There has been some really strong news recently from the two big mREIT companies, Annaly Capital (NYSE:NLY) and American Capital (NASDAQ:AGNC). Both companies have launched an assault against the Fed action of buying more mortgage backed securities to the tune of $40 billion each and every month, for as long as it takes the economy to heal.
The big move by NLY and AGNC was to buy back their own shares at the recently reduced prices. Those are bold and smart moves by these firms, and shows the extraordinary leadership and management that each have. The share prices have even risen on this news. That being said, the headwinds still remain the same for each of these stocks and I would avoid them for now if you do not already own them.
If you own them, selling into strength might be a wise move as well.
What Are The Key Reasons To Avoid These Stocks?
Since we already know what the Fed is going to do, then we need to be aware as to how it actually impacts these two companies, as well as all of the companies in the mREIT sector, specifically the ones in the agency backed sector.
- The Fed is continuing to push long term interest rates down. This affects the prepayment rates of existing mortgages at higher rates, which impacts the mREITs profitability.
- Since the Fed is buying an additional $40 billion MBSs each month. they are virtually in the same business as the agency mREITs. This will also impact the mREITs revenues and profits.
- The interest rate spread is staying compressed and with each new round of MBS buying by the Fed, the spread appears to compress further. This will impact profitability of the mREITs.
- With the compressed yield spreads, and the impact of lower profitability, dividends will almost certainly be reduced going forward.
- Annaly and American are very strong companies however they do not have the same cash resources as the Fed. Buying back shares will put off the inevitable crunch of the entire business sector. Simply put, where will this industry be able to make profits?
- NLY and AGNC book values have risen with prepays, and will obviously rise with buy backs. The question remains; what will they do with any cash they have after this buy back program?
- The wild card now is RISING interest rates. Once the Fed takes their foot off the "brake" on the interest rates, they might rise so quickly that the mREIT business will be impacted even further.
As you can see, the yields continue to drop and the spread continues to compress. I anticipate that this will get worse before it gets better. The entire landscape has changed for these agency mREITs, and their business is more difficult that ever before.
Hybrid or non-agency mREITs, such as Two Harbors (NYSE:TWO) and American Capital Mortgage (NASDAQ:MTGE), might be able to navigate through the current landscape more efficiently for now, but even these stocks face the same headwinds, and it might just be a matter of time before the "crunch" hits these stocks as well.
The Bottom Line
I still believe that in spite of both of these great companies efforts, now is not the time to rush back into these stocks. I believe we need to see the Fed get out of the way and let natural market forces begin to work again.
When the dust settles and the smoke has cleared, we can take a good look at these stocks once again, but not before.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.