Housing

No Bears Hibernating in High Dividend Mortgage REITs

Jon C. Ogg

The recent rise in long-term interest rates is crushing the high dividend mortgage REIT sector, as investors are looking to pare down their exposure to riskier assets and assets that will be hurt in a rising interest rate environment. Higher Treasury yields may even be competing against the classic high dividend yield stocks now. The mortgage REIT sector can be incredibly volatile because its yields often are up in the double-digit yield stratosphere, making for a huge risk-reward assessment.

As interest rates rise, the price of fixed-coupon bonds falls, and that pushes the yield higher on the underlying securities. Those investors holding long-term fixed income securities get to find out what a bear market in Treasuries feels like. The yield of the 10-year Treasury has risen above 2.20%, and the 30-year has risen above 3.40%. These are the highest yields since last April, as the bond bears have started coming out of the woodwork.

What investors have to really fear is that rates will not just rise from 1.60% to over 2.20% on the 10-year note. What if that rate starts to approach 3%? That is still very low on a historical basis, and if gross domestic product starts tracking above 2% in 2013, and if the FOMC is not spending $85 billion (plus funds from maturities), then rates could even go higher. That likely will crush mortgage REITs even further, and it seems like stop-loss orders and investors panicking out of the sector have started to consider this risk.

Annaly Capital Management Inc. (NYSE: NLY) often is considered the best run of the mortgage REITs. Shares are down another 1% to $13.40, against a 52-week range of $13.20 to $17.75. Its related REIT, a bit of a vulture REIT, is Chimera Investment Corp. (NYSE: CIM), and its shares are down 1.6% to $3.02, against a 52-week range of $1.81 to $3.34.

American Capital Agency Corp. (NASDAQ: AGNC) is down another 1.3% at $24.49, and its shares hit a new 52-week low of $24.01 today, versus a 52-week high of $36.77. Its yield screened out at almost 20% on Yahoo! Finance. Two Harbors Investment (NYSE: TWO) is down another 1.6% at $10.73 with a yield screening at close 12%. MFA Financial Inc. (NYSE: MFA) is down another 1% at $8.66 10% yield.

If you have been following us, some of these high dividend mortgage REITs are down another 5% to 10% in the past two weeks or so.

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% at $13.45, 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 $25.27, against a 52-week range of $23.35 to $29.90.

To take this one step further on the interest rate risk, 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 because the government has been effectively buying up the mortgage paper for all of the conventional mortgages lately. Rising rates also hurt the value of the portfolio holdings that these mortgage REITs have been able to make so much of a carry spread in.