For mortgage REITs, those specialized investment vehicles that make their money on the spread between short-term and long-term interest rates, the past few months have been rough. Investors accustomed to enormous yields and huge payouts began to panic as the Federal Reserve pondered an exit from its current quantitative easing program.
A recent article sums up this issue succinctly. An investor of one year's duration in CYS Investments (NYSE:CYS) tells Bloomberg that he worries about his dividend dwindling, given the recent volatility in the mREIT sector. He notes that the 12% yield caught his eye, and that he watches daily movements of the stock in an effort to assess whether he should stay put, or sell.
Does this investor have a right to be concerned? Certainly. But a narrow outlook is causing him needless suffering. Let's step back and take a look at another recent doom and gloom scenario: the start of QE3 last fall. Taking a look at how mREITs have fared amid all the twists and turns the Fed's easy money policy caused over the past few months just might provide a little insight into the current situation, as well.
The sky is falling!
When the Fed commenced QE3 in September 2012 with $40 billion of monthly mortgage-backed securities purchases, a shudder ran through the mREIT crowd, especially players like Annaly Capital (NYSE:NLY), American Capital Agency (NASDAQ:AGNC), and Armour Residential (NYSE:ARR). These trusts also bought MBSes backed by Fannie and Freddie and feared that such a large government presence in the market would upset their own apple carts.
They were right, and as long-term rates fell -- the main goal of QE3 -- the lovely spreads began to contract, impacting profits. Then, another nasty blow occurred as homeowners began to refinance their mortgages amid plummeting interest rates. MBS prices rose, as the same amount of paper faced more buyers. On the other hand, the legacy paper held by these companies went up in value, giving book values a lift.
No fatal wounds
The sector hasn't come through unscathed, but it hasn't been mortally wounded, either. Although all four of the above mREITs have lost share value and trimmed their payouts over the past year, yields are still sweet. On October 1, Annaly sported a 14% yield, and American Capital Agency's stood at 19%. Armour's was nearly 18%, and CYS beat them all, with a more than 23% dividend yield.
When most stocks were paying pennies in the zero-interest rate environment, mREITs were rockstars, providing investors with spectacular returns. Even the investor in the Bloomberg article noted that moving his money out of CYS wasn't much of an option, due to a dearth of appealing dividend-paying stocks.
Taking the long view
For historical perspective, Annaly is worth a look. Over 17 years, the trust has been paying quarterly dividends, but they have not always been robust.
Compared to its payout of $0.50 per share last September, its current $0.35 dividend looks piddling. But going back further, the company's payout fell from $0.50 to $0.10 from 2004 to 2005 -- after which it began to rise again. Investors who bought in at that time and bailed out after one year must certainly think less of Annaly than those that have stayed on, reaping the benefits of the long-term view.
Just as they made it through QE3, mREITs will likely survive the taper, just as they powered through the previous Fed money-easing programs. There will be pain and volatility along the way, however, and investors spoiled by gargantuan dividends will have to readjust their expectations. Patience will win out, I believe, and those who stay the course will be rewarded when the market eventually calms -- and mREITs can go back to the business of making money and paying juicy dividends.
Fool contributor Amanda Alix has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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.