Seeking Alpha

Growing thoughts of a tapering and then ending of QE∞ triggers panicky selling in the...

Growing thoughts of a tapering and then ending of QE∞ triggers panicky selling in the mREIT sector (MORT -2.3%) as Treasury yields hit their highest level in more than a year (the 10-year at 2.12%), and mortgage prices slide as well (MBB -0.4%). Leading the way is a 5.3% decline in American Capital Agency. Annaly (NLY -2.7%), Two Harbors (TWO -3%), Anworth (ANH -2.2%), Western Asset (WMC -4.7%), Apollo Residential (AMTG -3.7%), Javelin (JMI -4.3%), Invesco (IVR -1.8%), MFA Financial (MFA -1.5%).
Comments (83)
  • kmi
    , contributor
    Comments (3995) | Send Message
     
    mReits in falling knife mode...
    28 May 2013, 01:44 PM Reply Like
  • Dividend Pros
    , contributor
    Comments (154) | Send Message
     
    Predicted the exact same thing in this article: http://seekingalpha.co...
    28 May 2013, 02:45 PM Reply Like
  • tomlos
    , contributor
    Comments (1108) | Send Message
     
    Thoughts on a long term ownership positive in something mature like NLY? Will they be able to maintain an above average dividend (5%+)?
    28 May 2013, 01:53 PM Reply Like
  • Paulo Santos
    , contributor
    Comments (18319) | Send Message
     
    With any luck they'll go BK at some point. What is NLY and the mREITs in general? Just a giant levered bet on yield producing assets, and these assets would turn into long duration fixed income in the event of a jump in rates.

     

    Most of these things would blow up in such a scenario.
    28 May 2013, 03:12 PM Reply Like
  • Tack
    , contributor
    Comments (13002) | Send Message
     
    PS:

     

    You speak as though the MREITs have never seen high rates before. Most of these names have lived through 9+% rates before. They'll do it again, although one wants to watch, rather than own during the rising-rate environment.
    28 May 2013, 06:22 PM Reply Like
  • Paulo Santos
    , contributor
    Comments (18319) | Send Message
     
    Tack, it's very different living with 9% rates when you start with 9% rates, and living with, say, 5% rates when you start with 2% rates.
    28 May 2013, 06:26 PM Reply Like
  • Tack
    , contributor
    Comments (13002) | Send Message
     
    PS> I don't think the guys who run these things were born yesterday. Most of the older MREITs have very experienced management and have hedges in play.

     

    I don't say this because I recommend buying them at this moment in time, as they'll get squeezed and, no doubt, suffer dividend cuts. I just don't see them "blowing up" or going bankrupt. If the market prices them like that, then, that will be the time to buy them, again.
    28 May 2013, 06:30 PM Reply Like
  • marketwatcher23
    , contributor
    Comments (935) | Send Message
     
    Guys the MREITS will hedge by selling treasuries, if the are not doing so already. This should be fun to watch.
    28 May 2013, 06:32 PM Reply Like
  • dividend_growth
    , contributor
    Comments (2883) | Send Message
     
    They will more likely to go bankrupt if the yield curve inverts, but what we are dealing here is a widening of the yield curve.
    28 May 2013, 06:45 PM Reply Like
  • Paulo Santos
    , contributor
    Comments (18319) | Send Message
     
    No, the yield curve inverting would mean long rates would still be low. The operating environment could perhaps stop being worth it, but book value wouldn't disappear.

     

    These things are like a huge 6-10x levered fixed income portfolio,.. people have forgotten the risk from fixed income portfolios because of 30 years of lower rates, it seems.
    28 May 2013, 06:47 PM Reply Like
  • BPaone323
    , contributor
    Comments (33) | Send Message
     
    If the yield curve inverts, mREITs will be the least of our worries - the economy will collapse and we will all be reduced to hunting and gathering in a few months. Our economy is so dependent on cheap money, we will never see normal interest rates again. Did you see the latest Case Schiller housing numbers? We need 3.5% mortgages to see any gains in the housing market. Imagine if 30 year mortgage rates went back up to 5-6%? As soon as the Fed ends QE and short rates rise just a little, we will back in recession (or at least a soft patch) and its back to QE. I am long AGNC and JMI and will likely add to my positions.
    28 May 2013, 09:10 PM Reply Like
  • Paulo Santos
    , contributor
    Comments (18319) | Send Message
     
    The curve inverting with short term rates at 0% is kinda difficult.
    28 May 2013, 09:11 PM Reply Like
  • HarDiddy
    , contributor
    Comments (4) | Send Message
     
    Buying opportunity. Dividend coming in June.
    28 May 2013, 02:13 PM Reply Like
  • Mellowmix
    , contributor
    Comments (5) | Send Message
     
    This too will pass. Strong dividends will restore confidence as the relative value for these above average returns will keep this sector from free fall.

     

    Todays comments should have been already discounted in the market and even with IVR's somewhat lower earnings expectations this stock (IVR) will rebound. These results have been forecast for at least 18 months.
    28 May 2013, 02:14 PM Reply Like
  • ldavis3742
    , contributor
    Comments (2) | Send Message
     
    I hope you are right but I think Paulo Santos is most correct.
    29 May 2013, 12:04 PM Reply Like
  • Paulo Santos
    , contributor
    Comments (18319) | Send Message
     
    Do take into account that I'm not saying these things will blow up now or in the short term. I'm just saying that these are designed to blow up at some point (when conditions warrant).
    29 May 2013, 12:09 PM Reply Like
  • Tack
    , contributor
    Comments (13002) | Send Message
     
    PS:

     

    Maybe, you better define your concept of "blow up." That is one of those inflammatory expressions that conjures up fears, but illuminates little. And, saying "at some point" is equally meaningless, like saying some day we'l have a recession.

     

    One expects MREITs to fall in price and cut dividends in a rising-rate environment. This has been demonstrated by past results, but "blow up" conjures up Lehman spectacles, which one should seriously doubt unless some data can be presented that suggests that managements are incapable of hedging their exposures.
    29 May 2013, 12:17 PM Reply Like
  • Paulo Santos
    , contributor
    Comments (18319) | Send Message
     
    Tack, they are levered long duration fixed income portfolios, levered long duration fixed income portfolios are exposed the possibility of blowing up. Blowing up = going BK.

     

    Now, I don't expect that to happen while Bernanke is printing, but still ...
    29 May 2013, 01:24 PM Reply Like
  • Tack
    , contributor
    Comments (13002) | Send Message
     
    PS:

     

    It'simply not going to happen. They are not exclusively 100% long and unhedged. Their managements are not incognizant of the rate environment in which we exist.

     

    If there was a time when one would have expected MREITs to go bankrupt, it's when we had a complete liquidity freeze, preventing short-term financing, as well as triggering various loan covenants, accelerating short-term borrowing maturities. But, we didn't see MREITs going under, even in that crisis. It's hard to imagine that they would be unable to rebalance their portfolios to weather a gradual rate increase. yes, margins will suffer; their share prices will fall. But, they won't go bankrupt.
    29 May 2013, 02:36 PM Reply Like
  • Paulo Santos
    , contributor
    Comments (18319) | Send Message
     
    There can't be an effective hedging against the risk of rates going up, because that would destroy the business model due to the cost of hedging the possibility. It's not about them being aware of it. In a way, these businesses are somewhat of a con (as well as an arbitrage).

     

    (a gradual rate rise would probably not lead to BK, yes. A quick rate rise would)
    29 May 2013, 02:49 PM Reply Like
  • paul7777777
    , contributor
    Comments (52) | Send Message
     
    Ridiculous, elsewhere you get far less dividend so I think this is temporary and these stocks will go up again.
    28 May 2013, 02:14 PM Reply Like
  • Paulo Santos
    , contributor
    Comments (18319) | Send Message
     
    Just be sure you understand the nature of these equities.
    28 May 2013, 03:13 PM Reply Like
  • Mike Maher
    , contributor
    Comments (2501) | Send Message
     
    Widening spreads mean they should be able to maintain the dividends, not reduce them. Investors may have to give up 3-5% in BV to maintain the 15-20% dividends....sell-off seems overdone in AGNC, doesnt mean it wont go lower, but its too low here, imo
    28 May 2013, 02:15 PM Reply Like
  • Got That Swing
    , contributor
    Comments (249) | Send Message
     
    I bought several of them today, including AGNC, but in the long term I agree with P Santos. When they are insolvent, no theoretical spread will save them. They will not get the spread because no one will lend to them because their debt will exceed the value of their mortgages.
    28 May 2013, 06:29 PM Reply Like
  • Mellowmix
    , contributor
    Comments (5) | Send Message
     
    Even with a reduced dividend (IVR) will yield in the 13% range at current market prices.
    28 May 2013, 02:26 PM Reply Like
  • kingdad
    , contributor
    Comments (909) | Send Message
     
    GD Bernanke and his f'n meddling
    28 May 2013, 02:26 PM Reply Like
  • Paulo Santos
    , contributor
    Comments (18319) | Send Message
     
    The meddling is the reason these equities even float ...
    28 May 2013, 03:14 PM Reply Like
  • Mellowmix
    , contributor
    Comments (5) | Send Message
     
    Doubled my position in (IVR) today!
    28 May 2013, 02:32 PM Reply Like
  • macronaut
    , contributor
    Comments (35) | Send Message
     
    The mReit sector just recovered (sort of) from a massive selloff last October/November on news that the Fed was going to extend and increase QE. Now everyone is hitting the sell button because of news that QE is going to be tapered off, thus giving rise to an increase in spreads and rising dividends. Am I crazy or does the average investor in this sector just not have a clue as to how they function in various economic environments? mReits seem to behave like junior mining stocks...maybe a buying opportunity or time to just get the hell out. I'm sick of this unwarranted volatility
    28 May 2013, 02:55 PM Reply Like
  • Paulo Santos
    , contributor
    Comments (18319) | Send Message
     
    MREITS are giant levered funds putting their money in what would be long-durationg fixed income in the event of a jump in rates. Do you understand what would happen to a giant levered fixed income bet under such circumstances?
    28 May 2013, 03:15 PM Reply Like
  • macronaut
    , contributor
    Comments (35) | Send Message
     
    P.Santos;

     

    And the point you are trying to make is....???
    28 May 2013, 05:21 PM Reply Like
  • Paulo Santos
    , contributor
    Comments (18319) | Send Message
     
    That these are intrinsic time bombs, much like building a levered fixed income portfolio would be a time bomb.

     

    Obviously Bernanke makes it hard for them to go off, but still ...
    28 May 2013, 05:28 PM Reply Like
  • Boog
    , contributor
    Comments (103) | Send Message
     
    ....problem is FUD - especially looking out a year or so and seeing nothing much positive and lots of reasons to be negative - further weakened by strong market in other investments...
    29 May 2013, 11:53 AM Reply Like
  • argh11
    , contributor
    Comment (1) | Send Message
     
    all the so called comments are from bloggers, not analysts, if there is such a thing, they are throwing out babies, bath water and chicken necks all together. the only issue is will agnc still pay 1.25 in june and arr .07, if so then all is well. if agnce cuts to $100 and arr to .06 then these prices already reflect that. who is selling anyway? shorts?
    28 May 2013, 03:00 PM Reply Like
  • Paulo Santos
    , contributor
    Comments (18319) | Send Message
     
    People with brains and asses to protect ... do you understand the nature of these equities?

     

    Now, I don't believe yields will be allowed to go out of control, but still ...
    28 May 2013, 03:16 PM Reply Like
  • turtleuofs
    , contributor
    Comments (150) | Send Message
     
    This. The gov't can't afford to let yields get out of control..debt service would crush us.
    28 May 2013, 03:19 PM Reply Like
  • Mike Maher
    , contributor
    Comments (2501) | Send Message
     
    Healthcare costs are going to kill us, debt service is the least of our worries.
    28 May 2013, 03:30 PM Reply Like
  • rlamy
    , contributor
    Comment (1) | Send Message
     
    WMC is my favorite here, but AGNC will do very well too. The whole sector is bound for a rebound. Their CEOs all explained how the last bad quatercan be explained and their dividens, while may get trimmed will still bring up to some 15%
    28 May 2013, 03:00 PM Reply Like
  • fkevin1029
    , contributor
    Comments (28) | Send Message
     
    In the eternal struggle between BV and spreads in the agency MREIT sector, the BV bears appear to have the better of it right now. But rest assured, while increasing interest rates hammer BV they also increase spreads, and thus, eventually, profits.

     

    With respect to AGNC in particular, what concerns me are Kain's recent comments that the firm cannot or will not hedge what he calls basis risk, which I take to mean losses in BV on the existing portfolio caused by slowly increasing interest rates: he's quite clear that the firm's hedges are designed to protect against instantaneous interest rate swings of half a percent or more, but will do little or nothing against slower increases. So I don't see much improvement in BV anytime soon, as rates continue to rise on rumors (as opposed to actual Fed statements) of an end to the Fed's bond buying programs. But I would like to know whether the company can hedge basis risk and if it can, why it's not doing so.
    28 May 2013, 03:15 PM Reply Like
  • Paulo Santos
    , contributor
    Comments (18319) | Send Message
     
    The things will go Tilt at some point, so obviously every time BV gets challenged people turn defensive.
    28 May 2013, 03:22 PM Reply Like
  • 567335
    , contributor
    Comments (62) | Send Message
     
    Paulo,

     

    Is it your view that the weakest of these names will go under entirely, or "only" that their price will decline substantially?
    28 May 2013, 03:35 PM Reply Like
  • bill d
    , contributor
    Comments (1885) | Send Message
     
    His answer will tell you just how short he is.
    28 May 2013, 03:41 PM Reply Like
  • Paulo Santos
    , contributor
    Comments (18319) | Send Message
     
    My view is that given their nature, at some point most of the industry will go kaput. It's not about some being weaker (though some are), it's about the nature of the business itself.

     

    These are pools of levered yielding assets which behave like long-duration fixed income in the event of a jump in rates. Just think about it, the business is borrowing a lot of money and buying fixed income with it ... what could ever go wrong?

     

    Now, I myself don't expect them to blow up right away because I don't expect the Fed to let rates jump terribly. But still, the nature of this business should mean that at some point a good fraction of these players will end up going up in smoke.

     

    And worse still, from what one reads it looks like many people hold these stocks in levered accounts (trying to make the same kind of business, actually: lever up a high-yielding asset and "keeping the difference").

     

    This is a disaster waiting to happen, though Bernanke can keep it from happening for a while.
    28 May 2013, 03:44 PM Reply Like
  • BTM
    , contributor
    Comments (345) | Send Message
     
    Hate to disagree with Paulo Santos but....

     

    I see our future to resemble Japan. I think ZIRP is here for a long, long time. Every time Japan saw interest rates rise their economy quickly tanked. Even our demographics are beginning to mirror Japan as we become an older society likely with less consumer consumption.

     

    Paulo certainly could be right and his scenario certainly is not unrealistic.
    28 May 2013, 05:26 PM Reply Like
  • Paulo Santos
    , contributor
    Comments (18319) | Send Message
     
    Oh, but I agree with that as well - this could go on and on without blowing up.

     

    But it would still be a time bomb, because of its nature. Just one that wouldn't happen to blow up in a short time.

     

    I think many people buying these businesses don't really appreciate what they're buying and are in it just for the yield.
    28 May 2013, 05:29 PM Reply Like
  • macronaut
    , contributor
    Comments (35) | Send Message
     
    I think Mr. Santos has an agenda (short!) Certainly very little understanding or appreciation of the history of the mReit sector nor of the ability of management to hedge and trade their MBS portfolios. He says "...at some point the industry will go kaput." Yeah right.
    28 May 2013, 05:32 PM Reply Like
  • Paulo Santos
    , contributor
    Comments (18319) | Send Message
     
    It is you who probably doesn't know that this has blown up before. Mostly on non-GSE mREITs because of credit risk, but this time will be different. the GSE mREITs will blow up at some point as well due to rates, which have been falling since 1982 or so.

     

    Do you understand the nature of this business? Would you think a 6-10x levered portfolio of fixed income securities would have no risk of going to zero?

     

    I don't have a position here.
    28 May 2013, 05:44 PM Reply Like
  • Mark Humphrey
    , contributor
    Comments (599) | Send Message
     
    Japan is experiencing rapidly rising rates thanks to crazy money printing; long JGB rose from .4 to about 1%. Long US bond is back to its highest yield since 2008. When stocks get clocked, yields will fall for a while; then NLY might rally. But from what price?
    28 May 2013, 06:10 PM Reply Like
  • Zeus2012
    , contributor
    Comments (697) | Send Message
     
    Paulo - I think you may be too bearish on this group. Some of these mREIT lived through 2008-2009 credit crisis where many leveraged book were blown up. Having say that, I would not buy these companies right now as they are not sufficiently cheap yet.

     

    If things do play out with rates, there will be plenty of time to buy these stocks at a fraction of todays price as the dividends will be cut quite dramatically.
    28 May 2013, 07:45 PM Reply Like
  • Mark Gilliland
    , contributor
    Comments (92) | Send Message
     
    Some interesting comments Paulo, which I do appreciate.

     

    You keep describing the mReits as 6-10x levered portfolios that cannot last over the long term. But how is that different from the typical bank, which also borrows money short and lends it long, using 6-10x leverage? Banks have a better interest rate spread, but they also have loan loss reserves and operating expenses that mReits do not have.

     

    And I agree that the mReit portfolio is long-dated fixed maturity, but they're not required to hold it to maturity. They can hedge their rates and trade existing bonds for higher yielding bonds as rates go up. It may be painful, but shouldn't be life threatening. And over time, they should show a better spread.

     

    To me, the bigger threat to mReits is the possibility of being cut off from short term funding in a liquidity crisis a la 2008, a threat I consider to be very remote, given a world awash in currency.

     

    My strategy: I'm thinking the spread crunch was probably at its worst with the Q1 reports and might begin to improve from here. So, I'm watching to see where these mReits might bottom out. At some point, there could be some compelling opportunities, especially in mReits falling way below book value.

     

    Disclosure: Sold most mReits months ago, still long a small position in NLY which I will continue to hold, unless Paulo is correct and it goes BK.
    28 May 2013, 08:07 PM Reply Like
  • Paulo Santos
    , contributor
    Comments (18319) | Send Message
     
    I'm not saying that these things will go BK now, though. I am just saying they'll go BK eventually because of the business model.

     

    Anyway, banks have many different and illiquid assets with many different risks which they theoretically consolidate and hedge. It's not the same as having everything in a liquid, marked-to-market, levered asset.

     

    (still banks are risky in systemic crisis as we saw, because they're levered)
    28 May 2013, 08:14 PM Reply Like
  • ldavis3742
    , contributor
    Comments (2) | Send Message
     
    i think your assessment is very accurate on these. I have a position in this and it is very uncomfortable.
    29 May 2013, 12:04 PM Reply Like
  • Whitehawk
    , contributor
    Comments (3129) | Send Message
     
    mREITs are selling off on the prospect of higher rates and of the Fed reducing its Agency MBS purchases. What actually happens is far from clear. That is the problem with the Fed manipulating the markets and propping up Agencies - it is tough to predict what will happen. These structured vehicles carry plenty of risks; their tax structure can work in investor favor or against it. Best to buy them after a marked sell off to reduce principal risks.
    28 May 2013, 03:51 PM Reply Like
  • sederrj
    , contributor
    Comments (84) | Send Message
     
    I don't think the economy is recovering anywhere nearly well enough for the Fed to increase rates for the rest of this year, and probably the first two quarters of next . I'm not an economist but I see more and more houses going up for sale and fewer people employed. With those things happening, the potential for higher rates seems very weak to me. Just mho.
    28 May 2013, 04:00 PM Reply Like
  • Guardian3981
    , contributor
    Comments (1954) | Send Message
     
    Fed easing is what caused MREITs to lose their luster in the first place, now the fear of the easing ending is also harming them?

     

    In reality, if the Fed ended QE it would be bullish for MREITs because it would cause deflation pressures.

     

    MREITs do well during deflation just as long as the deflation is not so awful that all rates are zero.

     

    Deflation with some spread to work with is the ideal MREIT enviroment.

     

    But then again I could be wrong I am still trying to learn this sector. No holding right now, sold out of AGNC at 34 and glad I did!
    28 May 2013, 04:30 PM Reply Like
  • RSB_44
    , contributor
    Comments (7) | Send Message
     
    If one can borrow money (margin) at say 4.5%, and create a portfolio yielding 13.5%, then after tax income (33% tax rate) would be 6%.

     

    Question is what one does with the income. Taking a portion of (half?) the income to mitigate risk is prudent. Using technical analysis to determine entry and exits, rather than just chasing yield, can significantly improve results.

     

    Just my thoughts.

     

    28 May 2013, 04:48 PM Reply Like
  • Paulo Santos
    , contributor
    Comments (18319) | Send Message
     
    That's what I said people have been doing. This creates an incredibly risky preposition: its a portfolio of equities which are the equity tranche of another levered portfolio of fixed income securities.

     

    One can't make this stuff up, actually. This will blow up at some point, on both grounds.
    28 May 2013, 04:54 PM Reply Like
  • TruffelPig
    , contributor
    Comments (4069) | Send Message
     
    Paulo - that is the definition of modern banks ;P
    28 May 2013, 05:54 PM Reply Like
  • Paulo Santos
    , contributor
    Comments (18319) | Send Message
     
    There's a difference. The collateral these businesses have is the assets they buy, and are always marked to market. This means that if they get close to 0 equity (well before that, actually) they get called on it quickly, much like someone using margin in the markets.
    28 May 2013, 05:58 PM Reply Like
  • dividend_growth
    , contributor
    Comments (2883) | Send Message
     
    If the yield spread widens, shouldn't these guys be making more money?
    28 May 2013, 06:41 PM Reply Like
  • Paulo Santos
    , contributor
    Comments (18319) | Send Message
     
    Depends on how quickly. If you hold a 6-10x leveraged fixed income portfolio, what happens if rates go up quickly?

     

    Sure you'll make more money on interest at some point. if you don't go BK first.
    28 May 2013, 06:42 PM Reply Like
  • Tack
    , contributor
    Comments (13002) | Send Message
     
    dg:

     

    Go look at the historical price and dividend charts for MREITs. History seems to indicate that they get sold off, as rates rise, and that their net income falls, since their dividend histories show contraction during these rising-rate periods.

     

    They don't, however, go bankrupt, despite Paulo's apprehensions.
    28 May 2013, 06:49 PM Reply Like
  • Paulo Santos
    , contributor
    Comments (18319) | Send Message
     
    Tack, you had 30 years of rates going down, no wonder they never went BK (except because of credit problems, outside those holding GSE debt).
    28 May 2013, 07:14 PM Reply Like
  • BPaone323
    , contributor
    Comments (33) | Send Message
     
    Yes, look at Annaly's dividend history. The last time we had a flattening of the yield curve was 2006. Annaly paid the following dividends:

     

    2005: $1.44/sh
    2006: $0.48/sh
    2007: $0.89/sh
    2008: $1.92/sh
    2009: $2.29/sh
    2010: $2.76/sh
    2011: $2.51/sh
    2012: $2.17/sh

     

    And its share price fell from around $20 in late 2004 to under $11 in late 2005 and its yield fell to just over 4%
    28 May 2013, 09:22 PM Reply Like
  • 67g8i32
    , contributor
    Comments (203) | Send Message
     
    Tack

     

    I guess the rising rate environment you are talking is rising short rate, with compressed spred. Therefore they cut div. Now we are in a rising long rate environment. The spread is increasing. They should be able to raise div I hope.
    29 May 2013, 01:28 AM Reply Like
  • InvestoBullSG
    , contributor
    Comments (176) | Send Message
     
    Some funds are now busily buying up Fannie Mae and Freddie Mac.
    28 May 2013, 07:25 PM Reply Like
  • WisPokerGuy
    , contributor
    Comments (800) | Send Message
     
    @Paulo Santos either has some pretty strong feelings on mReits or he has WAY too much free time on his hands.

     

    Maybe next time make one comprehensive comment (either for or against) and leave it at that, huh? Leaving 20 different comments saying basically the exact same thing doesn't make your argument any stronger. You know? LOL
    28 May 2013, 08:44 PM Reply Like
  • Paulo Santos
    , contributor
    Comments (18319) | Send Message
     
    I was answering different people. Anyway, what matters is whether people understand the nature of the business.
    28 May 2013, 08:52 PM Reply Like
  • Regarded Solutions
    , contributor
    Comments (15838) | Send Message
     
    buy low sell high. Fear reigns and NLY will do fine. Just my two cents since I write about it all the time.
    28 May 2013, 10:15 PM Reply Like
  • TruffelPig
    , contributor
    Comments (4069) | Send Message
     
    Good idea. Indeed.
    28 May 2013, 10:39 PM Reply Like
  • bill d
    , contributor
    Comments (1885) | Send Message
     
    @RS - Wondered when you might chime in.
    I just hope you understand the nature of the business. (TPFIC)
    And BTW how are you doing?

     

    Bill
    29 May 2013, 03:25 PM Reply Like
  • Petrarch
    , contributor
    Comments (676) | Send Message
     
    This is a pretty diverse group so there is no one size fits all answer. To the extent the market takes them all down there will be opportunity.

     

    They make money two ways - as rates fall their book increases in value and if they can borrow cheap and buy securities with a higher yield they make a spread.

     

    Rising rates hurt two ways.

     

    Tough to own some of these at the moment but there will be value in here soon. But they are not all the same so look carefully at their strategies to discern potential winners as the game changes.

     

    P
    29 May 2013, 04:07 AM Reply Like
  • fkevin1029
    , contributor
    Comments (28) | Send Message
     
    P:

     

    I see interest rate movements as creating the yin and yang of the MREIT sector: whereas rising rates erode BV, they increase spreads and thus, in theory, profits, while also reducing CPR. Falling rates add to BV but decrease spreads and thus, in theory, profits, while also increasing CPR. So either way interest rates move, there is both a benefit and a detriment to the MREIT model. Am I wrong?
    29 May 2013, 10:16 AM Reply Like
  • Paulo Santos
    , contributor
    Comments (18319) | Send Message
     
    It depends on the speed at which rates move, fkevin. If they move quickly, the mREITs are levered long duration fixed income portfolios. Imagine how those behave.
    29 May 2013, 10:26 AM Reply Like
  • Dividend Living
    , contributor
    Comments (259) | Send Message
     
    fkevin1029, you are correct. Management has a balancing act with spreads and BV. They manage it with leverage and MBS picking and hedging with swaps based on what their outlook is for the future. The problem right now is they paid too much for MBS that were CPR protected and with rising rates those are falling in value. When the dust settles, they will start to make more money with rising long term rates and stable short term borrowing. But the FEDs ambiguity is what's making managements decisions difficult.
    29 May 2013, 10:27 AM Reply Like
  • Tack
    , contributor
    Comments (13002) | Send Message
     
    DL:

     

    This all sounds good in theory, but in practice the results are documented to be different.

     

    Go take a look at various MREITs during the last rising-rate period, June 2003 - June 2006. What you will find is plummeting MREIT prices accompanied by dividend cuts, despite theory that spreads should expand profits. Annaly, for example, fell from $20/share to $11.50, and dividends went from $0.45/share to $0.13/share. MFA went from $10.60/share to $5.75/share, and dividends went from $0.28/share to $0.05/share.
    29 May 2013, 10:37 AM Reply Like
  • Dividend Living
    , contributor
    Comments (259) | Send Message
     
    CorvetteKid has answered that splendidly here - http://seekingalpha.co...
    29 May 2013, 10:55 AM Reply Like
  • southgent1951
    , contributor
    Comments (2712) | Send Message
     
    Tack: I am curious whether you have any opinion on how much of the problem between June 2003-June 2006 originated from a rise in their borrowing costs.

     

    The Federal funds rate did not start to rise from 1% until June 2004, but the FED started to hike it fairly quickly thereafter. By June 2006 the rate was close to 5% and at 5.25% in July.

     

    Effective Federal Funds Rate
    http://bit.ly/136a6Rf

     

    It is entirely possible that short rates will remain firmly anchored at abnormally low levels for a couple of more years, through the continuation of ZIRP, even as longer term rates rise due to a normalization of interest rates (market based rates) as the FED first tapers and then stops QE. And, the rate rise will be slower too than the 2004-2006 period.
    30 May 2013, 03:09 PM Reply Like
  • ark2
    , contributor
    Comments (71) | Send Message
     
    This is where you're fundamentally wrong PS. I just read this whole thread of 20 comments and you basically believe 1) investors don't understand the nature of mReit stocks (probably true); and 2) they are destined to blow up because they borrow short and lend long, and when their short term rates go up equity goes to zero, and quickly with 6 - 10x leverage, because they are "giant levered bet on yield producing assets, and these assets would turn into long duration fixed income" (probably not true)

     

    You seem to miss that 1) they are substantially hedged and 2) short and long rates move together.

     

    Take AGNC as an example with ~$26 - 27 of book value today. My numbers are not exact here, but close enough for illustration. They borrow in the repo market for 50bps and buy 15, 20, 30 yr gov't guaranteed securities for 350bps. Then they spend 80bps on hedges to make sure that if rates move up quickly (by 100bps or so) they are protected.

     

    They have gotten crushed because long rates have trickled up by 30 - 50bps quite quickly and their hedges were not designed to protect them. Further they had pre-pay protected securities that lost value fairly fast. So book value was down to $29 from 31 and now is probably lower at $27 or so.

     

    But their spreads are UP. That is the basic business of borrowing short term and lending long term got better because 30 yrs are at 375 bps or so up from 325.

     

    Why this kind of structure should "blow up" is not clear to me PS. If spreads (30 yr - repo rates) stay around 150 - 300 bps and they leverage that by 6 - 10x, they will make 9 - 30% returns. Book value may decline sometimes when rates rise fast but not fast enough for hedges to kick in (like now) but spreads will also rise in that case so as they reinvest they earn more. When they report spreads soon it should be 220 bps on 27 of book value instead of 180 bps on 31 of book value.

     

    The blow up you refer to would be likely if they held forever securities that yield 350 bps and had to borrow at short term rates, unhedged. If those short term rates rose above 350 they would make negative returns and blow up. However they are constantly reinvesting and as short term rates go from 50bps to say 150bps in a normal environment, long term rates will go from 350bps to 500bps. Spreads remain intact and the companies keep doing the same thing.

     

    Like Mark said the business is not that different from banks - borrowing short term and lending long term, just with lower spreads and lower risk since the underlying security is government guaranteed. If that guarantee goes away they could blow up, but we'd all have bigger fish to fry in that scenario anyway...
    7 Jun 2013, 08:01 PM Reply Like
  • Paulo Santos
    , contributor
    Comments (18319) | Send Message
     
    ark, what rates have they hedged? Short term to protect the spread? The spread is not the problem. And hedging short term rates is not too expensive, but hedging long rates is brutal.

     

    The problem is similar to borrowing in a low yield currency to invest in a high yield currency - you cannot hedge the currency risk without eliminating the spread. Same thing here, there is no free lunch, you cannot hedge your levered long duration fixed income portfolio without destroying the spread.
    7 Jun 2013, 08:07 PM Reply Like
  • Tack
    , contributor
    Comments (13002) | Send Message
     
    PS:

     

    But, MREITs can seek to manage their exposure by balancing their asset allocations with floating-rate issues, as well as laddering the maturities of their long-dated positions.
    16 Jun 2013, 02:09 PM Reply Like
  • SERVANT22
    , contributor
    Comments (7) | Send Message
     
    Low short term borrowng and rising long term interest is ideal for NLY. They're handling their present crisis well. Let everything settle at this point and watch them rebound and rise. Every business is profits. Watch them strategically maximise theirs.
    29 May 2013, 11:58 AM Reply Like
  • almarks224
    , contributor
    Comments (2) | Send Message
     
    I worked at Freddie Mac for over 8 years as a Principal Analyst back in the mid-1990's. Paulo Santos is 100% correct in his understanding and analysis of mREITs. I own a few mREIT ETF positions now since most have recently fallen in price to very strong technical support lines (in their weekly charts). However I have fairly tight stop-loss orders on these positions too. Ben B. will probably continue the money-printing with more QE, as he has behaved in the past.
    16 Jun 2013, 02:01 PM Reply Like
DJIA (DIA) S&P 500 (SPY)
ETF Tools
Find the right ETFs for your portfolio:
Seeking Alpha's new ETF Hub
ETF Investment Guide:
Table of Contents | One Page Summary
Read about different ETF Asset Classes:
ETF Selector

Next headline on your portfolio:

|