Annaly Capital Management, Inc. (NLY), ARMOUR Residential REIT, Inc. (ARR), American Capital Agency Corp. (AGNC) : Buy These mREITs Before They Defy Gravity

The timing of the Fed’s third round of quantitative easing is among the top discussed topics today. While the exit has consequences for the general economy, it will have a much direct impact on the US financial sector, particularly the mortgage REITs sector. Under QE3, the Fed is buying mortgage backed securities at a record pace with the aim of bringing down mortgage rates. Mortgage REITs hold mortgage backed securities in their asset portfolios and earn asset yields on the securities held. The yields on MBS are related to the prevailing mortgage rates. Therefore, lower mortgage rates mean lower yields for mREITs.

When the third round was launched last year, the Fed did not announce any exit date. Instead, it was told that the easing would continue until the US housing and US labor markets show improvements as desired by the Fed. Today, when the Fed believes the economy will grow by 2.5% this year, many argue the rationale for continuing this expensive third round of quantitative easing. Further it is expected that unemployment will remain under 7%, while inflation will not cross the 2% minimum requirement.

Looking at the healthy expectations, cracks between the officials of the central banks have widened. According to the minutes of the latest meeting of the FOMC, several members of the committee are of the opinion that if the labor markets continue to improve, the quantitative easing has to slow down later in the year and stop by the end of the year.

According to Reuters, Dallas Fed President Richard Fisher, who has always voiced his concerns on the efficiency of the easing said, the US housing markets are showing signs of speculations, meaning they don’t need further stimulus. These comments came in hours after another Fed official termed a halt in easing as premature.

The release of the latest minutes of the meeting had the effect of depressing bond prices as they revealed extensive discussions and disagreements regarding the exit of $85 billion Treasury and mortgage bond buying each month.

A potential hindrance in the exit of this easing is the budget. Some of the members of the committee were of the view that the Fed should wait until it is certain how Congress plans to approach the coming budget. The officials at the Fed are concerned that if Congress tightens the fiscal policy, it will hurt economic growth. Therefore, the easing might prolong.

Sector That Underperformed

The mortgage REIT sector suffered a lot due to the easing over the last few quarters. Since the launch of QE3 in September last year, Annaly Capital Management, Inc. (NYSE:NLY), American Capital Agency Corp. (NASDAQ:AGNC), ARMOUR Residential REIT, Inc. (NYSE:ARR) and CYS Investments Inc (NYSE:CYS) reported 60 bps, 26 bps, 64 bps and 63 bps declines in their respective net interest rate spreads. Annaly Capital Management, Inc. (NYSE:NLY), ARMOUR Residential REIT, Inc. (NYSE:ARR) and CYS Investments Inc (NYSE:CYS) Investments were forced to cut dividends due this contraction in the spreads.