Capstead Mortgage Corporation (CMO) is one of the oldest publicly traded mortgage REITs dating back to 1985. Capstead has a fairly simple business model, they own adjustable rate residential mortgage securities issued by a government sponsored entity like Fannie or Freddie, then lever it up 7-8x and pay out substantially all the resulting net interest spread in the form of a dividend. Capstead is historically well managed, they were one of the few mortgage REITs to maintain their dividend throughout the pandemic and didn't get portions of their portfolio liquidated due to margin calls like so many others.
But times change, the returns available doing this "arbitrage" aren't what they used to be, forcing higher and higher leverage to the point where it doesn't make a lot of sense. In July, Capstead agreed to a reverse merger transaction with a public but non-traded traded REIT, Benefit Street Partners Realty Trust ("BSPRT"), with the proforma entity moving forward with BSPRT's management team and current middle market CRE loan strategy. Capstead is currently an internally managed REIT, the market likes those better as the incentives are more directly aligned, but as part of this reverse merger, the new combined entity will switch to an externally managed structure. To compensate Capstead shareholders and entice them to vote for the transaction, BSPRT and their management entity are paying a 15.75% premium over Capstead's book value in cash plus CMO shareholders will receive shares in the new entity on a book-for-book basis. The new entity will be called "Franklin BSP Realty Trust" and trade under the ticker FBRT, the external manager Benefit Street Partners is a subsidiary of Franklin Resources (BEN).
The 6/30 book value of CMO was $6.35/share, 15.75% of that is approximately $1/share in cash. The stock is trading for $6.77/share, if the proforma trades for book value, that's 8.5% upside for a deal that likely closes in the next month or two. This is a fairly simple investment thesis, really two questions you need to have some confidence in answering:
- How much, if any, has the book value moved in CMO since 6/30?
- What premium or discount to book value should FBRT trade at?
- $100MM repurchase program, with $35MM being funded by an affiliate of management, the repurchase program would kick in post close if FBRT is trading below book value.
- Approximately 94% of BSPRT shareholders will be locked up for 6 months post merger, so there shouldn't be the fear that this is an immediate liquidity event and all BSPRT shareholders will sell at the first chance they get.