NexPoint Real Estate Finance, Inc. Q1 FY2020 Earnings Call

Good day, and welcome to NexPoint Real Estate Finance First Quarter 2020 Conference Call. Today's call is being recorded. At this time, it is my pleasure to turn the conference over to Ms. Jackie Graham, Investor Relations. Ma'am, please begin.

Thank you. Good day, everyone, and welcome to NexPoint Real Estate Finance's conference call to review the company's results for the first quarter ended March 31. On the call today are Brian Mitts, Executive Vice President and Chief Financial Officer; Matt McGraner, Executive Vice President and Chief Investment Officer; and Matt Goetz, Senior Vice President, Investment and Asset Management. As a reminder, this call is being webcast through the company's website at www.nexpointfinance.com. Before we begin, I would like to remind everyone that this conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 that are based on management's current expectations, assumptions and beliefs. Forward-looking statements can often be identified by words such as expect, anticipate, intend and similar expressions and variations or negatives of these words. These forward-looking statements include, but are not limited to, statements regarding the company's business and industry in general and guidance for financial results for the second quarter of 2020. They are not guarantees of future results and are subject to risks, uncertainties and assumptions that could cause actual results to differ materially from those expressed in any forward-looking statements. Listeners should not place undue reliance on any forward-looking statements and are encouraged to review the company's registration statement on Form S-11 and the company's other filings with the SEC for a more complete discussion of risks and other factors that could affect the forward-looking statements. Except as required by law, NREF does not undertake any obligation to publicly update or revise any forward-looking statements. This conference call also includes an analysis of core earnings, which is a non-GAAP financial measure. This non-GAAP measure should be used as a supplement to and not a substitute for net income loss in accordance with GAAP. For a more complete discussion of core earnings, see the company's presentation that was filed earlier today. I would now like to turn the call over to Brian Mitts. Please go ahead, Brian.

Thank you, Jackie. I want to welcome everyone to our inaugural NexPoint Real Estate Finance quarterly earnings conference call. Today, we'll cover the highlights in the first quarter of 2020, which, given that our IPO was on February 11, will be somewhat of a brief part. Also, considering the unprecedented events we've seen with the COVID situation and how that's impacted everyone, we'll spend a fair amount of time on Q2 and what's happened post-COVID. I am Brian Mitts, Chief Financial Officer. I'm joined by Matt McGraner, who's our Chief Investment Officer; as well as Matt Goetz, who's our Senior VP in charge of Investments and Asset Management. I'm going to give some quick highlights of our financial performance and capitalization, which we think are considerable strengths for this company, certainly when compared to other mortgage REITs and debt funds. I'll turn the call over to Matt McGraner and Matt Goetz to discuss the portfolio, our strategy and some of the opportunities that we see ahead. As mentioned, we IPO-ed the company on February 11. Pricing was $19 per share, and we began trading on the New York Stock Exchange, raising total gross proceeds of $100.7 million. After offering costs, we used the proceeds to pay down debt. So I think once we launched, within a month, we were in the COVID situation. During that period, which pretty much decimated the mortgage REIT industry for a month, we did fairly well. We had no margin calls, no liquidity issues, no credit problems. I think today, we're positioned to take advantage of whatever unfolds. And Matt and Matt will go into more detail around that. Let me talk about our capitalization. As of March 31, we had a debt-to-book value ratio of 2.49x. Our debt as of March 31 consisted of the $788 million credit facility we have with Freddie Mac. That's collateralized by the $933 million single-family rental mortgage portfolio, which is matched in structure and duration to the underlying portfolio for both paid fixed rates, and each have an average remaining term of 8.1 years. This gives us long-term visibility and stability into the bulk of our portfolio. As of March 31, the rate on the facility is fixed at a weighted average of 2.44% against the yield on the underlying assets of a weighted average of 4.91%, or a locked-in 247 basis points spread over the cost of debt. On April 23, we entered into a $60 million repurchase agreement with Mizuho, which was collateralized by our K-62 and K-70 Freddie Mac B-Pieces. We contributed this at the IPO. We immediately utilized $49.8 million of that to purchase the K-107 Freddie B-Piece, which Matt Goetz will go into more detail during his remarks. As of April 30, the repo balance represents a 31% advance rate on the fair value of our CMBS portfolio, which bears interest at 2.75% over the 1-month LIBOR and rolls monthly. Including the repo as of today, only 5.9% of our financing is subject to mark-to-market, and we're at a very low leverage with a 31% advance rate. This provides ample cushion for any mark-to-market movements we may see in the future, allowing us to avoid the margin calls that many other companies are experiencing. Regarding our financial performance for the first quarter, which, keep in mind, is about half of a quarter, these are about half the numbers that we expect going forward, but we reported a net loss of $6.4 million or $1.22 per diluted share. This was driven primarily by a net interest income of $3.2 million or $0.18 per share, with an unrealized mark-to-market loss on the CMBS B-Pieces of $24.9 million or $1.41 per share. Matt Goetz will provide a little more color on B-Piece pricing in his commentary. We recorded a loan loss provision of $212,000 or $0.01 per share, which shows the credit quality of the underlying portfolio. We reported core earnings of $1.2 million or $0.28 per share. We ended the quarter with a book value of $83 million or $17.72 per share, which was a decrease of $1.44 per share from our post-IPO book value, or a 7.5% decrease, primarily driven by the $24.9 million mark-to-market unrealized loss. During the quarter, after the COVID situation hit, we repurchased 87,466 shares of our stock at an average price of $15.30 per share, which we believe was a good bargain at the time. We paid a prorated dividend of $21.98 per share for the first quarter. As of May 5, we had cash on hand of $4.3 million, near-term accounts receivable collections of $2.1 million and repo capacity under the current facility of $11.1 million. If we went up to the full amount, we'd be at roughly a 33% total advance rate. Currently, we have about $17.5 million of near-term liquidity that we can access. On Monday, the Board declared a dividend of $0.40 per share for the second quarter, payable on June 30 to shareholders of record as of June 15. For the second quarter, we are estimating core earnings of $0.38 to $0.42 per share and cash available for distribution of $0.40 to $0.44 per share. With that, I'll turn it over to Matt McGraner to talk about our strategy and portfolio.

Thanks, Brian. Before turning the call over to Matt Goetz to discuss the business, I would like to highlight a few themes and reinforce some important characteristics that we believe differentiate NexPoint Real Estate Finance and are as relevant now, if not more, than when we went public just a couple of months ago. First, we own a differentiated, purpose-built portfolio of investments concentrated in the most resilient property types: multifamily, single-family rental and self-storage. In good times and in bad, proven throughout prior downturns, these property types have exhibited resiliency and typically become liquid and recover earlier in cycles. Our underlying collateral consists of stabilized properties with 93% average occupancies, in-place cash flows and a locked-in earnings stream of over 7.5-plus years of duration. Consider for a moment that economic occupancy would need to fall to 70% on average before the underlying borrowers could not cover debt service. Contrast this with a peer group that owns or has originated loans on undergoing transitional business plans or redevelopment or worse, buildings that are closed, hotels or retail centers, for example, giving us relatively more conviction in the underlying cash flows to sustain book value and provide consistent distributions to investors. Our three property types are sectors in which we have deep operating expertise as owners and investors: multifamily with NXRT, SFR with VineBrook Homes, and self-storage through our publicly traded partnership with Jernigan Capital. We also believe the underlying credit portfolio is attractive, particularly at $0.60 on the dollar book value. Recall that over 95% of our portfolio consists of investments in loans in the affordable housing sector, both single-family and multifamily. Rather than discussing retail, office or hospitality loans, of which we have 0 exposure, our recent conversations with investors center around whether there's more or less demand and collection activity in stabilized Class A or Class B multifamily. In our view, which is shared by the National Multifamily Housing Council, demand for affordable housing post-COVID will be greater than ever. Specifically, we believe demand for lower-density housing, namely garden-style apartments and single-family rentals, will outperform for the foreseeable future. Single-family rental may even be more resilient than multifamily. Our single-family operating vertical and partner, VineBrook Homes, for example, collected almost all their rent in April, nearly 98%. What's more impressive perhaps is that they renewed 91% of their residents with leases expiring in April at positive leasing spreads. This is only one month of data, but we believe their operating performance exhibits the demand for affordable single-family rental housing. Recall, 75% of NexPoint Real Estate Finance's portfolio is comprised of single-family rental properties with high-quality sponsors just like VineBrook, and we are seeing the same trends. Our self-storage exposure through our partnership with publicly traded JCAP is a senior in the capital stack to common equity and represents about a 30% to 40% loan-to-value look-through to the underlying storage portfolio, which we believe is the highest-quality self-storage collateral in the United States. Another point I’d like to briefly touch on is our geographical exposure. Seventy percent of the portfolio is concentrated in states that are reopening or have already reopened, including Texas, Arizona, Georgia, and Florida. Not only is it helpful to have local economies actually open to generate underlying rents, these geographies tend to be more business-friendly and impose fewer restrictions on landlords' ability to collect rent and enforce the underlying leases. Putting aside for a moment that gateway and coastal markets are likely to reopen later and at a slower pace, we cannot know when these state and local governments will begin to actually enforce evictions and lift foreclosure moratoriums. For example, Los Angeles, New York, and San Francisco have placed a moratorium on evictions with no announced end date. In Massachusetts, there's a moratorium on all evictions until the earlier of August 18, 2020, or 45 days from the date the governor lifted the state of emergency. In our view, these factors provide additional qualitative support to our positive view on our underlying credit portfolio, especially on a relative basis compared to gateway and coastal markets. I'd now like to turn the call over to Matt Goetz to discuss our operating performance.

Thanks, Matt. As Matt just discussed, our diverse geographic exposure is mainly located in the Southeast and Southwest United States. We have $1.1 billion in current principal investment outstanding. Seventy-five percent of our portfolio is senior loans; roughly 20% is CMBS; 3.5% is preferred stock, which is the JCAP Series A preferred; 1.6% is preferred equity; and 0.3% is mezzanine debt. Historically speaking, multifamily securitizations in the Freddie Mac B-Pieces or K-Series transactions have had low losses. Annual defaults have reached 1% of loans outstanding only 3 times since 1994. Since 2009 through February of 2020, there have been only $18.8 million in losses on roughly $360 billion of issuances. Single-family rentals, although they are a relatively new asset class that was really institutionalized in the wake of the global financial crisis, are expected to exhibit the same resiliency akin to multifamily, specifically Class B. The current portfolio is capitalized by a secured credit facility with Freddie Mac that Brian mentioned. It is matched in both duration and structure to the underlying loans and has an 8.1-year average weighted term to maturity with a locked-in spread of 250 basis points. In total, our portfolio has 7.7 years of average remaining term, 99.7% stable occupancy, 64.5% weighted average loan-to-value, and a 1.78 debt service coverage ratio. We closed Freddie Mac B-Piece on April 23 to a fixed-rate deal, K-107, which has a weighted average coupon with the B-Piece balance being $82 million. Again, it's the lowest 7.5% of the stack. The weighted average coupon is 3.5%. But since you're purchasing it at a discount, the current yield on the equity is 6.1%. The underlying pool is $1.1 billion in outstanding mortgages, with a weighted average interest rate of 3.6%. The amortizing debt service coverage ratio is 1.73x, and the average loan-to-value is 64%. There are 50 properties in that pool. Diving into the portfolio of our current investments that we owned at IPO plus K-107, we have 122 loans across the 3 Freddie Mac B-Pieces we own. The current par value of approximately $181 million pertains to the B-Piece portion of it. We've received, to date, zero forbearance requests in the portfolio. We have no loans that are currently with the special servicer. We have a few loans that are on the watch list for minor deferred maintenance issues, one loan that's consistently on the watch list due to timing of payment with the special servicer. They always end up paying a day late, which triggers their addition to the watch list. Another is on the watch list for occupancy being below a threshold of 80%. The underwritten occupancy at the time of issuance was 70%, which was marked for that specific asset at the time. We feel pretty comfortable with the CMBS portfolio. The CMBS portfolio is about 65% LTV and has a debt service coverage ratio, including interest-only of around 2.75x. Our single-family rental portfolio comprises 9,780 homes. Within that portfolio, we have received zero forbearance requests to date. The portfolio has an extremely healthy debt service coverage ratio and a relatively low leverage or LTV of below 70%. Again, the remaining term on those loans is over 8 years, for which we have matched financing. Moving along to the preferred equity and mezzanine book, the weighted average LTV is roughly 75%, and the debt service coverage ratio is healthy at 1.6x. We received one forbearance request on a small deal in the preferred equity portfolio. We believe they were being proactive in reaching out and asking for forbearance. The loan or the preferred and the first mortgage loan have almost 2x coverage and is sub-60% LTV. They are current on their payments, and we are waiting for Fannie Mae to respond to their forbearance. At this time, we don't believe they actually need the forbearance. But, as I said, they were being proactive early in the game and requested it just as a precaution. As for occupancy, it has dipped about 230 basis points over the last 2 months but is still within the average range for the last few years of ownership of the property. The IO strips that we purchased on April 15 have a current yield of around 12%, which represents about an 800 basis point spread. The debt service coverage ratio is above 1.7, with more than 10 years of weighted average term remaining. All loans are current with one small loan on the watch list for hail damage. As McGraner mentioned, the preferred stock investment in Jernigan Capital, which is a publicly traded self-storage mortgage REIT or hybrid REIT, self-storage has historically outperformed during economic downturns. The Series B preferred, which is publicly traded, is currently trading at a 7.9% yield, whereas our Series A is in the capital stack with them between 20% to 40% and is almost 2x the yield. So, with that, I'll turn it back over to Brian for closing remarks.

Thanks, Matt. I think we'll, at this time, turn it over to any questions.

Our first question comes from Alex Kubicek with Baird Wealth Management.

Is the 40% advance rate you guys have taken out on the CMBS B-Piece portfolio a good gauge for how far you plan to take that in the current environment? Just any insight on your decision as you move into the coming months would be helpful.

Yes. It's Matt McGraner. I think that's right. There's no need to really push that at this point. Furthermore, it's just not available. Most repo facilities now are utilizing 50% to 65% haircuts.

Yes. And I'd say also, if you look at the overall CMBS portfolio and kind of where we estimate the marks are—right now we think it's more like a 31% advance rate. To reiterate what Matt said, repo financing can cut both ways, so we want to be very cautious with it. But given the asset we purchased, priced post-COVID, we think it made sense. We have tons of room and cushion. If marks move downward, we still have coverage and won't hit any margin calls.

Additionally, the 40% advance rate is only on the collateral that was pledged. We still have a significant amount of collateral that we haven't pledged, which would drop that number into the mid-20s.

And next, we have Stephen Laws with Raymond James.

I guess, first, guys, congratulations on your first quarter as a public company. It was an interesting 3 months that you decided to make that your debut. I guess, to start, interesting opportunities are out there. You have a very strong balance sheet relative to peers and have demonstrated that with the 2 recent investments. On more of the mezzanine or structured financing side, it seems like this environment would create a lot of interesting opportunities. Historically, you have been great at sourcing those and generating attractive returns across your different vehicles. So can you talk about your appetite for investments like that, that wouldn't require the use of leverage and your willingness to do something like that? Or is it still too early to consider those types of investments?

Yes. Steve, it's Matt McGraner. There are special situation opportunities beginning to appear as recently as one announced with Coke and Ladder. There are several others ongoing in various property types. It's a little too early for our bread-and-butter multifamily, single-family rental, and self-storage because, as we have found, payment on all those credits are holding up better in this environment. We absolutely have an appetite for it. When and if it comes, we're under the tent on a number of opportunities to the extent that they become transactionable. One thing we'd like to point out is that we know capital is out there that's nondilutive, whether it’s a joint venture or some GP opportunity to invest that we would look at with current partners or other fund verticals or new ones. We looked at potentially utilizing a partner for K-107 but felt that given where the yield transacted, it would enhance book value in a stabilized environment and benefit the company to take it down ourselves. So, that's sort of a long-winded answer, but hopefully, that provides some color.

Yes. That's great color, Matt. Appreciate that. I'm guessing sticking on the 2 primary asset classes through this and other vehicles. You're big investors in both multifamily and single-family rental. Can you talk about the dynamics there? Are you seeing a shift? Is this social distancing and COVID world going to push a marginal person to single family for more space? Are you not really seeing that, and is that just more of a theory that's not playing out? Any color from the macro side on that would be great.

Yes. I think there are two important points. First is geographical, which I hit on in my prepared remarks. I just reject the notion outright that coastal, gateway cities that are denser will outperform going forward. I don't see that, especially in high-tax states. That means you'll still have net migration into Florida, Texas, where there's more need for affordable housing. We think that garden-style apartments will continue to exhibit resiliency just as they did during the global financial crisis. Class A and Class C took the pain first, experiencing revenue declines of 5% to 7% in each of those categories, while garden-style apartments were closer to 0% to 3% and held up best in the near and intermediate term, as there has been a trade-down effect from Class A cohort renters. Class C has taken a larger hit, especially among hourly wage earners. New lease-ups in multifamily are challenging right now since prospective tenants are not touring properties, making securing new leases difficult. As for single-family rental, the asset class has impressed me personally over the last couple of years, even more so through this downturn. I believe that this asset class could prove even more resilient than multifamily as people prefer to have their own homes with yards at an affordable price point. We feel good about our exposure, which is heavily weighted towards property types.

Stephen, I'd add a little bit certainly on the single-family rental side in that I think this situation has unfolded so quickly. We're not even 2 months into it. It feels like a decade, but it's only been 2 months. I think what we've seen is retention has gone way up across multi and single-family. Some of these trends that may develop in the future—it's just too early to tell. From our point of view, we anticipate things that have been developing since the great financial crisis will accelerate once we get through the early stages. I believe this will benefit just the workforce housing sector, whether it’s multifamily or single-family. Single-family, in particular, could be a significant winner here with many opportunities, as it's still largely not institutionally owned. For example, our single-family rental company is seeing retention rates hitting the high 80s, up from the mid-70s typically. In May, they reported collections in the 80s compared to about 75% historically at this time, even despite the challenges posed from evictions and late fees being non-issues right now. The ability to collect that amount of money in the first 5 days of May speaks volumes regarding the SFR space.

That's great color and comments. I appreciate the detail. Brian, to shift to the Q2 guidance, NREF is unique in providing that. I can't think of any peers that are doing that now. What are the underlying assumptions in that, that we need to consider? Or is it built on any additional investments other than the two disclosed? Or is it largely built around the in-place portfolio and then some adjustments to factors for that?

I’ll let Matt and Matt take the second part of the question. On the first part, because of the structure of our portfolio, we have significant visibility into it. Our operating platforms give us more near-term visibility overall, leading to our confidence in being able to issue guidance. From the perspective of a lender, you'd typically receive a report around 25 to 30 days after month-end; data trickles in over time. Conversely, with our multifamily and single-family as well as storage portfolios, we are privy to operational realities concerning rent collections, and this provides us with added confidence. Matt referenced this multiple times: we are geographically in better locations regarding business-friendliness and affordability as well. So, Matt, if you and Matt want to share on the other deals factored into the guidance?

Yes. Stephen, it's Matt McGraner. The guidance primarily just assumes K-107, which we just closed, as additional investment in the coming months. There are not many new investments in the second quarter that we think might actually transact, providing some healthy cushion, I believe.

Our next question comes from Jade Rahmani with KBW.

I wanted to ask if you could comment on what the mark on B-Pieces is so far this quarter, if there's been any value recovery? And perhaps could you give a potential range around pro forma book value?

Yes. It's Matt McGraner. They have stabilized regarding the new ones or at least the guidance we have from Freddie Mac that they're sort of K— or was 82 and now is 87-ish. We've seen some retracements there. In a stabilized market, we think that K-107, which we just acquired, is probably unicorn paper in the sense that it's a fixed rate yield with a short pay aspect to it and is likely a 150 to 200 basis points wide from the prior B-Piece.

Yes. Jade, as you know, from following some of the servicers like Walker and Dunlop, many of the fears regarding rent payment in the market haven’t really come to fruition in the multifamily or single-family rental space. A lot of those 3/31 marks were driven by forced sellers of paper using repo financing to achieve 80% margin on their positions, which affected us too. But we haven’t seen forbearance requests in our portfolios and have spoken to other company executives today who are reporting similar experiences. So, I just wanted to add that color.

Is there a percentage of the $1.41 unrealized loss on a per-share basis that has been recovered thus far? Maybe one-fourth of that? Or what's a reasonable estimate?

I think that's a reasonable estimate.

It's in a quarter.

Excuse me?

It's in a quarter. Your estimate was—sorry.

Okay. How should we think about the risk of additional margin calls? Have there been any margin calls since the IPO? And how should we think about the risk of additional margin calls, and most importantly, the liquidity available to handle that?

Yes. So we've had no margin calls in the portfolio, and no forced sales. Through April 23, we had debt that had no margin call feature or mark-to-market feature. Now we're just under 6%. But with the advance rates that we have, it's very low. We use that to price a new deal post it. So it's already at the lower prices we've seen in the marketplace. We're not saying that there may not be a downward move if another shoe drops, but we have plenty of cushion and don't envision any mark-to-market movements that would force a margin call or necessitate any kind of sales on our part.

And what on the balance sheet would be the tool to meet a margin call? Is it excess undrawn borrowing capacity?

That and the potential of adding further CMBS Freddie K collateral to the collateral package with the lender.

Yes. As noted in our filings, we have a 40% advance rate that got us the $49 million of repo financing, which assumes we only posted a portion of the collateral. So we actually have a considerable amount of collateral that we have not pledged yet. We could repost that and draw down on it to meet any margin call.

And can you say how much that excess collateral is?

I believe it's $50 million to $60 million.

All right. And speakers, at this time, there are no more questions in the queue.

Great.

Thank you, everyone.

Thank you, ladies and gentlemen. This concludes today's teleconference, and you may now disconnect. Thank you for your participation, and please enjoy the rest of your day.