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On the day the Federal Reserve announced "QE Infinity" the broader stock market celebrated, but Annaly Capital (NLY) shares dropped by 1.3%. Now, Annaly's decline was more likely due to an SEC filing that day and not the Fed's quantitative easing program, given that its peers American Capital Agency (AGNC) and Chimera (CIM) fared well. Nonetheless, I believe the Fed's mortgage-backed securities purchases do work against Annaly and its peers over the short-term.

On September 13, when the Federal Open Market Committee (FOMC) issued its monetary policy statement, I was in the process of studying Annaly's listed "Risk Factors" found within its 10K Annual Report. Risk was the focus of my two part series on Annaly and mREITs in September, in which I asked whether the investment class was the right sort of investment for seniors (see Part I and Part II).

Potential risks are one thing; the realization of risks is another. Given QE3, some of Annaly's potential risks are now closer to being realized. The Federal Reserve committed to purchase agency mortgage-backed securities at a pace of $40 billion per month. That's added demand in the market where mortgage REITs buy income producing assets. Raised demand for MBS drives prices higher, raising the cost for mREITs, and at the same time, lowering the yield paid by MBS, or the payoff for companies like Annaly. It effectively pressures the REIT's net interest margin.

The Fed will also continue its efforts to lengthen the maturity of its holdings, which could have some influence toward flattening the yield curve. In my view, that is not likely to happen any time soon, due to the shape of the global economy and the safety U.S. treasuries continue to represent. However, the situation could change as the fiscal cliff nears. If it does, it would be bad news for Annaly and its peers, because it would further pressure net interest margins by raising borrowing costs for these firms while yields stay low on their income earning assets.

I have one final concern about mREITs that is being catalyzed by the Federal Reserve. As mortgage rates have come down, and given the nascent gains of home prices, mortgage refinancing is becoming an option for an increasing number of Americans. Last week, the Mortgage Bankers Association ((MBA)) reported that volume remained near its three-year high. The various forms of mortgage loans saw rates reach or flirt with historical record lows. In the past, refinancing has been limited because many homeowners who had purchased toward the last two years of the real estate bubble remained underwater. However, with home prices now rising, refinancing increasingly becomes an option for many to lower their cost of homeownership and living. When this happens, some mortgage-backed securities are affected, with the return opportunity for mortgage REITs reduced on the prepayment of higher yielding mortgages. In a recovering real estate market and low rate environment, eventually the yields earned by mREITs will diminish or the prices of the securities will decrease.

Company & Ticker

Change Since Sept. 12

Annaly Capital

-9.7%

Chimera

-1.1%

Two Harbors Investment (TWO)

-0.7%

CYS Investments (CYS)

-8.1%

Hatteras Financial (HTS)

-8.5%

MFA Financial (MFA)

-2.3%

Crexus Investment (CXS)

+5.8%

The shares of major mREITs, some of which are listed here, have produced mixed results since the Fed's latest quantitative easing announcement. The shares of several are down by nearly 10%, though some have paid dividends in the span, which impacts share value. Still, the impact of the Fed's latest actions could become clear should the risks discussed here be realized.

Source: Why QE Infinity Is Bad For Annaly