Mortgage-backed securities have experienced enough gains for some agency real estate investment trust investors to question how much room they have left to run, but REIT executives think the trend still has some legs to it.
American Capital Agency Corp. president and chief investment officer Gary Kain’s comments at the Citi U.S. Financial Services Conference in Boston last week largely centered on this question, suggesting it has been a key one for agency REIT stock and MBS buyers.
In Kain’s view, which he said is “contrary to public opinion,” mortgage-backed securities prices have “not done that well” and still have room to improve.
Although lower coupons and select prepayment-protected sectors with less exposure to refinancing pressures have experienced gains, the outperformance is “not…dramatic,” he said. Agency MBS could still “easily improve…in our opinion,” Kain said, noting that other fixed income sectors also have experienced tighter spreads.
MBS with higher coupons and prepayment risk have not done as well, but the executive said his company continues to find it can effectively address this concern by investing in low loan balance and Home Affordable Refinance Program sectors. As of Dec. 31, 2012, these made up 77% of his company’s fixed-rate portfolio, and Kain believes HARP will be extended into 2014.
But eventually industry investments could be heading, perhaps very slowly, toward a turning point in rates/market environment as indicators of housing market recovery and Federal Reserve officials’ mounting speculation about how long quantitative easing should last suggest.
Companies, of course, generally have strategies in place to address the possible contingency. Kain said he is confident given the focus there has been at the Federal Reserve on transparency, “We will get a fair amount of warning as to when the Fed will actually tighten short-term rates.” He noted that the company is using interest-rate swaps to hedge rate risk, adjusting them as needed in response to market conditions and indicators.
The stock market’s record high in the past week does suggest a shift in rate environment could be on the way, although mortgage rates did not move much in the past week.
With equities experiencing such gains, like in the agency MBS market (albeit with some consideration of the stock market’s more volatile nature), some are questioning the duration and direction of increases in this sector.
Again there are usual arguments to be made. Some think may already be too late to add investment allocations in industry stocks that have been on the upswing. Others say the upward trend is still establishing itself and is not over yet.
As American Capital Properties chairman and CEO Nicholas Schorsch and I discussed before his commercial REIT’s recent NASDAQ closing bell ringing, one consideration when it comes to real estate stock opportunities is that the options are still relatively limited.
This means that, among other things, investor interest is still not too diluted. So until or unless more players step in, gains could continue to be relatively more substantial for existing players than they might be in more crowded markets.
Other potential risks and rewards to consider when it comes to REITs’ investment prospects include how or whether they might be affected by the ongoing push for financial industry regulatory reform.
