The big threat for the mortgage real estate investment trust (mREIT) sector these days comes courtesy of the Fed. Ever since the early days of the COVID-19 pandemic, the Fed has been purchasing mortgage-backed securities in an attempt to stabilize the financial system. At the latest Federal Open Market Committee meeting, the central bank signaled that it is ready to begin reversing this policy. What does that mean for the big agency mortgage REITs like AGNC Investment (NASDAQ:AGNC), Annaly Capital Management (NYSE:NLY), and MFA Financial (NYSE:MFA)?
Agency mortgage REITs invest in mortgage-backed securities guaranteed by the U.S. government
Agency mortgage REITs invest primarily in mortgage-backed securities, which are guaranteed by the U.S. Government. These are typically mortgage-backed securities issued by the Government Sponsored Entities Fannie Mae and Freddie Mac. The price of these securities determine the interest rate that people pay on a mortgage. The Fed wanted to drive down mortgage rates partly to encourage refinancing activity, which is an easy way to put more money in people’s pockets.
Now that the economy has largely recovered and home prices are rising rapidly, the Fed wants to remove some of its support for the housing market. It will begin to reduce its purchases of mortgage-backed securities over the next year or so. Since mortgage REITs hold lots of these securities, the decline in demand could cause these securities to fall in price, which will negatively affect book value (and also dividends) for these stocks.
Will history repeat itself?
We do have some history to point to, which was the “Taper Tantrum” of 2013. During this year, then Fed Chairman Ben Bernanke signaled that the Fed would begin to reduce its purchases of Treasuries and mortgage-backed securities in May, and then began the formal reduction at the December FOMC meeting. During this period, mortgage rates and treasury rates increased dramatically.
The rise in interest rates wreaked havoc on the agency mortgage REITs, and many saw big declines in dividends and book value per share. During 2013, Annaly and AGNC Investment both saw declines of almost 25% in book value per share. MFA Financial saw a 7% decline in book value per share.
These declines in book value per share also caused dividend cuts. AGNC Investment cut its dividend by 48%, while Annaly cut its dividend by a third. MFA Financial was able to maintain its dividend; however, its March dividend increase was quickly reversed.
While the monetary policy circumstances today are similar to 2013, we have yet to see a big increase in interest rates. This is probably due to the fact that the Fed seems to have settled on a policy of not selling these securities back into the market, or even letting them mature and run off. Back in 2013, all potential options were on the table, while today we have a better view of how things should play out.
While the disaster scenarios for the agency REITs don’t seem to be in the cards, the stocks will be under pressure as we see how mortgage-backed securities perform in the market. So far, it doesn’t appear that the Fed’s potential actions are pushing up mortgage rates. If that continues, then this will probably be a false alarm for these stocks. That said, until we get through at least part of this process, these stocks will be vulnerable.