Analysts at Keefe, Bruyette & Woods state that they believe fears about a Federal Reserve Board exit from its mortgage-backed securities holdings in the near future “are overdone.” Mortgage real estate investment trusts invest in similar paper that the Fed is and this is affecting their valuation.
This lack of concern about a Fed exit mimics what the economists at the Mortgage Bankers Association said during their presentation at the recent National Secondary Market Conference.
When the fears about the Fed exiting are put to rest, KBW said, MBS prices should start going upward. “We see the agency REIT group trading at 0.93 times our mark-to-market book value estimates on average, and while we wouldn't necessarily say that represents a hard bottom we definitely like the dividend plus valuation upside potential,” wrote Michael Widner and Sean Tillman.
They did note that those REITs whose MBS portfolios are focused on the same low coupon, 30-year fixed-rate loans that the Fed desires will feel the most impact when the market gets scared the Fed will stop buying MBS.
“The further an mREIT stays from that, the more effectively pure interest rate risk can be hedged (and remember, volatility goes both ways as emotions shift),” KBW said.
Widner and Tillman said as a group they like the mREITs, but picking a top one depends on how the individual investor feels about Fed policy as well as their tolerance for risk.
However, “Today we happen to like CYS [Investments Inc.] as the best overall pick (trading at a sizable 10% discount to our book value estimate and having a bit less book value volatility than those heavier into 30-year fixed).” The analysts said they also like hybrid mREITs.