Potential losses and policy changes at the Federal Housing Administration (FHA) could change the way that the mortgage industry does business. These changes could also help boost some mREIT stocks by increasing mortgage market share for mREITs. The situation at the FHA could also lead to increased federal regulation of Real Estate Investment Trusts that invest in mortgages.
The FHA - which insures federally-guaranteed mortgages - could soon be in need of a bailout, Wall Street Journal writer Nick Timiraos speculated. Timiraos thinks that the potential losses from the number of delinquent mortgages that FHA is insuring could exceed the agency's cash reserves. He noted that the agency currently has 700,000 mortgages that were in foreclosure, or more than 90 days past due on its books. If it had to cover all those losses, the FHA would have to spend most of its $32.3 billion in cash reserves. In February, the White House Budget office audited the FHA and said that the only thing that kept it from exhausting its reserves was settlements it had made with banks.
Troubles at the FHA could be very bad news for those mREITs that specialize in investing federally-guaranteed mortgages. This includes such giants as American Capital Agency (AGNC) and Annaly Capital Management (NLY). It also includes such lesser players as Hatteras Financial (HTS), MFA Mortgage Investments (MFA), and Apollo Commercial R.E. Finance (AMTG).
A round of news stories about potential troubles at the FHA would send the stock value of these mREITs crashing down. These companies' entire business model is based on the presumption that the FHA would insure any risky mortgages they back. If the FHA is not able to do that, the added layer of security that they were counting simply would not be there.
Conservative investors and value investors would sell off such stocks out of fear of potential losses. Even rumors of FHA problems could lead to a panic that could spark such a selloff.
Tighter Mortgage Standards at Major Banks Could be Opportunity for mREITs
The potential crisis at the FHA could create a major opportunity for aggressive mREITs.
Some of the major banks are tightening up mortgage standards and refusing to invest in what they see as risky paper. On June 11, Wells Fargo (WFC) stopped purchasing FHA-backed mortgages issued to homeowners with a credit score below 640.
This move could mean that Wells Fargo executives think that there could be problems at the FHA. They might be afraid that the agency will try to force them to buy back risky mortgages.
Such a move should benefit mREITs, which could start buying up some of those mortgages. This could benefit both buyers of government-guaranteed paper, such as Anworth Mortgage Asset (ANH), and buyers of different kinds of mortgage loans, such as PennyMac Mortgage Investment Trust (PMT).
Some of those mortgages may still be sound investments because a credit score does not reflect a person's actual ability to pay his or her mortgage. Credit scores are not based on a person's cashflow, but on their history of paying bills on time. Many people with good jobs and lots of money in the bank have credit scores under 640.
The imposition of such rigid policies by major banks will increase the market share of mREITs. This should increase their cashflow and the amount of leverage they have to purchase mortgage securities. It should definitely increase their stock value because they are fast becoming the major source of mortgage credit in the United States. The biggest beneficiaries of this change should be large well-established mREITs such as Annaly.
Part of the reason why companies like Two Harbors Investment (TWO) and Cypress Sharpridge Investments (CYS) will benefit from this is that mortgage brokers will start going to them first for lending rather than to banks. If mortgage professionals know that they cannot get underwriting from a bank, they will turn to mREITs first. If mREITs become the lender of first result for most mortgages, their market share and stock values will go up.
Federal Mortgage Write-down Program Has Some Effect
The Obama Administration's effort to get lenders to write down underwater residential mortgages is having some effect. The Home Affordable Modification Program (OTCQB:HAMP) helped 802,000 homeowners avoid foreclosure as of April. That means the program was more successful than the Congressional Oversight Panel said it would be. The panel predicted the program could only prevent 700,000 to 800,000 foreclosures.
Despite its limited scope, HAMP could have a dampening effect on mREIT stock values. HAMP pays lenders to write-down underwater mortgages. The average write-down is around $69,000, or 31% of the mortgage. The program is an alternative to refinancing, which is the main product that mREITs offer. Part of the reason why mREITs have been flying high in recent years is that they've been in a position to offer refinancing. The combination of falling home values and record-low mortgages has made refinancing very attractive to homeowners.
The market share for mREITs could be hurt by proposals to extend HAMP or create a similar program with a much wider scope. The Wall Street Journal reported that the Treasury Department, Fannie Mae, and Freddie Mac are looking a proposal that would reward lenders for writing down underwater mortgages. If such a proposal were adopted, it could reduce the demand for refinancing.
It should be noted here that this kind of proposal will be a tough sell to Congress, particularly the Republican-controlled House of Representatives. House Republicans have been very critical of all of President Obama's mortgage relief efforts, so it is doubtful that the Obama administration will propose such a measure before the election.
The only way Congress might be persuaded to go along with such measures is if the Administration says they are necessary to save the FHA. Obama obviously doesn't want to touch the problems at the FHA because any publicity of such measures would hurt him. Republicans would undoubtedly use the FHA's troubles as a campaign issue.
FHA Politics Could Damage mREIT Stock Values
There is a potential danger to mREIT stock values in these politics. Congressional Republicans, sensing that the FHA debacle would help their electoral chances, might launch an investigation of the agency. The resulting media circus could generate negative publicity about federally-guaranteed mortgages that could lead to an mREIT stock selloff.
Investors thinking that another mortgage collapse is imminent could start pulling their money out of anything that looks like its mortgage-related. That could be a tremendous opportunity for value investors who could pick some really good mREIT stocks on the cheap.
Another side effect of such an investigation could be a tightening of credit for mREITs. The trusts could have plenty of business, but a hard time getting additional financing or selling new issues. That could lead to insolvency or even more rumors of an mREIT crash.
Contracting Housing Market Could Boost Two Harbors' Share Price
The housing market seems to be contracting in spite of foreclosure crisis and record-low mortgage interest rates. The number of homes listed for sale in the U.S. has fallen by 20% in the last year. Competition for existing homes is also increasing - 70% of the homebuyers surveyed by a company called Redfin said they faced at least one competitive bid for properties they were trying to buy.
News like this should help the stock value of Two Harbors Investment, which has gotten into the business of buying up single-family homes in some markets. If the housing market continues to contract, home values and rents will rise, and so could Two Harbors' cash flow and stock values. If this contraction continues, expect other REITs to jump into the single-family home market.