New York Mortgage Trust (NYMT), a seemingly unassuming REIT focused on mortgage-related residential assets, has recently attracted attention for its significant foray into agency RMBS. While this move has stabilized portfolio interest income, a deeper dive into their Q1 2024 earnings call transcript reveals a potential ticking time bomb: the company's aggressive pursuit of high-coupon agency RMBS, particularly those concentrated in the 5.5% to 6.0% coupon range. This strategy, while initially boosting income, exposes NYMT to substantial prepayment risk should interest rates decline, a scenario that is far from improbable given the uncertain economic outlook.

While the company acknowledges the potential for increased prepayment risk inherent in this strategy, their justification hinges on a belief that rates "will potentially stay higher for longer." They argue that their existing credit portfolio, accumulated when rates were lower, offsets the convexity risk of their high-coupon agency RMBS. However, this line of reasoning seems precarious at best. The economic landscape is far from certain, and factors such as potential recession, the ever-increasing US deficit and its impact on long-term rates, and the looming CRE debt maturity wall (estimated at $2.8 trillion over the next four years) could easily trigger a rate reversal.

"The transcript reveals that NYMT's average ZV Spread of spec pool purchases in Q1 was 149 basis points, significantly lower than the 176 basis points in Q4 2023. This decline in spreads, coupled with the company's desire to maintain an attractive current yield for shareholders, suggests a relentless pursuit of high-yielding assets, potentially at the expense of prudence. The company's CFO stated they expect "undepreciated earnings per share to remain below the current dividend as we continue to rotate excess liquidity for reinvestment in a more attractively priced market." This raises a crucial question: is NYMT prioritizing dividend maintenance over long-term portfolio stability?"

Their focus on BPL-Bridge loans, while offering high carry and short duration, adds another layer of complexity. Despite low historical principal losses, these loans are susceptible to delinquencies as borrowers grapple with refinancing in a higher rate environment. The transcript acknowledges that more borrowers are seeking loan extensions, a potential harbinger of increased delinquency rates in the future. NYMT's exploration of rated securitizations for BPL-Bridge, while potentially leading to better financing costs, also underscores the evolving risk profile of these assets.

Asset Allocation Breakdown (Q1 2024)

Source: NYMT Q1 2024 Earnings Call Transcript

Hypothetical Scenario: Interest Rate Reversal

If interest rates reverse course and begin to decline, NYMT could face a double whammy:

The looming CRE debt maturity wall adds another layer of uncertainty. While NYMT sees this as a potential opportunity, it's also a considerable risk. The spillover effect of a distressed CRE market could easily impact residential loan markets, further exacerbating the company's vulnerability.

Conclusion

While NYMT's move into agency RMBS has stabilized short-term income, their aggressive pursuit of high-coupon securities raises concerns about long-term portfolio stability. The uncertain economic outlook, coupled with the looming CRE debt maturity wall, could trigger a rate reversal, leading to significant prepayment risk and potential dividend cuts. Their BPL-Bridge portfolio, while offering high carry, is susceptible to delinquencies, adding another layer of vulnerability.

NYMT, despite its vast experience, seems to be walking a tightrope. Their aggressive strategy, while potentially rewarding in the short term, could lead to a painful fall should the economic winds shift. Investors should approach this REIT with caution, carefully monitoring interest rate movements and the company's ability to manage its risk exposure.

"Fun Fact: The term "REIT" stands for Real Estate Investment Trust. REITs are companies that own, operate, or finance income-producing real estate. They offer investors a way to invest in real estate without having to buy or manage properties directly."