How 7 REITs Could See A Buying Frenzy Soon

by: Dividend Kings

Politics could be what will make or break mortgage REIT stock values in the near future. Any successful federal effort to help large amounts of underwater homeowners refinance would increase business and profits for REITs that specialize in government-backed mortgages, such as AG Mortgage Investment (NYSE:MITT), Hatteras Financial (NYSE:HTS), American Capital Agency (NASDAQ:AGNC), and American Capital Mortgage Investment (NASDAQ:MTGE).

The effects of the last federal effort to help underwater homeowners, the Home Affordable Refinance Program (HARP), were limited, but they led to a huge increase in the number of those getting refinanced. The Hill newspaper reported that there was an almost astronomical increase in the level of refinancing in some states because of the last two federal attempts at refinancing HARP 1.0 and HARP 2.0.

The refinancing rate in Arizona, increased by 181.4%, the rate in Florida, went up by 125.9%, and the rate in Michigan, increased by 125.2%. That of course translates into lots of new business and increased earnings per share for mREITs. Even if HARP 2.0, President Obama's attempt to ramp up refinancing in order to boost his chance of re-election, is only partially successful, it could translate into even more market share increases for mREITs.

The REITs are posed to benefit from this because they are now the principal source of money for mortgage refinancing. Banks don't want to touch mortgages, so they've essentially handed the market off to the Real Estate Investment Trusts. They're the only people in position to underwrite all those mortgages in today's market.

The big road block to any increase in mREIT profits is red tape and bureaucracy. As anybody who has tried to get one knows, it is still extremely difficult to get a home refinanced. Lenders are still gun-shy because of the mortgage crisis, so they're putting anybody trying to get refinance through the wringer.

Proposed Legislation Could Help mREIT Business

Two Democratic Senators, Barbara Boxer of California, and Bob Menendez of New Jersey, are trying to rectify this with a new financing law. Among other things, their regulation would eliminate the requirement that homeowners seeking refinance get a physical appraisal and cut some fees. This would make the process faster and cheaper, which would presumably increase the number of financings and earnings at mREITs.

Three companies that would benefit from this move could be Annaly Capital Management (NYSE:NLY), MFA Mortgage Investments (NYSE:MFA), and Anworth Mortgage Asset (NYSE:ANH). These REITS could benefit from Boxer and Menendez's bill because it targets persons who refinance through Fannie Mae (OTCQB:FNMA) and Freddie Mac (OTCQB:FMCC). Annaly, MFA, and Anworth like to buy federally-guaranteed mortgage paper.

There is at least one other piece of proposed legislation on Capital Hill that could benefit mREITs. Senators Jeff Merkley (D-Oregon) and Dianne Feinstein (D-California) have introduced a bill that would make Federal Housing Administration backed mortgages available to underwater homeowners with private mortgages. This law would even have Fannie and Freddie pay some closing costs for such homeowners.

The Hill newspaper estimates that Feinstein's bill would make 3.5 million additional homeowners eligible for refinancing. That would mean 3.5 million additional customers for mortgage REITs. The mREITs would be posed to take advantage of that situation, because it is doubtful that banks would touch that kind of refinancing. The big mREITs would probably pounce on that opportunity.

Increasing the number of federally backed refinancings would also reduce the risks that the mREIT business is facing. In addition to increasing their business, these companies would be able to reduce some of the volatility and risk that is inherent in the business. They would have a stable stream of income for years to come from the refinanced mortgages.

If these bills or something similar were to pass, President Obama would probably sign it. Obama has made solving, or at least appearing to address the mortgage crisis a priority. The states hardest hit by the mortgage crisis, such as Arizona, Florida, Michigan, and Nevada, are the swing states whose support he needs to win re-election this fall. The difficulty is that Republicans know that and will try to kill or delay this legislation to hurt Obama's re-election chances.

Any successful mortgage refinancing reform effort on Capital Hill is bound to boost mREIT stock values. Expect to see the values of all mREITs that invest in federally guaranteed paper to increase if Congress can take action. We should also expect other mortgage REITs that don't buy FHA mortgages to jump into this market to take advantage of any federal action.

Mortgage Crisis Equals Opportunity for mREITS

The immediate future for mREITs looks very bright with or without federal help. The states devastated by the mortgage crisis could become a huge new market for mREITs. It is estimated that around 60% of the mortgages in Nevada alone are underwater. If just a quarter, or a third of those homes could be refinanced, that would be several hundred thousand new mortgages for mortgage REITs.

If there is a political solution or an economic recovery, states like Nevada and Florida is an opportunity for mREITs. If the economy rebounds and homes start moving again, people will need mortgages. Economic recovery also means that more homeowners will be in a position to refinance, which also means a bigger market for mREITs.

The potential market for refinancing is huge; the mortgage data outfit CoreLogic estimated that were around 11.1 underwater mortgages in the U.S. in March 2012. That translates into 22.8% of all residential mortgages in the United States, so there are lots of potential customers for mREITs out there.

Nor are these mortgages necessarily a risky investment; around 6.7 million of the underwater homes have only a primary mortgage. That means they have no liens or second mortgages, which makes them a safer investment. These figures indicate that mREITs could greatly increase their level of refinancing without necessarily incurring any serious risks.

The bottom line is that the numbers look really good for mREITs; the opportunity for a vastly increased market share is definitely out there. The question will be how to tap into it and if Uncle Sam is willing to help. Obama and Congressional Democrats seem willing to help, but Republicans are leery.

The question that investors have to ask is which mREITs are in the best position to tap into the huge refinancing market. The safest assumption would be that it is the buyers of federally guaranteed mortgage. Other mREITs which buy all kinds of residential paper, such as PennyMac Mortgage Investment Trust (NYSE:PMT) and Invesco Mortgage Capital (NYSE:IVR), could benefit.

mREITs seem to be Optimistic

The management team at Annaly seems to think the mortgage refinancing business's future is very bright. It has announced plans to raise $1 billion in cash from two different offerings. In a Seeking Alpha post Todd Johnson noted that the company would only be able to pay those offerings off if it was able to generate a rate of return higher than the cost of capital.

It is obvious that Annaly wouldn't take this move if it didn't think it was about to get a lot more business in the near future. That means Annaly's executives think that they will be able to maintain the current rate of return through 2015.

My guess is that other mREITs will launch offerings of their own to generate capital to take advantage of this situation. The question we have to ask ourselves is if mREITs will be able to find enough money to take advantage of this situation. That remains to be seen in today's capital market, although high returns from companies, such as CYS Investments (NYSE:CYS) and Hatteras, as well as Annaly itself, should attract investors and create potential for a buying frenzy.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.