MBS real estate investment trusts: a primer.
Pellerin, Sabrina R. ; Sabol, Steven J. ; Walter, John R. 等
Real estate investment trusts (REITs) have played a significant
role financing U.S. real estate going back to at least the late 1800s.
However, those REITs that invest predominantly in mortgage-backed
securities (MBS), the focus of this article, have a much shorter
history, dating to the mid-1980s. (1) MBS-focused REITs (mREITs) grew
quite rapidly after 2008--so much so that some observers have expressed
concerns that the largest might pose systemic risks for the broader
economy, which has led to speculation that they may be subjected to
heightened supervisory oversight (Solomon 2013). The two largest mREITs,
which account for 54 percent of all mREIT assets, have been the focus of
special attention from policymakers and the press. (2, 3, 4) Currently,
mREITs are not as tightly supervised as other financial entities that
are thought to pose systemic risks, such as large commercial or
investment banks.
Observers have raised concerns along the following three
dimensions: 1) mREITs invest in fairly long-term assets but fund
themselves with short-term liabilities, implying that they are sensitive
to interest rate and liquidity risks; 2) they hold large portfolios of
one type of asset, such that if mREITs become troubled and are forced to
liquidate holdings, MBS prices might be driven down; and 3) the assets
that they hold, predominantly government agency-backed MBS, play an
important role in the operation of the home mortgage market, implying
that if policymakers become concerned that mREITs might fail, these
policymakers could feel compelled to intervene to prevent such failures.
Typical discussions of these risks often provide only sparse
information from which one can evaluate them. Therefore, this article
sheds light on how mREITs operate, in what ways they are regulated, and
how their regulation compares to that of other similar types of firms.
It also explains factors contributing to their recent growth, provides
some analysis of the risks they face, how they manage these risks, and
the potential dangers for the broader financial system.
1. HOW mREITS OPERATE
mREITs are investment vehicles that hold MBS and finance these
holdings with equity and debt. Currently, mREITs predominantly hold
agency MBS--meaning those MBS issued by Fannie Mae, Freddie Mac, and
Ginnie Mae--which enjoy implicit or explicit government backing and
therefore have no credit risk. mREIT investors, i.e., the holders of
mREIT equity, typically receive greater earnings than they might by
simply buying MBS, because mREITs use short-term debt and leverage to
magnify returns such that, on average, mREIT assets are 7.4 times equity
(Table 1).
Because MBS have fairly long maturities, one might imagine that
mREITs would tend to fund themselves with equity and long-term debt.
Instead, mREITs typically are funded with short-term
instruments--largely repurchase agreements (repos). Indeed, because
short-term debt instruments typically pay a lower rate of interest than
long-term instruments, borrowing short-term and holding long-term assets
has tended to earn mREITs a significant spread that accounts for much of
their income. The combination of a high degree of leverage with an
asset-liability mix that emphasizes funding long-term assets with
short-term liabilities (such an asset-liability structure is often
termed maturity transformation) carries significant risks, leading them
to engage in hedging activities (discussed in Section 4).
[FIGURE 1 OMITTED]
Because repos play such a significant part in how mREITs operate,
it is fundamental to understand the broader functioning of the repo
market. A repo is the sale of an asset, by the borrower, with an
accompanying promise by the borrower to buy back the same (or like)
asset upon maturity. (5) In fact, they typically are thought of as
simply a collateralized loan, with the asset acting as the collateral.
In the tri-party repo market, the predominant assets backing repos are
MBS issued by Fannie Mae, Freddie Mac, or Ginnie Mae (36 percent of all
tri-party repo collateral), securities issued by the U.S. Treasury (35
percent), (6) and debt securities issued by Fannie Mae or Freddie Mac (6
percent). Interest rates on repo borrowing are among the lowest in the
funding markets because repos are typically fairly short-term
borrowings, repos are collateralized, and repo borrowing receives
especially beneficial treatment in bankruptcy.
[FIGURE 2 OMITTED]
A review of the financial statements of several of the largest
mREITs indicates that most of their repo funding comes from
broker-dealers. (7) Brokers receive agency MBS as collateral in
bilateral repo transactions with the mREITs and then subsequently use
this high-quality collateral to borrow from other financial firms (e.g.,
money market mutual funds) via the tri-party repo market. (8) As
illustrated in Figure 1, over the last several years the amount of the
increase in MBS-backed broker-dealer lending (approximately $300 billion
between June 2010 and December 2012) is almost exactly equivalent to the
amount of the increase in mREIT borrowing. In turn, as can be seen in
Figure 2, the amount of agency MBS collateral posted to the tri-party
market by broker-dealers--the dotted line--increased by about this same
$300 billion between June 2010 and December 2012. The total value of
agency MBS collateral in the tri-party repo market--the solid
line--appears to mirror movements in the dotted line, and both increase
by about $300 billion over the same period. Therefore, taken together,
Figures 1 and 2 suggest that the agency MBS that mREITs have pledged for
most of their recent borrowing has flowed through to the tri-party
market via broker-dealers and accounts for much of the growth over the
last several years in that market.
Broker-dealers benefit in two ways by performing an intermediary
role between mREITs and the tri-party repo market. First, broker-dealers
earn a spread between the interest rate paid to them by mREITs and what
they must pay to finance these loans. For example, in 2012 the largest
mREIT by assets, Annaly, paid a weighted average repo rate for its
borrowings with maturities of two to 59 days of 45 to 50 basis points
(Annaly 2012, F-19), whereas, the average 30-day MBS-backed repo rate in
the tri-party market was 25 basis points in 2012 (Bloomberg 2014).
Beyond the spread, broker-dealers also face lower "haircuts"
on their repo borrowings than do mREITs. (9) A haircut is the difference
between the current market value of the collateral and the amount the
creditor will lend, and it is typically stated as a percentage of the
value of the collateral. It provides a buffer to protect the lender if
the market value of the collateral declines. The lower the haircut a
firm faces, the more it can borrow and re-invest for a given amount of
collateral.
While mREITs face no regulatory leverage limits, the haircut itself
places a limit on the amount they can lever up, meaning haircuts limit
how large an mREIT can grow, given its equity. For example, if an mREIT
starts with $10 million in equity from shareholders and faces a 5
percent haircut, then the maximum amount it can grow without raising
more capital is $200 million. Here is how the process for this mREIT
would proceed: 1) starting with the $10 million in new equity, the mREIT
buys $10 million worth of MBS; 2) it then uses the $10 million in MBS as
collateral for a repo loan of $9.5 million because the lender requires a
5 percent haircut; 3) it buys an additional $9.5 million in MBS and
repos it out to receive $9.025 million in a second loan; and 4) it buys
an additional $9.025 million in MBS. This buying and "repoing
out" (meaning borrowing in the repo market) of MBS could go on
until the firm has MBS holdings equal to one divided by the haircut (in
this case 1/.05) times the original equity ($10 million), or 20 times
the original equity (meaning $200 million). However, mREITs'
leverage ratios are not typically this high--as of December 31, 2012,
their assets (mostly MBS) were on average 7.4 times their equity (see
Table 1).
The borrower not only must provide the lender with extra collateral
to cover the haircut percentage at the time the loan is initially
entered into, but also must ensure that the lender's haircut is
maintained throughout the life of the loan (Choudhry 2010, 151-3). If
the value of the posted collateral falls more than a specified amount,
the lender will issue a margin call requiring the borrower to send the
lender additional collateral to reestablish the haircut percentage. (10)
The possibility that the value of MBS collateral might fall--for
example, when market interest rates increase--provides one explanation
of why mREITs do not lever up as much as haircuts might allow. Instead,
they must maintain a portfolio of unencumbered assets--that is, assets
not used to back loans--in order to be prepared to respond to any margin
calls. (11) For example, as of the end of 2012, Annaly (2012, F-3) had
unencumbered MBS in its portfolio equal to 16 percent of its repo
borrowings.
Beyond these market-imposed limitations, an mREIT's payouts,
investments, and management and ownership structures must meet a set of
requirements found in the federal tax code (see Table 2) in order to
ensure that its income is not taxed. (12) Given that one of these
requirements is that an mREIT must pass 90 percent of its taxable income
to investors in the form of dividends (rather than retaining earnings),
it must fund its growth by acquiring new debt or equity financing.
2. HOW mREITS ARE REGULATED
Currently, mREITs face very limited regulatory oversight. In
addition to complying with the rules associated with maintaining REIT
tax treatment, the mREITs reviewed in this article are registered with
the U.S. Securities and Exchange Commission (SEC) and publicly traded
and therefore must comply with SEC disclosure and reporting requirements
and the rules of the exchange on which they trade (e.g., NYSE or
NASDAQ). (13) However, all SEC-registered and publicly traded financial
companies are subject to these rules.
One feature that makes the mREIT unique among its non-REIT
competitors is that its business model relies heavily on an exception
contained in the Investment Company Act of 1940 (the "1940
Act") that excludes, from the definition of investment company (and
therefore from the Act's rules), certain companies involved in
"purchasing or otherwise acquiring mortgages and other liens on and
interest in real estate." (14) The rationale behind this exception
is to differentiate companies exclusively engaged in the mortgage
banking business from those in the investment company business and allow
the former to benefit from less regulatory oversight since their
activities are providing important liquidity into the housing market
(National Association of Real Estate Investment Trusts 2011; Securities
and Exchange Commission 2011; Securities Industry and Financial Markets
Association 2011). To qualify for this exception, the SEC requires that
the exempt company invest at least 55 percent of its assets in mortgages
and other liens on and interest in real estate (or "qualifying real
estate assets") and at least 80 percent of its assets in the more
broadly defined "real estate-related assets." (15)
Traditional REITs that predominantly hold mortgages clearly fit the
mortgage banking exemption contained in the 1940 Act (Securities and
Exchange Commission 2011, 55, 301). However, mREITs, the first of which
appeared in 1985 (based on our definition of an mREIT), have relied on
SEC staff interpretations of the 1940 Act, which identify "whole
pool" agency and non-agency residential mortgage-backed securities
(RMBS) as being functionally equivalent to mortgage loans, and therefore
"qualifying real estate assets." (16, 17) Thus, most mREITs
hold at least 55 percent of their assets in whole pool agency MBS and
treat any "partial pool" agency MBS as satisfying the broader
requirements of a real-estate related asset. (18)
In 2011, the SEC released a proposal for comment expressing their
concerns that certain types of mortgage-focused companies that exist
today, such as mREITs, may not be the type of company originally
intended to be exempt from the rules of the 1940 Act (Securities and
Exchange Commission 2011). Moreover, while traditional REITs engage in
activities that are clearly tied to the mortgage banking business, the
SEC questions whether the mREIT business model is more similar to that
of an investment company and should therefore face the same regulatory
oversight as one. For instance, both mREITs and investment companies
pool investor assets to purchase securities, provide professional asset
management services, publicly offer their securities to retail and
institutional investors, and most avoid paying corporate income taxes
(Securities and Exchange Commission 2011, 55,303). While mREITs
generally have a higher concentration of their assets in real estate,
many other investment companies invest in some of the same kinds of
assets. (19) Nonetheless, according to a congressional statement
associated with the Investment Company Act Amendments of 1970, mortgage
REITs are excluded from the 1940 Act's coverage "because they
do not come within the generally understood concept of a conventional
investment company investing in stocks and bonds of corporate
issuers." So it seems likely that mREITs would meet this
congressional intent. (20)
If mREITs became subject to the 1940 Act, they would face stricter
regulation. Most importantly, the 1940 Act places limits on investment
companies' use of leverage. The Act also gives the SEC the
authority to monitor the companies' activities to ensure that, for
instance, they are accurately computing the value of their assets and
are not engaging in activities with affiliates that benefit insiders at
the cost of investors (Securities and Exchange Commission 2011, 55,
303). (21) In addition, it restricts affiliate transactions between the
investment company and any affiliate that holds at least 5 percent
ownership interest in the company. (22)
These additional restrictions could be very costly for mREITs,
especially the leverage requirements. Unlike their investment company
competitors, mREITs are able to rely more heavily on debt financing
because they have no statutory leverage limits. (23) In other words,
they can purchase more assets for a given amount of capital compared to
their competitors. Imposing additional restrictions would eliminate any
advantage they might have compared to investment companies that are
subject to greater regulatory oversight. Beyond investment companies,
mREITs also compete with other financial entities, which face even
greater regulatory oversight, such as banks, investment banks, insurance
companies, and other lenders. This comparatively light regulatory
oversight is likely one of the contributing factors to the growth of the
mREIT sector.
[FIGURE 3 OMITTED]
3. GROWTH OF mREITS
mREIT assets have grown eight-fold over the last decade (Figure 3).
They increased fairly significantly from 2003 until the time of the
financial crisis and then grew especially rapidly beginning in 2009.
mREITs' share of agency MBS (and agency debt) has also increased
considerably (Figure 4). While their share remains fairly small, mREITs
have grown to be important suppliers of agency MBS collateral. As of
September 2013, mREITs supplied, through broker-dealers, 54 percent of
the agency MBS collateral used in the tri-party repo market. (24)
Clearly, an important reason for their growth is their strong returns.
As seen in Figure 5, their dividend yield over the last five years has
consistently been around 15 percent, considerably higher than equity
REITs. One reason for mREITs' strong performance is the favorable
tax treatment that they receive compared to many of their competitors.
Of course this cannot be the only explanation given that, at least
recently, mREITs have produced much stronger returns than equity REITs,
which also enjoy this tax advantage.
Other factors that may have contributed to their strong growth and
high returns include a lack of regulatory restrictions on mREITs'
use of leverage, federal policies supporting the agency MBS market (and
therefore mREITs' main asset), and advantages associated with using
repo (their main liability) as a primary method of financing.
mREITs' ability to produce rapid growth has been dependent on these
factors taken together, as well as various external factors, including
the growth of securitization and of the repo market, and the interest
rate environment.
By investing predominantly in agency MBS, not only do mREITs avoid
credit risk, but they are also reliant on a sector that has benefited
from a large amount of government support. As a result of the recent
financial crisis, the Treasury and the Federal Reserve took actions that
stabilized the market for mortgage-related securities (see Table 3 for a
list of policy actions that have supported MBS). For instance, in an
effort to stimulate the economy, the Federal Reserve purchased a
significant amount of MBS (holdings total $1.3 trillion as of September
30, 2013) as part of its large-scale asset purchase program. (25)
[FIGURE 5 OMITTED]
While many sectors were contracting during the financial crisis,
existing mREITs continued to grow and new ones were formed. Of the 42
mortgage REITs (both listed and unlisted) existing today, 19 of them
were formed between 2008 and 2012 (see Figure 6). (26) One of the
recently formed mREITs--Five Oaks Investment Corporation--notes that the
government policies that support the MBS market created an attractive
investment opportunity for mREITs. In its registration statement, it
indicates that if such policies were to change, they could experience
significant financial hardship. (27) Even though some of this support
has dwindled, the MBS market has remained liquid and these securities
have consistently been relied on as high-quality collateral in repo
transactions with broker-dealers. Additionally, the fact that issuance
of non-agency MBS dried up following the crisis (see Figure 7) provides
further evidence that government support in the agency MBS market was
fundamental to the survival (and growth) of mREITs.
As can be seen in Figure 6, mREITs' total assets
(predominantly MBS) grew following a period in which MBS issuance had
risen significantly and mREIT assets have increasingly been funded by
repos (also see Figure 8), indicating that MBS and repo growth may have
contributed importantly to mREIT growth. The repo market is part of the
so-called "shadow banking system," which has grown
significantly over the last several decades. (28) The ratio of private
securitization to total bank loans grew from zero in the early 1980s to
over 60 percent prior to the financial crisis (Gorton and Metrick 2010,
265). The overall growth in repo usage and MBS issuance over the last
two decades has been attributed to the reduced competitive advantage
held by banks for deposits (due to certain innovations and regulations)
and the rise in "securitization and the use of repo as a money-like
instrument" (Gorton and Metrick 2010, 266). As institutional
investors, pension funds, mutual funds, states and municipalities, and
nonfinancial firms had a growing demand for nonbank alternatives for
deposit-like products, they turned to the repo market, which allowed
nonbank financial entities such as mREITs to acquire financing for their
activities in return for collateral. (29) The growth in securitization
meant that an increasing amount of collateral was available for repo
financing.
[FIGURE 6 OMITTED]
[FIGURE 7 OMITTED]
Additionally, bankruptcy's favorable treatment of repos, which
limits counterparty risk, may be another factor contributing to mREIT
growth. In a repo transaction, if the borrower defaults, the lender is
not subject to the automatic stay provisions of the code (whereby
creditors of a bankrupt firm are prevented, or "stayed," from
making any attempts to collect what they are owed) and can take
possession and immediately liquidate the assets pledged as collateral
under the repurchase agreement. Financial contracts that receive this
special treatment in bankruptcy (exemption from the stay) are called
qualified financial contracts (QFCs) and include repurchase agreements,
commodity contracts, forward contracts, swap agreements, and securities
contracts. While special treatment for certain financial contracts has
existed since 1978, only in 2005 was the definition of a QFC expanded to
include repos backed by MBS (Government Accountability Office 2011, 14).
(30) Because the risk to mREIT counterparties is greatly reduced, mREITs
receive repo financing on favorable terms (fees and haircuts), and
counter-parties may be more willing to be heavily exposed to mREITs. As
a result, repos' special treatment in bankruptcy could be a
significant factor in mREITs' growth. (31) Notably, the vast
majority of mREIT asset growth took place after the MBS repo exemption
and, as seen in Figure 8, repos have accounted for an increasing share
of mREIT liabilities since 2005. Importantly, mREITs rely, almost
exclusively, on the use of repo financing to attain leverage.
[FIGURE 8 OMITTED]
mREITs' ability to lever up without regulatory restriction
seems to be a critical part of their ability to produce high returns and
grow rapidly. According to Annaly, the largest mREIT, if leverage limits
were imposed its business model would have to be changed in a way that
would have a material adverse impact (Annaly 2012, 49).
[FIGURE 9 OMITTED]
While equity REITs also use leverage, their returns over the last
six years have been considerably lower than returns produced by mREITs
(Figure 5). An important differentiating feature that could account for
this earnings difference is that mREITs lever up using short-term debt.
This ability to lever up with short-term debt (repo) is particularly
advantageous during periods in which short-term interest rates are low
relative to long-term rates, for example over the last six years. During
such periods, mREITs benefit from holding long-term assets (MBS) at
favorable spreads over their funding (repo) costs and utilize leverage
to amplify returns. Figure 9 shows that when the yield curve environment
is favorable (when the spread between 10-year and three-month Treasury
securities is greatest), mREITs' asset growth and formations
increased.
The Effect of the Recent Increase in Interest Rates
In late 2012, long-term interest rates increased slightly and then
significantly in mid-2013, producing a less favorable environment for
mREIT earnings and growth. In the third quarter of 2012, mREIT assets
peaked at $449 billion (see Figure 3) and declined afterward in response
to this increase in interest rates.
The sell off of mREIT assets as rates increased could be explained
by three things. First, to the extent that investors shifted into mREITs
when interest rates were low and falling to "reach for yield,"
when interest rates started increasing these same investors may have
started shifting back to less risky investments. Second, mREIT managers
themselves may have developed concerns about the adverse effect that
increasing interest rates would have on their MBS portfolio and
therefore reduced leverage to an extent (by 1.4 percent to 7.2 percent
over a period of nine months) by selling assets and repaying debt. (32)
Third, repo counterparties could have become concerned about increased
mREIT risks and the risks of holding MBS collateral in a rising rate
environment and therefore may have become less willing to roll over
MBS-based repo funding or may have increased funding-related costs
(e.g., interest rates, haircuts, and fees).
Although recently mREIT assets have decreased somewhat, their
business model has generally remained favorable--meaning they continued
to provide investors with high dividend yields (Figure 5)--even in 2014.
However, mREITs carry some significant risks. In the following section,
we will look more closely at the risks inherent in their business model
and how they manage them.
4. mREIT RISKS AND RISK MANAGEMENT
mREITs are exposed to: 1) interest rate risk, 2) prepayment risk,
3) credit risk to the extent that mREITs hold assets other than
government-guaranteed MBS, and 4) liquidity risk. To mitigate these
risks, mREITs engage in measures such as hedging and taking steps to
reduce the fragility of their funding structure.
Interest Rate Risk
Because of the maturity mismatch between mREITs' assets and
liabilities, interest rate movements can affect their earnings and,
indeed, their solvency. As of December 31, 2012, mREITs' repo
maturities were, on average, about 48 days, (33) while their average MBS
maturity was 4.5 years. (34) This maturity mismatch implies that when
interest rates increase, mREITs' earnings will decline because
their repos re-price quickly while the yield on their MBS remains
unchanged or increases slowly.
If interest rates increase rapidly, the value of MBS holdings could
decline enough to threaten mREIT solvency. The way in which this could
happen is as follows. An interest rate-driven decline in the value of an
mREIT's MBS holdings will lead its creditors to issue margin calls,
requiring the mREIT to use its unencumbered assets to post additional
collateral to secure their repo funding. If interest rates increase
enough, all of the mREIT's unencumbered assets will be expended,
and the mREIT will be unable to meet additional margin calls.
Prepayment Risk
Prepayment risk exists because most mortgage contracts allow the
borrower the option to prepay, meaning pay back their mortgage prior to
maturity. Because 82 percent of mREITs' assets are agency MBS (as
of December 31, 2012), mREITs are highly exposed to prepayment risk. The
prepayment option can produce losses for mREITs when interest rates fall
or rise. When interest rates fall, homeowners are more likely to
refinance their mortgages, meaning they will prepay. As a result, MBS
holders are repaid more quickly than they would be if there were no
prepayment option, and they are likely to suffer losses when their funds
are returned to them and must be reinvested at the prevailing lower
market yields. When interest rates rise, homeowners are less likely to
refinance their mortgages, meaning MBS maturities (or, alternatively,
durations (35)) are extended. Therefore, the value of the MBS declines
in response to this rise more than it would for a "plain
vanilla" bond (one without any call or prepayment features). This
is because the increase in interest rates extends the maturity or
duration of the MBS--due to the embedded prepayment option in
mortgages--thereby producing more losses.
Credit Risk
Agency MBS has come to dominate mREIT holdings as non-agency MBS
issuance declined to just a few billion per year starting in 2008 (see
Figure 7). (36) Therefore, today's mREITs face little credit
risk--the danger that the issuer of the security (the borrowing firm)
will be unable to repay all of the principal or interest promised in the
security contract, leading to a loss for the security holder. However,
mREITs have historically held a mix of mortgage-related securities,
including non-agency MBS and therefore at times have been exposed to
credit risk (Figure 10). If the non-agency MBS market recovers, mREITs
may, once again, increase their holdings of non-agencies, thus making
credit risk a greater concern.
Liquidity Risk
Liquidity risk arises for mREITs because of their reliance on
short-term funding. If an mREIT's counterparties grew concerned
about its financial health, these counterparties could become unwilling
to roll over their repo funding. Because mREITs are highly dependent on
short-term funding, such unwillingness could quickly cause mREITs to go
out of business. For instance, the mREIT Thornburg Mortgage (Thornburg)
financed $29 billion of non-agency MBS it owned in the second quarter of
2007 with repurchase agreements and asset-backed commercial paper.
Between the second and third quarter of 2007, Thornburg began having
trouble rolling over its repos and eventually had to repay $14.2 billion
(37) of its repo borrowings, in part by selling assets. (38, 39)
Ultimately, Thornburg defaulted on JPMorgan when they failed to meet a
margin call on a repo agreement. (40, 41) This default triggered
"cross-default provisions"--a feature that is common to the
repo market--whereby the default on one repo contract automatically puts
the borrower in default on other repo contracts. These provisions can
exacerbate liquidity risk because they create the possibility that all
of an mREIT's repo creditors may instantly demand their money back
regardless of the maturity of repo contracts.
[FIGURE 10 OMITTED]
While for Thornburg the losses occurred because of its non-agency
MBS holdings, today's mREITs invest predominantly in agency MBS.
Excluding other problems at an agency-MBS-focused mREIT, one would
imagine that liquidity risk would be a fairly minor problem given that
repos backed by agency MBS could easily be rolled over because they
enjoy an implicit government guarantee. However, if lenders were to
become unwilling to accept agency MBS collateral, mREITs could
experience trouble rolling over their repos. Figure 11 suggests that
during the financial crisis repo lenders did become less willing to
accept agency MBS as collateral, at least relative to U.S. Treasury
securities, as evidenced by the widened spread between MBS-backed and
Treasury backed repo rates (Figure 11). As some observers have claimed,
there was a flight to the highest quality securities, i.e., Treasury
securities, during the financial crisis, which could be one explanation
for the widened spread. (42)
[FIGURE 11 OMITTED]
Risk Management
mREITs engage in several forms of risk management in order to limit
some of the risks we have just outlined. Because the fundamental feature
of mREITs is that they engage in maturity transformation, most of their
risk management efforts are focused on addressing interest rate risk,
but some efforts simultaneously address liquidity risk and prepayment
risk. One such activity that addresses both interest rate risk and
liquidity risk is laddering--spreading out the maturities of their
financing so that all of their liabilities do not come due at once.
Beyond laddering, mREITs also hedge using simple and complex
derivative-based strategies to address interest rate risk and the risks
associated with the prepayment option embedded in MBS. (43) Currently,
mREITs are less concerned with managing credit risk since their
portfolios are comprised largely of agency MBS.
Figure 12 illustrates the magnitude of the asset-liability mismatch
of one of the largest mREITs (AGNC) and the extent to which it hedges.
The size of the "bubbles" indicates the amount of either the
notional values of swaps and swaptions or market values of agency MBS
and repos. The vertical axis represents the interest rates earned on
assets (positive numbers), repo rates paid (positive numbers), and net
swap rates on hedges (fixed pay less floating receive rate). (44) The
horizontal axis represents the maturity (in days) of assets,
liabilities, or derivative contracts. From the figure, it is clear that
AGNC's MBS have a much greater average maturity (and yield) than
their repo liabilities, but some of this mismatch is offset by the swaps
and swaptions, albeit at a cost.
Laddering
Repo financing is typically thought of as being very short
term--having an overnight maturity. (45) If all mREIT repo financing was
overnight, they would be exposed to bank-like runs, since all of their
liabilities would mature daily. In other words, it is possible that all
mREIT creditors could, on a given day, refuse to roll over their repo
financing; just like all depositors of a bank could demand their funds
on a given day--producing a run. mREITs typically will arrange their
repo funding such that their contracts have various terms to maturity,
which can mitigate the possibility of bank-like runs.
[FIGURE 12 OMITTED]
While over the last couple of decades the majority of mREITs'
repo contracts have had maturities of fewer than 30 days, a large
portion of their repo financing has still been for greater than 30 days,
particularly in periods when interest rates were expected to rise. (46)
As seen in Figure 13, mREITs increased the proportion of repos with
maturities greater than 30 days beginning in 2002 and again in 2009,
periods during which it seemed clear that interest rates could only
increase. Creditors may have greater concerns about the health of firms,
such as mREITs, which have significant maturity mismatch, when rising
interest rates are expected to produce losses.
[FIGURE 13 OMITTED]
In addition to protecting them somewhat from liquidity risk,
lengthening repo maturities also reduces interest rate risk to a limited
extent because it reduces the maturity gap between their assets and
liabilities. Despite their use of laddering, as seen in Figure 12, their
liabilities (orange bubbles) still have significantly shorter maturities
than most of their assets (red bubbles). Thus, while laddering can
mitigate some of the rollover risk mREITs face, it still leaves them
exposed to interest rate risk.
Fixed-for-floating interest rate swaps
Of all their risk management activities, mREITs rely most heavily
on interest rate swaps to manage interest rate risk. In fact, the
notional value of their swaps at the end of 2012 totaled $160 billion
(equal to 37 percent of all mREIT assets) (Table 5). Because
mREITs' funding costs (determined by repo rates) adjust more
quickly than the interest earnings on their MBS portfolio, when interest
rates rise, their net income declines. To compensate for the increased
funding costs, mREITs enter into fixed-for-floating rate swap contracts
that pay off when interest rates rise. Fixed-for-floating swaps, in this
case, will pay the mREIT's swap counterparty a fixed rate while the
mREIT receives a floating rate tied to some short-term market interest
rate index, such as the London Interbank Offered Rate (LIBOR). Since
short-term interest rates tend to move together, the income that an
mREIT receives on its contract will increase at the same time that their
repo costs are increasing.
[FIGURE 14 OMITTED]
The average swap ratio for all mREITs--total notional value of
swaps divided by total repos--was only 50 percent as of December 31,
2012 (Table 5). This means that approximately 50 percent of any rise in
mREITs' repo funding costs resulting from an increase in market
rates will be offset by the income received on these swap contracts.
However, given that the two largest mREITs have recently added, rather
aggressively, to the amount of their interest swaps, this figure is
larger than it was in recent years and appears to continue to trend
upward. Combined, these mREITs increased the notional amount of their
swaps by $68 billion from 2010 to the second quarter of 2013, providing
evidence that they were expecting interest rates to rise (Figure 14).
Other commonly used hedging activities
Beyond laddering and entering into interest rate swaps, mREITs
engage in a number of other activities to hedge interest rate risk
caused by their maturity mismatch. mREITs use the measure duration to
estimate the size of their maturity mismatch. Specifically, mREITs
control their duration gap (duration of assets minus duration of
liabilities) by engaging in hedging activities such as swaptions,
options, futures, and short sales. (47) Table 4 shows the market values
and durations of all of AGNC's assets, liabilities, and hedges as
of the first quarter of 2013 and the resulting net duration gap. A
positive duration gap, such as AGNC's, means that a firm will
experience losses when interest rates rise. The larger the positive
duration gap, the larger the losses.
Some observers argue that there exists a feedback between hedging
and the volatility of market interest rates. Hedging, therefore, is seen
as one way mREITs potentially pose risks for the broader financial
system (Financial Stability Oversight Council 2013, 88-9).
5. RISKS mREITS POSE (SYSTEMIC RISKS)
While mREITs' holdings of MBS are only a small share of all
MBS outstanding (see Figure 4), a number of observers have raised
concerns about the potential systemic impact of mREIT problems. A sudden
rise in interest rates, a decline in MBS prices caused by other market
forces, or any event that causes mREITs to lose a significant portion of
their funding, could lead to rapid deleveraging by mREITs and possibly
declines in MBS prices broadly and problems for other financial firms.
(48)
For example, one observer argues that a 50-basis-point sudden
increase in interest rates could lead to a decline in the values of
mREITs' MBS portfolios and significant mREITs sales, and generate
"temporary dislocations in MBS markets" (International
Monetary Fund 20 1 3, 10). (49) More specifically, the idea seems to be
that an initial increase in market interest rates could produce mREIT
actions--sales of MBS--that could amplify the initial interest rate
movement, thereby producing large enough increases in mortgage rates to
slow the growth of home sales.
Observers have also noted that mREITs are important suppliers of
MBS collateral to the tri-party repo market, and that rapid mREIT sales
of MBS could have negative effects on this market (Office of Financial
Research 2013, 16). Presumably, the concern here is that the withdrawal
of this collateral from the market could impede the smooth functioning
of the tri-party market and perhaps reduce the ability of other
tri-party-dependent borrowers to raise funds in the tri-party market.
Still, this could only be a problem if the buyers of the MBS that are
being sold by mREITs tend to hold these MBS in portfolio, rather than
themselves returning them to the tri-party market in repo loan
transactions. (50)
Regardless of such systemic concerns, and the various risks faced
by mREITs (interest rate, prepayment, credit, and liquidity risks), the
mREIT industry seems to have weathered recent stresses reasonably well.
During the crisis of 2007 and 2008 only two mREITs failed, both of which
invested primarily in non-agency MBS, and the industry as a whole
produced fairly consistent earnings through the crisis (see Figure 5).
In the years following the crisis, short- and long-term interest rates
had been consistently falling or flat until long-term rates bottomed out
in mid-2012 and then, beginning in May 2013 increased rapidly through
the summer (10-year Treasury rate increased from 1.70 percent in May to
2.92 percent in September). One might expect that such an increase would
lead to significant MBS sales by mREITs, and that such sales could have
an impact on MBS interest rates. Indeed mREITs did sell following the
rate increase and interest rates on MBS rose over this period. However,
it is not clear that mREIT sales amplified interest rate increases.
Surprisingly, given mREITs' heavy reliance on leverage and
significant maturity mismatch, mREITs don't seem to have reacted as
strongly to rising interest rates as some other players. As illustrated
in Figure 1, mREITs' repo borrowings only account for about
one-quarter of the decline of dealer-provided MBS repo funding,
indicating that other parties reduced their MBS repo funding even more,
and likely sold even more MBS.
6. CONCLUSION
Policymakers, the press, and other observers have raised concerns
about possible systemic risks that may flow from mREITs, especially
given the speed with which they have grown over the last five years.
mREITs invest heavily in MBS, a long-term asset, and fund these
investments largely with term repo, a fairly short-term liability.
Clearly investors in mREITs have reason to be concerned given that
this asset-liability mix leaves mREITs critically exposed to interest
rate risk. In fact, recent interest rate increases have caused mREITs to
shrink and have produced significant declines in mREIT stock prices.
Still, the danger to the financial system more broadly is less
clear. For one thing, interest rates would need to increase
significantly and rapidly to cause widespread mREIT insolvencies.
Additionally, mREITs' share of all MBS outstanding, while not
insignificant, is only about 6 percent as of December 31, 2012
(Securities Industry and Financial Markets Association 2011; Table 5),
so that any problems at mREITs would have to be magnified by
counterparty actions in order to produce system-wide problems.
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The authors would like to thank Huberto Ennis, Roisin McCord,
Nicholas Trachter, and John Weinberg for comments on an earlier draft
and Elizabeth Marshall for validating our data. The views expressed in
this article are those of the authors and do not necessarily reflect
those of the Federal Reserve Bank of Richmond or the Federal Reserve
System. E-mail:
[email protected];
[email protected].
(1) See Pellerin, Sabol, and Walter (2013, 3-10) for a detailed
review of the history of REITs, mREITs, and MBS.
(2) While some observers define mREITs as those REITs that invest
in mortgages or MBS, we use the abbreviation "mREIT" to refer
only to REITs that invest in MBS. Additionally, we include in our
definition of mREITs only those that finance their assets predominantly
with repurchase agreements (or other short-term debt, such as commercial
paper).
(3) As of 2012:Q4. Please see Table 5 for data on other mREITs.
(4) For example, see Adrian, Ashcraft, and Cetorelli (2013),
International Monetary Fund (2013), and Stein (2013).
(5) Ennis (2011, 389-92) provides background on the repo market.
(6) Percentage figures from Federal Reserve Bank of New York
(2012).
(7) For mREITs that disclose details on their repo borrowings,
broker-dealers appear to be the predominant source of repo financing.
See, for instance, the second quarter 2013 10-Qs of the following
mREITs: Bimini Capital Management Inc., p. 15; Invesco Mortgage Capital
Inc., page 21; CYS Investments, p. 41; or page 11 of Armour Residential
REIT, Inc., "Company Update," December 19, 2013 (available at
www.armourreit.com / updates/ARR_Company_Update_Dec_19_2013.pdf).
(8) A bilateral repo transaction is one in which there are only two
parties to the transaction. In contrast, a tri-party repo transaction is
one in which the two counter-parties use a custodian bank or clearing
organization (the third party) to act as an intermediary, and typically
the holder of the collateral, to settle the transaction. For more
information on the tri-party repo market, see Ennis (2011, 389-92),
Copeland et al. (2012), and Adrian et al. (2013, 4-6).
(9) For instance, Annaly's (2012, 69) average repo collateral
haircut in 2012 was 5 percent, while the median repo haircut for cash
investors in agency MBS in the triparty market was only 2 percent (see
Federal Reserve Bank of New York [2012], Cash Investor Margin Levels,
Agency MBS).
(10) Specifically, mREITs are subject to two types of margin calls:
valuation and factor calls. Valuation calls occur when the value of the
collateral falls, whereas factor calls occur when prepayment frequencies
(prepayment factors) change, based on prepayment tables published by
Fannie Mae and Freddie Mac.
(11) Unencumbered assets can include cash, MBS, and other
securities.
(12) Note that mREIT distributions are taxable income for their
investors.
(13) Publicly listed companies must satisfy rules related to
corporate governance (including having a majority of independent
directors), liquidity, earnings, share price, and an internal audit
function. For the rule manuals of the NYSE and NASDAQ, see
http://nysemanual.nyse.com/lcm/ and http://nasdaq.cchwallstreet.com/,
respectively.
(14) The 1940 Act is the primary law that governs investment
companies. See Section 3(a)(1) of the Investment Company Act, p. 18, for
a definition of an investment company. The exclusion is contained in
Section 3(c)(5)(C) of the 1940 Act.
(15) These thresholds are based on SEC staff no-action letters and
other interpretations (Securities and Exchange Commission 2011, 55,305)
and are broadly recognized by mREITs as indicated in their 10-K
financial statements (see, e.g., Annaly [2012, 49] and CYS Investments
Inc. [2012]).
(16) From Annaly's (2012, 49) Annual Report: "This
interpretation was promulgated by the SEC staff in a no-action letter
over 30 years ago, was reaffirmed by the SEC in 1992 and has been
commonly relied on by mortgage REITs."
(17) A "whole-pool" certificate is a security that
represents all of the ownership interest in a specific mortgage pool.
From CYS Investments Inc. (2012): "We treat Fannie Mae, Freddie Mac
and Ginnie Mae whole-pool residential mortgage pass-through securities
issued with respect to an underlying pool of mortgage loans in which we
hold all of the certificates issued by the pool as qualifying real
estate assets."
(18) A partial pool certificate is a security that represents
partial ownership interest in a specific mortgage pool.
(19) Securities and Exchange Commission 2011, p. 55,303, fn. 27, p.
55,300, fn. 3.
(20) U.S. House Investment Company Act Amendments of 1970. House
Report 911382 (August 7, 1970), at 17.
(21) From ICI (2013) Factbook in reference to leverage limitations:
"these limitations greatly minimize the possibility that a
fund's liabilities will exceed the value of its assets." See
Section 2(a)(41) of the 1940 Act to see how registered investment
companies are required to value their assets.
(22) See Section 17 of the 1940 Act for prohibitions related to
registered investment companies engaging in certain transactions with
their affiliates.
(23) Note that repurchase agreements have restrictive covenants
that may also put restrictions on leverage.
(24) SNL Financial and Federal Reserve Bank of New York (2013).
(25) While Fed purchases of MBS could certainly be viewed as making
agency MBS more attractive (enhancing liquidity and, therefore, safety),
they have also driven up agency MBS prices to some extent, which tends
to make agency MBS somewhat less attractive. Data for Federal Reserve
MBS holdings from the Board of Governors (2013).
(26) Note that these figures include both listed and non-listed
mortgage REITs. As of December 31, 2012, 24 of these are publicly traded
mREITs (per our definition).
(27) From the Five Oaks Investment Corporation (2012, 32-3).
(28) Shadow banking "comprises a diverse set of institutions
and markets that, collectively, carry out traditional banking
functions--but do so outside, or in ways only loosely linked to, the
traditional system of regulated depository institutions. Examples of
important components of the shadow banking system include securitization
vehicles, asset-backed commercial paper conduits, money market mutual
funds, markets for repurchase agreements, investment banks, and mortgage
companies" (Bernanke 2012). Also see Pozsar et al. (2013) for a
thorough discussion of shadow banking.
(29) "In 2003, total world assets of commercial banks amounted
to USD $49 trillion, compared to USD $47 trillion of assets under
management by institutional investors" (Bank for International
Settlements 2007, 1, fn. 2).
(30) For the types of contracts currently exempt from the stay, see
the following sections of the Bankruptcy Code: 11 U.S.C. [section]
362(b)(6), (b)(7), (b)(17), 546, 556, 559, 560.
(31) For a discussion of potential inefficiencies that might arise
because of exemption of QFCs (e.g., repos) from the stay, see Roe
(2011).
(32) Leverage here is assets divided by equity (data from SNL
Financial). The leverage calculations here are not weighted by mREIT
assets, as they were in Table 1.
(33) Figures are for the 26 firms that fit our mREIT definition and
are as of December 31, 2012. See Table 5.
(34) We don't have a figure for the average maturity of all
mREITs' MBS holdings. This figure (4.5 years) is the weighted
average maturity of Annaly (2012, F-16) and American Capital Agency
Corporation (2012, 44) only.
(35) From Vickery and Wright (2013): "Duration is a measure of
the maturity of a fixed-rate security or, equivalently, its sensitivity
to movements in interest rates. A duration of four years implies that a
1 percent change in yields is associated with a 4 percent change in
price. Note that this market rule-of-thumb estimate of MBS duration is
approximate--because future prepayment rates are unknown, the expected
duration of an MBS will fluctuate over time because of variation in
market conditions and the term structure of interest rates."
(36) www.sifma.org/research/statistics.aspx, "U.S.
Mortgage-Related Issuance and Outstanding."
(37) Figure from the difference in repo holdings between 2007:Q3
and 2007:Q4 from Thornburg's 10-Qs.
(38) See Kingsbury and Wei (2007).
(39) From class action complaint: Case 1:07-cv-00815-JB-WDS
Document 68 Filed 05/27/2008, UNITED STATES DISTRICT COURT, DISTRICT OF
NEW MEXICO, IN RE THORNBURG MORTGAGE, INC Case No. 07-815 JB/WDS,
SECURITIES LITIGATION.
(40) See Bogoslaw (2008), Mildenberg (2008), and Thornburg (2008).
(41) Thornburg ultimately declared bankruptcy on April 1, 2009, at
which point any remaining repo contracts would have been terminated and
may have been immediately liquidated. See McCarty (2009).
(42) http://research.stlouisfed.org/publications/regional/10/07/treasury_securities.pdf, p. 18.
(43) One might imagine that mREITs would need to address prepayment
risk associated with declining interest rates (the chance that falling
interest rates will cause mortgage borrowers to refinance, and therefore
repay their mortgages, forcing mREITs to need to reinvest these received
funds at the new lower interest rate) because MBS contains such risk.
However, because mREITs' have longer-term assets than liabilities,
a decline in interest rates would reduce their funding costs, tending to
offset any losses produced by prepayments.
(44) Interest payments on repos are expressed as a positive number,
rather than a negative number, to allow readers to more easily visualize
the net interest margin (spread).
(45) Investopedia defines a repo contract as "a form of
short-term borrowing for dealers in government securities. The dealer
sells the government securities to investors, usually on an overnight
basis, and buys them back the following day"
(www.investopedia.com/terms/r/repurchaseagreement.asp).
(46) The decline in the use of repos with maturities greater than
30 days during the 2007-09 financial crisis could have been, in part,
due to broker-dealers' efforts to shorten the maturities of their
repo loans.
(47) mREITs may also modify their portfolio holdings as a means of
controlling their duration gap.
(48) These concerns are raised in the following: Financial
Stability Board (2013, 389), Financial Stability Oversight Council
(2013, 7 and 87-90), International Monetary Fund (2013, 9-14), and
Office of Financial Research (2013, 16-8).
(49) See the Financial Stability Board (2013, 39) and the Office of
Financial Research (2013, 16) for a discussion of similar concerns.
(50) Some observers refer to this as a reduction in
"collateral velocity." See Singh (2011) for more information
on collateral velocity.
Table 1 Financial Highlights for all mREITS and the Five Largest
Five Largest mREITS Total Assets Agency Repurchase
2012Y Securities Agreements
2012Y 2012Y
Annaly Capital Mgmt Inc. 133,452,295 127,724,851 102,785,697
American Capital Agency 100,453,000 85,245,000 74,478,000
Corp.
Hatteras Financial Corp. 26,404,118 24,057,589 22,866,429
CYS Investments 21,057,496 20,842,142 13,981,307
ARMOUR Residential 20,878,878 19,096,562 18,366,095
REIT Inc.
Total (includes all
other mREITs)
Average (includes all 434,421,733 359,902,940 319,384,054
other mREITS) 14,980,060 12,410,446 11,013,243
Five Largest mREITS Total Equity Leverage
2012Y Multiple
(Assets-to-
Equity)
Annaly Capital Mgmt Inc. 15,924,444 8.4
American Capital Agency 10,896,000 9.2
Corp.
Hatteras Financial Corp. 3,072,864 8.6
CYS Investments 2,402,662 8.8
ARMOUR Residential 2,307,775 9.0
REIT Inc.
Total (includes all
other mREITs)
Average (includes all 58,888,023
other mREITS) 2,030,621 7.4
Source: SNL Financial.
Table 2 REITs Requirements to Maintain REIT Status
1. Distribute at least 90 percent of each year's income to
shareholders.
2. Earn at least 75 percent of its gross income from real estate
investments, specifically from a) rents on real property; b)
interest earned on obligations secured by mortgages on real
property; c) gains from the sale or other disposition of real
property or mortgages; d) distributions from other REITs
or gains from the sale of shares in other REITs; and e) other real
estate-related activities.
3. Earn at least 95 percent of its gross income from: dividends;
interest; rents on real property; gains from the sale or other
disposition of stock, securities, and real property; and other real
estate-related activities.
4. Less than 30 percent of its gross income is derived from the
sale or other disposition of: stock or securities held for less
than six months; and real property held for less than four years.
5. At least 75 percent of the value of its total assets is
represented by real estate assets (which includes interests in
mortgages), cash and cash items, and government securities; and not
more than 25 percent of the value of its total assets is
represented by non-mortgage or non-government securities.
6. The entity issues transferable shares owned by at least 100
persons.
7. The entity is managed by one or more trustees or directors.
Notes: Government Printing Office (2010). The Cigar Excise Tax
Extension Act of 1960 (Public Law 86-779) amended Subchapter M such
that tax protection was given to REITs.
Table 3 Policy Interventions
Date Agency Policy Description
Mar-08 Federal Primary Dealer Overnight loans by the
Reserve Credit Facility Fed against essentially
(PDCF) tri-party eligible
collateral
Mar-08 Federal Term Securities The TSLF loaned Treasury
Reserve Lending securities to primary
Facility (TSLF) dealers for one month
against eligible
collateral. For so-called
"Schedule 1" auctions,
the eligible collateral
comprised Treasury
securities, agency
securities, and agency
mortgage-backed
securities. For 'Schedule
2" auctions, the eligible
collateral included
schedule 1 collateral
plus highly rated private
securities.
Jul-08 FHFA HERA FHFA becomes the new
established regulator and overseer of
FHFA as new Fannie and Freddie
regulator for
Fannie Mae and
Freddie Mac
Sep-08 FHFA FHFA appointed Increase the availability
as conservator of mortgage financing by
of Fannie Mae allowing these
and Freddie Mac Institutions to grow
their guarantees without
limit, while limiting the
size of retained mortgage
and security portfolios
and requiring these
portfolios to be reduced
over time
Sep-08 Federal Asset-Backed Lending facility that
Reserve Commercial financed the purchases of
Paper Money high-quality asset-backed
Market Mutual commercial paper (ABCP)
Fund Liquidity from money market
Facility mutual funds by U,S.
depository institutions
and bank holding
companies. The program
was intended to assist
money funds that hold
such paper to meet the
demands for redemptions
by investors and to
foster liquidity in the
ABCP market and money
markets more generally.
Oct-08 Federal Commercial The CPFF provided a
Reserve Paper Funding liquidity backstop to
Facility (CPFF) U.S. issuers of
commercial paper through
a specially created
limited liability company
(LLC), the CPFF LLC, This
LLC purchased three-month
unsecured and
asset-backed commercial
paper directly from
eligible issuers.
Oct-08 Federal Money Market Intended to provide
Reserve Investor Funding liquidity to U.S. money
Facility (MMIFF) market mutual funds and
certain other money
market investors, thereby
increasing their ability
to meet redemption
requests and hence their
willingness to invest in
money market instruments,
particularly term money
market instruments
Nov-08 Federal Term Asset-Backed Issued loans with terms
Reserve Securities Loan of up to live years to
Facility holders of eligible
asset-backed securities
(ABS). The TALF was
Intended to assist the
financial markets In
accommodating the credit
needs of consumers and
businesses of all sizes
by facilitating the
issuance of ABS
collateralized by a
variety of consumer and
business loans; it was
also intended to improve
the market conditions for
ABS more generally.
Nov-08 Federal Large-Scale $500 billion in purchases
Reserve Asset Purchases of Agency MBS
Mar-09 Treasury Home Affordable Provides homeowners with
Modification assistance in avoiding
Program (HAMP) residential mortgage loan
foreclosures
Mar-09 Federal Large-Scale Additional $750 billion
Reserve Asset Purchases in purchases of agency
MBS
2008 FHA Hope for Allows certain distressed
Homeowners borrowers to refinance
Program (H4H) their mortgages into
FHA-insured loans in
order to avoid
residential mortgage loan
foreclosures
2009 FHFA Home Affordable Allows borrowers current
Refinance on their mortgage
Program (HARP) payments to refinance and
reduce their monthly
mortgage payments at
loan-to-value ratios of
up to 125 percent and
without new mortgage
insurance
Sep-11 Federal Re-investments Begin reinvesting
Reserve interest and principal
payments in agency MBS
Oct-12 FHFA HARP 2.0 Increase HARP LTV ratio
above 125 percent.
Enables borrowers to go
to any lender to
refinance
Sep-12 Federal "Open-ended" Begin open-ended
Reserve LSAPs purchases of agency MBS
at a pace of $40 billion
per month
Table 4 AGNC Balance Sheet and Hedges
Assets Market Value Duration
Fixed 74.8 4.2
ARM 0.8 1.8
CMO 0.7 6.7
TBA 27.3 4.4
Cash 3.3 0.0
Total 106.9 4.1
Liabilities and Hedges Market Value/Notional Duration
Liabilities -66.3 -0.3
Liabilities (Other) -0.9 -7.0
Swaps -51.3 -4.5
Preferred -0.2 -8.4
Swaptions -22.9 -1.9
Treasury/Futures -13.6 -6.8
Total -3.6
Net Duration Gap 0.5
Notes: CMO balance includes interest-only, inverse interest-only,
and principal-only securities; "Liabilities (Other)" represents
other debt in connection with the consolidation of structured
transactions under generally accepted accounting principles;
the "Net Duration Gap" is derived from the weighted duration of
assets and liabilities and is not calculated by simply summing
the various durations listed here.
Source: American Capital Agency Group, Investor Presentation,
June 12, 2013, p. 24.
Table 5 mREITS-Financial Highlights
Some Facts
Name External Date Type Net
Manager Established Interest
Margin
(3)
AG Mortgage 1 3/7/2011 Hybrid 2.54
Investment trust
American Capital 1 1/7/2008 Agency 1.87
Agency Cop.
American Capital 3/15/2011 Hybrid 2.31
Mortgage Investment
Corp.
Annaly Capital Mgmt 1 11/25/1996 Agency 1.14
Inc.
Anworth Mortgage 1 10/20/1997 Agency 1.03
Asset Corp.
Apollo Residential 1 3/15/2011 Hybrid 2.7
Mortgage
ARMOUR Residential 1 2/5/2008 Hybrid 1.45
REIT Inc.
Bimini Capital Mgmt 1 12/19/2003 Agency 0.87
Inc.
Capstead Mortgage 9/5/1985 Agency 1.09
Corp. ARM
Chimera Investment 1 6/1/2007 Hybrid 3.64
Cap.
CYS Investments 0 1/3/2006 Agency 1.14
Dynex Capital Inc. 0 12/18/1987 Hybrid 2.05
Five Oaks 3/28/2012 Hybrid 5.3
Investment Corp.
Halteras Financial 1 11/5/2007 Agency 1.16
Corp. AFIM
Invesco Mortgage 1 6/5/2008 Hybrid 1.81
Capital Inc.
JAVELVIN Mortgage 1 6/18/2012 Hybrid 0.66
Investment Corp. **
MFA Financial Inc. 0 4/10/1998 Hybrid 2.7
New York Mortgage 6/24/2004 Hybrid 3.38
Trust Inc.
Newcastle Investment 1 10/10/2002 Multiple 4.23
Corp.
Orchid Island 8/17/2010 Agency 1.66
Capital Inc.
PennyMac Mortgage 5/18/2009 Multiple 2.21
Investment
Resource Capital Corp. 3/8/2005 Multiple 4.85
Starwood Property 5/26/2009 CMBS & 7.58
Trust Inc. CRE
Two Harbors 5/21/2009 Hybrid 2.64
Investment Corp.
Western Asset Mrtg 1 6/3/2009 Agency 3.68
Cap Corp
ZAIS Financial Corp 1 5/24/2011 Hybrid 3.92
Summary Statistics 2.6
Some Facts Swaps
Name Short- Swap Swaps Weighted
Term Ratio Notional Average
Leverage (2) (Bil. USD) Pay Rate
(1)
AG Mortgage 5.3 (a) 51.8 (b) 2.17 1.172
Investment trust
American Capital 6.8 62.9 (b) 46.85 1.46
Agency Cop.
American Capital 6.8 47 (c) 2.94 1.33
Mortgage Investment
Corp.
Annaly Capital Mgmt 6.5 45.6 (c) 46.91 2.21
Inc.
Anworth Mortgage 7.5 39.4 (c) 3.16 1.98
Asset Corp.
Apollo Residential 5.1 (a) 41.1 (c) 1.5 1.2
Mortgage
ARMOUR Residential 8 47.4 (c) 8.7 1.2
REIT Inc.
Bimini Capital Mgmt 42.6 0 (c) 0
Inc.
Capstead Mortgage 8.5 0 (c) 0
Corp.
Chimera Investment 0.4 (a) 88.2 (b) 1.35 1.81
Cap.
CYS Investments 5.8 (a) 53.6 (b) 7.49 1.27
Dynex Capital Inc. 5.8 (a) 41 (c) 1.46 1.53
Five Oaks 2.5 (a) 50 (b) 0.04
Investment Corp.
Halteras Financial 7.4 46.8 (c) 10.7 1.47
Corp.
Invesco Mortgage 6.1 50.9 (b) 8 2.13
Capital Inc.
JAVELVIN Mortgage 7.7 28.9 (c) 0.33 1.5
Investment Corp. **
MFA Financial Inc. 2.6 (a) 28.8 (c) 2.52 2.31
New York Mortgage 2.8 (a) 40.4 (c) 0.36
Trust Inc.
Newcastle Investment 0.9 (a) 16.1 (c) 0.15 5.04
Corp.
Orchid Island 7.06 0 (c) 0
Capital Inc.
PennyMac Mortgage 1.05 (a) 0 (c) 0
Investment
Resource Capital Corp. 0.2 (a) 127.3 (b) 0.14 4.94
Starwood Property 0.5 (a) 19.5 (c) 0.255 1.39
Trust Inc.
Two Harbors 3.7 (a) 99.6 (b) 12.57 0.85
Investment Corp.
Western Asset Mrtg 9.2 58.7 (b) 2.81 1.2
Cap Corp
ZAIS Financial Corp 1.8 (a) 25 (c) 0.03 1.51
Summary Statistics 6.3 50.2 160.435 1.82
Swaps Repurchase Agreements
Name Weighted Weighted Repurchase Weighted
Average Average Agreements Avg. Repo
Receive Years to (Bil. USD) Rate
Rate Maturity
AG Mortgage 0.309 4.42 4.19 0.78
Investment trust
American Capital 0.29 4.4 74.48 0.51
Agency Cop.
American Capital 0.32 5.5 6.25 0.57
Mortgage Investment
Corp.
Annaly Capital Mgmt 0.24 4.77 102.79 0.63
Inc.
Anworth Mortgage 3M LIBOR 2.8 8.02 0.47
Asset Corp.
Apollo Residential 3M LIBOR 5.3 3.65 0.61
Mortgage
ARMOUR Residential 0.21 5.3 10.37 0.49
REIT Inc.
Bimini Capital Mgmt 0.15 0.49
Inc.
Capstead Mortgage 12.78
Corp.
Chimera Investment 0.21 1.53 0.52
Cap.
CYS Investments 3M LIBOR 2.7 13.98 0.48
Dynex Capital Inc. 1M LIBOR 3.4 3.56 0.7
Five Oaks 0.08 0.85
Investment Corp.
Halteras Financial 2.6 22.87 0.47
Corp.
Invesco Mortgage 1M LIB0R 15.72 0.78
Capital Inc.
JAVELVIN Mortgage 9.3 1.14 0.62
Investment Corp. **
MFA Financial Inc. 0.22 1.4 8.75 0.85
New York Mortgage 0.89 0.54
Trust Inc.
Newcastle Investment 0.93 0.81
Corp.
Orchid Island 0.1 0.49
Capital Inc.
PennyMac Mortgage 0.16 0.64
Investment
Resource Capital Corp. .21 (1M 0.11 2.28
Starwood Property LIBOR) 1.31
Trust Inc.
Two Harbors 0.426 2.85 12.62 0.72
Investment Corp.
Western Asset Mrtg 7.2 4.79 0.48
Cap Corp
ZAIS Financial Corp 0.31 5.3 0.12 .49 Agency,
2.16 Non-
Agency
Summary Statistics 0.28 4.48 319.34 0.68
Repurchase Agreements
Name Weighted Weighted Avg
Avg Days Haircut
Till
Maturity
AG Mortgage 36.90% 6.90%
Investment trust
American Capital 118 < 5%
Agency Cop.
American Capital 50 4.7% Agent *,
Mortgage Investment 29.5% Non-Agancy
Corp.
Annaly Capital Mgmt 191 5%
Inc.
Anworth Mortgage 34 4.86%
Asset Corp.
Apollo Residential 20 3-7% for Agency
Mortgage MBS, 10-50% for
non-Agency MBS
ARMOUR Residential 34 4.80%
REIT Inc.
Bimini Capital Mgmt 14 5.10%
Inc.
Capstead Mortgage 4.50%
Corp.
Chimera Investment 56 5%
Cap.
CYS Investments 19.6 3-6%
Dynex Capital Inc. 67 7.4% Agency,
19.5% non-Agency
Five Oaks 17 10%
Investment Corp.
Halteras Financial 24.8 4.34%
Corp.
Invesco Mortgage 17 4.74% Agency,
Capital Inc. 17.86% non-Agency,
18.91% CMBS
JAVELVIN Mortgage 41 6.40%
Investment Corp. **
MFA Financial Inc. 79 4.8% Agency,
30.49% non-Agency,
1-74% Treasuries
New York Mortgage 39 5% Agency RMBS
Trust Inc. (excluding Agency
IOs). 26% Agency
IOs, 35% CLOs.
total Weighted
average "haircut of
6.90%
Newcastle Investment 36.5 5% FNMA/FHLMC,
Corp. 34% non-Agency
RMBS, 50% CDO VI
Orchid Island 15 5.60%
Capital Inc.
PennyMac Mortgage 69
Investment
Resource Capital Corp. 18 3.60%
Starwood Property
Trust Inc.
Two Harbors 85 8.40%
Investment Corp.
Western Asset Mrtg 19 3-5.5 percent for
Cap Corp agency, up to 25
percent of IOs and
IIOs, 30 percent
for Non-Agency
ZAIS Financial Corp 3-5% Agency,
20-40% non-Agancy.
Summary Statistics 47.66 5.4% (Agency),
29%(non-Agency)
Repurchase Portfolio Composition
Agreements and Assets
Name Counterparties Agency Secs Total
(list specific as a % of Assets
counterparties *) Total Assets (Bil. USD)
AG Mortgage 30 77.98 4.86
Investment trust
American Capital 32 83.33 100.45
Agency Cop.
American Capital 29 82.73 7.7
Mortgage Investment
Corp.
Annaly Capital Mgmt 92.89 133.45
Inc.
Anworth Mortgage 99.46 9.29
Asset Corp.
Apollo Residential 17 73.27 4.49
Mortgage
ARMOUR Residential 26 * 91.48 20.88
REIT Inc.
Bimini Capital Mgmt 6 * 89.47 0.19
Inc.
Capstead Mortgage 23 95.78 14.47
Corp.
Chimera Investment 23.39 7.74
Cap.
CYS Investments 23 * 98.77 21.06
Dynex Capital Inc. 19 * 81.54 4.28
Five Oaks 4 * 58.33 0.12
Investment Corp.
Halteras Financial 24 90.61 2.64
Corp.
Invesco Mortgage 26 * 67.69 18.91
Capital Inc.
JAVELVIN Mortgage 18 86.05 1.29
Investment Corp. **
MFA Financial Inc. 26 * 53.48 13.52
New York Mortgage 11 * 13.97 7.16
Trust Inc.
Newcastle Investment 5 * 20.76 3.95
Corp.
Orchid Island 4 * 100 0.12
Capital Inc.
PennyMac Mortgage 5 * 0 2.56
Investment
Resource Capital Corp. 3 * 0 2.48
Starwood Property 8 * 0 4.32
Trust Inc.
Two Harbors 21 * 69.01 16.81
Investment Corp.
Western Asset Mrtg 14 95.15 5.36
Cap Corp
ZAIS Financial Corp 3 35 0.2
Summary Statistics 17.05 81.8 432.06
Portfolio Composition
and Assets
Name Total Agency
Holdings
(Bil. USD)
AG Mortgage 3.79
Investment trust
American Capital 83.71
Agency Cop.
American Capital 6.37
Mortgage Investment
Corp.
Annaly Capital Mgmt 123.96
Inc.
Anworth Mortgage 9.24
Asset Corp.
Apollo Residential 3.29
Mortgage
ARMOUR Residential 19.1
REIT Inc.
Bimini Capital Mgmt 0.17
Inc.
Capstead Mortgage 13.86
Corp.
Chimera Investment 1.81
Cap.
CYS Investments 20.8
Dynex Capital Inc. 3.49
Five Oaks 0.07
Investment Corp.
Halteras Financial 23.92
Corp.
Invesco Mortgage 12.8
Capital Inc.
JAVELVIN Mortgage 1.11
Investment Corp. **
MFA Financial Inc. 7.23
New York Mortgage 1
Trust Inc.
Newcastle Investment 0.82
Corp.
Orchid Island 0.12
Capital Inc.
PennyMac Mortgage 0
Investment
Resource Capital Corp. 0
Starwood Property 0
Trust Inc.
Two Harbors 11.6
Investment Corp.
Western Asset Mrtg 5.1
Cap Corp
ZAIS Financial Corp 0.07
Summary Statistics 353.43
Notes: As of December 31, 2012. Short-term leverage is defined as
the amount of repurchase agreement liabilities as a ratio of
equity. Leverage ratios below 6 are in blue. Swap ratios above 50
percent are in blue with the red text and below 50 percent is in
pink with light blue text. NIM are from the SNL Financial
(Financial Highlights) for 2012:Q4. Year-end measures are used
instead of 2012:Q4 if no 2012:Q4 estimate is provided.
Sources: Respective 2012 10K/10Qs, Richmond Fed.
Notes: (a) Leverage ratios below 6 are in blue (b) Swap ratios
above 50 percent are in blue with the red text (c) below 50 percent is
in pink with light blue text.
Figure 4 Holders of Agency MBS and Agency Debt in 2008
and 2013
First Quarter 2008
Foreign Sector 21.7%
Federal-Reserve 0%
Depository
Institutions 15.6%
Insurers 6.7%
Pension Funds 5.1%
Mutual Funds 7.6%
GSEs 9.6%
Nonbanks (2) 13.9%
Mortage REITs 1.2%
Other (1) 12.1%
State % local
Governments 6.6%
Second Quarter 2008
Foreign Sector 11.4%
Federal-Reserve 16.7%
Depository
Institutions 22.9%
Insurers 6.1%
Pension Funds 5.4%
Mutual Funds 13.5%
GSEs 3.8%
Nonbanks (2) 6.5%
Mortage REITs 4.2%
Other (1) 3.2%
State % local
Governments 6.2%
Notes: Other includes nonfinancial corporations, households, U.S.
government, and credit unions; "Nonbanks" include security brokers
and dealers, ABS issuers, holding companies, and money market mutual
funds; as of the second quarter of 2013, total agency MBS and agency
debt equals $7.6 trillion, according to Z.1 data. Of this total, $5.8
trillion is agency MBS, according to Securities Industry and Financial
Markets Association data.
Source: Z.1 Federal Reserve Board of Governors' Financial Accounts of
the United States, Table L.210, 2013: Q2.
