The mortgage REIT sector has seen a lot of volatility during the past few months, thanks to speculation about the Fed’s exit from the Agency MBS markets that started in the mid-May this year. Last week, the Fed finally signaled that it will start tapering its bond buying later in this year, and a complete halt will come by the middle of next year. I believe this news will further amplify the volatility in interest rates. While mortgage REIT investors have suffered tremendous losses, the top executives at these mREITs continue to enjoy elevated compensations, thanks to the compensation structures being followed there. I will feature some mREITs in this article whose top executives are busy ensuring maximum compensation for them rather than worrying about the stock price and the company’s fundamentals.
Bloodbath for the mREIT investors
Mortgage REIT investors have suffered a lot at the hands of the speculations about the unwinding of the third round of quantitative easing.
Since the start of the current quarter, Annaly Capital Management, Inc. (NYSE:NLY), American Capital Agency Corp. (NASDAQ:AGNC) and ARMOUR Residential REIT, Inc. (NYSE:ARR) fell 18%, 25.5% and 28%, respectively. The entire sector has declined the most since the financial crisis of 2008.
Analysts believe “it’s going to take a couple of years of dividends to make up for the decline in the stock prices” of these mREITs. That’s a lot of time for you to claw back your losses. However, the top executives at most of the mREITs will continue to get elevated compensations despite the poor stock performance and weak fundamentals of their companies.
Elevated compensation levels
Would you be shocked to learn that the CEOs at some mortgage REITs are drawing even more compensation than the CEO’s of the country’s largest bank? Yes, that’s true.
Annaly Capital Management, Inc. (NYSE:NLY), the largest mortgage REIT, has a market cap of $12.8 billion and offers a return on equity of 10.9%. This is compared to JPMorgan Chase & Co. (NYSE:JPM)’s market cap of $202.5 billion and a return on equity of 11.55%. JPMorgan happens to be the largest bank in the US, but its CEO was paid $23 million last year, while Annaly Capital Management, Inc. (NYSE:NLY)’s CEO was paid $32 million, more than double the average compensation of the six largest banks in the US.
I’m sure this must have raised some eyebrows, particularly while investors are experiencing a bloodbath.
Why I believe compensation will remain elevated?
Now, I’m sure you must be wondering what makes me think that these elevated compensations will not discontinue. The answer is the compensation structure of the mortgage REITs. Most mortgage REITs, including American Capital Agency Corp. (NASDAQ:AGNC), Annaly Capital Management, Inc. (NYSE:NLY) and ARMOUR Residential REIT, Inc. (NYSE:ARR), compensate their top management on the basis of the assets they manage during the entire year.
During the first quarter, mortgage REITs raised $7.4 billion by selling shares. That’s the most in two years. ARMOUR Residential REIT, Inc. (NYSE:ARR) and American Capital Agency Corp. (NASDAQ:AGNC) Agency raised $444 million and $2 billion during the month of February. Since the offerings, American Capital Agency Corp. (NASDAQ:AGNC) and ARMOUR Residential REIT, Inc. (NYSE:ARR) have fallen 20% and 26%, respectively.
The top management at ARMOUR and American Capital Agency Corp. (NASDAQ:AGNC) is paid a management fee based on the REIT’s equity. The more money these executives raise, the more equity they accumulate and the more they get paid in annual compensation. Typically, American Capital Agency’s managers are paid 1.25% of the equity of the company, while ARMOUR Residential REIT, Inc. (NYSE:ARR)’s top executive is paid 1.5% annually on the company’s equity. Annaly Capital Management, Inc. (NYSE:NLY) has just swicthed to an external management structure. Its management gets paid 1.5% of the company’s equity. So, the compensation is clearly not linked to the company’s fundamentals, or stock price, at all three companies.
Given the volatility in interest rates, analysts believe that this was the absolute wrong time to raise money. So, the bad timing of the capital raises by American Capital Agency Corp. (NASDAQ:AGNC) and ARMOUR Residential raises many questions about the exact purpose behind them. I believe the intentions were clear. It was to further increase the compensation of the top executives of American Capital Agency and ARMOUR Residential.
The current compensation structure creates a conflict of interest, where shareholders’ money is put into bonds that perform worse under the rising interest rate environment, like ARMOUR Residential REIT, Inc. (NYSE:ARR) did.
Conclusion
The entire mortgage REIT sector has nosedived since the speculations about the Fed’s exit first erupted. Agency mREITs were hit the worst, and among them were American Capital Agency Corp. (NASDAQ:AGNC) and ARMOUR Residential REIT, Inc. (NYSE:ARR). However, it seems that the managers of both of these companies are more concerned about their annual compensation than about the stock price and earnings potential. I believe the external management structure, where executive compensation is attached to the assets under management, is flawed, and it needs to be more aligned to company performance. The current compensation structure creates a conflict of interest.
The article Should You Be Worried About Your mREIT’s Compensation Structure? originally appeared on Fool.com and is written by Adnan Khan.
Adnan Khan has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Adnan is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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