NexPoint Real Estate Finance, Inc.
Q2 2021 Earnings Call Transcript

Published: 31 Jul 2021

[Operator:]

Good day, and welcome to the NexPoint Real Estate Finance Second Quarter Conference Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Jackie Graham, Director of Investor Relations and Capital Markets. Please go ahead.

[Jackie Graham:]

Thank you. Good day, everyone, and welcome to NexPoint Real Estate Finance’s conference call to review the company’s results for the second quarter ended June 30. 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, Investments and Asset Management; and Paul Richards, Vice President, Originations and Investments.

[Brian Mitts:]

Thank you, Jackie, and thank you to everyone joining us today. On the call, we’re going to cover the second quarter of 2021 as well as discuss our portfolios and the acquisitions we’ve made this quarter and year-to-date and talk about our…

[Jackie Graham:]

Brian, you are cutting off a little bit.

[Brian Mitts:]

Hi, guys. Sorry about that.

[Matt McGraner:]

Okay. No problem, go ahead, Brian.

[Brian Mitts:]

Technology issues. So we purchased approximately 90% of the fixed rate Freddie Mac K Series principal-only B-Piece. We purchased five CMBS IO Strips. We sold three CMBS IO Strips. We had one preferred investment that paid off and one of the single rental loans that paid off. For the investments we sold, we redeployed those net proceeds from the sales and payoffs to acquire the new CMBS IO Scripts and the Freddie Mac B-Piece. For the results, net income for the quarter was $0.58 per diluted share compared to net income of $1 per diluted share for Q2 2020. Core earnings for the quarter were $0.59 per diluted share compared to $0.37 per diluted share in Q2 2020 and $0.53 per diluted share in Q1 of 2021. Book value per share increased 0.2% quarter-over-quarter to $20.38, year-over-year core earnings has increased 59%, cash available for distribution has increased 41% and book value per share of common stock has increased 19.3% on a per diluted share basis. We recognized the mark-to-market gain of $2.5 million in the second quarter on the company’s investment in NexPoint Storage Partners, which is formerly JCAP and $3.2 million on the company CMBS and IO Strip portfolio. Just to note, mark-to-market gains are a component of net income and earnings per share, but are excluded from our reported core earnings. We ended the quarter with 64 investments, totalling approximately $1.6 billion. As of June 30, our capital stack consisted of the following

[Matt Goetz:]

Thanks, Brian. The portfolio continued to perform strongly in the second quarter, and we were able to capitalize on a few opportunities. The current investment portfolio, as Brian said, is comprised of 64 individual investments with approximately $1.58 billion of total outstanding principal. The portfolio is still 100% residential with 57% invested in senior loans and 43% invested in multifamily via Agency CMBS, preferred equity and mezzanine debt. The portfolio’s average remaining term is 7.3 years, is 92% stabilized as weighted average loan-to-value of 66.9% and average debt service coverage ratio of 2.07x. The portfolio is geographically diverse with bias towards Southeast and Southwest markets, and 100% of our investments are current. As mentioned in our earnings, none of our underlying loans are currently in forbearance. No change from the first quarter of 2021. References as of the forbearance before published by Freddie Mac on June 25, roughly $5.4 billion or 1.5% of the total Freddie Mac securitized unpaid principal balances entered forbearance both metrics improving dramatically since the first quarter. We realized a 15.25% IRR and 2.12x multiple on invested capital on the redemption of the $3.8 million preferred equity investment. And we had one $15.3 million single-family rental loan that was repaid in full.

[Paul Richards:]

Thanks, Matt. During the second quarter, the company was highly active in the secondary bond market as well as new issue Agency CMBS. As previously discussed, we deployed approximately $76 million on a new issue floating rate Freddie Mac B-Piece and $89 million on a combined basis for Freddie Mac IO Strips and a seasoned Freddie Mac B-Piece in Q2. New issue agency bond pricing was relatively muted when compared to the previous quarter, with bonds pricing close to pre COVID levels. Our CMBS portfolio has greatly benefited as a direct result of the yield compression experienced since the mid-2020 and yet saw a meaningful increase in value this past quarter. We continue to be prudently levered on our repo at roughly 45% LTV at quarter end, which includes an additional $43.7 million of repo financing to close the season B-Piece, as previously discussed. We were also able to negotiate and achieve a lower cost of financing on our repo financing to the tune of approximately 50 basis points on a weighted average basis when compared to the previous quarter’s all-in rate. Lastly, we want to briefly touch on the continued performance of the SFR loan pool. All loans are current and performing as the demand and enormous tailwinds for single-family rental in general continues to accelerate. We fully expect this trend to persist as tenant retention and occupancies are at all-time highs.

[Matt McGraner:]

Thank you, Paul. You heard from Matt and Paul our multifamily and SFR verticals and their underlying fundamentals are performing extremely well. Revenue and NOI growth are reaching double digits and have further accelerated into July. Our storage platform is no exception. In Q2, the NSP partners saw strong performance as well. As a reminder, most of the NSP portfolio remains in the lease-up phase. But given the strong tailwinds in the sector, we believe the portfolio is well ahead of our pro forma expectations when we acquired Jernigan Capital back in Q4 of 2020. Across the entire portfolio, our properties gained nearly 700 basis points in occupancy in Q2 over Q1 and saw same-store NOI growth more than double as it was up 101% versus Q1. For the quarter, we outperformed our 2021 budget by 15%, bolstered by 14.8% growth in in-place rents quarter-over-quarter. We continue to evaluate options to monetize this investment but also believe that once stabilized, the NSP position could be worth another $3.50 to $5 per NREF share. That’s all I have for prepared remarks. Thanks to the team for continuing to execute. And now I’d like to turn the call over to the operator for questions.

[Operator:]

Thank you. We’ll take our first question from Stephen Laws of Raymond James.

[Stephen Laws:]

Good morning. I appreciate the comments in the prepared remarks. Can you guys touch on the new investment pipeline and then how you think about the investment opportunities relative to prepayments? What kind of visibility do you have in prepayments coming in? Kind of like to get some thoughts on how you’re able to match those up.

[Matt McGraner:]

Stephen, its McGraner. I think the two that we saw in this quarter were largely made up the bulk of the investments that can be prepaid that we’re unaware of. The rest of it are the B-Piece that either amortize off as the floating rate loans are working their way through the securitization and then the single-family pool that’s fixed and has a large fees. So we don’t expect a material amount going forward of repayments. Certainly, we’re not on the same treadmills as most of our peers to get capital back every two or three years. So our expectation is that this is, again, sort of the bulk of it and going forward, we’ll be looking to invest probably mostly in the B-Piece space.

[Stephen Laws:]

[Matt Goetz:]

Yes, the B-Piece – it’s Goetz. The B-Piece is going at about $0.10 per share to core. But because it’s a fixed rate and zero coupon, it doesn’t add anything to CAD. So that’s why there’s a difference between – large difference between core and CAD and our guidance for next quarter.

[Matt McGraner:]

On the Mezz side, there’s – it’s McGraner here. On the Mezz side, there are opportunities that we’re currently underwriting between the private preferred multifamily, where kind of where we made our name layering capital behind Freddie and Fannie. Given where cap rates are, 3.5% to 4.25% and debt so cheap right now, it’s the high kind of current coupon, opportunities are gone. But you can still find opportunities that can get you a double-digit return, but most of that is going to be an uptick to the sponsor. So you might do a 4% or 5% current and another 4% or 5% accruing. We are underwriting, I’d say, kind of $25 million-ish of that right now. And so we could do that. But it’s, I think, less attractive than like a floating rate B-Piece or a K deal that we could execute on in the third or the fourth quarter.

[Stephen Laws:]

I appreciate the comparison there. Last question for me, as you have a preferred from a year or two ago, you’ve got a year ago, you’ve got the unsecured notes now. Obviously, you’ve been able to use the ATM for about $8 million so far. As you think about your need for capital and outlook for growth and how you’d like to see the mix of your capital stack come together, what are your thoughts around that?

[Matt McGraner:]

I think to the extent we can issue equity above book value, we’ll do that first. To the extent we’re kind of at or at parity with book value, then we like the preferred market probably incrementally more than the secured note market or unsecured note market. I think that our cost of – I don’t think I know our cost of capital and the preferred perpetual markets come down. So we’ll continue to, I guess, evaluate that in order to fund the Q3 and Q4 investments that we have visibility into, which is probably in the neighborhood of $75 million to $100 million.

[Stephen Laws:]

Thanks for the color there. So it’s good to you have all those options to disposal. Thanks for the time today.

[Matt McGraner:]

Thanks, Stephen.

[Operator:]

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

[Jade Rahmani:]

Thanks very much. Core EPS came in at $0.59, and I believe the prior guidance midpoint for the second quarter was $0.64. Was the main difference between your guidance and core earnings due to timing of capital deployment? Or were there any other factors that you would note?

[Matt McGraner:]

Yes, it’s timing. The – it’s basically $0.04 for the repayments and then another kind of $0.02 for ATM issuances. And then we did redeploy that capital back into some accretive investments that, Paul, if you want to elaborate on, we can.

[Paul Richards:]

Hey, Jade. I guess, discussed recently was we redeployed capital into some Freddie BX ones as well as some just normal KDX ones. And then the big purchase was the roughly $67 million on B Piece that we purchased at the last day of the quarter.

[Jade Rahmani:]

Okay. So in your prior guidance, you contemplated that purchase taking place earlier?

[Matt McGraner:]

No, I think it’s more of the fact that we got 30 day notices on the repayments from the preferreds and that we didn’t necessarily anticipate.

[Jade Rahmani:]

Okay. Okay. And you’re not expecting something similar in the third quarter?

[Matt McGraner:]

No.

[Jade Rahmani:]

And what was the aggregate dollar amount of 2Q investments?

[Brian Mitts:]

Yes, it was about $170 million.

[Jade Rahmani:]

Okay. In terms of the yield compression, are you seeing it broadly across that space? And does that change what you think the business’ ultimate levered ROEs are going to be?

[Matt McGraner:]

I think – it’s McGraner. The yields are, for sure, compressing. I don’t think that they’re going to get necessarily that much tighter in the B-Piece market. And I think that, that’s – or in the K Deal market. And that’s largely where we’re focused in terms of generating at least in the near term new investments. We think that in sort of niche areas, self-storage and life sciences, we can get some outsized returns to bolster the ROEs and still maintain what we said when we went public. And so that’s – that would be the goal. And then just as a reminder, we don’t have to do anything new. The current book has over seven years of duration, and the earnings visibility and transparency of these earnings that bolster our ability to pay an outsized dividend with a superior credit profile are in place from here to the next four or five years.

[Matt Goetz:]

And just to add one thing to Matt’s comment to our financing has gone down dramatically as well, as mentioned before, repo financing has decreased roughly 50 basis points over the past quarter. And as Matt mentioned, we think we could get a better cost of capital on the preferred side as well as the unsecured note side.

[Jade Rahmani:]

Okay. Is the expectation for the dividend to be maintained? Or is there room for a potential increase?

[Matt McGraner:]

Yes. I mean we’re having healthy coverage, and we have to pay out almost all of it. So there’s certainly room for increase.

[Jade Rahmani:]

Okay. Can you remind us what the basis in NSP is?

[Matt McGraner:]

$44 million.

[Jade Rahmani:]

Okay. What is the timing of any potential realization events?

[Matt McGraner:]

Yes, two questions. So like we’ve looked at and constantly are looking at the cap stack of the company itself. And like we’ve been talking about financing rates come in, we can rightsize that company’s balance sheet, and we’ll do that probably in the fourth quarter of 2021. The portfolio we thought would be stabilized kind of 2024, it’s probably 2023 now. And we can certainly monetize the investment now, but we’re also excited about storage – in our storage fundamentals, believe that the NSP portfolio represents probably best-in-class urban infill, high-density storage in some of the best submarkets in the country. And we want to be cognizant of the ability to add that $3.50 to $5 per share for NREF share accretion to book value that I think is a differentiator amongst our peers. So we’re kind of weighing all of those considerations, but I think it’s a good problem to have at this point.

[Jade Rahmani:]

Okay. And so if the capital structure was rationalized, streamlined, the preferred would be paid off, and it would be – you said that there’ll be a gain of $3 to $5 a share potentially?

[Matt McGraner:]

No. If you recall, the current position is – was preferred that was contributor – that was converted into common. So the $44 million is a common special situations investment and a preferred that was converted into a common investment of the company. So we could go sell that common to a third party right now. We could sell it to our funds or we can wait for it to stabilize and then re-IPO or sell it at that point. The $3.50 to $5 per share is a stabilized range based upon a pro forma – a discounted pro forma cap rate range that’s conservative. And I think that we can – if we wanted to sell it today, we could probably get a couple of bucks per NREF share for sure. But I do think that that’s not going anywhere in the foreseeable future.

[Jade Rahmani:]

Got it. So if the company was recapitalized, the capital structure streamlined, that wouldn’t necessarily mean that you guys are selling down the position or anything?

[Matt McGraner:]

That’s right. I mean we could convert it if we wanted to, for example, into a preferred, but that would be a yield closer to 6% or 7%. Whereas if we took the capital weighted 1.5 years and then monetize it then, and then that $44 million turns into $90 million, we relever that. And then we’re reducing the book value and the ability to reinvest and drive earnings. So that’s an attractive option.

[Jade Rahmani:]

Okay. And lastly, on the single-family rental side, could you give an update on Progress Residential, former Front Yard, given where rates are today, rates are today, is there the potential for that loan to be prepaid increase?

[Matt McGraner:]

Jade, no, it still has so much term left on the actual loan that the yield maintenance bills well over $100 million, which, of course, would – it just doesn’t make sense for them to prepay or paying yield maintenance and refinance that loan. So it’s same story as last quarter.

[Jade Rahmani:]

Thanks for taking the questions.

[Operator:]

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

[Amanda Sweitzer:]

Thanks. Good morning, guys. Can you talk more about the potential timing for some of those mezzanine investments into either life science or self storage? Are there any near-term opportunities you expect to pursue? Or is this something where you’re thinking about timing it upon the recycling of that JCAP investment?

[Matt McGraner:]

Yes. I think the life – Amanda, it’s Matt McGraner. I think the life sciences investments will occur in the second half of the year for sure. We’re hopefully to get one or two done. We thought we might be able to get one done in the second quarter, and it’s been pushed into the – well, probably into the third quarter, at the end of the third quarter. But I will – I do think we’ll get some of those life sciences done this year. Self-storage is a little bit harder. We’re still working on some opportunities, aggregating enough size. We’re doing some one-off on like $10 million, $12 million underwritings on single assets that won’t really move the needle. But the life sciences, I think, will be a bigger splash in the second half of the year.

[Amanda Sweitzer:]

Okay. That’s helpful. And then are those investments on life science development projects? And how do you think about an exposure level that you’re willing to go to with life science and self storage?

[Matt McGraner:]

Yes. I mean, as you may know, we made a nine figure investment as a platform in one of Alan Gold’s companies, IQHQ, and have worked outside him for the last few years and have gotten familiarity with certain types of life science facilities that we’re comfortable investing in. I’d say the near-term opportunities are sale leasebacks of either some small cell manufacturing or other smaller kind of logistical type deals that are anywhere from $30 million to $50 million to $75 million a piece that we could do some Mezz or preferred on. And those are the types of opportunities that we’re looking at and think it’s a space that’s largely pretty interesting right now.

[Amanda Sweitzer:]

Yes, that is interesting. That’s all I had. Appreciate the time.

[Matt McGraner:]

Thanks, Amanda.

[Operator:]

Thank you. And at this time, we have no further questions in queue. I’ll turn it back to management for closing remarks.

[Matt McGraner:]

Yes. Thanks. It’s Matt McGraner. We appreciate everyone’s time and availability this morning and look forward to speaking to you during our third quarter conference call. Thanks again.

[Operator:]

This concludes today’s call. Thank you for your participation. You may now disconnect.