Betting on 3 stocks in the mREIT industry amid mortgage market turmoil

Zachs REIT and Equity Trust continue to bear the brunt of tighter monetary policy, with interest rate volatility rising, market liquidity below average and bond demand limited. Against this backdrop, higher mortgage rates led to a significant decline in originations, while widening spreads lowered book values ​​for industry players. Going forward, we expect corporate costs of funds to rise while conservative approaches and hedging will moderate growth expectations.

Nevertheless, narrowing prepaid spreads provide temporary reprieve by supporting asset yields and margins, while business diversification helps companies survive. We believe higher mortgage rates will be positive for mortgage servicers, but businesses that primarily hold variable-rate loans will see higher net interest income.Therefore, industry players AGNC Investment Co., Ltd. AGNC, Ladder Capital Co., Ltd. LADR and Armor Residential REIT Investment Corporation ARR is poised to weather the market blues.

About the industry

The Zacks REIT and Equity Trust industry consists of mortgage REITs, also known as mREITs. Industry participants invest in and structure mortgages and his MBS to provide mortgage credit to homeowners and businesses. These companies typically focus on either the residential or commercial mortgage markets, although some companies invest in both markets through their respective asset-backed securities. Agency securities are federally backed, which makes them a safer bet and limits credit risk. Such REITs also raise funds in both the bond and equity markets through common and preferred stock, repurchase agreements, structured finance, convertible and long-term notes, and other lines of credit. Net Interest Margin (NIM) is the spread between interest income and funding costs on mortgage assets and holdings and is a key earnings metric for mREITs.

What is shaping the future of the mREIT industry?

Cooling Residential Activity Impacting Residential mREITs: Mortgage market turmoil has worsened, with mortgage rates rising dramatically throughout the year, and the pace has accelerated in recent quarters. The housing market is cooling and mortgages may continue to fall. In fact, MBA forecasts predict a 50% decline in mortgage originations in 2022. Also, his 30-year fixed-rate mortgage rate is expected to end at his 6.7% in 2022, up from 3.1% in 2021. An additional challenge for residential mREITs is the potential reduction in margins on sales and gains on new investment activity.

Continued erosion of net interest spreads and book values: High bond market volatility, spikes in interest rates, and widening spreads between 30-year agency MBS and 10-year Treasury yields are impacting agency mortgage-backed securities valuations. Therefore, mREITs will continue to come under pressure on their book values. Also, debt-sensitive mREITs will revalue their funding costs faster than their asset yields. Therefore, we expect the cost of funds to be a headwind, reducing net interest spreads and profitability. This could distract his mREIT investors and lead to an outflow of capital from the industry, which could lead to an even greater decline in the company’s book value going forward. In addition to this, the majority of commercial mREITs have floating rate debt, which means that interest expense increases when interest rates rise.

A Conservative Approach to Temper Returns: Financial markets have become highly volatile, restricting financial conditions and negative bond flows as the Federal Reserve aggressively tightens monetary policy to curb persistent inflation. I’m here. Given these macro concerns, we expect mREITs to choose to invest and add assets to their portfolios as their exposure to higher credit risk assets increases. Many companies have also turned to higher hedge ratios to mitigate interest rate risk. Such a move may seem prudent in uncertain times, but it would moderate growth expectations for mREITs. In fact, robust returns are expected to remain elusive, at least in the short term, as companies prioritize risk and liquidity management over increasing returns.

Sachs’ industry ranks show dire prospects

Zacks REIT and equity trust industries are included in the broader Zacks Finance sector. Zacks Industry Ranked 174th, in the bottom 30% of over 250 Zacks industries.

The group’s Zacks Industry Rank, which is essentially the average of the Zacks Ranks of all member stocks, indicates that it is underperforming in the short term. Our research shows that the top 50% of industries ranked by Zacks are more than twice as good as the bottom 50%.

The industry’s placement in the bottom 50% of Zacks-ranked industries is a result of disappointing earnings prospects for constituent companies. Analysts appear to be slowly losing confidence in the group’s earnings growth potential, given the revised gross profit forecast. The industry’s earnings forecast for this year fell 1.8% from last November.

Before we dive into some of the stocks you might want to consider in your portfolio, let’s take a look at the industry’s recent stock market performance and valuations.

Industry lags sector and S&P 500

The Zacks REIT and Equity Trust industries have lagged the broader Zacks Finance Sector and the S&P 500 Composite over the past year.

The industry fell 36.5% over the period above, while the broader sector fell 17.2%. The S&P index has fallen 21.5% over the past year.

1 year price performance

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Industry Current Rating

The industry is currently trading at 0.87x versus 5.27x for the S&P 500, based on the last 12-month book value (P/BV), a multiple commonly used to value mREITs. It is also below the sector’s 12-month P/BV of 2.99X. Over the past five years, the industry has traded at a high of 1.16x, a low of 0.41x and a median of 0.96x.

Reservation price TTM

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3 mREIT stocks worth betting on

ladder capital: With assets of $5.9 billion at the end of the third quarter, this commercial REIT is a premier commercial real estate capital provider that specializes in underwriting commercial real estate and offers flexible capital solutions within a sophisticated platform. is. We have created and invested in a diversified portfolio of commercial real estate and real estate-related assets, with a focus on senior collateral assets.

The company’s balance sheet is well positioned to benefit from a rising interest rate environment. The company’s loan book consists of 89% variable rate first mortgage loans and more than 50% of its debt is fixed rate. This makes the company’s earnings appear to be positively correlated with rising interest rates. We believe Ladder’s conservative capital structure and moderate leverage are a favorable fit during the ongoing market turmoil. And the negligible losses on originated investments since 2008 underscore the impressive credit performance.

In contrast to some mREITs relying on dividend cuts to weather volatility, LADR announced a 1-cent dividend increase of 4.5% in September, demonstrating its commitment to increasing shareholder value.

The company currently boasts Zacks Rank #1 (Strong Buy). The Zacks Consensus estimate for Ladder’s 2022 earnings has been revised upwards by 4.6% to $1.13 over the past week. Additionally, his NII estimate for 2022 is $63.6 million, representing a 6.4% increase over the previous year. Revenue in 2023 is projected to grow 4.4% year-on-year to $1.18.

you can see See the full list of today’s Zacks #1 ranked stocks here.

Price and Consensus: LADR

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AGNC Investment: A self-managed REIT that mainly invests in agency residential MBS. As of September 30, 2022, 68% of his $61.5 billion investment portfolio in the company consisted of agency MBS. Given the Fed’s faster-than-anticipated balance sheet contraction, the company aims to operate in a more defensive position with significant hedge protection and low leverage.

Over recent quarters, the company has made significant efforts to reposition its portfolio to offset the risks associated with interest rate and prepayment uncertainties. Widening spreads have impacted investment propositions in existing agency securities, but will enhance future returns in new portfolios and boost the future value of AGNC’s business. Agency MBS’s improved supply outlook and lack of credit exposure in a recessionary scenario will increase the attractiveness of this bond alternative and thereby underpin his AGNC’s performance in the coming period.

The Zacks consensus estimate for the company’s 2022 earnings was revised upwards by 11.5% last month to $2.90. This represents a decrease of about 4% year-on-year. Additionally, AGNC’s 2022 NII pegged at $1.3 billion, marking a 27.4% year-on-year decline. AGNC currently holds Zacks Rank #2 (Buy).

Price and Consensus: AGNC

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Armor housing: The company also invests primarily in agency residential MBS. ARR’s securities portfolio is primarily supported by fixed rate, hybrid adjusted rate, adjusted rate mortgages, GSE and US Treasury unsecured bonds and bonds, and money market instruments.

As of the end of Q3 2022, the portfolio composition was 96.3% agency MBS, with 3.7% invested in US Treasuries, excluding short unannounced (“TBA”) security positions .

Rising interest rates and mortgage rates have significantly reduced the constant prepayment rate (“CPR”) of ARR’s agency portfolio. This decline in prepayment rates could provide a tailwind for book growth, NII, spreads and asset yields in the short term. Lower premium amortization costs due to lower prepayment expectations and lower portfolio turnover rates may lead to reinvestment in high-yield common assets, leading to future asset yield growth. There is a possibility.

In its most recent reported quarter, the company repurchased 780,000 shares of its common stock at an average price of $4.96 per share, demonstrating its commitment to increasing shareholder value.

The company’s 2022 earnings were revised up 2.5% over the past month to $1.20. This marks a 25% year-on-year increase with NII increasing his 87.3%. The top line is projected to continue its upward trend in 2023, with year-over-year growth he is estimated at 13.9%. Currently ranked 2nd in Zacks Rank.

Price and Consensus: ARR

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