Granite Point Mortgage Trust Inc (GPMT) 2017 Q4 法說會逐字稿

Hello, and good morning. My name is Chad, and I will be your conference facilitator. At this time, I would like to welcome everyone to Granite Point's Fourth Quarter 2017 Financial Results Conference call. All participants will be a listen-only mode. After the speakers' remarks, there will be a question-and-answer period.

I would now like to turn the conference call over to Maggie Field with Investor Relations for Granite Point. Please begin.

Thank you, and good morning, everyone. Thank you for joining our call to discuss Granite Point's fourth quarter 2017 financial results. With me on the call this morning are Jack Taylor, our president and CEO, Marcin Urbaszek, our CFO, Steve Alpart, our CIO, and Steve Plust, our COO.

After my introductory comments, Jack will provide a brief recap of market conditions and some business highlights. Steve Alpart will discuss our fourth quarter originations and portfolio, and Marcin will highlight key financials from our financials.

The press release and financial tables associated with today's call were filed yesterday with the SEC. If you do not have a copy, you may find them on our website or on the SEC's website at SEC.gov. In our earnings release and slides, which are now posted in the Investor Relations section on our website, we have provided a reconciliation of GAAP to non-GAAP financial measures. We urge you to review this information in conjunction with today's call. I would also like to mention that this call is being webcast and may be accessed on our website in the same location.

Before I turn the call over to Jack, I would like to remind you that remarks made by management during this conference call and the supporting slides may include forward-looking statements. Forward-looking statements reflect our views regarding future events and are typically associated with the use of words such as anticipate, expect, estimate, and believe, or other such words. We caution investors not to rely unduly on forward-looking statements. They imply risks and uncertainties, and actual results may differ materially from expectations. We urge you to carefully consider the risks described in our filings with the SEC, which may be obtained on the SEC's website at SEC.gov. We do not undertake any obligation to update or correct any forward-looking statements if later events prove them to be inaccurate.

I will now turn the call over to Jack.

Thank you, Maggie, and good morning everyone. On behalf of our team, we would like to welcome you all and thank you for joining us for our fourth quarter earnings call.

2017 was a transformative year for our business. After establishing our platform over the last few years as part of Two Harbors, we executed our IPO in June, allowing us direct access to the capital markets to take advantage of attractive investment opportunities in the senior floating rate commercial real estate lending sector. Over the course of 2017, we originated over $1.2 billion of loans and further expanded our footprint within the commercial real estate lending markets. We also grew our borrowing capacity to over $2.3 billion, and began diversifying our capital structure. We remain optimistic about our ability to continue to implement our business strategy and profitably grow the company in 2018 and beyond.

Please turn to Slide 5. Marcin will discuss our detailed financial results shortly, but I'd like to touch on some of the highlights and business activities from the fourth quarter. We grew our fourth quarter core earnings to $0.34 per share from $0.28 per share in the third quarter. Our common dividend for the fourth quarter was $0.38 per share, consistent with our prior guidance, and up from $0.32 per share in the third quarter. Our earnings and dividend benefitted from the continued deployment of capital and growth of our investment portfolio.

It was an active period for us in terms of originations and balance sheet activity. Our $344 million of total loan commitments and $277 million in total loan fundings in the fourth quarter deployed most of the capital remaining from the IPO and grew our loan portfolio to approximately $2.4 billion of funded loans at the end of Q4. While very pleased with our high volume of originations since the IPO and the flow of attractive investment opportunities available to us, midway through the fourth quarter, we slowed the pace of originations because we had rapidly deployed most of our investment capital and had experienced modest prepayment volumes. We decided to access the capital markets, but our timing to do so was impacted by the distribution by Two Harbors of approximately 76% of our common stock to its shareholders, which occurred on November 1.

After allowing for the resulting volatility in our stock price to diminish, we successfully issued $144 million of five-year convertible notes in mid-December, raising net proceeds to the company of approximately $140 million, including the over-allotment option, which was exercised in January. This transaction provided us with new capital to further grow the portfolio and earnings going forward. Note, however, that in the short term, we expect our earnings to be negatively impacted by the additional interest expense associated with the convertible bonds, while we begin investing the new capital.

Since raising the new capital, we have been building back up our investment pipeline. We have committed to over $130 million of senior floating rate loans, and have good visibility on growing that further during the remainder of the current quarter. We expect the majority of our first-quarter originations to close late in the quarter and in the second quarter of 2018. We continue to see many attractive opportunities and believe we will be able to ramp back up our origination pace.

The overall market for commercial real estate lending continues to be very favorable, especially for our strategy, which is focused on senior floating rate loans. Real estate fundamentals remain strong across most markets and property types, with ongoing rent growth and improving occupancies. In general, real estate valuations remain in line with historical averages. Sale transaction volume has moderated over the past 6 to 12 months, mainly in the gateway markets, tempering the pace of real estate price increases. We believe that supply and demand dynamics generally remain favorable across property types. We also believe that the lending markets remain rational with regard to loan terms, structures, and overall leverage. Though there has been competitive pressure on spreads, which we estimate at about 25 basis points over the past couple of months, we continue to find ample investment opportunities, and we have seen continued improved financing terms from our lenders, largely offsetting the decline in lending spreads. In our view, the manufacturing of senior floating rate loans continues to offer attractive risk-adjusted returns and should benefit from a rise in interest rates. We continue to believe that the alternative lending sector will be supported by enduring structural changes, healthy capital flows, and strong real estate fundamentals.

We also remain committed to our strategy of targeting both the primary and secondary markets, combined with our broad network of deep industry relationships and disciplined underwriting, and we believe this approach enables us to directly originate high-quality investments for our portfolio.

Now I will turn the call over to Steve Alpart to discuss our originations and portfolio in more detail.

Thank you, Jack, and we appreciate everyone's time this morning. I'll spend a few minutes reviewing our fourth quarter originations and highlighting our progress so far in the first quarter, and then I'll provide some key metrics on our portfolio.

Let's turn to slide six. We had an active fourth quarter in terms of originations. We originated six new senior floating rate loans and upsized two existing loans, representing total commitments of approximately $344 million. We funded approximately $277 million of loans, inclusive of approximately $25 million of fundings on loan commitments from prior quarters. As Jack mentioned earlier, our lower originations pace quarter-over-quarter was driven by our ability to deploy capital rates in our IPO at a strong pace in the third quarter and first half of the fourth quarter, rather than a lack of attractive investment opportunities. Our fourth quarter originations are secured by existing high quality, income-producing properties across our target markets and various property types. Approximately 71% of the fully funded loan amounts are secured by office properties. The remaining balance consists of a hotel property and a mixed-use property, which is primarily office, with a small retail component. While we continue to be selective in retail and hotel, we do believe that we can originate attractive investments that fit our risk and return parameters in these sectors, like the hotel loan we originated in Q4.

Our fourth quarter originations were geographically diverse and distributed between the west, southwest, and northeast regions, and the characteristics of these loans and the return profiles are in line with our overall investment targets. Our fourth quarter originations demonstrate our focus on a broader range of MSAs and on loan sizes below the general targets of some of our public peers. In the fourth quarter, these loans range in size from a $34 million loan secured by an office build in Phoenix, to a $75 million loan secured by an office building in Washington, D.C. We have longstanding relationships with the majority of these borrowers, which speaks to our ability to directly originate loans through our platform. The flexibility of our strategy and ability to execute on a variety of financings allows us to be selective and pick the best investments for our portfolio. We customize each financing structure to meet the specific business plans of our borrowers, without compromising on credit protections.

As we discussed on our last earnings call, we expected to begin receiving some prepayments on our portfolio as it continues to season. In the fourth quarter, we realized loan prepayments of approximately $98 million, which we're weighted towards the second half of the quarter. We believe that on the stabilized basis, our portfolio will likely pay off at an annual rate of approximately 25% as it becomes more seasoned.

Turning to the first quarter of 2018, we continue to see a strong flow of investment opportunities that fit our credit and return thresholds. To date, we have made total commitments of approximately $130 million of senior floating rate loans. Two of these loans closed in January, with combined total committed loan amounts of over $50 million and total funded balance of about $45 million. The remaining loans are expected to close later this quarter, and some possibly in the second quarter. We've been actively sourcing new loans for our pipeline and feel good about our growth going forward.

Moving on to Slide 7, let's discuss our portfolio as of December 31, which is 100% performing, with a total outstanding principal balance of $2.4 billion, a weighted average stabilized LTV of approximately 64%, and a weighted average asset yield of LIBOR plus 5.17%. In addition to our funded balance, we have over $330 million of future funding commitments, bringing our portfolio up to $2.7 billion on a fully-funded basis. We expect the majority of these future fundings to occur over the next 18 to 24 months. By property type, our portfolio was weighted toward the office and multi-family sectors, which we continue to find attractive. The portfolio is also well diversified across various markets and is over 97% floating rate.

If we take a look at Slide 8, you will see our interest rate sensitivity. We believe our portfolio is well positioned for a rise in short-term rates. For instance, if LIBOR were to increase 100 basis points, our annual net interest income per share on the existing portfolio would increase by approximately $0.18.

Turning to Slide 9, I'll briefly comment on two recent deal examples, to further illustrate our strategy and the types of high quality assets we originate through our large network of industry relationships. The first deal example is a $47 million senior floating rate loan collateralized by an historic boutique office building with ground-floor retail in the financial district of the Boston CBD. The Boston-based sponsor is a privately owned, owner/operator developer of high quality residential, commercial, and hospitality properties in high barrier to entry markets such as Boston, Washington, D.C., New York City, and Chicago. The firm was formed over 40 years ago and has been involved in the development, acquisition, and management of over 5 million square feet of office space and 16,000 apartment units, and currently own and operator approximately 3 million square feet of office and 6,000 apartment units. The sponsor is a repeat borrower of our team, and its business plan involves capital improvements and renovations, as well as the lease of a vacant space in a building which is currently 34% occupied.

We like this type of investment for several reasons. Our loan is secured by an historic boutique office building in the prime financial district submarket of Boston, with a submarket vacancy rate of approximately 8%. The property has unique features, including water views on three sides. The sponsor was a highly experience owner/operator with significant expertise executing similar business plans on value-add office properties in this market, including owning six properties totaling 1.4 million square feet in Boston, and with whom we have an existing relationship. And finally, our loan basis is attractive relative to the sponsor's basis, with the sponsor having $20 million of cash equity in the transaction when our loan is fully funded.

The second deal example is a $68 million senior floating rate loan collateralized by a class A LEED-Gold certified office building in the North Hollywood submarket of Los Angeles, California. The property was 100% occupied when we closed this loan. The sponsor's business plan is very straightforward and involves managing the lease expiration in approximately two years of a large tenant, with the loan providing protective structures and funding related to this scenario. The sponsor is a Southern California-based, fully integrated real estate organization with development, asset management, and leasing expertise. The company specializes in designing, building, and operating residential, office, and retail properties. The sponsor has been in the real estate business for nearly 60 years and is one of the largest privately owned development firms in Los Angeles.

We like this type of investment for several reasons. Our loan is secured by a high quality, class A office building. The property is located in the heart of the NoHo arts district, a pedestrian-friendly area of performing arts, theaters, galleries, recording studios, and entertainment companies, with easy access to the heart of the Southern California entertainment industry, and one block from a large public transportation hub. The North Hollywood submarket vacancy is approximately 7%. We have a highly experienced, well capitalized sponsor who is based in and active in this market, with similar properties. And finally, our loan basis is attractive relative to the sponsor's basis and recent sales.

So to summarize, we continue to see a great flow of investment opportunities that fit our overall strategy and investment criteria. Based on the strength of our platform, our industry relationships, and our reputation as a reliable counterparty, we are confident that we'll be able to continue to successfully execute on our business plan in a disciplined and prudent manner on behalf of our shareholders in 2018.

I'll now turn the call over to Marcin for a more detailed review of our quarterly financial results.

Thank you, Steve, and good morning everyone. I'll spend a few minutes discussing our financial performance, as well as our capitalization and liquidity.

Turning to Slide 10, our GAAP net income for the fourth quarter was $14.1 million, or $0.33 per share. Our core earnings, which is GAAP earnings adjusted for the non-cash equity compensation expense, was $14.5 million, or $0.34 per share. Taxable income for the fourth quarter was $17.9 million, or $0.41 per share. As you may recall, our taxable income includes an accretion of a GAAP-to-tax difference, resulting from our formation transaction, and for the next several quarters will cause our taxable income to be higher than our GAAP income. Consistent with the one-time guidance on our last earnings call, we declared and paid a fourth quarter dividend of $0.38 per common share, which translates into an attractive dividend yield. Our book value at December 31 was $19.17 per common share.

Let's touch base on a few drivers of our earnings and quarterly dividends. We had a good quarter in terms of originations and were able to commit nearly all of the remaining capital from our IPO. Similar to last quarter, the majority of our fourth quarter originations closed in the second half of the period, which slightly impacted our earnings. Since the company is in a growth phase, the timing of loan closings can have a relatively significant impact on our quarterly results. Over time, however, as our portfolio grows, the timing of loan closings should have a smaller impact on our results.

As a reminder, I'll quickly review our GAAP-to-tax difference and its impact on our dividends. As we discussed last quarter, as a result of our formation transaction, we recognized a lower tax basis than GAAP basis of approximately $22 million at the time of the transaction. This GAAP-to-tax difference will result in higher tax accretion versus GAAP accretion over the life of the loan portfolio contributed to us by Two Harbors. Tax planning and compliance are obviously important elements of maintaining our REIT eligibility. In 2017, we recognized approximately $6 million out of that $22 million of additional accretion in taxable income versus GAAP income. We estimate that through the end of 2019, the company will recognize approximately an additional $13 million of taxable accretion, which will result in taxable income being higher than GAAP earnings. This estimate, and the timing of its recognition, may change depending on factors such as additional fundings, prepayments, and any potential credit losses for those contributed loans, among other things.

Turning to Slide 11, as of December 31, we had approximately $1.5 billion outstanding on our financing facilities, and a total borrowing capacity of over $2.3 billion. We believe the financing markets remain healthy and are operating in an efficient manner. We've recently seen our cost of financing improve, as our lenders are working with us to manage our overall cost of capital, in light of the tightening loan spreads. We'll continue to seek to optimize our cost of capital and diversify our funding sources. As the markets evolve, we expect our financing sources to include syndicated loan positions or other forms of structured funding, including securitizations.

We ended the fourth quarter with a debt-to-equity ratio of approximately 2x. As we grow the portfolio and invest additional capital, we expect our debt-to-equity ratio to stabilize in the range of 2.5 to 3x, excluding any potential non-recourse sources of financing. We view this leverage target as prudent, given our focus on senior floating rate loans.

If you recall, during our last earnings call, we stated that at the end of the third quarter, we had liquidity to support approximately $400 million of additional loan originations. Given the fact that we committed our remaining capital midway through the fourth quarter, we decided to access the capital markets in mid-December and issue $144 million of five-year convertible debt to provide us with new capital and diversify our balance sheet. The net proceeds from this transaction were approximately $140 million, inclusive of the over-allotment option, which was fully exercised in early January. We are very pleased with the offering and believe it positions us well for the coming year.

As I mentioned earlier, our fourth quarter earnings were affected by the late timing of loan closings and recognition of a few weeks' of interest expense associated with the convertible notes transaction. Rolling forward to the first quarter of 2018, we expect a more significant impact to our earnings from recognizing a full quarter of interest expense on the convertible debt, as well as some lag in capital deployment. We believe this to be temporary and anticipate that we will return to growing our earnings in the remaining quarters of 2018, as we invest in new capital. Our liquidity at the end of the fourth quarter consisted of over $100 million in cash, a few loans that were funded with all cash, and approximately $120 million of available capacity on our financing facilities, related to pledged assets that haven't been fully financed. Adjusting for liquidity cushion, we estimate that at December 31, we had capacity to originate over $600 million of senior loans, depending on specific investments and available leverage. We anticipate receiving some additional repayments over the next several months, which would potentially provide us with more liquidity for additional originations.

Thank you again for joining us today, and now I will ask the operator to open the call to questions.

Thank you. We will now begin the question-and-answer session. (Operator Instructions) The first question comes today from Jade Rahmani with KBW. Please go ahead.

Thank you very much. Should we take your comments to imply a dip in 1Q earnings sequentially from the fourth quarter level?

Hi, Jade, it's Marcin. Good morning. Thanks for joining us. Yes, I think, look, as we mentioned in the prepared remarks, you know, when we recognize the full quarter of interest expense on the convertible and some like from capital deployment as we build out the pipeline, there will be an impact. It's hard to say exactly what that's going to be, but I think that's probably a good assumption.

In terms of where repayments are coming in, does the fourth quarter level represent an outsized quarter based on the seasoning of the portfolio, so prepayments should moderate? Or is that level something we should expect to be sustained?

Hey, Jade, this is Steve Plust. As the portfolio matures, we will be seeing more and more prepayments, such that when we get to a steady state, in the future, we should be expecting something like 25% of the portfolio to prepay over the course of the year.

Can you say whether -- oh, sorry; go ahead.

Sorry, Jade. We're looking right now. We think -- it's hard to put a spot estimate out, but we think that in the first quarter, we should be receiving something like $50 million to $100 million of prepayments.

Okay. Just a bigger question: For Granite Point to trade above book value and therefore have access to equity capital to meaningfully grow, it seems investors need to be convinced of two things. One, that you would not issue equity dilutively, and two, that you have the ability in the business model to achieve levered returns in the 9% range, or hopefully higher. So I just wanted to ask you if you could comment on those two specific things.

Well, with respect to the first, we have said that it is not our intention to issue equity dilutively, and we'll repeat that here today. Is there an echo? I heard -- okay. Secondly, I will ask Marcin to chime in if he wants, but we fully believe that we'll be able to hit those returns that you mentioned.

Yeah, look, I think that as we lever our portfolio and as we deploy the capital, obviously, we're under-levered today. We are at 2x debt-to-equity at the end of the quarter. We stated our target as 2.5 to 3. We think we'll get there over the next several quarters. So, you know, barring some unforeseen market events and, you know, craziness in spread markets and financing markets, we feel pretty comfortable. Looking at what our portfolio yields today and where our cost base is, we feel pretty comfortable we'll get to the market returns as we are fully stabilized.

And can you comment on your discussions with lenders about accessing additional financing capacity? Do you have the ability to increase financing capacity without the need for additional equity capital?

Yeah, so I'll let Marcin elaborate.

Look, I think, so we upsized two facilities. We have more than enough financing capacity today to deploy the capital that we have. But we also said in our prepared remarks that we've seen improvement in our funding costs recently, and I would say that's both on the cost, but also on the leverage. So, but there's only so far you can go with a repo line in terms of how much leverage you can get on it, but we've seen an improvement in both as the markets evolve.

Thanks very much for taking the questions.

The next question will be from Rick Shane of JPMorgan. Please go ahead.

Sure, really two questions here. Obviously, I realize at this point in your life as you're growing in the capital base is several billion dollars, the timing is incredibly sensitive. But I am curious about the decision to sort of reduce the origination pipeline, given what should have been some available leverage into the fourth quarter, and the implications of that going into 2018. And to just sort of continue that so we understand the timing going forward, with the incremental $140 million of capital probably leveraged about 2.5x, put it in the midpoint of your target range, how long do you think it will take you to fully deploy the proceeds from the preferred offering?

Sure. Hi, Rick, this is Marcin. Thanks for joining us; thank you for your questions. So I'll attack the last part of your question. I would say, as we said in the prepared remarks, we have liquidity to originate about $600 million of loans, plus or minus. That does not include additional prepayments. I think that should take us a couple quarters to deploy. Obviously, committing to the loans and actually closing them, there's a lag there, so please keep that in mind. As you know, as we get additional prepayments in the portfolio, that's going to be an additional source of liquidity, so you know, we'll be deploying capital throughout the year.

In terms of rationale for the deal, I would say that we, as we said, we deployed our capital midway through the quarter. We did not have -- when we say deployed, it's committed. We don't have additional ability at that time to borrow more. You know, if you look at our Q3 10-Q when we had $2 billion of assets pledged against $1.5 billion of repo lines, those assets were pretty fully levered. We had some assets that were unlevered. We have some mezzanine assets that are not levered. So we were at the point where, because of our strong originations in Q3 going into Q4, you know, we were essentially -- we had to slow down the originations to accommodate some capital constraints. We had some prepayments coming in later in the quarter, so we started originations later in the quarter, going into the first quarter. But that's just a constraint that we had that we had to accommodate, and we thought it was a good opportunity to issue some unsecured five-year debt that provided us some liquidity and provided us flexibility on our capital structure. So we executed the deal, and we are very happy with the outcome.

Got it. And again, when I look at the originations, seem to be pretty much on track. I guess where it creates noise is how quickly you can turn on and turn off that origination pipeline, and frankly, the implication's not for the third and fourth quarter, but potentially for first quarter originations versus expectations.

Hey, Rick, it's Steve Alpart. I'll take that question. So just a couple comments on the first quarter. You heard us say earlier that we have total funding commitments of about $130 million of senior floating rate loans. That's about $120 million on an initial funding basis. We mentioned that two loans, about $50 million of commitments, about $45 million of initial fundings, have closed, and the rest will close later this quarter, possibly into second quarter. In total for Q1, we're anticipating that we'll fund about $200 million, plus or minus. We think about a little over half of these loans will fund towards the end of March, although as we've noted and Marcin has noted, the timing of the closings is hard to predict with certainty. Some of that could flip past the quarter.

So just to kind of take off where Marcin left off, these loans, as you know, typically take six to eight weeks. They can take longer from term sheet to closing. So the Q4 slowdown that we talked about has impacted the pace in the beginning part of Q1, and therefore will probably impact Q1 overall. But we have very good visibility on the forward pipeline, and we are expecting to get back to our pace of originations that you've seen us do in prior quarters.

Got it. That's very helpful in terms of context for Q1. Last question: When we look at the difference between commitments and fundings in any given quarter or on any individual loan, over the life of a loan, what percentage of the commitment do you actually expect to fund? Is it 75%? Is it 95%? That will help us really sort of think about the differential between commitments and fundings.

Rick, it's Steve again. So it's going to vary deal by deal. Generally, we would expect to fund the majority of the commitment on every loan. That doesn't mean 100%. The way we would think about it is sponsor's business plan, these loans obviously are all customized around that. Oftentimes, the sponsors are expecting to lease up the property to 95% or more. We'll typically underwrite a little bit lower, but we'll side the loan towards their business plan. So there could be a small gap between what we're underwriting and what they're expecting, and there's always the possibility that they just sell or refi the property early. So, you know, I would say 90%, 95%, somewhere in that ZIP code as far as what we would typically expect to fund on the commitment.

Great. Thank you very much, guys.

Sure.

Our next question comes from Fred Small of Compass Point. Please go ahead.

Hey, good morning, thanks for taking the question. Just on the repayments on the 25% sort of annualized repayment rate, when do you expect that you'll be closer to that level? It just seems a lot higher than where you're run rating now.

This is Jack. I would say that the repayments, if you look at our portfolio, roughly half of it was originated within the last 12 months, so I don't think that we'll hit what I'll call in this context a stabilized run rate on prepayments until much later this year, because, you know, we're looking at loans that, for half the portfolio, were fairly recently originated. So we expect it would ramp up to that 25% per year estimate.

Okay, got it. And then, just so I understand the math right, on the originations or the fundings for the first quarter, you've got $120-odd million that's already expected this quarter. You've done $45 million, so there's $75 million left of that component. And then, if you're getting to $200 million, there's still $75 million or $80 million that's not in the pipeline yet that you expect this quarter?

Yeah, it's Steve. That's about right. So that's just basically near-term visible pipeline, doing estimates about what we think will get signed up and closed this quarter. Some of what we're expecting to sign off in the next week or two will close in the second quarter, but that's a good estimate for what we expect to fund this quarter.

Okay, and I mean, have you seen any -- just with sort of ramping that back up, have you seen any impact in the discussions from just sort of recent market volatility or rate volatility that you think could push more of that into the second quarter?

It's hard to predict with certainty, obviously, but when we come up with an estimate like that, it's based on a bigger pipeline than that number, and then making some estimates about what gets signed off and timing. These loans typically close in four to six weeks. Sometimes, they can go a little bit longer, so it's just us making best estimates, based on what we are seeing right now in front of us.

Okay, great. Thanks.

Ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the conference back over to Mr. Jack Taylor for any closing remarks.

Well thank you, Chad. We'd like to thank everyone for joining us today. We appreciate it, and we appreciate everyone's support for our business. We look forward to speaking with you all again soon. Thank you again.

And thank you, sir. The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.