Agency mortgage real estate investment trusts and other leveraged investors may face pressures to liquidate some of their mortgage-backed securities holdings, given the reliance on repo funding, analysts claim. 

Such pressures are due to the possibility of repo lenders tightening the terms and availability of funding. Such a deleveraging scenario could in fact create a ripple effect that extends to the boarder mortgage market, according to Fitch Ratings.

"The potential catalyst for agency MBS repo disruptions could be market-driven, such as a short term spike in interest rates or the disruption could be precipitated by increased risk aversion among repo lenders," explained Robert Grossman, managing director, and Martin Hansen, senior director for Fitch Ratings 

In any event, a repo market disruption could compel agency mREITs to liquidate some MBS holdings, given the fact that repos usually comprise about 90% of their liabilities, based on Fitch’s sample of five of the largest agency mREITs. 

Agency mREITs rely on repo funding from banks – that in turn borrow through the triparty repo market. 

Furthermore, money market funds, known for being short-term risk-averse investors, are major repo lenders to banks within the triparty market.

As a result, mREITs were compelled to deleverage and liquidate some of their MBS holdings – this selling pressure could affect MBS pricing, Fitch noted.

For example, recent research by the Federal Reserve Bank of New York indicated that a one-day liquidation of more than $4 billion in agency MBS could drive price declines.

Thus, a repo funding disruption in which leveraged MBS investors need to liquidate some of their holdings could create negative effects for the $6.7 trillion agency MBS market more broadly, according to Fitch. 

Major holders include commercial banks, with more than $1.3 trillion in agency MBS as of March 2013, the report concluded.