Analysis: With Summers out, implications for mortgage REITs
Summers is out after a couple influential Democrats refuse to support his nomination
The left despised the Larry Summers pick since day one, so it was no surprise that the knives came out early and often for him. Last week, Senators Elizabeth Warren (D-MA), Jeff Merkely (D-OR), and Jon Tester (D-MT) said they would oppose Larry Summers. The explanation they gave was that he supported banking deregulation in the ’90s, when he was part of the Clinton Administration, but he also had some political correctness issues that probably doomed his nomination as much as anything. This leaves President Obama with a few other possibilities, but the overwhelming favorite is Janet Yellen, currently the Fed Vice Chairman. Former Treasury Secretary Tim Geithner has supposedly said he doesn’t want the job, and former Fed Vice Chairman Don Kohn is a dark horse. Ignore all the drama—it’s Yellen.
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Summers was the favorite going into this weekend
Prior to this weekend, Summers was still the favorite. The reason why is because he was an outsider and would be more willing to get political and provide the President the support from the Fed for a more aggressive fiscal stimulus. Janet Yellen has spent her career at the Fed and believes the Fed should be politically independent. She would be less likely to agitate Congress for fiscal stimulus or get in the ring supporting spending versus tax cuts.
Summers is out: What does that mean for REITs?
Larry Summers was an outspoken supporter of additional fiscal stimulus through aggressive infrastructure spending. That said, he was also skeptical of the positive effects of quantitative easing. At the margin, a Summers Fed would be more aggressive in unwinding quantitative easing than a Yellen Fed would. Yellen is perceived as even more dovish (that is, even less aggressive) than Ben Bernanke. For REITs like Annaly (NLY), American Capital (AGNC), Capstead (CMO), MFA Financial (MFA), and Hatteras (HTS), the net effect is a positive, as it’s more likely that the Fed would continue asset purchases—particularly of mortgage-backed securities. Even non-agency REITs would benefit, as this would mean more support for asset prices and lower borrowing costs.
Overall, a Yellen Fed is better for the REITs than a Summers Fed would be. This is an incremental positive, but rates are going up regardless of what happens with QE, and that is negative for the REITs. Don’t lose the forest for the trees. Look at the chart above. Interest rate cycles are long. Investors must respect the macro backdrop. You still want to focus on the REITs with exposure to adjustable-rate mortgages (think MFA and Hatteras) that have less leverage. The non-agency space—PennyMac (PMT) and Redwood Trust (RWT)—will continue to benefit more than the agency space, as they have credit exposure as well as interest rate exposure. This makes them less sensitive to rate increases than an Annaly or an American Capital and have upside with as the securitization market slowly returns.