Mortgage REITs Worry About Fannie and Freddie -- With Good Reason
The movement to wind down Fannie Mae and Freddie Mac is gaining momentum, with legislation wending its way through Congress, and President Obama recently throwing his support behind the whole concept. Without the federal backing the two government-sponsored entities currently provide for home loans, the 30-year, fixed rate mortgage may fade away right along with Fannie and Freddie.
What does that mean for mortgage REITs, many of which invest in the type of mortgage-backed securities that feature those very loans? That is uncertain, but companies like Annaly Capital , American Capital Agency , and Armour Residential , all of which concentrate their holdings in agency-backed paper, have cause to be concerned.
How worried are they? I took a look at the 10-K filings of Annaly, Armour, and American Capital Agency to ascertain how these companies view the potential exit of the GSEs from the mortgage landscape. Here's what I found.
As risk factors go, Fannie and Freddie are huge
Since these three trusts have the same business model, it is not surprising to find that all voice the same concerns regarding the stability and staying power of the two GSEs. Their biggest worry is the availability of agency-backed paper if the two agencies are eliminated. A dearth of such MBSes would affect pricing, probably decreasing the spread through which these companies make their money. For its part, Annaly questions whether it will be able to continue buying agency paper at all.
Another huge concern is the volatility that changes to Fannie and Freddie will bring to the markets. Questions regarding the value of the legacy assets of these trusts will almost certainly decrease their value -- not a good thing when book value is so important. Financing may become extremely difficult, or even impossible. Of course, with little or no agency-backed MBSes available to purchase, this issue may well be moot.
What are they doing to prepare?
After all the market gyrations in response to taper talk and the ensuing book value massacres, mREITs have every right to be concerned about volatility. No doubt, investor anxiety regarding changes to the GSEs will likely cause the same kind of problem for mREITs as the uncertainty surrounding the tapering of QE3.
Although these companies are acutely aware of the dangers lurking behind the elimination of Fannie and Freddie, it is less clear that they are taking steps to protect themselves. Of the three, only Annaly, through its acquisition of CreXus, is branching out. The company also has plans to get involved in non-agency jumbo loan origination sometime in the future, through one of its subsidiaries.
For American Capital Agency, a smart move would be to absorb its hybrid sister company, American Capital Mortgage . Both trusts are managed by CIO Gary Kain, which should make the necessary transition into the non-agency sector easier. Armour, meantime, changed its charter a while back so that it now has the flexibility to invest in non-agency paper -- though it still hasn't done so.
It looks like Fannie and Freddie will be put out to pasture eventually, and mREITs need to plan ahead. The changing environment will test the management mettle of these three trusts, and it will be interesting indeed to see how each handles the prospect of a GSE-free future.
With all the uncertainty swirling around mortgage REITs, you may wonder if they are still a good bet. Even in volatile markets, however, the best investing approach is to choose great companies and stick with them for the long term. The Motley Fool's free report "3 Stocks That Will Help You Retire Rich" names stocks that could help you build long-term wealth and retire well, along with some winning wealth-building strategies that every investor should be aware of. Click here now to keep reading.
The article Mortgage REITs Worry About Fannie and Freddie -- With Good Reason originally appeared on Fool.com.
Fool contributor Amanda Alix has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
Copyright © 1995 - 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.