Why mREIT Stocks Soared on Friday

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Because mortgage REITs pay such massive dividend yields, their share prices aren't typically associated with elevated volatility. Investors usually buy and hold mREITs for the quarterly payouts as opposed to trading in and out of them.

It's for this reason that the past week has been unusual for investors in companies like Annaly Capital Management (NYSE: NLY  ) , American Capital Agency (Nasdaq: AGNC  ) , and ARMOUR Residential (NYSE: ARR  ) . At various points throughout the last five days, shares in these companies have declined by as much as 7%, 8%, and 13%, respectively, compared to their opening prices on Monday. And now, today, they're up by more than 3%.

What gives?
The answer to this question is twofold.

As I discussed in detail on Tuesday, it's been a tough back half of the year for mREITs. Thanks to the Federal Reserve's heightened presence in the agency mortgage-backed securities market since September, the yield on agency mortgage-backed securities has tanked. In the third quarter alone, American Capital's yield on earning assets fell by 18 basis points, ARMOUR's by 27 basis points, and Annaly's by a staggering 50 basis points.

These figures were nevertheless not the reason these stocks declined earlier in the week, as the quarterly earnings reports in which they were disclosed were all published either in the prior week or the week before that.

Instead, the declines this week were in response to Annaly's proposed acquisition of Crexus Investment Corp. (NYSE: CXS  ) , a roughly $1 billion REIT that operates under the Annaly umbrella, and specializes in higher yielding commercial real estate assets. Despite Crexus' relatively meager size (Annaly has more than $140 billion in assets on its balance sheet), this is a big deal because it signals that the pioneer of the agency mortgage REIT model is at least partially abandoning it.

Here's what Annaly had to say in its press release announcing the acquisition:

Since our inception in 1997, Annaly has maintained the capacity to diversify its asset base to include real estate related assets in addition to Agency mortgage-backed securities if we determined that compelling other long-term investment opportunities exist relative to the Agency market. While we remain committed to the Agency market, given the current environment, we believe it is prudent to diversify a portion of our investment portfolio. Therefore, we may allocate up to 25% of our shareholders' equity to real estate assets other than Agency mortgage-backed securities.

If you've come across other articles I've written this week, like this one or this one, then no doubt you've already read the paragraph above, as this is now the third time that I've cited it in the last few days. In case you haven't, I encourage you to read the paragraph closely, as it goes a long way toward explaining why the sector has performed so abysmally this week until today. Namely, investors are concerned that the agency mREIT model that Annaly, American Capital, and ARMOUR all employ may be headed for lean times.

So what about today?
Good question.

As best as I can tell, the impetus for the upward moves today came courtesy of Wells Fargo's (NYSE: WFC  ) decision to upgrade Annaly from "market perform" to "outperform."

That being said, there's two things to note. First, analyst ratings are notoriously biased and inaccurate. In case you don't believe me, read this. And second, for what it's worth, given what I just said, Wells Fargo's opinion about Annaly is clearly in the minority. After the announced acquisition proposal, three different investment banks downgraded it and/or dramatically reduced their price targets on its stock.

Do with that what you will. In the meantime, however, have a great weekend!

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Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 18, 2012, at 11:08 PM, jad9000 wrote:

    Here's my read. The MREITS have increased their book value substantially and are almost all trading well below book. The had record profits. They are buying back shares below book to increase their eps. Some are diversifying into commercial, which is way more profitable and way less volatile. In this mindless takedown, every classification of REIT was taken down (check RSO and others) for no good reason. Now that the hedge funds have scared out the timid they will drive it back up again. This is classic a GS/Cronies yearend cattle drive with a stampede thrown in.

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