This article was previously available to subscribers. Since the publication of this article for subscribers, I initiated a long position in MTGE. I am still bearish on NYMT and still bullish on MTGE.
New York Mortgage Trust (NASDAQ:NYMT) is one of the more complicated mortgage REITs. Since many retail investors are going to struggle with estimating valuation changes in the underlying portfolio there can be a larger emphasis on other metrics such as "signs of confidence". The latest one getting some press is that the new president of NYMT made two large purchases of NYMT's common stock. While his choice to buy common shares could be seen as a positive factor, I think the market is reading too much into it.
Bearish View Clearly Announced
I reiterated my bearish view on NYMT in a recent subscriber piece on American Capital Mortgage Investment (NASDAQ:MTGE). The piece was published after the market closed on 06/20/2016 and reinforced that I felt NYMT was expensive and a good candidate to sell to provide capital for buying MTGE.
Shares Down Over 6% on Claims of an "Investigation"
Shares of NYMT were down over 6% in the first several hours of trading on 06/22/2016. I checked the SEC for filings on NYMT and found no new filings. Then I checked the NYMT website for a news release and found no new releases. Finally, I checked Google News and found the following " story". This story looks like the most logical cause for the weakness.
To save readers a click, the premise is that the law firm is investing NYMT for breaches of fiduciary duty. I am a huge bear on NYMT and even I find this case to be baseless. As a reminder, I am not a judge, a lawyer, or any other kind of professional on rendering legal opinions. The law firm does not even state what act was breaching fiduciary duty, but my best guess is that it relates to the buyout of an external manager.
In a nutshell, I believe their "lawsuit" is based on the same series of transactions that are referenced in this article. While I don't love the way things went down, I do not see any evidence that would cause me to believe fiduciary duty was breached. I have seen no reason to believe that the new president had any fiduciary duty to sell his company to NYMT at less than the highest price he could reach. I have seen no evidence that the CEO of NYMT failed to negotiate in the shareholders best interest. Further, the expected savings from internalizing the management of that part of the portfolio appears to easily justify the cost.
Given the lack of information provided by the law firm, I see no evidence that they even looked into this transaction to the level of detail I will provide. I felt NYMT was priced at a level that was materially too high prior to this announcement because their discount to book value was weak compared to peers that I believe are stronger mREITs. However, this fluctuation in price seems to be panic over the news rather than a correction based on the flaws of overvaluing a small mortgage REIT with complicated operations.
Given that shares only reached being down 6% within the last hour or so prior to submitting this, readers may wonder how the analysis could possibly have been completed so fast. It simply wouldn't be possible. The rest of this article was prepared over a week ago and I was just working on the finishing touches. The sections labeled "Bearish View Clearly Announced", "Shares Down Over 6% on Claims of an Investigation", and "Remarkably Fast" are the only sections written on 06/22/2016. The rest of the article took several hours of research, they were simply done over a week in advance.
A Note on Valuation
The portfolio should be having a fairly solid quarter so book value should be bouncing back quite nicely if we exclude the expenses from buying the external manager. If the purchase gets a hefty allocation to goodwill rather than being treated as an expense it could keep book value looking much stronger at the end of the quarter and result in stronger "earnings".
Because the portfolio should see some significant fair value gains and could report strong earnings for the second quarter I think it is a little too dangerous to short at this point despite prices being higher than I think they should be.
I see a small mortgage REIT with significant fixed costs. If NYMT can get to a good place to issue a large volume of equity it would be very favorable for the long term performance of the mortgage REIT and it would strengthen the value of the preferred shares because there would be a larger buffer of common equity before the par value of the preferred could be hit by any valuation losses.
Because NYMT would benefit substantially from being able to issue more stock and improving their economies of scale (also an opportunity to boost salaries), I see a major reason for NYMT to consider declaring the same dividend for the next quarter even though it wouldn't be sustainable in the long term. This decision can easily be justified by the favorable impact to common shareholders from growing the company and improving economies of scale.
There have been some large purchases of NYMT's common stock by the new president. While some shareholders may find this to be a huge positive sign, I wouldn't want to bet on that. The new president is Kevin Donlon. He was previously running RiverBanc LLC. RiverBanc was an external manager for New York Mortgage Trust. To understand how Mr. Donlon is able to swing the millions of dollars to buy these shares, we should follow the money from the purchase of RiverBanc.
Ownership of RiverBanc
These figures were primarily assembled using a combination of the earnings release and Kevin Donlon's employment agreement. The 8-k associated with his employment is on file with the SEC, so it is fair game for analysis. I may also draw from an 8-k on NYMT's entry into a material definitive agreement.
NYMT owned a 20% of RiverBanc. They spent about $24 million in cash to acquire the remaining 80%. This puts a total value on RiverBanc of $30 million.
There are a few other entities to know about here. They can be mentioned with entire names or with acronyms, so I'm going to provide both terms and the ownership prior to the ownership transaction.
JMP Investment Holdings LLC = JMP - I don't believe JMP is important to this analysis
Donlon Family LLC = DF LLC - 100% Owned and managed by Mr. Donlon
RB Multifamily Investors LLC = RBMI - Partially owned by DF LLC, partially by NYMT, partially by JMP
RB Development Holding Company LLC = RBDH - Partially owned by DF LLC, partially by NYMT, partially by JMP
RiverBanc - 20% owned by NYMT, 59.4% owned by DF LLC
Now that we know the names and who owns them, it is time for a little practical application.
Since DF LLC is entirely owned by Mr. Donlon, cash sent to DF LLC is effectively sent to Mr. Donlon. For all intents and purposes, DF LLC's gains and losses accrue to the person that owns 100% of the LLC.
New York Mortgage Trust paid $24 million to buy the remaining 80% of RiverBanc. The total valuation is $30 million. DF LLC should receive 59.4% of $30 million. That should be roughly $18 million. To be more precise: $17,820,000.
Concurrent with NYMT buying RiverBanc, the employment agreement indicates that NYMT also purchased the remaining equity interests in RBMI and RBDH. Those interests were acquired for $7,687,500 and out of that amount there was $1,281,250 paid to DF LLC.
In a nutshell, it would appear DF LLC is pulling in cash in the amount of about around $19.1 million.
Insider Buying Put in Perspective
In the two transactions that have been highlighted the new president spent $1.2 million and $.366 million. The combined value of these transactions is under $1.6 million. Compare that to the roughly $19.1 million pulled out of selling equity interests in subsidiaries of his own LLC and suddenly $1.6 million looks like chump change.
In the filing on the employment agreement for Mr. Donlon, there was this other excerpt:
"On May 16, 2016, the Committee approved a grant of 100,000 shares of restricted stock to Mr. Mumma (the "Stock Award") pursuant to the 2010 Plan, one-third of which will become fully vested and non-forfeitable on each of the first, second and third anniversaries of the date of grant. The Stock Award was granted in recognition of the Company's successful closing of the RiverBanc Acquisition and the acquisitions of RBMI and RBDH described above, to better right-size Mr. Mumma's total compensation relative to the range of total compensation paid to the chief executive officers in the Company's peer group, and to provide additional incentive to the executive to remain with the Company over the longer-term. Except as set forth in the immediately preceding sentence, the Stock Award is subject to the terms and conditions of the 2010 Plan and the restricted stock award agreement for Company employees, a form of which was filed as an exhibit to the Company's Annual Report on Form 10-K for the year ended December 31, 2015."
This deal seems to work particularly well for management as well since management gets another bonus that will eat into the cost savings from buying the external manager. While the internal management is paid materially less than management of many internally managed mortgage REITs, the mortgage REIT still has two external managers and effectively paid out an incredible signing bonus to bring one on board.
There may be some increase in revenue from owning this new subsidiary as opposed to a straight hiring of another individual. However, on the earnings call management indicated that they would only break out segment level data for the subsidiary if it became material. Upon further inquiries, material meant $2.5 to $3 million per quarter. Management stated they would love to get it there, but the enthusiasm sounded like a sign that it was a pipe dream.
Regarding the "right-size" of compensation, I feel inclined to point out that to the best of my knowledge most internally managed mortgage REITs have zero external managers and most externally managed mortgage REITs have only one external manager. For shareholders, it would be ideal if total operating expenses were "right-sized". The most recently reported level of operating expense looks "over-sized".
Pitch for Subscribers
Since the Mortgage REIT Forum is a new exclusive research platform, the first 100 subscribers will be able to lock in their subscription rates at only $240/year. My investment ideas emphasize finding undervalued mortgage REITs, triple net lease REITs, and preferred shares. With the market at relatively high levels, there is also significant work on finding which securities are overvalued to protect investors from losing a chunk of their portfolio.
Disclosure: I am/we are long MTGE.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. This article is prepared solely for publication on Seeking Alpha and any reproduction of it on other sites is unauthorized. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis.