12-10-2013, 08:32 AM
(This post was last modified: 12-10-2013, 08:35 AM by hendi_alex.)
MREITs like NLY make most of their money from the spread between borrowing and lending. They generally borrow short term against bundled long term mortgages that they hold. There is very little that they can do about rising short term rates. They can go longer on their borrowings, but that hurts margins. They generally employ various hedges, but that cost also hurts margins. Some of their underlying securities will be ARMs. While those do reset every six months or so, after an initial fixed period, they still reset slower than short term rates rise. So even the ARMs holding get hurt when short term rates rise.
While rising short term rates will almost always hurt the existing portfolio, they may not hurt new underwritings if LT rates rise faster. As the spread, not the absolute rate is the key factor. Still, as rates reach a certain point, activity will slow and that obviously hurts business.
I've come to the conclusion that mREITs only represent fair weather holdings, to be accumulated near the top of a rising rate cycle and then to be held during the other side when the companies are almost printing money. As it has turned out, NLY, which is often consider the most conservative and BOB, could have been held for many years and turned an overall profit, however it would have been a much better play when purchased in tune with the fed cycle.
Many other MREITs simply went bust during the unfavorable periods. That is where NLY's strategy of only dealing in agency paper (government backed loans) paid off, as the agency paper continued to be liquid even in the downdraft. NLY has also made good management decisions at times, by hibernating during the most unfavorable periods.
I've not looked at MREITs in a long time, but find it interesting that that the sub-sector is doing so poorly during this period of historically low ST rates. I guess there are two main factors at work. First, although rates are very low, the spread are very narrow as well. Secondly, agency paper is in high demand, so buying bundles of agency loans is very competitive and the resulting high price hurts their spreads as well.
This is just a tiny overview of MREITs as I understand them. They are very complicated and I don't begin to understand the details, especially as relates to hedging, short term borrowing, leverage employed, loan covenants, prepay penalties and effect of prepays,.........
While rising short term rates will almost always hurt the existing portfolio, they may not hurt new underwritings if LT rates rise faster. As the spread, not the absolute rate is the key factor. Still, as rates reach a certain point, activity will slow and that obviously hurts business.
I've come to the conclusion that mREITs only represent fair weather holdings, to be accumulated near the top of a rising rate cycle and then to be held during the other side when the companies are almost printing money. As it has turned out, NLY, which is often consider the most conservative and BOB, could have been held for many years and turned an overall profit, however it would have been a much better play when purchased in tune with the fed cycle.
Many other MREITs simply went bust during the unfavorable periods. That is where NLY's strategy of only dealing in agency paper (government backed loans) paid off, as the agency paper continued to be liquid even in the downdraft. NLY has also made good management decisions at times, by hibernating during the most unfavorable periods.
I've not looked at MREITs in a long time, but find it interesting that that the sub-sector is doing so poorly during this period of historically low ST rates. I guess there are two main factors at work. First, although rates are very low, the spread are very narrow as well. Secondly, agency paper is in high demand, so buying bundles of agency loans is very competitive and the resulting high price hurts their spreads as well.
This is just a tiny overview of MREITs as I understand them. They are very complicated and I don't begin to understand the details, especially as relates to hedging, short term borrowing, leverage employed, loan covenants, prepay penalties and effect of prepays,.........
Alex