One popular option now offering some of the highest dividends among publicly traded equities would be agency mortgage REITs. Investors flock to thighhe yields and the perceived safety that the implied government backing generates.
Though numerous borrowers have defaulted and many more continue to default on agency-backed loans, agencies continue to pay and/or buy out the defaulting obligations. Prepayment buying of loans often has a volatile affect upon a mREIT's quarterly income, its yield and asset valuation, but prepayment is considerably preferable to a true default. Another concern is that rising interest rates could hurt the assets held by these mREITs, most of which leverage their assets in order to multiply the return. If rates rise, then the assets they hold may have similarly multiplied losses.
Below, I have provided recent performance rates for five reasonably liquid and high yielding Agency Mortgage REITs: American Capital Agency Corp. (NASDAQ:AGNC), Annaly Capital Management, Inc. (NYSE:NLY), Anworth Mortgage Asset Corporation (NYSE:ANH), Capstead Mortgage Corp (NYSE:CMO) and Hatteras Financial Corp (NYSE:HTS). I have provided one-week, 2012-to-date and three-month equity performance rates, as well as each REIT's yield.Click to enlarge
And below is a 2012-to-date performance comparison chart:
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Most investors came to these names for their yields and not for price appreciation, but they will take the 6.38% average equity appreciation so far in 2012. Some of this recent strength is likely due to Ben Bernanke's extending the estimated time frame for keeping the Federal Funds Rate near zero through 2014.
As mentioned above, agency mREITs achieve their substantial yields through leverage. These listed REITs last reported leverage rates between 5x and 8x assets. If these mREITs do not effectively hedge or curb their leverage usage, leverage risk will one day become a significant concern.
If interest rates do eventually spike up, or when they do, leveraged agency mREITs will likely suffer not only reduced spreads but also leveraged reductions to their book values. Nonetheless, until that happens these agency REITs should continue to occupy some of the highest-yielding space in the market.
Because of the risks associated with such leverage and potential peaking of Treasury valuations, exposure to agency mREITs should be limited to a reasonable percentage of a portfolio, based upon your risk profile, time-horizon, income needs and other investments. Additionally, most REIT dividends are taxed as regular income and not at the lower corporate dividend rate, making them substantially better performing investments when held within tax deferred or exempt accounts.
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.