While the Fed remains committed to keep the short-term rates near zero, its intentions of keeping the long-terms rate at their record low seems not to be working as imagined. The Fed has been taming the rates in order to support the US housing and labor markets. Through QE3 and the $45 billion monthly Treasuries acquisition, the Fed intends to provide cheap credit to home borrowers and encourage them to refinance. However, this is not happening. Mortgage rates continue to rise since the beginning of this year, while mortgage applications decrease.
Relief For Agency mREITs
Agency mortgage REITs, like American Capital Agency Corp. (NASDAQ:AGNC), Annaly Capital Management, Inc. (NYSE:NLY) and ARMOUR Residential REIT, Inc. (NYSE:ARR) invest in mortgage backed securities sponsored by Agencies and finance their investments by short-term borrowings or repurchase agreements. They earn a spread or margin between what they pay on their interest bearing liabilities and the interest they earn on their interest earning assets. Typically, the investments these three Agency mREITs have are linked to the 30-year and 15-year mortgage rates. As the rates increase, so does their asset yields. Therefore, in the event of record low short-term rates and increasing long-term rates, the spread or margin for AGNC, NLY and ARR is expected to increase.
Annaly Capital Management, Inc. (NYSE:NLY) stands to be the largest mortgage REIT in the US, with market cap of over $14 billion, offers a dividend yield of 12% and trades at 4% discount to its fourth quarter book value. The company has a history of maintain a large concentration in fixed rate Agency MBS (93% of the entire MBS portfolio at the end of the fourth quarter). Most of the fixed rate securities that NLY holds are high coupon securities exposed to higher prepayment speeds. At the end of the fourth quarter, NLY reported 19% prepayment speed for its investment portfolio, while the company reported 7 basis points sequential decline in the fourth quarter net interest spread of 0.95%.
American Capital Agency Corp. (NASDAQ:AGNC) is another major player in the US mortgage REITs sector, with a market cap of $11 billion. It yields 15.5% and trades at 3% premium to its book value. During the fourth quarter, when most of the other Agency mREITs slashed their quarterly dividends, American Capital maintained its dividend distribution. This is because it is being less negatively affected by the amortization costs due to prepayments. The company is considered to have a prepayment protected portfolio, which is why it reported 10% average projected portfolio life CPR as of December 31, 2012. Besides, the company reported net interest rate spread of 1.65%, up 12 basis points from the third quarter.
