Description

My thesis for this write up is similar to the write up for FTAI preferreds, I will skip most of my previous musings; but I am going to pull some of the verbiage directly from my previous write up because well..they apply here as well.

I will stick with my previous lead in somewhat:

This is a tough environment for a “value” investor.

In December 2019 I wrote up BKEP pref; it has been a long and volatile  ride but if you held it for 1 year you have made a 15.5% yield (in a market that has hated everything in the MLP space). Safe yield is loved.

I think I have another one that should offer a strong double digit return with investors. Most of my ideas that tend to have better risk adjusted returns have a credit angle and this one is no different.

I liked the write up from Rasputin998 from August on the idea and read the recent transcript from the management team and this felt like another idea where I can say ”I am a wimp. Historically if I like an idea as a write up and can find a double digit yielding idea further up the cap stack I would rather size up the investment and feel like I have a larger margin of safety; and If I can make a high teens return…well nobody ever complains about that”

Instead of re-writing the whole thesis on NYMT; I would rather focus the margin of safety and setup versus when the prefs were last at par (beginning of 2020).

The common has rallied substantially, I believe in order for equity to trade back towards book, the prefs will have to trade up as well. The management team seems to have a very defensive posture; but not one that is end of the world focused which makes me think the prefs are the right place to be. The last conference call was littered with questions about raising the dividend and buying back stock and the management team (who is sitting on a pile of cash) basically said yea sure we could boost the stock with a buyback but long term they want to focus on long term value; I am not here to argue the merits of their position it seems like an unambiguously positive posture from a preferred equity perspective.

The whole set up seems really attractive to me; probably because I am not an expert in the space.

In January these prefs were trading ABOVE par and we had $23.5bb in assets being supported by $2.2bb of equity with mark to market risks galore. Now we have $4.6bb in assets being supported by the same $2.2bb of equity with less mark to market risk and those assets now include $600mm of cash more than all of the prefs outstanding. The prefs seem less risky but are trading at a substantially higher yield. In fact; I would argue that they are now arguably very expensive capital for the company and safer than when they were trading above par back in early 2020.

I will focus on the “E”s for this analysis. These have a 7.875% coupon but will reset to 3 month libor + 642.9 bps starting in 2025. Where will LIBOR be? Heck if I know but if inflation is coming I will bet higher; if inflation isn’t coming well; earning a 645 bps spread for a safe asset is probably not a bad place to be because with all of this deficit spending and low rates if we haven’t seen inflation than spreads just will have to contract in all asset classes…by a lot.

The management team seems nervous which I think speaks to the prefs as a nice place to be-

“We continue to focus on improving our balance sheet strength ended the quarter was $650 million in cash, paying down all securities repurchase agreements subject to mark-to-market exposure completing a $365 million residential securitization in July and reducing our mark-to-market financing exposure by over $300 million ending the quarter at $626 million”

“And to your point we want to get back to a level that our shareholders have been used to, and so over time, we'll continue to look to grow the dividend, but at this point, I don't think we're really in a position to specifically state at what rates or level, but I would anticipate going upwards in the future.”

The balance sheet is simpler; and with that much cash and minimal mark to market risk the margin of safety is significant for the prefs.

Take a look at the balance sheet versus end of 2020; gearing went from 10x down to 2x today; cash went from 5.4% of equity to nearly 30% (yes that will go down over time but earnings power will increase); so cash up; leverage down, book equity up…but prefs down in price.

Prefs seem like a good place to be; and a trade up to par in 1 year will provide a 20%+ return.

Risks:

1)      The Company levers up a ton and jams the prefs

2)      Rates explode higher and you are stuck locked at a low rate for several years.

Catalyst

1.      Issuing common equity

2.      The company putting cash to work in a safe(ish) investment that adds to the pref coverage.