An Inverted Yield Curve Means Tough Times Ahead For mREITs

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Includes: AGNC, CHMI, CIM, MORL, MORT, MRRL, NLY, REM, REML, TWO
by: Kiefer Tuck
Summary

The yield curve has inverted.

Net Interest Margin for mREITs were already below 1.5%, the inverted curve is going to make it even tougher.

Dividend yields are sky high. Keep an eye out to see if prices go lower, even though dividends are less safe, it doesn't mean these companies are worth nothing.

The mortgage REITs are all falling together: Annaly Capital Management (NLY), Two Harbors Investment Corp (TWO), Chimera Investment Corp (CIM), AGNC Investment Corp (AGNC), as well as others. Any mREIT that holds mainly agency MBS is getting punched in the mouth. Even the mREITs that don't hold agency MBS are getting hurt.

Chart Data by YCharts
Chart Data by YCharts

Normally I would look to buy in this situation, but I'm still holding because of the yield curve. The yield curve recently inverted which hurts mREITs profitability.

I generated this in excel using data from treasury.gov. As you can see at the end of May 2019 the yield curve inverted. The 1 year, 3 year, and 10 year dipped below the 3 month yield. This trend of inversion is a global one as well.

Source: Matt Phillips and Stephen Grocer of the New York Times

An inverted yield curve has historically indicated that a recession is on the horizon. But whether you agree with that or not, an invested yield curve eliminates the chance of profitable trades for many mREITs.

mREIT Profit = (Yield of MBS - Repo Financing Rate) +/- (Swaps, Caps)

If the yield of MBS is less than the repo financing rate, you can say goodbye to profits regardless of leverage.

Current Rates according to WSJ:

Fannie Mae 30 year yield as of 5/30/2019 are 3.54.

6 month LIBOR, a reasonable indicator for guessing short-term financing rates, is 2.54.

This puts interest margins at approximately 1%. To put this in perspective lots of mREITs before this were averaging around 1.4% on their trades. There seems to be more pain in the future for mREITs. This doesn't mean that all mREITs are going to miss their dividends. It does mean that future profits are going to very low without excessive leverage. Let's look at some of the mREITs individually.

Bloomberg terminal calculated 12 month trailing net interest margin for the following mREITs:

NLY: 1.5%

TWO: 1.5%

AGNC: 1.1%

As you can see things were already bad especially for AGNC. NLY and AGNC have already cut dividends. TWO currently is producing around $0.49 per common share and paying common dividends of $0.47 per share. This yield curve problem could make things harder for TWO.

The market doesn't see dividends as safe as yields go through the roof.

Chart Data by YCharts

Note that NLY already announced a dividend yield cut so their yield is about 11.4%.

Even though things are terrible for mREITs keep an eye at the price. If it gets low enough it could warrant a purchase.

Disclosure: I am/we are long TWO. 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.