Two Harbors Investment Corp (TWO), Annaly Capital Management, Inc. (NLY): Hybrids vs Pure-Play mREITs

The Fed’s anticipated exit has increased volatility in the interest rates. So, higher leverage is the last thing the mREITs want in their capital structure. Higher leverage increases the volatility in the results of mREITs. ARMOUR Residential is leveraged over 9.16 times, one of the highest in the sector. This high leverage is causing significant depreciation in the company’s book value. Further, its recently purchased MBS perform worse when the rates start climbing. In short, ARMOUR was preparing for a prolonged QE, while the Fed has signaled its intentions to exit the Agency markets. Therefore, you can expect book value depreciation of over 12% sequentially.

On the other hand, Annaly Capital Management, Inc. (NYSE:NLY) seems to be well prepared for the Fed’s exit. It has a lower level of leverage (6.7 times) coupled with the presence of commercial real estate (CRE) loans in its portfolio. Both these provide cushion against book value. Besides, the company’s portfolio is structured to benefit from an increasing interest rate environment. To top it off, its recent acquisition of CreXus Investment gives Annaly Capital Management, Inc. (NYSE:NLY) exposure to the commercial MBS market with low double digit returns.

Conclusion

While hybrids are preferred over pure-play mREITs due to the diversification they provide, Two Harbors has implemented other strategies that will create significant benefit for the company in the coming future. This is why it remains my top pick among hybrids. Within the pure-play mREITs, only Annaly Capital Management, Inc. (NYSE:NLY) seems to be prepared for the Fed’s exit.

Adnan Khan has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.

The article Hybrids vs Pure-Play mREITs originally appeared on Fool.com and is written by Adnan Khan.

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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