In recent weeks, the mREIT sector has borne a disproportionate amount of liquidity-driven market turmoil triggered by the coronavirus crisis. With conditions showing signs of settling, for now, several Nareit mREIT members took a step back to give a first-hand account of what their companies have been dealing with.
As the full extent of the economic impact of the coronavirus became apparent, investors sought to shed risk exposure across all asset classes, and mortgage markets were no exception. Compounding this problem, businesses throughout the economy were drawing on their lines of credit and other financing facilities, putting additional pressure on the banking system.
For mREITs, the most severe liquidity issues largely centered on agency commercial mortgage backed securities (CMBS), which are backed by mortgages on multifamily properties and are guaranteed by Fannie Mae and Freddie Mac.
Funding pressures were “extreme,” according to one mREIT CEO, due to falling asset prices combined with an increase in margin calls. “This became particularly acute in March,” the CEO said.
Another mREIT CEO described funding pressures as “extremely serious because all markets became illiquid—even the liquid markets became illiquid and it rippled through the funding markets, not only in terms of margin calls but in terms of rates.”
As a comparison, the CEO noted that even during the 2006-2008 financial market crisis, “agency MBS never went illiquid like this.” In the current situation, “the markets just stopped functioning,” he said.
In the agency CMBS repurchase agreement “repo” markets, margin requirements roughly doubled, or even tripled, over the last month to over one point, a CEO noted.
While most repo lenders constructively worked with their mREIT counterparties, according to an mREIT chief investment officer, at least one repo provider seized REIT bonds and auctioned them off in a very distressed market, putting further downward pressure on pricing. Repo providers are now in the process of revaluating their footprint in the market while making levels more conservative or refusing to provide financing all together, he noted.
Meanwhile, repo lender haircuts on agency CMBS went from 5% to 8-10%, according to an mREIT executive, while some non-agency bonds weren’t offered financing at all. “Many providers took very draconian marks on bonds and forced REITs to pay margin calls on those bonds. When we saw pricing firm up, they were reluctant to move pricing up and return cash,” the executive said.
Another mREIT executive noted that mREITs are also owners of credit risk transfer (CRT) securities—general obligation bonds issued by Fannie Mae and Freddie Mac (GSEs) which were created by the Federal Housing Finance Agency (FHFA) in 2013 to transfer a portion of the credit risk associated with residential mortgage loans from the GSEs to the private sector. CRT securities are now the predominant form of non-guaranteed RMBS in the U.S. The pricing levels of CRTs went from 100-105 down to 60-80, causing severe disruptions. Lenders on the CRT repo side increased some haircuts exacerbating the issue, he said.
For now, at least, the outlook for agency CMBS appears to have improved.
In the wake of a request by Nareit and others, the Federal Reserve added agency CMBS to its agency MBS purchases. This was accompanied by an announcement that the Federal Housing Finance Agency (FHFA) authorized Fannie Mae and Freddie Mac to provide urgently needed liquidity to MBS investors.
“Pricing for agency paper has improved considerably in no small part due to Fed intervention,” a CEO said, reflecting “sheer exhaustion of selling volumes as levered players finish selling everything they need to meet margin calls, or otherwise have capitulated to their lending counterparties.” This is allowing the market to function more normally.
“It looks like the cash pressure on mREITs has been relieved because a lot of people have been able to sell,” a CEO said.
Another mREIT CEO pointed to an improvement in pricing for agency CMBS and non-agency AAA bonds. Spreads are approximately 100 basis points, “but levels remain well wide of month-ago levels,” he said.
For levered players that have met their margin call borrowing commitments, repo remains available, according to a CEO. “With the deleveraging across the board, many repo counterparties have dramatically reduced outstanding repo balances, indicative of strong demand on their part for future business.”
Trading volumes in agency products have “definitely improved,” another CEO said.