New York Mortgage Trust - Bigger Cushion For The Fat Yield

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About: New York Mortgage Trust, Inc. (NYMT), NYMTN, NYMTO, NYMTP, Includes: AGNC, TWO
by: Rubicon Associates
Summary

New York Mortgage Trust just did another equity raise.

More capital is good for the company and good for shareholders, but great for preferred.

My thoughts on the New York Mortgage Trust preferred and top pick.

Mortgage REITs can be volatile investments given the nature of their business. Generally speaking, they are leveraged spread investors, funding their portfolio at one rate (often in the repo markets) and investing at a higher rate (in the mortgage markets). Any change in the dynamics of their business - funding rates, investment rates, mortgage rates (which influence the decision to refinance - faster prepays - or keep the note - slower prepays), yield curve shape (which influences the spread between funding and investment) or hedge effectiveness - will affect the amount of funds available for distribution. The change in FAD will play a roll in their dividend decision, whether to increase or reduce the dividend.

Preferred stock investors will often trade the potential upside of company ownership for distribution stability. Essentially, the capital structure is used to accommodate an investor's risk profile. As a result, all investors have to be aware of changes to the capital structure and the impact changes will have on them.

One such change is the issuance or redemption of shares (common or preferred) and changes in debt levels. The issuance and redemption of common shares is a relatively frequent occurrence in the market as issuers buy back cheap shares and sell rich shares. Both of these events affect not only the common shares, but the rest of the capital structure. If a company issues common shares (because that capital is cheap), the funds available for distribution, while higher in dollar terms due to the creation of leveraged spread (leveraged assets generating net interest margin), must be shared amongst more investors and, as a result, common shares will trade lower. The impact on preferred shares, however, is decidedly positive. Preferred shareholders have a claim on distributions which is senior to common shareholders. As a result, there are more funds (the additional funds created through the leveraged spread) available to satisfy the preferred distribution. A bigger cushion if you will. Preferred investors generally benefit from the issuance of common shares.

Such a situation took place today.

New York Mortgage Trust, Inc (NYMT) is a REIT which invests in residential mortgage loans, including loans sourced from distressed markets, multi-family commercial mortgage-backed securities, direct financing to owners of multi-family properties through mezzanine loans and preferred equity investments, and Agency residential mortgage-backed securities.

Today, NYMT made the following announcement:

New York Mortgage Trust, Inc. announced today that it priced an upsized underwritten public offering of 12,600,000 shares of its common stock at a public offering price of $5.96 per share. NYMT also granted the underwriters a 30-day option to purchase up to an additional 1,890,000 shares of common stock.

NYMT estimates that the net proceeds from the offering will be approximately $72.8 million (or approximately $83.8 million if the underwriters exercise in full their option to purchase additional shares) after deducting the underwriting discounts and commissions and its estimated offering expenses. NYMT intends to use the net proceeds of this offering for general business purposes, which may include, among other things, acquiring its targeted assets, including both single-family residential and multi-family credit investments, and various other types of mortgage-related and residential housing-related assets that the Company may target from time to time and general working capital purposes.

This follows the November 7, 2018 announcement:

New York Mortgage Trust, Inc. announced today that it priced an underwritten public offering of 12,500,000 shares of its common stock at a public offering price of $6.11 per share. NYMT also granted the underwriters a 30-day option to purchase up to an additional 1,875,000 shares of common stock.

When a mortgage REIT's common stock is trading above book value (and expected book value), the REIT is issuing cheap shares (someone is willing to pay above the value of the portfolio) to fund their growth. NYMT is simply taking advantage of cheap shares to fund portfolio purchases.

Source: author spreadsheet

NYMT has once again created a bigger cushion for preferred shareholders. For full and early disclosure, I am one such preferred shareholder, owning the 8% Series D preferred shares (NYMTN). The deployment of this capital should help to increase the coverage of the preferred dividend (which was covered by net income by 5x as of 9/30/18). I like the bigger cushion.

The following table lists the outstanding series of NYMT preferred stock:

Source: author spreadsheet

The preferred have the following market characteristics:

Source: author spreadsheet

Of the three outstanding series, I prefer the Series D (NYMTN) for the following reasons:

  1. Higher stripped yield,
  2. lower dollar price,
  3. longer optional redemption lock-out,
  4. Much better volume, and
  5. the fixed to float structure (floats at 3m LIBOR + 569.5bps after 10/15/27).

All it is missing is the higher yield-to-call and it would be a slam dunk. Honestly, given the other attributes, I still view it as such.

NTMTN has traded at a lower dollar price than the Series C preferred (NYMTO) and the Series B preferred (NYMTP) for the last few months after generally trading in-line with the other series.

Source: author spreadsheet

The lower dollar price has resulted in a higher stripped yield for the NYMYN:

Source: author spreadsheet

Recent price performance of NYMTN has collapsed the yield spread to a below average level.

Source: author spreadsheet

Despite the recent performance of the Series D and resultant narrowing of the yield gap between NYMTN and NYMTO (as well as NYMTP), I continue to believe that the Series D is attractive relative to New York Mortgage Trust's other outstanding preferred stock issues.

Of course, an investor has many options when it comes to preferreds. The table below lists preferred stocks of similar mortgage REITs as well as newly issued preferreds.

Source: author spreadsheet

As the table above, and charts below show, the New York Mortgage Trust preferred stocks trade at a higher stripped yield and lower dollar price than the majority of their peers (which, honestly, is not a new phenomenon).

The stripped yield, graphically:

Source: author spreadsheet

Stripped price, graphically:

Source: author spreadsheet

One helpful way to look at the preferred shares is the amount of yield you are "paying" for the distribution safety. The following table shows the peer group's stripped yield, common dividend yield and yield spread.

Source: author spreadsheet

The "cost" of NYMT dividend stability is above average and trails only Two Harbors (TWO) and AGNC Investment (AGNC). This should help indicate that the market is willing to "pay up" for the stability - and certainty - of the preferred for NYMT.

The "cost of stability", graphically:

Source: author spreadsheet

While NYMT's stability premium is high, it is also trading near its tights over the last year as the yield on the preferred has widened out and the equity has performed well.

Source: author spreadsheet

It can also be helpful to look at the yields available in terms of "risk premium", or the yield spread to the risk free rate (I use the 10yr Treasury).

Source: author spreadsheet

The results are as you might expect - the highest yields have the highest risk premium, which means NYMT has the highest risk premium (and it also implies it is the riskiest).

The risk premium, graphically:

Source: author spreadsheet

NYMTN is currently trading near its average risk premium over the last year.

Source: author spreadsheet

As I stated earlier, the common equity of NYMT has done well versus peers over the last year, outperforming by a wide margin.

Chart NYMT Total Return Price data by YCharts

Bottom Line: I own New York Mortgage Trust's Series D preferred and recommend it to investors due to its attractiveness relative to other NYMT series and peers. I rate the Series D an OVERWEIGHT. That said, I also realize that the lunch isn't free (ever notice the tastiest treats might not be good for you over the long haul?) and this mortgage REIT has to be closely monitored for the reasons mentioned below.

A WORD ON RISK

There is no such thing as a free lunch. There is a reason that NYMT equity and preferred carry the yield they do - they take risk. For mREITs, there are numerous risks, but the two primary risks are leverage and credit.

For "safer" assets such as agency MBS, there is a narrower NIM due to the government/GSE backing of the collateral against default, and the returns are therefore driven by leverage, which is why agency mREITs employ higher leverage multiples.

For "credit" focused assets, there is a wider NIM as the collateral carried credit/default risk as it is "non-agency" collateral. Non-agency collateral has higher yields and, therefore, requires fewer turns of leverage to obtain the same returns.

NYMT is a credit investor and, as a result, faces credit losses (modification / default) in their underlying portfolio. The following table (made from two separate tables in the 10Q) shows where NYMNT's bread is buttered, and why.

Source: company 10Q

The NIM of 651 basis points in the MF book, and the amount of capital allocated to that sector shows the "where" and "why". They have allocated over half of their capital to the juiciest (recall the free lunch saying) sector they invest in.

Credit has had strong fundamental performance over the last few years as the economy has been in a sweet spot. Should the cycle turn (and it is turning), the probability of higher credit losses/impairments increases, which will affect the portfolio performance of credit focused mortgage REITs.

The bottom line is that these yields are not free lunches, whether the bet is leverage or credit, the risk is present. Investors should formulate their outlook for the economy, rates and mortgage sectors prior to deploying capital into these sectors and be willing to pull the ripcord when the thesis changes.

HELPFUL LINKS

NYMT 2018 Q3 earnings release

Series D (NYMTN) prospectus

01/08/19 share offering prospectus

Disclosure: I am/we are long NYMTN. 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.