mREITs: Bears Don’t Get It
Adnan is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Mortgage Market Update
Mortgage rates in the US have been climbing since the beginning of the year. This is despite record easing from the Fed to keep long term rates down. The average 30-year mortgage rate edged up 3.53%, it’s the highest since September, while the average 15-year rate increased 10 basis points to 2.81%. Mortgage rates are on the rise as housing inventories are shirking driving up home prices. The Case-Shiller index increased 5.5% in November, its biggest gain since August 2006.
While increased home prices are a sign of rebounding real estate, at the same time it makes housing more expensive for those who want to buy a house. This is reflected in a decline in home loan applications for the first time in January. The MBA index decreased 8.1%, after a 7% gain in the linked week, while the refinancing gauge fell 10.2% and the purchase index dropped 1.8%.
Mortgage REITs sector
I believe the above mortgage market update is a positive sign for the Agency mortgage REITs, which were hurt badly due to Operation Twist and QE3. Among the widely followed mREITs, Annaly Capital Agency , American Capital Agency (NASDAQ: AGNC) and Armour Residential (NYSE: ARR) are poised to benefit from the hike in mortgage rates. I believe if the rates continue to surge for the greater part of the first quarter of the current year, the aforementioned mortgage REITs will be able to sustain their current double digit dividend yields. The remaining of the investment thesis aims to look into each mortgage REIT’s projected income’s interest rate sensitivity and how a hike in rates can translate into a surge in projected income.
Annaly Capital
Annaly Capital is currently offering a dividend yield of 12% and is currently trading at a 7% discount to this third quarter book value. Annaly Capital would also be able to finally get control of CreXus Investment (NYSE: CXS) after Annaly raised its offer for the remaining 88% stakes in the commercial mortgage REIT. "This transaction represents a significant step toward Annaly's commitment to investing directly in commercial real estate assets," Annaly's Chief Executive Wellington Denahan said.
According to the company’s third quarter SEC filings, Annaly’s projected net interest income will increase by 0.46% if the base interest rate edges up 25 basis points. The company is scheduled to report its fourth quarter performance on February 4, 2013.
American Capital Agency
American Capital Agency is famous for its double digit dividend yield of 15.8%, which it had been able to maintain throughout the prior year. In contrast, Annaly Capital and Armour Residential were forced to cut their dividend distributions during the prior year. A prepayment protected portfolio is said to be the major reason why American Capital was able to sustain its dividend yield during challenging times. The company is currently trading at 14% premium to its third quarter book value.
According to the company’s third quarter SEC filings, American Capital’s projected income will drop by 0.7% if the rates increase by 50 basis points.
The company is scheduled to report its fourth quarter performance on January 7, 2013.
Armour Residential
Armour Residential, famous for its monthly dividend distribution, was forced to cut its dividends during the prior year. The company is also known for its prepayment protected portfolio, which has a large concentration of 15-year fixed rate MBS that the Fed is not interested in. Besides, the company’s charter allows the addition of non-Agency securities, which gives Armour room to breathe during the prevailing challenging times. The stock is currently offering a 13.4% dividend yield and is trading at an 8% premium to its book value. Armour just broke above its 200 day moving average of $7.11.
According the most recent quarterly filings of the company, Armour’s projected interest income will increase by 12.81% if the rates increase 50 basis points.
Conclusion
I am bullish on the pure play mortgage REITs. I believe the upward journey of the mortgage rates will help support the interest incomes of Agency mortgage REITs like Annaly Capital, American Capital and Armour Residential. Therefore, I recommend investors buy these stocks and benefit from their yields that are higher than CCC rated bonds.
equityfinancials has no position in any stocks mentioned. The Motley Fool owns shares of Annaly Capital Management. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!
