Why Shares of Annaly Capital Management, AGNC, and Orchid Island Capital Rose Today

What happened

Shares of several mortgage real estate investment trusts (REITs) rose today after they provided preliminary results for the third quarter of the year.

Shares of Annaly Capital Management (NLY 0.59%) rose 11.6%, while shares of AGNC Investment Corp (AGNC -1.28%) rose nearly 10.9%, and shares of Orchid Island Capital (ORC -2.78%) ended the day up nearly 13%.

So what

Yesterday, AGNC reported a preliminary loss in the third quarter of between $1.99 and $2.03 per share. It also estimated that its tangible net book value per common share at the end of Q3 was roughly between $9.06 and $9.10 per share. That means book value is expected to be down more than 20% from the second quarter.

AGNC also reported that its total investment portfolio at the end of Q3 was roughly $61.5 billion, and it had roughly $3.6 billion of cash and unencumbered agency mortgage-backed securities (MBS), which are guaranteed by the government-sponsored entities.

For its preliminary third-quarter results, Annaly estimated that its book value per common share had fallen roughly 15% from $23.59 in the second quarter to a range of between $19.85 and $20.05 at the end of the third quarter.

Annaly also estimated that its earnings available for distribution in the third quarter exceeded its third-quarter dividend of $0.88 per common share.

The company also expects to have about $4.1 billion of cash and unencumbered agency MBS and total unencumbered assets of $6 billion. Both Annaly and AGNC will report their full earnings results later this month.

Rapidly rising interest rates have created a difficult environment for mortgage REITs because MBS spreads have widened, with mortgage rates rising faster than the yield on the 10-year U.S. Treasury bill. Bond values and yields have an inverse relationship, so as yields rise, bond values take a hit, which is why so many of these mortgage REITs are seeing their book values decline.

To qualify as a REIT, companies need to pay out 90% of their taxable income to investors through dividends. With mortgage REIT stock prices struggling, all three of these mortgage REITs now have massive annual dividend yields ranging from 17.72% to 32.25%.

While the yields are super attractive, the dividends are paid from existing capital (book value) and earnings, which could continue to face pressure and may lead to dividend cuts in the future. Orchid Island had to cut its dividend earlier this year. 

Now what

Considering the harsh environment, I think investors were expecting to see a drop in book values at Annaly and AGNC, so perhaps it declined less than expected, or investors might have just been happy to see the dividends come through.

While the yields look great and most mortgage REITs trade below book value, the storm may not be over yet. As it stands, the Federal Reserve still expects to raise interest rates by another 1.25 to 1.50 percentage points before the year is over.

Furthermore, it's a bit hard to say how the Fed's effort to reduce its balance sheet in a process known as quantitative tightening, in which it lets its own bonds mature and run off, effectively pulling liquidity out of the economy, will impact MBS yields. They could go higher yet.

Due to all of this uncertainty, I am not currently planning to purchase any mortgage REIT stocks, despite their appealing valuations and dividend yields, but will be actively monitoring the situation.