Hi subscribers.
We aim to retain the same layout from week to week.
Weekly Notes From CWMF
Positions: No trades over the last week. I’ll look for opportunities to do some swaps between preferred shares.
Commentary: My notes are much shorter because the first weekly article of a new quarter requires rolling over a bunch of spreadsheets. The mREIT prices were down a bit. The BDC prices were up a bit. Projected book value (or NAV) changes were mostly pretty small for the week. Despite checking over the images a few times, the first article after the quarterly update is still the one most prone to errors. Therefore, I have devised a brilliant two-step process:
If you spot something, post a comment on the article.
To see if anyone else spotted something, check the comments on the article.
This series usually includes images with the dividend projections. We already have the dividend projections, but the sheet I use for the images in this series isn’t ready yet.
Rather than skipping the section, I’ve included the images from Scott’s sector updates. That’s in the exclusive section at the bottom of the article.
Weekly Notes From Scott
Positions: No purchased or sold positions.
BDC Weekly Change: Continuing the recent trend, spreads were relatively unchanged. Weekly NAVs were largely stable.
BDC Other Comments: Similar to the prior 12 weeks, muted volatility in high yield/speculative-grade debt this week. Regarding weekly recommendation changes (mainly due to stock price and projected NAV changes), 2 upgrades/downgrades occurred. ARCC moved from UNDERVALUED/BUY to APPROPRIATELY VALUED/HOLD. GAIN moved from APPROPRIATELY VALUED/HOLD to OVERVALUED/SELL. Generally speaking, sector stock prices largely “matched” projected changes in weekly NAV fluctuations in most covered stocks. With the continued market rally, valuations within the BDC sector are remaining “pricey” in some names. Just something to consider at this point.
Underlying Portfolio Company Credit Changes Held by BDCs (Weekly): 1 downgrade, 0 upgrades
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.
TPVG: (1) Down (Large Investment [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: 1 Up (Small Investment), (1) Down (Small Investment)
FSK: (1) Down (Medium Joint Venture Investment)
MFIC: (1) Down (Small Investment)
OBDC: (2) Down (Medium Joint Venture Investment, Small Joint Venture Investment)
OCSL: (2) Down (Small Joint Venture Investment, Large Investment)
PFLT: (2) Down (Small Investment [Restructuring], Small Joint Venture Investment)
PSEC: (2) Down (Medium Investment, Large Investment)
SLRC: (1) Down (Very Small Investment)
TCPC: (1) Down (Medium Investment)
BDC View: Same as last week. - Continuing the June - December 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 in late 2024. This expectation is already factored into price-to-book targets. Spreads will likely begin widening during 2024. Still tight relative to history. Continuing to watch the broader/macroeconomic impacts from the recent end of the 3-year student loan repayment pause (due to COVID-19) in October 2023 (and any new updates regarding this event). I correctly assumed the potential government shutdown in mid-November 2023 would be averted. I/We will continue to monitor the recent developments in the mid-East (including all escalations to more of a regional war) and broader macroeconomic impacts in the United States regarding private debt/credit markets.
MREIT Weekly Change: For the 3rd straight week, most agency mREIT BVs slightly decreased during the week (slight variations peer-to-peer). This was mainly due to agency MBS spreads slightly widening relative to underlying net (short) hedges. Most hybrid mREITs experienced slightly decreasing weekly BVs while most originator + servicer and commercial whole loan mREITs had slightly increasing weekly BVs.
MREIT Other comments: Regarding weekly recommendation changes (mainly due to stock price and projected BV changes), 3 upgrades occurred. AGNC moved from NOTABLY OVERVALUED/STRONG SELL to OVERVALUED/SELL. RC moved from UNDERVALUED/BUY to NOTABLY UNDERVALUED/STRONG BUY. NLY moved from OVERVALUED/SELL to APPROPRIATELY VALUED/HOLD. EFC moved from APPROPRIATELY VALUED/HOLD to UNDERVALUED/BUY. This was mainly due to weekly stock price decreases “trumping” projected NAV changes.
Regarding weekly agency mREIT BV movements, most agency MBS coupons experienced modest price decreases (including basically all specified pools; mainly HARP and LLB loans). Most (short) derivative instrument valuations slightly - modestly increased. Simply put, the vast majority of spread relationships I/we track (over 100 combinations) slightly widened.
There was a recent discussion in chat regarding RITM’s projected BV decrease during Q4 2023. Yes, it is going to be an underperforming quarter for RITM on the BV. That said, I DON'T see another quarterly 100 basis points (“bps”) move lower in mortgage interest rates/long-term U.S. Treasury yields occurring anytime soon (like we saw during Q4 2023). If anything, a slight-modest move higher to counter the very quick move lower in rates/yields. So, more of a "one-off" for Q4 2023 on the BV (which shouldn't be a surprise; have continued to highlight/point out).
MREIT View: Same as last week. Agency MBS spreads have still now moved a good ways below the October 2023 highs (a positive catalyst/trend). As pointed out for some time, I correctly anticipated the severity of widening during late Q3 2023 - early Q4 2023 would be a relatively short-term event. I (or really anyone) just could not “pinpoint”, to the exact week, when the November 2023 reversal would begin to occur. This net reversal continued into early January 2024. Higher risk tolerant investors may want to take “a stab” at initiating positions in the agency mREITs on any pullback in price (ONLY UNDERVALUED/BUY or NOTABLY UNDERVALUED/STRONG BUY recommendations). Some market participants thought agency mREIT valuations were attractive during the summer of 2023. Simply put, as continuously noted, the market was “ahead of itself” regarding agency mREIT valuations. A perfect example of this was the notable sell-off during September - late October 2023 which we correctly warned subscribers about beforehand via our weekly newsletter (regarding this sub-sector being overvalued prior to this prior sell-off; in particular AGNC).
Most agency mREITs remain in common share issuance mode (rebuild capital as MBS pricing remains historically attractive). However, some agency mREITs trading at notable discounts to estimated CURRENT BV will likely temporarily stop or notably reduce common stock issuance unless deemed necessary (due to greater BV dilution). MSR valuations were recently at their peak but remain elevated versus historical trends. I/We do not anticipate a notable drop in MSR valuations over the foreseeable future (especially within lower coupons). That said, to remain unbiased, I am projecting MSR valuations decreased during Q4 2023 (just not “notable”). Prepayments, across the mortgage landscape, have remained relatively subdued (even with the recent quick drop in rates/yields) but technically have “ticked higher”. Repo financing rates have likely peaked in late 2023. Agency net interest spreads (excluding current period hedging income) remain slightly - modestly negative. However, dependent on the utilization of interest rate payer swaps, adjusted net interest spreads remain acceptable for most peers (though slightly - modestly decreased during late 2023). Net interest spreads have likely “bottomed out” during Q4 2023 or will bottom out during Q1 2024. Then, a very slow, gradual increase will likely begin during the first half of 2024.
There will continue to be pressure in commercial whole loan pricing/valuations, especially in office and some isolated pockets of multifamily loans (BXMT was a perfect example of this during Q3 2023; 3 new non-accrual office loans), during late 2023 - early 2025. 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 and FBRT should come out of this credit cycle the least harmed out of the 4 covered sub-sector peers. This should be followed by ACRE and then GPMT. While GPMT should be trading at a notable discount to estimated CURRENT BV, I continue to believe the level of discount the market is pricing in is excessive (thus keeping GPMT very attractively valued). Just know GPMT is assigned a risk rating of 5 (very high risk; potential for very high reward) and it will take time to see this valuation strategy play out (very likely 1+ year out).
I also wanted to quickly highlight a recent discussion that took place in the chat feature of this service. A question was asked on where I believe we are currently at in the commercial mREIT/real estate credit cycle (indirectly tied to GPMT’s price targets). I provided the following reply in chat in late December 2023:
“...I’ll discuss a couple broader points. Remember, the market is ‘forward thinking’. So, pricing will be a bit ahead of itself versus the actual credit cycle. I believe we’ve seen this over the past couple of months via this market/sub-sector rally. I would continue to utilize the price targets set for GPMT to understand where we are in the credit/economic cycle. To use a baseball analogy, we’re still in the ‘early innings’ of the game. I would say the 3rd inning. There’s going to be more defaults. There’s going to be additional non-accruals. I’d pay attention to GPMT’s maturity schedule (including extensions). GPMT is actively managing the portfolio and achieving solutions over time. When compared to other mREIT sectors, it’s a longer-term process (more akin to the BDC sector). That is a good thing (gives time to come up with solutions over time). GPMT just has to properly navigate the ‘ripples in the water’/credit issues as they come. This cycle first started back in late 2022 and will very likely continue through 2026 (projected peak in late 2024 – early 2025). That said, as noted above, the market is forward thinking (usually by approximately 1 year but it varies). There really hasn’t been any recent notable deviations to the long-term modeling at this point in time (hence no GPMT percentage recommendation range/risk rating changes).
So, I’ll continue to monitor GPMT/the entire sub-sector and check actual developments versus both short- and long-term modeling…I continue to believe GPMT is notably undervalued and the recommendation ranges continue to reflect that. However, as ALWAYS pointed out, especially for GPMT, it’s going to take time for the stock price to rise closer to the targets. Personally, I’m fine with holding my existing position and remaining patient. I could add to my position on any notable pullback(s) in price but remember GPMT’s assigned risk/performance rating of 5…”
RITM’s BV was recently negatively impacted, to a very minor - minor extent, by the company’s revised purchase price of Sculptor Capital Management (“SCU”) from $11.15 to $12.70 per Class A common share. I have already factored in this change. A very minor - minor CURRENT BV “true down” adjustment in October 2023 sufficed. On 11/17/2023, SCU common shareholders (Class A + B) overwhelmingly voted FOR the RITM merger proposal (by nearly a 10:1 ratio). This ends a long, drawn-out/drama-filled process. Subscribers can simply use the chat search feature within this service to see the many, detailed conversations over the past several months in relation to the RITM/SCU merger (most important, the impact to RITM’s future operations).
I am still awaiting RITM SEC filings regarding the company’s “organizational changes” in relation to its proposed spin-off of its mortgage origination business (NewRez and affiliated subsidiaries) that could occur during 2024. Subscribers need to remain patient on this potential future event (regarding all financial reporting impacts). While I continue to "run" 2 sets of RITM BVs on the potential/future spin-off, it is still too early to publicly provide both sets of BVs since I/we do not know which exact subsidiaries are being spun-off. Remember, RITM has 10+ underlying investment sub-portfolios. As such, the final organization chart could be tens of combinations. While, yes, RITM’s BV per share will change if/when a spin-off eventually occurs, I would continue to point out current RITM shareholders will not be "losing anything" as RITM’s BV decrease will merely transfer to the spun-off entity (which shareholders would own as well). There continues to be the strong likelihood some “value creation” will be unlocked as NewRez (and all affiliated entities) is spun-off. On a related note, as I have stated from the start, dependent upon the "final makeup" of RITM after the potential spin-off, the REIT Forum will continue to cover the "mortgage operations" of the company. In other words, the REIT Forum will cover the mREIT operations of the company. That will very likely be the spun-off company and might not include the parent (for instance if the parent/RITM merely becomes an asset manager). Again, I currently cannot provide the specifics/breakdown of this spin-off because RITM has not provided such details but I will be on the continued lookout to do so.
EFC’s BV was negatively impacted in October 2023, to a minor extent, by the company’s termination of its previously announced merger with Great Ajax Corp. (AJX). That said, a 9/30/2023 BV “true-up” recently occurred as EFC increased the company’s hedges to account for the upcoming termination. So, more of a “timing event” on BV fluctuations. Termination fee aside, I don't mind this development/decision. That said, I am not thrilled by the $16 million termination fee EFC is paying but probably the lesser of 2 evils down-the-road. If I had to take a guess, EFC backed out of the deal. EFC is receiving a minor position in AJX via part of the termination fee but at a price of $6.60 per common share which is bad (stock currently trades well below this amount). The long-awaited AAIC merger vote was held on 12/12/2023. As correctly anticipated, the EFC/AAIC merger was approved.
RC’s quarterly dividend decreased from $0.36 to $0.30 per common share which was disappointing. Along with this dividend reduction, management stated the company was continuing to experience a short-term earnings “swoon”; mainly in relation to the BRMK merger. Management continues to believe longer-term earnings will rebound. However, management provided the same exact reasoning (only a short-term earnings "swoon") on not notably cutting the dividend prior to the Q4 2023 dividend declaration. As such, there seems to be a change in management’s tone/expectations which is a bit disheartening. In addition, even if/when RC “outearns” the company’s new $0.30 per common share dividend in the future, management implied there would not be a future dividend raise in lieu of protecting book value and preserving capital. In light of these changes in tone/sentiment, RC received a (5%) recommendation range downgrade during mid-December 2023 to account for the severity of the dividend cut and dimmer prospects of a raise down-the-road (earnings model also moved a bit lower). This decreased RC’s recommendation ranges by approximately ($0.75) per common share. This also resulted in a risk/performance rating downgrade from 3.5 to 4. RC still has a nice "cushion" on valuation but, yes, it narrowed some as a result of this downgrade (I always remain unbiased).
NYMT’s quarterly dividend decreased from $0.30 to $0.20 per common share which was also disappointing. I projected a dividend per share range of $0.25 - $0.30 per common share for Q4 2023. When calculated, NYMT has now reduced the company’s dividend per share rate by (50%) within only 3 quarters. Simply put, this is a negative catalyst/factor. NYMT has been an underperforming sub-sector peer for a while now which only solidifies prior downgrades to make this mREIT the most discounted sub-sector peer (and 2nd most discounted out of the 20 covered peers). This 2nd, notable dividend cut within just 3 quarters is making me a bit "antsy" regarding NYMT’s joint venture (“JV”) equity positions. NYMT is in the process of monetizing a good deal of these investments which likely is not turning out to be going well. These positions are low on the credit hierarchy (not 1st lien positions; subordinated). Even with NYMT’s recent shift into more agency RMBS recently, I would point out the company did not have existing interest rate payer swaps in place so net spreads remain an issue. As such, NYMT received a (2.5%) recommendation range downgrade during mid-December 2023 to account for the severity of the dividend cut. This decreased NYMT’s recommendation ranges by approximately ($0.30) per common share. This also resulted in a risk/performance rating downgrade from 4.5 to 5.
Regarding our final decision on which new mREIT common stock to cover (FBRT vs. SACH), FBRT was determined to be the clear winner when based on both valuation and risk/performance assessment. Additional details/reasoning were recently provided to subscribers in a chat note/theREITforum.com article. As such, full coverage of FBRT started on 1/1/2024 (AAIC merged with EFC; as noted above).
Public Disclosures
Our positions related to the sector:
CWMF is long: RITM-D, GPMT-A, DX-C, EFC-A, RITM-C, EFC-B, PMT-C, PMT-B, AGNCP, CIM-D, RITM-B, RITM, SLRC, GPMT, RC.
Scott Kennedy is long: RITM, RC, SLRC, GPMT, ARCC, GBDC, RITM-D, MITT-B, MITT-C, GAINL, ECCC.
Note: The paid version shows the sizing of each position (further down in the article).
Weekly Recommendations
NOTE: This article is usually published Sunday evening or Monday morning. Sometimes it takes a bit longer.
The updates below were live in the spreadsheets by Sunday night, so the delay is just in preparing and posting this article.
You’re now entering the exclusive section for paid members.