BXMT, NLY, RITM, and ARR Q3 2023 Updates by Scott Kennedy

Introduction section by Colorado Wealth Management Fund.

Article section by Scott Kennedy.

There are four articles contained in this post. They are earnings updates for:

1. Blackstone Mortgage (BXMT)

2. Annaly Capital Management (NLY)

3. Rithm Capital (RITM)

4. ARMOUR Residential REIT (ARR)

They will be presented in that order.

Each update is designed to serve as a stand-alone article, but I’m packing them all into one e-mail for simplicity. Consequently, if you decide to read all 3, you’ll notice some repetitive parts. If you’re only interested in one or two, you’ll be able to skip the other.

We may modify this layout in the future based on reader feedback. Specifically, sections about the process may be rolled into one article and linked. That will keep the information accessible while removing repetition for frequent readers.

Bringing More of Scott’s Work to Our Website

The REIT Forum is a service produced by Michael Vanloon (better known as Colorado Wealth Management Fund) and Scott Kennedy. After intense consideration, I decided to launch our service through Substack. Since then, we’ve seen great success. Substack enables us to give readers real-time alerts with entire articles delivered directly to their inboxes.

You’re probably used to seeing the “from” field saying: “ColoradoWealthManagementFund from The REIT Forum”.

In some of our future e-mails, it may say:

“Scott Kennedy from The REIT Forum”.

That will simply mean we’ve updated the backend of the website for Scott Kennedy to directly post his articles.

I want to make browsing our work as simple as possible for readers. This will be another step in that direction.

For the moment, I’ll be posting Scott’s work. The following articles are a direct copy and paste from Scott. While we get the back end set up, there is a delay in getting the articles posted. Rest assured that it should be solved soon.

Finding Our Positions

I posted a subscriber-exclusive article with links to our Google Sheets. You can always access our positions there. Scott’s positions are updated each week. CWMF’s positions are usually updated on the same day as the trade.

Sharing Article 1 & 2 for All

I’ll include the first 2 articles, BXMT and NLY, before we swap over the exclusive section for RITM and ARR.

Updating Book Value and Targets

Sunday or Monday, there will be another article for subscribers with updated price targets that include all the latest data as of Friday’s close. For agency mortgage REITs, book values have been moving significantly. Please be advised that the values are changing constantly, and targets are updated each week.

That update (the weekly series) will have more recent data (estimated book value and targets) than the earnings update below. That is simply because the weekly update will have Friday’s moves in the bond market included in the projections.

Our weekly series also includes a recap of how each REIT and BDC is doing relative to the projections so investors can see at a glance how each stock performed. It also includes dividend projections throughout the sector for the next quarter.

As a reminder, we just launched a referral program. Our referral program makes it really easy to earn a month of complimentary access.

The rest of this post is from Scott Kennedy.

Introduction:

Hi subscribers. For new members, my name is Scott Kennedy and currently I fully cover 20 mortgage real estate investment trust (mREIT) and 15 business development company (“BDC”) common stocks within this Investing Group regarding research/data, subscriber questions, weekly projected book values/net asset values (BV/NAV), and common stock recommendation ranges. Colorado (“CO”) Wealth Management handles the mREIT preferred stocks and he and his team handles all other applicable REIT sectors outside the mREIT sector. CO also provides some mREIT common stock and BDC articles from time-to-time which are more of an “overview/introduction” discussion; typically based either on my or our combined research/data. This also includes some macroeconomic trends and data. My name is always attached to all Investing Group articles I personally wrote so there is no confusion for subscribers.

This REIT Forum article is part of a series of articles over a span of 6-7 weeks which will analyze my previously projected BV/NAV and core earnings (or core earnings equivalent)/net investment income (“NII”) figures and compare these metrics to each mREIT’s and BDC’s actual reported results, respectively. For readers who are familiar with my public mREIT and/or BDC articles, these types of articles are beneficial to readers who desire to pursue a more active investing strategy and/or want more “real time” thoughts/analysis.

I hope my services/contributions ultimately help enhance a subscriber’s total investment returns or minimize their total investment losses within the mREIT and BDC sectors. At the very least, I hope subscribers will gain more insight into the mREIT and BDC sectors by reading my/our exclusive REIT Forum articles.

Article #1: Scott Kennedy’s mREIT Earnings Series: Assessing Blackstone Mortgage’s Performance For Q3 2023

BXMT’s BV and Core Earnings Q3 2023 Performance (Projected Versus Actual Results):

On 10/25/2023, Blackstone Mortgage Trust Inc. (BXMT) reported the company’s earnings results for the third quarter of 2023. Table 1 below provides BXMT’s BV and earnings summary.

Table 1 – BXMT Q3 2023 BV and Earnings Summary

Source: Taken Directly from the REIT Forum’s © Analytical Spreadsheets/Data

BXMT reported a BV as of 9/30/2023 of $25.90 per share (1.5% decrease) versus my prior projection of $25.90 per share (1.5% decrease). This is an exact match (no variance) and was well within my $25.20 - $26.60 per share range. In a nutshell, BXMT recorded extremely similar quarterly loss reserves and valuation fluctuations within the company’s investment portfolio when compared to my expectations.

First, let us discuss BXMT’s quarterly loss reserves. As noted throughout the quarter to subscribers in chat/comments, I correctly anticipated BXMT would increase the company’s current expected credit loss (CECL; just a fancier way of stating loan impairments/loss reserves) during the quarter on its investment portfolio. I also correctly anticipated the severity of BXMT’s CECL increase would be larger when compared to the prior quarter. Again, regarding setting an appropriate CECL, a very high degree of managerial judgement occurs/specialized expertise is needed. All of BXMT’s commercial whole loans are level 3 assets per Accounting Standards Codification (“ASC”) 820. Simply put, there is not a widespread, active marketplace for commercial whole loan pricing/valuations as each mortgage (and underlying collateral) is unique. This makes setting valuations difficult; especially pertaining to impairment testing. With overall deteriorating credit conditions within commercial real estate (especially the office sub-sector), BXMT increased the company’s total credit reserves by $100 million during the third quarter of 2023. In comparison, I projected an $85 - $115 million BXMT CECL reserve increase for the second third quarter of 2023 (mean increase of $100 million). This correctly assumed a modest decrease in BXMT’s overall investment portfolio size during the third quarter of 2023. When calculated, BXMT’s CECL reserve increase, when compared to my expectations, directly led to no BV variance this quarter.

Second, let us discuss BXMT’s quarterly investment portfolio valuation fluctuations when compared to my expectations. Outside the CECL reserve, BXMT’s commercial whole loan investment portfolio experienced a FMV decrease of (0.58%) during the third quarter of 2023. In comparison, I anticipated a FMV decrease of (0.65%) – (0.45%) (mean decrease of (0.55%)). When calculated, this slightly less favorable investment portfolio FMV fluctuation (versus my expectations) directly led to a BV underperformance of ($4) million or ($0.03) per share.

When the 2 variances noted above are combined, along with a core earnings outperformance of $0.027 per share (which will be discussed next) and de minimis equity activity, this directly calculates to BXMT’s BV exactly matching my expectations.

Regarding credit metrics, BXMT continued to keep 1 NY hotel loan, 1 DC office loan, 1 CA office loan, 2 NY office loans, and 1 FL office loan on non-accrual status as of 9/30/2023 when compared to 6/30/2023. As noted in prior BXMT earnings chat notes, I previously stated I expected additional credit risk/portfolio stress/non-accruals as 2023 progressed. This especially held true within the office subs-sector. This came to fruition during the third quarter of 2023. BXMT reported 2 CA office loans and 1 NY office loan were placed on non-accrual status during the third quarter of 2023. These specific loans were previously correctly identified as having extremely heightened credit risk. As such, these new non-accruals were not a surprise. These loans had a total principal balance of $305 million as of 9/30/2023.

BXMT’s non-performing/non-accrual loans increased from 4.34% of the fair market value (“FMV”) of the company’s investment portfolio balance as of 6/30/2023 to 5.81% as of 9/30/2023. In comparison, I projected a non-accrual FMV percentage as of 9/30/2023 of 5.50% - 6.50% (mean of 6.00%). As noted last quarter, I continue to believe non-accruals will experience at least a modest “uptick” during 2023 – the first half of 2024. We already began to see this occur during BXMT’s third quarter of 2023. Again, this is already “baked” into my/our sub-sector modeling, percentage recommendation ranges, and risk ratings.

Moving on, BXMT’s core earnings/earnings available for distribution (“EAD”) of $0.777 per share for the third quarter of 2023 was a minor outperformance versus my prior projection of $0.750 per share. BXMT’s core earnings/EAD was $0.794 per share for the second quarter of 2023. As such, I projected a core earnings/EAD decrease of ($0.044) per share. In actuality, BXMT reported a core earnings/EAD decrease of ($0.017) per share. The institutional analysts’ consensus average for BXMT’s core earnings/EAD was $0.701 per share for the third quarter of 2023. Even though LIBOR/SOFR/PRIME continued to net increase during the third quarter of 2023, I previously highlighted to subscribers last quarter that BXMT’s core earnings/EAD would likely be negatively impacted by a continued decreasing investment portfolio size and rise in non-accruals. As such, let us “hone in” on these 2 key metrics.

First, as of 6/30/2023, BXMT’s investment portfolio had a FMV of $24.1 billion. As of 9/30/2023, BXMT’s investment portfolio had a FMV of $23.3 billion. When calculated, this was a quarterly decrease of ($767) million. In comparison, I projected BXMT’s investment portfolio would decrease ($850) – ($750) million (mean decrease of ($800) million) during the third quarter of 2023. When calculated, BXMT reported a $33 million larger investment portfolio size as of 9/30/2023 when compared to my expectations. When calculated, based on BXMT’s weighted average quarterly yield plus the applicable 1-month LIBOR/SOFR/PRIME spread (including impacts of foreign currencies and their underlying hedges that combat this risk), this directly led to a core earnings outperformance of $0.006 per share when compared to my expectations.

Second, as noted earlier, BXMT added loans with a total principal balance of $305 million to the company’s non-accrual status during the third quarter of 2023. In comparison, I projected BXMT would add loans with a total principal balance of $350 million. 1 loan that not was not put on non-accrual status this quarter was (and currently is) a “risk rating 4” hospitality loan. Simply put, a positive quarterly event/outcome (not being place on non-accrual status during the third quarter of 2023). However, I expect this specific loan will eventually be placed on non-accrual status during the fourth quarter of 2023 – early 2024 so this is more of a timing issue. When calculated, based on this specific loan’s weighted average quarterly yield plus the applicable 1-month LIBOR/SOFR/PRIME spread, this directly led to a core earnings outperformance of $0.021 per share when compared to my expectations (no offsetting interest expense impact as non-accrual loans technically still are collateral for financing).

When the 2 variances noted above are combined, this fully reconciles to BXMT’s core earnings outperformance of $0.027 per common share during the third quarter of 2023 when compared to my expectations.

So, all-in-all, an exact match on BXMT’s BV (variance of 0.0%) and a minor outperformance on the company’s core earnings (variance of $0.027 per share). As anticipated, a bit of a “cautious” quarter from BXMT on overall investment portfolio health. Not a horrific quarter but not a great quarter either. Again, a rise in credit/recessionary risk has already been “baked” into the modeling for quite some time now.

When taking BXMT’s recent and projected performance into consideration, along with macroeconomic trends/events (mainly Fed monetary policy, the general projected movement of rates/yields, and projected economic performance over the foreseeable future), no change to my/our BXMT percentage recommendation ranges (relative to CURRENT BV) or risk rating (remains at a 3.5).

At a closing price as of 10/25/2023 of $19.69 per share, BXMT is deemed to be UNDERVALUED/a BUY recommendation (price target of $26.40 per share). As such, BXMT has some good value at or around current pricing. However, cautious subscribers may want to wait until more market participants believe it is safer to invest in commercial real estate as a whole. I currently believe, in a couple years, BXMT’s stock price will be higher than its current per share amount (especially with the recent move lower). However, it will likely be a “bumpy/see-sawing” road over the next couple of quarters. As continuously pointed out in the chat feature of this service, subscribers need to have patience for cycles/trends/catalysts to play out. For the commercial whole loan mREIT sub-sector (ACRE, BXMT, GPMT), this is still going to take some time (very likely not until 2024).

Article #2: Scott Kennedy’s mREIT Earnings Series: Assessing Annaly Capital Management’s Performance For Q3 2023

2) NLY’s BV and Core Earnings Q3 2023 Performance (Projected Versus Actual Results):

On 10/25/2023, Annaly Capital Management Inc. (NLY) reported the company’s earnings results for the third quarter of 2023. Table 2 below provides NLY’s BV and earnings summary.

Table 2 – NLY Q3 2023 BV and Earnings Summary

Source: Taken Directly from the REIT Forum’s © Analytical Spreadsheets/Data

NLY reported a BV as of 9/30/2023 of $18.25 per common share (12.0% decrease) versus my prior projection of $18.35 per common share (11.5% decrease). I consider this basically an exact match (at or within a 0.5% variance) and was well within my $17.75 - $18.95 per common share range.

I would just point out the extreme volatility, especially for the agency mREIT model, during the third quarter of 2023. BVs notably decreased during September 2023 (some peers in excess of 12%). In my personal opinion, any quarterly BV variance at or within 4% this particular quarter should really be considered an accurate estimate (larger “cone” per se). So, only a (0.5%) quarterly BV variance should be considered extremely accurate. In addition, as a reminder, the current subscriber spreadsheets are based on CURRENT BVs. For example, currently each company’s BV estimate as of 10/20/2023. In this chat note, I am comparing 9/30/2023 BV projections versus actual results. Something to mention for newer subscribers. Even though this was an extremely accurate BV projection, let me provide a reconciliation.

First, when reviewing NLY’s mortgage-backed securities (“MBS”)/investment sub-portfolio, there really were no notable surprises that “sprung up”. On top of the anticipated minor on-balance sheet agency MBS “run-off”, NLY continued to increase the company’s non-agency MBS/residential whole loan/securitized and mortgage servicing rights (“MSR”) sub-portfolios. All this was correctly anticipated. NLY’s total on-balance sheet MBS/investment portfolio decreased less than (1%) during the third quarter of 2023 when based on fair market value (“FMV”) fluctuations. In comparison, knowing NLY did not perform any bulk equity offerings during the quarter, I projected a total on-balance sheet MBS/investment portfolio mean fluctuation of 0%. As such, basically an exact match. When combined, NLY reported a MBS/investment net valuation loss of ($3.00) billion during the third quarter of 2023. In comparison, I projected a MBS/investment net valuation loss of ($2.98) billion. When calculated, this ($24) million variance directly led to a BV underperformance of only ($0.04) per common share.

Second, when reviewing NLY’s derivative instruments sub-portfolio, the company’s quarterly valuation fluctuations also basically matched my expectations. This was mainly due to the fact NLY continued to be cautious regarding the company’s off-balance sheet net long “to-be-announced” (“TBA”) MBS position while adding more net (short) U.S. Treasury futures during the third quarter of 2023. As such, NLY’s hedging coverage ratio increased from 109% as of 6/30/2023 to 115% as of 9/30/2023. An increased hedging coverage ratio was correctly anticipated. When combined, NLY reported a derivatives net valuation gain of $2.13 billion during the third quarter of 2023. In comparison, I projected a derivatives net valuation gain of $2.15 billion. When calculated, this ($23) million variance directly led to a BV underperformance of only ($0.04) per common share.

When the 2 variances noted above are combined, along with a normalized core earnings/earnings available for distribution (NCE/EAD) underperformance of ($0.017) per common share (which will be discussed next) and de minimis equity activity, this fully reconciles to NLY’s BV underperformance of ($0.10) per common share when compared to my expectations.

Moving on, NLY’s NCE/EAD of $0.658 per common share for the third quarter of 2023 was a very minor - minor underperformance versus my prior projection of $0.675 per common share (range $0.625 - $0.725 per share). NLY’s NCE/EAD was $0.719 per common share for the second quarter of 2023. As such, I projected a NCE/EAD decrease of ($0.044) per common share. In actuality, NLY reported a NCE/EAD decrease of ($0.061) per common share. The institutional analysts’ consensus average was NCE/EAD of $0.688 per common share for the third quarter of 2023.

First, as discussed earlier, NLY continued to suppress the utilization of net long TBA MBS. This actually resulted in a very minor amount of net dollar roll (“NDR”) expense. NLY reported a NDR expense of ($1) million during the third quarter of 2023. In comparison, I projected NDR income of $2 million. As noted last quarter, dollar roll “specialness” has really dried up during 2023 as demand for generic MBS has waned (mainly due to rapidly rising mortgage interest rates/U.S. Treasury yields). When calculated, this ($3) million variance directly led to a NCE/EAD underperformance of ($0.006) per common share.

Second, NLY slightly decreased the company’s interest rate payer swaps during the third quarter of 2023 (a minor amount of swaps matured). I assumed NLY would add a very minor amount of new swaps towards the longer-end of the yield curve but this did not occur. As such, a very slightly lower notional balance of interest rate payer swaps directly resulted in a slightly lower amount of current period hedging income when compared to my expectations. NLY reported current period interest income from interest rate swaps of $395 million during the third quarter of 2023. In comparison, I projected current period interest income from interest rate swaps of $405 million. When calculated, this ($10) million variance directly led to a NCE/EAD underperformance of ($0.021) per common share.

When the 2 variances noted above are combined, along with a remaining NCE/EAD net outperformance of $0.010 per common share deemed immaterial for discussion (various reconciling items), this fully reconciles to NLY’s NCE/EAD underperformance of ($0.017) per common share during the third quarter of 2023 when compared to my expectations.

So, all-in-all, basically an exact match on NLY’s BV (variance of only 0.5%) and a very minor - minor underperformance on the company’s NCE/EAD (variance of only $0.017 per share). Regarding NLY’s dividend sustainability, I continue to believe there is low risk regarding a reduction for fourth quarter of 2023. NLY recently had a large “reset” to a rate that management believes can be sustained over the foreseeable future. I continue to believe we are nearing a “trough/low point” regarding sub-sector core earnings/EAD (late 2023 – early 2024).

When taking NLY’s recent and projected performance into consideration, along with macroeconomic trends/events (mainly Fed monetary policy, the general projected movement of rates/yields, and projected economic performance over the foreseeable future), no change to my/our NLY percentage recommendation ranges (relative to CURRENT BV) or risk rating (remains at a 3.5). When compared to sub-sector peers, I/we correctly projected NLY would record a less severe quarterly BV reduction (a positive catalyst/trend). However, I/we also correctly projected NLY’s quarterly NCE/EAD decrease would be more severe (a negative catalyst/trend).

At a closing price as of 10/25/2023 of $15.07 per share, NLY is deemed to be APPROPRIATELY VALUED/a HOLD recommendation (price target of $16.70 per share). However, close to the start of my/our BUY recommendation range. As such, currently not “great” value but not “horrible” either. NLY is beginning to show a bit of value when compared to the prior several months. However, before I even consider an investment in this sub-sector based on valuation, I want to see some spread stabilization that lasts more than a week - a couple weeks. Very important to understand.

RITM and ARR will be in the exclusive section for paid members below.