Nexpoint Real Estate Finance, Inc. quarterly report, Q1 FY2023

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NexPoint Real Estate Finance, Inc. — Q1 2023 Form 10-Q

Reporting period: Three months ended March 31, 2023. NexPoint is an externally managed commercial mortgage REIT focused on real estate loans, preferred equity, securities and related investments. Amounts below are in U.S. dollars; financial statement figures are in millions unless otherwise noted.

Financial performance and position

  • Earnings: Net interest income was $3.9 million, down 82% from $22.3 million in Q1 2022. Net income was $9.4 million, down 48%; net income attributable to common stockholders was $6.6 million, down 47%. Basic and diluted EPS were $0.38 and $0.37, versus $0.90 and $0.78, respectively.
  • Drivers: Management attributed the NII decline primarily to lower prepayment penalty income. Interest income declined 48% to $16.2 million, while interest expense rose 38% to $12.2 million. Other income increased to $10.9 million from $1.8 million, primarily reflecting a larger positive change in net assets from consolidated CMBS entities ($11.0 million versus $3.4 million).
  • Expenses and returns: Operating expenses were $5.5 million, down 9%. There is no conventional operating-margin measure presented. EAD attributable to common stockholders, a company-defined non-GAAP measure, was $9.5 million ($0.54 per diluted share), down 51%; CAD was $10.0 million ($0.56 per diluted share), down 61%. These measures are not GAAP income or cash flow.
  • Cash flow: Operating cash flow was $15.0 million, down from $37.7 million. Investing activities provided $66.7 million and financing activities used $61.7 million. Cash, cash equivalents and restricted cash ended at $40.3 million, compared with $42.2 million a year earlier.
  • Assets, debt and equity: Total assets were $8.04 billion and total liabilities $7.57 billion. The balance sheet includes $6.75 billion of mortgage loans and $6.28 billion of related bonds in consolidated CMBS entities; these entities’ assets and liabilities are separate from the company’s own obligations. Company financing arrangements totaled $1.275 billion, including $350.4 million under master repurchase agreements, $687.5 million of secured financing and $205.2 million of unsecured notes. Stockholders’ equity was $377.3 million; common book value was $19.77 per share, down from $20.29 at year-end.
  • Liquidity: Management said cash, expected operating cash flow and potential financing would be sufficient for operations, debt service, potential preferred-unit funding and dividends for the 12 months after March 31. The filing does not provide a numerical liquidity forecast. Repurchase-agreement transactions have one-to-two-month tenors, carry a 6.72% weighted-average rate and are expected to roll; $967.1 million par value of securities collateralized $350.4 million of borrowings.
  • Dividends: Common dividends declared were $0.685 per share, including a $0.50 regular quarterly dividend and $0.185 special dividend. Series A preferred dividends were $0.53125 per share.

Material changes and unusual items

  • The company deconsolidated the Elysian at Hughes Center property effective January 1, 2023 after transferring its common equity interests to the asset manager. It now reports a preferred equity investment instead. The change reduced reported real estate assets and mortgages payable; it also generated a $1.5 million deconsolidation gain, not a remeasurement gain on the preferred investment.
  • The company adopted CECL on January 1, increasing its credit-loss reserve from $0.7 million to $2.3 million and reducing retained earnings by $1.6 million. The ending reserve remained $2.3 million at March 31. All 50 held-for-investment loans were rated “Satisfactory” by management; this is an internal assessment, not a guarantee of performance.
  • Fair-value movements were mixed: consolidated CMBS entities recorded an $11.0 million positive change, while CMBS structured pass-through certificates, MSCR notes, mortgage-backed securities and common stock investments recorded losses.
  • The portfolio had 87 discrete investments at quarter-end, compared with 71 a year earlier. Q1 originations and investments included approximately $35.8 million of preferred equity, common equity and mortgage-backed securities; repayments and redemptions totaled approximately $36.3 million.

Outlook, risks and contingencies

  • No earnings or dividend guidance was provided. Management describes a flexible investment strategy and expects to meet near-term liquidity needs, but access to capital may be affected by market conditions, leverage and lender restrictions.
  • Material risks include real-estate credit and collateral losses, interest-rate and credit-spread changes, concentrated exposures, substantial indebtedness, short-tenor repo funding, and the possibility that distributions may not be sustained. About 3.9% of portfolio principal was tied to LIBOR and 12.9% to SOFR; the company expected the announced LIBOR-to-SOFR transitions to have an immaterial effect on affected loan rates, while noting benchmark changes could affect funding costs and asset-liability matching.
  • Commitments include up to $30.9 million of additional preferred-unit funding under an existing agreement; $16.3 million of unfunded preferred units and $3.8 million of unfunded common equity for a Texas development; and $19.1 million of unfunded preferred units and $3.8 million of unfunded common equity for a Virginia development. A separate $24.0 million preferred-equity commitment for an Arizona project was unfunded at quarter-end. The company subsequently purchased $21.0 million of preferred units on April 6, 2023.
  • A guaranty related to NSP obligations has a stated maximum company exposure of approximately $83.8 million. Management considered payment under the guaranty remote and recorded no contingency. The company also fully guarantees its OP notes; management considered a call on that guaranty remote.
  • Disclosure controls and procedures were reported ineffective as of March 31 because of an unresolved material weakness previously identified in financial reporting. Management described acquisition-accounting checklist remediation but said the work was not complete and the weakness was not yet remediated.
  • The filing discusses litigation against the sponsor and affiliated individuals, not claims involving the company’s business or assets; management did not expect a material effect. The company reported no material change to previously disclosed risk factors.

Important facts for investors to verify

  • Whether lower prepayment-related income and the sharp NII decline persist, and how much earnings depend on CMBS fair-value changes.
  • Near-term refinancing and renewal of the short-tenor repo borrowings, collateral requirements, and the company’s capacity to meet scheduled maturities and commitments.
  • Actual funding timing and performance of the Texas, Virginia, Arizona and other preferred-equity commitments, including the subsequent April purchase.
  • Progress in remediating the material weakness and whether controls are later assessed as effective.
  • Dividend sustainability in light of Q1 common dividends of $0.685 per share versus company-defined EAD of $0.54 and CAD of $0.56 per diluted share; these non-GAAP measures are not cash available by themselves.
  • The filing describes the Virginia development as Richmond in one section and Mechanicsville in another; verify the property identification and related commitment details.
  • Performance and valuation assumptions for Level 3 investments, the NSP guaranty exposure, and the accuracy of the company’s internal loan-risk assessments.