Mortgage REITs Have Fallen, and They Can't Get Up

The carnage in the mortgage REIT sector that began in May has extended into June, as investors flee and the trusts watch their stock prices and book values plummet. Nerves are still jangling from Fed Chair Ben Bernanke's comments regarding the end of quantitative easing, and it doesn't look like things are going to quiet down any time soon.

All mREITs are taking it on the chin
The agency crew, led by heavy hitters Annaly Capital (NYSE: NLY  ) , American Capital Agency (NASDAQ: AGNC  ) , and Armour Residential (NYSE: ARR  ) , have all been close to hitting 52-week lows, but the blood-letting hasn't stopped there. Even hybrid mortgage REITs, which also buy some non-agency paper, have plunged, as well. Two Harbors (NYSE: TWO  ) , which enjoyed such a nice lift post-earnings about a month ago, recently sunk to new lows, and Invesco Mortgage Capital (NYSE: IVR  ) has also slipped, even after its CIO's recent show of faith, making a sizable insider purchase of stock less than two weeks ago.

In a way, the sector shot itself in the foot by staging a massive sell-off of mortgage-backed securities, which have fallen in value as long-term interest rates have risen, and markets price in a Fed retreat from QE3. Of course, the selling caused prices to drop further, creating a kind of sinkhole that sucked in the mREITs, pulling them under.

This action is exactly what the Financial Stability Oversight Council has been fretting about, though its main concern is destabilization of markets, rather than crashing mREITs. Despite the girth of Annaly and American Capital Agency, mREITs as a group hold only about 5% of all MBSes. Even so, the FSOC is concerned about their ballooning pile of assets, and is considering tightening regulations on the entire sector.

How long can this continue?
Since much of the market volatility has centered on Fed policy as it reacts to the health of the economy, it seems that Friday's upcoming jobs report for the month of May will very likely keep things wobbly for the rest of the week -- and, depending upon the unemployment picture, far beyond that.

For mREITs, though, even a settling of nerves won't be enough to put everything back to rights, in my opinion. The extent to which they have been dinged has brought them into the limelight, bringing into question their long-term investment value. In addition, the recent decline has exposed chinks, particularly in Armour Residential. Long thought to be a particularly risky prospect, the company has experienced heavy investor flight, indicating that stockholders are beginning to share that opinion. Comments from co-CEO Jeffrey Zimmer insisting that all is well surely haven't helped matters.

I still believe that, in the long run, the sector will survive and thrive -- although there may be a few casualties. QE3 was never meant to last forever, and the mREITs that planned ahead for this event will do just fine. In the short term, though, the sector will continue to suffer, as will its investors.

There's no question Annaly Capital's double-digit dividend is eye-catching. But can investors count on that payout sticking around? With the Federal Reserve keeping interest rates at historically low levels, Annaly has had to scramble to defend its bottom line -- and now faces additional headwinds as the Fed ponders exiting QE3. In The Motley Fool's premium research report on Annaly, senior analysts Ilan Moscovitz and Matt Koppenheffer uncover the key challenges the company faces and divulge three reasons investors may consider buying it. Simply click here now to claim your copy today!


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