Near-term growth prospects of mortgage real estate investment trusts (mREITs) are being questioned, as interest-rate hikes and periodic bouts of volatility in the broader financial markets continue to affect financials of these companies.
The Fed’s interest rate hike this June is particularly a concern. The rates topped 2% level for the first time since September 2008. Moreover, the number of interest-rate hikes in 2018 is projected to increase to four.
The business model makes it difficult for mREITs to survive in a rising interest-rate environment. Basically, mREITs buy mortgage-backed securities and collect funds from underlying mortgages. Since these companies borrow at short-term rates to purchase these loans, their profits are directly proportional to the gap between short-term and long-term bond rates. Hence, a rising rate environment usually affect net interest margins (NIM) of these companies.
An expected strain on NIM could compel mREITs to cut dividends — the attraction for REIT investors.
Understandably, mortgage rates, which shot up in the first half of the year, have reduced borrowers’ incentives to refinance. Per an outlook by Freddie Mac, U.S. weekly average mortgage rate escalated to 4.66% this May, from 3.99% recorded in the first week of January. For 2019, it expects mortgage rates reach 5.1%.
Nonetheless, surging mortgage rates have weighed down the housing market by eroding affordability. It has also resulted in lower mortgage originations. In its August report, Freddie Mac projects single-family mortgage originations to decline 8.4% year over year to $1.66 trillion. This is anticipated to further escalate the heightening competition among mortgage originators and aggregators, impacting prices of mortgages.
Furthermore, this will likely impact mREITs that support the housing market by originating and purchasing mortgage-backed securities. In fact, the Zacks Industry Rank for the REIT and Equity Trust industry, consisting of mREITs, is #174 (bottom 32% of the 250 plus Zacks industries).
Our back-testing shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.
Now, it’s time for investors to consider portfolio reshuffling and stay away from some stocks from this industry, which are unlikely to bounce back any time soon. Among these are:
Ellington Residential Mortgage REIT EARN: The company specializes in acquiring, investing and managing residential mortgage- and real estate-related assets. It primarily focuses on residential mortgage-backed securities (RMBS).
Per management, persistent flattening of the yield curve impacted the company’s NIM. In addition, higher interest rates resulted in price declines of its agency RMBS.
Earnings of this Zacks Rank #4 (Sell) company missed the Zacks Consensus Estimate in three out of the trailing four quarters. This translates to an average negative surprise of 6.06%. Also, the Zacks Consensus Estimate for its current-year earnings moved marginally downward to $1.39, over the last 30 days.
The stock registered a negative return of 19.7% over the past year, underperforming the industry’s decline of 3.2%.
(You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here)
MFA Financial, Inc. MFA: This Zacks #4 Ranked company witnessed strong downward estimate revisions for 2018 earnings of 9.7% to 74 cents, over the last 30 days. Additionally, it missed the consensus estimates in two of the trailing four quarters, resulting in an average negative surprise of 1.24%. During second-quarter 2018, the company realized lower income from residential whole loans at a fair value.
The stock fell 12.9% in a year’s time compared with the industry’s decline of 3.2%.
New York Mortgage Trust, Inc. NYMT: This Maryland-based company is focused on owning and managing a leveraged portfolio of residential mortgage securities and a mortgage origination business. The mortgage portfolio largely comprises prime adjustable-rate and hybrid mortgage loans and securities.
In the recently-reported quarter, it generated net interest income of $17.5 million, marking a sequential decline of $2.3 million. The company witnessed lower interest income in its distressed residential portfolio.
The consensus estimate for 2018 earnings moved 27.3% south over the last month to 24 cents. Further, the company has a very poor VGM Score of F.
Great Ajax Corp. AJX: This Maryland-based company focuses on mortgage loans secured by single- family residences and single-family properties. It also invests in commercial mixed-use, retail and residential properties.
This Zacks Rank #5 (Strong Sell) company witnessed a 2.4% downward revision for 2018 earnings estimates, over the last 30 days. Also, it missed the Zacks Consensus Estimate in each of the preceding four quarters. This translates to an average negative surprise of 12.25%.
Shares of the company have gained 5.3% underperforming the industry’s rally of 11.3% over the past six months.
We expect the aforementioned factors to impede the company’s near-term profitability. Hence, we recommend investors to stay away from these stocks until the Zacks Rank and estimates improve.
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