High-yielding mortgage REITs like Annaly Capital Management (NLY 3.60%), Two Harbors Investment Corp. (TWO 3.04%) and Invesco Mortgage Capital Inc. (IVR 13.16%) have lost a little of their luster with income investors over the past few months, sinking on worries over how the Federal Reserve's monetary policy would affect interest rates.
More recently, however, the sector has been a bit more green than usual. Is it time to consider adding some of these stocks to your portfolio, despite lingering uncertainty over interest rates? I believe there are still many reasons to like these trusts – here are just two.
Interest rate volatility is ebbing
The latest Federal Open Market Committee meeting minutes calmed fears about interest rates considerably, revealing a majority of committee members reluctant to raise short-term rates in the near future. With recent fears of a global economic slowdown, the Federal Reserve has indicated that a hike in rates might be postponed indefinitely.
With mREITs, the mere thought of interest rate increases tends to cause a rout in the sector, as it did when talk began of tapering the Fed's bond-buying program, known as quantitative easing, last year. Another bump occurred when new Fed Chair Janet Yellen made the mistake of mentioning a possible six-month timeline for a rise in short-term rates following the end of QE3.
If investors feel assured that there will be no appreciable uptick in rates through the end of the year, there's a very good chance that mREITs will continue to gain back much of the ground they lost last year.
Mortgage REITs still produce monster yields
Even with all the upheaval mREITs have experienced over the past year or so, it's hard to beat the yields, and – despite the decreases during that time – the dividends. Annaly, Invesco, and Two Harbors all have current yields of more than 10%, and all have kept their dividends stable so far in 2014.
These mREITs have all taken steps to diversify their businesses, as well. Annaly's acquisition of CreXus Investment, as well as its more recent partnership with affiliates of The Inland Real Estate Group of Companies, Inc. has resulted in a strong foothold in the commercial real estate market.
This diversification was a big change for Annaly, but it isn't the only one on the mREIT's agenda. In an interview this past spring, CEO Denahan noted that the changes on tap for mortgage giants Fannie Mae and Freddie Mac will likely open up a whole new world for companies like Annaly, which is anxious to provide the private capital needed to supplant the role currently played by those two government-sponsored enterprises.
Annaly isn't alone in this belief. Two Harbors' CEO Thomas Siering noted last June that his company is also interested in providing such a service to the mortgage market, and the company has an ongoing dialogue with Washington regulators on this subject. Similarly, Invesco's CEO Richard King sees his company involved in this future market, too. Like Annaly, Invesco and Two Harbors also have commercial segments to diversify their portfolios.
There's another positive for these three mREITs, as well: all three have recently become members of the Federal Home Loan Bank system, which allows them to access secure loans through captive insurance subsidiaries. Though pending regulations may stop such non-bank entities from joining this banking fraternity, the restrictions would still grandfather companies like Annaly, Invesco and Two Harbors for five years – giving them an advantage over others in the sector.
Though all mortgage REITs seem to have scored a reprieve from rising rates for the foreseeable future, these three are actively planning for a changing financial landscape, and expanding in areas other than residential mortgage bonds. For income investors, the combination of farsighted management and double-digit yields should make these particular mortgage REITs worthy of a second look.
Editor's note: A previous version of this article misidentified the name of one of Annaly's partners as the Inland Real Estate Corporation, when it should have read The Inland Real Estate Group of Companies, Inc. The Motley Fool regrets the error.