Today I received a note from Merrill Ross at Wunderlich pointing out the likely reason for the current deep discounts in the mREIT sector. It’s especially strange that the “pure” amREITs have gotten whacked so hard while the underlying portfolios have increased in value. There’s no prospect of an inverted yield curve (poison to the spread carry maturity mismatch business model).
From Merrill’s note today:
” There is no crisis more capable of inflicting damage than a liquidity crisis. We believe that the central banks stand ready to manage the potential of sovereign default, and that the banking system will not grind to a halt. We believe there is some potential for disruption, but limited potential for counterparty risk to result in permanent equity erosion among the mortgage REITs. For investors with a risk tolerance, today’s pricing levels represent an opportunity. Never before in history have the mortgage REITs traded at a discount to book value when the curve was positively sloped, and if this liquidity risk is more of a fear than a reality, there could be significant price recovery from current levels”
I’ve got join her in guessing that investors are selling their mREIT and amREIT stocks through fear that the domino theory of chained insolvency will hit repo providers who finance the Agency MBS in the amREIT portfolios.
How realistic is this fear?
As I asked in my post in late July “Who Plays AIG in the Sequel?” we do have the risk in the system that some large player in CDS land has too much exposure to some counterparty that has too much exposure to some counterparty that has too much exposure to some counterparty that has too much exposure to Greek sovereign debt.
We just don’t know. And we still haven’t plugged the famous Enron Loophole that lets banks, dealers, insurance companies and even pension funds take on “synthetic” credit risk by writing Credit Default Swaps without holding capital against those positions or disclosing the positions to any regulator. How can that be? See my next post for a cynical explanation.
Putting that aside, let me put a stake in the ground for continued operation of the MBS financing market. While central banks don’t seem to be able to control unemployment or seriously affect inflation in the deflationary downslope of the Kondratiev Wave, the one thing they can always do is create liquidity for secured financing of securities.
Most amREITs have a couple dozen repo providers. If we see an AIG sequel insolvency, I fully expect the ECB, the Fed and every other central bank to step up and provide financing for Agency MBS, non-government organization debt, sovereign debt, and other quasi-sovereign credits. After all, they even came up with the rationalization that the Fed could put its guarantee on corporate commercial paper way back in 2008. I’m not worried that amREITs will find themselves unable to refinance their portfolios.