Extensive Misery Ahead for Mortgage REITs

There is no sugar-coating the fact that mortgage real estate investment trusts are in a world of pain right now, having just come off a depressing third-quarter earnings season capped by Annaly Capital's (NYSE: NLY  ) $0.05 per-share miss on core earnings. Book value took a hit, with value per share standing at $12.70 at the end of the third quarter, compared to $13.02 for the prior period.

Two economic releases late last week didn't help even while delivering good news. The Bureau of Economic Analysis noted that the nation's gross domestic product increased at an annual rate of 2.8% last quarter, up from 2.5% in the second quarter and a giant leap higher than the 2% analysts had expected. On Friday, the Bureau of Labor Statistics revealed that the economy had added a whopping 204,000 jobs in October, compared to the 120,000 economists had predicted.

Lovely news for a struggling economy, but another blow to mREITs as bond prices toppled, dragging down share prices of Annaly, American Capital Agency (NASDAQ: AGNC  ) , and Armour Residential (NYSE: ARR  ) .

A murky future for mortgage REITs
The problem, of course, was the resurgence of taper terror, as investors and analysts focused on what the Federal Reserve would do with this data. Would the improved metrics indicate an economy hardy enough to withstand a move by the Fed's to wind down its monetary-easing policies?

Some analysts think the economy's apparent robustness will push the Federal Open Market Committee in the direction of tapering -- perhaps as early as next month -- while others feel that tapering isn't likely to occur until next spring.  

I join the latter group in believing that tapering won't be on the Fed's menu until next year, for a couple of reasons. One is the fact that more people than ever are dropping out of the workforce, with the employment participation rate dropping to 62.8% in October, the lowest in a year. Even so, the unemployment rate rose to 7.3% last month from 7.2% in September. Mix in the fact that the majority of the jobs added to the economy -- 53,000 -- were in the low-paid leisure and hospitality sector, and the jobs data looks a lot less rosy.

Uncertainty will continue to trouble the sector
Investors should expect the debate, and mREIT volatility, to wear on until the FOMC's next meeting on Dec. 17-18. If the committee's decision is to begin the exit from quantitative easing, mortgage REITs will take it on the chin, again; if the decision is to wait, the sector will still suffer, as speculation will surely continue into the new year.

For its part, Annaly continues to try to find its way forward. The company reduced its portfolio of agency mortgage-backed securities, increased cash on hand, and bumped up its commercial investments. With only MBSes backed by Fannie Mae and Freddie Mac on their books, both American Capital Agency and Armour Residential may fall in value more than Annaly in the near future, since the two former trusts don't have Annaly's commercial unit to help reduce the damage being done to companies that invest in only the same kind of paper as the Fed.

This week, Janet Yellen begins her slog through congressional confirmation hearings as Fed Chairman Ben Bernanke's probable successor. This means that the Federal Reserve will be in the spotlight more than usual, as Yellen is questioned on her own views on monetary policy. For investors who believe that the current strife is only a bump in the road for mREITs, the carnage might be viewed as a time to snap up some sweet bargains.

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  • Report this Comment On November 11, 2013, at 12:59 PM, cawkercitykid wrote:

    with the "family" sucking blood out of the heart of NLY - it's a wonder it has any life at all in it..

    they deserve a class action suit.

  • Report this Comment On November 11, 2013, at 3:44 PM, will1946 wrote:

    I agree with the previous comment, and I think that (very unfortunately for me, too) that reits are in a world of _______. I don't see any future for them unless the analysts lower the bar significantly.

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