Nexpoint Real Estate Finance Inc (NREF) 2020 Q3 法說會逐字稿

Good day, and welcome to the NexPoint Real Estate Finance Third Quarter 2020 Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Jackie Graham. Please go ahead, ma'am.

Thank you. Good day, everyone, and welcome to NexPoint Real Estate Finance's Conference Call to review the company's results for the Third Quarter ended September 30.

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 and Asset Management; and Paul Richards, Vice President, Originations and Investments.

As a reminder, this call is being webcast through the company's website at www.nexpointfinance.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, including unlevered IRRs, LTVs and yields, pro forma capitalization and guidance for financial results for the fourth quarter of 2020, including the company's estimated core earnings, dividend per common share and dividend coverage ratio for the fourth quarter of 2020. They are not guarantees of future results and are subject to risks, uncertainties, assumptions, that could cause actual results to differ materially from those expressed in any forward-looking statements. Listeners do 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, which is a non-GAAP financial measure. This non-GAAP measure 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, see the company's presentation that was filed earlier today. I would now like to turn the call over to Brian. Go ahead.

Thank you, Jackie, and welcome to everyone joining us for the Third Quarter 2020 NexPoint Real Estate Finance Earnings call.

Today, we'll cover highlights for the third quarter of 2020 and year-to-date. I'll give some quick highlights of our financial performance, capitalization, recent activity and guidance and then turn the call over to Matt Goetz and Paul Richards to discuss the portfolio and acquisition pipeline. We'll conclude our prepared remarks with some comments from Matt McGraner on the real estate credit markets, the strategy and update on the Jernigan Capital transaction we announced on our second quarter earnings call.

I'll start with the highlights in the third quarter. Overall, it was a busy quarter where we again found a way to raise capital and take advantage of opportunities in the market. On July 30, we purchased the Freddie Mac KF81 B Series for $67 million. On August 6, we closed the Freddie Mac K113 B-Piece for $36 million on $109 million par value and we also closed the X2A, X2B and X3IO strips for $36 million. As of October 28, our capital stack consisted of $787 million facility on the SFR loans. A $60 million facility on the mezzanine pool, which we purchased subsequent to the third quarter, $159 million of repurchase agreements, $36.5 million of unsecured notes that we placed subsequent to the third quarter, $46 million of preferred equity, $86 million of common equity and $265 million of redeemable noncontrolling interests.

Also, as of October 28, only 15.3% of our financing is subject to mark-to-market our repo lines are levered at 49.7% loan-to-value, providing plenty of cushion for mark-to-market down with movement before margin call. Overall, we're low levered at a 2.6x debt-to-equity, the weighted average cost of our debt is 2.44%, with a weighted average term of 6.5 years.

We also have ample liquidity with $12 million of unrestricted cash on the balance sheet as of October 28. Subsequent to the end of the third quarter, we continue to find ways to raise capital and put the work accretively by sourcing opportunistic investments. Thus far, in the fourth quarter, we've closed the following transactions. As previously mentioned, we closed a $36.5 million, 7.5% 5-year unsecured note that was priced at 98.9% of par, net proceeds from that offering were used to purchase pooled mezzanine loans originated by Freddie Mac for $99 million. In conjunction with that purchase, Freddie Mac extended a credit facility at 60% loan-to-value for approximately $60 million. The portfolio is priced to achieve a target internal rate of return of 17.3%.

Let me move to the results for the third quarter and year-to-date. Net income attributable to common shareholders for the third quarter was $2 million -- $2.9 million or $0.52 per diluted share. Year-to-date 2020, net income attributable to common shareholders is $1.8 million or $0.33 per diluted share. Core earnings for the third quarter was $2.3 million or $0.42 per diluted share and year-to-date is $5.4 million or $1 per diluted share.

We have increased our book value from $18.33 a share to $18.48 per share. For the third quarter and year-to-date, we recorded a loan loss provision of a $14,000 gain in the third quarter and a $279,000 reserve for the year. As of October 28, we've repurchased 237,000 shares, approximately, at an average price of $14.72 per share, representing a discount to the current book value of $18.48 of 20%. We paid a dividend of $0.40 per share in the third quarter.

And Monday, the Board declared a dividend of $0.40 per share payable on December 31 to shareholders of record as of December 15. We are issuing core earnings guidance for the fourth quarter of 2020 as follows: on the high end, $0.53 per diluted share; on the low end, $0.49 per diluted share; for a midpoint of $0.51 per diluted share.

So with that, let me turn the call over to Matt Goetz and Paul Richards to discuss details of the portfolio and our acquisition pipeline.

Thanks, Brian. Our third quarter results continued to strengthen our thesis on what we believe are the most resilient commercial real estate property types throughout all market cycles. The single-family rental and storage sectors have been 2 of the best-performing sectors in the equity markets and in terms of rental collections at the property level throughout the COVID-19 pandemic.

Multifamily, specifically workforce housing, located in the Southeast and Southwest of United States has also seen relative strength in collections in same-store NOI growth compared to their Class A peers who typically focus on gateway markets such as New York, Miami, Los Angeles and San Francisco.

All of which who appear to be more negatively impacted by COVID. 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 the outcome of the coming election, the future path of COVID-19 and the effects both might have on the commercial real estate sector, we believe our defensive strategy, namely credit investments and stabilized residential and storage assets conservative underwriting at low leverage with well-healed sponsors should provide consistent and stable value to our shareholders.

That said, we'd like to spend a few minutes discussing the current portfolio's performance and the opportunities we were able to take advantage off in the third quarter and immediately thereafter. The current investment portfolio is comprised of 62 individual investments with approximately $1.5 billion of total outstanding principal. The portfolio is 97% residential with 58% invested in senior loans and collateralized by single-family rental and 38% invested in multifamily via Agency CMBS, preferred equity and mezzanine debt. The portfolio's average remaining term is 8 years, which we believe is atypical in the commercial mortgage REIT space. The portfolio is 99% stabilized as a weighted average loan-to-value of 68.2% and a weighted average debt service coverage ratio of 1.9x.

The portfolio is geographically diverse with the bias towards the Southeast and Southwest markets, and 100% of our investments are current. As mentioned in our earnings, none of the underlying loans are currently in forbearance versus 1 multifamily property and 9 single-family rental loans at forbearance, representing 2% of our total consolidated investment portfolio on August 5.

For reference, as of the forbearance report published by Freddie Mac on September 25, roughly $7.5 billion or 2.4% of the total Freddie Mac securitized unpaid principal balances entered into forbearance, both metrics improving slightly since the second quarter.

One of our mezzanine investments, Palmetto Creek located in Charleston, South Carolina redeemed August 7 of this year. The $3.25 million investment was outstanding for 30 months and achieved an IRR and return on capital of 14% and 1.35x, respectively. As a reminder, we have 0 construction loans, no heavy transitional loans, no land loans and no for sale loans.

Moving to the opportunities, we were able to take advantage of during and immediately after the third quarter. As Brian mentioned, we have been able to deploy proceeds from our Series A preferred and unsecured notes offering into accretive investments for all of our stakeholders. On July 30, we purchased the Freddie Mac K-Series B-Piece with a par value of $67 million and a floating rate yield of 1-month LIBOR plus 900 basis points. The securitization has a weighted loan-to-value of 65.2%, 6.7 years of remaining term and 2.3x debt service coverage ratio.

On August 6, we purchased a fixed rate Freddie Mac K-Series B-Piece in associated interest-only bonds for a total purchase price of $72 million. The B-Piece or Tranche D has a par value of $109 million and a bond equivalent yield of 11.4%. The securitized pool is made up of 62 loans with a total price value of approximately $2.1 billion. The total unpaid principal balance is approximately $1.5 billion, representing an average loan-to-value of 69%. The investment has 9.7 years of remaining term and a debt service coverage ratio of 2.2x.

As mentioned, we also purchased 3 separate interest-only funds for a total purchase price of $36 million with these interest-only pieces, the total investment has an estimated current yield of 6.6%.

On October 20, we purchased a portfolio of 18 individual mezzanine loans collateralized by stabilized multifamily properties for $99 million plus accrued interest of $300,000. We received approximately 60% seller financing and have underwritten the portfolio to provide an estimated levered IRR of 17.3%.

The portfolio consists of 18 individual properties comprised of 6,640 multifamily units with a weighted average occupancy of 94% and a total appraised value of $1 billion. The last dollar of mezz equates to 83.4% of the total capital stack, the weighted average interest rate of the underlying mezzanine notes is 7.5%. The debt service coverage ratio through our last dollar of mezz is 1.4x, the implied cap rate on our life dollar of mezz is 6.4%.

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 in the single-family rental portfolio.

Thanks, Matt. During the third quarter, the company was not as active in the secondary market as we were in the second quarter of this year, due to the fact that we were able to deploy capital and purchase attractively priced new issue, Freddie Mac B-Pieces and IO strips, as Brian and Matt has previously mentioned.

We saw agency bond pricing squeeze even more as our 2 2019 floating rate B-Pieces made up significant ground during the quarter. Management expects this trend to continue and is excited on our thesis of the agency's possibly tightening new issue B-Piece pricing in the near future on both floating rate and fixed rate bonds as the world continues to normalize moving into 2021.

The appreciation -- I'm sorry, the application of our thesis would imply healthy embedded mark-to-market gains in our recent B-Piece purchases as original spreads on these specific purchases are approximately 300 basis points wider than pre-COVID new issue pricing. Expanding further upon Brian's initial comments regarding our repo financing the company entered into additional attractive repo financing, while maintaining a conservative LTV on the CMBS portfolio. We are prudently levered at 49.7% loan-to-value, implying it would take an approximate downward market value movement of $75 million on our current $320 million CMBS portfolio before LTV increased to 65%. To take it a step further, this implies a 23% decline in market value and spreads widening over 400 basis points on our repo book, which is price using pre-COVID bond valuations.

Lastly, we want to briefly touch on the recent news of Front Yard Residential, entering into a definitive merger agreement with Ares and Pretium how that could possibly affect the company's large loan in the SFR loan pool. Management does not believe this to be a negative to them at all, but rather a credit positive for the company, given the buyer's extensive experience and large footprint in the real estate sector. We do not believe the loan will be repaid given the approximate $160 million of defeasance or roughly 30% of the loan's unpaid principal balance associated with the underlying terms of the debt. To finalize our prepared remarks before we turn it over for questions, I'd like to turn it over to Matt McGraner.

Thanks, Paul. I don't have much other than to say the team has continued to execute and do a great job sourcing attractive credit investments in our core affordable residential and self-storage property types. We're pleased and excited to be speaking to you today about generating attractive risk-adjusted yields instead of expected credit losses or reserves or exposure to large single assets and gateway markets. We're also excited about welcoming the Jernigan Capital team to the NexPoint family here in Q4 and expect their network and expertise to generate attractive credit investments that won -- in risk benefit.

To that end, our various verticals here at NexPoint continue to inform and frankly validate our investment thesis, the credit investments in affordable housing and self-storage will continue to outperform and remain resilient throughout all credit cycles, including, especially during these difficult times. That's all we have for prepared remarks. And now I'd like to turn the call over to the operator for questions.

(Operator Instructions)

Our first question will come from Stephen Laws with Raymond James.

First off, congrats on a nice quarter and impressive guide. Looks like the new investments certainly accretive to existing returns. And along those lines, can you talk about, clearly, you did the roughly $100 million of mezz investing with the seller financing in place there. Can you talk about what's your remaining investment pipeline looks like? And kind of what you target from a leverage standpoint as you look at new investments from today forward?

Steven, it's Matt McGraner. Yes. So we think we're going to get kind of 2 or 3 B-Pieces in the coming year, 2021 from Freddie Mac. And so that's going to be a source of investment opportunities and expect a little bit of tightening there, but still very attractive. And especially if we can match with the term loan or a Series A -- something like a perpetual that we did earlier. So that's -- I think that's going to be the primary focus.

And I'll defer to Mitts on financing, but I think we're going to continue to stay at the same ratio or try to stay at the same leverage ratio.

Yes. I think that's right. And obviously, what we're trying to do here is get our stock price in line with our book value and look to issue equity at some point down the road. But I think in the interim, we found some ways to raise capital and obviously deploy it accretively. So we -- as part of our our capital we've been raising, there's a number of covenants that we have to be aware of, nowhere near them now. So we saw plenty of room. We would largely, I think, keep our leverage at current level and where we telegraph during the IPO roadshow and since then.

Great. And when I think about the guidance, I know the duration and stability of your portfolio is unique among the sector and really gives you better visibility than a lot of peers. Are there onetime items involved in this kind of $0.51 midpoint for Q4? And even with that said, is there a room, just from the current portfolio, given -- is that going to be higher, say in, Q1 because we didn't have the new mezz investments in the quarter for the first 20 days of Q4.

Yes. So there are no onetime items in that $0.51, Stephen. The -- as far as the investment, we closed the mezz investment pretty early in the quarter. So there will be a little bit of additional pickup in the first quarter, but not a ton. We are looking at some other things to do. The single-family rental space is pretty hot as is the financing side of that. So we're looking at things to do there. But yes, aside from that, I think the $0.51 without issuing any kind of formal 2021 guidance is a pretty solid number.

Great. And lastly, and I'll hop back in the queue to give others a chance. But when we think about the dividend based on that guidance, clearly, when we start to look at next year, you're -- at the current dividend level below the distribution requirements, how do you think about increasing the dividend in Q1 versus maybe underpaying the dividend short-term in order to buy back stock? I know you're somewhat limited given the liquidity, and you have been able to buy back roughly 0.25 million shares. But how do you think about what the best way to return shareholders -- return capital to shareholders between an increased dividend versus stock repurchase?

Yes. I think starting on the dividend policy. When we first kind of talked to the Board about this. And then as we were on the road for the IPO and kind of sense in our different public disclosures, the idea was to do what we've done. Obviously, it's a little bit different through code than what we originally planned. But ultimately to invest capital and lever the balance sheet. And then in 2021, look at the dividend and start to readjust to where we are.

I think we're kind of looking at, because of the REIT status, 95% of our core earnings is a payout we do have some pick in the portfolio, just be aware of that. But I think we're in good shape, and we're going to talk to the Board in the next quarter about 2021, go forward, but I think we're in good shape to, obviously, look at that and potentially increase just given where core earnings has gone, where we're currently paying out of $0.40.

So yes, I think that's the idea on the dividend. Sorry, was there another part of the question I didn't answer?

The stock repurchase and somewhat limited with liquidity, but thoughts around that.

Yes. So the stock repurchase, obviously, we've done this before in other formats. But if we could buy our stock at a 20% discount, we think that's a great investment. The problem is just the liquidity in the stock itself and the limits that we have to adhere to keep just from buying more, but that's fine. I think we're adding a lot of value of buying at 20 and it's not a ton of capital. So I don't think we're really pushing up against any of our liquidity constraints for covenants.

Our next question comes from Amanda Sweitzer with Baird.

Following up on your capacity, and apologies if I missed this in your prepared remarks, but do you have an update on kind of the most likely outcome for that JCAP preferred investment? And then if it is redeemed, what are the most likely use of that proceeds? Do you think you'd earmark it for additional self-storage investment? Or is that something that you put into the B-Piece investments that you're talking about?

Yes, Amanda. It's Matt McGraner. So the most likely outcome in our view is that, that will be taken out probably at some point in 2021. There's a tremendous amount of capital seeking self-storage investments, evidence, most recently, I think, a few days ago by CubeSmart's 3.5, 4 cap purchase of Storage Deluxe and then the Blackstone acquisition from Brookfield of that platform.

So you're seeing a lot of capital in the space, and I think we'll be -- we'll have a thoughtful approach to monetizing this investment that's accretive for our shareholders. And in return, I mentioned that we're adding the team here in Q4. They have a wealth of knowledge and a great network to generate opportunities. And I think you could see us utilize that network in the first half of next year, generating senior loans that we could then package and syndicate and hold the B-Piece. And so I think that $40-plus million would stay in self-storage, ideally, in the -- have our own kind of B-Piece in the storage sector.

Yes. Amanda, it's Brian. Just to note one thing. The guidance that we issued of $0.51 at the midpoint assumes that the JCAP investments converted from the current preferred, it's a common, and so we've stripped out any earnings from that. So to the extent that we can sell that and then redeploy that capital, that will be accretive to that $0.51.

Okay. That's helpful. And certainly, it seems like an interesting opportunity. And then on the mezz portfolio purchase. How did you guys just get comfortable with some of the geographic exposure of those assets is obviously outside of your traditional sunbelt targets?

And then going forward, do you think you'll expand the geographies that you're willing to invest on the mezz and preferred side? Or is this kind of a one-off opportunity that you saw?

So taking -- actually, I'll answer those in reverse order. I think we will continue to find mezz opportunities. This was just an opportunity to purchase a portfolio of mezz loans. These are actually all originated by Freddie Mac. It was part of a program where they would give borrowers additional financing if they signed an agreement to not raise rent on a portion of the property above CPI or a number of the units above CPI for a certain amount of years, just to kind of further their mandate on affordable housing.

So then to answer your first question on how do we get comfortable. So yes, we looked at the markets that we typically aren't in and got pretty comfortable just because of the high debt service coverage ratios even through COVID.

So currently, Delaware coverage ratio is 1.4x. Florida is 1.24x. We have a large geographical presence there with both NXRT and in the SFR portfolio.

Georgia is 1.3x, Iowa, which our property management company, BH Management is actually phased in Des Moines and they owned properties surrounding the property that we just invested in. It's 1.3x. Illinois, 1.3x, Maryland, 1.5x, New Jersey, 1.4x. The 2 lowest are Nevada and Pennsylvania. Nevada dipped down on 6.30 of this year to 1.2x than Pennsylvania, 1.16x. Pennsylvania, I believe, this is the smallest loan and Nevada obviously has its issues coming out of COVID and reopening, but we have a large geographical presence there with NXRT and see that market rebounding. So we got pretty comfortable looking at our portfolio -- our equity portfolio when underwriting that one. And then Texas is obviously extremely strong at over 1.6x coverage and then Washington, which is just outside of Seattle was 1.5x.

I'd add to that, the Maryland exposures, a well-healed sponsor, repeat, Freddie buyer, and then just being able to match the financing through Freddie Mac and then providing seller financing that sort of unicorn paper again, is all those things together, coupled with what Matt Goetz just said, I think, made it worth the investment.

Our next question comes from Jade Rahmani with KBW.

Philosophically, how do you think about putting leverage on these subordinate positions in the mortgage REIT space, commercial mortgage REITs, in particular, we don't often see companies putting leverage on mezzanine or B-Piece position. So maybe you could give some insight into that.

Yes, Jade, it's Matt McGraner. I think the reason you probably don't see it as often is because they're not generating investments in stabilized multifamily rather they're doing transitional loans on redevelopment properties that just can't -- there is no cash flow. Here, the duration of the cash flows with the investment property types are so durable that you can run a little harder.

And I think the nature of the program, the credit quality and the liquidity of the -- particularly the B-Pieces, and I think we're comfortable with that leverage. Not to mention our long experience in credit investing. So -- but primarily, the durability of the stabilized cash flows in multifamily properties that have been 93%, 94%, 95% occupied for decades.

With the recent improvement in the securitization market and some securitizations in the single-family rental market at very attractive levels. Do you still believe that the Front Yard loan is unlikely to repay?

Jade, it's Paul. Yes, we did the calculation and as discussed in the remarks, it was roughly $160 million for the defeasance penalty. And even looking at a sub-2% type refinancing of that loan, even the interest savings would take roughly 11 years plus to recoup the defeasance penalty. So we're pretty comfortable with the fact that we don't believe that the loan would be repaid.

And NREF's portion of that $160 million of defeasance would be something in the, I believe, $55 million range, is that correct?

Yes, that's approximately right. We would receive a portion of that $160 million. The exact number off top of my head, I can't remember.

It'd be a massive as book value gain, Jade. I got to think, is the point -- to your point.

Would the JCAP refinance be a book value gain?

Yes. I think the -- yes, there's -- the takeout of the conversion on the preferred is at 105. So there'll be a slight book value gain there.

Okay. And what do you...

So 5 points of...

What do you -- right, 5 points. Okay. Yes. I mean, I think it's good that you've created optionality in these investments to generate gains above book value, which would be accretive for shareholders.

Lastly, just what is the current capital availability in terms of new investment capacity?

Well, our repo line is under 50% right now. I think we can go up to 65%. We'd like to keep it lower than that and as values recover, that increases our potential. And then the note offering we just did, we can reopen that at any time. Same sort of goes for the preferred that we did in July. So we have a certain amount of capacity that we can tap on that. Obviously, it's dependent on the markets. But in both the unsecured note and the preferred equity, we're able to pull in some institutions that weren't previously invested, and I think there's some good opportunities to expand on those.

And then -- as we mentioned earlier, we have cash on the balance sheet right now that we can tap approximately $15 million. So I think we have a lot of avenues to get there even with the stock trading below book value.

At this time, I am showing no questions in the queue. I'll now turn the call back over for closing remarks.

Yes. I think that does it for us. Appreciate everyone's participation, and look forward to speaking next quarter.

Thank you, ladies and gentlemen. This concludes today's teleconference. You may now disconnect.