Weekly Series: mREIT And BDC Recommendations (And Price Targets) As Of 07/23/2023 + Brief Note On CCI

Summary points:

• BDCs and mREITs saw relatively small moves in share prices and projected book values or NAVs.

• Images now include the Q3 2023 dividend projections for mREITs and BDCs.

• Brief note on CCI at the top so it's easy to find.

Brief Note on CCI

Hijacking the top section to post the part on CCI since it isn't really part of the rest of the article.

I’ll have the article on Crown Castle International (CCI) out Monday. The research part for the update was finished over the weekend, but the piece doesn’t quite flow yet. The presentation just isn’t up to my standards yet.

Consequently, I’m providing an extremely brief version:

Earnings were a bit disappointing due to lowered guidance, but not overwhelmingly disappointing. We need to consider the standards. Even with lowered guidance, CCI’s normalized growth rate (adjusted for the swing in rates) is not that bad. This is a relatively rough year for CCI's real estate as CCI didn’t impress on driving leasing volumes headed into 2023. Despite that, the performance on the real estate is still better than we would expect for a REIT with a dividend yield over 5.8% and trading around 14x to 15x forward AFFO.

Some investors may focus on the reduction to services revenue as a sign that leasing volume is going to plunge. After significant modeling, I found no meaningful correlation between services revenue and leasing performance. I’ll share the charts in the update.

As it stands, CCI is priced as if AFFO growth will be weak for a decade or more. That’s very unlikely. In a future article (probably a sector update), I’ll demonstrate how we can model CCI’s revenue growth and how that growth informs our expectations for the bottom line (AFFO per share in this case) over multi-year periods. Seeing this process laid out may help investors understand our persistence with tower REITs.

In hindsight, I probably should’ve just published that 3 paragraph summary on Saturday after finishing the models attempting to connect services revenues to site leasing volumes (which drive recurring rental revenue). Those are the things you only realize late Sunday night.

CWMF’s Introduction (Weekly Article Begins)

Note: This article opens with a quick recap of roles and what you’ll find here. If you’re familiar with it, just scroll down to the heading “New Commentary and Images Begin”.

Hi subscribers.

Within the “New Commentary and Images” section, you’ll find brief summaries of what happened for fundamentals over the last week. Then you’ll find charts and tables covering all the major developments.

This article is a joint effort between CWMF and Scott Kennedy.

Who Does What?

Scott provides full coverage for:

• 20 Mortgage REIT common stocks

• 15 BDC common stocks

For each stock that includes:

• Research and data

• Modeling projected book values / net asset values (BV/NAV)

• Setting common stock recommendation ranges (targets / ratings)

• Answering a few questions on the stocks

Colorado (“CO” / “CWMF”) Wealth Management Fund provides coverage on:

• Equity REIT common stocks

• Mortgage REIT preferred stocks

• Introductory articles for relevant concepts

• Macroeconomic trends

Layout

The rest of this article is split into two major categories:

1. New commentary & images for this week. (Pretty fast)

2. Repeated sections (linked for the moment, as we revise the method for including them). 

You’ll know you’ve hit the repeated section. It has a pretty obvious image. With that said. Let’s get into the article. 

New Commentary and Images Begin

A Few Notes from Scott: 

Positions: No new or sold positions this week.

BDC Weekly Change: Pretty similar to the prior couple of weeks, NAVs relatively unchanged. Spreads were relatively unchanged. 

Other Comments: Continuing the June 2023 trend, market remains “cautiously optimistic” on high yield debt/speculative-grade credit.  Spreads remain resilient. 

Underlying Portfolio Company Credit Changes Held by BDCs (Weekly): 1 upgrade (PSEC previous troubled portfolio company had a restructuring) and 1 downgrade (FSK).

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.

FSK: 1 Down

MAIN: 1 Up

PSEC: 2 Up (Includes 1 Restructuring), (1) Down

ORCC: 1 Up

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

ORCC: (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. - Still expect an eventual mild recession to pressure NAVs late 2023 - early 2024. Factored into price-to-book targets. Spreads will likely widen beginning in late summer - fall 2023. Still tight relative to history. 

MREIT Weekly Change: Most BVs were relatively unchanged - slightly increased.  A pretty “quiet” week by Friday.  Agency mREITs who benefited the most had lower-coupon agency MBS and derivative instruments with a shorter tenor-maturity.    

Other comments:  With their higher durations, once again agency mREITs, as a whole,  experienced the largest weekly BV increases (percentage-wise).  Agency MBS pricing was relatively unchanged - experienced a very minor decrease.  This was “trumped” by slightly larger  (short) derivative instrument net valuation gains.  Simply put, the vast majority of spread relationships (I/we track over 100+ combinations) very slightly tightened which benefited BVs.  Most hybrid, originator + servicer mREITs experienced relatively unchanged BVs. Repo financing continued to creep higher during the week (as anticipated; likely Fed Funds Rate hike later this month).  That said, the rate of acceleration has notably slowed (was always correctly anticipated).  

View: Same as last week. Most agency mREITs are likely 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 attractive/acceptable for most peers (though likely slightly decreasing over the next several quarters).  Repo financing will likely move a bit higher during 2023.  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.  Continued pressure in commercial whole loan pricing/valuations, especially in office loans. Continued credit/recession risk. A bright spot for industrial loans. 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.  As previously noted, with continued pricing pressure on office valuations, I/we made the prudent decision to slightly lower the commercial whole loan mREIT’s percentage recommendation ranges heading into Q3 2023.  This included updated modeling 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 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 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 likely take some time (especially for this specific sub-sector) 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 so that is where more details will be provided.  

A Few Notes from CWMF:

Positions: 

On 7/17/2023, I swapped our position in AGNCP for DX-C. Nothing wrong with AGNCP (AGNCP), but DX-C (DX.PC) had underperformed recently and became a bit more attractive on a relative basis.

Commentary: The images for dividend projections have been updated to include Scott’s Q3 2023 dividend projection ranges for mortgage REITs and BDCs.

Weekly Recommendations