Federal Reserve Bank of New York President William C. Dudley said in a speech to the Economic Club of New York this week that agency mortgage REITs “deserve ongoing attention,” from regulators, who “must continue to take steps to mitigate the vulnerability of the economy to a sharp rise in long-term rates” and look “outside the banking system because some risks reside elsewhere.” Dudley also cited the risk of large outflows from bond mutual funds.

Primary Regulators

Low rates pose risks that investors in every market must be prudent about managing, Wellington Denahan, chief executive officer of Annaly, which has about $133 billion in assets, said in an e-mail. The mortgage REIT sector in particular does so through the use of swaps, she said, referring to derivatives that can protect against changes in interest rates.

Unlike banks and insurers, mortgage REITs have no primary regulators. They aren’t subject to the Investment Company Act, which limits leverage.

American Capital uses 7 to 8 times leverage -- borrowing that much compared to its capital, according to RBC’s Arnold. “They are not sticking their neck way out,” he said.

When Kain was at Freddie Mac he ran a much larger portfolio that was levered around 50 to 1, said Merrill Ross, an analyst with Baltimore-based Wunderlich Securities Inc. That gave him experience with different methods of risk management than the ordinary public company or even hedge fund would be exposed to, she said.

“Most investors are less used to leverage; we were used to more,” Kain said. “That’s a key reason why we’ve been successful and why we’ve been using very different hedging techniques than our peers over the years.”

‘Huge Market’

American Capital’s growth also still dwarfs the overall market and the prior holdings of Fannie Mae and Freddie Mac, which had $1.8 trillion in assets on their balance sheets at their peak, according to Kain.

“This is a huge market and we’re not concerned about our size,” he said. “The REITs are a long, long way from what’s in the banking system or what was in the government sponsored enterprises.”

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