Gundlach Steers Clear of MBS REITs as Homeowners Refinance

Jeffrey Gundlach
Jeffrey Gundlach, founder and chief executive officer of Doubleline Capital LP. Photographer: Jonathan Alcorn/Bloomberg

Investors should avoid real estate investment trusts that buy U.S. mortgage-backed securities because they’ll continue to cut dividends as homeowners refinance mortgages at lower rates, said DoubleLine Capital LP’s Jeffrey Gundlach.

“I expect further dividend cuts in the quarters ahead and would avoid MBS REITS for the time being,” Gundlach, who heads the $21 billion Los Angeles-based money manager, said in an e-mailed statement.

Mortgage REITs including Annaly Capital Management Inc., Hatteras Financial Corp. and Capstead Mortgage Corp. announced dividend reductions this month, while rivals American Capital Agency Corp., Two Harbors Investment Corp. and MFA Financial Inc. maintained their quarterly payouts. The industry’s shares have returned 0.65 percent over the past 12 months, assuming reinvested dividends, declining 5.7 percent since mid-year as loan rates fell to record lows, according to a Bloomberg index.

“I sold all MBS REITS a few months back,” said Gundlach, whose main bond fund has beaten 99 percent of rivals this year, according to data compiled by Bloomberg. “I figured the dividends were going to be cut.”

The trusts are lowering payouts because prepayments are increasing on government-backed securities, most of which are carried by REITs above 100 cents on the dollar, which means “their yields are going lower,” Gundlach said.

Record Mortgage Rates

Interest rates on 30-year loans averaged 4.08 percent last week, the lowest on record, according to surveys by the Washington-based Mortgage Bankers Association, as monetary policy by the Federal Reserve and Europe’s debt crisis restrains benchmark yields that guide consumer borrowing costs.

Gundlach’s view contrasts with Wunderlich Securities, which recommends investors should be “overweight” mortgage REITs. They trade at a discount to book value and can still reinvest proceeds from prepayments at “attractive,” though lower, yields relative to their funding costs, Merrill Ross, an analyst at Wunderlich, said in a Dec. 19 report.

“Despite what was, in most cases, modest dividend pressure, we continue to believe the group is undervalued,” Ross said.

The weekly pace of applications for mortgage refinancings has slowed 28 percent since this year’s peak in August after homeowners locked in lower borrowing costs, though remains almost twice as high as in February, Mortgage Bankers Association data released today show.

Flatter Yield Curve

Bose George, Jade J. Rahmani and Ryan O’Steen, analysts at Keefe Bruyette & Woods in New York, wrote in a Dec. 12 report on their outlook for 2012 that “we expect investment opportunities for mortgage investors including the mortgage REITs to remain reasonably attractive” next year.

“The main driver is slowing prepayments relative to the back half of 2011,” they said. That “should help offset a flatter yield curve,” or narrower difference between the short-term rates at which REITs borrow and the long-term yields on their investments, the analysts said.

Gundlach oversees the $14.9 billion DoubleLine Total Return Bond Fund, which has returned 9.4 percent this year, primarily investing in mortgage debt.

Dividend yields for mortgage REITs are almost 15 percent, so even cutting them in half would leave investors being paid about 5 percentage points more than 10-year Treasuries, said Jay Diamond, a managing director at New York-based Annaly Capital, the largest of the companies.

“Dividend yields are pretty attractive right now and if you take an extreme case, which I want to stress is not what I’m predicting is going to happen, you’re still doing pretty well,” he said in a telephone interview. “Since inception our annual return to investors has averaged over 14 percent and most of that is from cash dividends.”

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