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American Capital Agency Corp. (AGNC), Annaly Capital Management, Inc. (NLY), Two Harbors Investment Corp (TWO): Forget the Ugly Past and Look at the Bright Future of These Stocks

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The latest weekly Mortgage Bankers Association survey is out with some sigh of relief for the pure-play mREITs. The survey reveals a hike in mortgage rates, supported by a decline in the refinance index. Therefore, you can expect the pure-play mortgage REITs, like American Capital Agency Corp. (NASDAQ:AGNC)Annaly Capital Management, Inc. (NYSE:NLY), and Two Harbors Investment Corp (NYSE:TWO) to fly high as the trend continues. I recommend investors consider them as an investment opportunity before they appreciate in value.

American Capital Agency Corp. (NASDAQ:AGNC)

A haunting past

Mortgage REITs, including American Capital Agency Corp. (NASDAQ:AGNC), Annaly Capital Management, Inc. (NYSE:NLY), and Two Harbors Investment Corp (NYSE:TWO), took a lot of damage at the hands of the Fed and its easing programs. Even during the first quarter of the current year, American Capital Agency Corp. (NASDAQ:AGNC) and Annaly Capital Management, Inc. (NYSE:NLY) reported a 2 bps and 3 bps declines in their average asset yields, respectively. Two Harbors Investment Corp (NYSE:TWO) reported a flat asset yield during the first quarter compared to the prior quarter.

As a result, American Capital Agency Corp. (NASDAQ:AGNC) reported an 11 bps sequential contraction in its spread, while Annaly Capital reported 4 bps compression in its spread. Two Harbors reported a flat spread of 2.9% over the prior quarter.

While Annaly Capital Management, Inc. (NYSE:NLY) was forced to cut its dividend twice during the prior year, Two Harbors slashed its dividend once. In contrast, American Capital Agency maintained its quarterly shareholder distribution of $1.25 per share.

A bright future

According to the latest weekly mortgage market survey conducted by the Mortgage Bankers Association, the situation has become more favorable for the pure-play mREITs as the Refinance Index plunges along with the climb in long-term mortgage rates.

The survey reveals the mortgage rates increased to their highest since March. The average 30-year fixed mortgage rate on conforming loan balances increased 11 bps, while the 30-year fixed mortgage rate with jumbo balances increased 6 bps. At the same time, the 15-year fixed rate mortgage increased 8 bps. The hike in mortgage rates has a two-fold effect on mortgage REITs. First, the interest earned on the MSB is directly linked to the mortgage rates. Second, higher mortgage rates discourage refinancing.

A decline in refinancing activity was also reported in the latest weekly survey. The Refinance Index, which is the best overall gauge of mortgage refinance activity, fell 12% over the prior week. It has fallen 19% over the past two weeks to lowest since late March. This is particularly beneficial for mREITs as refinance tends to increase their prepayments causing higher amortization costs. This ultimately hurts profitability.

However, on the downside, mortgage applications also declined around 10% compared to the prior week. This is the second consecutive week that the survey reported a decline in mortgage applications. Fewer mortgage applications mean less home loans to be bundled to make mortgage backed securities. This means, less supply of MBS, which should increase the price and decrease the yield on them. Therefore, the decline in the mortgage applications would mean low asset yields in the coming quarters.

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