Federal Regulators May Slam Lending Window Shut on Mortgage REITs

Big names like Annaly Capital Management Inc. and Two Harbors Investment Corp. have been using the FHLB system – but that may soon change

Sep 4, 2014 at 11:08AM

Closed
Flickr / mlrs193.

There was blood in the water yesterday for the mortgage REIT sector, with Annaly Capital Management Inc. (NYSE:NLY), Two Harbors Investment Corp. (NYSE:TWO) and Invesco Mortgage Capital (NYSE:IVR) sinking fast amid proposed regulation of the trusts' use of the Federal Home Loan Bank system.

These mREITs, in addition to jumbo-loan investor Redwood Trust Inc. (NYSE:RWT), have been allowed access to the FHLB's lending window, obtaining secure loans just as member banks do. The trusts have managed this by setting up captive insurance subsidiaries, which are then placed under the oversight of insurance regulators.

But the head of the Federal Housing Finance Agency, Mel Watt, hasn't liked this idea from the start – and it now looks like something might be done about it.

Long-term commitment to mortgage lending
The crux of Watt's concern is valid: the insurance subsidiaries are borrowing on behalf of the mREITs, which differ greatly from banks. Unlike banks, they have no deposits on hand as security – and, with the FHLB network being backed by the American taxpayer, some regulators feel that mortgage REITs inject too much uncertainty into the system.

Captive insurers are very often used as a stand-in for the parent company, particularly in the insurance industry, so it is natural that mREITs' use of them would raise red flags. In June, the FHLB put the brakes on non-bank entities like Annaly and Two Harbors gaining access to the system, implementing a three-month moratorium on the practice.

But, insurers have been allowed membership since the system was set up in the early 1930s, buying stock in the network of banks in order to access reliable, wholesale loans. Often, mortgages are used as collateral, as well.

The proposed rules, which would take effect at all 12 Federal Home Loan Banks, would change all that. New requirements would state that borrowers would be required to make long-term mortgage loans, holding a minimum of 10% of their assets in residential mortgages. Captive insurers would no longer be granted membership, although those that are currently members can stay for five years – with restrictions on borrowing.

Too harsh?
Not everyone agrees with this new paradigm. A spokesman for the Council of Federal Home Loan Banks says that these captive insurers serve a vital purpose, supporting home mortgage lending at a time when the home-loan financing model is facing difficulties. 

Similarly, analyst Michael R. Widner of KBW believes that captive insurers are not outside of the FHLB's mission, and can actually help expand mortgage credit to both individuals and businesses.

For their part, Redwood Trust has indicated that the change would not affect them negatively. But investors in all four of the aforementioned mortgage trusts seemed to disagree, and all four mREITs saw a dip in their share values after the news of the proposed changes broke. 

On the plus side, the changes are simply proposals at this point, and the open comment period runs until November 1. Even if mREITs lose their ability to join the FHLB, Annaly, Two Harbors, Invesco, and Redwood will have a five-year grace period in which to weather some of the headwinds that an increase in short-term interest rates is bound to inflict – which may have been the main reason for mREITs joining the system in the first place. 

Mortgage REITs aren't the only dividend stocks around
The smartest investors know that dividend stocks simply crush their non-dividend paying counterparts over the long term. That's beyond dispute. They also know that a well-constructed dividend portfolio creates wealth steadily, while still allowing you to sleep like a baby. Knowing how valuable such a portfolio might be, our top analysts put together a report on a group of high-yielding stocks that should be in any income investor's portfolio. To see our free report on these stocks, just click here now.

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.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich" rated The Motley Fool as the #1 place online to get smarter about investing.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of fool.com.

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to www.fool.com/beginners, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. It's also featured on several dozen radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at www.fool.com/podcasts.

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.


Compare Brokers