Lument Finance Trust, Inc. Q1 FY2024 Earnings Call

Good morning, and thank you for joining the Lument Finance Trust's First Quarter 2024 Earnings Call. 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 Andrew Tsang, with Investor Relations at Lument Investment Management. Please go ahead.

Good morning, everyone, and thank you for joining our call to discuss Lument Finance Trust's First Quarter 2024 Financial Results. With me on the call today are Jim Flynn, our CEO; Jim Briggs, our CFO; Jim Henson, our President; and Zach Halpern, our Managing Director of Portfolio Management. On Thursday, May 9, we filed the 10-Q with the SEC and issued a press release to provide details on our first quarter results. We also provided a supplemental earnings presentation, which can be found on our website. Before handing the call over to Jim Flynn, I'd like to remind everyone that certain statements made during the course of the 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 Exchange Act of 1934. 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 results and uncertainties are discussed in the company's filings reported with the SEC, in particular, the Risk Factors section of our Form 10-K. It is not possible to predict or identify all such risks and listeners are cautioned not to place undue reliance on these forward-looking statements. The company undertakes no obligation to update any of these forward-looking statements. Further, 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 for 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. For the first quarter of 2024, the company reported GAAP net income of $0.11 and distributable earnings of $0.15 per share of common stock, respectively. In March, we also declared a dividend of $0.07 per common share of stock with respect to the first quarter. I will now turn the call over to Jim Flynn. Please go ahead.

Thank you, Andrew. Good morning, everyone. Welcome to the Lument Finance Trust's Earnings Call for the first quarter of 2024. We appreciate everyone joining today. Let's start just as we enter 2024. We are cautiously optimistic that the lending environment would begin to improve during the first half of the year. We are now in early May. The Fed has yet to implement any rate cuts and the economic data suggests inflation has remained stubbornly elevated. The economy and labor market have remained broadly resilient despite this increase in short-term rates that began over two years ago. Although the Fed has indicated that they do not expect future hikes in their remarks, a couple of weeks ago, the consensus view of higher for longer seems prudent until the trend and economic data suggests otherwise. The multifamily sector continued to be challenged during the first quarter with muted property sales activity leading to limited acquisition financing opportunities. Given the persistence of elevated interest rates, borrowers have also been reluctant to refinance their portfolios unless compelled to do so. Just this week, the MBA announced first quarter lending volume in multifamily is down 7% year-over-year in Q1 and down 29% from Q4 of 2023. Despite the challenging short-term environment, nearly $500 billion of multifamily mortgage debt is expected to reach initial maturity by the end of 2025, according to MBA estimates, combined with a potential cause in property sales transaction volume toward a new normal level of activity. We expect to see a return of attractive lending opportunities in the medium and long term. Multifamily as an asset class continues to outperform other CRE property types, and we believe this is the reason our company provides its shareholders with a unique value proposition. LFT has a deliberate focus on middle-market multifamily credit, success in active asset management, and strong sponsorship provided by the broader Lument and ORIX platforms. As a result, the company has been able to maintain stable dividends, better-than-average credit performance within its investment portfolio, and a superior dividend yield relative to many of our peers. Having effectively fully deployed our investable capital in the second half of 2023, our focus this quarter was on proactively managing our portfolio to protect shareholder capital. We successfully resolved the two 5-rated assets from our December 31 report and maintained a stable weighted average risk rating of 3.5 for the quarter ended March 31 with no specific reserves recorded during the period. We increased our available unrestricted cash quarter-over-quarter, ending Q1 with approximately $65 million compared to $51 million as of December 31. We believe the increased liquidity will allow us to maintain flexibility in achieving positive asset management outcomes for our shareholders and provide us with the potential to deploy capital into attractive investment opportunities outside of our two existing securitization structures. In the meantime, we have earned relatively attractive returns on our cash deposits given the elevated short-term rates. Our portfolio continues to be financed with long-dated secured financing that is not subject to mark-to-market margin costs. FL1, the CRE CLO, we closed back in 2021, is now beyond its reinvestment period and has begun to deleverage with repayments of its collateral. We continue to explore opportunities to refinance the portfolio. As of quarter-end, the cost of funds for FL1 was SOFR plus 157 and an effective advance rate of approximately 82%, levels which we believe are still attractive relative to other portfolio financing alternatives available in the market. The LMF financing transaction we executed mid-last year has the remaining reinvestment period that extends into July 2025, and we fully intend to reinvest capital as completion within that structure becomes available. With that, I'd like to turn the call over to Jim Briggs, who will provide details on our financial results. Jim?

Thanks, Jim. Good morning, everyone. Last 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 4 through 7 of the presentation, you will find key updates and earnings summary for the quarter. For the first quarter of '24, we reported net income to common stockholders of approximately $5.8 million or $0.11 per share. We also reported distributable earnings of approximately $7.6 million or $0.15 per share. There are a few items I'd like to highlight regarding activity during the period. Our Q1 net interest income was $13 million, compared to $9.1 million in Q4 of '23. The sequential increase was primarily driven by higher exit fee income due to greater quarter-over-quarter payoff activity within the portfolio and $3 million related to resolution of two defaulted loans, one collateralized by an office property located in Columbus, Ohio, in which we reduced our current value to zero, and the other collateralized by a multifamily property located in Virginia Beach, Virginia, which was modified during the quarter with, among other things, previously passed-through interest being brought current. Payoffs during Q1 totaled $97 million as compared to $43 million in the prior quarter. Associated Q1 exit fees totaled approximately $825,000 as compared to $210,000 recognized in the prior quarter. The majority of loan payoffs we experienced were driven by borrowers, either refinancing with another lender or selling the underlying properties. As a reminder, when one of our loans is refinanced with a permanent agency loan provided by an affiliate of our manager, the borrower exit fee is waived pursuant to the terms of our management agreement. In these instances, we do receive a credit equal to 50% of the waived exit fees against our reimbursable expenses due to our manager. Our credit for waived exit fees was flat quarter-on-quarter. Our total operating expenses were $4.3 million in Q1 versus $2.7 million in Q4 of '23. The majority of the sequential increase in expenses was driven by the accrual of incentive fees due to our manager, which are accrued and payable on a quarterly basis, equal to 20% of the excess of core earnings as defined in our management agreement over an 8% per annum return threshold. Distributable earnings can be used synonymously with core earnings in this context. Outside of that, operating expenses were largely flat quarter-on-quarter. The primary difference between reported net income and distributable earnings to common was approximately $1.8 million attributable to the increase in our allowance for credit losses, all with respect to our general CECL reserves. Property acquisition volume continues to remain depressed, leading to limited visibility in the market with respect to valuation and cap rates. The increase in general reserve is reflective of changes in the macroeconomic forecast, including current higher rates for longer sentiment as well as cautiousness in our modeling as it relates to CRE pricing during this period. As of March 31, we had two loans risk-weighted 5 for default risks. One is a $17 million loan collateralized by a multifamily property in Brooklyn, New York and risk-rated 5 due to imminent maturity default. The other asset is a $20 million loan collateralized by two multifamily properties near Augusta, Georgia, that is risk-weighted 5 due to monetary default. Both of these loans have been placed on non-accrual status while both of these loans have since made their April interest payments, which will be recognized in income on a cash basis. We evaluated both of these 5-rated loans individually to determine whether asset-specific reserves for credit losses are necessary. After an analysis of the underlying collateral, we determined that none were necessary as of March 31. As of year-end, the company's total equity was approximately $243 million. Total book value of common stock was approximately $183 million or $3.50 per share, up from $3.46 per share as of year-end. We ended the first quarter with an unrestricted cash balance of $65 million, and our investment capacity through our two secured financings was effectively fully deployed. We'll now turn the call over to Jim Henson to provide details on the company's investment activity and portfolio performance during the quarter. Jim?

Thank you, Jim. I will now share a brief summary of the recent activity in our investment portfolio. During the first quarter, LFT experienced $97 million of loan payoffs. A portion of these loan payoffs related to the defaulted loans discussed by Jim Briggs earlier. We did not acquire or fund any new loan assets during the first quarter. As of March 31, our portfolio consisted of 81 floating rate loans with an aggregate unpaid principal balance of approximately $1.3 billion. 100% of the portfolio was indexed to one-month SOFR and 94% of the portfolio was collateralized by multifamily properties. An analysis of our net interest income sensitivity to shifts in term SOFR appears on Page 12 of the earnings supplement. Our investment portfolio continued to perform well during the first quarter, and we ended the period with slightly more than 77% of the loans in the portfolio risk-rated A3 or better, marking a slight improvement versus the fourth quarter of 2023. Our weighted risk average rating remains stable at 3.5 sequentially. Our 5-rated aggregate loan exposure decreased to approximately $38 million this quarter versus $46 million as of year-end. At the time of our last earnings call, we had two 5-rated loans that have now been fully resolved. As expected, we received additional insurance proceeds in the amount of $13.5 million on the defaulted loan on the property in Columbus, Ohio, reducing the carrying value of this loan to zero after taking into consideration legal and other costs, resulting in the recognition of onetime income of approximately $2.5 million during the first quarter. The other 5-rated asset at the end of 2023 was a defaulted loan on a multifamily property in Virginia Beach, Virginia. We entered into a loan modification with the borrower and received a $3.6 million partial principal pay down during the first quarter. Last week, the borrower repaid the remaining loan balance in full in accordance with the terms of that loan modification. We are very pleased to have achieved positive asset management outcomes for these loans, thanks to the deep experience and diligent efforts of our team. With that, I will pass it back to Jim Flynn for closing remarks and questions.

Thank you, Jim. Thanks to our attendees and your interest. And operator, please open the call for questions.

Our first question comes from Crispin Love from Piper Sandler.

So no new investments in the quarter, but you did have some payoffs. So can you speak to some of the drivers that have expectations going forward in the quarter? Was it lack of opportunities, cautiousness in the market, or anything else you would call out? And then just how would you expect new investments to compare to payoffs in coming quarters?

Okay. Yes. So as noted on the call earlier, FL1, which is our 2021 securitization, is out of its reinvestment period. New investments previously were often reinvestments of that securitization. So right now, we're basically at capacity given that FL1 is out of the investment period, and LMF, the 2023 transaction is at capacity. We do have $60-plus million of cash. It's just a matter of strategically looking to finance FL1 and planning with that excess cash accordingly. So something to consider over the next couple of quarters as FL1 continues to deleverage. But over the near term, I don't know that we'll see FL1 refinance, but that will all be market-condition dependent. I think we're effectively fully deployed with obviously the elevated cash. So in answer to your question, I would expect to be able to fill any reinvestment capacity we have in a reasonable way unless it's at the very end of the quarter. Despite the relatively slow market, there are lending opportunities.

Right. Okay. That makes sense. I appreciate that. And then second question for me, can you just give us your views on credit in the portfolio? Provision increased a bit here. Credit metrics were stable and the resolutions were good to see. But are there some other competitors who have been having tougher experiences as of late? So anything on credit that you're seeing would be helpful. And then why do you think you might be performing better than some of the peers in the space here?

Well, the honest answer is I think that we've done a very good job of putting together a quality portfolio. And we've had good sponsors who have worked with us to come up with resolutions to challenging situations. We feel pretty confident and comfortable that we'll continue to be able to do that in the existing portfolio. We've had the structure of our loans that have always had rate caps. We've had milestones for drawing down new capital in terms of rental increases and actual business plan milestones that have provided opportunities to work with sponsors sometimes sooner than others may have been able to. In general, I think we did a good job on the front end and have a very good asset management and portfolio management group that spends a lot of time at the assets and with the sponsors, making sure that we're timely on top of issues. There's not something more secret than that other than I think we have a really good credit team.

Our next question comes from the line of Jason Weaver from JonesTrading.

First of all, you spoke to this in the last question regarding the wind down of FL1. I was curious with how much credit spreads have tightened in here quarter-to-date and over the first quarter, if the opportunity is more immediate to pursue that refinancing and where you're seeing generalized spreads out there.

So on the credit side, from a standpoint of 82% and 157 over, there's no opportunity that's really even close to that, whether private or public. But as you point out, as time goes by and we continue to deleverage, the cost of those funds will increase. You asked immediate, we're evaluating it like we have been and continue to do so depending on how you define immediate. We think that there is potential this year or early next year to potentially refinance that, but it's really going to be dependent on the capital markets. Obviously, we can get it done, I think I shouldn't say obviously, but I think you can get a refinance on the public markets. I think there are other structures with private or non-capital markets transactions that would provide for refinancing. But today, frankly, they're economically not as attractive to pull the trigger in our opinion, but we're getting closer to that. And we are working with our banking partners who have been the same with ways we might refinance that portfolio in a way that does make sense perhaps sooner than later. But the short answer is we feel comfortable with the financing today and want to continue to take advantage of the relative cost of capital and, frankly, higher leverage than we might otherwise achieve outside or in a new deal.

No, that's still very helpful. I was also curious if, with the liquidity build you've experienced so far and considering your response regarding anticipated repayments, there has been any change in your approach to potential share repurchases.

It's something that has been discussed with the Board. There are various issues to consider, particularly the size of the market. We definitely take it into account as we weigh the benefits of liquidity, future investment opportunities, and the immediate advantages for shareholders, and how these might affect long-term value.

Our next question comes from the line of Stephen Laws from Raymond James.

Nice start to the year, a good number out of the gate. I know you got the two 5-rated loans resolved. Can you touch on the resolution path for the new 5-rated loans? I know you've said both paid in April, no specific reserves. So good updates there. But can you talk about timing or resolution path on those two, I guess, two loans but three assets?

Yes, I can provide input on that.

Yes. I mean I think that is a very real-time conversation I don't think we're prepared to share the exact resolution path at present. But just like what you've seen from us in the past, this involves hands-on active management negotiation with the sponsors pushing towards quick resolutions.

Our next question comes from the line of Christopher Nolan from Ladenburg Thalmann.

The Brooklyn non-accrual, is that a rent-stabilized building?

Yes, it is the exact answer. I'm sure there's some. I don't have to check on it.

Right. It's primarily market rate.

To be clear, regarding the deal, its value is not an issue, and I want to emphasize that.

Okay. And then for the loan portfolio in general, do you have any interest-only loans?

Well, they're all included. For the floating loans, they are interest-only, which applies to the portfolio. The bridge portfolio is also interest-only. There are rebalancing requirements that necessitate principal pay downs, and these requirements exist across all forms. To recap, the underlying bridge loans usually have terms of two to three years, with floating rates and are interest-only. They include interest rate caps that are purchased by the sponsors. However, bridge loans, whether from us or our competitors, are primarily interest-only.

And I guess, given that, how does that affect your reserving methodology just because these borrowers sort of have a larger balloon payment at the end than normally?

I'll let Jim Briggs explain the process. Generally speaking, when we analyze our portfolio actively, one of the key metrics we focus on is the loans to value ratio. This is the main factor we consider. For example, we may have assets that initially had a loan to value ratio of 70, which might have increased to 75 or 80 today. This doesn't necessarily mean that equity has lost value; rather, our credit position remains strong. This is part of our evaluation process, along with assessing the market and comparable properties.

Yes. I mean it's going to be a combination of both. CECL requires a look-forward on what the macro environment and the forecast is going to be. We choose a one-year period for that. But to Jim's point, on collateral value and LTVs, that is a big driver as well. You're seeing that in our general reserve, right? I talked about our general cautiousness in this period as we model where there's not a lot of activity getting done and the observability of cap rates and valuation. That sort of speaks to LTVs, right, and collateral value. So the same drivers that Jim talks about is going to be a big driver of the reserve. There is going to be this macroeconomic look as well because it's expected losses over the life, and we need to be forecasting. We saw that macro for us, that macro forecast move to more of — we're not going to see rate cuts as soon as we thought we may and they're going to come later in the year, potentially. So it's a combination of both, but I would say that LTV is going to be a driver there and was a driver of reserve.

Our next question comes from the line of an analyst from UBS.

Good report. The recoveries on the commercial building I guess, to me sort of look like an extraordinary gain. If we strip out that gain, what do distributable income per share numbers look like?

Those one-timers work out to be about $0.06 for the one-timers. And I spoke about the incentive fee, so that's sort of going the other way for about $0.03. So the one-timers in particular were about $0.06.

There are no further questions at this time. I will now turn the call over to our presenters. Please go ahead.

I want to thank everyone for your time and interest and look forward to catching up again next quarter. Take care.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.