Real estate investment trusts that invest in mortgage debt have lost about 6% of their value in the past week, extending a decline that started after the Federal Reserve said in mid-September that it would buy an additional $40 billion of the securities a month.
The move by the Fed has pushed down bond yields, narrowed spreads and reduced homeowner borrowing costs—squeezing the firms’ earnings and dividends.
“As a company we’ve been through a lot of challenges,” said Denahan-Norris, who last week was named co-CEO of Annaly, one of largest mortgage investing REITs in the U.S. “Having such a large non-economic competitor is certainly posing a unique set of challenges.”
Mortgage REITs are losing investors who have been attracted by average annual dividend yields currently at about 13%, or almost seven times that of Standard & Poor’s 500 companies. The firms use cash raised through share sales and borrowed money to invest in government-backed mortgage securities, housing debt at risk from defaults, or both.
While dividends are set to fall, they’re far above those on competing investments such as high-yield corporate bonds, which are also being pushed lower by central bank efforts to stimulate their economies. Junk yields fell to a record low 6.95% last month, according to a Bank of America Merrill Lynch index.
“It’s not just at the mortgage REITs where the returns in this market are being put under assault,” New York-based Annaly’s Denahan-Norris said in a recent interview. “It’s the general global landscape where you have an incredible mispricing of risk that’s being delivered at the hands of academics at the central banks of the world.”
The immediate challenge to mortgage REITs comes from a jump in homeowner refinancing driven by record rates. That will force the companies to write off the premiums they paid for bonds faster and reinvest at lesser yields. Applications to replace mortgages rose last month to the highest since 2009.
“We are getting to a crossroads where refinancing activity will be pretty severe,” said Merrill Ross, an analyst for Baltimore-based Wunderlich Securities Inc. “The days of wild returns are in the rear-view mirror.”
