Massive Dividend Cut Sparks Panic Among Mortgage REITs

Massive Dividend Cut Sparks Panic Among Mortgage REITs

Just when it looked like mortgage REITs were moderating, disaster struck. Anworth Mortgage announced a reduction in its quarterly dividend last Friday, and it was a doozy: a mere $0.08 per share, a 33% drop from the previous payout of $0.12.

Reaction was swift, and Monday saw decimation in the sector. Anworth fell by more than 0.70%, while agency peers Annaly Capital dropped 1.21%, Armour Residential lost 1.34%, and American Capital Agency took the biggest hit, suffering a decrease of 2.70%.

FOMC meeting could make things worse
The rout occurred on the eve of the Federal Open Market Committee's last meeting of 2013, two days in which the market expects the Fed to announce a timeline for ending its current quantitative easing program. Previous to Anworth's announcement, the sector has been looking pretty hearty, even taking a dividend cut of 9% by Hatteras Financial in stride early last week.

But the Anworth news proved to be too much, and it looks like any hope of taper concerns being priced in the stocks of Annaly and American Capital Agency has been dashed.

Which brings us to this week. The conventional wisdom seems to be that a Fed tapering of QE3 is on the docket, and it may start as early as January. Scary? You bet. But the actual commencement might be helpful to mREITs once the dust settles, and here's why.

Calm will be restored -- eventually
That the end of QE3 is coming is quite clear, and the effect of the taper upon mREITs will surely cause more distress as interest rates rise and the Fed edges out of the market. Book values will continue to suffer, as will dividends. If long-term rates rise slowly, the damage will be less, as the trusts will have more time to plan their hedging strategies, knowing better what the Fed is planning. One thing is certain: Fed officials do not want to shock the recovering economy, so the pace of tapering is apt to be very slow.

What of a rise in short-term rates? This would be a real problem for mREITs, but the Fed has been clear on that score, too. Short-term rates will be held low at least as long as unemployment stays higher than 6.5% and inflation doesn't inch up much over 2%. In addition, some analysts feel that the jobless rate ceiling could well be lowered to 6%. Low borrowing rates coupled with higher long-term rates should help widen the spreads that mREITs rely upon to butter their -- and their investors' -- bread.

Investors who bought Annaly and American Capital Agency at their 52-week highs will be hurt the most, as dividends continue to dwindle for the near term. Remember, however, that the sector has been through this scenario at least twice before -- with the added insult of Operation Twist back in 2011, which sought to raise short-term rates as well as depress long-term rates. They survived then, and they'll make it through the current muddle, but not without a bit more short-term bruising.

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