NexPoint Real Estate Finance, Inc. Q3 FY2021 Earnings Call

Good day, and welcome to the NexPoint Real Estate Finance third quarter conference call. Today's call is being recorded. At this time, I would like to turn the call over to Jackie Graham. Please go ahead.

Thank you. Good day, everyone, and welcome to NexPoint Real Estate Finance's conference call to review the company's results for the third quarter ended September 30. On the call today are Brian Mitts, Executive Vice President and Chief Financial Officer; Matt McGraner, Executive Vice President and Chief Investment Officer; Matt Goetz, Senior Vice President, Investments and Asset Management; Paul Richards, Vice President, Originations and Investments; and David Willmore, Vice President of Finance. As a reminder, this call is being webcast through the company's website at nref.nexpoint.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. Listeners should not place undue reliance on any forward-looking statements and are encouraged to review the company's annual report on Form 10-K 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. The statements made during this conference call speak only as of today's date, and 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 non-GAAP financial measures. For a more complete discussion of these non-GAAP financial measures, 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 appreciate everyone joining us today. I'm going to jump right into our results for the quarter. Net income for the quarter was $1.17 per diluted share compared to net income of $0.52 per diluted share for the second quarter of 2020. Earnings available for distribution was $0.71 per diluted share in the third quarter compared to $0.42 per diluted share in the third quarter of 2020, an increase of 69%. Cash available for distribution was $0.70 per diluted share in the third quarter compared to $0.42 per diluted share in the third quarter of 2020, reflecting an increase of 55.6%. Book value per share increased 3.2% quarter-over-quarter to $21.04. We recognized a mark-to-market gain of $1.4 million on the company's investment in NexPoint Storage and $12.8 million on the company's CMBS and IO strip portfolio. During the quarter, we purchased six CMBS IO strips with a notional value of $115.1 million for $13.1 million. We also had two single-family rental loans repaid, totaling $22.6 million in proceeds plus yield maintenance penalties of $3.3 million. On September 17, we originated a $32.8 million, 4.58% bridge loan on a multifamily asset in Florida, which was repaid after quarter end on November 1. On September 29, we originated a preferred equity investment for $3 million, yielding 10%. After the end of the quarter, on October 26, we originated a $9.75 million mezzanine loan, yielding 11%. We ended the quarter with 68 investments totaling approximately $1.6 billion. Across the portfolio, our weighted average coupon is 5.99%. Our weighted average remaining term on investments is 6.9 years, our weighted average loan-to-value is 66.8% and our weighted average DSCR is 2x. The value of the collateral used to calculate the 66.8% weighted average loan-to-value is outdated as we know that the values for multifamily and single-family rental assets have moved significantly over the past few years and even the past few months. Paul and Matt will talk about the revised numbers we've calculated using estimates on the increases in that collateral value. At September 30, our debt capital consisted of $745 million of senior secured facilities on the single-family rental loans, $60 million of senior secured facility on the mezzanine pool, $223 million of repurchase agreements, and $111.5 million of unsecured notes. Our debt has a weighted average remaining term of 5.2 years and a weighted average rate of 2.59%. As of September 30, 20% of our financing is subject to mark-to-market through the repurchase agreements. Our debt-to-equity ratio was 2.29x at September 30. On August 18, we issued 2.1 million shares of common equity at $21 per share, raising gross proceeds of $43 million. We paid a dividend of $0.475 per share in the third quarter, and the Board has declared a dividend of $0.475 per share payable on December 30. Our dividend is 1.49x covered by earnings available for distribution and 1.47x covered by cash available for distribution. Let me update our guidance for the fourth quarter, or give guidance for the fourth quarter, and then I'll turn it over to the team. For the fourth quarter, we are issuing guidance for earnings available for distribution as $0.50 on the low end, $0.60 on the high end, and $0.55 at the midpoint. For cash available for distribution, we are issuing guidance of $0.46 on the low end, $0.56 on the high end, with $0.51 at the midpoint. With that, let me turn it over to Matt Goetz.

Thanks, Brian. The third quarter of 2021 results continued to show a strong performance across each of our investments and asset classes. We continue to focus on investment verticals where we believe we have an advantage due to our experience in owning and operating commercial real estate. Our ability to leverage information from being both an owner-operator and lender to commercial real estate investments allows us to find relative value throughout the capital stack with the goal of delivering higher-than-average risk-adjusted returns. We continue to believe that our investment strategy, focusing on credit investments and stabilized residential and storage assets, with conservative underwriting at low leverage and well-heeled sponsors, will provide consistent and stable value to our shareholders. We are also excited to begin investing in the life sciences real estate sector on both the preferred and debt basis. The life sciences sector presents the opportunity to put capital to work in one of the most exciting and fastest-growing real estate sectors over the last 20 years. Compelling life science real estate fundamentals, mainly limited supply and/or no availability in existing buildings, along with growing demand driven by demographic tailwinds and a requirement for continued innovation to solve evolving healthcare needs, are significant. Life science real estate plays a critical role as specialized space is required to support scientific research, development, and ultimately the manufacturing of novel drugs and therapeutics. The life sciences sector, as evidenced by Alexandria Real Estate's share price, has outperformed R&D by over 104% over the last 15 years. During the third quarter, the portfolio continued to perform strongly, and we were able to capitalize on a number of opportunities during this period and immediately thereafter. The current investment portfolio comprises 68 individual investments with approximately $1.6 billion of total outstanding principal. The loan portfolio is 100% residential, with 52% invested in senior loans collateralized by single-family rental and 48% in multifamily via agency CMBS, preferred equity, and mezzanine debt. The portfolio's average remaining term is 6.9 years, is 93% stabilized, and has a weighted average loan-to-value of 66.7% with an average debt service coverage ratio of 2.02x. As Mitts said, Paul Richards will expand on the LTV metrics, which we believe appear to be high compared to the current market-level valuations. The portfolio is geographically diverse with a bias towards Southeast and Southwest markets, and 100% of our investments are current. As mentioned in our earnings, some of our underlying loans are currently in forbearance, which has not changed from the second quarter of 2021. For reference, as of the forbearance report published by Freddie Mac on September 25, roughly $7.5 billion or 2.4% of the total Freddie Mac securitized unpaid principal balance has entered forbearance. During the quarter, we realized over 40% IRRs on two single-family rental loan repayments totaling $22.6 million. Moving to the opportunities, we were able to take advantage during the quarter by purchasing six CMBS IO strips with an aggregate notional amount of $115.1 million for $13.1 million in net cash proceeds with estimated current yields of approximately 14%. On September 17, we made a bridge loan of $32.8 million at a rate of roughly 4.5% with a 50 basis point fee, which was subsequently repaid on November 1. We also closed approximately $12.75 million of preferred equity and mezzanine debt on multifamily in the Atlanta market at around 11% all-in rates. In summary, we continue to find attractive investment opportunities throughout our target markets and asset classes, and we will continue to evaluate these opportunities with the goal of delivering value to our shareholders. I'd now like to hand the call over to Paul Richards.

Thanks, Matt. During the third quarter, the company was highly active in the secondary bond market. As previously discussed, we deployed a combined $115.1 million notional value or $13.1 million in net cash on Freddie Mac IO strips in Q3. Again this quarter, the company's CMBS portfolio has greatly benefited as a direct result of the yield compression experienced since the mid-2000s and yet again saw a meaningful increase in value, especially in the bonds purchased during COVID. We continue to be sensibly levered on the repo at a roughly 54.6% LTV at quarter end. As mentioned previously, we undertook the project of applying adjustments to the underlying collateral value at our SFR, mezzanine, and CMBS portfolios. For our SFR portfolio, we applied the Case-Shiller National Home Price Index based on the first payment date on each loan through August 31, 2021, which was the last data point available. For our multifamily, both mezzanine and CMBS assets, we applied the U.S. national apartment price per unit index based on securitization date on CMBS and loan origination date for the mezzanine portfolios through September 30, 2021, which was the last available data point on the original appraisal values. The combined results yielded a pro forma portfolio LTV of 51.9%, which is approximately 15% less than the stated LTV of 66.8%. These results demonstrate an even more robust credit profile backdrop and an even more attractive risk-return profile. Lastly, to briefly touch on the continued performance of the SFR loan pool, all loans are current and performing well as the demand and immense tailwinds for single-family rental, in general, continue to accelerate. We fully expect this trend to persist as tenant retention and occupancies are still at all-time highs. To finalize our prepared remarks before we turn it over to questions, I'd like to turn it over to Matt McGraner.

Thank you, Paul. We're making progress restructuring the capital stack for NexPoint Storage Partners, formerly JCAP, and expect to have an update during the first quarter of 2022. We're optimistic that these capital allocation moves will produce higher returns for NSP and ultimately NREF. We're also excited, as Matt said, about entering the life sciences space on the credit side, making an inaugural approximately $35 million investment upcoming this quarter in a pharmaceutical manufacturing facility with a high-quality sponsor. We're currently underwriting a half a dozen more opportunities in this sector and expect to transact on several of them in the first half of 2022. Overall, as Paul mentioned, the underlying credit quality and fundamentals of multifamily, self-storage, and single-family rental continue to accelerate and perform remarkably well. NREF's business is doing exactly what it was best designed to do, mainly producing a consistent, durable cash flow stream for investors backed by the highest quality assets in the commercial mortgage REIT sector. I want to congratulate the team for continuing to source and monitor high-quality investments. And with that, I'd like to turn the call over to the operator for questions.

We'll take our first question from Amanda Sweitzer with Baird.

I wanted to start on the guidance ranges, which are obviously a little bit wider than normal, given the equity issuance and redeploying those proceeds. But can you give an update on the near-term acquisition pipeline and the volume of potential opportunities that you could close by year-end?

Yes, Amanda, it's Matt. The guidance is a little bit wider because we have received a potential smaller payoff in the SFR, but the timing is uncertain. So we made it a little bit wider. Coupled with the pharmaceutical investment I just mentioned, which hasn't closed yet, we just don't have clarity on the timing. So we could potentially outperform that number, but we wanted to be appropriately conservative.

Okay. That's helpful. And then following up on that comment on repayments, beyond that SFR loan and the bridge loan being repaid, are there any other near-term loan repayments that you expect in the fourth quarter?

No.

Okay. That's helpful. And then finally, it sounds like you'll have a more fulsome update early next year. But any updated thoughts on the potential book value per share upside from the self-storage common stock? I think last quarter you said it ranged from $3.50 to $5.

Yes, it's still in that range. We're optimistic about the higher end of that range, but I still think that's a good range.

We'll take our next question from Stephen Laws with Raymond James.

Just to follow up on the pipeline question, it looks like you had a couple of deals closed here at the end of the year, including a mezz loan and a bridge loan, as well as another mezz loan in October. I know that you mentioned opportunities in life science, but can you talk about your pipeline for these investments? Are you looking to add any more CMBS B pieces? How is your pipeline of mezzanine loans building, and how do you think about deploying capital across your different investment options?

Yes. We think we'll have a K deal that will close in the fourth quarter. It's a 10% thickness deal for about $65 million, which we'll use some repo on. Roughly, we'll call it, $30 million to $35 million of equity.

And then obviously compared to life sciences, but... Yes. I wanted to follow up on the opportunities you see and ask how you view your available liquidity and any additional capital needs. I know you have the ATM in place, but given the trading volume, there may be some limitations. Can you discuss your outlook on liquidity following the secondary offering? When do you anticipate being fully deployed and looking to expand your balance sheet again?

Yes. Stephen, it's Matt McGraner. I think the next tool in our toolkit would be potentially reopening the notes offering that we did over the summer and pricing it tighter. We've received indications from our bankers, so we could potentially do that over the near term, which would likely be the most accretive, coupled with some repo financing. We just equitized the balance sheet a bit more. We believe that with those two tools, without having to tap the unsecured notes, we can be fully deployed by the end of fourth quarter this year.

Great. Appreciate the color there, Matt. Lastly, operating expenses, you guys have shown really good expense control here, largely flat through this year on a quarterly basis. Can you talk about the outlook there? Is this a good run rate? How should we think about those expenses as you grow the platform?

Yes. One of the benefits of the NexPoint platform is that this isn't the sole company and doesn't have to keep the lights on. So we've created a fee structure that we think is helpful and conservative. We don't expect that expenses should increase significantly. Therefore, I believe this is a pretty good run rate for the next 12 months or so. I agree. We focus on that a lot. One distinguishing factor about our portfolio is that we're not constantly receiving that capital back. Yes, we get small repayments occasionally, but largely the earnings stream is fixed. We're not on the treadmill of constantly repaying and eroding book value. Combined with production offices, we have one office here with great networks through owner-operators and the banks in the commercial real estate services company. So yes, I'm pleased, and we'll continue to monitor these expenses at this level.

Great. Well, congrats on another nice quarter, and appreciate your time this morning.

Thanks, Stephen.

We'll go next to Jade Rahmani with KBW.

The main reason that 4Q guidance for earnings is below 3Q is the equity offering and timing of capital deployment?

Yes, that's right, Jade.

Okay. In terms of deploying capital into mezzanine loans and preferred equity, what's your comfort level with the competition in that market space?

Yes, we feel pretty comfortable. Many of the people we're investing with are repeat clients with whom we've established relationships over the last 10 years. We take pride in being easy to work with, creative, nimble, and fast. We cater to everything a sponsor needs to close a deal without needing to support a large machine. Moreover, at our current size, there aren't many players in the $9 million to $20 million equity check segment concerning mezz and preferred. So we don't encounter substantial competition there. That said, competition exists at the higher levels, especially for the B pieces, but we have a robust pipeline for smaller mezz and preferred investments.

Can you quantify the magnitude of yield compression that you're seeing, maybe by product area?

On the CMBS side, regarding BP side, yes, from some of the COVID bonds that we bought back in May 2020, we were buying at roughly 11% bond equivalent yields, and we've seen prices on those compress down to mid-6s. We see meaningful yield compression on those types of bonds and are quite pleased with that. We believe there's still room to run given the demand for those types of bonds.

On the preferred and mezzanine side, since we're still operating in smaller dollar amounts, we're still able to achieve 10%, 11%, and 12% all-in rates on that paper.

With no additional questions in queue at this time, I'd like to turn the call back over to our speakers for your additional or closing remarks.

Yes, I think we're good over here. I appreciate everyone's time, and we'll be back in touch. Thank you.

That will conclude today's call. We appreciate your participation.