October 3, 2011
I would call myself an average investor, and I have invested in a number of publicly-traded mortgage REITs over the last few years, including Annaly Capital Management, Chimera Investment Corporation, American Capital Agency Corporation, and Invesco Mortgage Capital. My experience has generally been positive. I wanted to submit a few thoughts from the average investor's perspective for consideration by the Commission:
1. While current interest rates give paltry returns on savings accounts and CDs, these low rates are generally positive for REIT earnings. Moreover, REITs are required by the IRS to pay substantially all of their earnings to shareholders as dividends. Consequently, many mortgage REITs, including the ones referenced above, currently have dividend yields in the 10-20% range. This is a godsend to income-seeking investors, especially given that interest earned on bank deposit accounts is currently so miniscule. Dividends of this magnitude are simply not available with other types of investment vehicles, with the possible exception of master limited partnerships.
2. To generate significant return on equity and the attractive dividend yields mentioned above, it is necessary for these REITs to employ large amounts of leverage. This is one possible difference between mortgage REITs and other types of investment vehicles regulated by the Investment Company Act. Without the ability to employ significant leverage, the dividend yields would likely be many times smaller and offer much less appeal to investors.
3. For agency mortgage-backed securities, both the principal and interest are explicitly or implicitly guaranteed by the United States Government. Thus, REITs that hold mainly agency paper pose significantly less risk to investors than many other types of investments, even though these REITs must employ significant leverage to generate attractive returns. The relative safety of agency mortgage-backed securities compared to other investments is another possible distinguishing factor to justify special treatment for REITs. Also, although such REITs still pose greater risk to investors than FDIC-insured bank accounts or money market funds, the REITs I have invested in are generally very good at disclosing these risks in their publications and websites.
The bottom line is that the business model of mortgage REITs is unique in a number of ways. This is something I am sure the REITs themselves will discuss in greater detail in response to the Commission's solicitation for comments. These mortgage REITs offer a unique option to investors for the reasons I discussed above. While investors debate the merits of these REITs as investments, I doubt very many investors would like to be deprived of the option. Also, while protection of investors is very important, the Commission should be mindful of unintended consequences of regulatory change. A change in regulatory status that forced existing REITs to de-leverage would likely cause the share prices of these REITs to drop significantly and harm some of the very investors the Commission is supposed to be protecting. Thus, while clarity on the scope of the Section 3(c)(5)(C) exemption would be welcome, the Commission should be loath to disturb the settled expectations of both the REITs and their investors.