Good news for residential mortgage-backed securities (RMBS) REITs and those of us who love them. Just passed into law on April 4, 2012 when signed by President Obama, the STOCK (Stop Trading on Congressional Knowledge) Act is meant to address insider trading by members of Congress - rather ridiculous that this had to become an issue in the first place, but that is precisely why the law was needed once we discovered that nearly everyone with power has a body buried somewhere. The part I'm expressing gratitude for in this article is a bipartisan amendment that prohibits the executives of the federal institutions of US government-backed mortgages - Fannie Mae and Freddie Mac - from any more multi-million dollar bonuses, at least as long as these companies stay in conservatorships of the federal government. If you remember being furious earlier this year (I know I was), it seems that in 2011 the top executives of Fannie Mae and Freddie Mac were deemed worthy of huge bonuses by no other than the Federal Housing Finance Agency.
American Capital Agency (AGNC) is one of those mortgage REITs that focuses on the RMBS market, including pass-through securities, and therefore influenced by the behavior of both Fannie Mae and Freddie Mac. American Capital Agency is externally managed and advised by an indirect subsidiary of a wholly-owned portfolio company, so therefore helps diversify and manage risk for the main equity firm. It pays close attention to the prepayment and interest rate both now and going forward, and has no reason not to think that the type of confidence instilled in mortgage REIT holders and potential RMBS REIT buyers from this new legislation will be an asset to the company. It is implied that risk would be reduced when there are less through-the-roof rewards for top executives (while the so-called "99%" were losing their homes).
Of course American Capital Agency won't be the only REIT affected. Invesco Mortgage Capital (IVR), another mortgage REIT, handles both government-backed and other residential mortgages, and therefore also stands to benefit from a more fairly compensated Freddie and Fannie executive. I don't see yet how the buying public may react to the non-government backed mortgages, including those held by Invesco Mortgage. Since confidence in government institutions hit such a low in these past few years, this improvement (for example, less undeserving bonuses) may finally bring the RMBS to the level of confidence enjoyed by anything not affiliated with the government, or may merely raise it in confidence, but not yet up to how non-government backed securities are perceived. To my point, I may forgive a spouse who cheated (note: I wouldn't put money on that outcome), but Tiger Woods would still likely be a bad bet for marriage even as his likeability quotient slowly climbs out of the basement.
Like American Capital Agency, CYS Investments (CYS) also focuses on the RMBS market, specifically on pass-through securities. Also like American Capital, CYS Investments stands to benefit from increased confidence in government-backed securities. Anworth Mortgage Asset (ANH) represents a more varied array of securities and mortgage obligations, focusing primarily but not exclusively on RMBS holdings. Like CYS Investments, it is poised to benefit from the STOCK Act being signed into law. Like the other REITs mentioned, Hatteras Financial (HTS) invests in residential mortgage-backed securities, including pass-through securities, backed by the US government agencies. Again, the effect of more accountability for Fannie and Freddie should be positive for the related investments for Hatteras.
My recommendation for American Capital Agency is not very cryptic - everyone (except perhaps for criminals and/or executives at Freddie and Fannie and/or members of Congress) should benefit from an increased level of trust and faith that money generated by mortgage REITs will be more fairly distributed to the rightful owners of those REITs, and that less of our tax money will go to support the millionaires who took us to the poor house then drove away. American Capital Agency, and all the REITs I'm listing here today, by all rights should enjoy gains in all areas. Invesco Mortgage Capital, CYS Investments, Anworth Mortgage Asset and Hatteras Financial could see an increase in their respective price to earnings ratios, cash flow ratios, and other financial indicators as a result of an increased confidence in government-backed mortgages from the buying public. It surely may take the government agencies, as well as the entire federal government, a long time to repair the trust that had disintegrated; virtually no one expects an easy fix to recent economic woes and to longer-term bad practices. But the STOCK Act is a step in the right direction.
In a broader stroke, these same REITs above could and should benefit from a more general investment confidence from those who were reluctant to invest in anything at all these past few years. Knowing that REITs can be high-risk and high-reward, the more conservative investor may have avoided any new investing in REITs or other stock, ,believing they should bail in the bad times then take a "wait and see" attitude. More sophisticated investors look at the long run and take positive news in a positive way - by investing; they give courage to the others and tighter restrictions and oversight generally mean trust can be rebuilt.
I am not done reviewing the benefits of the STOCK Act, but as far as the Freddie Mac / Fannie Mae bonus amendment is concerned: Bye-bye unfairly rewarded executives, and Buy Buy RMBS REITs.