It's been a little over three months since I last addressed the mortgage real estate investment trusts (REITs), so I will do so now.
Mortgage REITs are interesting vehicles in that regardless of the stellar income they throw off there is constant worry about the stability of it. When interest rates are rising, there's fear that the value of the mortgages owned by the REIT will be negatively affected and cause the shares to decline. When interest rates are falling, the fear is that mortgagors will refinance, causing the fund to experience prepayments that could disrupt dividends.
Usually these two fears occur at different times, obviously. Right now, however, there is a unique situation in which both are being expressed simultaneously. This is because even as long-end yields continue to decrease, the Federal Reserve and financial media continue to promote the idea that the Fed will soon start raising interest rates.
Since I last wrote about the MREITs in April their respective prices have declined, even as their dividends have been maintained.
In the past three months, Annaly Capital Management (NLY) has dropped 3.1%, PennyMac Mortgage Investment Trust (PMT) 16%, Chimera Investment (CIM) 8%, American Capital Agency (AGNC) 10.5%, CYS Investments (CYS) 14.5% and Capstead Mortgage (CMO) almost 8%.
These are stunning declines and not what I was expecting. However, I do not see any reason to be concerned about the underlying fundamentals of the industry or for the possibility of a reduction in dividends.
The declines for all have resulted in prices now being almost exactly at the low levels that resulted from the taper tantrum-associated selloffs of 2013, with PennyMac actually trading at a 20% discount to that previous low.
I don't see any reason for this situation to have occurred except that investors appear to be convinced that the Fed is going to hike interest rates and that doing so is going to cause mortgage rates to increase.
There's an interesting quirk to that, though.
In 2013, long-end yields rose at the fastest rate in history during the latter half of the year. That was a legitimate reason for REIT holders to become nervous and for the REITs to sell off. I wrote about that in August 2013 in the column, "Mortgage Rates Are Rising Faster Than Ever."
This time that hasn't happened -- even as the Fed has been insisting that it is going to raise rates and the financial media have largely not challenged the logic of such, and endlessly debated whether it will start in September or December.
But the 10-year U.S. Treasury yield has declined by 0.30 percentage points in the past month, is almost exactly where it was at the start of the year, and is lower by about 0.80 percentage points from the high reached at the end of 2013 caused by the taper tantrum.
Even so, REIT investors appear to exhibiting a greater fear of the Fed's stated intentions and what they believe that will mean for mortgage rates, than what the bond markets are reflecting.
The aggregate belief among bond traders is that the Fed is not likely to raise rates, and that even if it does, it will not put upward pressure on long-end yields and mortgage rates.
What's interesting about this, too, is that the totality of economic data available, with the exception of auto sales, supports the assessment being exhibited by the bond markets.
The bottom line is that I see no rational reason for the mortgage REITs to have declined as much as they have this year and also no reason for there to be concern about dividend cuts.
The price declines have now resulted in dividend yields of between 11% on the low end at Capstead and an eye-popping 15.2% at CYS.
