by Bryan Perry | October 26, 2012 8:47 am
Like I’ve said before — plain Jane REITs that hold only fixed-rate residential mortgages backed by Fannie Mae and Freddie Mac aren’t cutting it in today’s market. But that doesn’t mean you should get out of the game entirely.
A smattering of negative articles have targeted the mortgage REIT (mREIT) sector and the consequences of QE-unlimited. And it’s true: When long-term interest rates fall, REITs have to take on more leverage risk to maintain their sky-high payouts.
Slow growth has also raised a caution flag for how mREITs like Annaly (NYSE:NLY), Apollo Residential Mortgage (NYSE:AMTG) and Capstead Mortgage (NYSE:CMO) will be able to maintain their juicy payouts if long-term interest rates fall further.
While this is a very legitimate argument, the recent trend for interest rates has, in fact, been up (see chart). The spread is actually widening and improving these companies’ ability to maintain the lofty dividend payouts.
One name that rebounded sharply from the brief spate of reactionary selling last Friday is ARMOUR Residential REIT (NYSE:ARR). It’s a hybrid alternative to “vanilla” mREITs that invest only in residential mortgage-backed securities (RMBS). Instead, ARR invests not only in fixed-rate mortgages but also in hybrid adjustable-rate and adjustable-rate RMBS. This is a key point because floating-rate loans don’t get prepaid like fixed-rate ones do.
ARMOUR’s current portfolio of $13.3 billion portfolio of agency securities consists of 78.6% fixed-rate agency securities, 100% of which have 20-year final maturities or shorter. Its portfolio also consists of 21.4% adjustable rate mortgages (ARMs) and hybrid ARMs. The ability to ramp up the adjustable percentage of holdings in the event of increasing interest rates appeals to me. That, and the use of portfolio insurance, is a big plus.
REITs that are structured like this are better suited for the current market that’s pressuring the spread of borrowing cheap money short and investing long.
Bryan Perry is editor of Cash Machine, a newsletter focused on dividends and income investing. As of this writing, he did not own a position in any of the aforementioned securities.
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