Weekly Series: mREIT And BDC Recommendations (And Price Targets) As Of 08/27/2023

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: No trades last week. This article is being published late this week due to the preferred share chaos. This week, I purchased some PMT-B after shares took a big hit. Prices are a bit lower now, but shares are ex-dividend which more than offset the drop.

Commentary: The announcement from Friday, 8/25/2023, took most my time over the weekend and the first half of this week. We’re past that now, so I can focus on a few other things:

1. Preferred share risk rating and target updates (#1 option in subscriber voting from the poll before the PMT chaos and even more important now)

2. New Portfolio Update because the month is ending

3. Tower REIT projections (#2 option in subscriber voting from the poll before the PMT chaos)

Weekly Notes From Scott

Positions: No new added or sold positions this week.

BDC Weekly Change: NAVs relatively unchanged. Spreads very slightly widened (nothing alarming). 

Other Comments: Similar to the prior 2 weeks, it was another quiet week in high yield/speculative-grade debt.

Underlying Portfolio Company Credit Changes Held by BDCs (Weekly): 2 downgrades (CSWC + MAIN; same portfolio company) + PSEC.

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 - 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 - 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 trend over the prior several weeks and increased.  The increases partially reversed the downtrend experienced earlier in August (in particular agency mREITs).   

Other comments:  With their higher durations, agency mREITs, as a whole,  experienced the largest weekly BV increases (percentage-wise).  mREITs who have hedged against a flattening yield curve were “rewarded” this week.  This was in direct contrast to the trend experienced the prior week.  This is due to this week’s flattening of the yield curve.  Agency MBS pricing experienced a relatively unchanged fluctuation (including most specified pools; HARP and LLB loans).  Most (short) derivative instrument valuations slightly - moderately increased.  Simply put, the vast majority of spread relationships (I/we track over 100+ combinations) slightly - modestly tightened.  We have now slightly moved away from October 2022/August 2023 spread/basis widening levels in most relationships.  While I expect spread/basis risk to begin gradually subsiding in the coming weeks (which includes this past week), even with the recent quick sell-off this past month, agency mREIT sub-sector valuations are still not attractive (continue to wait for a better opportunity).  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 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 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 very likely take some time (especially for this specific sub-sector; likely not until 2024/later in this credit cycle) 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.   

Weekly Recommendations

NOTE: This article is usually published Sunday evening or Monday morning. Share prices have moved and bond values have moved. These are the ratings and updates as of the weekend. I had to prioritize which research to get to customers first and decided the preferred share updates were the most critical information. 

The update below were live in the spreadsheets by Sunday night, so the delay is just in preparing and posting this article.

The mREITs: