Residential mREIT shares have declined over the past month and now trade at a 6% discount to book value. Despite the growing concern about Fed taper and rate increases, Agency-focused mREITs generally trade at a higher price to book multiple (96% vs. 93%) than credit focused names. While the discount makes the sector moderately more attractive, we continue to see more near-term risk to book values (than potential for upside) and therefore continue to be relatively cautious on the sector. Any pullback related to Agency spread widening would be a signal to be more constructive on the sector. NRZ, PMT, RWT remain our current top picks in the sector.
Estimates: We are lowering our 2023 EPS estimates by 2% on average with the Agency focused mREITs declining a larger 8% on average. The biggest factor driving the earnings decrease is our updated short-term rate outlook as we are now incorporating 5 rate hikes through the end of 2023 compared to 3 in our prior estimates. Other key factors in our estimates are the level of TBA specialness (we expect it to decrease but not go away completely) and leverage. As MBS spread widen (as we expect with Fed taper beginning), we expect the mREITs to increase leverage in response. Depending on the level of spread widening, most mREITs still have room to increase leverage beyond what is in our model, which could offer further upside to estimates. The biggest risks to our estimates are interest rate volatility and residential credit deterioration.
▪ Target Prices: We are lowering target prices for 6 Agency-focused mREITs by an average of 4% after incorporating our new rate hike assumptions into our model.