Weekly Series: mREIT And BDC Recommendations (And Price Targets) As Of 09/17/2023

Hi subscribers.

We aim to retain the same layout from week to week. The layout is carried over from last week.

Weekly Notes From CWMF

Positions: On Monday (September 11th, 2023), I closed out my position in RC-E (RC.PE) (RC.PR.E) with proceeds split between AGNCP (AGNCP) and CIM-B (CIM.PB) (CIM.PR.B). CIM’s statement that they were trying to avoid taking a position on CIM-B was disappointing.

Commentary: 

I’m looking favorably on the shares that float relatively soon. Based on the pricing for the Annaly (NLY) and AGNC (AGNC) preferred shares that are already floating, I think many of these shares will trend towards $25.00 as their floating date approaches. If short-term rates fall, that could have a significant negative impact. However, if short-term rates remain elevated, then many shares would yield over 10% even at a $25.00 price.

To some extent, this makes the yield-to-call metrics relevant (only for FTF shares, disregard for all others). While I’m not forecasting an actual call (but certainly possible with AGNCN / AGNCO / NLY-F), many shares may trade closer to $25.00. Beware that:

1. The yield-to-call metric does not consider risk ratings. Widening credit spreads, such as a recession scenario, can still bring prices down and do present fundamental risks (especially for the riskier shares).

2. Prices might not actually reach $25.00, though several may recover to values around there.

3. Focusing exclusively on yield to call will lead investors to bad decisions occasionally (or more frequently). 

4. The yield to call ignores the size of the floating spread. 

5. The yield to call figure is annualized, when shares are callable within a short time frame it can overstate the importance of a tiny move in the share price.

Often, I recommend treating it as one of the less relevant metrics because of lower probabilities of calls. It can still matter, but if a call is unlikely then the yield to call shouldn’t be very important. However, in the present environment, it merits a bit more attention.

On another note. I’m putting the finishing touches on a quick cell tower REIT update (focusing on CCI) to discuss the recent company presentations.

Weekly Notes From Scott

Positions: No new added or sold positions this week.

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

Other Comments: Similar to the prior 5 weeks, it was another quiet week in high yield/speculative-grade debt.

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.

ARCC: 1 Up, (2) Down

CSWC: (1) Down

OCSL: (1) Down

FSK: 1 Up, (1) Down

MAIN: 1 Up, (1) Down

PSEC: 3 Up (Includes 1 Restructuring), (2) Down (Including 1 Bankruptcy)

GBDC: (1) Down

SLRC: (1) Down

TCPC: 1 Up

OBDC: 1 Up, (1) Down (JV Portfolio Company)

TPVG: (1) Down (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 - August 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 - 2024. Factored into price-to-book targets. Spreads will likely widen beginning in fall 2023. Still tight relative to history.  Due to TCPC’s announced merger with BKCC, along with a (2.5%) base management free reduction (which positively impacts future operating performance/net investment income [NII]), this BDC received a 5.5% percentage recommendation range upgrade in early September 2023.  Continuing to watch the broader/macroeconomic impacts from the upcoming end of the 3-year student loan repayment pause (due to COVID-19) in October (and any new updates regarding this event).    

MREIT Weekly Change: Most BVs continued their negative momentum from the prior week and decreased.  Most decreases were minor (mainly hybrids) - modest (mainly agencies).  

Other comments:  A bit of an odd week whereas agency mREIT BVs decreased on the week yet stock price slightly - modestly increased.  As such, valuations within the sub-sector became even less attractive.  AGNC became notably overvalued while DX, NLY, and ORC moved to an overvalued recommendation.  Most agency MBS coupons experienced minor - modest price decreases (including most specified pools; HARP and LLB loans).  Most (short) derivative instrument valuations slightly increased.  Simply put, the vast majority of spread relationships (I/we track over 100+ combinations) slightly - modestly widened.  As noted above, agency mREIT sub-sector valuations remain unattractive (continue to wait for a better opportunity to initiate/increase one’s position).  Simply put, the market continues to be a bit “ahead of itself” regarding agency mREIT valuations.  Repo financing was, once again, relatively unchanged during the week (markets anticipate an unchanged Fed Funds Rate at the September 2023 meeting).  As anticipated, RC announced a quarterly dividend reduction from $0.40 per common share to $0.36 per common share.  Simply put, no surprise. This reduction was within my/our $0.35 - $0.40 per common share projection (much higher probability was assigned to a cut to $0.35 per common share versus an unchanged $0.40 per common share dividend).  After my dividend projection was provided several months ago, management recently "hinted" there would be a cut (again, within my previously-projected range). No change in RC’s percentage recommendation ranges or risk rating from this declaration. Simply put, this dividend reduction was already "baked" into RC recommendation ranges in conjunction with the announced BRMK merger months back.  I continue to anticipate no further RC dividend reductions over the foreseeable future (through, at a minimum, Q2 2024).  After a projected RC core earnings “dip” for Q3 2023 (mainly due to non-utilized capital obtained via the BRMK merger), I anticipate an increase heading into 2024 to support the current dividend level (as capital is deployed).  

View: Same as last week. Most agency mREITs likely remain in common share issuance mode (rebuild capital as MBS pricing remains historically attractive).  This is especially the case within the agency mREIT sub-sector.  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 within lower coupons).  The rate of financing cost acceleration has slowed over the past several months (which was previously correctly anticipated).  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 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.  While GPMT should be trading at a 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).  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.

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.

The mREITs: