BofA Raising High-Dividend Mortgage REITs, But Warns of Lower Dividends

We recently became worried about the future dividends of the high-yielding mortgage REIT sector due to QE3’s focus being on $40 billion in mortgage-backed securities. In fact, after our call of caution about the future dividends of mortgage REITs we could not help but see waves of downgrades in the following days. Now that the effects and real impact have started to be understood and digested, many of these mortgage REITs have seen their shares bounce back.

Now today comes word that Bank of America Merrill Lynch is not just defending its universe of Mortgage REITs. The analyst team is raising its targets selectively on the group “to reflect the positive yield characteristics of the group and increasing demand for income-oriented investments.”

The bank said that investors are being drawn even more to mortgage REIT stocks due to high yields, and a perceived support for asset values and exposure to healing housing markets. It said, “We are taking the valuation framework higher on excess returns.” It goes on to show that the Bloomberg Mortgage REIT index has risen 8.9% in the third quarter alone and 27.4% year to date as there is an insatiable demand for yield.

As we feared when the QE3 was announced, BofA is warning that mortgage REIT earnings and dividends will grind lower in the current interest rate backdrop. The additional note is that the sector’s fundamentals will likely lag the broader capital markets. It stated, “Reinvestment returns for mortgage REITs have compressed in the face of QE3, with many sectors now inside of 10% ROE, which will likely drive EPS lower.”

BofA is raising its price target objectives in shares of Annaly Capital Management, Inc. (NYSE: NLY), American Capital Agency Corp. (NASDAQ: AGNC), CYS Investments Inc (NYSE: CYS), Two Harbors Investment Corp. (NYSE: TWO), ARMOUR Residential REIT, Inc. (NYSE: ARR), Invesco Mortgage Capital Inc. (NYSE: IVR), and several others as you can see in the table below.

JON C. OGG