Some publicly traded mortgage funds are showing signs of stress, demonstrating just how big the disruption to financial markets has been.
We’re referring to mortgage REITs, which borrow short term to buy longer-term mortgage-backed securities. Most of their profits, which come from the difference between their short-term borrowing costs and the interest they earn on the mortgages they own, get paid out in dividends, making them popular with income-seeking investors.
But when financial markets go haywire, they can get hit as their short-term borrowing costs jump—and that’s what’s happening now. The declines are reminiscent of the 2008-09 financial crisis, but this time around the market’s stresses didn’t originate in the mortgage market.
On Tuesday, Invesco Mortgage Capital (ticker: IVR) lost about half its value after it said it can no longer meet margin calls and will delay its previously announced dividend payments until its cash situation improves.
At least two other mortgage REITs have also asked for forbearance from counterparties because they can’t meet their margin calls during the historic market volatility: New York Mortgage Trust (NYMT) and AG Mortgage Trust (MITT). Their shares were recently down 44% and 9%, respectively.
There’s more. At least four other mortgage REITs have changed their usual dividend plans because of recent weeks’ liquidity freeze. TPG RE Finance (TRTX) delayed its first-quarter payment until June so it could conserve liquidity and Ready Capital (RC) said it would pay 80% of its dividend in stock. And late last week, Two Harbors (TWO) and Anworth Mortgage (ANH) both said they would delay their quarterly dividend announcement.
All hope isn’t lost. The Federal Reserve’s decision Monday to buy an unlimited amount of agency mortgage-backed securities, or agency MBS, should help support the mortgage market. For now, it has put a floor under the price of two REITs that invest primarily in agency mortgage-backed securities on Tuesday. Annaly Capital Management (NLY) and AGNC Investment (AGNC) rose 7.5% and 11%, respectively. And the Schwab U.S. REIT exchange-traded fund (SCHH) was up 4%.
Even so, the two agency mortgage REITs are down more than 30% for the month. As the book values of the sector’s MBS investments have declined in recent weeks, analysts say, they have been forced to sell mortgages into a declining market, helping fuel further losses.
And because mortgage REITs are, as a general rule, leveraged, recent weeks’ dislocations in funding costs only squeezed their liquidity further. They lend out their securities in the market for repurchase agreements or “repo,” where rates stayed high for days after the Fed cut interest rates to zero. The mortgage REITs also hedge their interest-rate exposure in derivatives markets, which have also been roiled by severe volatility.
The collapse of two leveraged exchange-traded notes was another contributor to recent weeks’ market pressure. UBS redeemed its Etracs Monthly Pay 2x Leveraged Mortgage REIT ETN (MORL) and that ETN’s Class B shares (MRRL) after they slid 96% in seven days.
In a late Sunday post on Medium, Colony Capital CEO Tom Barrack warned about potential longer-term fallout in the corner of the market where investors finance businesses’ mortgages. He highlighted the recent crunch in MBS repo markets and warned that continued margin calls on those transactions could overwhelm the mortgage REITs.
While the cost of financing agency MBS has declined after the Fed’s interventions, mortgage REITs’ recent filings say it is still expensive to finance private-label MBS in repo markets.
In other words, the Fed’s recent moves aren’t a panacea for the sector. And the financing problem faced by Invesco’s fund is a good example of why.
Write to Alexandra Scaggs at alexandra.scaggs@barrons.com
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Mortgage REITs Come Under Stress That Even the Fed Might Not Be Able to Ease - Barron's
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