Lument Finance Trust, Inc. Q3 FY2021 Earnings Call

Good morning and thank you for joining the Lument Finance Trust Third Quarter 2021 Earnings Call. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. Today's call is being recorded and will be made available via webcast on the company's website. I would now like to turn the call over to Charles Duddy with Investor Relations at Lument Investment Management. Please go ahead.

Thank you, Gary, and good morning everyone. Thank you for joining our call to discuss Lument Finance Trust third quarter 2021 financial results. With me on the call today are James Flynn, CEO; Michael Larsen, President; James Briggs, CFO; and Precilla Torres, Head of Real Estate Investment Strategies. On Tuesday, we filed our 10-Q with the SEC and issued a press release, which provided details on our third quarter results. We also provided a supplemental earnings presentation, which can be found on our website. Before handing the call over to Jim, I would like to remind everyone that certain statements made during the course of this call are not based on historical information and may constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Act of 1934. When used in this conference, words such as outlook, evaluate, indicate, believes, will, anticipates, expects, intends, and other similar expressions are intended to identify forward-looking statements. Such forward-looking statements are subject to various risks and uncertainties that could cause actual results to differ materially from those contained in the forward-looking statements. These risks are discussed in the company's reports filed with the SEC, including its reports on Form 8-K, 10-Q and 10-K and in particular the Risk Factors section of our Form 10-K. Additionally, many of these risks and uncertainties are currently amplified by and will continue to be amplified by or in the future may be amplified by the COVID pandemic. It is not possible to predict or identify all such risks. Listeners are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. The company undertakes no obligation to update any of these forward-looking statements. Furthermore, certain non-GAAP financial measures will be discussed on this conference call. A presentation of this information is not intended to be considered in isolation nor as a substitute to the financial information presented in accordance with GAAP. Reconciliations of these non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP can be accessed through our filings with the SEC at sec.gov. With that, I will turn the call over to James Flynn. Please go ahead.

Thank you, Charlie. Good morning, everyone. Welcome to the Lument Finance Trust earnings call for the third quarter of 2021. 2021 has been a very busy year and an important year for Lument Finance Trust. During the year, we executed several significant capital transactions that allowed us to grow our capital and institutional investor base. At the same time, we've made significant incremental investments, observed continued strong performance in our portfolio and generally positive performance. These were all accomplished in an environment marked with uncertain economic considerations, interest rates, unemployment, and asset values, all exacerbated by the impact of such variables like COVID-19 and also the political and social unrest, particularly related to COVID-19. While the lending market continues to be competitive, the breadth of Lument's platform and its strength in multifamily, in particular, continue to provide us with compelling and large investment opportunities. During Q3, we invested over $300 million in new floating rate bridge loans, showing our ability to quickly deploy substantial amounts of recently raised capital. Our expansive origination capabilities have driven this strong deal flow and based on the current pipeline, we expect to be fully deployed ahead of schedule by the end of the year. As we continue to grow, we also expect to identify other investment opportunities in commercial real estate and to invest a portion of our capital in investments such as preferred equity, mezz loans, and other high-yield CRE instruments. It's important to acknowledge that our focus in multifamily bridge lending and the strength of our credit and asset management platform has allowed our portfolio to continue to perform well. As of the end of the quarter, September 30, our loan portfolio was again 100% performing, with no impairments, no loan defaults, and no loans subject to forbearance. Similar to previous quarters, I'm happy to report we have still not granted a single forbearance, and more importantly, have not had the need to grant a single forbearance during the COVID era. We continue to believe this is a testament to both our rigorous credit standards, our high-quality production, and our proactive asset management efforts. Perhaps, most importantly, our ability to continue to execute on our business plan is reflected in the results. Through September 30, on a year-to-date basis, our total distributable earnings have been $0.28 per share, which provides support for our dividend. While the company did experience a decline in distributable EPS during Q3, this was anticipated. As we discussed in previous calls, due to the successful closing of our preferred equity offering on May 5, the recalling of our prior two CLOs and the refinance into a billion-dollar CLO on June 14, we experienced a short-term decline in our distributable earnings as we deployed the proceeds from those transactions. We believe this capital deployment impact is transitory in nature, and we do not anticipate any negative impact on our long-term earnings outlook on a fully invested basis. We'll speak more about that later. But as discussed, our pipeline has grown significantly and the deal flow continues to increase in velocity. When the management team took over as the Manager of LFT in January 2018, we were clear on our goal of deploying capital into commercial real estate and investments with a focus on multifamily in order to provide stable earnings to support the market return to our shareholders. We indicated our desire to grow LFT to a larger scale, which we felt will provide the most value to our shareholders. This quarter, we've made progress on those goals. And I'm excited for our continued growth as we focus on executing our business plan. In the coming months, we hope to continue discussions with investors, to educate market participants about LFT and the opportunity that we offer investors. Although relatively small in the commercial mortgage space, our manager and the Lument platform are not. We are one of the nation's largest capital providers in the multifamily and seniors housing space executing over $16 billion in transaction volume in 2020. Lument services a $49 billion servicing portfolio and employs over 600 employees in more than 25 offices nationwide. The scale of that platform benefits the LFT investors and provides great support for the execution of our investment strategy. As we continue to show over these last years, we are utilizing the strength of our manager to focus our investments in middle-market multifamily bridge, which have continued to perform well. With that, I'd like to turn the call over to Jim Briggs, who will provide some details on our financial results. Jim?

Thank you, Jim, and good morning, everyone. On Tuesday evening, we filed our quarterly report on Form 10-Q and provided a supplemental investor presentation on our website, which we will be referencing during our remarks. The supplemental investor presentation has been uploaded to the webcast as well for your reference. On Pages 5, 6, and 7 of the presentation, you'll find key updates and an earnings summary for the quarter. For the third quarter of 2021, we reported net income to common stockholders of approximately $1.2 million or $0.05 per share. There were two primary distributable earnings adjustments for the quarter. The first of these was an approximately 150,000 non-cash hyper-amortization of purchase price premiums on two loans acquired into our recent CLO, which prepaid during the quarter and caused a non-recurring decrease in interest income during the quarter. The other non-distributable item experienced during Q3 was a $60,000 unrealized loss on mortgage servicing rights, driven by higher realized prepayment speeds in our legacy residential MSR portfolio. I'd like to note that as of quarter-end, the current value of our legacy MSR asset was less than $700,000. Therefore, we do not believe that any future changes in the value of this asset should be a meaningful driver of earnings. After these adjustments for the third quarter of 2021, we reported distributable earnings of $1.4 million or $0.06 per share, which represents a decrease relative to Q2's distributable earnings of $2.8 million or $0.11 per share. As Jim alluded to in his opening remarks, the primary driver of this decline was a cash drag as we work to deploy the proceeds from our recent capital raising transactions. The risk continues to exist in the short-term for some drag on net income to common stockholders, as we complete this capital deployment phase, we expect this phase to be transitory in nature and do not anticipate any negative impact to our long-term earnings outlook. I'd like to highlight a few additional drivers of the decline in distributable EPS during Q3 relative to prior quarters. The first of these is related to exit fees. LFT's loans are typically structured with exit fees, which are recognized as interest income when the loan pays off and the fee is collected in cash. Therefore, the timing of loan payoffs and the associated exit fee income can cause some variability in LFT's earnings from quarter-to-quarter. In Q3, LFT earned exit fees of approximately $800,000 on loan payoffs of approximately $118 million. In the prior quarter, LFT earned exit fees of $1.4 million on loan payoffs of approximately $176 million. Another driver of Q3's performance relative to Q2 was an increase in total expenses from $1.8 million to $2.4 million. There were a few primary reasons for this increase. First, Q3 was our first full quarter of management fees and expense reimbursements paid on our preferred equity offering, which closed on May 5th of this year. Secondly, G&A has historically included and continues to include a five basis point servicing expense on our bridge loan portfolio. Due to the increase in portfolio size from $611 million as of 6/30 to $803 million as of 9/30, we did experience an uptick there. Lastly, there is some seasonality to the timing of our recurring professional fee expenses, and the prior quarter was a bit below trend. With respect to our balance sheet, we discussed on last quarter's earnings call that on April 21st, the company entered into an amendment to a secured term loan, which among other things provides the company with an incremental secured term loan in the aggregate principal amount of $7.5 million and extends the maturity date of the secured term loan to February 2026. The incremental $7.5 million is funded on August 23rd, and therefore you'll see a corresponding increase to our liabilities on our 9/30 balance sheet. Our total stockholders' equity at September 30th was approximately $169 million, which represents a $55.5 million increase relative to the year-end stockholders' equity of approximately $114 million. As discussed on prior calls, this increase was driven by the execution of a preferred equity offering during Q2. Our common book value per share was $4.37 as of September 30th. As discussed in prior quarters, I'd like to remind everyone that as a smaller reporting company, as defined by the SEC, we have not yet adopted ASU 2016-13, commonly referred to as CECL or Current Expected Credit Losses, which is a comprehensive GAAP amendment of how to recognize credit losses on financial instruments. As a smaller reporting company, we are scheduled to implement CECL on January 1, 2023. Until then, we continue to prepare financial statements on an incurred loss model basis. As of September 30th, we do not consider any of our loans to be impaired under the incurred loss model and we have not recorded any impairments or allowance for loan losses in the current quarter. While the current performance of our bridge loan portfolio remains healthy, uncertainty about recovery continues to exist, including its impact on our borrowers and the value of the properties that collateralize our commercial mortgage loan investments. We will continue to evaluate the loan portfolio for credit losses and will record any impairments or allowances as incurred. With respect to our common dividends, in accordance with normal course timing and process, we have not yet made a dividend declaration for the fourth quarter of 2021. We expect to make a determination on our dividend in December after discussing with our Board in the normal course. I'll now turn the call over to Mike Larsen, who will provide details on our portfolio composition and investment activity.

Thank you, Jim, and good morning, everyone. I will start by touching on recent investment activity. The last several months have been very active for us from an investment standpoint. During Q3, we acquired 15 new investments from our manager with a totaled UPB of $309 million. All these acquisitions were secured by multifamily assets. These acquisitions had a weighted average spread to LIBOR of 339 basis points, a weighted average LIBOR floor of 16 basis points, and a weighted average LTV of 75.7%. We've been seeing a significant increase in bridge lending opportunities, particularly within the multifamily space, which we expect to continue due to high levels of acquisition activity in the market. During the quarter, we experienced $117 million in loan payoffs and at quarter end our total loan portfolio had an outstanding principal balance of $803 million. The portfolio consisted of 53 loans with an average loan size of $15 million, providing for significant asset diversity. Our portfolio has a weighted average spread to LIBOR of 346 basis points, and 98% of loans in our portfolio have a LIBOR floor above the current spot LIBOR rate with a weighted average floor of 83 basis points. Due to the general strength in the economic recovery, the high-level of acquisition activity in the multifamily sector, and a robust level of CRE CLO issuance, competition in the bridge lending space continues to be fierce. We have seen some stabilization in spreads, LIBOR floors have come down significantly over the last year, and we are seeing pressure on exit fees as well. Our overall loan portfolio at quarter end was 89% multifamily, representing an increase from 85% multifamily as of Q2. The second highest asset type concentration is self-storage, which represents 7% of our portfolio. As mentioned on previous calls, we believe that generally self-storage and industrial property types can have the least volatility and performance outside of multifamily. Typically, our self-storage debt investments are related to top national operators in our entering markets with per capita existing supply below historical national average of seven square feet per capita. Furthermore, we focus on moderately leveraged assets, as reflected by the weighted average LTV of 61% in our self-storage portfolio. Our exposure to retail and office remains very low as at the end of the quarter at 4% of total UPB on a combined basis. That's a decline relative to our year-end 2020 level of 9% of total UPB on a combined basis. Due to our manager's strong focus on multifamily, we continue to anticipate that the majority of our loan activity will be related to multifamily assets. However, we will look to supplement those multifamily investments with strong quality investments and other asset types that can offer strong return profiles relative to multifamily. As of 9/30, our loan portfolio was financed with one CRE CLO securitization weighted average spread of 143 basis points over one-month LIBOR and an advance rate of over 83%. This CLO has a reinvestment period running through December of 2023 that allows principal proceeds of repayments of our loans to be reinvested in qualifying mortgage assets. We do not currently utilize repo or warehouse facility financing at LFT and therefore, we are not subject to margin calls on any of our assets from repo warehouse lenders. After quarter-end, as of November 5th, LFT acquired an additional $98.5 million of loans from our manager. These loans have a weighted average interest rate of LIBOR plus 326 basis points and a weighted average LIBOR floor of 10 basis points. Year-to-date, we've made $745 million of new loan investments, and we continue to maintain a strong pipeline as we move into next year. This investment activity has allowed us to deploy a meaningful portion of our remaining CLO capital and we anticipate fully deploying that CLO capital by year-end. In general, market confidence and the economic recovery from COVID positively impacted borrower demand for bridge loans during the year and with this market dynamic and increase in our pipeline, we feel positive about our investment opportunities looking forward. With that, I’ll turn the call back to Jim.

Thanks, Mike. I appreciate the update. Thank you all for joining. As we've mentioned on the call, we've really begun to make progress on our business claim, and we're very excited about our ability to raise capital and deploy it quickly. We look forward to talking to you more about our ongoing plans at LFT; we look forward to updating you on our progress. And we appreciate your time today. And with that, I will turn it over to questions.

We will now begin the question-and-answer session. Our first question is from Stephen Laws with Raymond James. Please go ahead.

I am doing great, thank you. I hope you are all doing well. I appreciate the insights on the ramp and the information regarding G&A; that was very helpful. I wanted to discuss repayment fees. You provided details on exit fees and net interest income, so what kind of repayment expectations do you have for the upcoming quarters to ensure we accurately reflect the exit fee contribution on the top line?

We have observed that in 2021, prepayment fees have remained high, largely due to valuations and the execution of business plans occurring more quickly and in parts, leading to increased sales. We expect elevated payoffs in the fourth quarter, similar to recent quarters, but this will depend on the timing of the actual payoffs. Recent quarters can serve as a general guide for our expectations, and the portfolio has also expanded, which is a positive development. Additionally, we've experienced significant volume coming in on the front-end, and while capital constraints mean we don't necessarily welcome payoffs, they also create opportunities for us to conduct more business.

Great, appreciate the color on that. Follow-up, you mentioned looking at some preferred and mezz investments. Can you talk about a little more detail on that, sourcing maybe how much capital you're willing to allocate there, and then what type of coupons you're seeing and will you put any leverage on those assets, and if so, type of leveraging you are going to use?

There is a broad range of opportunities available. Although our capital outside of our CLO is somewhat limited, we do have some available, and we want to use a portion of that to generate returns. While this isn't a firm commitment, we aim to approach it on a leveraged basis, utilizing structural leverage within the asset, whether through a b-loan, preferred equity, or mezzanine loan. We are exploring opportunities with Lument to sponsor and are actively seeking options in the construction lending sector, particularly for b-loan or mezz positions that could be viable assets, primarily focusing on multifamily projects. We've also examined self-storage and some hospitality ventures more due to current opportunities rather than a specific strategic outlook. In terms of preferred and mezzanine financing, we offer these behind Fannie Mae and Freddie Mac loans and have assessed them alongside other long-term commercial real estate fixed investments. However, there are challenges; given the current debt yields and cap rates, the returns on these investments often do not surpass those of a standard leveraged first position. There may be opportunities on the construction side or with certain structured finance deals, but as rates continue to rise, this will likely lead to a natural increase in available capital. Presently, the risk/return profile for preferred and mezzanine financing faces difficulties unless we believe that debt yields and cap rates will remain exceptionally low for an extended period. Overall, the market hasn't shown significant demand for this type of financing, as there is plenty of equity capital accessible to sponsors, along with a substantial amount of first-lien capital at relatively high leverage. While we haven't completely ruled it out and have pursued a few deals, the overall pipeline appears to be narrower compared to historical trends.

I agree with everything you said, Jim. But to Jim's point, though, I want to emphasize that because of a number of direct relationships we have, we are able to explore and evaluate opportunities that provide some of these off-market type yields, and we will continue to focus on those as avenues for these types of opportunities.

Right, appreciate the comments from both of you and certainly nice having the source ability and flexibility to pursue those when appropriate. Thank you.

The next question is from Steve Delaney with JMP Securities. Please go ahead.

Thanks, Jim, I appreciate the detail on the expense items. A drop in distributable was certainly expected; we were at $0.07 against your $0.06, so a penny is really no big deal. One thing you didn't mention, or I didn't hear it, is that you had an existing CLO and then you completed a larger $1 billion CLO. Within that transaction, was there any write-off of deferred issuance costs related to the prior CLO that was paid off in full? I assume there probably was, but I didn't hear that in your commentary.

Thanks, Steve. The refinance occurred last quarter. The loss on extinguishment of debt noted in our nine-month figures reflects the acceleration of those deferred financing costs. This impacted our EPS as a distributable revenue item for last quarter and will show in our year-to-date results. The amount was approximately $1.7 million.

Yes, those are significant items. Mike Larsen, what would you estimate the peak size of the $800 million portfolio to be, excluding new capital? I am curious about how much capacity you have to grow that $800 million on a net basis. Thank you.

First, if you look at our business, the primary source of financing for our portfolio today is a billion-dollar CLO. So you're looking at a billion dollars, a little over a billion dollars, based on our current capital base for the peak portfolio. And as we discussed, we think there's real opportunity to grow the scale of LFT and continue to consider ways to grow our capital base as we move into next year so that we can increase the scale and efficiency of LFT.

So you think maybe a couple of quarters to fully utilize the capacity within the CLO?

As mentioned, we expect to fully deploy the CLO before the end of this year.

Oh, by the end of the year. Okay, very good. Jim Flynn, a lot of effort has gone into capitalization recently, especially with the preferred shares and the new supersize CLO. I'm trying to understand the next steps, as it seems you have a little over $216 million in total capitalization. We consider the term loan to be part of that capital from a portfolio perspective. My question is, while the current situation seems stable and long-term, 8% interest is quite high. Would it make sense to consider shorter-term unsecured notes of four, five, or six years as a next step toward achieving your capitalization goals and growing that base?

Yes, I have a few thoughts on that. From a market perspective, the debt markets, particularly for issuers in the CLO and corporate sectors, look quite attractive. Since we've conducted various debt capital raises over the past couple of years, there have been times when those deals appeared to have been more advantageous if we had waited. Ideally, it would be beneficial to replace our more expensive capital with the cheaper capital available today. While there are factors to consider, such as penalties for prepaying our term loans, we are regularly reviewing these options. There’s a point where it would make sense to replace our capital if it's beneficial, even with associated fees. We are not quite at that point yet, but we are close. It's important to assess what's available in the market and whether it makes sense to change our existing capital. Additionally, since we became the manager, a major focus has been proving our business plan, attracting new investors, and increasing our book value. We believe we've achieved that, allowing us to consider raising common equity. As I mentioned earlier, capital is currently our limiting factor, but we're committed to growth. We have substantial production and deal flow that will enhance this platform and benefit our shareholders. We are collaborating with our banking teams and advisers weekly to explore opportunities, such as recent deals with preferred stock and term loans. We anticipate being active moving forward and are considering various options to increase our capital.

Great, well, it's worth you've gotten stock up to a little bit over 90% of book. So congratulations on that. Thanks for your comments.

The next question is from Christopher Nolan with Ladenburg Thalmann. Please go ahead.

Hi, Jim Briggs on the follow-up on the loss of extinguishment of debt, was that a 3Q item or a 2Q item, I seem to recall this last quarter?

That's correct, Chris. It was last quarter. It was recorded at the time we gained the two existing CLOs and closed the $1 billion CLO, so last quarter item number is around $1.7 million.

Great, and I appreciate the detail you gave on all the expenses. Just clarification, why was the interest expense up so much this quarter versus last quarter?

We've got a full-quarter of the CLO, right. So we refinanced our two existing CLOs and put on the $1 billion CLO and the associated debt there. So this was our first full-quarter of interest expense on the CLO debt.

Okay.

I can share that the weighted average debt service coverage of the portfolio in LFT is about 1.5 times, which indicates a healthy position. As we originate assets, we are mindful of the yield and debt service coverage associated with these assets to maintain a balance. Occasionally, we engage in strong lease-up transactions that may reflect lower initial debt yield or debt service coverage, but overall, we are aware of these factors in our origination process.

Fair. And your observation in terms of rent stabilization laws, are they proliferating in your markets, they're pretty common in larger markets, but don't know how they are in the Southeast and Midwest?

So, to your point on the focus of our program, as historically been demonstrated is in the more middle markets, middle market sector, also in the middle of the country kinds of thing. So we found not to be generally in the markets, which have more stringent rent stabilization laws, which typically are in the East and West Coast. So, I'd say the substantial component of our portfolio historically is not impacted by that.

The next question is from Matthew Howlett with Nomura. Please, go ahead.

Hey, guys, thanks for taking my question. Just you talked about the board meeting on the dividend and we look at distribution also running ahead of this quarter's earnings, but is it to sort of reconcile get to a run rate number is it as easy as sort of saying, you have $44 million of cash in the quarter and $149 million of restricted cash, putting that most of that to work at 4% gets you sort of $0.07 per share quarterly increase from 3Q. I mean, it's as simple as just saying the cash isn't working, here is the EPS impact and this is our sort of quarterly run rate earnings?

You should consider those two categories of cash in slightly different ways. The $140 million that is restricted is what can be used within the CLO. When that cash is utilized, as you've mentioned, interest is already being paid. Therefore, it’s accurate to say that the return on investment for that amount is higher, but the incremental amount comes from the $40 million you mentioned. We won’t deploy all of our capital, even if we were to place loans on the balance sheet, regardless of whether they are high yield or not. However, I believe that your assumption of deploying around 50% to 60% of that $40 million is reasonable.

Got it. And you said by the end of the year, so maybe the fourth quarter, you don't get the full benefit all of it from day one. But is that, I guess, where I've gotten this is the board sort of look at the run rate when they look at the dividend; they look at the run rate?

Yes, we do expect the CLO to be fully deployed, and I would anticipate that about half of the $40 million in additional capital will be put to work this quarter or early next quarter.

Got it. Okay, great, I will definitely take that into account. And I don't know if you spoke about it recently, but if could just give us sort of the update on the merger, I know it was two years ago, Lument and ORIX and just sort of give us an update on the manager and how that's going, and where does LFT sit in on longer-term plans?

In terms of the merger, we have fully integrated into the Lument platform and sponsors platform without any silos. All of our lending and investment products under the Lument brand are functioning smoothly with unified leadership and consistent credit metrics. The integration has gone exceptionally well, especially considering that we have not returned to the office until recently, since March 2020. The team has done an outstanding job managing this transition. Regarding LFT, our business model as a sponsor includes a mortgage banking lending business, a servicing book, and fee-based services. We are expanding our advisory and investment sales, including M&A activities. Our capital-intensive operations, primarily bridge lending and high-yield investments, align well with LFT's market, which seeks stable cash flows and dividends. Successful lending and asset management generally cultivate a strong investor base. The management of these two business models complements each other effectively, and LFT serves as the right vehicle to enhance our overall strategy. We expect it to grow and become a significant part of our plans moving forward.

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

Thank you, and thanks all for the questions. Great call today from the attendees. Appreciate all that feedback. We hope to be in touch with all of you soon. And look forward to speaking during the quarter and on our next investor call. Thanks all for joining. Take care.

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