Agency reits (nly, anh etc) vs traditional saving & loan/bank

[hyten1]

folks,

 

interested in hearing everyones opinion on agency reits (nly, anh etc)

 

at the end of day these reits are very similar to bank they having funding cost 2% (reits) vs 0.50% (bank) and they earn interest on these fund. albeit there are many differences.

 

if anyone who are interested could comment on:

- probability of the curve becomes flat or invert

- the leverage deploy (approx 6x for agency reits) vs traditional bank leverage

- in the event of the fed fund rate goes up, what are some historical reference to that and how quickly could/do they usually happen

 

thanks

hy

[A_Hamilton]

folks,

 

interested in hearing everyones opinion on agency reits (nly, anh etc)

 

at the end of day these reits are very similar to bank they having funding cost 2% (reits) vs 0.50% (bank) and they earn interest on these fund. albeit there are many differences.

 

if anyone who are interested could comment on:

- probability of the curve becomes flat or invert

- the leverage deploy (approx 6x for agency reits) vs traditional bank leverage

- in the event of the fed fund rate goes up, what are some historical reference to that and how quickly could/do they usually happen

 

thanks

hy

 

I'd add to this: what is a sustainable leverage ratio for an agency REIT, and what kind of haircut should they expect repo lenders to take on their collateral.

[hyten1]

a hamilton

 

from my understanding agency reits like nly which deploy leverage of 6x or so are operating considerablely under that the repo market deem te max which i believe is typical 20x. so agency reits  like nly are comfortably with the boundary.

 

hy

[A_Hamilton]

a hamilton

 

from my understanding agency reits like nly which deploy leverage of 6x or so are operating considerablely under that the repo market deem te max which i believe is typical 20x. so agency reits  like nly are comfortably with the boundary.

 

hy

 

I agree that right now these guys are at very low leverage levels (6x being lower than NLY's historical average of 8-12x). However, realize that they are at 6x precisely because they realize that the duration of their MBS position is going to increase to absurd levels on a sustained 200-300 bps increase in mortgage rates (for instance w/o offsetting swaps, the duration of their book to equity could easily be 90 assuming durations on mortgages move out to 15 years (D/E *(duration of assets- duration of liabilities)) at 6x leverage...one better hope they have got their decimals right on their swap hedges!!!). Also, to the extent that operation twist/economic conditions cause long dated treasuries and mortgage rates to continue to decline, the spread on NLY's book will continue to narrow. Historically, they've levered up when spreads have narrowed to keep ROE flat. However, this won't be possible if yield curve continues to flatten out and they need to worry about the duration extension issue.

 

Separate of all this, on an extreme shock, I wouldn't be surprised to see haircuts move from 3-5-8% for agency paper...though the federal reserve would move quickly to add hundreds of billions to the monetary base to stop this from happening.

[hyten1]

a_hamilton,

 

i hear ya,  think nly mention they lower their leverage due to the 2008/2009 event. you are right in the past the leverage is higher.

 

i think at the end of the day the risk are very clear and how they will play out i don't think anyone knows.

 

hy

[hyten1]

my other question is so the market think the risk attach to agency reits warrents a 12 to 13% yield. i would think given the current environment the yield should be lower. but what do i know.

 

hmmm

[HJ]

my other question is so the market think the risk attach to agency reits warrents a 12 to 13% yield. i would think given the current environment the yield should be lower. but what do i know.

 

hmmm

 

While for the time being, teens yield may appear attractive, be very aware that you are buying a levered portfolio of agency mortgages.  Funding risk aside, FNMA 3% today trading north of 102.  If rates just rise by 1%, assuming these mortgage passthroughs extend to something like a 6 yr duration, you are down 6% NAV on an unlevered basis.  Applying 5x leverage ala Annaly, you are down 30% on equity, more than 2 years of dividends.  If you are levered like AGNC at 10x, it could get very ugly very quick.  Check out the price actions on NLY in rising rate environments, 2005-2006, 1999 - 2000.  You need to be able to navigate that environment.  These REITs have a place in a tax deferred portfolio at certain times, but arguably the best time to clip the pure agency mortgage carry has already passed us in this cycle. 

 

I would feel much more comfortable with a non agency version like CIM, where the leverage is only 2x and getting the same yield.

 

 

[ShahKhezri]

I think the hybrids are the best way to be invested.  Have done some work on pmt, two and Stwd.

[hyten1]

folks many mortgage reits have been hammer recently due to the chatter on fed tappering

 

anyone looking at these?

 

i am still looking, i have a very very small position (that i added a while ago) in nly

 

 

hy

[dcollon]

hyten1,

 

I think some of them are getting interesting (RWT & WMC would be two).  Obviously, the big question is dependent on each companies business model and structure.  In addition, then we have to guess what the fed and the yield curve are going to do to spreads and volume.

 

 

[BargainValueHunter]

a hamilton

 

from my understanding agency reits like nly which deploy leverage of 6x or so are operating considerablely under that the repo market deem te max which i believe is typical 20x. so agency reits  like nly are comfortably with the boundary.

 

hy

 

I agree that right now these guys are at very low leverage levels (6x being lower than NLY's historical average of 8-12x). However, realize that they are at 6x precisely because they realize that the duration of their MBS position is going to increase to absurd levels on a sustained 200-300 bps increase in mortgage rates (for instance w/o offsetting swaps, the duration of their book to equity could easily be 90 assuming durations on mortgages move out to 15 years (D/E *(duration of assets- duration of liabilities)) at 6x leverage...one better hope they have got their decimals right on their swap hedges!!!). Also, to the extent that operation twist/economic conditions cause long dated treasuries and mortgage rates to continue to decline, the spread on NLY's book will continue to narrow. Historically, they've levered up when spreads have narrowed to keep ROE flat. However, this won't be possible if yield curve continues to flatten out and they need to worry about the duration extension issue.

 

Separate of all this, on an extreme shock, I wouldn't be surprised to see haircuts move from 3-5-8% for agency paper...though the federal reserve would move quickly to add hundreds of billions to the monetary base to stop this from happening.

 

http://soberlook.com/2012/09/mortgage-reits-leverage-poses.html

 

The asset-liability mismatch has been the most troubling aspect of this business. Both Bear Stearns and Lehman were brought down due to their inability to roll short-term repo in a similar setup (not due to derivatives as is commonly believed). The advantage that mREITs have is that they tend obtain term repo lines rather than the overnight financing that investment banks ran prior to the crisis. That means if their lines are pulled, REITs have 2-3 months to sell their securities. And the average term of financing has actually increased recently - which should help with stability.

 

http://1.bp.blogspot.com/-KWZrlhopf4I/UE9YwfSqDJI/AAAAAAAAL30/sDchejBZ1x0/s1600/REpo+term.PNG

[A_Hamilton]

Bargain Value Hunter,

 

I see your links and post, was there something you were looking for in terms of response?

[BargainValueHunter]

Annaly used to have a GREAT blog discussing macro events and trends and how they relate to the mortgage bond market. I think when Mike Farrell got sick (and, sadly, died) they discontinued it and took it down.

 

The old Seeking Alpha version is still up and it provides great historical insights:

 

http://seekingalpha.com/author/annaly-salvos/articles

[hyten1]

forgive my ignorance and stupid question

 

i was wondering is there a banking institution that does what these mREITS does exclusively? instead of having to get short term loans like nly, these banks can do what these mREITS does? i guess they cannot be classify as REITS.

 

hy

[A_Hamilton]

forgive my ignorance and stupid question

 

i was wondering is there a banking institution that does what these mREITS does exclusively? instead of having to get short term loans like nly, these banks can do what these mREITS does? i guess they cannot be classify as REITS.

 

hy

 

A bank wouldn't ever do this exclusively because their after tax ROE's would be very low. Also, the FDIC/OCC has seen duration mismatches before (savings and loan crisis) and won't let a bank take on that much duration risk. The closest thing you will find is a thrift (CFFN, HCBK before MTB bought them...and many many others). However, few of them have the scale HCBK had and most institutions' expense line is very high given costs to operate branches, etc. I could see a bank with a huge DTA trying to run at the highest levels they could get away with to use up the DTA.

 

The ibanks regularly use these strategies. What do you think all of those Repos on the b/s are?

 

[jay21]

forgive my ignorance and stupid question

 

i was wondering is there a banking institution that does what these mREITS does exclusively? instead of having to get short term loans like nly, these banks can do what these mREITS does? i guess they cannot be classify as REITS.

 

hy

 

I am not entirely sure what you mean, but banks hold a lot of AFS securities which are mainly agencies.  They use deposits as their main funding source rather than repos which make them much more attractive imo.

 

Question: when should mREITs not trade at BV?  I see some of these trading at premiums and am hearing about PE and hedge funds trying to launch some these.

[A_Hamilton]

forgive my ignorance and stupid question

 

i was wondering is there a banking institution that does what these mREITS does exclusively? instead of having to get short term loans like nly, these banks can do what these mREITS does? i guess they cannot be classify as REITS.

 

hy

 

I am not entirely sure what you mean, but banks hold a lot of AFS securities which are mainly agencies.  They use deposits as their main funding source rather than repos which make them much more attractive imo.

 

Question: when should mREITs not trade at BV?  I see some of these trading at premiums and am hearing about PE and hedge funds trying to launch some these.

That is my view. Only mREIT I have ever owned was NYMT when it was trading at 0.25x BV in the crisis.

[plato1976]

NLY looks quite attractive with 13% yield, and I feel most rate hike risk is already priced in, I am in the camp doubting rate can go much higher.

 

But I am not familiar with the mortgage reit business model. Not sure if a 0.8nav mortgage reit is more attractive than a 1 p/b big bank ...

 

forgive my ignorance and stupid question

 

i was wondering is there a banking institution that does what these mREITS does exclusively? instead of having to get short term loans like nly, these banks can do what these mREITS does? i guess they cannot be classify as REITS.

 

hy

 

I am not entirely sure what you mean, but banks hold a lot of AFS securities which are mainly agencies.  They use deposits as their main funding source rather than repos which make them much more attractive imo.

 

Question: when should mREITs not trade at BV?  I see some of these trading at premiums and am hearing about PE and hedge funds trying to launch some these.

That is my view. Only mREIT I have ever owned was NYMT when it was trading at 0.25x BV in the crisis.

[TwoCitiesCapital]

NLY looks quite attractive with 13% yield, and I feel most rate hike risk is already priced in, I am in the camp doubting rate can go much higher.

 

But I am not familiar with the mortgage reit business model. Not sure if a 0.8nav mortgage reit is more attractive than a 1 p/b big bank ...

 

 

 

I agree. I picked up a small position on Thursday in NLY. I like fixed income investments at this point. You can find a lot that have been pummeled, have decent yields, and trade at discounts to NAV at this point which is great if you do think rates can't go much higher and/or are worried about the stock market. Especially mortgage securities given they have lower durational risk than a comparable bond due to higher yields, small principle return each month, and slowing prepayments.

 

The thing to keep in mind is that these mortgage REITs' price action will likely be highly correlated with that of the market - not really a true hedge like other fixed income assets might be. But at such discounts to NAV with high yields on low leverage, I can't think of a much better time to be buying them. The only thing they're missing is a guarantee of lower rates.