At -14.7%, they wrote, 2Q13 “was the second-worst total-return quarter in a decade” for mortgage REITs, only slightly better than the historic -15.9% reported in 3Q05.
Sharp rate increases drove both these performances. The only difference, analysts note, is that in 2005 the Federal Reserve implemented rate increases at the short end, while in 2013 the Fed delivered “tapering talk hitting the long end.”
In their view, while the sector is a lot cheaper than a quarter ago, going forward “visibility is poor.” But since most of the downward adjustments already have been implemented, estimated book values are “down across the group.”
Expectations also include “extreme MBS volatility” at quarter-end after portfolio changes during the quarter, and the nature of the said changes is revealed. Dividend declarations, which analysts see as a good indicator of earnings, were generally in line with projections of revised portfolio compositions and book values.
“We suspect some stocks have overreacted while others have not reacted enough,” they wrote, that are bound to result in both positive and negative book value surprises that will cause instability across various metrics. For example, “portfolio rebalancing, changes in prepay assumptions, changes in leverage and changes in hedging” may lead to muddy GAAP and core earnings.
Nonetheless, as of now it appears that book value declines and improved spreads are “likely to offset each other,” analysts conclude, as book value declines tend to depress earnings, while net spread improvements improve earnings.
This dynamic is expected to continue “a few quarters out,” after which improved spreads most probably will “win out and could drive 2014 estimates higher, particularly for REITs in hybrid ARMs,” they wrote.