Weekly Series: mREIT And BDC Recommendations (And Price Targets) As Of 09/10/2023

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: I closed out my position in FBRT-E (FBRT.PE) on Wednesday, with proceeds going to cash. I also placed a few trades today.

Due to the increase in Treasury rates, I decided to reduce allocations to fixed-rate shares. This was foreshadowed a few days ago in the Portfolio Update. I’m looking for market prices to rally on my new positions as the floating date approaches.

Commentary: 

I’ll be working on some equity REIT updates, including the tower REIT projections. Those projections may take quite a while as the modeling is more complex for tower REITs than for some of the other equity REITs. 

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 4 weeks, it was another quiet week in high yield/speculative-grade debt.  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 this past week.  Watching 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). 

Underlying Portfolio Company Credit Changes Held by BDCs (Weekly): 0 downgrades, 0 upgrades (quiet holiday week).

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

• 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. 

MREIT Weekly Change: Most BVs reversed their positive momentum from the prior week and decreased.  That said, most decreases were minor (roughly a 1% - 1.5% decrease).  

Other comments:  Projected BV net increases over the prior combined 3 weeks have partially reversed the downtrend experienced during August 2023 (in particular agency mREITs).  With their higher durations, agency mREITs, as a whole, experienced the largest weekly BV decreases (percentage-wise).  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 widened.  Agency mREIT sub-sector valuations are still not attractive (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 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 the past several months (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 within 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 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.