Earnings Call Transcript - LADR Q2 2022

Operator, Operator

Good afternoon! And welcome to Ladder Capital Corp's Earnings Call for the Second Quarter of 2022. As a reminder, today's call is being recorded. This afternoon Ladder released its financial results for the quarter ended June 30, 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. For the second quarter of 2022 Ladder generated distributable earnings of $43.7 million or $0.34 per share. In June, following five successive quarters of earnings and portfolio growth, we increased our quarterly dividend by 10% to $0.22 per share. Rising rates continue to provide a strong tailwind to our earnings given our $4 billion predominately floating rate loan portfolio and large component of long-term fixed rate unsecured bonds in our liability structure. As Paul will discuss in more detail, our earnings in the quarter were again supplemented by real estate sales, with our assets continuing to sell at a significant premium to underappreciated book value. In the second quarter we originated $371 million of loans, including 17 balance sheet loans totaling $365 million. More than 40% of those loans were made to repeat Ladder borrowers, and 77% of our second quarter originations were in multi-family or manufactured housing, with our multi-family originations focused on newly constructed properties. Our balance sheet loan portfolio continues to be primarily comprised of lightly transitional middle-market loans with a weighted average loan-to-value of 68%. Due to the significant loan payoffs we received, and our recent focus on newly built multi-family properties, our hotel and retail concentration in the balance sheet loan portfolio ended the quarter at 5% and 6%, respectively. Further, in July we received an early repayment of our largest hotel loan of $57 million, reducing our hotel exposure to less than 4%. Our real estate portfolio continues to contribute meaningfully to distributable earnings, by consistently producing double-digit returns on equity. The portfolio is primarily comprised of net lease properties with investment grade tenants and is financed with long-term, non-mark-to-market debt. Our securities portfolio ended the quarter with a balance of $617 million. On the asset and liability front, our balance sheet has never been stronger. The credit quality of our portfolio is very solid, and 84% of our capital structure is comprised of equity, unsecured bonds, and non-recourse, non-mark-to-market debt. Approximately 50% of our assets are unencumbered, with 76% of those assets being comprised of cash and readily financeable senior secured first mortgage loans. Also in July, despite volatile market conditions and tightening credit standards, we successfully expanded, upsized, and reduced the cost of our revolving credit facility with our non-bank syndicate, which now stands at $324 million. With $2.9 billion of unencumbered assets, strong liquidity, a low 1.8x adjusted leverage ratio, and 80% of our loan book now comprised of post-COVID originations, we are well positioned to continue to grow earnings by taking advantage of attractive opportunities in our space. In conclusion, our Multi-Cylinder business model is working, and we are very pleased with our positioning from a credit, earnings, and dividend perspective as we head into the second half of the year, with the wind at our back in a rising interest rate environment. With that, I'll turn the call over to Paul.

Paul Miceli, Executive Vice President

Thank you, Pamela. As discussed in the second quarter, Ladder generated distributable earnings of $43.7 million or $0.34 per share. Our three segments continue to perform well during the second quarter. Our $4 billion balance sheet loan portfolio is primarily floating rate and diverse in terms of collateral and geography. During the second quarter, loan origination activity outpaced pay-offs as we added a net of $161 million in balance sheet loans. As Pamela discussed, approximately 80% of our balance sheet loan portfolio was originated in the last 15 months with floors set at the time of origination. Therefore, our interest income continues to rise from the increases in 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. The second quarter also included a $3.1 million reversal of previously recognized provision on the successful resolution of a non-accrual office loan in Delaware. Our $1 billion real estate portfolio also 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 10 years. During the second quarter we sold two properties, a multi-family property and a property in Florida, and a student housing property in Oklahoma, which produced a net gain of $15 million and were sold at an aggregate 30% premium to underappreciated book value. Turning to our securities portfolio; as of June 30 our $617 million portfolio was 85% AAA rated, 98% investment grade rated, with a weighted average duration of approximately one year. Moving to the right side of our balance sheet, our capital structure remains anchored by a conservative combination of unsecured corporate bonds, non-recourse CLOs, and mortgage debt, with the corporate credit rating one notch away from investment grade from two of the three rating agencies. As of June 30 we had total liquidity of $483 million and our adjusted leverage ratio stood at 1.8x. As Pamela mentioned in July, we successfully extended, upsized, and reduced the cost of our revolving credit facility. The facility was extended for five years to July of 2027, upsized 22% from $266 million to $324 million, and furthermore the interest rate was reduced to SOFR plus 250 basis points, with further reductions upon achievement of investment grade ratings. This upsize of our revolver adds an additional tool to our financial flexibility that complements our large pool of unencumbered assets. As of June 30, our unencumbered asset pool stood at $2.9 billion and 76% of the pool is comprised of first mortgage loans and cash. During the quarter we repurchased $6 million of our unsecured corporate bonds at an average price of 88.6% to par. Also during the second quarter, we repurchased 400,000 shares of our common stock at a weighted average price of $10.11, and in July, our Board of Directors increased the authorization level for our share buyback program to $50 million. Our underappreciated book value per share was $13.57 at quarter's end, while GAAP book value per share was $11.84 based on 126.8 million shares outstanding from June 30. Finally, as Pamela discussed, in the second quarter we declared a $0.22 per share dividend, representing an increase of 10%, which was paid on July 15. For more details on our second 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, Founder & Chief Executive Officer

Thank you, Paul. The second quarter was a continuation of what we've seen over the last five quarters. We produced strong earnings from different parts of our Multi-Cylinder business model and benefited from our carefully constructed capital structure after correctly forecasting the Federal Reserve's hawkish plans to battle soaring inflation. In our last call, we indicated that we felt the Fed would have little choice but to raise rates into a slowing economy and that Ladder would benefit from aggressive rate hikes. So far this year, the Fed has increased the federal funds rate by 225 basis points and is likely to continue to hike rates through year-end. Because our earnings are positively correlated to rising short-term rates, we're experiencing a tailwind in our distributable earnings. I'd like to point out one item that illustrates one component of our earnings momentum. Over the last 12 months, our top line interest income has increased to $65.3 million in the second quarter of ’22, from $37.6 million in the second quarter of ’21. However, our interest expense actually has fallen over the same period from $45.2 million in 2021 to $42.7 million in the second quarter of 2022. This kind of operational efficiency is helping to drive our earnings and we're very pleased to report an after-tax annualized return on average equity of 11.3% in a very volatile second quarter. We expect the bulk of our earnings in the third and fourth quarters to come from growing net interest margin from our loan and securities portfolio and net operating income from our real-estate portfolio. Our highly curated real estate holdings are expected to continue to deliver strong returns in the years ahead and as cap rates rise, we expect to add to our real estate holdings over the next couple of years. For the second half of the year, we expect market volatility to continue as the market wrestles with the inflation versus recession question that central bankers are trying to manage. As the Fed has raised rates and slowed the U.S. economy, they've also strengthened the U.S. dollar, making earnings more difficult for multinational companies. Ladder does not own any financial investments outside of the United States, so we don't need to manage any exchange rates. As we look to the third and fourth quarters, we have Ladder on very firm footing with plenty of liquidity to deploy into a wide array of investment opportunities that invariably present themselves after a rapid rise in interest rates like we've experienced this year. We intend to take full advantage of market dislocations and feel very optimistic about our earnings in the quarters ahead. As the Fed cools the U.S. economy, our decades of experience will guide us in our lending efforts, staying focused on job one: always protect the principal. I'll now go to Q&A.

Operator, Operator

Thank you. Our first question is from Steven Delaney with JMP Securities. Please proceed.

Steven Delaney, Analyst

Congrats on the great quarter and the progress on the balance sheet. As always, I think it's important that we look at your earnings and try to at least identify the gain revenue, because clients will always ask us that; it's great that you have it. But the $0.34, it looks like there were gains on real estate about $0.12, so let's call it down to $0.22. But then you had some loss on your investment securities. It looks like about $0.02. So something in the – Paul, would something in the $0.24, $0.25 is, if we look at your earnings ex-gains. Is that a number that you feel is reasonable?

Paul Miceli, Executive Vice President

Yeah, we didn’t have any losses on securities this quarter. I think you might be looking at our mark-to-market on our loans held for sale. That really should be looked at, offset by our hedging gains, but…

Steven Delaney, Analyst

You’re absolutely right, it was the sale of loans, it was not your securities.

Paul Miceli, Executive Vice President

There's some G&A to be met off those numbers, and we did have a reversal of a provision when we resolved a non-accrual loan at a gain effectively. So I think you're in the ballpark, Steve, maybe slightly lower from a run rate.

Steven Delaney, Analyst

Okay, well that's very helpful. Thank you. We’ll try to clarify that and note. And then I guess, Brian, this thing cuts both ways on the interplay between interest rates and cap rates. I'm curious, well obviously you mentioned on your real estate side, and you’re obviously still finding some gains and your timing may have been earlier in the quarter before everything blew out, but as it has. But it sounds like you still think you will realize some and on the other hand you may be opportunistic and if things get really crazy with cap rates and buy more. On your loan portfolio, are you starting to see any signs that borrowers who have projects that are completed, recently completed and may be considering an investment sale process or just deciding to extend their loan with you and ride this out? And I guess the question is there, could there be less turnover in your portfolio, which I would think would be something of a benefit on really good, almost fully developed properties.

Brian Harris, Founder & Chief Executive Officer

Yes Steve, we are not really – we're not running into too many expansions right now, because that 80% portfolio is new. If you remember, it's probably – we probably originated this in the second quarter of 2021. So we're not even near the first maturity date on 80% of the portfolio. That said, I can speak generally and I think what's going on right now is, properties that were purchased a long time ago, in particular apartment buildings. Those rent increases have been attractive enough that they are keeping everybody in the game, and regardless of rate, it probably doesn't matter. What I can get into trouble are the loans that have tapped out in the last 12 months and anticipating they are going to have a period of rehab and maybe a Class C going to a Class B up in the building and raising rent 30%, 40%. I think that portion of the population, when you throw in gas and just, you know inflation around food and shelter, I think there's a limit to how far you can push those rents. Without any single lending issues, we have no problem, but I do think some of the equity numbers are not penciling out on the recent purchases, where people were paying up. What really happened is, when the Fed lowered rates effectively for 10 years, financial assets inflated. It’s important to realize that what you are witnessing right now when everything blew up; all you're seeing is the Fed trying to slow down the economy and the economy is slowing down. So, it’s opposite of them lowering rates and creating all kinds of liquidity and puffing up financial assets, and now you're seeing the opposite. This feels very much like a constructed situation. It doesn't feel like, you know, no one can fix this. This feels like exactly what they want to happen; housing prices were getting a little crazy. If they really want to slow things down furthermore, or if the pace of decline in the economy is too fast, we can easily slow things down and sell less mortgage-backed securities and do lots of other things. I think it’s a pretty healthy economy, and this should be a shallow recession, and it is very much under control at this point.

Steven Delaney, Analyst

I think, no question. They waited too long, but since they've acted aggressively, the ten-year has come down 80 some basis points from our top of 350 on June 14 to where we are today at 267. So you got to give the Fed some credit for that. Thank you for the comment, Brian.

Pamela McCormack, President

Steve, you know I would just add also. I know that we talked about how credit spreads got really wide, especially in the CLO business. I think that was a function of a technical and I think we’ve talked about this where the two-year was just galloping higher and LIBOR wasn't moving. I know at the end of today, the two-year is that 286 and three-month LIBOR is 78. So all those spread widening I think you saw were done for technical reasons. We could always see to far below the two-year. I think you're going to see a sharp reversal and a tightening in spreads here.

Steven Delaney, Analyst

That's awesome color. I think everybody will appreciate that. Thank you, Brian.

Pamela McCormack, President

Sure.

Operator, Operator

Our next question is from Jade Rahmani with KBW. Please proceed.

Jade Rahmani, Analyst

Thanks very much. Brian, where are you seeing the best relative value? You noted that as cap rates increase you think Ladder would be looking to buy more real estate in the past. You’ve also bought back bonds and I think that some of the mortgage REIT bonds might be attractive. Where would you look to incrementally allocate capital?

Pamela McCormack, President

It is a target rich environment right now. It is hard to find things that are not very attractive at this point, because a lot of the steam has been taken out of some of the crisis, so I'll go in order. I think like in the short term, when we purchase some of those bonds, we had some corporate bonds outstanding. The short bonds that are due in ‘25 for us. We were purchasing those between ‘91 to ’92. The 2027 was around 82 and the 2029 was actually around 78. There wasn’t a pile of 2029 trading in the low 70’s at one point, and these were intruding at those discounts because anybody thinks that those economies are having a problem. That's just where Double B’s are trading with the eight years of duration or seven or eight years left on them, so we took a little advantage of that. However, the yield that we were looking at on all three of those, they were really around eight to nine, and if I said we had an 11.3 return this year on assets in the quarter rather, and I – we're not having any trouble hitting a double-digit number across the board. I think in the short term one of the easiest places to add will be in the flat – the static CLO portfolios of A Class bonds because they, you know what the collateral is, it’s not going to change, and I think we saw them last week, where a complete multifamily deal traded the AAA's price with at 275 over LIBOR, with a DM of 275. That leverages to about a 24 return, and it is 90% levered that you can lower that if you feel like it, but the asset in those deals is about 85% levered, so it's clearly an attractive buy. The other one that I particularly like and where we've been trying to find them and we have found a few lately, are the AS bonds from 2019, because they have the A-Class and none of them are paying off or else there’s very little left and in some of those cases the subordination level is in the 70’s. So they are effectively linking into different credit losses, but they are still under-loved because they have office buildings and a few hotels and some industrial properties. So – but we're looking for those and we really like them. In the long term, I would say the stretch senior business is going to come back, meaning a lot of the deals that are getting done today are 65%, 70% levered. It's alright when you do that when you've got declining rents or any form of liquidity disruption, but you know I think that when they come up for refi or another little hidden landmine in a lot of these deals is the LIBOR cap. LIBOR caps, a lot of them – the LIBOR moves so fast that a lot of the caps from 2020 are at 1.5%, and if they come up for an extension, then LIBOR is at 3% when they have to buy a 1.5% cap, these get extraordinarily expensive. So I think there are going to be opportunities there. We actually had a situation where we sold one of our properties and the cap that we had put in place just a year earlier was worth 20% of the gain that we took while we were in the contract. So it’s a little wonky, but there are plenty of opportunities out there and I think – unfortunately I think the least attractive one is the actual loan origination process, but I think that's going to correct itself very quickly, because I do think these – I don't think you're going to see A Classes on static or A Classes on CLO deals; that’s 275, and I think it's going to snap in pretty hard.

Jade Rahmani, Analyst

So putting that in context with respect to Ladder, should we expect the company to be buying more securities, should we expect the company to slow originations or pivot that way? What do you think are Ladder's plans for the rest of the year?

Brian Harris, Founder & Chief Executive Officer

Well, I think we did slow origination a little bit inadvertently. We didn’t do it on purpose. What happened was rates moved up so quickly that some transactions just fell out, because the yields were falling apart on the equity side. Others did get to the finish lines, but they still had slightly lower prices. But no, I think we're going to pick up in our originations, because we believe that spreads are going to tighten in the CLO book. And yeah, so we're pretty comfortable with when it happens and so we’re going to move our spreads in that origination. And as far as security, you know I would love to add a lot of securities, whatever they’ve priced in the last month, but I don't believe we're going to be able to. I would like it in a $100 million or $200 million, but I don’t think we’re going to be able to buy a large amount of AAA bonds that are yielding 21%.

Jade Rahmani, Analyst

Okay. And in terms of the real estate portfolio, do you anticipate continued sales for the rest of this year or steady state? What’s realistic to expect?

Brian Harris, Founder & Chief Executive Officer

Well, things are for sale at Ladder often. If people want to buy something, again the 1031 market sometimes adds pricing. But we felt that cap rates were quite low and interest rates were very low, so we trimmed our portfolio in places, especially in some of the high dollars per foot assets that we own. But the way we look at it, really, we like cap rates wider when we’re acquiring, but we also have to have a company low interest rate in order to create the right spread to lever the return. So I think we will be adding, because basically I think cap rates are just a point higher, and a lot of that has to do, I don’t know about the stretch senior business; a lot of people are writing 65% loans, and we will too. But if you want to write a 75% loan, we could do a 65% senior and a 10% mezzanine and just push it together into a first mortgage, and I think we've got that kind of flexibility. So I think that’s another really good opportunity. It’s not for everybody, but it's going to be on the best credits; I think we'll do that.

Jade Rahmani, Analyst

And then in terms of credit across the portfolio and a looming potential or probable recession, what's been the company's approach? Are you buckling down in terms of asset management, making sure that credits across the portfolio look good? How do you feel about the credit standpoint?

Brian Harris, Founder & Chief Executive Officer

I believe that the credits are currently in excellent shape, and it's important to look back 18 months to understand how we reached this point. We originated some loans outside of the multifamily sector that we found attractive when others weren’t lending in that area. Most of those loans were placed into two CLOs we issued last year, and they are financed for a long duration, providing a match-funding strategy. Around November, we recognized that the widening spreads in the multifamily sector were not just a year-end occurrence, as many assumed. Therefore, we shifted our focus to new apartment buildings transitioning from construction loans, taking on the lease-up risk. If you had asked me in March, I would have pointed out that I was quite confident about apartments, especially considering the surge in housing prices that altered down payment dynamics for those seeking loans. As a result, many people chose to stay in their apartments, compounded by the recent college graduating classes that previously couldn’t move in due to the pandemic. This year, we saw a significant influx of demand, along with individuals selling their homes at high prices and moving into apartments. Consequently, the apartment market appears very promising, and rents are expected to increase. However, the lower-end sector may face challenges due to rising costs in gasoline, food, and rent. Conversely, the higher-end market seems to have room for growth as many can still afford those rents. Additionally, in the senior housing sector, adjustments for cost of living are anticipated to be substantial this year, likely outpacing rent increases. We began preparing for these changes last November by focusing on newer multifamily investments, and while we expect fewer transactions due to rising rates, we remain comfortable with our position. As Pamela noted, we experienced three payoffs at the end of the quarter and early July, including a modified hotel loan that paid off a year early, an unleveraged Delaware office building that was previously in default with a successful recovery of $3.5 million, and a payoff from a mall valued at about $28 million, which was also unleveraged. Overall, we received $112 million in cash over the course of a couple of weeks. Although this may slightly impact earnings, we believe it is easily replaceable.

Jade Rahmani, Analyst

Thank you.

Brian Harris, Founder & Chief Executive Officer

Yeah.

Operator, Operator

Our next question is from Ricardo Chinchilla with Deutsche Bank. Please proceed.

Ricardo Chinchilla, Analyst

Hey guys! Thanks for taking the question. I was wondering if you could comment on how you feel your liquidity position is for a recession at this point in time, and try to compare your position and your strategy towards this recession versus the prior recession and maybe what policies have you implemented to be prepared or what lessons did you learn from the last recession that you are thinking about applying into this recession, particularly when looking for opportunities, where to make incremental gains.

Brian Harris, Founder & Chief Executive Officer

I mean, thank you so much and it’s certainly the last recession you're talking about?

Ricardo Chinchilla, Analyst

The big recession, the last recession; 2008 maybe.

Brian Harris, Founder & Chief Executive Officer

2008, alright. In 2008 where I’ll call it the Great Recession, where actively residential homes were over-levered. We were always around the global commercial real estate group at UBS and my team and I had been backing down the portfolio for a year and a half at that point. We — our own business left UBS. We left around June of 2008. We're actually up close to $200 million, and that wasn’t because we were making that much. In the outskirts, we were selling everything. So in those telegraphed recessions, I thought, it didn’t really see anybody. You saw further defaults on subprime mortgage loans; 20% in the first month. I always questioned the wisdom of making loans to individuals, but the only thing you know about them is they don't usually pay their bills, so we avoided that and we pushed that out of that pretty clean for the most part. I wouldn't say at the time that they were just buying things in bulk and securitizing it. So that’s when we set up Ladder. You know the team and I left and the team that I left with set up the company through private equity that ultimately went public. So they are looking for any of the individuals of Ladder were with me in 2008 at that time. As far as going into this recession, we have a very low lever relatively. We’re one notch below investment grade at two of the three rating agencies. That’s been a long-term goal and most people who know us, and we’ve been saying that for the past eight years or so, getting laughed at a lot eight years ago, not getting laughed at more than now. So, we have plenty of cash. We just extended and upsized the revolver, the revolver so the 324 million, Pamela and the team did a great job on that. And we have lots of cash and we have great access to the corporate bond market, and I would just point out that we have underlying the differentiating feature of Ladder, which is we have $1.6 billion of ours in corporate bonds outstanding, and the bulk of them are not due until 2025, 2027 or 2029. And the rate on the $1.3 billion that's due in 2027 and 2029 is on average about 4.5% fixed. So as LIBOR goes higher and we’re now adding loans at 6.5% and 7% at the bottom line, because we're still paying here “4.5%” on that $1.3 billion of corporate bonds, and that’s really the operating leverage we keep talking about, and it's showing up. I mentioned in my comments you know what has gone on with the top line interest income line versus our interest expense. So I think we're as well positioned as anyone, and we do believe this is going to be a mild recession. Again, the Fed paused this; they did this on purpose and well, it was very expensive to hire people, you couldn't get enough people, housing prices were out of control. I gain absolutely was fine and so they wanted to slow the economy down, and I know that a lot of people haven’t seen a recession like this, but this is a little bit of what happened, and it's not something to be afraid of. This is not an over-leveraged financial situation where there is — I think China is having a 2008-style downturn in their real estate sector. But I’d say there is going to be a relatively shallow recession and a quick recovery. And I don't really think it's a great idea to have zero interest rates for 10 years, so hopefully we won't revisit that again.

Ricardo Chinchilla, Analyst

Perfect! That was very helpful. Thank you so much for taking the question.

Brian Harris, Founder & Chief Executive Officer

Sure.

Operator, Operator

Our next question is from Eric Hagen with BTIG. Please proceed.

Eric Hagen, Analyst

Hey thanks! Good afternoon guys! Hope you're well. So for loans that are maturing this year, I imagine some sponsors that have typically relied on financing from the CMBS market or an asset sale. So in cases where those options are either unattractive or uneconomical, what do you think is the source of take out, if you will, in those kinds of situations? Thanks.

Brian Harris, Founder & Chief Executive Officer

Well, if it’s in a CLO, I think the issuer is going to be very accommodative and modifying the terms, just keeping it going. But to the extent that it's on any line or if the loan is due at a bank, I think the banks especially with regulators are going to be less tolerant. And so as a result of that, I think the for sale sign will go up on the property or else as I mentioned earlier, that stretched in your concept where the guy is going to say I can't really refinance the loan I had, even though I didn't do anything wrong, that rents are doing what they are supposed to be doing, but interest rates have just eclipsed all of the income we’ve gained. Taxes in certain places are going higher, and so it's a lot of effort on the part of the equity sponsor that has been for nothing. Whereas I do think from the lender's perspective you're going to have a situation which I would think when your cap rates in the sixes and sevens, this is more normal. And there’s less leverage and people who can’t meet their maturity date with the full balance might very well wind up in a first mortgage with a mezzanine or as I often times called that out of stretch senior. Those are attractive because it isn’t like the properties that are falling at embedded value; they are simply drifting down because cap rates are going up, because interest rates have moved. Once interest rates stop climbing, the value tends to stabilize pretty quickly. And with the dollar being very strong, I think there's a whole lot of international interest too that might make this a very interesting scenario going forward. Look, we don’t like what we see coming here. It may be a little difficult for some of the equity guys to capitalize, but the debt side should be fine.

Eric Hagen, Analyst

It’s really interesting perspective, thank you. You know in the net lease portfolio, can you discuss how well-matched the underlying lease term is with the mortgage financing that you have against it? And does that have any bearing; I mean the matching have any bearings on the assets that you choose to sell? And then in cases where there's maybe a more meaningful mismatch in terms, how do you think investors should approach the value that they're getting there?

Brian Harris, Founder & Chief Executive Officer

Well, it’s a big portfolio. It’s 168 triple net properties, so – but I will say that for instance I know that we have four – these are wholesale costs and we’ve owned them for 10 years, and they are in CMBS deals and they are open to prepayment without penalty in September. So that's about $45 million worth of mortgages that have been out there for 10 years. I believe even at higher interest rates, given the fact that in those 10 years, best-based hotel clubs went from a private company to a public company. Obviously, the pandemic didn't hurt them, and so the cap rates have really collapsed there. And so we've got a reasonable gain there if we want to sell them. However, we also have an unfortunate scenario that if we refinance them, we’ll probably refinance into higher proceeds and do cash out refinance. And the cash flows are excellent, and the average lease term is 10 years. So we are pretty comfortable with those assets, and we can do either with them. Once we put them into another CMBS deal, we can't really sell them because the prepayment penalty is too high, although all the loans are assumable. So it’s a little hard to get to talk generally. We don't usually sell things if there's large prepayment penalties, or if we do we ask the buyer to pay that prepayment penalty and for the most part, they’ve been accommodating that. So we don’t have a lot of leverage in that portfolio, and the reason most buyers do pay that prepayment penalty is because they are able to borrow more than the debt we put on those assets. So we like that portfolio. We've been selling here and there, but not at all a concern. We think we are filled with options, with five to six years left on the mortgages, we are not selling those. The prepayment penalty is simply too high, although going down as rates rise. So the real estate book has ample gains in it. I think we've taken quite a few of them at this point, but when people are buying cap rates very tight and they are able to finance themselves at very low interest rates, I think you have to sell them sometimes. Sometimes I say I love our real estate assets, but it's like the kids going off to college; you're going to miss them, but they have to go. And that’s the way we approach it.

Eric Hagen, Analyst

That’s fair to say. Thank you very much. I appreciate it.

Operator, Operator

Our next question is from Matthew Howlett with B. Riley. Please proceed.

Matthew Howlett, Analyst

Thanks for taking my question. Brian, on the – you know last quarter you talked about, the force of its impact, LIBOR hit 150 at the end of June. Now we are well aware, you know, too close to 2.5. Can you just talk a little bit about the cadence of what to expect in the third and fourth quarter, given the Fed hike this week and then what probably may be 50 bps in September?

Brian Harris, Founder & Chief Executive Officer

Yeah, I mean last call, in our last call, I think we were talking. It’s funny we mentioned, I think if our estimates were the Fed raised, and we kind of talk about the Fed funds rate and LIBOR as if they are the same, so forgive me there. But we – they do track together, and so no one, though – I think at the time in April we were talking that the Fed would raise rates 200 basis points by year-end. We did. However, we did not think they would do it before the end of the next quarter. And so they did that all very quickly, the 275 have really been bold and a bit of a surprise. Not as surprised in the last week, but certainly from the April perspective. And at that time, I think we said on a gross basis its 100 basis points would give where we were with our portfolio, probably add $0.16 a share and 200 basis points would have added $0.36 a share gross. So I would not talk about 15% of that for expenses, and so at $0.36 you would maybe call it $0.28 or $0.29 a share. And the other part of that was that we had an estimate of what would pay off going into that, and the second part was we had an estimate of what we would originate going into that also. I think the origination part of that conversation has been a little bit slow, but I don't think it's a problem; I think it's just delayed. Because there are transactions that we are working on right now that have been going on for a while, but the loan proceeds are just not as high as they were three months ago, so there’s some price negotiations going on. So I'm pretty comfortable that the market is a little rate-shocked because it moved so quickly. However, I'm relatively certain through many years of experience that the commercial real estate market will do just fine with rates at 6%. I don't think that's going to be a problem. It just takes a little while for those rates to set in. So I do anticipate if the Fed, and I think the Fed will keep raising rates. I think they're probably going to get around 3% by the end of the year. Yeah, I would expect our top-line interest income to keep rising, and as you know our fixed rate $1.6 billion does not rise with it, so it's just additive and there’s a lot of operating leverage as a result of that. But we have to pick up and be patient a little.

Matthew Howlett, Analyst

Got you. And how inclined are you to keep raising the dividend? I mean obviously you covered the dividend next to real estate gains from real estate sales this quarter and I know there is obviously – you know I mean should we be going into what you think will be a potentially soft planning, but a minor recession. How much do you want to raise the dividend?

Brian Harris, Founder & Chief Executive Officer

I love raising the dividend. I’m one of the biggest shareholders in the company. However – and Paul you can chime in here or Pamela, but I'm pretty sure we're covering the dividend now out of interest and expect to cover it again in the third and fourth quarters, and unless the Fed starts cutting rates or we stop originating loans, I don't see that ending. So I suspect we've got an attractive runway here, and I will never get tired of raising the dividend as long as the funds are available and I think we’ve really built a machine right now that has the ability. You know people say what are you going to raise the dividend to? I would say, well, tell me where the Fed is going? And you know I have all the confidence in the world in our origination machine as well our credit standards, so we’ll get that right and I think the world is simply less liquid than it used to be, and that just benefits lenders, and I think we're one of them. So I'm very optimistic about the quarters ahead here.

Matthew Howlett, Analyst

And then lastly, just what’s the update on the investment grade? I mean, I’m a little surprised to hear the bonds, your bonds are getting that much of a discount when you're not away from investment grade. It just seems so ridiculous to me. But where are you in terms of the rating agencies? I know these are the line; if you could go down and you get the upgrade. Just what, how important is that to you and how close are we?

Brian Harris, Founder & Chief Executive Officer

Well, I won’t speak on behalf of rating agencies. I'll speak on behalf of my opinion, and again we have some general guidelines as to how rating agencies and they have different guidelines, but we generally understand how they look at it. But you know there's a – so we don't think we're too far away from that if we wanted to do it. Rates got too high for us to attempt to get that done. But like I said, instead of that being a problem, we made it into an opportunity and we acquired some of our bonds back. But the ratings agencies don’t stand still. Some of them will take a look at what they think or whatever recession is that's coming. But you know given that our 80% of our assets, which is a lot of payoffs, after the pandemic started because we had very high floors and we had very good credits when the Fed lowered rates, we got paid off more than most. So I think you might remember, it wasn’t that long ago, we were holding $2 billion in cash and we simply moved that $2 billion into the loan category. We are only levered 1.8x. So we are going to maintain rational leverage and hopefully allow us to have the option of making a run at going to an investment-grade level with an issuer. But you know a lot of things have to fall into place there and none of them are a promise. But we feel pretty good about it. We’ve studied this at large and we understand where we have to be, as long as the goal posts don't move too much. But as far as the bonds getting down and trading that low, that was indiscriminate selling and we were not singled out as one of the bad ones or the good ones. They were doing some fleets on everything as high yields sold off, as this 15 years of recession took hold, which surprises me, because so much of the high yield conflict is energy-related and a lot of it was caused by the energy crisis. But I'll never figure out what makes ETFs sell things, but rather than fight with it, I’ll just try to take advantage as it presents itself. But when we see yields in the eight to nine’s in our own paper, if we can beat eight or nine ROE pretty easily. So I can make a case for not buying them back, but given that we are uniquely positioned to take a 20-point gain the night we buy the bonds, which no one else can do, because they have to wait for the principals to come back to them in seven or eight years, you know sometimes that's a little tempting. It’s also, by the way, one of the unique features of Ladder and that we have that ability to go buy a lot of our debt back in the open market at a deep discount. If you are on a repo line, you don’t have that opportunity.

Matthew Howlett, Analyst

I mean, we’ll see the peers, but I doubt many of them bought back their good – but I think there are some of the securitization that I'm glad to see Ladder doing it. My message to the board would be, keep on that, both debt and stock when it’s there for you. I think that’s one of the benefits of being internally managed. Thanks guys for taking the questions.

Brian Harris, Founder & Chief Executive Officer

We try to always buy them both, because we don’t want bond investors thinking – we don’t want equity investors thinking we are just taking care of the bond guys and we don’t want bond investors thinking we just buy stock back. But in this case, given the selloff that took place and what we think was the worst half year in 40 years in the stock market, so that presents great opportunities, and we have plenty of cash, so we didn’t buy a lot. We spent a little bit, but we were doing very well in the overall portfolio. But if those opportunities present themselves, you should expect us to wait in there. And that's – I also want to point out, during the pandemic when our bonds sold off, you know we bought from them too. I think we bought about 100 of them, and those were the 2027’s that are out there now. There used to be 750 of them out there and now there's 650. So those are very nice instruments to have in the open market and if the overall market gets shaky and you're in good shape, we always try to be on the front foot, and I said today, we are on the front foot and we're not against buying other people's insurance either. When the whole sector gets sold off for any reason, again I would think we’ll step in there and take advantage of it.

Matthew Howlett, Analyst

That’s what I mean. Because we’ve had a dividend in the low sevens, we've got yields on our bonds in the sevens, so should we buy them back?

Brian Harris, Founder & Chief Executive Officer

Yeah, they are pretty cheap. But we can make so much by investing money right now, and I think that's how we best serve our shareholders.

Matthew Howlett, Analyst

And just one follow-up on that. I mean do you think that some of the bigger REITs could have problems, mortgage rates, you know what's being a hotel or a big office exposure, and there could be an opportunity for guys to step in somewhere?

Brian Harris, Founder & Chief Executive Officer

I don't know, I don't pay too much attention to other companies. But you know the sectors, the office market, we are going to see where it goes. I’m generally optimistic. I think that come September, I think the country is getting one more summer in, even though most people are acting like there’s nothing wrong out there, no ones in the office. I think in the fall the office market will come back. I think the hotels sector is doing fine right now. The only reason you're not seeing a lot of financing there is because it didn’t have 12 months of trailing 12 cash flows. But once they do, I think hotels are going to – should be just fine.

Matthew Howlett, Analyst

Thanks a lot. Thanks for answering my questions.

Brian Harris, Founder & Chief Executive Officer

Sure.

Operator, Operator

We have reached the end of our question-and-answer session. I'll turn it back to Brian Harris for closing comments.

Brian Harris, Founder & Chief Executive Officer

I don't have too much to say, other than we are focused on our plan. Our plan has come full circle at this point, and we’re set up to take advantage of it. Rates are higher that benefits its lenders, and we really do look forward to the year ahead. We had a good time, so thanks for staying with us and listening to us and well…

Operator, Operator

Thank you. This will conclude today's conference. You may disconnect your lines at this time and thank you for your participation.