Mortgage REITs Are Rolling Right Along

 | Nov 26, 2016 | 12:00 PM EST
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It's only been a few months since I last addressed the agency mortgage real estate investment trusts (mREITs) in the column, "Have Faith in Mortgage REITs," but because of the surge in Treasury yields, especially since the elections, it is appropriate to do so again. 

The gist of my intermittent columns on the mREITs, since the taper tantrum-related surge in yields catalyzed a crash in their price in 2013, has been that selling associated with yield spikes was exhausted in that episode and should not recur even if the yields spiked again. 

The importance of that for income investors is that they would be relatively protected from principal volatility and its psychological consequences regardless of the volatility in Treasuries that might occur after the 2013 spike. 

That has largely played out. 

Since yields hit their cyclical peak at the end of 2013 with the 10-year Treasury yield hitting 3% and the mREITs concurrently hitting their cyclical low prices, having declined by about 50% during 2013, even with the volatility in bonds since, the mREIT prices have been relatively stable. 

During this almost three-year timeframe, bond yields have moved aggressively both up and down, but Annaly Capital Management (NLY) , Chimera Investment (CIM) , AGNC Investment (AGNC) and CYS Investments (CYS) are all currently priced within 5% either above or below where they were at the end of 2013. 

The two outliers over that time period have been PennyMac Mortgage Investment Trust (PMT) and Capstead Mortgage (CMO) , down by about 30% and 15%, respectively. 

Despite the bad performance of those two, however, a diversified portfolio of mREITs would have been little impacted by it. 

From the perspective of the long-term income investors, this is exactly what you should want. 

Further, the mREIT prices did not move back up during the reversal in yields during 2014, signaling that investors most sensitive to principal volatility who exited the mREITs during the 2013 taper tantrum were not returning. 

That again is exactly what long-term income investors want to have happen. 

That also meant that when Treasury yields reversed again and rose and fell in 2015 and rose, fell and rose in 2016, the selling of the mREITs was muted by the fact that the principal-sensitive holders from 2013 and prior were not there to sell again. 

This too is very positive for long-term income-seeking investors.

Turning to the immediate effects of the spike in long-end Treasury yields of the past few weeks, with the 10-year moving from about 1.77% to 2.35%, the fastest increase in yields since the 2013 taper tantrum, the mREITs have exhibited some very interesting activity. Three of the six are down and three are up. 

Annaly, AGNC and CYS are down 2%, 4%, and 5%, respectively. That's a muted response to the Treasury yield spike, and again indicates that the sellers sensitive to such moves are no longer holding the mREITs. 

More importantly, though, is that PennyMac, Chimera and Capstead are up 4%, 1.5%, and 8.5%, respectively. 

This is a signal that income investors who've been waiting for proof that the mREITs principal sensitivity to Treasury yields was broken during the 2013 taper tantrum are finally beginning to determine that is indeed the case. 

I'm cautious about what this implies for income-investor psychology, but I think it's probably more reactive than proactive. The principal volatility many of the previous mREIT sellers have experienced in the bonds many opted for over the past few years, coupled with the relative lack of such that's occurred in the mREITs, has caused some to re-evaluate their strategies. 

I'm not anticipating this shift to gain momentum regardless of what happens to bond prices and yields, but it does appear to signal that the "fool me once, shame on you, fool me twice, shame on me" attitude concerning mREITs that took hold in 2013 has passed.

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