Earnings Call Transcript - LFT Q2 2023

Operator, Operator

Good morning and thank you for joining the Lument Finance Trust Second Quarter 2023 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 with Investor Relations at Lument Investment Management. Please go ahead.

Andrew, Investor Relations

Thank you and good morning, everyone. Thank you for joining our call to discuss Lument Finance Trust's second quarter 2023 financial results. With me on the call today are James Flynn, CEO; and James Briggs, CFO; James Henson, President; and Zachary Halpern, Senior Director of Portfolio Management. Yesterday on Tuesday, August 8th, we filed our 10-Q with the SEC and issued a press release, providing details on our second 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 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 Exchange Act of 1934. When used in this conference, words like 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 and uncertainties are discussed in the company's reports filed with the SEC, including its reports on Forms 8-K, 10-Q, and 10-K, and in particular the Risk Factors section of our Form 10-K. 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 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 at www.sec.gov. For the second quarter, we reported GAAP net income of $0.03 per share, while distributable earnings were $0.04 per share. In July, we paid a dividend of $0.06 per share with respect to the second quarter. I will now turn the call over to Jim Flynn. Please go ahead.

James Flynn, CEO

Thank you, Andrew. Good morning, everyone. Welcome to the Lument Finance Trust earnings call for the second quarter of 2023. We appreciate you all joining us today. Let's start with the market. With respect to the overall multifamily market, during the first half of this year, we observed a decrease in demand and a slight rise in vacancy rates, resulting in some modest rent growth of approximately 1% across the portfolio. It's important to note that that's a national trend and doesn't apply uniformly to all metro areas. In some cities, we've seen flat or negative rent growth; for instance, some of the bigger gainers over the years, like Vegas, San Francisco, and Phoenix, have shown less growth. On the other hand, cities like Boston, San Diego, and Knoxville have shown rent growth of right around 2% on historical averages. So, we need to pay attention to all of the markets specifically. Despite lingering economic uncertainty, over the long term, we do remain optimistic that the multifamily sector will manage to navigate through these hurdles and continue to be a well-performing asset class in commercial real estate. The multifamily economic backdrop remains constructive, with positive job growth, elevated single-family prices, and affordability in many locations across the country, along with favorable supply/demand demographics. Our cautious outlook for the multifamily lending environment in the second half of 2023 remains unchanged. While investment sales activity remains depressed, we are seeing some stability in rent conditions and positive albeit slowing net operating income growth. We view these signs of increasing stability and asset valuations as something that we project will translate into greater activity over the remainder of 2023 and into 2024. We believe the credit profile of the middle market housing continues to be supported by favorable supply/demand dynamics, demographics, and long-term rent growth trends, creating an attractive investment opportunity for LFTC shareholders. With respect to the asset financing market, the CRE/CLO securities market experienced significant limitations in Q2, as it has for quite some time. Access to the market and its attractive pricing and terms were largely unavailable. As a result, we pivoted from looking at a public transaction to executing a private collateralized financing transaction, which closed on July 12th. The collateralized CRE financing transaction was secured by approximately $386 million of first-lien floating rate multifamily mortgage assets. In connection with this transaction, which has similar match term non-recourse non-mark-to-market features of the CRE/CLO, approximately $270 million of investment-grade-rated senior secured floating rate loan was provided by a private lender, and approximately $47 million of investment-grade-rated notes were issued and sold to an affiliate of LFT's manager. The outstanding liabilities of this financing transaction have an initial weighted average spread of 314 basis points over 30-day terms SOFR, excluding fees and transaction costs. The initial collateral pool consisted of 25 first lien floating rate mortgage loans secured by 32 multifamily properties located across the United States. The weighted average spread of the initial collateral was approximately 365 basis points over 30-day term SOFR. The majority of the collateral was acquired from an affiliate of the manager at an aggregate discount to par of approximately 1.5%, which we estimate results in an effective spread on the initial collateral pool north of 425 basis points. All the mortgage assets were originated by an affiliate of our manager. This financing transaction provides for a 24-month reinvestment period that allows principal proceeds from repayments of the mortgage assets to be reinvested in qualifying replacement mortgage assets, subject to certain conditions. Despite disruptions in accessing the traditional CRE/CLO market, we were able to successfully pivot and execute the private transaction structure that significantly increases our leveraged investment capacity at attractive economic terms. We are aware of the need to maintain a strong liquidity position as we potentially enter a challenging part of the market cycle, both to opportunistically deploy capital into new investments and to drive positive outcomes on underperforming assets in the portfolio. The company is well-positioned to manage through the changing market conditions as all of our secured financing is match term and non-mark-to-market, including the collateralized financing transaction we closed subsequent to the end of this quarter. Furthermore, the company does not have any corporate debt maturities until February of 2026. With that, I'd like to turn the call over to Jim Briggs, who will provide us with details on our financial results. Jim?

James Briggs, CFO

Thank you, Jim, and 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 four through seven of the presentation, you will find key updates and an earnings summary for the quarter. For the second quarter of 2023, we reported net income to common stockholders of approximately $1.4 million or $0.03 per share. There are a few items I'd like to highlight with regard to the Q2 P&L. Our Q2 net interest income was $7.5 million compared to $8.2 million in Q1 of 2023. This decline occurred primarily because our investable capital was intentionally held as significant undeployed liquidity during the period in anticipation of the execution of a collateralized financing transaction, which we ultimately closed in mid-July. Our unrestricted cash balance throughout Q2 was in excess of $95 million. The June 30 pro forma unrestricted cash, giving effect to our July 12th financing transaction, was approximately $40 million. Increased earnings rates on our cash balances helped mitigate some of the impact of cash drag; however, this was more than offset by the increase in incurred interest expense related to our CLO liabilities as SOFR rose 22 basis points during the quarter from 4.87% to 5.09%. Exit fee and other pre-payment-related income was also down by approximately $400,000 sequentially. Our total expenses were $4.4 million during Q2 versus $2.7 million in Q1. This quarter-over-quarter increase was driven primarily by $1.7 million or $0.03 per share of deal costs we incurred in pursuit of executing a CRE/CLO securitization transaction that Jim mentioned we pivoted from. Given volatility in the capital markets and significant execution risk, we determined to terminate this transaction before it went to market and instead pursue the transaction that closed in July. For Q2, we reported distributable earnings of approximately $1.9 million or $0.04 per share. The primary difference between reported net income and distributable earnings was the approximately $550,000 increase to CECL general reserves in the quarter, primarily due to changes in the macroeconomic forecast. As a non-cash unrealized item, these charges are adjusted out for the purpose of calculating distributable earnings. Excluding the previously mentioned $0.03 per share of costs expensed in Q2 relating to the abandoned public CRE/CLO transaction, distributable earnings for Q2 would have been $0.07 per share. As of June 30th, the company's total book equity was approximately $239 million. Total common book value was approximately $179 million or $3.43 per share. I will now turn the call over to James Henson who will provide details on the company's investment activity during the quarter and portfolio performance.

James Henson, President

Thank you, Jim Briggs. I will provide a brief summary of our portfolio activity during the second quarter. During the second quarter, we experienced $72 million of loan payoffs, which included the loan on our sole retail collateralized asset. This represents an increase relative to the $52 million of loan payoffs experienced during the first quarter. The $72 million of payoffs experienced during the second quarter represented a 28% annualized payoff rate. While this payoff rate is below our long-term historical average, we expect we will continue experiencing similar payoff speeds over the coming quarters due to persistent interest rate volatility and economic uncertainty. During that period, we acquired approximately $73 million of loans from an affiliate of our manager. Seventy-five percent of these acquisitions were collateralized by multifamily properties, and the remaining 25% were collateralized by healthcare-related properties. As of June 30, our portfolio consisted of 66 floating rate loans with an aggregate unpaid principal balance of approximately $1 billion. Approximately 89% of the portfolio was collateralized by multifamily properties located across the country. Approximately 74% of the portfolio was indexed to LIBOR as of June 30th. On July 6th, we successfully transitioned all of these loans to SOFR, and our portfolio is now 100% indexed to SOFR. Our investment portfolio performed well during the second quarter. While we have experienced some modest risk migration, from an average of 3.2 in the prior quarter to an average of 3.4 in this period, only one multifamily loan remains rated a 5. We have not recorded any specific allowance on this loan, which remains in monetary default, and for which we are pursuing all available remedies. During the period, we had no additional loans in the portfolio rated as a 5. As Jim Flynn described earlier, after the quarter end, we acquired an additional 25 floating rate mortgage assets in connection with the execution of a $386 million collateralized financing transaction, which closed on July 12th. Slide 17 in our supplement provides further detail relating to the 25 loans and the initial collateral pool for that financing. Slide 23 in the supplement provides a pro forma capital structure for the company, giving effect to the July 12th transaction. As discussed earlier on the call, we expect to continue to rely on the depth and breadth of our manager's active asset management capabilities to mitigate risk within our portfolio and to protect shareholder value. With that, I will pass it back to Jim Flynn for some closing remarks.

James Flynn, CEO

Thank you, James Henson. We look forward to updating everyone on our progress. We appreciate your time and interest, and I'm happy to open the call up to questions.

Operator, Operator

We will now begin the question-and-answer session. The first question comes from Crispin Love of Piper Sandler. Please go ahead.

Crispin Love, Analyst

Thanks. Good morning, everyone. Appreciate you taking my questions. First one, just looking at the weighted average remaining term of your portfolio about 15 months or so. Just given the macro and rate environment here in multifamily, I'm curious how you expect maturities to be handled for many of these loans that may mature over the next several quarters? Would you expect some extensions here, any infusions of cash, or does otherwise, how would you expect maturities to be handled?

James Flynn, CEO

Thanks for the question. I think there's a little bit of a blend. We've actually seen across our broader platform some higher payoffs, frankly, than we might have expected a quarter ago or two. So, we actually do expect a reasonable amount of payoffs coming here over the next couple of quarters as you point out. We also expect to have some loans extend with pay downs and other terms changing on the lenders' behalf to get those executions. It’s going to be a mix, but in all of the borrowers that we've been speaking with, we've generally had constructive and positive conversations where we expect their plan is to either move forward with a sale, which will get paid off, or have plans to refinance at lower leverage.

Crispin Love, Analyst

All right. Thanks. Appreciate the color there. Sorry, not refinance. Yes. Okay. Jim, I believe you mentioned this in your prepared remarks, but I might have missed it. At the end of the quarter, your cash balance was just under $99 million. The pro forma cash balance, including LMF 2023-1, was that $40 million?

James Flynn, CEO

That's $40 million. That's correct.

James Briggs, CFO

4-0, that's right, Crispin.

Crispin Love, Analyst

Perfect. That's what I thought. Okay, thanks. And then just if I could sneak one more in, how close were you to completing that abandoned CLO transaction? And can you just explain the key reasons for going with the private transaction, pricing, anything else at play? And then just any detail on that $1.7 million, how that was spent?

James Flynn, CEO

We were very close to completing the transaction. The reasons for not finalizing it were related to SVB, Signature Bank, and CS. We were on the verge of launching a public deal or even placing it in direct accounts when the banking crisis escalated. We were prepared and had been dual tracking, exploring various options, including private transactions. Given the volatility in the capital markets, we had anticipated opportunities for both. At that moment, we believed we had a chance to complete the trade, but the banking issues deteriorated rather quickly. We looked for another opportunity, but the situation on the banking side only got worse. Even if we had managed to proceed, we likely wouldn't have been able to include a reinvestment period. Circumstances shifted against us rapidly, leading us to focus on the private transaction, which we pursued vigorously. Unfortunately, we were unable to move forward as we had hoped. While it was a static deal, I believed the pricing could have been a bit more favorable, but with the market changes, the options became less appealing or unachievable entirely.

Crispin Love, Analyst

All right. All makes sense. Appreciate the color there. Thanks.

Operator, Operator

The next question comes from Stephen Laws of Raymond James. Please go ahead.

Stephen Laws, Analyst

Hi, good morning.

James Flynn, CEO

Good morning.

Stephen Laws, Analyst

Congratulations on the private deal in July. I understand this financing is something you've been pursuing for several quarters, so it's great to see the deal come to fruition. Regarding your last point about the managed collateral pool, the reinvestment period is still open in your first CLO through year-end. Can you explain how accretive turnover is? What are the typical spreads you're observing on maturing loans being paid off compared to where those funds can be redeployed?

James Flynn, CEO

Yes. I think it's obviously a little bit better. Most of the loans paying off would have interest rates in the mid to high 3s. New loans are generally in the range of 4 to 4.50, with 4.25 being typical for those that are being completed or traded. Therefore, I would expect a modest increase, as we've seen lower leverage in the market as well. However, it will be a modest increase, likely around 25 to 50 basis points on average, depending on the expense payoff.

Stephen Laws, Analyst

Great. And then just I want to make sure we've still got just the one 5 rated loan that didn't change. But it looks like 4 rated loans dropped from 12 to 10. I think I'm guessing maybe one was the retail loan that I mentioned in your prepared remarks, but maybe I'm wrong on that. So, can you talk about what you're seeing in that 4 bucket, any trends, either geographic, or you're mostly multi? So, any geographic trends? Is there any correlation or response to concentration among those loans?

James Flynn, CEO

No. I'll actually introduce Zac Halpern to provide some insights on that. Regarding the last question, I want to clarify that the new transaction was associated with spreads of about 4.25 based on our acquisition costs. For our first CLO, the payoffs have been around 3.60 in that pool as loans are paid off. My point about reinvestment and the pickup spread pertains specifically to the first CLO, not the second.

Zachary Halpern, Senior Director of Portfolio Management

Hey, Stephen. This is Zach.

James Flynn, CEO

Yes. Go ahead, Zach.

Zachary Halpern, Senior Director of Portfolio Management

Yes, I was just going to jump in quickly on risk ratings. I don't think we're seeing any super negative geographic trends or anything super specific there. As you know, implicit in these risk ratings or explicit really is the debt service and interest rates, and as SOFR ticking up, we're just seeing a little bit of downward migration in debt service coverage. And so I think that's really what you're seeing with selected here. It's not geographic-specific or sponsor-specific at present?

Stephen Laws, Analyst

Great. Appreciate the comments this morning.

James Flynn, CEO

Thanks, Stephen.

Operator, Operator

The next question comes from Matthew Erdner of Jones Trading. Please go ahead.

Matthew Erdner, Analyst

Hey guys. Thanks for taking the question. So, you mentioned single reinvestment. The first one expires at the end of this year, I believe. How much do you have left there to reinvest?

James Flynn, CEO

So, it's full today, but we expect to have a couple of payoffs in the next few months. It depends on whether those happen in time, but we could see a reasonably high number. We have assets in our Q that we're reviewing that we can move in there. We're encouraging people to complete their payoffs as quickly as possible so that we can put new assets into that securitization. In general, while we've seen elevated payoffs, most have taken longer than originally projected by the owners. We are actively managing and engaging with sponsors not just on payoffs, which is a critical component right now, but in general. I expect to see some meaningful payoffs before the end of the year, and we are optimistic about being able to put new deals in on time, but it's all a matter of timing. After that, we'll focus on deleveraging the pool.

Matthew Erdner, Analyst

Okay. Thank you. And then as a follow-up to that, now that loans are ramped, is there a plan to kind of address and possibly increase the dividend, especially with that $1.7 million charge being a one-time thing?

James Flynn, CEO

Look, obviously, as we said, we do talk about the dividend with the Board every quarter. We'll continue to do that this quarter, where we are hopeful that based on our pro forma look at our earnings that we're optimistic to see earnings growth. And obviously, we'll talk to the Board about how they want to reflect that on the dividend.

Operator, Operator

The next question comes from Christopher Nolan of Ladenburg Thalmann. Please go ahead.