Lument Finance Trust, Inc. Q4 FY2024 Earnings Call

Good morning. Thank you for joining the Lument Finance Trust Fourth 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 conference over to Andrew Tsang with Investor Relations at Lument Investment Management. Please go ahead.

Thank you. Good morning, everyone. Thank you for joining our call to discuss Lument Finance Trust's fourth 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 Wednesday, March 19, we filed our 10-K with the SEC and issued a press release to provide details on our recent financial 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 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, 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 statement. These risks and uncertainties are discussed in the company's reports filed 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. 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. 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 fourth quarter and fiscal year 2024, we report GAAP net income of $0.07 per share and $0.34 per share of common stock respectively. For the fourth quarter of fiscal year 2024, we reported distributable earnings of $0.10 and $0.44 per share of common stock respectively. This past December, we declared a quarterly dividend of $0.08 per share with respect to the fourth quarter with an additional one-time special dividend of $0.09 per share, bringing our cumulative dividends declared for 2024 to $0.40 per common share. I will now turn the call over to Jim Flynn. Please go ahead.

Thank you, Andrew. Good morning, everyone. Welcome to Lument Finance Trust's earnings call for the fourth quarter of ‘24. I appreciate everyone joining us today. We'll start with a quick view of the overall market. The broader macroeconomic environment continues to be shaped by geopolitical uncertainty, financial market volatility, and to a lesser degree today, inflation. As we entered 2024, we anticipated multiple rate cuts over the course of the year, but given the resilience of the economy and the ongoing inflationary pressures, most of those cuts did not materialize, and now it's clear that interest rates will remain elevated. With inflation currently moderating and the economy cooling, the Federal Reserve is currently projected to make two cuts in 2025. Despite the volatility, we are encouraged by increasing stability in commercial real estate, particularly cap rates, which have begun to normalize after a period of dislocation. Rental growth is anticipated in nearly all major ventures this year and beyond, and transaction volumes, while below historic norms, have also picked up in recent months. We believe the positive momentum for lending activity that we saw in late 2024 relative to earlier in the year will continue in 2025. Although we remain cautious, we are optimistic that as market conditions continue to stabilize, opportunities to deploy capital at attractive risk-adjusted returns will emerge. On the asset management side, we continue to prioritize proactive asset management across our portfolio to drive positive outcomes. The credit risk ratings have remained largely stable, reflecting disciplined underwriting and ongoing borrower engagement. And while we've made modest increases to specific reserves, these adjustments have been prudent and in line with our expectations for the portfolio performance. Managing our existing book of credit remains a core focus, and our team continues to work closely with all borrowers to maximize recovery values and ensure that assets perform in line with our underwriting expectations. We remain confident in our ability to effectively navigate this environment and optimize outcomes for all shareholders. While the manager's lending affiliate Lument continues to actively deploy capital into new loan investments with a focus on multi-family backed by strong sponsors, LFT's investment activity during the quarter was modest, primarily limited by the available reinvestment capital. Our 2023 secured financing vehicle, LMF23-1, remains in its reinvestment period until July of this year, and we expect to source new loan assets as investment capacity becomes available. During the period, we also had significant payoffs of seasoned loans in the portfolio. In terms of our financing strategy, as our 2021 securitization continues to deleverage, we have dedicated significant time with our lending partners and advisors to explore options to refinance our investment portfolio. Given that our portfolio today is primarily comprised of seasoned assets, and we expect some loan borrowers will be challenged to exit our loans at the time anticipated in their underwritten property business plans, we believe it prudent to continue to defer the execution of the CRE CLO or similar securitization transaction until we have more visibility into those loan resolutions. In the interim, we have engaged in active discussions with select counterparties for other forms of potential secured financing, including bank-provided warehouse facilities, which provide us with the flexibility to better manage both our performing loan portfolio and the handful of more challenged assets, and expect to provide additional details in the coming quarter as these conversations progress. We expect such secured financing will allow us to remain highly flexible from a liquidity perspective and position ourselves to achieve positive asset management outcomes for our existing portfolio without sacrificing significant economics. That said, we continue to believe that a securitization transaction later this year remains a viable potential option, as obtaining non-mark-to-market match-term secured financing, as always, is an attractive economic priority for the company. As we look ahead, we remain committed to our core investment strategy of deploying capital into transitional floating rate mortgages with a particular emphasis on middle market multi-family assets. Multi-family fundamentals remain strong, supported by robust demand, constrained supply, and resilient rental trends. We continue to leverage the origination, underwriting, and asset management expertise of our manager and its affiliates to identify and capitalize on compelling investment opportunities. Our ability to navigate the current environment, prudently manage our liquidity, and optimize capital deployment on a levered basis will be key to delivering long-term value to our shareholders. 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 Annual Report on Form 10-K 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 four through seven of the presentation, you'll find key updates and earnings summary for the quarter. For the fourth quarter of ‘24, we reported net income to common stockholders of approximately $3.6 million or $0.07 per share. We also reported distributable earnings of approximately $5.4 million or $0.10 per share. Few items I'd like to highlight with regards to the Q4 P&L. Our Q4 net interest income was $9.4 million, which is relatively flat to the $9.5 million recorded in Q3. The weighted average coupon and average outstanding UPB of the portfolio declined sequentially, largely due to declines in the SOFR-ed benchmark rate and the deleveraging of our 2021 securitization. These reductions in net interest income were largely offset by increased exit fees related to loan payoffs. Payoffs during Q4 totaled $144 million as compared to $51 million in the prior quarter, with the company recognizing approximately $1.1 million of exit fees during Q4 compared to approximately $150,000 in Q3. Our total operating expenses were largely flat quarter on quarter, we recognized expenses of $2.8 million in Q4 versus $2.9 million in Q3. The primary difference between our reported net income and distributable earnings was a $1.8 million net increase in our allowance for credit losses. I'll walk through the components of that. As of December 31, we had six loans risk rated of five, including four assets downgraded to five in Q4. All six loans were collateralized, five loans were collateralized by multi-family assets, and one of those loans is collateralized by healthcare. Jim Henson will provide a bit more detail on the six in his remarks. We evaluated those six five-rated loans individually to determine whether asset-specific reserves for credit losses were necessary. After analyzing the fair value of the underlying collateral, we increased our specific reserves to $3.7 million as of 12/31, an increase of $2.9 million versus the prior quarter. Our general reserve for credit losses decreased by $1.1 million during the period, primarily driven by payoffs of performing loans and the move of four assets to specific evaluation. In terms of basis points of reserve on the general pool, that was flat quarter on quarter. We ended the fourth quarter with an unrestricted cash balance of $69 million and our investment capacity through our two secured financings was fully deployed. The company's total equity at the end of the quarter was $238 million. The total book value of common stock was approximately $178 million or $3.40 per share, decreasing sequentially from $3.50 per share as of September 30 as a result of aggregate dividends, including the $0.09 special common dividend paid on January 15. As a REIT, we are required to distribute at least 90% of our taxable income in order to meet testing requirements. Our $0.09 special dividend declared in December was calibrated to distribute 100% of our taxable income so that the company will not be taxed at the corporate rate for any of its 2024 taxable income. The $0.09 special dividend also largely tracks the annual difference between distributable income and GAAP income of $0.10, which was driven by unrealized provisions for credit losses during '24, which do not impact taxable or distributable income. I will now turn the call over to Jim Henson to provide details on the company's investment activity and portfolio performance during the quarter.

Thank you, Jim. During the fourth quarter, LFT experienced $144 million of loan payoffs and acquired one new loan asset with an initial principal balance of $13 million and a weighted average coupon of SOFR plus 375 basis points. As of December 31, our portfolio consisted of 65 floating rate loans with an aggregate unpaid principal balance of approximately $1.1 billion. 100% of the portfolio was indexed to one month SOFR and 92% of the portfolio was collateralized by multi-family properties. As of the end of the fourth quarter, our portfolio had a weighted average floating note rate of SOFR plus 358 basis points and an unamortized aggregate purchase discount of $3.5 million. The weighted average remaining term of our book as of quarter end was approximately 26 months, assuming all available extensions are exercised by our borrowers. The CRE CLO securitization transaction we issued in 2021 provided effective leverage of 75% to our loan assets at a weighted average cost of funds of SOFR plus 171 basis points. The LMS financing completed in 2023 provided the portfolio with effective leverage of 83% at a weighted average cost of funds of SOFR plus 314 basis points. On a combined basis, the two securitizations provided our portfolio with effective leverage of 78% and a weighted average cost of funds of SOFR plus 226 basis points as of quarter end. As of December 31, approximately 64% of the loans in our portfolio were risk rated a three or better compared to 60% at the end of the prior quarter. Our weighted average risk rating remained relatively unchanged, improving modestly to 3.5 versus 3.6 at the end of Q3. We had six loan assets rated risk rated five with an aggregate principal amount of $98 million, or approximately 9% of the unpaid principal balance of our investment portfolio. One was a $15 million loan collateralized by two multi-family properties in Philadelphia, Pennsylvania. This loan asset was risk rated five due to monetary default. During Q4, the company recognized approximately $432,000 of cash received from the borrower as a reduction in our carrying basis of this loan. Another five-risk rated asset was a $32 million loan collateralized by a multi-family property in Dallas, Texas that was in technical default. Both of those loans were also risk rated five at the end of the third quarter. The third five-risk rated asset was a $20 million loan collateralized by property in Orlando, Florida that was in monetary default. The fourth five-risk rated asset was a $15 million loan collateralized by a multi-family property in San Antonio, Texas that was in technical default. The fifth risk-rated loan was a $6 million loan collateralized by two multi-family properties in Orlando Florida MSA that was in monetary default. The sixth risk-weighted asset was a $10.5 million loan collateralized by a multi-family property in Colorado Springs that was in monetary default. During the fourth quarter, we were successful in achieving positive outcomes on two of the four loans that were five-rated as of September 30. These included a $20 million loan collateralized by multi-family properties in Augusta, Georgia, and a $17 million loan collateralized by a multi-family property in Brooklyn, New York. We received full recovery of principal on both of these investments, thanks to the diligent efforts of our manager's asset management team. There were no existing specific reserves on these two resolved assets. We continue to work closely with borrowers on the six five-rated assets that were outstanding at the end of the year. With that, I will pass it back to Jim Flynn for closing remarks and questions.

Thank you, Jim. I would like to take the opportunity to thank Jim Henson for his dedication, sage advice, and support of the LFT platform. We wish Jim the best in his retirement. And I'd also like to welcome Greg Calvert as our new President. Being part of a large organization with a well-capitalized parent, as we are, gives us the opportunity to have a deep bench of experienced professionals. Greg has had a more than 30-year career in real estate, primarily on the investment and credit side, and he will be a great addition to our team in 2025. Lastly, I want to thank all of our guests. We appreciate your time and your interest in our platform. We look forward to hearing from you. And with that, I'll ask the operator to open the call to any questions.

Thank you. We will now begin the question-and-answer session. Your first question comes from Stephen Laws with Raymond James. Please go ahead.

Hi, good morning. Thank you for the comments in the prepared remarks. I wanted to ask about the 2021 CLO. Since it has been paid down, how does its blended financing cost compare to current market conditions for a new CLO? Also, regarding your remarks, I understand you are considering some financing lines and other options. As you contemplate doing another securitization or deal later this year, will you consider collapsing the FL-1 from 2021 and rolling the collateral in? How do you approach managing the financing side of the balance sheet throughout the year?

Yeah. So obviously, we are looking at all of those things. We are looking to basically refinance the portfolio as we move forward here in the coming quarters. FL-1 today is about 75% advance at a cost of 171 over SOFR. The cost is still attractive, but the leverage obviously is lower. We've seen deals going off kind of in the mid-to-high 80s on an advanced rate. So in terms of how we're looking at the portfolio, as we said. We are working with some of our partners to consider some alternatives that give us a little more flexibility in the short term around dealing with some of these assets that we're working through with existing borrowers or potentially new borrowers and do expect to move forward with one or more of those types of financing arrangements as we move through the year.

Great. And then as I hear we are almost into Q1. Can you give us an update on originations and repayments year to date? And how do we think about when leverage is going to trough? I assume you need a new financing facility in place before we see it turn up, but is that a 2Q event with leverage troughing?

Sorry, the Q2 event for what's the significance of that?

Well, I guess first question year to date originations, we were almost at the end of Q1. So can you talk about portfolio, how much is runoff repayments versus originations in Q1?

On the origination side, we've seen very few activities because we lack capacity at FL-1, and LMS has been minimal. We’ve experienced about $25 million in payoffs and expect more in the coming quarters. Broadly at the parent level, we've originated around $400 million to $500 million since around October. The beginning of 2024 was light across the industry, but it has picked up significantly. While we haven't returned to peak levels, we're seeing significant opportunities and are actively making loans, which are reflected on our manager's balance sheet. We're managing our book effectively, supported by a highly experienced management team in special assets and REO, and we've achieved positive outcomes in LFT's book as well as most of the parent's book as necessary. The main challenge we face has been the timing of these resolutions, which are largely outside our control and often take longer than expected. This is prompting us to consider financing options that provide us with the necessary flexibility.

Great. Appreciate the comments this morning. Thank you.

And your next question comes from the line of Steve Delaney with Citizens Bank. Please go ahead.

Good morning, everyone. Thank you for your question. It seems there has been some activity regarding downgrades with the new five risk ratings, and it appears you have increased your specific reserves. Can you confirm if the specific reserves for five-rated loans was $3.7 million at the end of 2024? Is that the accurate figure?

Yeah. That's right, Steve.

Okay. And so look, these are you've got what six loans, $98 million, so $15 million or so average loan size it would seem. As we're everything runs nicely through GAAP, but then as we're modeling for this year and trying to come up with distributable EPS, can you give us some sense of like from your where you sit internally your expectations of timing of resolutions? Are you going to get after well, first quarter is already done and we're not talking about anything. Well, yes, of course, you're reporting on 4Q. Is it going to be more back end weighted in 2025 in terms of the resolutions as we want to try to start loading some realized losses into our distributable earnings estimates? I guess I'm just trying to get a sense, I know you can't be specific, but how we should sort of look at 2025 with respect to those realized losses? Thanks.

Thank you, Steve. It's certainly a challenging question to answer, especially given our current situation. Nevertheless, I've noticed that the market is starting to show signs of easing, as people are eager to reach resolutions. This applies particularly to sponsors, who may want to disengage or believe they can still derive value from their assets. However, the timing for these resolutions can be complicated. In some instances, when borrowers aren't engaging with us towards a solution, we've had to resort to foreclosure and other measures to either prompt discussions or to find someone else who is willing to engage. We have assets that have required reserves, but others have been resolved successfully with full repayment, including default interest and associated costs. I believe this will hold true for some of our assets. However, we've also encountered more significant challenges with other assets than we initially expected. Overall, I think our portfolio remains relatively strong compared to the market. We haven't modified loans with sponsors through various structures as others in the market have. We see opportunities to introduce new sponsors into our deals, potentially through seller financing or other arrangements that might appeal to them. Timing is crucial for new sponsors as they consider the longevity of their investment, especially if they are attracted to the prospects of well-performing assets. Regarding resolutions, I would say we are focused on our ongoing discussions, either with existing or new sponsors, to convert these into performing assets. We expect steady rent growth across nearly all markets, although we will need to address some absorption challenges in specific markets over the next year. Ultimately, we remain optimistic about achieving positive outcomes as we have in the past.

Thank you for the context provided. I understand your perspective clearly. I have a quick follow-up regarding your loan portfolio, which amounts to approximately $1.1 billion with around $240 million in capital. Jim Flynn, you mentioned a new state-of-the-art CLO. Beyond the credit resolution issue we previously discussed, looking at the portfolio from a broader perspective, do you foresee the potential for a slight expansion of the portfolio with the current capital base by mid-2025, given the anticipated improvements in the financing structure?

The short answer is yes. Over the past couple of years, we have maintained higher liquidity than we historically have for good reasons. We are currently deleveraging through the FL-1 payoffs. In a normalized market, as we resolve these assets positively, I believe that with matching term financing like a CLO, and considering the size of this entity, we are slightly under-leveraged compared to past norms. If we are comfortable with our liquidity position and the assets we want resolved, I think there is a reasonable expectation for slight portfolio growth. Additionally, much of what I'm discussing relates to liquidity. We cannot predict when we will need liquidity, and there may be times when we require it for multiple assets in one quarter, which would change our perspective. Thus, maintaining this flexibility does create a drag, but we hope to reduce it in the coming quarters.

Thank you both for the additional color this morning.

Thank you. Your next question comes from the line of Christopher Nolan with Ladenburg Thalmann. Please go ahead.

Hi. On a question of loan loss provision expenses, what's the correlation between your risk rating and provision charges?

On the specific reserves there, Chris, as is policy when we specifically evaluate those, we're looking at the fair value of the underlying collateral. So, five, we look at individually. In terms of the general pool for the portfolio, clearly the risk ratings are going to bring with it a higher probability of default as you scale up from threes to fours. And as I mentioned, the fives are specifically evaluated. So, it's also dependent upon underlying loan metrics that's going to drive risk rating, but it's also going to be driving probability of default in the model that we and others use for the general pool.

Great. Thank you. Please go ahead.

But to be clear for the fives, we're looking at the underlying collateral.

Okay. Understood. And then in the early market comments, talking about the stability of multi-family cap rates, Does the changing market expectation in terms of rate cuts start derailing refinancing and negotiations for any portfolio companies or so? Is that really coming in affecting it at all or is really the financing all about the cash flow of the property?

A reduction in short-term rates clearly benefits current sponsors. However, I don't believe that a 25 or 50 basis point cut this year will significantly alter people's perceptions or behaviors; it may actually be a positive development. It's important to note that rate cuts typically happen either when inflation is under control or due to concerns about the economy's health and potential recession, which isn't exactly encouraging. Nevertheless, historically, the multi-family sector tends to perform well during such economic periods. When home buying decreases, people are more likely to stay in their apartments and rent. This creates an interesting dynamic between the economy and multi-family performance. The primary influence is that the 10-year yield has remained in the low-4% range for several months. Expectations for the year-end 10-year yield have moderated slightly in the last quarter and a half, with most projections leaning towards the 4% to 4.5% range, which I see as a significant factor. There is considerable capital ready to be deployed, including substantial international investments looking to re-enter the U.S. market after being inactive. This could drive value appreciation and increase transaction volume, presenting several positives. As you might know, supply deliveries have peaked in most markets, leading to some absorption challenges, yet there remains a long-term supply-demand imbalance in many areas. This is contributing to rent growth across nearly all major metropolitan areas, with expectations for continued rent increases throughout the year. Overall, these indicators are making sponsors and individuals managing assets or contemplating re-entering the market feel more optimistic than they have been in the past couple of years.

Okay. Thank you.

Thank you. And I'm showing no further questions at this time. I would like to turn it back to James Flynn for closing remarks.

Just appreciate everyone joining and the interest in the platform. And look forward to speaking to you all again next quarter. Take care.

Thank you. And ladies and gentlemen, this concludes today's conference call. Thank you all for joining. You may now disconnect.