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An Enormous Headwind Buffeting Mortgage REITs

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The recent election was depressing for the mortgage REIT sector, with visions of unlimited QE3 bond-buying and a probable continuation into next year of Operation Twist. As if that wasn't enough, the Financial Times notes that an even bigger threat is looming for the industry: the possible replacement of Edward DeMarco, the controversial head of the Federal Housing Finance Agency.

Obama is not a big fan of DeMarco, but mREITs may see it differently
A big brouhaha ensued last summer when DeMarco bucked the White House on principal reduction for underwater mortgages, claiming that doing so does not have a positive effect on foreclosure rates, nor is the practice a wise use of public money. Treasury Secretary Timothy Geithner even wrote DeMarco a letter trying to change the regulator's mind, but to no avail. The result? Supposedly, whispers have been circulating that DeMarco will soon be looking for another job now that Obama has been elected to a second term.

The upshot for the mREIT industry is that a DeMarco replacement may not be averse to an accelerated refinance program, thus opening up scads of Fannie and Freddie-backed loans that were previously considered ineligible for refinancing. Many believe this concern is the basis for the recent plunge of both mREIT stocks and agency-backed paper since the election.

The mREIT sector's concern is understandable. Not only will pools of loans be up for grabs under this doomsday scenario, but they will likely be older, with higher interest rates. Prepayment of these, with commensurate replacement with loans sporting much lower interest rates, will crimp net interest margins more tightly than ever. Agency mREITs like Annaly Capital (NYSE: NLY  ) and American Capital Agency (Nasdaq: AGNC  ) , in particular, have been hit hard by NIM issues, as well as the election results.

What's the real risk?
While some analysts are expecting the worse, others believe that the whole issue is being hyped unnecessarily. The latter group notes that there has been a definite rally of mREIT stocks over the last day or so, and attributes this to the realization that banks, barely able to handle the current refi activity, likely aren't going to be taking on any more -- no matter what political changes are made.

In addition, these analysts note that not only is a changing of the guard at the FHFA no cake walk, but a change in the agency's charter would be necessary to spur the kind of refinance activity that investors fear.

Is it possible that the sky is not falling, after all? Probably. Still-nervous investors may want to consider some mREITs that buy up non-agency paper, at least for the time being. Credit Suisse has suggested that hybrid REITs such as Invesco Mortgage Capital (NYSE: IVR  ) , with its mix of agency, non-agency, and commercial loans, might be more resilient in the current climate.

Diversification is always a good thing, as is investor due diligence. Look before you leap, but don't spend too much time worrying about mortgage REITs. This strong headwind may bend them a bit, but I don't see them breaking because of it.

Annaly Capital Management has a long history of paying huge dividends to shareholders and has recently made some changes to bolster its returns. But there are some crucial issues investors have to understand about Annaly's business model before buying the stock. In this brand-new premium research report on the company, our analyst runs through these absolute must-know topics, as well as the future opportunities and pitfalls of their strategy. Click here now to claim your copy.

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10/21/2016 4:00 PM
AGNC $19.48 Down +0.00 +0.00%
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