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Annaly Capital Management, Inc. (NLY), Javelin Mortgage Investment Corp (JMI): Mortgage REITs Rallied, But Why?

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Stocks snapped a losing streak late last week with a big rally after the release of a series of positive data, including encouraging jobless claims and upbeat retail sales. The data also overshadowed fears about growth in Japan. The mortgage REITs sector also rallied as measured by a 4.8% rally in the sector’s ETF. However, the mREITs sector had its own reasons for the rally.

Annaly Capital Management, Inc. (NYSE:NLY)

Annaly Capital Management, Inc. (NYSE:NLY) and

American Capital Agency Corp. (NASDAQ:AGNC) gained 5.4% and 5.3%, respectively. The mREIT sisters, Javelin Mortgage Investment Corp (NYSE:JMI) and ARMOUR Residential REIT, Inc. (NYSE:ARR) were up 7.2% and 3.7%, respectively. Let’s see what I believe were the reasons behind this mortgage REITs sector’s rally and what will be the implications of the recent release of the encouraging macroeconomic data on the sector.

mREITs rally

The mREITs sector took a breath of relief after the release of some encouraging labor market data and the upbeat retail sales figures. While the data swept away concerns about Japan, the mortgage REITs had their own reasons for the rally.

I believe it was largely the announcement made by the two sister mREITs, ARMOUR Residential REIT, Inc. (NYSE:ARR) and Javelin Mortgage Investment Corp (NYSE:JMI). In contrast to popular opinion, both mREITs maintained their monthly dividend rates. This is considerable positive news, particularly amid rising interest rates that are eroding their book values.

Bloomberg reported both ARMOUR Residential REIT, Inc. (NYSE:ARR) and Javelin Mortgage Investment Corp (NYSE:JMI) as the worst, and the second worst performing mREITs around the unwinding of the QE, while in my previous article, I was also of the view that both these mREITs will face pressure on their book values and also on the spreads, which is why dividend cuts can’t be ruled out. However, they proved otherwise.

If you look at the sustainability of dividends from another angle, it could mean fewer compression in the companies’ net interest rate spreads.

Significance of recent encouraging data

While the release of the recent data related to retail sales and the U.S. labor markets is encouraging for the general economy, it is not for the mREITs sector. Encouraging numbers mean may lead to stability and growth in the economy, but for the mREITs, it means an early Fed’s exit from the Agency MBS markets.

Although much of the effects of the Fed’s exit have already been priced in and the interest rates have started increasing, the exit itself will further increase volatility. While higher mortgage rates and the resultant higher Agency MBS spreads might mean higher spreads for mortgage REITs in the longer-term, in the short-term, the book values of ARMOUR Residential REIT, Inc. (NYSE:ARR) and Javelin Mortgage Investment Corp (NYSE:JMI) will fall significantly. According to Reuters, JAVELIN has an 8 times debt to equity ratio, while ARMOUR Residential REIT, Inc. (NYSE:ARR) reported 9.2 times debt. Both are considered to be highly leveraged, which is why the results of the book value erosion will be magnified.

We saw a glimpse of this during the first quarter when ARMOUR reported 8.2% decline in its book value coupled with a 20 bps contraction in the spread. Javelin Mortgage Investment Corp (NYSE:JMI) does not have much of a history to compare it with. However, from the fourth quarter, it reported a 7% decline in its book value while the spread came down 40 bps.

Approach for the future

For both JAVELIN and ARMOUR, the future lies in the re-balancing and active management of the companies’ assets. While JAVELIN is already a hybrid mREIT, ARMOUR Residential REIT, Inc. (NYSE:ARR)’s charter permits the company to include securities other than Agency residential MBS. However, the company is only invested in Agency residential MBS till now. Diversification into the non-Agency space, getting rid of some of 30-year fixed rate Agency paper, and active management of assets to capture attractive opportunities as and when they come is the only way out for ARMOUR Residential.

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