Earnings Call Transcript - NREF Q1 2023

Operator, Operator

Good morning. My name is Abby, and I will be your conference operator today. I would like to welcome everyone to the NexPoint Real Estate Finance Quarter One 2023 Conference Call. Today’s conference is being recorded. Kristen Thomas, you may begin your conference.

Kristen Thomas, Moderator

Thank you. Good day, everyone, and welcome to NexPoint Real Estate Finance conference call to review the company’s results for the first quarter ended March 31, 2023. 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, 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 invest.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 understanding 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 Brian Mitts. Please go ahead, Brian.

Brian Mitts, CFO

Thank you for that, Kristen. Thank you for joining us today. I’ll get started by briefly going through our results for the quarter, and then I will go into guidance for Q2 before turning it over to the team to discuss some of the things we did in the quarter, what we are seeing in the world today, and what we see in the lending environment. So starting with Q1 results. For the first quarter, we reported net income of $0.30 to $0.37 per diluted share compared to net income of $0.78 per diluted share for the first quarter of 2022. The decrease in net income year-over-year is a result of lower prepayments in Q1 ’23. If you recall, we had quite a few prepayments last year, particularly in the first quarter. Earnings available for distribution were $0.52 per diluted share in the first quarter compared to $1.20 per diluted share in the same period in 2022. Cash available for distribution was $0.55 per diluted share in Q1 compared to $1.55 per diluted share in the same period in 2022. Again, as with net income, earnings available for distribution and cash available for distribution were lower year-over-year due to lower prepayments in the first quarter of this year. We paid a dividend of $0.50 per share in the first quarter, and the Board has declared a dividend of $0.50 per share payable for the second quarter. The Board has also declared again a special dividend of $0.185 per share for the second quarter, and we intend to declare special dividends of $0.185 for each remaining quarter this year. Our dividend in the first quarter is 1.04 times covered by earnings available for distribution and 1.1 times covered by cash available for distribution. Book value per share decreased 2.2% quarter-over-quarter to $19.59 per diluted share, primarily due to the special dividend and mark-to-market adjustments on our common stock investments. During the quarter, we originated 6 investments with $34.8 million of outstanding principal with a combined current yield of 11.4%. During the quarter, we had one investment partially redeem for $11.5 million of outstanding principal and another investment that fully redeemed for $24.7 million. Now let me move to guidance for next quarter. For earnings available for distribution, we’re guiding to $0.46 per diluted share at the midpoint with a range of $0.41 on the low end and $0.51 on the high end. Cash available for distribution is guiding to $0.50 per diluted share at the midpoint with a range of $0.45 on the low end and $0.55 on the high end. The decrease in cash flow for distribution and earnings available for distribution from the first quarter is primarily driven by a one-time gain on the deconsolidation of the multifamily property that we consolidated for 2022. With that, I’ll turn it over to the team for additional commentary.

Matt Goetz, SVP, Investment and Asset Management

Thanks, Brian. During the quarter, the loan portfolio continued to perform strongly and is currently composed of 88 individual investments with approximately $1.7 billion of total outstanding principal. The loan portfolio is 95% residential with 44% invested in loans collateralized by single-family rental and 51% invested in multifamily, primarily via agency CMBS. The remaining 4% of the loan book consists of life sciences and self-storage. The portfolio’s average remaining term is 5.4 years and is 92% stabilized with a weighted average loan-to-value of 68.7% and an average debt service coverage ratio of 1.9 times. The portfolio is geographically diverse with a bias towards the Southeast and Southwest markets; Texas, Georgia, and Florida combined for approximately 51% of our exposure on a geographic basis. As Brian mentioned, during the quarter, we originated 6 investments with $34.8 million of outstanding principal with a combined current yield of 11.4%. One investment partially redeemed for $11.5 million and one investment fully redeemed for $24.7 million. The 6 new investments consisted of a $14 million preferred equity investment in a build-to-rent portfolio in Forney, Texas, a suburb of Dallas, with a well-heeled repeat sponsor. The preferred has a fixed rate of return of 11%. We also invested $500,000 in common equity into the project for additional upside. An $11.2 million preferred investment was made with the same sponsor on a build-to-rent portfolio located in Richmond, Virginia. This investment also has a fixed rate of return of 11% and included another $500,000 of common equity for additional upside. Two follow-on life sciences preferred investments were made for a total of $2.7 million and have an average fixed rate of return of 10%. One follow-on multifamily investment was made for $1.2 million and has a fixed rate of return of 11%. The property is located in Houston, Texas and is owned by a repeat sponsor with 80,000 units under management across the country. We also purchased a floating rate BP with an outstanding principal balance of approximately $15 million with 2 years left until maturity and a current yield of 13.1%. After the quarter ended, we made a $20 million preferred equity investment into the CGMP facility in Temecula, California with a repeat sponsor. The preferred equity has a fixed rate of return of 10%. The 2 redemptions in the quarter consisted of a partial redemption of approximately $11.5 million of preferred equity on a stabilized multifamily property located in Las Vegas, Nevada and a full redemption of a mezzanine investment for a mixed-use project located in Los Angeles, California in the amount of $24.7 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.

Paul Richards, VP, Originations and Investments

Thanks, Matt. As previously discussed, during the first quarter, the company was able to source, underwrite, and acquire a seasoned agency BP splitter, providing a very attractive yield of SOFR plus 8.5%. We’ve again stressed the entire CMBS portfolio by shocking interest rates to determine how far implied yields would have declined and marks at half the fall to equal a decline of $142 million in market value. $142 million represents the difference between our book value and market value as of close last night. The stress test fueled a result of implied yields almost doubling to approximately 21%, which is equivalent to a 25% decrease in the CMBS portfolio value and over a realized 40% plus decline in the underlying multifamily and single-family property values to recognize any real impairment. These types of losses would be on par or worse than what was experienced during the great financial crisis. We firmly believe in the resiliency of the residential space in the current inflationary environment and the safety of these investments, as evidenced by the performance in these verticals. We continue to be prudently leveraged on our repo financing at approximately 60% LTV at quarter-end and are in continuous dialogue with our repo lending partners on the state of the market and the finance portfolio. Lastly, regarding the continued performance of the SFR loan pool. Our SFR loans in the portfolio are currently performing and displaying strong DSCRs with NOI growth as the demand for SFR continues to show great strength. The portfolio did not have an SFR paydown during the first quarter. To finalize our prepared remarks before we turn it over for questions, I’d like to turn it over to Matt McGraner.

Matt McGraner, EVP, Chief Investment Officer

Thank you, Paul. Underlying NOIs embedded in our stabilized SFR multi-life science and storage collateral continue to outperform other property types, providing a resilient base of earnings for distribution and stable yields to our investors. NREF’s business is doing exactly what it was designed to do, namely produce a consistent, durable cash flow stream for our investors backed by the highest quality assets in the commercial mortgage REIT sector. We’re pleased to be speaking to you this morning about special dividends, unrivaled credit quality, and originations of quality CGMP and residential investments, not CECL reserves for office loans and other watchlists. On the origination front, we have a robust pipeline of low double-digit yielding preferred and mezzanine investments in the CGMP and SFR sectors and expect to continue recycling capital into these opportunities in the coming quarters. I want to thank the team for continuing to source and monitor high-quality investments. And with that, we’d like to turn the call over to the operator for questions.

Operator, Operator

Your first question comes from Crispin Love from Piper Sandler. Your line is open.

Crispin Love, Analyst

Thanks. And good morning, everyone. Just first off on credit quality. And Paul, I appreciate your comments that you just made, but I’m just looking for a little bit of an update on the credit outlook. Recently, there seems to be just more caution on multifamily properties broadly in the industry with some defaults in the news, not related to NREF but others. So just curious about your thoughts on the current credit environment and kind of where we could be headed over the next few quarters in multifamily and SFR, especially as you continue to have no loans in default or forbearance?

Matt McGraner, EVP, Chief Investment Officer

Chris, it’s Matt McGraner. I’d say yes. As I mentioned, the underlying NOI, at least in our portfolio that’s largely underwritten in conjunction with a quality sophisticated servicer like Walker & Dunlop or CD, or something like that, plus our underwriting with Freddie. Most of the multifamily that we see are still producing positive NOIs, well covering a 1.2 to a debt service coverage ratio and are fine. Where you’re seeing problems, I think, are the 2020, 2021 sort of vanilla vintage debt fund or CRE CLO deals that were struck at low 3 caps, 3.5 caps, 4 caps that are going to have to be cash and refinance or just extended from a valuation scenario. Most of those, are like I said, CRE CLOs or like a debt fund. So we don’t have any exposure to those types of assets. So I think the position is one where we will continue to underwrite the source on the Freddie K side and leave the problems elsewhere to those who struck those deals. Paul, do you have anything to add on SFR?

Paul Richards, VP, Originations and Investments

No, same plan.

Crispin Love, Analyst

Thanks, that was helpful. And then I think I might have missed this in the prepared remarks, but just an update on the Las Vegas multifamily investment that triggered the material weakness in the 10-K. It sounds like you were able to deconsolidate that. I think I heard you mention that there was a one-time gain. Can you just dig a little bit deeper into that one-time gain? Was that in the first quarter? Is that a second-quarter event?

Brian Mitts, CFO

Yes, it’s Brian. So we did correct the issue with the investment. It’s now recorded as a preferred investment, which was the intent all along. And so there was a gain in deconsolidating that. But that happened in the first quarter. We’re working closely with the auditors through that process, and I don’t expect any more issues from that. We are also working closely with them and the Board to remediate that material weakness, which we expect to happen this year and are taking other measures to ensure that we avoid something like that in the future.

Crispin Love, Analyst

Alright. Thanks, Brian. And how large was that gain?

Paul Richards, VP, Originations and Investments

$1.5 million.

Brian Mitts, CFO

$1.5 million.

Crispin Love, Analyst

Appreciate it. Thank you so much for taking my questions.

Brian Mitts, CFO

Sure.

Operator, Operator

Your next question comes from the line of Stephen Laws from Raymond James. Your line is open.

Stephen Laws, Analyst

Hi, good morning. You guys are a little more narrow focus from a property standpoint than most of your peers, but do have the flexibility to do a much broader range of investments than many other CRE mortgage REITs. And maybe the recent prep investment activity is a sign. But can you talk about your investment pipeline, where you’re seeing the best opportunity to put money to work? And then, Matt, I know you ran through a couple of redemptions and a couple of new investments, but maybe kind of netting that all out, what is your appetite for new investment from a net growth standpoint or sort of net flat? How do we think about appetite for new investments?

Matt McGraner, EVP, Chief Investment Officer

Yes, Steve, good morning. I think the lack of bank activity in general right now makes it a pretty opportunistic and attractive time to put money to work really anywhere, especially in our verticals. The CGMP focus will continue to be a primary focus for us because even in a normalized banking environment, this is a non-bank sector. With the reshoring wave of pharmaceutical manufacturing and other specialty manufacturing coming back, coupled with lack of liquidity in the space, there is just a tremendous opportunity. So we’re spending a lot of time with sale-leasebacks from users and CDMOs and will continue to try to source those opportunities. We love that space and understand it. And again, it’s non-bank. Spread on Freddie K, I think we will continue to provide an attractive source of investments. In some cases, as Paul mentioned, you're earning 3 times the unlevered asset yield and a great credit position. So I think those two spaces, for me, will continue to be attractive.

Stephen Laws, Analyst

Great. Thanks. And Brian, I wanted to touch – ask quickly on the unrealized loss. I think in your prepared remarks, you mentioned it was mainly related to the common stock, but do you have a breakout for what was unrealized from the security mark versus common on that?

Brian Mitts, CFO

Do we have that? Yes, I'll have to get back to you on the details on that, Steve.

Stephen Laws, Analyst

Follow-up there. When you look at the common stock investments, I guess the two small ones recently relate to the preferred equity you talked about. But the bigger ones, can you talk about what your return expectations are and kind of monetization outlook? And how you think about that capital allocation versus capital allocated to cash flow and debt investment?

Matt McGraner, EVP, Chief Investment Officer

Yes. I mean the big ones, Steve, and it’s Matt. Our GLR ground lease investment and the NexPoint Storage Partners investments, kind of take them in reverse order. The storage portfolio is, in our view, one of the highest quality storage assets or storage portfolios out there, a lot of exposure to Florida, a lot in Miami. In fact, I think we might be the largest self-storage owner in Miami now. So, we like that investment long-term. I think it’s not the right time to monetize that one because of lack of liquidity, although we get some addressing of values from the recent life and EXR deal. So, we feel really good about that investment, but it’s just not the right time to monetize it. When we do, we think we are looking at $2 or $3 a share in book value gains from that investment. The GLR investment is another attractive one. Obviously, that’s more of a bond-like equity investment as well, but I think it’s also, I think $2 to $3 in share book value accretion. So, we like these investments for the total return aspects that obviously differentiate our portfolio from just a steady yield. We think this can get these two investments when we monetize together $5 or $6 per share in book value accretion.

Stephen Laws, Analyst

Thanks for the color on that. Thanks for your time.

Brian Mitts, CFO

You bet.

Operator, Operator

Your next question comes from the line of Jade Rahmani from KBW. Your line is open.

Jade Rahmani, Analyst

Thanks very much. So, as it stands today, a follow-up on the credit question. You are not expecting any deterioration or default pressure on performance. I mean, it just seems that with the magnitude of rate increases we are seeing, many of the multifamily deals by necessity meeting interest rate caps that eventually there are going to be pressures. So, what are your expectations?

Matt McGraner, EVP, Chief Investment Officer

Yes. Jade, it’s Matt McGraner again. We don’t have a – or we are not aware of any underlying issues in any of our credit investments or preferred investments. And in the case of a preferred investment in a multifamily deal, their underwritten structure is such that to the extent there is a default, we can take over the management and equity position at our basis and think that we have underwritten those given our multifamily experience and our operating partnerships in that space very prudently. So, those are all deals that are performing well with quality sponsors, repeat sponsors that to the extent there were issues, we could have them recap the equity if necessary. But again, there are no issues. And then Paul, I will kick it over to you for some of the securitization.

Paul Richards, VP, Originations and Investments

Yes. Also, the single-family rental too, those deals were struck back in ‘18, originated back in ‘18, where are all fixed-rate investments, all 4%, 5% type of fixed-rate debt. So, DSCRs are growing on those aspects. NOI growth has been great for those specific investments as well. So, there isn’t much stress on the SFR side. As far as the securitizations go, our BPs were fairly consist of finishes anywhere from ‘19, ‘20, ‘21, ‘22, both fixed and floating, and we haven’t seen much stress in terms of the floaters where people are getting new caps, etcetera, or DSCRs are still performing, going up, increasing. So it feels like really good performance throughout the securitization book as well.

Brian Mitts, CFO

Yes. And I would add one thing and then I will give an update on Stephen’s question earlier. Most of the multifamily REIT public world has reported thus far, and it’s been pretty positive. Obviously, they are low-leveraged compared to some of the sponsors that we work with that are recent in the CapStack; fundamentally, it’s shown that multifamily is still performing pretty well overall. I think the SFR industry or sector is expected to have similar results when they report in the public markets. Stephen, just to answer your question directly, GLR was down $1 million, NSP, the storage platform was down $240,000, and then the remainder of the loss was from the CMBS book.

Jade Rahmani, Analyst

On the follow-up question, if I can ask.

Matt McGraner, EVP, Chief Investment Officer

Yes, go ahead, Jade.

Jade Rahmani, Analyst

Do you know what the debt service coverage ratio is on the Freddie Mac BP side?

Matt McGraner, EVP, Chief Investment Officer

Our entire portfolio is 1.9%. On the Freddie Mac side, it is from technology to wrong number. We will follow up on the exact pool because we break it down by combined loan and our internal notes, so we can aggregate that and get back to you.

Jade Rahmani, Analyst

Do you know what percentage of the deals have floating rate debt and interest rate caps?

Matt McGraner, EVP, Chief Investment Officer

So, right now, we have roughly four securitizations for B-pieces that are floaters, and those all would have some sort of caps. And of course, that would differ because of the vintages; some are in ‘19, some are ‘20, some are ‘21, and the caps are usually 3-year, 4-year caps. So, they come up at different times. So, it’s more of a steady wave of when those caps need to be replaced.

Matt Goetz, SVP, Investment and Asset Management

Hey Jade. This is Goetz. So, Freddie required all of those borrowers to purchase caps for any floating rate debt unless it’s super low leverage.

Jade Rahmani, Analyst

So, on the preferred side, the preferred multifamily deals you have done, not the BPs, what percentage of floating and what – not the preferred, but the underlying floating debt and what percent has interest rate caps do you know?

Matt Goetz, SVP, Investment and Asset Management

Yes. All of the floating-rate preferred deals that we have done have caps on them. They may not have been done.

Jade Rahmani, Analyst

I was going to say, is most of the underlying debt floating?

Matt Goetz, SVP, Investment and Asset Management

I have to go and find the exact breakout. I would say it’s probably majority floating. So, we can get back to you.

Jade Rahmani, Analyst

Alright. Thanks for taking the questions.

Matt McGraner, EVP, Chief Investment Officer

And Jade, to answer your question about what the DSCR is of the floating rate securitization, it’s 2.9 times.

Jade Rahmani, Analyst

Okay. Great. Good. That’s good coverage. So, thanks for that.

Operator, Operator

There are no further questions at this time. Mr. Brian Mitts, I will turn the call back over to you.

Brian Mitts, CFO

Yes. Thanks. Just want to highlight one thing before we go. Paul had mentioned the stress test we did internally. I think if you look at where the stock is trading versus the underlying fundamentals of the portfolio, not to mention the almost 16% yield, including the special dividends. I think it’s a pretty strong value. Hopefully, investors will see that and see the results from this quarter and sort of the guidance that we have issued for next quarter and recognize that value proposition. Having said that, I appreciate everyone’s time and participation in questions. We will get back to you on some of that information that we couldn’t answer here. But with that, thank you, and we will see you next quarter.

Operator, Operator

This concludes today’s conference call. You may now disconnect.