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  1. Home
  2. / Investing
  3. / Real Estate

Mortgage REITs Producing Huge Income

The fear of steadily-rising rates seems to have passed.
By ROGER ARNOLD Feb 05, 2014 | 03:00 PM EST
Stocks quotes in this article: NLY, CYS, CIM, AGNC, CMO, PMT

I last discussed residential mortgage real estate investment trusts this past November as a proponent of the instruments as income vehicles.

The dominant concern at the time about their prospects was their probable negative trajectory. That was based on the belief that interest and mortgage rates would continue to rise, causing mark-to-market losses at the firms on their existing mortgage holdings. It was also based on concerns that they are not properly hedged or overly leveraged.

The premise was pretty simple. Federal Reserve tapering would help to cause long end treasury yields and mortgage rates to rise, which would cause revenue, earnings, and asset values at the REIT's to fall.

The problem with this scenario, as I pointed out two months ago, is that the prices of the REIT's were already reflecting the anticipation of such happening and with no consideration of the opposite.

As expectations of Federal Reserve tapering began in earnest last May, treasury yields and mortgage rates rose at the fastest pace in U.S. history, as I discussed in the column "Mortgage Rates Are Rising Faster Than Ever".

The rise in mortgage rates scared investors out of the REIT's and their stock prices crashed. Since then the Fed has implemented tapering in two rounds of $10 billion each and yet treasury yields and mortgage rates have declined. Most importantly for REIT investors, the value of their holdings has increased. As the U.S. dollar carry trades into emerging market debt and equities has unwound, investors have parked their gains in U.S. treasuries, helping to drive down yields and mortgage rates.

In the original column on November 27, 2013 I discussed Annaly Capital Management, Inc. (NLY), American Capital Agency Corp. (AGNC), and Chimera Investment Corporation (CIM). Since then the price of each issue has increased respectively by 6%, 4%, and 4%. Those are two-month nominal returns of the spot price -- not annualized -- and not taking into account dividends. The dividends being provided are also still staggeringly high at high 13.6%, 12.4%, and 11.5% respectively.

There are other REIT's however that have exhibited similar performance.

PennyMac Mortgage Investment Trust (PMT) has increased in price in the last 3 months by 4% while delivering a dividend of 10%.

Capstead Mortgage Corp. (CMO) has increased by 4% while providing a dividend of 9.8%.

CYS Investments, Inc. (CYS) has increased by 3% while delivering a 17% dividend.

The spot price of some of these REITs has been more stable than others over the past year. The fear of steadily-rising rates caused by Fed tapering and an expected eventual increase in short-end rates seems to have passed. That fear had caused some investors to flee the REIT's.

The passing of this fear is causing risk-averse income investors to once again move into the REIT's. Although it is possible that something else will spook investors out of REIT's again, the downside risks are minimal as they are still trading near their 2009 lows.

Long-term fixed mortgage rates have pulled back about half of their run up from their low levels of last May. Owner-occupied 30-year fixed mortgage rates moved from about 3% par to 5% from May to September and now have pulled back to about 4%.

A 4% 30-year fixed rate with a strong demand for housing this spring, helped by buyers who postponed buying last year as rates spiked, should help increase investor confidence in the REIT's as well.   

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At the time of publication Arnold had no positions in securities mentioned.

TAGS: Investing | U.S. Equity | Real Estate | Financial Services | Economy | Stocks

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