Description

"Buffett is an idiot"

"All I do is make money, this game is f*cking easy.  Literally the easiest game I've ever played.  All I do is print money."

“I should be up a billion dollars.”

Dave Portnoy @stoolpresidente

Welcome to the day trading bubble of 2020.

This is a recommendation to short MITT and IVR paired with a long position in REM (the mortgage REIT ETF) to hedge the short. It’s a mean reversion pair-trade, so if that’s not your thing, please feel free to skip this recommendation. Apologies for the short writeup.  We rushed to get it out because we’re not sure how long this dislocation will last.

There’s a speculative phenomenon that has been going on among retail investors with the advent of commission free trading that started in the fall of 2019. Most popular online retail platforms now offer commission free trading. The speculative retail day trader mania was evident even before the pandemic hit in stocks like Virgin Galactic Holdings Inc. (SPCE) which returned 3x from Jan to Feb this year, only to crash during the March selloff. 

With the breathtaking bounce off of the March 23 lows and the NASDAQ now trading above its all time high, the speculative day retail trader mania has now gone parabolic with bankrupt stocks like HTZ up more than 5x in 3 days (and just written up on VIC as a short) and CHK, whose bonds are signaling zero recovery for the equity, also soaring 5x in 3 days. 

The retail mania has now piled into mortgage REITs, which have historically never been the subject of any type of retail day-trading mania before.  A number of speculative mortgage REITs have seen dramatic runs recently. MITT and IVR are the two most egregious.  MITT is the better valuation short but the borrow is quite difficult (IBKR fee rate of 116%). Even though the valuation of IVR is not as egregious as MITT, it’s much easier to borrow (IBKR fee rate of 12%).  You can size the relative positions of MITT and IVR based on your risk preference and ability to borrow.

MITT provided an estimate of its book value in the range of $1.80 - $1.90 as of 4/30/20: https://www.sec.gov/Archives/edgar/data/1514281/000151428120000058/mitt8-k572020.htm

Although the value of the underlying assets have moved up somewhat since 4/30/20, MITT is one of only 2 mortgage reits that is currently still struggling to meet margin calls and is in the midst of margin forbearance agreements: https://www.businesswire.com/news/home/20200601005756/en/AG-Mortgage-Investment-Trust-Company-Update#.XtWYP2nqkS8.twitter

IVR has been written up previously on VIC. While IVR is in a much better situation than MITT, the valuation disconnect is also quite stark compared to the rest of the MREIT space.  IVR’s latest estimate of book value was in the range of $2.75 - $3.75: https://www.sec.gov/ix?doc=/Archives/edgar/data/1437071/000119312520110832/d913052d8k.htm

Compare the valuation of MITT at 3.90x book value and IVR at 1.85x-2.54x book value to the mREIT industry bellwethers NLY and AGNC, which are both trading in the range of about .90x of book value.  We don’t have an exact estimate of book value for all the stocks in the REM ETF, but the book value is certainly no higher than the valuations of NLY & AGNC, which generally garner the highest valuations in the sector.

The speculative momentum can be seen by tracking the number of account holders holding IVR and MITT on Robinhood. IVR is #6 on the list of popularity changes on Robintrack:

https://robintrack.net/popularity_changes

https://robintrack.net/symbol/IVR?symbol=IVR

https://robintrack.net/symbol/MITT

The volume over the last 2 days for these two stocks is off the chart compared to the average volume over the last 30 days. For example, the volume for MITT today was 30.6 million shares and 13 million shares last Friday. MITT has 33 million shares outstanding.  IVR has 165 million shares outstanding. It traded 131 million shares today and 54 million shares on Friday. There’s an obvious disconnect, which has been driven by rampant speculation by day traders and the algorithms that feed off of this type of price movement. This is very reminiscent of the price/volume trading dynamic from the tech bubble in the 1998-2000 period.

Admittedly, it’s quite challenging to short into a speculative mania. However, what gives me more confidence in shorting these two stocks is that the fundamental values are anchored by book value. Mortgage REITs are not speculative high-flyer stocks of infinite future value like a SPCE or TSLA. Mortgage REITs do not trade on a NPV of some massive cash flow expected 10-20 years from now. Rather, they have a fairly ascertainable NAV based on their portfolio of underlying mortgage assets. They have typically traded in a range of slightly above or below book value. Agency and hybrid mREITs never traded far above book value, even in the post-2009 ZIRP world with investors reaching for yield -- the highest valuation we can remember is about 1.25x book value (i.e., when investors were confident in the management team and the value of the underlying assets in the portfolio).  That’s not the case today with either MITT or IVR. It’s actually the exact opposite.  Both of these names have been mis-managed and performed horribly during this downturn. And arguably, the value of the underlying assets of MITT and IVR have never been more uncertain than during this period. They both deserve to trade at a discount to book value.

We recommend having a long position in REM to hedge against these two short positions.  REM holds a diversified assortment of agency, hybrid and commercial mortgage REITs.  The ETF only holds a 0.25% position in MITT and a 1.5% position in IVR: https://www.ishares.com/us/products/239543/ishares-mortgage-real-estate-capped-etf. Hedging with REM also provides a dividend hedge.

Fair value of the MITT is a large discount to the last publicly disclosed book value of $1.80 - $1.90. The fair value of IVR is a 20%-30% discount to the last publicly disclosed book value of $2.75 - $3.75. The underlying assets have appreciated somewhat since the dates of the disclosed book values, so the current fair values may be somewhat higher.  In any case, the downside for MITT from the aftermarket closing price today of $7.98/share to $1.30/share (35% discount to $2.00/share) is 84%. The downside for IVR from the aftermarket closing price today of $7.50/share to $2.44 (25% discount to $3.25/share) is 68%. These are attractive potential returns.

Risks

• Our book value estimates for MITT and IVR could be off. This is certainly possible given the uncertainty we face with the pandemic and its consequences. However, we take some comfort in the fact that even if we are off by a sizable margin, the pair trade still makes sense. Some of the other mortgage REITs have experienced some book value appreciation on the order of 5%-10% since the end of March or April, while others such as EFC have seen a more modest 1%-2% fluctuation.

• The speculative mania continues. Size according to your risk appetite with stop losses that let you sleep at night.

Legal Disclaimer: This research report expresses my research opinions, which I have based upon certain facts, all of which are based upon publicly available information. Any investment involves substantial risks, including complete loss of capital. Any forecasts or estimates are for illustrative purpose only and should not be taken as limitations of the maximum possible loss or gain. Any information contained in this report may include forward-looking statements, expectations, and projections. You should assume these types of statements, expectations, and projections may turn out to be incorrect. This is not investment advice nor should it be construed as such. You should do your own research and due diligence before making any investment decision with respect to securities covered herein. The author and/or his employer has a position in this stock and may trade this stock. 

Catalyst

• Valuations revert to historical norms.

• The companies issue equity. It would make sense for MITT and IVR to issue equity at these premium valuations to book value. It’s hard to imagine what institutional investors in their right mind would buy any deal above book value. Any offering around book value should crater the stock.