In last week's column, "Mortgage REITs Remain Great Income Vehicles," I observed that there had been "stunning declines" in the prices of real estate investment trusts during the preceding three months that I was not expecting, and could find no logic to justify other than that REIT investors were once again acting on fears of rising rates.
In response to that column, in the Comments section below it, Real Money subscriber levimax suggested that it might have more to do with expectations of rising mortgage defaults than of rising rates.
That's a very interesting observation, so I decided to investigate and will discuss that issue here.
In the June column, "Past-Due Mortgages Are Piling Up," I discussed the fact that, based on second-quarter bank call report data, the level of newly defaulting mortgages -- those carried by the banks as 30 to 89 days late -- had remained at historically very high levels throughout the past several years, even though real estate values were rising and the financial market meme during that period has been that the economy was mending.
With the third-quarter bank data now available, I'll consider that situation first.
In the third quarter the aggregate dollar value of residential first trust mortgages that are carried by the money centers increased slightly at Bank of America (BAC) and JPMorgan Chase (JPM) while decreasing slightly at Wells Fargo (WFC) and Citigroup (C).
For all four money centers there was also only a slight change in the carried value of restructured mortgages that have gone into arrears again.
I'll address those issues in more detail in another column, but for the purposes of this column there's nothing in these numbers that suggests that rising defaults are imminent, thus justifying a selloff of the mortgage REITs.
The next issue to consider is the performance of the mortgage insurance companies over the same three months as the mortgage REITs.
The four largest companies listed in descending order by market valuation are Radian Group (RDN), MGIC Investment (MTG), Genworth Financial (GNW) and Essent Group (ESNT).
In the last three months Radian and MGIC are up about 2.5%, while Essent is up about 6%. Genworth is down about 35%, almost all of which occurred after it announced poor second-quarter earnings Aug. 4.
The other three all beat estimates for their respective second-quarter earnings, so the Genworth issue appears to be unique to it.
There's nothing in the performance of these companies that indicates investors are expecting an imminent increase in defaults that would cause insurance payouts by these companies to increase.
The next area to consider are the mortgage servicers.
The three I'll consider here are Nationstar Mortgage Holdings (NSM), Ocwen Financial (OCN) and Walter Investment Management (WAC).
The issue gets murkier here as the performance of the servicers is much closer to that of the REITs than of the mortgage insurance companies, and the servicers business is also much more similar to the REITs than the insurance companies, too.
In the past three months Nationstar, Ocwen, and Walter are down by 10%, 29% and 5%, respectively.
Some portion of these declines is probably associated with increasing concerns among investors about an acceleration in prepayments due to the declines during the last three months in the 10-year Treasury yield and 30-year fixed mortgage rates. Accelerating prepayments, due to the refinancing of mortgages, cause servicers to expend capital to reinvest in new mortgages that also carry lower yields.
However, the magnitude of the declines is outsized in comparison to the decline in mortgage rates, which very well may imply and indicate that investors are concerned about rising defaults.
There is another issue, though, that may be more indicative of investors' concerns about the housing and mortgage industries in the immediate future. That is the report by the Office of the Special Inspector General for the Troubled Asset Relief Program that I wrote about a few weeks ago in the column, "Report Turns Up the Heat on Banks."
Since then, all four mortgage insurance companies and all three mortgage servicers discussed in this column have declined in price. Also, five of the six mortgage REITs I've written about in previous columns are trading at or below the level that prevailed prior to the release of that report.
Only Annaly Capital Management (NLY) is trading higher, by about 2%.
In addition, all nine of the home builders I write about regularly are trading below the levels they were at before the SIGTARP report was released.
In total, investors in the housing and associated areas appear to be more concerned about increasing government intervention than about rising defaults or interest rates in general.
