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They yield +10% so why aren't US mortgage Reits dividend heroes?
by David Campbell on Aug 14, 2013 at 09:49
Of all the casualties of the Q2 correction, none has fallen as hard or as fast as US mortgage Reits.
Some of the leading sector vehicles such as American Capital Agency and Hatteras Financial are trading at discounts to book value of 13.3% and 20% respectively and yielding in the double digits.
The dominant exchange traded fund in the sector, the iShares Mortgage Real Estate fund, which accounts for almost 90% of passive money in the asset class, saw its assets under management fall by 20% in the two months to the end of June, from $1.26 billion to $996 million.
That followed a 12-month period in which assets under management quadrupled. The fund currently yields 14.72% and unlike bond funds, which fell equally hard in May, has yet to find buyer support.
‘The recent 100 basis point [Treasury] rates backup seems to have caused a fundamental shift in investor sentiment towards agency MBS (mortgage backed securities),’ said Nomura fixed income analyst Ohmsatya Ravi.
‘In our view, the recent sell-off is more vicious than the other four 100+ basis point sell-offs seen over the past decade, as the magnitude of the backup in 10-year Treasury yields as a percentage of the level of rates is a lot higher this time than on prior occasions.’
He added that all the previous sell-offs were marked by a sharp spread tightening within two to three months of the initial sell-off. Almost two months on from the rate correction, the spread is currently still yawning and if anything, getting wider.
Mortgage Reits were, for a period, effectively a triple play on quantitative easing. MBS benefited from both a gigantic buyer (the Federal Reserve), and being eligible for repo, from the collateral drought caused by Fed buying.
Third, they benefited from accelerated mortgage payoffs, as US homeowners took as much advantage as they could of record low rates to pay down 30-year mortgages.
While the assumed slowdown in Fed purchases later this year or early next year has been a big factor in the move in valuation, the prepayment factor explains why, unlike corporate bonds, the outlook remains a lot more clouded for mortgages.
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