Earlier this week, the Treasury announced that it will begin selling its portfolio of mortgage bonds guaranteed by Fannie Mae and Freddie Mac (also known as agency paper). The sales will start this month, and will be subject to market conditions. It is estimated that selling the holding could result in a profit of as much as $20 billion.
So is it a Good Time to Buy Agency Paper?
Mortgage-backed securities are hard to own individually, but investors can invest in these products through Real Estate Investment Trusts, or REITs. The biggest name in this market is Annaly Capital Management (NLY), but there are other players such as American Capital Agency (AGNC) and Invesco Mortgage Capital (IVR).
These companies seem to be excited about the news of more securities to be hitting the market. Several of them have made quick attempts to raise more capital in order to purchase more securities. This is a good sign for investors, who can usually profit from these REITs.
How Do These REITs Work, and What is the Risk?
These companies essentially profit by borrowing money at extremely low rates (0.25-0.5%), buying these mortgage securities that yield 4-7%, and the companies profit on the difference. Since these companies are set up as REITs, they must pass through 90% of the net profits to the shareholders, thus the large dividend payments. These payments, however, are treated as ordinary income.
So, the risk for these companies is that short-term interest rates will rise considerably. If this happens, their dividends will decrease as the rate at which they borrow funds will increase, thereby lowering the spread. Given what the Fed has been saying, though, this seems unlikely in 2011. At the end of the day, we could end up going to a digital currency anyway.
As a result, it seems that these securities will remain attractive to investors through the remaining half of the year. The College Investor would love to see more investors attracted to this product to drive the price up and the yield down a bit.
The College Investor is long AGNC.
Readers, what are your thoughts on Agency Paper and Mortgage Backed REITs?