The purpose of this article is to evaluate the BlackRock Income Trust (NYSE:BKT) as an investment option at its current market price. While I have been advocating going long on mortgage debt for years, I continue to see value in the space. The American homeowner is making good on their mortgage obligations, as delinquencies reached a new post-recession low last quarter. Furthermore, fewer Americans are borrowing against their homes. Outstanding home equity lines of credit (HELOCs) are declining consistently, which tells me homeowners are acting responsibility and are not overextended on their property. This reality should support performance in the underlying sector.
While my macro view of housing is optimistic, I have been advocating caution on some of the PIMCO CEFs that I cover, even though they are heavily exposed to the mortgage sector. The reason for this is because the valuations on many of those funds have skyrocketed, which is making me reluctant to recommend new positions now. However, BKT does not have this drawback. The fund trades at a discount to its underlying value, which investors should find compelling. Further, the fund is almost entirely exposed to mortgage debt, which I believe is a positive. While this investment clearly lacks diversity, I believe the underlying assets will perform well going in to the new year and view this fund as a great way to play the strength in the sector.
First, a little background on BKT. The fund is managed by BlackRock (BLK), and its objective is to “manage a portfolio of high-quality securities to achieve both preservation of capital and high monthly income”, primarily through exposure of agency mortgage backed securities. Currently, BKT trades at $6.02/share and yields 6.83% annually, by paying monthly distributions. This is my first review of BKT, and has come about because I am looking for funds that offer mortgage debt exposure, but that also trade at attractive valuations. While I typically use PIMCO CEFs for exposure to the mortgage sector, the majority of their funds are trading at levels I do not find enticing, and my search has brought BKT on my radar. After reviewing the fund, I believe investors could benefit from adding it to their portfolio, and I will explain why in detail below.
Mortgage Delinquencies Declined Further in Q3
As I mentioned in the opening, I am very bullish on mortgage debt as an asset class right now, especially when compared to other debt sectors. And this outlook is critical to explaining why I like BKT specifically, because the fund is very overweight this asset class. In fact, almost the entire portfolio is agency mortgages, as shown in the chart below:
Therefore, what is going on in the mortgage market is extremely critical when deciding whether or not to buy BKT.
Fortunately, this is an area of the market that has been performing extremely well of late. Mortgage delinquencies, which soared during the recession, have been dropping steadily, especially since 2013. While the delinquency rate is not quite yet at the pre-recession low, it is nearly there. Further, the rate has continued to drop each quarter this year. Consider that in Q2, the mortgage delinquency rate on single family residential mortgages across the U.S. sat at 2.59%, which is a pretty low number. However, last week, the St. Louis Federal Reserve released the Q3 figure, and that number showed even more improvement. Currently, the delinquency rate sits at 2.45%, as shown below:
Source: St. Louis Federal Reserve
Clearly, this is a strong performing asset class, as homeowners are increasingly making good on their mortgage obligations. This is due to a combination of factors, such as low unemployment, rising wages, and increasing home prices – which gives homeowners added incentive to remain current on their properties. Looking ahead, these are metrics I expect to hold up reasonably well in 2020, so I believe the delinquency rate will either hold steady or continue modestly lower. This is good news for the underlying holdings within BKT.
Mortgage Debt Holding Up Much Better Than Other Forms Of Consumer Credit
My second point on the mortgage debt sector relates to its performance compared to other types of consumer debt. While I just noted how mortgage delinquencies are quite low right now, the story is even better when we look at relative performance, rather than just in isolation. When investors look to earn yield off consumer loans, they have many options, including credit card debt, student loans, and auto loans, in addition to mortgage debt. However, while mortgage loans and HELOCs are seeing their delinquency rates sit at decade-level lows, other types of credit are not seeing the same strength. To illustrate, consider the graph below, which shows the percentage of total debt that is 90 days or more delinquent for varies types of loans:
Source: New York Federal Reserve
As you can see, the consumer picture is challenging beyond housing debt. For example, student loans and credit card debts, while stable, are sitting at fairly high levels of delinquencies. Even more worrying is the auto loan picture. The percentage of debt delinquent for auto loans is rising steadily and is nearing levels not seen since 2009, which is when the U.S. was in the middle of the worst recession in decades.
My takeaway here is that investors, especially those looking to limit risk, probably want to remain exposed to HELOC or mortgage debt as opposed to other types of debt assets. Considering BKT is made up almost exclusively of the sector that seems to be outperforming, in terms of on-time payments, it seems to me to be a relatively smart investment to make.
Slowing HELOC Market Instills Confidence
My next point concerns the market for HELOCs, which are not held within BKT but are important to understanding my bullish outlook for the mortgage debt sector. Specifically, it has been homeowners recent lack of demand for this product that has me optimistic. Thinking back to the recession, many people overextended themselves with multiple homes or a home they could not afford. While this is well known, what is discussed less is that many consumers took out lines of credit on their home, using the equity to fund unrelated expenditures or to make home improvements. When home prices failed to keep rising, the debt from the HELOC put many homeowners in foreclosure.
Therefore, while a HELOC is not inherently a bad thing, because they can be used productively, the over-extension of credit off the value of a property does raise some red flags. Fortunately, despite being a decade post-recession, the use of HELOC’s appears to have fallen out of favor. While mortgage rates have broadly declined, interest rates for HELOC’s have only started to level off, after rising for the last few years. This has helped stifle demand for the product, as HELOC volume now sits at a historically low level, according to data compiled by Bloomberg, as shown below:
My point here is that this provides further support for a healthy housing market in the U.S. Even if home prices, wages, and employment figures were rising, if Americans were aggressively borrowing off their homes, I would be uncomfortable going overweight this sector because it would be prone to a sharp correction if things changed. However, homeowners appear to be behaving more responsibly, and are not gambling with the equity of their homes. Considering that home prices have been rising, this suggests homeowners have had ample opportunity to borrow against their properties, but are actively choosing not to. The bottom-line is this is bullish for the underlying mortgage debt.
While the graph above notes that HELOC volume is sitting near a 13-year low, I want to further illustrate how this contracts with other types of consumer debt. According to the data from the New York Fed, balances on HELOCs have been declining since 2009, and the current outstanding balance sits around $396 billion. This decline has been driven by the falling number of people taking advantage of this product. By comparison, the number of accounts for credit cards and auto loans has risen sharply, especially in the last couple of years, as shown below:
Source: New York Federal Reserve
My takeaway here is that the American consumer does appear to be borrowing, and quite heavily in the short term, but they are not putting their homes at risk to do so. Outstanding mortgages have been rising only slightly over the last couple of years, while HELOCs have actually declined. This tells me Americans are seeking out credit, but the housing market is not getting wrapped up in this debt binge the way it did ten years ago. I again view this as support that BKT is exposed to the right type of assets going forward.
Final Point – Valuation Is Attractive
While my primary reason for liking BKT has to do with its underlying holdings and the strength of the mortgage sector, there is another important reason why I prefer it to the multitude of alternative funds out there. This is BKT’s valuation, as the market price sits at a healthy discount to the fund’s NAV. With equity markets sitting near all-time highs, and many fixed-income CEFs sporting expensive premiums, BKT’s discount looks especially attractive. To illustrate this point, consider the chart below:
|BKT’s NAV||BKT’s Market Price||Current Discount To NAV|
My takeaway here is quite positive. I would likely be bullish on BKT at a valuation at par, but the current discount is icing on the cake. With many of my favorite PIMCO CEFs sitting at premium prices that make me a bit uneasy, BKT has a solid discount that allows investors to buy-in to the underlying assets for less than their fair value. This is a compelling proposition.
With equity indices hitting new highs, I am focusing more of my assets on fixed-income. This has included preferred shares and municipal bonds, but mortgage debt continues to make up a good chunk of my portfolio. Going into 2020, I wanted to increase my exposure to this sector, and BKT is a unique way to do that. The fund is almost exclusively tied to the agency mortgage market, which provides an easy way to bet on the sector. With a discount to NAV, an above-average yield, and plenty of underlying strength in this housing market, I feel BKT will be a welcome addition to my portfolio. Therefore, I am going to initiate a position in this fund and would recommend investors give BKT serious consideration at this time.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in BKT over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.