Sell Your mREITs Immediately

Includes: AGNC, HTS, NLY
by: Todd Johnson

I believe that investors should immediately liquidate their mREIT holdings. My opinion is based upon analyzing the current environment background, political landscape, and estimate potential capital losses for readers of my articles. The reason to sell is an action to minimize capital losses to mREIT investors.

On July 15th, my initial concerns were presented in this article: mREITs: Protect Your Investments if Debt Ceiling Unresolved. My “debt ceiling” concerns have escalated to the point where investors have to take swift and decisive action. I feel compelled to write this article because my articles have advised buying mREITs during the current difficult economic background. This is not a scare-tactic article. I am honestly concerned for the readers’ mREIT investments.

Many investors and insiders can state their “opinions” on likelihood outcomes of non-resolution of debt ceiling. Facts can be stated, normal business model scenarios described, and common sense information disseminated to the investing community. What cannot be described by anybody with any authority is the worse case scenario for mREITs if a debt ceiling resolution is not reached. It is for these reasons that I present my rationale for advocating the selling of mREITs and capital preservation.

On July 11th, I wrote an article with my favorite dividend stocks: My Top 10 Must-Own Dividend Stocks. As a blue-blooded American, I assumed our political system would take draconian action to ensure our debt ceiling issues were resolved far before present date. This assumption was incorrect. At this point, capital preservation is my number one goal. Here is my rationale for recommending the sale of your mREITs:

1. has admitted - in their Debt vs. Myth Report - that if the debt ceiling issue is not resolved, the U.S. will suffer “...catastrophic economic consequences....”. This is reason enough for me to realize that a potential financial crisis could occur if the political parties do not come together. I cannot rest my financial future on political parties agreeing to any agreement in the next week.

2., on July 18th, has confirmed that the lack of governmental spending constraints can be perceived as a “credit negative"., on July 14th, confirmed the U.S. Federal debt is on “Credit Watch Negative”.

3. The U.S. Government debt can be labeled “default” or “technical default”. If the debt ceiling issue is not resolved, domestic and worldwide credit agencies will downgrade the U.S. Treasury market. The dates when Moody’s or Standard & Poor’s would issue such a downgrade are not provided in the U.S. public news wires or to worldwide investors.

4. I will use American Capital Agency Corp. (NASDAQ:AGNC) to discuss repurchase agreements. Per AGNC’s 10k, the following repurchase agreements exist:

  • Page 3, “We fund our investments primarily through short-term borrowings structured as repurchase agreements.”
  • AGNC Financing Strategy, “As part of our investment strategy, we borrow against our investment portfolio using repurchase agreements. Our borrowings generally have maturities that range from 30 to 90 days, but may have maturities up to 364 days. We expect our leverage will range between five to 10 times the amount of our stockholder's equity...”.
  • AGNC relies upon their primary dealers. Lehman Brothers and Bear Stearns were Federal Reserve primary dealers during the 2008 financial meltdown. They were removed when they both collapsed and entered into bankruptcy. If AGNC’s primary dealers require additional collateral, then a worldwide credit de-leveraging could ensue.
  • AGNC is long Government Sponsored Entities (GSE) longer-duration debt obligations. These entities include Freddie Mac, Fannie Mae, and Ginnie Mae. If longer term interest rates increase, this would decrease the book value of AGNC’s long holdings. A decrease in credit worthiness for specific long positions on AGNC’s position could also force primary dealers to demand additional AGNC collateral on their hedged portfolio.

5. I will use Hatteras Financial Corp (NYSE:HTS) for the issue of mREIT leverage. mREITs borrow cheap and lend dear. In other words, mREITs will borrow short-term and lend longer-duration debt instruments. Per HTS’s March 31st, 3011, 10k, page 35, "...As of March 31, 2011, the weighted average haircut under our repurchase facilities was approximately 4.49%, and our leverage (defined as our debt-to-shareholders equity ratio) was approximately 6.1:1...."

  • Per HTS’s 10K, their leverage was last stated at 6.1x.
  • If a primary dealer increases collateral requirements, this could place pressure on HTS’s ability to raise funds. The use of leverage only accentuates the problem of raising capital in a difficult situation. Longer-term bonds decreasing in value, due to credit risk or rising rates, will suffer in a “...catastrophic economic consequences....” scenario, as quoted earlier by leadership.

6. I will use Annaly Capital Management (NYSE:NLY) to discuss the issue of “primary dealer haircut”. NLY is the largest mREIT market cap with arguably the sharpest management team in the business. Michael A. J. Farrell has been running NLY since 1997. NLY has hedges in place, derivatives in place, a barbell strategy on the balance sheet. How does Mr. Farrell plan for a scenario that has so many unknowns? I don’t know the answer. I trust his judgement but the debt ceiling, interest rate impact, and credit agency downgrades could have unfathomable damage.

  • The primary dealer’s haircut percentage is based upon assets’ liquidity and credit worthiness.
  • Per the Federal Reserve, “the lendable value of such collateral incorporates a haircut that reflects the liquidity and credit and interest rate risk of the asset...”
  • Per NLY’s March 31st, 2011’s 10k, page 35, “....Our debt-to-equity ratio at March 31, 2011 and December 31, 2010 was 6.3:1 and 6.7:1, respectively...”
  • Per the Federal Reserve, a “haircut” calculation is based in part on the following data inputs: “...For assets that cannot be marked to market, a haircut is applied to the par value in the case of a security or to the outstanding balance in the case of a loan.The haircuts applied to such non-priced collateral are generally substantially larger than those applied to collateral that can be marked to market to account for reduced liquidity....”

A “haircut” increase could require mREITs to put up additional collateral. Because mREITs are levered as a basic business model, the effects of valuation and haircut terms could have serious negative consequences upon the GSE and mREIT markets.


By my own admission, the recommendation to liquidate one’s mREIT holdings may be an act of unnecessary concern or my assumption(s) of the worst case scenario. Please use your own discretion in deciding to hold, buy, or sell your mREITs. My action plan is to sell all my mREITs today and buy back when our political leadership has resolved the debt ceiling issue.

Hopefully - and I am hopeful - the situation is resolved quickly and financial disaster is diverted. In this case I will repurchase my mREITs. In the worst case scenario, mREIT shareholders should be aware of unforeseen risks. Let’s walk away and fight to play another day.

Disclosure: I am long AGNC, HTS, NLY.