In my last post titled “I’m Back. Markets Are Not.”, I spoke about how repo market liquidity was drying up and why it would impact counterparties that rely on the market for financing. In the post, I used mREITs as an example of how dire the situation had become, as investors began dumping their shares hand over fist in an effort to get ahead of any possible solvency issues:
“The equity market is essentially looking at these companies and saying, “Yeah, we’re gonna wake up one morning and one of these guys won’t be able to open for business” (read: bankruptcy). If the repo market completely dries up, there will be another Bear / Lehman event. The banking business is entirely built upon borrowing short to lend long, so any material interruption in that business model will prove absolutely fatal for some of the more highly-leveraged financial institutions.”
As of 6:30am ET this morning, we received our first look into how bad it had really become. AG Mortgage Investment Trust (NYSE: MITT), a publicly traded hybrid mREIT managed by Angelo Gordon, filed an 8-K stating that they had missed posting collateral Friday evening for their margins calls, and that they do not expect to be able to meet expected margin calls later this week. As a result, they’ve entered into discussions with their financing counterparties on forbearance agreements in order to avoid triggering a technical default under their current financing agreements. MITT’s stock cratered, both common (-38%) and all classes of preferreds (-66%). The only reason the common wasn’t down in tandem is because it had gotten absolutely massacred as of late, but pref investors up until now thought they may be spared from the carnage of dividends cuts / suspensions.
It’s hard to say what exactly is happening at MITT, but I think I have a pretty good idea so I’ll take a stab at it. MITT has an investment portfolio of $4.3B, but only $3.4B is comprised of relatively liquid mortgage securities. The rest of their portfolio is made up of illiquid whole loans, commercial loans and investments in affiliate entities (and very, very little cash). Alongside those investment assets, MITT has $3.5B in current financing arrangements. In and of itself, this isn’t a problem – MITT’s business model is to utilize leverage in order to juice returns for their investors. The problem is that the market for mortgage securities is, to put it nicely, in a state of uncertainty. Investors are worried that in light of the COVID-19 pandemic, mortgages will not be getting paid – which would impair the mortgage bonds that MITT owns and effectively eliminate the bid for the bonds in the open market. As a result, investors are dumping the bonds and as the value of the bonds decline, MITT’s financing counterparties are demanding they post more collateral to support their positions.
Enter the negative feedback loop. What I believe is likely happening to MITT is simple: (i) the value of the bonds they own decline; (ii) they’re required to post additional collateral; (iii) they become a forced seller of the bonds to raise cash at whatever respectable bid they can find; (iv) forced selling at buyer-friendly prices leads to larger bond price declines; and (v) MITT is now required to post more collateral. Trying to sell securities into a down market that’s experiencing liquidity issues in an effort to cover margin calls will usually result in one thing: insolvency. If they can’t convince a large majority of their counterparties to enter forbearance agreements, it will likely be impossible for MITT to liquidate assets in an orderly manner to fulfill immediate repayment obligations. Barring some sort of miracle, MITT is essentially toast.
I don’t want to pick on MITT though, because they’re not the only one going through this (and they won’t be the last). This evening, New York Mortgage Trust (NYSE: NYMT) issued a press release stating that they too were unable to meet margin calls issued for today. As a result, they’ve preemptively suspended all dividends on common and preferred shares, likely diverting that cash to help shore up their collateral position. I suspect we’ll see more actions like these from competitors and, as a betting man, I’d put my money on Cherry Hill Mortgage Investment Corporation (NYSE: CHMI) to be the next shoe to drop.
The regrettable part about this mess is that to a large extent, these firms didn’t really do anything wrong. They acted within the manner they told investors they would, using leverage to finance the U.S. mortgage market. The bonds they hold aren’t dogshit like they were during the GFC, they’re just being adversely impacted by some black swan virus that threatens to decimate the global economy. That won’t matter, though, people will still peg them as reckless when shit hits the fan:
In any event, I think this whole thing is just getting started. The credit markets remain strained despite all of the help pledged by the Fed. The government is amazingly repeating the mistakes they made during the GFC by bitching and moaning about fiscal stimulus. Markets will likely continue to decline and the real economy will continue to bare the brunt of everything. As I see this all unfolding, I’m reminded of a great quote from everyone’s favorite Marxist, Lenin:
“There are decades where nothing happens, and there are weeks where decades happen.”
There is a chance we’re living through a few weeks that will define the next decade and beyond. The bankruptcies of some obscure mortgage funds won’t cause the next great financial upheaval, but they’re sure as hell trying to let you know that one is lurking around the corner.