Bear Market in Bonds Could Crush Mortgage REITs and Their High-Yield Dividends

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Rising interest rates on 10-year Treasuries suddenly may start competing against the high-dividend and high-yield stock sectors. The real question is which sectors will hold up and which ones will fall apart if interest rates rise too much. One such at-risk segment is the volatile and somewhat controversial sector of mortgage real estate investment trusts (REITs) because their yields often are up in the double-digit yield stratosphere.

As interest rates rise, the price of fixed-coupon bonds falls, and this takes the yield higher on the underlying securities. This is unfortunate for those investors who are holding fixed income securities. The yield of the 10-year Treasury has risen above 2.10% for the first time since last April, and now the so-called bond bears may start coming back out of the woodwork.

Investors might want to consider that the 10-year yield’s near-term cycle high in 2012 was 2.30% to 2.40%. If you go back to the cycle-high on the 10-year Treasury yield in 2011, that was closer to 3.50%. The thought that rates rising from 1.70% to 2.40% would crush investors seems hard to get too excited about, but what if that rise really ends up being a cycle move from under 1.70% to 3.50% or so? That is nearly a 2% rise in rates and that would likely crush mortgage REITs further.

Annaly Capital Management Inc. (NYSE: NLY) often is considered the best run of the mortgage REITs, and shares are down 1.9% at $14.14 against a 52-week range of $13.72 to $17.75. Its related REIT, a bit of a vulture REIT, is Chimera Investment Corp. (NYSE: CIM), and its shares are flat at $3.16 against a 52-week range of $1.81 to $3.34.

American Capital Agency Corp. (NASDAQ: AGNC) is down 4.7% at $26.61, and its shares hit a new 52-week low as the new 52-week range is $26.33 to $36.77. Its yield screened out at 18% on Yahoo! Finance.

Two Harbors Investment (NYSE: TWO) is down 1.4% at $11.33, with an 11% yield. MFA Financia, Inc. (NYSE: MFA) is down 1.6% at $8.93, with a 9.7% yield.

There are two exchange traded fund (ETF) products as well that track the mortgage REIT sector. One is the iShares FTSE NAREIT Mortgage PLUS Capped Index Fund (NYSEMKT: REM), which is down 1.8% at $14.22, versus a 52-week range of $12.85 to $15.86. Then there is the Market Vectors Mortgage REIT ETF (NYSEMKT: MORT), which is down 1.4% at $26.76, against a 52-week range of $23.35 to $29.90.

To take this one step further, you have to consider what is happening in the market as well. Mortgage REITs have been challenged to find new stable mortgage-backed securities to invest in. The government has been effectively buying up the mortgage paper for all of the conventional mortgages over what is getting to be close to a year now.

A lack of investable paper also has come at a time when those who could refinance have refinanced. With prepayments expected to remain low and with rates at risk of possibly rising even more than what we have already seen, the double-digit dividend yield chasers are likely to look for cover in the volatile mortgage REIT sector.

Read also: Short Sellers Become Tactical in the Top High-Yield Dividend Stocks

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