Weekly Series: mREIT And BDC Recommendations (And Price Targets) As Of 09/24/2023
We aim to retain the same layout from week to week. The layout is carried over from last week.
Weekly Notes From CWMF
Positions: Purchased some additional shares of CIM-B (CIM.PR.B) (CIM.PB) and started a position in CIM-D (CIM.PR.D) (CIM.PD). The Floating Rate Period is coming quickly (begins 3/30/2024), though we have yet to see if CIM will follow through on their word by having CIM-B float.
Management recently indicated (9/14/2023, we already posted a CIM-B update) that they are still trying to determine if they can change the terms to contradict their prior statements. Since the replacement benchmark must be “clear and practicable”, needing weeks with legal professionals to determine if they meet the criteria makes it pretty obvious they don’t. However, they still have to decide if they will try to do it anyway.
I’m updating targets for AGNCN (AGNCN) and NLY-F (NLY.PR.F) (NLY.PF). Our targets update constantly with dividend accrual to give investors more accurate targets. However, I found the current targets are just a tiny bit too high. I want the targets for AGNCN and NLY-F set at that point where the worst-cash-to-call (total return if a call is announced that day) is just slightly negative. Prior to this update, it was set a bit too high.
Before update: Target for AGNCN allowed negative $.09 and target for NLY-F allowed negative $.16.
Update 1: “Buy under” target for AGNCN was reduced by $.06.
Update 2: “Buy under” target for NLY-F was reduced by $.09.
After update: Target for AGNCN allows negative $.03 and target for NLY-F allows negative $.07.
Note: Worst-Cash-to-Call = Share price minus $25.00 minus total dividend accumulation through the effective call date. This includes an adjustment for the difference between ex-dividend dates and dividend payment dates. A negative value indicates an investor buying on that day could still have a negative return if a call is announced immediately.
Call risk still isn’t “high”, but it does remain an area of concern for AGNCN and NLY-F.
I see the potential call risk becoming more significant if we see credit spreads thin again. It would be reasonable for AGNC and NLY to consider issuing new preferred shares and calling these shares. Therefore, I want to be wary of endorsing prices where investors lose more than a few cents.
Note: Targets and dividend accrual are shown rounded to the nearest penny. Consequently, those values may swing by about a penny in any direction.
The other thing that stands out to me is the action in mortgage REIT common shares over the last week. There were 6 upgrades on the week! On average, share prices declined by about 4.7% while average book values were down about 1%. That doesn’t put everything in bargain territory, but it helps to swing the sector back from the high valuations seen a week ago.
For irony, the biggest decline on the week was New York Mortgage Trust (NYMT) at 9.3%. For contrast, the projected book value dip was only 0.8%. This wasn’t due to a dividend cut. NYMT declared their dividend back on September 11th, 2023. It was maintained at $.30 per share. NYMT did have a dividend cut in Q2 2023, but that’s clearly not the factor in late Q3 2023.
This series includes charts with the dividend history and Scott’s projections for the upcoming dividend. With almost all Q3 dividends announced, I’ve updated the charts to include the Q3 dividend and whether the dividend landed in the projected range.
Almost all were within range. ACRE came in low by $.02 and GBDC had a surprise $.04 special dividend during the quarter. We don’t have a Q3 2023 announcement for IVR yet, so the square for that dividend remains blank for now. In Q2 2023 they waited until after close on 6/21/2023 to announce the dividend, so this isn’t the first time they waited a long time. In Q1 2023 they waited until after close on 3/27/2023 for the announcement.
Given the long delay before announcing, perhaps it isn’t surprising that IVR saw the worst weekly price change in the agency group at negative 7%. IVR’s dividend projection came with the odds at only 80%. Many of the stocks under coverage have 90% odds of declaring dividends within the projected range.In my experience, Scott’s accuracy has regularly been even higher than the odds imply. However, we’ll see what happens with IVR. That dividend announcement could push the price in either direction.
Weekly Notes From Scott
Positions: No purchased or sold positions this week (continuing to build cash/capital to eventually deploy).
BDC Weekly Change: NAVs relatively unchanged. Spreads relatively unchanged.
Other Comments: Similar to the prior 6 weeks, it was another quiet week in high yield/speculative-grade debt. A bit surprising as general market volatility ticked up surrounding the Fed’s rhetoric at the September FOMC meeting which threw markets a bit of a curveball (we were not surprised though; always assumed “higher for longer” as rates/yields are basically plateauing).
Underlying Portfolio Company Credit Changes Held by BDCs (Weekly): 0 downgrades, 1 upgrade
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
PFLT: 1 Up (JV Portfolio Company)
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 - September 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 2 weeks and decreased. Most decreases were minor (most hybrids, originator + servicers, and commercial whole loans) - modest (most agencies).
Other comments: Unlike the prior week when most mREIT stock prices increased while most sector BVs decreased (which led to various valuation-related recommendation downgrades), most mREIT BV decreases were matched by stock price declines this week. In some cases, stock price declines were more severe when compared to projected weekly BV declines. This directly led to a handful of valuation upgrades this past week (see the accompanying tables for details). Most agency MBS coupons experienced modest - notable price decreases (including most specified pools; 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 - modestly widened. Spread/Basis widening is once again approaching October 2022 levels (negative catalyst/trend). Repo financing was, once again, relatively unchanged during the week (markets correctly anticipated an unchanged Fed Funds Rate at the September 2023 meeting). 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. A perfect example of this was the sell-off this past week (we warned subscribers this sub-sector was overvalued prior to this past week’s sell-off; in particular AGNC).
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 couple 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 anticipated, RC recently 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).
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