Repurchase Agreement

What is a repurchase agreement?

A repurchase agreement, usually called a repo, is short-term secured financing. One party transfers securities to a lender for cash and agrees to buy them back later at a higher price. The difference between the two prices represents the financing cost.

How mortgage REITs use repo

Mortgage REITs often use repo agreements to finance mortgage-backed securities. The securities serve as collateral. The lender usually advances less than the full market value of that collateral. The difference is called a haircut and provides the lender with a cushion.

Repo agreements are commonly short term, so they must be renewed or replaced. The borrowing rate, haircut, available counterparties, and value of the pledged assets can all change. If collateral values fall, the lender may require more cash or securities. That request is a margin call.

A simple example

A mortgage REIT transfers $100 million of mortgage-backed securities to a lender and receives $96 million in cash. The $4 million difference is the haircut. If the securities fall in value, the lender may ask the REIT to provide additional collateral or repay part of the borrowing.

The Fly High perspective

Fly High follows repo costs and liquidity because they can affect the company-specific earnings measure and dividend coverage. We do not turn repo risk into a separate mandatory score. The central question is how the financing changes sustainable earning power and the support for the dividend.

This article is for general education. It is not personal investment advice or a recommendation to buy or sell any security.