Sterne Agee has downgraded many targets on its mortgage REIT sector. Investors can find extremely high-yield dividends here, often north of 10%, but the risk versus reward often can be too much for many investors. The recent rise in interest rates has driven rates to 2.65% the 10-year Treasury note and 3.65% in the 30-year Treasury bond. Stern Agee noted that this has done considerable damage to Agency Residential mortgage-backed securities and to the book values of agency-only mortgage REITs. Sterne Agee said that it would continue to avoid this sub-corner of the mortgage REIT market.

The firm said that REPO dealers will start to reduce advance rates at the same time mortgage REITs want to buy agency bonds, and the dividends at agency-only mortgage REITs will fall over the next few quarters to levels more in line with reported core earnings per share. In the case of American Capital Agency Corp. (NASDAQ: AGNC) and Annaly Capital Management Inc. (NYSE: NLY), this suggests future dividends below $0.78 (versus $1.05) and $0.28 (versus $0.40) per quarter, respectively.

Two Harbors Investment Corp. (NYSE: TWO) and AG Mortgage Investment Trust Inc. (NYSE: MITT) also were covered here. They were said to both operate with blended strategies and are suffering some of the down pressure on book values, but nothing akin to what the agency-only mortgage REITs are suffering. Sterne Agee said:

In the case of MITT, we are expecting a quarterly dividend of $0.70 to $0.80 per quarter (consistent with reported 1Q13 core EPS of $0.75) and estimate current book value at $18.82. TWO has made a number of dynamic shifts in its agency portfolio this quarter, owns I-Os and sub-prime bonds and in its latest filings has indicated its book value is positively skewed towards higher rates. TWO: expected dividend $0.25 to $0.30; estimated book value as of July 5th — $10.58.

Three other companies in the report are said to be clearly earning their dividends: Home Loan Servicing Solutions Ltd. (NASDAQ: HLSS), PennyMac Mortgage Investment Trust (NYSE: PMT) and MFA Financial, Inc. (NYSE: MFA). Sterne Agee said that Home Loan Servicing Solutions Ltd. (NASDAQ: HLSS), PennyMac Mortgage Investment Trust (NYSE: PMT) are actually likely to see book values move higher. The firm said:

MFA has the bulk of its capital invested in non-agency bonds and is likely to experience a very modest decline in book value due to the lower valuations placed on the agency only assets it holds. Improving trends in consumer credit quality and rising home price appreciation (HPA) are aiding all three of these companies.

We have included a table below showing the price target cuts seen in Sterne Agee’s notes:

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