By Ilaina Jonas - Analysis
NEW YORK (Reuters) - A crisis in credit markets triggered by a collapse of the U.S. subprime mortgage market has shuttered several mortgage real estate investment trusts and threatened the sector, rekindling memories of a similar crisis 30 years ago.
In the 1970s when mortgage REITs were new to investors, risky loans and too much leverage forced most of them out of business and tarnished the reputation of equity as well as mortgage REITs for more than a decade.
Equity REITs own property while mortgage REITs lend money to property owners.
That crisis, caused by a collapse in construction lending, led investors to wonder if the REIT structure was inherently flawed.
"In my opinion, the legal structure doesn't make a damn bit of difference," said Lawrence Longua, director of the New York University Real Estate Institute REIT Center, and an REIT industry veteran.
Longua said that many of today's mortgage REITs were done in by overly aggressive lending practices that led to questionable loans, which were pooled and sold as bonds to investors in the capital markets.
"They couldn't do it unless they had someplace where these loans would end up," he said.
Loose lending standards, rising interest rates in 2005 and 2006, and falling house prices have resulted in increasing numbers of less credit-worthy U.S. borrowers defaulting on their so-called subprime home mortgages in 2007.
The REIT structure requires companies to pass along a minimum of 90 percent of what would have been taxable income in the form of dividends to shareholders. The minimum 30 years ago was 95 percent. In exchange, a company's income is not taxed.
Without the ability to retain earnings, mortgage REITs have historically relied on borrowed money to fund their mortgages.
Many of the modern mortgage REITs, and those of 30 years ago, borrowed money based on the value of the loans. As borrowers had difficulties repaying loans, the value of the loans declined and banks called for mortgage REITs to put up more money.
A DOLLAR SHORT
With no retained earnings, mortgage REITs such as New Century Financial Corp (NEWCQ.PK: Quote, Profile, Research), American Home Mortgage (AHMIQ.PK: Quote, Profile, Research), and the former REIT HomeBanc Corp (HMBN.PK: Quote, Profile, Research) have come up empty-handed in the current subprime market and have filed for bankruptcy protection.
"They were so levered they couldn't come up with more collateral," BMO Capital Markets David Chiaverini said. "But even if they were regular corporations, the banks providing the facilities would have still shut them down."
Today's mortgage REIT business is rooted in home mortgages and mortgages for office, industrial, hotel, shopping center or apartment properties.
Mortgage REITs whose businesses were tied to subprime residential mortgages were dealt the harshest blows.
Deerfield Triarc Capital Corp (DFR.N: Quote, Profile, Research), CBRE Realty Finance (CBF.N: Quote, Profile, Research), RAIT Financial Trust (RAS.N: Quote, Profile, Research) have come under pressure and the chief executives of Thornburg Mortgage Inc (TMA.N: Quote, Profile, Research) and Impac Mortgage Holdings Inc (IMH.N: Quote, Profile, Research) have publicly said their companies do not intend to seek bankruptcy protection.
Had they not been REITs, mortgage lenders might still be facing the same scenario.
"If they retained cash, they would have just borrowed more. It would just be bigger, perhaps," Chiaverini said.
And like their predecessors, the difficulties of some mortgage REITs are making times hard for the sector.
The iShares FTSE NAREIT Mortgage REITs Index Fund (REM: Quote, Profile, Research), an exchange-traded fund launched in May by Barclays Global Investors and designed to track mortgage REITs, traded at an all-time low of $25 per share on Wednesday after a high of $51.06 in early June.
BMO's Chiaverini said mortgage REITs should have weaned themselves off bank credit and issued unsecured corporate bonds when their stocks were trading at highs over the past few years.
"Debt investors would have been receptive to investing in that unsecured debt," he said.
(Additional reporting by Jonathan Keehner)
