mREITs continue to feel the pressure as the Federal Reserve’s continual asset buying depresses the yields on their mortgage assets, squashing interest received by the companies, their net income, and investor returns.
mREITs, or mortgage real estate investment trusts, work by borrowing money in order to purchase mortgage backed securities (MBS). The borrowing is usually in the form of a repurchase agreement (REPO) for which the company pays a yearly rate of interest. The funds received from the REPO are then used to purchase MBS, which offer a yield based on the credit quality of the individual mortgages in the security.
The difference between what the company pays to borrow and the income that it receives from the MBS is called the interest rate spread, and it is this that is coming under pressure as the Fed’s open market operations drive down the yields on MBS, while borrowing rates remain constant.
How is this affecting the largest mREITs?
Across the sector, mREITs and their shareholders are suffering as interest spreads, net income, and dividends fall. This has affected some of the largest mREITs in the sector, driving down share prices and total returns for investors.
American Capital Agency Corp. (NASDAQ:AGNC)
|Average asset yield (11)||2.8%||2.82%||2.55%||2.73%|
|Average cost of funds (12)||-1.28%||-1.19%||-1.13%||-1.08%|
|Average net interest rate spread (13)||1.52%||1.63%||1.42%||1.65%|
American Capital Agency Corp. (NASDAQ:AGNC) has seen the average yield on its assets actually remain relatively stable compared to the rest of the sector. However, during 2012 the company has been expanding its balance sheet into non-agency, higher yield assets, which has kept the company’s average yield constant. That said, the company’s cost of borrowing has risen slightly during this process, but dividends have been maintained.
Hatteras Financial Corp. (NYSE:HTS)
|Average asset yield (11)||2.06%||2.1%||2.2%||2.4%|
|Average cost of funds (12)||1.1%||0.96%||1.1%||0.94%|
|Average net interest rate spread (13)||1.1%||1.1%||1.3%||1.5%|
Hatteras has not had the same luck as American Capital Agency Corp. (NASDAQ:AGNC). The average yield on Hatteras assets has declined from an average rate of 2.4% to just over 2%. However, the company’s cost of borrowing has remained low.
Hatteras Financial Corp. (NYSE:HTS) average interest spread has fallen over 30% and now stands at 1.1%, down from 1.5% at the beginning of the year. Furthermore, the company’s dividend has fallen in-line with the declining spread and is now down 22% year-over-year.
ARMOUR Residential REIT, Inc. (NYSE:ARR)
|Average asset yield (11)||2.33%||2.45%||2.65%||2.95%|
|Average cost of funds (12)||0.98%||0.95%||0.9%||0.8%|
|Average net interest rate spread (13)||1.35%||1.5%||1.75%||2.15%|
The average yield on ARMOUR’s assets has also declined, down to 2.3% from 2.95%. Meanwhile, the company’s cost of borrowing has been erratic, resulting in the interest rate spread falling from 2.15% to 1.35%.
This falling rate spread has forced the company to cut its dividend 20% during the course of the year. In addition, ARMOUR Residential REIT, Inc. (NYSE:ARR)’s share price has declined from an average of $7.20 down to $5.80, a further 20% decline.
CYS Investments Inc (NYSE:CYS)
|Average asset yield (11)||1.8%||1.97%||2.25%||2.62%|
|Average cost of funds (12)||1.05%||1.03%||1.01%||0.91%|
|Average net interest rate spread (13)||1.16%||0.94%||1.24%||1.71%|
CYS has seen the average spread on its assets fall 30%, while the average cost of its borrowing has risen about 10%. This has translated into a significantly smaller interest rate spread for the company of 1.16%, down from 1.71% during Q2 2012 but higher than its lowest point during Q4 2012, when CYS Investments Inc (NYSE:CYS)’ net interest rate spread fell as low as 0.94%.
The volatility of CYS’ net interest rate spread has translated into both lower dividends and a lower share price. Investors have seen dividends fall 36% over the year, while the company’s share price has fallen 15%.
Will these declining rates continue?
There are several schools of thought regarding this question. Foremost, however, is the question of whether or not the Fed will continue its asset purchases to drive down yields. The Fed has previously said that it will continue its asset purchases at the rate of $85 billion a month until unemployment is down to 6.5%, or inflation is 2.5%, but many investors are now calling on the Fed to taper its open market operations, in order to reduce the shock that will be felt when it finally unwinds its operations.
Indeed, it appears that the majority of analysts believe that the Fed will end its purchases during this year, and when it does the prices and yields of the assets that it has purchased will weaken and rise, respectively.