Welcome Signs For Annaly Capital & Other Agency mREITs
Adnan is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The second half of 2012 resulted in the flattening of the yield curve as a result of the Fed’s Operation Twist and the third round of quantitative easing, also known as QE3. However, the situation seems to have reversed. It would not be incorrect to say that the markets are rejecting the Fed’s QE3 as average mortgage rates are pushed higher in the second week of the year, according to the Freddie Mac’s weekly survey. Following last year December’s employment report, fixed mortgage rates have edged higher. The 30-year rate averaged at 3.4%, the highest in eight weeks, and above last week’s average of 3.34%. The 15-year rate averaged at 2.66%, up 2 basis points from its last week’s average of 2.64%. The 1-year treasury-indexed ARM surged 3 basis points week over week to 2.6%.
Mortgage application activity was also higher. Mortgage applications increased 11.7%, while refinancing applications increased 12%. MBA Purchase Price Index added 10% within a time span of 1 week. Improvement in the US labor market is supposed to be the reason for increase in mortgage application demand causing the fixed mortgage rates to edge up. According to the Bureau of Labor, the economy added 155,000 jobs, maintaining the unemployment rate 7.8%.
Net Interest Spread
During the third quarter, the net interest spreads for most of the mortgage REITs was significantly and negatively affected. On a sequential basis, the spread for Annaly Capital Management (NYSE: NLY) decreased 50 basis points. The decline was even worse on a year over year basis.
The net interest spread for American Capital Agency (NASDAQ: AGNC) decreased 23 basis point sequentially to 1.42%. The decline was 72 basis points year over year. For Armour Residential (NYSE: ARR), the decrease in net interest margin during the third quarter was 33% compared to the same quarter last year.
The flattening of the yield curve was took the blame for a decline in the net interest spreads for these mortgage RIETs. With the surge in the longer-term rates, as noted above, I believe the markets have rejected the third round of easing by the Fed and the yield curve has started steepening. The steepening of the yield curve will expand the net interest spreads for these mortgage REITs in the coming quarter.
Elevated Dividends
Mortgage REITs are famous for their elevated dividend distributions. Annaly Capital’s stock offers a dividend yield of 12.2%, while American Capital and Armour Residential offer dividend yields of 16.11% and 13.85%, respectively. Previously, both Annaly Capital and Armour Residential were forced to cut their dividends. Annaly Capital slashed its quarterly dividend by 10% in December 2012, while Armour Residential’s monthly dividend was cut by 10% September 2012 to $0.09 per share.
The surge in mortgage rates is a welcome sign for mortgage REITs. Therefore, I believe that if the rates keep climbing the dividends currently offered by mREITs will stay intact.
Valuations
Compared to most of its peers, Annaly Capital has attractive valuations. Annaly Capital is trading at 11% discount to its third quarter book value, while Armour Residential is trading at 12% discount. In comparison, American Capital Agency is trading at 5% discount to its third quarter book value. American Capital has a highly protected MBS portfolio.
Conclusion
The effectiveness of QE3 can be judged by the impact it is making on flattening the US interest rate yield curve and the downward pressure it is creating on US mortgage rates. While the interest rate yield curve is beginning to steepen (the spread between 1 month and 30-year treasury has widened by 4 basis points since the beginning of the year) and mortgage rates climb, I believe QE3 is not delivering as imagined by the Fed. Given that, I also believe that the yield curve will continue to steepen and the mortgage rates will continue their upwards journey. Therefore, Agency mortgage REITs like NLY, AGNC, and ARR will experience expansion in their net interest margins, presenting an excellent buying opportunity for investors who are looking for regular income given the ultra low interest rate environment.
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