NexPoint Real Estate Finance, Inc. (NYSE:NREF) Q3 2020 Earnings Conference Call October 29, 2020 11:00 AM ET
Jackie Graham – Investor Relations
Brian Mitts – Executive Vice President and Chief Financial Officer
Matt McGraner – Executive Vice President and Chief Investment Officer
Matt Goetz – Senior Vice President-Investments & Asset Management
Paul Richards – Vice President-Originations & Investments
Conference Call Participants
Stephen Laws – Raymond James
Amanda Sweitzer – Baird
Jade Rahmani – KBW
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 & Asset Management; and Paul Richards, Vice President, Originations & 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 those 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 of 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 BP’s 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. The $60 million facility on the mezzanine pool, which we purchased subsequent to the third quarter, a $159 million of repurchase agreements, $36.5 million of unsecured notes that we play subsequent to the third quarter; $46 million of preferred equity, $86 million of common equity and $265 million of redeemable non-controlling interest.
Also as of October 28, only 15.3% of our financing is subject to mark-to-market. And 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 2.6 times 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 to work creatively by sourcing opportunities to investments. Thus far in the fourth quarter, we’ve closed the following transactions. As previously mentioned, we closed the $36.5 million, 7.5%, five-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 was 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 $2.9 million or $0.52 per diluted share. Year-to-date 2020 net income attributable to common shareholders $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. The third quarter and year-to-date, we recorded a loan loss provision of a $14,000 gain in third quarter and a $279,000 reserve for the year.
As of October 28, we had 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 at 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 mid-point $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 in our acquisition pipeline.
Thanks, Brian. Our third quarter results continue 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 two 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 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 have appeared 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 in 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 portfolios’ performance and opportunities we were able to take advantage of 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 eight years, which we believe is atypical in the commercial mortgage REIT space. The portfolio is 99% stabilized, has a weighted average loan-to-value of 68.2% and a weighted average debt service coverage ratio of 1.9 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, none of the underlying loans are currently in forbearance, versus one multifamily property and nine single family rental loans at forbearance, representing 2% of our total consolidated investment portfolio on August 5.
For reference, as with 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 balance has 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 in and it used an IRR. And return on capital of 14% and 1.35 times, respectively.
As a reminder, we have zero 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 an immediately active 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 the par value of $67 million in a floating rate yield of one month LIBOR plus 900 basis points.
The securitization has a weighted loan to value of 65.2%, 6.7 years of remaining term and 2.3 times debt service coverage ratio. On August 6, we purchased a fixed rate Freddie Mac K-Series B-Piece and associated interest only bonds for a total purchase price of $72 million to B-Piece of Tranche D has par value of $109 million and a bond equivalent yield of 11.4%. The securitized goal just 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 2.2 times. As mentioned, we also purchased three separate interest-only bonds for our total purchase price is $36 million with these interest-only pieces just 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 multi-family properties for $99 million plus accrued interest of $300,000. We received approximately 60% seller financing and underwritten the portfolio to provide an estimated levered IRR of 17.3%. The portfolio consists of 18 individual properties comprised of 6,640 multi-family units with a weighted average occupancy of 94% and the total of price value of $1 billion.
The last dollar of mez equates to 83.4% of the total capital stack. The weighted average interest rate of the underlying mezzanine loans is 7.5%. The debt service coverage ratio through our last dollar of mez is 1.4 times. The implied cap rate on our last dollar of mez is 6.4%.
In summary, we continue to find a 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 a new issue Freddie Mac B-Pieces and I/O Strips as Brian and Matt has previously mentioned. We saw agency bond pricing squeeze even more as our 2019 floating rate B-Pieces made up significant ground during the quarter.
Management expect this trend to continue and as excited on our thesis of the agency’s possibly tightening new issue B-Piece pricing in the near future on those 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 track of repo financing, while maintaining a conservative LTV on the CMBS portfolio. We are prudently levered at 49.7 loan 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 priced 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 and how that could possibly affect the company at large Sloan in the SFR loan pool.
Management does not believe that to be a negative, but then 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 loans 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 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 sites. We’re pleased and excited to be speaking to you today about generating attractive risk adjusted deals instead of expected credit losses or reserves or exposure to large single assets in 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 will nerve to the in risk benefit.
To that end, our various verticals here at NexPoint continue to inform and frankly validate our investment thesis to 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.
So we have for prepared remarks and I would like to turn the call over to the operator for questions.
Thank you, sir. [Operator Instructions] Our first question will come from Stephen Laws with Raymond James.
Hi, good morning. First off, congrats on a nice quarter and impressive guide looks like the new investment, certainly accretive to existing returns. And along those lines, can you talk about, clearly, you did the roughly $100 million of mez investing with 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.
Hey, Steve. This is Matt McGraner. Yes, so we think we’re going to get kind of two or three 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 a term loan or Series A preferred. So 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 the same leverage ratio.
Yes, I think that’s right. And obviously, 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 accretively. So we – as part of our capital we’ve been raising, there’s a number of covenants that we have to be aware of nowhere near now. So we saw plenty of room. We would largely I think keep our leverages current level and where we’d telegraph during the IPO roadshow and since then.
Great. And when I think about the guidance, I know the duration stability of your portfolio is unique among the sector and really gives you better visibility than a lot of peers. Are there one-time 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 mez investments in the quarter for the first 20 days Q4.
Yes. So there are no one-time items in that $0.51, Steven. As far as the investment, we close the mez investment pretty early in the quarter. So there will be a little bit of additional pick up in the first quarter, but not at time. We are looking at some other things to do the single-family rental space is pretty hard 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 and to give some 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 is 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’re 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 reach status 95% of our core earnings is a payout. We do have some taken the portfolio is 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 work order and just gone and where we’re currently paying out of $0.40. So, yeah, I think that’s the idea on the dividend. Sorry, was there another part of the question I didn’t..
Did stock repurchase and you’re somewhat limited with liquidity, but thoughts around that?
Yes. So, the sock repurchase, obviously, we’ve done this before in other formats. but if we could buy our stock at 20% discount, I think that’s a great investment. The problem is just the liquidity in the stock itself and the limits that we have to here to keep us from buying more, but that’s fine. I think we’re adding a lot of value of buying it 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.
Great. Well, again, congratulations on a great quarter and then attractive new investments and look forward to speaking with you soon.
Thank you. Our next question comes from Amanda Sweitzer with Baird.
Thanks. Good morning, guys. 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, where the most likely use of that proceeds, do you think you’d earmark it for additional self-storage investments or is that something that you’d put into the BP investments that you’re talking about?
Yes. thanks, Amanda. I’m Matt McGraner. So, the most likely outcome in our view is that’ll be taken out probably at some point in 2020, 2021. there’s a tremendous amount of capital seeking self-storage investments, evidence most recently, a few days ago [indiscernible] and then the Blackstone acquisition from Brookfield of that platform. So, you’re seeing a lot of capital in this 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 VPs. And so I think that $40 million plus would stay in self-storage ideally and we have our own kind of BPs in the storage sector.
Yeah. And Amanda, it’s Brian, just note one thing that the guidance that we issued a $0.51 of 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’ll be creative to that $0.51.
Okay. That’s helpful. Certainly, seems like an interesting opportunity. And then on the mez portfolio purchase, how did you guys just get comfortable with some of the geographic exposure of those assets? Would that be sleep outside of your traditional Sunbelt targets and then going forward, do you think you’ll expand the geography that you’re willing to invest on the mez 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 mez opportunities. This was just an opportunity to purchase a portfolio, mez 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 for 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 1.4 times. Florida is 1.24 times. We have a large geographical presence there with both in XRT and in SFR portfolio. Georgia is 1.3 times. Iowa, which our property management company, BH Management is actually based in Des Moines. And they own properties surrounding the property that we just invested in. It’s 1.3 times. Illinois 1.3 times. Maryland 1.5 times. New Jersey 1.4 times.
The two lowest are Nevada and Pennsylvania. Nevada dipped down on 630, of this year to 1.2 times. And Pennsylvania 1.16 times. Pennsylvania, I believe is the smallest loan and Nevada obviously has its issues coming out of COVID and reopening. But we have the largest geographical presence there within XRT 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 made over 1.6 times coverage and in Washington which is just outside of Seattle is 1.5 times.
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 them providing seller financing. That is sort of unicorn paper again, is all those things together coupled with what Matt has just said, I think made it worth investment.
Yes, that makes sense. Thanks for all that data. That’s it from me.
Thank you. Our next question comes from Jade Rahmani with KBW.
Yes. Thank you very much. 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 a BP 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 and stabilize 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, I think we’re comfortable with that leverage not to mention our long experience in credit investing stuff. But primarily durability of the stabilized cash flows and multifamily properties that have been in 93%, 94%, 95% occupied for decades.
Thank you. With the recent improvement in the securitization market and some securitizations in the single-family rental market had very attractive levels. Do you still believe that the front yard loan is unlikely to repay?
Hey, Jade; it’s Paul. Yes, we did the calculation at discussing the remarks, it was roughly $160 million of the defeasance penalty, and even looking at a sub 2% type refinancing of that loan even 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 perhaps portion of that $160 million of the defeasance would be something in the, I believe $55 million range. Is that correct?
Yes. That’s approximately correct. We would receive a portion of that $160 million, the exact number off the top of my head, I can’t remember. It’d be a massive book value gain, I got to think is the point – to your point.
Would the JCAP refinance be a book value gain?
Yes, I think the – there is – the takeout or the conversion on the prefer is at 105, so there’ll be a slight book value gain there. So five points…
Right. Five points, okay. Yes, I mean, I think it’s good that you’ve created an 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 would 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 depending 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 in. I think there is some good opportunities to expand on those. And then as we mentioned earlier, we have cash in the balance sheet right now that we can tap approximately $50 million. So I think we have a lot of avenues to get there, even with the stock trading below book value.
Thanks very much.
At this time. I am showing no questions in the queue and I’ll turn the call back over for closing remarks.
Yes, I think that does it for us. I 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.