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Dividend Cuts Are Not a Death Knell for Mortgage REITs

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In a repeat of a common scenario in the mortgage REIT sector lately, the brief rally following the Federal Reserve's decision to postpone tapering its long-standing monthly bond purchases lost its momentum quickly. Heartwarming spikes in share prices from 2% to 7% did not last, and within a day, purchasers of mortgage-backed securities guaranteed by Fannie and Freddie slashed their dividends, sending investors into a panic.

Armour Residential (NYSE: ARR  ) announced a huge cut in its dividend on September 18, dropping the payouts for the rest of the year from $0.07 per share to $0.05. Armour's announcement was followed by news that both Annaly Capital (NYSE: NLY  ) and American Capital Agency (NASDAQ: AGNC  ) were also slashing payouts. Annaly reduced its dividend by 12.5%, or $0.05 per share, while American Capital Agency chopped 24% from its last payout, leaving investors with an $0.80 per share dividend.

Protecting the portfolio
Dividend cuts are always disconcerting, but in the case of mREITs, not unexpected. Investors familiar with the ups and downs of the sector as of late were probably not surprised to see another drop in the payouts of these three agency players.

These trusts are weathering the storm as best they can. Armour stated that, in an effort to reduce its exposure to market volatility, it has reduced its portfolio by nearly $10 billion while keeping its hedges, which currently cover nearly 89% of its borrowings, in place. American Capital Agency noted that it has repurchased almost 12 million of its shares in the third quarter at a nifty discount of $22.16 per share. When you consider that the company has bought back a little less than $15 billion worth of shares since the program's inception in the last quarter of 2012, the effort made to prop up value in the past three months is impressive.

Annaly is planning ahead in several ways, one of which was its purchase of CreXus Investments, which adds some commercial paper into the mix. On its last conference call, management noted its increased hedging, to 53% of its fixed-rate holdings, as well as plans to securitize some of the commercial debt it holds. Annaly also has plans to originate jumbo home loans through its subsidiary Shannon Funding, LLC.

A painful, but not mortal wound
Investors should realize that the pain will continue for some time, but will eventually pass. Even with these falling payouts, mREITs are still serving up some spicy yields: Annaly's is still over 11%, American Capital Agency's is well over 13%, and Armour's yield is currently more than 14%. Not too shabby for an industry that takes a shock every time the word "taper" is mentioned.

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Related Tickers

9/26/2016 4:00 PM
AGNC $19.82 Up +0.12 +0.61%
American Capital A… CAPS Rating: ***
ARR $22.45 Down -0.06 -0.27%
ARMOUR Residential… CAPS Rating: ***
NLY $10.92 Up +0.13 +1.20%
Annaly Capital Man… CAPS Rating: ****