A Motley Update

A hodgepodge of updates macro, portfolio, positions.

To start this write-up, which will cover my thoughts on macro, ABR, and each position, I want to share all my thoughts chronologically from the start of this past week. I got swamped with some work, so I’d like to rewind this past week and share what I thought during those days and the reasoning behind a couple of trades.

First, let’s return to the morning of the FOMC meeting (Jan 31^st). The morning of this meeting, we got our first taste of a potential banking contagion since the Silicon Valley Bank, FRC, and SBNY blowups in March 2023. New York Community Bank (NYCB) reported earnings during pre-market of the 31^st, dropping 38%. Before explaining why this occurred, let me set a backdrop for New York Community Bank. NYCB is the bank that acquired Signature Banks assets when it went bankrupt last year in March; these assets were acquired at pennies on the dollar and created immense value for NYCB post-acquisition (see price chart after March 2023); these assets were not the reason why NYCB plummeted. The problem was related to NYCB’s legacy business, specifically multi-family and New York CRE. NYCB provided $552 million in loan loss provisions, citing future losses in CRE and multi-family due to rent stabilization. The bank cut its dividend by 70% to meet regulatory capital requirements. This is a pretty idiosyncratic risk to NYC and multi-family rent stabilization and will not result in a more significant banking crisis. However, it does mean that office CRE and multi-family real estate are being forced to be marked to current market prices finally. The companies that should be worried most are bridge loan financers and class C or class B CRE owners. Moreover, following this report, we saw office REITs fall across the board; Kilroy Realty (KRC) fell 10% this past week. Additionally, multi-family bridge loan financers dropped significantly, namely Arbor Realty (ABR), down 7% over the past week. On Wednesday morning, I sold half of our KRC position at $36.50/share, and fast forwarding to today, KRC last closed at $34.88/share. My thoughts on KRC are that this CRE risk is idiosyncratic to lower-quality properties, and KRC operates only class A properties. Still, the problem is that the market will perceive these data points (like NYCB) as harmful and future credit risks. KRC is undervalued here, but it can definitely get cheaper (see October prices); the good thing is, the average price we own the KRC shares at is $27.67, so it allows much flexibility, and we aren’t sitting on any losses. KRC is on the chopping block if I can find a favorable investment alternative. Following the sale in KRC, I allocated to TLT. This trade is mostly just a hedge to the portfolio's CRE and risk of recession exposure. The spread worked well as TLT was only down about 0.5% since we entered, whereas KRC fell another 5%. Not much to add to the TLT hedge; if I close KRC, I will likely close TLT.

Moving further through Wednesday to the FOMC meeting, we heard from the FED that the March rate cut expectation was essentially pushed out into May or the summer. Honestly, this meeting was dull, and we heard almost all or largely expected rhetoric. So, I won’t spend too much time writing about it. However, one very interesting thing we saw throughout the week was significant volatility in SOFR futures. ZQH4 (March fed funds rate probability) saw the expectation of a rate cut change from 62.3% at the start of this year to 20% on the day of the Fed meeting, and now this has moved to 38%. The way I perceive this data is that going into the start of the year, we were riding off the December FED meeting, and the rate-cut bulls were riding on their high horses, ignoring what the Fed has been saying for the last 18 months, that the inflation target is 2%, not 3.3%. Fast forwarding to the day of the meeting, the SOFR market realizes this, and the expectation falls to 20%, which was an extreme and has now changed to a more normalized number, a 38% chance of a rate cut in March. I think this expectation is largely fair.