We've gotten a lot of questions about mortgage REIT activity lately, as filings and offerings in this space continue to increase. But while there appears to be a clear uptick in overall deal activity, the recent success of these offerings has been all over the map. We have a few burning questions of our own, so we recently sat down with Morningstar equity analyst Alan Rambaldini to get some answers.
There's been an obvious increase in mortgage REIT activity in 2009. What are some of the factors driving this trend?
While there are a number of factors behind the recent spate of mortgage REIT IPOs, it basically boils down to managers taking advantage of the current favorable environment for the REIT business model. Like any financial company, mortgage REITs make money from the spread between the cost of their financing and the yield on their investments. The greater the spread, the more money they make, and the current spread is as wide as it has been in years.
Mortgage REITs not only use equity capital, like the cash proceeds from an IPO, to purchase assets, but they also need to lever up with debt financing to generate adequate returns for shareholders. Generally, mortgage REITs use short-term (60- to 90-day) financing like reverse repurchase agreements to invest in longer-term assets. Right now, all manner of government efforts are keeping short-term rates low in comparison to long-term rates, and mortgage REITs are benefiting from the steep yield curve. The availability of special financing vehicles like the Federal Reserve's Term Asset-Backed Securities Loan Facility (TALF) and the U.S. Treasury's Public-Private Investment Program (PPIP) also plays into the timing of the REIT filings, as these sources of financing are potentially more stable and lucrative, which helps in drawing in potential investors.
On the asset side of the balance sheet, the mortgage REITs are seeking to exploit a buyer's market for residential and commercial mortgage-backed securities (RMBS and CMBS) and distressed loans and properties, as the illiquid markets for these investments depress prices. Purchases of these "toxic" assets at prices below fair value would give the REITs high yields as well as the opportunity for capital appreciation.
