While the U.S. financial sector has been one of the top performers over the past one year, mortgage REITs have been in the red zone for quite some time now. One of the major reasons for this is the Fed’s aggressive bond buying and the prevailing ultra-low interest rate environment. Through this post, I will focus on some positive signs for managements and investors of mortgage REITs.
Easing coming to an end?
The Fed’s bond buying program has long been a source of trouble for mortgage REITs. For long, analysts have been debating the anticipated time of a halt to these programs. However, nothing could be said with certainty as the economy in general, and the U.S. housing sector in particular, continued to emit mixed signals.
Most recently, San Francisco’s Fed President addressed the issue and expressed his desire to halt the easing programs by the end of the current year. He is of the opinion that the cost of these programs are exceeding their benefits and that even without these programs, Fed’s policy would remain extraordinarily stimulative.
If the easing comes to an end, you can expect mortgage REITs to post higher profits and the resultant hike in dividend distributions coupled with appreciation in stock price.
Markets pricing in the halt?
I believe that the markets are pricing in the potential halt of the ongoing easing programs. This is exactly why Mortgage Bankers Association’s most recent weekly survey revealed declines in mortgage applications, mortgage loan volumes, and refinance activity. While at the same time, it reported a hike in mortgage rates.
Mortgage applications plunged 7.3% while mortgage loan volumes decreased 7.3% compared to the prior week. The Refinance Index declined 8% over the same time period.
The average 30-year fixed mortgage rate with conforming and jumbo loan balances surged 8 bps each, while the average 15-year fixed mortgage rate increased 7 bps over the prior week.
If the trend continues, you can expect wider spreads for the mortgage REITs resulting into higher profits in the coming quarter. Now, let’s look at how the spreads for some of the REITs will be affected if the interest rates increase 50 bps.
American Capital Agency
American Capital Agency reported in its most recent quarterly SEC filing that its projected net interest income will plunge 4.3% if the interest rates increase 50 bps. This was also evident when the company reported its first-quarter performance. During the first quarter, mortgage rates climbed as the market began pricing in a potential halt in the Fed’s easing programs. As a result, the company reported a comprehensive loss of $1.57 per share at the end of quarter.
Annaly Capital Management
Annaly Capital Management reported that if the interest rates surge 50 bps, its projected net interest income will increase 16.91%. At the same time, the company reports a negative interest rate sensitivity gap. This means that the company has more asset sensitive liabilities than asset sensitive assets. Therefore, if the rates increase, the reduction in the value of its interest sensitive liabilities will be more than the decrease in its interest sensitive assets. In short, Annaly has constructed its portfolio in such a way that it will benefit if the rates increase.
Invesco Mortgage Capital
Invesco Mortgage Capital is a hybrid mortgage REIT with investments in both Agency and non-Agency residential mortgage backed securities. It has constructed its portfolio in such a way that it will also benefit from a hike in the interest rates. According to its latest SEC quarterly filings, the company reports that its projected net interest income will increase 19.24% if the rates go up 50 bps.
While the entire mortgage REITs sector will welcome the anticipated halt in the Fed’s easing programs and the resultant hike in the interest rates, there are a few mREITs that will be at a disadvantage. One such example is American Capital Agency. It has positioned its investment portfolio in such a way that it will be at a disadvantage if the rates start climbing up. However, Annaly Capital and Invesco Mortgage Capital are the best alternatives in such a scenario.
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