The mortgage industry is deeply unpopular right now. Mortgage bankers are facing declining origination volumes as interest rates rise, and mortgage real estate investment trusts (REITs) are under the dark cloud of Fed policy.
Despite the difficult environment, some mortgage stocks are better positioned than others. AGNC Investment (AGNC 0.56%) is the classic agency mortgage REIT, while New Residential (RITM 0.96%) is a mortgage REIT that also originates mortgages. Which one is better positioned for this environment?
To get an idea of which one is better positioned, it is important to first understand the economic backdrop. The economy is strong, inflation is rising, and interest rates are going up. The Federal Reserve is entering a tightening cycle -- in other words, a series of increases in the federal funds rate, and will begin to reduce its holdings of mortgage-backed securities.
AGNC Investment is more exposed to the Fed
These two effects will hit AGNC Investment most directly. AGNC invests primarily in agency mortgage-backed securities, which are guaranteed by the U.S. government. That said, AGNC invests in slightly different agency securities than the Fed does -- it has sophisticated algorithms which help it select securities that have more protection against early payoffs -- but it will still be affected by the movements of the entire market.
New Residential has more credit exposure
New Residential invests in agency mortgage-backed securities as well, but it also invests in loans that don't qualify for government guarantees. These loans generally carry higher interest rates; however, if the borrower defaults, New Residential could lose money. These loans generally have a minimum of 20% down, so most borrowers will not walk away from that sort of equity, especially in a rising home price environment.
Rising rates are good for mortgage servicing assets
New Residential also invests in mortgage servicing, which is an unusual asset. Mortgage servicers are responsible for administering the loan. They collect payments, pay the taxes and insurance, and deal with the borrower if he or she gets in trouble. The servicer is paid one-quarter of 1% of the loan per year. If rates rise, the servicer is expected to earn that payment for longer, which means that servicing is an asset that increases in value as rates rise. There are few assets that have that characteristic.
Given the posture of the Federal Reserve, along with rising home price appreciation and a tight labor market, investors should prefer taking credit risk to taking interest rate risk. AGNC Investment has almost no credit risk since its assets are guaranteed by the government. On the other hand, it has a lot of interest rate risk. New Residential, on the other hand, has less interest rate risk but has a lot of credit risk.
If we hit a recession, then the calculus changes
If the Fed causes the economy to slip into a recession, then investors will be better off with AGNC Investment than New Residential. If we hit a recession, then more borrowers are likely to lose their jobs and be unable to make mortgage payments. That won't be an issue for AGNC, as those payments are backstopped by the government. In addition, rates generally fall in a recession, which will benefit AGNC more than New Residential. So, in choosing between these two stocks, you have to keep the economic backdrop in mind. But given the current environment, New Residential is more attractively positioned as an investment option.