KBW: MBS REIT Book Value Declines Due to Three Factors

There are three items contributing to the recent book value decline in mortgage real estate investment trust stocks: Prepay protection premiums evaporation; duration and duration extension risk; and mortgage basis risk, a Keefe, Bruyette Woods analyst report said.

According to the report, evaporation of prepay protection premiums drove about 60% of the book value declines for the REITs heavily invested there. The remainder was about equally divided between duration risk and mortgage basis risk.

Analysts Michael Widner and Sean Tillman believe 75% of the prepay protection premium risk is gone for the entire class and 85% is gone for the group that had significant exposure.

They added that Duration risk remains, particularly for the heavy fixed rate portfolios, but we see it as contained.

As for mortgage basis risk, the report notes it has already widened 25 basis points and depending on the Federal Reserve could either widen another 25 bps or narrow 25 bps.

We figure about a 4% book value swing either way depending on the basis tightening or widening, KBW said. The stocks least exposed to book value volatility are those exhibiting lower prepay protection premiums, higher concentrations in hybrid ARMs, and tighter duration gaps.

So their top stock pick depends on what the investor thinks will happen. If the Fed keeps buying mortgage-backed securities, then the biggest stock rebounds likely come to those having seen the biggest fallsREITs with the 30-year fixed prepay protected portfolios. If an investor is not so sure about that, then the risk/return tradeoff probably favors the hybrid adjustable rate mortgage investing REITs, KBW said.

Article source: http://www.nationalmortgagenews.com/dailybriefing/kbw-says-mbs-reit-value-declines-due-to-three-factors-1036973-1.html

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