Events were starting to shape up quite nicely for the embattled mortgage REIT market, thanks to a very dovish Federal Reserve. This accommodative Fed looked to help keep the spread wide between short and long term rates, a situation which is welcomed news for mortgage REITs.
That is because these types of companies borrow short term debt and then take this capital and buy longer-term mortgage securities. These firms generally use leverage as well, so a wide (and stable) spread between the short and long term is crucial for their success (read No Taper? No Problem for These Dividend ETFs).
Yet despite some confidence on the rate front, the actual trading in the mortgage REIT space hasn’t been too great lately, largely thanks to earnings. In particular, American Capital Agency Corp (AGNC) saw extreme weakness following its latest earnings report.
AGNC in Focus
The company missed the Zacks Consensus Estimate of 84 cents a share, earning just 61 cents a share instead. This compares unfavorably both with the previous quarter and the year ago quarter, while the firm also reported a hefty dividend cut of just 80 cents per share, a cut of nearly 24%.
"We continued to see substantial volatility in both interest rates and mortgage spreads," said President and CIO Gary Kain in a statement. "We remained disciplined in our approach to risk management and prioritized book value preservation over short-term earnings."
AGNC’s miss unfortunately continues the recent trend for the company at earnings season, as it has seen four misses in a row now. They have all been pretty big misses too, as all of the last four were by double digit percentages (see Bet Against Real Estate with These Short REIT ETFs).
Thanks to this trend, the stock was down significantly on the day following the report, with the stock slumping by almost double digits before trending towards an 8.3% loss. The stock also saw huge volume, with more than four times as many shares moving hands for the session than in a normal day.
Industry and ETF impact
The news also trickled down into a number of other players in the space, as these also sold off heavily in tandem. In particular, firms like Annaly Capital Management (NLY) - down 3.5%, Invesco Mortgage Capital (IVR) - down 8.2%, Hatteras Financial (HTS)- down 2.9%, and ARMOUR Residential REIT (ARR)- down 6.6%, were hit extremely hard, and most are now within striking distance of their 52 week lows.
As you might imagine given this widespread bearishness, mortgage REIT ETFs also plunged on the day. Currently, there are two such products tracking the space, and we have highlighted both in greater detail below:
iShares Mortgage Real Estate Capped ETF (REM)
REM tracks the FTSE NAREIT All Mortgage Capped Index, measuring the performance of the residential and commercial mREIT market in the U.S. The portfolio consists of 34 securities in its basket, while it charges investors 48 basis points a year in fees (see all the Top Ranked ETFs here).
Top holdings in this ETF include Annaly Capital (17.2%), and then the in-focus American Capital Agency Corp (14.2%). Beyond that, a smattering of other firms account for between 3%-7% of the portfolio, giving the fund a focus on its top ten as over two-thirds of the assets go to these firms.
The ETF plunged by 3.5% on the session, on volume that was nearly three times normal, while it is down about 11% YTD. However, the product does pay a tremendous yield of nearly 13.3%, so it is definitely an income destination for those willing to tolerate big moves.
Market Vectors REIT Income ETF (MORT)
Another option is the less popular MORT form Van Eck. This fund follows the Market Vectors Global mREIT Index, a benchmark that looks to track the overall performance of publically traded mortgage REITs. The basket includes 26 securities in total, while the net expense ratio comes in at just 41 basis points a year.
This product also has heavy weights in its top ten securities, and NLY/AGNC as well. However, NLY makes up 15.9% while AGNC accounts for 12.7% in this fund. The result is then a small cap focus, though large caps account for about 15% of the fund.
MORT also tumbled by 3.4% on the session, though it has performed a bit better from a YTD look, losing just 6%. However, the yield on this product is 10.5% in 30 Day SEC terms, so it does get beaten by REM on this front.
The short term looks very rocky for the mortgage REIT market, especially after the AGNC issues. And given how others in the space have reacted, this might be a widespread issue that could afflict the entire sector (see all the Real Estate ETFs here).
This may be especially true if the Fed introduces some uncertainty on the rate front, or if short term rates creep up on their own. Thanks to these factors, mortgage REITs might be avoids in the near term, though with a huge yield they still could be interesting choices for medium term focused investors who have a high tolerance for volatility.
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Author is long MORT
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