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Hatteras Financial Corp. (HTS), American Capital Agency Corp. (AGNC): Is it Time to Buy mREITs?

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Unless you have been living in a cave for the past half year, you will have heard that mortgage REITs, and REITs in general are not doing terribly well in the current market. As the Federal Reserve hints that it could soon begin tapering its asset purchases, the value of assets held by mREITs is in for a decline, wiping out months of asset value gains.

Having said that …

However, there are some signs that the Fed may not start to taper any time soon. For example, inflation is still low and unemployment, although falling, is not really falling in any sustainable way. That said, the Fed will have to slow and stop its asset purchases soon, as it is estimated that the central bank will own the majority of the MBS and CDO market by the end of this year.

The possibilities

Let’s consider the scenarios that could occur if and when the Fed tapers. Firstly, if the Fed stops buying assets, this year, the base rate will still be 0.25%, as the bank has guided that it is looking for an unemployment rate of less than 6.5% before raising rates again. This means investors will still be looking for yield in the market and the best place to find this will be the MBS, CDO and junk debt markets. In this case, although the Fed will not be buying, investors will be and the price of these assets will not collapse.

Additionally, mREITs will not have to pay higher borrowing rates for their repo agreements as the base rate will be low.

Secondly, during the first half of this year the rally in junk debt and CDO’s has been fuelled by the hunt for yield. With many economies still recovering, China in trouble and South America noticing a sizeable economic slowdown, uncertainty persists and the hut for yield will continue.

So, mREITs now look attractive

After an over-zealous sell off in the mREIT and REIT sector since May, many of these company’s now look attractive as the majority of the selloff has been based on fear and concern that the book prices will collapse as the Fed stops buying.

Hatteras Financial Corp.In addition, most mREITs are taking action to counter these fears and trends. Hatteras Financial Corp. (NYSE:HTS), for example, whose management noted within the second quarter earnings report that they were taking steps to minimize negative movements in the credit markets by restructuring the company’s portfolio of assets, moving to shorted dated securities with less sensitivity to interest rates and selling down long term assets. This will incur losses, but it is prudent for de-risking the company’s future income.

Moreover, Hatteras Financial Corp. (NYSE:HTS) now trades at a discount to its book value, even after a 21% fall in book value during the last quarter. Management is also looking to reduce leverage through run-off, so the company should see an improving fiscal position. With a 13% dividend yield, investors are rewarded for risk, but the risk of a payout cut is very real if interest rates move higher in the medium term. (Remember, this will only happen if unemployment falls to 6.5% — several years away at the current rate).

Elsewhere, American Capital Agency Corp. (NASDAQ:AGNC) actually reported a rise in net year-on-year interest income for the second quarter, to $414 million from $384 million, and, according to management, the company is trading at a record historical low price-to-book value.

American Capital Agency Corp. (NASDAQ:AGNC)’s management is also taking actions to reduce leverage and sensitivity to interest rates. The company’s leverage ratio has dropped from 8.5 times at the end of June, to 8 times at the end of July. Moreover, management have restructured the company’s balance sheet, moving from a 34% allocation of shorter duration 15-year MBS, to a 42% allocation, reducing sensitivity to interest rates. So, American is positioning well for the future.

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