Granite Point Mortgage Trust Inc. (GPMT) Q3 2019 Earnings Report, Transcript and Summary

Good morning. My name is Jacob, and I will be your conference facilitator. At this time, I would like to welcome everyone to Granite Point Mortgage Trust’s Third Quarter 2019 Financial Results Conference Call. All participants will be in a listen-only mode. After the speakers’ remarks, there will be a question-and-answer session.I would like to now turn the conference over to Chris Petta with Investor Relations for Granite Point.

Thank you and good morning everyone. Thank you for joining our call to discuss Granite Point's third quarter 2019 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 summary of our business activities and a brief recap of market conditions. Steve Alpart will discuss our third quarter originations, our portfolio and pipeline; and Marcin will highlight key items from our financials.The press release and financial tables associated with today's call as well as our Form 10-Q 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 of 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, Chris, and good morning everyone. We would like to welcome you all and thank you for joining our third quarter 2019 earnings call. Over the course of the year, we have been successfully executing on our investment strategy while meaningfully growing our business. Our strong third quarter loan originations of over $630 million, again, illustrate the capabilities of our direct origination platform and our highly experienced team. Through the first nine months of the year, we originated over $1.3 billion of new senior loans, an increase of about 47% over the same period last year.We expect our robust capital deployment to continue for the rest of the year as evidenced by our forward pipeline of over $650 million of loans. Although our pace of originations has increased, we've maintained our emphasis on credit underwriting and loan structuring while generating attractive risk adjusted returns. Assuming all the loans in our pipeline closed by year-end, we are on track to directly originate about $2 billion of new senior loan investments for the full year, which would be a record for our business and represents an increase of more than 25% over our originations volume in 2018. Our strong third quarter originations combined with the fundings of our existing loan commitments resulted in record quarterly capital deployment of over $530 million.That combined with manageable prepayments generated another quarter of strong net portfolio growth of over $365 million or about a 10% increase over the second quarter. The outstanding principal balance of our portfolio at quarter end was about $4 billion and $4.7 billion including our future funding commitments. We are pleased with the ongoing strength of the credit quality of our portfolio. We remain focused on deploying our capital into strong credit stories backed by high quality properties and sponsors with business plans meeting our underwriting criteria, which in aggregate produces a well secured and well diversified portfolio.During the third quarter, one of our loans that had been previously risk rated four was repaid at par. This approximately $18 million loan on a multifamily property in New York was refinanced with another lender reaffirming our earlier views on the credit quality of this asset. We continue to actively monitor the one other loan that we have risk rated four. Active credit monitoring of our investments is a key tenet of our overall asset management program and approach to risk mitigation.We believe that in general the fundamentals are the commercial real estate market along with the overall credit environment remains attractive. Even though the overall economic conditions have remained relatively stable with solid trends in the employment market, in a preemptive set of actions over the last few months, the Fed has cut short-term interest rates significantly, which had a negative impact on our financial performance in the third quarter. This along with some temporary shifts on our balance sheet, which Marcin will describe in more detail later contributed to a decline in our earnings quarter-over-quarter.On the outset, we have been incorporating LIBOR floors from the vast majority of our loans as a partial offset to declining short-term rates. However, a significant portion of our portfolio is in older vintage investments with much lower LIBOR floors, which resulted in a disproportionate impact on our portfolio yield as short-term rates declined. As of September 30, less than 10% of our portfolio had LIBOR floors that were in the money. However, our originations for the first nine months of the year have a weighted average LIBOR floor of approximately 2.02%.As our portfolio seasons and the older vintage loans, those with lower LIBOR floors continue to pay off. The sensitivity of our portfolio to further declines in short-term rates is expected to improve. We have made substantial progress executing on our strategic goals and growing our company while taking advantage of attractive investment opportunities available in the commercial real estate debt markets. We remain confident that our strategy will generate an attractive risk adjusted returns for our shareholders as we continue to grow and stabilize our business.Now, I will turn the call over to Steve Alpart to discuss our investment activity in more detail.

Thank you, Jack, and thank you all for joining our call this morning. We continued our strong originations momentum in the third quarter and close 15 new loans with total commitments of over $636 million, taking advantage of the plentiful attractive lending opportunities in our market. Our aggregate loan fundings of $535 million were the highest we've had since the inception of our business and consisted of about $475 million of initial fundings of new loans, about $58 million of future fundings from preexisting loan commitments and $2 million from the upsizing of two loans.The newly originated loans are secured by high quality properties, mainly in the office and multifamily sectors with a well balanced geographical exposure. Our third quarter originations have attractive credit profiles with experienced sponsors, a weighted average stabilized LTV of 66% and a weighted average yield of LIBOR plus 3.65%. During the third quarter, we realized about $167 million of prepayments and principle amortization. However, we expect a volume of prepayments to exceed $300 million in the fourth quarter, driven primarily by the further seasoning of our portfolio as more of our sponsors have now had the time to successfully implement their business plans, leading them to either sell or refinance their properties.Since the end of the third quarter, we have already realized over $135 million of loan prepayments. Driven by record loan fundings and relatively consistent prepayments, the principle balance of our investment portfolio grew to about $4 billion this quarter with a fully committed balance of about $4.7 billion. Our portfolio continues to exhibit strong credit characteristics and is well diversified across property types, markets and sponsors. The weighted average stabilized LTV across our portfolio is under 64% and the weighted average yield at origination is LIBOR plus 4.40% with senior loans accounting for over 98% of our investments. Consistent with our strong focus on deep credit underwriting and our investment philosophy emphasizing diversification, our portfolio remains well-insulated from exposure to binary risks and significant sponsor or tenant concentrations.Turning to our forward pipeline. To date, we have generated aggregate new loan commitments of over $650 million, which have over $500 million of initial fundings. So far, we have funded over $325 million of loans, which includes funding of about $30 million from our prior commitments. We expect most of the remaining loans to close at some point during the fourth quarter, though some may delay the next year subject to customary closing conditions. Similar to our third quarter originations, our pipeline is mainly concentrated in loans on multifamily and office properties located across a diverse array of markets and with strong credit characteristics.We currently estimate the loans in our forward pipeline to produce yields in the low to mid 3s over LIBOR. Considering the higher expected level of Q4 prepayments and assuming that most of our pipeline loans close by year end, we would anticipate a more modest portfolio growth in the fourth quarter compared to the third quarter subject to timing of loan closings.I will now turn the call over to Marcin for a more detailed review of our financial results.

Thank you, Steve, and good morning everyone. Thank you for joining our call. Our strong originations in the third quarter continued our robust capital deployment this year and resulted in a healthy 10% net portfolio growth. Our financial results, however, were affected by lower short term interest rates and movements on both sides of our balance sheet. Despite the strong portfolio growth, our interest income increased by only about 6%. It was impacted by the significant decline in one-month LIBOR during the third quarter as well as lower credit spreads on our newly originated loans relative to the spreads on the legacy loans that have repaid.Over the course of the quarter, we increased our borrowings to provide us with the additional liquidity to fund our significant volume of originations in the third quarter and heading into the fourth quarter, some of which were delayed causing negative carry on our excess cash. As a result, we recognized higher interest expense, which contributed to the decline in our net interest income of about a penny per share versus the second quarter. Additionally, the prepayments of our CLO finance loans created some additional drag on third quarter earnings as closings of new loans targeted for the deployment of those funds were also delayed. Since quarter end, we have largely reinvested the liquidity in our managed CLO.The decline in net interest income and lack of prepayment fees combined with slightly higher servicing expenses driven by portfolio growth largely accounted for the decrease in our core earnings from $19.4 million or $0.36 per share in the second quarter to $18.5 million or $0.34 per share in the third quarter. The recognition of additional shares outstanding issued through our ATM in the second quarter accounted for less than a penny of impact to our EPS results in the third quarter. Our book value at September 30 was $18.65 per common share.Turning to our financing and leverage, the outstanding balance on our credit facilities increased to over $1.8 billion, driven by the growth of our portfolio and drawing down available borrowings to fund new loan originations. Additionally, at quarter end, we carried a much higher restricted cash balance as a result of the prepayments of loans financed through the CLOs that I referred to earlier. Our total borrowing capacity, inclusive of our options to upsize some of our facilities, was $2.5 billion unchanged from the second quarter.During the third quarter, we partially exercised our option to upsize the JPMorgan facility from $350 million to $425 million. We can further grow the borrowing capacity on this facility up to $500 million. Since quarter end, we have also partially exercised our option to upsize the Wells Fargo facility from $200 million to $275 million, which can be further increased to $350 million. We ended the third quarter with our recourse leverage at 1.8 times and including the non-recourse, non mark-to-market CLO debt, our total debt to equity ratio was three times. We would expect our total leverage to generally remain around this level in the near-term as we continue to deploy our remaining capital and reinvest the liquidity we expect to realize from loan repayments.Thank you again for joining us today and now I will ask the operator to open the call to questions.

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Jade Rahmani with KBW. Please go ahead.

Good morning. This is actually Ryan on for Jade. Thanks for taking the questions. Marcin, I appreciate the commentary in your prepared remarks around the interest expense and the interest income. I didn't quite catch the main drivers of the reason why interest expense spiked so much in the quarter. Can you just try to clarify for that that for us a bit further, please? Thanks.

Sure. Good morning. Thank you for joining us. So look, the overall theme for the third quarter was the excess liquidity we carried, which puts some pressure on net interest income and impacted our results. We were keeping extra liquidity on the balance sheet and we're also preserving the funds available for reinvestment in our managed CLO for the large number of loans that we’re closing, including some larger loans, the closings of which were unfortunately delayed, which resulted in the larger interest expense without the offsetting interest income as the loans close later. Most of that excess liquidity has been deployed. And if you think about it, given our smaller relative size, having $100 million to $150 million of extra liquidity for a couple months, which is financed obviously through the borrowings at, call it, 3.5% to 4%, that carries a little bit more significant impact to our results, and that's essentially what happened this quarter.

Marcin, this is Jade. Are you expecting earnings to reach the dividend level in the fourth quarter? And just broadly thinking about the dividend in the way it was established as a follow on to the Two Harbors transaction. Based on where returns are today and given the outlook for interest rates, do you expect to reach the dividend level next year in terms of core earnings? Or should the dividend be adjusted to reflect current perspective levered returns?

Good morning, Jade. Thank you for the question. So I'll take the Q4 first and I will address the dividends after that. I'd say, look, it's difficult to predict the exact number for the fourth quarter as obviously as you know there are many factors influencing our earnings such as the timing of loan closings and prepayments. We expect a higher level of prepays this quarter as Steve mentioned in his prepared remarks. So that will be a driver along with the trends in the short term rates. We still have some exposure to LIBOR, obviously, as we are largely a floating rate portfolio.Also Steve mentioned, we estimate the yields in our forward pipeline to be somewhere in the low to mid 300s over LIBOR. So that combined with the higher yields on the loans that are paying off will also have an impact. So taking all of those factors into consideration and the fact that, as I just mentioned, the movements in our balance sheet to support a high volume of loans can have also some temporary effect on our EPS, it's hard to pinpoint a number for the fourth quarter. Now, so speaking of the dividend, also, there are a lot of factors that affect that. We are focused on longer-term supporting the dividends through a stable run rate of core profitability. That'll obviously depend on a variety of different things such as returns available in the market for our strategy. We do not expect to change the credit and risk profile of our investments in order to generate additional yield. Also, obviously, I alluded to earlier, for the Q3, the excess liquidity we had. Now we have funded over $300 million of loans in the second half of Q3 and over $325 million so far in the fourth quarter as Steve mentioned.So we've invested most of that excess liquidity, so the interest income earned on these new loans should definitely help to offset the extra interest expense during the quarter. Third, our first CLO, which is a static deal, has been deleveraging as loans have been paying off, making it a little bit less efficient. We expect this trend to continue as a meaningful portion of our expected prepayments are loans financed in that trust. We're looking at a variety of different options to address this issue, but it will take some time for us to implement that. Additionally, even though we ended the third quarter at three times debt to equity ratio, the kind of the average leverage for the quarter was about 2.7 times, so somewhere around that level. To me that illustrates that we were underlevered for the quarter. So we have some more room to lever out the portfolio on a more consistent basis up to that three times level, maybe a little bit higher once we are done with rationalizing our liabilities.So we're focused on investing our remaining capital with reinvesting the funds we will be getting from repayments and doing more work on our abilities to make the funding structure more efficient. And taking all those factors into consideration, once we bring our balance sheet toward a more stabilized level of leverage and assess the effects of all the other variables, we will have a discussion with our board regarding the longer term, more sustainable level of our core profitability and reevaluate the level of the dividend against that and making the necessary adjustments in the future.

Thanks for that. I think it's worth being realistic and considering that your current dividend implies the return of 9% on book value given the expense structure and G&A, that would require around 12%, 12.5% gross ROEs. Some have been commenting that achievable ROEs are more in the 11% to 11.5% range. One thing I have asked you guys about in the past, given your track record and history in the CMBS market, is ancillary businesses, which typically conduit-type businesses generate high ROEs. Wondering if you have any updated thoughts on that.

Hi, Jade. This is Jack. Good to speak with you. Well, I think, as we discussed in the past, we're always evaluating and open to evaluating various business opportunities that will drive extra returns. And our team really has strong capabilities to execute on a variety of investment strategies as we've done so over many different formats over our long careers. But since going public two years ago, we've been solely focused on deploying our capital and growing the balance sheet and bringing our business to more run rate performance. So we're not currently actively looking to expand the business, but we won't rule out doing so. We won't rule out potential partnerships or JVs that could help us do that if that makes sense as well from both a strategic and a risk perspective. So the answer is nothing imminent, but not excluded.I just want to add something to what Marcin was saying about the improving our financing for our company. And he referred to CLO market. As we've said in the past, also we view the CLO market as very complementary and attractive way to finance our business in conjunction with the other types of borrowings we do. And we've positioned our company to be a repeat issuer in the CLO market. And we've executed two CLOs today. As you know, both of which were really well received and supported by a broad array of institutional investors, many of them repeat investors in the second deal.And as origination pace has picked up and we've grown our portfolio significantly this year, we have ample asset capacity to take advantage of the CLO market. So we've been paying close attention to the developments in the CLO market, including what I'll call the noticeably more advantageous executions available to issuers. So we've been considering another securitization that should be beneficial to our balance sheet and in a way help us to catch up with the new developments in the CLO market that some of our peers have been able to take advantage of. And so depending on overall market conditions, we may elect to access the CLO market over the next several months.

Thanks very much.

Thank you.

The next question comes from Rick Shane with JPMorgan. Please go ahead.

Hey guys, thanks for taking my questions this morning. Marcin, you talked about the average leverage during the quarter. What was the average cash balance?

I think if you look at the cash on the balance sheet and some of the funds that we had in our managed CLOs definitely north. The access liquidity, I would say, was definitely north of $100 million. We try to maintain – our covenant requires at least $40 million. We try to keep a cushion above that, somewhere between that and $100 million. So we definitely had excess liquidity of, I would say, $100 million to $150 million over the course of the quarter. What happened was if you recall last quarter we mentioned one of our, this was one of the impacts, one of our larger loans the Northeast office loan that repaid actually was in the managed trust. It repaid at the end of the second quarter. We had another great large office loan slated for that to replace it. Unfortunately that loan got delayed, so it was partially why we had some negative carry on that. So.

Got it. And okay, so that's helpful context. If we look at – and this sort of ties into the question that Jade just asked. If we look at the dividend, the implied or the required ROE at book value today to achieve that's about 9%. That's frankly above where ROE has been at any point in the history of the company. You're in an environment where, at a bare minimum, base rates are working against you. In order to achieve that dividend, you either need to grow book value, widen spread, lower funding costs or substantially increase leverage. What's the best tool there? And to the point is the dividend sustainable?

Thanks, Rick. Look, as I said earlier, there are a lot of different factors that affect it. But for our equity offering in the first quarter, I would assume that we probably would have earned the dividend in Q1 of 2019. Obviously that was diluted by our equity raise, which was strategic for us for many reasons. Since then a lot of things happened. I think as Jack mentioned, we have some additional earnings power potentially coming from another CLO. We have the first CLO that's becoming more and more inefficient. Releasing some of that excess capital that's stuck in that trust will definitely provide us with – looking at market today will definitely provide us with some additional earnings power.But look we are realistic about the market conditions and about the structure of our business. We are continuously discussing this with our board. And once we've had the time to rationalize our liabilities, our assets, we've proven that we can produce a lot of very quality, high quality and well returning assets. So once we've done addressing our liability side of the balance sheet, we will again reassess our core profitability of the business and take any actions as necessary as we discuss it with our board.

Great, thank you so much.

[Operator Instructions] The next question comes from Arren Cyganovich with Citi. Please go ahead.

Thanks. You had mentioned that prepayments are likely to be elevated in the fourth quarter around $300 million. Do you think this is getting to more of what you would see as kind of a sustainable level of repayments as your portfolios starting to season here? And will there – do you expect any significant prepayment income relative to those prepayments for the fourth quarter?

Hey, Arren, this is Steve Plust. Good morning. Thanks for the question. We've said repeatedly on these calls that we think a sustainable level of prepays when the portfolio matures, something like a 25% rate annually and the $300 million certainly is approaching that. Obviously, quarter-to-quarter these are lumpy assets or quarter-to-quarter these numbers are going to move around and they're not going to be smooth and consistent. And with respect to prepayment fees, I'll pass it onto Marcin.

Thanks, Steve. Hey, Arren. As of right now, it's depending on which loans repay when. There are – it's a mix of loans that are older vintage, which are obviously out of the call protection and yield maintenance period and some newer ones, which may have that that period expire over the course of the fourth quarter. So it's really hard to estimate. We've obviously had prepayment income between zero and almost a million dollars quarterly. So it's – again, depending on the time of the loans, it's really hard to say right now whether we're going to have anyone on.

Okay. And I guess with your stock now trading kind of at or slightly below book value and it doesn't sound like you're going to increase your leverage too much. Do you think you have enough of a recycling of the portfolio that can consistently provide enough capital to fund what you have in the pipeline into next year?

Yes, we do. This is Jack. Thank you for your question. And I'll say we do have enough to cover our origination pipeline that's in hand and we have about $200 million plus of additional growth origination capacity in excess of that. And we do, as we noted, expect meaningfully higher prepayments in this fourth quarter, but also beyond and that should generate additional liquidity to originate new loans beyond that. So that's not for growth, that's to reinvest the capital. So, we're well covered in our ability to take care of our pipeline. We have the capacity to generate, as we've just shown about $2 billion a year out of our platform. And depending on how stable the market conditions are and what our prepayment rates will be, will depend on whether or not we're actually going to grow the net growth of portfolio. But we're always very careful to make sure we have the capacity to cover what we're doing.

Thank you.

The next question comes from Jade Rahmani with KBW. Please go ahead.

Thanks. I'm sorry if I missed this earlier, but the risk four rated loans, I think there are two last quarter, now one. And could you just provide color on that?

Hey, Jade. It's Steve Alpart. Thanks for the question. Thanks for joining. So we're continuing to monitor that asset for Q3. We maintain the risk rating of four at 9/30 loan is current on its debt payment. And we do not expect to create any reserves for that loan other than what might be required under CECL. We mentioned in the past we still are believing that we're well secured on the asset and it's 100% performing. So that's – so basically really no change since last quarter.

And last quarter were there are two risk four rated loans and now there's one. I guess, what happened to the other loan?

Sure. As Jack mentioned earlier, during Q3, we had a multifamily asset in New York and that loans are repaid at par.

Was that subject to rent control?

That asset had a few units in it that were subject to rent control. But as is our general approach, it was a de minimis part of the business plan and we typically don't underwrite to those types of assets, leading rent control. So if it had not paid off, we were not concerned about that one being impacted by the new loss.

Thanks for that. I wanted to ask a broader question, again, drawing upon your experience in the industry. Everyone talks about how benign the credit cycle has been, but that's because most commercial real estate loans have ten year maturities and we're not yet at the doorstep of those anniversaries even though there has been a lot of refinancings, about 50% of defaults in the commercial real estate business are due to maternity loan default. So just looking away from GPMT's portfolio, but for the industry overall, are you expecting a pickup in loan default next year as we come upon the anniversary of the 2020 – the 2010 originations?

Hey, Jade. Good morning. It's Steve Plust. Sorry if I'm being a little too soft when speaking. It's really hard to say because from our experience, unless you've got a macro cycle going against you, most defaults are really episodic. And what I would say, call it, idiosyncratic and specific to a particular business plan or a particular market. For sure, I would imagine there were some snafus made in originations 10 years ago, but I don't see a global macro or – local or global macro conditions getting in the way of refinancings right now.

And in terms of your own internal asset management process, what's the level of frequency of dialogue with borrowers?

It's pretty high given the nature of the assets. We're doing a lot of future fundings. There's business plans that require our participation as a result, where, I wouldn't call it constant, but very frequent dialogue with the sponsors about the state of what's going on, reviewing leasing activity reports, reviewing CapEx plans, annual budget review. So we're in fairly continuous dialogue with our sponsors on these business plans.

Thanks very much.

It’s our pleasure.

This concludes our question-and-answer session. I would like to turn the conference back over to Jack Taylor for any closing remarks.

Well, thank you operator, and I will just say, I'd like to thank everyone for joining us today and for taking the time and for your support of our business and we look forward to speaking with you all again soon. Thank you.

The conference has now been concluded. Thank you for attending today's presentation. You may now disconnect.