Blackstone Mortgage Trust, Inc. Q1 FY2023 Earnings Call

Good day, and welcome to the Blackstone Mortgage Trust First Quarter 2023 Investor Call. Today's call is being recorded. At this time, all participants are in a listen-only mode. I would like to turn the conference over to Tim Hayes, Vice President, Shareholder Relations. Please go ahead.

Good morning, and welcome everyone to Blackstone Mortgage Trust first quarter 2023 conference call. I'm joined today by Katie Keenan, Chief Executive Officer; Tony Marone, Chief Financial Officer; and Austin Pena, Executive Vice President of Investments. This morning we filed our 10-Q and issued a press release and 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. 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 audio cast is copyrighted material of Blackstone Mortgage Trust and may not be duplicated without our consent. For the first quarter, we reported GAAP net income of $0.68 per share, while distributable earnings were $0.79 per share. A few weeks ago, we paid a dividend of $0.62 per share with respect to the first quarter. If you have any questions following today's call, please let me know. With that, I'll now turn things over to Katie.

Thanks, Tim. BXMT's results this quarter stand in clear contrast to the negative macro backdrop. We reported $0.79 per share of distributable earnings, an increase of 27% year-over-year. Our earnings covered our dividend by a considerable margin of 127%. Our credit performance was steady with no defaults. Our CECL reserve increase was therefore modest and more than offset by the earnings we retained in excess of our dividends, maintaining our book value. And we ended the quarter with a substantial $1.6 billion of liquidity to insulate our balance sheet and capitalize on opportunities. More than a year into one of the most aggressive Fed tightening cycles in history, the resilience of our business continues to come through in our results. For the outsized income across the 97% of our loans that are performing, offsetting the challenges of the 3% that aren't. We've taken our reserves up substantially, 2.7 times over the last year. For the strong current dividend we've delivered far outstrips the book-value impact of these reserves for our shareholders. On the current share price that return dynamic is even more powerful. We're trading at a 14.7% dividend yield and an 18.7% earnings yield with significant downside protection given the deep discount to book. Being a lender is distinct from being an equity owner. Today the divergence is particularly meaningful and the economic experience along the way. As a floating-rate lender, our cash flows are growing and the interest we collect on each loan, each payment date derisks our return and that of our investors with every passing quarter. This is the power of current income, a critical differentiator for any business in a volatile period. And in addition to the significant cash flow generation of our portfolio, as a senior lender, we start with a 36-point margin of safety. Credit enhancement ensures value declines are first absorbed by the equity before we feel any impact on our recovery. Put in a different way, if the value of an asset is down 10%, 20%, or even 30%, the expected outcome is the same, full recovery of our loan. We are well aware of the liquidity challenges and credit headwinds in the market, and they are not new in the last 90 days. We proactively positioned the business to withstand them. Starting with our first principles of low leverage floating rate senior lending and a well-structured match funded balance sheet, and more recently with a conservative strategic positioning we adopted a year ago. At the outset of 2022, we raised the bar on originations, shifted our asset management strategy to reduce credit risk at every opportunity and executed on the plan to bolster liquidity ahead of the volatility, raising $1.2 billion of fresh capital during the year and terming out all of our corporate debt. We will not be immune from credit impact, especially in the office market. That is why we have both significant reserves against our most challenged five-rated office loans, over 20% of carrying value on average, implying roughly 50% reduction in real estate value from origination. We are realistic that there will be more challenges over the coming quarters. Hence, our watchlist. But our four-rated and five-rated office loans remain just 7% of our overall portfolio. We have been extremely proactive in managing our office loans. On many of our four-rated office deals, we are in active negotiations for additional equity commitments, something we have already achieved on 16 office loans in the last year, including two on the West Coast, just in the last few weeks. This quarter, we were paid off on $300 million of office loans, adding to the $1.5 billion of office repayments we collected last year, reflecting the benefit of our basis and position as a senior lender. 25% of our overall loan portfolio is U.S. office. While our pre-COVID underwriting did not contemplate today's hybrid work pressures, we've always been deliberate and selective about real estate quality, location, and sponsorship. As a result, we believe our office portfolio is meaningfully better positioned than the market as a whole. Across the top U.S. markets, less than 5% of office stock has been built since 2015. But our performing portfolio is nearly 50% post-2015 ground up or substantially renovated new construction. In contrast to the capital-starved assets that populate the CMBS market. As a transitional lender, our assets by definition have gone through recent CapEx plans, making them better positioned to compete for tenants, particularly as capital for renovation and leasing costs becomes more scarce. We have substantial concentration in Europe and Sunbelt markets. Together, 48% of our office portfolio where fundamentals are more stable. Moreover, the office risk is deeply priced in to our market valuation. We are trading today at 0.64 times book-value. The dimension of the losses and fires equates to an impairment of over 90% across all of our four-rated and five-rated office loans. Effectively a full principal loss on first mortgage loans. This is extremely punitive and credit outcomes take time during which period we benefit from current income. For the five-rated office loans we put on cost recovery as of the beginning of the year, we have already reduced our basis as we continue to collect interest across all of our loans including needs. And all else equal, our highly attractive dividend would remain covered by DE, even if we place all of our four-rated office on cost recovery as well. Across the overall portfolio, we are seeing strong performance. For multifamily, hotels, essential retail, and many other segments of the real estate market, cash flows are robust. So rent growth has decelerated in some areas, absolute rents are still well above levels at origination. Rising costs in capital markets and liquidity have significantly reduced the new supply pipeline. As a result, we see business plan progress, as well as repayments despite the highly liquid environment. We had 10 upgrades this quarter, primarily multifamily and hotel loans. This included a four-rated New York City hotel, reflecting a strong cash flow growth over the last 12 months. We see the same recovery story across many of our four-rated hotel loans as well as in the one-two-three risk rating segment of our portfolio. Our upgrades also included one of our largest office loans, Burbank Studios, a Frank Gehry designed trophy new build asset where construction is substantially completed and Warner Media took occupancy. Unsurprisingly, given the environment, we saw some downgrades as well, primarily office loans in New York and San Francisco. Altogether, our weighted average risk rating has moved negligibly in the last year, reflecting improvement across many assets balancing the deterioration we see in some segments of our office portfolio. Today, one-rated and two-rated loans represent 29% of our portfolio, the highest level since before COVID. Nearly $600 million of loans repaid this quarter with more than half in office and the remainder virtually all in retail and hotel. While we continue to expect the absolute levels of repayments to be tempered, the diversification of our portfolio makes them likely to continue apace. New originations will also be measured, a result of the much lower transaction environment as well as our preference for maintaining maximum optionality in this environment, which we can well afford to do given our robust earnings power. As a balance sheet lender, our earnings are not dependent on the pace of new originations, but rather on the interest income we derive from our well-invested portfolio. And that income is at near record levels. There is no doubt the coming quarters will continue to be challenging. We expect short rates to remain elevated. The failures in the regional banking sector will likely tighten the regulatory environment for all banks. While long-term rates are lower, recession concerns are driving sustained dislocation in the capital markets. But for our business, we have not lost sight of the opportunity on the other side of this storm. Direct lending is tailor-made for this environment. Many banks will have less money to lend and their capital will be more expensive. With quickly changing markets and more opaque underwriting conditions, fewer platforms will have the real-time knowledge to skillfully assess opportunities. Available lending capital will become more scarce and command a higher return. While the transaction environment is subdued at the moment, the passage of time will eventually push deals into the market. We started the Blackstone real estate debt business in the aftermath of the global financial crisis, stepping into the void of a similar realignment of the bank regulatory framework. Since then, we have built a $60 billion AUM platform with truly differentiated information, expertise, relationships, and investment talent. On the other side of this turmoil is a singular investment opportunity for our business, and no platform is better equipped to capitalize on it than Blackstone. And with that, I will turn the call over to Tony.

Thank you, Katie, and good morning, everyone. This morning BXMT posted another quarter of strong earnings. Providing clear support for our stable dividend and a compelling return for our stockholders. Our 1Q GAAP net income of $0.68 per share is up considerably from last quarter's GAAP net loss of $0.28, with no significant CECL reserves running through our results this quarter. Our distributable earnings or DE remains strong at $0.79 per share for 1Q, roughly in line with the earnings we generated in the fourth quarter, excluding the notable $0.07 prepayment fee we received in December and highlighted on our previous call. This consistent level of DE reflects the continued performance of the vast majority of our floating-rate loan portfolio and the continued benefit of rising rates, which added about $0.04 per share to our 1Q earnings. This was counterbalanced by a handful of loans on cost recovery status or the interest we collected this quarter, about $0.06 per share, which did not generate earnings, but instead reduced our basis on new loans. Similar to last quarter, we continue to collect all amounts due from our borrowers including these cost recovery loans. Lastly, our book value per share of $26.28 was slightly up for the quarter as our delivery to retained earnings outpaced our modest 1Q CECL reserves. On the topic of CECL, we recorded a net reserve increase of $10 million this quarter, primarily related to asset-specific reserves. Our general reserve was up slightly quarter-over-quarter after a significant increase in 4Q to reflect the more volatile macro-environment. In terms of asset-specific reserves, we recorded one new impairment against a small office loan in Brooklyn, which we also moved to cost recovery accounting. This was significantly offset by CECL reduction driven by incremental cash flows collected from one of our previously impaired loans. Our total asset-specific CECL reserve of $197 million represents about 20% of our five-rated loans. We are carrying an aggregate of $352 million or $2.04 per share total CECL reserve as of 331. This reserve reflects our quarterly bottoms-up, loan-by-loan analysis to identify impairments and risk in our portfolio, as well as the impact of broader macroeconomic conditions. Our 1Q risk review also resulted in seven loan downgrades and 10 upgrades reflecting the migration of our portfolio away from atypical three ratings. Certain loans remain challenged while others advance the business plan and improve our credit position. Continuing on credit, we added an additional metric to our reporting this quarter, net loan exposure, to facilitate understanding by investors of where credit risk may lie in our business. This metric takes our existing disclosure of gross loan portfolio and excised our senior syndications and CECL reserves, resulting in a net credit exposure we have to each loan. GAAP treatment of loan syndications sometimes accomplished through sales and sometimes synthetically through uncrossed, non-recourse term match loan structures. Areas depend on the legal structure of each transaction. Some structures remain on balance sheet, while others do not, but all accomplish the same economic outcome of limiting our capital at risk to our net subordinate position. Our net loan exposure creates parity among all syndication structures and properly reflects the credit risk we have sold for the senior portions of these loans, as well as where we have already taken loss reserves against our portfolio. Our 10-Q also includes net loan exposure as of 12/31 to show how our portfolio has migrated in 1Q on an equivalent basis. Turning to the right-hand side of the balance sheet. Our capital structure remains well insulated from market volatility with stable asset level financing, long-dated corporate debt, and ample liquidity. While our financing activity was light in 1Q given the slow transaction environment, we continue to benefit from our deep banking relationships as part of the Blackstone franchise and the structure of our financing, none of which allow for margin calls driven by market-based valuation. Further, 63% of our total financings are fully non mark-to-market either structurally immune from any form of margin call or mark-to-market provisions limited to default assets only. Our liabilities are term matched for assets, eliminating the risk of duration mismatch. Following the $220 million repayment of our convertible notes this quarter, we have no corporate debt maturities until 2026. Our adjusted debt-to-equity ratio of 3.5 times is down slightly from 3.6 last quarter reflecting the benefit of 1Q retained earnings and $150 million of net principal cash flows from our portfolio. As $594 million of repayments outpaced $444 million of funding under existing loans. This partial deleveraging has also contributed to our $1.6 billion of liquidity at quarter end, consistent with our effective liquidity at 12/31, at a level we have established to manage our business through a period of generally less liquid capital markets and stress in the banking system. Our liquidity is composed of cash on hand and immediately available undrawn borrowings under our revolving credit facilities, concentrated with top global banks with no exposure to Credit Suisse, Signature Bank or other high focus banks. We believe the strength of our portfolio and our defensive posture with respect to our liquidity and capitalization will allow us to continue delivering consistent, reliable, current income for our stockholders as we continue to navigate in a more challenging macroeconomic environment. With that, I'll ask the operator to open the call to questions.

Thank you. We'll go first to Steve DeLaney with JMP Securities.

Good morning, everyone, and thank you for the question. Prepayments $600 million, it looks like it represents only about a 9% annualized rate. And that would just on the surface would appear to be low on loans with a three to four year life expectancy. Katie, I was just wondering, if we're sort of in a shock-and-awe moment maybe here with the bank failures, et cetera. Looking out for the balance of 2023 and into early part of next year, where do you expect prepays to kind of settle in? Do you expect them to be a little higher than what we saw in the first quarter? Thank you.

Thanks, Steve. So certainly, we saw a slower pace of repayments this quarter which, I think we expected and have been talking about for a while. It's a natural impact of the capital markets illiquidity and everyone sort of going to the sidelines. Obviously, our portfolio remains well-invested. We're able to sort of match the repayments and make sure we keep a well-invested portfolio and strong earnings power. I think looking ahead, there are a couple of elements. One, I agree with you that I think as the market sort of settles in, we'll see a bit more. We have a lot of loans in the portfolio that are stabilized and certainly available in a good place from their business plans to be repaid, sold, refiled, et cetera. I think the other element is, looking at the five-year and the 10-year, they have obviously come down quite a lot and stabilized. So I think that when you think about liquidity in the fixed-rate market, whether it's the agency, CMBS, insurance, all markets that we're seeing much more active. I think that's going to result in more turnover over time. I think from our perspective though, what's really most important and what we've seen in the history of our business is that origination volumes and repayments are certainly lumpy. We have periods when they are very high, we have periods when they are lower, but they tend to be very well correlated. And we expect that to continue as we look out for the balance of the year.

Great. I appreciate that. And my follow-up, 5% of your portfolio is in Ireland, including your large $1 billion office portfolio loans. Could you talk a little bit about leasing conditions there in the Dublin market? We know there is some political unrest picking up again, unfortunately. And the work-from-home, WFH, is that similar in Europe and in Ireland, as we're experiencing here in the States? Thanks.

Sure. So, I would say, as a general matter, when we look at Europe and the office markets there, we see a lot more stability, lower vacancy rates, more positive dynamics on rents, those markets on the office side, historically, have had a lot less in the sort of leasing concession, amenity, dynamic, and so the economic experience of owning an office building in Europe, especially a new quality, high standard office building is quite different from what we see in the U.S. I would say as far as Dublin and Ireland, particularly, the portfolio we have, they are the large one. It is actually across a portfolio of office and industrial. The industrial has been extremely strong. The office has been very stable, well-leased, long-duration leases with multinational tenants. So, from our collateral perspective, we're in a very stable place. As the market at large, there's obviously more tech exposure there. I think that will take time to play out. But the dynamics that make Ireland a strong long-term market, cost of living, well-educated population, English-speaking part of the Eurozone, we feel good about those dynamics over time and as far as the near-term performance of our collateral, we see a lot of stability there as well.

Great. I appreciate those comments and I do note that there are some technical difficulties.

Thanks.

We'll take our next question from Sarah Barcomb with BTIG.

Hi, everyone. Thanks for taking the question. So you spoke to preserving liquidity in the current environment and we didn't see any new originations. I was hoping you could first talk about some of the spreads that you saw on any deals that didn't cross the finish line relative to the previous quarter. And also the attractiveness of maybe buying back stock and debt versus new originations going forward.

Sure. I think on the investment environment, the spread dynamic we're seeing is certainly still attractive from an absolute perspective. I mean, spreads are certainly wider than they've been. Base rates are obviously higher. I think the challenges from an origination perspective, we're also very focused on credit and higher spreads, higher base rates means more interest burden. We're very focused on DSCR, making sure the deals stand up to the return we want, but also the risk profile we want and also not compromising on the quality of borrowers and investment collateral that we target. And to bring all those things together, we have not seen a ton of deals that meet that bar, again really because the transaction environment is so slow. I think transaction volumes were down like 50% year-over-year. And even more so in sort of larger assets, so it's a very slow environment. But we continue to look at things, and I think that spreads are wider for deals that we see. There are also other interesting investment opportunities that are starting to crop up, especially the potential to buy seasoned portfolios at a discount, where you have legacy lower spreads, but you're buying them at a discount, so the return works for a lender, but the DSCR math is a little bit easier. So I think we're starting to see that, but really the position we're taking is maintaining that maximum optionality, because we think the more interesting investment opportunities are really to come. We haven't seen a lot of them yet, and we really want to have the dry powder to address those very compelling investment opportunities that we think might come. I think as far as looking at various parts of the capital structure and buybacks, certainly we think that the way the various parts of the strict capital structure are trading are not reflective of the risk profile. I spoke to that a bit in my script. And so we always look at that, but I think we're also again, really focused on maintaining that maximum optionality for our business to address what we think may be a very interesting environment.

Okay. Great. And then, I was hoping for a little bit more detail on that new five-rated, New York office loan. Could you talk about what was happening on the ground there?

Sure. So that's a very small loan in our portfolio, it's an asset that we have reduced our basis in over time, but ultimately sort of hitting a decision point around maturity. It's time for us to put it on five-rating and take what we think is an appropriate impairment. And we are working with the sponsor and I think we both expect to bring it to a close over the coming quarters. It's a well-located asset maybe has an alternative use away from office. Overall, it's a small loan and not particularly impactful to the overall portfolio.

Great. Thank you.

We'll take our next question from Doug Harter with Credit Suisse.

Thanks. Can you talk about what loans you have maturing in the next 12 months and how those conversations with sponsors are going about maybe needing to put additional equity in order to get an extension or to refinance?

Absolutely. So we don't have a ton of maturities over the next 12 months or 2023; the numbers I have are 7% of the total portfolio, and 13% of our office portfolio. I would say, as we look ahead at the maturity, they do really fall into a couple of categories. There are a number of loans we've already addressed. We've gotten significant pay downs from sponsors, reduced our basis and put the loans on a stable position. There are other loans that we have a clear path to repayment, so under for refi, et cetera, and I would say, especially on the office side the rest of the sort of 2023 maturities that don't fall into those two categories, we've already put on the watch-list. So we really don't see a lot of additional risks in that segment of the portfolio. And I think that as far as the conversations with the sponsors, the tenure has been very good. I think one of the benefits of having the types of sponsors we have is they have a lot of capital. And obviously, they also have to see equity value to protect over the long term, you need the ability and the desire to protect the asset, but having sponsors that have plenty of capital makes the conversations work better. And we've been very successful over the last year getting pay downs on loans from well-capitalized sponsors and putting them on stable footing to get through this period. I think in the last year, we got about $500 million of incremental equity just on office loans, which I think is again just a good indication of how we're able to negotiate with our sponsors, the quality of our assets, the basis we have, and the equity value our sponsors feel they have to protect.

And can you just remind us on your typical loan or they recourse, back to the sponsor or is it like CMBS where if they don't see equity that they can kind of hand the keys back to you?

Yeah. I would say it's in-between. We are primarily non-recourse lenders, so we don't have a lot of principal payment guarantees in our loans, but we do have a lot of very thoughtful other structures, whether that's carry guarantees, completion guarantees, equity contribution guarantees, or other forms of structure in the loan that allow us to, along the way, improve our credit positioning as we go through these conversations with our borrowers. So, that's the approach we've taken and I think that we found over the last year that these structural elements that we've always baked into our loans, which really didn't come into play for a lot of the last 10 years have proven to be incredibly valuable in terms of being early warning signs and allowing us to have those positive credit outcomes early, not necessarily have to wait until maturity to touch our loans and improve our credit position.

Great. Thank you, Katie.

We'll take our next question from Stephen Laws with Raymond James.

Hi. Good morning, Katie. Good morning all. And I guess, Katie to start, I wanted to follow-up really on Sara's question, but I know liquidity is in a defensive position to party here, but given your comments in the prepared remark about the disconnect between valuation, and what that implies on loss severity across parts of your portfolio that seem to be unrealistic. What are the thought processes around stock repurchases or debt buying back debt when you do decide it's time to lean in. I mean, how do you think about the repurchase opportunity versus a return on new investment, given the current valuation of the stock?

Yeah. I mean, I think it's a constant evaluation. I mean, we’re obviously looking at all the different opportunities both within the portfolio and outside of the portfolio. The investment opportunities that we think are coming and again, maintaining that optionality. So, I think it is all of the elements I mentioned and it's a constant evaluation. We certainly see the value of the various parts of the capital structure and spend time thinking about it. But again, just looking at all of those different options and I think optionality is most valuable right now. But as we see things play out, some repayments in our portfolio, et cetera., certainly something we consider.

Thanks. As a follow-up, I would like to delve deeper into Doug's comments regarding your insights on structural protections in loans. There seems to be significant discussion around interest rate caps. Could you provide details about how many of your loans include these caps, when they were implemented, their duration, and whether they originated with springing caps? Additionally, I would appreciate any insights on other structural protections in loans that may enhance the ability of borrowers to make interest payments. Thank you.

Absolutely, I think over time, we've been really successful in maintaining the credit protection on the interest coverage in our portfolio. We continue to have 95% of the portfolio with either rate caps, carry guarantees or very significant interest reserves and so I think that's one of the reasons why we continue to see a 100% interest collection in our portfolio, and obviously that cash income coming in derisks our return and derisks our basis. It's something we anticipated and that we were very disciplined on in terms of structuring these loans going in and I think that it's proving out over time. The rate caps, the way they usually work is they follow the maturity schedule at the loans that we have had a lot of conversations with borrowers and add extensions to extend the rate caps and I think that 95% number sort of tells you what you need to know in terms of how those conversations have gone. I think that other structural elements we have in our loans, I cover some of them earlier, but we have a lot of hurdles, leasing hurdles, extension tests, cash flow sweeps. So when we see cash flows moving in the wrong direction, we started sweeping cash right away in a lot of cases and that's proven to be difference-making in some situations, so it's really the function of being a thoughtful transitional lender. When we set these deals up, we really thought carefully about how we were going to put guard rails into our loans to be early warning signs and really just keep us out of the danger zone, if we saw things moving in the wrong direction. Not perfect, we obviously have some loans that are challenged and where we sort of exhausted all of those remedies. I will say in a lot of those cases, the structure we had along the way has mitigated our basis on those loans. So whatever the ultimate outcome will be, we have benefited over time from deleveraging or other credit enhancements over time, and that will mitigate our exposure when we ultimately come to a conclusion on these loans. But, I think that it's really been a hallmark of our business to think carefully about how to keep ourselves out of the danger zone as much as possible using those structural protections from originations.

Great. Appreciate all the color on that, Katie. Thank you.

We'll take our next question from Don Fandetti with Wells Fargo.

Hi, Katie. I guess one of the challenges in this environment is just the lumpiness of the reserve build. As you look at your reserve, it reflects the risk as you see it today. So would you be surprised to see like a meaningful reserve build in Q2 as you sit here today?

Well, I think as we sit here today, obviously our reserves reflect what we see in the market. But I think that it's absolutely appropriate to know that we're in a dynamic environment, conditions can change over time in either direction. We obviously had a reserve release this quarter on one loan, but I think it's certainly possible that we could see more reserves over time. I think when we think about it though looking at watchlist percentage of our portfolio, particularly the office loans. Our four-rated and five-rated office loans are 7% of the portfolio. So thinking about the potential for reserve build, I think as we see it today, it's really within that universe of assets. A lot of them were working on positive margin, as I mentioned with our borrowers, more capital coming in et cetera. We also have many examples of four-rated loans over time either repaying, being upgraded, or staying as performing loans for quarters or years. So I think the environment is dynamic, we go through a rigorous process, we've obviously raised our reserves quite a bit over the last couple of quarters. But we don't have a crystal ball. It is a pretty illiquid environment and things could change, but I think, big picture, the universe of where we see challenges in the portfolio, it's a small portion of the portfolio, the materially higher earnings of everything else is really a very significant offset. And today, the performance has been very strong, a 100% collection, no defaults. The challenges in the portfolio really limited to a pretty small overall percentage.

And I think in the prepared remarks, there was a mention, the discounted book market supplying significant 35% type discount. What do you think the disconnect is where investors sort of don't appreciate your office risk? Is it just the kind of new Class-A high quality like where do you think the disconnect is?

Well, I think that in this environment where it's really sort of a risk-off environment. There's a lot of broad brush going on in the market and people sort of trading schemes and thinking about the big picture versus spending the time to really dig into each individual business and its positioning. I think you can see that from the fact that a lot of the sort of most recent challenge and market trading performance came with the regional bank failures, which was an overall challenge in the market, but obviously not directly impactful to our business or really many of the others in the space, but clearly, we felt that in that trading performance. So, I think it's really just a broad brush approach to being risk-off on commercial real estate as a whole, obviously broader office concerns and perhaps just lack of sort of deep dive underwriting of what's going on in each individual portfolio.

Thank you very much. First question would just be squaring the very modest CECL reserve levels with what numerous banks have reported thus far this quarter. It does seem disconnect, it seems out of trend with what many of the CRE concentrated banks are reporting with an average CECL reserve on their overall CRE loan books of 2.05%. Yeah. They should have lower LTVs more stabilized assets than the commercial mortgage REITs, so. Just an overall question about how you think about the CECL reserve in context with a $25 billion portfolio that has a predominant in office and is transitional and the rightsizing of that reserve.

Thanks for the question, Jade. I guess the first comment I would make is that we are very comfortable with the level of our reserves, this goes, I mentioned in my remarks, this goes through a detailed ground-up, loan-by-loan process in a SOX controlled environment that's subject to audit. First and foremost, we believe our reserves are totally appropriate. When you think about comparing us to the banks, we're running at about 1.5% of our portfolio in terms of our total CECL reserve. I think it's important to differentiate our business from the banking model, right? We don't take deposits. We do not have the leverage they do. We are not regulated the way that banks are. When the CECL rules came out, excuse me, they are very analogous to the CCAR reserving that banks have to do for regulatory capital purposes. And a lot of banks leverage their CCAR models or in some cases just use their CCAR models for CECL. That is a much more macroeconomic statistical top down view, which I think is appropriate if you're a national bank with hundreds and thousands of loans that you can't necessarily go through loan-by-loan, as we do for our 199 loans. So I think there's a little bit of a procedural difference in terms of how banks approach CECL and how we do. And then your comments on the composition of the portfolio. We are a transitional lender, but I think Katie mentioned in her remarks, we are benefiting from that business model where the assets that collateralized our loans are able to pursue business plans and improve their cash flows and make it improve our credit position. Although we do have a focus on office which may be outsized relative to some comps in our space or the banks. If you take out the European component, which we covered earlier, it is a fairly different story. You're left with about 25% of the portfolio in U.S. office and about half of that in Sunbelt or new-build office collateral. So that is a relatively modest portion of our portfolio that is probably more comparable to the generic office portfolio you might see if you're just looking across the market in general.

Thank you. As a follow-up, I was just wondering if you could comment on a few of the downgrades. The San Jose office, the San Francisco office, New York mixed-use, New York office, and I think also, if I recall correctly, in New York multifamily. Can you comment on some of the downgraded loans and the outlook there?

Yeah. I think the New York multifamily was from last quarter, but as far as the recent downgrades, I think you hit it, they're all office loans primarily. New York, San Francisco area where liquidity is particularly challenged right now. Certainly looking ahead, as I mentioned at the sort of 2023 maturity decision point, but engaged in very constructive conversation on a lot of them. I think it's also worth noting at this point when we look at our office with near-term maturities and that's sort of non-new build assets we have in these markets, there's not a lot that we hadn't put on the watchlist because for obvious reasons. We're focused on the prospects of what's going on with these types of assets. So I think that they reflect the risk we've talked about in our portfolio. They really are, they do stand apart from a lot of the rest of the office which, as I've mentioned, and Tony mentioned, 50% newer substantially renovated since 2015, a lot of Europe and Sunbelt, a lot of new equity coming into our deals, low basis loans. And so we've tried to identify where we see most susceptibility to risk, and it's in those older vintage more challenged markets and where we see less susceptibility to risk, and that really comes down to flight to quality, better quality buildings and markets that have less of a challenge from a fundamentals perspective like the Sunbelt, like Europe.

We will now take our next question from Rick Shane with JPMorgan.

Thanks for taking my questions this morning. Katie, you mentioned that 95% of the loans have rate caps. I didn't catch, did you mention how long the weighted average remaining life of those caps is?

It's 95% of the loans that have rate caps or other carry guarantees. The duration varies significantly, but it tends to align with maturities. We've maintained that 95% rate for as long as we've been monitoring, which is probably over the last year. During this time, we've faced many maturities and had extensive discussions with borrowers, successfully keeping those caps in place. Considering the current shape of the yield curve, while there may be debates about the Federal Reserve and interest rate changes, looking ahead for the next one to three quarters, the cap dynamics seem to remain quite stable.

I understand. What I'm trying to clarify is that you mention these are linked to the maturity. However, there is both an initial maturity and a maximum maturity. We tend to focus on the maximum maturity, where most loans typically have a two-year extension option. Are these related to the initial maturity, or are the caps actually associated with the maximum maturity? This distinction is quite important.

No, absolutely. I mean caps are tied to initial maturity, but the caps are required to be renewed as part of the condition of extension caps, and that's where I get at the fact that we have been very consistent and successful in getting those caps renewed at each point where they come to an extension test.

Understood. But I assume that borrowers are considering their decision as those caps have significantly increased in cost at this point. So today, the impact of the floating-rate portfolio has really not been neutral between you and the borrower; it's been balanced between you, the borrower, and a counterparty on the cap. Presumably, as those caps mature and you reach initial maturity, a larger portion of the cost of higher rates will actually be incurred by the borrowers.

Yeah. That's right. And I think that the fact that we have maintained our interest collection and maintained the cap experience in our portfolio indicates how that structure has worked. At the end of the day, the borrowers have to pay the interest on the loans and whether that comes in the form of a lower strike price rate cap or a higher strike price rate cap that they then deposit the difference in an interest reserve or they're just putting the growth look forward interest amount in an interest reserve. There are a lot of thoughtful ways we can cut it, but at the end of the day, I think we're benefiting from the requirements we have in our loans and the ability to ensure that our interest is well sourced, whether it's from any of those areas that I mentioned. It really just comes down to the fact that we can get effectively a prepayment of interest in one form or another when we hit these extensions.

We'll take our next question from Arren Cyganovich with Citi.

Thanks. Yeah. I just wanted to follow up on the maturities question. You have two that are maturing in this quarter. One actually, I guess, already matured was an $84 million rated-five office loan in April, and then there's one looks like next week, $345 million, it's four-rated. What are the conversations like on those two specific loans?

As I mentioned, the near-term office loans maturing in 2023 fall into two categories: either we have clear visibility on repayment or they are on our watchlist. For the ones we discussed, the five-rated loan remains at that rating, and we are actively engaging with the borrower to resolve it. If market liquidity allows, both we and the borrower would be eager to move forward. Ultimately, our discussions aim to maximize value for our shareholders, and we are exploring all options to achieve that in a cooperative manner. The borrower is currently not willing to invest additional capital, which is why the loan is rated five, and we have set a suitable reserve for it. It is a relatively small loan, and we anticipate resolving it in the near term if possible. The larger loan, on the other hand, involves a well-capitalized, strong long-term borrower, and we are actively working with them to stabilize the loan for the coming years.

Thank you. The smaller loan had an original LTV of 64, and while there is significant equity helping to protect it, what has surprised me so far in this early part of the cycle is that there are individuals willing to walk away. They are leaving behind a substantial amount of equity because they perceive the value to be lower than expected. This reflects a significant drop in office value. From our perspective, it is challenging to assess why one situation is unfavorable while others may be better. Any clarity you can provide on these differences would be appreciated, as it seems to contribute to the current discount in your shares due to the uncertainty surrounding that issue.

Yeah. No, I think that makes a lot of sense. We obviously talked about that a fair bit on last quarter's call. I think when you look at the new five-rated loan and the ones we downgraded previously, they really do share a commonality and that is older vintage loans in a non-core location. So the new 5 is in Brooklyn, our previous downgrades we've had outer boroughs Washington DC. Assets that targeted relatively niche demand base that has really changed, so as we mentioned last quarter, GSA being amongst common one from that perspective. And in some cases sponsors who are at the end of their fund lives or may otherwise have other considerations away from the deal. But of course, the value of the deals impacts their view. And I think, as I mentioned in the script, we are very realistic about the value of certain types of office having declined significantly. But I think that it is really important to know that it's non-monolithic; it's not across the board. What we're seeing from the fundamentals for newer-build high-quality office is positive net effective rent growth, a 10-point differential in occupancy level pretty consistently across markets. Positive net absorption, much less sublease space, all of those fundamental dynamics that really do make a difference on individual assets. The real estate market, every asset is its own underwriting, its own location, its own dynamics and I think that sort of core to how we've approached this business. And so when we look at the composition of the portfolio, we've tried to be very clear about where we see most susceptibility to risk, and it's in those older vintage more challenged markets and where we see less susceptibility to risk, and that really comes down to flight to quality, better quality buildings and markets that have less of a challenge from a fundamentals perspective like the Sunbelt, like Europe.

We'll take our next question from Jade Rahmani with KBW.

Thank you. Could you provide an update on two loans? One is the Chicago loan amounting to $310 million at One South Wacker. The other is regarding the Woolworths building. What is the status of these two loans? Woolworths is definitely historic, but it requires repositioning and re-evaluation. Please share your thoughts on these loans. Thank you.

Certainly. Regarding the two loans you've mentioned, both have been placed on our watchlist as indicated in our portfolio overview, largely due to the liquidity of their market locations. They have both performed well, and the sponsors are actively involved in their management. Each of these loans falls into a category where we are having constructive discussions with the sponsors about increasing equity in the deals. Additionally, we have observed recent leasing activity at both sites. Given the locations and the nature of these assets, it makes sense for them to be on our watchlist. However, both properties are demonstrating ongoing solid performance. One South Wacker, located in an excellent area, has undergone a strong renovation and offers great amenities. Woolworths has remained a consistent performer, benefiting from its advantageous location and strong appeal for tenants. Overall, we see stability in these assets and are actively engaging in discussions about their future, hence their place on the watchlist.

Thank you. On the liquidity side, so you have over $500 million in cash. So the remaining liquidity is primarily undrawn repo capacity, what exactly is it? And to put new loans on repo requires repo lender approval, correct?

Sure, Jade. I can jump in. So correct on your last question, but that doesn't relate to the liquidity point, so the way I would think of it as you said is correct, the rest of the balance is availability under our credit facilities, but that is not conditional availability. The way I would think of that is, we put a $100 million loan on our credit facility, get it approved by the bank, it's pledged, it's locked. And we can borrow $80 million against it. Once we have that approval for $80 million. We can revolve that balance up and down, just like any other revolving credit facility you might have. So we paid down $40 million, because we had excess cash sitting around, we can call the bank and get the other $40 million back basically the next day, and they don't have any approval mechanics. So the $1.1 billion or so of liquidity that we quote, which is the availability under the credit facilities is that dynamic, I just described where it's basically as good as cash in 24 hours. The availability under the credit facilities to post incremental assets which would require approval of the banks that is not in our $1.6 billion, that would be upsized, if we actually had new assets put on and approved.

So in an environment of declining asset prices, which we are in clearly, the repo lenders won't require updated appraisals on the underlying collateral since they've already previously approved it?

No. Generally, no, they don't. And we don't face valuation-based capital markets margin calls on our facilities, so that's not really the dynamic that we face.

And how generally are they speaking to you about their exposure? I see that the advance rate on your term loans on your asset-specific financings and CLOs is close to 80%, but much lower on the repo side; are they, I know you're leaving cushion and liquidity available, but are the repo lenders concerned at all about, you know, the underlying value of the collateral?

I want to highlight that we have very active and constructive communication with our lenders; we engage with them daily and weekly. They are fully informed about everything in our portfolio, and it's important to understand that these credit facilities represent a comprehensive view of our portfolio. As I mentioned earlier, our four-rated and five-rated office makes up 7% of the overall portfolio. The remainder of the portfolio is performing very well, which is reflected in the credit facilities' diversity. Our lenders also have strong relationships with us; they trust our ability to manage the collateral effectively, utilizing all the resources available to us. They value our ongoing discussions about the strong performance of most of their collateral. These conversations have consistently been positive. As Tony noted, our ability to adjust the credit facilities is independent of the credit analysis. On the credit analysis front, we have maintained good dialogue and received favorable treatment from the banks, which reflects the solid track record of our portfolio and their confidence level.

Thank you. That will conclude our question-and-answer session. At this time, I'd like to turn the call back over to Tim Hayes for any additional or closing remarks.

Thank you, operator and everyone joining us today. Please reach out with any questions.