Mortgage real estate investment trusts, or mREITs, have not had a good year. Down on average 30% during the past year, the likes of Annaly Capital Management (NYSE: NLY ) , American Capital Agency (NASDAQ: AGNC ) , Two Harbors Investment (NYSE: TWO ) , and ARMOUR Residential REIT (NYSE: ARR ) have seen the value of mortgage-backed assets, on which they produce the majority of their income decline, pressuring interest income and shareholder returns.
In addition, recent talk of Fed-induced tapering has spurred many mREITs to reduce their leverage and exposure to the debt markets, in an attempt to reduce the effect that a rise in interest rates will have on their asset portfolios.
However, one of the most attractive traits of mREITs are their higher-than-average dividend yields. So this got me thinking: Do the total returns of the mREITs make up for their poor stock price performance so far this year?
Bigger is usually better
To start let's take a look at the biggest mREIT by market capitalization, Annaly Capital Management. If you had purchased Annaly stock a year ago, you would have paid $15.89 per share. Since then, you would have received $1.65 in dividends, or 10% of the initial investment.
However, during the same period the share price has fallen 24%! Still, if we include dividends, the decline has only been 13%.
Next in line is American Capital Agency, and the picture is much the same here. During the last year, American Capital has paid out $4.35 in dividends but over the same period the stock price has declined 25% (before today's sell-off). Nonetheless, if we add dividends in for a total return, the declines have been limited to 12%.
ARMOUR Residential pays a monthly distribution, so investors have more options and flexibility when it comes to the company's payout. Still, this has not made it exempt from the general declines hitting the sector. During the past year, ARMOUR has paid out $0.89 in dividends.
Over the same period, the stock price has declined an astonishing 38%. However, including the dividend payouts the company has achieved a total return of -25%, which is not good, but it's better than -38%.
As I mentioned briefly above, one of the reasons for these companies' poor performances is the declining value of their underlying assets, mainly agency mortgage securities. Indeed, with the mREIT stock prices usually linked to the value of their underlying assets, a fall in the value of mortgage-backed securities will hurt the book values of mREITs and thus affect their stock prices.
In particular, during the last five quarters, Annaly's book value per share has declined 20%, American Capital Agency's book value has declined 14%, and ARMOUR's book value has declined 21%.
Having said that, one company that has not seen its book value fall is Two Harbors. Actually, Two has seen its book value per share rise 3.2% over the same period. This has not stopped the company's share-price atrophy, however, and since September last year, the stock is down 19.5%. Still, including dividends, total return gives a decline of only 4%.
Bucking the trend
Part of the reason Two Harbors' book value expanded during the last year was the company's increase in leverage. In particular, it increased its leverage 3.1:1 during the first quarter of 2013, to 3.6:1 during the second quarter. In other words, it went from borrowing $3.1 for every $1 of equity to $3.6 for every $1, a 16% rise.
You might have noticed that Two Harbors has a lower level of leverage than its larger peers. The reason for this is simple: Two Harbors' take on much more risk, investing in non-agency-backed mortgage securities. These securities have a higher yield but also come with more credit risk as they are not guaranteed like agency securities. This heightens the risk that Two Harbors could suffer a default of losses on its securities.
Dividends at these companies can somewhat smooth out stock declines. That said, there may be further declines ahead, especially if the Federal Reserve stops its monetary easing operations.
Still, it would appear that some of these declines are temporary and self-inflicted as the companies are reducing leverage while there is so much uncertainty in the market. It is likely that when there is more clarity in the market, these REITs will start to borrow again and returns will improve.
All in all, the total returns of mREITs look to be worth it, in the long term at least.