Prepare for illustrations and data, as they convey information more effectively than words alone. This analysis builds on Scott Kennedy’s weekly updates in the REIT Forum. We greatly value your feedback, so please leave a comment with suggestions.
PennyMac Mortgage Trust (PMT) has been the center of attention recently. Their recent announcement regarding “fixed-to-floating” shares has prompted a thorough reassessment.
To address this, we undertook several updates:
- A Friday night update on PMT preferred shares, involving hours of diligent research to provide more valuable insights.
- A Sunday night update for the sector, exploring the language used in each prospectus.
- A Tuesday night update with previews of our conclusions on various shares for faster access to valuable information.
- A Wednesday update during market hours, presenting the evidence and rationale behind the conclusions shared on Tuesday.
Additionally, we have several ongoing writing projects:
- Updating risk ratings and targets for preferred shares, incorporating recent developments and prior progress.
- Providing a monthly portfolio update, highlighting current positions and potential opportunities.
- Offering projections for cell tower REITs in the coming years.
Reviewing the “Immediately Preceding Dividend Period”
While we typically don’t publish full subscriber articles to the public, we want to share some of our recent findings.
To evaluate preferred shares, it is crucial to examine the presence of specific clauses in each prospectus. This was our main focus during the weekend.
One phrase that causes confusion is the term “immediately preceding dividend period.” Many companies interpret it as referring to the prior fixed-rate dividend if the share is not already floating. However, the lack of clarity in the following clause creates ambiguity:
“If fewer than three New York, New York banks selected by us quote rates in the manner described above, the three-month LIBOR for the applicable dividend period will be the same as for the immediately preceding dividend period, or, if there was no such dividend period, the dividend shall be calculated at the dividend rate in effect for the immediately preceding dividend period.”
Clarifying the “No Such Dividend Period”
The phrase “no such dividend period” adds further confusion.
As a non-legal expert, it seems that the “final rule” implementing the LIBOR Act has a role in this sentence. It potentially disqualifies the need for polling and the use of prior LIBOR rates. This leaves us with the clause, “or, if there was no such dividend period, the dividend shall be calculated at the dividend rate in effect for the immediately preceding dividend period.” The key question is: how should we define “such”? The dividend period must exist by definition since it measures the time between two dates.
Can the clause “or, if there was no such dividend period” be removed? The LIBOR Act does not offer grounds for excising that clause.
Therefore, to achieve a fixed-rate dividend, PMT needs to assert that there was “no such dividend period.” However, we know that every dividend period must exist since it pertains to a specific time frame. Even if LIBOR is no longer in use, the period itself did exist.
PMT must demonstrate why the term “such” should be defined in a way that negates the existence of the dividend period.
While the phrase “immediately preceding dividend period” appears in numerous contracts, some REITs have already declared they will transition to SOFR.
For example, NLY-F, AGNCN, IVR-B, and IVR-C have explicitly stated that they will use 3-month Term SOFR plus 26.161 basis points as a substitute for 3-month LIBOR, which is widely accepted in the industry.
AGNC currently trades at a price-to-book ratio of about 1.13x, whereas DX trades at .95x based on our latest estimates. There is a significant disparity between the two.
Why are investors inclined towards AGNC? It offers a higher dividend yield of 14.5% compared to 12.0% for DX. However, dividend yields alone do not justify the investment. Some mortgage REITs offer even higher yields until they decrease. One notable factor is AGNC’s remarkably high consensus earnings yield, nearing 23%.
In contrast, DX has a negative earnings yield.
This leads us to question whether AGNC’s operations can generate significantly more wealth for shareholders in the future. We remain skeptical. Consensus earnings estimates tend to be flawed due to the calculation of Core EPS. Despite both mortgage REITs holding agency fixed-rate mortgages and hedging against interest rate movements, AGNC’s unique portfolio structure inflates Core EPS figures. This accounting discrepancy does not reflect meaningful differences in portfolio performance; it is merely an accounting difference.
Another noteworthy mention is Ready Capital (RC), which still offers excellent value at a price of $10.92, trading at approximately 76% of book value.
Our charts have not been updated to accommodate the issues with fixed-to-floating shares that may not transition to floating. They are currently presented as fixed-to-floating.
Stock Comparison Tables
Here is a table summarizing common shares that will be displayed in our charts:
If you are looking for a particular stock not mentioned, you can find it in the charts below. These tables offer unique comparisons based on price-to-book value, dividend yields, and earnings yields, not found elsewhere.
For mortgage REITs, refer to the charts for AGNC, NLY, DX, ORC, ARR, CHMI, TWO, IVR, EARN, CIM, EFC, NYMT, MFA, MITT, AAIC, PMT, RITM, BXMT, GPMT, WMC, and RC.
For BDCs, consult the charts for MAIN, CSWC, ARCC, TSLX, TPVG, OCSL, GAIN, GBDC, SLRC, ORCC, PFLT, TCPC, FSK, PSEC, and MFIC.
Our comprehensive series provides the latest sector comparisons in one convenient place.
Residential Mortgage REIT Charts
Please note that the book value per share used in the chart for our public articles is based on the latest earnings release. Our targets and trading decisions rely on the current estimated book value per share, which is available in our service but not included in the charts below. PMT and NYMT do not provide a quarterly “Core EPS” metric, and thus no earnings yield metric is shown for these REITs. Similarly, a few other REITs lack a consensus estimate.
A second note on the charts: historical amortized cost and hedging can significantly impact earnings metrics, resulting in material discrepancies between mortgage REITs with similar portfolios. Exercise caution when relying heavily on consensus analyst estimates, which determine the earnings yield. Notably, throughout late 2022, the comparability of earnings metrics for many REITs diminished.
Commercial Mortgage REIT Charts
Please note that we have adjusted the coloring. We have also yet to update our charts to account for the issues concerning fixed-to-floating shares that may not transition. They are currently displayed as fixed-to-floating.
In addition to the charts, we provide readers with various metrics for preferred shares.
Since preferred shares without cumulative dividends do not align with our coverage, any preferred shares mentioned in our column will have cumulative dividends. You can verify this information using Quantum Online, for which we have included links in the table below.
To enhance table organization, we have abbreviated the column names:
- Price = Recent Share Price (Charted)
- BoF = Bond or FTF (Fixed-to-Floating)
- S-Yield = Stripped Yield (Charted)
- Coupon = Initial Fixed-Rate Coupon
- FYoP = Floating Yield on Price (Charted)
- NCD = Next Call Date (earliest possible call date)
- Note: For all FTF issues, the floating rate would start on the NCD.
- WCC = Worst Cash to Call (lowest possible net cash return from a call)
- QO Link = Link to Quantum Online Page
Feel free to consult the tables below for the relevant information:
We also have additional batches:
And a third batch:
Our primary objective is to maximize total returns. This entails incorporating “trading” strategies as they prove to be most effective. We regularly adjust our positions in mortgage REIT common shares and BDCs due to the following reasons:
- Stock prices often exhibit inefficiencies.
- Over the long term, share prices generally converge around book value.
- In the short term, price-to-book ratios can deviate significantly.
- While book value is not the sole criterion for analysis, it serves as a crucial foundation.
We also allocate resources to preferred shares and equity REITs. We encourage buy-and-hold investors to consider incorporating more preferred shares and equity REITs into their portfolios.
Outlook: Bullish on RC, Bearish on AGNC