The strategic repositioning of mortgage real estate investment trusts has continued apace as fallout from the pandemic has dramatically altered macroeconomic conditions and the relative attractiveness of individual companies' chosen investment strategies.
The latest move carries additional significance as it entails the sale of one of the oldest independent, publicly traded entities in the sector and the eventual discontinuation of its residential focus. Following the proposed acquisition of Capstead Mortgage Corp. by Benefit Street Partners Realty Trust Inc. in a deal valued by S&P Global Market Intelligence at $818.5 million, the combined company will pursue investments in middle-market commercial mortgage loans under a new name.
Capstead went public in 1985 with an initial focus on the issuance of and investments in collateralized mortgage obligations, hence its "CMO" stock ticker. During the 1990s, Capstead transitioned to an internally managed business model and dabbled in mortgage servicing before fully shifting its focus toward investing in adjustable-rate-mortgage-backed securities issued by government-sponsored enterprises Federal National Mortgage Association, Federal Home Loan Mortgage Corp. and Government National Mortgage Association. Minimizing credit risk through investments in agency-guaranteed securities served Capstead particularly well through the global financial crisis, a period during which a number of residential nonagency-focused mortgage REITs collapsed under the weight of severe pressure on liquidity and asset quality.
The strategy again held up in March 2020 as market dislocation, including in the agency MBS space prior to the onset of massive Federal Reserve intervention, triggered significant liquidity challenges and broad-based deleveraging across the mortgage REIT sector. But the company was not totally unaffected as it sold a portion of its portfolio toward the end of the first quarter of 2020 to provide additional financial flexibility. Pandemic-era market dynamics highlighted by the continued presence of the Fed created further challenges from risk and returns perspectives, eventually leading Capstead's board to consider the company's strategic alternatives for maximizing shareholder value.
Capstead's portfolio of residential mortgage investments totaled $7.43 billion as of June 30, up slightly from $7.41 billion as of March 31, but down from $7.94 billion at the end of 2020. The portfolio was valued at $11.22 billion at the start of that year. Although Capstead replaced the runoff of existing investments during the second quarter with new positions that the company projects will generate returns in the upper single digits, it had not fully done so in the two previous periods. President and CEO Phillip Reinsch, speaking during an April conference call, cited "strong demand for agency-guaranteed MBS in general, including agency ARMs" fueled by the Fed and commercial banks for Capstead's decision to keep some of its powder dry.
The CEO added at the time that returns had been reduced to levels that Capstead considered to be "unacceptable ... in many instances" due to the resulting "crowding out of private capital."
More lucrative opportunities may lay ahead for the new combined REIT. Benefit Street Partners Realty Trust Chairman, President and CEO Richard Byrne conceded during a July 26 call that investments in middle-market commercial mortgages will make for a "dramatic change" from Capstead's current focus. But Byrne said that the approach, which the publicly registered, non-listed Benefit Street Partners Realty Trust pursues through its management by a Franklin Resources Inc. subsidiary, has been generating returns on equity of 10%-plus and benefits from what the executive believes to be "significant long-term growth potential."
Benefit Street Partners Realty Trust said that the new combined entity would rank as the fourth-largest publicly traded commercial mortgage REIT from a stockholders' equity standpoint behind Starwood Property Trust Inc., Blackstone Mortgage Trust Inc. and Apollo Commercial Real Estate Finance Inc. on a pro forma basis. The REIT said it currently ranks No. 9 on a stand-alone basis, also lagging BrightSpire Capital Inc., Ladder Capital Corp, TPG RE Finance Trust Inc, KKR Real Estate Finance Trust and Ready Capital Corp. Annaly Capital Management Inc., the largest publicly traded mortgage REIT by total equity, is in the process of selling its commercial real estate business to a third party.
Both Reinsch and Byrne noted the propensity of the larger commercial mortgage REITs to trade at premiums to their book values; Starwood and Blackstone Mortgage Trust closed July 28 at price-to-book multiples of 1.67x and 1.19x relative to Capstead's pre-announcement level of 0.91x as of July 23.
With Capstead's sale, S&P Global Market Intelligence data shows that Dynex Capital Inc. would rank as the oldest remaining publicly traded, residential-focused mortgage REIT based on its date of incorporation in 1987.
