NYMT - New York Mortgage Trust: Why We Rotated Our Allocation In The Preferred Suite Part 2

2023-10-10 12:09:20 ET

Summary

• In a previous article in this series, we discussed a rotation within the mortgage REIT CIM preferreds suite.
• In this Part 2, we discuss another mortgage REIT preferred rotation - this time in the NYMT suite.
• As before, the goal of the reshuffling was to take advantage of relative value, marginally derisk portfolio exposure, and lower the fix-for-life risk seen in other preferreds.
• Our "lazy-man" infrequent rotation strategy continues to deliver significant alpha and top up the beta of the preferreds.

This week we reshuffled some of our mortgage REIT preferreds holdings in the High Income Portfolio. In a previous article, we highlighted one of these rotations, specifically within the mortgage REIT Chimera Investment Corp ( CIM ) preferreds suite, from [[CIM.PR.D]] to [[CIM.PR.B]].

Since that move, two good things happened. One, CIM confirmed they are transitioning their preferreds to SOFR from Libor. Our view in the last update was that this wasn't really up for debate given its reliance on a Calculation Agent to determine a successor rate to Libor and that the Libor Act specifically created a safe harbor for Calculation Agents to pick SOFR as just that successor rate. And two, CIM.PR.B has had a nice run, outperforming CIM.PR.D by around 8%.

In this Part 2, we discuss our thoughts around another mortgage REIT preferreds rotation, that of the New York Mortgage Trust ( NYMT ). As before, the goal behind the rotation was to take advantage of a better relative value opportunity, to marginally de-risk portfolio exposure in light of a frothy credit market, and to lower the fix-for-life risk that we saw in other preferreds this year. Specifically, we moved our NYMTM allocation to NYMTL which trades at a 9.45% yield with a likely large yield step-up on its first call date in 2026, unless redeemed.

NYMT Snapshot

NYMT is primarily focused on investing in single-family and multi-family credit mortgage assets.

Over the last quarter recourse leverage ratio increased to 0.7x from 0.4x, however, that was primarily due to the acquisition of Agency RMBS. This is a very welcome addition to the NYMT portfolio even at the cost of increased leverage as Agencies tend to rally during periods of market distress, which is what we saw in 2020 (after a very short wobble).

Nearly two-thirds of the company's borrowings are non-mark-to-market - a robust feature that mitigates the risk of a negative feedback loop of lower prices leading to margin calls which leads to forced selling and more negative prices.

Book value has fallen over the last couple of years, most recently due to impairments in multi-family equity assets as a result of higher market cap rates.

However, this is mitigated by a decent equity / preferred coverage of 3x, still low leverage, significant non mark-to-market borrowings, $550m of Agency assets - strengthening portfolio quality and liquidity profile and recently preferred share buybacks. Specifically, NYMT has repurchased 37,863 shares of preferred stock at an accretive average repurchase price of $18.88 per preferred share.

NYMT Rotation

This is what the NYMT preferreds suite looks like.

We first allocated to NYMT preferreds in early 2021, going with Series D ( NYMTN ), then rotating to Series E ( NYMTM ) in June of the following year and now going with Series F ( NYMTL ). This is what the allocation timeline looks like.

If we plot total returns from the start, they look like the following. The rotation strategy has come out ahead in the suite, particularly versus NYMTN which has underperformed since our rotation away from it.

Overall, the strategy (blue bar) has delivered a 22% return since early 2021.

Across the broader mREIT preferred suite, the NYMT rotation strategy has come out close to the top of the entire sector since its start in 2021.

The reason for our latest rotation to NYMTL from NYMTM has to do primarily with a stronger relative value case for NYMTL. Specifically, NYMTL offers a superior yield today up to the NYMTM first call date in early 2025. After the NYMTM first call date in 2025, NYMTM expected yield moves ahead until NYMTL's own first call date towards the end of 2026 when NYMTL floats, unless redeemed. If both stocks are redeemed then they will enjoy a roughly similar yield-to-call.

Another way to look at it is that NYMTL has underperformed NYMTM since its issuance and now looks much more compelling.

The second reason why NYMTL looks more compelling is that it is a SOFR-linked security and does not present the kind of fix-for-life risk that we have seen materialize across the market, particularly for State Street, PennyMac, Morgan Stanley and other preferreds. In our view, this risk is minimal for NYMT given its use of a Calculation Agent to determine the successor rate to Libor (recall that CIM used the same language and has confirmed its transition to SOFR), however, it's arguably not zero.

Outside the floating rate-fixing risk, credit valuations look somewhat frothy to us. In this context we decided to only rotate half of our NYMTM position to NYMTL, with the other half going to a more resilient, lower-beta security.

Overall, we continue to like NYMT preferreds. However, as our experience has shown, investors can significantly top up the beta of the preferreds with a kind of "lazy-man" alpha, using infrequent relative value rotations.

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