Dear Valued Visitor,

We have noticed that you are using an ad blocker software.

Although advertisements on the web pages may degrade your experience, our business certainly depends on them and we can only keep providing you high-quality research based articles as long as we can display ads on our pages.

To view this article, you can disable your ad blocker and refresh this page or simply login.

We only allow registered users to use ad blockers. You can sign up for free by clicking here or you can login if you are already a member.

American Capital Agency Corp. (AGNC), Annaly Capital Management, Inc. (NLY): Bernanke’s Words Look Promising for mREITs

As the world readies for a tapering of QE3, interest rates have adjusted for an eventual Fed exit. The 10-year US Treasury yield sits at 2.53%, up from 1.6% in May.

10 Year Treasury Rate data by YCharts

Long-dated maturities see the biggest change. Mortgage-backed securities took a beating on the Fed’s words of a taper, but yields have since come off their highs.

Let’s examine how this plays out for mREIT investors.

Annaly Capital Management, Inc. (NYSE:NLY)Bernanke’s reversal

It first appeared that the Federal Reserve would begin tapering by the end of 2013, if not September 2013, a month cited in several analysts’ reports. The market responded quickly, pushing yields higher.

Since then, Bernanke has stepped off the tapering talk. He said yesterday that the Fed’s purchases “are by no means on a preset course,” adding that the Fed will be “responding to the data.” In essence, Bernanke’s not sold on the taper if economic reports show a slowing economy.

Bernanke’s latest move is genius. In announcing a potential tapering of asset purchases, Bernanke forced the markets to move rates up, without any exit from the Fed. The Fed is buying the same amount of U.S. Treasuries and mortgage-backed securities, however the market responded as if the Fed pulled out completely.

Bernanke slowed any bubble that may have been forming, all the while enabling the Fed to justify perpetual asset purchases in excess of $1 trillion each year.

Why mREITs should succeed

Mortgage REITs are the most exposed to higher rates. Mortgage REITs borrow in the short-term to invest in long-term securities. They use leverage, up to 8x their equity, to generate double-digit yields for investors.

In effect, an mREIT will borrow at 2% and lend (invest in MBS products) at 4-5%, paying out the spread to investors.

Bernanke’s latest signal suggests that he’s happy with rates on the long-end of the yield curve. Higher rates dampen discussion about a real estate bubble, while slowing speculative credit issuance and record borrowing.

Higher rates also bode well for mREIT profitability. As long-dated yields find a new plateau at 4.5% for 30-year mortgages, mREITs earn a larger spread between short and long-term rates.

mREITs in Focus

The two largest mREITs, American Capital Agency Corp. (NASDAQ:AGNC) and Annaly Capital Management, Inc. (NYSE:NLY) should fare better than their share prices let on.

Mortgage REITs produce earnings and losses from two different mechanisms. First, there are the underlying book values, which change in response to rates. Higher rates mean lower MBS prices, and thus lower book values. Lower rates mean higher MBS prices, and thus higher book values.

DOWNLOAD FREE REPORT: Warren Buffett's Best Stock Picks

Let Warren Buffett, George Soros, Steve Cohen, and Daniel Loeb WORK FOR YOU.

If you want to beat the low cost index funds by 19 percentage points per year, look no further than our monthly newsletter.In this free report you can find an in-depth analysis of the performance of Warren Buffett's entire historical stock picks. We uncovered Warren Buffett's Best Stock Picks and a way to for Buffett to improve his returns by more than 4 percentage points per year.

Bonus Biotech Stock Pick: You can also find a detailed bonus biotech stock pick that we expect to return more than 50% within 12 months.
Subscribe me to Insider Monkey's Free Daily Newsletter
This is a FREE report from Insider Monkey. Credit Card is NOT required.