Michael Nierenberg: How to Invest in Securitized Non-Agency Residential Mortgages

Investment, Residential

Securitized mortgages are created when lenders combine multiple real estate loans into a marketable security. The practice of financial securitization originated in the 17th century, and securitizing real estate loans began in the middle of the 19th century with farm railroad mortgage bonds. Modern securitization vehicles can be traced to 1970 when residential mortgage-backed securities were established by the U.S. Department of Housing and Urban Development.

Most 20th century versions of securitized residential mortgages featured loans involving federal agencies such as the Government National Mortgage Association (GNMA or Ginnie Mae). These were often packaged as “trusts” that represented fixed portfolios of mortgages without any ongoing management of underlying assets. The lack of asset management proved to be a serious limitation for many investors.

 

As mortgage lending rapidly increased in volume about 15-20 years ago, lenders developed new variations of securitized residential mortgages — this expansion included the addition of non-agency securitized mortgage pools, especially in the aftermath of the credit crisis starting around 2007. Approximately 70 percent of residential real estate financing is now securitized.

 

Reasons for Non-Agency Securitized Debt Securities in the 21st Century

 

While each lender is likely to have unique reasons for securitizing debt, the decision of residential mortgage originators to securitize mortgages will frequently be based on one or more of the following factors:

 

  • Transform Illiquid Assets into Liquid and Marketable Securities — Individual residential mortgages are illiquid and not readily marketable assets that can be sold to another party. By securitizing an entire portfolio of residential loans, an originator can facilitate a sale to interested buyers.
  • Lock in Profits — For any lender that wants to book a profit when the opportunity arises, securitizing mortgage loans removes the risk that the profit will disappear later due to unforeseen circumstances. This gives originators more control over the timing of profitable transactions.
  • Remove Specific Assets from Balance Sheets — In addition to freeing up capital that allows more lending, securitizing can help lenders clean up their balance sheets by removing specific loans that have a higher potential of under-performing over the life of the mortgage. Originators can continue to retain higher-quality mortgages on their balance sheets.
  • Enhance Earnings — Since a lender’s parent company might be looking for an earnings boost prior to the end of a quarter, a mortgage portfolio securitization could be one of the few realistic options available on a short-term basis. Without an actual sale via securitizing, earnings will not be impacted. The potential negative earnings impact of a sale can also influence lenders to avoid selling mortgages if market values of certain loans have declined.
  • Reduce Funding Costs — Securitizing allows some companies to enhance their cash flow by securitizing mortgage loans at a higher credit rating than the overall company enjoys. It is not unusual for credit agencies to downgrade a specific company’s overall rating (for example to BB or BBB) while continuing to rate mortgage-backed securities at a higher rating (such as A, AA or AAA) because of stronger collateral and cash flow from the securitized loan portfolio.
  • Transfer Risks — Risk-averse lenders can choose to transfer the risk of carrying mortgage assets to parties that understand how to analyze and manage the risks. The underlying risks of mortgages can include excessive asset concentration, prepayments, illiquid assets, non-performing loans and credit issues.

 

 

How to Invest in Non-Agency Residential Mortgage-Backed Securities (RMBS)

 

As described above, mortgage lenders have their own specialized rationale for securitizing residential real estate loans. Investors on the other side of the transaction (those acquiring the securitized mortgage portfolio) need to apply a thorough due diligence review process before buying these portfolios. In addition to deciding whether to purchase a specific non-agency RMBS portfolio, investors need to plan ahead for the ongoing asset management requirements — for example, refinancing and converting under-performing assets to re-performing mortgages.

NEW YORK CITY, NY – NOVEMBER 20: Michael Nierenberg attends THE SAMUEL WAXMAN CANCER RESEARCH FOUNDATION Benefit: Collaborating For A Cure at 69th Regiment Armory on November 20, 2008 in New York City. (Photo by PATRICK MCMULLAN/Patrick McMullan via Getty Images)

New Residential Investment Corp. is a real estate investment trust (REIT) that incorporates actively managed non-agency mortgage-backed assets in their portfolio. The Company’s investment managers feel that non-agency RMBS assets and potential recovery values are often misunderstood and undervalued. To take advantage of these pricing discrepancies, New Residential also includes call rights on non-agency mortgage securitizations among their key holdings.

 

 

About New Residential Investment Corp. — REIT Based in New York

 

Michael Nierenberg is New Residential’s Board Chairman, President and CEO. The Company is managed and advised by Fortress Investment Group LLC, a global alternative investment manager. New Residential was created in 2013 by a spin-off from Newcastle Investment Corp. and operates as a separate and publicly traded company (NYSE: NRZ). New Residential specializes in residential mortgage investing and actively managing a portfolio that primarily includes residential real estate investments.

 

Recent financial ratios include 100.98 for price/book value and 7.89 for price/earnings. The Company’s annual dividend (paid quarterly, regular cash) was $1.98 for 2017 and $2 for 2018. During a 52-week period ending February 4, 2019 the stock’s trading range was $13.86 to $18.75. New Residential’s market valuation is $6.2 billion as of February 4 ($17 per share).

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