Granite Point Mortgage: 7.5% Yield Preferred Shares Turn Attractive (NYSE: GPMT)

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Introduction

In November of last year, I took a closer look at the Granite Point mortgage (NYSE: GPMT) preferred stock that was issued in 2021 by Mortgage REIT. Trade as (NYSE:GPMT.PA), this is the only preferred stock issued by Granite Point and with a preferred dividend yield of 7%, I was already quite charmed by the issue both from a dividend security and asset coverage perspective. As interest rates rise, the preferred stock now trades at a discount of approximately 6% to par value of $25/share, further increasing the preferred dividend yield.

Chart
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We need to look at financial results before determining the appeal of preferred stocks

In 2021, Granite Point’s balance sheet was reduced, which weighed on the company’s interest income and net interest income. Looking at fiscal 2021 results, GPMT reported net interest income of just under $93 million. Despite this lower result, it was able to improve its pre-tax result thanks to the absence of non-recurring expenses. In fact, while Granite Point recorded nearly $75 million in provisions for credit losses and realized losses on the sale of investments as well as nearly $50 million in restructuring charges, it’s been relatively smooth sailing in 2021.

income statement

GPMT Investor Relations

That being said, the company’s net income of $68.4 million was boosted by about $11 million in one-time gains. You also see that the preferred stock dividend was only $0.8 million, but this is obviously due to the fact that the preferred stock was not issued until the end of the year. There were approximately 4.6 million preferred shares outstanding at the end of 2021, but the company issued an additional 3.63 million preferred shares in January, bringing the current number of preferred shares down to just a little more than 8.2 million preferred shares. These securities have a pro forma value of $205 million (based on the par value of $25 per preferred share) and since the preferred dividend is $1.75 per preferred share per year, the normalized amount of preferred dividends payable during in a given year is just over $14 million. .

Granite Point Mortgage used the proceeds of these preferred shares to repay a portion of the 8% senior secured loan. This is a good decision because the company used equity with a cost of capital of 7% to pay off debt with a higher cost of capital. Although only $50 million was refunded (and a $3 million refund penalty was owed), this is a good decision as it will save Granite Point hundreds of thousands of dollars per year. year: it will reduce its interest costs by $4 million while $50 million in preferred interest equity will only cost $3.5 million.

Although the REIT has a good track record of managing its risks, it does occasionally have to take a loss. In the first quarter of 2022, one of the loans related to an office building which was already accounted for as an outstanding loan, was settled, resulting in a loss of $10 million for Granite Point. A provision of $8 million had already been accounted for, so there will be an additional impact of approximately $2 million.

While a $10 million loss on a $54 million senior loan isn’t huge, it shows that even when a loan goes bad, senior creditors are usually able to limit the damage. At the end of 2021, the portfolio was approximately 99% senior first mortgage loans with an average LTV ratio of 63.5%. The distribution of LTV ratios in the image below shows that around 80% of the portfolio has an LTV ratio below 70% with only 2% of loans having an LTV ratio above 75%. This doesn’t mean Granite Point is immune to defaults, but it does indicate that it should be able to keep loan losses relatively limited.

Distribution of the loan book

GPMT Investor Relations

Another important feature of the loan portfolio is variable rate, as approximately 98% of loans are variable rate with an average markup of just over 4% on LIBOR.

Series A preferred shares are attractive

As explained in my previous article: the new preferred shares were valued on November 22 and the preferred dividend was set at $1.75 per year for a preferred dividend yield of 7%.

The preferred dividend will be fixed for approximately five years (until January 15, 2027), after which it will become a floating dividend with a quarterly reset based on the guaranteed overnight funding rate (“SOFR”) plus a spread of 5 .83%. With the SOFR at 0.3%, this implies that the preferred dividend would be reset to 6.13% of the face value of $25, or $1.5325 per share per year. Of course, there is still a long way to go until the actual reset date in January 2027, but this example helps set expectations.

The preferred stock came out of the gate pretty strong and less than a month after the issue date, it was trading at a 4% premium to par, at $26/share. But when interest rates began to rise, the value of Granite Point’s preferred stock began to decline to adjust to the net interest rate environment. On Wednesday, preferred shares closed at $23.30 for a yield of 7.51% based on the annual preferred dividend of $1.75 through January 2027.

I think preferred dividends have a good coverage ratio because we saw that even after filtering out the one-time items, the income would likely exceed $55 million. Which means that the annual preferred dividend cost of just over $14 million is still very well covered.

Balance sheet

GPMT Investor Relations

Moving on to the balance sheet, we see that Granite Point has reduced leverage as its equity ratio (equity to total book value) fell from 22.67% to 25.4%, mostly under l impetus of a smaller balance sheet and the issuance of preferred stock.

At the end of 2021, the total value of preferred shares was $116 million ($1 million in 10% preferred shares callable from June 2022) and $115 million of recently issued Series A preferred shares, which which represented just over 11% of the capital. If we include the recent issuance of an additional 3.6 million preferred shares, we can assume that the total value of the preferred shares is $206 million out of a net worth of $1.1 billion for a ratio of approximately 18%.

Investment thesis

I’m comfortable with the preferred dividend coverage ratio as well as the level of asset coverage, but I’m not convinced that the current preferred dividend of 7.51% is the best I can do on the current market, like for example the New York Mortgage preferred shares are yielding more than 8%, while the preferred shares of non-mortgage REITs like Global Net Lease and Necessity Retail REIT are also yielding around 7.1% to 7.7%.

While this preferred issue from Granite Point Mortgage Trust is certainly attractive, I don’t believe it is a “must buy now” as the current sell-off in the preferred stock market will create further opportunities.

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