April 6, 2020
Orion’s brokers are experts at the supply side of mortgages: working with borrowers, understanding the programs and processing, underwriting, and funding, and knowing how important it is to produce a quality product. But we’ve been receiving a lesson in the demand side of the equation lately: who is buying the product we produce? The Federal Reserve has been purchasing increasing amounts of Agency MBS, throwing off the equilibrium. But where have the Real Estate Investment Trusts been lately?
In a normal economy the main risk with mortgage REITs is spiking interest rates since they borrow money at short-term interest rates and collect interest on mortgages for 15 to 30 years. As short-term rates spike, profit margins fall or even disappear entirely. But rates have never been lower. Recession fears (can borrowers make their payments?) are making the value of the mortgage-backed securities (MBS) owned by these REITs decline in value, especially for those that own mortgages not guaranteed by Fannie Mae or Freddie Mac: non-QM and jumbo. Some REITs have been forced to sell mortgages at a loss due to liquidity concerns, adding to the supply already coming out of lenders.
Mortgage REITs also use derivatives and other hedges against rising interest rates, and as volatility heated up and interest rates took an unprecedented dive, these instruments resulted in massive losses as well. On top of that, borrower’s refinancing are resulting in early pay offs of existing securities which hit any holder of MBS.
As the coronavirus statistics grow, and the number of unemployed increases, the fear of a recession increases. Investors in REIT securities are nervous, and have been selling their stock. (If you want to see for yourself, check out New York Mortgage Trust or Annaly.) Some REITs have suspended dividends, and some have been issued margin calls that have not been paid yet. Unfortunately at this point they are not “the smartest guys in the room.” Haven’t they ever heard about the Savings & Loans and borrowing short and lending long?
Unfortunately analysts predict more mortgage REITS will be unable to meet margin calls, and there's a limit to how much patience their creditors will have. This impacts their demand for Agency MBS, which impacts rate sheet prices for borrowers not only from Orion but everyone. And reminds us about supply and demand.