Investment trusts that buy residential home loans are piling into mortgage bonds, taking on a more prominent role in the housing market as the government retreats.
Mortgage real-estate investment trusts were once small players in housing finance, but they’ve increased their mortgage-bond portfolios by almost 28% to $308 billion over the 12 months through March.
It was the largest stockpile in a half-dozen years, according to an analysis of 15 REITs by industry research group Inside Mortgage Finance. Annaly Capital Management Inc.NLY 0.22% and AGNC Investment Corp.AGNC 0.17% , the two biggest companies in the sector, accounted for the majority of the growth.
REITs often are publicly traded entities that invest in all types of real estate and pass most of their profits along to shareholders via dividends. They typically fund investments by raising capital in the equity and debt markets, including through short-term financing, and they use leverage to amplify their bets.
The REITs focused on home loans are small relative to the $11 trillion mortgage market. But they have become a key source of capital in the housing market, particularly as the Federal Reserve trims its portfolio of mortgage bonds accumulated through stimulus measures. Additionally, government efforts to overhaul the housing-finance system could benefit REITs if policy makers clear the way for more private capital to enter.
Yet some analysts worry these vehicles are putting more of the mortgage market into the hands of leveraged firms with minimal oversight. Some of the more risky mortgage REITs went bust during the last financial crisis. The last boom time for this sector, in 2013, prompted calls for increased regulatory supervision, but they didn’t result in any new regulations.
“To get the returns they needed, they were leveraged pretty dramatically,” said Ted Tozer, a fellow at the Milken Institute and former president of government mortgage corporation Ginnie Mae, speaking of REITs in 2013. Still, he said he believes the presence of mortgage REITs in the current market is welcome.
REITs have gone in and out of style over the years, but recently they have been on the upswing. REITs focused on mortgages raised $6.2 billion in equity to increase their investment portfolios last year, the most since 2013, according to data provider Dealogic. They are on pace to have a bigger 2019.
Some traders and former bankers have migrated to REITs. David Finkelstein, once a trader at Barclays PLC and Citigroup Inc., is now chief investment officer at Annaly.
William Roth, once in sales and trading at Citigroup Inc., is now chief investment officer atTwo Harbors Investment Corp. Michael Nierenberg, who oversaw securitized products at JPMorgan Chase & Co. and then Bank of America Corp. , is now chief executive at New Residential Investment Corp.
REITs and banks maintain a somewhat interdependent relationship. Banks are taking a less active role in the mortgage market than they did before the financial crisis, people in the industry say. But banks provide short-term financing to REITs that are making these same investments.
“We’re doing the things they don’t want to do,” said Kevin Keyes, the chief executive officer at Annaly, and a veteran of Bank of America and Credit Suisse Group AG .
For investors, mortgage REITs have produced mixed results in recent years, despite their large dividend payouts.
Annaly’s stock returned 34% over the past five years, including dividends, while Two Harbors returned 30%. New Residential returned 143%, one of the few mortgage REITs to beat the S&P 500’s 63% return over the past five years.
Proponents of REITs say the structure makes them an optimal backbone for the mortgage market. They are able to quickly raise and deploy money when they see an opportunity. They also employ less leverage than in earlier eras and manage risks carefully, industry representatives say.
Home-financing mortgage REITs had a median leverage ratio of almost 12 times equity before the financial crisis but were more recently at five times, according to Nareit, a trade group.
“If you want to have more private capital in the market, you need to manage the risks,” said Calvin Schnure, senior vice president for research and economic analysis at Nareit. “Mortgage REITs hedge all of those risks.”
Aside from vanilla mortgage bonds, some mortgage REITs are looking farther afield for investments. New Residential, which is managed by the private-equity firm Fortress Investment Group LLC, owns the servicing rights on more than half a trillion dollars of mortgages, the result of a buying spree in recent years. That asset entitles the firm to a stream of income from tasks such as collecting mortgage payments, dealing with taxes and handling delinquencies.
Annaly and other firms have been buying up mortgages that have traditionally been the domain of Fannie Mae and Freddie Mac and putting them into private mortgage bonds. It is an area of the market that could grow if the government tries to shrink the two mortgage giants. Mortgage REITs also have structured and invested in deals made up of jumbo and unconventional mortgages that Fannie or Freddie don’t purchase.
REITs are big buyers of securities sold by Fannie and Freddie that transfer default risk associated with the mortgages they back. In a sign that traditional players are making room for REITs, Fannie and Freddie recently tweaked these investment vehicles to make them easier for REITs to buy.
“If the goal is to disperse more and more risk, you have to get more investors involved,” said Michael Fratantoni, chief economist at the Mortgage Bankers Association.