NEW YORK: A crisis in credit markets triggered by a collapse of the US 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.
Loose lending standards, rising interest rates in 2005 and 2006, and falling house prices have resulted in increasing numbers of less creditworthy US borrowers defaulting on their so-called subprime home mortgages in 2007.
The REIT structure requires companies to pass along a minimum 90% of what would have been taxable income in the form of dividends to shareholders. Thirty years ago, the minimum 95%. 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.
With no retained earnings, mortgage REITs such as New Century Financial Corp, American Home Mortgage and the former REIT HomeBanc Corp 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.”
He 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. – Reuters