Favorable Market Helps
Mortgage-REIT Offerings
WASHINGTON -- With investor demand strong, mortgage real-estate investment trusts are taking advantage of low short-term interest rates and a steep yield curve by issuing a string of secondary offerings.
On May 23, Apex Mortgage Capital Inc. filed with the Securities and Exchange Commission to sell 4.4 million of its common shares. On May 28, Anworth Mortgage Asset Corp. filed to sell 6 million shares, and on May 30, America First Mortgage Investment Inc. increased the size of a secondary offering to 9 million from 5 million shares.
In addition, Impac Mortgage Holdings Inc. on May 23 filed to sell 3.6 million shares from time to time through selling agent UBS Warburg LLC. And Thornburg Mortgage Inc. said on June 5 that it had sold 714,000 shares through Cantor Fitzgerald & Co. under a similar shelf-type sales arrangement.
'Opportunity And Need'
According to Richard Eckert, a sell-side analyst for Wedbush Morgan Securities, the offerings reflect "the confluence of opportunity and need" that mortgage REITs are experiencing in a low interest-rate environment.
Mortgage REITs need the capital from secondary offerings to expand their portfolio of mortgage-backed securities, known as MBS. And investors want to buy mortgage-REIT stocks now because of their high dividend yields that result from strong profits in a low interest-rate environment.
In general, mortgage REITs use both short-term borrowings and funds from stock offerings to purchase MBS issued by the government sponsored-entities Fannie Mae, Freddie Mac or Ginnie Mae. The REITs also sometimes originate their own mortgage loans through a subsidiary and then securitize those loans to increase their asset base.
With short-term rates low, mortgage REITs can take advantage of a steep yield curve -- or the difference between short-term and long-term interest rates. This allows their borrowing costs to fall below the principal and interest yields they receive from their MBS assets, which in turn lifts profits and the dividends the REITs can pay out.
Jim Ackor, analyst at RBC Capital Markets, says hefty dividend yields of 13% to 14% are very attractive to investors. Mr. Ackor also cited mortgage REITs' high-quality MBS and transparent earnings as other attractive qualities of the sector.
Mr. Ackor noted that the yield curve hasn't been this steep in the U.S. in 10 years. He noted that this spread expansion has been in progress for almost 18 months.
The fear, Mr. Ackor said, is that in a rising short-term interest rate environment, funding costs could begin to move higher than asset yields. This could make it harder for mortgage REITs to access the capital markets if investors forecast a drop in profits resulting from a spread contraction.
"Mortgage REITs have every motivation in the world to raise capital before rates go up," Mr. Eckert said. "While the window is open, it's almost a fiduciary obligation for them to jump through it. Why wouldn't you take advantage of the opportunity?"
Rate Hikes Not Seen Imminent
Mr. Eckert said he was also certain there would be more mortgage-REIT stock offerings during the summer. He said he didn't think the Federal Reserve would raise interest rates at its next Federal Open Market Committee meetings June 25 and 26. He sees another rate increase in August, at the earliest.
Mr. Ackor concurred. Although rising short-term rates are inevitable, he said, he doesn't expect them any time soon. He said the Fed will probably side with raising rates later rather than sooner so as not to choke off any economic growth occurring now.
"The economy's going to have to be on fire" before the Fed raises (interest rates) a lot, he said. He also said that with the war on terrorism, violence in the Middle East and corporate accounting irregularities grabbing attention at home, there aren't many compelling reasons to raise rates right now.
All in all, Mr. Eckert said, inflation seems subdued. He also said that the recent jump in housing prices seems to be demand-driven and not speculative in nature. He cited Greenspan's statement in early May that he didn't see a bubble in house prices within the U.S. residential real-estate market.
Mr. Eckert said that even if the Fed did begin to start raising rates soon, it probably would take a quarter or two before mortgage REITs would feel the effect in their portfolios.
Four of the five mortgage REITs that recently tapped the capital markets have something else in common. Anworth Mortgage, Impac Holdings, America First Mortgage and Thornburg all invest in adjustable-rate mortgages, or ARMs. America First Mortgage and Thornburg purchase ARMs exclusively, while Impac Holdings and Anworth invest in both ARMs and fixed-rate mortgages.
ARMs can be attractive to home buyers faced with rising property prices in the red-hot housing market. Lenders generally offer ARMs to buyers at a lower rate than a 30-year fixed mortgage rate, but can then adjust that rate periodically in accordance with an agreed index such as the London interbank offered rate, or LIBOR. Buyers, in turn, accept the risk that their interest rate may increase after a certain term, which would be the case if short-term interest rates should rise.
There are traditional ARMs and hybrid ARMs. Traditional ARMs reprice monthly, semiannually or in one year. Hybrid ARMs have a fixed interest rate for usually three to five years before converting to a traditional ARM for the remaining term.
ARM Lending On The Rise
According to a May 31 survey by Freddie Mac, consumer interest in ARMs has been "rekindled," with the one-year ARM rates of the last few months rivaling those of six years ago. Freddie Mac said that the one-year ARM share of the mortgage market rose to nearly 20% in April compared with only 10% a year ago.
"The time is excellent for us right now," America First Mortgage Chief Financial Officer William Gorin said. Mr. Gorin said his company buys ARM securities that become adjustable after three years.
"Adjustable-rate mortgages are the place to be," Anworth Mortgage Chief Financial Officer Pam Watson said. "With the yield curve shaped as it is right now, we're making record earnings."
William Ashmore, chief operating officer at Impac, said that the company has made a "conscious decision" to increase its investments in ARMs. The company's loan-originating division has increased its ARM production to 70% so far this year, with the rest being fixed-rate mortgages. In 2001, the company's total origination of ARMs was at 49%.
ARMs An Advantage For Thornburg
Leanne Gallagher of Thornburg's investor-relations department looks at the company's ARM niche as an advantage over other mortgage REITs that invest only in fixed-rate mortgages.
In Thornburg's 2001 annual report, the REIT said it focuses solely on ARMs because the yield on ARMs changes in accordance with shifts in financing costs, limiting exposure to interest-rate fluctuations.
The Santa Fe, N.M.-based REIT said that as interest rates begin to rise, it expects to realize higher returns because the yields on its traditional ARMs will adjust upward.
"The question to ask is: Will the fixed-rate mortgage REITs be able to sustain their dividend yield as interest rates go up?" Ms. Gallagher said.
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