Blackstone Mortgage Trust, Inc. Q2 FY2020 Earnings Call

Good day, everyone, and welcome to the Blackstone Mortgage Trust Second Quarter 2020 Investor Call. My name is Leslie, and I’m the event manager. Operator Instructions: And I’d also like to advise all parties that the conference is being recorded for replay purposes. And now I’d like to hand you over to Weston Tucker, Head of Investor Relations. Please go ahead, Weston.

Great. Thanks, Leslie, and good morning, everyone and welcome to Blackstone Mortgage Trust’s second quarter conference call. I’m joined today by Mike Nash, Executive Chairman; Steve Plavin, Chief Executive Officer; Jonathan Pollack, Global Head of Real Estate Debt Strategies; Tony Marone, Chief Financial Officer; and Doug Armer, Executive Vice President, Capital Markets. Katie Keenan is out on maternity leave currently. This morning, we filed our 10-Q and issued a press release with the presentation of our results, which are available on our website and have been filed with the SEC. I’d like to remind everyone that today’s call may include forward-looking statements, which are uncertain, and outside of the company’s control. Actual results may differ materially. For a discussion of some of the risks that could affect results, please see the Risk Factors section of our most recent 10-K and 10-Q reports. We do not undertake any duty to update forward-looking statements. We will also refer to certain non-GAAP measures on this call. And for reconciliations, you should refer to the press release and our 10-Q. This audiocast is copyrighted material of Blackstone Mortgage Trust and may not be duplicated without our consent. So a quick recap of our results. We reported GAAP net income per share of $0.13 for the second quarter, while core earnings were $0.62 per share. Two weeks ago, we paid a dividend of $0.62 per share with respect to the second quarter. If you have any questions following today’s call, please let me know. And with that, I’ll now turn things over to Steve.

Thanks, Weston. BXMT’s key advantages, namely our portfolio of senior loans, a well capitalized balance sheet and a market leading real estate franchise continue to provide strength and stability. We had another great quarter of portfolio income with 100% of scheduled interest collected driving $0.62 of core earnings in line with previous quarters. This performance is a testament to the caliber of the underlying real estate, the quality of our borrowers and the proactive approach of our dedicated asset management team. We further strengthened our balance sheet in the quarter by accessing both the debt and equity markets to raise $607 million of new capital, increasing our liquidity by 60% to $1.3 billion. We added a new term loan B tranche at accretive pricing, and issued common stock at a premium to book value, underscoring BXMT’s superior access to the capital markets amid a challenging backdrop for commercial mortgage REITs. In the broader markets, there was a more significant recovery, including a reopening of the CMBS market. With our increased liquidity, we are very well positioned to take advantage of the anticipated recovery and growth in origination opportunities as well as to protect our portfolio in the event of a prolonged period of disruption. And while we are optimistic about the benefits of this broader capital markets recovery, we remain vigilant and proactive on the asset management side, working closely with our borrowers, especially on those assets most impacted by COVID-19. With this wide range of activity in BXMT, the resources of Blackstone’s market-leading real estate platform continue to provide us with great advantages. Blackstone’s global real estate ownership, along with the ongoing investing activity of this $167 billion AUM business, provides real time data and insights into every market where we are active as a lender, in addition to unrivaled operating expertise. This connectivity across the platform helps us to create our existing high-quality loan portfolio that is now helping us to manage that portfolio and evaluate new opportunities. Our sponsors have stepped up and provide great support for their loans. Many of these sponsors are institutionally backed, repeat borrowers that have protected their assets with additional cash investment. With our active and collaborative management, we expect continued strong performance across our loan portfolio with a 64% origination LTV. While we believe that our senior lending strategy and proactive asset management will continue to translate to credit outperformance, we will not be completely immune to the impact of COVID-19. In Q2, we increased our CECL reserve by $57 million, primarily related to two specific properties directly impacted by the pandemic: one New York City hotel and one transitional New York City rent-regulated apartment building. In each case, it was a combination of COVID-related and asset-specific challenges that led to the impairments. Our exposure to similarly impacted properties is limited. Our total New York City hotel exposure is three loans representing 3% of the portfolio. The two additional loans each have lower leverage, 50% to 60% at the time of origination. Our total loans backed by New York City regulated multifamily properties account for less than 1% of our portfolio. As we look forward now, relative to a quarter ago, I wanted to share a few additional observations. Our Q2 repayments exceeded our Q2 future advances, all of which were financed as expected by our lenders. With transaction activities slowly resuming, we expect repayments to continue to be a source of liquidity. We also expect to see our pipeline build. Many of our market-leading sponsors have dry powder to invest in new opportunities and we are standing by to support them. We have capitalized BXMT for the road ahead, for both the continuing recovery with a potential opportunity to make new loans and for the possibility that the recovery will be prolonged for certain assets and markets. In conclusion, fueled by our second quarter capital raising and backed by our $18 billion senior loan portfolio, we have established both staying power and fire power at BXMT, ideal positioning for the current environment. And with that, I’ll turn the call over to Tony.

Thank you, Steve, and good morning, everyone. As we review BXMT’s performance this quarter, we will see positive results in terms of core earnings, liquidity and balance sheet stability, notwithstanding the isolated valuation impacts that Steve mentioned earlier. Let’s start with earnings, where we reported GAAP net income of $0.13 per share and core earnings of $0.62 per share, both of which benefited significantly from interest rate floors embedded in our loan agreements, as LIBOR and other benchmark rates declined to near zero levels during the quarter. Looking specifically at USD LIBOR, our most common floating rate index by far, we had $8.8 billion of loans with active floors as of 6/30 at an average rate of 1.47%, which we expect will continue generating incremental earnings going into 3Q as well. The primary difference between this quarter’s GAAP net income and core earnings is $57 million, or $0.41 per share, increase in our Current Expected Credit Loss or CECL reserve, which was driven by the two loans Steve referenced in his remarks. Similar to our treatment of the general CECL reserve we recorded last quarter, these loan-specific provisions are excluded from core earnings until they are realized, and at this point, we may still see a future recovery above the current mark. Further, as a result of the CECL provisions we recorded in 2Q, these loans will be accounted for under the cost recovery method going forward, which essentially defers all income recognition and reflects any cash interest received as a reduction to the assets’ carrying value on our balance sheet. Overall, our portfolio continues to be strong with 100% interest collection through July, including the two loans where we took reserve. We had an active quarter on the asset management front, completing 13 loan modifications that generally required additional borrower equity or contained other lender-favorable terms, reflecting the collaborative nature of these conversations with our borrowers and their continued support of their assets. As always, we draw on the deep experience and resources of Blackstone’s broader real estate platform, as we re-underwrite these loans and evaluate our borrowers’ positions. Our $18 billion portfolio size was roughly flat quarter-over-quarter, as $386 million of repayments slightly outpaced $317 million of loan fundings. Our weighted average risk rating remained at 3.0 on our five-point scale, the same level as 3/31 with no new four-rated loans this quarter. Our portfolio continues to benefit from a LTV of 64% reflecting the significant equity our well-capitalized institutional borrowers have invested in these assets. One of our key focus areas during the quarter has been to build on our strong liquidity position, providing us the resources to address future cash needs as well as originate new loans. We ended the quarter with $1.3 billion of liquidity, almost entirely held in cash. We increased liquidity this quarter by nearly $0.5 billion driven by our successful term loan B and common stock issuance during the quarter. Our New Term Loan B raised a net of $315 million, is coterminous with our existing term loan in 2026, and priced at LIBOR plus 4.75% with a 1% floor. We raised a net $278 million from our common stock offering during the quarter, which priced slightly above book and added $0.06 to our 2Q book value per share. We also continue to focus on the stability of the right-hand side of our balance sheet, which has no corporate debt maturing until 2022, with 96% of our asset-level financing term-matched to the underlying collateral. Further, 30% of our asset-level financing is through non-debt structures, either syndications or securitizations. And we have reached agreements with our seven largest credit facility lenders covering 84% of our outstanding borrowings to temporarily suspend credit mark provisions for the loans and those collateral pools that have been more heavily impacted by COVID-19. As part of these credit facility modifications, we pledged $414 million of previously unencumbered assets, which modestly reduce the advance rate under these facilities. We closed the quarter with a debt to equity ratio of only 2.6 times, down from 2.8 times at 3/31, as we further de-levered our balance sheet during the quarter. As we move into the second half of 2020, we will continue to benefit from the key pillars we have in place with incremental earnings power through our LIBOR floors, market-leading asset management capabilities and a stable balance sheet with ample liquidity. Thank you for your support. And with that, I will ask the operator to open the call to questions. Operator Instructions

Thank you, everyone. Your question-and-answer session will now begin. Operator Instructions: And your first question comes from Don Fandetti from Wells Fargo. You’re live in the call. Don, please go ahead.

Yes. Good morning. So Steve, obviously, you have a lot of cash on hand and made some good defensive moves. How do you balance offense in this kind of environment, because it’s still a high-risk situation in the markets and for your company? Do you think it makes more sense to be defensive for a while? Or what are your plans and how do you think about that?

Hey, Don, great question. I think our capital raising was really about the opportunity to return to offense as well as to maintain an appropriately conservative posture through the COVID-19 disruption period. We raised a meaningful amount of cash and as you know, $1.3 billion is the highest level of liquidity we’ve ever had. So we really feel well-positioned both to get back on offense — there’s not a lot of loan demand yet, but we do expect to see loan demand increase through the second half of the year — and to be very well-positioned for defense. We obviously have a lot of liquidity to defend our book and to do whatever is necessary to carry our portfolio through. So we feel that we’re ideally positioned for both offense and defense and we’ve struck the right balance.

And can you talk about the New York hotel property that you reserved for — kind of what’s going on on the ground there? Also, is occupancy increasing at the hotels in your portfolio? Can you give us a sense — are any of these at breakeven level, or are you seeing improvement at the underlying assets?

Let me first talk about the New York City hotel. It was a 2018 acquisition by a real estate opportunity fund, so that’s a lot of equity in the transaction. But with the COVID impacts on demand and operating costs, the hotel is facing an extended period of operating deficits that need to be funded. We’re in discussions with the borrower about the path forward on the asset. There is no agreement yet, but we’re still engaged with the borrower. As it relates to hotel performance generally, we haven’t really seen the beginning of the comeback yet. Some hotels have opened and in some cases we are seeing midscale, economy and drive-to hotels pick up in performance. But we haven’t seen that across the portfolio broadly. Given the potential for a second wave of COVID-19, we’re cautious, so it’s a little early to predict the recovery. Ultimately, though, the long-term prospects for hotels are favorable.

Thank you. Your next question comes from Doug Harter from Credit Suisse. Please go ahead.

Thanks. Just again on liquidity: you talked about the pipeline building but said it’s not really there yet. Can you help us size what the lending opportunity might be like in the second half? And how do you think about the minimum level of liquidity that you would want to hold versus the current $1.3 billion?

Well, as we think about the opportunity, it’s really about positioning — having the liquidity to take advantage of the opportunity that exists. We’re monitoring the pace of repayments as we look at our portfolio, but having the liquidity gives us a significant advantage. There aren’t a lot of lenders in our segment that are positioned to make loans as the market recovers. It’s difficult to predict the size of the opportunity, but we want to be positioned to capitalize on it regardless of its magnitude, and we obviously have the ability with our $18 billion portfolio and the scale of the company to be a significant participant in the resumption of loan demand that we expect to see.

Got it. And then just to follow up, is there been any sense yet or enough sort of transactions to get a sense as to what the spreads or returns on incremental loans might look like compared to pre-March?

It’s still a little early to make that determination. I will say spreads in general are wider and leverage on the loans we’re seeing is generally lower, which is what we would expect coming out of a period of volatility. We wanted to replenish our capital base to take advantage of what we think will be very good opportunities to make new loans in the early stages of the resumption of loan demand. That’s our expectation; we’ll see how it unfolds as the pipeline builds over the next couple of quarters, but we think it will be a favorable environment and we’ll be well-positioned to take advantage of it.

Thank you. Your next question comes from Steve Delaney from JMP Securities. Please go ahead.

Good morning, everyone. First, thank you for the additional data point — you gave us a weighted average LIBOR floor of 1.47%. Repayments for the quarter were about 2% of the total book; do you have any visibility you can share about what we might see over the second half of this year?

It’s difficult to predict what repayments will be for the second half. With the reopening of the CMBS market and a bit more transaction activity generally, that will ultimately lead to some more repayments. We were pleasantly surprised in the quarter that our repayments exceeded our fundings. Repayments will be a meaningful contributor to our liquidity, though not at the historic pace until the market is more regular. On the margin they will add liquidity, but the game changer in our liquidity was the capital we raised.

So you’re saying that you’ve got some three-year-old loans that are reaching a point of stability where they might return to a longer-term takeout or sale? Borrowers are mostly sitting with existing lenders in terms of attitudes?

When you’re an owner of an asset you consider whether to sell or refinance. Sellers will act when the transaction markets accommodate their assets. With our loans, we often see takeouts via sale because we finance opportunity funds and business plans that sell when stabilized. It’s still a little early for an attractive selling environment broadly, but the opening of the CMBS market makes financing acquisitions possible, which will help lead to the reopening of that market. Except for the assets most heavily impacted by the pandemic, signs are favorable for the resumption of transaction or refinance activity, which will lead to more origination opportunities for us and more repayments.

Thank you. Your next question comes from Jade Rahmani from KBW. Please go ahead.

Thank you. On the New York multifamily loan that you took a reserve on, can you give a sense as to how the reserve was bifurcated between the increased capital costs in the current environment to operate multifamily versus the impact of rent regulation? What drove the magnitude of the reserve — it seems pretty high: a 65% LTV loan with a 28% reserve implies a substantial decline in asset value. Any color on that asset would be helpful.

Sure, Jade. This is a 2014 acquisition loan on a rent-regulated multifamily asset with a plan to improve units and increase rents; they were still relatively early in that plan in 2019 when rent regulations changed. There was some renovation and improvement completed, but the asset was still in the middle of its business plan. The 2019 rent regulation changes limited the upside achievable in that business plan — owners are no longer able in the current regulatory environment to make capital investments and see the same uplift in rents. That curtailed the upside. The added impact we’re seeing now is general downward pressure from COVID in city-center apartment rents. The city lost seasonally driven demand from new hires and students, which didn’t occur this year, so we’re seeing reduced demand and meaningful occupancy pressure. For market-rate units, which we thought had better prospects pre-COVID, pressure on rent and occupancy levels has affected the near- and intermediate-term potential. We do believe the long-term prospects for this market are good, but it will take time to work through the pandemic-impacted operating environment for the city and apartments.

And with respect to New York City exposure overall, how are you thinking about that within office and hotels? Office is about 21% of the portfolio and hotels about 27% though only a few loans. Could you comment on the outlook for New York City?

As it relates to the city, there’s a lot of near-term pressure, but we are long-term believers that New York City is a good place to be and will recover after the pandemic. We focus heavily on asset selection within the city. The majority of our office assets are in Hudson Yards and Midtown West; they’re newer assets that appeal to the new economy and the talent that wants to work and live there. We’ve avoided commodity office in Midtown that’s under the most pressure, so we’re confident those office loans will perform well given asset selection. Regarding hotels, demand is down and the road out will be longer. One benefit is a hard stop to the supply growth that existed; hotel construction will largely stop and we expect the supply of hotel rooms to be down substantially from hotels that don’t reopen post-COVID. That supply reduction should benefit owners who can get through to the other side. Our other hotel loans have strong sponsorship, lower leverage and cash investment from sponsors so far; we believe they’ll be able to see those assets through the pandemic and ultimately perform well.

Okay. Thank you. And your next question comes from Rick Shane from JPMorgan. Please go ahead.

Hey, good morning, everyone. This is Charlie Arestia actually on for Rick today. What are your thoughts around maturity defaults on loans that are coming due in the near term? How are you looking to manage that, given that more borrowers are probably looking to exercise embedded extension options?

Great question. We don’t have a lot of near-term maturities — less than 10% of our portfolio has final maturities over the next year. You might see interim maturities with extension tests that won’t be met, but we’ve seen strong sponsor performance in those cases. Sponsors have made substantial cash investments in impacted assets. For example, one of our larger loans, a $750 million loan, saw the sponsor pay down over $100 million to comply with an extension test in Q2. So we’re seeing strong sponsor support on both interim and final maturities. I don’t think maturity issues will become a loan problem; rather, they’ll help create liquidity in our portfolio. As we get closer to maturities, borrowers may stretch a bit more on exit terms, but conversations so far have been favorable and have boosted loan performance.

Got it. That’s really helpful color. Thanks. And then just secondly, unrelated: are you seeing any divergence in collateral performance in the international portfolio versus U.S. assets?

No, we’re seeing very good performance internationally as well. Office in London continues to hold up well; we have transitional office buildings that continue to lease. Our assets in Spain have begun to recover as we get through the initial wave of the pandemic. European assets are well-positioned like our U.S. assets — strong sponsor equity, concentration in major markets, and favorable long-term prospects. We expect to see new business opportunities in Europe as loan demand resumes, and while loan demand hasn’t ramped yet, we anticipate more opportunities both in Europe and the U.S.

Thank you. Your next question comes from Stephen Laws from Raymond James. Please go ahead.

Hi, good morning. First, I saw you modified a number of the credit facilities and reached agreements covering 84% to eliminate near-term credit marks or suspend those for a period of time. Can you talk about what you had to give in order to get those modifications? Did you agree to lower advance rates or higher cost on those facilities? What was the trade-off to modify the credit facilities?

Stephen, I’ll take that one. We pledged some additional collateral, just north of $400 million of senior mortgage loans in our portfolio, and made some cash payments just north of $200 million. That constituted the de-leveraging of those facilities in return for which we got the suspension of credit marks through year end and additional asset management flexibility, which is important relative to loan modifications and asset management initiatives in our portfolio. We didn’t change the rates on those facilities, and we didn’t otherwise alter the terms. As a reminder, those are long-term match-funded credit facilities as part of our match-funded liability structure overall.

Just wanted to understand the trade-off. Thanks, Doug. And thinking about the business plans behind the assets you lend to — have there been material changes since COVID in March to alter those business plans for the post-COVID world? Maybe changes in office layouts, more private offices versus open space, or other modifications developers are making that you’ve already approved over the last four months?

As it relates to construction-heavy transitional deals, most have proceeded on course. We’re comfortable with new construction delivery timeframes for tenants; we have significant pre-leasing in our construction and transitional loan portfolio. For design and space utilization, we’ve seen some changes — flexible office companies can adapt more quickly, and landlords are adding distance, reducing density, and rethinking collaboration space to address immediate needs. I haven’t seen permanent changes yet that would alter long-term density materially, but landlords and owners are adapting quickly to tenant needs. That adaptability, along with highly skilled operating partners and sophisticated sponsors, is a real benefit in our portfolio.

Thank you. And your final question comes from George Bahamondes from Deutsche Bank. Please go ahead.

Hi, good morning. I had a follow-up on the CECL reserves for the quarter and how we should think about reserves being recorded going forward. Can you provide additional context around the CECL reserves and how they’re recorded? I know you mentioned revenue generation headwinds and high operating costs as key drivers. What’s the performance threshold that assets need to hit before a CECL reserve is recorded? Is it triggered when loan modification discussions begin? Is there a certain debt service coverage threshold that needs to be met? I assume it depends on the situation, but any incremental color on how to think about this going forward would be helpful.

Sure. It’s situational and there is technical guidance. There are two specific provisions under the GAAP accounting rule you would evaluate. One is modifications: if you have a modification that is considered a troubled debt restructuring — essentially taking the can down the road like we saw in the global financial crisis — the rules say you must test for an incremental CECL reserve specific to that asset. We did not have any of those this quarter. The other scenario is where you assess whether it is probable that you will collect all principal and interest due under the loan. The accounting guidance uses the term probable, which is a higher threshold and more likely than not — more than 50%, but it does not have to be extremely high. So you look on a case-by-case basis at factors like missed interest payments (we don’t have those in our portfolio), breaches of covenants or technical defaults (also not present), or conversations with borrowers that indicate a near-term change in circumstances. There’s some gray area in when exactly you trip the probable threshold. When we looked at our portfolio this quarter, we determined we met that threshold in two specific instances based on conversations and information as we flipped into July and the 6/30 balance sheet. For the rest of the portfolio, we didn’t trip that threshold. I know that’s a lot of accounting detail, but that’s the framework we use going forward.

That’s great. That’s helpful color and helpful for me today. Thank you.

That was your final question. I would now like to hand the call back to Weston Tucker for final remarks.

Okay, great. Thanks everyone for your time this morning. Please let me know after the call if you have any follow-up questions.

Thank you, Weston, and thank you to all your speakers. That concludes your conference call for today. You may now disconnect. Thank you for joining and enjoy the rest of your day.