These 5 Stocks Hurt By Rising Mortgage Rates Are Set To Bounce Back

Includes: AGNC, BAC, C, NLY, TOL
by: Markos Kaminis

On Wednesday the Mortgage Bankers Association (MBA) published its latest Weekly Application Survey covering mortgage activity for the period ending August 16. There are several factors at play today in the mortgage market, some seasonal, some cyclical and some secular in nature. Whatever the factor, stocks operating across the real estate spectrum have been harmed of late. I examine the latest real estate data herein and study its significance to 5 relative stocks, which I think could bounce back after Fed tapering actually begins.

The MBA indicated in its report that its Market Composite Index measuring overall mortgage activity declined by 4.6% in the latest reported period. However, the details of the report reveal that the headline hides important nuances for relative industry players. Let's start with the lenders.

Mortgage Type

Rate Change

Average Rate

Effective Rate

30-Yr. Fixed on Conforming

+12 Basis Pts.



30-Yr. Fixed on Jumbo

+17 Basis Pts.



30-Yr. Fixed FHA Sponsored

+15 Basis Pts.



15-Yr. Fixed

+11 Basis Pts.



5/1 ARMS

+8 Basis Pts.



The MBA's Refinance Index fell by 8% week-to-week due to sharp increases in mortgage rates across all types of mortgage loans. You can see the details of the latest rate increases in the table above. The yield curve has been steepening since May, which is good for the margins of lenders Bank of America (NYSE:BAC) and Citigroup (NYSE:C). However, there is concern that if mortgage rates rise too much, then real estate activity and mortgage origination will decline. In other words, there's a threshold that should not be crossed, where relative business decline will offset and maybe outweigh wider net interest margins for banks. This is of supreme significance to major mortgage lenders BofA and Citi. It's probably the reason why the two stocks, which had initially spiked on rising rates, leveled off later. You can see it in the chart here.

Chart forBank of America Corporation

Chart at Yahoo Finance

Still, while the latest mortgage data showed a steep drop off in refinancing activity, it also showed the seasonally adjusted Purchase Index rose 1.0%. If mortgage applications for the purchase of real estate are increasing even as rates spike, then real estate activity is not contingent on the record low mortgage rates that had persisted through April of this year. Obviously, the purchase of a home is an activity that comes after significant thought and effort, and so one week's sharp increase in rates is not going to necessarily stop the deal in the works. It could do so if the difference in financing costs actually disqualifies the potential purchaser, and since this data point only measures applications, we cannot say for sure if there is not some impact in this way. Furthermore, if rates continue to rise, they will keep an increasing number of potential homebuyers from purchasing homes.

Still, the pace of Existing Home Sales reportedly increased by 6.5% in July to an annual pace of 5.39 million home sales. That was better than the expectation of the consensus of economists, which on average forecast a pace of 5.15 million. Sales were up 17.2% year-over-year. This data does not show a significant sensitivity to increased mortgage rates, though rates have risen further recently. New Home Sales though, declined in July to an annual sales pace of 394K, down from the revised lower prior month pace of 455K. So sensitivity may reach new home builders first, as indicated by the varying messages offered by the existing and new home sales reports.

This past week, the FHFA reported home prices increased by 0.7% in June, which is good news for the real estate sector and homebuilders especially. Toll Brothers (NYSE:TOL) chimed in during its earnings day this past week, announcing it would be raising prices for its higher end homes. The higher end of the market may be less sensitive to changes in interest rates than the lower end. Still, I believe we have seen that people who make more money still tend to seek homes at the limits of their own affordability, so I'm not so sure about rate sensitivity not existing at all at the higher end. Still, Toll Brothers has not enjoyed the ride upwards as much as its peers in the housing sector. So, given its lesser sensitivity to rising mortgage rates, capital invested in some of those other builders might just migrate into TOL shares now. The chart here shows TOL's 2-year underperformance versus PulteGroup (NYSE:PHM) and KB Home (NYSE:KBH), and I think it's about to revert to the mean.

Chart forToll Brothers Inc.

Chart at Yahoo Finance

Investors in mortgage REITs have been terrified by the rise of interest rates and the perceived threat to the value of mortgage securities held by REITs like Annaly Capital (NYSE:NLY) and American Capital Agency (NASDAQ:AGNC). Rates are on the rise again now, as seen in the latest mortgage application data, and the shares of NLY and AGNC are on the decline. The chart here shows just the last three months of slide.

Chart forAnnaly Capital Management, Inc.

Chart at Yahoo Finance

Yet, my feeling about the famed Fed tapering is that it will happen this fall as expected. When it does happen, though, it will have already been discounted by the yield curve, stocks, the real estate sector and everything else. In fact, I expect it will have been overly accounted for, and that we will have a buy the news event for the securities that have been harshly hit, after a sell the rumor lead up. Annaly Capital and American Capital Agency are two securities that fit that bill for me along with the other three companies discussed previously. Each of these shares stand ready to rise on a relief rally in my view.

What many are missing with regard to the mortgage REIT operating environment is that the removal of the Fed will improve pricing for the buyers of mortgage-backed securities. An improved economy, which is the purported reason for Fed tapering, should also add supply to the mortgage market. With these high-yielding stocks having already taken a significant hit to their valuations, opportunity for extraordinary capital appreciation upside may now avail.

Of course, all this depends on interest rates settling and potentially even easing from recent levels, and on economic improvement and ongoing housing growth. Some of these assumptions are certainly in question and depend greatly on capital flows, interest rates and global economic recovery. However, the latest economic data, analyzed in a recent post at my blog, seems to show signs of just that. The dividend yields of NLY and AGNC at 14.2% and 19.2%, respectively, are thought to represent dividends that may dwindle. However, if rates subside after the news of what I expect will be a modest start to tapering, it may be that the share prices of the two securities recover instead.

In conclusion, Bank of America, Citigroup, Toll Brothers, Annaly Capital and American Capital Agency have endured criticism recently and experienced price decline. It's the result of announced Fed tapering and interest rate rise. I believe that when the market sees that the Fed tapering will be moderate and tiered, interest rates will reverse course. The latest data seems to indicate that investor concern might also be appeased by moderate economic strengthening. If interest rates have overcompensated for the removal of Fed tapering and the real estate market can stand on its own supports, then these five real estate relative stocks stand to recover lost ground. Thus, I believe now is a fine time to add BAC, C, TOL, NLY and AGNC to portfolios.

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.

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