Earnings Call Transcript - NREF Q4 2020

Operator, Operator

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

Jackie Graham, 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 ended December 31. On the call today are Brian Mitts, Executive Vice President and Chief Financial Officer; and Matt McGraner, Executive Vice President and Chief Investment Officer; Matt Goetz, Senior Vice President, Investments & Asset Management; and Paul Richards, Vice President, Originations & Investments. As a reminder, this call is being webcast through the company’s website at t 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. 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, investment activity, estimated IRRs, guidance for financial results for the first quarter of 2021 including the company’s estimated net income, core earnings, dividend per common share, cash available for distribution and dividend coverage ratio for the first quarter of 2021. 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 analysis of core earnings and CAD, which are non-GAAP financial measures. These non-GAAP measures should be used as a supplement to and not a substitute for net income loss computed in accordance with GAAP. For a more complete discussion of core earnings and CAD, see the company’s presentation that was filed earlier today. I would now like to turn the call over to Brian. Please go ahead, Brian.

Brian Mitts, CFO

Thank you, Jackie, and welcome to everyone joining us for the fourth quarter 2020 NexPoint Real Estate Finance earnings call. I’ll just quickly highlight our financial performance, capitalization, actions during the year and guidance for Q1 2021 and then turn the call over to Matt Goetz and Paul Richards to discuss the portfolio and opportunities we see. We’ll conclude our prepared remarks with some closing comments from Matt McGraner. Let me start with highlights in 2020. In February, we completed our IPO of $19 per share raising approximately $110 million of gross proceeds and using net proceeds to pay down 100% of our financing. In mid-March, as a result of the pandemic, credit markets froze up creating panic signs in margin calls on repo lines. This had an adverse effect on mortgage REIT stocks including NREF that dropped to a low of $6.34 per share, although NREF had no repo financing at the time. Book value dropped to $19.13 per share last to a low of $17.72 at the end of the second quarter. In May, markets began to recover, we drew on our repo lines to make attractive and higher yielding investments employing those increases. In July, we launched a preferred equity offering raising $46 million in gross proceeds using the net proceeds to acquire two more stabilized loans, and then NREF PA. In October, we launched a private unsecured notes offering raising gross proceeds of $36.5 million. The net proceeds were used to purchase a pool of multifamily mezzanine loans from Freddie Mac. As of December 31, our capital stack consisted of $781 million facility on the SFR loans, $60 million facility on the mezzanine pool, $151 million of REPO financing, $36.5 million of unsecured notes, $27.5 million preferred equity, and $90.7 million of common equity with $276 million redeemable non-controlling interests. The $781 million credit facility is collateralized by $854 million in SFR mortgages and maximum construction duration in the underlying SFR portfolio is roughly fixed rates. Each has a weighted average remaining term of 7.4 years. The rate on the facility at December 31 is fixed at a weighted average of 2.44% against the yield on another one half at 4.9% or 246 basis points throughout the cost. The $60 million facility is collateralized by $98 million of multifamily mezzanine loans. As of December 31, the rate on the facility is fixed at a weighted average of 30 basis points against the yield on underlying assets of a weighted average 7.46% or 716 basis points prior the cost of the debt. In both, the weighted average remaining term is 8.8 years. The $160 million repurchase or REPO balance is collateralized by $372 million of securitized loans for our 51% LTV and carrying interest at 0.329 annualized. For the December 31, 60% of our financing is subject to mark-to-market. The low level at 2.57 times debt to equity. We raised the average cost of debt to 2.49% and the weighted average term of 6.4 years with ample liquidity of $30 million of unrestricted cash as of December 31. For 2020, which was a short year since we went public in early February, we had net income attributable to common shareholders of $3.6 million, or $0.47 per share. Core earnings were $2.9 million, or $0.54 per share. We reported a loan loss provision for the year of $320,000. As of December 31, we repurchased 327,422 shares at an average price of $14.61 per share representing a discount for the current price at 25%. We paid a dividend of $0.40 per share in the fourth quarter. On Monday, the Board declared a dividend of 47.5 cents per share payable on March 31 to shareholders of record as of March 15, which represents an 18.5% increase in dividend. For the first quarter, we are issuing core earnings guidance of $2.9 million at the midpoint, $2.8 million on the low end, and $3 million on the high end. That equates to $0.54 per diluted share with the midpoint of $0.52 per diluted share on the low end, and $0.56 per share on the high end. And at the midpoint, that will give us a good range covering the 47.5 cents or 1.14 times coverage. With that, let me turn it over to Matt Goetz and Paul Richards to discuss the portfolio.

Matt Goetz, SVP, Investments & Asset Management

Thanks, Brian. Our fourth quarter and full year results continue to favor growth and strength in what we believe is the most resilient commercial real estate property types throughout all market cycles. We believe this trend will continue into the near future as more and more gateway residents look to move to less densely populated markets, which should continue to strengthen our targeted and underlying asset classes. While we can’t predict potential legislation, the future path of COVID-19, and the effects each might have on the commercial real estate sector, we believe our defensive strategy, namely credit investments in stabilized residential and storage assets, conservative underwriting at low leverage with well-heeled sponsorships should provide consistent and stable value to our shareholders. Strong development strength is evidenced by Freddie Mac across recent transactions in securitization which was transacted at yields at pre-COVID levels in 250 to 275 basis points described in our last fixed and floating rate VPs investments. That said, we’d like to spend a few minutes discussing the current portfolio’s performance as well as discussing the opportunities we are able to take advantage of in the fourth quarter and immediately thereafter. The current investment portfolio comprises 62 individual investments with approximately $1.4 billion in total outstanding principal. The loan portfolio is 100% residential with 60% invested in senior loans, collateralized by single-family rentals and 40% invested in multi-family via agency CMBS, preferred equity, and mezzanine debt. The portfolio’s average remaining term is 7.6 years with $3 billion in the commercial mortgage REIT space. The portfolio is 96.1% stabilized with a weighted average loan value of 68.3% and a weighted average debt service coverage ratio of 2.04 times. The portfolio is geographically diverse with a bias towards the Southeast and Southwest markets, and 100% of our investments are current. As mentioned in our earnings report, none of the underlying loans are currently in forbearance. Similar to last quarter, Freddie Mac's forbearance portfolio, as of October 25, saw roughly $7.6 billion or 2.4% of total Freddie Mac’s securitized unpaid principal balances enter into forbearance, but both metrics have improved slightly since the third quarter. As you know, the new administration has extended the forbearance of portfolios in moratoriums for federally backed mortgages until June 30th of this year. As of now, we don’t expect any material impact on our portfolios, evidenced by the strength of the portfolio’s debt service coverage ratio and the strong sponsorships. One mezzanine investment located in Columbus redeemed on December 11. The $10 million investment was outstanding for 65 months and it used an IRR and ROC at 1.6 times, or 1.6% to 1.63 times, respectively. As a reminder, we have zero construction loans, no heavy transitional loans, no land loans, and not for sale loans. Moving to the opportunities, we were able to take advantage of during and immediately after the fourth quarter. As Brian mentioned, we have been able to deploy proceeds from our unsecured senior notes offerings and redemption into accretive investments for all of our stakeholders. On October 28, we purchased a portfolio of 18 individual mezzanine loans collateralized by stabilized multifamily properties for $99 million plus accruing interest. We received approximately 50% from the financing, underwritten the portfolio to provide us with an IRR of 17.3%. On January 21, 2021, we closed the $26.4 million mezzanine investment with multibillion-dollar sponsorship for a multifamily redevelopment in Los Angeles, California. In summary, we continue to find attractive investment opportunities throughout our target markets and asset classes. And we’ll 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 to discuss what we are currently seeing in the bond market, repo financing, and the asset bond portfolio.

Paul Richards, VP, Originations & Investments

Thanks, Matt. During the fourth quarter, the company was not as active in the secondary or new issue agency CMBS market since we were able to deploy capital and purchase accretive mezzanine loans. Both from Freddie Mac was equally as attractive loan financing that Brian and Matt mentioned. New issue agency bond pricing came in tighter through the fourth quarter and the beginning of 2021 with both floating rate and bonds continuing to increase in value. As mentioned on the Q3 earnings call, management expected the spreads to tighten as the world continued to stabilize. Since this was the culture, we have seen spreads on bonds on both floating rate and fixed rate tighten slightly by 250 plus basis points from the new listed pricing. Now the application of these new listed pricing and market bases into the Q4 2020 book value; we fully expect and have seen markets starting to see an increase against the floating. We continue to increase these levers on the REPO at 51% LTV at quarter end, implying we are taking approximately a downward market value movement of $75 million on our current $370 million CMBS portfolio before the LTV increase to 55%. Taking it one step further, this would imply a 29% decline in market value and spreads widening roughly 750 basis points on the REPO book market’s new issue pricing. Lastly, we want to briefly touch on recent news of Front Yard Residential entering into a definitive merger agreement with Ares and Pretium and how these transactions closed in January of this year. We still view this as credit-positive for the company and expect its performance to be optimal just as for the entire pool. To finalize our prepared remarks, before we turn it over for questions, I’d like to turn it over to Matt McGraner.

Matt McGraner, CIO

Thanks, Paul. I’d like to end with a couple of brief thoughts. First, I am proud of the team and the results we generated in 2020 in tough credit and operating conditions. The team’s ability to capitalize on the market dislocation last year is already bearing fruit, as you can see with the significant increase in the book value this quarter. We are also proud to deliver on our expectations for the year and for our valued investors. We appreciate your trust. We are pleased and proud, as Brian mentioned, to substantially increase the dividend by double digits while maintaining true coverage and delivering on yet another promise to our shareholders. As we move into 2021, we expect to continue to do what we’ve been doing, and that is leveraging the core verticals to continue to source attractive opportunities to forge in commercial and residential asset classes. So that’s all we have for prepared remarks and I would like to turn the call over to the operator for questions.

Operator, Operator

And we will take our first question from Stephen Laws with Raymond James.

Stephen Laws, Analyst

Hi, good morning. I guess, first off, you are all doing good while, in fact, given the weather. But congrats on a nice quarter and strong dividend increase. Brian, can you maybe talk about the capacity for new investments, where do you see leverage moving? And I guess part of that discussion, it’s also the portfolio mix changed quite a bit sequentially, and I am wanting to get your thoughts on maybe where you see that mix shifting over the course of 2021?

Brian Mitts, CFO

Yes. I’ll cover the half of your question and then I’ll pull Matt to jump in on sort of where the portfolio will go in the future. We had success last year in creating and raising capital through deferred equity, unsecured notes, and then using that with the REPO mix as that market recovered. And it seems that there is a pretty big upside from the yield out there. So we think we can continue in a lot of the communities and probably at higher prices than we did in the July quarter and October. We have a number of things that we are looking at, and I think I would talk about that, but I think you can frame those and we are proactive about sourcing the ability to fund anything that comes our way.

Matt McGraner, CIO

Yes. Hey, Stephen, this is Matt McGraner. I think you’ll see, because we are in the Freddie Mac close, primarily our first investments this year will be significant ones in the multifamily and commercial mortgage-backed security space. They are also – and you know that they created, and we work closely with them on opportunities like the mezzanine investment we made. So, that’s probably where we will be spending most of our time now.

Matt Goetz, SVP, Investments & Asset Management

And Steve, as Matt mentioned, sort of what we had said during last year, our priorities fit for that. What happened with COVID, one of the things we’ve been talking about was being patient and thoughtful in terms you can get the stock price up above the book, and then initially having a decline in book value – it declines up above the IPO. Book value all indicates we are using pricing on CMBS book in January and into February, and expect book value to continue to increase. But we take that in – that increase is very, very helpful in getting the stock price up and keeping to put up good earnings numbers and making further investments. So, what we may say in that – like to raise common equity to and you were asking to both.

Brian Mitts, CFO

One, he asked for trading the wealth that’s still in place today.

Stephen Laws, Analyst

Sure, sure. I guess, just to follow up, sourcing on this new investment competition you are seeing in the market, I think, Paul touched a little bit on spreads tightening where we see those today back to – at the pre-COVID levels. Can you talk a little bit about returns on new investments on CMBS and also the competition you are seeing for new mezz and other types of investments you are looking to add?

Matt Goetz, SVP, Investments & Asset Management

Yes, it’s Goetz. On the CMBS front, yes, like I said, the strengths on a repeats toward the transactions went off at 250 and 275 basis points inside our last purchases which are, I think, 25 basis points above the low level. In terms of competition in the CMBS space for the Freddie Mac repeat hit, it’s still rendered just because of the high bar that it set for becoming a select sponsor and BTH bids. So probably about 20 active bidders in that space and they give will you an auction maybe once or twice a quarter, and then after that the securitization is due to spikes. In the mezz world, you are doing more debt funds, but in the state that we play in we are reconnecting our $5 million or $10 million mezz investment on our multifamily asset in the Southeast or Southwest. We don’t have a ton of competition. The bigger players are looking to put up a lot more money, and it’s not really worth the time to spend on $5 million and $10 million loans.

Stephen Laws, Analyst

Great. Appreciate the comments today.

Brian Mitts, CFO

Thank you.

Operator, Operator

We’ll now take our next question from Amanda Sweitzer with Baird.

Amanda Sweitzer, Analyst

Thanks. Good morning all. Do you have any update you can share on your plan for the self-storage common stock investment? And could that be a potential source of funds this year?

Matt McGraner, CIO

Yes. Hey Amanda. It’s Matt McGraner. We’ve been working with a number of funds or actively working with a number of funds to recap that. We think that can be a 2021 source of funds, highly likely that you can do that for sure.

Amanda Sweitzer, Analyst

Okay. That’s helpful. And then following up on the mezz investment you made in January, can you just talk a bit more about how you got comfortable with exposure, a little bit different than where you’ve been investing in the past and then that’s slightly higher LTV for the largest portion of that investment?

Matt McGraner, CIO

Yes. I think for us, in terms of markets and gateway markets, we are not huge fans of gateway markets. As you know, from your coverage, certainly, back in LA it’s a different bucket and across the multifamily spectrum during COVID. And then in terms of the underlying, we’ve been really watching this mezzanine pool, I think, for over a year. So we’ve been working with Freddie Mac. They kind of put it on hold negotiating with us during COVID, and then we think – we monitored this book through COVID, right through the years, and we felt comfortable enough over the course of 12 to 14 months watching the performance of the pool that ultimately excited us to close on it and save a lot of things.

Amanda Sweitzer, Analyst

That’s helpful. And then, it’s small, but in your book value bridge you noted $0.03 per share of realized loss in the fourth quarter. Is that related to the Georgia preferred equity redemption or something else during the quarter?

Matt McGraner, CIO

It’s due to a spin-out that we purchased at a premium. So we felt that premium was put into lots.

Amanda Sweitzer, Analyst

That makes sense. Thanks for all the comments.

Brian Mitts, CFO

Thanks, Amanda.

Operator, Operator

We’ll now take our next question from Jade Rahmani with KBW.

Jade Rahmani, Analyst

Thank you very much. Given where your credit spreads are in the CMBS space, do you have a range of mark-to-market book value you might be able to provide? Should we be assuming the 19.48 is up something around perhaps 4%?

Paul Richards, VP, Originations & Investments

Hey, Jade, it’s Paul. Yes, looking at January’s numbers, yes, I would say that a 3% to 4% increase would be correct given where pricing is, and that gets to start before it could be potentially higher in February and March. That's still seen to be on where our brokers come out with the March, but I think that’s a fair assessment.

Jade Rahmani, Analyst

Thank you. What should we expect from the pace of capital deployment this year either on an annual or quarterly basis in terms of how there is available to deploy into new investments?

Matt McGraner, CIO

Yes. Hey, it’s McGraner. I think what we are targeting is around $100 million this year, so $25 million a quarter would be an optimistic goal for us. And once we think it’s doable, as long as we keep each funnel, and other preferreds that we discussed earlier, while opportunities further, which we are actively sourcing and you saw them.

Jade Rahmani, Analyst

Thank you. On the credit front, when I look at Freddie Mac versus Fannie Mae, it’s clear that in Freddie Mac, there is a noticeable increase or greater proportion of loans in forbearance, about 2.4% of securitized EPB which is about 1200 loans or $7.7 billion collateralized as of November. Yes, in the NREF portfolio you cite that there are no loans in the portfolio that have come in forbearance. Can you talk about what would explain the difference between the NREF portfolio and Freddie Mac’s overall securitized book?

Brian Mitts, CFO

Yes. So, fortunately, the NREF portfolio was purchased – I think we bought through repeats since - and get three repeats and obviously the mezz book was all different, but the three repeats this has the additional interest reserves and so the credit underwriting was much stronger compared to having securitization.

Matt McGraner, CIO

And then this is our stack and insurance accrual reserves that aren’t common, and everybody implemented before through the preferred.

Jade Rahmani, Analyst

So even though there is about 2.4% of the Freddie Mac securitized loans in forbearance, there are still in the Freddie Mac repeat portfolios that NREF owns. There are no loans within those pools that are in forbearance?

Matt Goetz, SVP, Investments & Asset Management

That’s correct. Back in the second quarter, there were a number of loans in the BP portfolio that were in forbearance. Those have exited forbearance. So, at one point, we did have loans in forbearance, but we don’t anymore.

Jade Rahmani, Analyst

Great. Thank you for that. On the residential portfolio, I am wondering if it’s your expectation that ultimately Pretium and Ares, which thought residential, plan to refinance that debt either through securitization and some other means, perhaps they could capitalize the tenancy which I believe is 10%. So, do you – will they be able to create probably a higher earnings stream, a higher ROE going forward if they eventually plan to exit that? And that’s, they could capitalize the interest, to capitalize the cost to exit that piece of debt, refinance it cheaper, and show a higher earnings stream and then have a more graceful exit. So, what are your expectations with respect to that investment?

Brian Mitts, CFO

Yes. Hey, it’s Brian. I’ll let Paul talk about the actual numbers here, but we were discussing with Pretium, and they’ve indicated they don’t intend to refinance that. And then Paul, once don’t you get through the numbers in detail we’ll sit and watch.

Paul Richards, VP, Originations & Investments

Hey, Jade. Yes, we calculated the actual prepayment penalties that they have to use to break the loan. It’s roughly 25% to 30% given current rates. We can provide approximately $130 million to $150 million of yield as you deepen. With that, even when we have challenges, for example, we are trying. If so, it would make sense at breakeven – getting toward breakeven. I’ve shared those numbers.

Jade Rahmani, Analyst

Okay. And if that were to happen, it seems that you – I would assume that huge gain to book value to get that prepayment penalty up, that’s season and be able to deploy it elsewhere sort of call it a good new item, if that did happen?

Paul Richards, VP, Originations & Investments

Expecting to occur.

Jade Rahmani, Analyst

Thank you very much.

Brian Mitts, CFO

Thanks, Jade.

Operator, Operator

It seems there are no more questions from the phone lines. I will now hand the conference back to our presenters for any final comments or closing statements.

Brian Mitts, CFO

Yes, thank you for everybody joining the call. And I reiterate on those closing comments. We are happy with 2020 and glad that we were able to perform as we said we would during our IPO roadshow and continue doing that into 2021. So, thank you and we’ll talk next time.

Operator, Operator

And once again, that does conclude today’s conference. We thank you all for your participation. You may now disconnect.