Trouble Ahead For Mortgage REIT ETFs? [American Capital Agency Corp., Annaly Capital Management, Inc.]

real estateUnlike last year, 2014 has seen a pretty decent performance from the mortgage REIT sector. Contrary to the popular belief that escalation of Fed taper will result in rising rates, interest rates have actually moved in the opposite direction.

Thanks to lackluster economic data, weak U.S. equity markets, geo-political crises and an emerging market lull during the first quarter of the year, risk adverse investors used U.S. government debt as a flight to safety. This pushed yields southwards, working favorably for mortgage REITs, which have performed decently since the start of the year.

However, this time around companies are reporting narrower spread margins primarily due to lower long-term yields. Mortgage REIT companies borrow short-term debt and then use this capital to buy longer-term mortgage securities. Hence a wide (and stable) spread between the short and long term is crucial for their success.

However, both Annaly Capital Management Inc. (NYSE:NLY) andAmerican Capital Agency Corp (NASDAQ:AGNC) have reported declining net interest income for the first quarter of 2014. However, what was noteworthy was that the erosion in the book value per share for both these companies has come to a halt, at least for the time being (read: 3 Long Term Bond ETFs Surging as Rates Stay Low).

NLY in Focus

Annaly Capital Management missed the Zacks Consensus Estimate of 27 cents a share, earning just 23 cents a share instead. This compares unfavorably both with the previous quarter and the year-ago quarter.

Spread compression during the quarter due to lower long-term yields, adversely impacted the company’s net interest income, which dropped 16.2% sequentially and 5.1% year over year.

Following the weak earnings results, NLY’s shares dropped roughly 3%, but recovered 0.96% during the next trading day. A sequential rise in the company’s book value per share and a year-over-year fall in leverage during the reported quarter seem to have given some relief to investors.

AGNC in Focus

AGNC on the other hand reported encouraging first-quarter 2014 results with adjusted income per share comfortably beating the Zacks Consensus Estimate of 68 cents.

Concerted efforts towards portfolio repositioning and shrinking its capital base by share repurchases enabled the company to post impressive numbers. However, the company reported a drop in net interest income from the preceding quarter.

ETF Impact

Despite the earnings miss by NLY, Mortgage REIT ETFs that have huge exposure to the company were unaffected delivering flat performance over the past few trading sessions. In fact, these funds have gained modestly in the past two weeks following strong earnings by AGNC (see all the Real Estate ETFs here).

iShares Mortgage Real Estate Capped ETF (NYSEARCA:REM)

REM tracks the FTSE NAREIT All Mortgage Capped Index, measuring the performance of the residential and commercial mREIT market in the U.S. The fund consists of 36 securities in its basket while it charges investors 48 basis points a year in fees.

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