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How the government shutdown will affect mortgage REITs

Brent Nyitray, CFA, MBA

Shutdown analysis: REITs and homebuilders (Part 3 of 4)

(Continued from Part 2)

The effect on REITs will depend on the business model of the REIT

Mortgage REITs aren’t all the same. Some focus on agency mortgage-backed securities, some focus on non–agency-related securities, and some focus on origination. They will all be affected differently by the shutdown

Effects on agency REITs

The agency REITs like Annaly (NLY) and American Capital Agency (AGNC) buy mortgage-backed securities backed by the Federal Government. The government has pledged that Ginnie Mae mortgage-backed securities will still receive principal and interest payments on schedule. In all the past shutdowns, Ginnie Mae paper has always been honored, and this time shouldn’t be any different. As a practical matter, the servicer is required to forward principal and interest payments to the investor and the government only steps in when the servicer fails. Fannie and Freddie mortgage-backed securities are more or less in the same boat as far as the servicer is concerned, although these securities don’t have an explicit government guarantee. So for the agency REITs, the shutdown doesn’t introduce any credit risk. If anything, the fact that quantitative easing may stay in place a while longer is a benefit, so they should (and did) react positively to the shutdown.

Effects on non-agency REITs

Non-agency REITs like Two Harbors (TWO) buy mortgage-backed securities that aren’t guaranteed by the government, which means they have credit risk. This makes them sensitive to interest rates and the general economy. So bad economic news isn’t necessarily a good thing for them the way it is for agency REITs. If the shutdown lasts a long time, the effects of furloughed government workers and the companies that depend on the government will begin to filter through to consumption data. This means higher delinquencies and ultimately lower non-agency mortgage-backed security prices even if overall rates are falling.

Effects on REITs that originate mortgages

The shutdown won’t affect mortgage originators like PennyMac (PMT) and Redwood Trust (RWT)—at least not initially. Fannie Mae and Freddie Mac will continue to purchase securities and Ginnie Mae will continue to issue securities. That said, they aren’t the only agencies that matter. The biggest one is the IRS, as originators depend on the IRS to verify a borrower’s income and whether they have actually paid their taxes. The inability to verify income and taxes is a deal-killer for all originators. This means loans that are in process will get funded if the originator has been able to verify tax data already. The ones that haven’t will probably not be able to fund until the shutdown is over. This can create cash flow issues. An extended shutdown would sting originators.

Continue to Part 4

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