NexPoint Real Estate Finance, Inc. Q2 FY2022 Earnings Call

Good day. And welcome to the NexPoint Real Estate Finance Q2 2022 Conference Call. As a reminder, today’s conference is being recorded. At this time, I would like to turn the conference over to Jackie Graham. Please go ahead, ma’am.

Thank you. Good day, everyone. And welcome to NexPoint Real Estate Finance’s conference call to review the company results for the second quarter ended March 31, 2022. On the call today are Matt McGraner, Executive Vice President and Chief Investment Officer; David Willmore, Vice President of Finance; Matt Goetz, Senior Vice President, Investment and Asset Management; and Paul Richards, Vice President, Originations and Investments. As a reminder, this call is being webcast through the company’s website at www.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 take 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 as such 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, please see the company’s presentation that was filed earlier today. I would now like to turn the call over to Matt McGraner. Please go ahead, Matt.

Thank you, Jackie, and I appreciate everyone joining us today. I’ll start by addressing second quarter highlights and then turn it over to Dave to review the financial results followed by Matt and Paul’s comments on the portfolio and new investments. First, NREF’s credit investments primarily stabilized short-term lease duration assets with lower capital expenditures and should continue to maintain dynamic pricing power in today’s inflationary environment. Underlying NOI is embedded in our stabilized SFR, multifamily, and storage collateral, which continue to outperform other property types, providing a resilient base of earnings for distribution to provide stable yields to our investors. We believe our two special situation investments, converted equity in NexPoint Storage Partners and our ground lease investment, roughly $80 million of notional value, provide a differentiated total return profile compared to our commercial mortgage REIT peers, insulating and enhancing book value growth in the coming years, and when monetized and redeployed, significant capital growth. Though the capital markets were volatile during the quarter, we didn’t sit still. The team originated 11 new investments totaling $150 million, all of which were institutional and/or repeat sponsors in SFR, multifamily, and self-storage, as Matt will detail in his prepared remarks. Finally, it’s an exciting time for our business. We believe our portfolio’s credit profile is second to none and positioned in the most enviable property types, again providing a stable and transparent earnings stream for the next five plus years. NexPoint’s relationships across multi-family, self-storage, ground leases, and life sciences continue to provide steady deal flow. Indeed today, our pipeline consists of over $150 million of new investments across Freddie K and preferred and CGMP, multifamily and storage, all at attractive integrated yields. Now I’d like to turn the call over to Dave to review NREF’s financial highlights for the quarter. Dave?

Thank you, Matt. I’m going to briefly discuss our results for the quarter and the year, provide guidance for the third quarter, and then turn it over to the team for detailed commentary on our portfolio and the lending environment. For the second quarter, we reported net income of $0.34 per diluted share, compared to net income of $0.58 per diluted share for the second quarter 2021, a decrease of 41% on a per share basis. Interest income increased 37% over Q2 in 2021, driven by a 41-basis-point increase in average yield on investments. Interest expense increased 20%, driven by $125.6 million of additional borrowings and a 49-basis-point increase in average rate. Overall, net interest income increased 61% over Q2 of 2021. Earnings available for distribution was $0.56 per diluted share in Q2, compared to $0.41 per diluted share in the same period of 2021, an increase of 36.9% on a per share basis. Cash available for distribution was $0.63 per diluted share in Q2, compared to $0.47 per diluted share in the same period of 2021, an increase of 34.3% on a per share basis. We paid a dividend of $0.50 per share in the second quarter and the Board has declared a dividend of $0.50 per share payable for the third quarter. Our dividend in the second quarter was 1.12 times covered by earnings available for distribution and 1.26 times covered by cash available for distribution. Book value per share decreased 0.9% quarter-over-quarter to $21.59 per diluted share. During the quarter, we originated or purchased eight investments with $82.7 million of outstanding principal, with a combined current yield of 6.1%. Two investments were redeemed with $13 million of outstanding principal for a total gain of $1 million. One investment was converted from a note to equity at a 12.5% discount valued at $25 million. For the six months ended June 30, 2022, we reported net income attributable to common shareholders of $1.14 per diluted share, compared to net income of $1.83 per diluted share for the same period of 2021. Earnings available for distribution was $1.78 per diluted share year-to-date, compared to $0.83 per diluted share in the same period of 2021, an increase of 113.8%. Cash available for distribution was $2.21 per diluted share year-to-date, compared to $0.94 per diluted share in the same period of 2021, an increase of 170.7%. Our dividend in the year was 1.78 times covered by earnings available for distribution and 2.21 times covered by cash available for distribution. Book value per share increased 5.9% year-over-year to $21.59 per diluted share. Moving to guidance for the third quarter, we are guiding the earnings available for distribution and cash available for distribution as follows. Earnings available for distribution of $0.44 per diluted share at the midpoint with a range of $0.39 on the low end and $0.49 at the high end, and cash available for distribution of $0.51 per diluted share at the midpoint with a range of $0.46 on the low end and $0.56 at the high end. The decrease in cash available for distribution and earnings available for distribution from the second quarter is driven primarily by non-recurring prepayment penalties from SFR loans, a preferred investment and an interest-only share. Now I’d like to turn it over to the team for a detailed discussion on originations and the portfolio.

Thanks, Dave. The first quarter continued to show strong performance across each of our investments and asset classes. As of today, the portfolio currently comprises 75 individual investments with approximately $1.6 billion in total outstanding principal. The loan portfolio is 98% residential, with 44% invested in senior loans collateralized by single-family rental and 54% invested in multifamily primarily via agency CMBS. The remaining 2% of the loan book is life sciences and self-storage. The portfolio’s average remaining term is 6.4 years, is 94% stabilized, has a weighted average loan value of 68.5%, and an average debt service coverage ratio of 1.63 times. The portfolio is geographically diverse, with a bias towards the Southeast and Southwest markets. Texas, Georgia, and Florida combined for approximately 47% of our exposure on a geographic basis. 100% of our investments are current. Moving to opportunities, we were able to take advantage of, as Matt mentioned, through today, we closed 11 new investments totaling $152 million, with a weighted average unlevered yield of 7.75% and an average levered yield of 11.3%. During the quarter, we originated an $8 million preferred equity investment collateralized by three stabilized self-storage properties located in Central and Coastal Texas with an unlevered yield of 10.5%. We also originated or purchased $9 million of MSCR notes with an average unlevered yield of 8.5% and levered yield of 13.6%. We originated or purchased $26 million in single-family rental debt securitizations with an average unlevered yield of 8% and levered yield of 1.6%, originated a $4.5 million preferred equity investment collateralized by a stabilized Class A multifamily property in Rogers, Arkansas at one month minimum plus 10.78. We also purchased, as of today, a Freddie Mac floating rate K-Series B-Piece at SOFR for 5.5 for a purchase price of $70 million. 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 would now like to hand the call over to Paul Richards to discuss the bond market, repo financing, and SFR portfolio.

Thanks, Matt. During the second quarter, the company was active in the secondary bond market sourcing a $41 million Freddie Mac small balance loan B-Piece, which has an unlevered yield to maturity of approximately 8% and the levered yield in the low to mid-teens, which was prudently levered with attractively priced repo financing. As Matt discussed, the company also closed on a new issue Freddie Mac floating rate B-Piece for approximately $70.5 million just this past afternoon. The bond yields a 30-day average over plus 5.25% and we were able to finance the bond via cash on balance sheet and attractive repo financing. The bond gives a great geographical presence, prudent balance, and excellent sponsorship. Lastly, through the syndication process, the company bid on Freddie Mac Risk Transfer Certificates, and were allocated roughly $9 million of the B1 and M2 bonds posting attractive yields of 30 days over plus 950 and 60, respectively. As discussed in the previous quarter’s commentary, the market continues to experience inflation headwinds, along with the Fed’s continuous rate hiking cycle. Though, as previously mentioned, there has been insatiable demand for residential and therefore heightened demand for Freddie Mac B-Piece bonds. We continue to be sensibly levered on a repo facility at roughly 60% loan-to-value at quarter end. Lastly, I want to briefly touch on the continued performance of the SFR loan pool and then Q2 2022 loan paydowns. All SFR loans are currently performing and demonstrating strong metrics in terms of rent growth and occupancies, as demand for single-family rentals is still robust. The portfolio had one SFR loan payoff in the second quarter, which generated an IRR of 31.2% compared to the original underwriting IRR of only 9%. Due to the early prepayment penalty, the investment was able to generate outside net proceeds than the original underwriting and roughly one-third of the original investment time horizon. That concludes our prepared remarks. I will now turn it back over to the Operator for Q&A.

Thank you. We’ll take our first question from Stephen Laws with Raymond James.

Hi. Good afternoon. Matt or Brian, I guess, to start, can you talk about what type of returns you’re seeing on new investments versus three months or six months ago, given the dislocation in the markets and where spreads and rates have moved? And when you think about your pipeline, what pockets look most attractive on a relative basis that we should expect to see new investments during the second half?

Yeah. Hey, Stephen. Good afternoon. Returns on new investments during the quarter and then regarding our pipeline, as Matt alluded to, we’re getting probably another 2% to 3% more in yield right now in the current environment. In the pipeline, we have coming up and this goes to your second question, we’re having a lot of success sourcing convertible or preferred investments in CGMP facilities, the pharmaceutical manufacturing facilities where we basically provide financing upon certificate of occupancy for new builds with well-established sponsors. This is a great place to be. It’s two to three-year kind of money and it’s usually around 10% to 12% yields. Again, in life sciences and the reshoring of pharmaceutical manufacturing, we just like that space a lot. The second area where we’re doing a lot of work and seeing a lot is on the storage sides, where we are originating kind of private preferred and we’ll probably be in the market purchasing new issue storage B-Pieces as well, that type of credit is SOFR+ kind of 600, 700 at the moment. We also have a great job continuing to source the multifamily private preferred, obviously with negative leverage in the market, there’s second chance opportunities, re-trades, and loan-to-value tests not hitting with the agencies. We’re seeing a lot of GAAP financing opportunities, and those are likely to come fast and furious in the third and fourth quarters. As transaction volumes pick up, the agencies aren’t quite there, and there’s still negative leverage in most multifamily property types, so there’s got to be some GAAP financing the sponsors will seek. It’s kind of a high-level overview but basically doing the same thing we’ve been doing but getting just, like I said, 2% to 3% more.

Great. Appreciate the color on that. One follow-up, when I think about the repayment or prepayment fees, certainly slowing around the asset bar. Can you talk about what your expectations are there and kind of how you saw that slowdown in the quarter?

Hey, Stephen. It’s Paul. During the quarter, we saw the one loan pay down. I think what you’re still seeing though is, you still have higher rates on the SFR loan book and HPA build-up from 2018, 2019 originations. So what you’re seeing or continue to see are smaller loan balances, a lot of these operators are printing a realized gain on those and the prepayment penalty might not be as devastating for them to realize those gains. So I don’t think a question to see some of these smaller loans pay off and these operators could size up a good gain for them for the year. So that’s how we kind of see that in our loan book right now.

Great. Appreciate the color for that. Thank you.

Thank you, Stephen.

Thank you. And we’ll take our last question today from Jade Rahmani with Keefe, Bruyette & Woods.

Thank you very much. Can you quantify the impact in multifamily, single-family rental, and self-storage from higher rates to cap rates and overall valuations? Either currently, so far, I know it’s slow-moving deals take time to close. But what’s your expectation for range moving cap rates?

Good question, Jade. We notice that similar to the NexPoint Q call from a few days ago, current cap rates for multifamily properties, especially for Class A and Class B, have increased by approximately 40 to 60 basis points, which has resulted in an average value decline of about 10% to 15%. There's some market adjustment from sellers around the 4% cap rate, and we've started to see some transactions happening in recent weeks. For storage, the cap rates have shifted similarly to multifamily, falling within the same range. As for single-family rental (SFR) cap rates, they have moved around 25 basis points, which is somewhat less than what we are observing in multifamily and storage, leading to a value adjustment of around 7% to 10%. SFR cap rates didn’t decrease as much as multifamily's, occasionally going below 3% in Q4 and Q1, but generally remaining in the low 3% range. Overall, we are looking at about a 10% to 15% adjustment in values based on current conditions.

And in terms of performance of the company and the recession, what do you think the impact would be? Would it be loans in forbearance, would it be slightly lower, more moderate rent growth than expected, different occupancy? Since you’re primarily in the debt capital structure, what would be the impact and also maybe if you could touch on either the BDC exposure or preferred equity? Thanks a lot.

Yes, that's a great question. The recent test of our credit profile and portfolio performance during challenging times was evident during COVID. During that period, our business functioned as intended in resilient property types that continued to outperform. As mentioned in my prepared remarks, despite the potential for a consumer-led recession, our net operating incomes across our portfolio in single-family rentals, multifamily, and self-storage are currently growing between 7% and 15%. Right now, they are performing well, and during the downturn, we experienced no losses; even with a few deals in forbearance under the Freddie K program, those performed adequately. On the multifamily side, our structures with borrowers and sponsors provide insulation. If any issues arise, we can take over the asset and eliminate equity, retaining ownership at our original investment, which serves as an additional risk mitigation measure in severe situations. Our portfolio also performed exceptionally during COVID. While we can't predict everything, I believe our credit portfolio is quite resilient and has proven its strength in recent history.

Anything further Jade?

Thank you very much.

You bet. Operator, thank you. And we have no further questions. We appreciate everyone dialing in today and look forward to discussing Q3 earnings with you here in a few months. Thanks and have a great day.

Thank you. And that does conclude today’s teleconference. We do appreciate your participation. You may now disconnect.