Granite Point Mortgage Trust Inc. (GPMT) Earnings Call Transcript & Summary

Hi, and welcome to Citi's 2021 Virtual Global Property CEO conference. I'm Arren Cyganovich with Citi Research, and we're pleased to have with us Granite Point Mortgage Trust and CEO, Jack Taylor. This session is for Citi clients only. If media or other individuals are on the line, please disconnect. Disclosures are also available on the webcast. If you're joining us here today, please remember that you can simply ask questions by putting them in the question box on the screen. And they'll come directly to us, and we'll be able to ask them during the session.

So Jack, maybe you could first start off and tell us a little bit about coming out of the pandemic if an investor were to choose only 1 real estate stock to own, what are 3 reasons that they should invest in GPMT?

Well, thank you, Arren. And good to see you and speak with you, and thank you for having me join you today. And congratulations on such a well-executed virtual conference. Well, to answer your question first, only Granite Point stock is really a great way to get exposure to the real estate sector, but in a derisked position with significant borrower equity cushioning a carefully underwritten portfolio of senior first mortgage loans. Look, we have a pretty straightforward investment strategy focused on moderately levered senior loans secured by institutional quality real estate and across a broad set of markets in the United States. Our collateral properties are owned and managed by experienced and well-capitalized sponsors. Our broad geographical diversification provides greater protection for our portfolio against concentrated event shocks, such as the pandemic. Second, we have one of the most seasoned and cohesive teams in the industry. That has worked together for a long time, many of us for decades, and have successfully managed these types of portfolios over multiple economic, real estate and interest rate cycles. Our management team is fully aligned with our stockholders as we're an internally managed company. Additionally, as an internally-managed REIT, we anticipate realizing significant economies of scale and cost efficiencies as we grow our business over time. That should benefit our stockholders through improved returns and dividends. And the last point I'll make is we believe that our stock is undervalued and the price doesn't fully reflect the intrinsic value of our asset, which has shown resilience over the past year. It doesn't fully reflect also the potential economies to scale benefits that I just mentioned from future growth. So we believe our stock today provides not only an attractive yield given the interest rate environment we're in, but also a compelling total return opportunity for investors looking for exposure to the real estate market recovery and as the valuation gap closes versus our book value.

So we think about where we were a year ago, actually in Florida at this conference versus virtually. Maybe you could talk a little bit about how the past year has evolved for GPMT? You've mentioned some pretty big milestones that you've had during the year. And then just kind of more from an environmental standpoint as well. How you manage through the depths of the pandemic? And then how you're thinking about it from an offensive perspective now today?

Well, I'll take the latter part first and then go to the overall environment. We managed through by being very methodical in how we approach the crisis. It was a big shock to leverage lenders such as ourselves. And we decided to be very thoughtful and methodical so that we could raise really well-priced capital at the end of the process that would help see us through and position us through the future. So we worked very closely with our line lenders and got tremendous support for them. And as importantly, we worked very closely with our borrowers to make sure that they had the runway to -- and it's been quite successful, the runway to work through the pandemic. Now today, the real estate lending market, we believe, are quite rational. We've seen a positive shift in the market sentiment and transaction activity. Of course, that started in late 2020 with the announcement of the vaccines and their proposed rollout and also with the Fed's accommodated policies. So now with, I would say, some of the political uncertainty now behind us and a large fiscal stimulus coming as was just approved last night, we're now in a much more favorable market condition for the commercial real estate industry. And this is, as many have commented, I'm sure, is supported by the large amounts of dry powder that both debt and equity investors have and are looking to start investing. Our lending activity has really been down from 2019, but it seems like every week that goes by, both transaction activity and lending activity picks up. And then close acquisitions, refinancings and repayments. We believe that this will accelerate throughout 2021 and that will present ample opportunities for Granite Point as a debt investor. We're already seeing a significant pickup in loan requests from our borrowers, both repeat and new borrowers, starting with the multifamily and industrial sectors, where the activity is quite vibrant, and we expect that activity to broaden to other sectors as the year progresses. And it's already starting to do so in other sectors. With real estate fundamentals improving, we believe it's particularly good time to be a debt investor. And that 2021 will mark the restart of our free flowing market, which is the type of market we really do like and we plan to take advantage of those opportunities.

So maybe we could just talk a little bit about the spread environment and what you're seeing from opportunities today versus prior to the pandemic? Prior to the pandemic it was getting fairly competitive and spreads were getting relatively tight. Now we have LIBOR at a very low level. And maybe you could just talk about where you're seeing opportunities there?

Well, first, I would say, overall portfolio returns are a function of a few different factors in combination with loan credit spreads. Right now, new origination leverage returns that we're seeing are roughly comparable to pre-COVID. That's a function of many variables. And I would say, in addition to the loan spreads, those variables are -- the returns are impacted by the cost of funds and the amount of employed leverage. Very attractive trends in the commercial real estate CLO market play a very big part currently in keeping the overall return to where they are. So as a function of the healthy CLO market, we've also seen bank warehouse credit providers trend down as well and try to match those markets. So spreads widened quite dramatically in the early part of the pandemic. Since then, the spreads have been declining as market participants have gained more confidence, especially when the light at the end of the tunnel started to emerge in literature. And as liquidity has been returning in both the real estate sector and in the fixed income markets. Overall, we believe the spreads are still wider than they were pre-pandemic, but that's very property specific.

And maybe we can just take a step back and talk about Granite Point's philosophy, the types of properties that you're investing in and how you differ somewhat from some of the other commercial mortgage peers that are out there?

Well, it's a good question because I don't think it's really understood well enough by the market. So thank you for asking that. First, like a lot of our public commercial mortgage market, commercial mortgage REIT peers, we're focused on floating rate senior first mortgage loans. Unlike some of the peers, we don't pursue other strategies like buying and leveraging CMBS securities or manufacturing conduit loans and securitizing them. There are a few key factors that differentiate us against those that are doing a very similar strategy goal. First, as I said, our management team is very cohesive and has worked through for decades through cycles like this, so this has its own unique characteristics. They always all do, and this one is the most unique. Second, our deep experience has led us to a strategy that is highly focused on diversification and relative value. We believe that the high degree of diversification in our portfolio by property type, markets, sponsor, reduces the risk of systemic shock. We have a significantly broader geographic diversification than most of our peers. As a result of landing in the top 25 and generally up to the top 50 MSAs in the United States. That's a -- we do have between 40%, 45% of our portfolio in the top 5 markets. We like those markets. We're active in them because they're large and liquid, but we don't usually compete with the large loan lenders in those markets because we focus on loans under $100 million. They tend to start at $100 million or $150 million and up. And I'd say on the markets beyond the top 5 to 10, they generally have higher cap rates, which from a debt-lending's perspective is important because that means, on average, there's more cash flow to service our loans. So we have a broader geographic reach. That's a part, I think, that's not well understood. But also, our target loan size between $20 million to $150 million, but most fits in the $25 million to $75 million range. I would say we're averaging typically between $35 million and $40 million currently. And as such we invest in what you might call the larger part of the middle market, where, for the most part, we don't really compete with the larger loan peers and some of the major banks because of their loan size. But our borrowers and sponsors and our properties are of institutional quality. We believe that this approach provides us with the best risk-adjusted returns, where we avoid strong competition from larger loan lenders while doing business with established borrowers, providing us with strong credit loan. So I think those would be the 3 main differentiators.

Okay. The -- talking about focusing on the kind of more of the middle market type of institutional product, are you seeing any kind of divergence in the activity or the cash flows from smaller markets versus the top 5 or top 10 markets?

When you say divergence in activity. So what do you mean?

In terms of -- are you seeing recoveries faster in any other smaller geographies versus the larger?

Well, it's interesting. Yes, I'd answer that with a very general observation. By being spread out across the top 25 and up to the top 50 markets, the pandemic -- they call it a pandemic for a reason. It goes everywhere, right? But it doesn't go everywhere with the same timing or strength or critically the same response from the different markets. So we view this as kind of like a rolling recession. There are -- over the last year, if there's been markets that opened up earlier than others and then maybe had to shut down again. There were dense urban areas that got impacted more heavily. So what we've been seeing is that there are certain of our locale, certain of our geographies actually hit a recovery pace much sooner than others. And then maybe slowed down a little bit. But like I said, it's kind of like a rolling recession. So that's part of the benefit of having the geographic diversion -- diversification, is that we are seeing that across different markets.

And then maybe we can talk a little bit about the -- some of the property types that you're lending to, the largest exposure you have is the office, it's about 45% of your portfolio. What's your thoughts there? We've definitely heard and read a lot about the kind of deurbanization trends, and I'm working from home. I'm anxious to get back to the office, at least for the majority of the week. What's your thoughts on office? And is that an area that you're continuing to pursue as new investment opportunities?

Yes, we definitely are. We're going to shift our asset class mix a bit. With more of our focus on multifamily and warehouse logistic properties, also sell stores, life sciences, which we've done quite -- with considerable amount successfully over our careers. But there's no redlining of office. And in fact, one of the benefits of our strategy is that we don't need to make major macro calls about urbanization or not, right? And in fact, if you were to look at our portfolio, we have a broad mix of markets where there is more CBD. There is a little bit more suburban. And our view is that you can find gems under a whole variety of circumstances. So we're not having to make that call. We believe that call is largely a call for an equity investor risk and shouldn't be ours. And so what we are doing consistently with office and all of our asset types, we will continue to emphasize the relative value, the bottom-up credit underwriting, the diversification, et cetera, and we'll continue to look at a broader rate. I personally believe that people are yearning to go back to the office. I know we are. We're working very efficiently from home. But as you all presented at the opening of the conference, there is a very high premium of people collaborating with each other in the office. Our business is very straightforward. We're a deal-driven business. It's an information flow activity business. And so we really desire and need it and like it. But we don't have to make that bet. And we're not making that bet.

And then moving on to multifamily. That's the second largest property type in your portfolio. It's about 24%. Maybe you can talk a little bit about what the strategy is for multifamily, the types of properties and geographies that you have within that portfolio?

Well, what we have now in our multifamily portfolio was predominantly Class A. That's in the mid-50s percent side. Class B in less workforce housing. Historically, we really liked workforce housing. We think it's being supported now by the government programs, if you will. And we will continue to look at multifamily. One of the benefits of the multifamily market is that even -- it allows you to have even a more broad geographic reach. You can see you can find terrific multifamily assets and through many, many different markets and something like urbanization and/or the suburbanization. People talking about people fleeing cities. You can really find great multifamily assets. Now it's a more competitive part of the market. We've always proven our ourselves able to compete and to access that product, and we will continue to do so.

And then kind of moving to a couple of areas that are obviously under a lot more pressure in the hotel, you have about 17% of the portfolio in hotel and a little under 9% in retail. Maybe you can talk about what you're seeing from either of those and how you've been able to work with sponsors to help support those properties?

Sure. Well, first, I'll say, we're very pleased with the performance and the resilience of our portfolio over the last year. And with respect to hotels and retail, I would say considering the severity of the economic and real estate market dislocation caused by the pandemic, it would be very surprising to not have any credit if that's out of a portfolio of over 100 loans. However, we do have a strong asset base. And as we discussed on our earnings call, we are closely monitoring, in particular, about $240 million of loans out of a $4 billion portfolio. And I would say -- I'm giving this as a backdrop to talking about the hotel and retail. I guess, a significant portion of that $240 million is in the hotel and retail. Well, I would say we have quite a few hotel assets that are performing very well. So we would expect with the vaccine rollout and the distribution -- accelerating distribution and the fiscal stimulus that we'll see positive credit migration over time in our portfolio. And that will outperform over the cycle. Now with the hotels, we've been in very active discussions with our hotel borrowers, about the status of their business plans and how the assets have been impacted by COVID. To date, these conversations have been very constructive, and we're seeing that our borrowers have been stepping up to protect their assets with new capital, and we're finding thoughtful ways to be supported to our borrower responses. Our hotels are secured by excellent existing hotel properties with institutional high-quality sponsors. And the original business plans were very sound. The loans were moderately leveraged when we made them, which means our borrowers have real motivation to protect their equity as the hotel market recovers. Now business plans have either been delayed due to the effects of the pandemic and severely hurt for a period of time when there were shutdowns. But we did start seeing hotel reopenings in May and June of last year. And today, given the reduced business in leisure travel, we're typically seeing [indiscernible] still a very reduced occupancy levels. So both -- though, again, not all of our hotels. So we're expecting a slow ramp back up and in our discussions with our borrowers, sponsors, reflect that. There will be a lot of variability by the market and the type of hotel, for example, leisure, select service and drive-to assets will ramp, I think, considerably sooner than Group, CBD, Flytour properties. And with the vaccine rollout, hopefully, we'll be surprised to the upside. But it's really too early to predict -- I'm sorry, the timing of the recovery. And so we have a generally cautious outlook on this sector right now. However, we feel that these markets and assets will come back. And importantly, if you had a good asset prior to COVID, you're very likely to be having a good asset after the rebound, even if it takes some time. Now on the retail side, I'll be a little briefer there. We only have a couple of retail loans in our portfolio, and they were conservatively underwritten with significant borrower equity to protect. And certainly pre-COVID, the underlying properties were the type of retail that you wanted to have, strong local demographics and also the tenant base is more resistant to e-commerce intrusion. We have no exposure to malls or power centers, and none of these loans were construction loans. Most of our retail exposure is in mixed-use assets with an office and/or a multifamily component, and most of the retail use would be considered convenience retail or lifestyle centers, often with grocery and/or drug store component. So the business plans like with the hotels were delayed. In the back half of 2020, we've seen a gradual reopening of local economies with increased store openings accompanying that. And in 2020, our sponsors have been working with their tenants on rent deferrals and rent abatements -- arrangements, and we've seen a gradual increase in collection rates. So we're continuing to closely monitor our retail assets as the economy has reopened, and we're starting to see tenants begin to return and reopen.

Okay. That's helpful. The low interest rate environment on the short end has provided a nice boost to you and your peers in terms of LIBOR forms that were set at higher rates. You had mentioned earlier in our conversation about the earnings power or the types of returns that you can get today are similar than to what they were prepandemic because of the various changes there. But maybe you could talk about the earnings power of GPMT and how you expect as you're replacing these kind of healthy LIBOR floor assets as they roll off? How that's going to impact your earnings power over the next few years?

Sure. I think it's a really good and valid question. So as I mentioned a few moments ago, there are a lot of variables driving the overall portfolio returns and company profitability. Loan spreads, LIBOR floors are one of them, we'll address the loan fees, liability pricing leverage, and so we are seeing, right now, about the same level of returns as near prepandemic levels. But as you note, we do have a relatively larger proportion of loans with higher earning LIBOR floors. We're glad we were able to accomplish that. And although -- first, it will take -- allow for all these loans to repay. And it's very difficult to predict the exact timing and volume of loan repayments, but that will depend on the rate of recovery in the economy. So we expect that benefit will be around for a while. We believe that somewhat higher loan spreads should partially offset the lower LIBOR floors. And we're currently seeing those LIBOR floors in the 25 basis point range, maybe a little more. But in addition, and this will be central, we are also focused on improving our overall cost of funds over time, which that should also provide more stability to our overall portfolio return. So as that rolls off, we also believe that our cost of funds will come back.

And we didn't really talk about your kind of expectations yet for portfolio growth. Are you expecting that you will largely just be kind of recycling the repayments that you get over the next year or so? Or you anticipate you'll actually be adding to your kind of loan -- overall loan portfolio?

Well, so let me delve into that with a little more detail. So the timing of loan repayments and the closing of new originations will cause some variability on a quarter-to-quarter basis and the portfolio balance. But we expect it to be relatively stable over the course of the year. Barring some really adverse developments in the market. I wish there could be variants and things like that, but I think the market is looking much more positive. So we're building our pipeline and quoting loans currently, and we expect to start funding some new investments in the second quarter. And any repayments we receive before then will cause our portfolio balance to come down, so -- until we redeploy it. But we think we'll be able to manage that in a pretty tight timeframe. And by the way, we've proven over the last couple of years, our ability to capitalize on the strength of our direct origination platform and generated a very significant volume of originations and attractive investments that meet our loan criteria. And by the way, it's always been the fact that the markets are competitive, and we welcome that. That's what I meant earlier when I said we like pre-COVID markets. We like competitive markets, so you can pick and choose your spots and where you want to deploy. And we originate about $2 billion of loans in 2019. So we have plenty of origination capacity as that repayment flow comes in. But I'll say, we definitely intend to grow our capital base and our portfolio over time. And so the balance will vary during the course of the year. And in a variety of ways, it will be exactly what would be growing our capital base and therefore our portfolio.

Yes. I think that's actually an interesting point since you internalized the company, you would be one of the few commercial mortgage REITs that would be able to actually start to experience some economies of scale on the expense side. Maybe you could just talk a little bit about that decision to internalize and how that's progressing? And what do you see the benefits of that over the long term?

Well, so first off, it's progressed in that we're able to close at the end of 2020. And so we are now a fully internalized REIT. And there are central benefits, one is an alignment of interest with stockholders, and the economics of scale that we talked about as you grow. There's no management fee paid out to the external manager as part of your growth, any growth is -- endures to the benefit of the stockholders. And there's greater flexibility, I would say, in ways to grow and avenues to pursue. And there are no other competing interest, if you will. And there's no other dependence on outside parties, if you will, to facilitate that growth.

And would you foresee in the future maybe managing any other assets for an additional fee stream that would come to Granite Point? Or is that just not something that you're focused on?

Well, there's nothing imminent to discuss, but that's definitely an avenue, a path for us to pursue when the moment is right for us.

Okay. And on the funding side, CLOs have been showing very tight spreads. You can talk a little bit about, I guess, 2 things. One, are you seeing any competition from CLOs for any of the assets that you would invest in and the other side being how you'll continue to utilize CLOs as a financing mechanism going forward?

Well, so definitely, I would say commercial real estate CLOs are clearly one of the most compelling sources of financing for a majority of our loans. And I would say, as I've mentioned earlier, the warehouse lines will try to compete and will compete with the CLOs, but we've established ourselves as a long-term repeat issuer in -- and are quite well-respected repeat issuer in the CLO market. And we would intend to be given favorable market conditions, continuing access in the CLO market. And it accomplishes a couple of things for us. One is it's quite favorable cost of funds now. It's married to a non-mark-to-market match term financing structure as well. And we've been, for years now, big advocates of the commercial real estate CLO market and calling, predicting -- I don't like predicting things, but when there's a natural lead, a natural raison d'être for a phenomenon to exist. You try to pursue that and understand it and take advantage of it. There is a natural need -- the commercial real estate CLO market is a financing mechanism for issuers just like us. And the structures have held up quite well. Through -- this is why I believe part of the reason there's such demand for commercial real estate CLO composite. Throughout the pandemic, the structures have held up quite well. So it's not an arbitrage vehicle. It's a financing vehicle that provides tremendous benefit to entities such as ourselves, and we believe to the investor base. So that's what I mean about a natural reason for existence. And so we'll be taking advantage.

And I guess, this kind of gets into the growth question before, but what level of leverage do you think you'll be comfortable with heading into this year and/or through this year? And do you anticipate increasing or decreasing the leverage level that you have in the portfolio?

Yes, a great question because it's one of the variables I mentioned about overall portfolio return. And so as we stated on our earnings call, our target for total leverage is between 3x and 3.5x debt to equity. And so our current 3.2x, I should say, at the end of the year is right in that zone. The actual leverage will vary from quarter-to-quarter. Some portfolio mix changes due to the loan repayments, new originations and the like. So as we manage our business for the long term, we don't expect our leverage to much exceed the upper limit of our target range. And also, keep in mind that leverage is a function of the type of financing that we will use for the company to fund our business. So more non-mark-to-market term matched nonrecourse financing generally allows for more stability in the balance sheet and more comfort with a high level of leverage employed. So over time, our leverage will reflect the type of funding we use and the overall market conditions, and we would anticipate adjusting our leverage accordingly. And it is a goal of ours to increase the percentage of non-mark-to-market financing. And I'd just like to throw at the end of this part.

And I actually mean to ask this whenever you're discussing the internalization. Is there an intention to continue to grow your investment team or portfolio management team? And what are your thoughts about kind of expanding the team that you have right now?

Well, that's a great question. It is fairly easy to answer. As we grow our portfolio, we will add incrementally to our team. We like organic growth. We're open to many things as we're looking through our multiyear strategy, if you will. But for now, I would say we will be looking at portfolio growth and the requisite growth in our team to match that.

And do you find that there's a strong bid for those kind of originators in the market? And do you feel like there's ample opportunity to add to the team over time?

I will give the honest answer, though it might sound like a politician's answer. The honest answer is we're viewed by market participants, meaning originators, securitizers, asset managers as a really great place to work with a great discreet to core and so we're expecting to continue to be able to attract really great talent when we're able and wanting to add that talent. For what we do, I would say there's an ample bid in the market for talent. And it's an easy -- complex in the detail, but it's easy. This is a great value proposition for investors to be in the LIBOR floating rate transition loan market. And so there's great demand from the capital side to get deployed into it. It's not easy to get deployed because with the debt vehicle, you have to have broad reach quickly, right? It's a very hard to enter market, right? And so if you have an established platform, that's quite valuable for capital that wants to get invested. And this is a great spot for capital as I won't go through it again to be invested. So we have a really great team, and people will and do want to join the team. And for similarly situated companies, I would say there's a good bit.

Great. All right. We're almost wrapped up here, so we'll just shift to the rapid-fire section here.

All right. I'm ready for the rapid part.

So the first question is, when we are sitting physically together in Florida a year from today, what will be the one thing that will have surprised people the most about your business over the prior 12 months?

Our particular company business. I would say we believe that our overall portfolio performance will surprise to the upside as we're highly confident in our diversification strategy as I've discussed as well as our credit underwriting and loan structuring approach. We believe there's a misconception in the market that if you're not originating mega loans on the largest properties in the top 5 or maybe 10 markets, then your loans are of a lesser quality. And in fact, we've often seen lenders originate D quality loans in A markets. And meanwhile, you can make A quality loans in B markets, which is what we often are doing, even though we're also in the A market. So overall, I'd say our experience is there is great value in having a more broadly diversified portfolio, and this has served us well over many market cycles. So the one thing we intend to be discussing in a year is how well our business performed through the downturn.

And what do you think your corporate travel budget will be next year, meaning 2022, as a rough percentage of what you spent in 2019?

I would say it's about the same or a little more because given the breadth of our portfolio, the number of lending relation sets our team has and the forward pipeline of opportunities that we're starting to see and expect to see. We'd expect the travel budget to be at least equal to one we had in 2019 when we originated or maybe exceeding -- when we originated about $2 billion of loans across 45 investments.

And the last question, your crystal ball on where the 10-year treasury yield will be 1 year from there. I think it's around 1.5 now?

So I was going to go into a long discussion of looking at the deflators, but we're not macroeconomists, and we're not interest rate traders. That's kind of core to our business, as we're not trying to trade interest rate. But given the current monetary and fiscal stimulus, that huge support from both sides, we wouldn't be surprised to see the 10-year around 2% or a little higher in a year.

All right. Well, thanks so much, Jack. Appreciate you being with us, and look forward to speaking with you again soon.

Thank you. Yes. It's been a pleasure. Great to see you. Bye-bye.