A lot of the REITS particularly the mortgage REITS are in trouble. The earnings are sliding not because business is bad but because borrowing money has become expensive. The banks have raised their rates and the equity and hedge funds aren't refinancing debt any longer. The REITS cannot borrow enough to make new deals or get better options on their CMOs. A lot of their portfolios are made up of long-term yields which are good for dividends but as rates rise so does the NOI and eventually dividends will be the first area of cuts.
Mortgage REITs (mREIT for short) have long been favorites of dividend investors, and especially before taper concerns came back into the picture. Securities in this space often pay double digit yields, and with such a sluggish market for income, these were preferred picks by many.
The structure of mREITs also increased their appeal when rates were stable. That is because mREITs generally borrow at short-term rates and then invest in longer term securities. So in this strategy, a big spread between short term and long term rates is key for strength in their business model.
However, as taper talk has resumed the spread has shrunk between these two key figures, while there is a threat of further compression in the weeks and months ahead as well. This has been terrible news for the space and many have jumped out of stocks in this corner of the market as a result.
In particular, one to watch for further losses is American Capital Agency Corp (AGNC).
AGNC’s Recent Earnings
The latest earnings report for AGNC was pretty terrible by any estimation. Third quarter results came in at 61 cents a share, falling well short of the consensus estimate of 84 cents a share. Results also represented a decline sequentially too, as last quarter saw 66 cents of earnings, while the year ago period saw 79 cents a share.
Especially concerning from the report was the average yield on its agency security portfolio, which slumped by 33 basis points down to just 2.59%. Meanwhile, its cost of funds which was more or less stable—down just four basis points—to 1.39%. This means that the interest rate spread declined by 29 basis points to just 1.20%, eating into the company’s profits and future prospects as well.
Live by the dividend, Die by the dividend
Dividends, one of the main reasons to buy a mortgage REIT, have also been on the decline for AGNC. The firm’s Q3 dividend came in at 80 cents a share, a nearly 24% decline from the previous quarter, and when annualized, a huge drop from previous years.
Thanks to declining margins and slumping yields, investors have sold off AGNC in droves. Shares of the company are down more than 30% YTD, and the stock is within striking distance of its 52 week low as well.
Estimates are falling too
And based on the latest earnings report and the sluggish trend in the interest rate market, many analysts seem to believe that the slump isn’t over for AGNC. In fact, analysts have been slashing their forward estimates for AGNC to the bone as of late, suggesting that more pain is on the way.
The magnitude of these revisions has been colossal too, with estimates for the current year falling from $6.92/share 30 days ago to just $4.37/share today. Next year figures are also depressing, with estimates falling from $3.26/share 30 days ago to just $2.60/share today, representing a decline of over 20%.
Due to these factors, and a horrendous history at earnings season—four straight misses of at least 11%– we have no choice but to assign AGNC a dreaded Zacks Rank #5 (Strong Sell). So we are looking for more underperformance from this struggling company to close out the year, and especially so if the interest rate spread compresses even more in the coming months.
Unfortunately, the mREIT industry has a terrible industry rank, coming in at just 229 out of 260, putting it near the bottom 10%. Yet despite this poor rank, there is one company that appears well-positioned in the space and could actually be a decent pick; Ellington Residential (EARN).
This company has a Zacks Rank #1 (Strong Buy) and this actually represents an increase from a week ago when the stock had a Rank of 3. The firm also saw a strong surprise in the previous earnings release, and solid estimate revisions higher too.
So if you are looking to stay in the mREIT space, consider going a little smaller and focusing on EARN. This company has a double digit yield and it could be better positioned than the struggling AGNC at this time.