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Mortgage REITs, like banks and insurance companies, have lately been feeling the pangs of net interest margin compression. It's no wonder. Painfully low interest rates are being squelched further by the Fed's open-ended QE3 program, making profitability a real hardship for those in the business of borrowing short and lending long. For mREITs, the situation is most dire because this is pretty much their entire business -- unlike insurance companies and banks, which at least have other products to sell.
It is into this environment that Invesco Mortgage Capital (NYSE: IVR ) presented its Q3 report, and it was pretty sweet: Net income of $84.1 million, compared with $79.8 million in Q2 and $82.2 million in the year-ago quarter. The company's book value, so important to mREITs, grew to $20.93, quite a lift from last year's $16.47. Interest income rose, too, though interest expense did, as well -- causing net interest income to drop a bit from this time last year.
An epidemic of tiny yield spreads
Invesco is certainly not alone when it comes to the spread squeeze. Hatteras Financial (NYSE: HTS ) , which, unlike Invesco, invests primarily in government agency-backed mortgage-backed securities, recently noted its own struggles with this issue. The company's NIM fell to 1.22% from 1.49% in Q2, something that Hatteras' CEO blames on QE3. Another agency mREIT, the well-known Annaly Capital (NYSE: NLY ) , recently noted that the Fed's involvement in MBS purchasing is pushing down yields and causing investors to turn away.
Invesco, a hybrid REIT, doesn't limit itself to just GSE securities. In days past, this type of REIT, being more risky than, say, Annaly, was avoided by some investors. Presently, however, hybrids like Invesco and Two Harbors (NYSE: TWO ) are gaining some prestige as QE3 threatens to gobble up the majority of agency MBSes, making them scarcer than hen's teeth -- and pricier, too. Sure, this is a great thing for these REITs' book value, but where's the advantage when there is nothing left to buy?
Just a quick look at how stock prices have fared over the past year points to how investors seem to feel about these two types of REITs. While Hatteras' value has climbed about 6% over the past year and Annaly's share values has risen less than 1%, Invesco sports a 50% increase, and Two Harbors a jump of over 27%.
Invesco is well-positioned to battle QE3 headwinds
Happily, there are some bright spots on the horizon that will lift the entire sector: Housing appears to be rebounding, and prepayment risk may be abating, as the refinancing rate fell by 13% for the third week of October, compared to the previous week.
Until the clouds lift entirely, Invesco's CEO notes that the company has taken steps to arrange its portfolio in order to take advantage of QE3, mentioning the hybrid nature of that strategy. Though Invesco isn't immune to the NIM problems affecting the entire sector, it looks to me to be in a better position to ride out the present storm than some of its peers.
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