How QE3 Slaughtered Mortgage REITs

Nearly three months ago, the Federal Reserve announced a third round of quantitative easing aimed at driving down long-term interest rates. Under the program, the Fed committed itself to buying $40 billion in agency mortgage-backed securities until the labor market improves "substantially."

At the time, many analysts, myself included, speculated that the size of QE3 and its focus on the agency MBS market would disproportionately impact mortgage REITs that specialize in these same securities, including Annaly Capital Management (NYSE: NLY  ) , American Capital Agency (NASDAQ: AGNC  ) , CYS Investments (NYSE: CYS  ) , Hatteras Financial (NYSE: HTS  ) , and Two Harbors Investment (NYSE: TWO  ) , among others.

With the benefit of hindsight, we can now gauge the impact it's had on the valuations of these stocks. As you can see below, all five of the companies mentioned are currently trading at markedly lower price-to-tangible book multiples than they were at the beginning of the second quarter. Since then, in fact, all but one, CYS Investments, went from trading for a premium of tangible book value per share to a discount thereof.

NLY Price / Tangible Book Value Chart

NLY Price / Tangible Book Value data by YCharts.

Of course, for the experienced investor, this begs the question: Is it time to buy?

Before answering this, let me start out by saying that I'm no fan of the mREIT industry, and Annaly Capital Management in particular. As I laid out yesterday, there are at least six reasons that I believe prospective investors should flee from its stock -- as well as the stock of its operationally related subsidiary, Chimera Investment Corp. (NYSE: CIM  ) .

At the same time, however, for those who disagree with my thesis on Annaly, or for investors looking at any of the other mREITs listed above, it's impossible to deny that these valuations present a seemingly attractive opportunity.

If you are so inclined, I'd encourage you to consider two points. First, keep in mind that QE3 will continue for a considerable time period, or, as the Fed put it, until the labor market improves "substantially."

And second, the agency MBS market is now comparatively crowded. This has driven up the portfolio values of mREITs, accounting for a portion of the concomitant decline in the valuation metrics charted above, and also essentially guarantees that all of these investment vehicles will be less profitable going forward than they have been over the recent past.

In other words, despite the increasingly high yields, I don't believe now is the time to buy into this sector, as there may very well be cheaper entry points going forward.

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  • Report this Comment On December 05, 2012, at 10:54 AM, kjurow wrote:

    Though I write Minyanville.com's Housing Market Report, I also follow the RMBS market very closely.

    No one apparently wants to discuss the credit risks of the Fannie/Freddie guaranteed RMBS. How many Fool readers know that jumbo conforming prime mortgages have rising delinquency rates which approach 20%? Or that Fannie has guaranteed more than $500 billion subprime mortgages which are totally hidden by Fannie because they do not consider them subprime? Scary?

    You also need to take a good look at the non-Agency RMBS market where the credit risks are enormous. Fool readers see that these have rallied since the end of 2011 and they haven't a clue about the default risks of the awful mortgages inside these RMBS. Watch out with these -- they'll explode before too long.

  • Report this Comment On December 06, 2012, at 12:56 AM, cummingsr wrote:

    Query: Wouldn't the fed's purchases of RMBS securities tend to support their value and strengthen their pricing? So if that is true and the value of MREIT portfolios gain support from this Fed program, does that not improve their balance sheets and their bottom lines? Now going forward I can see that this program might depress yields on RMBS but that will only show over a longer period of time as the new paper works into their portfolios.

    What am I missing?

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