QE4 & the Mortgage REIT for 2013

Mohsin is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

QE4 is here to replace Operation Twist and Ben Bernanke has promised an extended easing at a rate of $85 billion a month. The easing is here to stay until the US unemployment rate, which is currently at 7.7%, falls below 6.5%. The new buying program will be purely of Treasury purchases, unlike QE3.

It is widely anticipated that the new easing will add more accommodation to the banking sector, which is why major financials like Wells Fargo, Bank of America and JPMorgan welcomed the news and their stocks rallied. While the stock markets at large welcomed the decision, a part of the US financial sector is put under challenge.

Increased purchases by the Fed prolonged low interest rates will create an even more challenging situation for pure play Agency mortgage REITs like Annaly Capital Management (NYSE: NLY), American Capital Agency (NASDAQ: AGNC) and Armour Residential (NYSE: ARR). Mortgage rates have already touched their lowest ever. The 30-year rate is at 3.32%, while the 15-year rate has plunged to 2.66%. Increased purchases will result in possible dividend cuts by the above mentioned Agency-only mREITs. Therefore, I recommend Investors to invest in PennyMac Mortgage (NYSE: PMT).


If in the future the Fed decides to increase its MBS purchases, then investors can expect further declines in mortgage rates, which will compress the net interest margins that mortgage REITs earn. Besides, investors can expect acceleration in prepayments. Since PennyMac (PMT) largely invests in distressed residential MBS, its margins will not be compressed and it will benefit from accelerated prepayments. As the distressed securities that PennyMac acquires are purchased at a discount, accelerated prepayments will mean more cash inflows which could be invested in higher coupon securities.  Besides, PennyMac has a diverse business mix. The company generates around 60% of the revenues by originating loans to be securities or resold. This diverse business mix gives the company an edge during the prevailing situation.

I believe Basel III will result in increased availability of distressed securities as more and more banks are forced to get rid of their toxic holdings. This will create an opportunity for PennyMac to fill the void that will be created when the large cap banks exit their positions. The stock was recently raised to outperform by KBW. 

American Capital Agency

Among the Agency mortgage REITs, American Capital Agency is best placed for the challenges of the coming year. The company has a low CPR of 9% and its MBS portfolio is prepayment protected. A large proportion of the company’s assets portfolio is composed of securities with lower loan balances and originated under HARP, reducing the risk of accelerated prepayments. This is why the company is able to maintain its quarterly dividend. The company announced $1.25 in quarterly dividends per share for the fourth quarter of the current year. The stock offers a dividend yield of 16.06%, which I believe is sustainable.

Annaly Capital Management

Annaly Capital was hit the most during the third quarter of the current year. Its net interest margin was squeezed to half compared to a year ago. It posted a CPR rate of 20% for its MBS portfolio, much higher than the CPR of fellow American Capital Agency. The company’s net interest margin is under immense pressure which is why the company was forced to cut its fourth quarter dividend. Therefore, if the Fed decides to accelerate its MBS purchases, Annaly Capital would be hit the most.

The company’s charter allows for inclusion of securities other than Agency MBS. The addition of such securities into the company’s MBS portfolio is one way to steer the company out of the challenging macroeconomic situation. The company is already is talks to purchase CreXus Investments.

Armour Residential

Armour Residential is in a better position compared to Annaly Capital. The company’s MBS portfolio is not prepayment protected. However, it reported one of the lowest CPRs of 13%. This is because it focuses largely on 15 and 20-year mortgage backed securities with stable prepay characteristics. The Fed is more concerned in buying MBS with longer durations. Therefore, Armour Residential would not be hurt much by accelerated MBS purchases. Still the company slashed its monthly dividend to $0.08 per common share from the previous $0.09.


SmartEquity has no positions in the stocks mentioned above. The Motley Fool owns shares of Bank of America, Annaly Capital Management, and Wells Fargo & Company. Motley Fool newsletter services recommend Wells Fargo & Company. 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!

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