In May of this year, we gave you the rationale why America First Multifamily Investors, LP (NASDAQ:ATAX) was a much better alternative to mortgage REITs and municipal bond ETFs. While the stock did not fit The exact characteristics of the two comparisons had many similarities, including playing real estate loans and the tax-sheltered nature of most of his income. This is an amazing success story.
ATAX outperformed mortgage REITs and the Annaly Capital Management Inc. trio by a wide margin. (NLY), AGNC Investment Corp. (AGNC) and Dynex Capital (DX) lost more than 30%.
ATAX was much less brutal on muni bond funds that we assumed would lose. Still, our four comparisons in this space, Nuveen AMT-Free Quality Muni Income (NEA), Nuveen Quality Muni Income (NAD), Nuveen AMT-Free Muni Credit Income (NVG) and Nuveen Municipal Credit Income (NZF), were enough bad that investors notice.
The biggest advantage ATAX had over similar mortgage REITs was simply its relative lack of leverage. Less leverage means less volatility in times of stress. Less leverage means less reduction in tangible book value, a metric that should concern any investor. Over the past 3 years, ATAX’s lower leverage has helped quite a bit in this arena.
We’ll find out why ATAX outperformed muni bond funds when we see Q3 2022 results.
Recent ATAX press releases have had plenty of good news for bulls. ATAX held its second special distribution this year.
America First Multifamily Investors, LP (the “Partnership” or “ATAX”) announced that the board of directors of Greystone AF Manager LLC (“Greystone Manager”) has declared a distribution of $0.57 to unit certificate holders (“BUC”) of the Partnership . at BUC. The distribution consists of a regular quarterly cash distribution of $0.37 per BUC plus an additional distribution paid in the form of additional BUCs of $0.20 per BUC. An additional distribution will be paid at the rate of 0.01044 BUC for each issued and outstanding BUC on the record date
Source: ATAX press release
These special splits occurred when ATAX sold many of its properties at bargain prices. Looking at the 10-Q, we can see that the profit on sales was $10.6 million this quarter and $39.7 million in the first 9 months.
These are huge amounts for the company, with only 22.2 million units (or BUCs, as they like to call them) outstanding. Another way to look at the impact is to look at cash available for distribution, or CAD per unit. ATAX is derived from net income to arrive at this CAD figure. You will notice that they do not deduct the profit from the sale when arriving at the CAD.
This paints a more problematic picture for the company. If you subtract the gain from the sale amounts, ATAX would have almost the same CAD ($11.7 million minus $10.6 million) in the third quarter of 2022. Year to date excluding CAD, sales profit would be approximately $11 million. With 22 million units outstanding, we expect about 50 cents in CAD. This has major implications for inventory and distribution in the coming year.
ATAX sees a huge drop in normalized (minus all sales gains) CAD. The question is whether they can continue to sell properties at a profit while their income on the mortgage bond side remains weak. The bigger question is whether we would want to. One advantage ATAX had over muni bond funds was the actual physical real estate they owned. These home values were and still are positively correlated with inflation. This has provided it with a natural hedge, a hedge that allows it to outperform muni bond funds. We believe these sales will decline and this likely allows for much lower CAD and distribution next year.
ATAX is also sensitive to interest rates, both on the balance sheet and the income statement. On the income statement side, further rate hikes will reduce the already tightly normalized CAD.
This sensitivity is despite ATAX adding significant safeguards.
On the balance sheet side, total capital is steadily declining, although it is buoyed by a large gain on the sale of real estate.
This decline is now moving the capital/assets ratio into unfavorable territory.
The outperformance relative to mortgage REITs and bond munis was driven by lower leverage and perhaps the crystallization of its physical real estate values. We believe that both advantages are coming to an end.
ATAX’s leverage is increasing as the rate hike cycle even affects its equity values.
Investors focused on big draws pushed ATAX to a high tangible equity premium.
The above chart does not include book values from Q3-2022 results, which would increase the ratio to 1.35X. Further increases in interest rates at the long end will further reduce the value of ATAX’s mortgage bonds. This could be offset to some extent by spread compression, but risks are still high at these levels. Our relative call review here tells us that muni bond funds are now trading at large discounts to NAV as well. This is also the driver of ATAX’s performance.
Therefore, we believe now is the time to no longer demand that ATAX outperform either mortgage REITs or muni bond funds. Indeed, given the very high premium coupled with much lower CADs in the coming year, we downgrade ATAX to a sell rating on valuation. We would aim to move to neutral, maybe 15-20% lower.
Please note that this is not financial advice. It might seem like it, it might sound like it, but surprisingly it isn’t. Investors are expected to do their own due diligence and consult with a professional who knows their goals and limitations.