Mortgage REITs: We May Be Down, But We Are Not Out

What a difference a day makes. After experiencing a swoon over investor concerns about the economy and the Federal Reserve's money policies, mortgage REITs gathered at the Keefe, Bruyette & Woods Mortgage Finance Conference on Tuesday and strutted their stuff. Several presenters, such as Western Asset Mortgage (NYSE: WMC  ) , Two Harbors (NYSE: TWO  ) , CYS Investments (NYSE: CYS  ) , and Hatteras Financial (NYSE: HTS  ) showed that, while the sector may be a little bit bruised, it is by no means beaten down.

Times are tough, but there are bright spots, too
Much of the pain felt by mREITs since the Fed's QE3 program began last September has been in the area of tightening spreads, crimping profits. As Western Asset and CYS noted in their presentations, however, spreads have widened a bit over the past few months, affording some relief. Hatteras, for instance, is counting on a return on equity of 11.73%, based on a spread of 1.30%. 

The two biggest concerns, rising interest rates and prepayment risk, were both addressed as well. Two Harbors noted that it has hedged against a rise in rates, and that hedging costs remain low. Hatteras has increased its purchase of adjustable-rate mortgages to protect its portfolio, and CYS also has hedges in place, while noting that 30-year mortgage bonds are already pricing in a tapering of QE3. 

On the subject of prepayment, most of these companies feel that their risk is low. While Two Harbors expects the government's HARP program to continue through 2015, CYS notes that refinancing activity is already dropping. Indeed, the most recent survey from the Mortgage Bankers' Association shows that refinancing rates have tumbled in response to higher interest rates. Prepayment risk for all mREITs, it appears, has become less of a worry.

Volatility will continue, but mREITs will weather the storm
As a group, these trusts seem resigned to a roller-coaster ride for the foreseeable future, as markets jump around in response to economic indicators -- and their perceived influence on the Fed's stimulus program. CYS, for its part, seems to question if Fed Chair Ben Bernanke's uneven testimony before congress recently wasn't just a test to see how markets would respond to the subject of a QE3 exit.

Overall, the conference mood seemed upbeat, which seemed to calm investors' jitters, at least for the short term. Today is another day, and the effect seems to be wearing off already -- but, then, the entire financial sector looks depressed at the moment. For investors with the tried-and-true long view, this might be a good time to do a little shopping.

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  • Report this Comment On June 05, 2013, at 10:47 PM, HectorSector wrote:

    It's a deep dark mystery as to why so many investors fail to understand that QE has been bad for MREITs and its termination will be welcome. Spreads and profits were both greater before Mr. Bernanke and his friends had their brain siezures. This is a buying opportunity, sure enough.

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