Earnings Call Transcript - GPMT Q4 2022

Operator, Operator

Good morning. My name is Diego, and I will be your conference facilitator. At this time, I would like to welcome everyone to the Granite Point Mortgage Trust Fourth Quarter and Full Year 2022 Financial Results Conference Call. Please note, today's call is being recorded. I would now like to turn the call over to Chris Petta with Investor Relations for Granite Point.

Chris Petta, Investor Relations

Thank you, and good morning, everyone. Thank you for joining our call to discuss Granite Point's fourth quarter and full year 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 my introductory comments, Jack will provide a brief recap of market conditions and a review of our current business activities. Steve Alpart will discuss our portfolio, and Marcin will highlight key items from our financial results. The 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. We expect to file our Form 10-K next week. I would like to remind you that remarks made by 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 our risks that could affect results. We do not undertake any obligation to update any forward-looking statements. We will also refer to 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 those 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'll now turn the call over to Jack.

Jack Taylor, CEO

Thank you, Chris, and good morning, everyone. We would like to welcome you to our fourth quarter and full year 2022 earnings call, and thank you for joining us today. Despite the challenging market backdrop and the Fed's dramatic actions in raising interest rates, we successfully navigated this unstable environment and accomplished many of our objectives over the course of 2022. Earlier in the year, we opportunistically grew our equity base through the $87.5 million add-on preferred equity offering and repaid the remainder of our higher-cost term loan borrowings. We refinanced two of our legacy deleveraged funding vehicles, releasing a substantial amount of capital, further strengthening our liquidity position. During the second half of the year, we closed on two new credit facilities with an aggregate borrowing capacity of up to $300 million, which are designed to fund performing, subperforming, and nonperforming loans on a non-mark-to-market basis. These facilities highlight our ability to add to our already diverse funding sources and provide us with more asset management and liquidity flexibility during the current volatile environment. In anticipation of potential macroeconomic challenges and consistent with our conservative approach to managing our business, early in the first half of 2022, we shifted our business objectives from originating new loans and growing our portfolio to preserving our liquidity to further bolster our balance sheet. For example, we further emphasized proactive asset management, working with our borrowers and driving loan repayments through active dialogue well in advance of loan maturities. This contributed to a healthy volume of loan repayments of about $1 billion over the course of the year. These and other actions allowed us to strengthen our balance sheet while also redeeming the $144 million of convertible notes that matured in December with cash on hand without needing to access the funds in the capital markets, which were quite challenging at the time. As we have said in the past, we expect the commercial real estate and capital markets environment to remain challenging and uncertain in the near term. It remains unclear when the Fed will ultimately stop raising short-term interest rates or for how long they will keep them elevated or when the market environment will stabilize or when the commercial real estate markets will improve. While we continue to see headwinds in the office sector, they are impacting properties and markets very unevenly. In our portfolio, the biggest impact has been on those markets and properties more affected by the pandemic and work-from-home trends. We are a high-quality, well-located property with a strong sponsor that has encountered a very tough leasing market. These trends, coupled with rising interest rates, have resulted in a few borrowers electing to stop funding additional equity. However, these loans have been the exception. In general, we are seeing ongoing commitment by our borrowers to their properties and the loan assets in our portfolio. We recognize and are addressing the challenges in the office sector. Consistent with our intermediate-term macro views, we have significantly increased our CECL reserves over the last couple of quarters to about 2.4% of our portfolio commitment as of the end of 2022. In the near term, we will continue to manage our business in a conservative manner, protect our balance sheet, and maintain lower leverage while emphasizing liquidity and collaboratively working with our borrowers to maximize outcomes. As we have seen during previous global dislocations, the U.S. commercial real estate market has always been viewed as a compelling place to invest over the long term and has attracted significant amounts of capital over time. Currently, a lot of capital is on the sidelines and is waiting for more intermediate clarity and capital market stability. We believe that our significantly deleveraged balance sheet, combined with our team's proven expertise, will allow us to both mitigate the effects of market uncertainty on our portfolio and ultimately take advantage of attractive new market opportunities as we normalize our levels of leverage. We believe that our strategy of targeting middle market and moderately leveraged U.S. commercial real estate loans with an average loan size of about $37 million, with significant borrower equity cushion, is more resilient in a market like this. Given the environment, we intend to maintain our cautious stance while drawing on the broad expertise and experience of our team, to successfully navigate the challenges as we have done over our long careers in real estate lending. 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. During 2022, we funded approximately $565 million of loan balances with an average balance of $38 million. Our reduced origination pace for the year reflected our cautious approach to an uncertain market environment and our goal of increasing liquidity. We ended the quarter with an aggregate committed balance of $3.6 billion, and a principal balance of about $3.4 billion, including $230 million of future funding commitments, which accounts for approximately 6% of our total commitments, down from a high of over $750 million in Q1 2020, and is reflective of the light transitional nature of our loans. Our portfolio continues to benefit from broad diversification across property types and geographies 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 yield of about 8.4% with a weighted average stabilized LTV at origination of 63%. During the fourth quarter, we funded about $109 million of total principal consisting of approximately $31 million on existing commitments and a $77 million acquisition financing related to the resolution of the Pasadena retail loan. We realized almost $1 billion from repayments and two loan sales during 2022, with about 44% of that being office loans. We believe this healthy pace of repayments is due to there being more liquidity in the middle market compared to the large loan market and validates our strategy of working with our borrowers to allow them time to execute their business plans and sell the property or refinance our loan while incrementally deleveraging our loans and/or enhancing our loan economics or structure. Our repayments continued throughout the year with about $362 million of loan repayments, paydowns, and one loan sale in the fourth quarter, with approximately 47% of that being office loans. The repayments outpaced loan fundings in the fourth quarter, which resulted in a roughly $250 million decline in our portfolio balance. As of December 31, our portfolio's weighted average risk rating was 2.5, which was largely unchanged from the prior quarter of 2.6. During the quarter, we moved one of our office loans with a UPB of $32 million to a risk ranking of 5 and placed it on non-accrual status. We are in active discussions with the borrower and are evaluating a variety of potential resolution alternatives, and we'll provide more information as we have it. With the addition of this 5-rated loan in the fourth quarter and the resolution of the Pasadena retail loan, at 12/31, we have four loans totaling $247 million, with a risk rating of 5 and associated CECL reserves of about $39 million which were all secured by office properties. We remain very focused on pursuing various strategies on these loans with the exact timing and outcome being difficult to predict. We aim to maximize economic outcomes, release trapped capital and eliminate the meaningful drag that these loans impose on our earnings as we successfully accomplished with the Pasadena retail loan during the fourth quarter. Apart from these 5-rated loans, our office portfolio is very granular with 28 loans across over 20 markets with an average size of about $34 million. Some of these properties are located in markets with positive fundamentals like Miami, Nashville, and the affluent suburbs in the New York City Tri-State area. We're seeing capital improvement programs continuing and being completed. Rent collections have remained strong and continued sponsored financial commitment as exhibited by ongoing healthy equity contributions. It's also important to note that the vast majority of the office properties in our portfolio have been or are in the process of being substantially renovated and have or will have the amenities and other physical and locational features most desired by tenants. We'll continue to be proactive and vigilant with our borrowers as we manage through the year. In light of the slowdown in real estate transaction volume, pressure on property values, market uncertainty, and our desire to increase liquidity, we expect to remain measured in our approach to originations. We don't expect to match the robust repayment pace we experienced in 2022. However, we do expect repayments to outpace new fundings. So as a result, we do expect to see a modest decline in our portfolio balance over the near term. 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 fourth quarter GAAP net loss of $9.9 million or $0.19 per basic share, which includes a provision for credit losses of $16.5 million or $0.32 per share and a loss on a loan sale of $1.7 million or $0.03 per share related to an opportunistic sale of a $22 million mixed-use office and retail loan. Distributable loss for the fourth quarter was $8.2 million or $0.16 per basic share and includes a $15.5 million realized loss related to the resolution of our retail loan in Pasadena, which we previously disclosed. Adjusted for the realized losses, our Q4 distributable earnings were $9 million or $0.17 per basic share. Our fourth quarter book value declined by about $0.38 per common share to $14.86 and was mainly affected by the increase in our CECL reserves. For the full year, we reported GAAP net loss of $55.3 million or $1.04 per basic share which was mainly driven by a provision for credit losses of $69.3 million or $1.32 per basic share and a loss on early extinguishment of debt of $18.8 million or $0.36 per basic share related to our repayment of the term loan borrowings earlier in the year. Our full year 2022 distributable earnings were $14.7 million or $0.28 per basic share inclusive of $27.3 million or $0.51 per basic share realized losses related to the resolutions of two nonaccrual loans and the sale of one loan. Adjusted for the realized losses, our full year 2022 distributable earnings were $42 million or $0.79 per basic share. At quarter end, our CECL reserve totaled $86.6 million or $1.65 per common share and represented about 2.4% of our total loan commitments. Our allowance for credit losses includes about $39 million of reserves allocated to the four risk-rated 5 nonaccrual loans. The $16.5 million provision for credit losses in the fourth quarter was mainly driven by more conservative macroeconomic forecasts used in our analysis. Turning to our capitalization and liquidity, our fourth quarter total debt-to-equity ratio decreased to 2.3x from 2.6x at the end of Q3, mainly due to the repayment of our $144 million convertible notes, which matured in December, and continued repayments within our loan portfolio. We ended the quarter with about $133 million in cash after repaying the convertible notes and continue to actively manage our liquidity and emphasize stable funding. During the quarter, we added a new $100 million secured credit facility, providing us with loan level financing on a non-mark-to-market basis and allowing for additional funding flexibility, especially with respect to nonperforming loans, giving us more optionality within our capital structure as we continue to actively manage our balance sheet during this highly uncertain market environment. Thank you again for joining us today. And now, I would like to open the call for questions.

Operator, Operator

Our first question comes from Doug Harter with Credit Suisse.

Doug Harter, Analyst

Hoping you could talk about your plans to generate more liquidity to handle the convert that comes due in the fourth quarter?

Marcin Urbaszek, CFO

Thank you for joining us and for the question. This is Marcin. We will continue to be opportunistic regarding any potential capital market transactions that we did not complete in the fourth quarter to address the 2022 maturities. Our portfolio is quite deleveraged, and we are looking at opportunities to refinance some of our funding vehicles, which could provide significant capital to help us manage the bond. We will remain agile and may decrease the portfolio slightly, but we will also assess any refinancing opportunities that arise.

Doug Harter, Analyst

Just following up on that comment about the under-levered portfolio. Just looking at Slide 12. Can you help us with the non-mark-to-market repurchase facility, the secured credit facility, and what type of advance rates could you get on those facilities as we think about the potential for finding liquidity there?

Marcin Urbaszek, CFO

Sure. It really varies by different assets. These facilities are currently operating at an advance rate between 40% and 55%. It depends on the specific loan. We established these facilities to assist with the financing of some underperforming and nonperforming loans, which we are pleased with. They are a valuable tool for managing our overall liquidity. We see numerous opportunities to potentially refinance FL2 with the second CLO, which is currently below a 40% advance rate. We are exploring that option. However, the portfolio is quite deleveraged. We believe we will have opportunities to possibly exchange some corporate debt for asset-related debt over time.

Jack Taylor, CEO

Doug, this is Jack Taylor. I would just add one thing. I wouldn't use this as an operative assumption that any refinancing of under-leveraged assets is put on to the $200 million non-mark-to-market repurchase facility or the secured credit facility.

Doug Harter, Analyst

Okay. Is that suggesting that there is an interest or availability for new secured financing facilities in the current market?

Jack Taylor, CEO

We're in a good position with our existing banks and wouldn't need to reach out to new lenders. So we also have inquiries from new lenders as well.

Operator, Operator

Our next question comes from Steve Delaney with JMP Securities.

Steve Delaney, Analyst

The new 5-rated, I'm sure everyone on the call wants to learn a little more about the new 5-rated office loan in Dallas. I'm not really familiar with that market, but could you just generally describe what submarket, what part of Dallas it's located in? And maybe some comments about the age of the building, the business plan for the sponsor, and what the current occupancy and tenant mix looks like.

Steve Alpart, CIO

This is Steve Alpart. I'll keep this high level. This is a small loan secured by an office property in Dallas that we downgraded to a 5 in the fourth quarter. We have had other office loans in Dallas that have performed very well. We currently have another Dallas loan nearby that is also performing well. However, this specific loan has underperformed due to sluggish leasing in the North Dallas area. As we have discussed, performance has been uneven across different markets, within markets, and by buildings, and this one has not met expectations. This is why we moved it to a 5. In terms of potential outcomes, we're considering various options, including a potential sale of the property or a deed in lieu. The timing for resolving this is uncertain, but we are focused on addressing all 5-rated assets and improving run rate earnings.

Steve Delaney, Analyst

Understood. It was a 2017 loan. So I assume it was originally like three years and one one-year extension. So is it pretty much part of the decision that they kind of reached the end of their second extension?

Steve Alpart, CIO

Yes, that's a fair assumption. Most of these loans had a couple of extension options. This one is after maturity. Those are all the factors that contributed to moving this one to a 5, due to underperformance and maturity. However, we're in discussions with the borrower. The conversations, like with almost all these deals, are very cooperative. We need to explore the range of options.

Steve Delaney, Analyst

Got it. Jack, you mentioned in your opening remarks that we've experienced many cycles over the years and there's a significant amount of real estate equity capital still available. Some of that may be categorized as distressed or rescue capital. I assume there are credit funds involved in that space. As we assess the market conditions now, what do you believe is necessary for that capital to start flowing in? Is it a matter of waiting to see the Federal Reserve's final decisions? We understand there's an expectation for terminal rates. If you could share your thoughts on when we might see investment in the commercial real estate market from that type of capital over the next year or so, that would be helpful.

Jack Taylor, CEO

Well, thank you for the question, and good to speak with you. I think it's an excellent question, and it goes to a very fundamental point, which is the commercial real estate market is not monolithic. It is composed of many different types of investors with different objectives and needs. The credit-oriented funds or capital that has been raised or is being raised will probably come in when there's more distressed selling and opportunities for them to realize their higher yields or access to the properties through buying notes that will get to the properties very quickly, and then they can operate on the properties themselves and hold on for a longer period. The bigger issue, I think, is the inflection point. And my view is that the primary driver for so much of the healing in the capital markets will be more clarity about when rates are going to stop being raised and how long they'll be there. That's a very iterative process. There's been a lot of head fakes in both directions over the last six months. You can look at not only official statements but prognosticators. I think that the general view is that once the Fed pivots or the market believes they've pivoted, there will be a ratchet back up in not only transaction volume but also capital moving into the space and leveling off of the problems. Most people can't entertain a longer-term hold on a property or an acquisition if they don't know what their liabilities cost. And all liabilities are being driven by that uncertainty right now.

Steve Delaney, Analyst

And the equity markets. I mean, the 10-year is 50 basis points higher this morning than it was on February 2. So thank you, February. I appreciate everybody’s comments this morning.

Operator, Operator

Our next question comes from Stephen Laws with Raymond James.

Stephen Laws, Analyst

A couple of things but I wanted to follow up on the new financing facility. Jack, can you talk about the parameters for financing the nonperforming loans, kind of what type of advance rate do you get on that line? And what is the cost of that financing to put that in place on a non-marked 3-year basis?

Jack Taylor, CEO

I'll actually turn it over to Marcin.

Marcin Urbaszek, CFO

Stephen, it's Marcin. Good question. So when you look at our Page 12, it's 650 over SOFR. And again, as I mentioned to Doug earlier, the advance rates will differ based on different loans, somewhere between 40% and 60%. But it really is asset-specific, as it is with any type of financing on any type of facility. It's all really highly dependent on a particular asset that you're financing at the time.

Operator, Operator

Our next question comes from Jade Ramani with KBW.

Jade Rahmani, Analyst

When we look at the leverage of the company, I'm puzzled as to why there is more leverage available. Just looking at many of your peers, quite a lot of them have on the asset level north of 4x leverage. And when I look at GPMT, the leverage really never got to those levels and now is among the lower peers. Yet it doesn't seem that there's an immediate source of liquidity aside from cash. So what do you think the main reasons are for that if the credit performance is likely to be resilient, given the lower average loan size compared to those that play in, say, the $100 million plus range?

Marcin Urbaszek, CFO

Jade, it's Marcin. Thanks for the question. Look, I think when you look at the overall leverage of the company, obviously, there's a lot of factors that go into it, and it's very funding-source specific. So if you look at some of our GLO financing, it's at 80% or north of 80% financing, right? So you can get a lot of financing in the CLO market, which all of us have, right? And then as the CLO sort of delever as we have with the second CLO, it's below 40%. So when you have to look at it sort of on a specific source of funds, the total leverage on the company is obviously a summation of all of those. So we have, as you just sort of say, we have availability to lever up certain assets, and we intend to do so over time. We are maintaining lower leverage right now due to the uncertainty in the markets. We obviously have the bonds coming due by the end of the year, so we're planning on that. It's a holistic approach, but we definitely have sources of financing to relever the company. We just have to wait for some market ability to do that.

Jade Rahmani, Analyst

And with respect to the existing repurchase facilities that were in place, excluding the new facility that was added, the $100 million, is there unused capacity that's currently available based on the existing collateral that's on hand to get to like a 75% advance rate?

Marcin Urbaszek, CFO

There are opportunities to enhance some of those assets, but this is specific to each asset and depends on the facility and the particular loan. As Jack mentioned earlier, we are in good standing with our lenders, who are eager to engage in more business with us. We are keeping all of this in mind.

Jade Rahmani, Analyst

How much capacity do you think there is? I don't have the 10-K; I don't think it's yet. But as of September 30, it was something around $700 million.

Marcin Urbaszek, CFO

Yes, that hasn't really changed that much.

Jade Rahmani, Analyst

Okay. But you said it's asset-specific. So not all of the $700 million would be available.

Marcin Urbaszek, CFO

Correct.

Jade Rahmani, Analyst

Okay. And then the second question would just be about more of a strategic approach to the business. I've seen mortgage REITs trade at these kinds of levels relative to book value, and there are lots of reasons for that. One of the reasons is investors are looking forward. So they're applying a discount to forward book value, modeling in CECL reserves; they would expect book value to go down and also perhaps the dividend being above earnings. But in addition to that, it's where the next source of capital comes from to bridge any gap the company has. Is there a chance to change the conversation to perhaps buyback stock or partner with an outside investor to do some sort of creative financing that might combine preferred and common stock or perhaps a convertible of some sort, warrants, perhaps that could really be accretive to shareholders on a book value basis and provide leverageable capital to put the company in a totally different position?

Jack Taylor, CEO

Jade, this is Jack. Nice to speak with you. And so things like stock buyback and other things, we don't comment on that. So I won't go to anything specific or fundamental, but it is part of our thinking about accretive capital raises, whether in the public or private market that could provide more momentum because we do believe we're confident that our trading value at the stock is not reflective of the inherent value of the company. So we will be analyzing these things, are analyzing them and will be proceeding. But we can't comment specifically about it, but of course, we think about our strategic future in terms of accessing more capital.

Jade Rahmani, Analyst

And do you think that? Go ahead.

Marcin Urbaszek, CFO

Just to add to that, just in terms of profitability. We have a lot of capital and sort of earnings capital trap and earnings drag from these nonaccrual loans, right? So I mean, we estimate that the nonaccruals cost us over $4 million in interest income in the fourth quarter. So that's a pretty significant amount. So we are really focused on resolving these. And once we do that, you sort of got a double benefit from releasing some trapped capital, but also turning them into earning assets. So the run rate profitability can improve dramatically once those loans are resolved, and that can be financed in a more efficient way. So it's sort of a combination of the two. And going into the pandemic, we were 3.5x leveraged on a total company basis. So there's definitely an opportunity to relever back up, but we're looking at all the different potential outcomes here.

Jade Rahmani, Analyst

But I think once those loans are resolved, I mean, there's probably going to be a pipeline of other loans that go through issues, I mean considering what's playing out in the office, considering what's playing out in real estate more broadly and the price correction. So I think, hopefully, some kind of capital plan is priority #1 rather than resolving those risk-5 rated loans and thinking that that will produce earnings and that will get the stock up?

Jack Taylor, CEO

I have a couple of comments about that. Firstly, our CECL reserve process reflects our current views, and we can elaborate on that further. However, regarding the pipeline, the market is extremely uncertain. The level of problem loans you may be considering is different from our perspective. As I mentioned, we are exploring various ways to strengthen the balance sheet. The resolution of nonaccruals doesn't mean we are unaware that more issues may arise depending on market conditions. We are very conscious of the dynamics in the office market. We believe our portfolio is often misunderstood due to the notion that bigger is better. We maintain that our portfolio is quite resilient, but we anticipate challenges as borrowers deal with rising costs. It’s likely that at some point, someone will approach us for extensions or relief. We are aware of such possibilities and have accounted for them in our risk assessments and reserves. Even if our estimates are slightly off, I believe it won't be as significant as you might anticipate.

Jade Rahmani, Analyst

Okay. And I wasn't pointing to GPMT's portfolio, in particular, but just the environment overall. But I really appreciate you taking the questions.

Operator, Operator

And there are no further questions at this time. So I'll hand the floor back to Jack Taylor for closing remarks.

Jack Taylor, CEO

I would like to thank everybody for participating in the call today specifically want to include our team, not only in the C-suite, but throughout the company for all the hard work they're doing to support this company and to move through these challenging markets. It's been superb efforts on everybody's part and a fantastic execution being exhibited. Most importantly, I want to thank our shareholders for continuing to support our company. Thank you very much.

Operator, Operator

Thank you. And that concludes today's conference for today. All parties may disconnect. Have a good day.