Weekly Series: mREIT And BDC Recommendations (And Price Targets) As Of 09/06/2024

Hi subscribers.

We aim to retain the same layout from week to week. 

Weekly Notes From Colorado Wealth Management Fund

Positions: No trades for me last week. However, that’s being pretty technical. We did a skip week in this series. I closed my position in PMT-B (PMT.PR.B) on 8/30/2024. That was a great trade. Counting the dividend we earned 8.13% to 8.51% in a trade that took less than 2.5 months with minimal volatility. Yeah, I’m quite happy with the way that played out. I haven’t put that cash back to work yet, but it is in a short-term Treasury ETF earning a nice rate of interest.

Commentary: 

Last week we provided an update on the net lease REIT sector. The major story was a material increase to targets for National Retail Properties (NNN) and a negative revision to W.P. Carey (WPC).

I want to thank the readers who provided suggestions for me over the last week. I plan to start a YouTube channel soon. Rather than distracting me from my efforts here, it should enhance them. I don’t intend to create any high-budget films. No fancy video editing. If I ever need that, I’ll find someone to do it.

For years I have prepared some of my articles by turning on my camera and just talking about the topic. Those videos were only ever seen by REIT Forum Support. He would type out a transcript, I would scan over it, then it would be an article.

Now we have an opportunity for me to prepare some article summaries this way. 

After discussing the idea with many members, I plan to try two types of videos:

1. Article Summaries
2. Sharing My Thoughts on Bad Articles

Both are intended to be short-form videos. More than 30 seconds. Generally under 2 minutes for summaries and probably under 4 minutes for reviewing bad articles. We’ll figure out some of it as we go. I might expand at some point, but right now I want to keep it simple.

Besides being a quick way to share notes with members, this should help us with building awareness. That’s already something I have to work on regularly. This method allows me to generate something our members will enjoy at the same time. If everything goes according to plan, this may also take less time than current efforts to build awareness.

I’ll start with some notes about the article summaries.

Article Summaries

Does it take longer to watch an article summary than to read one? Yes. Most of the time. Video summaries generally won’t require charts to be understood. That means investors can enjoy them with or without looking at the screen.

This actually fits nicely with how I consume research. I often watch videos on economics or businesses while eating breakfast. My brain isn’t fully engaged at that point, but I can still follow along and I can look deeper into any of those topics later.

Of course, I want articles, databases, and charts, when I’m ready to dive into the research for the day.

Consequently, these videos will probably be most useful for people who want a casual way to keep up-to-date with events.

I know there are some analysts who I follow primarily by using their YouTube channel.

I should mention that some (or many) of my videos will be unlisted. I’m not going to allow anyone on YouTube to dig into our research. Because they’re unlisted, the only way to find them will be to look at the articles where I embed them.

Sharing My Thoughts

Many investors know I loved writing rebuttal articles. They are often some of the funnest articles to prepare. It doesn’t require coming up with a new thesis. It simply involves demonstrating why a terrible thesis is wrong.

That’s often easy.

What if instead of putting in an hour or two to highlight what was wrong with the article, I could just turn on my camera briefly and share my thoughts? Well that might be thoroughly engaging and even faster.

In these videos, I’ll essentially be demonstrating what you wouldn’t want to do as an analyst. I won’t be taking at aim at people I need to work with. That wouldn’t be wise.

However, there are plenty of people posting awful "research" because they can get a few bucks for pretending to know something about a stock. They pretend to be experts while giving investors terrible “research”. That seems unethical to me. Who better to poke fun of than someone caught doing something unethical?

Of course, instead of being engaging and fast, it might be a disaster.

Part of the fun is finding out.

The Website

Many members who are joining us from Seeking Alpha don’t know that we have a website.

This email that you’re reading is actually an article. It’s posted to the website.

Simply scrolling up you’ll see a button labeled “View in Browser”.

Since this one is behind our membership wall, members would need to be logged in on the website to read it. However, that process is extremely fast. You can tap the button to "View in Browser", hit the “sign in” button, and have a link inside your email in about 5 seconds. Click that link and you're done.

The website allows me to organize our research and provide members with organizational tools.

If you want to know more about the website, you can view the "about" section.

Note: We began building our presence outside of Seeking Alpha by using Substack. We migrated off of Substack to have more control over the website and slash commissions so we could drive prices lower.

Weekly Notes From Scott Kennedy

Positions: No new or sold positions this past week.  In general, personally I am continuing to be patient regarding selectively deploying capital in attractively-valued mREIT common stocks .  My sector allocation to mREIT common stocks remains high (thus aligning with continuing to hold existing positions for future appreciation).  Patience remains key as catalysts/events will take time to play out (especially within commercial mREITs).

BDC Weekly Change: Similar to the prior 3 weeks, high yield/speculative-grade credit spreads remained relatively unchanged (markets were “calm”). 

BDC Other comments (Current Week): Along with broader market stability, underlying performing portfolio company valuations/pricing remain strong.  That said, I correctly expected an “uptick” in non-accruals during calendar Q2 2024 earnings season partially due to continued high interest rates/yields starting to weigh on struggling/underperforming portfolio companies.  Non-Accruals will trend slightly - modestly higher regarding a majority of peers during 2024 - 2025 which needs continued monitoring.  This is already factored into sector modeling/pricing.

I currently believe the first (25) basis points (“bps”) Fed Funds Rate cut will occur in September 2024 and (100) bps in cumulative cuts will occur through June 2025.  IF there are faster/more severe cuts, this will negatively impact future BDC sector earnings, versus my current modeling, to some extent.  If such a scenario unfolds, this will likely result in a minor, sector-wide, reduction in recommendation ranges and price targets (just something to be mindful of).

Regarding weekly recommendation changes (mainly due to stock price and projected NAV changes), 2 upgrades and 0 downgrades occurred.

ARCC, OCSL: APPROPRIATELY VALUED (HOLD) to UNDERVALUED (BUY)

PART 1 of our quarterly BDC sector comparison article (which included updated metrics regarding all 15 covered peers) was recently provided to subscribers.

PART 2 of our quarterly BDC sector comparison article (will include updated metrics and Q4 2024 dividend projections regarding all 15 covered peers) will be available to subscribers early this week (Monday or Tuesday night).

Calendar Q1 + Q2 2024 Recommendation/Target Range + Risk/Performance Upgrades (Downgrades) (Running Tally):

Underlying Portfolio Company Credit Changes Held by BDCs (Weekly): 4 downgrades, 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 (Bolded Indicates Current Week Change).

ARCC: (1) Down (Very Small Investment*)

CSWC: (2) Down (Small Investment, Medium Investment)

FSK: (3) Down (Medium Investment, Very Small Investment, Large Investment)

GAIN: (1) Down (Medium Investment)

GBDC: 1 Up (Medium Investment)

MAIN: (2) Down (Small Investment, Medium Investment)

MFIC (3) Down (Medium Investment, Medium Investment**, Small Investment**)

OBDC: (3) Down (Medium Investment, Small Investment, Medium Investment)

OCSL: (1) Down (Small Investment)

PFLT: (2) Down (Small Investment, Medium Investment)

SLRC: (1) Down, (Very Small Investment***)

TCPC: (2) Down (Medium Investment, Large Investment)

TPVG: (2) Down (Small Investment, Medium Investment)

* = Regarding ARCC’s credit downgrade, this pertains to a portfolio company in the healthcare sector (health provider) who is continuing to exhibit heighted credit risk and operational weakness.  That said, ARCC’s exposure to this portfolio company is only 2 very minor - minor senior secured 1st lien debt investments.  Still, continued losses/mark-downs will likely occur within this portfolio company during Q3 2024 which is already considered in our weekly CURRENT NAV projection.  My/Our models have these loans having non-repayment risk at maturity (late 2024).  Even a total/(100%) loss would result in an additional NAV decrease of only ($0.02) per share ((0.1%) per share).

** = Regarding 2 of MFIC’s credit downgrades, this pertains to portfolio companies which were added to the company’s investment portfolio directly through the recent AFT + AIF merger).

*** = Regarding SLRC’s credit downgrade, this pertains to a portfolio company in the retail sector (maker and distributor of toys) who is seeking Chapter 11 Bankruptcy protection (reorganization/restructuring).  My/Our models already had this loan as having risk of non-repayment at maturity.  That said, SLRC’s exposure to this portfolio company is only a very minor senior secured 1st lien debt investment.  Still, losses/mark-downs will very likely occur with the proposed restructuring during Q3 2024 which was already considered in our recent weekly CURRENT NAV projection. Even a total/(100%) loss would result in a NAV decrease of only ($0.04) per share (less than (0.4%) per share).  I anticipate some type of debt-to-equity exchange and/or partial pay-off of this loan (consider the credit hierarchy).

BDC View (Same as last week):  Continuing the June 2023 - August 2024 trend, the market remains “cautiously optimistic” on high yield debt/speculative-grade credit.  Spreads still remain fairly 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).  However, I still expect an eventual mild recession to pressure NAVs in late 2024 - 2025.  This expectation is already factored into per share recommendation ranges and price targets. Spreads will likely begin widening during 2024. Still tight relative to history.  We have seen some of this  widening occur during early August 2024.

I believe the majority of sector earnings are near their peak (plateauing).  The rapid net investment income (“NII”) growth during 2022 - 2023 will not occur during 2024 - 2025.  As the FOMC begins to reduce the Federal Funds Rate (likely beginning in September), sector earnings will GRADUALLY decrease over time.  The severity of decreases will vary peer-to-peer (which I/we continuously project/model).  This notion is already embedded in all price targets.  That said, with the recent general sector sell-off, several BDCs now have a bit of value (however, to remain non-bias, not nearly as good of a deal as most of 2023).   

I will continue to monitor the recent/any new developments in the Middle East (including all escalations/responses to a larger regional war) + Ukraine and broader macroeconomic impacts in the United States regarding private debt/credit markets.

mREIT Weekly Change: A majority of agency mREIT BVs were relatively unchanged this past week.  This could be a surprise to some subscribers as weekly rates/yields modestly decreased.  This was due to a majority of agency MBS spreads remaining relatively unchanged versus underlying net (short) hedges.  Most hybrid mREITs likely experienced a slightly increasing BV this past week.  The commercial whole loan mREITs likely experienced a relatively unchanged BV.  The originator + servicer mREITs likely experienced a slightly decreasing BV (modest MSR valuation losses slightly “trumped” non-MSR mortgage-related investment valuation gains).   

mREIT Other comments (Current Week): Regarding weekly recommendation changes (mainly due to stock price and projected BV changes), 0 upgrades and 0 downgrades occurred.

Regarding weekly agency mREIT BV movements, most agency MBS coupons (especially lower coupons) experienced modest - notable price increases (including most specified pools; mainly HARP and LLB loans).  However, higher coupon generic/TBAs underperformed (prepayment risk).  Higher coupon specified pools performed a bit better versus generic/TBAs but still underperformed versus lower coupons.  Most (short) derivative instrument valuations modestly - notably decreased (especially towards the shorter-end of the yield curve).  Simply put, the vast majority of spread relationships I/we track (over 100 combinations) remained relatively unchanged.  

PART 1 of our quarterly mREIT sector comparison article (which included updated metrics regarding all 20 covered peers) was recently provided to subscribers.

PART 2 of our quarterly mREIT sector comparison article (will include updated metrics and Q4 2024 dividend projections regarding all 20 covered peers) will be available to subscribers in late September 2024.

Subscribers need to remain patient regarding catalysts playing out in the hybrid and commercial whole loan mREIT sub-sectors (longer-term horizon/mind set).

Calendar Q1 + Q2 2024 Recommendation/Target Range + Risk/Performance Upgrades (Downgrades) (Running Tally):

mREIT View (Same as last week):  1) Agency mREIT Sub-Sector Trends: Valuations, as a whole, remain unattractive in some agency mREITs.  As such, patience is key.  While repurchase financing rates have likely peaked in late 2023,  agency net interest spreads (excluding current period hedging income) remain slightly - modestly negative.  However, dependent on the utilization of interest rate payer swaps, adjusted net interest spreads remain acceptable for most peers.  A slow, gradual increase in net spreads will likely begin during late 2024 but this will be a “slow go”.  This already factors in (100) bps of Federal Funds Rate cuts during September 2024 - June 2025. 

2) Commercial Whole Loan Sub-Sector Trends:  There will continue to be pressure in commercial whole loan pricing/valuations, especially in office and some isolated pockets of multifamily loans during 2024 - 2025. ACRE, BXMT, FBRT, and GPMT were a perfect example of this during Q3 2023 - Q2 2024 (new non-accrual and/or “watch list” loans).  Could even put RC into this category to some extent.  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 June 2023 - May 2024 of all 4 sub-sector peer’s peak non-accrual rate this credit cycle (above the high end of my/our previous range).  These adjustments were to account for a quicker/more severe spike in credit risk (versus previous expectations) impacting my/our modeling (mainly impacting performance during late 2024 - 2025).  This already factors in (100) bps of Federal Funds Rate cuts during September 2024 - June 2025. ACRE, BXMT, FBRT, GPMT, and even RC will continue to have heightened monitoring regarding asset/loan resolution within the office (and more recently multifamily) sub-sector and all other troubled loans.   While GPMT should be trading at a notable 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 5.5 (extremely high risk; potential for very high reward) and it will take time to see this valuation strategy play out (very likely 1+ year out).  

3) RITM’s Likely Proposed Spin-Off: I am still awaiting RITM SEC filings regarding the company’s “organizational changes” in relation to its proposed spin-off of its mortgage origination business (NewRez and affiliated subsidiaries) that could occur during 2024 (or beyond).  As discussed during RITM’s Q1 + Q2 2024 earnings call, management has continued to delay this spin-off.  I am fine with this delay as it is a very large divestiture and RITM’s mortgage origination and servicing sub-portfolio continues to generate notable earnings for the company.   Subscribers need to remain patient on this potential future event (regarding all financial reporting impacts).  Remember, RITM has 10+ underlying investment sub-portfolios. As such, the final organization chart could be tens of combinations. While, yes, RITM’s BV per share will change if/when a spin-off actually occurs, I continue to point out current RITM shareholders will not be "losing anything" as RITM’s BV decrease will merely transfer to the spun-off entity (which shareholders would own as well).  There continues to be the strong likelihood some “value creation” will be unlocked if NewRez (and all affiliated entities) is spun-off.    

4) Federal (“Fed”) Funds Rate: Regarding Federal Open Market Committee (“FOMC”) monetary policy, my previous 2023 - early 2024 projection of 2 - 3 rate cuts during 2024 was revised down to 1 - 2 rate cuts back in April 2024.  I currently believe (100) bps of Federal Funds Rate cuts will occur during September 2024 - June 2025. 

As a reminder for subscribers, mREIT/BDC earnings assessment articles take a deeper dive into each company's operational performance metrics and future catalysts/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 any delay is just in preparing and posting this article.

The mREITs:

The BDCs:

Please check the Google shared spreadsheets regarding intra-week recommendations, as stock prices fluctuate.

Positions

The following charts show position sizes for Scott Kennedy and CWMF as of Sunday night.

CWMF’s portfolio also includes equity REITs and cash; this presentation includes those positions.

Note: CWMF’s cash position may not be updated immediately for dividends arriving. 

Earnings Estimates and Performance

Note: 

• The mREITs and BDCs have BV projections.
• The mREITs will have earnings projections soon. The BDCs have earnings projections already filled in.

The mREITs:

The BDCs:

Dividend Projections

Note: Check comments on this article after a day for any corrections. I’ve transcribed the values from Scott’s articles. However, mistakes can happen. It is rare, but there’s quite a bit of data to move. If there is an error, a member usually catches it quickly.

The mREITs:

BDCs:

Who Does What? (Repeated)

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

Investing (Repeated)

As continuously stated to subscribers, Scott will continue to “nibble on” some mREIT common and BDC positions when they have at least a BUY (if not STRONG BUY) recommendation. Also, just because I find a handful of mREIT and BDC stocks attractively-very attractively valued at any given point in time, this does not mean I am going to initiate a position in each and every stock.

Moving on, if a subscriber has a LOW-MEDIUM tolerance for risk, an alternative could be to look towards the mREIT preferred stock sector which is covered by CO. Subscribers can also look at the other REIT sectors covered by this service (which are covered by CWMF and his team).

Disclosure

Disclosure: CWMF is long the positions in CWMF’s Portfolio. Scott Kennedy is long the positions in Scott Kennedy’s Portfolio. Positions can be seen in this weekly article and checked using our Google Sheets. Those sheets are all linked on this page. Note: This requires logging in to the website, which is just entering your email address and clicking the login button I send you in a few seconds.