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Annaly Capital Management, Inc. (NLY), American Capital Agency Corp. (AGNC): mREITs’ Relationship With QE3

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Investors in mortgage REITs haven’t had a lot to cheer about since last September, when the Federal Reserve instituted its latest round of quantitative easing. Although many of these trusts still deliver yields in the double digits, the crimped spreads of mREITs like Annaly Capital Management, Inc. (NYSE:NLY) have reduced yields and dividends, as well.

Annaly Capital Management, Inc. (NYSE:NLY)

However, there is a flip side to this story. The added competition for mortgage-backed securities guaranteed by Fannie and Freddie has caused prices to rise, as scarcity is apt to do. This scenario has bolstered the mREITs’ book value, so necessary if the trusts are to raise additional funds for investment.

Is QE3 helping or hurting mortgage REITs? As it turns out, it’s doing a little of both.

Tiny spreads are lousy, but a Fed exit might be worse
Contracting spreads of agency mREITs like Annaly Capital Management, Inc. (NYSE:NLY) and CYS Investments Inc (NYSE:CYS) have hogged the headlines since the advent of QE3, while the lustier metrics of American Capital Mortgage Investment Crp (NASDAQ:MTGE) American Capital Agency Corp. (NASDAQ:AGNC) have inspired awe in the hearts of investors.

But Gary Kain, CIO of that well-performing trust as well as hybrid mREIT American Capital Mortgage Investment Crp (NASDAQ:MTGE), recently learned a painful lesson when rumors of a QE3 wind-down gained steam in the first quarter of this year: Book values plummeted, and both his trusts suffered losses when bond prices fell and interest rates ticked upwards a bit.

Though much of the damage has been ameliorated during the second quarter, discussion regarding an end to the Fed’s bond-buying program keeps cropping up — much of it by the members of the board itself.

Kain: Not a question of if, but when
In an interview with Bloomberg, Kain made the point that, though he doesn’t think QE3 will end soon, mREITs must prepare. While noting that the higher-priced pools of securities in which American Capital Agency Corp. (NASDAQ:AGNC) invested were the reason for the losses in the first quarter, he also maintains that these types of securities are the best with which to weather an extended QE3 program. In addition, these bonds are hedged in case of interest rate increases, preserving their attractiveness as an investment — so, when prices fell, the trust bought even more.

Kain isn’t the only manager protecting his companies from the effects of QE3. Annaly Capital Management, Inc. (NYSE:NLY) is in the process of acquiring Chimera Investment Corporation (NYSE:CIM) , whose stable of commercial MBSes will hopefully give the agency player’s own portfolio a needed lift. And, as Annaly’s CEO noted on the company’s first-quarter earnings call, the company also employs interest rate swaps to protect against rate hikes.

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