Hallbergman
In this article, we'll be looking at mortgage REIT New York Mortgage Trust (NYMT). Specifically, we'll be discussing the company's shift in strategy and highlighting its new bond offering, the 9.125% 2029 Notes (NASDAQ:NYMTI). We find this bond very attractive given the company's low risk profile. The bond is trading at a yield of 9.13%.
Shift in strategy
NYMT has historically been a credit-focused mortgage REIT. Several years ago, the company made a strategic shift into full multifamily ownership through a joint venture equity strategy. This involves equity ownership of a number of multifamily properties with operating partners, primarily in the South and Southeast. The strategy has a target IRR of 13-17%, with income derived from rental income and sales after renovation.
This strategy has performed poorly and, as we show below, is the primary reason for the significant decline in book value over the past few years, both in absolute terms and relative to other mortgage REITs.
The losses are due to declining valuations of the real estate portfolio, which is a result of rising cap rates in the market. As interest rates have risen over the past two years, so have cap rates. Secondary factors include slowing rental growth, rising vacancy rates due to a large supply of additional units (management calls this “oversupply”), and lower than expected real estate income. Decreasing transaction activity in the multifamily market has also further pressured valuations. In retrospect, investing in multifamily properties at ultra-low interest rates/cap rates, alongside a surge in construction with new supply expected in 2-3 years' time, was not a good move.
If there's any good news, it's that this strategy is coming to an end. The strategy now accounts for less than 1% of portfolio assets and less than 5% of equities. Instead, the firm has been expanding its agency portfolio, which should significantly reduce book volatility and drawdowns. The overall agency market is attractive not only because of rising long-term interest rates, but also because agency spreads remain wide.
The portfolio allocation has changed significantly, as the following chart shows: Management expects the agency allocation to continue to increase over time.
Despite the sizeable agency allocation, the company's recourse leverage remains low at 1.7x.
Another key element of the firm's strategy is to reduce reliance on mark-to-market repos of margin securities: A key lesson from 2020 is that the combination of declining prices, lack of liquidity and mark-to-market margins can be a recipe for disaster.
Many mortgage REITs, including NYMT, missed margin calls in 2020 because of this issue. But since then, the company has reduced its reliance on mark-to-market repos in its credit portfolio, reducing them by more than 80% from 2019 and replacing them with securitized financing. The advantage of securitizations is that there is no mark-to-market and no recourse. Securitization lenders have no recourse and cannot make margin calls on the company's assets outside of the specific securitization. This often makes securitizations a more expensive source of financing, but it provides significant benefits to the company's preferred stock and bondholders. Specifically, it ensures that the company's remaining assets cannot be seized and sold off due to margin calls.
Large mark-to-market repo lines on agency bonds are not a concern. First, agency bonds are relatively liquid even in the event of severe market dysfunction, as in 2020. Since agency bonds have no credit risk, their value is much clearer. Second, even if traders don't want to trade agency bonds, the Fed will. In 2020, the Fed bought agency bonds outright, as shown below. As interest rates plummeted during the COVID crash, agency bonds actually rose in value. This means that the negative feedback loop of margin calls, forced sales, falling prices, more margin calls is much less likely to occur.
The company's recourse leverage in its credit portfolio is just 0.3x, one of the lowest in the mREIT space. Looking at the company's portfolio in terms of overall recourse leverage (y-axis) and agency allocation (x-axis), we can see that either the leverage is too low relative to the agency allocation, or the agency allocation is too high relative to the leverage.
All of this translates into portfolio de-risking in the broader sector. NYMTI bonds are particularly attractive because their yields are competitive in the mREIT bond sector.
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