American Capital Agency Corp. (AGNC), Annaly Capital Management, Inc. (NLY)- Disaster Strikes Mortgage REITs: What Investors Need to Know

When Hatteras Financial Corp. (NYSE:HTS) declared second-quarter earnings earlier this week, it was not a pretty sight, as earnings per share missed the mark by $0.04. But that wasn’t what set the stage for the carnage that spread throughout the sector: Hatteras Financial Corp. (NYSE:HTS) reported a huge — more than 20% — drop in book value from the first quarter, sending the stock down more than 10% on Wednesday.

Everyone got stung
The huge drop in share price, along with the unusually heavy trading volume, smacked of investor panic. Adjustable-rate mortgage investors like Capstead Mortgage Corporation (NYSE:CMO), which reported earnings on Thursday, also took a dive. Even players in the 30-year mortgage market, such as American Capital Agency Corp. (NASDAQ:AGNC) and Annaly Capital Management, Inc. (NYSE:NLY) got dinged, right along with the ARM crowd.

This constant battering of mREITs is understandable, of course, as investors used to seeing big dividends from this sector worry about more cuts to those juicy payouts. Last week, fellow ARM-buyer CYS Investments Inc (NYSE:CYS) started another upset for mREITs when it also reported a decrease in book value from last quarter of nearly 19%.

As earnings season progresses, what can investors expect?

More trouble on the way
With mortgage rates ticking upwards, no mortgage REIT will escape some damage to book value. Add in the threat that the Federal Reserve’s QE3 program may be tapering off soon — which would decrease the value of MBSes even further — and you’ve got a perfect storm of bad luck brewing for the sector.

Short-term, things will be less than rosy. For example, American Capital Agency Corp. (NASDAQ:AGNC) will declare second-quarter earnings on Monday and will very likely throw everyone into a tizzy. American Capital Agency Corp. (NASDAQ:AGNC) started the book-value plunge worries with its first-quarter results, which showed a nasty turn of events for the rising star, with a $1.57 per share loss, and a plunge in book value of 8.6% from the previous quarter.

While there were extenuating circumstances for this event, such as a secondary offering at the beginning of the year, things may have gotten worse for Gary Kain’s biggest mortgage REIT, so investors shouldn’t be thrown for a loop. As for Annaly Capital Management, Inc. (NYSE:NLY), which is also expected to announce earnings soon, it will be interesting to see if its absorption of CreXus Investments, with its stable of commercial mortgage bonds, offered the company any insulation from the recent firestorm.