An article on Bloomberg reveals that the Fed might consider increasing the pace of its easing. This is in contrast to the debate among Fed members on the timing of a reduction in the bond buying program. While the increase in the pace of bond buying may be advantageous to the general economy in general, it has the potential to create headwinds for the US mortgage REITs. The remainder of this investment thesis aims to explore the specific effects of such an increase on the mREIT sector.
The Bloomberg article reveals that the debate of reducing the pace of or exiting the bond buying program has shifted away to extending the stimulus. This is a direct result of the condition of the economy, particularly cooling inflation and the US jobless rate. Currently, around 11.7 million US citizens are unemployed.
Members of the Fed’s Open Market Committee who earlier advocated exiting or slowing down the stimulus are now leaning towards extending the programs. Seven of the five voting members have supported this new stance. Therefore, I believe the policymakers will confirm their pledge to continue the easing until the job markets improve as imagined by the Fed. The committee is scheduled to meet next on April 30.
Inflation for the month of February came in at 1.3%, below the Fed’s preferred 2% level, while last month’s unemployment of 7.6% was above the 5.2%-6% desired range. Increased or prolonged easing will have the effect of creating further downward pressure on the long-term mortgage rates. While it will encourage mortgage loan borrowers to take out more loans or refinance their prior mortgages, it will also accelerate prepayments on the residential mortgage backed securities held by Agency mREITs. The combination of low mortgage rates and accelerated mortgage rates will cause Agency mREITs to report lower income during the coming quarters, threatening their dividends.
Some of the heavily followed Agency mortgage REITs include Annaly Capital Management, Inc. (NYSE:NLY), American Capital Agency Corp. (NASDAQ:AGNC) and CYS Investments Inc (NYSE:CYS).
Annaly Capital Management, Inc. (NYSE:NLY) is the largest Agency mortgage REIT and has suffered the most since the launch of QE3. Besides reporting a sequential 52 bps decline in its quarterly net interest rate spreads during the third quarter of the prior year, it was forced to cut its dividends 9% and 10% during the prior year. The dividend per share dropped from $0.55 to $0.45. The company is scheduled to report its first quarter performance April 29. The consensus earnings estimate for the first quarter is $0.34 per share, down from the prior quarter’s actual earnings of $0.35 per share.