Earnings Call Transcript - GPMT Q2 2022

Operator, Operator

Good morning. My name is Chuck and I'll be your conference facilitator today. At this time, I would like to welcome everyone to the Granite Point Mortgage Trust Second Quarter 2022 Financial Results Conference Call. All participants will be on a listen-only mode. After the speakers’ remarks, there will be a question-and-answer period. Please note, today’s call is being recorded. I would now like to turn the call over to Mr. Chris Petta with Investor Relations for Granite Point. Please go ahead, sir.

Chris Petta, Investor Relations

Thank you, and good morning, everyone. Thank you for joining our call to discuss Granite Point's Second Quarter 2022 Financial Results. With me on the call this morning are Jack Taylor, our President and Chief Executive Officer; Marcin Urbaszek, our Chief Financial Officer; Steve Alpart, our Chief Investment Officer and Co-Head of Originations; Peter Morral, our Chief Development Officer and Co-head of Originations; and Steve Plust, our Chief Operating Officer. After introductory comments, Jack will review our current business activities and provide a brief recap of market conditions. Steve Alpart will discuss our portfolio. Marcin will highlight key items from our financial results. Press release and financial tables associated with today's call were filed yesterday with the SEC and are available in the Investor Relations section of our website along with our Form 10-Q. I would like to remind you that remarks of management during this call and the supporting slides may include forward-looking statements, which are uncertain and outside of the company's control. Forward-looking statements reflect our views regarding future events and are subject to uncertainties that could cause actual results to differ materially from expectations. Please see our filings with the SEC for a discussion of some of the risks that could affect results. We do not undertake any obligation to update any forward-looking statements. We will also refer to certain non-GAAP measures on this call. This information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with GAAP. A reconciliation of these non-GAAP financial measures to the most comparable GAAP measures can be found in our earnings release and slides, which are available on our website. I will now turn the call over to Jack.

Jack Taylor, CEO

Thank you, Chris, and good morning, everyone. We would like to welcome you all to our second quarter 2022 earnings call. Over the first half of 2022, we made significant progress on several aspects of our business. We refinanced two inefficient legacy funding vehicles and repaid high-cost term loan borrowings, resulting in improved run rate earnings and greater balance sheet flexibility. We've also been deploying capital into attractive investment opportunities, mainly in the multifamily and industrial sectors. Through the first two quarters of 2022, our loan fundings of over $380 million exceeded the $290 million of repayments, resulting in modest growth in portfolio balance. In general, our portfolio has been performing well despite the challenging market conditions. We've seen over prior economic cycles that US commercial real estate is viewed favorably by institutional investors globally during periods of volatility and uncertainty. We're in one of those periods today with elevated macroeconomic uncertainty and capital markets volatility, mainly driven by the rapid increase in interest rates over the last few months, which have reduced real estate transaction volume and impacted views on property values. Given the uncertain markets and volatility, we have substantially reduced our loan origination activities in the third quarter, while focusing on further building our liquidity levels for any additional market deterioration or unforeseen credit developments in our own loan portfolio. We believe the markets may stabilize over the coming months, as new data should provide additional clarity on the likely forward path of macroeconomic trends and the Fed's monetary policy over the coming quarters. Our lending activity over the rest of the year will largely depend on capital availability and the overall market environment, as we intend to maintain our measured approach. Given the uncertain macroeconomic landscape and broader market trends, during the second quarter, we increased our reserve for credit losses and downgraded one of our office loans to a risk rating of five. We continue to actively work on resolutions of our two risk-rated five loans, which we believe should resolve before the end of the year. Though given the overall market uncertainty, the exact timing remains hard to predict. Since quarter end, we funded about $54 million in loan balances and realized over $155 million of repayments. The repayments year-to-date totaled approximately $450 million and have been spread across various property types, including over $185 million of office loans. Due to our measured approach to capital deployment and repayment expectations, we anticipate that the balance of our portfolio may modestly decline over the remainder of the year, though it is difficult to be precise in our projections, given current market conditions. Our accomplishments over the first half of the year have benefited our business, improved our run rate profitability, and provided additional balance sheet flexibility. Repayment of the high-cost term loan borrowings in the second quarter helped to meaningfully offset the earnings impact of rising short-term rates. The current level of benchmark short-term interest rates is above all the benchmark rate floors in our loans, and our portfolio is now positively correlated to additional increases in short-term interest rates going forward. We remain focused on prudently managing both sides of our balance sheet, improving our run rate earnings and driving shareholder value by closing the gap between our current stock price and our book value. Consistent with this approach, given our liquidity position, low leverage and the discounted valuation of our stock, during the second quarter we accretively repurchased in the open market over 1.5 million common shares totaling over $15 million, which benefited our second quarter book value by about $0.17 per share and helped meaningfully offset the charge related to the repayment of the term loan borrowings. We will remain opportunistic in further rationalizing our funding and capitalization to better position us for future growth, as markets regain more stability over time. Despite unprecedented interest rate and overall market volatility, our business has delivered solid operating performance led by our well-diversified and resilient portfolio of senior loans, generating good run rate earnings, supporting an attractive dividend. Our seasoned team has successfully navigated multiple economic, credit and interest rate cycles over their long careers, including periods of macroeconomic uncertainty and volatility. Our conservative approach to credit underwriting, risk management and protecting our investors' capital has been a key tenet of our strategy, and we believe it will deliver attractive risk-adjusted total returns to our stockholders over time. I would now like to turn the call over to Steve Alpart to discuss our portfolio activities in more detail.

Steve Alpart, CIO

Thank you, Jack, and thank you all for joining our call this morning. In the second quarter, we continued to deploy capital into high-quality loans that meet our credit and return criteria. We closed five new loans totaling about $202 million in commitments and over $165 million of initial fundings. We also funded over $40 million on existing commitments, bringing total future fundings for the quarter to over $210 million. Over 75% of our Q2 originations were secured by multifamily assets, consistent with our theme this year to focus on more defensive property types, with favorable credit profiles. The newly originated loans carry attractive risk-adjusted return characteristics, with a weighted average yield of SOFR +3.95%, and a weighted average stabilized LTV of approximately 64%. Our repayments and loan paydowns totaled about $120 million in the second quarter, which were outpaced by loan fundings and resulted in modest portfolio growth. Consistent with broader market trends, the pace of our repayments has moderated along with the overall slowdown in real estate transaction activity. Our portfolio ended the second quarter with an aggregate committed balance of $4.2 billion, including $360 million of future funding commitments. Our portfolio is well diversified across geographies and property types, and includes 104 investments with an average loan size of approximately $37 million. Our loans continue to deliver an attractive income stream, with a favorable overall credit profile, generating a realized yield of about 5%, with a weighted average stabilized LTV of 63%. As of June 30, our portfolio weighted average risk rating was 2.5, which was unchanged from the prior quarter, as new loan originations offset select rating downgrades, which were mainly driven by overall market conditions. During the quarter, we moved one of our office loans to a risk ranking of five, put the loan on non-accrual status given our expectations for a potential loss, and established a $4.5 million credit reserve. The collateral property securing this $94 million loan has been negatively impacted by a soft leasing market in San Diego driven by the ongoing impact of the pandemic. This quarter, we also added a previously rated four loan, collateralized by an office property in Minneapolis, to our watch list due to the property being negatively impacted by slow office leasing in this market. We are in active discussions with both of these borrowers as we evaluate a variety of resolution alternatives. We are also continuing on a path to resolving the Pasadena retail loan which we expect to occur by the end of the year. Given the uncertain market conditions which have significantly shifted from last quarter, it is difficult to predict the exact timing of these resolutions. Now within these specific cases, we have a well-diversified portfolio of over 100 investments and the overall credit quality of our portfolio remains stable. Given the overall market uncertainty, the slowdown in real estate transaction volume and pressure on property values, we will remain measured in our approach to new loan originations until there is more clarity on overall market conditions and available liquidity. So far in the third quarter, we have funded approximately $54 million in loan balances and realized over $155 million of repayments. Our year-to-date repayments of about $450 million across various property types include over $185 million in office loans with the remainder spread across hotels, multifamily and other sectors. Our repayment pace has been slower than usual and impacted by overall market conditions. However, our borrowers have continued to successfully repay our loans through refinancings and property sales, even during these challenging market conditions which underscores our conservative underwriting and the overall credit quality of our portfolio as a whole. I will now turn the call over to Marcin for a more detailed review of our financial results.

Marcin Urbaszek, CFO

Thank you, Steve. Good morning, everyone, and thank you for joining us today. Yesterday afternoon, we reported a second quarter GAAP net loss of $17.4 million or $0.32 per basic share as compared to GAAP net income of $1 million or $0.02 per basic share in Q1. Our Q2 GAAP results include a provision for credit losses of about $0.26 per basic share and a previously disclosed charge on early extinguishment of debt of about $0.25 per basic share, which was related to repayment of the senior secured term loan and term financing facilities. Distributable earnings for the second quarter were $11.7 million or $0.22 per basic share, which excludes the provision expense and the loss on debt extinguishment. Our June 30 book value was $16.01 per share, down from $16.39 per share last quarter. Book value reflects the GAAP results and the dividend which were partially offset by our accretive share repurchases during the quarter that we estimate benefited our book value by about $0.17 per share. We remain focused on improving shareholder returns over time, and repurchasing over 1.5 million common shares at a meaningful discount is consistent with the strategy. In total, we have repurchased over 2.8 million common shares over the last few quarters which have meaningfully benefited our book value and helped offset some of the impacts associated with repaying the high-cost term loan borrowings. Consistent with industry trends, our second quarter CECL reserve increased to about $50 million or 118 basis points of total portfolio commitments. The increase was mainly driven by implementing more conservative macroeconomic forecasts in our analysis, given the economic and market backdrop, as well as establishing a specific reserve on an office loan, which Steve discussed earlier. In total, about $18.6 million of our CECL reserve is allocated to the two risk-weighted five loans. Turning to interest rate positioning. As we discussed on prior calls, becoming positively correlated to higher short-term rates was mainly dependent on the speed at which benchmark rates would increase, given the relatively higher LIBOR floors in our loans. As of June 30, benchmark rates were higher than about 80% of the rate floors on our loans. Given the recent increase, the current level of benchmark interest rates is above all of our floors, so our portfolio is currently 100% correlated to additional interest rate increases. With respect to liquidity and leverage, we ended the quarter with about $150 million of unrestricted cash, and our total debt-to-equity ratio at June 30 modestly increased to 2.7x from 2.5x at the end of March. Thank you again for joining us today and I will now ask the operator to open the call for questions.

Operator, Operator

And the first question will come from Doug Harter with Credit Suisse. Please go ahead.

Doug Harter, Analyst

Thanks. You made comments that you expect to slow loan origination volume in light of the current environment. Can you talk about how you would view continued share repurchase in light of those views?

Jack Taylor, CEO

Doug, this is Jack Taylor. Thank you for joining us. Well, it is our general policy not to comment on potential buybacks or their timing as we've stated in the past, but we've always been focused on generating attractive risk-adjusted shareholder returns. And as we assess what to do with our liquidity, one of the things that we'll look at is our discount to book valuation as a factor, and we'll take that into consideration. So we can't comment specifically on what we'll do on share buybacks, but it's something that's part of our toolkit.

Doug Harter, Analyst

Great. Last quarter you had in your slide deck some of the initiatives to drive ROE higher. Can you just give us an update as to where you are in kind of achieving those and kind of when we can expect those steps of driving higher ROE?

Marcin Urbaszek, CFO

Sure, Doug. Hi, it's Marcin. Good morning. Thanks for joining us. I would say, out of the list that we had in that slide, most of that has taken place. We repaid the term loan. We refinanced some of our legacy inefficient funding vehicles. Obviously, considering we're taking a measured pace to originations, I think that last piece is probably a little bit slower. And as you heard us say in the prepared remarks, we continue to work on resolving some of the non-accrual assets. So we've accomplished a lot. We have a little bit more to go, and it really depends going forward on resolving these assets, which we expect to potentially happen by the end of the year and then just going from deleveraging the portfolio and growing it from there while benefiting from higher rates as well.

Doug Harter, Analyst

Great. Thanks, Marcin.

Operator, Operator

The next question will come from Steve Delaney with JMP Securities. Please go ahead.

Steve Delaney, Analyst

Good morning, everyone. Thank you for taking my question. Regarding the office loan situation in San Diego, could you provide more details about the tenant occupancy mix? How is that property positioned in the market? Also, was it a loan from late 2019? What stage is it at in terms of renovations and similar matters? Thank you.

Steve Alpart, CIO

Hey, Steve. Good morning. Thanks for joining. It's Steve Alpart. So, as we mentioned on the call, we downgraded the risk ranking on this asset to five during the quarter. The building itself is very well located. It's recently renovated to a Class A property. It's in the San Diego CBD. It's like a lot of the CBD office has been impacted by a slow leasing market. So as I mentioned in the prepared remarks, we placed the loan on non-accrual status and took the asset-specific reserve that we mentioned of $4.5 million. We've been in ongoing constructive conversations with the sponsor. They have a significant amount of equity in the property. The CapEx portion of the business plan is complete, but leasing has been slow for the reasons that I mentioned. I also mentioned that the borrower is currently in the process of marketing the property, and as I said, we're in active dialogue as we communicate with the sponsor and kind of monitor that process.

Steve Delaney, Analyst

Okay, that’s helpful. It seems you have a borrower who is somewhat beneficial to the situation right now, and you may not want to provide more details than that, but I think it’s a positive sign and I appreciate the insight. I'm sorry, please continue.

Steve Alpart, CIO

No, go ahead.

Steve Delaney, Analyst

Okay. Regarding the two 2021 CLO deals you mentioned in the context of reworking inefficient financing vehicles, were you talking about those two CLOs? Also, could you remind me if they had two-year or two-and-a-half-year reinvestment periods? Thanks.

Marcin Urbaszek, CFO

Hi, Steve, it's Marcin. Thank you for joining us and thanks for the question. So, we had two legacy facilities that we refinanced earlier in the quarter. That was the first FL1 from 2018 and then the term financing facility. So we took care of those two. We have FL2, which is a 2019 legacy, which we are looking to potentially refinance at some point. That had a two-year managed period which ended. And the 2021 FL3 is the static deal, and the FL4 has a two-year reinvestment period, so it's still active.

Steve Delaney, Analyst

Okay. Three static, okay. So you have one active one open CLO.

Marcin Urbaszek, CFO

Correct.

Steve Delaney, Analyst

You plan to reinvest in that CLO as cash becomes available. I understand that you don't expect significant loan growth in the next couple of quarters, but will you work to keep that CLO fully invested?

Marcin Urbaszek, CFO

Yes, that's our goal.

Steve Delaney, Analyst

Okay. Good. Well, thanks for the comments. I appreciate it.

Operator, Operator

Our next question will come from Stephen Laws with Raymond James. Please go ahead.

Stephen Laws, Analyst

Hi. Good morning. You mentioned some of this earlier, but I have a follow-up. When considering buybacks, originations, and improving liquidity, what are your priorities? In your prepared remarks, you referred to market conditions and liquidity as two factors that might influence increasing leverage later this year or being more proactive with originations. Is it mainly the resolution of the two loans this year that would enable you to do that, or are there other factors you're considering?

Jack Taylor, CEO

Hi Stephen, this is Jack Taylor. It's great to hear from you, and I appreciate your question. The use of liquidity will largely depend on future events and overall market conditions. We believe that once the markets stabilize, it will create a favorable environment for lenders to operate on conservative terms, potentially with even better structures, although the current structures have been quite solid. I mentioned earlier regarding the share buyback; this also involves a cost-benefit analysis compared to other liquidity uses. The resolution of our loans is an important part of this analysis. While it's not the only factor, it is one of many considerations that influence our decision.

Stephen Laws, Analyst

As we consider unfunded commitments with a potential slowdown in originations, we may see fewer additions. How should we approach the drawdowns as the portfolio matures and these projects progress through their plans? What kind of drawdowns do you anticipate from the unfunded commitments in the second half of the year?

Jack Taylor, CEO

We've been managing around $50 million a month for several years, but the actual size of the future funding pool has decreased and is now running closer to $40 million. We anticipate that this will trend slightly lower in the upcoming quarters.

Stephen Laws, Analyst

Great. Appreciate your comments this morning.

Jack Taylor, CEO

Thank you, Steve.

Operator, Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Jack Taylor for any closing remarks. Please go ahead.

Jack Taylor, CEO

Thank you very much, operator, and I would like to thank all of you for joining our call today. And also, I'd like to thank you for your continuing support of our business. We wish you good health during these continuing times, and we look forward to speaking with you soon.

Operator, Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.