Earnings Call Transcript
Ladder Capital Corp (LADR)
Earnings Call Transcript - LADR Q2 2024
Operator, Operator
Good morning, and welcome to Ladder Capital Corp's Earnings Call for the Second Quarter of 2024. As a reminder, today's call is being recorded. This morning, Ladder released its financial results for the quarter ended June 30, 2024. 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 earnings supplement presentation, which is available in the Investor Relations section of our website. We also refer you to our Form 10-K and earnings supplement presentation for definitions of certain metrics, which we may cite on today's call. At this time, I'd like to turn the call over to Ladder's President, Pamela McCormack.
Pamela McCormack, President
Good morning. We are pleased to present an overview of Ladder's performance for the second quarter of 2024 and an update on our progress towards becoming an investment-grade company. During the quarter, Ladder generated distributable earnings of $40.4 million, or $0.31 per share. This performance yielded a return on equity of 10.2%, supported by modest adjusted leverage of 1.4x. In addition, we successfully priced a $500 million, seven-year unsecured corporate bond offering, resulting in positive rating actions from all three rating agencies. We're pleased to note that both Moody's and Fitch placed Ladder on positive outlook and S&P upgraded both our corporate credit rating and our bonds. Moody's and Fitch are one notch away from assigning Ladder an investment-grade rating. We believe this milestone will enhance our distinction among peers in the commercial mortgage REIT space and position us as an attractive option for traditional equity REIT investors. Pro forma for the $500 million offering, 53% of our debt is comprised of unsecured corporate bonds. As of July 25, Ladder has $1.9 billion in liquidity with $1.6 billion, or approximately 30% of our balance sheet comprised of cash and cash equivalents. With this enhanced liquidity, we can now squarely focus on offense. As we have stated in the past, our core objective is striving for the highest possible return on equity while prioritizing principal preservation and employing modest leverage. This disciplined and differentiated strategy, supported by our diversified business lines and conservative capital structure, has enabled Ladder to generate stable and attractive returns. Specifically, over the past 12 months, and against the challenging backdrop, we have reduced assets to $5 billion from $5.6 billion from loan payoffs and asset sales, almost doubled our liquidity to $1.9 billion as of July 25, reduced debt resulting in a modest adjusted and gross leverage of 1.4x and 2.2x, respectively, increased our component of unsecured debt to 53% from 40%, pro forma for the bond offering that closed in July, grew unencumbered assets to $3.1 billion, or 62% of assets with 82% comprised of cash, securities, and first mortgage loans, preserved a stable book value, and finally, we achieved all of this while providing a healthy return on equity to shareholders of over 10% while building up a large liquidity position. Turning now to our balance sheet loan portfolio, which totaled $2.5 billion as of quarter end, with a weighted average yield of 9.48% and limited future funding commitments totaling $94 million. Our earnings for the second quarter included a $1.6 million, or 5.4% gain from the sale of approximately $29 million of fixed-rate loans into a recent CMBS securitization. In the second quarter, we originated a $16 million first mortgage balance sheet loan secured by an industrial portfolio in Florida. Additionally, we made a $13 million passive equity investment in a joint venture with a seasoned operating partner to strategically acquire a Class A office building in the Plaza District of New York City. The asset was acquired from an institutional investor who owned the asset for over 20 years with favorable financing arranged through the existing lender. We're well capitalized and anticipate further expansion of our loan portfolio, for which our originators are actively pursuing new investments. Regarding our current loan portfolio, we remain proactive in asset management. In the second quarter, we received $255 million in loan pay downs, including the full repayment of 13 loans totaling $242 million. In addition, four more loans totaling $56 million were repaid after the quarter ended. Year-to-date, we received $668 million in total loan pay downs, including the full repayment of 32 loans totaling $618 million. We've also been active in opportunistically divesting owned real estate. In total, we sold three assets securing loans that defaulted during the first half of the year at a gain above our basis. Two multifamily assets located in Longview, Texas, and Los Angeles, California, with a total carrying value of $20 million were sold in the second quarter resulting in a net gain of $1 million. Additionally, a third multifamily asset in Texas valued at $11.5 million was sold at a gain above our basis after the quarter ended. We're continuing to demonstrate that defaults do not necessarily lead to losses. We take pride in our capability to own and manage properties, including our readiness to inject capital when necessary or to strategically expedite asset sales as appropriate to maximize their value. There were no specific impairments identified during the quarter, and we modestly increased our general CECL reserve to $54 million, which we believe is sufficient to cover any potential loan losses we may incur. Turning now to our securities and real estate portfolio. We purchased $81 million of AAA rated securities with a weighted average yield of 7.1% during the quarter. We ended the second quarter with a $481 million securities portfolio primarily consisting of AAA rated securities earning an unlevered yield of 6.92%, and we've been actively acquiring new securities to add to the portfolio in the third quarter. Our $947 million real estate portfolio contributed $14.7 million in net rental income in the second quarter and continues to be mainly comprised of net lease properties with long-term leases to investment-grade rated tenants. We sold four properties for a net gain of $3.4 million during the quarter, including the two REO assets previously mentioned. In conclusion, we maintain ample liquidity, a strong balance sheet, conservative leverage and a well-supported dividend, positioning us to seize opportunities as 2024 progresses. With that, I'll turn the call over to Paul.
Paul Miceli, CFO
Thank you, Pamela. In the second quarter of 2024, Ladder generated $40.4 million of distributable earnings, or $0.31 per share of distributable EPS, for return on average equity of 10.2%. Our earnings in the second quarter continued to be driven by strong net interest income and stable net operating income from our real estate portfolio and was complemented by gains from the sales of real estate properties. As Pamela discussed, the unsecured bond issuance that priced at the end of June and closed in July further strengthened our balance sheet. Ladder issued $500 million of unsecured corporate bonds at 7.0% with a seven-year term, which is callable after year three in 2027. Unsecured corporate bonds are the foundation of our capital structure with now $2.1 billion outstanding across four issuances. Pro forma for the issuance 91% of our debt is comprised of non-mark-to-market financing with 53% of total debt being unsecured corporate bonds with a weighted average maturity of over four years and an attractive weighted average fixed rate coupon of 5.2%. We remain committed to the corporate unsecured bond market as our primary source of financing and are now the closest we have been to an investment-grade credit rating than at any point in Ladder's history. As Pamela discussed, both Moody's and Fitch placed Ladder on positive outlook and Moody's upgraded and unnotched the rating on our bonds to Ba1, aligning our bonds with our corporate credit rating. Additionally, S&P also issued an upgrade to our rating on both our bonds and our corporate credit rating. With Moody's and Fitch just one notch away from investment grade, and now with a positive outlook on our corporate rating, Ladder is one step closer to achieving our long-held goal of becoming an investment-grade company, which opens Ladder to the more accessible and broader investment-grade bond market where we believe Ladder will ultimately achieve a more attractive cost of capital and enhance our return on equity to shareholders over time. Our balance sheet remains highly liquid. As of July 25, we had $1.6 billion in cash and cash equivalents or $1.9 billion of liquidity with our $324 million unsecured revolver, which remained fully undrawn. Our loan portfolio totaled $2.5 billion as of quarter ends across 85 balance sheet loans representing approximately 50% of our total assets. We did not record any specific impairments in the second quarter. However, we increased our CECL reserve by $5 million, bringing our general reserve to $54 million for an approximate 213 basis point reserve on our loan portfolio. The increase was driven by the continued uncertainty in the state of the U.S. commercial real estate market and overall global market conditions. Our $947 million real estate segment continues to generate stable net operating income and includes 155 net lease properties representing approximately 70% of the segment. Our net lease tenants are strong credit, primarily investment-grade rated and committed to long-term leases with an average remaining lease term of eight years. As we have historically demonstrated, we have a long track record of maximizing the value of real estate assets that we own and operate. This was demonstrated through the sale of four properties, including the two REOs previously mentioned, that generated a total of $3.4 million of net gains for distributable earnings during the second quarter. As of June 30, recurring value of our securities portfolio was $481 million. 99% of the portfolio was investment-grade rated with 86% being AAA rated. As of July 25, our entire securities portfolio was unencumbered and readily financeable, providing an additional source of potential liquidity complementing the $1.9 billion of same-day liquidity as of that date. As of June 30, 2024, our adjusted leverage ratio was 1.4x and has continued to trend down as we delever our balance sheet while producing steady earnings, strong dividend coverage and double-digit return on equity in the second quarter of 2024. As of June 30, our unencumbered asset pool stood at $3.1 billion, or 62% of our balance sheet. 82% of this unencumbered asset pool comprised the first mortgage loans, securities and unrestricted cash and cash equivalents. Our significant liquidity position, large pool of high-quality unencumbered assets and capital structure that has been further strengthened with a new corporate bond deal provides Ladder with strong financial flexibility as we head into the second half of 2024. As of June 30, Ladder's underappreciated book value per share was $13.71, which was net of the $0.42 per share of CECL we have established. In the second quarter of 2024, we repurchased $212,000 of our common stock at a weighted average price of $10.75 per share. Year-to-date, through June 30, 2024, we have repurchased $860,000 of our common stock at a weighted average price of $10.77 per share. Finally, our dividend remains well covered. In the second quarter, we declared a dividend of $0.23 per share, which was paid on July 15, 2024. For details on our second quarter 2024 operating results, please refer to our earnings supplement, which is available on our website, and Ladder's quarterly report on Form 10-Q, which we expect to file in the coming days. With that, I will turn the call over to Brian.
Brian Harris, CEO
Thanks, Paul. We're pleased with our second quarter results, especially because we were able to issue a $500 million unsecured corporate bond with constructive commentary from all three rating agencies. The issuance was another important step in our continued quest to become an investment-grade company. It also sets the table for us to increase our asset base and grow earnings in the years ahead. With the Fed signaling that they are likely to begin an easing cycle before year-end, market optimism has become more prevalent. At Ladder, we share that optimism, and why not? Our quarterly cash dividend is well covered, despite our use of relatively low leverage while having nearly $2 billion of liquidity providing us with substantial earnings power going forward. Because we are beginning to invest our significant cash position into higher yielding investments at a time when lending in commercial real estate is increasingly falling under the domain of non-bank lenders, we think the future looks bright for our shareholders in the quarters ahead. Our loan portfolio continues to pay off at a comfortable pace, and even when we've had to take back a few properties, we've been able to sell them in short order generally at a gain to our basis. We still feel like the acquisition of securities offers the best risk/reward proposition for our investment dollars. As Pamela mentioned earlier in the second quarter, we acquired $81 million of AAA rated securities at an unlevered yield of 7.1%. We have continued to acquire additional AAA securities into the third quarter. We also purchased a minority interest in a Class A office building in Midtown Manhattan for $13 million. Our purchase price was at a price of just under $350 per square foot. Our investment was made just a few weeks before news of J.P. Morgan's agreement to purchase 225 Park Avenue for $575 per square foot with a likely plan to tear it down and build something modern. The two assets described are just a five-minute walk from each other. The Plaza District around Grand Central Terminal in Manhattan is bucking the trend in the office sector with financial services companies like Aries Capital, Blackstone, Citadel and J.P. Morgan making major long-term commitments to this vibrant pocket of real estate. And we hope to benefit from this momentum with our recent purchase nearby. The expectation of lower interest rates has given way to a sense that commercial real estate in general may have bottomed in the last six months. While office will be the slowest to recover overall, there is a sense that the worst may be over at this point. There will certainly be more foreclosures and properties changing hands, but green shoots are showing up in many places. We've even seen politicians in Philadelphia and San Francisco calling for workers to return to office in person, creating safer streets. It's become apparent that hollowed-out downtown business hubs ultimately cause deficits in municipal budgets, and residents in many of the hardest-hit places are increasingly calling for new leadership that prioritizes their safety and well-being. While the mood of the market seems to have improved lately, caution is still warranted because liquidity is thin and can become almost non-existent very quickly without warning. Despite new supply being on the low side for years now, credit spreads in CMBS and commercial real estate CLOs are still wide by historical standards. That's why we like buying them, but we generally keep to the AAA classes due to this concern around liquidity. Increasingly, we are seeing the actual rate on a new mortgage, especially on larger dollar amounts, being set by the public markets and not by a bank lender. By taking the bank out of the risk position relating to spreads, the larger investors in securities have a lot to say about what rate a borrower should pay if they want these large buyers to buy their bonds. This new way of setting mortgage rates after the securities have been placed on order will probably be around for a while, but this shift in pricing power to the buyer of the securities away from the bank lenders is resulting in spreads staying wide at least for now, despite a general lack of supply. I'm sure T-bills with rates in the mid-5s have also caught the attention of a lot of these investment dollars, dampening demand for mortgage bonds. But keep in mind; it's possible that the holders of the losses stemming from mortgage investments in the last decade of lower interest rates may now be involved in determining the mortgage interest rate for sponsors seeking to borrow against commercial real estate. Loans secured by unusual property types or relating to a large cash-out refinancing or loans to sponsors that have walked away from other properties have been seeing wide pricing after the deal is first introduced to the market. That's a new development. So now that the first half of 2024 is in the history books, we can probably look forward to some much-needed relief in the second half with rates expected to fall in the quarters ahead. With a large cash position, low leverage, and a strong credit culture, we feel that our differentiated funding model has us in an enviable position to take advantage of the investment opportunities ahead. We can now take some questions.
Operator, Operator
Our first question comes from Stephen Laws with Raymond James. Please proceed.
Stephen Laws, Analyst
Hi, good morning. Hey, Pamela. Hey Brian, I want to start with the investment pipeline and focus on offense. And I know you guys both touched on security purchases. And Brian, I think you mentioned those provide where you're seeing most attractive returns. But given the leverage, you don't get a lot of capital deployed there. So if you think about moving on offense in the second half of the year, when do you see kind of new loan investments accelerating? Is that a 3Q event, or is it going to take time to kind of get the pipeline and origination activity restarted and more 4Q growth on the loan portfolio? And when you look at, what are you looking at there, are you looking at maybe helping fill the void in construction financing? Are you looking at possibly mez loans? Kind of how do you think about turning the loan originations back on?
Pamela McCormack, President
So hey Stephen, so a couple of things, I think you asked a lot of questions there. On the securities portfolio, I just want to be clear. Right now, our securities portfolio is unlevered. So we actually are deploying cash, and it's really quite competitive with the returns on loans right now. It's over 7% unlevered. And given our cash position, it's a nice complement to that. On the loan portfolio, listen; we are actively looking at loans. We are not waiting to go on offense, waiting to see the right opportunities to deploy our capital. Given the fact that we are covering our dividend well and we feel comfortable with our credit, we're looking to add accretively. So I do think we're starting to see the pipeline build close along this quarter. We have loans in the pipeline, but realistically, I think you'll start to see some momentum in the third quarter, and we're hoping it will really rev up in the fourth quarter.
Stephen Laws, Analyst
Great.
Pamela McCormack, President
I think that answers your questions.
Brian Harris, CEO
That's fine. Stephen and I want to clarify that we do not plan on entering the construction lending space, as it's not our area of expertise. Currently, there isn't much demand for it. As I previously noted, production volumes have been low, not only for us but also in the CMBS and CLO markets. The Wall Street Journal recently published a decade-long chart showcasing CMBS and single-asset deals. While single assets have seen an uptick due to large sponsors needing to borrow, overall volumes have sharply declined since 2017 and 2018. One might expect this decline to lead to supply issues, making for tight pricing, but the reality is quite the opposite—spreads are surprisingly wide, almost at historical highs. This seems counterintuitive but may be influenced by T-bills in the mid-5s. Additionally, there's been a subtle shift in how mortgage interest rates are established, moving away from large loans in major cities due to saturation among lenders. In the past, we felt we could not meet our desired hurdle rates due to intense competition, but that's changed. Markets are now determining mortgage deal rates at closing by proposing structures with input from rating agencies, and currently, the consensus is that commercial real estate should be priced wider. We've seen significant growth, with over $80 million secured in the first quarter and more than $100 million already in the first half of July. These unlevered yields are in the low-7s with hefty spreads that, when leveraged, could reach the 20s. Given our recent capital raise and existing cash reserves, we're focusing on maintaining an unlevered position for a while before leveraging a portion of our securities, which should comfortably surpass our dividend rate. When evaluating the liquidity and financeability of those bonds versus whole loans at 250 or 300, I believe bonds offer a superior investment opportunity. We're not missing any opportunities in the current market since overall demand is low, a sentiment echoed by banks and competitors. Rates remain wide, and there's considerable interest in refinancing, though many end up in equity positions by chance. In acquisitions, competition is stiff, resulting in tight pricing. I'm pleased to be acquiring AAAs priced at 200 over instead of selling them at that rate.
Stephen Laws, Analyst
Appreciate the color there. As a follow-up around the dividend, incredibly strong coverage now seems like the outlook as you move to offense both out of cash into higher yielding securities and loans, and then eventually leverage, probably sometime next year, that coverage likely only continue increasing. So, when you have your discussion with the Board and you look at the dividend, it's like a six-handle yield on undepreciated book value. What are the considerations that go around? When is the right time to increase that dividend? Or if increasing is the right way to go, how do you think about setting the right level for the dividend moving forward?
Brian Harris, CEO
Well, higher dividends follow higher earnings, especially in a REIT that distributes 90% of its income. So, one, the earnings will come first, and then the dividend will follow. But if you just take a look at cash holdings on our balance sheet right now, if we simply lever that 50% and you can easily see how our asset base can get a lot bigger, it can go up to $3 billion, and that will create tremendous earnings power. So if we're out earning our dividend while holding almost $2 billion in cash, it shouldn't be a big step to start thinking about raising it as we get through the tail end of the downturn and also the beginning of what I would call the expansion. Yes, thank you.
Operator, Operator
And the next question comes from the line of Steve DeLaney with JMP Securities. Please proceed.
Steve DeLaney, Analyst
Thanks. Good morning, everyone. Congratulations on the new bond issue and all that it entails, and also on a very solid quarter overall. So, Brian, we now have more clarity regarding the Fed and the outlook for the next couple of years. If we see a 50 basis point increase this year, that would net something around 100 basis points. How significant is this for the overall commercial real estate market? While that affects short rates, we also need to consider how the Fed's actions will influence longer-term rates. Will this rate environment over the next 15 to 24 months encourage new institutional equity to enter the commercial real estate market? Isn't that necessary for creating new transitional bridge loan opportunities? It seems that there aren't enough borrowers right now, even with banks pulling back. I'm interested to see how this plays out competitively in a lower rate environment. Thank you.
Brian Harris, CEO
Sure. I believe the first step is that transaction volume will increase as more money goes to equityholders compared to lenders. For example, in the first year, we expect to see a rise in transaction volume. If that happens and there's plenty of equity available, we’ve already seen interest; we sold about four properties in the last quarter. Normally, when we consider selling, we get calls from interested parties even before we set up an auction. Often, these are buyers who have been eyeing the asset but haven’t communicated with us—just the previous owner. We might also be experiencing some basis trading because I think some of these properties are priced attractively. The key first step is lower interest rates. The discussions around lower rates have already generated a more optimistic sentiment in the market, reminiscent of January when everyone was anticipating several rate cuts and indulging in expensive cabernets. That optimism faded quickly, but now it appears we may be nearing the end of the Fed's tightening cycle, moving towards a period of lower rates. I’ve never believed they would reach 2% inflation; I think we’re at around 3%, and that seems to be what they're accepting. On the other hand, while they have a dual mandate, they tend to focus on just one aspect at a time. With the economy showing signs of slowing, I think they will become more concerned about job market participation in light of the 3% inflation, and instead of solely combating inflation, they’ll ensure they don't jeopardize job growth. We need this to happen, as it’s typically easier to see movement in the real estate market when stock markets are hitting new highs. Investors often sell overperforming stocks to purchase apartment buildings. Real estate tends to lag behind the stock market. If the stock market continues to rise, it's worth noting that most of its valuation growth has come from reduced multiples rather than actual earnings increases. We have some concerns about market volatility, as evidenced by the quick rise of the VIX above 18 recently; this indicates we’re not completely in the clear. Such rapid changes in the VIX, from 12 to 18 without clear cause, are concerning. Therefore, we will maintain a conservative approach. As long as we have AAAs yielding 175 to 200 available, we’ll allow others to handle lending for now while we focus on acquiring finished products. Once conditions stabilize, and I believe the Fed will lead to a steepening of the yield curve—recently, we observed a bullish steepening—I'm inclined to think that while the two-year yields will decrease more significantly, the ten-year yields won't rise as much. That shift is when the real estate market starts to gain momentum.
Steve DeLaney, Analyst
And real quick follow-up, you did this JV part interest in a partnership. Could we see a transaction where you saw a building, you and other investors created a partnership bought the building that needed to be rehabbed or whatever. Could you put equity into a project and also make the bridge loan to the partnership? Would you get two bites at the same apple?
Brian Harris, CEO
Sure. I'll even offer a third bite. There's a scenario where you stretch a senior and you basically make your equities a debt instrument. Sometimes we call it dequity internally, and instead of just owning the real estate with the partner, because all of your investment dollars are senior to his, then you just put a rate on it. So you combine a senior with a mez, and you take a participation in the building. So there's three versions of it. One is, yes, we could be a lender to the partnership. Two, we could be an equity borrower in a debt outfit with a higher stretch on the size of the loan. Or else, we could just be equity in the deal and borrow from somebody else like we just did.
Steve DeLaney, Analyst
Thank you very much.
Operator, Operator
The next question comes from the line of Jade Rahmani with KBW. Please proceed.
Jade Rahmani, Analyst
Thank you very much. You all have been sitting on ample amounts of cash for quite some time and are in an enviable position versus competitors. Yet, originations were pretty subdued in the quarter. So I'm wondering if you feel that the market is actually in fact too competitive with debt funds chasing a very limited pool of deals. For example, CRE showed commercial mortgage originations up 38% and they said debt fund volumes were up 70%. Isn't the market too competitive actually?
Brian Harris, CEO
The market that's a big word, and it covers a lot of ground. But the addressable market, in our opinion, not exclusively, but largely lands in borrowers seeking debt on acquisitions. So you just got rid of 75% of the addressable audience. And if it's multifamily, then it's too competitive. Yes, I think it is. But it isn't too competitive because there's too many competitors. It's because there's really no volume. But you're seeing the market react. And it is the purchase that we made during the quarter of an office building. That's a reset on price. And as you see more and more of that happen, you'll see more and more acquisitions. So I don't think it's too competitive. I think there is just a lack of demand. When there is a high-quality investment possibility on a lending assignment, it is very competitive, but it's not like they're losing money. I know it's not that bad. But what is happening, I think is that a lot of volume is being driven by the sake of transacting as opposed to margins, or making a lot of money. Because I don't really understand how you make money lending at 250 to 275 over SOFR and then selling AAAs at 190 to 200. And you would think with a lack of supply, like you just mentioned, there is this tremendous widening going on in the securities market, because I just believe the pricing mechanism is inefficient. And for the first time in my career, we're seeing the price of the interest rate on a mortgage being set by the public markets, not by a banker who's taking a risk.
Jade Rahmani, Analyst
On the origination side, could you say as to the volume of term sheets you put out and the success rate you're hitting? I'm just trying to gauge competition, if you're really actually losing out on a lot of deals.
Brian Harris, CEO
We're not missing out when we bid on assets we like. We do lose some, as is typical, but not significantly—perhaps even at a lower rate. The real issue we're experiencing comes from the influx of new buyers in the market who have managed their capital wisely over the past decade and haven't taken on debt at low interest rates. They are now able to purchase assets at lower prices due to the market reset. Many of these buyers aren't familiar with documentation from CMBS or CLOs; they primarily come from banking backgrounds. When they review our documents, they often find them intimidating, which leads them to withdraw from deals or choose to fund them entirely in cash, even after we've provided a term sheet. There are various reasons why the limited volume we're sending out isn't resulting in productive outcomes, and this isn't primarily driven by competitors offering lower rates—it's more complex than that.
Jade Rahmani, Analyst
Okay. Just in terms of property type mix on the loan portfolio, office increased to 34% from 31%. And I think that you probably are seeing repayments proportionately outside of office, there's probably some office, but maybe more in the other asset types. Are you at all concerned about the increased concentration in office? And do you maybe provide a comment on how you feel about the office portfolio?
Brian Harris, CEO
Sure. Multifamily loans are the easiest to pay off, while office loans are the hardest. As a result, we are prioritizing hiring as we manage a billion in payoffs over the year. The office sector isn’t performing particularly well in our portfolio. However, we appreciate that we assess every loan, whether office or multifamily, as if we might have to take it back, and we plan for that possibility. In the CMBS market, many office loans are being included in deals at lower debt levels, which makes sense. It used to be difficult to include office loans, but now they represent a significant property type concentration, likely due to current market resets. We have been monitoring our office portfolio for a couple of years, and most of our sponsors are managing their situations well and making payments, allowing us to reduce leverage. Each time a borrower makes a significant payment toward their loan and invests in necessary costs, it indicates a lower risk of default, which is a trend we are observing. The majority of our portfolio is seeing this effect. The riskiest part of the portfolio is in large cities where challenges persist, such as slow returns to the office. Washington, D.C. is particularly problematic, though we do have a few small loans in underperforming buildings that we might end up taking back, but these amount to relatively small sums. Despite some challenges, those buildings are in better condition now than before. While we may face issues, we haven't incurred losses yet, which is somewhat surprising. I believe we are well protected by our CECL reserves and don't foresee immediate concerns. Given that we haven't originated many loans recently, we are becoming more familiar with every loan and potential risks in the portfolio. There are instances where borrowers promise to surrender keys but sometimes don’t follow through, complicating predictions. Nevertheless, our main concern is the basis, and we even purchased an office building recently because we saw it as a good value, despite having no prior relationship with it. Overall, we aren't overly worried about our office portfolio and don't anticipate needing to touch our $50 million CECL reserve.
Jade Rahmani, Analyst
Great. Thanks so much.
Brian Harris, CEO
Sure.
Operator, Operator
The next question comes from the line of Tom Catherwood with BTIG. Please proceed.
Tom Catherwood, Analyst
Thank you, and good morning, everybody. Maybe Pamela or Paul, appreciate the commentary in your prepared remarks on Moody's and Fitch's outlook for Ladder. What are the next steps or hurdles that the rating agencies are looking for as you progress toward an investment grade rating?
Pamela McCormack, President
I can start, and Paul, feel free to jump in. The short story is we have met the objective. They have objective tests, and we met them already with the last issuance, which is why I think you saw some positive action on us. I think we made it really difficult for them to do nothing. We would have liked to have achieved the investment-grade rating when we hit the hurdle. But given the market backdrop in commercial real estate, all the agencies were reluctant to do anything too aggressive in terms of an investment-grade rating in this environment. So if you ask me with not a lot of knowledge, I can tell you, I think if we continue to perform, we demonstrate what Brian said earlier. We have real confidence in our CECL reserve, which is currently $54 million. We think that should be more than ample to cover any potential losses we may incur. As we turn the balance sheet, the market moves out of this state of distress and we start to see rates come down. I think with the next issuance, we are very hopeful to see an investment-grade rating. Paul, is there anything you'd want to add to that?
Paul Miceli, CFO
I'd say, as we mentioned in the remarks, Tom, 53% of our liabilities are now unsecured corporate bonds, and we're well over 50%, in other words, in utilizing our secure corporate bonds in our liability structure. So as Pamela said, quantitatively, within the hurdles, it's really a matter of the series backdrop that we think is the biggest hurdle.
Tom Catherwood, Analyst
Understood. Appreciate those thoughts. And then last for me, maybe Brian, given your comment earlier that you're happier to be acquiring securities at 175 to 210 over rather than originating them. Is it likely that activity on the conduit side of the business could remain more muted in the near-term?
Brian Harris, CEO
Likely, I think, and you'll really see the first sign of a thawing out in that business will be when you don't have 13 originators, each putting in three loans. That's a pretty unusual roster of originators, and that just tells you they don't have enough size or demand to go it alone. So they're combining forces with a lot of other lenders. But I think the security the CMBS business will pick up when you see a steepening of the yield curve, because if you write a 10-year loan off of a rate that's lower, a base rate that's lower than the two-year, you have to hedge that. And when you start hedging a 10-year that's below the two-year you start, there's no carry in the business, pretty much, and it is a substantial component of profitability when that business is functioning properly. So I think as the Fed cuts rates, the curve will steepen, and that business will pick up. It will start in the five-year category, and it will progress to the 10-year category.
Tom Catherwood, Analyst
Got it. Got it. That's it for me. Thanks, everyone.
Brian Harris, CEO
Okay.
Operator, Operator
Our next question will come from Matt Howlett with B. Riley Securities. Please proceed.
Matt Howlett, Analyst
Yes. Hey, thanks. Good morning. Just to follow-up on the investment-grade rating, what do you think it will save you? I mean, I know once you get it, there might be a lag in terms of the yields on the new debt that you issue, but just sort of, what do you think you could do debt at, you did what 7% on the seven-year debt. Just curious, what do you think will save you ultimately?
Brian Harris, CEO
Yes, Pamela, you can take it if you want, but I think for the first one, probably not that much, since you're somewhat new to the space. However, having completed seven issues so far, you never know. If I were to guess, and I’ll listen to Pamela and Paul, who may have more insight, I would estimate about 200 basis points initially and maybe 300 at the end.
Pamela McCormack, President
I believe it's slightly lower than that. Regarding the crossover credit, we were aiming to build on it. For the first crossover credit, we hope to achieve at least 50 basis points in savings. For us, this is a long-term strategy. We believe there is a significant place in the market for a mortgage REIT that focuses primarily, if not exclusively, on senior secured assets that can deliver a high-single-digit to low-double-digit return. The reality for Ladder is that, due to our significant insider ownership and internal management, we have consistently operated this company since its inception in 2008 with leverage between 2x and 3x. These will be the leverage constraints we will adhere to. The main change will be an increased proportion of unsecured debt, which we consider safer and beneficial in the current environment. We currently have the lowest cost of funds available. Therefore, we believe this will lead to long-term savings. We are also eager to attract traditional equity REIT investors as we meet nearly all of their criteria, such as internal management, insider ownership, and low mark-to-market debt. The only criterion we don't satisfy is the investment-grade requirement, which may limit us. We are not expected to be a high-growth company, but we believe there will be significant interest in our offerings. As a result, we anticipate not only activity on the debt side but also a shift in our institutional and retail ownership in terms of equity as well.
Brian Harris, CEO
What I'd also add, Matt, is that it's important to monitor the flow of funds and where things currently stand. The high yield market isn’t offering much of a premium due to the low number of defaults. If you examine the ETFs like JNK and LQD, you can get a sense of the differential. Although we operate in the commercial real estate sector and trade on the wider end, we are likely more aligned with the middle of the high yield index since we are not rated as single B. It's worth noting that this is a four-year average rather than a seven-year average. If we were to explore investment-grade credit, LQD is yielding slightly over 5%. It might be considered aggressive, but it's difficult to predict. The first time you approach this, you'll gain valuable insights, and you might not receive the rate you desire because of your newness in the space, which could lead to penalties. However, in the long run, the high yield market is significantly smaller compared to the corporate bond market in the investment-grade category. This market consists of a much larger pool of investors, who often have repeated investments in the same entities, and we haven’t yet been established in the investment-grade sector. There are many factors to consider in this equation, but I still believe that pricing will be wider initially, and subsequent efforts will yield better results.
Matt Howlett, Analyst
It's going to put you in a stronger position. We already have one of the best balance sheets in the industry right now. Given the current news and the challenges faced by your peers, at what point do you think you might become more aggressive? Are you seeing any potential deals on the horizon? Are bankers reaching out about possible acquisitions? With plenty of cash and liquidity available, and given that many peers are struggling, it seems there could be opportunities emerging. Are you considering making a significant move? Are you holding onto capital for that purpose?
Brian Harris, CEO
No. Ladder is not a flashy company at all, and not at all interested in making it splash. Far more interested in just developing an attractive return profile safely. We don't like big flashy buildings, we don't like big flashy companies, and we don't like high leverage, which makes us a little unique in the REIT space. So, no, we're not saving it. We just think there's a big opportunity coming, but we'll probably stick to our knitting. The only thing I would tell you that I think is developing is if you have a $20 million loan, you can rebalance it. Yes, I mean, there is a place you can go. You may pay more than you want to, but it's not like it can't be done. And if you have a $350 million loan, you can go to one of the big banks and have them take it to the rating agency. And yes, they'll take you to market and the market will tell you what your rate is. But if you have an $80 million or a $90 million loan, you're sort of in this air pocket between too big for a bank and too small for a single asset deal. So I think that $70 million, $80 million, $90 million area is a very, very attractive place for somebody who wants to commit capital without going to, with the certainty of the capital markets spreads. So to me that's an inefficiency that has bubbled up here that I think will stay there for a little while. The trick to that though is if you want to start writing $80 million loans to securitize them, you can't write two or three of them; you have to write 10 or 20 of them. And therein is the rub. But I think if the volume picks up and transaction buildings start getting. So I think we might very well go into that kind of states and acquire $1.5 billion, $2 billion worth of loans and do a single sponsor securitization, where we hold the B piece because we know all the credit and go sell the bonds to the public. But we would have the rate on the mortgage definitely, because it won't all close on one day.
Matt Howlett, Analyst
Got you. Just to follow up on that, one of your newer peers mentioned the need for secondary market supply. I believe he’s referring more to senior loans rather than securities, noting that leverage yields range from 12% to 16%. We’ve raised a fund specifically to acquire these assets, likely from banks over the next few years. Do you recognize a secondary market opportunity where banks might surrender assets due to capital regulations, leading to those leverage yields?
Brian Harris, CEO
The banks are facing significant regulatory pressure, which is accurate. However, I would point out that if a bank is selling loans, likely with some financing and generating returns of 12% to 16%, that may be acceptable. Yet, it raises the question of why they would opt for that when they could achieve 20% to 25% on a AAA investment.
Matt Howlett, Analyst
Right.
Brian Harris, CEO
With leverage and the ability to sell quickly in most markets, I wouldn't recommend taking a risk at 12% or 13% on a bank sale. I prefer to move towards the safety of AAAs. As Pamela mentioned, we aren't leveraging them at this time. We have a significant amount of cash and liquidity, along with a few hundred million dollars in unlevered AAAs if we want to generate cash. Our priority has been to keep the balance sheet strong, as investors tend to prefer robust balance sheets during tough times. However, as we progress further in the cycle, I expect these yields to compress. I don't think we'll be discussing AAA yields of 200 or 190 over for much longer.
Pamela McCormack, President
We are actively engaging with our originators and monitoring any potential sales. We will evaluate any opportunities that arise in light of what Brian mentioned.
Matt Howlett, Analyst
These assets are truly AAA. They have about 20% subordination, which is significant.
Brian Harris, CEO
I mean, we have 70% subordination.
Matt Howlett, Analyst
This is just incredible.
Brian Harris, CEO
Interestingly, in the CLO market, as loans start to default at an increasing rate, if the sponsor is in a strong position, they can pull those loans from the deal, making it appear as though there has been a payoff. In such cases, bad circumstances can actually be beneficial unless you're holding them at a premium. However, if you manage to buy them at 99 and then receive full payment on a defaulted loan, that's quite appealing. In the CLO space, the subordination level begins around 40 to 45 percent. Once a few payoffs or defaults occur, you quickly move to 60 or 70 percent subordination, and they're still being traded very widely.
Matt Howlett, Analyst
That's incredible. I hope these deals last for a while, but as you mentioned, I don't think they will.
Brian Harris, CEO
I don't either but will, we're very good at taking what the market gives us rather than forcing our opinions. So we can live a long time. We don't need the market to tighten. We don't need to lever them. But yes, if the market does tighten, we'll sell some and maybe we'll lever some others when we need to. But the best time to borrow money is when you don't need money. And I think in our supplement, on our website, if you want to just get the picture that sold all the bonds, it's on Page 5. It's a snapshot of us last year and this year. And when we look at the rating agencies, they were saying it's a very difficult market. And we said, yes, look what we did in that market. Let's go back a year. We took a billion in payoffs, and we delevered the company. We raised a lot of cash. So yes, that's experience. We've been out in bad weather before, and yes, we saw it there for what it was, and we're not out of it yet. We still think there's a little bit left in this downturn. But I think we're and past the most dangerous part. I don't think we'll be surprised by anything at this point.
Matt Howlett, Analyst
Look, you've been right all along, Brian, on this, so I got to give you credit. Definitely paying attention to you when you give out that, that when you call bottoms like this and start talking about things, I certainly pay attention. So I really appreciate all the color and comments.
Brian Harris, CEO
Yes. I mean, if you think no one will ever go to an office again, then we might be mistaken. I don't believe that. I don't think it will return to how it was before. I don't believe people will rush back from the beaches in the Hamptons on Sunday afternoons to prepare for work on Monday. However, if you're only in the office four days a week or still leasing office space, the main issue is not that you can't rent it; you often have to pay a lot for tenants. In most of our office loans, the buildings are leased at rents that exceeded our initial expectations. The biggest issue is they are not fully leased. There are significant costs associated with tenant acquisition to get them into the building, and the return on equity is just poor. When asked to purchase a cap at 1% or 2%, while the prevailing SOFR rate is 5.30%, it becomes very costly. So what you'll observe, not just with us but with many others as well, is that they will be reclaiming buildings that are doing reasonably well. They are not empty, and there is some cash flow. It may not be ideal, but it also wouldn't indicate a major loss.
Matt Howlett, Analyst
Well, you certainly made a great call in New York City. You were one of the first to recognize that. So congrats on the insight.
Brian Harris, CEO
You can feel it, right? I mean, New York City is doing better. And if you walk around that area of the Plaza District North of Grand Central on Park Avenue, or that that's doing just fine. And when I say fine, I mean there is massive expansion going on there. And so the idea that I don't think J.P. Morgan is buying an extra building next to its headquarters because they think the office market's going South.
Matt Howlett, Analyst
No, not at all. I really appreciate it.
Brian Harris, CEO
Sure. Thank you.
Operator, Operator
Ladies and gentlemen, there are no further questions at this time. I'd like to turn the call back to Brian Harris for any closing remarks.
Brian Harris, CEO
I'll just end by saying thank you for hanging with us. Especially thank you to the bondholders that, that purchased our recent offering. We won't let you down there. And we hope to be revisiting that space down the road in an investment-grade outfit. So thanks again, and yes, see you soon. Bye.
Operator, Operator
This concludes today's conference. You may now disconnect your lines. Enjoy the rest of your day.