Concerns raised by the debt ceiling debate present minimal potential short-term risks for REITs that invest in agency MBS, and the sector should be viable under all “reasonable” scenarios, according to a new report from Keefe, Bruyette & Woods (KBW).
KBW said the one negative scenario that is increasingly likely -- but still considered a relatively low risk -- is one where an agreement is reached on the debt ceiling but sovereign debt is still downgraded. Another likely outcome is an agreement reached without a debt downgrade.
While there also could be a situation where no agreement is reached and there is a downgrade, KBW said if this occurs it would be very unlikely to persist for a “meaningful” period of time.
The upshot of the most likely negative scenario would likely be a situation where U.S. Treasuries are downgraded, government-backed Ginnie Mae MBS also are downgraded, and the market treats the agency MBS ‘implicit’ ratings similarly.
KBW considers the most likely downgrade would be to double-A, the second highest investment grade rating.
The report suggests that a downgrade would likely result in a 10-20 basis point increase in yields for agency MBS, which moves in the opposite direction from price.
This could affect the securities repurchase markets that agency REITs use as a source of funding. (A downgrade would reduce the availability of top rated assets available for securities lending and borrowing and likely lead to the use of lower rated assets.)
Despite these potential downgrade concerns, the pricing of assets that could be directly affected such as U.S. Treasuries have been holding up fairly well, noted analyst Bose George, one of the authors of the agency REIT report. In a brief interview Tuesday he said, “It could happen, but if the Treasury markets are saying, ‘We can cope with it,’ they are basically saying the rest of the market can handle it as well.”