The mREITs Face Even Greater Headwinds - Avoid Them

Oct 13 2013, 19:15  | 9 comments  |  about: NLY, AGNC

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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More...)

Sometimes the most difficult aspects of investing are realizing that some companies should be avoided at times of uncertainty. I read articles written on Seeking Alpha extolling the virtues of some of the most difficult stocks to hang on to in our current economic situation: the mREIT stocks, specifically Annaly Capital (NLY) and American Capital Agency (AGNC).

First of all I have owned both of these stocks myself. Annaly was a stock that I have discussed in various positive articles for quite some time and it had been very good to me at various points of my owning it. I can say the same about AGNC, but I did not own that one for as long.

The sector itself is difficult to understand when the interest rate environment is stable. When it is in a state of flux, this sector becomes a lighting rod for all that is wrong with seeking high yielding investments. The dividends look so very compelling that we just keep coming back to them, and begin making excuses and rationalizing the continuous storm clouds that make these stocks just too damn risky right now.

More Storm Clouds Are Forming

We all know about how the Fed has been tinkering with interest rates and mortgage backed securities. To say the least, we really have no idea what tomorrow will bring. Yes, a new "dove" has been selected to take over for Bernanke, but so what? Does that mean the coast is clear and it will be QE forever? Will interest rates stabilize enough for these companies to get their houses in order to continue making money to keep book values up and dividends at least the same, and not being continually cut?

The truth is that none of us really knows. These companies have no products being made, no products being sold, and they make money in the confusing world of "trading money."

Both of these companies need a stable interest rate environment, a wide spread between the 2-10 year treasuries, a solid housing market, and an increasingly strong mortgage market for these companies to turn over their "inventory".

Unfortunately none of these "needs" is currently being met.

10-2 Year Treasury Yield Spread data by YCharts

As you can see from this 3 month chart, the spread has been all over the place. This makes navigating the market very difficult for these mREITs and more concerning, unpredictable. As a result, both of these companies had to cut the dividends they pay out once again.

In addition to the spread, we also have this chart to look at:

US 30 Year Mortgage Rate data by YCharts

Over the last few years, the 30 year mortgage rates were very desirable for homeowners to either re-finance or actually purchase new homes. The rates led the way to the current housing recovery we have enjoyed, yet as you can see, the rates have risen to a point now where new applications are being negatively impacted.

Builder data tracked by the Mortgage Bankers Association (MBA) indicates mortgage applications for new home purchases decreased from August to September..... MBA's monthly Builder Application Survey (BAS), which uses application volume from mortgage subsidiaries of homebuilders, suggests new home purchase application volume declined 1 percent month-over-month in September

While the refinancing numbers have worked in favor of the mREITs, the market for new mortgages is now weakening, so in my opinion the mREITs will be somewhat "stuck" with existing inventories at low rates.

That means to me that these firms cannot take that much advantage of the spread yield right now, and prospects for revenue and income growth is crimped.

To add to this scenario, which is NOT the end of the world, these firms have to face this:

Regulators should boost oversight of the largest real-estate investment trusts that use borrowed money to invest in mortgage-backed securities because rising interest rates may push the firms into asset sales that destabilize markets, the International Monetary Fund said....Repercussions might roil the REITs' lenders, disrupt the $5.3 trillion market in which they invest and damage the broaderU.S. economy, according to its Global Financial Stability Report.

Of course this might never come to pass, but it also on the heels of what Federal Reserve Governor Jeremy Stein said earlier this year, with which the IMF now agrees:

The IMF joins Federal Reserve Governor Jeremy Stein and the U.S. Financial Stability Oversight Council in saying this year that the companies led by Annaly Capital Management Inc. (NLY) andAmerican Capital Agency (AGNC) Corp. pose risks to markets....."Sizable disruptions in secondary mortgage markets against a backdrop of rising mortgage rates could also have macroeconomic implications, jeopardizing the still-fragile housing recovery," according to the report....Authorities also "could consider changing the exemption status for certain" mortgage REITs, or label the largest as systemically important and in need of more oversight, the group said.

If you recall, back in 2011 the SEC asked for comments about the very same statements being made now, but nothing was ever done. In my opinion, this brings the issue to the forefront once again. With the bright lights being shown on not only the housing market, but the financial markets themselves, the issue could tighten the noose even further around the "necks" of these companies.

The question an investor needs to ask themselves is if all of this is worth placing a bet on? Yes the yields are wonderfully attractive, but in the last year or so the total returns have stripped away the dividends, with lower share prices AND dividends being cut continuously.

Do we really want to "hope" that everything settles down so that we can actually enjoy the dividends? I know that there are some investors who have been invested in NLY for 15 years. Those lucky folks have virtually a zero net cost basis after all this time. Does that mean an investor right now can look forward to that same luxury 16 years from now? To be honest, I simply do not see that happening at this point.

Keep in mind that there are more investors who paid much more for shares of these two stocks, while dividends have been cut:

NLY data by YCharts

AGNC data by YCharts

NLY Dividend data by YCharts

For AGNC, the dividend has dropped from $1.40/share to $.80/share quarterly. The NLY dividend has been cut from $.65/share to $.35/share quarterly. The share price of AGNC has dropped roughly 33% in one year, and for NLY the drop has been about 35%.

As far as I am concerned, since 2011, these 2 stocks have not been good investments as I once thought they were.

Now that we are facing even more headwinds, I am wondering what the upside actually is that attracts so many positive articles and bullish opinions?

NLY Price / Book Value data by YCharts

Most of the bullish opinions seem to come from the price/book value percentage. There is no disputing that each are selling at a serious discount to book value, but what does that actually mean?

To me, the market is saying that the current share prices are not worth more than what they are selling for. What is even worse is that these stocks, facing the headwinds I described above, could be in for further share price deterioration, dividend cuts, and even greater discounts to book value.

We simply do not know, and the landscape changes almost every single day. But wait, there is more.

Tighter Credit Makes Business Even More Difficult For The mREITs

It seems to be tough enough right now for adequate profits to be made by the mREIT sector. Of course when the credit markets themselves start tightening up, business is not just difficult, but more like pulling teeth.

Mortgage lending remains tight compared to historical norms, and lending could tighten even further as the government takes steps to lessen its role in the market, according to a recent report byMoody's Analytics and the Urban Institute.....While the report concedes "underwriting does not appear overly tight in terms of debt-to-income or loan-to-value ratios," the report's authors said the credit scores required to obtain a mortgage loan today areabnormally high.....Looking ahead, the researchers say, "Some impending moves by Fannie and Freddie and possibly the FHA will tighten the credit box further."....."Reducing Fannie and Freddie's outsize role in the mortgage market is ultimately desirable, but will significantly tighten the credit box and impair the housing and economic recoveries....

This credit tightening goes directly to the heart of the mREIT business and when you combine this issue with the others I have detailed above, this sector is not one that I would embrace.

I would avoid this sector and these stocks right now.

My Opinion

I know that plenty of folks love the dividends, and I was one of them. The game seems to have changed for now and just because we might see a decent check every quarter (in the face of a depleting portfolio value, and dividend cuts themselves), why would a prudent investor, especially a retired one, consider buying these stocks right now?

Do not buy what you cannot figure out, and know when to let go and seek greener pastures.

Disclaimer: The opinions of the author is not a recommendation to either buy or sell any security. The author is NOT an mREIT expert and you should remember to do your own research prior to making any investment decisions.

http://seekingalpha.com/article/1742652-the-mreits-face-even-greater-headwinds-avoid-them?source=email_rt_article_readmore

As mortgage rates spike, a market distortion appears

As mortgage rates spike, a market distortion appears

Posted: 05 Sep 2013 08:15 PM PDT

Mortgage rates hit another high today, touching levels not seen since early 2011. We have now experienced an almost 150bp spike (over 40% relative increase) from the lows in a matter of a few months.

Something highly unusual is happening in the mortgage market however. Recently jumbo (see definition) mortgage rates have been lower than conforming rates. This is one of those market dislocations that most would have never thought possible. Yet here we are.

Source: MND

Jumbo mortgages have generally been considered riskier by banks simply because they typically can not offload them to Fannie and Freddie as they can and do with conforming mortgages. Therefore banks would charge a premium for having to tie up balance sheet.

What's driving this distortion? As the Fed prepares to reduce its purchases (which include MBS), agency MBS bonds are selling off. The latest price decline in fact has been quite sharp.

Price of 30yr Fannie MBS with 4% coupon (source: MND)

Conforming mortgages are priced based on a spread to these bonds, and therefore very much tied to the MBS market fluctuations. As the MBS market sold of, conventional mortgage rates spiked. Jumbo loans on the other hand are not financed with MBS. Flush with deposits, banks have access to extraordinarily cheap capital and are seeking to earn more interest income. Seeing stability in high-end property values in certain areas, they are more willing to take additional risk these days. Of course jumbo mortgage applicants better have top credit scores, high incomes and high down payment to qualify for these loans - a set of requirements which is often even more stringent than the conventional mortgage applicants. With willingness to deploy some balance sheet and competition for wealthier clients, banks are charging less for these loans.

Qualified applicants who are now on the borderline between a conventional and a jumbo mortgage will be incentivized to buy a larger property in order to get a lower rate. Lenders in effect are charging the same borrower less for borrowing more money. High-end properties will therefore benefit from this effect at the expense of lower-priced homes. This is yet another market distortion created through government-based housing finance, with securities in this market dominated by the Fed.

Ah, so that’s how these REITs were able to pay out such large dividends! // wer schon immer mal wissen wollte wie mREIT funktionieren....

22 October 2012

Mortgage REITs: Does Doubling the Leverage Make Them a Good Investment?

By David Schawel, CFA

Categories: Alternative Investments, Income Investing, Investment Topics, Mortgage

Having recently passed the four-year anniversary of the Lehman Brothers collapse, it’s tempting to believe that our economy and capital markets have learned from their mistakes. After all, big banks are heavily scrutinized (see J.P. Morgan’s “London Whale” debacle), fancy new regulations are in place or being proposed (see Dodd–Frank and Basel III), and skepticism seems to be a permanent part of investor psyche. You could be forgiven for thinking that, big, bad Wall Street might have caught us off guard before, but it won’t again.

Nevertheless, every now and then Wall Street reminds us that it has “fallen off the wagon,” so to speak, and reverted back to scary old ways of the bad old days. One of those old tricks is to add unnecessary leverage to assets that may not be safe to begin with. And one of those reminders came recently when UBS announced a new 2× leveraged mortgage REITexchange-traded note (ETN).

I couldn’t blame you for asking, “What is a mortgage REIT, and why is this so bad?” Let’s examine what’s happening in the mortgage REIT market before looking at this offering in particular.

Brief Background on Mortgage REITs

REITs typically purchase 30-year agency mortgage pools (issued by Fannie Mae and Freddie Mac) and lever them up by six or eight times. Mechanically, the REIT takes a new, purchased agency mortgage-backed securities (MBS) pool and enters into a repurchase agreement (repo) with a dealer, where the dealer gives the REIT cash. Then the REIT purchases another agency MBS pool.

REITs repeat this process until they have achieved six to eight times leverage.

The appeal of this model is easy to understand once you consider the shape of the yield curve. Repo rates are based on the short-term end of the curve (let’s assume a cost of 25–50 bps, for example; a basis point is 1/100th of a percent); agency MBS pools, in contrast, price off of the belly (5- to 10-year) part of the yield curve, where rates are higher. In short, the model allows the funds to capture some of this difference in interest rates.

For the better part of the last few years, 30-year current coupon MBS pools yielded 2.5% to 3.5%. In addition to incurring the repo cost, REITs typically also enter into derivatives to hedge the interest rate risk of the fixed-rate mortgage pools. The resulting net spread — after the costs of hedging — has been around 2% for some of the larger agency-only REITs.

American Capital Agency (Ticker: AGNC), for instance, had a net interest spread of 2.14% in 3Q2011 and a spread of 1.60% in 2Q2012. Remember that these interest spreads are being levered six or eight times, which means that the leveraged net interest spread ran between 12% and 18% on average.

Ah, so that’s how these REITs were able to pay out such large dividends!

How Did We Get Here, and Why Is This Scary?
The short answer is that the Fed’s quantitative easing (QE) programs have resulted in extremely distorted pricing of both duration and credit risks. Although QE is one of my favorite topics to describe (mostly because it hits so close to home), I will not go through an in-depth explanation of how QE has distorted fixed-income risk assets. Interested readers can go back to an earlier post on Inside Investing, titled “The QE Aftermath: What it Means and How it’s (not) Different”

In short, there’s an insatiable appetite for yield in the fixed-income markets. Think of it as being like a “yield piñata”: Investors far and wide are scrambling to pick up as much yield as possible before it’s all gone. Investment-grade corporate bonds, high-yield, leveraged loans, non-agency MBS, and commercial mortgage-backed securities (CMBS) are just a few asset classes that have seen prices charge higher.

Both institutional and retail investors have been smitten with mortgage REITs and the 10%+ yields available from AGNC, Two Harbors Investment (Ticker: TWO), Armour Residential REIT (Ticker: ARR), Western Asset Mortgage Capital (Ticker: WMC), and others. Yes, these have had a remarkable run in terms of share appreciation and total return from dividends, but it’s important to remember how this has occurred. The Fed has purchased well over $1 trillion of agency MBS thus far, and this figure is only growing with the QE3 plan of an additional $40 billion per month.

As stocks continued to deliver strong returns, mortgage REITs took advantage of this opportunity by selling additional stock. Because some of these companies are compensated by assets under management (AUM), they had every incentive to keep selling shares to grow the REIT as large as possible. The chart below from J.P. Morgan shows mortgage REIT MBS holdings over the past 10 years in a hockey stick–shaped chart. Does this look healthy?

I’d be scared to own mortgage REITs even before you double the leverage, for the following reasons:

Record high MBS prices. Shortly after QE3 was announced, 30-year 3% Fannie Mae mortgage pools traded at 106 cents on the dollar, for a projected yield to maturity between 1.8% and 2%. As the REITs purchase new bonds, the yield at purchase is significantly lower than what’s already on their books.

Extremely tight spreads. Spreads over a comparable maturity U.S. Treasury or swap are also at historically low levels; thus, these bonds don’t have the ability to tighten in spread to offset a decline in price.

Expected increase in prepayments. Given the recent drop in mortgage rates, there has been a dramatic pickup in refinancing activity as measured by the refinancing index. The problem for the mortgage REITs is that an increasing amount of their earlier purchased bonds yielding 3% or higher will be returned at par (100), instead of where they may be currently trading.

Margin compression. The implication of reasons one through three is that mortgage REITs are facing and will face strong margin compression in the coming quarters. High-yielding bonds are running off and being replaced with lower-yielding securities, while the cost of their funding hasn’t changed. This is a perfect combination for future dividend cuts, which have already begun in some cases.

Dividend popularity. With dividend paying stocks now in vogue, mortgage REITs are trading under a halo; they are one of the few places to find a significant yield. As quickly as these stocks have come into favor, they can also fall out of favor. Stocks that were trading at a premium to book value could quickly find themselves trading at a discount.

So, Should We Buy These on Leverage? 
Wall Street has created a product to magnify the return of an already extremely leveraged product. The 2× levered exchange-traded fund (ETF) will essentially create a vehicle that will be 12–18× levered to agency MBS.

The cynic in me wonders whether UBS has created this product solely so that institutional clients can bet against agency MBS by shorting this ETF at a time when MBS prices have never been higher.

The average investor likely has no idea how mortgage REITs operate and what circumstances could cause a material fall in their share prices. As an investor who deals in the MBS markets regularly, I am downright frightened that such a product is being created at a time when so many red flags are apparent.

I am not saying that MBS prices cannot continue to rise or that this product will be a failure, but the dark side of QE, the yield-chasing investors, and the capitalizing nature of Wall Street have created a product ripe for trouble down the road. Caveat emptor!

http://blogs.cfainstitute.org/insideinvesting/2012/10/22/mortgage-reits-does-doubling-the-leverage-make-them-a-good-investment/

MORL Declares August Monthly Dividend, Lower But Still Yielding 30% Compounded

Aug 7 2013, 08:41  | 28 comments  |  about: MORL (UBS ETRACS Monthly Pay 2x Leveraged Mortgage REIT ETN), includes:AGNC, ARR, CYS, MORT, NLY, RAS, SFI

Disclosure: I am long MORL, AGNC, CYS, ARR. (More...)

ETRACS Monthly Pay 2xLeveraged Mortgage REIT ETN (MORL) declared a monthly dividend of $0.1062 with an ex-date of August 12, 2013 and payable August 20, 2013. The previous monthly dividend in July was $1.1045. However, as I explained in: 30% Yielding MORL, MORT And The mREITS: A Real World Application And Test Of Modern Portfolio TheoryMORL pays widely varying dividends each month since most of the mREITs in the basket pay dividends quarterly on various schedules. ARMOUR Residential REIT Inc. (ARR) being one of the few mREITs in the basket that pays monthly. During any three-month period all of the components would have paid their dividends. Thus, the key comparison is with the $0.1263 dividend MORL paid in May. The August payment is a decline of 15.9% from May.

As I indicated earlier, I expected a reduction in MORL's July dividend relative to April since the two largest components of MORL, Annaly Capital (NLY) and American Capital Agency Corp. (AGNC) have recently cut their dividends. However, two of the components of MORL, Cypress Sharpridge Investments (CYS) and Rait Financial Trust (RAS) raised their dividends during the same period. This slightly mitigated the impact of the larger cuts by NLY and AGNC. July's dividend of $1.1045 was a 16.4% decline from the April dividend of $1.3213

I think that the dividends of MORL and Market Vectors Mortgage REIT ETF (MORT), which is the basket of 25 mREITs but without the 2X leverage, can be sustained at close to these levels. There may be one or two more months of declines near the 16% level. For MORL the annualized rate of the last three months' dividends is $5.30, which is a 26.9% simple annualized yield with MORL priced at $19.70. On a monthly compounded basis the effective annualized yield is 30.5%.

The questions that must be considered when evaluating the sustainability of an mREIT's dividend are what causes an mREIT to reduce or eliminate its dividend. As investors in non-agency mREITs are all too aware, defaults by the mortgages held by the mREIT can quickly reduce or eliminate dividends. iStar Financial Inc. (SFI), a component of MORT and MORL, has still not reinstated its dividend. Credit issues are not a concern to the extent that an mREIT holds agency paper. Defaults on the underlying mortgages are the problems of the issues such as Federal National Mortgage Association Fannie Mae (FNMA) and Federal Home Loan Mortgage Corp. (FMCC). The mortgage securities of those GSEs(Government sponsored enterprises, the agencies) are still effectively guaranteed by the U.S. Government.

Credit issues played no part in the recent dividend cuts by mREITs. There are other reasons why mREITs cut their dividends. One reason could be because they can. Remember that REITs must distribute at least 90% of their income, as defined in Internal Revenue Service regulations, in the form of dividends to the shareholders. In some cases if there is any way that a REIT can avoid paying dividends, while not incurring a tax penalty, they will do it. A dollar not paid to shareholders in dividends is one more dollar of book value. Many REITs' management fees are a function of book value.

What allows REITs that want to avoid distributing income to reduce or eliminate dividends are realized losses. Most REITs today do not want to reduce dividends; rather they know that higher dividends can allow them to do secondary share offerings, which can boost their assets under management and thus their fee income. The mREIT dividend reductions in the past year, except the most recent month, have been entirely due to declining spreads between the interest rates paid on the mREIT's assets and their cost of funds.

Declining long-term rates combined with prepayments of principle on their older higher-yielding mortgage securities have reduced the spread and the incomes of the agency mREITs. They have reduced their dividends accordingly. However, the recent dividend cuts by mREITs were not a result of the spread declining. As I indicated in my article: Federal Reserve Actually Proping up Interest Rates: What this means for mREITs,higher long-term rates while short-term rates remain low actually increases the spread income of agency mREITs.

The recent dividend cuts by mREITs were primarily due to caution or if you prefer fear, on the part of their management. They are conserving cash in order to reduce leverage and possibly use more cash for hedging activities such as buying swaptions. The worst fear for an agency mREIT is that it will not be able to roll-over its repo debt. If my forecast that short-term rates will remain low for much longer, the agency mREITs might gather up their courage and begin to increase their dividends as their spreads and income increase.

If someone thought that over the next five years interest rates would remain relatively stable and thus MORL would continue to yield 30.5% on a compounded basis, the return on a strategy of reinvesting all dividends would be enormous. An investment of $100,000 would be worth $378,488 in five years. More interestingly, for those investing for future income the income from the initial $100,000 would increase from the $30,500 initial annual rate to $115,439 annually.

http://seekingalpha.com/article/1612482-morl-declares-august-monthly-dividend-lower-but-still-yielding-30-compounded?source=email_rt_mc_related_0

die amerikanischen halbstaatlichen Hypothekenbanken Fannie Mae und Freddie Mac. Jetzt sollen sie abgewickelt werden. Immobilienfinanzierung soll in Amerika künftig anders funktionieren.

Fannie Mae und Freddie MacObama will Hypothekenbanken abwickeln

06.08.2013 ·  Sie standen im Zentrum der Finanzkrise: die amerikanischen halbstaatlichen Hypothekenbanken Fannie Mae und Freddie Mac. Jetzt sollen sie abgewickelt werden. Immobilienfinanzierung soll in Amerika künftig anders funktionieren.

ArtikelBilder (1)Lesermeinungen (12)

© REUTERS

Häuser, die keiner mehr bezahlen kann: So sah es in der Finanzkrise in Amerika aus.

Sechs Jahre nach dem Beginn der Finanzkrise will sich Amerikas Präsident Barack Obama für eine Reform der Immobilienfinanzierung einsetzen. Obama werde am Dienstag in einer Rede vorschlagen, die verstaatlichten Finanzierer Fannie Mae und Freddie Mac im Laufe der Zeit abzuwickeln, verlautete aus Regierungskreisen.

Fannie Mae und Freddie Mac wurden ursprünglich geschaffen, um mehr Immobilienkredite zu vergeben. Im Zuge der Finanzkrise wurden die beiden Gesellschaften verstaatlicht, was den Steuerzahler 187,5 Milliarden Dollar kostete. Inzwischen sind beide wieder profitabel.

Obama wird am Dienstag in Phoenix im Staat Arizona seine Rede halten. Die Region wurde von der Immobilienkrise so schwer getroffen wie kaum eine andere. Der Markt hat sich aber wieder erholt.

Weitere Artikel

• IWF: Frankreich soll schneller reformieren - und langsamer sparen 

Jetzt will Obama ein Modell vorstellen, in dem Privatfirmen Hypothekenkredite kaufen und neu verpackt an Investoren weiterreichen. Diese Verbriefung ist wichtig, damit Geld in den Immobilienmarkt fließt und Hauskäufer Kredite bekommen. Die Regierung würde mit dem neuen Modell eine kleinere Rolle als bisher spielen. Sie würde Garantien oder Versicherungen gewähren und die Aufsicht haben, hieß es. Die Reformen dürften Jahre in Anspruch nehmen.

Quelle: FAZ.net / Reuters

http://www.faz.net/aktuell/wirtschaft/immobilien/fannie-mae-und-freddie-mac-obama-will-hypothekenbanken-abwickeln-12399228.html