Back to the Well

HTS and CYS both priced secondary issues this morning.

Cypress Sharpridge was going to issue 10 million shares, but found appetite for 13 million.  The price just under $13 a share was less than last quarter’s stated book value, but may be slightly above today’s book value, given the spread widening in Agency MBS land lately.  Their non-Agency paper has continued to tighten, but more on that later.  For them, the add-on capital is probably more about getting critical mass to support the management team than it is about increasing earnings per share by issuing new stock above book.

HTS came with 5 million shares in the high 20’s.  That’s in the range I suggested in my Hatteras overview, and will take their market cap into the billion and a quarter range, giving them up to $10 billion in MBS to play with.

As I’ve pointed out before, selling new stock at above book value is a “virtuous” Ponzi, assuming that they can put new capital to work just as efficiently as the old capital.

It’s that second part of the formula that worries me.

For years, the entire mREIT universe was so tiny that its holdings were a fraction of the daily trading volume in MBS.  Today, with much lower volume and much lower (or nonexistent) originaition, that has become problematic for amREITs and especially for non-Agency mREITs.

For example, one of my industry contacts told me that several lists of seasoned non-Agency paper traded between 6% and 6.5% loss-adjusted yields yesterday.  Penciling in the numbers for a levered portfolio says that LIBOR plus 100 or higher funding leaves a pretty paltry margin unless the portfolio managers are willing and able to get leverage up in the4:1 or 5:1 or higher neighborhood.  Unfortunately, the 15% to 20%  equity in that arrangement is just about the size of the margin calls that Peleton, Carlyle and Thornburg got when they went under.

Even in Agency paper, size is starting to be a concern.  Some of the players in the amREIT game pursue specific sub-sectors, and supply has been choked off there, too.

Hatteras has basically positioned themselves as a  shop investing in almost any subsector of Agency paper, but without a hold-to-maturity mindset.  They are traders, and they’ve been enhancing their financing profits with nearly equal trading profits.

That can end, and sometimes ends badly.  While Paulsen and Bass get lionized for their big profits from betting against subprime, we don’t hear too often about Peleton, who posted an 87% investor return in 2007 by being in exactly the same trade.  Unfortunately for their investors who got wiped out, Peleton switched to the long side of the trade in early 2008 when the market briefly firmed up, and they got caught like Wile E. Coyote above the canyon when the subprime debacle began its next leg down in March of 2008.

For the time being, none of the amREITs are pushing the leverage envelope so far that they couldn’t take their lumps and get out if the underlying MBS were to start trading at higher yields and higher durations.  That is, unless the change happened overnight.

I once had a deal based on FHA project loans fail because Thailand had a crisis over the weekend.  You might ask what did Thailand have to do with US government guaranteed apartment loans?  The answer — our customer was funding the transaction in the swap market, and swap spreads widened by 15 basis points that weekend.  The deal went from millions in profit to millions in losses while the US market was closed.  Monday morning there was nothing to be done about it.

If Portugal Ireland or Spain were to lose funding for their banks some night, the repercussions could turn a levered US MBS REIT into a basket case.  Check the spike in LIBOR rates to 4% last year (right hand side of this graph) while simulatneously the Fed was lowering rates from 2% to zero and T-bills actually traded at negative yields a couple of time.  External events like that can be life-threatening for levered MBS holders.

Today the market is so much smaller and the holdings of the mREITs so much larger that I start to worry about their ability to liquidate if (or when) the bear market starts in earnest for Agency MBS.  Rising rates are the natural result of bonds being sold, and with MBS you get the double-whammy of longer assumed duration as people adjust their expectation of future prepayments.  It;s the slow death version of MBS pain.

Such a circumstance (extension risk and rising rates) is so expensive to hedge that no one can afford to be fully hedged all the time.  Everybody is left with the old adage “the only perfect hedge is a sale ticket.”  Great truth to live by, but those who sell into a bear market can’t do that without shedding some blood.

Now that the amREIT group is pushing past $100 billion in assets, it’s a very big pile compared to today’s drastically smaller daily MBS trading volume and dealer inventory limits.  Some may find they don’t get off the train fast enough when the time comes.



2 Responses to Back to the Well

  1. Patrick says:

    Thanks for the comments Howard. I recently commented that I was totally out of the amREIT space because I’d don’t think there’s any room left for capital gains. While the outsized dividends are plenty generous, the risk/reward scenario has tipped towards the risky end. If and when the bond bubble bursts, the amREIT book value will erode quickly and shut off the offering spigot.
    I’ve shifted mostly out of the REITs, locking in some modest profits, and moved into the BDC sector for now.

    • hhill51 says:

      Patrick —

      I understand what you’re saying, though I don’t see that BDC’s would be any kind of port in a “bond bubble” bursting. If anything, junk bonds (and junk bank loans) have had a much more extreme rally than MBS, both in rate and in spread. The book value of BDC’s seems fundamentally more at risk than you seem to be saying. They also tend to require either a robust IPO market or healthy American economy (being mostly American businesses) or both to see the portfolio investments pay out as agreed.

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