Have Faith in Mortgage REITs

 | Sep 14, 2016 | 5:00 PM EDT
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Stock quotes in this article:

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pmt

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It's been over a year since I last specifically addressed the mortgage real estate investment trusts (mREITs), and since the pop in long-end U.S. Treasury yields of the last few months is giving bond investors heartburn, as I discussed yesterday, this is a good time to revisit the subject. 

Since the Taper Tantrum of 2013 caused long-end bond yields to rise and mREITs to crash in price, I've advised that further downside risk is well contained, regardless of what happens to interest rates, and that these are great income vehicles for investors with a long-term-hold horizon. 

I still believe that to be the case, but have also heard repeatedly from investors having experienced the 2013 crash that they'll never buy the REITs again and want another vehicle with a similar profile for principal volatility and income. 

Although there are a variety of active trading strategies that can produce income, the mREITs represent the best passive method of producing such and I think are the best options available for retail investors, especially given their 10%-12% average range. 

One of the principal concerns investors have expressed to me is that a replay of the 2013 crash could occur again if long-end yields spike as they did then. 

That concern would be warranted if the REITs had increased in price back to near where they were the last time long-end U.S. Treasury yields were at current levels, which was just before they spiked in 2013. That hasn't happened, though. 

The last time Treasury yields were at current levels, in April 2013, Annaly Capital Management (NLY) was priced 40% above current prices, PennyMac Mortgage Investment Trust (PMT) and American Capital Agency (AGNC) 60%, CYS Investments (CYS) 37% and Capstead Mortgage (CMO) 30%. 

The only one that's risen back to the price it was trading for before the 2013 spike is Chimera Investment (CIM)

Looking at it from another perspective, even as the 10-year U.S. Treasury yield has declined to the 1.7% range from the 3% it hit at the end of 2013, Annaly has only increased in price by 7%, Chimera 2% and American Capital is unchanged. 

The outliers are CYS, up 15%, while PennyMac and Capstead have declined by 35% and 18%, respectively. 

More instructive of this phenomenon is the performance of the iShares Mortgage Real Estate Capped ETF (REM) , which has declined in price by 45% since yields were last at current levels but is also down 8% from the beginning of 2014. 

It's also had a relatively stable dividend since the post-Lehman crisis era began, and no indication that will change soon. 

Although dividend payments have been slowly declining on average for the industry, they are all currently priced as though there will be an abrupt negative change to the business environment, requiring substantial dividend cuts soon. 

However, that has been the case since the 2013 crash, has not yet occurred and I don't think is likely to. 

Since the surge in yields that began in early July, the mREITs, except one, are either up or unchanged in price. The only one that's down is PennyMac, by about 9%, but that's due to an operating loss in the second quarter that was larger than expected, not because of the increase in Treasury yields. 

Even the spike in 10-year Treasury yields on Tuesday, from about 1.66% to 1.75% by midday, had little impact on the prices of the REITs. 

All told, it appears that mREIT investors have acclimated to the environment, with those who could not having already sold. 

If you've been hesitant about getting involved in the sector because of the events of 2013, the most recent performances should supply support for the idea that both principal and dividend stability are more robust than in the pre-Taper Tantrum environment.

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