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Earnings: Mortgage REITs Annaly and American Capital On Deck

By Alex Dumortier, CFA – Feb 3, 2014 at 10:15AM

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The gorillas of the mortgage REIT sector report today.

Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.

After closing out the worst month since May 2012, U.S. stocks opened down on Monday, with the benchmark S&P 500 and the narrower Dow Jones Industrial Average (^DJI) dropping 0.90% and 0.83%, respectively, at 10:15 a.m. EST. Two of the largest mortgage real estate investment trusts, Annaly Capital Management (NLY -2.77%) and American Capital Agency (AGNC -1.38%), report their fourth-quarter results today (see below). Investors are also anticipating the following events this week:

Wednesday: Microblogging platform Twitter will report its first set of results as a public company. Competitor Facebook already announced outstanding fourth-quarter numbers, which sent the stock up 15% last week – no pressure, little birdie!

Thursday: The largest U.S. auto manufacturer, General Motors, issues its fourth-quarter results, the first such report for newly appointed CEO Mary Barra.

Friday: The Labor Department releases its employment report for January. The consensus forecast has the unemployment rate at 6.7%, unchanged from December. Last week, the Federal Reserve opted to continue reducing the size of its monthly bond purchases, signaling it expects the economy to continue improving. This Friday's numbers will give us a glimpse of the employment picture at the start of this year.

The Fed's decision to continue the taper of its bond purchase program has significant implications for mortgage REITs, including the gorillas of the sector, Annaly Capital Management and American Capital Agency.

With quantitative easing, the Fed became the dominant actor in the mortgage-backed securities market (the same bonds Annaly and American Capital hold as "inventories"). There are concerns regarding the impact on this market from the Fed's rollback on purchases.

However, the knock-on effect on mortgage REITs is complex and varied. On the one hand, the Fed is removing a massive source of demand for these bonds (albeit in a very progressive manner), which puts downward pressure on prices and, thus, on the value mortgage REIT portfolios. On the other hand, the Fed has decided to taper on the basis of improvements in the economy; if the recovery continues and rates normalize, it's altogether possible that mortgage REITs will be able to capture a wider spread between the short-term rate at which they borrow money and the rate at which they are effectively lending money when they buy bonds.

Annaly and American Capital trade at roughly a 15% to 20% discount to their book values (they've not traded above book value since the first half of 2013). Look for management commentary regarding the way they are positioning their portfolios "through the taper" (the Fed will probably exit the mortgage bond market altogether this year). However, the only thing investors can be fairly certain of at this stage is that the shares of these leveraged vehicles will remain volatile for the foreseeable future.

Alex Dumortier, CFA 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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Stocks Mentioned

Dow Jones Industrial Average (Price Return) Stock Quote
Dow Jones Industrial Average (Price Return)
$34,347.03 (%)
Annaly Capital Management Stock Quote
Annaly Capital Management
$21.05 (-2.77%) $0.60
AGNC Investment Corp. Stock Quote
AGNC Investment Corp.
$9.76 (-1.38%) $0.14

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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