Earnings Call Transcript - NREF Q4 2021

Operator, Operator

Good day, and welcome to the NexPoint Real Estate Finance Q4 2021 Quarterly Conference Call. Today’s call is being recorded. At this time, I would like to turn the conference over to Ms. Jackie Graham. Please go ahead, ma’am.

Jackie Graham, Conference Call Host

Thank you. Good day, everyone, and welcome to NexPoint Real Estate Finance’s conference call to review the company’s results for the fourth quarter and full year ended December 31, 2021. 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; and Paul Richards, Vice President, Originations and Investments. 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.

Brian Mitts, CFO

Thank you, Jackie. I appreciate everyone joining us today. I’m going to discuss our results for the quarter and the year and then turn it over to the team for detailed commentary. Net income for the year was $3.93 per diluted share compared to net income of $1.74 per diluted share for 2020. Earnings available for distribution were $1.89 per diluted share in 2021, compared to $1.46 per diluted share in 2020, an increase of 29.5%. Cash available for distributions was $2.21 per diluted share in 2021 compared to $1.67 per diluted share in 2020, which is an increase of 32.7%. Net income for the quarter was $0.90 per diluted share compared to net income of $1.32 per diluted share for Q4, 2020. Earnings available for distribution were $0.54 per diluted share in Q4, 2021, compared to $0.44 per diluted share for Q4, 2020, and $0.51 per share in Q3, 2021, an increase of 22.7% and 5.9% respectively. Cash available for distribution was $0.63 per diluted share in the fourth quarter of 2021 compared to $0.47 per diluted share in the fourth quarter of 2020 and $0.62 per diluted share in the third quarter of 2021, or an increase of 34% and 1.6% respectively. Book value per share increased 2.2% quarter-over-quarter and 10.4% year-over-year to $21.51. We recognized a mark-to-market gain of $9.1 million on the company’s investment in Nexpoint storage and $900,000 on the company’s CMBS and IO strip portfolio. During the quarter, we originated the following investments. We purchased a $61.3 million floating rate Freddie Mac K-Series B-Piece with an estimated yield of 525 basis points over SOFR. We originated mezzanine convertible notes with an aggregate principal amount of $40.8 million. Matt and Brian will discuss this investment in his remarks. We originated a preferred equity investment for $30 million yielding 10%. We originated another preferred equity investment of $3.8 million yielding 10%. We originated a third preferred equity investment for $5 million yielding 10.5%. After the quarter-end, we funded an additional $41.8 million to this investment. We ended the quarter with 74 investments totaling approximately $1.7 billion. During the quarter, two single-family rental loans were repaid totaling $20.2 million, with penalties of $3.6 million paid. The gross proceeds received amounted to $80.6 million, which was used to pay down the Freddie Mac senior facility. As of February 17, 2022, across the portfolio, the weighted average coupon is 6.32%. The weighted average remaining term on investments is 6.5 years. The weighted average loan's value is 67.9%, and the weighted average DSCR is 1.99 times. The values used for the collateral that we use in the LTV calculations were based on the time the loan was originated. Values for multifamily of our assets moved dramatically over the past few years and months. Paul will talk about these revised weighted average loan values using our estimates of the changes in the underlying collateral value during his prepared remarks. As of December 31, our debt capital consists of the following: $726.3 million of senior secured facility on single-family rental loans, $59.9 million of senior secured facility on the mezzanine pool, $286.3 million in repurchase agreements, $171.5 million in unsecured notes, and $32.5 million in mortgages payable. As of February 17, 2022, our debt has a weighted average remaining term of 4.8 years and a weighted average rate of 2.79%, which provides a 353 basis point spread over our investment income or the cost of our debt. As of December 31, 23.9% of our financing is subject to mark-to-market. Our debt to equity ratio was 2.5 times at December 31. We paid a dividend of $47.5 per share in the fourth quarter, and the board has declared a dividend of $0.50 per share payable on March 31, for the first quarter of 2022. For dividends, our earnings cover is 1.14 times for the earnings available for distribution and 1.3 times covered for the tax available for distribution. Today we’re issuing guidance for earnings available for distribution and tax available for distribution for the first quarter of 2022 as follows: earnings available for distribution per diluted share is projected to be $1.22 and cash available for distribution per diluted share is projected to be $1.57, increases over the prior quarter and prior year driven by prepayment penalties on the single-family rental loans that we have received for this quarter. Now let me turn it over to the rest of the team to provide their commentary.

Matt Goetz, SVP, Investments and Asset Management

Thanks, Brian. The fourth quarter and full year 2021 results continue to show strong performance across each of our investment and asset classes. We continue to focus on investment verticals where we believe we have an advantage due to our experience in operating and managing 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 our investment strategy focusing on credit investments in stabilized assets with conservative underwriting at low leverage with well-capitalized sponsors will provide consistent and stable value to our shareholders. During the fourth quarter, the loan portfolio continued to perform strongly and is currently composed of 69 individual investments with approximately $1.7 billion of total outstanding principal. The loan portfolio is 98% residential, with 45% invested in senior loans collateralized by single-family rental homes, and 53% invested in multifamily via agency CMBS preferred and mezzanine. Only 2% of the loan book is in life sciences. The portfolio’s average remaining term of 6.5 years is made up of 91% stabilized assets and has a weighted average loan to value of 67.9 with an average debt service coverage ratio of almost three times. As Brian mentioned in his earlier remarks, we believe the market amount and value of the entire book is approximately 52%, as new appraisals have not been performed on a large portion of assets since they originated in 2018 or 2019. The portfolio is geographically diverse, with buyers in the southeast and southwest markets. Texas, Georgia, and Florida combined for approximately 50% of our loan exposure on a geographic basis. 100% of our investments are current. As mentioned in our earnings, a number of underlying loans are currently in forbearance. For reference, the multifamily forbearance report published by Freddie Mac on a monthly basis shows there are 243 forborne loans totaling $2.1 billion of outstanding UPV, equating to 90 basis points of the total Freddie Mac securitized loan population by loan account and 60 basis points of the securitized unpaid principal balance. Moving to the opportunities, we were able to take advantage of during this quarter. During the quarter, we originated two mezzanine notes on stabilized multifamily assets located in Dallas, Texas, and Bentonville, Arkansas, with an aggregate principal amount of $20.4 million. The sponsors on the two transactions are repeat borrowers and have extensive experience in evaluating the multifamily sector. The properties are 98% and 95% occupied and have a weighted average debt service coverage ratio of 1.92 times. Our mezzanine investments have an average current yield of 6.5% and an all-in unlevered estimated yield of approximately 11%. On November 8, we purchased $30 million in preferred equity collateralized by a single-tenant stabilized pharmaceutical manufacturing property with a current yield of 10%. On December 9, we purchased $60.13 million of Freddie Mac K-Series B-Piece with an estimated yield of SOFR + 525 basis points. This originated at a tighter spread than our previous A-Series floating investments, as it represents the bottom 10% versus 7.5% of the debt capital stack, and has an underwriting debt service coverage ratio of over 2.3 times, with strong sponsorship on the underlying loans. During the quarter, we also originated a convertible note in the amount of $20.5 million for a well-capitalized sponsor focused on ground leases with an estimated yield of 9%, with future upside and a loan to value of 18%. Two of the single-family rental loans repaid had a total principal balance of $20.2 million, and the combined IRR realized on these investments was 31.4%. Paul Richards will go into more detail on how the capital was creatively reinvested in his prepared remarks shortly. 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.

Paul Richards, VP, Originations and Investments

Thanks, Matt. During the fourth quarter, the company was again active in the primary bond market. As previously discussed, we deployed $61.3 million on a Freddie Mac floating rate benchmarked against SOFR plus 525 basis points. Even as the market has experienced inflation headwinds, which have caused the market to price in multiple rate hikes, there has been an insatiable demand for Freddie Mac VP bonds. We’ve continued to see pricing tighten, as evidenced by the last auction, with spreads on the small balance loan VP coming in tighter than pre-pandemic levels. We continue to be sensibly leveraged on a repo at roughly 57.5% LTV at quarter-end. Lastly, we want to briefly touch on the continued performance of the SFR loan pool and the Q1 2022 loan paydown. All loans are current and performing as the demand tailwinds for single-family rental continue to pick up speed. We fully expect this trend to persist, with lease retention rates and occupancy at all-time highs, creating a tremendous backdrop, especially for us as lenders to high-quality institutional SFR sponsors. The portfolio has experienced two SFR loan paydowns in the first quarter of 2022, which generated a combined IRR of roughly 35% versus the original underwritten IRR of only 9%. Due to the early prepayment penalties, these investments were able to generate an additional $7 million of net proceeds than originally underwritten and in approximately one-third of the original investment time horizon. To finalize our prepared remarks before we turn it over for questions, I would like to turn it over to Matthew McGraner.

Matt McGraner, CIO

Thanks, Paul. We’re obviously pleased with our fourth quarter and full year results for 2021 and look forward to another strong year in 2022. I wanted to quickly touch on a special situation investment we made late in the fourth quarter that Matt Goetz just mentioned. A sophisticated ground sponsor faced delays in financing due to supply chain and COVID-related issues and needed a quick and efficient financing solution late in the year. We responded within two weeks in late December and met the sponsor’s needs by originating $75 million in convertible notes, yielding an advantageous 9% with an ability to convert to common equity at a 12.5% discount. The attachment point of our investment is roughly 18% LTV and creates a profound risk-reward investment for us both in terms of yield and total return potential. Finally, we’re in the middle of refinancing Nexpoint storage partners’ capital stack as we speak. We’ve chosen a lender to refinance to a senior debt portion at more favorable rates and proceeds and expect these efforts, along with the strengthening of the self-storage sector generally, to be beneficial to the common equity held by the company. We expect to close this financing in Q2 and will provide an update during our next quarterly results. That’s all we have for prepared remarks today. And now I’d like to turn the call over to the operator for questions.

Operator, Operator

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

Stephen Laws, Analyst

Hi, good morning. First of all, congrats on a nice quarter and certainly another dividend increase you guys delivered to investors. Can you talk maybe, Brian, a little bit about the guidance that looks like a big Q1? What items are being pulled in? I think your earnings available for distribution is like 40%, 45% of next year’s total guide is in Q1. So can you talk a little bit about what’s going to drive the one-time items in Q1 to benefit earnings?

Brian Mitts, CFO

Yes, most of that increase is related to prepayment penalties from the prepayment of SFR loans. It’s just a function of how that’s calculated and the calculation of that metric. It’s something that the SEC has been focused on across the sector. So with these prepayments that we’re seeing, which we will probably continue to see given the strength in the single-family sector, we may see more of that down the road. That’s what’s driving most of that increase for the first quarter. Obviously, the remainder is from the new debts that we’ve made, as discussed, and then creatively reinvesting the payments we’re receiving from prepayments into higher-yielding investments, like the ground lease that Matt mentioned.

Stephen Laws, Analyst

So piggybacking on that, Brian, when you think about the guidance you guys just issued for the full year, how conservative or how did you go about thinking of calculating expected contributions? Maybe not in the next three months, but say, in the second half of this year and your guidance?

Brian Mitts, CFO

Yes. We didn’t make any assumptions around prepayments or one-time items. So we tried to give a more smoothed-out, stabilized return profile, just based on the investments that we have. Obviously, if people make those prepayments, we generally view that as a positive because we can clip a big penalty and recognize that immediately, then redeploy that in higher-yielding investments. We’ve run those analyses and scenarios that show if the entire book repaid in 2022, what that would look like and what we could drive in terms of earnings. It would be hugely accretive to book value and our earnings available for distribution and cash available for distribution.

Stephen Laws, Analyst

Great. Switching over to the portfolio, one item, common stock investment looks like it depreciated nicely in Q4. But can you talk about your intentions with that? When may you look to harvest those gains and recycle capital in the cash flowing investments? Any timing to that?

Matt Goetz, SVP, Investments and Asset Management

So we’re probably going to close the refinance to the senior debt in May. Following that, we’re going to restructure the extra space preferred. We expect to blend that down to enhance the profile of the common equity yield to make it as valuable as we can. Once we do that, I think we either look to recap that out or if we think it’s better to hold for an exit upon re-IPO in 2023, which we think is viable. Look for an update in the second half of the year, probably in Q2, and we’ll have better visibility into it. Either one of those outcomes, I think, would be greatly appreciated for this company.

Stephen Laws, Analyst

Right. Yes. That’s helpful, Matt. Appreciate you taking my questions this morning. Take care.

Operator, Operator

We can go ahead and take our next question from Jade Rahmani with KBW.

Jade Rahmani, Analyst

Thank you very much. Can you say more about the ground lease investment? What kind of entity was this and in the capital structure? Is this secured by investment by a portfolio or some kind of equity interest? If you could elaborate, that would be helpful.

Brian Mitts, CFO

Yes, sure, happy to. It’s a private REIT that was formed, I think, around early 2020. They went out, raised capital of $140 million for an offering, raised about $110 million of equity, and began originating deals through 2021. We came in to bridge this with the instrument at the corporate level, allowing the company to fund these investments. As we stated earlier, we like this risk-reward dynamic, and we think it’s a great investment opportunity both in terms of yield and total return potential.

Jade Rahmani, Analyst

Was it just a preferred equity investment?

Brian Mitts, CFO

No, it is through convertible notes.

Jade Rahmani, Analyst

I guess, any update on the progress of the residential single-family rental portfolio? It seems that has not started to prepay? And if not, when might you expect that to occur?

Brian Mitts, CFO

We haven’t received any communications or indications from them, so it’s hard to tell. I mean, it’s a significant number they would have to prepay as part of the progress deal. They are definitely issuers of securitizations. That said, that market has widened recently. It really depends on what progress and their party want to do with that portfolio. If they want to repay, we would immediately start to look for places to put that capital.

Paul Richards, VP, Originations and Investments

No, that’s exactly what I think. It’s roughly a $75 million to $80 million prepayment penalty. As it currently stands, it's still up in the air.

Jade Rahmani, Analyst

So far prepayments you’re getting, what is the refinancing going into? Are they planning to start with lenders or something else?

Paul Richards, VP, Originations and Investments

You are breaking up a little bit, but I think we got the gist of the question. I think they’re looking at either securitizations or getting another bank for refinancing, which isn't necessarily cheaper than the current rates they are rolling out at. Because the value has increased so much, they are getting additional proceeds. Their analysis suggests it’s worthwhile to pay the prepayment penalty while securing a more considerable LTV on their investments. Many of these investments are underwritten at 60% to 65%, and today they can finance those at 80% to 85%, even higher in some cases. I think the math is working out in their favor, and that’s where they are headed.

Jade Rahmani, Analyst

And the spread widening you mentioned in the security market. What do you think is driving that? Is it a supply issue based on the magnitude of issuance in January that we saw or something else?

Paul Richards, VP, Originations and Investments

Yes, I think that’s correct. We saw a significant increase in supply in Q4 last year and a continued rise in Q1 of this year. The interest rate shock on the five and seven years didn’t help either. You’ll probably see LTVs in general are 88.5% in some cases on these deals. They’re higher, as Brian alluded to, compared to our current rate, which is a 65% LTV loan.

Jade Rahmani, Analyst

Okay, I guess. Is there a range of earnings post the first quarter or a return to the first quarter? Can you tell us what earnings would be excluding the outsize repayment income just to have an anchoring earnings expectation beyond these accelerated figures?

Paul Richards, VP, Originations and Investments

We can calculate that number and pull out the prepayment stock. However, we want to be cautious since the SEC has been monitoring disclosures of these different metrics pretty closely. We want to ensure that we stay in line with their expectations and not provide anything outside of that.

Jade Rahmani, Analyst

Does the dividend increase contemplate any benefit from the prepayment income? Because I assume the language of the press release suggests an increase in the quarterly dividend, which does not cite just specifically the first quarter. So that implies that this is a recurring dividend of $0.50 for the foreseeable future. Is any part of the dividend increase due to the SFR early prepayment income?

Paul Richards, VP, Originations and Investments

No. It’s meant to be a consistent dividend. It is not a special dividend and wasn’t driven by any prepayment numbers.

Jade Rahmani, Analyst

So it’s fair to assume that recurring earnings might be something close to that?

Paul Richards, VP, Originations and Investments

That’s right.

Jade Rahmani, Analyst

Okay. Let’s see. A couple of second couple of things. Yes. Thanks so much. Really appreciate your time.

Operator, Operator

It appears there are no further questions at this time. I would like to turn the conference back to the speakers for any additional and closing remarks.

Jackie Graham, Conference Call Host

Yes, thank you. I appreciate everyone’s time and the questions. We’ll be in touch next quarter. Thank you.

Operator, Operator

And this concludes today’s call. Thank you all for your participation. You may now disconnect.