Franklin BSP Realty Trust, Inc. Q1 FY2023 Earnings Call

Good morning, and welcome to the Franklin BSP Realty Trust First Quarter 2023 Earnings Conference Call. Please note, this event is being recorded. I would now like to turn the conference over to Lindsey Crabbe, Director of Investor Relations. Please go ahead.

Good morning. Thank you, Gary, for hosting our call today. Welcome to the FBRT First Quarter Earnings Conference Call. As the operator mentioned, I'm Lindsey Crabbe. With me on the call today are Richard Byrne, Chairman and CEO of FBRT; Jerry Baglien, CFO and Chief Operating Officer of FBRT; and Mike Comparato, President of FBRT. Before we start today's conversation, I want to mention that some of today's comments from the team are forward-looking statements and are based on certain assumptions. Those comments and assumptions are subject to inherent risks and uncertainties as described in our most recently filed SEC periodic reports and actual future results may differ materially. The information conveyed on this call is current only as of the date of this call, May 4, 2023. The company assumes no obligation to update any statements made during this call, including any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. Additionally, we will refer to certain non-GAAP financial measures, which are reconciled to GAAP figures in our earnings release and supplementary slide deck, each of which are available on our website at www.fbrtreit.com. We will refer to the supplementary slide deck on today's call. With that, I'll turn the call over to Richard Byrne.

Thanks, everyone, for joining us this morning. I'm Rich Byrne, the Chairman and CEO of FBRT. As mentioned, our earnings release and supplementary deck were posted to our website yesterday. This morning, I will discuss our financial results for the first quarter of 2023. Starting with our performance, we were pleased with our results in the first quarter. The key highlights were our earnings growth and improvements in our portfolio. Our GAAP net income per share rose by 76% this quarter to $0.44 per diluted share, compared to $0.25 in the previous quarter. Our distributable earnings per share grew by 19%, with FBRT generating $0.44 per fully converted share versus $0.37 in the prior quarter. Our distributable earnings comfortably covered our consistent common stock dividend of $0.355, reflecting a yield of about 9% on our book value of $15.78 as of March 31. The significant earnings increase was driven by higher base rates on our floating rate portfolio and other positive developments. Jerry will elaborate on this in his financial overview. Another highlight for us was the progress in our portfolio. Despite market unpredictability, we ended the quarter with only three loans on the watch list, down from five at the end of the previous quarter. After the first quarter, two more loans were removed from our watch list, leaving us with just one asset, a small CBD office loan in Portland, Oregon. One asset that came off the watch list was our Brooklyn Hotel loan, which we sold for $96 million in mid-April, recovering 100% of the principal and about $20 million in additional proceeds. We are pleased with this successful resolution, which allows us to redeploy considerable capital. In terms of our balance sheet, we closed $200 million in new loans this quarter while remaining patient to find the right opportunities. Our portfolio size slightly decreased to $5.1 billion across 157 loans, primarily focused on multifamily, and our book value remained flat from the last quarter. While origination volume was lighter, we found attractive investment opportunities, with one of the largest loans being a limited service hotel portfolio. Our weighted average spread on new loans this quarter was 580 basis points. Mike will provide further details on this and our recent investments and pipeline. We ended the quarter with $230 million in cash and $1 billion in total liquidity. We believe a strong liquidity position is prudent in protecting our portfolio against unforeseen credit events and allows us to seize attractive deal flow in the market. We capitalized on opportunities to buy back our debt and common stock at significant discounts this quarter, both of which positively impacted our book value. Specifically, we repurchased $17.5 million of our unsecured debt at 75% of its face value. Jerry will provide more details shortly. We also repurchased $3.7 million of our common shares in the first quarter and an additional $4.5 million subsequently. In total, since initiating our buyback programs in 2022 and 2023, we have purchased nearly $60 million of FBRT stock, leaving about $40 million remaining in our authorized amount for additional repurchases. Finally, I want to express our confidence in our portfolio's quality, enhanced by its multifamily focus and limited office sector exposure, which constitutes only 6% of our assets. Our floating rate loans are prioritized in the capital stack, we maintain light external leverage, and our liquidity levels are strong. While we are taking a defensive stance, we will continue to pursue origination opportunities that enhance shareholder returns. I will now turn it over to Jerry for a detailed review of our quarterly performance.

Thanks, Rich. Hello, everyone. This is Jerry Baglien, the Chief Financial Officer and Chief Operating Officer of FBRT. I appreciate everyone being on the call today. Moving on to the results, let’s start on Slide 5. In the first quarter, FBRT generated GAAP earnings of $43.8 million, which translates to $0.44 per diluted common share, resulting in an 11% return on equity. This quarter's GAAP earnings included two one-time events: one related to the sale of securities, including arms and CRE CLOs, and the second involved a partial extinguishment of unsecured floating rate debt. We successfully acquired and simultaneously extinguished $17.5 million of the unsecured debt at a price of $0.75 on the dollar. As Rich mentioned, this led to an immediate book value gain for shareholders and reduced our ongoing annual debt service on that unsecured debt by approximately $1.5 million based on current rates. Our distributable earnings for the first quarter were $44.8 million, or $0.44 per fully converted share, reflecting an 11.1% return on equity. You can find a detailed comparison of the distributable earnings to GAAP net income in the earnings release. Our commercial real estate portfolio concluded the quarter at a principal balance of $5.1 billion. Transaction volume in the first quarter remained subdued, allowing us to be selective in our originations and grow the portfolio when it is most beneficial. Loan spreads increased slightly during the quarter, positively impacting our earnings. However, we have observed a tightening of spreads in the market since the end of the quarter, which Mike will discuss further. We maintained a position of $246 million in real estate securities, comprising CRE-CLO bonds and ARM securities. Our leverage position decreased this quarter, with net leverage finishing at 2.3 times and recourse leverage at 0.46 times, both of which we believe are appropriate for our portfolio. The book value remained flat at $15.78. Moving to Slide 6, we experienced our fourth consecutive quarter of growth in distributable earnings, primarily due to increases in SOFR, the base rate for most of our assets, as well as fees from certain asset payoffs. Turning to Slide 7, we reviewed our portfolio activity for the quarter. We received $380 million in loan repayments, with 58% coming from multifamily loans and 25% from office loans. No new assets were added to real estate owned (REO) this quarter, but we took title to five Walgreens properties, leading to $25 million in foreclosures or deeds in lieu of foreclosures. After the quarter, we took title to all remaining Walgreens properties, now fully encompassing our retail portfolio as REO. Including the 24 Walgreens properties, our foreclosure REO comprises approximately 2.5% of our total portfolio. The remaining two REO properties include a Class A multifamily property and an office tower. We marked down the multifamily property by $1.3 million in the first quarter based on updated market information. We continue to market both assets for sale and are comfortable holding these properties depending on pricing. On Slide 8, we present an overview of our capitalization. Our average cost of debt during the quarter was 6.7%. Although short-term rates continue to increase our borrowing costs, we actively manage our CLO portfolio and have reinvested available funds through July 2024. 79% of our financing in our core book is through non-recourse and non-mark-to-market facilities. We have not needed to market with CLOs in 2023, but we continue to monitor that space. Historically, we have been a leading CLO issuer and will seek opportunities to issue when it adds value to our business. Finally, Slide 10 highlights our liquidity position. As Rich mentioned, we closed the quarter with $1 billion in total available liquidity, made up of cash on hand, available CLO reinvestment, and capacity on our warehouse lines. Our funding sources are diversified, involving six separate counterparties on our warehouse lines. This liquidity strengthens our balance sheet and positions us to seize future origination opportunities. Now I will hand it over to Mike for an update on our portfolio.

Thanks, Jerry. Good morning, everyone, and thank you for joining us. I am Mike Comparato, President of FBRT. I'm going to start on Slide 12. Our commercial loan portfolio is over 99% senior mortgages and 98% floating rate. It continues to be predominantly multifamily with 76% of our exposure in this sector. We've discussed our office exposure in great detail on the last few earnings calls. That exposure continues to decrease and represents only 6% of our total portfolio at quarter end. We continue to view multifamily as having the best credit quality and risk-adjusted returns within the CRE credit space. Our multifamily focus has made our portfolio very liquid. Geographically, we continue to be heavily invested across the Southeast and Southwest and favor assets in areas with positive population trends. As I mentioned last quarter, we have no international exposure and no intention to add international exposure in the near future. Slide 13 shows our activity specific to the first quarter. We originated 4 loans in the quarter for a total commitment of $200 million at a weighted average spread of 580 basis points. Deal flow is meaningfully better today than in the prior two to three quarters. We are seeing strong deal flow with attractive credit metrics and terms. Interestingly, we have seen a meaningful tightening in credit spreads in the whole loan market in the past 4 to 6 weeks. While I believe a portion of that is credit quality improvements on new origination, I believe there is also a tightening due to scarcity of product, specifically within multifamily credits. The good credit is getting a lot of attention in the market and is being bid tighter. I also believe several lenders are looking at whole loan coupons versus the components of the coupon. If you can write a good credit loan with an 8 handle coupon that is very compelling given where coupons have been for the prior 20 years. Hospitality was our largest add in the quarter, driven by one large loan. We wrote a $120 million loan on a cross-portfolio of 12 limited service hotels. The loan has strong in-place cash flow, included significant equity investment from the borrower at closing and also has a meaningful mezzanine lender in the capital stack. This loan size is greater than our typical loan size, which averages $32 million. Current market conditions are creating opportunities where historically we have not been an active participant. We've discussed how we are waiting for the right opportunities and are able to fill voids in the lending market as we see fit. This is most obvious in both the large loan market as well as the construction loan market. As we've discussed for several quarters, negative leverage continues to be a market issue and one that has not resolved itself. We have seen cap rate widening as well as debt coupon tightening and believe within the multifamily sector, we are making positive progress on the severity of negative leverage currently in the floating rate market. Finally, on Slide 14, we have three loans on the watch list as of March 31. Two loans were removed from our watch list in the first quarter, one by way of loan pay off at par together with additional penalties and the other by loan modification, which included a meaningful investment of equity by the borrower. We ended the quarter with three loans on our watch list, the Brooklyn Hotel, the Walgreens portfolio and a CBD office complex. As of today, the only loan still on the watch list is a CBD office complex. As Rich said, the Williamsburg Hotel sale was completed in April. On top of a complete recovery of our carrying value, we received an additional $20 million in proceeds at closing. A meaningful amount of capital was freed up with this loan payoff that can be put back to work in our portfolio. We are extremely proud of our team who worked diligently throughout the bankruptcy process to bring this loan to a positive resolution. The Walgreens portfolio continues to be in litigation. And as Jerry mentioned, as of today, it is now entirely held in REO. With that, I would like to turn the call back over to the operator and begin the Q&A session.

Our first question is from Matthew Erdner with JonesTrading.

On for Jason right now, congrats on the great quarter. So you mentioned that you're seeing opportunities in large loans and construction. Are the large loans similar to the one that got off this quarter and the one in Florida?

It's Mike Comparato, Yes, they are very similar. Can't quite put my finger on why the deal flow has increased right now, but it is a tremendous increase for us. I would say I'm going from looking at two, three, or four loans a day for the prior few quarters to now well over 10 to 15 a day. So the deal flow has been really tremendous. And noticeably, we're getting some larger loan requests that historically, we just haven't been a competitive bid for.

Yes. Do you think that has to do with what the banks have been experiencing?

Yes. I think it's a combination of what's going on in the banking sector as well as what's going on within the mortgage REIT and debt fund sector. I think we're privileged to have about 5% of our book exposed to office, whereas some others have 25% to 50% in-office, and it's probably harder to play offense given that profile. So I think we're just seeing lenders that historically played in that space, not playing today.

Right. And then given those opportunities, when would you expect to capitalize on them would it be later half of this year, early half of '24. What's the expectation there on your end?

Well, I'm hoping we capitalize on them right now. So we've already closed quarter-end to date, just under $200 million in new originations. And again, the pipeline is the strongest that it's been. So I'm hoping that we really see an uptick in closed credits here in the coming weeks and months.

The next question is from Sarah Barcomb with BTIG.

I agree with the congratulations on the excellent quarter. Regarding the previous question, should we anticipate some diversification beyond multifamily in your new originations? How are you approaching new investments and sector exposure moving forward, considering that the Q1 deal is now one of your top three credits in the hospitality sector?

It's Mike again. Thanks for the question. I think multifamily is really embedded in our DNA. So I would expect us to always be running an allocation fairly close to where we are today. We're 76% today. Could that ebb and flow in the next few quarters down to 70 or up to 80%, it could go either way. I'll continue to say what I've been saying for the last several quarters, we want to focus on multifamily, and we want to focus on hospitality and specifically, probably more leisure-oriented, less business-oriented travel hospitality. So I think if you look at the book today and certainly, as you look at our forward pipeline, it is entirely multifamily and hospitality. We are not bidding on office, except for wildly unique situations. We have a bid for other asset classes. We actually have a few interesting industrial deals that we're quoting right now. But predominantly, I would expect us to be multifamily and hospitality focused, keeping our exposure to multi, again, right where we've been for the past several quarters.

Okay. And just given most of your portfolio, of course, is Sunbelt multifamily, just thinking about those originations that were done in 2021 and 2022, when we saw rapid rent growth, higher LTV lending at low-interest rates. You mentioned the negative leverage in your prepared remarks. And I was curious if you're starting to see any signs of NOI at the property level, perhaps coming in below previous expectations on deals that were maybe penciled with negative leverage back when rates were near 0. And are you seeing any risk in your sponsor's ability to service their debt as a result of that?

That’s a good question. The CRE industry is likely facing significant challenges over the next two years. Borrowers from 2021 and 2022 are either completing or nearing the end of their business plans. Overall, we are seeing rents at or above the levels we anticipated when these plans were finalized, which is a positive outcome. Regarding debt service payments, borrowers have essentially been managing fixed-rate loans for the last 18 to 24 months. Almost all the loans we issued had low SOFR caps that were surpassed over a year ago. Consequently, the increase in SOFR has primarily affected the cap providers rather than the borrowers. The real challenge will come at loan maturity when these caps expire, and borrowers will face significant costs to secure new caps, which will expose them to higher expenses. Currently, there are no issues with servicing debt, largely because the burden has fallen on the cap providers. However, as loans reach maturity, that’s when the more difficult discussions will begin.

The next question is from Stephen Laws with Raymond James.

I wanted to touch base on the reallocation of the capital that's freed up from Williamsburg. Can you talk about kind of how you think about allocating that between new investments and you've been very active with repurchase. But that varies on attractiveness versus what you see in your investment pipeline. So when we think about earnings accretion as that capital gets redeployed into performing loans, how should we think about the impact? And is that more of a 3Q event? Or how quickly do you expect to recycle that capital?

Rich here. Let me start by saying it's not just about the proceeds from the Brooklyn Hotel. We have a substantial cash position and overall liquidity, giving us plenty of capital to deploy. We've been cautious in our approach and want to balance our options effectively. Our opportunities include making traditional loans, as Mike has discussed regarding our pipeline, as well as buying back our stock. We even had a chance to repurchase our bonds at a significant discount. All of these options are available to us. Many of our peers are prioritizing liquidity for understandable reasons, such as maintaining enough cash to handle any potential issues in the portfolio. As we consider our strategy, we will buy our stock when it is undervalued, and we will also look to purchase our debt at a discount while making loans. We'll assess each option based on the best returns for our shareholders. Did that address your question?

It does, Rich. And I've got a follow-up, I guess, for all of you, but maybe for Jerry, I mean as you think about the financials, I guess, first off, Mike, where are we seeing LIBOR floors in new loans. And then as we think about the forward curve and how it may be a quick trip for short-term rates at these levels, not a lot of capital is going to recycle in this environment to get a 4 handle, hopefully, LIBOR 4. Have you thought about looking at buying your own floors to protect some of this portfolio earnings power as you look at where the forward curve has rates going next year?

That’s a great question, Steve. This afternoon, Jerry, our Head of Capital Markets, Dave Henschke, our Chief Credit Officer, Matt Jacobs, and I will be discussing this. We are actively exploring ways to take advantage of the declining SOFR. We had previously identified concerns about rising rates back in Q4 '21 and considered hedging at that time. However, since the increase in SOFR benefited our overall performance, we felt it was best to take no action. The situation is different now that rates are decreasing, and we are looking into it. No decisions have been made yet. Regarding your first question, it’s a competitive market. We aim to secure the highest floors possible while borrowers seek the lowest. We typically meet somewhere in the middle for transactions. We've been offering borrowers options with tighter overall spreads for wider overall floors as part of our business strategy. This is an ongoing discussion and negotiation, and we're not rigid on any particular terms. Our focus remains on good credits that enhance our return on equity.

I appreciate the color. And I guess if you buy your own floors, she can ask for those wider spreads, right? Yes. And then lastly, Mike, just larger picture, you've been remarkably accurate in some publications I've seen on CLO markets and volumes. I mean, can you talk bigger picture, what you're seeing there, what do you think we need to see? I guess they're not closed, but for pricing to get more attractive and to view that, especially given the high mix of CLO financing that the mortgage REIT uses.

Yes. Thanks, Steve. Again, CLO is the alternative financing vehicle for this space. I'm not going to say by any means that it's a new concept. But for decades, mortgage REITs, debt funds, et cetera, operated on warehouse facilities. And I think just the fundamental question, not rocket science, is until spreads and leverage in the CLO market are better than what we can experience financing our loans on the warehouse facility, the market is just not there. As to the void of buyers or seeming void to buyers in the CRE CLO space, I can't quite put my finger on it. I think it's a size issue more than it is a credit issue. We're seeing a decent amount of action on the secondary market. There seems to be bids up and down the capital stack at fairly compelling levels, but you're talking sizes that are $2 million here, $6 million there, the occasional $10 million or $20 million. And I think the issue really is, if you come out with an $800 million new issue CLO, is there enough demand out there to soak up that kind of volume? And I think that's what the issue is today. And I can't tell you when that's going to change. But I don't think it's going to change immediately.

Appreciate those comments, and I appreciate you taking my questions this morning.

This concludes our question-and-answer session. I would like to turn the conference back over to Lindsey Crabbe for any closing remarks.

Thank you for joining us this morning. Please reach out with any questions.

Thanks, everyone.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.