Warren Buffett's Berkshire Hathaway (BRK.A) is a step closer to taking ownership of ResCap's (Residential Capital) loan portfolio. This will make it easier for Berkshire to enter the residential mortgage business and compete with mREITs. Recently, a New York bankruptcy court named Berkshire the lead bidder for ResCap's loan portfolio. Berkshire will pay $1.44 billion for ResCap's loans if the court accepts its bid. In this article, I will show how this development could directly and indirectly impact Western Asset Mortgage Capital (WMC), MFA Mortgage Investments (MFA), Anworth Mortgage Asset (ANH), Two Harbors Investment (TWO), Armour Residential REIT (ARR), and Resource Capital Group (RSO).
Berkshire lost its bid for ResCap's mortgage unit, which was sold to mREIT operator Fortress Investment Group (FIG) for $2.45 billion. Fortress will fold the ResCap assets into its Nationstar Mortgage Holdings (NSM).
The bankruptcy judge also approved a request by Buffett's lawyers to have ResCap's relationship with its parent company, Ally Financial (ALLY), reviewed by an unidentified outside expert. The Associated Press reported that Berkshire's legal team thinks ResCap assets worth billions of dollars could have been transferred to Ally shortly before the mortgage company filed for Chapter 11 bankruptcy last month. Berkshire asked for this step because it owns large numbers of unsecured ResCap bonds.
This development means that Berkshire will be a player in the mortgage securities business, but it won't have the resources it needs to service residential mortgages. One of Buffett's main reasons for bidding on ResCap was to get its mortgage servicing unit, which he could have used to expand his mortgage business. The AP reported that Berkshire has around $2.8 in billion-mortgage backed securities.
This means that Warren Buffett's entry into the mREIT business is delayed, not stopped. Buffett will keep trying to buy his way in because he thinks that housing is about to recover and residential mortgages are a good investment right now.
This move could make Fortress a really good buy because it is low-priced and now owns a much larger mortgage portfolio. Nationstar Mortgage Holdings could be a good buy as well because its resources have increased. Fortress also manages a number of mREITs, including Newcastle Investment (NCT).
Number of mREITs Growing
Warren Buffett may not be the only new player in the mREIT game. At least one new mortgage real estate investment trust, Western Asset Mortgage Capital, went public recently. This company is designed to take advantage of the record lows that mortgage interest rates are sitting at by buying up mortgage securities backed by Freddie Mac and Fannie Mae. Western Asset Mortgage Capital is managed by Legg Mason (LM). It seems to be doing fairly well - its stock was sitting at $19.02 a share at the close of business on June 21, 2012.
The expansion of the industry should drive up stock prices for the foreseeable future because it increases competition for mortgage securities and profits. This move also indicates that Legg Mason's experts believe that there is sufficient capital and demand for a new mREIT to be successful.
Western Asset has also kept its value since premiered last month. Its shares started trading at $18.93 on May 10 and have increased in value despite the recent drops in the overall market. Not even the Greek debt crisis in Europe has seriously hurt this stock.
Refinance Applications More than Doubled in Volume in a Week
It is easy to see why companies such as Legg Mason are jumping into the mREIT arena - business is booming. On Wednesday, June 20, the Mortgage Bankers Association reported that the number of government refinance applications had more than doubled in a week. A Reuters article indicated that the amount of applications had grown by 121.3% in just one week. This number was 410.9% bigger than the number of applications in June 2011.
This means that refinancing applications now make up 81% of the mortgage applications in the United States. Only 19% of the applications were for home purchases.
The reason for the increase was new lower premiums that the Federal Housing Authority is offering, Michael Fratantoni, the Association's Vice President of Research, told Reuters.
The increase in refinancing should boost the stock value for mReits such as MFA Mortgage Investments, Anworth Mortgage Asset, and Western Asset. These companies specialize in buying government-backed mortgage securities. Most of the new refinancing applications are for FHA insured mortgages.
The overall number of mortgage applications fell again, which indicates that there could be a ceiling for the market's growth. If the overall market and the housing market don't recover, refinancing will be the only opportunity for mREIT expansion. When it is exhausted, mREIT profits and stock values could start dropping.
Housing Supply and Rate of Home Sales Falling
The number of mortgage applications is not the only falling number that could hurt mREITs. Sales of existing homes actually fell in May, according to the National Association of Realtors.
The reason for the decline is obvious - the supply of homes for sale is contracting. The number of houses for sale last month was about 20% lower than it was in May 2011. This doesn't mean that the housing recovery predicated by Warren Buffett and others is beginning. It means that the market is still stumbling because of the mortgage meltdown.
Large numbers of people simply are not selling because of low housing values. There are also around 5,570,000 foreclosures that need to be dealt with. The huge number of foreclosures is still slowing the process and keeping large numbers of homes off the market.
The housing supply has tightened in some areas of the country. In the Washington DC suburbs, the market is so tight that the Northern Virginia Association of Realtors has launched a special "Ask Me" campaign to try to get people to sell their homes. The Association's analysts think that there is only a two-month supply of homes available in their area.
The tight housing market may not help mREIT stocks that much because one key group seems to be missing from the current picture. That group is first-time homebuyers who now make up just 34% of home purchasers. Normally around 45% of house hunters are first-time buyers.
Several factors, including difficulty getting mortgage approval, apprehension about employment and the overall economy, and fears that property values will stay low are probably keeping buyers away. This development could dampen the growth of mortgage securities and mREIT stocks because it could limit the amount of potential business.
The only thing that would fuel a significant growth in the mortgage market and the number of securities is a true housing recovery. No housing recovery will begin until first-time buyers return to the market.
Without a housing recovery, companies such as Two Harbors Investment and Armour Residential REIT will have limited growth prospects. A weak housing market will mean greater competition between mREITs and fewer opportunities to leverage securities. That means lower profits and lower dividends for high fliers such as Resource Capital Group.
A housing recovery is the only thing that would enable the large number of mREITs that have appeared on the market in recent years to survive. These companies will need a growing market in order to generate the kind of profits needed to sustain the high dividends that make them so attractive to investors.
The lack of a housing recovery could lead to a shakeout in the mREIT marketplace in which a number of the smaller and weaker players disappear. It could also lead to a fall in mREIT stock values that would only be reversed by a true housing recovery. Unfortunately, such a recovery is probably several years away, even with a tightening housing market.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.