The once red-hot mortgage REIT sector is in for a cold dose of reality — which could spill over to the already-cool housing market.
Mortgage real-estate investment trusts have been exempt from the Investment Act of 1940, which regulates the fees that can be charged to investors and limits the amount of leverage a fund can use. But the Securities and Exchange Commission (SEC) said recently that it had initiated a review of that exemption, as mortgage REITs are beginning to look more like mutual funds.
The SEC's review has rattled the mortgage REIT industry, which analysts call a narrow-but-important source of liquidity for the housing market. Property prices are depressed, demand for new home loans is low, and banks and government-sponsored agencies Fannie Mae and Freddie Mac are still trying to sell their backlogs of foreclosed homes.
"If the SEC were to regulate [mortgage REITs], to make their strategies unprofitable or unable to generate the necessary returns, they would be stanching a good bit of the flow of private capital to the housing and housing finance markets," said analyst Rich Eckert of B. Riley & Co.
He said mortgage REITs can play "an even larger role in the post-Fannie and Freddie world when you are eventually able to privatize the mortgage market. Why would you want to shut these players out?"
Eckert, who covers real-estate companies including American Capital Agency Corp., Anworth Mortgage Asset Corp. and Hatteras Financial Corp., said he does not think the SEC will ultimately remove the exemption for all mortgage REITs.
Other analysts also downplayed the likelihood of widespread regulatory changes to the industry, but warned about the possible consequences if the SEC does in fact remove the exemption.
"This exemption has serious implications for mortgage REITs in terms of leverage, legal liability, capital raising and hedging," analyst Jason Stewart of Compass Point Research & Trading wrote in a note to clients this month. "While we believe the odds of wholesale changes to the exemption are low, the implications of any changes could be significant."
Even just the prospect of increased regulation has derailed some deal activity in the mortgage REIT sector.