REITs Relish The Fed's Start Of Taper And Promise Of Low Interest Rates

Includes: AGNC, ARR, WMC
by: Tom Dorsey

REITs will start out 2014 on a positive note, as the Federal Reserve, at its meeting on December 17-18 2013, announced the beginning of the 'taper' of its bond buying. This was good, but the really exciting news is that the Fed plans on keeping the interest rates down throughout 2014 to enhance economic growth. Many REITs borrow money short term to fund buying long term investments. They are sensitive to interest rate hikes, which caught them off guard early this year in May 2013, when the Fed first used the word 'taper,' and the market reacted negatively with a huge selloff of REITs. Many REITs pay a double digit return, and I will highlight several later in the article. First I want to discuss the Fed's statement, their position and how it will affect the marketplace for investors.

Here are several quotes from the Federal Reserve Board's meetings, and their statements that can be found on the Federal Reserve Board's website.

Beginning in January, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $35 billion per month rather than $40 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $40 billion per month rather than $45 billion per month. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction.

This is a positive move based on the economy's recover over third and fourth quarters. The slight reduction of agency mortgage-backed securities will allow the market to adjust to the slight reduction, but maintain stability in the market. We were expecting a $5-10 billion reduction when the Feds started to taper and due to the strong numbers through the fall the Fed will begin in January 2014.

The Committee will closely monitor incoming information on economic and financial developments in coming months and will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability. If incoming information broadly supports the Committee's expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective, the Committee will likely reduce the pace of asset purchases in further measured steps at future meetings.

The markets, financial sector and investors have seen continued improvement in strong employment numbers, lower unemployment numbers (which don't always correlate but here we see a strong synchronization between them), the best housing numbers since 2006 and a global economy that is growing at a mild pace. The key to this statement is the Feds will 'closely monitor' and react accordingly. This implies the Feds will not let the market over react, or let the economy take a down turn or unemployment numbers rise without action by the Fed. This may be the strongest statement that the Feds will remain a major factor by managing the monetary policy.

The Committee also reaffirmed its expectation that the current exceptionally low target range for the federal funds rate of 0 to 1/4 percent will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee's 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored. In determining how long to maintain a highly accommodative stance of monetary policy, the Committee will also consider other information, including additional measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments.

The committee has targets on unemployment, managing low rates on borrowing money and restricting inflation growth that they are monitoring and will adjust policy to reach and maintain these goals. The Fed is keeping its finger on the pulse of the economy by monitoring these key indicators. I think the one dissenting vote against the action was by Eric S. Rosengren, who believes that the action was premature because the unemployment rate is still elevated and the inflation rate well below the target. Although the majority voted for the tapering to begin, most of the board strongly supports his reasoning, which can influence the vote quickly if the markets are negatively affected due to the tapering.

The major banks will benefit from the Federal Reserve holding the interest rates down, because Americans wanting to buy homes will continue to have lower interest rates and be able to buy more homes. When interest rates rise, the affect will push the cost of money up and push home buyers into less expensive homes. It will depress the market of home prices. Banks usually make their money on the cost of doing the loan, and then sell the loan, so the bank is concerned with more sales. More mortgages means more income. With lower interest rates through 2014, we should continue to see sales strong.

Several of the larger REITS are expected to continue double digit returns on dividends through 2014. Armour Residential REIT Inc (ARR) announced on December 18, 2013 that it will continue its dividend of $0.05 per share for January, February and March of 2014. Currently that yield is 16% on the stock price of $3.74 during midday trading on December 19, 2013. Last May when the Fed openly stated the term 'tapering,' the market reacted violently and a large selloff began. ARR is down 42% for the year, but we assess that ARR, along with many other REITs, have found the bottom. ARR, along with several other REITs, reshuffled their portfolios to prepare for the increase in interest rates. With the Fed being interest rate sensitive, ARR and other REITS will be less impacted over the course of 2014 as the Fed manages the monetary policy. This is a good monthly dividend payer to be in over the long run.

American Capital Agency Corp ( AGNC) just declared their fourth quarter dividend on December 18, 2013, of $0.65 per share. Based on the current stock price of 19.46, this is annualized over 13.3% return. This is another double digit return, and the Fed's statement about keeping interest rates low should result in a bump of over $20 per share and continue the dividend at or about the same rate heading into 2014. AGNC was down about 31% for 2013, and 2014 will shape up to be much better. The financing cost between what the company pays to borrow money and what it lends it for widened during November and December, and if this holds in 2014, we expect a steady stream of double digit throughout 2014.

Another quarterly paying REIT I like is Western Asset Mortgage Capital (WMC). WMC paid a dividend of $0.90 per share for 3rd quarter, 2013. This was a 22% return, and this coming quarter, WMC is expected to announce a 4th quarter dividend by the end of December for payment in January 2014. We expect another solid dividend from WMC, as the market has been steady and dividend returns remain near the current levels. The 22% return is higher than most, and the company is reporting no information that there is a change in the business operations. We believe WMC is in for a strong 2014 also.

Investors have a good opportunity to get on board with REITs right now, because the Fed is interested in holding interest rates down, and REITs will do well in 2014. The initial reaction from the market did not sour on REITs, and with a long drawn out process to extract itself from QE3, the Fed's plan is to avoid negatively impacting the economy, which is a good sign for REITs.

Disclosure: I am long ARR, AGNC, WMC. 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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