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## Mortgage REITs Outperform as Interest Rates Shift **Mortgage Real Estate Investment Trusts (mREITs)** have significantly outpaced **Business Development Companies (BDCs)** over the past year, marking a notable divergence in performance within the high-yield investment landscape. This trend is clearly observable through the **VanEck Mortgage REIT Income ETF (MORT)**, which has demonstrably outperformed both the **VanEck BDC Income ETF (BIZD)** and the **Putnam BDC Income ETF (PBDC)** during this period. The primary drivers behind this shift include a favorable environment created by declining short-term interest rates for mREITs and heightened investor concerns regarding BDC loan defaults, exacerbated by recent corporate bankruptcies. ## Divergent Performance Across High-Yield Sectors The outperformance of **MORT** against its BDC counterparts has been substantial across various timeframes within the last 12 months. This divergence can be attributed to the inherent sensitivities of each sector to interest rate fluctuations and credit market conditions. **Mortgage REITs** generally benefit from a gradual reduction in the **Federal Funds Rate**. Such declines can decrease their borrowing costs for repo financing, which is crucial for leveraged portfolios focusing on **agency mortgage-backed securities (MBS)**. Companies like **Annaly Capital Management, Inc. (NLY)** and **AGNC Investment Corp. (AGNC)**, significant players in the agency MBS space, are particularly sensitive to these rate changes. As interest rates fall, the value of their existing lower-yielding MBS holdings tends to climb, contributing to book value appreciation and improved cash flow. This easing of pressure follows a challenging period for mREITs characterized by an inverted yield curve and rising long-term rates. Conversely, the **BDC market**, often viewed as a proxy for the $1.7 trillion private credit sector, has faced considerable headwinds. Rate cuts have squeezed payouts by reducing lending income from floating-rate loans and intensified competition from banks has further pressured lending spreads. This has led to a marked underperformance, with the **BDC index** lagging the **S&P 500** by a wide margin in 2025. Specific publicly traded BDCs have experienced significant declines, with **Blackstone Secured Lending Fund** down approximately 21%, **Blue Owl Capital Corp** off 19%, and **Ares Capital Corp** lower by roughly 12%. ## Impact of Rate Cuts and Credit Quality on BDCs The adverse impact on BDCs has prompted managers to trim dividend distributions. For example, the **Blackstone Private Credit Fund (BCRED)**, the industry’s largest BDC, cut its dividend by 9% last month—its first-ever reduction. Other firms, such as **Oaktree Strategic Credit Fund** and **Golub Capital Private Credit Fund**, have also reduced payouts by 10% and 15%, respectively. Analysts suggest that a 75-basis-point reduction in benchmark rates could translate into an 8–10% fall in total BDC dividends, given that dividend coverage ratios currently hover near 100%. Adding to credit quality concerns, the September 2025 bankruptcy of **First Brands Group**, a major automotive parts supplier, has exposed critical vulnerabilities within the private credit and BDC sectors. With estimated liabilities between $10 billion and $50 billion, this event triggered a cascade of losses for institutional investors. The firm’s opaque financing structures, including $4 billion in shadow debt, masked unsustainable leverage. BDCs with significant exposure to such distressed debt face potential margin calls or forced liquidations, contributing to systemic risk concerns within the financial system. ## Mortgage REITs Positioned for Improvement In contrast, the outlook for **mREITs** appears increasingly positive. The easing of the inverted yield curve, where short-term borrowing costs exceeded long-term asset yields, combined with falling interest rates, is creating a more favorable operating environment. **Annaly** and **AGNC Investment Corp.**, for instance, are showing positive momentum in their MBS values and anticipate reduced borrowing costs. Current valuations for major mREITs reflect this optimism, with **Annaly (NLY)** estimated at a price-to-book value of approximately 1.08x and **AGNC Investment Corp. (AGNC)** at 1.23x, according to recent data. These figures indicate book value increases, suggesting a potential for greater returns through multiple expansion. Industry experts corroborate this positive shift. **Steve DeLaney** of Citizens JMP notes: > "Within the mREIT industry, the largest positive impact will likely be seen in the commercial mREIT segment, where higher rates have increased the cost of carry for borrowers with floating-rate bridge loans and higher NOI capitalization rates have lowered real estate property valuations." **Jade Rahmani** of Keefe, Bruyette & Woods adds that the Commercial Real Estate (CRE) environment is **"set to improve in the fourth quarter and 2025"** due to impending rate cuts. This improvement is expected to be driven by increased transaction volumes and attractive returns on new equity and debt investments, along with better financing markets. ## Investment Considerations and Outlook The contrasting fortunes of mREITs and BDCs present nuanced investment considerations. While the sustained outperformance of mREITs could attract further capital, driving valuations higher, BDCs may face continued pressure if credit quality concerns persist and the interest rate environment remains challenging for their business model. The **Federal Reserve's** future interest rate decisions will remain a critical determinant for both sectors in the short to medium term. For investors seeking stability, particularly in a volatile market, **preferred shares** and **baby bonds** in both sectors offer attractive yields (typically 9-10%) with significantly less volatility than common shares. While some analysts suggest opportunities in carefully selected BDCs following their price declines, caution is advised when chasing high dividend yields in common shares of mREITs like **AGNC**, **ARMOUR Residential (ARR)**, or **Orchid Island Capital (ORC)**. Their strong earnings may be temporary, influenced by expiring interest rate swaps, which could lead to declining net interest spreads and reduced dividend coverage ratios. A discerning approach, focusing on underlying fundamentals and the sustainability of payouts, is essential.
## Federal Reserve Eases Policy Amidst Declining Mortgage Rates On September 17, 2025, the **Federal Open Market Committee (FOMC)** implemented a 25-basis-point reduction in the federal funds rate, lowering the benchmark to a range of **4.00% to 4.25%**. This decision, the first rate cut in nine months, was primarily driven by concerns over a weakening labor market and slowing job growth. The **FOMC** further signaled the possibility of two additional rate reductions before the close of the year. In tandem with the **Federal Reserve**'s policy shift, U.S. mortgage rates continued their downward trajectory, reaching their lowest point in nearly a year. The average rate for a 30-year fixed loan declined to **6.26%** as of September 17, 2025, according to **Freddie Mac**, down from **6.91%** at the beginning of the year. This decrease has spurred a notable uptick in refinancing activity, with the **Mortgage Bankers Association (MBA)** reporting a significant jump in related applications. ## Annaly Capital Management's Performance and Strategic Positioning **Annaly Capital Management (NLY)** has demonstrated robust performance amidst these market dynamics. The company's stock has advanced **18.6%** year-to-date, considerably outperforming the broader industry's **5.9%** growth. This strong showing is largely attributable to the favorable interest rate environment, which has bolstered **Annaly**'s net interest income (NII). The firm reported **$493.2 million** in NII for the first half of 2025, a substantial increase from **$47.1 million** in the same period last year. In the first quarter of 2025, **Annaly**'s NII reached **$220 million**, marking its highest quarterly NII since the third quarter of 2022. The company's net interest margin also expanded to **0.87%** in the first quarter of 2025, reflecting a 12-basis-point quarter-over-quarter improvement. This expansion is a direct benefit of lower funding costs on the liability side of its balance sheet. Further signaling financial strength, **Annaly** recently increased its dividend by **8%**, offering a current yield of **14.5%** while maintaining a dividend payout ratio below 100%. **Annaly**'s diversified investment strategy, encompassing Agency mortgage-backed securities (**MBS**), residential credit, and mortgage servicing rights (**MSR**), is central to its resilience. As of June 30, 2025, its portfolio aggregated **$89.5 billion**, with **$79.5 billion** allocated to highly liquid Agency MBS. This multi-asset approach, combined with a **60-40 hedging mix** of treasury and swap exposure, is designed to mitigate interest rate risk and navigate a normalizing yield curve environment. ## Market Reaction and Broader Sector Implications The prevailing market sentiment for mortgage real estate investment trusts (**mREITs**) is bullish, driven by the declining mortgage rates and **Federal Reserve** rate cuts. The substantial increase in loan demand, mortgage originations, and refinancing activities creates a constructive backdrop for the sector. The **MBA** reported a **43%** surge in mortgage loan application volume and a **58%** jump in the refinancing index last week, indicating significant market responsiveness to lower rates. Companies such as **Ellington Financial (EFC)**, **Annaly Capital Management (NLY)**, and **Orchid Island Capital (ORC)** are identified as potential beneficiaries of these trends. The expectation is that lower rates will ease operational and funding pressures for **mREITs**, enhance gain-on-sale margins, and stimulate new investment activity. In comparison to **Annaly**'s year-to-date gain, peers like **AGNC Investment (AGNC)** and **Starwood Property Trust (STWD)** returned **9.7%** and **7.1%**, respectively, over the same period. From a valuation perspective, **Annaly** currently trades at a forward 12-month price-to-tangible book (**P/TB**) multiple of **1.13X**, which is above the industry average of **1.08X**. **AGNC** and **STWD** trade at **1.26X** and **1.07X**, respectively. Analysts, however, rate **Annaly** as a "Moderate Buy," with an average 12-month price target of **$20.83**, despite implying a potential downside of **-5.96%** from current levels, recognizing the company's recent operational outperformance. ## Expert Commentary and Future Outlook The future trajectory of interest rates and their impact on the housing market remain subjects of varied expert opinion. The **Federal Reserve**'s latest **Summary of Economic Projections** revealed a broad range of views among committee members, with the median projection for 2026 implying only one additional rate cut, bringing the rate to **3.25% to 3.5%**, which is higher than the sub-3% implied by the fed funds futures market. Inflation is not expected to reach the Fed's **2%** target until 2028. **Morgan Stanley Research**, in contrast, anticipates a more aggressive easing cycle, forecasting five additional 25-basis-point cuts by July, culminating in a terminal rate of **2.75% to 3%**. However, **Jay Bacow**, Co-Head of Securitized Product Research at **Morgan Stanley**, cautions that **Fed** rate cuts do not always directly translate to lower 30-year fixed mortgage rates, citing the stronger correlation with Treasury bond yields and the forward-looking nature of financial markets. For sustainable growth in home sales, **Morgan Stanley Research** estimates that mortgage rates would need to decline approximately 100 basis points, to around **5.5%**. The persistent gap between the average rate on existing 30-year mortgages (**4.1%**) and new loans (**6.5%**) continues to discourage homeowners with lower rates from selling, thereby limiting supply and contributing to elevated prices. **Orphe Divounguy**, Senior Economist at **Zillow**, suggests that if current "somewhat lower rates stick," it could motivate some marginal buyers but may not significantly impact sellers. **Realtor.com** data indicates that over **80%** of borrowers still hold mortgages below **6%**, reducing their incentive to relocate or sell. Looking ahead, **Annaly**'s strategic balance sheet management, diversified asset allocation, and proactive capital deployment are expected to position it favorably to outperform peers in the **mREIT** sector. Key factors to monitor include the **Federal Reserve**'s subsequent rate decisions, movements in Treasury yields, evolving labor market data, and the broader housing market's response to continued adjustments in interest rates.