Granite Point offers a 15% return – but for how much longer?

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I monitor the financial health of Granite Point Mortgage Trust (NYSE: GPMT), a mortgage REIT focused on commercial real estate, to ensure that my investment in the REIT’s preferred shares remains a good idea. Due to the sharp rise in interest rates and growing concerns about the general well-being of the global economy, the common unit price also began to decline.

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Focus on Q3 results

At first sight, the results of Q3 are quite disappointing. Although interest income increased, interest expense increased at a faster rate, causing net interest income to decline by more than 15% to just $18.3 million.

income statement

GPMT Investor Relations

As you can see in the image above, Granite Point also recorded a provision for credit losses of $35.4M and after deducting operating expenses of $8.4M, GPMT recorded a loss net loss of $25.5 million and after deducting preferred dividend payments, the net loss attributable to common unitholders of Granite Point was approximately $29.1 million or $0.56 per share.

While you can argue that GPM would have remained profitable had it not been for the loan loss provision, that’s hardly comforting. Even if not a single dollar would have been recorded as an allowance for loan losses, the net income attributable to common unitholders of GPMT would still have been just over $6 million or $0.12. per share. And that doesn’t even come close to the quarterly distribution of $0.25.

Even looking at distributable earnings, it’s now the fourth consecutive quarter (before accounting for write-offs) that the distribution on ordinary shares has gone uncovered.

Calculation of Distributable Profits

GPMT Investor Relations

A portion of the loan loss provision will materialize in the fourth quarter, so it may not be entirely fair to add the full $35.4 million to distributable earnings, given that there will be a blow in the fourth quarter. Or as explained in the GPMT press release:

In October 2022, successfully resolved a senior loan of $114.1 million that was in non-recognition status. The resolution involved a coordinated sale of the collateral commercial property and GPMT providing the new group of owners with a new senior loan of $77.3 million backed by new equity invested in the property by the new sponsor. As a result of these transactions, GPMT expects to realize a loss of approx. ($16.5) million, which had been reserved through the provision for credit losses.

That being said, if a $16.5 million haircut is what was needed to support the new owners and make the new loan perform well, it might be worth it depending on the terms of the new loan (we’ll find out likely after Q4 results are released as the new $77 million loan is expected to be in the top 15 largest loans). While I appreciate the decisive action to ensure an unmatured loan starts contributing to GPMT’s bottom line again, it raises questions about further reorganizations in the near future. Based on the breakdown at the end of September and knowing that the unexpired loan was a $114 million loan on an asset in Pasadena, California, the restructured loan should be the one I highlighted below. While I originally liked the relatively low LTV ratio of GPMT investments, I am negatively surprised to see a discount of over $16 million on a loan that has a stabilized LTV ratio below 60%.

Breakdown of largest loans

GPMT Investor Relations

Fortunately, Granite Point will likely be a little more conservative in the coming quarters as it aims to collect repayments but does not plan to invest heavily in new loans.

But we certainly expect to see a slowdown in the pace of repayments over the course of the year. But this is offset by the fact that we are building liquidity and being very cautious in this uncertain market. So we’re not looking to add a lot of short-term loans. So while repayments will slow down, our originations will remain quite modest in the meantime.

Although I don’t mind a speculative investment, I stick to preferred stocks

As you may recall from older articles, I currently have a long position in Granite Point preferred stock, which is trading with (NYSE:GPMT.PA) as a stock symbol.

As a reminder, the preferred shares were issued last November and the underwriters confirmed that the issue price would be $25 and the preferred dividend would be $1.75 per year for a preferred dividend yield of 7%. . As mentioned in the introduction, the preferred dividend will be reset in 2027 (if Granite Point does not call the preferred securities). The call date is November 30, 2026, and from the next preferred dividend payment, in 2027, the preferred dividend is updated at the three-month SOFR rate plus a mark-up of 583 basis points. A second interesting feature is that there is a floor: the minimum preferential dividend will be 7%, even if the three-month SOFR would be zero.

The three-month SOFR rate is currently around 4.26%, which would indicate that the preferred shares would have a return of around 10% on the principal value of $25 per share if the SOFR rate remains at the current level. But even at 3.5% for example, the preferred dividend would increase to 9.33% * $25 = $2.3325 per share. Assuming the current price of preferred shares is below US$20, this would imply a current yield of 12.1% based on Thursday’s closing price of US$19.27 per preferred share.

Stock Price Chart

Looking for Alpha

The higher the SOFR rate, the more likely Granite Point Mortgage is to call the securities if the cost of capital becomes too high. With the first call date still four years away, it’s far too early to start speculating on a call, and for now I’m happy to collect the $1.75 in annual preferred dividend payments.

Investment thesis

Based on distributable earnings, the preferred dividend is still fully covered, but after including the $16 million write-off on the California loan that was restructured after the end of the quarter, even the preferred dividend would not have been covered. . Hopefully the other loans that are currently placed in non-recognition status can be resolved soon without much impact. Finding a solution for all of these loans is important, as the lack of interest payments on these outstanding loans negatively impacted Q3 results by 8 cents per share.

While common units of GPMT are trading at almost a 60% discount to NAV/share over $15, I’m still sticking with Cumulative Preferred Shares for now.

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