Real estate investment groups in the US are set to raise more funds to buy subprime and other private mortgage-backed securities, aided by attractive returns and rising share prices.
Real estate investment trusts, or Reits, have already been big buyers in the market for packages of mortgages backed by Fannie Mae, Freddie Mac and other government agencies, creating what some have termed a “shadow” financing system for US mortgages.
They are increasingly turning their attention to the market for subprime and other riskier “non-agency” mortgage securities, drawn by high yields relative to the low cost of borrowing, which is a result of the Federal Reserve’s move to keep rates at close to zero until 2014.
“The non-agency trade is very attractive right now,” said Ted Conway, managing director in investment banking at Barclays Capital.
In a sign of the growing demand, in January the Fed was able to sell about $7bn of non-agency mortgage-backed securities that it owns as part of its 2008 bail-out of AIG. Efforts to sell the portfolio last year were lacklustre.
Several Reit groups focused on non-agency securities are waiting to go public, and others are eyeing their rebounding share prices as an opportunity to sell additional shares to purchase more mortgages.
“If the stocks continue to hold ground, we will see increased follow-on activity, which is typically a leading indicator of the strength of the market and support from the buyside,” said JT Deignan, managing director of equity capital markets at UBS.
Apollo Residential Mortgage and Invesco Mortgage Capital have risen 12 per cent this year and Chimera Investment Corporation is up 20 per cent.
Several Reits that had hesitated to raise more cash – with their share prices valuing them well below book value – may now be reconsidering.
In January, Two Harbors and AG Mortgage Investment Trust raised $400m via secondary offerings. Provident Mortgage Capital Associates updated its initial public offering filings last week, a signal it is soon aiming to list.
“Our long-term view [is] that the market for [non-agency] loans . . . will grow [and] we expect our portfolio to become increasingly focused on this asset class over time,” PMCA said in its prospectus.
Western Asset Management Company and Pimco, two of the world’s largest fixed-income fund managers, have also filed to raise equity capital for such Reits.
“The long-term expectation and hope is for Reits to be a major non-bank source of funding in the private mortgage market,” said Mahesh Swaminathan, a mortgage strategist at Credit Suisse.
US regulatory reform aims to require originators of mortgage bonds to retain the riskiest portions, but Basel III requirements on banks are likely to force them to hold large amounts of capital against these holdings.
“Clearly, with [new banking rules] there is no appetite on the part of banks to hold lower-rated securities,” Mr Swaminathan said.