Weekly Series: mREIT And BDC Recommendations (And Price Targets) As Of 08/13/2023

Hi subscribers.

Within the “New Commentary and Images” section, you’ll find brief summaries of what happened for fundamentals over the last week. Then you’ll find charts and tables covering all the major developments.

This article is a joint effort between CWMF and Scott Kennedy.

Who Does What?

Scott provides full coverage for:

• 20 Mortgage REIT common stocks

• 15 BDC common stocks

For each stock that includes:

• Research and data

• Modeling projected book values / net asset values (BV/NAV)

• Setting common stock recommendation ranges (targets / ratings)

• Answering a few questions on the stocks

Colorado (“CO” / “CWMF”) Wealth Management Fund provides coverage on:

• Equity REIT common stocks

• Mortgage REIT preferred stocks

• Introductory articles for relevant concepts

• Macroeconomic trends

Layout

The rest of this article is split into two major categories:

1. New commentary & images for this week. (Pretty fast)

2. Repeated sections (linked for the moment, as we revise the method for including them). 

You’ll know you’ve hit the repeated section. It has a pretty obvious image. With that said. Let’s get into the article. 

A Few Notes from Scott

Positions: No new or sold positions this week.

BDC Weekly Change: NAVs relatively unchanged. Spreads were relatively unchanged. 

Other Comments: It was just a very quiet week in high yield/speculative-grade debt.

Underlying Portfolio Company Credit Changes Held by BDCs (Weekly): 0 downgrades + 0 upgrades.  That said, many downgrades to regional banks occurred (outside the BDC space).

Underlying Portfolio Company Credit Changes Held by BDCs (Current Quarter-to-Date):

This is a running tally of the credit upgrades and downgrades for companies held by each BDC.

ARCC: 2 Down

OCSL: 1 Down

FSK: 1 Up, 1 Down

MAIN: 1 Up

PSEC: 3 Up (Includes 1 Restructuring), (1) Down

GBDC: 1 Down

SLRC: 1 Down

TCPC: 1 Up

OBDC: 1 Up

TPVG: 1 Declared Bankruptcy

Underlying Portfolio Company Credit Changes Held by BDCs (Prior Quarter):

This is a running tally of the credit upgrades and downgrades for companies held by each BDC.

ARCC: 2 Up (1 Solely Unfunded Commitment), (2) Down

CSWC: 1 Up, (1) Down

FSK: (2) Down (1 Portfolio Company Double Downgrade + Declared Bankruptcy)

MAIN 1 Up, (1) Down

OCSL: (1) Down

OBDC: (4) Down, 1 Up

SLRC: (1) Down 

PFLT: (1) Down

PSEC: (4) Down (Already Anticipated Hence Our Prior Recommendation Range and Risk Rating Downgrade Back in May; Prior To The Actual Credit Downgrades)

TCPC: (1) Down

TPVG: 3 Declared Bankruptcies

View: Same as last week. - Continuing the June - July 2023 trend, the market remains “cautiously optimistic” on high yield debt/speculative-grade credit.  Spreads remain resilient as the market continues to “grapple” between plateauing short-term interest rates and economic uncertainty (typically impacting the longer-end of the yield curve).  Still expect an eventual mild recession to pressure NAVs late 2023 - early 2024. Factored into price-to-book targets. Spreads will likely widen beginning in late summer - fall 2023. Still tight relative to history. 

MREIT Weekly Change: Most BVs continued to decrease (outside any applicable earnings-related true up (down) CURRENT BV adjustments).  The declines were less severe versus the prior week.  Agency mREITs who had lower-coupon agency MBS and derivative instruments with a longer tenor-maturity were most negatively impacted.    

Other comments:  With their higher durations, agency mREITs, as a whole,  experienced the largest weekly BV decreases (percentage-wise).  Agency MBS pricing experienced a  modest - notable decrease (including basically all specified pools; HARP and LLB loans).  Derivative instruments slightly - moderately increased in valuations.  Simply put, the vast majority of spread relationships (I/we track over 100+ combinations) slightly - modestly widened.  While not there yet, we are approaching October 2022 spread/basis widening levels in most relationships.  I expect spread/basis risk to begin gradually subsiding in the coming weeks.   Repo financing was relatively unchanged during the week (markets anticipate an unchanged Fed Funds Rate at the September 2023 meeting).  The rate of financing cost acceleration has slowed over recent weeks (which was previously correctly anticipated).  

View: Same as last week. Most agency mREITs likely remain in common share issuance mode (rebuild capital as MBS pricing remains historically attractive).  MSR valuations have likely recently peaked but remain elevated versus historical trends.  I/We do not anticipate a notable drop in MSR valuations over the foreseeable future (especially on lower coupons).  Repo financing rates should peak in late 2023.  Agency net interest spreads (excluding current period hedging income) are slightly - modestly negative.  However, dependent on the utilization of interest rate payer swaps, adjusted net interest spreads remain attractive/acceptable for most peers (though will continue to slightly - modestly decrease over the next several quarters).  Net interest spreads will continue moving lower during the second half of 2023 and will likely “bottom out” towards year-end.  Then, a slow, gradual increase will likely begin in early 2024.  There will continue to be pressure in commercial whole loan pricing/valuations, especially in office loans. Simply put, continued credit/recession risk. However, there continues to be a bright spot for industrial loans (especially with the notion of a possible “soft landing” for the economy as a whole). Could even throw hospitality and retail loans in that mix (certainly better than the COVID-19 trends) but isolated credit events will occur in these sub-sector as well.  This included updated modeling in late June 2023 of all 3 sub-sector peer’s peak non-accrual rate this credit cycle towards the high end of my/our previous range.  This negatively impacted per share recommendation ranges a bit back in late June 2023.  ACRE, BXMT, and GPMT will continue to have heightened monitoring regarding asset/loan resolution within the office sub-sector and all other troubled loans.  As the risk ratings indicate, BXMT should come out of this credit cycle the least harmed out of the 3 covered sub-sector peers.  This notion was only solidified after fully analyzing BXMT’s Q2 2023 earnings results in late July 2023.  This should be followed by ACRE and then GPMT.  At GPMT’s level of discount to estimated CURRENT BV, subscribers should be eyeing/hoping for an eventual acquisition/merger by a 3rd party.  Similar to AAIC, this will likely take some time (especially for this specific sub-sector; likely not until 2024) so subscribers have to be patient with GPMT’s prospects. As a reminder for subscribers, each company's earnings assessment article (linked in the tables deeper in this article) takes a deeper dive into a company's investments/sub-portfolio trends.  Refer to those articles for company-specific details.   

A Few Notes from CWMF

Positions: No change.

Commentary: Still checking in for opportunities to swap between preferred shares occasionally. I’ll have a preference for buying fixed-to-floating shares in any trade, though going between two fixed-rate shares is still possible. I may also look to close out any preferred shares that significantly outperformed peers over the last 1 to 3 months. Just looking for that bit of extra alpha. I might park a little cash in RCC (RCC). Baby bonds with a maturity in under 3 years could be a fine choice. 

Mostly I’ll be working on a few updates for members. Based on reader feedback, I’ll be working on an update for W.P. Carey (WPC) followed by Realty Income (O). 

Weekly Recommendations

The mREITs:

The BDCs: