Claros Mortgage Trust, Inc. Q2 FY2025 Earnings Call

Hello, and welcome to Claros Mortgage Trust Second Quarter 2025 Earnings Conference Call. My name is Becky, and I'll be your conference facilitator today. I would now like to hand the call over to Anh Huynh, Vice President of Investor Relations for Claros Mortgage Trust. Please proceed.

Thank you. I'm joined by Richard Mack, Chief Executive Officer and Chairman of Claros Mortgage Trust; Mike McGillis, President, Chief Financial Officer and Director of Claros Mortgage Trust. We also have Priyanka Garg, Executive Vice President, who leads Credit Strategies for Mack Real Estate Group. Prior to this call, we distributed CMTG's earnings release and supplement. We encourage you to reference these documents in conjunction with the information presented on today's call. If you have any questions, please contact me. I'd like to remind everyone that today's call may include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in our other filings with the SEC. Any forward-looking statements made on this call represent our views only as of today, and we undertake no obligation to update them. We will also be referring to certain non-GAAP financial measures on today's call, such as distributable earnings, which we believe may be important to investors to assess our operating performance. For reconciliations of non-GAAP measures to their nearest GAAP equivalent, please refer to the earnings supplement. I would now like to turn the call over to Richard.

Thank you, Anh, and thank you all for joining us this morning for CMTG's second quarter earnings call. While the elevated rate environment remains a headwind for commercial real estate, we're encouraged to see signs of healing. Investor sentiment has meaningfully improved and transaction volumes have been steadily recovering. This backdrop has been constructive for CMTG, and we have made notable progress in achieving our key objectives for the year. To quickly recap, at the start of 2025, we outlined three strategic priorities that we believe will deliver long-term shareholder value: resolving watch list loans, improving our liquidity, and accretively redeploying capital for uses such as taking assets REO, reducing leverage, and potentially refinancing or extending our TLB. I'm pleased to say that we have made significant progress across all three priorities. The healing of the real estate capital markets and consequent increase in transaction volume has benefited CMTG. During the second quarter, we resolved eight loans totaling $873 million of UPB. This activity included four loans that were paid off by the borrower in full, representing $480 million of UPB, and the resolution of four watch list loans representing $393 million of UPB. In addition to these eight resolutions, during the quarter, we also resolved two additional watch list loans collateralized by multifamily assets, representing $147 million of UPB. Thus far in the third quarter, this resolution momentum has continued with three additional watch list loan resolutions totaling $548 million of UPB, one through a discounted repayment and two through multifamily mortgage foreclosures. In aggregate, 2025 resolutions to date total $1.9 billion of UPB, consisting of $1.5 billion of loan resolutions and $305 million of foreclosures on multifamily properties. Accounting for these resolutions, CMTG's watch list is now down to 17 loans and $2.1 billion of UPB, a net decline of $758 million of UPB and seven loans from the first quarter end. This progress demonstrates the management team's focus on resolving watch list loans for optimal outcomes across our stated priorities. We have been proactively asset managing our loans on a case-by-case basis and, if needed, working with borrowers who demonstrate both the financial wherewithal and the operational commitment to the underlying asset. In this regard, we have been and will continue to be proactive in exploring all options available to us as a lender, including loan sales, discounted payoffs, and foreclosures. All this progress has enabled us to achieve our second priority of enhancing our liquidity position. As of August 5, we reported $323 million in total liquidity, representing a $221 million increase compared to our position at December 31. Mike will provide more color on this and the realizations I just discussed in his remarks. As I've noted in the past, we believe that one of our competitive advantages is our sponsor's experience as a value-add owner, operator, and developer of real estate assets. We believe this perspective has enabled us to evaluate opportunities within the existing portfolio to foreclose on loans when we see an opportunity to enhance value and ultimately recapture this value for our shareholders. For example, you may recall that in 2023, we foreclosed on a mixed-use New York City building with office, retail, and signage components in Times Square. I'm pleased to share that during the second quarter, we completed the commercial condominiumization of the building. Subsequently, we completed the sale of five office floors, which generated $29 million in gross proceeds. We believe that the commercial condominium strategy will maximize recovery of our original investment and is a strong example of how our sponsor's deep real estate experience positions us well to create value. We also previously shared our plans to pursue foreclosure on a number of cash flowing multifamily assets. Once again, we believe we can significantly optimize recovery values by taking over under-managed assets, repositioning them to improve cash flows in order to enhance asset value and sell the assets in a strengthening supply-demand environment. As mentioned, we recently completed four mortgage foreclosures, two during the second quarter and two subsequent to quarter-end. We're optimistic about our approach to these multifamily REO assets and anticipate being in a position to monetize the first of these assets in the coming quarters.

Thank you, Richard. For the second quarter of 2025, CMTG reported a GAAP net loss of $1.30 per share and a distributable loss of $0.77 per share. Distributable earnings prior to realized losses were $0.10 per share. Earnings from REO investments contributed $0.01 per share to distributable earnings, net of financing costs. CMTG's held-for-investment loan portfolio decreased to $5 billion at June 30 compared to $5.9 billion at March 31. The quarter-over-quarter decrease was primarily the result of loan resolutions that occurred during the second quarter. Of the eight full loan realizations totaling $873 million of UPB that Richard mentioned, four loans totaling $480 million were regular way full repayments, two loans totaling $304 million were through loan sales, and two loans totaling $89 million were negotiated discounted payoffs. We also received $25 million of partial loan repayments, resulting in total repayment and sale proceeds of $773 million for the quarter, net of charge-offs. As mentioned on our first quarter call, we received the discounted payoff of an $88 million Texas office loan that was previously a watch list loan. The realization of this loan resulted in proceeds equal to 73% of UPB and allowed us to resolve a watch list loan while reducing our office exposure. We also received the discounted payoff of a sub-$1 million residual loan position on a $125 million loan that was otherwise repaid. Moving on to the two loan sales, which were at a weighted average recovery of 67% of UPB. The first loan was the sale of a California condo loan. The loan was previously classified as held for sale and non-accrual at our carrying value of $146 million at March 31, which reflected a previously recorded $78 million loss on UPB. As this loan was unencumbered, the $146 million of sale proceeds received were the primary driver in the increase in liquidity during the quarter. The second loan was an $80 million loan collateralized by a previously four-rated Southern California hospitality loan originated in 2018 that was sold at 70% of UPB after consideration of customary prorations and transaction costs. Given the sponsor's challenges, we view this decision as an opportunity to proactively resolve a watch list loan and reallocate capital to more accretive uses. Not only have we remained proactive in pursuing resolutions, but we've also taken a disciplined approach, balancing effectuating loan resolutions, deleveraging the balance sheet, and generating liquidity. We believe this discipline is reflected in our results. As Richard mentioned, on a year-to-date basis, we had a total of $1.9 billion of UPB in loan resolutions, consisting of $1.55 billion of loan repayments and sales and $305 million of multifamily property foreclosures. On a blended basis, we achieved an 88% recovery rate on these loans. We have reduced our watch list loans by $776 million of UPB, now down to $2.1 billion since year-end 2024. Turning to portfolio credit, while we have made meaningful progress in resolving loans and reducing our watch list, we continue to experience negative credit migration in the portfolio. During the quarter, we moved four loans from a four risk rating to a five risk rating. The first is a $402 million loan collateralized by multifamily property located in Southern California. The borrower recently initiated a sales process. However, the sale of the property did not materialize, which was a key factor behind the downgrade. We are currently evaluating all options available to us to pursue our remedies as a lender. The second and third loans totaling $212 million of UPB are both collateralized by multifamily properties located in Dallas, Texas. After evaluating the borrower's financial wherewithal and operational commitment to the asset, we determined that it would be prudent to foreclose on these loans in order to reposition these assets and improve operating cash flow under our sponsor's management, similar to the four assets that Richard mentioned. The fourth loan downgrade was resolved last week at our carrying value. As disclosed at year-end 2024, we entered into a contingent discounted payoff arrangement with a borrower on a $390 million loan collateralized by a multifamily property in New York City. The borrower was able to perform in accordance with the modification agreement and completed the discounted payoff at 90% of UPB. This transaction resulted in additional liquidity of $107 million, which will be redeployed into more accretive uses. In addition, during the quarter, we also downgraded a $71 million office loan located in Seattle to a four-rated loan. The loan is in good standing and the borrower is performing under its guarantee obligations. However, there is a pending maturity and the performance at the asset is tracking below our expectations. It's important to note that we have seven office loans with a UPB and carrying value of $834 million and $782 million, respectively, in our portfolio. Reflecting third quarter resolutions to date, loans with a risk rating of four or five or $2.1 billion of UPB or 42% of the loan portfolio based on carrying value compared to $2.8 billion of UPB or 46% of the loan portfolio based on carrying value at March 31. As it relates to CECL, our total CECL reserve on loans at June 30 is $333 million or 6.4% of UPB compared to $243 million or 4.1% of UPB at March 31 and our general CECL reserve increased by $15 million to $139 million or 3.8% of UPB, subject to our general CECL reserve compared to 2.4% as of the first quarter. General CECL reserve levels reflect our conservative outlook amidst capital market and political uncertainty. Specific CECL reserves also increased during the period to reflect the credit downgrades during the quarter. Moving on to CMTG's REO portfolio. We continue to leverage our sponsor's platform as a key component of our loan resolution strategy. This approach enables us to apply a value-add approach to optimize recovery results. Richard already spoke to the mixed-use New York City asset, so I'll turn to the rest of the REO portfolio. Starting with the hotel portfolio, operating performance of the underlying assets remains strong. During the second quarter, we successfully executed the CMBS refinancing of the portfolio and secured attractive pricing on a non-recourse loan with up to five years of duration. The portfolio remains held for sale on our balance sheet, generating an attractive leverage yield as we continue to seek an exit amidst uncertainty around the upcoming New York City election. As Richard mentioned, we have identified seven multifamily loans where we believe that foreclosing and leveraging our sponsor's multifamily ownership and management platform will allow us to reposition these assets and optimize outcomes for our shareholders. During the second quarter, we began executing the strategy and completed mortgage foreclosures on two loans. The first was a $50 million loan collateralized by a multifamily property comprising a total of 206 units in Phoenix, Arizona. The second was a $97 million loan secured by a multifamily complex totaling 376 units in the Las Vegas MSA. Subsequent to quarter-end, we completed mortgage foreclosures on two additional multifamily loans. The first was a $119 million loan on two assets in Dallas, Texas, comprising a total of 555 units. The second was a $39 million loan on a multifamily asset also located in Dallas totaling 370 units. Collateral for all four loans are cash flowing, and we believe they provide opportunities for value creation. We intend to implement a value-add strategy across each of these properties, drawing on our sponsor's multifamily operating expertise to stabilize operations, improve cash flow, and ultimately maximize recovery value. Looking forward, we expect to foreclose on the three remaining multifamily loans, which we have targeted for foreclosure. Moving to the right side of the balance sheet. In March, we closed on a $214 million financing facility that specifically enables us to finance non-performing loans and hold the underlying collateral as REO assets upon foreclosure. During the second quarter, we upsized the facility to $664 million, pledging an additional five loans, four of which are performing, which improves our cost of capital for this facility. Securing this facility has been a critical component in effectively executing our REO strategy as it's allowed us to complete four mortgage foreclosures on a cash-neutral basis. During the second quarter, we continued to aggressively reduce our indebtedness by $652 million in accordance with our stated priorities. The deleveraging includes $188 million of incremental deleveraging, which reduced our net debt-to-equity ratio from 2.4 to 2.2x. Quarter-to-date in the third quarter, we further reduced leverage by $255 million in connection with loan repayments received, reducing our net debt-to-equity ratio on a pro forma basis to 2.0x. We feel positive about the progress that has been made in executing our strategic priorities year-to-date, resolving watch list loans, enhancing liquidity, and redeploying capital into more accretive uses. Given this progress, an additional focal point remains on addressing the upcoming maturity of our Term Loan B in August of 2026. As it stands as of August 5, one of the potential uses of the $323 million of current liquidity and $513 million of unencumbered assets could be used to facilitate a partial paydown in connection with an extension of the existing term loan or to facilitate replacement financing. To reiterate, year-to-date, we've resolved $1.9 billion of UPB of loans, reduced the UPB of outstanding financing by $1.1 billion, and increased our liquidity position of $323 million. Looking ahead, we anticipate continued momentum as we further resolve watch list loans and execute on our REO strategy. We look forward to updating you on our progress next quarter.

Just wanted to make sure that the liquidity number you gave, does that already factor in the discounted payoff of the New York City multifamily?

Yes, the $323 million amount reflects the liquidity generated by the New York multifamily loan in July.

Great. And then clearly, success in generating payoffs and liquidity in the first half. What is your outlook for continued resolutions payoffs in the second half and kind of the amount of liquidity that those payoffs might generate?

It's Priyanka. Doug, I'll jump in here. The capital markets are improving, and we're observing increased activity. We anticipate additional payoffs between now and the year's end. That said, we've been utilizing all available resources to generate liquidity and address those watch list loans. The number is larger due to this approach, but it's what we committed to in order to enhance shareholder value. We've achieved significant equity given our low leverage. Moving forward, we plan to depend more on regular payoffs from our borrowers, unless unique situations arise.

As you consider the liquidity, what indicators are you looking for to potentially start utilizing that liquidity? Would this involve further reducing the term loan debt or possibly initiating a stock buyback at the current valuations? How are you planning to approach the use of that liquidity?

Sure, Doug. Thanks for the question. We'll continue to focus on reducing our debt, even though we believe the stock price presents an attractive buying opportunity. There are other factors we need to consider. We've made significant progress in improving our liquidity over the past couple of years by reducing our unfunded loan commitments. This should result in a less substantial use of cash moving forward, as our future funding obligations are now about $123 million after existing financing, most of which is related to leasing activities. Additionally, we want to ensure we can secure replacement financing for our term loan or extend it. A combination of these developments may lead us to reconsider our strategy and take a more aggressive approach.

I'd like to focus on the REO and some of this may be redundant, but there's just so many moving parts. I just want to make sure we have this all right. Ended the quarter with about $525 million of REO foreclosed on another, call it, $235 million. So as of today, REO balance would be $650 million to $660 million. Is that correct on the balance sheet?

Yes, that's correct.

Understood. You mentioned six assets, each with a strategy outlined for asset sales, unit sales, and improving operational performance in preparation for asset sales. Could we discuss each of the six assets individually and provide a rough timeline on how long you expect this to take? I know this is a challenging question, but could you estimate it might take two quarters for the hotel portfolio and six quarters for the multifamily in Dallas? It would be helpful to understand how this will progress over the next 18 to 24 months.

Yes, absolutely, Rick. It’s challenging to provide precise timelines since it relies on various external factors. Starting with the hotel portfolio, its performance has been outstanding, with year-to-date figures through June 30 peaking during our ownership. We’ve seen significantly higher EBITDA compared to last year, with the second quarter showing a 16% increase. The remainder of the year looks very promising in New York City, particularly in the traditionally strong third and fourth quarters. We’ve also refinanced the portfolio, allowing us time to facilitate a sale. We are maintaining it as an asset for sale, aiming to ensure we achieve the right value, and plan to proceed with this over the next few quarters. It’s definitely not intended as a long-term hold, and we believe we've effectively demonstrated value through the increased EBITDA. Regarding the mixed-use property, we've made progress on our strategy to convert to commercial condominiums. We’ve successfully sold five of the nine office floors, with two more under contract, indicating imminent sales. The majority of the remaining value lies in the retail and signage elements, which are currently being marketed. We’ll assess incoming bids to decide whether to retain these leased assets for their cash yield or sell them to reinvest and improve our balance sheet. For the multifamily aspect, we've seen higher unsolicited offers on the Arizona and Nevada properties since we foreclosed on them several months ago. The value has increased due to the improvements we've implemented. We believe these properties could see resolutions in the near term. Operations have improved in these markets, and we remain optimistic about them. The Dallas properties are newer foreclosures, and we need to perform similar enhancements there before we can discuss timelines, akin to what we’ve done with the other two. Does that address your question, Rick?

Somewhat along the lines of one of Doug's questions, I wanted to look back to the start of the year where you mentioned transactions underway at the time that could lead to $2 billion of gross proceeds. Now that we're a bit more than halfway through the year, we've seen that $1.9 billion of loans resolved. How should we be thinking about that initial $2 billion number? Has that changed? Has it gone in line with your expectations? And how are you viewing that playing out throughout the rest of 2025?

Thank you. This is Mike. I'll take a shot, and Priyanka can add on. I think, based on what we see coming down the pike, which Priyanka touched on a little bit, I think we're tracking to exceed that target. All these resolution activities are good just because it results in churn of the portfolio and generation of liquidity for us that we can use in other ways in line with our stated priorities. So we feel pretty comfortable we'll exceed that $2 billion target of UPB of resolutions that we laid out earlier in the year.

Yes, I agree with everything mentioned and have nothing to add. We're utilizing all available tools to ensure we achieve our goal of turning over the portfolio. I believe we've made significant progress, but there will still be some additional work to do before the end of the year.

Great. Very helpful. And then following Rick's question about the REO, just wanted to go a little into that. For the two recently foreclosed Texas assets, I know it's still early days. What sort of CapEx operating improvement needs are you seeing at those properties? Just curious sort of what that whole process is going to look like before they're in a more stable state the way the Arizona and Nevada ones are.

Yes, I appreciate that question, John, because it highlights the sponsor's capability to make improvements. We've been pleasantly surprised by the potential for quick wins. There isn’t much that needs to be done to effectively reposition these assets in the market. For instance, rebranding is essential, which includes removing the former sponsor's name from the buildings. It's important to ensure that the consumer experience aligns with the product we intend to offer, particularly in terms of online feedback and reviews. Beyond that, there are numerous easy improvements to be made regarding landscaping and curb appeal. Additionally, while we believe in upgrading units, we will only pursue such renovations if they provide a return on investment. In certain Dallas assets, the financials don’t justify extensive upgrades since they primarily serve a market that values affordability. With proper management, minimal capital investment can lead to significant improvements in just a few quarters.

I might be wrong, but it does sound like the outlook for resolutions in the second half of the year is a bit muted. I'm not sure if you agree with that, but that is a little bit at odds with the very strong transaction environment we're seeing the CRE brokers report as well as the select commercial mortgage REITs that are robustly originating loans right now. So what do you think is driving that? Is it the stories of each of the assets or something else?

Yes, Jade, it's Priyanka. I'll take that one. We have accelerated a lot of our activities and have experienced significant turnover year-to-date on a percentage basis, much higher than our peers and what many others have seen. It’s primarily a timing issue, and we focused on encouraging that activity to happen more swiftly. We believe we can now be more patient regarding regular repayments, and we have several loans where our sponsors are under term sheet and working on refinancings. However, I do not control those outcomes, which makes me hesitant to offer forward-looking guidance on that. That said, I completely share the sentiment regarding transaction volume and the strength of the capital markets, as well as the sponsors' ability to refinance. We just don’t control those outcomes, so we are being careful with our responses to those inquiries.

Okay. That's great. Just on the July New York multifamily, I'm not sure if you said this, there's lots of conference calls at this time. But do you know what the discounted payoff was, if you could give that amount?

On the one that happened in July, yes, it was $0.90 of par. So $3.90 was the loan amount, $3.50 was the discounted payoff number.

Okay. Is that the only realized loss...?

I want to clarify that the loss was already included in our book value as of year-end.

Okay. That's good to know. Are there any other expected losses in the third quarter that you know of right now?

No. Everything that we know of, we have reflected in our numbers at this point.

Okay. And then could Mike give an update on the term loan refi, how that's going, what you're thinking there? Will you downsize the loan? Will you go with a private credit option or issue some other form of debt? And then just broadly speaking, the capital structure of the company, do you think issuing a preferred would be attractive because that would bolster total equity and therefore, improve the financing options, the leverage options because there'd be a much bigger equity base, which would help cushion some of the transitions you're seeing in these assets like the REO and such?

Thank you, Jay, for the thoughtful question. We're currently navigating the term loan process, so I can't provide many specifics, but we are in discussions with several private credit providers. Regarding our existing lenders, we've begun engaging with them, and I anticipate that we'll decrease the size of that financing due to the liquidity available on our balance sheet and our goal of lowering leverage. As for preferred equity, we have considered it. Our primary source of capital remains focused on resolving some of the watch list assets in our portfolio to generate liquidity for deleveraging. While a preferred would be beneficial in the future, we aim to approach that from a stronger position, which we believe we are continuing to achieve.

Thank you. And I want to again thank everyone for the thoughtful questions. I would summarize by saying we're ahead of our projections for our priorities and just restate them again, which is resolving watch list loans, improving liquidity, and redeploying cash to higher and better uses, including stabilizing the business. But before I let everyone go, I want to follow many of our mortgage REIT peers by acknowledging the magnitude of loss created by the senseless tragedy, which occurred at 345 Park. We live in a very small New York City real estate community, and many of us here at CMTG have close ties with the victims and with the Blackstone and Rudin teams. I just want to say on behalf of everyone at CMTG that we mourn their passing, we send our condolences to their families and their colleagues and just note that the world is a much poorer place for their loss. Thank you all, and we look forward to reconvening next quarter.

This concludes today's call. Thank you for joining us. You may now disconnect your lines.