A rising inflation rate has been a drag on the U.S. stock market for much of 2022. The Fed’s recent moves to curb inflation by raising interest rates multiple times may have kept inflation from growing much worse. But as Fed chairman Jerome Powell noted in his speech the other day, high inflation remains a significant ongoing problem, and the Fed will continue raising rates until inflation is substantially reduced.
Powell’s early morning speech shook the markets, and all three indices sold off the rest of the day. The Dow and S&P 500 each lost over 3%, while the Nasdaq declined by just under 4%. Curiously, the mortgage real estate investment trust (REIT) sector, which has had a volatile ride throughout 2022, fared somewhat better than the overall market.
Annaly Capital Management Inc. NLY, the largest mortgage REIT, lost 2.09%, but Orchid Island Capital Corp. ORC, which has lost 42% of its value over the past year, actually gained 0.70%.
Arbor Realty Trust Inc. ABR, which is down nearly 17% over the same time frame, lost 1.75% but also climbed 2.04% after hours. AGNC Investment Corp. AGNC was down 1.28% on the day but climbed 1.46% after the closing bell.
ARMOUR Residential REIT Inc. ARR lost 0.54% but also gained 1.37% after hours. Both AGNC and ARR have suffered significant losses this past year as well.
Mortgage REITs borrow money to purchase pooled groups of discounted loans, called mortgage-backed securities (MBS). When they issue a new mortgage, the spread between the price they pay and what they receive in loan payments is how they make their money. But when interest rates rise, the amount they pay for loans increases and so the spread declines. In addition, higher interest rates make variable rate loans they provide more at risk for default.
Since by law these REITs must pay shareholders 90% of their taxable income, should this income decline, then so too will the dividends they pay out. And the high yield dividends of mortgage REITs are basically the most attractive reason for investors to buy these stocks.
For example, Annaly’s current annual dividend yield of 13.4% makes it a favorite among mortgage REITs. But NLY’s volatile stock price is not for everyone. The stock has traded in a range between $8.94 and $5.45 over the past 52 weeks. Investors who bought NLY near the top of the range are down about 25% at the current price of $6.56. Even with the dividends factored in, that’s still a significant loss. If NLY has to cut its dividend, it could see more downside going forward.
But one has to wonder if most of the negative interest rate news has already been factored into these mortgage REIT stock prices, thus the muted response to Powell’s speech on Friday. The stock market often looks six months or longer into the future. Historically, many of these stocks were beaten down during past interest rate spikes, only to be purchased at lower levels by investors when they felt the worst was over, even if the dividends were cut or remained flat for a few years.
Buying mortgage REIT stocks at present is a risk that’s certainly not suitable for all investors. And the problem is that the very investors who need the income the most, such as retirees, are the ones who should be the most risk aversive. But for more adventurous investors, the mortgage REITs are worth watching to see if they are actually bottoming in price.
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