Have Income Investors Returned To Agency mREITs?

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

Back in December last year, Agency mortgage REITs were trading on deep discounts to their book values Since the beginning of the year 2013, Agency mortgage REITs have appreciated in price greater than the year to date performance of S&P (the broad market). However, most are still trading at discounts to their book values yielding attractive double digit dividends under the ultra low interest rate environment.  

Year To Date Performances

The following chart shows the year to date performances of some of the mostly followed Agency mortgage REITs. Hatteras Financial (NYSE: HTS) takes the lead in price appreciation with 8.86% YTD, followed by CYS Investments (NYSE: CYS) at 8.72%. The worst performer, Annaly Capital Management (NYSE: NLY) was still produced 5.76% return, beating the broad market index. American Capital Agency (NASDAQ: AGNC) and Armour Residential (NYSE: ARR) appreciated 8.4% and 8%, respectively.

<img src="/media/images/user_14999/mreits-ytd_large.jpg" />

Relative Valuations

Share price appreciation since the beginning of the year has caused the book value discounts to narrow down. The following table summarizes the relative valuations of the Agency mortgage REITs considered in this article. It is evident that Armour Residential is trading at the maximum discounts of 12% to its third quarter book value, followed by Annaly Capital and CYS Investment at 11% discount.


<img src="/media/images/user_14999/mreits-02_large.jpg" />


Mortgage REITs have a special place in the hearts of investors due to their elevated dividend distributions. Under the prevailing ultra low interest rate environment, most of the Agency mortgage REITs are offering attractive double digit dividend yields, where the 10-year treasuries are offering only 1.88%. The Fed is committed to flatten the yield curve by keeping the policy rate near zero and brining the long-term rate down through its aggressive bond buying programs. This flattening has caused many Agency REITs do slash their quarterly dividends in year 2012. The following table summarizes the dividend distributions being offered by each of the mREIT under consideration.


<img src="/media/images/user_14999/mreits-03-dividends_large.jpg" />

Spread Widening

It is evident from my previous article that since the beginning of this year, mortgage rates have started their upwards journey despite Fed’s continuous efforts to keep the long term borrowing rate at their minimum. Interest rates have continued to climb since my last article. The average 30-year mortgage rate edged up 4 basis points to 3.42%, it’s highest since last September. Similarly, the 15-year rate averaged at 2.71% from 2.64% at the beginning of this year. Much of this surge in mortgage rates is a result of improvement in the US labor markets as mentioned in this article in detail. The rising mortgage rates cause the spread for mortgage REITs to widen. This is a bullish trend for mREITs as interest income is a primarily source of profits for them.

Having said that, investors should also keep an eye on Fed's intentions on going ahead with unprecedented easing or not. Details and the consequences of an unprecedented easing can be viewed in this article.

Fool Takeaways

In conclusion, in believe there is not enough opportunity to invest and find the sort of dividend income at such discounts which Agency mortgage REITs are offering. Although American Capital Agency is considered to be the best run Agency REITs, its not trading at much of a discount to its book value and hasn’t cut its dividend during the prior year. However, Armour Residential, Annaly Capital and CYS Investment on the other hand are trading at cheap valuations and offering the elevated dividend yields. The Armour’s charter allows it to include high yielding assets other than Agency MBS. This could further enhance its spread. If the mortgage rates continue their journey upwards, mortgage REITs will move upwards to narrow down the book value discounts. 

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