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Without an Act of Congress, Mortgage REITs Could Face a Ruinous Year

By Amanda Alix – Jan 6, 2014 at 5:23AM

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The lapse of the emergency unemployment benefits extension could mean a dip in unemployment rates -- and an earlier end to quantitative easing.

In a speech on Friday at the annual meeting of the American Economic Association, Ben Bernanke looked back at the Federal Reserve under his leadership and discussed the central bank's future plans, as well.

Bernanke reaffirmed the Federal Open Market Committee's commitment to keeping short-term interest rates low as long as the national unemployment rate remains above 6.5% and inflation doesn't float over the Fed's 2% mark. He noted that those factors were not "triggers," and reaching one or the other wouldn't necessarily prod the committee to begin raising the federal funds rate.

Reaching either of these thresholds could prompt the committee to begin considering such a move, Bernanke said. If Congress fails to reinstate extended jobless benefits now that legislators have returned from the holidays, dumping 1.3 million persons from the unemployment rolls could cause the jobless rate to drop much more quickly than anyone previously expected.

A devastating scenario for mortgage REITs
For mortgage real estate investment trusts such as Annaly Capital (NLY 1.06%), American Capital Agency (AGNC 1.02%), and Armour Residential (ARR 2.39%), this could mean big trouble. Last year was a tough one for the sector, as fears surrounding the Fed's timing for tapering its quantitative easing program caused plummeting share prices and book values.

Now that the Fed has decided to start a slow taper of the stimulus program with the advent of the new year, changing the unemployment picture can only increase the pain. There is a good chance that removing more than 1 million people from the ranks of the unemployed will drop the jobless rate by as much as 0.5%, as those people are no longer considered unemployed. The percentage could fall further as another 1.9 million lose their extended benefits by June. A corresponding situation occurred in North Carolina in 2013, when tens of thousands of people lost benefits, and the state jobless rate dipped by 1.4 percentage points. The possibility of the same scenario occurring at the national level is very real.

Though Bernanke said short-term rates would stay low for some time after the unemployment rate dropped to 6.5%, what might happen if it kept falling? The Fed would probably further decrease its monthly purchases of bonds and securities beyond the reduction of $10 billion that begins this month. It would also begin considering an increase in short-term rates, especially if the unemployment rate appeared to be steadily moving downward.

Speeding up the taper is likely to further erode book values, and diminishing dividends may disappear entirely. Since December 2012, Annaly's quarterly dividend has fallen from $0.45 to $0.30 per share, and American Capital Agency's has dropped to $0.65 from a robust $1.25. Armour has decreased its own monthly payout from $0.09 per share to $0.05, which it plans to hold steady for the entire year. 

It is likely that this scenariowould precede the hiking of short-term rates by several months. The majority of FOMC members have said that the federal funds rate won't rise until 2015, and then "only modestly" during that year. But that estimate coincides with an unemployment rate of 6.5% being achieved by the end of 2014, not several months earlier.

Needless to say, escalating borrowing costs is not a complication mREITs need right now. If emergency unemployment funding is not reinstated once again, 2013 could begin to look like a cake walk compared to the damage these trusts may be forced to endure during the coming year.

Fool contributor Amanda Alix has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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.

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