The past two years have been downright awful for mortgage real estate investment trusts (REITs). First, the COVID-19 pandemic caused the mortgage-backed securities market to freeze, triggering a wave of margin calls. The margin calls caused every mortgage REIT to sell parts of its portfolio at fire-sale prices to raise capital. Every mortgage REIT either cut or suspended its dividend. Finally, the interest rate hikes and potential sale of the Fed's mortgage-backed securities portfolio has caused mortgages to underperform Treasuries. What does this mean for the mortgage REIT sector going forward?
Chimera recently cut its dividend
Chimera (CIM 1.70%) recently cut its quarterly dividend from $0.33 to $0.23 per share. Chimera owns a portfolio of government guaranteed and non-guaranteed mortgage-backed securities and whole loans. It buys portfolios of loans (largely seasoned reperforming loans) and business purpose loans. It then issues securities against them.
The volatility of the interest rate market has been difficult for everyone, especially those that hold loans that are not guaranteed by the government. The liquidity in this market comes and goes, and we have seen mortgage bankers fold due to exposure to these loans. That said, even with the dividend decrease, Chimera still yields close to 15%.
AGNC Investment is the safest of the bunch
AGNC Investment (AGNC 1.85%) is probably the safest bet in the mortgage REIT space. It invests almost entirely in mortgage-backed securities, which are guaranteed by the U.S. government. Mortgage-backed securities have underperformed the Treasury market this year, which is a function of interest rate volatility and of worries about the Federal Reserve.
The Fed owns just under $2.8 trillion worth of mortgage-backed securities, which it bought during its quantitative easing programs. The Fed has said it plans to let the portfolio run off, which means that it will let up to $35 billion of its portfolio mature per month. The problem for the Fed is that refinance activity is almost nonexistent right now, and the market is worrying that the Fed might have to sell some of its portfolio into the market. This would be a negative for the mortgage REIT sector.
AGNC pays a monthly dividend of $0.12 per share, which gives it a dividend yield of 15.8%. This is at the high end of its range and approaching levels right before it cut its dividend in the early days of COVID. Given the market environment and the underperformance of mortgages versus Treasuries, a dividend cut cannot be ruled out.
Data by YCharts.
Annaly Capital just did a reverse stock split
Annaly Capital Management (NLY 1.69%) just did a 4-for-1 reverse stock split. Reverse stock splits are not the same as normal stock splits. In a reverse stock split, the number of shares outstanding decreases and the value of the stock increases. The company did this in order to get its outstanding shares to be more like other mortgage REITs of the same market capitalization. This caused the dividend to increase fourfold and the stock price to rise by a similar amount.
Annaly has been active in mortgages that are not guaranteed by the U.S. government, especially those that fall outside of the credit box for Fannie Mae and Freddie Mac. These loans are typically done by professional real estate investors who plan on using rental income to support mortgage payments. These borrowers tend to put up 25% or more, which means they have a lot of skin in the game. These non-QM loans have nothing in common with the subprime loans of the bad old days.
If Annaly was planning on cutting its dividend, it probably would have announced it with the reverse stock split. However, given the backdrop, a decrease in book value per share is probably in the cards for the third quarter.
Bottom line: Watch and wait for the Fed to get out of the way
The mortgage REITs have been hit especially hard toward the end of the third quarter. The mortgage banking space, in general, has seen company after company announces layoffs, and some companies are barely hanging on. One ended up going bankrupt. The fallout from the carnage is going to negatively affect mortgage REITs in general, and investors should expect another quarter of declines in book value per share.
That said, once the Fed is done with its tightening cycle, the outlook for the sector should improve vastly. So income investors should keep an eye on the sector, and if the Fed signals it is pausing rate hikes (which the Fed Funds futures imply would be the end of the year), then the sector might be investible again. At the moment, the REITs are a falling knife.
