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, with many subcategories and hybrid types also existing.
Agency mortgage REITs should have portfolios exclusively composed of residential mortgage backed securities insured by federal agencies. The government agencies underwrite mortgages and then issue such mortgage backed securities. 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 agency mREITs for their yields and the perceived safety that the implied government backing generates.
Though numerous borrowers have defaulted over the last three to four years and more continue to default on agency-backed loans each day, the agencies continue to pay and/or buy out the defaulting obligations and the government continues to fund the operation. Prepayment buying of mortgages upon which borrowers defaulted has a volatile and often unpredictable affect upon a mREIT's quarterly income, its yield, asset valuation and the spread or margin that the mREIT can achieve. Nonetheless, prepayment is considerably preferable to an actual 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. Agency mREITs now have leverage rates between five and nine times their asset valuations, and some of the more leveraged have been increasing their leverage over time.
Below, I have provided recent performance rates for five reasonably liquid and high yielding Agency Mortgage REITs: American Capital Agency Corp. (AGNC), Annaly Capital Management, Inc. (NLY), Anworth Mortgage Asset Corporation (ANH), Capstead Mortgage Corp (CMO) and Hatteras Financial Corp (HTS). I have provided one-week, one-month, 2012-to-date and six-month equity performance rates, as well as each REIT's yield.
And below is a 2012-to-date performance comparison chart:
As mentioned above, agency mREITs achieve their substantial yields through leverage. If these mREITs do not effectively hedge or curb their leverage usage, leverage risk will one day become a significant concern.
On March 7, AGNC announced a large secondary for gross proceeds of about $2.0 billion, following the stock going ex-dividend. The mREIT distributed a $1.25 quarterly dividend after 10 quarters of maintaining a $1.40 dividend. Then earlier this week, on March 26, HTS announced its own secondary, also in the wake of going ex-dividend.
Annaly, the largest agency mREIT, goes ex-dividend on Wednesday, March 28, and many investors may now expect Annaly to follow suit with its own secondary shortly thereafter. Annaly currently has one of the lower leverage rates within the agency mREIT industry and has refrained from issuing a secondary offering since shortly before the debt ceiling spectacle last summer.
If interest rates do eventually spike up, or when they do, leveraged agency mREITs may suffer reduced spreads and should sustain leveraged reductions to their book values that could end up overshadowing the yield. 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.
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.