New York Mortgage Trust Inc. (NYMT) is a real estate investment trust [REIT] engaging in acquiring, investing in, financing, and managing mortgage-related and financial assets in the United States. It primarily invests in agency residential adjustable-rate, hybrid adjustable-rate, fixed-rate, interest only and inverse interest only, and principal only mortgage-backed securities, and multi-family commercial mortgage-backed securities.
On February 4, I wrote this article discussing how NYMT was very close to doing a secondary offering and that investors should sell before the deal and buy back at a lower price afterward. On the day that the article was published, the stock price dropped from the open at 7.15 to the close of 6.85. In my opinion, this effectively prevented NYMT from doing the secondary. Since book value at the time was 6.52, the stock was only 5% above book at the close. This isn't enough of a premium to book to issue the secondary and attract significant participation. After the cut to cut to the broker, the deal would have been dilutive to book.
Further, unbeknownst to us investors, the company was in the middle of a "bad quarter". In my opinion, it did not want to upset the would-be participants in an offering by selling them stock only to come out shortly thereafter with an earnings miss. NYMT does not want to upset its participants, because they need to keep going back to the trough for more capital. The strategy is extremely capital intensive, and I expect at least 4 additional stock offerings in 2013. It did 4 offerings last year, and it shows no sign of stopping now.
A lot has happened over the last 6 weeks, and I am now aggressively shorting the stock.
First, there was the earnings miss. In Q4 2012, The Street expected 25 cents, and NYMT came in at 19 cents. In conjunction, book dropped from 6.52 to 6.50. Spread compression and prepayment acceleration were largely responsible. In Q1 2013, interest rates have moved up. This will cause spreads to widen but it will also cause book value to take another hit - If the quarter ended today, I estimate book would drop to 6.38 or lower.
Second, the company is low on cash. The 8-K shows only $32 million of cash as of December 31, 2012, and the company has been continuing to buy securities since then, as discussed on the quarterly conference call. It delayed doing an offering until Q4 results were out. In my opinion, it will delay a little further, because it is about to pay another dividend. It won't issue stock right before the dividend, because that would only send more money out the door. However, in my opinion, the company will do a deal immediately after the ex-div date, which will occur in the last week of March. Management has openly stated they want to aggressively grow the company and have been doing so over the past year. They will continue. The more they grow, the more they can pay themselves.
Third, the valuation has gotten excessive. At a recent price of 7.55, the stock is 116% of stated book and 118% of my estimate of current book. This is way out-of-line with the company's history and with other mortgage REITs. Here is a sampling of some other REITs and their Price/Book ratios:
Armour Residential (ARR)
CYS Investments (CYS)
MFA Financial (MFA)
American Capital (AGNC)
N.Y. Mtg Trust
After trading around 6.90 for most of February, NYMT has recently become a "high-flyer," as retail investors have chased its high 14% yield. This article recently came out heavily promoting the stock, and its effect has been extraordinary. Retail investors read the article, saw the yield, and then bought like crazy. But while you could argue the stock was a buy at 6.90; its most definitely a sell at 7.55.
Retail investors, why do you think the yield is so high? Do you think you are getting a "free lunch"? Do you think NYMT somehow has access to superior assets that are more favorable in terms of risk/reward? That nobody else can get these superior assets - only NYMT can get them? Which brings me to my next point.
Fourth, the company has taken on substantial risk. (Think about it - how else would NYMT be able to pay out such a high dividend?) 116% of book is a lot to pay for a company that has taken on the extreme risk that NYMT has, as it has exponentially grown its portfolio over the past year. The carrying value of NYMT's investments has tripled - going to $1.485 billion at year-end 2012, from about $425 million at the end of 2011.
Now NYMT is somewhat unique among REITs in that it takes on a combination of credit risk and interest rate risk whereas most REITs focus on interest rate risk alone. But the problem with credit risk is that it doesn't show up right away. Debt instruments do not default immediately after they are issued. It takes awhile for a problem to show up and turn a loan bad. But NYMT buys the riskiest loans to get the highest yield. Any small problem could jeopardize the principal. For example, in the last conference call, Steve Mumma, President, said
We closed on 3 Freddie Mac K Series multi-family investments during the quarter, including a floating-rate first loss security issued by Freddie Mac, their first, bringing the total investment at the end of the year to $195 million. Company owns 8 first loss securities, including 100% of 4 of these securitizations, requiring the company to consolidate the underlying loans and related by liabilities, resulting in $5.4 billion of financial assets and $5.3 billion of financial liabilities being recorded in our financial statements.
These K Series loans are first loss. Any hiccup anywhere in the entire pools will hit these tranches first. NYMT has purchased the riskiest tranches in order to obtain the highest yield. The yield looks great now because the risk may falsely appear low since the loans are brand new - but remember a default doesn't happen immediately after a loan is issued. It may happen down the road, and any problem in these pools will hit these tranches first. These are high-risk, high-yield.
NYMT's risk appetite is further displayed on the interest rate risk side. In my opinion, $100 million of IOs is a lot for a company of this size. Like the other REITS, NYMT invests in Agency RMSs and utilizes leverage to juice the yield and take on interest rate risk. But NYMT has essentially doubled its leverage over the past year. It takes on more risk than its competitors so it can juice the yield higher.
In the conference call, Steve Mumma said:
This portfolio is financed in part by $806 million in repurchase agreements, bringing the year-end leverage ratio to approximately 7.8 to 1 for this investment silo.
Here again is our REIT sampling. We compare NYMT's leverage ratio for their RMBS silo to those reported for year-end 2012 by the other REITs:
N.Y. Mtg Trust
While Armour Residential (ARR), CYS (CYS) and MFA (MFA) have leverage ratios similar to NYMT, their Price to Book is much lower - all less than 100%, while NYMT is at 116%. I would not recommend investing in ARR, CYS or MFA. ARR in particular has issues for investors - some are discussed very clearly here.
Note also that Annaly (NLY) has reduced leverage down to 6.5 during the same time that NYMT was increasing leverage up to 7.8. Annaly is the market leader among leveraged REITs. It is widely viewed as having the top expertise in the industry in managing interest rate risk through leverage. It occurs to me that Annaly is keeping its leverage low for a reason. Interest rates have already started moving up, and I would have cause for concern regarding investing in any REITS with high leverage in the current environment.
Finally, it irks me off how much these guys pay themselves. $11.4 million of administrative expenses is a lot for a company of this size. Steve Mumma, the President, received a salary of $300,000, and a cash bonus in December 2012; and 70,000 shares of stock and another $300,000 bonus in early March. To me, this seems excessive for a job that entails picking through high risk securities and choosing the riskiest, highest yielding tranches.
But Steve's compensation has increased with the size of NYMT's book, and this relationship will continue going forward. Steve has every incentive to increase the block through additional secondary offerings to further increase his take. NYMT did four secondary offerings in 2012, they are currently low on cash to invest, and in my opinion, will do another offering immediately after the ex-div date in the last week of March. Sell now and buy it back after the secondary when the price comes back down to earth.