Several Reasons Why I Think The Double-Digit Mortgage REIT Yields May Soon Decline

Includes: AGNC, CIM, NLY, TWO
by: Matt Schilling

In the last few weeks, the behavior of many of the stocks in the Mortgage REIT sector has proven to be erratic. On one hand, shares of Annaly Capital (NYSE:NLY) took a beating as the company missed earnings, and on the other hand, shares of American Capital Agency (NASDAQ:AGNC) popped since the company surpassed estimates. Will the Mortgage REIT sector be able to survive, given the fact the current political landscape may not necessarily work in their favor?

Before we go jumping to conclusions with either a straight answer of 'Yes' or 'No', we need to first consider several variables. In my opinion, the two most important catalysts are the behavior of the Federal Reserve during QE3 and the watchful eye investors must keep on the potential 'Fiscal-Cliff' occurring on January 1st.

Should potential investors consider a position in the Mortgage REIT sector based on the Fed's recent purchasing behavior? The low interest rate environment that is driving more and more homeowners to refinance is the direct result of the Federal Reserve's third round of quantitative easing, and that could be a problem for potential investors.

It's pretty obvious that the Federal Reserve is strengthening its role as pseudo-Mortgage REIT, since it plans on purchasing an additional $40 billion of mortgage backed securities each month. Considering the fact Annaly, American Capital, Chimera (NYSE:CIM), and Two Harbors (NYSE:TWO) all engage in a similar practice, such an action by the Fed directly affects not only the revenues of each firm, but the profits as well. If investors were to take into consideration the collective buying power of these companies as a whole and compare it to the Fed, it would still be nowhere near the buying power of the Fed, and as a result, the Fed's ability to out-purchase firms should deter potential investors at this time.

The behavior of the Federal Reserve isn't the only thing potential investors should be worried about. The looming 'Fiscal-Cliff' could also be a nightmare for the high-yield investor. Most of the companies within the Mortgage REIT sector have double-digit yields, and although a majority of these yields have been declining over the last 12-24 months, come January 1st, investors could be in for much more than they have bargained for. According to Brendan Conway of

S&P Capital IQ strategist Sam Stovall has found that sectors within the S&P 1500 which were yielding 3.00% or more, had fallen an average of 1.30% from the end of September.

It should be noted that, between September 30th and November 2nd, shares of American Capital Agency, Annaly Capital, and Chimera Investment Management, had fallen 6.35%, 5.01%, and 3.32%, respectively.

Final Analysis

In my opinion, the combination of the two aforementioned negative catalysts could in fact form a perfect storm targeting the high-yield investor. The Fed's purchasing power could in fact limit the overall supply of residential and commercial mortgage, and as a result, hinder both the revenues and profits of companies such as Annaly, American Capital, Chimera and Two Harbors. If by January 1st, the third round of quantitative easing is still in effect, the looming 'Fiscal-Cliff' will implement a series of increased taxes aimed at the dividends of these stocks and as a result, investors could experience more than just a headache come tax time.

Will the Mortgage REIT sector survive, given the current political landscape? I don't see Mortgage REITs evaporating come January 1st, but I do think the double-digit yields that high-yield investors love to chase will soon be few and far between come 2013.

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.