Last year brought a spate of initial public offerings of residential mortgage real estate investment trusts, but 1998 may usher in a slowdown.
REITs use investor capital to purchase mortgages or properties, and can pay out handsomely in part because they are not required to pay corporate federal income taxes.
In all, eight residential mortgage REITs went public in 1997, almost doubling the number of players in the market. There are "at least five" different mortgage REITs with initial offers pending, said Craig Peckham, analyst at Bear Stearns.
But faced with a wary investment community, some REITs have delayed their initial offerings, or raised less capital than they had planned. Apex Mortgage Capital Inc., for example, hit the street at $14 on Dec. 4, about one-third of the anticipated price.
"There are a lot of portfolio managers who are have become more cautious," Mr. Peckham said. "There are a number of deals in the pipeline that have been put on hold."
Rising prepayment rates have made the performance of REITs more risky, investors say, and the rock-like drop of a highly touted REIT stock in mid- 1997 has made them distrustful.
"I'm not wild about the group," said Samuel A. Lieber, portfolio manager for Evergreen U.S. Real Estate Equity Funds, a Purchase, N.Y., fund. "If rates go down, prepays go up . . . my gut is that unless they have figured out very good hedging strategies, this could be a difficult time."
REITs that specialize in purchasing residual, or "B" pieces, from mortgage-backed securities pose a particularly high risk, Mr. Lieber noted, especially those that are buying from a sponsor company. "If these (purchases) are being packed and priced by Wall Street then it's competitive, but if the sponsor is pricing for its subsidiary, the potential for a conflict of interest is huge," he said.
Judging from their stock performance, REITs that went public in 1997 have had their share of problems. Only Ocwen Asset Investment Corp. and Hanover Capital Mortgage Holdings were trading above their IPO price by yearend, up 12.33% and 0.76%, respectively.
Ocwen Asset Investment Corp. was spun out of distressed asset manager Ocwen Financial Corp. in May. As of Dec. 31, the West Palm Beach, Fla.- based corporation had built up $288 million in assets.
Most recently, the firm announced an agreement with subprime lender Aames Financial Corp. to purchase up to $600 million in residuals this year. Buyers for such residuals are expected to be in high demand in the future, as subprime mortgage companies look to transfer earnings off their balance sheets to become cash-flow positive.
Hanover Capital Mortgage Holdings, a New York-based subprime mortgage purchaser, was next out of the gate with an IPO on Sept. 6. The company also offers due diligence services to other mortgage portfolio buyers and sellers.
Redwood Trust Inc., Mill Valley, Calif., was the sectorwide loser. The company has lost almost half its value, falling from a high of $57.125 on May 30 to a yearend price of $20.375. The company announced in March that rising interest rates were hurting spreads, and investors began to sell out.
Most of the newcomers have one thing in common, Mr. Peckham said-they all specialize in a fringe sector of the mortgage market. "Low documentation, subprime, ... they are all trying to carve out little niches for themselves."
Laser Mortgage Management Inc. is one of the most recent out of the box, with an IPO on Nov. 26 at $14.50 a share. As of Monday, it was trading at $15.625. Mr. Peckham initiated coverage of the company with a "buy" rating, citing its management's expertise and the company's niche.
Most residential mortgage REITs that purchase mortgage backed securities choose adjustable-rate product, Mr. Peckham said, while Laser is specializing in fixed-rate loans. "Prepayment rates on fixed-rate loans are better understood," he said.
