Speaking at a press conference earlier today, the Chairman of the Federal Reserve, Ben Bernanke, remained noncommittal about whether or not the central bank would initiate another round of quantitative easing. According to Bernanke, the Fed would "provide additional policy accommodation as needed."
While the market had hoped for a more tangible commitment, the Fed's decision to remain on the sidelines is good for at least one group of stocks: high-yielding mREITs, like Annaly Capital Management
The typical mREIT is nothing more than a leveraged fund that specializes in mortgages or mortgage-backed securities. They borrow money at low short-term interest rates, typically in the repo market, and then use that money to purchase higher yielding asset-backed securities. The difference between the yields, known as the interest rate spread, is the source of both their profit and, because they're statutorily obligated to distribute at least 90% of earnings, their generous dividend yields of 12.7% and 14.4%, respectively.
With this in mind, the last few years have been a veritable bonanza for these companies, as short-term interest rates are literally as low as they can go. Yet, in the middle of last year, it seemed like this gravy train might be under threat by the Fed's aptly-named operation twist, a variation on the theme of quantitative easing.
Under traditional monetary policy, the Fed sets its sights on lowering short-term interest rates by buying near-dated Treasury bonds. Alternatively, under quantitative easing, the Fed's objective shifts to decreasing long-term rates through the purchase of longer dated bonds. Because the latter ostensibly brings long- and short-term rates together, it's known as flattening the yield curve.
While lower long-term rates are great for most companies and consumers, because it allows them to borrow money inexpensively for many years out, it's anathema to mREITs like Annaly and Chimera. As I said before, these funds make money on the difference between the cost of low short-term interest rates, and the proceeds from higher long-term rates. In the second quarter of this year, for instance, Annaly's average interest rate spread was 1.54%, a 91 basis point decrease from the same period a year ago.
Foolish bottom line
At the end of the day, the Fed's decision to leave the spread as is couldn't be better news for yield-seeking investors in mREITs.
