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 (NYSE: NLY  ) , American Capital Agency (NASDAQ: AGNC  ) , and Armour Residential (NYSE: ARR  ) , 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 (NASDAQ: MTGE  ) . 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.

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Read/Post Comments (7) | Recommend This Article (2)

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  • Report this Comment On August 19, 2013, at 1:47 PM, jonkai3 wrote:

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    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

    ----------------------

    you do realize that everyone of the plans, including the Presidents comments include "federally backed" mortgages... right? it doesn't matter what they call it, as long as the fed backs 30 yr loans. without if of course the country would dip into a depression that will make 2008 look like a walk in the park... and 1939 look like a tea party.

    and they all know it....

  • Report this Comment On August 19, 2013, at 1:51 PM, jonkai3 wrote:

    ------------

    concerns regarding the stability and staying power of the two GSEs.

    --------------------

    you also realize that Fannie and Freddie just returned a $10 billion dollar profit this last quarter... and have paid pack their $120 Billion loan from the tax payers and are set to earn a huge profit for Tax payers... leave it to our government to want to screw that up.... yet a gain.....

    the only Congress idiots i know who want to get rid of a cash making machine for the people of the US, and we elect them for those kind of decisions.... wonderful...

  • Report this Comment On August 19, 2013, at 2:25 PM, techy46 wrote:

    The FED will replace Fannie and Freddie will something new and lose even more of the taxpayers money. Socialized housing isn't going away it will be expanded and called Homecare so that it fits in well with Medicare.

  • Report this Comment On August 19, 2013, at 4:09 PM, spokanimal wrote:

    Question for Amada Alix:

    Regarding your comment as follows:

    "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"

    ... could you please describe in detail why you believe that a decreased availability of agency backed paper would decrease the spread between the cost of borrowed funds and the rate of return on their investments?

    Are you trying to assert that the rate received for investments in non-agency paper is lower than that received for agency paper?

    How old are you, Amanda?

    Spok

  • Report this Comment On August 19, 2013, at 5:32 PM, RonLitchman wrote:

    RT Spok: If they have a keyboard, isp and an opinion, it doesn't matter on the 'web how old they are . . . or whether they have any experience, or know what they're talking about. (I suppose having a duplex apartment and a housecleaning business counts for something, cf. Amanda's profile.)

    Anyway, I'm long NLY -- and holding some "married puts" for days like today, when the www is awash in opinion . . . and the puts completely offset the downdraft.)

  • Report this Comment On August 19, 2013, at 6:40 PM, TMFHurricane wrote:

    @Spok

    I think what Amanda may be saying is that if the GSEs were dissolved and no federally run insurance fund (like proposed in the Corker-Warner bill) was established and the MBS market was shifted entirely to the private market, it's possible that the demand for pre-existing agency MBSes could be quite high b/c of the risk-free profile. Thus, driving up the price and the yield down.

    However, the President's plan and the Corker Warner bill do not take the government's hand out of the MBS market -- just put private capital ahead of the taxpayer on the risk spectrum. In that scenario liquidity in a new quasi-Agency MBSes would likely be uninterrupted because the holders on the MBS paper would not be on the hook for default.

    Current Agency MBS holders most likely do not fear the President's plan or the Corker Warner Bill -- but may fear the bill proposed by Jeb Hensarling that eliminates government involvement in the MBS market.

    David

  • Report this Comment On August 19, 2013, at 8:44 PM, ffllooyydd wrote:

    ARR down $0.34 today. Up $0.04 since close. A bump up in the AM may be a good sign to buy and dump before days end. I need some money back from this loser.

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