Why the Mortgage REIT Sector Was Slammed

Although we don't believe in timing the market or panicking over market movements, we do like to keep an eye on big changes -- just in case they're material to our investing thesis.

What: Shares of mortgage real estate investment trusts -- those which purchase mortgage-backed securities and loans -- were pounded, including Anworth Mortgage Asset (NYSE: ANH  ) , and ARMOUR Residential (NYSE: ARR  ) , which lost as much as 13% and 10%, respectively, following today's strong jobs data.

So what: U.S. jobs data released today showed that the U.S. created 195,000 jobs in June compared to a forecast from economists of 165,000. The considerably better-than-expected jobs report could signal that the Federal Reserve's plan to wind down its $85 billion in monthly bond purchases, which include long-term U.S. Treasuries and mortgage-backed securities, may begin relatively soon. The wind down is complicated in that it'll stop pumping free money into the market, which has helped artificially reduce long-term lending rates. Low lending rates help boost the net interest margin of highly leveraged mREITs. Conversely, with the Fed purchasing fewer mortgage-backed securities, there will be a more purchasable selection for mREITs to choose from, which should serve them positively.

Now what: While rising interest rates aren't good news for the mREIT sector, I'd say that investors, on the whole, are largely overreacting to the news. Admittedly, it depends which road of the sector you decide to go down. Agency-backed mREITs like Annaly Capital Management (NYSE: NLY  ) and American Capital Agency (NASDAQ: AGNC  ) purchase only mortgage-backed securities which are backed by the federal government. This means that they're both covered in case of default. On the other side of the equation are non-agency backed MBS purchasers, who have no backing from the government if their loans default. While agency-backed MBS purchasers' net interest margins are smaller than non-agency backed companies, their dividends are a lot safer. Both Anworth and ARMOUR also invest in agency-backed mortgage-backed securities, so I'd say that today's move lower could represent an intriguing opportunity, but would highly advise you dig deeper into each unique company.

Craving more input? Start by adding Anworth Mortgage Asset and ARMOUR Residential to your free and personalized Watchlist so you can keep up on the latest news with each company.

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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 July 05, 2013, at 9:20 PM, randynnc wrote:

    It was never true that the Fed's purchasing of MBS and Treasuries benefited mREITs. The Fed managed to depress both ends of the yield curve which squeezed margins and limited their returns. The end of QE is positive for them because the short-term borrowing rate can stay low, which the Fed can do, while allowing the long-term lending side to rise, making the spreads larger. The mREIT panic selling is due to the leverage they use, which is great on the upside and killing on the downside. Well, we've reached the downside. But its an overreaction because once the portfolios are adjusted to reflect the reality of rising interest rates the big returns will resume. I don't think it'll take more than a quarter to adjust.

  • Report this Comment On July 06, 2013, at 1:30 PM, jackm12 wrote:

    Overreaction by who ?......who is the investor..? you and I, the retail guys ?........No sir, it's all them Hedge funds who are into" overreaction".

    In all honesty, when Hedge funds become day traders, that is what happens.

  • Report this Comment On July 06, 2013, at 8:43 PM, jad9000 wrote:

    The reason that mReit's bv declined in Q1 was largely because the Fed signaled an end to QE, the mReits responded by paying large amounts for hedges and the Fed reversed course a month before the end of the quarter leaving the mReits with big costs and a marginal increase in rates. At the same time all reported increasing spreads and income but not enough to cover the huge expenses they incurred through their premature hedging activity (compliments of a schizophrenic Fed). All of those hedges are in the money in Q2, income is spiking up and the combination of these activities will limit much of a loss in bv. We already know per statements from WMC and various 10K's that a 1% increase in rates will add between 20% and 35% to net interest income for the mReits. Assuming their hedging activities worked, and we have no reason to think they did not, they should see paper losses on assets, paper profits on hedging and huge increases in net interest income - cash in the bank. In addition, all the mReits are buying back shares below bv. Now they can purchase at 10% to 20% below bv which will, in turn, drive up bv for the remaining shares.

  • Report this Comment On July 07, 2013, at 2:59 PM, buchemist wrote:

    This article should be retracted. The misinformation on mREITs on this website seems perpetual. The fed kept long term rates low with QE which HURT the spread but HELPED the book value on MBSs already purchased. The selling has been due to analysis that the book value could reach $12 a share with the taper due to on hand MBSs losing value with increasing long term rates. However, dividends should rebound once NLY levers up to take advantage of the bigger spread, as short term interest rates should remain stable as long as the fed does not raise their short term rates while longer term rates have increased with the taper talk.

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