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Why Mel Watt gained no new fans at the Senate Hearing — Part 5

Negative EquityEnlarge GraphContinued from Part 4

Watt faces an uphill climb

Mel Watt’s confirmation hearing predictably fell along partisan lines, with Democrats enthusiastically supporting him (Elizabeth Warren, D-MA, said she would vote for him twice, and Watt gamely replied she might have to) and Republicans questioning his ability to act independently of the President as well as his technical expertise when it comes to overseeing a multi-trillion portfolio of mortgage-backed securities. The ranking member Senator Mike Crapo (R-ID) said, “Any nominee to this important position must be politically independent and have the necessary expertise.” Senator Bob Corker (R-TN) went further, saying, “I’m not sure I know of anyone today in Congress that I would feel good about in this position.” If Watt can’t convince Corker, he probably isn’t getting any Republican support.

Another name mentioned was Mark Zandi, currently the chief economist of Moody’s. Zandi has been an advocate for principal modifications and certainly is no politician. Questions will remain over whether he has the necessary experience in housing finance to do the job. If Watt isn’t confirmed, look for Zandi to be the nominee.

Implications for the mortgage REITs

The REITs most vulnerable to principal mods would be the agency REITs like Annaly (NLY), American Capital (AGNC), MFA Financial (MFA), and Capstead (CMO). The REITs with a primary focus on 30-year fixed-rate mortgages would probably have the most exposure, since adjustable-rate mortgages have lower duration risk. Any of these REITs with large amounts of non-HARP refinanceable paper from the bubble years of 2005–2007 will have exposure and see some of their MBS that are trading above par go to par very quickly.

Non-agency REITs like Chimera (CIM) or Two Harbors (TWO) probably have nothing to worry about. Principal mods will only affect Fannie and Freddie mortgages, and non-agency REITs typically have a core competency in evaluating credit risk and tend to buy subprime, Alt-A, and jumbo mortgage-backed securities. Nothing that comes out of FHFA will affect those mortgage-backed securities.

Are there any REITs who’d benefit from principal mods? Indeed there are—any that focus on origination, like PennyMac (PMT) or Nationstar (NSM). Mortgages with principal mods will be immediately refinanced, and that will drive business for these companies. Finally, companies like Ocwen (OCN) or Nationstar (NSM) that possess large servicing portfolios will have some additional prepayments at the margin, which will affect the value of their MSR portfolio. That said, the increase in interest rates recently has already worked in their favor.