The Tide Has Gone Out On mREITs And Might Get Worse

Includes: AGNC, NLY
by: Regarded Solutions

The risks are evident within the agency mREIT business sector. With the Fed purchasing an extra $40 billion in MBS's each month, virtually "forever", one cannot fight the Fed for very long. Companies such as Annaly Capital (NYSE:NLY) and American Capital (NASDAQ:AGNC) are facing similar issues, and even with their spectacular management teams, they do not have the printing presses at their disposal to play the Fed's game for very long.

The tide has gone out on these companies for now, and I have absolutely no idea when the trend will reverse. The simple facts remain that in the short and intermediate term, these stocks are riskier now than they have ever been. I will not be placing any long term bets either.

The Unavoidable Issues Being Faced Right Now

  • The spreads have narrowed and could continue to narrow and impact profits.
  • Prepayments have become increasingly apparent and will impact profits.
  • The influx of cash to the companies has no place to go but to purchase their own shares back, and that cannot go on forever.
  • Dividends will likely be cut dramatically in the coming quarters.
  • As dividends are cut investors will flee from the stocks to seek other dividend paying investments.
  • Once investors flee the stocks the share prices will drop further. To me this could be a "doom loop" until the Fed gets out of the business.

Recent Developments

Annaly just came out with a miserable earnings report and the stock is getting beaten up right now. This "Market Current" says quite a bit:

"9:39 AM Annaly (NLY) slides 3% in early action following last night's earnings report - likely the worst of the mREIT sector - and the just-completed conference call. "Our balance sheet is not a trading vehicle," says the CEO, maybe disappointing those hoping for asset sales to lock in high MBS prices and fund buybacks/dividends. Nevertheless, book value is $16.60. It's hard to see the shares - now at $15.41 - a whole lot lower."

Maybe the share price right now is low, but as the CEO has said, this is not a trading vehicle. Yes I realize that the BV is at $16.60, but where will they invest cash now? I believe that their dividend will be cut significantly. I have no idea where the bottom is for the share price, but it has gone down well below $8 bucks in the past.

On the other hand, American had a stellar earnings report and the stock popped on the news but has since backed off. I believe the smarter money realizes that just because AGNC had a great quarter, that the future is less rosy than the company has stated in their conference call.

Actually this Market Current says more than the entire conference call as far as I am concerned:

"Thursday 9:27 AM Mortgage REIT owners shouldn't take any comfort from recent downticks in mortgage refinance activity, says American Capital Agency CEO Gary Kain on the earnings call. Interest rates ticked up a bit and mortgage companies have capacity issues, but don't expect either to last. He again points out, AGNC's concentration on low balance mortgages protects it somewhat from prepayment risk."

Kain seems to be speaking out of both sides of his mouth, and that is not a knock, but he says he is comfy in the conference call, but then says that shareholders "shouldn't take any comfort" in the very issue that is hazardous to the mREIT sector. I think he is quite correct that shareholders should take no comfort. The entire situation is not good, and murky at best.

Future Scenarios Could Be Even Worse

What would happen if the Fed decides to double down on the $40 billion after the election? After all, they doubled down on HARP, HAMP and HAMP II when those programs did not live up to the hype. What would happen if the Fed takes their foot off of the zero interest policy brake; ZIRP, and let short term rates float higher for savers, but keeps putting downward pressure on long term rates? That COULD see the yield curve invert, and then ALL bets are off for this sector.

If the yield curve inverts, then these companies cannot make any money. If they do not make money, then they will not pay dividends, and as a shareholder of NLY in the past I have seen the dividends cut down to $.04/share. I was younger back then and the environment was completely different.

The Fed was not in the mREIT business as they are today.

The next scenario is that the Fed stops everything and interest rates soar higher quickly. In that scenario, the mREIT sector would not be able to unload inventory quickly enough if at all, and their business will suffer further.

The only scenario that would bring me back to the mREIT sector would be if the Fed kept the zero interest rate policy, but stopped buying MBS's. Period.

The Bottom Line

For now, I think these stocks are dead in the water for my risk tolerance.

Take one more peek at the price charts up there. At today's share prices versus just about a month ago, shareholders have given up 3 dividends if the share prices stay this way, even if the dividends do NOT get cut. Not a pretty picture for now.

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.