Mortgage REITs are currently offering double-digit yields, some in excess of even 20%. This is why mortgage REITs have a special place in the portfolios of income-oriented investors. However, such dividend yields don’t come without associated risks, particularly amid the prevailing volatility in the mortgage rates. Therefore, investors must clearly understand the impact of moves in interest rates and their resultant impact on the dividend yields of their favorite mortgage REITs.
Yield curve steepening
The interest and mortgage rates are on the rise since the start of the current year as the markets start pricing in the unwinding of the QE. While the Fed is still committed to keeping the short-term rates at near-zero, the rise in the long-term rates have caused the interest rate yield curve to steepen.
Theoretically, the steepening of the yield curve has a positive impact on the interest incomes of mortgage REITs, which should ultimately mean higher shareholder distributions in the form of increased dividends. However, the situation on ground remained different as some of the biggest mREITs announced dividend cuts. Therefore, it demands deeper insight.
The largest mREIT
Annaly Capital Management, Inc. (NYSE:NLY) is the largest mortgage REIT. Before, its CreXus Investments acquisition, Annaly was classified as an Agency-only mREIT. However, now it has some exposure to the commercial MBS markets.
The company declared a quarterly dividend of $0.40 per common share for the second quarter. Compared to the first quarter, this was an 11% decrease despite a steeper yield curve. So, it’s obvious that Annaly Capital Management, Inc. (NYSE:NLY) has not been able to benefit from the steeper yield curve. The stock is currently yielding 13.2% in dividends and there are reasons that lead me to believe that its current dividend rate will be sustainable.
During the current quarter, Annaly Capital Management, Inc. (NYSE:NLY) should experience growth in both its top and bottom lines, which will guarantee the current sustainability of the current dividend rate. The company’s recent exposure to the commercial MBS markets and the double-digit returns available in that market will help increase its revenue. Further, the externalization of Annaly’s management structure will help the company reduce its compensation expense. This will provide further support to the bottom line.
Higher dividends on capital depreciation
The current volatility in the Agency MBS spreads makes hybrid mREITs the most favored. Invesco Mortgage Capital Inc (NYSE:IVR) is one of the hybrid mortgage REITs which maintained its quarterly dividend at $0.65 per common share. The company is currently yielding 16.4% and has been able to maintain its current dividend distribution since the fourth quarter of 2011. I believe the current dividend rate will continue in the coming quarters.
That’s because Invesco Mortgage Capital Inc (NYSE:IVR) has a large concentration in the fixed Agency paper. At the end of the first quarter, around 70% of its portfolio was invested in the Agency residential MBS, for which the spreads have widened. The high yielding non-Agency and commercial MBS formed 17% and 11% of the portfolio, respectively. So, investors should expect an expansion in the company’s net interest income, leading to stable dividends in the future.
However, Invesco Mortgage Capital Inc (NYSE:IVR)’s investors must also be prepared for a significant book value decline this quarter as around 57% of the entire portfolio is composed up of the 30-year fixed rate Agency paper, whose value is considered highly sensitive to changes in interest rates.