Making Sense of mREITs Post-Dividend Cuts
Sep 20th 2013 3:34PM
Updated Sep 20th 2013 3:36PM
Mortgage REITs soared after Bernanke announced that the Fed wouldn't taper at its September meeting. Now, two days later, the industry is signaling that their business models are still weak, with many announcing dividend cuts.
Dividend Cut As a Percentage
|American Capital Agency||$1.05||$0.80||-23.8%|
|American Capital Mortgage||$0.80||$0.70||-12.5%|
|Annaly Capital Management||$0.40||$0.35||-12.5%|
American Capital Agency and American Capital Mortgage announced large repurchases of 3% and 6% of shares outstanding, respectively, suggesting they were in the market to acquire shares at less than book value.
What's wrong with mREITs?
Dividend cuts are never a good sign, especially when the reason for owning a stock is to collect the quarterly payments. Mortgage REITs make money on the spread -- the difference between what they pay for capital and what they earn on their mortgage investments. This spread income is what fuels regular dividend payments.
The industry also generates gains or losses based on the changes in their asset values. As rates rise, the value of existing mortgage-backed securities goes down. Thus, as mortgage rates have rocketed from 3.5% to 4.5% in just the past few months, mortgage REITs are holding capital losses on their books.
To put it simply, the value of mREITs' assets went down as rates went up. The amount of debt they have is not changed by an increase in rates. Declining mortgage values means a plunging book value.
How mREITs are navigating the storm
Mortgage REITs may operate in the same business -- buying long-term investments with short-term leverage -- but their strategies differ from manager to manager.
At the end of the last quarter, Annaly Capital Management took a much more conservative strategy to navigate challenges stemming from Fed indecision. The company reduced leverage to 6.2 times book value. American Capital Mortgage followed, dropping its leverage to 6.4 times book value in the second quarter.
American Capital Agency derisked its portfolios using other methods, increasing its holdings of 15-year mortgages to 42% of its portfolio and holding leverage nearly constant at 8 times equity.
American Capital Agency noted that having 15-year mortgages reduces risk. A 15-year mortgage levered 9 times is just as risky as a 30-year mortgage levered 6 times.
The industry did agree on what it plans to do with principal payments: buy higher-yield mortgage-backed securities to reduce their exposure to interest rate volatility going forward.
What's in store for the dividend?
The dividend cuts are merely a response to lower leverage levels and bigger investments in 15-year mortgages. Lower leverage reduces returns on equity. Likewise, 15-year mortgages provide smaller yields, squeezing the spread between borrowing costs and investment returns, and ultimately the potential dividend payment to investors.
Mortgage REITs are fighting a battle on two fronts. First, mortgage REITs want to see stablization in long-term rates. Secondly, they want to see short-term rates stay at their current lows. Investors should hope for no change in the Fed's asset purchases, as well as no changes in the Federal funds rate. While the focus has been centered on long-term rates, short-term rates are just as important for mREITs to earn their interest rate spread.
The odds of new tapering before 2014 look unlikely given that Bernanke won't want to shake the markets before a crucial fourth-quarter holiday spending binge. That's good for mortgage REITs and their dividend sustainability.
More high-yielding stocks
Dividend stocks can make you rich. It's as simple as that. While they don't garner the notoriety of high-flying growth stocks, they're also less likely to crash and burn. And over the long term, the compounding effect of the quarterly payouts, as well as their growth, adds up faster than most investors imagine. With this in mind, our analysts sat down to identify the absolute best of the best when it comes to rock-solid dividend stocks, drawing up a list in this free report of nine that fit the bill. To discover the identities of these companies before the rest of the market catches on, you can download this valuable free report by simply clicking here now.
The article Making Sense of mREITs Post-Dividend Cuts originally appeared on Fool.com.Fool contributor Jordan Wathen has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
Copyright © 1995 - 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.