Initial Jobless Claims tick up above 350,000 better for non-agency REITs than agency REITs

Market Realist

Initial jobless claims fell to an annualized rate of 360,000 for the week ended July 5.

Initial jobless claims are one of the few labor market indicators released every week. Unemployment is a profound driver of economic growth, and persistent unemployment has been the Achilles’ heel of this recovery. While it seems like the big layoffs are largely finished, firms are still reluctant to add staff aggressively. Aside from the Hurricane Sandy–influenced spike in late October, initial jobless claims have been holding steady in the 340,000 to 380,000 range.

Historically, real estate prices have tracked very closely with incomes. In fact, up until the real estate bubble burst, the ratio of median home price to median income remained in a relatively tight range of 3.2x to 3.6x. So if unemployment is rising, there’s little upward pressure on wages, which tends to be negative for home prices. Plus, the unemployed are unable to qualify for a mortgage, so the pool of buyers shrinks.

Initial jobless claims are back to pre-bust normalcy

Before the housing bust, initial jobless claims averaged around 356,000 from 1990 to 2007. This doesn’t indicate a healthy economy, where claims are below 300,000. Given that some of the economic indicators are starting to turn downward, initial jobless claims may rise again.

For all the fears about increasing unemployment, from the sequester, so far there has yet to be any visible effect. The homebuilders noted that skilled construction workers are in short supply, and that they’re having to pay up for talent. This bodes well for the labor market going forward.

The bond market has been selling off globally since May 1. Ben Bernanke added fuel to the fire when he disclosed that the default path for the Fed is to start pulling back purchases this year with an eye towards fully ending quantitative easing by mid-2014. Since then, the mortgage REIT sector has been under severe pressure.

Impact on mortgage REITs

Non-agency mortgage REITs, such as Chimera (CIM), PennyMac (PMT), or Two Harbors (TWO), which invest in non-government–guaranteed mortgage-backed securities, are sensitive to the economy, as delinquencies and defaults can influence returns. The unemployment rate is by far the biggest driver of defaults. Agency REITs, such as Annaly (NLY) or American General (AGNC), that invest in Ginnie Mae (government-guaranteed) or conforming (Fannie Mae, government-sponsored) consider defaults to be just a different type of prepayment. Typically, the higher coupon loans have default issues, and once the loans become 90 days delinquent, they’re generally purchased out of the pool by the lender and repaid at par. This lowers returns for the portfolio going forward.

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