A Primer on Fed Policy’s Impact on Your U.S. Mortgage REITs

Last week was a solid one for your Dividend Pro portfolio, as stock markets across the globe regained their footing. Your stock-related picks — Hospitality Properties Trust (HPT) and Global X SuperDividend ETF (SDIV) — jumped strongly.

Three of your current seven Dividend Pro holdings are U.S. mortgage real estate investment trusts (REITs) — Two Harbors Investment Corp. (TWO), American Capital Agency Corp. (AGNC) and iShares FTSE NAREIT Mortgage REIT (REM). Each of these sold off in the past two days, as a direct result of the Fed’s re-commitment to “Operation Twist.” 

So, I wanted to give you a quick primer on why the sell-off happened… and why I think U.S. mortgage REITs remain a terrific investment.

The Fed announced it will prolong “Operation Twist” through the end of the year, selling $267 billion of shorter-term securities and buying the same amount of longer-term debt in a bid to reduce borrowing costs and spur the economy.

Why does this matter to REITs?

REITs borrow on the short end of the curve (say 0.25%) and lend money on the long end of the curve (say, 1.6%). REITs make money on this “spread.” They then leverage this trade up 5x or even 10x times to multiply their profits. These profits then are paid out to you in the form of a high dividend – producing an annual yield of over 15% in the case of AGNC and TWO.

If the Fed intentionally keeps interest rates low on the longer end of the yield curve, it makes it more difficult for REITs to make money. A narrower spread is clearly less profitable for REITs.

But the good news is that the Fed also re-committed to its ZIRP (zero interest rate policy) through at least late 2014. So, some kind of “spread” is set to remain. 

Right now, REITs still have a spread of about 1.35% to "play" with. And REITs also have the opportunity to increase their profits by increasing their leverage — though this increases their risk, as well.

The bottom line? Between a continued interest rate spread and the improving fundamentals of the U.S. real estate market, I continue to believe that U.S. mortgage REITs are possibly the very best investment opportunities among your current Dividend Pro recommendations.

And in the meantime, enjoy the huge dividend payment set to hit your brokerage account over the course of the next few weeks.

Portfolio Update

Hospitality Properties Trust (HPT) jumped 3.26% this past week, bouncing strongly off of its lows. The company announces earnings on Aug. 5. Still trading below its 50-day moving average, HPT is a HOLD.

Global X SuperDividend ETF (SDIV) bounced strongly, rising 3.19% as global markets recovered. With much of the world’s institutional money going into safe, large-cap stocks, this global high yielder may have more upside than you expect. And that’s beyond its impressive 7.45% yield. Trading just a hair above its 50-day moving average, SDIV is back to a BUY.

Two Harbors Investment Corp. (TWO) dropped 2.37%, as the stock went ex-dividend. The $0.40 dividend is payable on July 20, 2012, to common stockholders of record at the close of business on June 22, 2012. Falling just below its 50-day moving average, TWO is now a HOLD.

American Capital Agency Corp. (AGNC) tumbled 3.77%. Yesterday, June 20, 2012, AGNC’s board of directors declared a cash dividend of $0.556 per share for the second quarter of 2012. The dividend is payable on July 16, 2012, to preferred shareholders of record as of July 1, 2012, with an ex-dividend date of June 27, 2012. Still above its 50-day moving average, AGNC remains a BUY.

Prospect Capital Corporation (PSEC) soared 3.09% last week and will pay you a dividend of 10.2 cents per share tomorrow, June 22. Trading above its 50-day moving average, PSEC is a BUY.

iShares FTSE NAREIT Mortgage REIT (REM) dropped 1.90% over the past week. It declared a new dividend of $0.44, up from $0.41. The dividend record date is set for Thursday, June 21, 2012, with a pay date announced as Monday, June 25, 2012, and an ex-date of Tuesday, June 19, 2012. REM’s current dividend yield is about 11.2%. Trading a single penny below its 50-day moving average, REM is now a HOLD.

PIMCO Municipal Income Fund II (PML) rose 0.24% during its first week in your Dividend Pro portfolio. This steady income generator will pay you a monthly tax-equivalent yield of over 9%. It remains a BUY.