Investing.com -- The Federal Reserve's recent decision to cut interest rates by 50 basis points may have sparked the next bullish cycle for mortgage REITs (mREITs), according to a new report from B. Riley.
The firm notes that historically, rate-cutting cycles from the Fed have coincided with rising performance in mortgage-related stocks, as mREITs, which are highly sensitive to interest rate changes, benefit from reduced funding costs and improved earnings potential.
B. Riley emphasizes that mREITs rely heavily on short-term debt financing, which typically matures in 30 to 90 days.
As interest rates decline, B. Riley explains that mREITs can refinance at lower rates, which "enhances carry-on long-duration MBS holdings" and boosts earnings power.
The note also highlights how lower rates allow management to operate with higher leverage and widen duration gaps, further improving profitability.
"We believe most mortgage stock valuations today do not capture the expected improvement in fundamentals," B. Riley states, pointing out that residential mREITs currently trade near 0.9x book value with a 13% forward dividend yield.
Agency mREITs, such as ARMOUR Residential REIT (NYSE:ARR) and Cherry Hill Mortgage (NYSE:CHMI) Investment, are expected to see the greatest benefit from the Fed's rate cuts due to their reliance on fixed-rate mortgage-backed securities (MBS) and short-term financing.
Hybrid and non-agency mREITs, including Ellington Financial (NYSE:EFC) and New York Mortgage (NASDAQ:NYMT) Trust, are also expected to gain from improved securitization economics and higher mortgage origination volumes.
Meanwhile, commercial mREITs, such as Franklin BSP Realty Trust, are expected to benefit from improved cap rates and increased transaction volumes, despite modest spread compression.
B. Riley concludes that with the Fed likely to continue cutting rates, mREITs are well-positioned for a sustained bullish cycle.