Mortgage REITs in 2022 - Not Immune to Weakness but Primed for Strength
As the Federal Reserve (“Fed”) changed its tune on inflation, it hiked the Fed Funds rate over 400 basis points (bps) by year end and ceased purchasing Agency MBS. Hawkish actions by several other central banks sent global markets into a tailspin, resulting in losses of more than $30 trillion in market value during 2022.
Among most sectors, Mortgage REITs were not immune to weakness. Mortgage REIT indices were down ~26% for the year, which roughly matched the price decline for larger equity REIT indices. Much of the decline in mortgage REIT stocks for the year was the result of two precipitous drops – one in June and the other in September.
We believe retail investors were heavy sellers of the indices during these periods as memories of mortgage liquidity issues in 2020 created a palpable sense of panic. These investors most likely overlooked the fact that most mortgage REITs have virtually eliminated short-term leverage borrowing against Non-Agency MBS — which was the real source of trouble in 2020. Painting mortgage equities with a broad brush is, in our view, also short-sighted since material differentiation exists in portfolios and business models. Some mortgage REITs/companies focus on loan origination or mortgage servicing, some own portfolios of Agency MBS or Non-Agency MBS/loans, some focus on shorter term loans, or on loans tied to commercial properties
We believe that certain publicly traded REITs (and funds that own them) are poised to outperform private REITs and similarly structured investment funds. Private REITs, which primarily own illiquid assets, generally lagged the price declines of more readily traded securities/funds in 2022. Also, any investment fund that mismatches assets and liabilities is generally “playing with fire” given inevitable bouts of illiquidity in the market.
We are currently focused on mortgage REITs and servicers, which hold portfolios of residential mortgage debt with, what we perceive to be, low credit risk and effective interest rate hedges in place.