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Two Harbors Investment Corp (TWO), ARMOUR Residential REIT, Inc. (ARR): The Best and Worst mREITs Amid the Fed’s Exit

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Bloomberg reports that mortgage rates have climbed to their highest in a year despite the Fed’s continuous efforts to curtail them through its MBS buying program. The rise in the mortgage rates signals strength in the US economy in general and the housing market in particular.

The average 30-year fixed mortgage rate jumped 22 bps to 3.81% over the prior year, while the 15-year fixed rate climbed 21 bps over the same time frame. The yields on the 10-year US Treasury reached 2.23%, its highest since April last year.

The markets have started to price in a halt in the stimulus efforts, as Ben Bernanke has mentioned that the Fed could begin to scale back stimulus if the employment outlook shows sustainable improvement. While the Fed’s exit would certainly mean higher mortgage rates, which will translate into widened mortgage spreads for mREITs, it will also mean a decline in book values.

Given the situation, this article will feature the mREITs that will gain and lose depending on the structure of their investment portfolios.

Two Harbors Investment Corp

Why hybrids will gain?

The key to mortgage REIT sector right now is book value preservation. Given the continued strength of the non-Agency MBS market, hybrid mortgage REITs have been able to withstand the volatility of the market better. This protection of book value leaves the hybrid mortgage REITs in a better position to take advantage of the better spread environment on Agency MBS today.

I believe Two Harbors Investment Corp (NYSE:TWO) is the hybrid mortgage REIT that is best positioned for the prevailing macroeconomic environment. The company has a very well diversified investment portfolio of residential mortgage backed securities, both Agency and non-Agency. Besides, the company has a portfolio of real estate facilities which generates rental income for the company. Therefore, there are two diverse revenues streams for the company.

Further, it has constructed its portfolio in a way that the company will benefit from an increasing interest rate environment. You can expect the company to report around a 7% increase in its net interest income if the rates climb 50 bps.

Two Harbors Investment Corp (NYSE:TWO) has a track record of investing in alternative MBS investments, and its further diversification in other asset classes, including whole loans and excess MSRs, will continue to differentiate and provide support to the company’s bottom line, justifying a premium.

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