Earnings Call Transcript - GPMT Q3 2022

Operator, Operator

Good morning. My name is Jason. I will be your conference facilitator. At this time, I would like to welcome everyone to Granite Point Mortgage Trust Third quarter 2022 Financial Results Conference Call. Please note this call is being recorded. I would now like to turn the call over to Chris Petta with Investor Relations for Granite Point. Please go ahead.

Chris Petta, Investor Relations

Thank you, and good morning, everyone. Thank you for joining our call to discuss Granite Point's third 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 my introductory comments, Jack will review our current business activity and provide a brief recap of market conditions. 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 on the Investor Relations section of our website along with our Form 10-Q. 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 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 intended to be considered in isolation or as a substitute for 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 now 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 all to our third quarter 2022 earnings call. Over the course of the third quarter, volatility in the capital markets continued to increase with rapidly rising interest rates, tightening financial conditions and reduced liquidity across asset classes, while the geopolitical environment remained unstable. While many market participants expect the Fed to pause in 2023, given the magnitude and speed of recent rate increases, there is less clarity about the full impact of the Fed's actions on the broader economy. With respect to commercial real estate, transaction volume has declined and there is downward pressure on property values. But as we have seen historically, U.S. commercial real estate remains a global safe haven in times like these. While the market uncertainty has kept many investors on the sidelines for now waiting for more clarity, there are several hundred billion dollars of capital waiting to be invested. As compared to the global financial crisis, banks are far better capitalized and the supply and demand fundamentals of commercial real estate are generally in better balance. Our strategy of originating first mortgage loans on high-quality U.S. real estate has proven to be resilient, with our loans supported from the volatility of real estate values by the healthy equity investments of our borrowers and Granite Point benefits from our granular portfolio. As of September 30, our $3.6 billion portfolio consists of 97 loans with an average balance of $37 million. Nevertheless, given these uncertain times, it is prudent in the near-term to maintain a cautious stance emphasizing liquidity and actively managing both sides of our balance sheet. To that effect, we have scaled back our originations by closing only one new loan during the third quarter, which resulted in the lower portfolio balance as we continue to realize loan repayments and build up our liquidity position. Despite the market volatility, during the third quarter, we realized over $340 million of loan repayments. Over 40% of these repayments included loans on office properties and over 30% were hotel assets. Additionally, so far in the fourth quarter, we have realized about $150 million of repayments, of which about 80% were office loans. Year-to-date, repayments totaled over $740 million with about 50% being office loans. These repayments have continued despite the ongoing market uncertainty and demonstrate the resilience of our portfolio, our asset managing capabilities and the benefits of our strategy. In this regard, our repayments have benefited from what seems to be somewhat more liquidity for middle-market property sales and financings. Also, we proactively work with our borrowers to provide them with more flexibility and time to navigate market challenges as they continue to invest additional equity to support their properties. We are seeing an ongoing commitment by our borrowers to their assets with over $125 million of fresh equity invested into their properties over the last year or so. Our leverage remains moderate at 2.6x at quarter-end and is meaningfully below our targeted 3x to 3.5x, while our financing sources are diverse and we continue to increase our funding flexibility. We maintain a well-balanced financing mix with the majority of our total fundings being non-mark-to-market. During the third quarter, we closed on a new $100 million non-mark-to-market loan financing facility, further expanding our funding capacity for a wider range of assets while enhancing our liquidity management. We are currently exploring additional funding sources to potentially add to our financing mix and provide us with further optionality. Our portfolio generally has performed well despite the current difficult market and select individual credit issues. Even so, considering the evolving environment, headwinds remain for the industry. Therefore, for the third quarter, we have adjusted down our risk rankings on select loans and increased our CECL reserves. With this period of elevated macroeconomic uncertainty and capital markets volatility, we intend to maintain our measured stance while drawing on the broad experience of our team to successfully navigate this environment as we have done during prior cycles. 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. We ended the third quarter with an aggregate committed balance of $3.9 billion and a principal balance of about $3.6 billion, including $313 million of future funding commitments, which accounts for less than 10% of our total commitments. Our portfolio is well diversified across geographies and property types and includes 97 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 5.6% with a weighted average stabilized LTV at origination of 63%. Given our cautious stance due to the market environment, during the third quarter, we closed one new multifamily loan with a total commitment of $45 million and funded about $70 million of total loan principal, which included approximately $28 million on existing commitments. Despite the decline in commercial real estate transaction activity, our repayments and loan paydowns totaled approximately $347 million in the third quarter, which outpaced loan funding and resulted in a $270 million decline in our portfolio balance over the quarter. As of September 30, our portfolio weighted average risk rating was 2.6, which was largely unchanged from the prior quarter of 2.5 as rating downgrades, which were mainly driven by overall market conditions and challenges in the office sector were offset by rating upgrades. During the quarter, we moved two of our office loans with total UPB of $123 million to a risk rating of 5, placed them on non-accrual status and established a $20 million CECL reserve for these two loans. The collateral properties securing these loans have been negatively impacted by the ongoing impacts of the pandemic on office leasing and reduced market liquidity, especially for office properties. We are in active discussions with each of the borrowers and are evaluating a variety of potential resolution alternatives, and we'll provide more information as we have it. As of September 30, we had four loans with risk ratings of 5, totaling $330 million in principal and CECL reserves of about $50 million. During October, we successfully resolved one of our 5-rated non-accrual loans, the $114 million loan secured by a retail property in Pasadena, California. The resolution involved the property sale through a deed in lieu with Granite Point providing this well-capitalized buyer with a new loan supported by their meaningful cash equity investment. We are pleased with the outcome as it allowed us to resolve the loan, while also creating a new earning asset on a deleveraged basis. We continue to actively work to resolve our other risk-weighted five loans. Given the overall market uncertainty, the exact timing and outcome remain hard to predict. In light of the slowdown in real estate transaction volume and pressure on property values, we expect to remain measured in our approach to originations. We've been very pleased with the relatively healthy pace of loan repayments we've experienced this year, particularly in the office sector. Considering the continued repayments in the fourth quarter, we expect a modest decline in portfolio balance by the end of the year. 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 third quarter GAAP net loss of $29.1 million or $0.56 per basic share, which reflects a provision for credit losses of $35.4 million or $0.68 per basic share. Distributable earnings for the third quarter were $8.7 million or $0.17 per basic share and exclude the provision expense. Our Q3 book value declined by about $0.77 per share to $15.24 and was mainly affected by the increase in CECL reserves, which at quarter end totaled $85.6 million or $1.63 per common share and represented about 218 basis points of our total loan commitments. Away from the credit reserve build, our third quarter results were also affected by a $3.6 million or $0.07 per basic share decline in net interest income, driven by two factors: one, our non-accrual loans; and two, loans with high-rate floors that did not benefit from a full quarter of higher interest rates. As of September, the benchmark rates were above all of our interest rate floors, and our portfolio is now 100% rate sensitive, excluding the non-accruals. During the third quarter, we downgraded two office loans to a risk rating of five and placed them on non-accrual status. At September 30, we had four loans with a total principal balance of about $330 million that were on non-accrual status. We estimate that these assets impacted our interest income by about $4 million or about $0.08 per share during the third quarter. However, as Steve just discussed, we successfully resolved a non-accrual loan in late October, that $114 million retail asset in California, resulting in a new earning asset and releasing additional capital. During the third quarter, we increased our CECL reserves to $85.6 million from $50.1 million at June 30. About $30 million of the increase was related to our four loans with risk ratings of 5. At quarter end, the aggregate allowance allocated to these loans totaled about $50 million. As just mentioned, one of these loans was resolved in the fourth quarter. The main driver of our Q3 CECL reserve increase relates to deteriorating market conditions, reduced liquidity in the capital markets, delays in execution of business plans and our overall conservative view of the macro environment. Turning to our capitalization and liquidity. Our total debt-to-equity ratio at September 30 modestly decreased to 2.6x from 2.7x at the end of June, mainly due to loan repayments and deleveraging of certain assets. We ended the third quarter with about $168 million in unrestricted cash, plus another $45 million in restricted cash, mostly in our CLOs. Since quarter-end, we contributed certain loan assets into our CLOs, releasing capital, and realized additional prepayments. As of November 7, we had over $220 million in unrestricted cash on the balance sheet. We anticipate satisfying our convertible bond maturity in December with cash on hand, and we continue to work on further improving our liquidity and developing additional financing sources. To that point, during the third quarter, we closed on a new $100 million facility, providing us loan level financing on a non-mark-to-market basis, allowing for additional funding flexibility within our capital structure. Our risk-weighted five loans have been meaningfully deleveraged over time, and two of them are financed on a non-mark-to-market basis, and we anticipate that the remaining non-accruals will also be financed on a non-mark-to-market basis in the near term. Thank you again for joining us today. And with that, we would like to open the call for questions.

Operator, Operator

Our first question comes from Doug Harter from Credit Suisse. Please go ahead.

Doug Harter, Analyst

Thanks. Just wanted to follow up on that last thing you said, Marcin, about adding some potential leverage against some of the non-accruals. Is there any way you could help size that and just to give us some added comfort in the liquidity and how that looks post the convert maturity?

Marcin Urbaszek, CFO

Sure, Doug, thanks for being here and for your question. The advance rates are specific to each loan, so it's difficult to provide a precise figure. We expect that after we pay our bonds, we'll be able to build up our liquidity to around $100 million, which we view as a suitable level. We might go slightly higher as we receive more repayments. As mentioned in our prepared remarks, we are focused on managing our liquidity and liabilities. The financing we secured in the third quarter offers us more funding flexibility, and we might consider adding another similar facility to further enhance that flexibility if we need to move assets between different financing options. Additionally, remember that during the pandemic, our repo exposure was nearly double what it is now, and we've significantly reduced our leverage, which gives us more options to re-leverage some assets once the market stabilizes.

Doug Harter, Analyst

And just on the new facility, it looks like as of 9/30, it was like a 35% advance rate. Can you talk about was that kind of an interim level of leverage on that? What is kind of a stabilized advance rate on that facility?

Marcin Urbaszek, CFO

It really depends on the specific assets involved. The variation occurs based on which loans are being financed, and it differs with each type of facility depending on the asset.

Doug Harter, Analyst

Okay. Thanks.

Operator, Operator

Our next question comes from Steve Delaney from JMP Securities. Please go ahead.

Steve Delaney, Analyst

Thanks. Good morning, everyone. I wanted to ask about the new Phoenix loan. It has been around for some time, 2017 origination. Can you just give us sort of some background on that loan? And what recent event or development triggered the downgrade? I assume it was a four previously, but what triggered the downgrade to a five at this point?

Steve Alpart, CIO

Hi, Steve, it's Steve. Good morning. Thank you for joining us this morning. Yes. So the Phoenix office loan, this is more of the loans that we moved this quarter from a four to five. The property itself is well located. It's been nicely renovated. It has institutional quality sponsorship. The borrower had come very close on some leasing. However, the leasing market in Phoenix has been sluggish. So it was just really continued slowness in the business plan, soft leasing market were some of the triggers going to your question why we decided to downgrade it this quarter. We're looking at a bunch of options as we mentioned, and we'll provide more information as we have it.

Steve Delaney, Analyst

It sounds somewhat similar to our previous discussion about San Diego, probably from the last quarter. The key difference is that this time we have a $30-some million loan instead of a $90 million loan, which makes things a lot easier to manage. That's good to know. You mentioned earlier that approximately $30 million of your CECL reserve is allocated across your three 5-rated loans, right?

Marcin Urbaszek, CFO

It was $50 million at the end of the quarter of those four loans and one was resolved in October, the retail loan.

Steve Delaney, Analyst

That was the Pasadena. Okay. Got it. So $15 million, including Pasadena, right? How much was on Pasadena?

Marcin Urbaszek, CFO

You can see now it gets about $16 million, $16.5 million.

Steve Delaney, Analyst

$16 million. Very good, $16 million, correct. I remember that was your estimated loss. Thank you. Regarding the portfolio, I understand your comments about the convert maturity. I wasn't aware of that, so it makes sense why you're restricting lending to recover some cash along with the new facility. Once you get through the fourth quarter and the convert, do you have a target level for the portfolio? I think total commitments were around $3.9 million in September. How small do you foresee the portfolio potentially growing? We need that information for modeling purposes. Thanks.

Operator, Operator

There are no more questions in the queue.

Jack Taylor, CEO

I'm sorry, I was on mute and didn't realize. This is Jack, Steve. Good to speak with you as always. We believe there will be a slight decline in the portfolio balance by year-end. We anticipate that the rate of prepayments will decrease throughout the year. We had a healthy rate this year, as we've noted, even in the first month of this quarter. Historically, on a normal market run rate, we expect portfolio prepayments to be around 25%. We came close to that this year but may fall short. However, we do expect a slower pace of repayments this year, which is offset by our focus on building liquidity and being cautious in this uncertain market. Therefore, we're not looking to increase our loan portfolio significantly in the near term. While repayments will slow, our originations will remain modest for now. We foresee a slight decline in portfolio balance at the beginning of the year until we see greater stability.

Steve Delaney, Analyst

Understood. So not just a one-time event, but we should expect kind of limited originations for another quarter or two is what I'm hearing. So that's very, very good. All right. Thanks for clarifying that, Jack. Stay well. Bye-bye.

Operator, Operator

There are no more questions in the queue. This concludes our question-and-answer session. I'd like to turn the conference back over to Jack Taylor for any closing remarks.

Jack Taylor, CEO

Well, thank you very much, operator. And for those of you that have been attending with us, we'd like to thank you for joining our call. And also, I'd like to thank you for your continuing support of our business. Thank you to the team here, helping us navigate through this tough environment and getting ready for the future. And we look forward to speaking with you all soon.

Operator, Operator

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