Despite the continued volatility in interest rates and the resultant pressure on the book values, insiders at some of the highly followed mortgage REITs are busy increasing their stakes in their respective companies. Given the situation, the million-dollar question is whether mREITs have found a bottom. The Fed has not started QE tapering yet. When it does, there is a possibility rates might climb further, which could leave mREITs at a disadvantage.
QE impact
Since the start of speculation about the Fed’s exit from the Agency MBS markets, interest rates have been on the rise coupled with increased volatility. Given the backdrop, mortgage REITs across the board have experienced pressure on their book values.
For mortgage REITs, book value represents the fair value (price) of the MBSes held minus liabilities. Book value has an inverse relationship with the prevailing interest rates. The prices of already-held MBSes go down as higher yielding securities enter the market. This inverse relationship becomes even more sensitive when the maturities of MBSes held are longer. Maturity is the time period until the MBS ceases to exist.
Bullish insiders
Among mREITs, Annaly Capital Management, Inc. (NYSE:NLY), CYS Investments Inc (NYSE:CYS), and Invesco Mortgage Capital Inc (NYSE:IVR) have reported recent insider buying by some of their top executives. Normally, insiders are considered to have a better insight into the future of the company — meaning their buying is possibly a bullish signal for the aforementioned companies. Even still, more book value losses could be on the way.
Largest mREIT
Annaly Capital Management, Inc. (NYSE:NLY) reported its CEO recently bought additional shares at an average price of $10.97 per share. Previously, the company reported its co-CIO increasing his stake in the company by 8.5% at an average price of $11.72 per share. The stock is currently priced at $11.05 per share.
Annaly Capital Management, Inc. (NYSE:NLY) has an abundance of government-backed fixed-rate mortgage-backed securities in its investment portfolio (92% of entire portfolio). The prices of these securities are often the most exposed to interest rates moves. This is also why analysts at Credit Suisse predict a 7% decline in the company’s book value during the third quarter. This is the second largest prediction among mREITs that invest in government-backed securities only behind CYS Investments Inc (NYSE:CYS). Annaly Capital Management, Inc. (NYSE:NLY)’s balance sheet is fairly sensitive to a shift in interest rate — a 100 basis point upwards movement in rates could cause the company’s book value to plunge nearly 20%.
Most exposed
CYS Investments Inc (NYSE:CYS) reported its CEO bought shares of the company at an average price of $6.90 per share to increase his stake by 6.1%. This is despite the fact that CYS Investments Inc (NYSE:CYS) was one of the worst performers during the prior quarter after it reported one of the highest book value declines among mREITs that buy government-backed securities.
The future is not very different for CYS Investments Inc (NYSE:CYS), either. Credit Suisse analysts expect a low double-digit decline in its book value during the current quarter. This was the highest among the mREITs that invest exclusively in government-backed securities. Also, its current quarter’s book value sensitive to a 100 basis point upwards movement in interest rates remains the highest. You can expect a nearly 30% decline in its third-quarter book value if rates go up 100 basis points.
The reason CYS Investments Inc (NYSE:CYS)’ book value is most exposed is because of the recent portfolio rebalancing effort conducted by its management. During the second quarter, management got rid of some 15-year MBSes and added more of the troubled 30-year MBSes. The increased presence of long maturity securities have increased CYS Investment’s book value sensitivity.
Hybrid in nature
Invesco Mortgage Capital Inc (NYSE:IVR) reported its CEO bought shares of the company at an average price of $15.40 to increase his stake by 13%. The stock is trading below the CEO’s average purchase price.
Invesco Mortgage Capital Inc (NYSE:IVR) reported a second-quarter book value decline smaller than the declines experienced by Annaly Capital Management, Inc. (NYSE:NLY) and CYS Investments. That’s because Invesco Mortgage Capital Inc (NYSE:IVR) has an investment portfolio that is composed of a mixture of government-backed securities and securities without government backing. In additional to residential mortgage-backed securities, the company has investments in commercial mortgage-backed securities, too.
This hybrid nature of the company’s investment portfolio provides it with some diversification. Credit Suisse analysts predict a 2% decline in its third-quarter book value. This is much lower than the declines expected for Annaly Capital Management, Inc. (NYSE:NLY) and CYS Investments. Also, a 100 basis point upwards movement in interest rates will lead the company to report the smallest decline in its book value among the three mREITs. A non-agency portfolio is typically less leveraged, and therefore less sensitive to interest rates movements, compared to an agency portfolio. This diversified portfolio is one of the major reasons Invesco Mortgage Capital Inc (NYSE:IVR) is predicted to report lower book value declines.
Invesco Mortgage Capital Inc (NYSE:IVR)’s investment portfolio may be better positioned to withstand future pressures on its book value — one of the major reasons for that is the hybrid nature of its investment portfolio.
Critical September
The month of September is critical for the mREITs sector because this is when the Fed’s Open Market Committee is meeting next to decide the fate of QE. If the Fed decides to slow down or cut its bond buying program, interest rates could increase further, and investors could see more volatility in rates.
Despite the recent insider buying, mREITs may not have bottomed out. The month of September could bring increased volatility in rates, causing mREITs to dip again. When the rates do ultimately stabilize, Invesco Mortgage Capital maybe the best investment opportunity among these companies.
The article mREIT Insiders Are Increasing Their Stakes — Should You? originally appeared on Fool.com and is written by James Clarkson.
James Clarkson has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.
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