1 Question Every Annaly and American Capital Agency Investor Needs to Ask Themselves

With the eventuality of rising increase rates creeping closer, every mREIT investor needs to ask themselves this one crucial question.

Jul 10, 2014 at 6:56PM

On Wednesday, the Federal Reserve released minutes from its June meeting. While much was discussed it can be summarized fairly quickly: The economy is improving slowly, the Fed will end its bond buying program in October, and they discussed -- though coming to no clear conclusion -- when to raise interest rates.

All of which is in line with what Annaly Capital Management (NYSE:NLY) and American Capital Agency (NASDAQ:AGNC) investors have been hearing for the last several months. We know what's happening now, what will happen soon, and what will likely happen a year or so down the road.

What seems to be missing is the most important question of all: What happens after that?

mREITs aren't new
Eventually, there will be an increase in both short and long-term interest rates. Because rising rates puts pressure on Annaly and American Capital Agency's borrowing costs, as well as lowering the market value of their currently held securities, it creates a less-than-ideal investing scenario.

The problem is we don't know how long the rising rate environment will persist, or how sharp the incline will be. Moreover, considering at just 17 years old Annaly is the oldest of the more popular mREITs it's unclear how they could perform in a prolonged rising rate environment. 

Luckily, today's mREITs aren't the first. In fact, they've been around since 1969, rising and falling in a fairly predictable manner for the last 45 years. 

The chart below shows mREIT "hot spots." Throughout mREIT's history, the industry's collective market cap has risen when the federal funds rate -- short-term interest rates set by the Federal Reserve -- has been low or falling, and declined as rates increased. This cycle often starts with the creation of new companies, only for several to eventually fall on their sword, and the cycle starts over again. 

Fed Funds Rate And Reits Graph

mREIT's saving grace
While that sounds pretty bleak, I believe where the mREITs of old may have perished, Annaly and American Capital Agency have a few distinct advantages:

  1. Hedging techniques 
  2. More aware of risk
  3. Communication with the Federal Reserve 

In 1981, the first interest rate swap – allowing two counter-parties to exchange interest rate payments -- was completed between IBM and the World Bank. Therefore, any mREIT before that point was unable to trade their floating-rate payment for a fixed-rate. By doing so, today's mREITs aren't as susceptible to rising rates increasing borrowing costs at they once were. 

However, that doesn't explain why many of the mREITs from the late 1980s and 1990s never made it to today. My belief is, first, that hedging tools were either misused or underutilized. Second, the failing of mREITs during the financial crisis was, in part, due to making heavy bets on risky assets, such as subprime mortgages. 

Since the vast majority of Annaly and American Capital Agency's securities are protected against defaults, the risk of failing assets is almost zero. Though, it should be mentioned that Annaly is creating a net lease position – or owning physical real estate. While these assets are not protected against default, equity REITs over the last 40 plus years have been much more consistent than their mREIT brethren. 

Finally, today's Federal Reserve has been extremely forthright as to the the inevitability of increasing interest rates. Unlike in the past when rates were increase with less warning, Annaly and American Capital Agency have had time to prepare their portfolios. 

The last word 
Annaly and American Capital Agency, along with the rest of today's mREITs, may have an advantage over mREITs of old, however, despite this leg-up the future looks far from advantageous. 

While I believe that both companies have done what is necessary to navigate this environment, that doesn't mean long-term returns will be attractive. Therefore, I would suggest investors proceed with caution.

Top dividend stocks for the next decade
Knowing what the road ahead may not be kind to mREITs, our top analysts put together a report on a group of high-yielding stocks that should be in any income investor's portfolio. To see our free report on these stocks, just click here now.

Dave Koppenheffer has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

So you can imagine how shocked I was to find out Warren Buffett recently told a select number of investors about the cutting-edge technology that's keeping him awake at night.

This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

That's how Buffett responded when asked about this emerging market that is already expected to be worth more than $2 trillion in the U.S. alone. Google has already put some of its best engineers behind the technology powering this trend. 

The amazing thing is, while Buffett may be nervous, the rest of us can invest in this new industry BEFORE the old money realizes what hit them.

KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

Yet according to one J.D. Power and Associates survey, only 1 in 5 Americans are even interested in this technology, much less ready to invest in it. Needless to say, you haven't missed your window of opportunity. 

Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

Don't let that happen again. This time, it should be your family telling you, "I can't believe you knew about and invested in that technology so early on."

That's why I hope you take just a few minutes to access the exclusive research our team of analysts has put together on this industry and the one stock positioned to capitalize on this major shift.

Click here to learn about this incredible technology before Buffett stops being scared and starts buying!

David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't 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.

©1995-2014 The Motley Fool. All rights reserved. | Privacy/Legal Information

Compare Brokers