Despite a relatively quiet day in the markets, shares of virtually every mortgage real estate investment trust are sharply lower today. To name only the best known, industry giant Annaly Capital Management (NYSE:NLY) is down by 4.2%, American Capital Agency (NASDAQ:AGNC) by 3.8%, and ARMOUR Residential (NYSE:ARR) by 4.4%. What gives?
A tough year for mREITs
Let's begin with the fact that it's been a tough year for mREITs in general. As the Federal Reserve has sought to drive down long-term interest rates via quantitative easing, the interest rate spread that these funds rely on to make money has contracted. Since the third quarter of last year, Annaly's went from 2.08% down to 1.02% today, and American Capital's from 2.14% down to 1.42%.
It follows that the compression of interest rates has obligated these companies to decrease their lucrative dividends payouts. Over the last 12 months, Annaly's quarterly payout went from $0.60 a share down to $0.50, American Capital's from $1.40 a share to $1.25, and Chimera Investment's (NYSE:CIM) from $0.13 a share to $0.09. And this, in turn, has put downward pressure on many of these companies' stock prices.
Is Annaly's acquisition of Crexus a canary in the coal mine?
But all of these things have been known for some time now and are accordingly not the impetus for the industry's terrible performance today. That unenviable handle goes instead to an announcement yesterday that Annaly has submitted a bid to purchase Crexus Investment Corp. (UNKNOWN:CXS.DL.DL), a REIT that specializes in commercial real estate.
On the surface, the deal doesn't look like anything to write home about, as Annaly already owns 12.5% of Crexus and controls the company via its wholly owned subsidiary FIDAC. In addition, as I discussed earlier today, with less than $1 billion in assets, Crexus' holdings will be but a drop in the bucket compared to Annaly's $141 billion balance sheet.
It nevertheless matters because of what it says about the current travails of the mREIT industry, and particularly those mREITs like Annaly that focus on so-called agency mortgage-backed securities that are insured by government sponsored entities such as Fannie Mae and Freddie Mac. Over the past year, the yields on these securities have declined significantly as competition for them has heightened in the wake of Operation Twist and QE3 -- through which the Federal Reserve is purchasing $40 billion to $65 billion a month, or a lion's share, of new agency-backed MBS issues.
Annaly's proposed purchase of Crexus, in turn, is being seen as an acknowledgement that the agency MBS model is unable to function in the current environment -- a canary in the coal mine, if you will. And it's for this reason FBR Capital Markets reduced its price target on Annaly this morning to $13.50 from $16 and maintain its underperform rating on the stock -- the company currently trades for $14.25 a share.
It's worth noting, moreover, that FBR's move comes on the back of similar downgrades at other investment banks. In the middle of last week, no less than three analysts preemptively followed suit. Barclays downgraded Annaly to equal weight, Nomura cut its price target on the company to $15 from $17.25 previously, and analysts at Jefferies Group maintained their hold rating. All of these moves followed Annaly's disappointing third-quarter results, which missed the consensus estimate on the bottom line.
What's an income investor to do?
While many analysts and commentators have been anticipating a downward move in mREIT stock prices, that is no consolation to investors currently holding shares in the likes of Annaly, American Capital, or Chimera -- though Chimera has its own set of more serious problems. To those shareholders, I say it's my opinion that the market is overreacting to general trends that we've seen coming for some time now.
Here at The Motley Fool, we implore investors to avoid the allure of trading stocks on the heels of information like this. What investors should do instead is educate themselves further about the companies they own. It's for this reason that our in-house specialists on Annaly Capital Management have created a new, in-depth report on the mREIT giant. The report identifies both the opportunities and a number of shocking risks that the company faces. To download a copy of this report instantly, simply click here now.
John Maxfield has no positions in the stocks mentioned above. The Motley Fool owns shares of Annaly Capital Management. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.