Earnings Call Transcript - LADR Q1 2022

Operator, Operator

Good afternoon, and welcome to Ladder Capital Corp's Earnings Call for the First Quarter of 2022. As a reminder, today's call is being recorded. This afternoon, Ladder released its financial results for the quarter ended March 31, 2022. Before the call begins, I'd like to call your attention to the customary safe harbor disclosure in our earnings release regarding forward-looking statements. Today's call may include forward-looking statements and projections, and we refer you to our most recent Form 10-K for important factors that could cause actual results to differ materially from these statements and projections. We do not undertake any obligation to update our forward-looking statements or projections unless required by law. In addition, Ladder will discuss certain non-GAAP financial measures on this call which management believes are relevant to assessing the company's financial performance. The company's presentation of this information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with GAAP. These measures are reconciled to GAAP figures in our supplemental presentation, which is available in the Investor Relations section of our website. At this time, I'd like to turn the call over to Ladder's President, Pamela McCormack.

Pamela McCormack, President

Thank you, and good evening, everyone. This time last year we described our goal for 2021 to restore our earnings back to a level that comfortably covered our cash dividend, by deploying the outside cash we built in 2020. While loan payoffs during that tumultuous year confirm the strength of our underwriting and real estate valuation skills, our ample liquidity will limit earnings until those payoffs are replaced with new investments. Our disciplined deployment of that capital led to successive earnings growth in each quarter of 2021, and full dividend coverage by the fourth quarter. Today, 75% of our balance sheet loan portfolio is now comprised of newly originated loans. We expect our strong loan originations momentum accompanied by significant improvements in our capital structure to benefit our shareholders in the quarters and years ahead. For the first quarter of 2022, Ladder generated distributable earnings of $31.5 million or $0.25 per share. We continued to drive Ladder's earnings and portfolio growth with another strong quarter of balance sheet loan originations. In the first quarter, we originated $732 million of loans, including 19 balance sheet loans totaling $677 million, with more than 25% of those originations made to repeat Ladder borrowers. 80% of first quarter originations were either multi-family or mixed-use assets, with a significant portion of the mixed-use assets having a multi-family component. We also continue to have a strong pipeline of additional loans under application. As both Paul and Brian will discuss in more detail, Ladder is positively correlated to a rising rate environment, both by way of our large and growing portfolio of floating rate loans, as well as our significant base of fixed rate liabilities. Our balance sheet loan portfolio continues to be primarily comprised of lightly transitional middle market loans, with a weighted-average loan to value ratio of 68% and a weighted-average yield of 5.45%, excluding exit fees. Further, as a result of the significant loan payoffs we received, our hotel and retail concentrations in the balance sheet loan portfolio are now down to 5.5% and 5.6%, respectively. As for our real estate portfolio, it continues to produce double-digit returns on equity from net operating income, primarily generated from our net lease portfolio. Our distributable earnings in the first quarter were supplemented by a $15 million net gain from the sale of two net leased assets, representing a profit margin of over 20% over our undepreciated basis in these assets. As of March 31, our securities portfolio totaled $663 million, down from over $700 million in the fourth quarter, as we continue to reallocate capital into our balance sheet loan business. As of quarter end, we have total liquidity of approximately $700 million and our adjusted leverage stood at 1.6 times net of cash; 38% of our total debt is comprised of fixed rate unsecured bonds and 79% of our total debt is comprised of unsecured bonds and non-recourse financings. We continue to maintain a differentiated approach to our capital structure within the commercial mortgage REIT space through our strategic use of unsecured corporate bonds and ongoing pursuit of becoming an investment grade rated company. In conclusion, we believe Ladder has a simple and compelling story that offers a somewhat unique value proposition to our investors. So I want to leave you today with a few key highlights. First, we have a strong and conservatively underwritten portfolio of balance sheet loans with more than half of the portfolio comprised of multifamily and mixed-use loans. Second, after demonstrating our strong credit skills and asset management skills through robust payoffs, over 75% of our $3.9 billion balance sheet loan portfolio is now comprised of new loans originated in the last 12 months, with fresh valuations and business plans. Next, we are beginning 2022 with a significantly enhanced capital structure, with the vast majority of our debt comprised of unsecured or non-recourse debt, as we continue on our path to becoming an investment grade company. Finally, we have positive earnings momentum from strong loan originations, enhanced by a rising rate environment. With that, I'll turn the call over to Paul.

Paul Miceli, CFO

Thank you, Pamela. As discussed in the first quarter, Ladder generated distributable earnings of $31.5 million or $0.25 per share. Our originations and pipeline remain very strong, and our capital structure remains anchored by a conservative combination of unsecured corporate bonds, non-recourse CLOs, and mortgage debt. Our best-in-class capital structure has been recognized by the rating agencies with corporate credit ratings one notch from investment grade from two of the three rating agencies. As of March 31, we had total liquidity of $698 million and our adjusted leverage ratio stood at 1.6 times, net of cash. Further, 85% of our capital structure was comprised of equity, unsecured bonds, and non-recourse, non-mark-to-market debt. Our three segments continue to perform well during the quarter; our $3.9 billion balance sheet loan portfolio is 93% floating rate, diverse in terms of collateral and geography, with less than a two-year weighted average remaining maturity. During the first quarter, loan origination activity produced net payoffs as we added net $306 million in balance sheet loans. The portfolio continues to perform well, and we continue to feel positive about the underlying credit of our freshly originated loan portfolio. As Pamela discussed, over 75% of our balance sheet loan portfolio was originated in the last year with floors set at the time of origination. Therefore, our interest income directly benefits from any rise in interest rates. This benefit is complemented by our liability structure, of which over 50% is fixed rate, including $1.6 billion of unsecured corporate bonds with our nearest maturity in October of 2025. Our $1.1 billion real estate portfolio continues to perform well and includes 158 net lease properties, representing approximately two-thirds of the segment. Our net lease tenants are strong credits, primarily investment grade rated, that are committed to long-term leases with an average remaining lease term of over 10 years. As Pamela discussed, the sale of two net lease properties during the first quarter produced a net gain of $15 million and generated combined IRRs of over 16% during the respective hold periods. Earnings from our securities portfolio, as of March 31, of $663 million securities portfolio was 86% AAA rated, and 99% investment grade rated with a weighted average duration of approximately two years. 93% of our portfolio is floating rate, and therefore, also positively correlated to a rising interest rate environment. Further, the portfolio continues to benefit from strong natural amortization and therefore liquidity, as the majority of the positions are front-pay bonds. As of March 31, our unencumbered asset pool stood at $2.8 billion, and 77% of the pool is comprised of first mortgage loans and cash, thereby continuing to provide us excellent financial flexibility. During the first quarter, we repurchased 55,000 shares of common stock at a weighted average price of $11.13. We have $43.5 million remaining under our $50 million board authorized stock repurchase plan. Our underappreciated book value per share was $13.52 at quarter end, while GAAP book value per share was $11.81 based on 127.2 million shares outstanding as of March 31. We declared a $0.20 per share dividend in the first quarter, which was paid on April 15. For more details on our first quarter operating results, please refer to our earnings supplement, which is available on our website as well as our 10-Q, which we expect to file tomorrow. With that, I will now turn the call over to Brian.

Brian Harris, CIO

Thanks, Paul. We are happy with the results from the first quarter, seeing a fourth consecutive quarter of increased distributable earnings. As credit spreads widened, starting in the fourth quarter of 2021, we took full advantage of prevailing market conditions and focused on originating mortgages secured by newer and higher quality real estate assets at the most attractive yields we've seen in years. Assuming the Fed does move ahead with the market narrative of several increases to the Fed funds rate over the next six months, we would expect our earnings per share to continue to rise in the quarters ahead. Ladder's earnings are positively correlated to rising one-month LIBOR and SOFR. During the first quarter, the one-month LIBOR index moved up from 10 basis points to 45 basis points, while the Fed hiked the Fed funds rate by just a quarter of a point, while two additional consecutive 50 basis point hikes in the second quarter were nearly unimaginable just three months ago, but now seem likely. If one-month LIBOR were to follow that logic and rise by 1% to 1.45% by the end of June, rough math would indicate that our third quarter net interest margin should also increase by about $0.04 per share. It's also helpful to note that just four weeks into the second quarter, one-month LIBOR has already increased by 30 basis points to 0.75%. Moving on to our products, we feel particularly confident in our inventory having essentially recalibrated our asset base over the last 2.5 years. Because we had shorter maturities going into 2020, we received $2.5 billion in bridge loan payoffs since the first quarter of 2020. This figure speaks volumes about how strong our credit skills are. Over just the last 14 months, we've originated approximately $3.3 billion in new bridge loans, just as rates began to rise and inflation started to rate higher, and we started to sort out the post-pandemic economy and the so-called new normal. Our origination efforts were supported by our highly enhanced capital structure. Today, we have far more loans on multifamily and mixed-use properties than we have had in the past with less retail and hotel loans. Our securities portfolio has been greatly reduced and is paying off rapidly, while our highly curated real estate portfolio has shown incredible resilience under difficult market conditions. If rates do rise as expected, we think our sales of real estate may slow down after the second quarter ends, but our net interest income from our increased loan portfolio is ready to step in as the workforce of our earnings engine. To wrap things up today, I'll just say that the Fed is in a tough spot these days in an incredibly volatile world. Given their dual mandate and an economy exploring the lowest unemployment rate ever, and the highest rate of inflation in 40 years, it would seem that the Fed has little choice but to raise rates into a slowing economy. With that backdrop and our large component of long-dated fixed rate liabilities, Ladder is positioned to benefit greatly from rising short-term interest rates. Rate hikes from the Fed should increase earnings at Ladder and, by extension, allow us to distribute more of our earnings to our shareholders in the quarters ahead. If we get any help at all from the loan securitization business, that will just add to what is already a very positive earnings picture. I'll now turn the call over to Q&A.

Operator, Operator

Our first question is from Jade Rahmani of KBW. Please go ahead.

Jade Rahmani, Analyst

Thank you very much. Just curious about your view on the state of the commercial real estate market overall. Do you expect borrowers in the current market to be able to handle higher rates as they face debt maturities this year? Typically, there's about $400 billion of commercial mortgage debt maturing each year. Wondering your thoughts on the likelihood of a potential uptick in commercial real estate loan defaults.

Brian Harris, CIO

Thanks, Jade. This is Brian. I believe they'll manage. I don't think anyone expected interest rates to remain at such low levels for a long time. However, there's been some shifts in the sector that aren't affecting all types of commercial real estate equally. Specifically, apartment loans due shouldn't face major issues unless they are rent controlled. That situation is complicated since there might be a backlog of unpaid rent due to eviction moratoriums, which could lead to problems when loans mature if tenants haven't paid for several months. On the other hand, newer apartment buildings that are not rent controlled should fare well, as rising housing prices will naturally increase apartment rents. There are some exceptions in certain cities. Hotels should do reasonably well since international travel is still limited, though rising gas prices might impact that sector somewhat. The office market is seeking a balance between occupancy and cash flow, and I suspect a hybrid model will emerge, so it should hold up. However, I'm concerned about businesses nearby, like delis, pizza places, and drugstores in residential buildings. There will be both successes and failures in this environment. Grocery stores seem to be increasing in value because their utility is clear compared to relying solely on delivery services. Currently, interest rates aren't excessively high, so they should manage fine. The Fed has two main objectives: low unemployment, which is being met, and price stability, which is still a concern. If they really focus on controlling prices through short-term interest rates, there could be further implications. When I observe the general public, I hear that consumers are doing well, but I'm not sure who they're referring to. Wealthy individuals or those with homes or stock portfolios are doing fine, but for those who aren't wealthy, rent, energy, and food prices are significant concerns. While inflation is reported at 8.5%, I believe those three costs are rising even faster.

Jade Rahmani, Analyst

Thank you very much. In terms of the economic outlook, there seems to be a decent probability of a recession over the next say, 18 months. Have you adjusted any asset management policies, increased surveillance, increased dialogue with borrowers? How do you overall think the company would be positioned?

Brian Harris, CIO

We are aware of that and we do believe that will happen. The word recession needs to have some degree attached to it. We don't think at this point we're expecting a severe recession, which means if you are under 45, you probably don't know what I'm talking about. Unless you've been reading a lot of books, but a recession isn't necessarily a bad thing. It's a normal part of a business cycle, and I think it's fine if growth shrinks or goes negative for a few quarters; not terribly problematic. I don't think of this recession that may come as an echo to 2008 or the pandemic downturn that we saw. So I think the one before this was really around 1998, 1999 is the one I would look at. I don't think a recession is something that should be feared, but yes, it is something that should be dealt with. I think equity returns in a recession don't do as well, but debt returns tend to do pretty well.

Operator, Operator

Our next question is from Ricardo Chinchilla of Deutsche Bank.

Ricardo Chinchilla, Analyst

I was wondering if you could please comment on how your conversations with the rating agencies have evolved over the last couple of months? And what are the main milestones toward the goal that you guys have of becoming investment grade?

Paul Miceli, CFO

This is Paul. We have ongoing conversations with the rating agencies pretty frequently these days, specifically with two of them, Moody’s and Fitch. Our upgrade considerations are primarily quantitative in nature, and it generally means more unsecured corporate debt as part of our liability structure. So we're big believers in the use of unsecured corporate debt for flexible reasons and various other reasons. So it's primarily quantitative in nature, the upgrade considerations, and they also like our internalized structure and significant center ownership. Our alignment, we are with shareholders and bondholders. So the conversations with all three rating agencies continue to go on and go well.

Operator, Operator

Our next question is from Eric Hagen of BTIG.

Eric Hagen, Analyst

Just a couple from me. First, just regarding underwriting and credit, what variables would you say you are most discerning with respect to right now, which is maybe a little different or which has evolved over time? And then in the net lease portfolio, can you remind us if there's any embedded rent increases in there?

Brian Harris, CIO

I'll start the answer and ask Rob, who is with us for asset management, about the net lease and its combination. Regarding underwriting and our current origination strategy, we felt that in 2021, as the CLO market was operating well, multifamily loans were being bid too aggressively by originators focusing on CLOs. That shifted in the fourth quarter when spreads began to widen, and this was seen by many as just a year-end issue due to supply concerns. However, we took the opportunity to intentionally focus on areas we hadn't previously targeted. While we weren't avoiding multifamily, we weren't actively targeting it. In the fourth quarter of ’21 and the first quarter of ’22, we directed a significant portion of our efforts towards originating products like apartments and mixed-use buildings with retail on the ground level. Approximately 85% of our loans stemmed from this profile, a notable change from the previous three quarters of 2021. During a recession, it's crucial to assess replacement value and stick to basics: cost per square foot, alternative usage, and available land are key considerations. Currently, we're facing economic conditions in major cities that need thoughtful consideration before assuming that cities such as San Francisco, Los Angeles, Chicago, and New York can raise rents freely. Until social issues are resolved, we see this as a warning. Generally, we start with significant filters, and the underwriting process at Ladder remains largely unaffected apart from adjustments in our future assumptions. For instance, we may have previously done an 80% loan-to-cost acquisition, but now it's probably around 75%. We're more cautious about hotels, seeing them as the most cyclical type. While we’ve shunned malls for years, we’re now somewhat more open to necessity-based retail, reflected in our triple-net property ownership. Regarding industrial properties, we're comfortable with that type but recognize it too could be overbuilt soon. Ultimately, our current position is less significant than where we'll be in three years when the loans mature. We need to plan ahead, and as we've indicated, we anticipate a mild recession next year. Consequently, we are taking a more conservative approach, opting for shorter maturities and lower loan-to-values. Our portfolio's loan-to-value might be slightly elevated, largely due to its multifamily concentration. This explains our focus; we aren't pursuing high-risk opportunities right now but are instead emphasizing basic real estate underwriting. Rob, would you like to address the other question about bumps?

Robert Perelman, Asset Management

Sure. Eric, this is Robert Perelman. The triple-net book is varied in rent step; about half the book has annual rent steps, and half is flat to stepping every five years under certain leases.

Brian Harris, CIO

Anyone else, operator? Hello, operator?

Operator, Operator

Our next question comes from Matthew Howlett with B. Riley.

Matthew Howlett, Analyst

Thanks for taking my question. Brian, with basically two Fed meetings here during the quarter, my expectations are 50 basis points each; what's not to prevent Ladder from raising the dividend, five, maybe more, in the second quarter?

Brian Harris, CIO

There are two questions there. One has to do with the direction and the other has an amount attached to it. The second one, we won't communicate a dividend policy on this call. But to the extent that the Fed does move 50 basis points in May and 50 in June, which I actually think will happen, what would stop us? Obviously, I have to ask for the Board's approval to raise the dividend, and I'd imagine a nuclear bomb might stop that request. Other than that, I'd imagine, we are going to try to start adding on to some of our distributions.

Matthew Howlett, Analyst

Investors should consider adjusted EPS, which may lag behind initially, but over time it will align with dividends.

Brian Harris, CIO

Yes, sure. I mean, we are shareholders, and then we try to be shareholder friendly. We think our shareholders have been very patient with us in our conservative maneuvers that we have taken in the last two years. Strangely, the plan we laid out two years ago is almost exactly where we are today. We are now covering, and we expect the Fed to raise interest rates. Our net interest margin has been rising quarter after quarter. I think it was, I don't know if it's $56 million this quarter top-line. Obviously, we have that big liability set, which is fixed in rate, which should benefit us as floating rates rise. So, yes, I would anticipate it. Obviously, there are other things going on in the world besides the Fed moving interest rates, but we are having a little bit of a hand-off session right now in our multifaceted earnings division. We have been taking some gains as interest rates were low from real estate. I'd imagine that will slow as time goes on and rates go up, as you would expect. But we expect to hand off the earnings but onto the bridge loan portfolio, which is in terrific shape to handle it right now. We haven't really mentioned the conduit business much in a very long time. I don't know that we should be mentioning it now either, because that's long-duration fixed-rate loans. But that used to be a very big money maker at Ladder. If the yield curve steepens, as we expect that, I think that could easily get back on stage here.

Matthew Howlett, Analyst

Well, that would certainly be interesting to see how that develops. The CMBS spreads are wide right now. I would love to hear; you mentioned the CLO market; you said if that cooperated, that could even be better for you guys. Just walk me through the cash generation. Cash is coming down, which is a great thing. How do you look at liquidity really as you grow your portfolio in the next couple of quarters here, if the CLO market doesn't cooperate? If it does, just walk me through how things progress.

Brian Harris, CIO

It's a complex issue. Currently, we are not overly worried about the CLO market as we've transitioned from the Federal Home Loan Bank to CLOs. We completed two CLOs, one in June and another in November, which provides us with matched funding for a couple of years. Additionally, we increased our unsecured debt last year, and even though we have $1.650 billion maturing, with the earliest due in late 2025, our lowest rate obligations include two $650 million bonds maturing in 2027 and 2029, totaling about $1.03 billion at an average rate of 4.5%. If the Federal Reserve or inflation trends continue, this could become a significant asset for many years, extending possibly five or six years. Therefore, the CLO market isn't particularly critical for us at this moment. We currently have unencumbered assets nearing $2.8 billion, and we could access the CLO market now, potentially three times over with $3.9 billion available. However, we are closely monitoring the rating agencies and their views on our secured versus unsecured asset mix. To achieve investment-grade credit status, we need to maintain roughly a three times leverage ratio, whereas many competitors are much more leveraged. If we pursue that path, we would issue another large unsecured bond offering while retaining our unencumbered assets, which are essential for that market. It's worth noting that Paul mentioned the input from Fitch and Moody's; we have a clear understanding of what is needed to advance, and S&P recently placed us on a positive watch as a reflection of our unencumbered assets.

Matthew Howlett, Analyst

That's certainly encouraging. Do you need the securities portfolio? Is that just going to run down over time? Just curious on that side of it?

Brian Harris, CIO

We don't need it at all. I've said a few times, I think that goes to zero. There are occasionally in a world like this, where there's this whipsawing market with people in the office and out of the office. Sometimes you can pick up some pretty attractive pieces of that. Obviously, with a total of about $600 million - $700 million, not a lot. But we have received, I know, $70 million in payoffs in the last two months in that portfolio. So it is really short at this point. Yes, right now, they are LIBOR based primarily because they're from 2019. Most of them. Right now, we would like to see LIBOR catch up with where the two-year gap is off to, and we suspect that will happen in a couple of quarters here.

Operator, Operator

Our next question is from Chris Muller of JMP Securities.

Chris Muller, Analyst

So I have a slightly different one on the dividend. It's obviously great to see distributable earnings back to covering and exceeding the dividend. But I wanted to ask how the board thinks about the real estate gains when they're considering it; are these more considered a recurring item or non-recurring when they're looking at the level to set that at? And Brian, your comments on the real estate sales flowing in 2Q are helpful in terms of where you think the earnings power is going to shift to.

Brian Harris, CIO

The board evaluates the entire business based on the capital we have allocated to real estate, securities, or cash. However, we do not differentiate the distributable earnings based on the source of gains, unless it relates to the conclusion of our real estate gains, which we believe is not the case. We are confident that our portfolio has significant gains. While we haven't conducted a major sale to demonstrate this to the market, we earned around $26 million to $27 million in real estate sales last year and expect to surpass that this year. I am not certain of our current figures, but I foresee a few sales in the second quarter. It's important to note that we are not actively seeking to sell; we can refinance the portfolio as needed. We value this portfolio for its stability and recurring income, generating double-digit returns without frequent sales. We consider ourselves reluctant sellers. Consequently, the board assesses the company's earnings with an eye toward the future; if there were an unusual distribution or one-time gain, we would not factor that into future dividends. Our goal is to maintain a consistent dividend without fluctuations that could surprise anyone.

Operator, Operator

Ladies and gentlemen, we have reached the end of the question-and-answer session, and I would like to turn the call back to Brian Harris for closing remarks.

Brian Harris, CIO

Yes, I'll just close by saying it's been an interesting time coming out of what I consider coming out of the pandemic. Who knows if the virus thinks that – but we indicated, I think a long time ago we thought this would take a couple of years, and it did. I would say that all of our higher rate financing that we entered into during the pandemic is going to be over with now. That'll be another tailwind to earnings. I think we've signaled that in the past. So we look forward to a very, very positive rest of this year. We do believe the Fed will continue raising interest rates, and we have positioned this company not just to survive it, but to actually benefit from it. We are positively correlated in that direction, and we are really looking forward to what lies ahead. So thank you again for staying with us, and we hope to make you all very happy this year.

Operator, Operator

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.